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In brief:    In an important win for the Commissioner, the Federal Court has held that there was error by the AAT in valuing a 1/3rd holding of shares in a private company by discounting the sale price for a ‘lack of control’. The taxpayer was one of 3 equal shareholders in the company who together contracted to sell all the shares for a total price of $17.7M, with each shareholder receiving $5.9M. The market value of the taxpayer’s shares was critical in determining whether he satisfied the $6M net asset value test and was entitled to the small business CGT concessions.

More:    This case involves 2 issues. The first is the precise identification of the relevant CGT asset or assets involved and the second is the determination of the market values of those assets for the purposes of s152-20. So that latter question necessarily involves principles of valuation law, in the context of the Income Tax Assessment Act 1997. And the case is very important, given the significance of market values in many areas of tax law.

Although commencing with the price actually received by the taxpayer, the AAT had discounted that price in recognition of the relative lack of control of a minority shareholder. It had done so on the basis that the contemporaneous sale of all shares owned by the other shareholders were ‘special circumstances’ that should be recognised in the valuation process. The Court disagreed and held in any case that the AAT had erred by not having regard to market realities and the recognition in valuation principles of a buyer willing to pay more for an asset than others ‘because they are in a better position to exploit the particular attributes or potentialities of the asset’. (FC of T v Miley [2017] FCA 1396)

In brief:    In a complex case, contested both by the Commissioner of Taxation and the wife of the taxpayer who controlled the transferor trust, the taxpayer has successfully obtained a declaration in the Federal Court that CGT rollover relief under Subdivision 126-A applied. The Family Court order was for the transfer of shares in a listed public company to the wife, although they were actually transferred to the trustee of a trust at the wife’s direction. It was held that rollover relief applied to the change in beneficial ownership in favour of the wife at the time the Court orders were made. In any case, the Court would have held that a rollover under s 126-15 applied for a trust to trust transfer given that the wife was sufficiently ‘involved’.

More:    The Court’s comments about CGT rollover on divorce applying on a trust to trust transfer is controversial – it has been commonly understood that the rollover only applied for spouse to spouse transfers or those from companies and trusts to a spouse. Also, the Court was prepared to hold that a change of beneficial ownership (without transfer of the legal title) constituted a CGT event A1. In any case, an appeal by the Commissioner (and presumably the wife) seems likely. The company shares which were the subject of the Family Court’s order appear to have had a value of approximately $20M so presumably a substantial tax liability is at stake. This case (which also included complex trusts law and other legal points) illustrates the need for deep analysis and consideration of the tax issues involved in divorce and other relationship breakdowns – whatever the ultimate outcome of an appeal, one or other of the husband and wife in this case will no doubt be bitterly disappointed. (Sandini Pty Ltd v FC of T [2017] FCA 287)

In brief:    The Full Federal Court has held that there was no error by the AAT in concluding that the $2M turnover test had not been satisfied and that, consequently, no small business CGT concessions applied on the sale of mining tenements. The case turned on whether disbursements totalling $55,106 for fuel costs under 2 contracts constituted ‘*ordinary income that the entity *derives in the income year in the ordinary course of carrying on a *business.’ (s 328-120(1)). The AAT had held that receipts from fuel disbursements were ordinary income, despite the normal practice that customers of the drilling contractor provided fuel and the initial contracts for the 2 relevant drilling jobs required the customers to provide fuel.

More:    The taxpayer’s drilling company was a ‘connected entity’ and had undertaken drilling exploration on the mining tenements from which the taxpayer derived the capital gain. And the Commissioner had accepted that the basic conditions for the small business CGT concessions would have been satisfied if the drilling company’s annual turnover had been less than $2M for the previous year of income. This case continues the steady stream relating to the small business CGT concessions and illustrates how important it is to step through each of the relevant tests for the concessions in fine detail. (Doutch v Commissioner of Taxation [2016] FCAFC 166)

In brief:    The Commissioner has issued several draft Law Companion Guidelines in relation to the super reforms commencing on 1 July 2017. Two relate to defined benefit interests but the other 2 are particularly relevant to SMSFs. LCG 2016/D8 covers the transitional CGT relief for assets supporting exempt income streams and which are affected by the $1.6M transfer balance cap or loss of exemption relating to TRIS pensions. LCG 2016/D9 provides guidance about how the $1.6M transfer balance cap operates for account based income streams.

