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

Small business tax review finds first steps for improvement

On 20 January 2015, the Government announced the release of the Board of Taxation’s report on taxation impediments to the success and growth of small business, together with the Government’s response to that report. The Board had provided its report to the Government at the end of August 2014.

The Government said it wants to simplify small business interactions with the tax system and make Australia one of the best places to start and grow a business. The 126-page report focused on short and medium-term priorities for small business tax reform, with a particular focus on simplifying processes and cutting red tape.

The Board’s recommendations included the following:

• That the ATO revise Miscellaneous Taxation Ruling MT 2006/1 and other guidance material to include activities which will evidence that an applicant is intendingto carry on an enterprise and is therefore eligible for an ABN.

–        The report said the additional activities should be typical of the kinds of things, from a practical perspective, that a person may do prior to actually carrying on an enterprise but are not currently within the guidance material;

–        further, the activities should be able to be selected from a list as part of the ABN application process;

–        specifically, the Board recommended the online ABN application tool ask whether the applicant intends to carry on an enterprise, followed by a drop-down menu with the extended list of activities that confirm an applicant’s eligibility for an ABN.

In its response, the Government noted that the ATO had already taken steps to implement this recommendation, and is already working to deliver improvements to the ABN online registration facility that will make it easier for start-up businesses to self-assess their entitlement to an ABN.

• That the ATO review its employee/contractor tool.
• That the ATO should continue to develop a prototype online decision tool relating the personal services income (PSI) rules. The Board also recommended that:

–        the tool should go further than just working through the PSI tests; it should – where possible –incorporate material that clarifies what the results mean for the taxpayer;

–        furthermore, where the PSI tool is used in good faith, the tool should provide a decision that will provide protection from the imposition of penalties where the user relies on the outcome.

In its response, the Government said the recommendation is in the process of being implemented by the ATO, with consultation on a prototype having commenced in August 2014.

• That the ATO, and its relevant advisory groups, review whether the quarterly reporting obligations for small businesses could be significantly simplified.
• The alignment of the 21 July Taxable Payments Reporting System (TPRS) reporting date with the 28 August BAS lodgment date to the latter date.
• That the small business entity turnover threshold be increased to at least $3 million, including investigating the feasibility of an increase to $5 million. In its response, the Government said it would consider small business taxation in the context of the Tax White Paper.
• An increase to the “minor and infrequent” FBT threshold from $300 to at least $500. In its response, the Government said it would consider FBT in the context of the Tax White Paper.
• That there be an investigation of the possibility of aligning the FBT year to the income tax year. In its response, the Government said it would consider FBT in the context of the Tax White Paper.
• That the superannuation guarantee charge (SG charge) is calculated on the basis of ordinary time earnings (OTE), rather than salary and wages, to align with the way superannuation contributions are calculated. While OTE is a more complex definition, it would mean no change to employers’ current calculations. In its response, the Government said it supports this recommendation and has agreed to implement this proposal from 1 July 2016 as part of the package of reforms to be implemented to reduce small business superannuation compliance costs. The Government will consult with stakeholders on implementation details.
• That the calculation of the SG charge components be redesigned by legislation. In its response, the Government said it supports this recommendation and has agreed to simplify and reduce the severity of the SG Charge with effect 1 July 2016 as part of the package of reforms to be implemented to reduce small business superannuation compliance costs. The Government will consult with stakeholders on implementation details.
• That the SG charge and any employer contributions paid to a superannuation fund that are used to offset the SG Charge payable should be deductible to the employer when the amounts are paid.The Government said it does not support this recommendation. The Government has agreed to reduce the severity of the current SG Charge arrangements and, in the context of these changes, considers that retention of non-deductibility is important to deter non-compliance.
• The Board recommended allowing employers to assess superannuation obligations for employees against a quarterly threshold of $1,350 (currently, the threshold is $450 per month). Employers who do not wish to change their current systems and processes would still meet their superannuation obligations if they continue to test on a monthly basis. The Board said it recognised that this may exclude some low-income earners from superannuation coverage. However, it considered it would reduce compliance costs for small businesses, particularly for those with a large number of short-term casual employees. The Government said it does not support this recommendation. It said the proposal could reduce superannuation for some low-income earners and would not reduce compliance costs for the majority of small business that pay their superannuation guarantee monthly.

