Monthly tax training notes - July 2016

Brown Wright Stein tax partners: Andrew Noolan E: [email protected] P: 02 9394 1087 Chris Ardagna E: [email protected] P: 02 9394 1088 Geoff Stein E: [email protected] P: 02 9394 1021 Michael Malanos E: [email protected] P: 02 9394 1024 TAX TRAINING NOTES Monthly tax training July 2016 www.bwslawyers.com.au Brown Wright Stein Lawyers Level 6, 179 Elizabeth Street Sydney NSW 2000 P 02 9394 1010 1 Cases......................................................................................................................................................4 1.1 D Marks Partnership – limited partnership...........................................................................................4 1.2 Millar – sham and withholding..............................................................................................................8 1.3 Fowler – small business entity .......................................................................................................... 11 1.4 Rowntree – loans or ordinary income ............................................................................................... 13 1.5 Anjum's Air-conditioning – whether voluntary disclosure made........................................................ 16 1.6 FLZY – revenue and capital.............................................................................................................. 18 1.7 Oswal No. 6 –intention to defraud creditors...................................................................................... 21 2 Legislation .......................................................................................................................................... 25 2.1 Progress of legislation....................................................................................................................... 25 2.2 Foreign resident CGT withholding .................................................................................................... 25 2.3 NSW State Budget 2016-17.............................................................................................................. 25 3 Rulings ................................................................................................................................................ 26 3.1 Foreign CGT withholding: ATO's variation power............................................................................. 26 3.2 Foreign resident CGT withholding: amount payable to ATO............................................................ 26 3.3 Foreign resident CGT withholding regime: options........................................................................... 28 4 Determinations................................................................................................................................... 30 4.1 Division 7A benchmark interest rate ................................................................................................. 30 4.2 Improvement threshold ..................................................................................................................... 30 4.3 Refunds of increasing adjustments................................................................................................... 30 5 ATO materials..................................................................................................................................... 32 5.1 Foreign resident CGT withholding forms .......................................................................................... 32 5.2 Mutuality and taxable income ........................................................................................................... 32 5.3 Foreign investment in Australia – Land registration form ................................................................. 32 www.bwslawyers.com.au Monthly tax training – July 2016 About Brown Wright Stein Brown Wright Stein is a medium-sized commercial law firm based in Sydney. 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Liability limited by a scheme approved under Professional Standards Legislation Monthly tax training – July 2016 1 Cases 1.1 D Marks Partnership – limited partnership Facts On 29 August 2003 Quintaste Pty Ltd was incorporated and on 23 September 2003 the Marks Trust, a discretionary trust, was established with Mr Marks as the ‘Principal Beneficiary’. On 23 September 2003 Mr Marks was appointed as the sole director of Quintaste and held 12 shares in Quintaste for the Marks Trust. On 10 October 2003 a ‘Deed of Limited Partnership’ was executed by Quintaste as general partner and Mr Marks as trustee of the Marks Trust. On 24 October 2003, the ‘Marks Partnership’ was registered under the Partnership (Limited Liability) Act 1988 (Qld) and a ‘certificate of formation and composition’ was issued pursuant to s 8(3) of that Act. Under the Queensland law, to be a limited liability partnership you need to be a partnership generally, where a partnership is defined to mean: Partnership is the relation which subsists between persons carrying on a business in common with a view of profit. On 24 October 2003 HL Securities Pty Ltd resolved to create a new class of shares known as Z Class shares with an issue price of $1 per share. Quintaste applied for and was allocated 10 Z Class shares in HL Securities on behalf of the Marks Partnership. The terms of the Z class chares were as follows: Each share shall be redeemable at the direction of the directors, at any time, for the issue price, and, at the end of 47 months following its issue, shall be automatically redeemed at its issue price and cease to exist at the expiration of that time, whether or not its redemption price has been paid. Dividends were paid to Quintaste (in its capacity as general partner of the Marks Partnership) by HL Securities in each of the 2004, 2005 and 2006 years and loans were made in the 2004 year by HL Securities and RMI Australia Pty Ltd to Quintaste as general partner of the Marks Partnership. HL Securities and RMI were two companies associated with Mr David Marks that were in the business of insurance broking. Division 5A of the Income Tax Assessment Act 1936 (Cth) provides for certain limited partnerships, ‘corporate limited partnerships’, to effectively be treated as companies for tax purposes. Accordingly, Quintaste and Marks maintained that they were to be assessed for tax on the dividends and loans on the basis that the partnership was a company for tax purposes and that the loans were not to be taxed as deemed dividends under Division 7A. However, even if the Marks Partnership was a limited partnership, the partners would not have been entitled to imputation credits for dividends in relation to the Z Class shares if those shares were considered to be debt interests under Division 974 of the ITAA1997. In determining whether an interest is a debt interest or equity interest you need to consider the debt and equity tests in Division 974. Where an interest satisfies both the debt and equity test, it will be treated as a debt interest. An interest will satisfy the debt test where: 1. the scheme is a financing arrangement for the entity; 2. the entity, or a connected entity of the entity, receives, or will receive, a financial benefit or benefits under the scheme; 3. the entity has, or the entity and a connected entity of the entity each has, an ‘effectively noncontingent obligation under the scheme’ to provide a financial benefit or benefits to one or more entities after the time when: a. the financial benefit is received if there is only one; b. or the first of the financial benefits is received if there are