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It was interesting to see the well known old case of Arthur Murray (Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLR 314) cited as authority for the Commissioner's views expressed in a recent Taxation Ruling. The ruling is TR 2014/1, dealing with the derivation of income by commercial software developers for the licensing of proprietary software and ‘hosted’ or ‘cloud’ arrangements for the use of such software.
The Commissioner states the normal position that a taxpayer conducting a business generally derives income for income tax purposes when a recoverable debt arises. In the Arthur Murray case, that normal position was held not to apply to prepayments for a series of dance lessons, when it was the practice of the dance studio to make refunds for lessons not used and to account for income only when the lessons to which the income related, were provided. The income was held to be derived for income tax purposes only as lessons were provided, rather than on receipt at the start of the arrangement.
In TR 2014/1, the Commissioner expresses the view that software developers in an analogous position to the dance studio in Arthur Murray will derive income progressively over the life of their contracts. That is, upfront consideration will not be wholly derived immediately if there is a contractual obligation to make a refund for non-performance, a demonstrated commercial practice to make a refund or exposure to contractual damages for breach of ongoing obligations.
The ruling is a good reminder that the Arthur Murray principle is one of general application to the issue of income derivation and can apply in different factual situations (Taxation Ruling 2014/1).
One might think it impossible that an elderly person in a nursing home and suffering from dementia could be carrying on a business of share trading. The taxpayer's argument to that effect failed in this AAT decision but the Tribunal accepted as a matter of principle that it was plainly possible, which is most certainly the case.
The way that such a person could carry on business is through the activities undertaken by the person's agent. In a similar way, a passive partner carries on business with his or her partners through the agency of one or more of the other partners who manage the partnership business. The agent in this case was the taxpayer's nephew who, together with another, had been appointed as the taxpayer's attorneys.
It did not assist the taxpayer in this case that her share profits for the 2007, 2008 and 2010 years were returned as capital profits (it was submitted on the taxpayer's behalf that the 2010 income tax return was incorrect), but that the losses of approximately $800,000 in the 2009 income year were submitted to be losses from the conduct of a business. But of probably more significance was the Tribunal's finding relating to the scope of the agency and consequent rights and obligations of the taxpayer's nephew – that the nephew was not authorised to conduct a share trading business. It was held that, viewed in that context, the activities of the nephew did not amount to the conduct of business (Executor for the late JE Osborne v FC of T [2014] AATA 128).
The Bill introducing the new penalty regime for SMSFs received Royal Assent yesterday. The new regime will apply from 1 July 2014 and is intended to provide alternative sanctions for breaches of the Superannuation Industry (Supervision) Act 1993 and Regulations.
It can be expected that the Commissioner of Taxation will heartily embrace these new rules and that SMSF trustees and directors of corporate trustees are far more likely to be penalised for future breaches. After all, the purpose of the new regime is to provide the Commissioner with ‘effective, flexible and cost-effective mechanisms for imposing sanctions that reflect the nature and seriousness of the breach’. Other current sanctions will remain in place – the ability to make an SMSF non-complying, court imposed civil and criminal penalties, enforceable undertakings and trustee disqualification.
The new regime confers powers on the Commissioner to:
give rectification directions to rectify SIS contraventions,
give education directions to require a person to undertake a specified course of education, and
impose administrative penalties for breaches of specified SIS provisions (examples include recordkeeping breaches, lending to members, borrowing breaches and in-house asset breaches).
(Tax and Superannuation Laws Amendment (2014 Measures No 1) Act 2014)
NSW payroll tax has been held to apply for the years 2003 to 2009 in the case of one of the models used by Freelance, a business that provides services relating to the engagement of independent contractors. Under the relevant business model, Freelance contracted with clients for the provision of services by contractors. Freelance did that in its capacity as the trustee of a discretionary trust and the contractors became beneficiaries. Although not bound to do so, it seems in practice that Freelance invariably distributed to each contractor (less a fee) the earnings attributable to the contractor's work.
The NSW Supreme Court held that Freelance was an ‘employment agent’ and that the distributions to its contractors were subject to payroll tax. The decision is relevant in Queensland and other States that also have ‘employment agency’ provisions in their payroll tax legislation. For this purpose, the meaning of an employment agent extends well beyond the popular meaning. One certainly need not be a traditional recruitment agency in order for these provisions to apply – they potentially apply to ‘a contract under which a person (an employment agent) procures the services of another person (a service provider) for a client of the employment agent’.