More:    These LCGs will be useful in helping practitioners digest the new reforms and their implications for clients in various circumstances. That will include potential impacts on estate planning, particularly where reversionary pensions will cause the $1.6M cap to be exceeded after the death of a primary pensioner (although there will be a 12 month window to adjust benefits for the reversionary pensioner in that case). In addition to decisions about potential rearrangements relating to existing income streams and adopting the transitional CGT relief, planning prior to 1 July 2017 should also include maximising both concessional and non-concessional contributions where appropriate.

In brief:    A Bill has been introduced to increase the small business entity turnover threshold from $2M to $10M for most purposes (but not for the small business income tax offset, for which the turnover threshold is proposed to be $5M). The change is intended to apply from 1 July 2016 and will have a number of implications for small businesses, including imputation changes for companies that qualify as small business entities.

More:    The proposed $10M turnover threshold is not to apply for accessing the small business CGT concessions – the existing $2M threshold will continue for that purpose. However, it is the new $10M threshold that will apply for the new small business restructure roll-over. In relation to the associated proposed reduction of the corporate tax rate to 27.5% for small business companies from 1 July 2016, it will no longer be possible to attach franking credits based on the 30% corporate rate. Instead, maximum franking is to be based on the particular company’s tax rate for the income year in which the distribution is paid, assuming that its turnover is the same as for the previous year.

As set out in the Explanatory Memorandum to the Bill, the $10M small business entity threshold is intended to apply for a number of other small business concessions, including immediate deductibility for start-up expenses, simpler depreciation rules, simplified trading stock rules, immediate deductions for certain prepaid business expenses, accounting for GST on a cash basis, etc. [Treasury Laws Amendment (Enterprise Tax Plan) Bill 2016]

In brief:    A family group with substantial building, property development and investment activities has successfully argued in the AAT that its $40M profit from the sale of a property was not a revenue gain. Rather, it was held to be a capital gain with the general 50% CGT discount consequently available. This was despite the sale having occurred within months of completion of the site’s redevelopment.

More:    This decision emphasises the importance of properly characterising the activities from which any profit has arisen. The Tribunal accepted that, separately from the group’s building and development businesses, one of its discrete activities was the acquisition of commercial properties to hold for rental as capital assets. It was held that the relevant profit was derived from this activity and consequently was capital. This was supported by evidence from family members that was accepted by the Tribunal. (FLZY v Commissioner of Taxation [2016] AATA 348)

In brief:    The new non-resident withholding tax regime on purchases from foreign residents commences on 1 July, for contracts entered into on or after that date. It has very substantial potential implications for both purchasers and vendors. Purchases affected are those of both direct and indirect interests in Australian real property or mining rights, as well as options or other rights to acquire such property. But no withholding is required unless at least one of the vendors is taken to be a foreign resident or, for real property interests in any case, if the purchase price is less than $2M. The tax is a non-final withholding and affected vendors will be entitled to credit the amount withheld from their actual income tax liabilities.

More:    The default position under the new withholding regime is that it is assumed to apply (even if the vendor is in fact an Australian resident), unless a particular exclusion applies. This raises issues for conveyancing lawyers, but all advisers need an awareness of the rules – a failure to withhold will not affect the purchaser's obligation to pay 10% of the price to the Commissioner and there might be difficulty recovering that amount then from the vendor. Although the withholding regime partially aligns with the assets to which CGT applies for non-residents (since the Commissioner has had difficulties in the past recovering tax from foreign residents on CGT events), it also applies to relevant assets that constitute trading stock or revenue assets – both capital and revenue assets are CGT assets. One of the exclusion mechanisms is for vendors to obtain a clearance certificate from the Commissioner – an online system for obtaining those certificates is being established by the ATO.

