CURRENCY:

This issue of Client Alert takes into account all developments up to and including 13 April 2016.

Tax planning

There are many ways in which entities can defer income, maximise deductions and take advantage of other tax planning initiatives to manage their taxable incomes. Taxpayers should be aware that in order to maximise these opportunities, they need to start the year-end tax planning process early. Of course, those undertaking tax planning should be cognisant of the potential application of Pt IVA and other anti-avoidance provisions. If done correctly, however, tax planning can provide a number of tax savings for entities.

Common tax planning techniques include deferring the derivation of assessable income and bringing forward deductions. It is equally important to consider any pending changes to the tax legislation, and to specifically take note of any commencement dates and transitional provisions.

Tax practitioners should also be aware of the ATO publication Building confidence, available at https://www.ato.gov.au/General/Building-confidence. The publication is a central source of information about the compliance risk areas the ATO perceives and what it is doing about them.

Tax reform is currently high on the political agenda. Tax professionals need to be aware of proposals that may cause their clients angst, and be ready to respond. At the time of writing, the Government had yet to release its “tax plan”.

Deferring assessable income

The timing for including income in the assessable income of a taxpayer depends on whether it is statutory income or ordinary income. Statutory income is included in assessable income at the time specified in the relevant provisions dealing with that income. Ordinary income is included in assessable income when it is derived, unless a specific provision includes the amount in assessable income at some other time.

Consideration must be given to the nature of any particular income – is it revenue or capital? – because the difference in tax treatment will ultimately have an impact on the taxpayer’s tax position.

Business income

The time at which ordinary income of a business is derived and included in assessable income depends on whether the business returns income on a cash basis or an accruals basis. If a business uses the cash basis, ordinary income is generally derived in the year in which the business receives the income. If the business reports income on an accruals basis, ordinary income is derived when a recoverable debt is created, such that the taxpayer is not obliged to take any further steps before becoming entitled to payment.

Payment received in advance

Income received in advance of services being provided is generally not assessable until the services are provided (the Arthur Murray principle). This principle applies regardless of whether a taxpayer reports its income on an accruals basis or on a cash basis.

Work in progress

In relation to manufacturers, partly manufactured goods that are not “finished” goods are treated as trading stock, and it is necessary to determine the difference between the opening and closing value of the trading stock for the income year. (See Trading stock on page 9.)

TIP: Taxpayers who provide professional services may consider, in consultation with their clients, rendering accounts after 30 June in order to defer the income.

Income from property

Income from property is essentially all income that is not personal exertion income. It includes interest, rent, dividends, royalties and trust distributions. For non-business taxpayers, the time at which each category of such income is derived is as follows:

Category	When income is derived
Interest	In the year of receipt
Rental income	In the year of receipt
Dividends	In the year of receipt
Royalties	In the year of receipt
Trust distributions	In the year in which the income is derived by the trust

• STOP: If the income has been applied or dealt with on behalf of a taxpayer, the taxpayer is taken to have received the income as soon as it is so applied or dealt with, even though the taxpayer has not physically received the income (the principle of constructive receipt): see s 6-5(4) of the Income Tax Assessment Act 1997 (ITAA 1997).

Sale of depreciating assets

A taxpayer is required to calculate the balancing adjustment amount that results from the disposal of a depreciating asset. The balancing adjustment amount is calculated by comparing the termination value and the adjustable value. If the termination value is greater than the adjustable value, the difference is included as assessable income of the taxpayer. If the termination value is less than the adjustable value, the difference is a deduction available to the taxpayer.

TIP: If the disposal of an asset will result in assessable income, the taxpayer may want to consider postponing the disposal to the following income year. However, if it is not possible to delay the disposal, they may consider whether a balancing adjustment rollover relief is available. If the disposal of an asset will result in a deduction, it may be beneficial to bring the disposal forward to the current year.

Balancing adjustment rollover relief

Balancing adjustment rollover relief effectively defers a balancing adjustment until the next balancing adjustment event occurs. Broadly, the rollover relief will apply automatically if the conditions listed in s 40-340(1) of ITAA 1997 are satisfied.

If the automatic rollover relief applies, the transferor must give a notice containing sufficient information about the transferor’s holding of the asset for the transferee to work out how Div 40 applies to the transferee’s holding of the depreciating asset. The notice must be given to the transferee within six months after the end of the transferee’s income year in which the balancing adjustment event occurred, or within such further time as allowed by the Commissioner.

TIP: Rollover relief may be available for balancing adjustments arising from an involuntary disposal of assets where replacement assets are acquired.

An optional rollover relief is available in a partnership scenario if the composition of the partnership changes, or when assets are brought into or taken out of the partnership. To defer any balancing adjustments, the existing partners and the new partner can jointly elect for the rollover relief to apply. The choice must be made in writing and within six months after the end of the transferee’s income year in which the balancing adjustment event occurred, or within such further time as allowed by the Commissioner.

TIP: A small business entity can access the optional rollover relief.

• STOP: The optional rollover relief is not available unless the original holder retains an interest in the asset after the change.

Maximising deductions

Deductions are divided into general deductions and specific deductions. General deductions are allowable under s 8-1 of ITAA 1997, whereas specific deductions are provided for by other sections of ITAA 1997 or the Income Tax Assessment Act 1936 (ITAA 1936). If an item of expenditure would be a deduction under more than one section, it is deductible under the provision that is most appropriate.

 

Meaning of “incurred”

Taxation Ruling TR 97/7 outlines the Commissioner’s view on the meaning of “incurred” for the purposes of s 8-1 of ITAA 1997. The following general rules assist, in most cases, in defining whether and when an outgoing has been incurred:

• A taxpayer need not actually have paid any money to have incurred an outgoing, provided the taxpayer is definitively committed in the year of income. There must be a presently existing liability to pay a pecuniary sum.
• A taxpayer may have a presently existing liability, notwithstanding that the liability may be defeasible by others.
• A taxpayer may have a presently existing liability even though the amount of the liability cannot be precisely ascertained, provided it can be reasonably estimated.
• Whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise.
• If a presently existing liability is absent, an outgoing is incurred when the money is paid.

The phrase “presently existing liability” means that a taxpayer is definitively committed (or completely subjected) to the outgoing, ie the liability is more than impending, threatened or expected.

An outgoing is still incurred even if the amount cannot be quantified precisely, provided it can be approximately calculated based on probabilities.

TIP: An outgoing may be incurred in one income year even if the liability is not discharged until a later year. Therefore, a taxpayer can claim a deduction for the outgoing.

Bad debts

A deduction is allowable under s 25-35(1) of ITAA 1997 for a debt (or part of a debt) that is written off as a bad debt in the income year, provided:

• the amount owed, except in the case of a money-lending business, was included as assessable income of the taxpayer in the current or a former income year; or
• the debt is in respect of money lent in the ordinary course of a business of lending money by a taxpayer who carries on that business.

The other conditions that must be satisfied before a bad debt may be deducted under s 25-35(1) are as follows:

• there must be a debt in existence at the time of writing off;
• the debt must be bad; and
• the debt must be written off as bad during the income year in which the deduction is claimed.

In Taxation Ruling TR 92/18, the ATO sets out a list of circumstances in which a debt may be considered to have become bad. These circumstances include the disappearance of a debtor, leaving little or no assets out of which the debt may be satisfied, or a corporate debtor going into liquidation or receivership with insufficient funds to pay the debt.

Before a debt can be written off as “bad”, a taxpayer must have taken appropriate steps in an attempt to recover the debt. In TR 92/18, the ATO lists the steps to be taken to establish that a debt is bad. These include attempting to contact the debtor, issuing reminder notices and taking more formal measures.

It is important to note that while the factors listed in TR 92/18 are indicative of the circumstances in which a debt is considered bad, the question of whether the debt is bad is ultimately one of fact and depends on all the facts and circumstances surrounding the debt.

TIP: Taxpayers should review all outstanding debts before year-end to determine if there are any potential debtors who will be unable to pay their bills. Once a taxpayer has done everything in their power to seek repayment of the debt, they can consider writing off the balance as a bad debt. Ensuring bad debts are dealt with before year-end is crucial, as a deduction is only allowable in the year in which the bad debt is written off.

TIP: If a bad debt is not deductible under s 25-35, it may be deductible under s 8-1.

TIP: A bad debt deduction is also available for a partial write-off of a debt, provided the s 25-35 requirements are satisfied. A single debt may, over a period, be subject to several partial write-offs.

 

 

TIP: A bad debt does not need to be written off in the account books of a taxpayer. In the case of a company, the requirements of s 25-35 will still be satisfied in the following circumstances:

• where a board meeting authorises the writing-off of a debt and there is a physical record of the written particulars of the debt and board’s decision before year-end, but the writing-off of the debt in the taxpayer’s books of account occurs subsequent to year-end; or
• there is a written recommendation by the financial controller to write off a debt, agreed to in writing by the managing director before year-end, followed by a physical writing-off in the books of account after year-end.

Additional requirements for companies

A company may not be able to deduct a bad debt unless it satisfies certain continuity of ownership or same business tests (there is an alternative test for companies held by non-fixed trusts). Companies that have undergone a change in underlying ownership due to a sale of the business during the year need to pass the “same business test” to claim a deduction for bad debts.

• STOP: A company cannot claim a deduction for a debt incurred and written off as bad on the last day of an income year.
• STOP: The specific anti-avoidance provisions contained in Subdiv 175-C must be considered.
• STOP: Where, as part of the purchase of a business, the purchaser takes over the vendor’s debts and those debts subsequently become bad, the purchaser is not allowed a bad debt deduction. This is because the debts have not been included in the assessable income of the purchaser, but rather (assuming the vendor is an accruals taxpayer) in the assessable income of the vendor: see Easons Ltd v C of T (NSW) (1932) 2 ATD 211.

Additional requirements for trusts

Special rules apply to deny trusts a deduction for bad debts unless certain strict tests are passed. The applicable tests will depend on the nature of the trust.

Carried forward losses

The deductibility of tax losses carried forward from previous income years depends on the entity claiming the losses.

Corporate tax entities

The entitlement of corporate tax entities to deductions in respect of prior year losses is subject to certain restrictions. An entity needs to satisfy the continuity of ownership test before deducting the prior year losses. If the “continuity of ownership” test is failed, the entity may still deduct the loss if it satisfies the same business test.

TIP: A corporate tax entity can choose the amount of prior year losses it wishes to deduct in an income year. That is, the entity can choose to “ignore” the carried forward tax losses and pay tax for the income year to generate franking credits for its distributions.

• STOP: The loss carry-back rules for corporate tax entities were in place for one year only. Thus, in the 2012–2013 income year, corporate tax entities could carry-back up to $1 million worth of losses to obtain a refund of tax (by way of a tax offset) paid in the 2011–2012 income year.

Other taxpayers

The method for deducting earlier tax losses incurred by other taxpayers is governed by s 36-15 of ITAA 1997. If a taxpayer derives net exempt income for an income year, the carried-forward loss needs to be offset against net exempt income before becoming available for deduction against assessable income.

TIP: It is prudent for a taxpayer who has incurred a tax loss or made a net capital loss for an income year to retain records relevant to the ascertainment of that loss. These records should be retained until the later of the end of the statutory record retention period (eg under s 262A of ITAA 1936) and the end of the statutory period of review for an assessment for the income year when the tax loss is fully deducted or the net capital loss is fully applied: see Taxation Determination TD 2007/2.

• STOP: It is net exempt income that is offset against any carried forward tax losses, not exempt income. Net exempt income is defined in s 36-20 of ITAA 1997 and exempt income is defined in s 6-20 of ITAA 1997.
• STOP: Try to avoid deriving exempt income in an income year if there are carried-forward losses.

 

 

Depreciation (capital allowances)

A deduction may be available on the disposal of a depreciating asset if a taxpayer stops using it and expects never to use it again. Therefore, asset registers may need to be reviewed for any assets that fit this category.

The effective life of an asset can be recalculated at any time after the end of the first income year for which depreciation is claimed by a taxpayer, if it is no longer accurate because of changed circumstances relating to the nature of use of the asset. The use of an asset may therefore be considered to determine whether the asset’s effective life can be recalculated, possibly resulting in an increased or decreased rate of depreciation.

Immediate deduction

Non-business taxpayers

Non-business taxpayers are entitled to an immediate deduction for assets costing $300 or less, provided:

• the asset is used predominantly to produce assessable income that is not income from carrying on a business;
• the asset is not part of a set of assets that the taxpayer started to hold in the income year where the total cost of the set of assets exceeds $300; and
• the total cost of the asset and any other identical, or substantially identical, asset that the taxpayer starts to hold in that income year does not exceed $300.

TIP: If two or more taxpayers jointly own a depreciating asset, a taxpayer is still eligible to claim an outright deduction, provided their interest does not exceed $300 (even if the asset costs more than $300).

Small business entities

Small business entities (see Small business entities on page 16) that choose to apply the Subdiv 328-D capital allowance rules are entitled to an outright deduction for the “taxable purpose proportion” of the “adjustable value” of a depreciating asset if:

• the asset is a “low-cost asset”; and
• the taxpayer starts to hold the asset when the taxpayer is a small business entity.
• STOP: Since an outright deduction is only available for assets acquired while the entity is a small business entity, assets already pooled in the general small business pool (see Pooling on page 6) must remain in the pool after an entity becomes a small business entity.

The deduction is available in the income year in which the taxpayer starts to use the asset, or installs it ready for use, for a taxable purpose.

A depreciating asset is a “low-cost asset” if its cost at the end of the income year in which the taxpayer starts to use it, or installs it ready for use, for a taxable purpose is less than the relevant threshold.

The thresholds are as follows:

• For depreciating assets first acquired by the taxpayer at or after 7.30 pm on 12 May 2015 AEST (“the 2015 Budget time”) and first used, or installed ready for use, by the taxpayer for a taxable purpose at or after the 2015 Budget time and before 1 July 2017, the threshold is $20,000. The requirement for a depreciating asset to have been “first” acquired (by the taxpayer) after the 2015 Budget time ensures that assets previously acquired at an earlier time, temporarily disposed of and then reacquired at or after the 2015 Budget time do not qualify for the $20,000 threshold. However, a second-hand depreciating asset can qualify for the $20,000 low-cost asset threshold if the taxpayer first acquires it after the 2015 Budget time.
• For depreciating assets first acquired on or after 1 July 2014 and before the 2015 Budget time, the threshold is $1,000.
• For depreciating assets acquired at or after the 2015 Budget time but first used, or installed ready for use, for a taxable purpose before the 2015 Budget time, the threshold is $1,000.
• For depreciating assets acquired on or after 1 July 2017, and depreciating assets acquired before 1 July 2017 but first used, or installed ready for use, for a taxable purpose on or after that date, the threshold is $1,000.

In the usual case, the “adjustable value” of a low-cost asset is the cost of the asset. The “taxable purpose proportion” is (broadly) the proportion that relates to use of the asset “for a taxable purpose”.

 

 

• STOP: If there is additional expenditure on a low-cost asset (ie an amount is included in the second element of cost) and the additional expenditure is less than the relevant threshold (ie $20,000 or $1,000), the taxable purpose proportion of that expenditure is also deductible. However, in certain circumstances where additional expenditure is incurred, the asset is allocated to the general small business pool (see Pooling on page 6), even if the expenditure is incurred during an income year for which the taxpayer is not a small business entity or has not chosen to use the Subdiv 328-D rules:
• the additional expenditure is equal to or greater than the relevant threshold; or
• the taxpayer has deducted (or can deduct) an amount under s 328-180(2) for an amount previously included in the second element of the asset’s cost.

Business taxpayers

For business taxpayers that are not small business entities, all capital items must be written off over their effective lives under Div 40 of ITAA 1997, regardless of the cost (including low-value items). However, the ATO has adopted an administrative practice allowing an outright deduction for low-cost capital assets in certain cases (see ATO Practice Statement Law Administration PS LA 2003/8).

Broadly, an expenditure of $100 or less (inclusive of GST) incurred by a taxpayer to acquire a capital asset in the ordinary course of carrying on a business will be assumed to be revenue in nature and therefore deductible in the year of the expenditure. It is important to note that the threshold includes GST, so the threshold is effectively $90.91 for a business registered for GST.

• STOP: The administrative practice does not apply to expenditure incurred in establishing a business or building up a significant stockpile of assets, nor to a variety of assets, including those held under a lease, hire purchase or similar agreement, certain assets included in an assets register, trading stock, spare parts or assets that are part of another composite asset.

Pooling

Certain depreciating assets can be pooled, with the result that the decline in value is calculated for the pool instead of the individual assets.

Starting from the 2012–2013 year, there is one general small business depreciation pool for a small business entity (ie the “general pool” and the “long-life pool” are consolidated). If the value of the general small business pool falls below the relevant threshold, a small business entity can claim an immediate deduction for the pool balance (provided it is greater than zero). The relevant thresholds are:

• $20,000 for income years ending on or after 12 May 2015 and before 1 July 2017 (ie 2014-2015, 2015-2016 and 2016-2017 for entities that balance at 30 June);
• $1,000 for the 2014-2015 income year if the entity’s 2014-2015 income year ended before 12 May 2015; and
• $1,000 for income years ending after 30 June 2017.

For other taxpayers, there is the option of pooling “low-cost” and “low-value” assets to a low-value pool. A “low-cost” asset is a depreciating asset that costs less than $1,000. A “low-value” asset is a depreciating asset that has been depreciated using the diminishing value method, has an opening adjustable value of less than $1,000 in an income year, and is not a “low-cost” asset. If a taxpayer sets up a low-value pool, all low-cost assets must be allocated to the pool. However, low-value assets do not need to be allocated to the pool.

Category of taxpayer	Assets allocated to pool during year are depreciated at:	Assets allocated to pool in a previous income year are depreciated at:
Small business entity – General pool (from 2012–2013)	15%	30%
Other taxpayers – Low-value pool	18.75%	37.5%

 

TIP: Taxpayers should review their tax asset registers to identify any low-cost and/or low-value assets that may be pooled to access an accelerated rate of depreciation.

TIP: If two or more taxpayers jointly own a depreciating asset, a taxpayer can set up a low-value pool to take advantage of the accelerated rate of depreciation even though the asset costs more than $1,000, provided that taxpayer’s interest is less than $1,000.

 

 

“Blackhole” expenses under s 40-880

Special provisions (s 40-880 of ITAA 1997) provide systematic treatment for certain business expenditure of a capital nature – sometimes termed “blackhole” expenses. In Taxation Ruling TR 2011/6, the ATO sets out the Commissioner’s views on the interpretation of the operation and scope of s 40-880. It identifies the key issues that need to be resolved to establish entitlement to a deduction under s 40-880.

If capital expenditure is deductible under s 40-880, the deduction is spread over five years in equal proportions (ie 20% of the expenditure each year), commencing with the year in which the expenditure is incurred. Further, if a taxpayer is wound up, the entitlement to deduct any remaining undeducted expenditure is lost for income years after the one in which the taxpayer is wound up: see ATO ID 2009/6.

Small business entity start-up expenditure

A small business entity (see Small business entities on page 16) is entitled to an immediate deduction for pre-business expenditure incurred after 30 June 2015 if the expenditure is:

• a payment of government fees, taxes or charges relating to establishing a business or its operating structure (eg incorporation fees and duties on the transfer of assets); or
• the cost of advice or services that relate to the proposed business’s structure or operation: s 40-880(2A).

The immediate deduction also applies to post-30 June 2015 expenditure incurred by a non-business taxpayer who is not connected with, or an affiliate of, an entity that is not a small business entity, but who carries on a business.

Donations

Gifts and donations valued at $2 or more (whether cash or property) are deductible under s 30-15 of ITAA 1997 if the rules in Div 30 are satisfied.

TIP: Written evidence of donations or gifts (eg receipts) are generally required; however, documentary evidence is not required if the gift does not exceed $10 (eg a “bucket donation” to a deductible gift recipient (DGR), and if the total of all deductible amounts not exceeding $10 does not exceed $200 for the income year.

A taxpayer can spread a deduction over five years for a gift of money or a gift of property to an eligible charity or Cultural Gifts Program valued by the Commissioner at more than $5,000.

TIP: The taxpayer must specify in a written election the percentage (if any) to be deducted each year. If they anticipate an increase in assessable income in a future year, the taxpayer may consider allocating a greater percentage to that year.

In certain circumstances, a deduction is available under s 30-15 for a gift of trading stock valued at $2 or more, subject to special conditions being met. If the trading stock was purchased during the 12 months before the gift was made, the amount deductible is the lesser of the market value (excluding GST) on the day the gift was made and the purchase price.

Legal expenses

It is difficult to formulate an all-encompassing “rule” about the deductibility of legal expenses because each expense must be considered on its own merits. However, in accordance with general principles, legal expenses are deductible under s 8-1 if incurred in gaining or producing assessable income, or if necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. In general, the courts have established that if the advantage that is sought to be gained by incurring the legal expenses is of a revenue nature, the expenses will also be of a revenue nature, and if the advantage that is sought is of a capital nature, the expenses will be of a capital nature.

TIP: The success or failure of legal proceedings has no bearing on the deductibility of expenses incurred in those proceedings.

TIP: Certain legal (or legal-related) expenses (eg obtaining tax advice, preparing leases and discharging mortgages) are specifically deductible under various provisions of ITAA 1997.

TIP: Certain legal costs that are capital in nature (termed “blackhole expenditure”) may be deductible over five years under s 40-880. (See “Blackhole” expenses under s 40-880 on page 7.)

 

 

Non-commercial losses

Individual taxpayers should consider whether a loss from their business activity (whether carried on alone or in partnership) will be deferred under the non-commercial loss rules, which are contained in Div 35 of ITAA 1997. This is because the individual’s overall tax position will be impacted when the loss is deferred.

In essence, an individual may only offset a loss arising from a business activity against other income derived in the same income year if the business activity satisfies at least one of the four commerciality tests – the assessable income, profits, real property, or other assets tests. If the individual does not satisfy at least one of the tests, the loss is carried forward and applied in a future income year against assessable income from the particular activity.

TIP: Business activities of a similar kind may be grouped together as one activity. This is not compulsory, although it is likely to benefit the taxpayer. For example, an olive grower who produces and sells olive oil may also start an olive bottling business. These are similar activities and may be treated as one activity. However, where the olive grower also produces an insecticide for olives and earns royalties from its patent, the activity is of a different kind and would be treated separately. It is a question of fact and degree whether business activities are of a similar kind. Taxation Ruling TR 2001/14 states that this involves a comparison of the relevant characteristics of each business, such as the location where they are carried on, the type of goods and/or services provided, the market conditions in which those goods and/or services are traded, the type of assets employed in each, and any other features affecting the manner in which they are conducted. The ruling also states that the broader in nature any business activities are, the more likely it is that they will have similar characteristics. However, note the Administrative Appeals Tribunal (AAT) decision in Re Heaney and FCT [2013] AATA 331, in which it was held that the taxpayer’s cattle and sheep farms constituted discrete business activities and not a single farming business.

The Commissioner has the discretion to override the provisions of Div 35. The exercise of this discretion is to be based on assessment of the facts of each case, having regard to the language of the section and the policy and context of the non-commercial loss rules: Taxation Ruling TR 2007/6.

Further, an exemption is available for individuals who carry on a primary production or professional arts business and whose assessable income for the year from other sources (eg salary and wages) does not exceed $40,000.

High-income earners

Losses incurred by individuals with an adjusted taxable income of $250,000 or more from non-commercial business activities will be quarantined even if they satisfy the four commerciality tests. The effect of this is that these individuals cannot offset excess deductions from non-commercial business activities against their salary, wages or other income.

