Tax Facts

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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.

In brief:  The AAT held in this case that no costs relating to the taxpayer's enrolment in a postgraduate business management course were properly allowable. There was no evidence that the course was required in order for the taxpayer to fulfil his role as a teacher or that it would lead to an increase in income from his current role. There was some prospect that the course might assist the taxpayer to gain promotion, but that could only be to a role quite different from the taxpayer's current position. In the words of the Tribunal, that promotion would mean ‘more pay for doing a different job’ – so the self-education expenses had insufficient nexus to that potential increased income.

More:  The ATO prior to the hearing had conceded that expenses relating to 4 out of the 6 subjects undertaken by the taxpayer should be allowable. The AAT consequently allowed the taxpayer's objection to the extent of the costs of those 4 subjects, despite its finding that none of the expenses relating to the course were deductible. It may be correct in this fact scenario that no deductions should be allowable, but it is objectionable for the ATO to argue about specific subjects in the course if it is accepted that the course overall has sufficient nexus to the derivation of income. (Re Ting v C of T [2015] AATA 166)

In brief:  A former tax principal at Ernst & Young has been sentenced to 11 years prison, with a non-parole period of 7 years. The charges on which he was convicted related to conspiring to deal with the proceeds of crime and conspiracy to defraud the Commonwealth, the relevant section of the Criminal Code for that latter offence providing that:

135.4(5) A person is guilty of an offence if:

1. the person conspires with another person to dishonestly cause a loss, or to dishonestly cause a risk of loss, to a third person; and 
2. the first-mentioned person knows or believes that the loss will occur or that there is a substantial risk of the loss occurring; and 
3. the third person is a Commonwealth entity.

Although such tax prosecutions are relatively rare, it is worthwhile reminding oneself (and some clients) of the conduct that might lead to prosecution. The relevant provisions of the Criminal Code are broadly based and, in principle, potentially apply irrespective of whether the amounts involved are large or small.

More:  The case involved false depreciation claims ‘of many hundreds of millions of dollars’ which supposedly offset very substantial income from financing arrangements involving several major banks. The resultant potential tax loss for the Commonwealth was approximately $135M and the defendant and his co-conspirator received over $63M. That latter amount represented funds paid to the conspirators’ company, that were paid overseas before being transferred back into Australia for the benefit mainly of the 2 conspirators. The judge remarked on sentencing that, “Having regard to its size, scale, timespan and tactics [the defendant's] offending falls into the worst category of cases under s 135.4(5).” (R v Dickson (No 18) [2015] NSWSC 268)

In brief:  A Bill introduced into Parliament last week is intended, from 1 July 2015, to significantly change the taxation of employees’ shares and share rights acquired under employee share schemes. This has been a controversial topic since changes made by the former Government in 2009, which resulted in a sharp drop in such schemes offered by companies. Also, a new concession for start-up companies is to apply.

More:  A new form of concession is to be provided in relation to eligible start-up companies (broadly, unlisted companies incorporated for less than 10 years and with group turnover not exceeding $50M). The concession is that no upfront tax is to apply to shares or rights in the start-up and the CGT rules are to apply from the time of acquisition. But to be eligible, shares must be issued at a discount of not more than 15% of the market value and the strike price of rights to shares must not be less than the market value of the shares at the time of issue. Also, the shares or rights must generally be held for at least 3 years.

For other employee share schemes more generally:

• tax may be deferred even where there is no real risk of forfeiture, if there are genuine restrictions on disposal;
• the maximum deferral period will be increased from 7 years to 15;
• the taxing point on share rights will be the time of exercise (rather than the time when an employee may exercise); and
• the 5% limit of any employee's holdings in the relevant company issuing the shares or rights will be increased to 10%.

(Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015)

In brief:  A successful plaintiff in an action for negligent tax advice failed to establish that forfeiture of franking credits in the holding company of his group resulted in any damages to him. In one sense, this outcome was the result of specific facts in the case but, in another sense, it is a reminder to question the value of franking credits in a company. Remember that franking credits only come as an attachment to a franked dividend – that can only have a positive impact on the recipient shareholder if their marginal tax payable on the grossed up dividend is less than the franking credit (such as in the case of retired taxpayers with little other assessable income or an SMSF).

One would always prefer more franking credits rather than less, since more at least gives some prospect of additional benefits. But, on their own, franking credits in a closely held company generally have no inherent value to the extent that they exceed the amount necessary to frank all profits.