In brief:    The new incentives to encourage innovation will commence from 1 July 2016. For ‘early stage investors’, these comprise a non-refundable, carry-forward tax offset of 20% of their investment (subject to a maximum annual offset cap of $200,000 and a total annual investment limit of $50,000 for retail investors) plus CGT concessions on sales of shares that have been held for at least one year in qualifying innovation companies. An investor may disregard a capital gain from qualifying shares held for between 1 and 10 years. For shares held longer than 10 years, the cost base and reduced cost base will be deemed to be the market value on the 10th anniversary of acquisition, so that only incremental gains or losses after that time will have effect for CGT purposes.

More:    The trade-off for investors in early stage innovation companies is that capital losses on qualifying shares will effectively be disregarded, irrespective of how long the shares are owned. Other amendments in the amending act are aimed to improve access to capital and make existing tax regimes for venture capital limited partnerships more attractive to investors.

In brief:    The new Small Business Restructure Roll-over has been enacted and will commence on 1 July 2016. It will be a very useful concession in the right circumstances but, as is typically the case, requires very careful thought as to the best way in which it should be applied. That is particularly the case in relation to the price (if any) for which assets are transferred. These 2 draft Law Companion Guidelines from the ATO about the operation of the new roll-over are helpful aids and very worthwhile reading.

More:    It is particularly important that note be taken of the Commissioner's views in LCG 2016/D3 about what amounts to ‘a genuine restructure of an ongoing business’ for the new roll-over. That is an essential element to engage the concession and it is evident that it will be a potential attack point if the ATO views a restructure as overly aggressive. It is also noted in the LCG that the general anti-avoidance provisions in Part IVA may still apply in appropriate circumstances, even if the 3 year ‘safe harbour’ rule for a genuine restructure is satisfied. (LCG 2016/D2 & LCG 2016/D3)

In brief:    This important question was addressed in a decision handed down this week. The taxpayer was one of 3 equal shareholders in a private company that was sold for a total price of $17.7M. His1/3rd share of the sale price was consequently $5.9M which, together with the net values of other assets, exceeded the $6M threshold for the maximum net asset value test. The taxpayer nevertheless argued that the market value of his shares in the company was less than the actual sale price of $5.9M. And that, consequently (given that all other conditions were satisfied), he was entitled to the small business CGT concessions on the sale of his shares.

Deputy President Frost in the AAT agreed with the taxpayer. His short point of principle was that the market value of the taxpayer's shares for the purposes of the maximum net asset value test must be determined by reference to the well established formulation in Spencer v The Commonwealth [1907] HCA 82. And in applying that principle, the Deputy President accepted that a discount should apply to the sale price in order to recognise the taxpayer's lack of control as a minority shareholder. The taxpayer's objections were allowed in full.

More:    There are numerous occasions in tax practice where the correct determination of the market value of an asset is of critical importance. But the concept is not well understood and market value issues are often the subject of controversy. This case is a very important one because it directs us to the precise question that must be addressed – what is the market value of the relevant asset(s) on the basis of the Spencer formulation, without ‘factors that are extraneous to the purpose for which such a value is to be ascertained’? In this case, the contemporaneous sales of the shares owned by the other 2 shareholders, giving the buyer 100% control of the company, were factors extraneous to the valuation of the taxpayer's shares alone.

These principles have widespread implications! (Miley and Commissioner of Taxation [2016] AATA 73)

In brief:    A Bill to enact the proposed new Small Business Restructure Rollover with effect from 1 July 2016 was introduced yesterday. It contains significant changes from the exposure draft legislation released last November. In particular, rollover assets (other than depreciating assets) will need to be active assets, small business entities will not now also need to satisfy the $6M net asset value test in order to qualify, consideration for asset transfers may be provided and a rollover transaction must be part of a ‘genuine restructure of an ongoing business’ (with an optional safe harbour rule for a genuine restructure, comprising a period of 3 years after the transaction with no relevant changes relating to rollover assets). Further, the Bill has a provision that will neutralise any other direct tax consequences where the rollover applies.