The adjusted taxable income is the sum of an individual’s:

• taxable income;
• reportable fringe benefits total;
• reportable superannuation contributions; and
• net investment losses.

Any excess deductions from a non-commercial business activity that are subject to Div 35 are to be disregarded in working out the adjusted taxable income of the individual.

While an individual with an adjusted taxable income of $250,000 or more is precluded from accessing the four commerciality tests, they may apply to the Commissioner to exercise discretion to not apply the non-commercial loss rules. They can do so where they can satisfy the Commissioner that, based on an objective expectation, the business activity will produce assessable income greater than available deductions within a commercially viable period for the industry concerned.

Prepayments

One of the simplest methods to accelerate deductions is prepayment of deductible expenses. Expenditure that is deductible under s 8-1 of ITAA 1997 is generally allowable in full in the income year in which it is incurred. However, Subdiv H of Div 3 in Pt III of ITAA 1936 (the “prepayment rules”) modifies the operation of s 8-1 by preventing the immediate deductibility of certain advance (“prepaid”) expenses. Where Subdiv H applies, the prepaid expenditure must be deducted on a straight-line basis over a period of time not exceeding 10 years.

TIP: The deductibility of audit fees depends on the terms of the audit contract. Taxpayers should consider agreeing to prepay their audit fees under their audit engagement at the start of the audit, in order to claim a deduction for the full expense in the current year. Taxation Ruling IT 2625 considers the deductibility of audit fees.

• STOP: It is important to note that the prepayment rules merely alter the timing of certain deductible amounts. They do not affect the underlying entitlement to the deduction or the amount of the allowable deduction.

Excluded expenditure

Various expenses are specifically excluded from the prepayment rules. This means a taxpayer can claim an outright deduction. Excluded expenditure includes:

• expenditure of less than $1,000;
• expenditure required to be made under a court order or by law (eg car registration fees); and
• expenditure on salary or wages.

TIP: If a taxpayer is entitled to an input tax credit for an expenditure, the $1,000 is the GST-exclusive amount. If the taxpayer is not entitled to an input tax credit, the $1,000 is the GST-inclusive amount.

• STOP: If two or more prepayments, each of less than $1,000 are made for the purpose of exploiting the $1,000 threshold for “excluded expenditure”, Pt IVA may deny the advantage: Taxation Determination TD 93/118.

Small business entities and non-business individuals

Small business entities and non-business individuals can access the 12-month prepayment rule. If the prepaid expenditure is not excluded expenditure, it is deductible outright in the income year it is incurred, subject to two provisos: the eligible service period must not exceed 12 months, and it must end in the expenditure year or the income year immediately following. If the prepayment has an eligible service period of greater than 12 months, the expenditure will be apportioned over the relevant period (on a daily basis) up to a maximum of 10 years. The eligible service period is the period over which the relevant services are to be provided.

Other taxpayers

If the eligible service period covers only one income year, the expenditure will be deductible in that particular year. If the eligible service period covers more than one income year, the expenditure is apportioned (on a daily basis) over those years up to a maximum of 10 years in accordance with this formula:

Expenditure	x	No. of days of eligible service period in the year of income
		Total no. of days of eligible service period

Speculators and losses from shares

Generally, speculators are denied a revenue deduction for any losses arising from the disposal of shares, unless a speculator is carrying on a business in relation to the shares (ie is a share trader). The significant factors in determining whether a person is a share trader include:

• whether there is an intention to buy and sell at a profit rather than hold for investment;
• the frequency and volume of transactions; whether the taxpayer is operating to a plan;
• the setting of budgets and targets and keeping of records;
• whether the taxpayer maintains an office;
• whether the share transactions are accounted for on a gross receipts basis; and
• whether the taxpayer is engaged in another full-time profession.

If the taxpayer is a share trader, losses may be deductible against other income. If the taxpayer is not a share trader, indexation or the CGT 50% discount may apply to reduce the capital gain.

• STOP: Taxpayer Alert TA 2009/12 warns against an arrangement whereby taxpayers seek to re-characterise their shareholding status from that of a long-term capital investor to a trader in shares.

Trading stock

The tax treatment of trading stock, which is contained in Div 70 of ITAA 1997, impacts on year-end tax planning. This is because the taxpayer is required to either include in or deduct from its assessable income for an income year the difference between the opening and closing value of the trading stock.

A taxpayer can elect to use the cost, market-selling value or replacement value to value each item of trading stock on hand. However, this does not apply to obsolete stock or for certain taxpayers. There is no requirement to permanently adopt any one of the three methods of value.

TIP: There is no compulsion to use the same method to value all closing stock. A taxpayer can use different methods for different items of trading stock to maximise deductions or minimise assessable income.

Small business entities

If a small business entity elects to apply the trading stock concession under Div 328, it is permitted to ignore the difference between the opening and closing value of trading stock if the difference between the opening value of stock on hand and a reasonable estimate of stock on hand at the end of that year does not exceed $5,000. The effect of electing to apply this concession is that the value of the entity’s stock on hand at the beginning of the income year is the same as the value taken into account at the end of the previous income year.

However, a taxpayer could choose to account for changes in the value of trading stock even if the reasonably estimated difference between opening and closing values was less than $5,000.

TIP: Accounting for the difference between the opening and closing stock is a good tax planning method to avoid a large adjustment in the calculation of taxable income in a future year when the benefit of Div 328 is not available, or to claim a deduction in the current year for a reduction in the value of trading stock.

Obsolete stock

A deduction may be available for obsolete stock. Therefore, taxpayers should review their closing stock to identify whether any obsolete stock exists. In Taxation Ruling TR 93/23, the ATO states that obsolete stock is stock that is either:

• going out of use, going out of date, becoming unfashionable or becoming outmoded (ie becoming obsolete); or
• out of use, out of date, unfashionable or outmoded (obsolete stock).

When valuing obsolete stock, a taxpayer does not need to use any of the prescribed methods (ie cost, market value or replacement value). Rather, provided adequate documentation is maintained, the ATO will accept any fair and reasonable value that is calculated taking into account the appropriate factors: see
s 70-50 of ITAA 1997.

Repairs and maintenance

A deduction is available for repairs to premises, a part of premises or a depreciating asset (including plant) held or used by a taxpayer solely for the purpose of producing assessable income: see s 25-10(1) of ITAA 1997. If the relevant premises or assets are used or held only partly for income-producing purposes, expenditure on repairs is only deductible to the extent that it is reasonable in the circumstances: see
s 25-10(2).

A common issue that arises is the distinction between restoration of an item to its former condition (which is deductible) and improvement of the item (which is capital and thus not deductible). It is important to understand that the mere fact of using different materials from those replaced will not of itself cause the work to be classified as an improvement, particularly in circumstances where the previous materials are no longer in current use. If the change is merely incidental to the operation of the repair, the deduction will generally be allowed.

Initial repairs, replacement of the entire item, and improvements are not deductible, but may qualify for a periodic write-off under the capital allowance provisions. In addition, the expenditure may form part of the cost base of an asset for capital gains tax purposes.

TIP: The ATO has stated that if a taxpayer replaces something identifiable as a separate item of capital equipment, the taxpayer has not carried out a repair. Therefore, the taxpayer is required to depreciate the item over its effective life.

TIP: Taxpayers should seek an itemised invoice to separate the costs of work if the work includes both repairs and improvements.

Superannuation contributions

Deductions for employer contributions

An employer is entitled to a tax deduction under s 290-60 of ITAA 1997 for contributions made to a complying superannuation fund or a retirement savings account (RSA) for the purpose of providing superannuation benefits for an employee, if certain conditions in Subdiv 290-B of ITAA 1997 are satisfied.

TIP: To maximise the deductions available, employers should ensure that the contributions are paid to their employees’ superannuation funds or RSAs before 30 June. Note that contributions are considered “paid” when they are “received” by the super fund.

TIP: Taxation Ruling TR 2010/1 sets out the Commissioner’s views regarding specific rules about deducting superannuation contributions.

TIP: For employees turning 75, the contribution must be made by the employer within 28 days after the end of the month in which the employee turns 75. However, the age limit does not apply in respect of a deduction for an amount that is required to be contributed under certain industrial awards, determinations or agreements: s 290-80. From 1 July 2013, an employer can deduct the amount of a contribution that reduces the superannuation guarantee percentage in respect of an employee aged 75 or over, following the abolition of the superannuation guarantee age limit.

• STOP: The mere accrual of a superannuation liability or a book entry is not sufficient to qualify for a deduction.
• STOP: A company can only deduct a contribution for a director if the director is entitled to payment for the performance of duties as a member of the company’s executive body.

Change to the minimum level of employer support

Between 1 July 2002 and 30 June 2013, the prescribed minimum level of superannuation support was 9% of an employee’s earnings. From 1 July 2013, the rate gradually increases from 9%, starting with 9.25% for 2013–2014 and 9.5% for 2014–2015, until it reaches 12% from 1 July 2025.

Employers must use ordinary time earnings to calculate the minimum superannuation guarantee contributions required for their employees. An employer that provides less than the required minimum level of support will be liable to pay a non-deductible charge called the superannuation guarantee charge (SGC).

• STOP: In certain cases, a person who describes themself as an “independent contractor” may in fact still be an “employee” for superannuation guarantee purposes (in a similar manner as for PAYG purposes and for some state payroll tax laws).

Superannuation guarantee charge

The SGC is imposed if an employer does not make sufficient quarterly superannuation contributions for each employee by the relevant quarter’s due date. The SGC is calculated, and the SGC is payable, on a quarterly basis. If an employer has a shortfall for a quarter, the employer is required to lodge a superannuation guarantee statement by the 28th day of the second month following the end of the relevant quarter. The SGC is payable by the same date. The SGC is not deductible: s 26-95 ITAA 1997. Note that the liability to pay the SGC remains with the employer even if the employer (if a company) goes into liquidation: see ATO ID 2008/28.

An employer who has made a contribution for an employee after the due date for the quarter and who has an outstanding SGC for the employee for that quarter may elect (using the approved form) to use the late payment offset to reduce their SGC liability. This election is irrevocable.

However, the late contribution can only be offset against an SGC that relates to the same quarter and to the same employee. The offset cannot be used to reduce the administration component. If an employer has been assessed on its SGC for a quarter, the employer can seek an amendment of the assessment to elect to use the offset. However, the amendment must be made within four years after the employer’s SGC for the quarter became payable.

TIP: The SGC is the only tax that the Commissioner wants employers to avoid paying.

• STOP: The SGC and late payment offset are not deductible to an employer. Therefore, the employer still has a strong incentive to continue making its superannuation guarantee quarterly payments on time.
• STOP: Directors have been made personally liable for their companies’ unpaid SGC amounts, following the extension of the director penalty regime. The Commissioner can make an “estimate” of the unpaid SGC for a quarter under Div 268 of Sch 1 to the Taxation Administration Act 1953 (TAA) and recover the estimated amount through a director penalty under Div 269 of Sch 1 to TAA. The extension of the director penalty regime to SGC liabilities applies in respect of superannuation guarantee statements due and payable from 28 August 2012.

Personal superannuation deductions

Self-employed (and other eligible) persons are entitled to a full tax deduction under s 290-150 for their personal concessional contributions until age 75, consistent with employer contributions made on behalf of employees. The contribution is only deductible for the year in which the contribution is made: s 290-150(3).

If the taxpayer engages in activities as an employee, they must also meet the 10% work test. That is, less than 10% of the total of their assessable income, reportable fringe benefits total, and reportable employer superannuation contributions for the income year is attributable to those activities as an employee: s 290-160.

The contribution is deductible in full, although the maximum amount deductible is restricted to the amount stated in the notice of intention to claim a deduction given to the trustee of the relevant superannuation fund.

• STOP: Income attributable to a taxpayer’s employment activities also includes worker’s compensation payments, unused long service leave and annual leave payments, to the extent they are assessable in the income year: Taxation Ruling TR 2010/1.
• STOP: Any excess concessional contributions a taxpayer has for the corresponding financial year are disregarded for the purposes of the 10% test for deducting personal contributions: s 290-160(3). This follows the introduction of rules whereby any excess concessional contributions are included in a taxpayer’s assessable income.
• STOP: Note that a deduction is not available in respect of any financing costs on a loan connected with a personal superannuation contribution.

TIP: A deduction for personal superannuation contributions should only be made towards the end of the income year when it is certain that a taxpayer will satisfy the 10% rule (and other eligibility conditions).

TIP: A taxpayer who has not engaged in an employment activity during the income year in which they make a contribution is not subject to the 10% earnings test. For example, a person receiving workers’ compensation payments (but who is no longer employed) is not subject to the 10% test: see Taxation Ruling TR 2010/1.

Valid notice to claim deduction

In order to be eligible for a deduction for a personal superannuation contribution, the individual must give a notice to the fund trustee or RSA provider of their intention to claim a deduction, and must receive an acknowledgment of receipt of the notice: s 290-170 of ITAA 1997. The notice must be given by the time the person lodges their income tax return for the year in which the contribution is made or, if no return has been lodged by the end of the following income year, by the end of that following year.

A notice will not be valid where:

• the person is no longer a member of the fund (eg because the person’s benefits have been paid to them or they have rolled over their benefits in full to another fund);
• the trustee no longer holds the contribution;
• the trustee has commenced an income stream based in whole or part on the contribution; or
• the taxpayer has made a spouse contributions-splitting application that has not been rejected.

If the member has chosen to roll over a part of the superannuation interest held by a fund, a valid deduction notice is limited to a proportion of the tax-free component of the superannuation interest that remains after the rollover.

A valid notice cannot be withdrawn or revoked, but it may be varied so as to reduce the amount stated in relation to the contribution (including to nil). A notice of intent to vary a deduction cannot increase the amount to be claimed.

The ATO provides a “Notice of intent to claim or vary a deduction for personal super contributions” (NAT 71121) form on its website.

• STOP: If a valid notice is not provided, the taxpayer will not be entitled to a deduction for the personal superannuation contributions. The Commissioner may also impose an administrative penalty for failing to provide the notice within the time limit.
• STOP: The ATO says it will only accept notices that include all of the mandatory information and the member declaration.

Investment schemes

Cases concerning “tax effective” investment schemes show that the deductibility of expenditure incurred in relation to such schemes depends on the particular circumstances, especially an analysis of the agreement under which the relevant fees are paid (typically the management agreement, but also the loan agreement when considering the deductibility of interest payments).

• STOP: It may be advisable to invest only in a “tax effective” investment scheme for which a product ruling has been issued. A product ruling is a form of binding public ruling and sets out the taxation consequences of investing in a particular scheme. However, a product ruling is only binding to the extent the arrangement is implemented as proposed in the application for the ruling. The ruling does not guarantee the viability of a project, whether charges are reasonable or represent industry norms or whether projected returns will be achieved or are reasonably based.

Companies

The tax treatment of companies depends on their classification as a private or a public company. For example, only a private company is subject to the operation of Div 7A in Pt III of ITAA 1936.

Companies are subject to a flat rate of tax on the entirety of their taxable income. The standard company rate is 30%. However, with effect from the 2015–2016 income year, the corporate tax rate is 28.5% for small business entities that are companies. A “small business entity” is an entity with an aggregated turnover of less than $2 million (see Small business entities on page 16.) These rates apply whether the company is public, private, resident or non-resident.

Dividends: benchmarking rule

Companies should ensure that all dividends paid to shareholders during the relevant franking period (generally the income year) are franked to the same extent to avoid breaching the benchmark rule.

If an entity to which the benchmark rule applies franks a distribution in breach of the rule (by either over-franking or under-franking the distribution), the recipient of the distribution can still get the benefit of the franking credits attached to the distribution, but a penalty (in the form of over-franking tax or a debit) will be imposed on the entity.

Loans and payments by private companies

Loans, payments and debts forgiven by private companies to their shareholders and associates may give rise to unfranked dividends that are assessable to the shareholders and associates. To minimise any adverse Div 7A consequences, taxpayers must consider the following.

For loans by a private company, taxpayers should:

• repay private company loans by the earlier of the actual lodgement date or the due date for lodgement of the company’s return for that year;
• ensure a loan agreement is in place by the earlier of the actual lodgement date or the due date for lodgement of the company’s return for that year; and
• ensure that the interest rate on the loan for years of income after the year in which the loan is made equals or exceeds the benchmark interest rate for the year.

The following apply for payments by a private company:

• Section 109C(3) contains an extended definition of “payment”, which includes the crediting of amounts to, on behalf of, or for the benefit of an entity, and the transfer of property to an entity. If property is provided, companies should consider requiring shareholders to pay market value.
• The concept of “payment” also extends to the provision of an asset for use by a shareholder or the shareholder’s associate. If a company-owned asset (eg a boat) is made available for use by shareholders or their associates, the company should consider requiring payment of an arm’s-length fee or ensuring the company retains full and unfettered access to the asset.
• Section 109D(4A) allows a payment by a private company to a shareholder (or an associate) to be converted into a loan before the lodgement day for the company’s tax return. The loan can be repaid (before the lodgement day) or a written loan agreement that complies with s 109N may be entered into.

For debts forgiven by a private company:

• a debt is also taken to be forgiven (even if it has not actually been forgiven) if a reasonable person would conclude (having regard to all the circumstances) that the private company will not insist on the entity paying the debt or rely on the entity’s obligation to pay the debt; and
• a deemed dividend may arise if a shareholder dies and the debt is forgiven during administration of the deceased’s estate (and the dividend will be taken to be paid to the legal personal representative of the shareholder).

Other considerations include that:

• payments under a guarantee can trigger a deemed dividend and must be considered carefully;
• a deemed dividend can only arise to the extent of a company’s distributable surplus, so this issue needs to be considered along with planning opportunities; and
• the exemptions available should be considered and used if possible.

Section 109RB gives the Commissioner discretion to disregard a dividend that would otherwise be deemed to arise under Div 7A, or to allow a company to frank a deemed dividend, where the failure to satisfy Div 7A is the result of an honest mistake or inadvertent omission. The meaning of these terms is considered in Taxation Ruling TR 2010/8. A request for the discretion must be lodged in writing.

TIP: Taxpayers should ensure that any loans or payments are repaid by the earlier of the due date for lodgement of the company’s tax return or the actual lodgement date. If repayment is not made, taxpayers should ensure that loan repayments and applicable interest are documented through loan agreements between the taxpayer and related party.

• STOP: Practice Statement Law Administration PS LA 2011/29 provides guidance for ATO staff exercising the discretion. The Practice Statement describes a two-step procedure: first, the identification of an honest mistake or inadvertent omission giving rise to a Div 7A deemed dividend, and second, the application of factors in s 109RB(3) to determine whether the discretion should be exercised. Potentially relevant matters include the sophistication of the taxpayer, corrective action (if any) taken by the taxpayer, the complexity of the Div 7A provisions at issue, and whether the taxpayer should have sought professional advice.

Research and development

Companies should consider whether they have undertaken eligible research and development (R&D) activities that may be eligible for the R&D tax incentive. Eligible R&D activities are experimental activities conducted in a scientific way for the purpose of generating new knowledge or information. The R&D tax incentive provides two types of tax offsets:

• a 45% refundable offset for smaller companies; and
• a 40% non-refundable offset for larger companies and companies controlled by tax-exempt entities.

The 45% tax offset is available to R&D entities with an aggregated turnover of less than $20 million per annum (unless they are controlled by one or more tax-exempt entities). The 40% tax offset is available to R&D entities that do not qualify for the refundable 45% offset.

The company’s R&D activities need to be registered with AusIndustry within 10 months after the end of the income year. For example, this means that a companies with a standard year of income of 1 July 2014 to 30 June 2015 wishing to apply for the R&D tax incentive for the 2014–2015 income year must lodge its application with AusIndustry by 30 April 2016. (As 30 April 2016 falls on a Saturday, companies can lodge until midnight on Monday 2 May 2016.) Information on registration requirements is available online at www.business.gov.au/grants-and-assistance/innovation-rd/RD-TaxIncentive/Pages/default.aspx.

TIP: Companies are required to maintain records to demonstrate, not only to AusIndustry, but also to the ATO, that the activities carried out are eligible R&D activities and that incurred expenditure related to those activities.

• STOP: Still before the Senate at the time of writing, the Tax and Superannuation Laws Amendment (2015 Measures No 3) Bill 2015 proposes to reduce the rates of the tax offset available under the R&D tax incentive for the first $100 million of eligible expenditure by 1.5 percentage points. The higher (refundable) rate of the tax offset would be reduced from 45% to 43.5% and the lower (non-refundable) rates of the tax offset would be reduced from 40% to 38.5%. The changes are proposed to apply to income years starting on or after 1 July 2014.
• STOP: If an R&D entity’s notional deductions exceed $100 million, the full R&D tax offset applies to the first $100 million, while the excess is subject to a reduced tax offset rate – the relevant corporate tax rate. This measure applies for income years commencing on or after 1 July 2014.
• STOP: The ATO and AusIndustry have cautioned primary producers in the broadacre farming sector against claiming the R&D tax incentive for the cost of fertilisers and soil improvers which do not relate to R&D activities, but rather to business-as-usual farming activities. Further details are contained in Taxpayer Alert TA 2015/3.

Tax consolidation

Companies may consider consolidating before year-end, in order to reduce compliance costs and take advantage of tax opportunities available as a result of the consolidated group being treated as a single entity for tax purposes. However, an entity’s individual circumstances should be carefully analysed before making such a decision.

Carried-forward losses

Companies should carefully consider whether deductions are available for any carried-forward losses, including analysing the continuity of ownership test and the same business test.

Monthly pay-as-you-go (PAYG) instalments

A monthly instalment system is being phased in, to apply as follows:

• from 1 January 2014, corporate tax entities that meet or exceed the $1 billion threshold;
• from 1 January 2015, corporate tax entities that meet or exceed the $100 million threshold;
• from 1 January 2016, (i) corporate tax entities that meet or exceed the $20 million threshold; and (ii) all other entities, including super funds and trusts, that meet or exceed the $1 billion threshold; and
• from 1 January 2017, all non-corporate tax entities (including individuals) that meet or exceed the $20 million threshold.

An entity that reports and pays GST on a quarterly or annual basis will only become a monthly payer if it meets or exceeds the $100 million threshold: s 45-138. The head company of a consolidated group or the provisional head company of a multiple entry consolidated (MEC) group will be a monthly payer if it meets or exceeds the $20 million threshold.

 

 

Trusts

The provisions governing trusts, including in whose hands trust income is assessed and the amount assessed, are complex. The trust deed is always a good starting point. This is because the deed governs the operation of the trust.

Taxpayers should review trust deeds to determine how trust income is defined; for example, whether capital gains are included as trust income or whether trust income is equated with taxable income. This may have an impact on trustee tax planning.

TIP: It is critical to check who the trust beneficiaries are, and to ensure that all distributions of income are valid under the deed.

Family trust election

Trustees should consider whether a family trust election (FTE) is required to ensure any losses or bad debts incurred by the trust will be deductible, and to ensure that franking credits will be available to beneficiaries. Similar considerations can apply for companies owned by trusts.

If an FTE has been made, trusts should avoid distributing outside the family group to avoid the family trust distribution tax. Family trust distribution tax is payable on the amount or value of income or capital to which a non-family member is presently entitled or that is distributed to a non-family member. The rate of tax is equal to the top personal marginal tax rate plus Medicare levy. The rate is:

• 5% for income years before 2014–2015;
• 49% (incorporating the increase in the Medicare levy to 2% and the 2% temporary budget repair levy) for 2014–2015, 2015–2016 and 2016–2017; and
• 47% for 2017–2018 and later years.

