Tax Facts

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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:    In this case, the individual trustees of an SMSF (a husband and wife) and the corporate trustee of related custodian trusts were included in a payroll tax group. Since each member of a group is jointly and severally liable for the payroll tax liabilities of all group members, those trustees faced substantial payroll tax debts for assessments on several operating entities in the group. In an application for judicial review, the Qld Supreme Court held that there was no legal error by the Commissioner in refusing an application to exclude the trustees from the relevant payroll tax group.

More:    This matter illustrates the readiness of State Revenue Offices to utilise the very broad grouping provisions that apply for payroll tax purposes, although here there were dealings between the trustees and relevant operating entities that made it more difficult to establish that the trustees operated independently of the operating entities. It is somewhat counterintuitive that trustees of an SMSF and custodian trusts should be part of a payroll tax group, since they invariably do not carry on any business or engage workers. The Commissioner emphasised the definition in s 66 of the Payroll Tax Act 1971 (Qld), under which ‘business includes …. the carrying on of a trust, including a dormant trust’. And the Judge accepted that the breadth of intention of that provision would encompass a trustee merely holding assets as a bare trustee. That same definition appears in the payroll tax legislation of other States. (Scott and Bird v Commissioner of State Revenue [2016] QSC 132)

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 Commissioner says in Taxpayer Alert TA 2016/6 that the ATO is reviewing certain arrangements where an individual receives little or no remuneration for services provided to an unrelated party. Instead, income is channelled through another entity to an SMSF in which the individual or their associates are members. The income may be received by the SMSF purportedly as a return on investment in the other entity or on some contractual basis. Apart from the question of whether the income remains assessable to the individual in spite the arrangements, the Commissioner believes that amounts received by the SMSF may constitute contributions to which contributions caps accordingly apply or non-arm's length income to which the highest marginal tax rate applies.

More:    The arrangements appear somewhat naive and very unlikely to succeed, at least on the basis of the brief description provided in the Alert. Arrangements to attempt to achieve the sorts of aims involved in such circumstances will always be controversial and anyone contemplating them would be well advised to act cautiously and seek specialist advice.

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:    This case in the Administrative Appeals Tribunal concerned unfavourable decisions by the Commissioner on objections lodged against private rulings issued to each of the taxpayers. Although the Tribunal agreed with the Commissioner, no order was made and the applications were instead remitted to the Commissioner to request the applicants to make another ruling application. The reason for this unusual outcome was that, in the course of the AAT hearing, additional information provided was ‘materially different’ from the factual scheme on which the rulings were based. The Tribunal referred to the recent case of Rosgoe Pty Ltd v FC of T [2015] FCA 1231 (currently subject to the Commissioner's appeal to the Full Federal Court), in which it was held that the AAT in such a case is confined to the facts stated by the Commissioner in the private ruling.

More:    This case emphasises the importance of the scope and accuracy of the factual information provided to the Commissioner in an application for a private ruling. The present law is that the AAT is not free to make its own findings of fact in a review relating to a private ruling – it is confined to the facts stated by the Commissioner in the ruling.

In this case, the issue was whether a $500,000 superannuation death benefit would be exempt from tax. The married taxpayers who received the death benefit had unsuccessfully sought private rulings that they each had an interdependency relationship with their 22 year old son, who was killed in a motorcycle accident. On the basis of the facts contained in the private ruling, the Tribunal agreed that there was no interdependency relationship – but materially different additional facts were provided at the AAT hearing. (Case 2/2016 [2016] AATA 264)

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:    The Commissioner has failed in his bid to quarantine losses (including costs of a captain and crew) incurred by two companies successively carrying on a business of chartering luxury yachts. At issue was whether each company used its vessel (only one yacht was used at any time by each company) ‘mainly for letting it on hire in the ordinary course of a business’ carried on by each respective taxpayer company (s26-47(3)(b)). Although chartered from time to time by the high wealth person who controlled both companies, it was observed that he was scrupulous in ensuring that commercial charter rates were paid for his use. Also, the yachts were available publicly for charter, charters from unrelated parties were entered into and each corporate taxpayer presented themselves publicly as carrying on a business and were administered internally in that way. Despite the substantial losses incurred from the charter operations, Logan J held that the respective operations amounted to the conduct of a business ‘with an expectation and purpose of profit’.