More:  Following an ATO audit, there was a settlement reached under which the plaintiff in this case (the founder of Aussie Home Loans) paid over $7M to the ATO and the holding company of his group forfeited franking credits of over $5M. The plaintiff then successfully sued lawyers, Gadens, in respect of tax advice relating to the corporatisation of his group, being awarded damages of approximately $5M. The NSW Court of Appeal reduced the damages award by approximately $1.3M (plus associated pre-judgement interest), being the amount relating to the loss of franking credits. This amount had been assessed by reference to the additional tax payable by a shareholder on aggregate dividends unfranked to that extent. But, on appeal, it was held that no damages in that respect had been proven – there was no evidence that the reduction in franking credits made any difference to the price paid by the Commonwealth Bank for the subsequent purchase of 80% of the business or that the company's remaining franking credits would not be sufficient to frank all prospective dividends that the plaintiff might receive. (Gadens Lawyers Sydney Pty Ltd v Symond [2015] NSWCA 50)

In brief:  Death benefit nominations for super death benefits are a vitally important matter and it is wrong to treat them glibly. This case is a stark example because the estate of the deceased was very small. So the practical reality was that all the ‘deceased's wealth’ was contained in the SMSF in which he and his second wife were members. Yet his apparent intentions for death benefits from the fund to benefit his 2 daughters from his first marriage, as well as his second wife, were frustrated. It is a very sad and costly saga that could easily have been avoided.

The outcome in this case would surprise many practitioners, since a purported binding death benefit nomination made by the deceased nominating the "Trustee of Deceased Estate" was held not to comply with the trust deed requirements for a binding nomination or even with the provisions of the SIS Regulations for cashing benefits. It is a good example of why practitioners need to be very careful about death benefit nominations, particularly given limitations under their professional indemnity insurance policies about legal work. The bottom line is that super death benefit nominations are equally important, and warrant the same level of consideration and advice, as the preparation of a person's will.

More:  The purported binding nomination with the expression, "Trustee of Deceased Estate", was held not to comply with the trust deed requirements or provisions of the SIS Regulations because super death benefits are generally permitted only to dependents of the deceased or the deceased's ‘legal personal representative’, defined to mean the executor of the deceased's will or administrator of his or her estate. Although not commonly appreciated, it is a trite matter of law that the executor of a deceased estate holds an office quite distinct from that of a trustee of estate property (even though the same persons often hold both offices). The failure to address that distinction has resulted in the trustees of the SMSF in this case being left free to exercise discretion about who is to benefit from the deceased's accumulated benefits. That discretion is consequently one exercisable by the deceased's second wife and her daughter, who was appointed as co-trustee after the deceased's death. (Munro v Munro [2015] QSC 61)

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.

The Court of Appeal in West Australia last week dismissed an appeal by the executors of a deceased SMSF member against a decision by the sole surviving trustee to pay the death benefits from the deceased's account to himself.

The sole surviving trustee was the deceased's husband and the executors were 2 of the deceased's children from a former marriage. The deceased in her will had purported to give her entitlements in the SMSF to her 4 children (stating specifically that she did not want any of her super entitlements paid to her husband), but the executors accepted that the deceased's SMSF interest did not form part of her estate. That purported gift in the will was also inconsistent with 2 separate binding nominations by the deceased in favour of her husband, although both had lapsed before the death of the member.

The executors had little to support their case. Their first argument was that their stepfather was obliged by s17A of the SIS Act (the provision that defines an SMSF) to appoint one of the executors as a co-trustee and not to make any decision about payment of the death benefits relating to their deceased mother until after that appointment. The second main argument was that their stepfather's decision to pay the death benefits to himself was vitiated by a lack of bona fides. However, there was simply no evidence in the case to support that latter argument and the Court of Appeal held that the provisions of s17A allowing the appointment as trustee of a deceased's executor are permissive only – not a mandatory requirement.

So a purported gift of super benefits in a person's will, or an expression of wishes in a person's will about who should receive super benefits, will be very unlikely to have any effect unless the superannuation death benefits are paid into the deceased's estate. The real lesson from this case is that certainty about who will receive super death benefits is not achieved by leaving the decision as a discretionary one for surviving trustees. And that effective estate planning requires alignment of a person's will with control mechanisms and decision-making powers under associated SMSFs, trusts and companies. (Ioppolo & Hesford v Conti [2015] WASCA 45)

A purported loan of $600,000 arranged by the taxpayers’ long term accountant from a private Samoan bank controlled by the same accountant was held by the AAT to be a sham. Consequently, the 2 taxpayers were liable to be assessed under former s26AFB of ITAA36 on $300,000 each as receipts out of or attributable to assets of their SMSF, in breach of SIS rules. As a condition of the purported loan, the taxpayers’ SMSF had been required to lodge a $600,000 deposit with the same Samoan bank, which was sent to the bank 3 days before the same amount was received back in Australia as a loan. Further, no interest or loan repayments were made by the taxpayers and their SMSF received no interest on its deposit for over 10 years. Presumably, the fund also was or will be assessed on the basis that it became a non-complying fund.

In the circumstances, the Tribunal also held that there had been evasion of tax and the normal time limits by which the Commissioner is empowered to amend assessments did not apply. And for good measure, the Commissioner's assessments of administrative penalties (75% for the first year when the purported loan of $600,000 was received and 90% for each of the following years) were also upheld.