more than one; 4. it is substantially more likely than not that the value provided will be at least equal to the value received; and Brown Wright Stein Lawyers © 2016 page 4 Monthly tax training – July 2016 5. the value provided and the value received are not both nil. The primary issue in relation to the Z Class shares was whether it was substantially more likely that not that the value provided by HL Securities would be at least equal to the value received. Following an audit, the Commissioner assessed Quintaste and Marks on the basis that the Marks Partnership was not a limited partnership for tax purposes and, therefore, that they were not entitled to imputation credits and that the loans were taxable as deemed dividends. Section 995-1 defines a limited partnership as follows: [A]n association of persons (other than a company) carrying on business as partners or in receipt of ordinary income or statutory income jointly, where the liability of at least one of those persons is limited The Commissioner contended that the requirement that the liability of at least on the partners is limited could not be met as Quintaste and Marks did not carry on any business for profit as would be necessary for the Marks Partnership to be a partnership under section 5 of the Partnership Act 1891 (Qld) or at general law. As it was not a statutory or general law partnership, the Marks Partnership could not be a limited partnership under the Partnership (Limited Liability) Act 1988 (Qld). Therefore, it could not be said that either of Quintaste or Marks was a person whose liability was limited. The Commissioner further concluded that the Z class shares were debt interests, so that any dividends paid to the partnership would not be frankable. As the amount received on redemption of the Z Class shares was equal to the issue price, the Commissioner contended that the requirement that it was substantially more likely that not that the financial benefit provided by HL Securities would be at least equal to the financial benefit received was met. As the Z Class shares satisfied the debt test, they were debt interests. The Commissioner imposed a penalty of 25% for failure to exercise reasonable care or, in the alternative, for treating an income tax law in a way that was not reasonably arguable. Quintaste and Mr Marks objected to the amended assessments and the penalty assessments. Quintaste and Mr Marks accepted that they did not carry on business in common with a view of profit within the meaning of s 5 of the Partnership Act 1891 (Qld) or under the general law. However, they argued that the certificate that had been issued for the Marks Partnership under section 8(3) provided conclusive evidence that the Marks Partnership had been formed as a limited partnership notwithstanding the fact that it was not a partnership because of section 8(4). Section 8(4) provides as follows: (4) A certificate issued under subsection (3) – (a) shall be conclusive evidence that the limited partnership to which it refers was formed on the date of registration referred to in the certificate; and (b) shall be evidence and, in the absence of evidence to the contrary, conclusive evidence that the partnership to which it refers consists or consisted of the general partners and limited partners named in the certificate as such. The Commissioner disallowed the objection. Quintaste and Mr Marks applied to the Tribunal for review. Before the Tribunal, Quintaste and Marks argued that, even if they were wrong on the limited partnership and debt interest issues, for the purpose of the penalty assessments, they had a reasonably arguable position on both issues and therefore no penalty should be imposed. As to whether the Marks Partnership was a limited partnership under section 995-1, the Tribunal noted that the provisions of the Partnership (Limited Liability) Act 1988 (Qld) did not purport to confer limited liability upon persons other than one which was a ‘partnership’ as contemplated by that word in s 6(1). The Marks Partnership was not a limited partnership because it did not exist as a partnership before registration as a limited partnership. Brown Wright Stein Lawyers © 2016 page 5 Monthly tax training – July 2016 As to whether the Z Class shares were debt or equity interests, the Tribunal agreed with the Commissioner that the Z Class shares were debt interests as upon redemption the holder would receive at least the issue price back. In response to an argument that $10 today is not equal to $10 in 47 months, the Tribunal noted that section 974-35 of the ITAA 1997 provides as follows: the value of a financial benefit received or provided under a scheme is its value calculated: i. in nominal terms if the performance period ... must end no later than 10 years after the interest arising from the scheme is issued;... Accordingly, there was no basis to compare each financial benefit based on their net present values. In relation to the question of penalties, the Tribunal was not satisfied that Quintaste and Marks' position on either issue was reasonably arguable. Issues 1. Whether Quintaste and Marks were in limited partnership for tax purposes? 2. Whether the Z Class shares in HL Securities were debt or equity interests? 3. Whether Quintaste and Marks had adopted reasonably arguable positions? Decision Was the Marks Partnership a limited partnership? A majority of the Full Court agreed with the Tribunal's conclusion for the following reasons: 1. as Quintaste and Marks were not carrying on a business in common with a view of profit, they could not be a partnership under the Partnership Act 1891 (Qld) or under general law; 2. as they were not a partnership, the Marks Partnership could not be a limited partnership under the Partnership (Limited Liability) Act 1988 (Qld); 3. as the Marks Partnership was not a limited partnership, it was not an association of persons for which the liability of at least one of those persons is limited; 4. therefore, the Marks Partnership did not meet the definition of a ‘limited partnership’ in section 995-1 of ITAA 1997; and 5. as the Marks Partnership was not a limited partnership it could not be a corporate limited partnership for the purposes of section 94 of the ITAA 1936. In terms of the effect of the certificate issued under section 8(3) of the Partnership (Limited Liability) Act 1988 (Cth), the majority of the Full Court held that the certificate provided conclusiveness of registration and that the partnership referred to in the certificate consists or consisted of the general partners and limited partners named in the certificate as such. However, the certificate did not operate as conclusive evidence that persons are a partnership or a limited partnership. That was still to be determined by whether the persons were carrying on a business in common with a view of profit. Debt or equity interest? The only questions in dispute before the Full Court in relation to whether the debt test was satisfied for the Z Class shares were as follows: 1. whether the $10 payable to HL Securities for the Z Class shares was a ‘financial benefit’ within the meaning of s 974-20(1)(b); and 2. whether HL Securities had an ‘effectively non-contingent obligation’ under the scheme to provide a financial benefit after the time when it received the financial benefit. Pagone J, writing on this point for the majority, noted that the definition of ‘financial benefit’ includes 'anything of economic value' and that such words encompassed the payment of an amount of $10 Brown Wright Stein Lawyers © 2016 page 6 Monthly tax training – July 2016 notwithstanding that $10 might not be a significant