More:    This case largely turned on factual considerations relating to the yachting operations. From that perspective, it is a good illustration of the need for careful documentation and execution of arrangements in order to achieve the tax outcomes anticipated. And it was particularly important that oral evidence from the controller of the companies about the background circumstances and charter activities was accepted by the judge as reliable and candid. (Lee Group Charters Pty Ltd v FC of T [2016] FCA 322)

In brief:    A foreign taxpayer has been unsuccessful in its argument that a debit of over $3.9 billion to a negative ‘share buy-back reserve’ account, as part of an off-market share buy-back in a listed company in which the taxpayer owned a majority of shares, constituted an amount debited ‘against amounts standing to the credit of the share capital account’. The consequence was that the amount so debited was taken to be a dividend paid to the taxpayer as a shareholder out of profits derived by the company – the foreign taxpayer was consequently not entitled to a refund of approximately $452.5 million withheld as dividend withholding tax.

More:    The circumstances of this case arose from the takeover of Optus by the SingTel group. The tax at stake was substantial and an appeal to the Full Federal Court has already been lodged. But the principles involved apply to a company of any size and illustrate one of the significant disconnects between tax law and company law, exacerbated by legislative liberalisation of the maintenance of capital doctrine in company law. The essence of the disconnect is that there are no prescriptive rules in the Corporations Act about how a share buy-back need be funded and it is possible for the aggregate consideration payable by a company for a buy-back to exceed the company's issued capital and realised profit funds – however, for tax purposes, the general rule is that the buy-back consideration will be taken to be a dividend payable out of profits except to the extent debited against amounts standing to the credit of the company's share capital account. In the Cable & Wireless case, a substantial part of the buy-back consideration was funded by borrowings from the SingTel group as part of the takeover arrangements.

The taxpayer relied on the High Court decision in FC of T v Consolidated Media Holdings Ltd [2012] HCA 55, where the opposite conclusion had been reached. However, that decision was distinguished because there the buy-back involved a reduction of capital. In the Cable & Wireless case, the ‘share buy-back reserve’ was a funding mechanism for funding of the takeover by loan advances from the bidder. (Cable & Wireless Australia & Pacific Holding BV (in liquidation) v FC of T [2016] FCA 78)

In brief:    An innocent error by a taxpayer, despite engaging and acting on the advice of both a tax agent and financial planner, has resulted in an unexpected tax bill of over $83,000 for excess non-concessional contributions tax. The taxpayer made a non-concessional contribution of $450,000 in the 2011 year of income – the maximum for 3 years at the time under the ‘bring forward’ rule. However, that rule had already inadvertently been triggered in the 2010 year of income and a substantial part of the subsequent contribution of $450,000 constituted an excess contribution. And, in the circumstances, the Administrative Appeals Tribunal held that there were no special circumstances for the purposes of s292-465(3) that would enable part of the contributions to be allocated to a different year of income.

More:    It is ironic that rules intended to be beneficial for taxpayers can have such catastrophic affects when things go wrong. Although the extreme harshness of the regime with excess contributions has been substantially alleviated from the 2014 year of income onwards. As well as the need to carefully check past contributions, this case is also a good reminder of the importance of communication and coordination if the affairs of a client involve 2 or more advisers. A failure to seek/advise relevant information from and to other client advisers is a dangerous practice that can fairly easily amount to a prima facie case of negligence in appropriate circumstances. (Brady v FC of T [2016] AATA 97)

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:    A recent case in the Queensland Supreme Court illustrates the potential dangers involved where one spouse is intended to control a family trust after divorce. In this case, the parties had agreed that the husband take future control of the trust after their divorce, but the power given to them both under the trust deed to appoint and remove trustees was not dealt with in the Family Court consent order dealing with the property of the marriage. After the husband's subsequent death, the wife and de facto spouse of the deceased husband purported to appoint the wife as trustee of the trust in place of the corporate trustee, then controlled by the husband's daughter from an earlier marriage.

The Court refused to grant the wife's application for a declaration that she had been validly appointed. Although the wife was still named in the trust deed as a person having the joint power, it could only be exercised with the surviving spouse of the deceased husband. And, as a matter of construction of the trust deed, the husband's de facto spouse did not come within that definition. In any case, it was held that the Family Court was the appropriate forum in which any dispute about the trust should be resolved.