Trusts and Division 7A

An amount of trust income to which a private company is or has been presently entitled, but that has not been distributed to the company, may be regarded as a loan made by the company to the trust for the purposes of the deemed dividend provisions of Div 7A.

The Commissioner has indicated that Div 7A will apply where there is an unpaid present entitlement (UPE) from a trust to an associated private company. The approach that the Commissioner will adopt in UPE cases is outlined in Taxation Ruling TR 2010/3, and guidance about how that ruling will be applied is contained in Practice Statement Law Administration PS LA 2010/4.

In broad terms, a trust distribution that remains unpaid to a beneficiary who is a private company may be regarded by the ATO as a deemed dividend in the hands of the trustee. Such deemed dividends could be avoided if the UPE (that arises on or after 1 July 2011) is paid out, or if a complying loan agreement is entered into, by the due date for lodgement of the private company’s tax return.

Note that the ATO has also issued a supplementary guide that taxpayers should read in conjunction with the Ruling and PS LA 2010/4. This guide is available on the ATO’s website at https://www.ato.gov.au/business/private-company-benefits—division-7a-dividends/in-detail/fact-sheets/division-7a—unpaid-present-entitlement/.

Income of a trust estate

The existence or absence of a beneficiary’s present entitlement to “income of the trust estate” is used in Div 6 to determine the liability of the beneficiary or the trustee, in a particular income year, to tax on the “net income of the trust estate”. Although the term “net income of the trust estate” is defined in s 95, the term “income of the trust estate” is not defined in ITAA 1936 and there remains some uncertainty as to its meaning.

In FCT v Bamford (2010) 75 ATR 1, the trust deed permitted the trustee to determine that a capital gain should be treated as income of the trust estate. For the 2001–2002 income year, the trustee made such a determination and distributed equal shares of a capital gain to Mr and Mrs Bamford. The Commissioner argued that the capital gain, by its nature, was not “income of the trust estate”. The High Court held that the term “income of the trust estate” took its meaning from “the general law of trusts, but adapted to the operation of the 1936 Act upon distinct years of income”. The High Court noted that “income”, under the general law of trusts, can include a capital gain. Therefore, in Bamford, the “income of the trust estate” included a capital gain treated by the trustee as distributable income in accordance with the terms of the trust deed.

In contrast, capital gains were found not to be part of the income of a trust estate in Colonial First State Investments Ltd v FCT (2011) 81 ATR 772. The basis for this decision was that there was no provision in the constitution of the trust that permitted the trustee to treat capital gains as income of the trust estate.

The ATO now accepts that a provision of a trust instrument, or a trustee acting in accordance with a trust instrument, may treat the whole or part of a receipt as income of a period, and it will thereby constitute “income of the trust estate” for the purposes of s 97: see the ATO’s Decision Impact Statement on the Bamford case and Practice Statement Law Administration PS LA 2010/1. However, the ATO considers that the Bamford case has not resolved “the effect of a recharacterisation clause that requires or permits a trustee to treat as capital what is otherwise received as income”.

Tax returns for the 2009–2010 income year and previous income years that were prepared on the basis of an interpretation of the law that was reasonably open prior to the Bamford litigation will not be disturbed unless there has been a deliberate attempt to exploit Div 6 or there is a dispute for some other reason: see Practice Statement Law Administration PS LA 2010/1.

The ATO has set out its preliminary views on the meaning of “income of the trust estate” as used in Div 6 in Draft Taxation Ruling TR 2012/D1. The draft ruling states there is no set or static meaning of the expression “income of the trust estate” as used in Div 6, and the meaning in the case of a particular trust will depend principally on the terms of that trust and the general law of trusts. Following Bamford, the ATO said it considers that “it is clear that the determination of the income of a trust is grounded in trust law and generally involves a focus on the receipts and outgoings for an income year”. Further, the ATO said the statutory context in which the expression is used may also influence its meaning.

Note that the ATO has in fact withdrawn the draft ruling from its ruling program pending the ATO’s consideration of the Federal Court decision in Thomas v FCT [2015] FCA 968 (concerning whether franking credits could form part of the income of a trust estate). However, despite its withdrawal, the ATO said the draft ruling continues to represent the Commissioner’s preliminary, though considered, view on the meaning of income of a trust estate in the meantime.

(See Trust reforms on hold on page 16.)

TIP: Taxpayers should avoid retaining income in a trust because it may be taxed in the hands of the trustee at the top marginal tax rate.

• STOP: For the 2010–2011 and subsequent years, new rules contained in Subdiv 115-C apply to capital gains made by trusts.

Trust reforms on hold

On 24 October 2012, the then-Government released a policy options paper for reforms to the taxation of trusts. The options paper considered two possible models for taxing trust income: an economic benefits model and a proportionate assessment model. The then-Government indicated that the new measures would apply from 1 July 2014; however, there have been no further developments since the release of the options paper. In November 2013, the Assistant Treasurer of the time (Arthur Sinodinos) said he would not push the review “to report prematurely” because it was a complex issue.

Trust issues on ATO radar

The ATO is leading a taskforce to combat the misuse of trust structures. The ATO says the Trust Taskforce is cracking down on those exploiting trusts to conceal their interests, mischaracterise transactions and artificially deal with trust income to avoid paying their fair share of tax.

Taxpayer Alert TA 2015/4 describes an arrangement where a purported partnership with a private company partner is used to enable individuals to access business profits without paying top-up income tax at their marginal rates of tax. The ATO says the profits are usually channelled to the partnership via a discretionary trust or through dividends from a private company, such as under a “dividend access share” arrangement.

Small business entities

Under the small business entity regime, a taxpayer does not need to elect to enter into the regime. Instead, it will be apparent from a small business entity’s tax return whether it has used the tax concessions.

Concessions available

The tax concessions available to small business entities (subject to any additional criteria set out in the particular concessions themselves) include:

• capital allowance concessions – an immediate deduction for depreciating assets (see Depreciation (capital allowances) on page 5);
• simpler trading stock rules – being allowed to ignore the difference between the opening and closing value of trading stock (up to $5,000) (see Trading stock on page 9);
• concessional tax rates – from 2015–2016, the tax rate applicable to small business entities that are companies is 28.5% (rather than the standard 30% rate) and other types of small business entities will be entitled to a tax discount in the form of a tax offset (see Small business tax offset on page 17);
• start-ups – an immediate deduction for certain expenses incurred when starting up a business (see SBE start-up expenditure on page 7);
• optional rollover relief – for changing a legal structure without changing the ultimate economic ownership of the relevant asset(s) (see Small business restructures on page 19);
• small business CGT concessions – the 15-year exemption, 50% reduction, retirement exemption and rollover concession (see Small business CGT concessions on page 18);
• the prepaid expenses rules (see Prepayments on page 8);
• the use of the GDP-adjusted notional tax method for working out PAYG instalments;
• the FBT car parking exemption;
• the FBT exemption for portable electronic devices – from the 2016–2017 FBT year, a small business entity will be able to provide more than one work-related portable electronic device to an employee and claim the FBT exemption for each device, even if the devices have substantially identical functions and are not replacement items (see Portable electronic devices on page 26);
• GST concessions – the choice to account for GST on a cash basis, apportion GST input tax credits annually and pay GST by instalments; and
• the two-year period of review.

Definition of a small business entity

An entity is classified as a small business entity for an income year if:

• it carries on a business in the current year; and
• it had an aggregated turnover for the previous year of less than $2 million, or is likely to have an aggregated turnover for the current year that is less than $2 million.

The aggregated turnover is the annual turnover of the entity’s business plus the annual turnover of any businesses that the entity is connected to or affiliated with.

An “affiliate” is an individual or company that acts, or could reasonably be expected to act, in accordance with the directions or wishes of the taxpayer or in concert with the taxpayer in relation to the affairs of the business of the individual or company: s 328-130(1).

An entity is connected with another entity if: (a) one of the entities “controls” the other entity; or (b) the two entities are “controlled” by the same third entity, in which case all three entities are connected: s 328-125(1).

• STOP: A person who is a partner in a partnership in an income year is not, in their capacity as a partner, a small business entity for the income year: s 328-110(6).
• STOP: The connected entity test was amended by the Tax Laws Amendment (2013 Measures No 1) Act 2013 to remove references to beneficial ownership of interests. As a result, the test is now based on ownership of interests rather than beneficial ownership of interests. As a result, the small business concessions in Div 328 apply to structures involving trusts, life insurance companies and superannuation funds in the same way as they apply to structures involving other types of entities. In addition, companies in liquidation, bankrupts, absolutely entitled beneficiaries and security providers are treated as the owners of CGT assets for the purposes of the small business connected entity test.

Small business tax offset

To complement the reduction in the company tax rate from 30% to 28.5% for a small business company,
a small business entity that is not a company is entitled to a tax discount (by way of a tax offset) under Subdiv 328-F for income years commencing on or after 1 July 2015 (ie the 2015–2016 and later income years for an entity that balances at 30 June). The offset is available to individuals (ie sole traders) who are small business entities, individuals who are partners in a partnership that is a small business entity and individuals who are beneficiaries of a trust that is a small business entity. A foreign resident may qualify for the offset and the offset can apply to the foreign business income of an Australian resident. The offset is not available to individuals in their capacity as a trustee.

The amount of the offset is equal to 5% of the income tax payable on the portion of an individual’s taxable income that is net small business income (but subject to a $1,000 cap): s 328-360. The income tax payable on the portion of an individual’s taxable income that is net small business income is worked out in accordance with the following formula:

Your total net small business income for the income year x Your basic income tax liability for the income year

Your taxable income for the income year

• STOP: The $1,000 cap applies regardless of the number of small business entities that cause the taxpayer to be entitled to the offset for the income year.

Proposed new incentives

The Government proposes to introduce tax law changes to encourage new investment in Australian early-stage innovation companies with high growth potential by providing tax incentives for investors in such companies.

These incentives include a 20% carry-forward non-refundable offset on investments capped at $200,000 per year, and a 10-year exemption on CGT for investments held in the form of shares in the innovation company for at least 12 months, provided that the shares held do not constitute more than a 30% interest in the innovation company.

The tax offset would be available upon investment, not when the funds are used by the innovation company, and any sale of the shares would be taxed on a “deemed capital account” basis. These amendments would apply in relation to shares issued on or after the later of 1 July 2016 or Royal Assent. At the time of writing, the Bill to introduce the changes – the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 – was still before the House of Representatives.

• STOP: All investors need to be aware that the incentives are subject to various qualifications, including integrity measures.
• STOP: “Retail (non-sophisticated) investors” are subject to a total annual investment limit of $50,000. These investors will not be entitled to a tax offset if their investment exceeds this maximum threshold.
• STOP: These tax incentives form part of the Government’s National Innovation and Science Agenda (December 2015). There are also other important incentives including proposed changes to venture capital limited partnerships, increased access to company losses, faster depreciation for intangible assets, and relaxed document disclosure requirements for employee share schemes. These proposals are subject to public consultation. Further information is available online at http://www.innovation.gov.au/.

The Government has also announced that small business entities with a turnover of less than $2 million will be entitled to a $100 non-refundable tax offset for expenditure on standard business reporting enabled software (ie software purchases or subscriptions) made in the 2017–2018 financial year only. At the time of writing, legislation had yet to be introduced in Parliament.

Capital gains tax

Taxpayers may consider crystallising any unrealised capital gains and losses in order to improve their overall tax position for an income year. For example, if the taxpayer anticipates a significant capital gain in an income year, they may consider reducing the gain by crystallising a capital loss in the same income year. However, the Commissioner’s view on “wash sales”, contained in Taxation Ruling TR 2008/1, must also be considered, particularly if a taxpayer reacquires the assets being disposed of (or identical assets), or somehow retains dominion or control over the original assets.

Small business CGT concessions

Broadly, the small business CGT provisions contained in Div 152 of ITAA 1997 provide a range of concessions for a capital gain made on a CGT asset that has been used in a business, provided certain conditions are met.

There are two basic conditions that must be met in order for a capital gain made by a taxpayer to qualify for the small business concessions. Firstly, the taxpayer must satisfy the “maximum net asset value” test or be a “small business entity”, or be a partner in a partnership that is a “small business entity” where the CGT asset is an interest in an asset of the partnership. Secondly, the CGT asset that gives rise to the gain must be an “active asset”. This can include shares or trust interests, subject to satisfying certain conditions.

The concessions are:

• The 15-year exemption: A capital gain may be disregarded if the relevant CGT asset has been continuously owned by the taxpayer for at least 15 years. If the taxpayer is an individual, they must be at least 55 years of age and the CGT event must happen in connection with the taxpayer’s retirement, or they must be permanently incapacitated at that time. If the taxpayer is a company or trust, a person who was a significant individual just before the CGT event must satisfy the requirements.
• The 50% reduction: A capital gain resulting from a CGT event that happens to an active asset of a small business may be reduced by 50%.
• The retirement exemption: A taxpayer may choose to disregard all or part of a capital gain up to a lifetime maximum of $500,000.
• The asset rollover concession: A taxpayer may disregard all or part of a capital gain if a replacement asset that is an active asset is acquired.

TIP: The 15-year exemption has priority over the other concessions, because it provides a full exemption for the capital gain. In addition, the exemption is applied without first having to use prior year losses or the CGT discount.

TIP: The concessions are available to the legal personal representative (LPR) or beneficiary of a deceased estate, a surviving joint tenant and the trustee of a testamentary trust provided: (a) the deceased would have qualified for the concessions just before their death; and (b) the CGT event that gives rise to the gain in the hands of the LPR or beneficiary occurs within two years of the deceased’s death (or such further time as the Commissioner allows).

TIP: The concessions are available for any capital gain made on the sale of a business under an earnout arrangement under the newly enacted CGT “look-through” treatment of earnout arrangements (see Earnout arrangements on page 19).

TIP: Good records are necessary to help substantiate claims for any of the small business CGT concessions. Records kept should include the market value of relevant assets just before the CGT event, evidence of carrying on a business (including calculation of turnover) and calculations relating to carried-forward losses. Other documents that should be kept include relevant trust deeds, trust minutes, the company constitution and any other relevant documents.

• STOP: Under the maximum net asset value test, the net value of all the CGT assets of the taxpayer, entities
  “connected with” the taxpayer, the taxpayer’s “affiliates” and entities “connected with” the taxpayer’s affiliates (subject to certain exceptions) must not exceed $6 million. A debt owed to the taxpayer, affiliate or connected entity would be such a CGT asset, and would, prima facie, be brought into account at its face value. However, note that some CGT assets are specifically excluded from the test (eg shares in an affiliate): see s 152-20(2) of ITAA 1997.
• STOP: The ATO has issued Taxation Ruling TR 2015/4 which sets out how “unpaid present entitlements” of trusts are accounted for under the maximum net asset value test.

Rollover relief

Rollovers defer the immediate consequences from a CGT event (either automatically or at the taxpayer’s option). Rollovers are available in a broad range of situations, including on the transfer of assets on the breakdown of a marriage; if one asset is replaced with another, such as on its loss or destruction (replacement asset rollover); or if there is a change in the entity holding a CGT asset without a change in the beneficial ownership of the asset (same asset rollover). Apart from disregarding any capital gain or loss that would arise from the CGT event, the effect of a rollover is usually to place the entity that receives the asset in the same CGT position as the entity that originally owned the asset. If the asset being transferred was a pre-CGT asset, it will generally retain its pre-CGT status in the hands of the transferee. Similarly, if the asset was a post-CGT asset, the rollover will generally transfer the transferor’s cost base to the transferee.

Small business restructures

The Government has introduced legislation to provide an optional rollover for small business owners who change the legal structure of their business on the transfer of business assets from one entity to another. The effect of the rollover is that the tax cost of the transferred asset(s) rolls over from the transferor to the transferee. The rollover is in addition to existing rollovers where an individual, trustee or partner transfers assets to, or creates assets in, a company in the course of incorporating their business (new Subdiv 328-G). The amendments will take effect on 1 July 2016.

• STOP: There are strict eligibility requirements in order to access the rollover. Among other things, the asset transfer must be part of a genuine business restructure without changing the ultimate economic ownership of the asset(s).
• STOP: The ATO has issued two draft law companion guidelines on the new rollover. Draft Law Companion Guideline LCG 2016/D2 explains the consequences and adjustments that occur when the transferor and transferee choose to apply the rollover. Draft Law Companion Guideline LCG 2016/D3 explains the meaning of “genuine restructure of an ongoing business”. When the draft guidelines are finalised, they will apply to transfers occurring from 1 July 2016.

Earnout arrangements

The Government has introduced legislation to provide a CGT “look-through” treatment for eligible earnout arrangements: Subdiv 118-I. Where a business is sold under an “eligible” earnout arrangement (ie where the buyer and seller agree that subsequent financial benefits may be provided based on the future performance of the business or business assets), the value of the “earnout right” will not be bought into account (for CGT purposes) as capital proceeds for the vendor, or as the cost for the purchaser, until such time as any future financial benefits are paid or received.

Nevertheless, any capital gain or loss arising to a vendor from any fixed amount received for the sale of the business asset(s) will be bought into account in the income year during which the sale or disposal occurs, with adjustments made to the capital proceeds of the vendor for any subsequent financial benefits received and to the cost base to the purchaser for any subsequent financial benefits paid.

• STOP: The new rules will apply to all earnout arrangements entered into on or after 23 April 2015 (the day when the draft legislation was released). There are specific transitional measures for taxpayers who have reasonably and in good faith anticipated these changes as a result of the announcement by the previous Government on 12 May 2010.
• STOP: Because the CGT treatment of earnouts will result in the amount of a capital gain or loss changing as a result of financial benefits received in later years, the rules extend the period of review for relevant taxpayers to four years after the final date when financial benefits could be provided under the look-through earnout right. This includes where amendments have to be made for the application of any CGT small business concession.

Superannuation

Superannuation should not necessarily be viewed as a year-end planning matter, but rather as a long-term retirement savings approach. However, it is worth reflecting on the various concessions and deductions available under the superannuation system, which may impact on taxpayers’ tax position.

• STOP: Superannuation incentives continue to be a hot-button topic. Although the Government has been careful to neither confirm nor deny changes, tax advisers should stand ready to respond to any possible changes.

Areas for taxpayers to consider include:

• checking the individual’s age to identify the relevant contributions caps;
• investigating or reviewing superannuation salary sacrifice arrangements;
• responding to changes in personal circumstances, such as pay rises or extended time off work, that would alter the amount of concessional contributions made;
• making additional after-tax non-concessional contributions;
• triggering the bring-forward provisions of the non-concessional contributions cap;
• identifying concessional contributions relating to multiple jobs;
• (if the person has a spouse) making a contribution on behalf of their spouse;
• checking eligibility for the Government’s co-contribution scheme;
• (if the person has multiple funds) reviewing reasons for having more than one superannuation fund;
• checking the amount of employer-paid costs, such as insurance premiums, as they may count toward the concessional contributions cap.

Timing of contributions

A contribution is considered to be “made” by a taxpayer or an employer when a cheque, or an amount of cash, is “received” by the trustee of a superannuation fund or RSA, except in the case of a post-dated or dishonoured cheque. According to Taxation Ruling TR 2010/1, a contribution by electronic funds transfer (EFT) is not made until an amount is credited to the fund’s bank account.

TIP: Individuals who wish to take advantage of the concessionally taxed superannuation environment while staying under the relevant contributions caps should keep track of their contributions and avoid making last-minute contributions that would be allocated to the next financial year. However, if individuals decide to make a payment before 30 June, they should allow for possible delays and ensure that the fund will receive the amounts on time. For example, funds paid by electronic funds transfer on 30 June may not be received by the fund until the next day (ie 1 July). Using other payment options (eg via mailed cheque or via a clearing house) may cause additional delays.

TIP: Individuals with salary sacrifice arrangements for superannuation may want to have early discussions with their employers to ensure their contributions are allocated to the correct financial year.

Types of contributions and annual contribution caps

Superannuation contributions are classified as either “concessional” or “non-concessional”. The following table summarises the types of contributions and annual contribution caps.

 

 

Type of contribution1, 2, 3	Annual contribution cap 2014–2015, 2015–2016 and 2016–2017 ($) 5, 6
Concessional – under age 50	$30,000
Concessional – age 50+	$35,000
Non-concessional	$180,000
Non-concessional (three-year)4	$540,000
1. Concessional contributions are essentially contributions made by or in respect of an individual for a financial year that are included in the assessable income of the complying super provider, eg employer contributions for superannuation guarantee purposes, salary sacrifice contributions, deductible personal contributions covered by a valid s 290-170 notice. 2. Non-concessional contributions essentially include contributions made by or in respect of an individual that are not included in the assessable income of a super provider, eg personal contributions made from the member’s after-tax income. There are several specific inclusions (eg excess concessional contributions) and exclusions (eg government co-contributions and proceeds from the disposal of assets that qualify for the small business CGT exemptions up to the lifetime CGT cap of $1.395 million for 2015–2016 and $1.415 million for 2016–2017). 3. If a member’s TFN has not been quoted to a super fund by 30 June each year, this “no-TFN contributions income” is taxed at 49% in the hands of the receiving fund. A super fund must return non-concessional contributions within 30 days where the member has not quoted a TFN. 4. The non-concessional contributions cap is indexed to $180,000 from 2014–2015. Individuals under 65 may bring forward the non-concessional cap for the next two years (ie $540,000 over three years from 2014–2015). 5. The concessional contributions cap is indexed to $30,000 from 2014–2015 (but only increases in $5,000 increments). The cap for 2016–2017 is unchanged at $30,000. 6. A $35,000 concessional contributions cap applies from 2014–2015 for those who are 49 years or over on 30 June for the previous income year. A $35,000 concessional cap applied for 2013–2014 for those who were 59 years or over on 30 June 2013.

Excess contributions

Contributions above the annual contributions caps may be subject to excess contributions tax levied on the individual, who can withdraw an amount from their superannuation fund to meet the excess contributions tax liability. From 1 July 2013, excess concessional contributions tax has been abolished. Instead, excess concessional contributions are included in an individual’s assessable income from the 2013–2014 income year (and subject to an interest charge). Excess non-concessional contributions tax continues to apply where relevant. The excess non-concessional contributions tax rate is generally the top personal rate plus Medicare levy (ie 49% for 2014–2015, 2015–2016 and 2016–2017). Individuals have the option of withdrawing from their superannuation fund any excess non-concessional contributions made from 1 July 2013 (plus 85% of the associated earnings).

Extra 15% Division 293 tax for higher income earners

From the 2012–2013 income year, individuals above a “high income threshold” of $300,000 are subject to an additional 15% “Division 293 tax” on their “low tax contributions” (essentially concessional contributions). As a result, the effective contributions tax has been doubled from 15% to 30% for certain concessional contributions (up to the concessional cap) for “very high income earners” with income (plus the relevant concessional contributions) above the $300,000 threshold.

TIP: Despite the extra 15% tax on concessional contributions for individuals with incomes above $300,000, there is still an effective tax concession of 15% (ie the top marginal rate – excluding the 2% temporary budget deficit levy – less 30%) on their concessional contributions up to the cap of $30,000 for 2015–2016 and 2016–2017 (or $35,000 for those 50 or over). Nevertheless, taxpayers who exceed the $300,000 high income threshold should review their superannuation contributions and salary sacrificing arrangements to take into account any impact of the additional 15% Division 293 tax.

 

 

ATO administrative penalties for SMSF trustees

Trustees of self managed superannuation funds (SMSFs) should be aware of ATO powers to impose administrative directions and penalties for certain super law contraventions. The Commissioner can give rectification directions, such as a direction that a trustee ensures that the fund begins complying with the relevant legislation, and education directions to ensure that a trustee’s knowledge of the relevant legislation comes up to the requisite standard. The Commissioner can also impose administrative penalties on SMSF trustees for certain contraventions of the superannuation law.