amount to a company with the level of assets held by HL Securities. On the question of whether there was an ‘effectively non-contingent obligation’, Pagone J accepted that this test is, in broad terms, a question of whether the debt has to be repaid. The majority in the Full Court accepted the Tribunal's conclusion that the redemption was not made to depend upon any prior payment by Quintaste of the issue price. Quintaste and Marks had adopted reasonably arguable positions? Logan and Griffiths JJ noted that ultimately it did not matter whether Quintaste and Marks had adopted a reasonably arguable positions, as the Commissioner had also concluded that a 25% penalty should be imposed for a false and misleading statement that resulted from a failure to exercise reasonable care. Accordingly, even if it were accepted that Quintaste and Marks had adopted reasonably arguable positions, the penalty of 25% would remain for failure to exercise reasonable care. Griffiths and Pagone JJ, who formed the majority that agreed that the Marks Partnership was not a limited partnership and that Z class shares were debt interests, disagreed on the question of whether they had a reasonably arguable position. Pagone J considered that they did not have reasonably arguable positions noting that the test requires a conclusion that ‘what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect’. Pagone J made the following comments concerning the application of this test to the circumstances: The taxpayers in the present case relied only upon their construction being ‘open’. Their written submissions were that their ‘arrangements and the application of the tax legislation was open to be construed’ as they had ‘contended on the language of the relevant State legislation, and the tax legislation; being a construction as to which some other construction was reasonably open’. However, those are not the words of the statutory test for a matter to be reasonably arguable. … The taxpayers in the present case depended primarily upon their contention that they could take advantage of s 8(4) of the 1988 Queensland Act in circumstances where they had not been partners seeking registration as limited partners. They are entitled to make an argument that the effect of s 8(4) extended to those obtaining registration notwithstanding that they were not otherwise partners, but had no objective reference point to support their construction beyond their argument. The same is true about each of the other constructions for which they contended in the appeal. It was for the taxpayers to establish that their construction was not just argued, but that it satisfied the statutory test of being reasonably arguable, and they have failed to do so. The taxpayers did not, for instance, rely upon or point to a public ruling or an opinion by experienced independent senior counsel or other adviser dealing with the specific point (c.f Walstern at [112]) which independently supported the construction they advanced. Griffiths J disagreed with Pagone J on this issue and concluded that Quinataste and Marks had adopted reasonably arguable positions. In particular, Griffiths J disagreed with Pagone J’s approach on the basis that it seemed to require that the taxpayers’ preferred construction of the relevant substantive legislative provisions needed not only to be more than ‘arguable’ but must also be supported by some external reference point, such as a public ruling or an opinion of an experienced senior counsel or other advisor that independently supports that construction. Griffiths J considered that was notable that the Commissioner himself issued primary and alternative assessments, the latter being based on the hypothesis that, as was contended by the taxpayers, the D Marks Partnership was a valid corporate limited partnership in the relevant years. Brown Wright Stein Lawyers © 2016 page 7 Monthly tax training – July 2016 Logan J considered that Quintaste and Marks had reasonably arguable positions as he had concluded that the Marks Partnership was a corporate limited partnership and that the issue price for the Z Class shares was not a financial benefit. COMMENT – limited partnerships have in the past been used so that a corporate tax rate could be paid on income, while loans from the entity were not subject to Division 7A. That position changed when Division 7A was made to apply to most limited partnerships from 1 July 2009. Citation D Marks Partnership by its General Partner Quintaste Pty Ltd v Commissioner of Taxation [2016] FCAFC 86 (Logan, Griffiths and Pagone JJ, Brisbane) w http://www.austlii.edu.au/au/cases/cth/FCAFC/2016/86.html 1.2 Millar – sham and withholding Facts Mr and Mrs Millar wished to buy an apartment on the Sunshine Coast and made an offer, which was accepted by the vendor, to purchase an apartment for $1.1 million. The purchase was financed in part by a loan of $600,000 from St George Bank and the balance from what purported to be a loan facility between Mr and Mrs Millar and a Samoan entity called the Hua Wang Bank Berhad. The Millars’ long term accountant and financial adviser, Mr Vanda Gould, advised Mr and Mrs Millar that they could borrow $600,000 from Hua Wang on condition that an equivalent amount of $600,000 was placed on deposit with Hua Wang. On 11 October 2000 $600,000 was transferred from the Millar’s superannuation fund to Hua Wang. On 14 October 2000 Hua Wang transferred $600,000 to the solicitors for the Millars in accordance with a loan facility agreement between them and Hua Wang which they had entered into shortly before the transaction but which was expressed to be with effect from 1 July 2000. Interest was charged and capitalised on the loan from Hua Wang to the Millars and the Millars claimed interest deductions but did not withhold and remit to the ATO any amounts in relation to such interest as required where interest is paid to an overseas person under section 12-245 of Schedule 1 to the TAA 1953. On 28 January 2011 Hua Wang transferred an amount of $720,000 to the Millar's superannuation fund. The Millars’ asserted that this was a repayment of the principal amount that had been lent ($600,000) plus interest ($120,000). The Commissioner treated the arrangement between the Millars and Hua Wang as a sham to disguise Mr and Mrs Millar accessing funds from their superannuation fund contrary to the payment standards in the SISR. The Millars were assessed under s 26AFB of the ITAA1936 on the $600,000 as a benefit to the Millars from their superannuation fund and the interest deductions claimed were disallowed. Amended assessments were issued to the Millars. The Commissioner's power to amend the assessments, given that they were outside the statutory period of review, required a conclusion that there was ‘fraud or evasion’. The Commissioner contended that, even if the transactions were not a sham, the interest deductions were still not allowable because of the failure by the Millars to withhold tax. Section 26-25 of the ITAA 1997 provides that interest is not deductible where the taxpayer was required but fails to withhold and remit the withheld amount to the Commissioner. The Millars’ lodged an objection against the assessment, and when that objection was disallowed, commenced proceedings for review in the Administrative Appeals Tribunal. Importantly, Mr Gould did not give any evidence in the proceedings, with the explanation being that he was facing criminal charges of conspiracy to cause a loss, or a risk of loss, to the Commonwealth, and conspiracy to deal with property intended to become an instrument of crime concerning matters unrelated to the