The finding of a sham is an extreme one, although plainly the facts in this case were quite extreme – particularly the actions of the accountant, which were effectively imputed to the taxpayers. It can be quite different where there has been an innocent mistake, even a mistaken view of the law held innocently by a taxpayer's tax adviser. The Commissioner may not be empowered in that case to issue amended assessments after the relevant limitation periods have expired. (Morrison and FC of T [2015] AATA 114)

The Federal Court has rejected a mining group's claim to input tax credits for acquisitions made by the group in providing and maintaining residential accommodation for its workers in the Pilbara region. This is a test case and an appeal to the Full Federal Court has already been lodged by the taxpayer.

There was no dispute about the facts involved. The taxpayer group owns approximately 2,300 houses and apartments in towns that it established to support its Pilbara mining operations. The accommodation is provided to workers on a subsidised basis and expenditure on providing the housing substantially exceeds the rental income received from workers. The Commissioner accepted that the acquisitions fell within the basic test for ‘creditable purpose’, being acquisitions in carrying on the enterprise of the taxpayer. However, the Commissioner’s view was that a creditable purpose was nevertheless denied because the acquisitions related ‘to making supplies that would be *input taxed’ (see s11-15(2)(a) of the GST Act). The Court agreed. The taxpayer argued alternatively that there should be an apportionment of input tax credits on the basis of revenue from its operations – the group’s income from iron ore production was 99.88% of the aggregate income from iron ore and from accommodation rental for the year involved, so it was argued that the taxpayer was entitled to 99.88% of the total input tax credits. However, the Court held that the acquisitions related wholly to the provision of accommodation and no apportionment was warranted.

This sort of matter also arises where tax consequences depend on the purpose or use of something and there is both an immediate and wider purpose and use involved. An example is an accommodation unit provided in a motel or hotel to the manager – that use of that accommodation unit is plainly a business one from the perspective of the owner, but equally plainly is a private use by the manager to the extent that that is the relevant use. But the tests in the matter before the Court were more difficult for the taxpayer – an acquisition by the group in the course of carrying on its enterprise, as opposed to acquisitions that relate to input taxed supplies. (Rio Tinto Services Ltd v FC of T [2015] FCA 94)

The relatively brief reasons of the Administrative Appeals Tribunal in a recent case belie the complexity of the underlying tax concepts involved. The AAT agreed with the Commissioner's private ruling that profits derived by a corporate trustee on the sale of 2 adjoining blocks, after obtaining development approval, were ordinary income and taxable accordingly. The reason was a finding that the profits were derived in the course of the business conducted by the taxpayer and, even if the taxpayer's activities did not amount to the conduct of a business, the purchase of the blocks was for the purpose of profit making.

The directors of the trustee were 2 experienced builders and developers. They had caused the trustee to acquire the blocks for aggregation and redevelopment in a joint venture with a larger, unrelated company. The JV did not proceed, but the directors’ associated development management company was engaged to obtain development approval for the blocks. No other improvements to the blocks were undertaken and the only use of them during the taxpayer's ownership was for rental. The taxpayer had argued that its intention to develop the blocks had been abandoned when it was unsuccessful in concluding the JV and that the blocks from that time began to be held as capital assets rather than trading stock.

There was an additional difficulty for the taxpayer in this case since, on an appeal or review to the Federal Court or AAT about a private ruling, the matter must be determined according only to the facts contained in the private ruling (the taxpayer complained that the ruling did not include important facts that had been provided to the Commissioner in support of the ruling application). That is consequently an important consideration about whether to object against a ruling or to object against an assessment arising from lodgement of a tax return. (Re WWXY and C of T [2015] AATA 130)

For Qld duty purposes, s30 of the Duties Act 2001 provides that ‘transactions must be aggregated and treated as a single dutiable transaction’ if they ‘together form, evidence, give effect to or arise from what is, substantially 1 arrangement.’ And the section specifies that all relevant circumstances (including those listed in the section) must be taken into account in determining whether there is substantially 1 arrangement.

Section 30 creates practical difficulties for taxpayers, particularly since it is difficult to be definitive in various situations as to whether or not aggregation should apply. In a recent decision in the Queensland Civil and Administrative Tribunal, it was held that the Commissioner of State Revenue was wrong to aggregate 2 separate transfers to different groups of beneficiaries under a testamentary trust.

The decision is noteworthy because the transferor was the same for each of the transfers – namely, the trustees of the trust. And whether any parties to any relevant transactions are the same, is one of the circumstances that must be taken into account for the purposes of s30 (the 2 groups of transferees were also cousins in this case). The Tribunal nevertheless held that there were 2 separate transactions, separately negotiated, not conditional on each other in any way and not with any intention for the properties to be used by the respective transferees for any common purpose. The circumstances were also a bit easier for the taxpayers since there was no relationship between any prices for the separate transactions – the transfers were trust distributions so no negotiations in relation to price had been necessary. (Rawlings v Commissioner of State Revenue [2015] QCAT 10)

‘Mr M’s work ties outweighed his family ties, even though he financially supported his family by sending the bulk of his income to the joint bank account held with his wife in Australia. Mr M ordered his lifestyle around his work commitments.'