SMSFs and collectables: compliance deadline looming

The ATO has reminded trustees that if their SMSFs have investments in collectables or personal-use assets that were acquired before 1 July 2011, time is running out to ensure the SMSFs meet the superannuation law requirements for these assets. From 1 July 2011, investments in collectables and personal-use assets have been subject to strict rules under the superannuation law.

Assets considered collectables and personal-use assets include items like artwork, jewellery, antiques, vehicles, boats and wine. Investments in such items must be made for genuine retirement purposes and not provide any present-day benefit. Investments held before 1 July 2011 must comply with the rules by 1 July 2016. The ATO has said that SMSFs trustees need to consider what actions are appropriate. Action may include reviewing current leasing agreements, making decisions about storage and arranging insurance cover.

SMSFs and related party LRBAs

The ATO has issued Practical Compliance Guideline PCG 2016/5 setting out the Commissioner’s “safe harbour” terms on which SMSF trustees may structure related-party limited recourse borrowing arrangements (LRBAs) consistent with an arm’s-length dealing. The ATO generally takes the view that an SMSF may derive non-arm’s length income (taxable at 47%) if the terms of an LRBA are not consistent with an arm’s-length dealing: see ATO IDs 2015/27-28. If an LRBA is structured in accordance with PCG 2016/5, the ATO accepts that the non-arm’s length income rules will not apply.

Superannuation splitting

A member of an accumulation fund (or a member whose benefits include an accumulation interest in a defined benefit fund) can split with their spouse superannuation contributions made from 1 January 2006. The spouse contributions splitting regime also covers employer contributions to untaxed superannuation schemes and exempt public sector superannuation schemes.

While the relevance of spouse contribution splitting has been reduced with the abolition of reasonable benefit limits and end benefits tax for those aged 60 years and over, splitting contributions between spouses can still be a useful strategy to effectively transfer concessional contributions to the spouse who will reach age 60 (and attain tax-free benefit status) first. In addition, contributions splitting may be relevant to access two low rate cap thresholds for superannuation benefits taken before age 60. However, it is not possible to split “untaxed splittable contributions” (eg non-concessional contributions) made after 5 April 2007.

• STOP: Importantly, it is not mandatory for a superannuation fund to offer a contributions-splitting service for its members. However, a trustee that accepts a valid application must roll over, transfer or allot the amount of benefits in favour of the receiving spouse within 30 days after receiving the application.

Low income superannuation contribution

Until the 2016–2017 income year, the Government will make a low income superannuation contribution (LISC) of up to $500 for individuals with an adjusted taxable income (ATI) that does not exceed $37,000.

• STOP: Payment of LISC will cease in respect of concessional contributions made on or after 1 July 2017. While LISC will continue to be payable in respect of concessional contributions made up to and including the 2016–2017 income year, the ATO has noted that determinations of LISC will cease at 30 June 2019.

Government co-contribution

Certain low income earners (including self-employed persons) may qualify for a government superannuation co-contribution payment. This is available where an individual makes eligible personal superannuation contributions during an income year and the individual’s income does not exceed the relevant total income thresholds. For 2015–2016, the lower income threshold is $35,454 (phasing down for incomes up to $50,454). For 2016–2017, the lower income threshold is $36,021 (phasing down for incomes up to $51,021). That is, a government co-contribution up to a maximum of $500 per annum is available for a $1,000 eligible personal superannuation contribution during an income year for those under the lower income threshold. The amount of the government co-contribution reduces with increasing income, and is not available when the individual exceeds the upper income threshold.

Lost superannuation transfers to ATO

Trustees of regulated superannuation funds are required to report details about small accounts of lost members, and inactive accounts of unidentifiable lost members, and pay these amounts to the ATO. The account balance threshold below which accounts of “lost members” must be transferred to the ATO has been increased to $4,000 from 31 December 2015 (and will increase to again to $6,000 from 31 December 2016). In addition, the period of inactivity before “inactive accounts” of unidentifiable members must be transferred to the ATO is 12 months.

TIP: Fund members whose benefits have been treated as unclaimed money may request that the Commissioner pay the amount to a single complying fund. If the amount is less than $200, the Commissioner can pay the amount tax-free to the person. The Commissioner will pay interest (generally at the 10-year Treasury bond rate) on payments of unclaimed superannuation money.

Spouse contributions tax offset

A tax offset of up to $540 is available under s 290-230 of ITAA 1997 for resident taxpayers who make eligible contributions to a complying superannuation fund or an RSA for the purpose of providing superannuation benefits for their low-income or non-working resident spouse (including a de facto spouse).

• STOP: The assessable income, reportable fringe benefits and reportable employer superannuation contributions of the spouse must be less than $10,801 in total to obtain the maximum tax offset of $540, and less than $13,800 to obtain a partial tax offset. The entitlement to the offset is also subject to certain restrictions.

Transition to retirement pensions

A member of a regulated superannuation fund who has reached their preservation age (currently age 55) can access their superannuation benefits as a non-commutable income stream without needing to retire. As a result, workers have the option of retaining a connection with the workforce, rather than being forced to retire early simply to gain access to their superannuation.

Upon the taxpayer attaining preservation age, this limited condition of release (also referred to as a “transition to retirement pension” or “pre-retirement pension”) allows superannuation benefits to be accessed through the existing range of non-commutable income streams. Importantly, eligibility for this condition of release is not subject to a work test (ie part-time and full-time employees qualify).

The minimum pension standards apply to transition to retirement pensions for persons who have reached their preservation age. However, transition to retirement pensions have a maximum annual payment limit of 10% of the account balance at the start of each financial year. Note that the Commissioner’s administrative policy to allow a superannuation income stream to continue despite a failure to meet the minimum pension standards from 1 July 2007 may apply to transition to retirement pensions in respect of breaches of the “minimum” payments (but not the maximum 10% limit). (See Minimum payment rules on page 25.)

The category of “transition to retirement income stream” or “non-commutable allocated pension or annuity” cannot be cashed or commuted to a lump sum while the person is still working, unless they have satisfied a condition of release with a “nil” cashing restriction (eg permanent retirement from the workforce or reaching age 65).

Note that it is not compulsory for superannuation funds to offer their members these non-commutable income streams. Furthermore, the fund’s trust deed must allow access to benefits when a member reaches preservation age, without needing to retire, and must allow the payment of a non-commutable complying or allocated pension.

• STOP: It will not be possible to receive a pension (including a transition to retirement pension) from a MySuper product from 1 July 2013. MySuper members will need to switch to a separate choice product before commencing a transition to retirement pension.

Tax treatment of transition to retirement pensions

A pension paid from a taxed source to a person aged 60 years or over is totally tax free (ie not assessable and not exempt income). As such, it is not counted when working out the tax payable on any other assessable income of the taxpayer.

For a pension paid to a person under age 60, the “taxable component” of the pension paid from a taxed source is included in the person’s assessable income. A taxpayer above his or her preservation age (but below age 60) is entitled to a 15% tax offset in respect of the taxable component of the pension. Any tax-free component of a pension paid from a taxed source is tax free, regardless of the pension recipient’s age. Once the pension recipient reaches 60 years, their pension is received tax-free.

Transition to retirement pensions and salary sacrifice strategies

The availability of transition to retirement pensions has brought to light various tax-effective strategies. A taxpayer who is above preservation age can draw down their superannuation via a transition to retirement pension while at the same time salary-sacrificing employment income back into retirement savings.

Instead of being taxed as employment income at the taxpayer’s marginal rate, the salary-sacrificed contributions are only taxed at the rate of 15% on entry into the superannuation fund. However, the annual concessional contributions cap effectively restricts the amount available for salary sacrificing. (See Types of contributions and annual contribution caps on page 20.)

Note that the effective contributions tax has been doubled from 15% to 30% for certain concessional contributions for those above the $300,000 income threshold. Taxpayers whose income exceeds this threshold should review their superannuation contributions and salary-sacrifice arrangements to take into account any impact of the additional 15% tax. (See Extra 15% Division 293 tax for higher income earners on page 21.)

To access income to live on, the person can access their superannuation via a non-commutable income stream (eg a transition to retirement pension). A pension paid to a person aged 60 years or over is totally tax-free. A pension paid to a person under age 60 but above preservation age is included in their assessable income, but a 15% tax offset applies in respect of the taxable component of the pension.

While this strategy results in less overall tax payable on the pension income (compared with employment income), the greatest advantage from converting employment income to pension income is the income tax exemption available to the superannuation fund in respect of income derived from assets that are set aside to support the fund’s current pension liabilities.

• STOP: The advantages of such a strategy depend on the individual’s particular circumstances, especially the individual’s marginal tax rate and whether increasing the salary sacrifice amounts will drop the individual into a lower tax bracket.
• STOP: Any salary sacrifice arrangement must strictly comply with Taxation Ruling TR 2001/10.

Simplified pension rules: minimum standards

Minimum standards apply for private superannuation pensions and annuities under the SIS Regulations. All pensions and annuities that meet the simplified minimum standards are taxed the same on payment. Earnings on assets supporting these pensions remain tax-exempt. Existing allocated pensions and annuities can also operate under the minimum payment rules.

Under the standards set out in subregs 1.05(11A), 1.06(9A) and Sch 7 of the SIS Regulations, pensions and annuities effectively fall into two classes:

• account-based income streams –where there is an account balance attributable to the recipient; and
• non-account based income streams – where there is no attributable balance (eg traditional lifetime and life expectancy income streams generally offered by life insurance companies); however, this category can no longer commence from an SMSF.

Broadly, the minimum standards for account-based pensions and annuities require:

• payments of a minimum amount to be made at least annually, allowing pensioners to take out as much as they wish above the minimum (including cashing out the whole amount): SIS reg 1.07D;
• no provision to be made for an amount to be left over when the pension ceases; and
• that the pension can be transferred only on the death of the pensioner (primary or reversionary, as the case may be) to one of their dependants or cashed as a lump sum to the pensioner’s estate.

The deeming rules in the Social Security Act 1991 have been extended to superannuation account-based income streams for the purposes of the pension income test, to ensure that all financial investments are assessed under the same rules from 1 January 2015. Products held by pensioners before 1 January 2015 are grandfathered provided that such pre-1 January 2015 income support continues uninterrupted from that day. Similarly, another amending Act applies the deeming rules to untaxed superannuation income streams for the purposes of the income test for the Commonwealth Seniors Health Card (CSHC) from 1 January 2015. The CSHC income threshold is $52,273 for singles (and $83,636 for couples) from 20 September 2015. For people who have continuously held a CSHC from before 1 January 2015, account-based pensions and annuities in place before 1 January 2015 are grandfathered under the original rules. Therefore, advisers need to consider the implications of disrupting established pre-1 January 2015 account-based pensions after 31 December 2014 and potentially triggering the new social security deeming rules.

• STOP: From 1 January 2016, a 10% cap applies to the “deductible amount” of income streams received by members of defined benefit superannuation schemes (excluding military superannuation schemes) for social security purposes: Social Services Legislation Amendment (Defined Benefit Income Streams) Act 2015.

Minimum payment rules

Account-based pensions and annuities must meet the minimum payment rules set down in Sch 7 of the SIS Regulations. The payment rules specify minimum annual limits only. From 2013–2014, the minimum draw-down amounts are calculated according to the standard percentage factors in Sch 7 to the SIS Regulations.

Minimum annual draw-down factors
Age of beneficiary (years)	Minimum annual draw down for 2013–2014 + (%)
0–64	4
65–74	5
75–79	6
80–84	7
85–89	9
90–94	11
95+	14

Personal services income

Broadly, the personal services income (PSI) rules attribute income derived by an interposed entity to the individual providing services to the entity. This is achieved by “forcing” individuals to include the income generated by their personal skill or efforts in their personal tax returns. The deductions of a taxpayer who receives PSI are, generally, limited to the amount that they would be entitled to deduct if they had received the income as an employee.

However, the PSI rules do not apply to individuals or interposed entities if one of the required personal services business (PSB) tests (results test, unrelated clients test, employment test and business premises test) is satisfied. The primary test to be applied is the results test. If this test is met, there is no further requirement to self-assess against the other tests and the PSI rules do not apply. Taxation Ruling TR 2001/8 provides the ATO’s interpretation of the results test. The ruling states that the results test is based on the traditional criteria for distinguishing independent contractors from employees.

In addition, the Commissioner has the power to grant a determination, which has the effect of exempting an individual or a personal services entity from the PSI regime. Generally, a determination will be granted if unusual circumstances existed that prevented the business from satisfying the tests, or if the business would have had, but for the unusual circumstances, two or more unrelated clients in the current income year.

• STOP: If a taxpayer fails the results test and the 80% rule in an income year, the taxpayer is not permitted to self-assess against the remaining tests. The PSI rules will apply unless a PSB determination is obtained from the ATO.

Fringe benefits tax

FBT rate

The FBT rate has increased to 49% for the FBT years ending 31 March 2016 and 31 March 2017. As a result, the gross-up rates have also increased for those years:

• the type 1 aggregate fringe benefits amount is 2.1463 (previously 2.0802); and
• the type 2 aggregate fringe benefits amount is 1.9608 (previously 1.8868).

The FBT rate will return to 47% for the FBT year ending 31 March 2018. The gross-up rates will also return to 2.0802 and 1.8868, respectively, for that year.

Car fringe benefits

Rules for car expense deductions

The rules for individuals claiming car expense deductions have changed. The “12% of original value” method and the “one–third of actual expenses” method are no long available. As a result, if employers reimburse expenses relating to an employee’s use of their own car, only two methods are available for calculating the taxable value of this fringe benefit (when employers apply the “otherwise deductible rule”). The two methods are the “logbook” method and the “cents per kilometre” method. The cents per kilometre method has also been amended. It now only provides for a single rate of deduction, set by the Commissioner. The rate for the 2015–2016 income year is 66 cents per kilometre. The changes apply from 1 April 2016 and later FBT years.

• STOP: The ATO has updated information about use of the cents per kilometre method for claiming car expenses and for fringe benefits calculations. The ATO acknowledges there has been uncertainty about the correct rate to apply for the 2016 FBT year. Therefore, a special arrangement exists for 2016 whereby the ATO will also accept 2016 FBT returns based on the 2014–2015 rates (65, 76 or 77 cents per kilometre, depending on the engine capacity of the employee’s car). For future FBT years (ending on 31 March), the ATO says employers should use the rate determined by the Commissioner for the income year (ending on the following 30 June). For example, for the FBT year ending 31 March 2017, employers should use the basic car rate determined by the Commissioner for the 2016–2017 income year. See the ATO’s statement, available online at https://www.ato.gov.au/Business/Income-and-deductions-for-business/Business-travel-expenses/Motor-vehicle-expenses/Calculating-your-deduction/Cents-per-kilometre/
• STOP: The changes to the rules for individuals claiming car expense deductions also affect employers who pay car allowances. Employers now need to withhold tax if the car allowance exceeds 66 cents per kilometre.

Statutory formula: 20% flat rate

The four rates used in the statutory formula method for determining the taxable value of car fringe benefits have been replaced with a single statutory rate of 20% for fringe benefits. There has been a three-year phase-in period.

For those with pre-existing commitments (contracts entered into up to 10 May 2011) that are financially binding on one or more of the parties, the old statutory rates continue to apply. However, where there is a change to pre-existing commitments, the new rates apply from the start of the following FBT year. Changes to pre-existing commitments include refinancing a car and altering the duration of an existing contract. Changing employers will cause the new rates to apply immediately for the new employer.

• STOP: From the 2014–2015 FBT year, the FBT statutory rate is 20% no matter how far the car is driven.
• STOP: An employer can choose to skip the transitional arrangements and directly use the flat 20% rate, but only with the consent of any employees who would be worse off as a result of the employer making that choice. The way an employer’s return for the relevant FBT year is prepared will be sufficient evidence of the making of the choice.

Salary packaged entertainment benefits

The Fringe Benefits Tax Assessment Act 1986 has been amended to introduce a separate gross-up cap of $5,000 for salary sacrificed meal entertainment and entertainment facility leasing expenses for certain employees of not-for-profit organisations. Any meal entertainment benefits that exceed the gross-up cap may be considered in calculating whether an employee exceeds their FBT exemption or rebate cap. In addition, all salary packaged meal entertainment and entertainment facility leasing expense benefits will become reportable and included in an employee’s payment summary.

The amendments also remove access to elective valuation rules when valuing salary packaged entertainment benefits. This means employers will no longer be able to calculate the taxable value of salary packaged meal entertainment benefits under the “12-week register” method or “50/50 split” method. Similarly, salary packaged entertainment facility leasing expense benefits cannot be valued under the 50/50 method. The amendments will apply from the 2016–2017 FBT year and for all subsequent FBT years.

Portable electronic devices

The Fringe Benefits Tax Assessment Act 1986 and has been amended so that the FBT exemption applies to employees with more than one work-related electronic device. In order to be eligible for the extended exemption, an employer must be a small business entity (see Small business entities on page 16) for the FBT year which the portable electronic device was provided.

The usual work-related use test still applies to portable electronic devices provided to an employee. An item is primarily for use in an employee’s employment if it is provided principally to enable the employee to do their job. This is referred to as the ”work-related use test”. Determining whether an item is primarily for use in an employee’s employment is a decision based on the employee’s intended use at the time the benefit is provided to them. The changes will apply for the 2016–2017 FBT year and later FBT years.

“Fly-in, fly-out” employees

The “otherwise deductible rule” was applied in John Holland Group Pty Ltd v FCT [2015] FCAFC 82 to reduce to nil the taxable value of residual fringe benefits that consisted of the taxpayer paying for “fly-in, fly-out” employees to fly from Perth to Geraldton and back. The Full Federal Court held that if the employees had incurred the costs, they would have been entitled to income tax deductions for those costs.

Individuals

Tax-free threshold

For the 2015–2016 income year, the general tax-free threshold available to Australian resident taxpayers is $18,200. The tax-free threshold does not apply to foreign residents. The tax-free threshold has to be apportioned if a taxpayer becomes an Australian resident, or ceases to be an Australian resident, during the income year.

Tax offsets

A “tax offset” reduces a taxpayer’s basic income tax liability.

Dependent (invalid and carer) offset

A taxpayer may be entitled to the dependant (invalid and carer) offset (DICTO) under Subdiv 61-A ITAA 1997 if they contributed to the maintenance of an eligible dependant: s 61-10(1). There is an income test which must be satisfied before a taxpayer is entitled to DICTO. The maximum amount of DICTO for 2015–2016 is $2,588. It is indexed annually in accordance with Subdiv 960: s 61-30.

Low income offset

Certain low income taxpayers are entitled to an offset under s 159N ITAA 1936. The maximum offset for 2015–2016 is $445. The offset phases out at the rate of 1.5 cents for every dollar by which taxable income exceeds $37,000 (the phase-out threshold). This means that the offset ceases to be available once taxable income reaches $66,667 (the phase-out limit).

Medical expenses offset

A resident taxpayer who during the income year pays net medical expenses for themselves or for a resident dependant is entitled to an offset under s 159P ITAA 1936 (commonly called the net medical expenses tax offset). The medical expenses offset is being phased out and will no longer be available after 2018–2019. There are specific transitional arrangements.

Private health insurance offset

A tax offset is available (under Subdiv 61-G of ITAA 1997) to individual taxpayers and some trustees in respect of private health insurance premiums, including if the premiums are paid by an individual’s employer as a fringe benefit. The private health insurance offset has been means tested since 1 July 2012. There are three private health insurance incentive tiers.

Travellers with student debts

Australians who have student debts and are travelling overseas or living overseas will soon have the same repayment obligations as people who are still living in Australia. These overseas Australians need to register their contact details with the ATO. Repayment obligations will commence from 1 July 2017 (for income earned in the 2016–2017 financial year).

 

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CURRENCY:

This issue of Client Alert takes into account all developments up to and including 16 March 2016.

Deadline looming for SMSF collectables compliance

From 1 July 2011, self managed superannuation fund (SMSF) investments in collectables and personal-use assets have been subject to strict rules under Superannuation Industry (Supervision) Regulation (SIS Regulation) 13.18AA.

The ATO has reminded trustees of SMSFs that acquired such collectables or personal-use assets before 1 July 2011 that time is running out to ensure they meet the SIS Regulation requirements. Assets considered collectables and personal-use assets include artwork, jewellery, antiques, vehicles, boats and wine.

Investments in such items must be made for genuine retirement purposes and must not provide any present-day benefit. Under the rules:

• items cannot be leased to or used by a related party;
• items cannot be stored or displayed in a private residence of a related party;
• decisions about storage must be documented and the written records kept; and
• items must be insured in the fund’s name within seven days of their acquisition.

In addition, if an item is transferred to a related party, a qualified independent valuation is required.

For investments held before 1 July 2011, SMSF trustees have until 1 July 2016 to comply with the rules. The ATO said trustees need to consider what actions are appropriate. Actions may include reviewing current leasing agreements, making decisions about storage and arranging insurance cover.

Trustees disposing of a collectable or personal-use asset can transfer it to a related party without a qualified independent valuation, but only if the transfer takes place before 1 July 2016 and the transaction is made on arm’s-length terms.

As trustees have had since July 2011 to make appropriate arrangements, the ATO expects that they will ensure their SMSFs meet the requirements before the deadline.

Source: ATO media release, “Collectables – don’t leave it too late!”, 3 March 2016, https://www.ato.gov.au/Super/Self-managed-super-funds/In-detail/News/Collectables—don-t-leave-it-too-late/.

Overseas student debts: repayment thresholds

From 1 July 2017, anyone with a Higher Education Loan Programme (HELP) debt and/or a Trade Support Loans (TSL) debt who is living overseas and earning above the minimum repayment threshold will be required to make loan repayments, just as they would if they were living in Australia.

Repayment income and rates

A notice has been gazetted specifying the HELP repayment incomes and rates for the 2016–2017 financial year. The details are displayed in the following table.

HELP repayment thresholds and rates 2016–2017
For repayment income in the range	Percentage rate to be applied to repayment income
Below $54,870	Nil
$54,870 to $61,120	4%
$61,121 to $67,369	4.5%
$67,370 to $70,910	5%
$70,911 to $76,223	5.5%
$76,224 to $82,551	6%
$82,552 to $86,895	6.5%
$86,896 to $95,627	7%
$95,628 to $101,900	7.5%
$101,901 and above	8%

Source: Commonwealth Gazette, “Notification of repayment incomes and repayment rates for the Higher Education Loan Program (HELP) for the 2016-17 income year”, 1 March 2016 https://www.legislation.gov.au/Details/C2016G00298

ATO data-matching for insured “lifestyle” assets

In January 2016, the ATO advised it was working with insurance providers to identify policy owners on a wider range of asset classes, including marine vessels; aircraft; enthusiast motor vehicles; fine art; and thoroughbred horses.

The ATO has since gazetted a notice formally announcing the data-matching program. The ATO will acquire details of insurance policies for these assets where the value exceeds nominated thresholds for the 2013–2014 and 2014–2015 financial years. The asset thresholds are as follows:

• marine vessels: $100,000;
• aircraft: $150,000;
• enthusiast motor vehicles: $50,000;
• fine art: $100,000 per item; and
• thoroughbred horses: $65,000.