The broad thrust of the rollover is nevertheless unchanged from the exposure draft. The proposed rollover will be optional and is to extend to trading stock, depreciating assets and revenue assets, as well as other CGT assets generally. And there must be no material change in the proportionate interests of individuals who have the ‘ultimate economic ownership’ (a term not defined) of the assets. However, there will be no change in the ultimate economic ownership interests if a discretionary trust that has made a family trust election is a party and all individuals having ultimate economic ownership before and after the transfer are members of the family group relating to the trust.

More:    If the Bill is enacted, the rollover will provide a welcome concession to small business entities (including their affiliates and connected entities). It is an exciting development – providing a mechanism by which previous structuring errors can be fixed and facilitating some very beneficial planning strategies. The new rollover also opens up additional options for passing a business to the next generation, although it will often be preferable to capture the small business CGT concessions rather than opt for the rollover in those cases.

In brief:    Dismissing the Commissioner's appeal, the Full Federal Court has confirmed that the small business participation percentages in a company were not affected by a ‘dividend access share’ in the company. Consequently, the small business CGT concessions could be applied to the capital gain of nearly $4.4M derived by the company from its sale of shares in another company.

More:    At issue was the effect of the words ‘the percentage of any dividend that the company may pay’ in item 1 of the table in s 152-70(1) of the Income Tax Assessment Act 1997. It is often the case that, if the whole of a dividend may be declared for the benefit of holders of dividend access shares, ordinary shareholders cannot be said to hold any percentage at all of any dividend that the company may pay. And the benefit of the small business CGT concessions may then be lost if it is necessary to have a significant individual or CGT concession stakeholders in the company.

The outcome in this case turned on matters of company law – the correct interpretation of members’ entitlements, against the background of the company's Constitution and company law generally. In the particular circumstances of this case, the directors were not free to pay a dividend on the issued dividend access share immediately before the relevant CGT event – there was an intervening pre-condition that had to be satisfied before that next step to declare a dividend on the dividend access share could be taken. And that meant that the dividend access share could effectively be disregarded in determining whether there was a significant individual or CGT concession stakeholder in the company. (FC of T v Devuba Pty Ltd [2015] FCAFC 168)

In brief:    The Commissioner in a recent Federal Court decision was successful in denying application of the small business CGT concessions. At issue was whether a ‘loan’ from a family trust to the individual who controls the trust, and was the sole trustee of the trust, had to be counted for the $6M net asset value test. The taxpayer argued that the loan was statute barred and consequently that no value should be attributed to it.

The Court held that action to recover the loan would be one under the relevant South Australian Limitation of Actions Act 1936 ‘to recover trust property’ and that no limitation period was prescribed in that case. In any case, the Court said that a statute barred debt continues in existence. A limitation statute creates a defence that can be pleaded by the debtor, but generally does not extinguish the cause of action. Also, Courts were generally empowered to extend certain limitation periods. And the debtor in this case was the sole trustee of the trust to which the ‘loan’ was owing, so a breach of trust would likely be involved if the trustee pleaded expiry of any limitation period for his own benefit.

More:    The outcome in this case could be different in other circumstances. Although a limitation statute might not extinguish the cause of action for a debt, expiry of a limitation period would undoubtedly affect the value of the debt. And it is the market value of the debt, not its face value, that is relevant for the $6M net asset value test. However, the case appears to have been run on the basis only that the whole value of the debt should be excluded, not that its value was less than face value. And the reason for that was presumably that the total net values of other assets were agreed by the taxpayer and Commissioner to amount to $5,930,913. (Breakwell v FC of T [2015] FCA 1471)

In brief:    Exposure draft legislation has been released for the proposed restructure rollover for small businesses to apply from 1 July 2016. The proposed rollover will be optional and is to extend to trading stock, depreciating assets and revenue assets, as well as other CGT assets generally. It is to apply to small business entities that also satisfy the $6M net asset test, and affiliates or entities connected with such small business entities.