This is another decision that underscores the substantial armoury that State Revenues have to counter the potential loss of the payroll tax base (Freelance Global Ltd v Chief Commissioner of State Revenue [2014] NSWSC 127).
A recent case serves as a stark reminder of the significance of properly applying the income/capital dichotomy. The case involved an employee of the Glencore Group who, on termination of his employment with the group in the 2007 year of income, became entitled to receive an amount of over $100Mby instalments (with interest) over 5 years.
The facts are relatively complex but, essentially, the taxpayer had accrued rights under the group's employee profit participation plans while employed by Glencore overseas and also after having arrived in Australia and worked here for the group. He initially took the view that the rights under the plans comprised income at the time they accrued, but subsequently constituted capital rights and that he derived a capital gain in the 2007 year upon crystallisation of those rights in exchange for the $100M sum, but with an entitlement to the general 50% CGT discount.
The court held that the instalments were ordinary income, assessable upon receipt over the 5 year payment period. The short point of principle, despite the very large sum involved, was that it was receipt of the instalments that constituted the reward for employment services – not the contractual right accrued under the plans. The court drew an analogy to the ordinary payment of salary to an employee – it is not the case that the right to be paid salary is income and receipt is then nothing more than the realisation of that right. Rather, it is receipt of the salary that constitutes the reward for services and, consequently, ordinary income (Blank v FC of T [2014] FCA 87).
April 6 will mark 20 years since Tax Strategies commenced practice. We are proud to achieve this milestone and very grateful for the substantial ongoing support that we enjoy – thank you. And it is particularly gratifying that we still advise a number of firms who have been with us right from the start or from very early days.
We have plans to make our anniversary year a special one, starting soon ….
Tax planning arrangements can fail for a number of reasons. One of those reasons has little to do with technical tax rules. With a real-life example, this episode of Tax Solutions illustrates how tax planning can go wrong because of a fatal legal flaw in the underlying transactions or circumstances on which the tax plan is based. With the result that the practitioner involved is highly exposed.
The small business CGT concessions provide very substantial benefits in situations where they apply. And given the policy intent to direct the concessions to business assets, one of the central conditions that must normally be satisfied is the ‘active asset test’.
This episode of Tax Solutions emphasises a class of CGT assets that achieve a special status for the purposes of the small business CGT concessions. Those assets continue as active assets indefinitely – retaining that status even long after they have ceased being used in any business controlled by the owners!
Widely drafted beneficiary classes in discretionary trusts can create headaches in dealing with various State taxes. A recent example is Victoria’s new 3% additional duty on foreign buyers of residential property – where a trustee is the buyer and a family beneficiary lives overseas. A starker example that applies in all States and Territories is payroll tax grouping of businesses controlled by family relatives, where at least one of the businesses is operated by a discretionary trust.
Having extraordinarily wide beneficiary classes is an outdated practice that creates problems, rather than serving any useful purpose. There is really no point in including a whole range of relatives who are never intended to benefit. A narrow class of beneficiaries is required, with a simple and practical mechanism to add others to whom it is desired to distribute.
Frustrations with ATO views about UPEs of corporate beneficiaries have led to companies more frequently being used to acquire and operate small and medium sized businesses. But the problem is not discretionary trusts owning businesses, it is Division 7A. And there will usually be ways to deal with Division 7A anyway.
Some advisers believe that a business owner can still access the small business CGT concessions on a future business sale, by selling shares in the company that owns the business. But how realistic is it to hope that that is the way things will turn out. This edition of Tax Solutions emphasises 2 reasons why clients with a business owned by a company may not actually benefit from the CGT concessions.
One of the best things you will ever do for some of your small business clients is to deliberately trigger a CGT event and capture the small business CGT concessions. In the right client circumstances, this strategy can produce several very substantial benefits. That will particularly be so if 100% CGT exemptions can be achieved without duty applying to the transaction.
A restructure for this purpose should always be kept in mind, particularly for clients who may grow to the point where they can no longer satisfy either the $2M turnover test or $6M net asset value test. But it warrants greater consideration at the moment, given the apparent increased political risk of changes to CGT concessions.