The ATO will obtain policyholder identification details (including names, addresses, phone numbers and dates of birth) and insurance policy details (including policy numbers, start and end dates, assets insured and physical locations of the assets). The data-matching program will assist the ATO with:

• profiling taxpayers (providing a more comprehensive view of a taxpayer’s accumulated wealth);
• identifying possible compliance issues; for example:
• asset betterment – taxpayers may be accumulating or improving assets but not including sufficient income in their taxation returns to show the financial means to pay for them;
• income tax and capital gains – taxpayers may be disposing of assets and not declaring the revenue and/or capital gains on those disposals;
• goods and services tax (GST) – taxpayers may be purchasing assets for personal use through businesses or related entities and claiming input tax credits they are not entitled to;
• fringe benefits tax (FBT) – taxpayers may be purchasing assets through their business entities, but applying those assets to the personal enjoyment of an associate or employee, which gives rise to an FBT liability; and
• superannuation – self managed superannuation funds (SMSFs) may be acquiring assets but applying them to the benefit of the fund’s trustee or beneficiaries; and
• identifying avenues available to assist in debt management activities.

It is estimated that records of more than 100,000 insurance policies will be obtained. Further details, including the list of insurers participating in the data-matching program, are available on the ATO website at https://www.ato.gov.au/General/Gen/Lifestyle-Assets-Data-Matching-Program-Protocol/.

Source: Commonwealth Gazette, “Notice of Data Matching Program – Lifestyle Assets”, 16 February 2016, https://www.legislation.gov.au/Details/C2016G00243.

Market value of shares is not the selling price

In a noteworthy decision, the AAT has ruled that the “market value” of a parcel of shares in a private company that a taxpayer sold in an arm’s-length transaction (together with the other two shareholders’ shares in the company) was not his proportion of the sale price received from the sale of all the shares, but a discounted amount. This caters for the fact that the market value of his shares alone as a “non-controlling” shareholder was a lesser amount. As a result, the taxpayer passed the $6 million “maximum net asset value” (MNAV) test for the purposes of qualifying for the capital gains tax (CGT) small business concessions, where otherwise he would not have.

Background

The taxpayer was one of three equal shareholders in a private company. The three shareholders sold their shares in the company for $17.7 million under a contract of sale to an arm’s-length purchaser. The taxpayer was entitled to $5.9 million in respect of his one-third shareholding in the company. The issue for the AAT’s consideration was whether the taxpayer passed the $6 million MNAV test. Taken together with the market value of the taxpayer’s other assets, a market value of $5.9 million for the shares sold would mean the taxpayer failed the test.

The taxpayer drew the AAT’s attention to the established test in Spencer v The Commonwealth [1907] HCA 82; (1907) 5 CLR 418 for determining the market value of an asset – namely, what “willing but not anxious parties” would be prepared to buy and sell the assets for. He argued that the market value of his shares was not necessarily equal to the amount paid by the arm’s-length purchaser in his case, but was something less. The Commissioner, on the other hand, essentially argued that in an arm’s-length transaction the market value of an asset was its selling price.

Decision

The AAT first noted that it is often the case, but not always, that the actual selling price of an asset at a particular time represents its “market value” just before that time. Therefore, it would be entirely “uncontroversial” to find that the market value of an asset in an arm’s-length transaction is its actual selling price – provided that the parties were “willing and not anxious” and the subject matter of the contract was identical to the property whose “market value” needed to be determined.

However, the AAT found that was not true in this case, as the subject matter of the sale agreement was the entire 300 shares in the company, giving the buyer “complete control of the company, which the sale of [the taxpayer’s] shares alone would not have done”. The AAT recognised the relative lack of control enjoyed by the taxpayer as a result of his owning only one-third of the total shares in the company, and therefore agreed with his valuer’s application of a discount to the taxpayer’s one-third share of the total capital proceeds received for the sale of all the shares.

As a result, the AAT ruled that “the correct enquiry is directed towards determining the market value of the taxpayer’s shares alone – not as part of a package comprising the entire 300 shares in the company”. It found that the consideration the taxpayer received for his shares was more than a hypothetical “willing but not anxious” purchaser would have paid if purchasing the taxpayer’s shares alone.

The AAT concluded that the actual consideration the taxpayer received should not be ignored as an indicator of the market value of his shares just before the time of the CGT event, but it was not determinative of that market value. In these circumstances, the AAT agreed that the market value of the taxpayer’s shares was $5.9 million less a 16.7% discount for the “lack of control” factor. This decision meant that the taxpayer passed the $6 million MNAV test for the purposes of qualifying for the CGT small business concessions, where otherwise he would not have.

Appeal

The Commissioner has appealed to the Federal Court against this AAT decision.

Re Miley and FCT [2016] AATA 73, AAT, File No 2013/6008, 2013/6009, Frost DP, 15 February 2016, http://www.austlii.edu.au/au/cases/cth/AATA/2016/73.html.

Individual not a share trader

The AAT has found that a taxpayer was not carrying on a business of share trading, and accordingly was not entitled to claim a loss resulting from her share transactions.

Background

The taxpayer, a childcare worker, began trading shares during the 2011 income year. She incurred a $20,000 loss for the income year, which she sought to claim as a deduction. As a childcare worker, the taxpayer earned around $40,000 in the 2011 income year. In contrast, she turned over approximately $600,000 in share transactions (including both purchases and sales) for that income year.

The taxpayer told the Commissioner that she usually spent five to 10 hours per week conducting research and share trading, although she later altered this information, saying it was approximately 15 to 25 hours weekly. The taxpayer’s oral evidence before the AAT demonstrated that she had very little knowledge of the companies she had invested in, as she was unable to list many of the names of the “blue chip” companies in which she had purchased shares or to recall what industries they operated in. Furthermore, the AAT noted that the single-paged business plan the taxpayer produced (which was not previously shown to the Commissioner) was written for the tribunal proceedings and did not exist in the 2011 income year.

Decision

In deciding that the taxpayer was a share investor and not a share trader, the AAT considered each of the key indicators established in case law, in particular those listed in AAT Case 6297 (1990) 21 ATR 3747. The AAT decided that a lack of regular and systematic trade, especially in the second half of the 2011 income year – when only 10 transactions were made – went against the taxpayer’s contention that she was conducting a share trading business.

It was more likely, the AAT said, that the taxpayer was only spending the originally purported five hours per week on researching and trading stock. Furthermore, the AAT found that the taxpayer’s methods of research (eg reading financial newspapers) lacked the “sophistication to constitute a share trading business”. In particular, the taxpayer lacked the knowledge and experience to trade in shares, and was likely relying on her husband’s advice. While the AAT did concede that the capital involved in the taxpayer’s transactions was substantial, it noted that this could indicate either share investment or a business of share trading. Accordingly, as the relevant factors weighed against the taxpayer, the AAT affirmed the Commissioner’s decision to treat her as a share investor and to deny a deduction for her losses.

Re Devi and FCT [2016] AATA 67, AAT, File No 2014/4297, Lazanas SM, 9 February 2016, http://www.austlii.edu.au/au/cases/cth/AATA/2016/67.html.

Small business restructures made easier

The Tax Laws Amendment (Small Business Restructure Roll-over) Act 2016, passed on 8 March 2016, amends ITAA 1997 to provide an optional rollover for small business owners who change the legal structure of their business on the transfer of business assets from one entity to another (new Subdiv 328-G). The effect of the rollover is that the tax cost of transferred assets is rolled over from the transferor to the transferee.

This is in addition to existing rollovers which are available where an individual, trustee, or partner transfers assets to, or creates assets in, a company in the course of incorporating their business.

Eligibility

The new optional rollover will be available where a small business entity transfers an active asset of the business to another small business entity as part of a genuine business restructure, without changing the ultimate economic ownership of the asset.

The rollover applies to gains and losses arising from the transfer of active assets that are capital gains tax (CGT) assets, depreciating assets, trading stock or revenue assets between entities as part of a genuine restructure of an ongoing business.

Genuine restructure

The transfer of the assets must be part of a “genuine” restructure of an ongoing business (as opposed to an “inappropriately tax-driven scheme”).

Whether a restructure is “genuine” will be determined with regard to all of the facts and circumstances. Relevant matters include whether it is a bona fide commercial arrangement undertaken to enhance business efficiency, whether the transferred assets continue to be used in the business and whether the restructure is a preliminary step to facilitate the economic realisation of assets.

A “safe harbour” rule provides that the restructure is “genuine” for three years after the rollover if there is no change in the ultimate economic ownership of any of the significant assets of the business (other than trading stock); those significant assets continue to be active assets; and there is no significant or material use of those significant assets for private purposes.

Entities that can access the rollover

To be eligible for the rollover, each party to the transfer must be:

• a small business entity for the income year during which the transfer occurred;
• an entity that has an affiliate that is a small business entity for that income year;
• connected with an entity that is a small business entity for that income year; or
• a partner in a partnership that is a small business entity for that income year.

“Small business entity” takes its usual meaning, as defined in Subdiv 328-C of ITAA 1997.

The rollover also applies to “passively held” assets of a small business that may, for example, be held in an entity other than the one carrying on the business (eg an affiliate or a connected entity that is a small business entity).

Ultimate economic ownership

The transfer must not have the effect of changing the ultimate economic ownership of transferred assets in a material way. The ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset. Ultimate economic ownership of an asset can only be held by natural persons. Therefore, where a company, partnership or fixed trust owns an asset, the natural person owners of the interests in these interposed entities will ultimately benefit economically from that asset.

If more than one individual is an ultimate economic owner of an asset, there is an additional requirement that each of the individuals’ shares of that ultimate economic ownership be materially unchanged, maintaining the same proportionate ownership in the asset.

Discretionary trusts may be able to meet the requirements for ultimate economic ownership “on their facts”; for example, where there is no practical change in which individuals economically benefit from the assets before and after the rollover, there will not be a change in ultimate economic ownership on the facts.

Otherwise, a discretionary trust may meet an alternative ultimate economic ownership test, whereby every individual who had ultimate economic ownership of the transferred asset before the transfer and every individual who has ultimate economic ownership of the transferred asset after the transfer must be members of the family group relating to the family trust.

Eligible assets

Where a party to the transfer is itself a small business entity, the asset being transferred must be a CGT asset that is “active” (as defined in s 152-40).

Where a party to the transaction is an affiliate or connected entity with a small business entity, the asset must be an active asset that satisfies s 152-10(1A). Among other things, this requires that the relevant small business entity carries on business in relation to the asset.

Where a party to the transaction is not a small business entity, but is a partner in a partnership that is a small business entity, the asset must be an active asset and an interest in the asset of the partnership.

Other

Both the transferor and the transferee of the assets must be residents of Australia. The transferor and transferee must both choose to apply the rollover. The rollover will not apply for a transfer to or from an exempt entity or complying superannuation entity.

Effect of the roll-over

The rollover provides for tax-neutral consequences by “switching off” the application of the existing income tax law – but only for the purpose of the transfer, and not for the purposes of goods and services tax (GST), fringe benefits tax (FBT) or stamp duty.

The rollover provides that the transfer takes place for the asset’s “rollover cost” – which is the transferor’s cost of the asset for income tax purposes, such that the transfer would result in no gain or loss for the transferor. The transferee will be taken to have acquired each asset for an amount that equals the transferor’s cost just before the transfer.

CGT assets

For the transfer of a CGT asset, the tax law will apply under the rollover as if the asset had been transferred for an amount equal to the cost base of the asset. Further, pre-CGT assets transferred under the rollover will retain their pre-CGT status in the hands of the transferee.

In respect of the availability of the CGT discount to the transferee, the period of eligibility for the CGT discount will recommence from the time of the transfer.

Trading stock

Assets that are trading stock of the transferor will be held as trading stock by the transferee. The transferee will inherit the transferor’s cost and other attributes of the assets as the transferor just before the transfer.

To the extent that the asset is trading stock of the transferor, the rollover cost will be the cost of the item for the transferor at the time of the transfer; or, if the transferor held the item as trading stock at the start of the income year, the value of the item for the transferor at that time.

Revenue assets

The rollover cost is the amount that would result in the transferor not making a profit or loss on the transfer. The transferee will inherit the same cost attributes as the transferor just before the transfer.

Depreciating assets

Rollover relief will be available for depreciating assets (under s 40-340) where a rollover under the new measures would be available if the asset were not a depreciating asset. As a result, the transferee can deduct the decline in value of the depreciating asset using the same method and effective life as the transferor used.

Membership interests

Where membership interests are issued in consideration for the transfer of an asset, the cost base of those new membership interests is worked out based on the sum of the rollover costs and adjustable values of the rollover assets, less any liabilities that the transferee undertakes to discharge in respect of those assets, divided by the number of new membership interests.

The rollover does not require that market value consideration, or any consideration, be given in exchange for the transferred assets.

However, an integrity rule ensures that a capital loss on any direct or indirect membership interest in the transferor or transferee that is made subsequent to the rollover will be disregarded, except to the extent that the taxpayer can demonstrate that the loss is reasonably attributable to something other than the rollover transaction. This rule also applies where a transfer of value from an entity results in the creation of tax losses on later disposal of the membership interests.

It is important to note that in particular cases, restructuring to obtain timing advantages or other significant tax benefits in relation to membership interests and other interests in the entities involved in the transaction may mean that the “genuine “ restructure requirement is failed.

Small business concessions

Where the transferor has previously chosen to apply a small business rollover under Subdiv 152-E and a replacement asset is transferred under this rollover, the transferee is taken to have made the choice for the purposes of CGT events J2, J5 and J6.

For the purpose of determining eligibility for the 15-year CGT exemption for small businesses, the transferee will be taken as having acquired the asset when the transferor acquired it.

Date of effect

The amendments apply to:

• transfers of depreciating assets, where the balancing adjustment event arising from the transfer occurs on or after 1 July 2016;
• transfers of trading stock or revenue assets, where the transfer occurs on or after 1 July 2016; and
• transfers of CGT assets, where the CGT event arising from the transfer occurs on or after 1 July 2016.

Source: Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016, http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;page=0;query=BillId%3Ar5606%20Recstruct%3Abillhome.

Tax law changes to treatment of earnouts

The Tax and Superannuation Laws Amendment (2015 Measures No 6) Act 2016, passed on 25 February 2016, amends ITAA 1997 to change the capital gains tax (CGT) treatment of the sale and purchase of businesses involving certain earnout rights. As a result, capital gains and losses arising in respect of look-through earnout rights will be disregarded. Instead, payments received or paid under the earnout arrangements will affect the capital proceeds and cost base of the underlying asset or assets to which the earnout arrangement relates when they are received or paid (as the case may be).

The Act also amends the rules relating to amendments to assessments, interest charges, recognition of capital losses and access to CGT concessions. This is to ensure the new treatment provides taxpayers with outcomes consistent with those had the value of all of the financial benefits under the earnout right been included in the capital proceeds from the disposal of the underlying asset for the seller and the cost base of the underlying asset for the buyer at the time of the disposal.

Changes from the draft Bill

The Act as passed is essentially the same as the original draft legislation. However, the following changes are notable:

• Financial benefits must be provided within five years in order to qualify as an “eligible” earnout arrangement. This was extended from the four-year period in the draft.
• It was unclear under the draft legislation how the measures would interact with the rules for accessing the CGT small business concession via the maximum net asset value test and, in particular, whether this would be determined only at the time of disposal without regard to any future potential future financial benefits to be provided. However, under the Act, taxpayers can elect to take into account any future financial benefits for this purpose.
• The Act explains in detail how the earnout measures will interact with the new “foreign resident CGT withholding” measures (also introduced in the Act).

Look-through earnout rights

A look-through earnout right is a right to future financial benefits which are not reasonably ascertainable at the time the right is created. The right must be created under an arrangement involving the disposal of a CGT asset that is an  “active asset” of the seller, and the financial benefits under the right must be contingent on and reasonably related to the future economic performance of the asset (or a related business). As a result, a look-through earnout right must be created as part of an arrangement for a disposal of the business or its assets (ie the disposal must cause CGT event A1 to happen).

A right will also be a look-through earnout right if it is a right to receive financial benefits provided in exchange for ending a right that is a look-through earnout right.

For these purposes, an “active asset” is an asset of the taxpayer used in the taxpayer’s business or a “connected” or “affiliated” entity. The definition allows interests in foreign entities to be active assets for the purpose of this measure.

A membership interest in an Australian resident company or trust will also be an active asset if at least 80% of the assets of the company or trust (by value) are active assets. However, special rules apply in this case: if, for example, the sole asset of Company A is a share in Company B, which itself only holds a share in Company C, the character of interests in both A and B will depend on the character of the assets of C.

Further, in determining if such interests are active assets, the amendments provide that an eligible share or an interest in a trust is treated as an active asset in the hands of an entity for the purpose of determining if a look-through earnout right exists. For these purposes, the entity holding the share or interest must either:

• if they are an individual – be a CGT concession stakeholder in relation to the company or trust; or
• if they are not an individual – own a sufficient share of the business that they would be a CGT concession stakeholder were they an individual.

In addition, the trust or company must carry on a business and have done so for at least one prior income year, and at least 80% of the assessable income of the trust or company for the immediately preceding income year must have come from the carrying-on of a business (not derived as an annuity, interest, rent, royalties or foreign exchange gains, or derived from or in relation to financial instruments). Importantly, this test allows taxpayers to avoid having to value the assets of the trust or company. Instead, they need only look at how the trust or company earned its income over the past income year.

It is important to note that look-through earnout rights must be created as part of arrangements entered into on an arm’s-length basis. The look-through measures are not intended to provide tax benefits to temporary transfers (such as a loan or granting of a lease), ongoing business relationships (such as the purchase of an ownership interest) or complex financing arrangements where there is no final disposal of the underlying asset.

Contingent on the future economic performance of the asset

To be a look-through earnout right, the future financial benefits provided under that right must be linked to the future economic performance of the asset or a business in which the asset is used and not reasonably ascertainable at the time the right is created. Where the measure of performance relates to a business, there must be a reasonable belief at the time of disposal that the asset will actually be used in this business. In the case of the entity disposing of the asset, this will be based on what is reasonable given their knowledge of the intention of the other party.

Whether a particular measure appropriately identifies economic performance will depend on the context of the business or asset in question. Measures that may be appropriate include financial measures such as the profit, sales or turnover of the business (or the business in which the asset is used), and non-financial measures such as the number of clients retained. However, any measure adopted must be reasonable in the particular context. For a right to be a look-through earnout right, the value of the benefits must also reasonably relate to the performance.

Five-year payment limitation

For a right to be a look-through earnout right, it must not require financial benefits to be provided more than five years after the end of the income year in which the relevant CGT event occurs in relation to disposal of the relevant active asset. This ensures concessions for look-through earnout rights are not available to long-term profit-sharing arrangements and avoids providing an excessive and distorting benefit to look-through earnout rights.

However, this requirement is not breached simply because one party or another may be late in providing a financial benefit under the look-through right, even if the other party tolerates this lateness. It will also not be breached if the agreement includes provisions that allow for a delay in payment contingent on events, such as a dispute over the terms of the agreement being subject to a binding arbitration process. The relevant contingency must be outside the control of either party.

The five-year requirement will be breached if the agreement includes an option for the parties to extend the period over which financial benefits are provided, or to enter into a new agreement providing for continuation of substantially similar financial benefit. Further, the right will be taken to have never been a look-through earnout right if the parties vary the right to extend the period over which financial benefits are provided beyond five years or enter into a new agreement to create an equivalent right to further future financial benefits.

Consequences of a right being a look-through earnout right

If a right is a look-through earnout right, the value of the right is disregarded for the purposes of CGT, and the value of any financial benefits made or received under the right is included in either the capital proceeds arising from the disposal (for the seller) or the cost base of the acquisition (for the buyer). Accordingly, any capital gain or loss arising in respect of the creation or cessation of a look-through earnout right will be disregarded.

Similarly, the value of a look-through earnout right will not be taken into account in determining the capital proceeds of the disposal of the active asset for the seller, nor the cost base and reduced cost base of the asset acquired by the buyer. Instead, the value of any financial benefits subsequently provided or received under or in relation to such a right will be included in the original capital proceeds of the disposal for the related asset for the seller, or the initial cost base and reduced cost base of the asset for the buyer as at the date of the original acquisition.

However, where a taxpayer subsequently disposes of an asset that is subject to an ongoing look-through earnout right before their obligations or entitlements in relation to financial benefits under the right are exhausted, their cost base for the asset may change as a result of any subsequent financial benefits they pay or receive. In this situation, the taxpayer will need to adjust the capital gain or loss on that subsequent disposal.

Choices and timing

This treatment of earnout rights results in the amount of a capital gain or loss changing because of financial benefits provided or received in subsequent income years. A number of special rules are required to ensure that this does not disadvantage taxpayers or impose unnecessary compliance and administrative costs.

First, as the financial benefits may be provided up to five years after the end of the income year in which the CGT event occurred, the period of review for the income year in which the CGT event occurred may have passed before the taxpayer has provided or received the financial benefits requiring the amendment. Therefore, the period of review will be extended for all of a taxpayer’s tax-related liabilities that can be affected by the character of the look-through earnout right to the later of (a) the period of review that would normally apply and (b) four years after the end of the final income year in which financial benefits could be provided.

Importantly, this period of review extension includes liabilities in subsequent years for taxes other than income tax. For example, the small business CGT retirement concessions provide, broadly, that certain contributions to superannuation linked to capital gains arising from the sale of business assets do not count towards non-concessional superannuation contribution caps. If the amount of the relevant gain for a taxpayer changes as a result of the financial benefits provided under an earnout right, the extended amendment period would apply to the assessment of the taxpayer’s non-concessional contributions.

This extension also applies to a taxpayer’s right to object where they are dissatisfied with an assessment.

Second, where the amount of a gain or loss may substantially vary from the amount of the gain or loss identified in the year in an uncertain way, the amendments will permit taxpayers to amend a choice made previously in relation to a capital gain or loss that can be affected by financial benefits provided under a look-through earnout right. However, the decision to vary a choice must be made by the time the taxpayer is required to lodge a tax return for the period in which the financial benefits under the look-through earnout right is received.

Third, in relation to the imposition of the general interest charge (GIC), taxpayers will not be subject to interest on any shortfall that arises as a consequence of financial benefits provided or received under a look-through earnout right, as long as they request an amendment to their relevant income tax assessment within the lodgment period for their income return for the year in which the financial benefit was provided or received. (Likewise, the Commissioner will not be liable to pay interest on any tax overpayment that arises as a result of financial benefits provided or received.)

However, the taxpayer will be subject to the shortfall interest charge (SIC) to the extent they have accessed a concession for which they are ultimately not eligible due to these financial benefits.

Finally, in cases where entities dispose of assets and receive a look-through earnout right that initially results in a capital loss position, such capital losses will be “temporarily disregarded” until and to the extent that they become certain. Once such losses become certain, they will be available from the year in which the loss was originally incurred, not when the amount became certain.

Access to CGT concessions

The changes to the treatment of look-through earnout rights are only intended to affect a taxpayer’s entitlement to CGT concessions insofar as this may occur because of the underlying disposal value, including all of the amounts provided for and under the earnout right. Taxpayers may reconsider any choices and their entitlement to concessions in light of subsequent receipts and payments to ensure that the resulting gain, loss or cost base reflects any concessions that are available.

Likewise, in some cases a taxpayer may not initially be in a position to elect that a concession apply to a CGT event. Alternatively, a taxpayer may be concerned that anticipated future financial benefits in respect of a look-through earnout right may mean they are not eligible for a concession after they have taken irrevocable actions based on this concession (such as making contributions to superannuation). In these cases, the taxpayer can now simply wait until it is clear whether they will be finally eligible for the concession before making any choice.

However, while the receipt of financial benefits under a look-through earnout right may allow the taxpayer to remake choices, it does not entitle them to undo actions they have taken in that period. For example, if a taxpayer has made contributions to superannuation in order to access a concession, they cannot withdraw these contributions if the concession is no longer available.