On medium- to longer-term reforms, the Board said it considers a more fundamental review of the small business CGT concessions is warranted given the potential for significant simplification and reduction in compliance costs.

The Board said a more complex issue unlikely to be resolved in the short- or medium-term is whether tax treatment should be consistent regardless of business structure or entity type. Recognising that this would be a very difficult and complex review, the Board considers it should be reviewed given the substantial benefits it could provide. A related issue is the taxation of trusts which, although is relevant across the business sector, presents particular challenges for small businesses as it is a common entity used by them.

The Small Business Minister and the Assistant Treasurer said the report will also be an important input to the Government’s broader considerations on small business taxation and is particularly timely ahead of the Government’s release of its Tax White Paper.

Source: Small Business Minister’s media release, 20 January 2015, http://bfb.ministers.treasury.gov.au/media-release/005-2015; Board of Taxation’s Review of Tax Impediments Facing Small Business paper, http://taxboard.gov.au/content/content.aspx?doc=reviews_and_consultations/impediments_facing_small_business/default.htm&pageid=007; Government’s response to Board of Taxation report, 20 January 2015, http://taxboard.gov.au/content/reviews_and_consultations/impediments_facing_small_business/report/downloads/govt_response.rtf.

Valuation reports for tax purposes could be easier

The Assistant Treasurer Josh Frydenberg released, on 19 January 2015, the Inspector-General of Taxation’s report into the ATO’s administration of valuation matters. He said valuation requirements have been an area of ongoing concern for taxpayers. In his 129-page report, the Inspector-General has identified inherent difficulties associated with the nature and associated costs of valuations. Given these issues, the Inspector-General has made nine recommendations to the ATO, almost all of which the ATO has agreed to, aimed at taking a more practical and transparent approach to assessing taxpayer valuations and developing administrative safe harbours. They are largely aimed at preventing disputes from arising by, for example, the ATO adopting a more transparent and proportionate approach to challenging taxpayer valuations and allowing some divergence in valuations where they are purely attributable to the differing professional judgment of each party’s valuer.

Specifically, the IGT has recommended that the ATO:

• risk-assess taxpayers’ instructions to valuers during pre-lodgment processes;
• develop a preliminary risk assessment process as a less costly and less formal alternative to a valuation critique;
• use legal and valuation expertise to assist in issue identification, information gathering and instructing valuers, as well as staff training;
• revise its standard template for instructing valuers;
• allow taxpayers access to the ATO’s instructions to its valuers; and
• only use publicly available information or information that can be disclosed to the taxpayer in arriving at its market valuations.

The IGT has also recommended that the ATO improve and promote the market valuation private ruling system, which can offer taxpayers greater certainty, as well as provide more detailed guidance on the application of valuation-related penalties. While the ATO agreed with this, it said it would not be able to bear the cost.

The report says disputes between taxpayers and the ATO may be purely attributable to differences in the professional judgment of each party’s valuer. In these circumstances, given the nature of the self-assessment regime, the IGT is of the view that the taxpayer’s valuation should be accepted notwithstanding that it is not exactly the same as the ATO’s valuation. Accordingly, the IGT has recommended that the ATO provide guidance to its compliance officers to help them determine when to accept a taxpayer’s valuation.

The Government welcomed the recommendations, including the ATO’s commitment to develop a standard template for instructing valuers, which contribute to cutting red tape and reducing compliance costs for taxpayers.