The rollover will only apply if no consideration is provided in relation to the asset transfers. And there must be no change in the proportionate interests of individuals who have the ‘ultimate economic ownership’ (a term not defined) of the assets. However, there will be no change in the ultimate economic ownership interests if a discretionary trust that has made a family trust election is a party and the other parties to the transfer are members of the same family group.

More:    There will plainly need to be some complimentary provisions so that a rollover from a private company will not constitute a Division 7A ‘payment’ and trigger an unfranked dividend accordingly. But, if enacted along the lines of what is presently proposed, the rollover should enable some previous structuring errors to be fixed and facilitate some other useful planning strategies. Genuine gifts of a business to children of a proprietor will also be possible in some situations, although it will often be preferable to capture the small business CGT concessions rather than opt for the rollover in those cases.

In brief:   CGT roll-over relief can be obtained on the transfer of a CGT asset to a wholly owned company by an individual or trustee (s122-15) or all the partners in a partnership (s122-125). But, in both cases, the relief is limited to gains from several specified CGT events. In this case, the Federal Court held that the roll-over relief was not available to a couple who created a trust over their land for the benefit of a company wholly owned by them, pursuant to a contract with the company for it to acquire the beneficial ownership of the land. The reason was that CGT event E1 applied (creation of a trust over a CGT asset by declaration or settlement – s104-55) and, even if another CGT event also potentially applied, event E1 was the event most specific to the circumstances of the taxpayers and consequently it was the relevant event to apply (s102-25(1)). And the CGT roll-over relief sought under Division 122 simply did not apply in the case of an E1 event.

More:   So this is a further case where the desired tax outcomes failed because the intended outcome under the general law was not achieved – the case turned on matters of trust law. The critical question was whether the arrangements entered into created a trust over the taxpayers’ land by declaration or settlement, which the Court held to be the case. (Kafataris v DC of T [2015] FCA 874)

In brief:  The Board's post-implementation review has been released, with it concluding that Div 7A is "complex, inflexible and costly to comply with" and in "urgent need for improvements" – this will be no surprise to any tax practitioner advising SMEs! The Board advocates a much more flexible approach for the repayment of loans, with the same treatment afforded to unpaid trust entitlements of corporate beneficiaries.

The ‘Amortisation Model’ model proposed by the Board also has an additional feature to assist trading trusts wanting to retain profits as business working capital. The proposal is that a trust may elect that loans and UPEs owed to corporate beneficiaries will not be subject to Div 7A, although the trust will consequently forgo the general 50% CGT discount on assets other than goodwill and intangibles inherently connected with its business. The idea is that Div 7A would apply to such trusts in a similar way as it applies to trading companies.

More:  The proposal for trading trusts warrants consideration by practitioners in the context of structuring for SME business acquisitions. The Board's proposals to simplify Div 7A are also welcome – the main changes proposed are:

• 10 year repayment terms (except for grandfathering of existing 25 year loans);
• flexible interest and principal repayments, subject to achieving repayment milestones (loan balance not to exceed 75% of original amount at the end of year 3, 55% at the end of year 5, 25% at the end of year 8 and 0% at the end of year 10);
• no formal loan agreement, but some written/electronic evidence required; and
• a higher interest rate (linked to small business overdraft rates), fixed at the start of the loan.

In brief:   In an objectionable move, the ATO has finalised its guidelines about risk assessment as to whether Part IVA might apply to the allocation of profits from a professional firm. They are to apply to situations where practice structures are otherwise effective and income of the firm does not constitute personal services income under Part 2-42 of the 1997 Tax Act. Principals in such firms will be regarded by the ATO as low risk, and consequently unlikely to be subject to ATO compliance review, if they satisfy one of the following benchmarks:

• the remuneration package of the principal is at least as great as the lowest paid member of the upper quartile of professional employees in the firm providing equivalent services;
• the principal is assessed in his or her hands to 50% or more of the income from the firm to which the principal and associated entities are collectively entitled for the year; and
• the effective tax rate on the income of the principal and associated entities is at least 30%.