Further, the CGT small business concessions can require action within a fixed period of time. For example, the CGT small business retirement exemption generally requires taxpayers to contribute a relevant amount to their superannuation when the proceeds are received or at the time the choice is made for an individual, or within seven days for a trust or company. In such cases the period for accessing such concessions will be extended appropriately.

Access to CGT concessions: the MNAV test

The maximum net asset value (MNAV) test has been revised. When working out the value of an entity’s CGT assets “just before the time of a CGT event”, taxpayers should be able to elect not to include the value of any look-through earnout right the entity may hold, but instead to take into account any financial benefits that the entity may have provided or received under the look-through earnout right after that time. The election to use this method may only be made once no further financial benefits can be provided under the look-through earnout right.

Foreign resident CGT withholding and look-through earnout rights

Where relevant taxable Australian property under the foreign resident CGT withholding rules (contained in the Act) is an active asset of a business, it may also potentially be subject to a look-through earnout right as part of the sale. As a result, if a transaction to which foreign resident capital gains withholding applies involves a look-through earnout right, the taxpayer does not need to include any amount referable to the future financial benefits under the look-through earnout right.

Instead, if the original transaction required a purchaser to pay an amount to the Commissioner, the purchaser must also pay an amount with respect to any financial benefits provided under look-through earnout rights when the benefits are received. However, the purchaser must still pay 10% of the financial benefit to the Commissioner.

This obligation to withhold with respect to the original transaction may be relieved where there are changes in the residency circumstances of the person who ultimately receives the financial benefit. Alternatively, the financial benefit may be directed towards a person who was not a part of the original transaction. In either case, the question of whether the person receiving the benefit is a relevant foreign resident is reassessed at the time the financial benefit is provided or received.

Date of effect

These amendments apply from 24 April 2015. However, taxpayers who have made statements to the Commissioner and undertaken other actions in reasonable anticipation of announcements made about the amendments in the 2010–2011 Budget are protected against the Commissioner applying the law in a way that is inconsistent with what they have anticipated.

Source: Tax and Superannuation Laws Amendment (2015 Measures No 6) Bill 2015, http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;page=0;query=BillId%3Ar5585%20Recstruct%3Abillhome.

ATO administrative treatment: non-qualifying rights

The ATO says that taxpayers who cannot satisfy the requirements of the law enacted on 25 February 2016 will need to apply the treatment detailed in Draft Taxation Ruling TR 2007/D10.

Source: ATO website, “Non-qualifying rights”, 1 March 2016, https://www.ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-on-capital-gains/CGT–Look-through-treatment-for-earnout-rights/?page=2#Administrative_treatment.

 

CURRENCY:

This issue of Client Alert takes into account all developments up to and including 17 February 2016.

Tax relief for small businesses that restructure on the way

The Tax Laws Amendment (Small Business Restructure Rollover) Bill 2016 was introduced in the House of Representatives on 4 February 2016. It amends the ITAA 1997 by inserting new Subdiv 328-G, to provide an optional rollover for small business owners who change the legal structure of their business on the transfer of business assets from one entity to another. The effect of the rollover is that the tax cost/s of the transferred asset/s roll over from the transferor to the transferee.

The rollover is in addition to existing rollovers where an individual, trustee, or partner transfers assets to, or creates assets in, a company in the course of incorporating their business.

Eligibility

The optional rollover will be available where a small business entity transfers an active asset of the business to another small business entity as part of a genuine business restructure, without changing the ultimate economic ownership of the asset.

The rollover will apply to gains and losses arising from the transfer of active assets that are CGT assets, depreciating assets, trading stock or revenue assets between entities as part of a genuine restructure of an ongoing business.

Genuine restructure

The transfer of the asset/s must be part of a “genuine” restructure of an ongoing business (as opposed to “inappropriately tax-driven schemes”).

Whether a restructure is “genuine” is a question of fact determined with regard to all of the facts and circumstances. Relevant matters include whether it is a bona fide commercial arrangement undertaken to enhance business efficiency, whether the transferred assets continue to be used in the business and whether it is a preliminary step to facilitate the economic realisation of assets.

Also, a “safe harbour” rule provides that the restructure is “genuine” for three years after the rollover if:

• there is no change in the ultimate economic ownership of any of the business’s significant assets (other than trading stock);
• those significant assets continue to be active assets; and
• there is no significant or material use of the significant assets for private purposes.

Entities that can access the rollover

To be eligible for the rollover, each party to the transfer must be either:

• a “small business entity” for the income year during which the transfer occurred;
• an entity that has an “affiliate” that is a small business entity for that income year;
• “connected” with an entity that is a small business entity for that income year; or
• a partner in a partnership that is a small business entity for that income year.

(“Small business entity” takes its usual meaning, as defined in Subdiv 328-C.)

Likewise, the rollover applies to “passively held” assets of a small business that may, for example, be held in an entity other than the one carrying on the business (eg an “affiliate” or a “connected entity” that is a small business entity).

Ultimate economic ownership

The transfer must not have the effect of changing the ultimate economic ownership of transferred assets in a material way. The ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset. Ultimate economic ownership of an asset can only be held by natural persons. Therefore, where a company, partnership or fixed trust owns an asset, the natural person owners of the interests in these interposed entities will ultimately benefit economically from that asset.

If more than one individual is an ultimate economic owner of an asset, there is an additional requirement that each of the individuals’ shares of that ultimate economic ownership be materially unchanged, maintaining the same proportionate ownership in the asset.

Discretionary trusts may be able to meet the requirements for ultimate economic ownership “on their facts” (eg where there is no practical change in which individuals economically benefit from the assets before and after the rollover, there will not have been a change in ultimate economic ownership on the facts).

Otherwise, a discretionary trust may meet an alternative ultimate economic ownership test, whereby every individual who had ultimate economic ownership of the transferred asset before the transfer and every individual who has ultimate economic ownership of the transferred asset after the transfer must be members of the family group relating to the family trust.

Eligible assets

Where a party to the transfer is itself a small business entity, the asset being transferred must be a CGT asset that is an “active asset” (as defined in s 152-40).

Where a party to the transaction is an affiliate or connected entity with a small business entity, the asset must be an active asset that satisfies s 152-10(1A), which, among other things, requires that the relevant small business entity carries on business in relation to the asset.

Where a party to the transaction is not a small business entity, but is a partner in a partnership that is a small business entity, the asset must be an active asset and an interest in the asset of the partnership.

Other

Both the transferor and the transferee of the assets must be residents of Australia. The transferor and transferee must both choose to apply the rollover. The rollover will not apply to a transfer to or from an exempt entity or complying superannuation entity.

Effect of the rollover

The rollover provides tax neutral consequences for a transfer by “switching off” the application of the existing income tax law – but only for the purpose of the transfer, and not for the purposes of GST, FBT or stamp duty.

The rollover provides that the transfer takes place for the asset’s “rollover cost” – which is the transferor’s cost of the asset for income tax purposes, such that the transfer would result in no gain or loss for the transferor. The transferee will be taken to have acquired each asset for an amount equal to the transferor’s cost just before the transfer.

CGT assets

For the transfer of a CGT asset, the tax law will apply under the rollover as if the asset had been transferred for an amount equal to the cost base of the asset. Further, pre-CGT assets transferred under the rollover will retain their pre-CGT status in the hands of the transferee.

Note that in respect of the availability of the CGT discount to the transferee, the time period for eligibility for the CGT discount will recommence from the time of the transfer.

Trading stock

Assets that are trading stock of the transferor will be held as trading stock by the transferee. The transferee will inherit the transferor’s cost and other attributes of the assets as the transferor just before the transfer.

To the extent that the asset is trading stock of the transferor, the rollover cost will be the cost of the item for the transferor at the time of the transfer; or if the transferor held the item as trading stock at the start of the income year, the value of the item for the transferor at that time.

Revenue assets

The rollover cost is the amount that would result in the transferor not making a profit or loss on the transfer. The transferee will inherit the same cost attributes as the transferor just before the transfer.

Depreciating assets

Rollover relief will be available for depreciating assets (under s 40-340) where a rollover under the new measures would be available in relation to the asset if the asset were not a depreciating asset. As a result, the transferee can deduct the decline in value of the depreciating asset using the same method and effective life as the transferor used.

Membership interests

Where membership interests are issued in consideration for the transfer of an asset/s, the cost base of those new membership interests is worked out based on the sum of the rollover costs and adjustable values of the rollover assets, less any liabilities that the transferee undertakes to discharge in respect of those assets, divided by the number of new membership interests.

The rollover does not require that market value consideration, or any consideration, be given in exchange for the transferred assets.

However, an integrity rule ensures that a capital loss on any direct or indirect membership interest in the transferor or transferee that is made subsequent to the rollover will be disregarded, except to the extent that the taxpayer can demonstrate that the loss is reasonably attributable to something other than the rollover transaction. This rule also applies where a transfer of value from an entity results in the creation of tax losses on later disposal of the membership interests.

Note that restructuring to obtain timing advantages or other significant tax benefits in relation to membership interests and other interests in the entities involved in the transaction may, in particular cases, mean that the “genuine” restructure requirement is failed.

Small business concessions

Where the transferor has previously chosen to apply a small business rollover under Subdiv 152-E, and a replacement asset is transferred under this rollover, the transferee is taken to have made the choice for the purposes of CGT events J2, J5 and J6.

For the purpose of determining eligibility for the 15-year CGT exemption for small businesses, the transferee will be taken as having acquired the asset when the transferor acquired it.

Date of effect

The amendments apply to:

• transfers of depreciating assets, where the balancing adjustment event arising from the transfer occurs on or after 1 July 2016;
• transfers of trading stock or revenue assets, where the transfer occurs on or after 1 July 2016; and
• transfers of CGT assets, where the CGT event arising from the transfer occurs on or after 1 July 2016.

Source: Tax Laws Amendment (Small Business Restructure Rollover) Bill 2016, http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;page=0;query=BillId%3Ar5606%20Recstruct%3Abillhome, still before the Senate at the time of writing.

Trust ABNs to be cancelled if no longer carrying on business

The ATO has advised that the Registrar of the Australian Business Register (ABR) will begin cancelling the ABNs of approximately 220,000 trusts, where there is evidence they are no longer carrying on an enterprise.

Trust ABNs will be cancelled in February 2016, where information available indicates that for the last two years the trust has not lodged BASs and/or trust income tax returns. Exclusions to these ABN cancellations apply for trusts that are registered with the Australian Charities and Not-for-profits Commission or are non-reporting members of a GST or income tax group.

The ATO says entities will receive a letter if their ABN has been cancelled. The letter will include the reason for the cancellation, and a phone number to ring to have the ABN reinstated immediately if the entity does not agree with the decision. The ATO also notes that if an entity’s ABN is cancelled and neither the entity nor its tax representative receives a letter, it could mean the entity’s contact details are not up to date on its ABN record.

Source: ATO website, “Cancellation of trust ABNs”, 22 January 2016, https://www.ato.gov.au/Tax-professionals/Newsroom/Your-practice/Cancellation-of-trust-ABNs/.

Car expense deduction changes

The Government has simplified car expense deductions for individuals from 1 July 2015.

Prior to 1 July 2015, there were four methods for claiming car expenses:

• cents per kilometre – capped at 5,000 km;
• logbook – unlimited kilometres;
• 12% of original value; and
• one-third of actual expenses.

To simplify the rules, from 1 July 2015 the Government has abolished the 12% of original value and one-third of actual expenses methods. The cents per kilometre method (with the existing 5,000 km cap) and the logbook method (with unlimited kilometres) remain.

The cents per kilometre method has been simplified to use a standard rate of 66 cents per kilometre for the 2015–2016 income year, rather than a rate based on the engine size of the car. The Commissioner of Taxation will set the rate for future income years.

Withholding tax for car allowances

Employers should be aware that the ATO has set the approved pay as you go (PAYG) withholding rate for cents per kilometre car allowances at 66 cents per kilometre from 1 July 2015.

Employers should withhold from any amount above 66 cents for all future payments of a car allowance. Failure to do so may result in employees having a tax liability when they lodge their tax returns.

Employees who have been paid a car allowance from 1 July 2015 at a rate higher than the new approved amount should consider whether they need to increase their withholding to avoid any tax liability at the end of the year.

Source: ATO, “Car expense substantiation methods simplified”, 17 December 2015, https://www.ato.gov.au/general/new-legislation/in-detail/direct-taxes/income-tax-for-individuals/car-expense-substantiation-methods-simplified/.

Travellers with student debts need to update contact details

Australians with a Higher Education Loan Programme (HELP) debt and/or a Trade Support Loans (TSL) debt who are moving overseas for longer than six months need to provide the ATO with their overseas contact details within seven days of leaving the country. This requirement follows recent legislative changes.

ATO Assistant Commissioner Graham Whyte said that affected people can provide the ATO with international contact details using online services (eg an ATO account linked to myGov).

“Don’t worry if you don’t know your new international residential address yet. Just provide us with your best contact address while you’re away, like your parents’, and update your contact details when you’re settled. The most important thing is that you’re still able to receive correspondence from us while you’re overseas”, Mr Whyte said.

From 1 July 2017, anyone living overseas and earning above the minimum repayment threshold will be required to make loan repayments, just as they would if they were living in Australia.

“We will be in touch closer to the time with more information about how to report income and make loan repayments”, Mr Whyte said. “For now, all travellers with a HELP and/or TSL debt need to do is update their details and factor in potentially making repayments from 1 July 2017”, he added.

Further information is available on the ATO website at https://www.ato.gov.au/Individuals/Study-and-training-support-loans/Overseas-repayments/.

Source: ATO, “Square away with the ATO before you ship off overseas”, 9 February 2016, https://www.ato.gov.au/Media-centre/Media-releases/Square-away-with-the-ATO-before-you-ship-off-overseas/.

Small business tax concession refused as threshold test failed

The Federal Court has confirmed that the face value of a debt of $1.1 million owed to a taxpayer had to be taken into account, under the maximum net asset value test, for the purposes of determining if the taxpayer qualified for the CGT small business concessions. This was despite the taxpayer’s claim that the debt was statute-barred from recovery under relevant state legislation and therefore had a nil value. As a result of the Court’s confirmation, the debt amount was included in the test and the taxpayer failed to qualify for the concessions.

Background

The taxpayer was both a beneficiary and the trustee of a family trust that held units in a unit trust which operated a finance broking business. The unit trust sold the business in the 2008 income year for a capital gain of $500,000, to which the taxpayer was entitled. The taxpayer argued that in determining whether the “maximum net asset value” (MNAV) test was satisfied, a debt of $1.1 million owed to the family trust (a connected entity), resulting from a loan it made to him, had a nil value and was not to be taken into account under the MNAV test. He argued this on the basis that the debt was “statute-barred” from recovery under the six-year statute of limitations in s 35(a) or 42(1) of the Limitation of Actions Act 1936 (SA) (the Act).

However, in Re Breakwell and FCT [2015] AATA 628, the AAT found that this was not the case, on the basis that the debt had been legally acknowledged by the trustee of the family trust as being recoverable (by way of signing the relevant balance sheets) and was legally in existence at the relevant time. Therefore, the AAT found that the face value of the debt was to be included in the MNAV test, and that the taxpayer failed to qualify for the concessions.

Before the Federal Court, the taxpayer first argued that the AAT wrongly determined the debt was recoverable and had wrongly found there was no acknowledgement contained in writing signed by the taxpayer or by his agent, as required by s 42(1) of the Act, to find that the debt was still in existence and not statute-barred from recovery. Alternatively, the taxpayer argued if this issue was not an appealable question of law, then the signing of the balance sheet could not amount to an acknowledgement of a debt for the purposes of s 42 of the Act, as it was at best an acknowledgement of an asset, and not of “a debt owing”.

Decision

In dismissing the taxpayer’s appeal and confirming that the amount of $1.1 million was to be included in the MNAV test (and therefore that the taxpayer failed to qualify for the concessions), the Federal Court first found that the statutory time limit in s 35(a) of the Act did not, by itself, have the effect of extinguishing the trust’s claim in contract for repayment of the loan after six years. The Court found that while the section may “bar the remedy”, it did not bar “the cause of action”. Instead, the Court said s 35(a) (and similar legislation) acted to create a defence which could be raised by a debtor or defendant in an action against them and which, moreover, could be waived by a debtor or defendant.

The Court also found that s 48 of the Act allowed a court to extend such a limitation period – and that it was possible that an arm’s-length trustee in this case would seek such an extension. The Court noted that it would be difficult to see how the taxpayer in this case, as a debtor-beneficiary of the trust, would raise the statute of limitation defence when, in his capacity as trustee of the trust, he also had fiduciary duties to act in the best interest of the trust.

Accordingly, the Court ruled that the family trust’s claim against the taxpayer could not be regarded as statute-barred under s 35(a) of the Act (nor under s 38 of the Act) and that the debt owed to it could not be regarded as having no value. In addition, the Court found that the present case was an action by a trust to recover trust property, and that there was no limitation period in this case in accordance with s 32(1) of the Act.

Breakwell v FCT [2015] FCA 1471, Federal Court, White J, 22 December 2015, http://www.austlii.edu.au/au/cases/cth/FCA/2015/1471.html.

“Wildly excessive” tax deduction claims refused

A professional sales commission agent has been largely unsuccessful before the AAT in claiming deductions for work-related expenses, including home office expenses, various grocery items and overtime meal allowances.

Background

The taxpayer was a professional sales commission agent. His employer did not provide him with a dedicated office or workspace. In his 2010 to 2012 income tax returns, he claimed large deductions for home office expenses and work-related travel. Originally, the taxpayer claimed that 31.6% of his house (including the family living room, which he called the “meeting room”, and a roof storage area) was being used solely for work purposes.

The taxpayer was audited on his 2010 tax return (where he claimed over $97,000 worth of expenses to reduce his taxable income to $21,000). When the matter came before the AAT in 2014, it disallowed numerous home office deductions and rejected his claim that his living room was a “meeting room”, but allowed a home office percentage of 11.7% (see Re Ogden and FCT [2014] AATA 385).

The current case concerned the taxpayer’s deduction claims in his 2011 and 2012 tax returns. His original claims (which changed throughout the course of the audit and AAT proceeding), totalled over $63,000 for 2010–2011 and over $53,000 for 2011–2012, which represented at least 30% of his employment income. The Commissioner disallowed various deductions and applied a 25% shortfall penalty for failing to take reasonable care.

When the matter came before the AAT, the claims that were still in dispute included the amount of the home office expenses, overtime meal allowances, “staff and client amenities” (including toilet paper, pocket tissues, Bega Stringers Cheese, Tiny Teddies and Weight Watchers Lamingtons), “business meals” for his accountant, a desk in his son’s bedroom, sunscreen, sunglasses and $383 on a pair of RM Williams rubber-soled shoes, which the taxpayer claimed prevented his computer being damaged by static electricity. The taxpayer also claimed expenses spent on a Dora the Explorer pencil case, heart and star shaped stickers, depreciation on an outdoor patio setting and a $5,388 payment to his seven-year-old son for “secretarial assistance” (a claim which the taxpayer abandoned during the proceedings).

Decision

The AAT found that the taxpayer’s home office claims were “wildly excessive”, and that the taxpayer and his representatives failed to critically analyse how these claims helped produce the taxpayer’s assessable income. In particular, the AAT said that the claim that the family living room was being used solely for work meetings “should never have been made”, noting that the taxpayer’s approach had been to find “some relationship, no matter how remote” to his work in order to claim deductions. In relation to an initial claim for 31.6% of his home loan interest expenses, the AAT said it was “difficult to understand how a registered tax agent could allow such a claim to be made”. The AAT found that the taxpayer’s home office represented around 1.8% of the family home.

The AAT rejected everything claimed under “staff and client amenities”, as it considered the products were overwhelmingly consumed by the taxpayer’s family, thereby making the claims “outrageous and utterly unacceptable”. The claimed meal allowances were also rejected in their entirety. Regarding expenses on the rubber-soled shoes, the AAT commented that it appeared to be yet another example of the taxpayer’s evidence ranging from “the exaggerated to the implausible”, and accordingly rejected the claim. The AAT did not seek to disturb heating and lighting expenses that the Commissioner had allowed, but noted that the taxpayer was “fortunate” to have been allowed these.

Considering the various deductions claimed, the AAT said a 25% administrative penalty appeared “somewhat generous” to the taxpayer. The AAT gave leave to the Commissioner to reconsider the penalty issues, and to consider whether to apply a 20% uplift, given the numerous statements made by the taxpayer and how they changed over time. It also noted that different levels of culpability may apply to different statements.

Re Ogden and FCT [2016] AATA 32, AAT, File Nos 2014/5943; 2014/5957; 2014/6763; 2014/6764, Frost DP, 29 January 2016, www.austlii.edu.au/au/cases/cth/AATA/2016/32.html.

GST credits not available for payments on behalf of super funds

The ATO has issued GST Determination GSTD 2016/1 on whether employers can claim input tax credits for expenses paid on behalf of superannuation funds. The Determination notes that an employer may, for “administrative convenience”, pay expenses on behalf of a fund, with the payment being reclassified as a superannuation contribution in the employer’s accounts. However, the ATO’s preferred approach is for all superannuation fund expenses to be paid directly out of the fund itself, and for superannuation contributions to be made directly to the fund.

GSTD 2016/1 provides that an employer is not entitled to an input tax credit if a superannuation fund makes an acquisition and the employer pays the expense on the fund’s behalf. This is because the supply is made to the fund and not to the employer. However, the ATO notes that the fund may be entitled to claim a reduced input tax credit under the financial supply rules (Div 70 of the GST Act), provided the requirements of those rules are satisfied.

GSTD 2016/1 includes an example (reproduced below) where a superannuation fund engages a solicitor to provide legal advice and the employer sponsor pays the legal fees. As the supply (the legal advice) is provided to the fund, the employer cannot claim an input tax credit for the payment.

Example

Lazy Days Pty Ltd is the employer sponsor of the Lazy Days Superannuation Fund. Lazy Days Pty Ltd is registered for GST and employs 15 staff. The Lazy Days Superannuation Fund is registered for GST purposes.

The Lazy Days Superannuation Fund engaged a legal firm to provide advice about its activities. Lazy Days Pty Ltd pays the legal fees associated with this advice.

Lazy Days Pty Ltd is not entitled to an input tax credit as a result of paying for the advice provided to the Lazy Days Superannuation Fund. This is because the supply of the advice was made by the legal firm to the Lazy Days Superannuation Fund, which is a separate entity from Lazy Days Pty Ltd. Lazy Days Pty Ltd has not acquired anything for the payment and therefore has not satisfied the requirements in s 11-5 for making a creditable acquisition.

The Lazy Days Superannuation Fund may be entitled to a reduced input tax credit in relation to the payment if the requirements in Div 70 are otherwise satisfied.

The GST Determination applies both on and after its date of issue (27 January 2016).

MT 2005/1 and GSTA TPP 003 withdrawn

The GST Determination was not previously released as a draft. It replaces the previous ATO rulings on the topic, MT 2005/1 and GSTA TPP 003, both of which were withdrawn on and with effect from 27 January 2016. The Commissioner’s views in GSTD 2016/1 are the same as those expressed in the withdrawn Miscellaneous Tax Ruling and GST Advice.

Source: ATO, GST Determination GSTD 2016/1, https://www.ato.gov.au/law/view/pdf/pbr/gstd2016-001.pdf.

CURRENCY:

This issue of Client Alert takes into account all developments up to and including 13 January 2016.