The Inspector-General has also made three recommendations for the Government’s consideration. They seek to limit the need to conduct valuations particularly for small businesses, and include the following:

• valuations only where it has the “highest net benefit”;
• shortcuts or safe harbours as an alternative to conducting fresh and full valuations;
• consultation on ways to reduce reliance on valuations to access small business CGT concessions; and
• tapering the eligibility criteria for tax concessions.

The Government said it will give full consideration to these recommendations, noting that the upcoming Tax White Paper will be an opportunity to provide a longer-term, considered approach to tax reform.

Source: Assistant Treasurer’s media release, 19 January 2015, http://jaf.ministers.treasury.gov.au/media-release/004-2015/; Inspector-General of Taxation’s Review into the Australian Taxation Office’s administration of valuation matters, http://www.igt.gov.au/content/reports/ato_valuation/downloads/ATO_valuation.pdf.

Employee share scheme tax law changes on the way

On 14 January 2015, The Government released draft legislation and draft regulations designed to improve the taxation arrangements for employee share schemes (ESS). Public consultation closed on 6 February 2015.

Currently, for ESS interests acquired after 30 June 2009, the ESS tax rules contained in Div 83A of the ITAA 1997 apply.

The proposed amendments to the ITAA 1997 (primarily Div 83A) would:

• reverse some of the changes made in 2009 to the point at which rights issued as part of an employee share scheme are taxed for employees of all corporate tax entities;
• introduce further tax concessions for employees of certain small start-up companies; and
• allow the ATO to work with industry to develop safe harbour valuation methods, supported by standardised documentation that will streamline the process of establishing and maintaining an employee share scheme for businesses. The ATO has commenced consultation with stakeholders to identify appropriate safe harbour methodologies and develop standardised documentation.

Currently, where an ESS right is subject to deferred taxation, the taxing point occurs at the earliest of one of the following times:

• when the employee ceases the employment in respect of which they acquired the right;
• seven years after the employee acquired the right;
• when there are no longer any genuine restrictions on the disposal of right (eg being sold), and there is no real risk of the employee forfeiting the right; or
• when there are no longer any genuine restrictions on the exercise of the right, or resulting share being disposed of (such as by sale), and there is no real risk of the employee forfeiting the right or underlying share.

In ESS deferred schemes where income tax is deferred, the proposed amendments would make the taxing point the earliest of the following:

• For shares:

–        when there is no real risk of forfeiture of the shares and any restrictions on the sale are lifted;

–        when the employee ceases employment; or

–        15 years after the shares were acquired.

• For rights:

–        when there is no risk of forfeiture of the rights and any restrictions on the sale are lifted;

–        when the employee exercises the rights;

–        when the employee ceases employment; or

–        15 years after the rights were acquired.

Small start-ups

Under other proposed amendments, employees of certain small start-up companies would receive further concessions when acquiring certain shares or rights in their employer or a holding company of their employer. These further concessions would be an income tax exemption for the discount received on certain shares and the deferral of the income tax on the discount received on certain rights which are instead taxed under the CGT rules.

New valuation tables

It is also proposed that the Income Tax Assessment Regulations 1997 be amended to replace the valuation tables set out in subregs 83A 315.08(1) and 83A 315.08(1) of the Regulations. Specifically, the purpose of the proposed amending Regulation is to amend the existing ESS taxing rules by updating the safe harbour option valuation tables to reflect current market conditions. The amendments would apply to ESS interests acquired on or after 1 July 2015.

CGT amendments

In terms of the proposed CGT amendments, where the discount on the ESS interest does not need to be included in the employee’s assessable income because it is considered “small” (ie in the case of shares, where the discount is less than 15% of the market value of the share when acquired and, in the case of rights, at the time they are acquired, the exercise price is equal to or greater than the market value of an ordinary share in the company), then the CGT consequences are as follows:

• for a share, it will be subject to CGT with a cost base reset at market value;
• for a right, once the resulting share is acquired, it will be subject to CGT with a cost base equal to the employee’s cost of acquiring the right.