More:    The applicant wife was unsuccessful in this case, although not before the drama and costs of a Supreme Court action. And a lay observer might think that the wrong outcome was reached, given that it seems that the unsuccessful wife intended to administer the trust to benefit the children of her and the deceased, as well as the deceased's de facto spouse at the time of his death. So, on the face of things, there was limited estate planning for the deceased. That is one lesson from the case.

The other lesson is that it is important to have a clean, effective break if one spouse is to assume complete control of a family trust after divorce. This is the reason why Tax Strategies’ trusts now contain automatic mechanisms to remove one spouse as a beneficiary and from any other role under the trust, such as the power to appoint and remove trustees. That is achieved by only one spouse being nominated as the main beneficiary to start with (called the ‘Family Beneficiary’) – the one who will logically take control of the trust if there is a relationship breakdown. The other will still have their normal rights in relation to the trust property as a matter of family law, but it will be plain that that other is completely excluded. And that exclusion will occur right from the moment of separation, even if the parties are still legally married. (Kneipp v Annunaka Pty Ltd [2015] QSC 359)

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:    The Administrative Appeals Tribunal has held that a commercial pilot who worked overseas for a foreign airline was nevertheless an Australian tax resident and liable to tax on his earnings accordingly. The taxpayer was found to be a resident according to ordinary concepts. In any case, the Tribunal said that he would also be a resident because of his Australian domicile during the relevant years of income, without a permanent place of abode outside Australia. The Tribunal said that the taxpayer was a ‘fly-in fly-out’ worker, working overseas in order to access better career opportunities.

More:    There was evidence of shared accommodation available to the taxpayer overseas during some periods. And also family tensions because his wife had to manage the family home in Australia and their children, mostly on her own. Nevertheless, the taxpayer spent nearly one half of each of the 3 years of income under consideration physically in Australia during his days off work as part of his monthly rotation. And that time was mostly spent with his wife and children in the family home. (Hughes v C of T [2015] AATA 1007)

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:    A recent case involving an objection against a private ruling from the ATO emphasises the limitations of the private ruling system in relation to questions of fact on which the Commissioner makes a ruling. The Federal Court upheld the taxpayer’s appeal from the Administrative Appeals Tribunal in this case, since the Tribunal had relied on a critical fact that was not included by the Commissioner in the facts of the arrangement stated by him for the purposes of the ruling. The court held that the Tribunal was not free to make its own findings of fact – it was confined to the facts stated by the Commissioner in the ruling. That is in stark contrast to the usual jurisdiction of the AAT in reviewing a taxpayer's objection against an assessment, where the Tribunal must reach its own conclusions of both fact and law.

More:    In this case a plan by the trustee of a discretionary trust to acquire property and develop it in joint venture with an unrelated company was abandoned after acquisition of the land, because of the global financial crisis. The land was sold several years later for a substantial profit, which the taxpayer claimed should be taxed solely under the CGT regime. The AAT had found as a fact that the taxpayer was carrying on business in relation to the land, although that was not a fact included by the Commissioner in his description of the arrangement for the purposes of the private ruling. Disregarding the AAT's finding that the taxpayer was carrying on business, the court held that the profit on sale was outside the profit-making scheme for which the land was acquired and its sale was consequently the mere realisation of a capital asset. (Rosgoe Pty Ltd v FC of T [2015] FCA 1231)

In brief:    A recent application for leave to appeal to the Queensland Court of Appeal is a good reminder of the practical difficulty in contesting disputed Queensland payroll tax (and duty or land tax). Section 69(1)(b) of the Taxation Administration Act 2001 (Qld) provides a right of appeal only if the ‘taxpayer has paid the whole of the amount of the tax and late payment interest payable under the assessment to which the decision relates.’ Leave was refused in this case – an arrangement for payment of the assessed payroll tax by instalments did not mean that the tax was no longer ‘payable’ for the purposes of s69(1)(b).

More:    The need for the disputed tax and late payment interest to have been paid in full is a substantial obstacle to any further appeals if the Commissioner of State Revenue has disallowed an objection. This may be particularly so in the case of payroll tax, where the disputed liability might arise from recurring payments to workers over a substantial time. This highlights the importance of addressing and managing payroll tax risks. (Commercial Property Management Pty Ltd v Comm of State Revenue [2015] QCA 209)