Millars' transactions. The Tribunal noted that the principles concerning the meaning of ‘sham’ as set out in Raftland Pty Ltd as trustee of the Raftland Trust v Commissioner of Taxation (2008) 238 CLR 516 are as follows: Brown Wright Stein Lawyers © 2016 page 8 Monthly tax training – July 2016 1. that the term ‘sham’, when correctly employed, denotes ‘an objective of deliberate deception of third parties’; 2. the idea that ‘the parties do not intend to give effect to the legal arrangements set out in their apparent agreement, understood only according to its terms. In Australia, this has become essential to the notion of sham, which contemplates a disparity between the ostensible and the real intentions of the parties’; and 3. ‘sham’ is an expression which has a well-understood legal meaning. It refers to steps which take the form of a legally effective transaction but which the parties intend should not have the apparent, or any, legal consequences’. The Tribunal concluded that it was not satisfied that the arrangements were not a sham, stating as follows: ‘The taxpayers have not satisfied me that the documents taken at face value represent the real agreement between the parties. In particular, they have not satisfied me that the loan documents are anything other than a façade to disguise the reality of the arrangements, which is that the $600,000 is a distribution to them of money from their superannuation fund, with HWBB an intermediary. In summary, the taxpayers have not disproved sham.’ The Tribunal rejected the submission by the Millars that so long as the Tribunal was satisfied that the Millars' signed the loan agreements in the belief that they were binding legal documents, then the loan was not a sham, irrespective of whether the person who signed the loan documents on behalf of Hua Wang intended and expected the documents to be binding. In relation to the claim that the $720,000 was a repayment of the entire capital and interest, the Tribunal noted that it could not satisfied of this on the evidence, particularly as the interest charged of 5% by the Millars' superannuation fund should have resulted in a far greater amount of interest than $120,000. The Tribunal concluded that the Millars had not satisfied the Tribunal, given Mr Gould's failure to give evidence, that the avoidance of tax was not due to evasion and therefore accepted that the Commissioner had the power to issue the amended assessments. The Millars appealed the Tribunal's decision to the Federal Court where Griffiths J, at first instance, disallowed the appeal. Griffiths J summarised the position as follows: ‘It seems to me that the core of this appeal essentially relates to the applicants’ burden under s 14ZZK of the TAA 1953. To discharge this burden the applicants had to defeat the Commissioner’s claim that the loan was a sham. In the particular circumstances of this case it was insufficient for them simply to persuade the AAT (as they did) that they genuinely believed and intended that the transaction was a loan. The difficulty the applicants faced was that, as the AAT found, they placed their total trust and faith in Mr Gould ([83] of the AAT’s reasons for decision), such that Mr Gould’s actions were ‘properly imputed to the taxpayers’ (at [84]). Once that point was reached, and given all the unanswered questions regarding the transaction which the AAT found Mr Gould could probably answer because of his prominent role in implementing and administering the arrangements (see [46]-[50]), it was a short and legitimate further step for the AAT to find that, because the evidence left unclear what Mr Gould’s intention was, the applicants failed to discharge their burden of demonstrating that the assessments were excessive.’ In relation to the interest deductibility point, although it was not necessary to decide it, Griffiths J rejected the Millars’ submission that 26-25(3) of the ITAA 1997 did not apply to deny them a deduction because section 12-245 of Schedule 1 of TAA 1953 did not require an amount to withheld in relation capitalised interest. The Millars then appealed to the Full Federal Court. Brown Wright Stein Lawyers © 2016 page 9 Monthly tax training – July 2016 Issues 1. Was there a genuine loan between Hua Wang or were the arrangements a sham? 2. If there was a genuine loan, were Millars entitled to the interest deductions where they had not withheld an amount for tax? Decision Sham A majority of the Full Court accepted that the Tribunal was not obliged to accept as sufficient the evidence of the Millars that they held the genuine belief that their superannuation fund had made a deposit with Hua Wang and that they had obtained a legally effective loan from Hua Wang on the terms of the loan agreement. The Full Court noted that the Millars might well not have had a positive intention to create a pretence, as the Tribunal found, but to discharge their burden it was necessary to look more broadly at the impugned transactions and at the position of Mr Gould. The Full Court concluded that it was not sufficient that the Millars believed the loan was legally effective, rather it was necessary that they establish, to meet their burden, that the loan was, in fact, legally effective. Given their limited knowledge of the transactions and their reliance on Mr Gould, that Mr Gould have failed to give evidence, meant that any evidence the Millars gave fell short of disproving sham. The Full Court disallowed the Millars’ appeal. Interest deductions Although it was not necessary to consider it given the conclusion that there was not a legally effective loan, a majority of the Full Court upheld the Commissioner's contention that the interest deductions could not be claimed by the Millars where an amount had not been withheld. The Millars argument was that, as interest had been capitalised, they had not ‘paid’ interest within the meaning of section 12-245 of Schedule 1 of the TAA 1953 and therefore there was no obligation to withhold. The Millars argued that the capitalisation of interest did not come within the ‘constructive payments’ provision in section 115 of Schedule 1 of the TAA 1953 that deems interest to have been paid for the purpose of section 12-245. Section 115 relevantly provides as follows: (1) In working out whether an entity has paid an amount to another entity, and when the payment is made, the amount is taken to have been paid to the other entity when the first entity applies or deals with the amount in any way on the other’s behalf or as the other directs. (2) An amount is taken to be payable by an entity to another entity if the first entity is required to apply or deal with it in any way on the other’s behalf or as the other directs. The Full Court concluded that section 115 was expressed broadly and was sufficient to capture the capitalisation of interest as the contractual ability of Hua Wang to capitalise interest was an application or dealing with the amount on behalf of the Millars or as directed by them through the terms of the loan facility agreement. COMMENT – Section 26-25(3) of the ITAA 1997 causes interest to become deductible retrospectively once the withholding tax is paid. Accordingly, if the Court had accepted the Millars' argument that the loan was legally effective, the Miilars' appeals may have been allowed in respect of the interest deductions, conditional upon their payment of the interest withholding tax. Citation Millar v Commissioner of Taxation [2016] FCAFC 94 (Logan, Pagone and Davies JJ, Sydney) w http://www.austlii.edu.au/au/cases/cth/FCAFC/2016/94.html Brown Wright Stein Lawyers © 2016 page 10 Monthly tax training – July 2016 1.3 Fowler – small business entity Facts Peter Fowler practised as a solicitor from the late 1940s to the early 1970s. During the 1950s he undertook some property development activities. From the 1960s to the 1990s he acquired a total of 11 properties, each of which was let from time to time. In 1986 Peter purchased a property in Manly with his wife for $590,000. The property was a block of 10 residential units. For the entire time that Peter owned the property, the units on the property were rented out. The purchase of the property was financed in part by the sale of other properties that he owned. Peter sold the property in the 2012 income year for $4.1 million making a capital gain of approximately $3.4 million. When lodging his tax return for the 2012 year, Peter applied the small business CGT concessions, presumably the 15-year retirement exemption, to reduce the gain to nil. The Commissioner disagreed that the basic conditions for the small business concessions had been satisfied in relation to gain, primarily that Peter was not a small business entity and the property was not an active asset. The Commissioner issued amended assessment to include a $1.7 million net capital gain in Peter’s income from the sale of the property. The Commissioner also imposed a 25% penalty for failure to exercise reasonable care. Peter objected and his objections were disallowed. Peter then applied to the Tribunal for review but died before the case was heard so the application was progressed by the executors of Peter's estate, with most of the evidence given by Peter's son, Greg Fowler. Greg’s evidence was to the effect of the following: 1. the types of activities his father undertook at the property could be divided into two distinct periods. The first period was from 1986 to 2006; the second period was from 2006 to 2011. The demarcation between the two periods was a result of Peter’s failing health in his late 70s; 2. during the period when he was still reasonably active, Peter conducted a number of types of ‘day to day activities’ in relation to the property, such as advertising, interviewing prospective tenants, cleaning units, receiving phone enquiries, checking references of potential tenants, lodging rental bonds, arranging payment of expenses, ground and general maintenance, minor refurbishments of units and rent collection including reconciling rent receipts against his bank statement; 3. from 2005-2006 Peter’s health started to decline and his physical involvement in the Manly Property was reduced; 4. between 2008 and 2010, Peter was diagnosed with dementia; and 5. from at least late 2010, and probably earlier, the property had some fairly large maintenance issues. Issues 1. Whether Peter was a 'small business entity' for the 2012 income year? 2. Was the property an active asset? 3. Whether there was a failure to exercise reasonable care and, if so, whether the safe harbour penalty provisions applied to disregard the penalty on the base that the agent had been provided with ‘all relevant information’? Decision Small business entity In broad terms, to be an SBE you must have an annual turnover of less then $2million and must also carry on a business in the current year. The $2 million turnover was satisfied for Peter so the real contest was whether he carried on a business in the 2012 year (or whether he was winding up a business in that year that he had previously carried on). Brown Wright Stein Lawyers © 2016 page 11 Monthly tax training – July 2016 It was submitted on behalf of Peter’s estate that the abovementioned activities amounted to Peter carrying on a business, being a business of ‘property ownership and management of the property’ or ‘managing and letting property’. The Commissioner submitted that the evidence did not support a finding that Peter was carrying on a business of either of those descriptions and Frost DP agreed. Frost DP also noted that while Peter had no other means of support aside from the rental income that did not mean his overall activity was conducted as a business. Frost DP concluded that ‘the evidence in favour of the existence of a business was quite vague and ultimately unconvincing’ and consequently, Peter was not a small business entity for the 2012 income year and therefore did not meet the basic conditions for the small business CGT concessions. The Commissioner also submitted that if Peter was carrying on the business then the proper outcome may be that the gain on the sale of the property was not a capital gain as first thought, but instead a revenue gain. Peter’s estate responded that the Commissioner could not raise that entirely new ground on this review because it was not raised either at the audit stage or during the Commissioner’s consideration of the objection. Frost DP did not consider it necessary to determine this point given his conclusion that Peter had not been carrying on a business in the 2012 year. Active Asset An asset will not be an active asset where the ‘main use’ by the taxpayer is to derive rent. It was submitted on behalf of Peter’s estate that the main use of the property by Peter was to secure an increase in its value over time. It was argued that the word ‘use’ in the expression ‘main use’ is not restricted to physical uses of the asset but can include non-physical use and that holding land for the purpose of securing an incremental accrual in the market realisable value of the land, year to year, is relevantly a ‘use’ of the land. Frost DP found that the evidence did not support a conclusion that the main use of the property was to secure an increase in its value over time. In a document filed in Supreme Court proceedings in 1995 Peter had stated that the reason for purchasing property was to consolidate his assets into one property and the properties that the property replaced all appeared to have been rent-producing. Frost DP also noted that he doubted that ‘use’ in sub-section 152-40(4) was referring to any use other than a physical use and that the only physical use of the property by Peter was to derive rent. The property was not an 'active asset' under section 152-35 of the 1997 Act. TRAP – during an audit or objection caution should be exercised to ensure that the client's tax position is not made worse by the arguments that are being made. The argument made on behalf of Peter in this case, that he was carrying on a business and further that the main use of the property was to secure an increase in the realizable value of the land, could have led to a conclusion that the property was an revenue account and not capital. In such circumstances, Peter's estate would have lost the benefit of the 50% CGT discount. TIP – the ATO broadly consider that an asset will only be used to derive rental income where the asset is subject to a lease. Where the asset is only subject to a licencing arrangement, such as a room in a hostel, then they do not consider that ‘rent’ is being derived – see TD 2006/78. Citation The Executors of the Estate of the late Peter Fowler and Commissioner of Taxation [2016] AATA 416 (Frost DP, Sydney) w http://www.austlii.edu.au/au/cases/cth/AATA/2016/416.html Brown Wright Stein Lawyers © 2016 page 12 Monthly tax training – July 2016 1.4 Rowntree – loans or ordinary income Facts Bruce Rowntree entered into three loan arrangements with number of companies in which he held an interest. The relevant entities involved in the arrangements were as follows (noting that the ‘Limited’ companies were companies limited by guarantee that Division 7A does not apply to): 1. BR Redd Holdings Limited (Redd Holdings) - Rowntree was the sole director and main shareholder. The company has now