Reducing compliance costs

The proposed amendments also support the ATO in working work with industry to develop and approve safe harbour valuation methods to improve certainty and reduce compliance costs in maintaining an ESS. The amendments would introduce a new power for the Commissioner to approve market valuation methodologies. Approved methodologies will be binding on the Commissioner but the taxpayer remains able to choose another methodology if they believe the alternate methodology is more appropriate in their circumstances.

The ATO will also work with industry and ASIC to develop standardised documentation that will streamline the process of establishing and maintaining an ESS. The standard documentation will be issued under the Commissioner’s general powers of administration.

Proposed date of effect

The proposed amendments would apply to ESS interests acquired on or after 1 July 2015. The current law would continue to apply to ESS interests acquired before 1 July 2015. The Commissioner’s safe harbour market valuation methodologies would apply from the date specified by the Commissioner in a legislative instrument.

Source: Treasury, Improvements to the taxation of employee share schemes, draft legislation and accompanying materials, 14 January 2015, www.treasury.gov.au/ConsultationsandReviews/Consultations/2015/Improvements-to-the-taxation-of-employee-share-schemes.

ATO code of settlement

The ATO released its code of settlement as Practice Statement PS LA 2015/1 on 15 January 2015. The code sets out the ATO policy on the settlement of tax and super disputes including disputes involving debt. It states that settlement negotiations or offers can be initiated by any party to the dispute and can occur at any stage, including prior to assessments being raised.

The ATO notes that when deciding whether or not to settle, it will consider all the following factors:

• the relative strength of the parties’ position;
• the cost versus the benefits of continuing the dispute; and
• the impact on future compliance for the taxpayer and broader community.

According to the ATO, settlement would not generally be considered in situations where there is a contentious point of law which requires clarification, or when it is in the public interest to litigate, or when the taxpayer’s behaviour is such that the ATO needs to send a strong message to the community.

The ATO says its decision to settle must be fair, effective, and efficient. It says the decision will also be based on an informed understanding of relevant facts and issues in dispute, and on any advice of a settlement advisory panel, or legal or other expert opinions. In addition, the ATO notes that a settlement can only be approved by an officer who has delegation or authorisation to do so.

The settlement itself must be finalised by the parties signing a written agreement which sets out the terms, the ATO says. Further, it says a settlement agreement will only be varied in exceptional circumstances if requested by the taxpayer who is party to the agreement.

The ATO notes that it has model deeds available to use as a basis for a deed of settlement. It has also released a practical guide to the code of settlement that provides examples and illustrations of how the code operates. These are available, respectively, at the following sites:

• https://www.ato.gov.au/General/Correct-a-mistake-or-dispute-a-decision/In-detail/Avoiding-and-resolving-disputes/Settlement/Model-settlement-deeds.
• https://www.ato.gov.au/General/Correct-a-mistake-or-dispute-a-decision/In-detail/Avoiding-and-resolving-disputes/Settlement/A-practical-guide-to-the-ATO-code-of-settlement.

In relation to future years, the ATO says a settlement agreement provides a reasonable basis for treating similar issues unless it is specifically stated that the agreement does not apply to future years or transactions, or the following:

• the taxpayer’s circumstances change materially;
• the application of the law remains unclear;
• there have been subsequent amendments to the law;
• a taxation ruling has been subsequently released on the issue; and
• there has been a subsequent court or tribunal decision on the issue.

Where required, the ATO notes that it can provide greater certainty to taxpayers for future years.

Source: ATO, Practice Statement PS LA 2015/1, http://law.ato.gov.au/pdf/psr/ps2015-001.pdf.

Court confirms tax on transfer of land to joint-venture trust

The Full Federal Court has unanimously dismissed a taxpayer’s appeal and confirmed that a transaction effecting the transfer of land from the taxpayer to a joint-venture trust for the purposes of redevelopment was a “resettlement” that triggered CGT event E1. It also confirmed that the exception for “no change in the beneficial ownership of a CGT asset” did not apply in the circumstances.