Single Touch Payroll pilot and tax offset proposed

On 21 December 2015, the Assistant Treasurer released details concerning the Government’s proposed Single Touch Payroll (STP) to streamline business tax and superannuation reporting. “Employers currently manually report PAYG withholdings to the ATO,” Ms O’Dwyer said. “Under the new STP this information will be automatically reported to the ATO through Standard Business Reporting (SBR) software.”

Ms O’Dwyer said reporting of superannuation contributions will also be automatically sent to the ATO when payments are made to super funds. In addition, employers will also have the option to pay their PAYG withholding at the same time they pay their staff. In relation to individuals commencing employment, they will have the option of completing their TFN declaration and Superannuation Standard Choice forms using myGov or through their employer’s business management software.

As noted in the MYEFO 2015–2016, the ATO will be conducting a pilot in the first half of 2017 focusing on small businesses. From 1 July 2017, all businesses will be able to commence STP reporting, with the option to make voluntary payments. In addition, the ATO will transition employers with 20 or more employees to STP. From 1 July 2018, employers with 20 or more employees will be required to use STP enabled software for reporting to the ATO. The Assistant Treasurer said the Government will make a decision on timing for rolling out STP reporting for employers with less than 20 employees after the pilot is completed.

To assist small businesses with a turnover of less than $2 million, the Government will offer a $100 non-refundable tax offset for SBR-enabled software. This offset is proposed to apply from 1 July 2017 and for software purchases or subscriptions made in the 2017–2018 financial year only.

STP welcome, but cashflow concerns an issue

While supportive of the STP initiative, some commentators have highlighted the policy objective needs to take into account the fact that many SMEs struggle with cashflow. The ATO has been undertaking consultation on the design and development of the STP and has been urged to better understand the business impact on SMEs.

Real time pay day reporting to the ATO has a number of public benefits. It gives the ATO an earlier intervention signal to contact struggling businesses to see what can be done to get things back on track. Reducing current levels of aged tax and superannuation debt is another aspect of the ATO’s thinking. Employees will also benefit by being alerted if their tax and superannuation entitlements are not being paid.

However, a significant concern is the proposal for PAYG withheld and super to be paid by businesses more frequently, on the same day employees get paid. The current law allows super to be paid into funds quarterly, and SMEs enjoy a time lag for remitting PAYG withholding to the ATO.

Source: Assistant Treasurer’s media release, 21 December 2015 <http://kmo.ministers.treasury.gov.au/media-release/042-2015/>; MYEFO 2015–2016 <http://budget.gov.au/2015-16/content/myefo/html/index.htm>

GST simplified accounting methods for small food retailers

Many small food retailers buy and sell products that are taxable as well as products that are GST-free. Others buy taxable and GST-free products and sell only taxable products. Depending on the point-of-sale equipment they use, accurately identifying and recording GST-free sales separately from those that are taxable can be difficult, which makes accounting for GST complicated.

The ATO has updated a publication setting out simplified GST accounting methods for food retailers. The publication is designed to help taxpayers work out the amount of GST they are liable to pay at the end of each tax period. There are five methods (see summary below) and the ATO says taxpayers need to choose which method is the best for their business. The ATO adds that taxpayers cannot use the averaging involved in the methods to set prices (prices are to be set in line with the Australian Competition and Consumer Commission guidelines).

The publication covers eligibility conditions to use a SAM, the difference between the five SAMs, how to choose a SAM, how to notify the ATO on which SAM is elected, record-keeping requirements, and how to complete an activity statement.

Summary of the SAMs

Method	Business norms	Stock purchases	Snapshot	Sales percentage	Purchases snapshot
Turnover threshold	SAM turnover of $2 million or less	SAM turnover of $2 million or less	SAM turnover of $2 million or less	GST turnover of $2 million or less	GST turnover of $2 million or less
How to estimate GST-free sales and/or purchases	Apply standard percentages to sales and purchases.	Take a sample of purchases and use this sample.	Take a snapshot of sales and purchases and use this.	Work out what percentage of GST-free sales is made in a tax period and apply this to purchases.	Take a snapshot of purchases and use this to calculate GST credits.

 

The ATO has prepared the following FAQs:

Q. Which SAM should I choose?

You should choose the method you are eligible to use that best suits your business.

Q. If my projected turnover is more than the relevant turnover threshold before the end of the first 12 months, will I need to use a full accounting method from that point?

No. If you meet the turnover threshold requirements when you choose your SAM, you can continue using it for the remaining tax periods in that first 12 months. The threshold is a SAM turnover of $2 million or less for the business norms, snapshot and stock purchases methods, and a GST turnover of $2 million or less for the sales percentage and purchases snapshot methods.

However, you will not be eligible to use a SAM in tax periods that start after the first 12 months.

Q. If I buy adequate point-of-sale equipment part way through the year, do I continue to use the SAM for the rest of the year?

No. Once you have installed point-of-sale equipment that you are satisfied accurately identifies and records GST-free sales separately from taxable sales, you are no longer eligible to use the SAM you have chosen.

You must stop using this method from the beginning of the tax period after the day you purchased the point-of-sale equipment.

Note: This rule does not apply to the sales percentage method or the purchases snapshot method.

Q. With the business norms method, why are the GST-free rates higher for hot bread shops than convenience stores?

The business norms percentages are based on the average values for each industry.

The percentages have been developed in consultation with a wide range of industry groups, including shop owners, industry representatives and peak bodies. Every industry has different characteristics and trading, so it makes sense they have different levels of GST-free stock purchases and sales.

Q. Can I just estimate my GST-free sales but fully account for my purchases?

Only if you use either the stock purchases method or the snapshot method.

If you use the business norms method, you have to use the business norms percentages for your business type to calculate both your GST-free sales and your GST-free purchases. You cannot estimate the GST-free sales under the sales percentage and purchases snapshot methods.

Source: ATO publication, “Simplified GST accounting methods for food retailers”, 26 November 2015 <https://www.ato.gov.au/business/gst/in-detail/your-industry/food/simplified-gst-accounting-methods-for-food-retailers/>

Government’s Innovation Agenda contains tax incentives

The Government on 7 December 2015 released its National Innovation and Science Agenda. The Government said Australia is falling behind on measures of commercialisation and collaboration, and through the new Agenda, the Government will invest $1.1 billion to incentivise innovation and entrepreneurship, reward risk taking, and promote science, maths and computing in schools by focusing on four priority areas:

1. culture and capital, to help businesses embrace risk and incentivise early stage investment in startups;
2. collaboration, to increase the level of engagement between businesses, universities and the research sector to commercialise ideas and solve problems;
3. talent and skills; and
4. government as an exemplar.

Tax and related incentives

A suite of new tax and business incentive measures are included under the Agenda, including:

• new tax breaks for early stage investors in innovative startups. Investors will receive a 20% non-refundable tax offset based on the amount of their investment, as well as a 10-year CGT exemption for investments held for three years. The scheme is expected to begin during 2016 as soon as amendments to the enabling legislation are passed into law;
• introducing a 10% non-refundable tax offset for capital invested in new Early Stage Venture Capital Limited Partnerships (ESVCLPs), and increasing the cap on committed capital from $100 million to $200 million for new ESVCLPs. The new arrangements are expected to begin during 2016 as soon as amendments to the enabling legislation are passed into law;
• relaxing the “same business test” that denies tax losses if a company changes its business activities, and introducing a more flexible “predominantly similar business test”. This will allow a startup to bring in an equity partner and secure new business opportunities without worrying about tax penalties. The “predominantly similar business test” will apply to losses made in the current and future income years; current tests will continue to apply to existing losses;
• removing rules that limit depreciation deductions for some intangible assets (like patents) to a statutory life and instead allowing them (ie provide an option) to be depreciated over their economic life as occurs for other assets. The changes will apply to assets acquired from 1 July 2016; and
• limiting the requirement for disclosure documents given to employees under an employee share scheme (ESS) to be made available to the public. The Assistant Treasurer said that, currently, offer documents to employees have to be lodged with ASIC and could result in the release of commercially sensitive information. The Government plans to limit the requirement for these documents to be made publicly available. This is designed to allow otherwise non-disclosing companies to offer shares to their employees without having to reveal commercially sensitive information to competitors. Legislation is expected to be introduced in the first half of 2016.

The Government said it will also reform insolvency laws, for example:

• reducing the default bankruptcy period of three years to one year;
• introducing a “safe harbour” for directors from personal liability for insolvent trading; and
• banning “ipso facto” contractual clauses.

Source: Government’s National Innovation & Science Agenda <www.innovation.gov.au>

ATO data matching real property transactions

The ATO has gazetted a notice specifying that it will acquire details of real property transactions for the period 20 September 1985 to 30 June 2017 from various State Revenue offices and tenancies boards. Information to be obtained will include: rental bond number of identifier for rental bond; unique identifier for the landlord; full name of the landlord; full address of the landlord; period of lease; date of property transfer; property sale contract date; settlement date; and valuation details.

The ATO expects that around 31 million records for each year will be obtained. Based on current data holdings, the ATO estimates that records relating to 11.3 million individuals will be matched. The purpose of this data matching program is to ensure that taxpayers are correctly meeting taxation and other obligations administered by the ATO in relation to their dealings with real property. These obligations include registration, lodgement, reporting and payment responsibilities.

Note that the ATO intends to continue this data matching program from 2017. In the 2013–2014 Federal Budget, the Government announced that it would legislate to make the reporting of real property transfers to the ATO mandatory in the future. The current Government confirmed that it would proceed with this proposal. Amending legislation to implement the proposal is contained within the Tax and Superannuation Laws Amendment (2015 Measures No 5) Act 2015.

Source: Commonwealth Gazette, Notice of Data Matching Program – Real Property Transactions, 8 December 2015 <https://www.comlaw.gov.au/Details/C2015G02019>; ATO, Real property transactions 1985-2017 data matching program protocol, 7 December 2015 <https://www.ato.gov.au/General/Gen/Real-property-transactions-data-matching-program-protocol/>

Tax treatment of earnout rights on business sale

The Tax and Superannuation Laws Amendment (2015 Measures No 6) Bill 2015 was introduced in the House of Reps on 3 December 2015. It proposes to amend the ITAA 1997 to change the CGT treatment of the sale and purchase of businesses involving certain earnout rights. As a result, capital gains and losses arising in respect of look-through earnout rights will be disregarded and, instead, payments received or paid under the earnout arrangements will affect the capital proceeds and cost base of the underlying asset or assets to which the earnout arrangement relates when they are received or paid (as the case may be).

The Bill also amends the rules relating to amendments to assessments, interest charges, recognition of capital losses and access to CGT concessions to ensure the new treatment provides taxpayers with outcomes consistent with those that would have arisen had the value of all of the financial benefits under the earnout right been included in the capital proceeds from the disposal of the underlying asset for the seller and the cost base of the underlying asset for the buyer at the time of the disposal.

Changes from draft Bill

The Bill is essentially the same as the original draft legislation. However, note the following:

• the original four-year period in which financial benefits must be provided in order to qualify as an “eligible” earnout arrangement has been extended to five years;
• it was unclear under the draft legislation how the measures would interact with the rules for accessing the CGT small business concession via the maximum net asset value test and, in particular, whether this would be determined only at the time of disposal without regard to any future potential future financial benefits to be provided. However, under the Bill, taxpayers will be able to elect to take into account any future financial benefits for this purpose; and
• the Bill explains in detail how the earnout measures will interact with the new “foreign resident CGT withholding” measures (also introduced in the Bill).

Look-through earnout rights

A look-through earnout right is a right to future financial benefits which are not reasonably ascertainable at the time the right is created. The right must be created under an arrangement involving the disposal of a CGT asset that is an “active asset” of the seller, and the financial benefits under the right must be contingent on and reasonably related to the future economic performance of the asset (or a related business). As a result, a look-through earnout right must be created as part of an arrangement for a disposal of the business or its assets (ie the disposal must cause CGT event A1 to happen).

Note also a right will also be a look-through earnout right if it is a right to receive financial benefits provided in exchange for ending a right that is a look-through earnout right.

For these purposes, an “active asset” is an asset of the taxpayer that is used in the business of the taxpayer or a “connected” or “affiliated” entity. Note also that the definition of active asset allows interests in foreign entities to be active assets for the purpose of this measure.

A membership interest in an Australian resident company or trust will also be an active asset if at least 80% of the assets of the company or trust (by value) are active assets. But note that special rules apply in this case so that if, for example, the sole asset of Company A is a share in Company B, which itself only holds a share in Company C, the character of interests in both A and B will depend on the character of the assets of C.

Further, in determining if such interests are active assets, the amendments provide that an eligible share or an interest in a trust is treated as an active asset in the hands of an entity for the purpose of determining if a look-through earnout right exists. For these purposes, to be “an eligible share or interest” the entity holding the share or interest must either:

(a) if they are an individual – be a CGT concession stakeholder in relation to the company or trust; or

(b) if they are not an individual – own a sufficient share of the business that they would be a CGT concession stakeholder were they an individual.

In addition, the trust or company must carry on a business and have carried on a business for at least one prior income year and for the immediately preceding income year, at least 80% of the assessable income of the trust or company must have come from the carrying on a business (and not been derived as an annuity, interest, rent, royalties or foreign exchange gains, or derived from or in relation to financial instruments). Importantly, this test allows taxpayers to avoid the need to value the assets of the trust or company and, instead, only look at how the trust or company has earned its income over the past income year.

Note that look-through earnout rights must be created as part of arrangements entered into on an arm’s-length basis. Note also that the look-through measures are not intended to provide tax benefits to temporary transfers (such as a loan or the granting of a lease), ongoing business relationships (such as the purchase of an ownership interest) or complex financing arrangements where there is no final disposal of the underlying asset.

Contingent on the future economic performance of the asset

For a right to be a look-through earnout right, future financial benefits provided under the right must be linked to the future economic performance of the asset or a business in which the asset is used and not reasonably ascertainable at the time the right is created. Where the measure of performance relates to a business, there must be a reasonable belief at the time of the disposal that the asset will actually be used in this business. In the case of the entity disposing of the asset, this will be based on what is reasonable given their knowledge of the intention of the other party.

Note that whether a particular measure appropriately identifies economic performance will depend on the context of the business or asset in question. Measures that may be appropriate include both financial measures such as the profit, sales or turnover of the business (or the business in which the asset is used) and non-financial measures such as the number of clients retained. However, any measure adopted must be reasonable in the particular context. Note also that for a right to be a look-through earnout right, the value of the benefits must also reasonably relate to the performance.

Five-year payment limitation

For a right to be a look-through earnout right, the right must not require financial benefits to be provided more than five years after the end of the income year in which the relevant CGT event occurs in relation to the disposal of the relevant active asset. This ensures concessions for look-through earnout rights are not available to long-term profit sharing arrangements and avoids providing an excessive and distorting benefit to look-through earnout rights.

But note that this requirement is not breached simply because one party or another may be late in providing a financial benefit under the look-through right, even if the other party tolerates this lateness. It will also not be breached if the agreement includes provisions that allow for a delay in payment contingent on events, such as a dispute over the terms of the agreement being subject to a binding arbitration process. However, the relevant contingency must be outside the control of either party.

However, the five-year requirement will be breached if the agreement includes an option for the parties to extend the period over which financial benefits are provided or to enter into a new agreement providing for the continuation of substantially similar financial benefit. Further, if the parties vary the right to extend the period over which financial benefits are provided beyond five years or enter into a new agreement to create an equivalent right to further future financial benefits then the right will be taken to have never been a look-through earnout right.

Note that in the draft legislation, this period was four years only.

Consequences of a right being a look-through earnout right

If a right is a look-through earnout right:

(a) the value of the right is disregarded for the purposes of CGT; and

(b) the value of any financial benefits made or received under the right is included in either the capital proceeds arising from the disposal (for the seller) or the cost base of the acquisition (for the buyer).

Accordingly, any capital gain or loss arising in respect of the creation or cessation of a look-through earnout right will be disregarded.

Similarly, the value of a look-through earnout right will not be taken into account in determining the capital proceeds of the disposal of the active asset for the seller nor the cost base and reduced cost base of the asset acquired by the buyer. Instead, the value of any financial benefits subsequently provided or received under or in relation to such a right will be included in the original capital proceeds of the disposal for the related asset for the seller, or the initial cost base and reduced cost base of the asset for the buyer as at the date of the original acquisition.

But note that where a taxpayer subsequently disposes of an asset that is subject to an ongoing look-through earnout right before their obligations or entitlements in relation to financial benefits under the right are exhausted, their cost base for the asset may change as a result of any subsequent financial benefits they pay or receive. In this situation, the taxpayer will need to adjust the capital gain or loss on that subsequent disposal.

Choices and timing

This treatment of earnout rights results in the amount of a capital gain or loss changing as a result of financial benefits provided or received in subsequent income years. As a result, a number of special rules are required to ensure that this does not disadvantage taxpayers or impose unnecessary compliance and administrative costs.

First, as the financial benefits may be provided up to five years after the end of the income year in which the CGT event occurred, the period of review for the income year in which the CGT event occurred may have passed before the taxpayer has provided or received the financial benefits requiring the amendment. As a result, the period of review will be extended for all of a taxpayer’s tax-related liabilities that can be affected by the character of the look-through earnout right to the later of:

(a) the period of review that would normally apply; and

(b) four years after the end of the final income year in which financial benefits could be provided.

Note this extension of the period of review includes liabilities in subsequent years for taxes other than income tax. For example, the small business CGT retirement concessions provide, broadly, that certain contributions to superannuation linked to capital gains arising from the sale of business asset are not counted towards non-concessional superannuation contribution caps. If the amount of the relevant gain for a taxpayer changes as a result of the financial benefits provided under an earnout right, the extended amendment period would apply to the assessment of the taxpayer’s non-concessional contributions.

Note also this extension also applies to a taxpayer’s right to object where they are dissatisfied with an assessment.

Secondly, where the amount of a gain or loss may substantially vary from the amount of the gain or loss identified in the year in a way that is uncertain, the amendments will permit taxpayers to amend a choice made previously where the choice relates to a capital gain or loss that can be affected by financial benefits provided under a look-through earnout right. However, the decision to vary a choice must be made by the time the taxpayer is required to lodge a tax return for the period in which the financial benefits under the look-through earnout right is received.

Thirdly, in relation to the imposition of the general interest charge (GIC), taxpayers will not be subject to interest on any shortfall that arises as a consequence of financial benefits provided or received under a look-through earnout right, as long as the taxpayer requests an amendment to their relevant income tax assessment within the period they must lodge their income return for the income year in which the financial benefit was provided or received. (Likewise, the Commissioner will not be liable to pay interest on any overpayment of tax that arises as a result of financial benefits provided or received.)

But note that to the extent a taxpayer has accessed a concession for which they are ultimately not eligible due to these financial benefits, the taxpayer will be subject to the shortfall interest charge (SIC).

Finally, in cases where entities dispose of assets and receive a look-through earnout right that initially results in a capital loss position, such capital losses will be “temporarily disregarded” until and to the extent that they become certain. However, once such losses become certain, they will be available from the year in which the loss was originally incurred, not when the amount became certain.

Access to CGT concessions

The changes to the treatment of look-through earnout rights are only intended to affect a taxpayer’s entitlement to CGT concessions insofar as this may occur as a result of the value of the underlying disposal now including all of the amounts provided for and under the earnout right. As a result, taxpayers may reconsider any choices and their entitlement to concessions in light of subsequent receipts and payments to ensure that the resulting gain, loss or cost base reflects any concessions that are available.

Likewise, in some cases, a taxpayer may not initially be in a position to elect that a concession to apply to a CGT event. Alternatively, a taxpayer may be concerned that anticipated future financial benefits in respect of a look-through earnout right may mean that they cease to be eligible for a concession to apply after they have taken irrevocable actions based on this concession (such as making contributions to superannuation). In these cases, as the taxpayer can remake choices they can simply wait until it is clear whether or not they will be finally eligible for the concession before making any choice.

But note that while the receipt of financial benefits under a look-through earnout right may allow the taxpayer to remake choices, it does not entitle the taxpayer to undo the actions they have taken in that period. For example, if a taxpayer has made contributions to superannuation in order to access a concession, they cannot withdraw these contributions now they are no longer available.

Further, the CGT small business concessions can also require things to be done within a fixed period of time (eg the CGT small business retirement exemption generally require a taxpayer to contribute a relevant amount to their superannuation when the proceeds are received or at the time the choice is made for an individual, or seven days after these times for a trust or company). In such cases the period for accessing such concessions will be extended appropriately.

Access to CGT concessions – the MNAV test

The maximum net asset value (MNAV) test will be revised to provide that when working out the value of an entity’s CGT assets “just before the time of a CGT event”, taxpayers should be able to elect not to include the value of any look-through earnout right the entity may hold, but instead take into account any financial benefits that the entity may have provided or received under the look-through earnout right after that time. The election to use this method may only be made once no further financial benefits can be provided under the look-through earnout right.

Note that, under the draft Bill, it was not clear how this issue would be treated but it appeared that the MNAV test would be determined solely at the time the earnout arrangement was entered into, without any regard to payment of future benefits.

Foreign resident CGT withholding and look-through earnout rights

Where relevant taxable Australian property under the proposed foreign resident CGT withholding rules (contained in the Bill) is an active asset of a business, it may also potentially be subject to a look-through earnout right as part of the sale. As a result, if a transaction to which foreign resident capital gains withholding applies involves a look-through earnout right, the taxpayer does not need to include any amount referable to the future financial benefits under the look-through earnout right.

Instead, if the original transaction required a purchaser to pay an amount to the Commissioner, the purchaser must also pay an amount to the Commissioner with respect to any financial benefits provided under look-through earnout rights at such time as the benefit are received. However, the purchaser must still pay 10% of the financial benefit to the Commissioner.

Note that this obligation to withhold with respect to the original transaction may be relieved where there is a change in circumstances relating to the residency of the person ultimately receiving the financial benefit. Alternatively, the financial benefit may be directed towards a person who was not a part of the original transaction. In either case, the question, of whether the person receiving the benefit is a relevant foreign resident, is reassessed at the time the financial benefit is provided or received.

Date of effect

These amendments will apply from 24 April 2015. However, taxpayers that have made statements to the Commissioner undertaken other actions in reasonable anticipation of announcements made about the amendments in the 2010–2011 Budget are protected against the Commissioner applying the law in a way that is inconsistent with what they have anticipated.

ATO administrative treatment

The ATO has released details of its administrative treatment pending the formal enactment of legislation. Further details are available on the ATO website at: https://www.ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-on-capital-gains/CGT–Look-through-treatment-for-earnout-rights/?page=2#Administrative_treatment

Source: Tax and Superannuation Laws Amendment (2015 Measures No 6) Bill 2015, before the House of Reps at the time of writing, <http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;page=0;query=BillId%3Ar5585%20Recstruct%3Abillhome>

Are your super saving goals on track?

The new calendar year is a good time to conduct a superannuation health check and set some new goals to help boost superannuation savings. Although there have been no seismic shifts in the superannuation landscape of late, it may be prudent to reacquaint yourself with the rules. The following are some considerations.