been deregistered; 2. Voluntary Credits Limited (Voluntary Credits) - Rowntree was the sole director of Voluntary Credits. There are two main shareholders of Voluntary Credits, Redd Holdings until 1 July 2010 and Eugenius Pty Limited (Eugenius) from 1 July 2011 until 4 July 2011; 3. Eugenius - Rowntree is the sole director and the sole shareholder as trustee of the Rowntree Trust until 22 July 2011 and Eugenius Holdings Pty Limited (Eugenius Holdings) thereafter; 4. Eugenius Holdings - Rowntree is the sole director and the sole shareholder as trustee of the Rowntree Trust; 5. Galerius Pty Limited (Galerius) - Rowntree is the sole director and the sole shareholder as trustee of the Rowntree Trust; and 6. Galerius Holdings Limited (‘Galerius Holdings’) - Rowntree is the sole director and the sole shareholder as trustee of the Rowntree Trust. First Arrangement On or around 12 August 2009, Voluntary Credits paid a dividend of $500,000 to Redd Holdings. On or around the same day Redd Holdings transferred the same amount ($500,000) to Rowntree said to be made under a Loan Facility Agreement between Rowntree and Redd Holdings. On or around 5 January 2010, Voluntary Credits paid a further dividend of $140,000 to Redd Holdings. On or around the same day Redd Holdings transferred the same amount ($140,000) to Rowntree said to be made under a Loan Facility Agreement between the Rowntree and Redd Holdings. On or around 14 February 2011 the debt due by Rowntree to Redd Holdings ($640,000) was assigned to a company named Europium Limited (Europium) in accordance with an Agreement to Assign, which referred to an advance made on 30 June 2010. On 14 June 2014 the debt due was further assigned by Europium to Eugenius Holdings. Thus, after 16 June 2014, Rowntree asserted that he owed an amount of $640,000 to Eugenius Holdings. Second Arrangement Voluntary Credits paid dividends to Eugenius as follows 1. 10 August 2010 - $500,000 2. 16 November 2010 - $150,000 3. 25 April 2011 - $150,000 4. 4 July 2011 - $800,000 In each case on the same day as the dividend was paid, Eugenius transferred the full amount of the dividend to Rowntree as a loan under a loan facility agreement said to have been made between Rowntree and Eugenius. Accordingly, Rowntree owed Eugenius $1,600,000. On or around 22 July 2011 the share held by Rowntree in Eugenius in his capacity as trustee of the Rowntree Trust was transferred to Eugenius Holdings in consideration for the allotment by Eugenius Holdings of 1.6 million shares in itself to Rowntree as trustee for the Rowntree Trust. On the same day Eugenius declared a dividend of $1.6 million to Eugenius Holdings the then new owner. Brown Wright Stein Lawyers © 2016 page 13 Monthly tax training – July 2016 On the same day, Eugenius Holdings lent Rowntree $1.6 million, which was used to reduce the amounts owing to Eugenius and offsetting the amounts owed to Eugenius Holdings. On 22 July 2011 a Loan Facility Agreement was entered into between Eugenius Pty Ltd as Lender and Rowntree as Borrower, which was stated to apply to ‘any advance or loan made to the Borrower by the Lender after the date of this Agreement’. Third arrangement Voluntary Credits paid dividends to Galerius as follows: 1. 19 October 2011 - $200,000 2. 15 February 2012 - $100,000 3. 21 May 2012 - $500,000 4. 17 July 2012 - $1,000,000 5. 18 December 2012 - $80,000 In each case on the same day as the dividend Galerius transferred the full amount of the dividend to Rowntree as a loan said to be made under a loan facility agreement between Rowntree and Galerius. On or around 19 July 2012, the share held by Rowntree in Galerius in his capacity as trustee of the Rowntree Trust was transferred to Galerius Holdings in consideration for the allotment by Galerius Holdings of 1.7 million shares in itself to Rowntree as trustee for the Rowntree Trust. On the same day Galerius declared a dividend of $1.7 million to Galerius Holdings, the then new owner of Galerius. On the same day, Galerius Holdings lent the Applicant $1.7 million which was used to reduce the amounts owing to Galerius and offsetting the amounts owed to Galerius Holdings. As a result, Rowntree was said to owe Galerius Holdings $1.7 million as at 19 July 2012. On 19 July 2012 a Loan Facility Agreement was entered into between Galerius Pty Ltd as Lender and the Applicant as Borrower which was stated to apply to ‘any advance or loan made to the Borrower by the Lender after the date of this Agreement’. Rowntree claimed that 1. as at 16 June 2014, he owed to Eugenius Holdings $2,240,000 under the First and Second Arrangements; and 2. as at 19 July 2012, owed Galerius Holdings $1,700,000 under the Third Arrangement. Rowntree commenced making payments, that he described as repayments of the loans due to Eugenius Holdings and Galerius Holdings on or around 30 June 2014. The repayments involved amounts of $5,000 per month and other amounts as and when available. Rowntree was assessed on the amounts received under the three arrangements on the basis that the amounts were income. Rowntree objected and, once the objection was disallowed, applied to the Tribunal for review. Issues 1. Were the amounts that Rowntree claimed to have received as loan funds were properly characterised as loans, or were they his income? 2. If the amounts were income, was the penalty of the shortfall amount appropriate for the years following the 2010 income year? 3. Should that penalty and any increase in that penalty be remitted in whole or in part? Brown Wright Stein Lawyers © 2016 page 14 Monthly tax training – July 2016 Decision Were the amounts loans to Rowntree? In relation to the First Arrangement, the Tribunal noted that there was no evidence of any written loan agreement, of the terms of the loan (such as whether interest was payable) or resolutions passed by Redd Holdings to make such a loan. The Tribunal accepted that the Agreement to Assign, the subsequent repayments and references to the loans in accounts of Euegenius and Galerius provided some evidence of the loans but that such evidence was diminished by the fact that: 1. the Agreement to Assign referred to a loan agreement dated 30 June 2010 when the advances were, in fact, made on 12 August 2009 and 5 January 2010; and 2. the loan repayments only commenced after Rowntree became aware that the ATO was looking into the arrangements; 3. there was no other relevant evidence of the loans, for example, reference to the loans in resolutions or bank statements; and 4. the accounts were unsigned and unaudited and were for companies for which Rowntree was the sole director and he was the very person asserting the existence of the loans. Accordingly, the Tribunal concluded that it was not satisfied that any of the payments under the First Arrangement were loans. In relation to the Second Arrangement, the Tribunal noted that the evidence of the loans suffered the same problems as with the loans under the First Arrangement, other than a post-dated loan agreement, which on its face, did not apply to the advances pre-dating the agreement. In relation to the Third Arrangement, for the same reason the Tribunal did not accept any of the advances made prior to 17 July 2012, being the date on which the loan facility was stated to apply from, were loans but accepted that the $1,000,000 advance on 17 July 2012 and the $80,000 advance on 18 December 2012 were loans. Administrative penalties The Tribunal concluded that the shortfall amount did not arise from an intentional disregard of a taxation law, finding that Rowntree did not deliberately choose to ignore the law but that he genuinely believed that there were