Background

The taxpayer was a corporate trustee that acquired land in Melbourne in 1995 for some $8.5 million including stamp duty and other costs. In 1997, it began discussions with owners of adjoining land with the idea of commercially developing the combined lots and selling them off. In August 1998, the taxpayer and the adjacent landholders executed a joint venture agreement (JVA) for this purpose with the effect that a “joint venture trust” was created over the land held by the parties. Importantly, the JVA required the conveyance of the taxpayer’s land to the trust.

The Commissioner later assessed the taxpayer for the capital gain made on the transaction (by reference to the land’s cost base and its market value at the time of the transaction) on the basis that “the taxpayer ceased to be the absolute owner of land and became entitled, together with the adjacent landholders, as tenants in common in equity collectively to an interest in the whole of the land which the taxpayer had previously owned separately” and that “as such, a new trust was created for the purposes of the joint venture and was completed by the transfer of the parcels of land to the trustee”.

The taxpayer argued there had not been the requisite change in the beneficial ownership of the land as required by CGT event A1, CGT event E1 or CGT event E2 of the ITAA 1997, and that if any of those events did apply, then the relevant exceptions in those events for “no change in the beneficial ownership” of an asset operated. The taxpayer also argued that other provisions in the CGT law applied to exclude the transaction from CGT (eg s 106-50 dealing with absolutely entitled beneficiaries). In the alternative, the taxpayer argued that the market value of the land at transfer was equivalent to its cost base.

At first instance in Taras Nominees Pty Ltd v FCT [2014] FCA 1, the Federal Court held that the taxpayer had effected the disposal of land to the “joint-venture trust” by way of a “resettlement”. It therefore found that CGT event E1 (and CGT event A1) applied to the transaction and that the exception for “no change in the beneficial ownership of a CGT asset” did not apply in the circumstances. It also dismissed the taxpayer’s claim that the market value of the land at transfer equated with its cost base.

On appeal, the taxpayer challenged the finding that a “settlement” of the land had occurred for the purposes of triggering CGT event E1, as well as certain calculation issues.

Decision

In unanimously confirming that such a “settlement” had occurred, the Full Federal Court first noted that a “key indicator” of a settlement was “the vesting of property in a trustee for the benefit of others”. It then found that in terms of the relevant trust deed and the JVA between the parties, the taxpayer had divested itself of legal title to the land and subjected its equitable interests in the land to the joint venture trust for the benefit of others (in addition to itself). In short, the Court concluded that there had not been a declaration that the land was held on trust for the benefit of the taxpayer alone but rather to give effect to the JVA for the benefit of all the parties.

As a result of this finding, the Court also confirmed that the settlement of the land was not excluded from the CGT Event E1 (or CGT event A1) exclusions. This was because the taxpayer was not the sole beneficiary of the joint venture trust. Further, it found that the taxpayer was not absolutely entitled to the land as against the joint venture trustee because it did not have a vested, indefeasible and absolute entitlement to the land and could not deal with the land other than in accordance with the rights and obligations which had been created by the trust deed and the JVA.

The Full Court also confirmed that CGT event A1 also applied to the transaction for the same “reasons for concluding that CGT event E1 happened” – namely, that there was a change of ownership of the land from the taxpayer to the trustee of the “joint-venture trust” brought about by the resettlement. Specifically, the Court said that CGT event A1 occurred because there was a change of ownership by transfer of the land as the taxpayer was no longer the sole beneficial owner of the land upon its transfer to the trustee pursuant to the terms of the trust deed and the JVA.

Finally, the Court dismissed the taxpayer’s claim that “the taxing provisions of the 1997 Act should be interpreted so that no taxable gain could arise in circumstances where [it] had not received any capital proceeds from a CGT event”. It also confirmed that $5.5 million of development costs were correctly included in the market value of the land in determining the capital proceeds for the event – albeit subject to a favourable adjustment to the taxpayer for the cost base of the land to reflect half of the development costs it incurred by way of improving the land.