• Check employer super contributions – for the 2015–2016 financial year, the super guarantee rate is 9.5%. The rate will stay at 9.5% until 1 July 2021 in which it will start to gradually increase to 12% by 1 July 2025. Note that Norfolk Island has been brought into the superannuation guarantee fold. A transitional rate starting at 1% will apply from 1 July 2016 for the 2016–2017 financial year.
• Monitor the concessional contributions caps – the general concessional contributions cap is $30,000 for the 2015–2016 financial year (same as for 2014–2015). A higher concessional contributions cap of $35,000 applies for 2015–2016 for people aged 59 years or over on 30 June 2013. For the 2015–2016 financial year, this temporary concessional cap of $35,000 also applies for those aged 49 years or over on 30 June 2014 and for those aged 49 years or over on 30 June 2015. This temporary $35,000 concessional cap (not indexed) will cease when the general cap reaches $35,000 through indexation (expected to be 1 July 2018).
• Monitor non-concessional contributions cap – this has increased to $180,000 (or $540,000 every three years for those under age 65) for the 2015–2016 financial year (same as for 2014–2015).
• Consider salary sacrificing superannuation – individuals may want to inquire about salary sacrificing superannuation or consider reviewing an existing arrangement with their employer.
• Check the government co-contribution – a 50% matching applies whereby the Government will pay a co-contribution up to a maximum of $500 for a $1,000 eligible personal contribution for individuals with total incomes up to $35,454 for 2015–2016 (phasing down for incomes up to $50,454).
• Check superannuation savings – in addition to becoming more familiar with superannuation, individuals may also want to protect their superannuation from identity crime. For example, they may want to change passwords for accounts that can be viewed online.
• Look for small lost super accounts – the threshold below which small lost super accounts will be required to be transferred to the Commissioner of Taxation has increased. The account balance threshold has gone from $2,000 to $4,000 from 31 December 2015, and will go from $4,000 to $6,000 from 31 December 2016.
• Consolidate multiple superannuation fund accounts – consider consolidating multiple superannuation fund accounts. There may be legitimate reasons for keeping multiple accounts. Now is the time to reassess those reasons.
• Think about life expectancy – people are generally healthier and living longer than previous generations. Retired men can expect to live to 86, retired women to 90.

The list above is not exhaustive.

Practitioners may want to also review the ATO’s Key superannuation rates and thresholds publication for other considerations. The publication (last updated 18 September 2015) is available on the ATO website at: https://www.ato.gov.au/Rates/Key-superannuation-rates-and-thresholds/

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CURRENCY: This issue of Client Alert takes into account all developments up to and including 17 November 2015.

Tax negotiation limited to known debt amounts

Two corporate taxpayers have unsuccessfully applied to the Federal Court to have statutory demands set aside.

Facts

Two individuals, Mr C and Ms B, carried on property development activities in Western Australia through several entities, including the taxpayer companies. Mr C alleged that, in April 2014, he reached a “global deal” with the ATO to bring to an end debt recovery action against the companies if adequate security was provided. He claimed the ATO agreed not to issue statutory demands while objection and review proceedings were in process. However, he said the ATO then sought demands that were contrary to this oral agreement, including $8 million security from a related trust. He also claimed that ATO officers repeatedly threatened to issue statutory demands “to coerce implementation of the global deal and to obtain other benefits”.

Following the April 2014 meeting, the taxpayers entered into deeds of agreement with the ATO. In September 2014, after the taxpayers allegedly defaulted on the deeds, the Deputy Commissioner served statutory demands on the taxpayers pursuant to s 459E of the Corporations Act 2001. The taxpayers applied to the Federal Court to set aside the statutory demands under s 459J(1)(b) of the Corporations Act 2001 (which gives the Court the power to set aside a statutory demand “for some other reason”). The taxpayers claimed that the statutory demands were unconscionable and were not issued for a proper statutory purpose.

Decision

The Federal Court dismissed the taxpayers’ applications, finding that they failed to establish a proper basis for setting aside the statutory demands.

In the Court’s view, the taxpayers presented no probative evidence to support their allegation that the statutory demands were issued for any purpose other than to set in train winding-up proceedings against the companies for their unpaid taxation debts. The Court said it did not doubt that Mr C held a “genuine subjective belief” that he and the ATO had entered into a binding legal agreement that went beyond the terms of the deeds of agreement subsequently executed. However, the Court considered that Mr C’s subjective belief was not supported by either objective documentary evidence or by the evidence of the ATO representatives who attended the meeting, which it preferred.

The Court also found that there was no probative evidence to support the taxpayers’ claim that the statutory demands were issued for the improper purpose of coercing other entities to pledge security in respect of their disputed liabilities. The Court accepted the ATO’s evidence that the negotiations involved only “established debts” reflected in a spreadsheet that was used at the meeting and did not include further tax liabilities, including those of the trust.

Source: MNWA Pty Ltd v DCT (No 2) [2015] FCA 1128, www.austlii.edu.au/au/cases/cth/FCA/2015/1128.html

CGT roll-over for small business restructures on the way

The Government has released exposure draft legislation that proposes to provide roll-over relief for small businesses that change their legal structure. The proposed measures were announced in the 2015–2016 Federal Budget, and will apply to the transfers of assets occurring on or after 1 July 2016.

The proposed measures will insert new Subdiv 328-G into the ITAA 1997 to provide an optional roll-over where a small business entity transfers a business asset to another small business entity without changing the ultimate economic ownership of the asset. The roll-over can also apply to affiliates or entities connected with the small business entity for assets they hold that are used by the small business entity.

The roll-over will apply to gains and losses arising from the transfer of CGT assets, depreciating assets, trading stock or revenue assets between entities as part of a small business restructure. Discretionary trusts may be able to access the roll-over if the assets continue to be held for the benefit of the same family group.

Note that the proposed new roll-over is in addition to roll-overs currently available where a sole trader or partner in a partnership transfers assets to, or creates assets in, a company in the course of a business restructure.

Eligibility for the roll-over

The two types of entities that may be eligible for the roll-over are:

• small business entities in the income year in which the transfer takes place that satisfy the $6 million maximum net asset value (MNAV) test in s 152-10 or the $2 million “small business entity” turnover test in Subdiv 328-C. In this case, the entity may access the roll-over for CGT assets that are assets of the business carried on by the entity; and
• an affiliate of, or connected with, a small business entity for the income year that satisfies the MNAV test at the time of the transfer. These entities may access the roll-over in relation to CGT assets that satisfy requirements relating to passively held assets that are used by the small business entity in their business.

Effect of the roll-over

Under the proposed measures, the tax cost/s of the transferred asset or assets is rolled over from the entity that transferred the asset or assets (the transferor) to the entity to which the asset or assets are transferred (the transferee). This will be achieved by providing that:

• the transferor is taken to have received an amount which would result in them making neither a gain or loss under the transfer; and
• the transferee is taken to have acquired each asset for the amount that equals the transferor’s tax cost for the asset just before the transfer.

However, different costs apply to an asset depending on the asset, as follows:

• for CGT assets, the relevant cost for income tax purposes is the cost base of the asset, while pre-CGT assets will retain their pre-CGT status in the hands of the transferee. In relation to discount capital gains, a transferee receiving an asset under the roll-over is treated as having acquired the CGT asset either when the entity that owned the CGT asset before the roll-over acquired it or, if the asset has been involved in an unbroken series of roll-overs, when the entity that owned it before the first roll-over in the series acquired it;
• for trading stock, the roll-over cost for income tax purposes is the cost of the item for the transferor at the time of the transfer or, if the transferor held the item as trading stock at the start of the income year, the value of the item for the transferor at that time. In addition, the transferee will inherit the same cost attributes of the asset as the transferor just before the transfer. This is to ensure that any deductions claimed by the transferor up to the date of the transfer are taken into account;
• for revenue assets – to the extent that an asset is being assessed as a revenue asset – the roll-over cost is the amount that would result in the transferor not making a profit or loss on the transfer and the transferee will inherit the same cost attributes as the transferor just before the transfer; and
• for depreciating assets, the roll-over relief will be available for depreciating assets under s 40-340 to prevent an amount being included in or deducted from the transferor’s assessable income because of a balancing adjustment event. Instead, the transferee can deduct the decline in value of the depreciating asset of the depreciating asset using the same method and effective life (or remaining effective life as relevant) as the transferor was using.

Requirements for roll-over

The roll-over will be available where:

• the transferor transfers a CGT asset or all of its business assets that are CGT assets, depreciating assets, trading stock and revenue assets;
• the transferor chooses to apply the roll-over;
• the transaction is a restructure that has the effect of changing the type of any or all of the entities and/or the number of entities through which all or part of the business is operated;
• no consideration is provided for the transfer (as the ultimate economic ownership of any entity to which assets are transferred under the roll-over will not change);
• the transferor, transferee and the ultimate owners of the assets transferred are Australian residents;
• the transfer does not have the effect of changing the ultimate economic ownership of the asset or assets transferred; and
• the transferee is not an exempt entity or a complying superannuation entity, or none of the transferees are exempt entities or complying superannuation entities.

The roll-over also applies where a small business transfers assets as part of a restructure which either:

• changes the type of any or all of the entities through which all or part of the business is operated; or
• changes the number of the entities through which all or part of the business is operated.

Note also that each of the transferor, the transferee and the ultimate economic owners of the assets must be a resident of Australia in terms of the relevant residency test that applies to them (eg in relation to companies or trusts).

In relation to the requirement that the transaction “must not change the ultimate economic ownership of the transferred asset or assets”, the ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset. If there is more than one such individual, those individuals’ share of that ultimate economic ownership is unchanged, maintaining proportionate ownership in the asset. Where the transferor (or transferee) is an individual – such as a sole trader – the transferor (or transferee) will also be the ultimate economic owner of the asset transferred.

In the case of discretionary trusts, a transaction will be taken as not having the effect of changing the ultimate economic ownership of assets where:

• immediately before or after the transaction took effect, the asset was included in the property of a discretionary trust (a “non-fixed trust”) that was a family trust; and
• every individual who, just before or just after the transfer took effect, had ultimate economic ownership of the asset was a member of the family group of that family trust.

In this regard, the draft Explanatory Memorandum prefaces this rule by stating: “… discretionary trusts that have made a family trust election are administered for the benefit of a specified family group. For the purposes of the roll-over members of this group will be the ultimate economic owners of the business assets.”

Consequences for membership interests

Under the proposed roll-over, the cost base of membership interests in the transferor (eg shares in a company, units in a unit trust), if any, is reduced to the extent of any “transfer of value” from the transferor (but not below zero). This ensures that an owner of membership interests in a transferor entity cannot realise an artificial loss on disposal of those interests, following the reduction of value of the entity from the assets transferred.

For these purposes, the transfer of value is worked out by multiplying the “asset value” by the “membership interest percentage” for each asset transferred. The asset value is the market value of the asset transferred at the time of the transfer. The membership interest percentage is the proportion of the owner’s membership interests in the transferor, expressed as a percentage of all of the membership interests in the transferor. This ensures that the cost base of each owner’s membership interests is reduced in proportion to their membership interests in the transferor.

But note that this rule has no operation where no membership interests in the transferor exist, including where the transferor is a sole trader.

Date of effect

The proposed amendments will apply to transfers of assets occurring on or after 1 July 2016.

Comments

Comments are due by 4 December 2015.

Source: Treasury, “Small Business Restructure Rollover”, exposure draft legislation, 5 November 2015, www.treasury.gov.au/ConsultationsandReviews/Consultations/2015/Small-Business-restructure-rollover

ATO starts issuing “certainty” letters

The ATO announced on 6 October 2015 that it will commence a “certainty letter” initiative through which it will send letters to approximately 500,000 taxpayers informing them that their 2015 tax returns are finalised.

 

The aim of this initiative is to provide certainty to taxpayers who have met their tax obligations for the 2015 income year. Only select taxpayers who meet the following criteria can expect to receive the letters. Broadly these taxpayers have:

• straightforward tax affairs;
• a good lodgment and compliance history;
• lodged their income tax return through myTax, e-tax or a tax agent;
• taxable income of less than $180,000;
• derived income only from salary and wages, allowances, Australian Government allowances, interest and dividends; and
• claimed deductions for work-related expenses, interest, dividend deductions, gifts, donations or the cost of managing their tax affairs.

As this is only a pilot program, not all taxpayers who meet the above criteria will receive a certainty letter. It is noted that the ATO considers taxpayers with straightforward affairs as those with no links to other entities. This means that certain taxpayers (such as beneficiaries of trusts) would not expect to receive a “certainty letter”. Regardless of whether the letter is received, all taxpayers are still required to maintain accurate and detailed tax records for their 2015 tax returns.

The ATO has indicated that it will use sophisticated data-matching techniques and third party sources (eg banks and other financial institutions) to carry out routine checks on the information disclosed in the 2015 tax returns prior to issuing the letters. Accordingly, taxpayers who receive certainty letters should not be subject to further review or audit for their 2015 tax returns, unless the ATO later becomes aware that there may have been fraud or evasion. In such circumstances, the certainty letters will be void.

This pilot program will cover the 2015 tax return only and therefore does not preclude the ATO from undertaking an audit on earlier income tax returns. Furthermore, the certainty letters do not prevent taxpayers from amending their 2015 returns. However, once a return is amended, comfort letters may be reconsidered. The ATO will also still retain the discretion to amend returns in cases of fraud or evasion. As such, while certainty letters may provide some comfort as to taxpayers’ standing with the ATO, they do not provide 100% certainty in all situations.

Take home messages

Whilst this initiative is welcomed because of its aim to provide taxpayers with greater certainty in relation to their tax obligations, this is only a pilot program and not every taxpayer who meets the criteria will receive a letter. Those who receive the letter will have “peace of mind” in relation to their 2015 tax obligations. On the other hand, taxpayers who do not receive a certainty letter should not worry as this does not mean that there is necessarily anything wrong with their tax return.

It remains to be seen how the letters will operate in practice, particularly if the Commissioner will change his position on the issued letter when taxpayers amend their 2015 tax return or if the Commissioner relies on the concept of fraud or evasion to invalidate the certainty letter. It would appear that, depending on the success of the pilot program, this initiative could potentially become part of the ATO compliance program.

Source: ATO media release, “Half a million taxpayers to get the A-OK”, 6 October 2015, https://www.ato.gov.au/Media-centre/Articles/Half-a-million-taxpayers-to-get-the-A-OK/

Government rejects SMSF borrowing ban recommendation

Direct borrowings by superannuation funds via limited recourse borrowing arrangements (LRBAs) are safe (at least for the next three years), following the Government’s decision to reject the Murray Financial System Inquiry (FSI) recommendation to ban or restrict LRBAs. This is welcome news for trustees of self-managed superannuation funds (SMSFs) who have faced uncertainty about the future of such borrowing arrangements which have become popular for investments in direct property and shares.

The final report of the Murray Inquiry, previously released in December 2014, included a recommendation to restore the general prohibition on direct borrowings by superannuation funds by removing the current exception for LRBAs in s 67A of the Superannuation Industry (Supervision) Act 1993 on a prospective basis.

In releasing its response on 20 October 2015, the Government said that it did not agree with this recommendation. While the Government noted that there are “anecdotal concerns” about LRBAs, it said the data is not sufficient to justify a significant policy intervention at this time.

However, the Government said it will commission the Council of Financial Regulators and the ATO to monitor leverage and risk in the superannuation system and report back to Government after three years. According to the Government, this timing will allow recent improvements in ATO data collection to wash through the system. The agencies’ analysis will be used to inform any consideration of whether changes to the borrowing rules might be appropriate at a future date.

So what are the SMSF borrowing stats?

The most recent ATO statistics estimated that SMSFs held $15.6 billion in LRBAs as at June 2015 (ie only 2.6% of the total SMSF assets of $590 billion): see the ATO’s Self-managed super fund statistical report – June 2015, released in September 2015. The ATO notes that these figures are estimates based on SMSF tax return data. Changes were made to the 2012–2013 SMSF tax return to improve reporting on LRBAs. As more data becomes available from subsequent tax returns, the ATO expects to be able to provide more accurate estimates.

Note also that ATO statistics (see the ATO’s SMSF statistical overview for 2012–2013, released in December 2014) provided a more detailed breakdown of LRBA assets by value. It suggested that the bulk of LRBAs were invested in commercial real property (47%), followed by residential property (42%) and Australian shares (5%). However, that 2012–2013 data was based on less reliable data (prior to the 2012–2013 changes to the SMSF tax return).

Proceed with caution!

Despite the Government’s “green light” for LRBAs, a decision to establish an SMSF and invest in property using an LRBA is not one to be taken lightly. A borrowing arrangement is only permitted where it complies with the strict rules under superannuation law – namely, the Superannuation Industry (Supervision) Act 1993. This means that each step in the process of establishing an SMSF, putting in place an LRBA (and the property investment itself), must strictly comply with the full range of superannuation rules.

Before committing to purchase a property via an LRBA, an SMSF trustee will need to employ a methodical approach (generally with the assistance of a licensed professional) to ensure compliance with the tax and superannuation borrowing rules. To this end, it would be prudent to identify any possible LRBA issues that should be considered before committing to purchase a property via an SMSF.

Source: Government response to the Financial System Inquiry, “Improving Australia’s Financial System”, 20 October 2015, www.treasury.gov.au/~/link.aspx?_id=194A2D59EB6F4F9A8B09ACC059978F47&_z=z

Car expenses and FBT concessions on entertainment

The Tax and Superannuation Laws Amendment (2015 Measures No 5) Bill 2015 has been introduced. The Bill proposes the following amendments:

Work-related car expenses

The Bill proposes to repeal the 12% of original value method and the one-third of actual expenses method. That is, subdivs 28-D and 28-E of the ITAA 1936 will be repealed. Taxpayers will continue to be able to choose to apply the cents-per-kilometre method (for up to 5,000 business kilometres travelled), or the logbook method, depending on which method in their view best captures the actual running costs of their vehicle.

According to the Government, the changes are not expected to adversely affect the vast majority of taxpayers who it says currently use the two methods that will be retained. Citing ATO figures, the Government says the removal of the two methods is expected to affect only 2% of taxpayers.

The Bill also proposes to provide a streamlined process for calculating the cents-per-kilometre method by providing a single rate of deduction. That is, the current three rates based on vehicle engine capacity will be replaced with a single rate of deduction. In the 2015–2016 income year, the rate will be set at 66 cents per kilometre. This rate is said to represent the average per-kilometre running cost of the top five selling cars (a mix of small to large cars) in Australia.

The Commissioner will be provided with the power to set the cents-per-kilometre rate for later years via legislative instrument. When setting the rate of deduction, the Commissioner is to take into account the average running costs of a car. The Commissioner should consider the fixed and variable costs of operating a vehicle including such matters as fuel costs, servicing costs and the cost of replacing tyres, registration and insurance expenses. The Commissioner, at his or her discretion, may determine more than one rate if he or she wishes to set different rates for different classes of car in later income years. The Commissioner is to also publish the rate at the beginning of the income year. This will enable taxpayers to make a more informed choice between the logbook method or the cents-per-kilometre method, depending on which method they feel better captures the running costs of their vehicle.

The changes may affect the way untaxed allowances are calculated. For example, if an employer currently pays their employee an allowance in respect of their motor vehicle use and the allowance is calculated using one of the methods which will be repealed by this Bill, the employer will need to update the method of calculating the allowance. Further, if the rate of the allowance paid by an employer is higher than 66 cents per kilometre, then the employee will need to report this allowance in their tax return. The employee will be entitled to claim a deduction for the amount, up to 66 cents per kilometre, and be subject to tax on amounts exceeding 66 cents per kilometre. Alternatively, an employee may utilise the logbook method to claim for their work-related car expenses.

Note that there will be minor consequential amendments to the FBTAA 1986 to, among other things, remove references to the two methods to be repealed.

Date of effect

The amendments are proposed to apply to the 2015–2016 income year and later income years. Note that consequential amendments to the FBTAA 1986 will apply from 1 April 2016 and later FBT years.

FBT concessions on salary packaged entertainment benefits

The Bill proposes amendments to the FBTAA 1986 to introduce a separate grossed-up cap of $5,000 for salary sacrificed meal entertainment and entertainment facility leasing expenses for certain employees of not-for-profit organisations, and all use of these salary sacrificed benefits will become reportable.

The Bill proposes to limit the concessional treatment of salary packaged entertainment benefits by:

• removing the reporting exclusion in respect of salary packaged entertainment benefits. This ensures salary packaged meal entertainment and entertainment facility leasing expense benefits will always appear as part of an employee’s reportable fringe benefits total which is included on their payment summaries;
• removing access to elective valuation rules when valuing salary packaged entertainment benefits to prevent unintended and excessively concessional values being applied to those benefits; and
• introducing a cap on the total amount of salary packaged entertainment benefits that employees can be provided by exempt employers (covered by s 57A) and rebatable employers (covered by s 65J) that are subject to a reduced amount of FBT.

Key features of the proposed new law:

• Meal entertainment benefits and entertainment facility leasing expense benefits will be only excluded from forming part of an employee’s individual fringe benefits amount and reportable fringe benefits total where they are not provided under a salary packaging arrangement.
• An employer can elect to calculate the taxable value of all meal entertainment benefits under the 12-week register method or the 50/50 split method. However, the methods do not apply to calculate the taxable value of meal entertainment benefits not provided by an employer or where the benefit is provided under a salary packaging arrangement.
• An employer can elect to calculate the taxable value of all entertainment facility leasing expense benefits under the 50/50 split method. However, the method will not apply to calculate the taxable value of entertainment facility leasing expense benefits provided under a salary packaging arrangement.
• Employers covered under s 57A (public benevolent institutions, health promotion charities, public and not-for-profit hospitals, and public ambulance services) are exempt from FBT where the total grossed-up value of benefits provided to each employee during the FBT year is equal to, or less than, the capping threshold (the standard threshold is either $30,000 or $17,000 depending on the employee and employer). If the total grossed-up value of fringe benefits provided to an employee is more than that capping threshold, the employer will need to pay FBT on the excess.

–        However, in calculating the value of fringe benefits for the purposes of the capping threshold non-salary packaged entertainment benefits (amongst other benefits) will not be taken into account.

–        Salary packaged entertainment benefits currently excluded will be included in the standard capping threshold. If, however, the total value of fringe benefits for the purposes of the standard capping threshold is exceeded in a particular year, it is raised by the lesser of: $5,000 and the total grossed-up taxable value of salary packaged entertainment benefits.

• Rebatable employers are entitled to have their FBT liability reduced by a rebate equal to 47% of the gross FBT payable (subject to a $30,000 standard capping threshold). If the total grossed-up taxable value of fringe benefits provided to an employee is more than $30,000 a rebate cannot be claimed for the FBT liability on the excess amount.

–        However, in calculating the value of fringe benefits for the purposes of the capping threshold non-salary packaged entertainment benefits (amongst other benefits) will not be taken into account.

–        Salary packaged entertainment benefits currently excluded will be included in the standard capping threshold. If, however, the total value of fringe benefits for the purposes of the standard capping threshold is exceeded in a particular year, it is raised by the lesser of: $5,000 and the total grossed-up taxable value of salary packaged entertainment benefits.

Date of effect

The amendments are proposed to apply to the 2016–2017 FBT year and all later FBT years.

Other changes proposed

Other amendments contained in the Bill are as follows:

• Third party reporting – proposes to amend Sch 1 to the TAA to increase the information reported to the Commissioner of Taxation by a range of third parties. Under the changes, third parties will be required to report, among other things, payments of government grants, consideration provided for services to government entities, transfers of real property, etc. Date of effect: applies to some transactions that happen on or after 1 July 2016 and other transactions that happen on or after 1 July 2017. Several minor amendments are proposed to apply from Royal Assent.
• Zone Tax Offset (ZTO) – proposes to amend the ITAA 1936 to ensure that the ZTO is appropriately targeted to people genuinely living in the designated geographical zones by limiting access to the ZTO to those people whose usual place of residence is within a zone. Date of effect: applies to the 2015–2016 year of income and later years of income.

Source: Tax and Superannuation Laws Amendment (2015 Measures No 5) Bill 2015, parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;page=0;query=BillId%3Ar5536%20Recstruct%3Abillhome