arguments to support his view of the existence of the loans. The Tribunal concluded that it was appropriate to apply a 50% penalty for recklessness. Remission of penalties Having regard to the circumstances of the case and Rowntree's own individual circumstances, the Tribunal came to the conclusion that the penalty imposed could not be described as harsh or unreasonable given Rowntree's recklessness in the conception of the financial arrangements of his companies. Accordingly, the Tribunal concluded that a remission of penalties was not warranted. COMMENT – This case reinforces the need to exercise care when documenting arrangements. If the loan facility agreements entered into in relation to the Second Arrangement and Third Arrangement had referred to the earlier advances, it is likely that the Tribunal would have also accepted that such amounts were loans. Similarly, if the Agreement to Assign had referred to the correct advance dates, then the Tribunal may have accepted that the advances under the First Arrangement were loans. This case also demonstrates the limited reliance on company accounts to support transaction between the company and a person who is the sole director of the company. Citation Rowntree and Commissioner of Taxation (Taxation) [2016] AATA 420 (Deutsch DP, Sydney) w http://www.austlii.edu.au/au/cases/cth/AATA/2016/420.html Brown Wright Stein Lawyers © 2016 page 15 Monthly tax training – July 2016 1.5 Anjum's Air-conditioning – whether voluntary disclosure made Facts Mr Anjum is the sole director of Anjum's Air-Conditioning & Refrigeration Service Pty Ltd. The company carries on an enterprise of air-conditioning and refrigeration repairs and installations. During the period 1 July 2010 to 30 June 2012, the company also carried out solar panel installation work. On 14 March 2013, an ATO officer contacted Mr Anjum and advised him that the company had been selected for a review of its tax affairs due to the Company's reported income being outside the ‘small business benchmarks.’ The ATO officer suggested that Mr Anjum check the company's records and if the company had not disclosed income that should have been disclosed, or claimed a deduction that it was not entitled to, a voluntary disclosure should be made, in which event, the company could receive a reduction in any penalties imposed. On 18 March 2013, the ATO officer telephoned Mr Anjum on two separate occasions. In the first phone call, the ATO officer enquired how the company had managed to make significant payments on its mortgage. In the second phone call, the ATO officer indicated to Mr Anjum that she had been reviewing the company's tax returns and was trying to reconcile the amounts of rent that the Company had reported. The ATO officer said she would require documents to be provided. On 25 March 2013, Mr Anjum wrote to the Commissioner and provided the requested documents. In his response, Mr Anjum admitted that there were unreported sales from an additional business activity that the company conducted in the relevant period, being the solar panel installation work. He informed the Commissioner that the income relating to the unreported sales from the solar panel installation work had been deposited into the company's loan account. Mr Anjum advised the Commissioner that the amounts of the company's unreported sales were $34,000 and $94,000 for the 2011 and 2012 income years, respectively. On 2 April 2013, the Commissioner notified the company in writing about the finalisation of the review and about the commencement of a tax audit. On 9 May 2013, a few ATO officers interviewed Mr Anjum and his former tax agent as part of the tax audit. A summary record of the interview reveals the following: Asked Muhammed why he did not report the income received from solar panel installations and he stated that as the money was received into his personal accounts and then transferred to the mortgage account, the income was missed… When asked, [the tax agent] stated he was unaware of the solar income when he prepared the income tax returns. He simply prepares them from the figures reported on BAS which is prepared by the taxpayer... On 27 June 2013, there was another telephone discussion between an ATO officer and Mr Anjum. The ATO officer had advised Mr Anjum that he could make a disclosure, however Mr Anjum stated that the disclosure had already been made. On 16 October 2013, the tax audit was finalised with the total unreported sales from the solar panel installation work being calculated by the Commissioner as follows: 1. $167,754 for the year ended 30 June 2011; and 2. $176,697 for the year ended 30 June 2012. Accordingly, the Commissioner assessed the Company on the additional GST and income tax liabilities as well as administrative penalties calculated as 75% of the shortfall amount plus a 20% increase in the base penalty amount. The Company lodged an objection to the assessments and asked the Commissioner to ‘waive all the penalties and interest charges… in full on this occasion.’ Following this, the Commissioner reduced the penalties from 90% to 50% of the income tax and GST shortfall amounts. Brown Wright Stein Lawyers © 2016 page 16 Monthly tax training – July 2016 On 2 October 2014, the Company lodged an application for review of the Commissioner's objection decisions with the Tribunal. Issues 1. Was the Company liable to pay an administrative penalty at the rate of 50% for recklessly making a false or misleading statements? 2. Should the Commissioner have reduced all or part of the respective penalties imposed on the Company for any voluntary disclosure made? 3. Should the Commissioner have exercised his discretion to remit all or part of the respective penalties imposed on the Company? Decision Was the company reckless so a 50% penalty should apply? The Tribunal affirmed the Commissioner's objection decisions as to the 50% rate of penalty in respect of both the GST and income tax shortfalls agreeing with the Commissioner's submission that the company had been reckless in failing to report the taxable supplies and income from the solar panel installation work because it disregarded and or was indifferent to the risk and potential consequences of not reporting the true position. In doing so, the Tribunal took into account the following factors: 1. the unreported taxable supplies and income were not isolated errors but occurred repeatedly in eight quarterly BASs and in two income tax returns; 2. when compared to the income that the Company did declare when lodging its income tax returns, the income from the unreported solar panel installation work was a sizable proportion; and 3. the Company retained a tax agent to assist with the preparation of its income tax returns however all the BASs were prepared by Mr Anjum and his wife. They did not tell their former tax agent about the income from the solar panel installation work. The Company made false and misleading statements to the Commissioner in the BASs and income tax returns. Had the company made a voluntary disclosure? The reduction in penalties for a voluntary disclosure broadly operates as follows: 1. where the disclosure of a shortfall or part of a shortfall is made prior to the commencement of an examination, the taxpayer is entitled to an 80% reduction in the base penalty; 2. where the Commissioner tells the taxpayer that an examination is to be made of its taxation affairs, and, after that time, the taxpayer voluntarily tells the Commissioner about the shortfall, the part of the shortfall or the false or misleading nature of the statement, the taxpayer is entitled to a reduction of 20%, . In this case, the