More:   The ATO has also now revised its view about the potential application of Part IVA to Everett assignments. Such assignments that occur on or after 1 July 2015 will only be considered low risk if one of the 3 benchmarks is satisfied.

Examples to illustrate the ATO's views about the benchmarks are contained in the guidelines situated on the ATO's website – below is a link to the guidelines.

https://www.ato.gov.au/Business/Starting-your-own-business/In-detail/Professional-firms/Assessing-the-risk--allocation-of-profits-within-professional-firms/

In brief:  In a controversial decision, the Administrative Appeals Tribunal has decided that the small business participation percentages in a company were not affected by the existence of an issued share with discretionary dividend entitlements. Consequently, the small business CGT concessions could be applied to the capital gain of nearly $4.4M derived by the company from its sale of shares in another company.

More:  At issue was the effect of the words ‘the percentage of any dividend that the company may pay’ in item 1 of the table in s 152-70(1) of the Income Tax Assessment Act 1997. A commonly held view is that if the whole of a dividend may be declared as payable to the holders of dividend access shares, ordinary shareholders cannot be said to hold any percentage at all of any dividend that the company may pay. The Tribunal took a contrary view, deciding that the holders of ordinary shares in this case had the only rights to dividends until the directors first took the step of resolving that a dividend be paid on the dividend access share. To some extent, the matter is one of construction of the particular company's Constitution against the background of corporations law generally. But if the affect of the company's Constitution is that the directors may declare a dividend on ordinary shares or the dividend access share, to the exclusion of the other class shares in either case, it is difficult to see how the holders of any class have any greater rights than the holders of the other. The Commissioner will undoubtedly appeal against this decision. (Devuba Pty Ltd v C of T [2015] AATA 255)

In brief:  Foreshadowing the Government's Jobs and Small Business package to be announced in the 2015 Budget next week, the Treasurer yesterday announced several changes to benefit small business owners. One proposal is that, from July 2016, ‘new start-ups’ are to have an immediate deduction for professional costs associated with starting a business (rather than deductions over 5 years under the ‘blackhole’ rules). More significantly, ‘small business owners will also be able to change the legal structure of their business without incurring a CGT liability.’ This is presumably also intended to start from July 2016.

More:  The ability to change the legal structure will be a welcome benefit if the Government can successfully legislate it. There will presumably be minimum cost to the Revenue, since most small business owners already have access to the small business CGT concessions. But such a change should substantially reduce compliance costs and, for those less than 55 years old, obviate the need to pay the CGT exempt amount under the retirement exemption into a complying super fund. The range of beneficiaries will be limited, unless the Government expands the $2M turnover threshold that currently defines a small business. And it will be interesting to see how narrow the change is – so, for instance, whether it will be possible to pass businesses to children of the proprietors. Since there are times when it is very beneficial to deliberately trigger a CGT event for a small business, some business proprietors wanting to achieve that might ironically try to avoid application of the new concession.

An entity's small business participation percentage in a trust or company is relevant in determining whether there are significant individuals and CGT concession stakeholders in a company or trust, as well as where the CGT asset to which a CGT event has happened is a share in a company or interest in trust. And for the purposes of determining direct small business participation percentages in trusts under s152-70(1) of ITAA97, there are different tests depending on whether or not entities have entitlements to all the income and capital.

The Commissioner in Interpretive Decision ATO ID 2015/8 has expressed the view that a trust is capable of being one where entities have entitlements to all the income and capital, even though the trustee has power to accumulate income or capital of the trust. This interpretation is important because, for example (depending on the terms of a particular unit trust deed and, particularly, the way in which income is defined), a trustee may need to accumulate income to the extent that it exceeds the net income under s95(1) of ITAA36 so as to avoid a potential CGT event E4 for unit holders. However, for other contexts, a power to accumulate income will mean that the trust is not a fixed trust, at least without a favourable exercise of discretion by the Commissioner.