[Note that before the Federal Court handed down its decision at first instance, the Court of Appeal of the Supreme Court of Victoria in Commissioner of State Revenue v Victoria Gardens Developments Pty Ltd (2000) 46 ATR 61 held that the taxpayer was liable for stamp duty on the transaction on the basis there was an immediate change in the beneficial ownership of the land transferred to the “joint venture trust”. At the same time, the Court assessed the stamp duty on the basis that the transfer had taken place by reference to the land’s (then) market value of some $17 million.]

Taras Nominees Pty Ltd v FCT [2015] FCAFC 4, www.austlii.edu.au/au/cases/cth/FCAFC/2015/4.html.

Personal services income when no service is provided

Taxation Determination TD 2015/1 states that a payment received by a personal services entity (PSE) from a service acquirer during a period the service provider is not providing services to the acquirer until further called upon, is personal services income (PSI) within the meaning of s 84-5(1) of the ITAA 1997.

For the purposes of this Determination, the ATO provided the following definitions:

• personal services entity is an entity within the meaning of s 86-15(2), ie a company, partnership or trust whose ordinary statutory income includes the personal services income of one or more individuals;
• service acquirers are entities that acquire the personal services of an individual directly from the individual or through a PSE;
• service providers are the relevant individual in respect of who the definition of PSI in s 84-5(1) is being applied.

The TD says it might be thought that a payment made by a service acquirer to a PSE during a period in which the service provider is not called upon to do anything is not PSI as defined because the payment appears to be in consideration for doing nothing. On this view, the ATO says a payment made during a period of paid leave would not be personal services income. However, the ATO considers that such a view is “clearly not in accord with the intention of the legislature given the alienation measure is targeted at salary-like payments”. The ATO notes that the Second Reading speech to the New Business Tax System (Alienation of Personal Services Income) Bill 2000, for example, states that the object of the measure is to “treat earnings from work in the same way under the income tax law, regardless of the legal structure used by the income earner”.

According to the TD, payments under a contract of retainer are also intended to come within the meaning of PSI in s 84-5(1). So much is clear from para 7.15 of the EM to Taxation Laws Amendment Bill (No 6) 2001, which inserted s 87-40 of Pt 2-42, which relevantly states:

“… At least 75% of the agent’s personal services income from the principal must be income based on the agent’s performance in providing services to the customers on the principal’s behalf, such as a percentage of income generated or fees for service. The agent may have up to 25% fixed remuneration, such as retainer or salary like payment, and may still satisfy these conditions …”

The ATO also considers that payments made during a period of “gardening leave” are not materially different to those paid under a retainer. They enable the service acquirer to continue to call upon the skills of the service provider and as such constitute PSI within the meaning of s 84-5(1) [the proviso is that unless the contract expressly terminates the right to continue to call upon the service provider’s skills (which may, in turn, bring the employment contract to an end)].

The Determination includes an example in which a sole director/shareholder (“Jim”) provides his expertise and skills to a client company for a flat monthly contractual fee that is non-contingent. During a specified period, a dispute arises between Jim and the client company which results in no work being performed for the period. However, Jim is still paid the monthly contractual fee. According to the ATO, the monthly fee during the dispute period is considered to be personal services income under s 84-5(1) notwithstanding that the client company did not call upon Jim to undertake further services.

The Determination was previously issued as Draft Taxation Determination TD 2014/D15 and is the same.

Date of effect

Applies both before and after its date of issue (ie 28 January 2015).

Source: ATO, Taxation Determination TD 2015/1, http://law.ato.gov.au/atolaw/view.htm?docid=%22TXD%2FTD20151%2FNAT%2FATO%2F00001%22.

Important: Clients should not act solely on the basis of the material contained in Client Alert. Items herein are general comments only and do not constitute or convey advice per se. Also changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of the areas. Client Alert is issued as a helpful guide to clients and for their private information. Therefore it should be regarded as confidential and not be made available to any person without our prior approval.