disclosure must reasonably be estimated to have saved the Commissioner significant amounts of time or significant resources in the examination; and 3. where a disclosure is made after Commissioner tells you that an examination is being conducted, the Commissioner has discretion to treat the taxpayer as having made the disclosure before being told about the examination if the Commissioner considers it appropriate to do so. Lazanas SM concluded that no reduction should be made under section 284-226 as the company only made the disclosures after the Commissioner had already asked for the specific information and documents that would have revealed the understated amounts from the solar panel installation work. Therefore, the disclosures were not voluntary in nature, and furthermore the information provided by the company did not save the Commissioner a significant amount of time or resources. Should the penalties be otherwise remitted? Lazanas SM concluded that there should not be a further remission of penalties as the Commissioner had already significantly reduced the penalties from 90% to 50% in his objection decision. These Brown Wright Stein Lawyers © 2016 page 17 Monthly tax training – July 2016 reductions were made in circumstances where the evidence suggests that the Company was, at the very least, reckless as to the operation of the income tax and GST laws. TRAP – to obtain a benefit from making a voluntary disclosure, it is not only the timing of the disclosure (pre or post notification of an audit) but also whether it is voluntary that determines whether a penalty reduction is available. Citation Anjum’s Air-conditioning & Refrigeration Service Pty Ltd and CoT [2016] AATA 433 (Lazanas SM, Sydney) w http://www.austlii.edu.au/au/cases/cth/AATA/2016/433.html 1.6 FLZY – revenue and capital Facts Ivan was the founder of a property building, development and investment group of companies called the Doma Group. In 1975, Ivan incorporated a company, Jure Investments Pty Limited (JIPL) which became a trustee of the Domazet Family Trust and also a member of the Doma Group. Ivan's son, Jure joined the group as Managing Director in 1998. In early 1999 the JIPL, as trustee of the Domazet Family Trust, purchased an office building (Sirius Building) and carpark (Carpark) in the Woden Town Centre in Canberra. The Sirius Building and Carpark were offered for sale, as a package, by the Commonwealth through its agent Colliers Jardine. Mr Paul Powderly, an agent with Colliers, had a pre-existing relationship with the Doma Group. Mr Powderly had told Jure that he thought the package would be an ideal purchase for the Group for the following reasons: 1. it was well located in the Woden Town Centre; 2. it was leased to a Commonwealth tenant until 2002 and, since there were no alternative buildings in the area, there was a strong likelihood that the tenant would enter into a further lease at the expiry of the current one; and 3. they would provide a reliable stream of rental income for the Doma Group with Colliers managing the property on behalf of the Group with minimal management issues for a few years. Jure gave evidence that at the time of purchase of the Sirius Building and the Carpark, it was his intention that the Doma Group would retain both of them as commercial property investments for the purpose of producing rental and other income. Neither the building nor the carpark had been built in accordance with the ACT Building Code and neither of them had a Certificate of Occupancy, as the Commonwealth did not have to comply with the Building Code when it built the buildings. This had been known prior to the purchase and did not create a problem so long as the Commonwealth either owned the properties or was the sole occupier of them. However, if a private owner such as the Doma Group were to make the Carpark available for public parking or for parking to persons other than the Commonwealth, it was required to comply with the ACT Building Code. The Commonwealth extended its lease of the Sirius Building to 2007 but indicated that it no longer required the Carpark. While the Doma Group may have been able to find private individuals or corporations to license the Carpark, that was not legally allowed. As a result, the undercover portion of the carpark, representing half of its car spaces, had to be closed. The Doma Group canvassed other possibilities to redevelop the Carpark but was unable to find any viable solutions due to cost involved in ensuring the Carpark complied with the building code. One of the problems was that the Carpark was in a precinct of the Woden Town Centre that required not only the retention of the current car parking capacity, but also the provision of an additional 2.5 car parks per 100 m² of gross floor area in the event that it was redeveloped. Anticipating approval of a Master Plan for the Woden Town Centre (that was ultimately approved in April 2004) that was to ease some of the current development restrictions in the area, in February 2004 the Brown Wright Stein Lawyers © 2016 page 18 Monthly tax training – July 2016 Doma Group successfully lodged a Development Application to construct an 8 storey office building on the Carpark known as the ‘Glasshouse’. The DA was approved in May 2005. From about 2001 Jure would receive, from time to time, unsolicited offers for the purchase of the Woden carpark site and then the Glasshouse. He rejected the offers because, he said, it had always been his intention, and the intention of the Doma Group, to retain the Woden carpark and then the Glasshouse as part of the Doma Group’s income producing commercial property assets. In early 2005 the Doma Group demolished the Carpark and commenced excavation for the Glasshouse development. On 19 October 2005 JIPL entered into an agreement for lease with the Civil Aviation Safety Authority for four floors of the Glasshouse for 15 years. In and around this time, some circumstances suggested that JIPL was considering selling the Glasshouse. These circumstances were as follows: 1. In November 2004 the Doma Group received some advice on the taxation consequences of any future sale of the Carpark. Jure explained that he sought this advice not because he was thinking of selling but because he wanted to understand the after-tax value of the Carpark and he had come to recognise that his understanding of the distinction between revenue assets and capital assets and the tax consequences of that distinction was inadequate; 2. On 20 October, Jure on behalf of the Group wrote to St George Bank requesting construction finance. In that letter he said: On completion, the Phillip property could be sold, refinanced or the construction facility could be converted to an FDA with the Bank with the asset to provide core security. This is subject to its effect on the lending limits of the Bank. 3. In September 2005 Mr Powderly prepared a ‘Strategy Paper’ which was sent to Jure and which outlined three ‘Disposal Options’ for the Glasshouse. Jure said that he did not solicit this Strategy Paper and stated as follows in his affidavit: We had no interest in selling the asset. I also advised him that we did not need to sell Glasshouse to access equity as we had significant capacity to borrow further funds against the Glasshouse and other assets in the Doma Group. A St George Bank document dated 29 August 2006 noted that the building ‘will be retained on completion for investment’. Colliers valued the Glasshouse at $61 million in July 2006 and towards the end of that month the Doma Group received an offer of $63 million. Then in August 2006 Mirvac offered $70 million for the site and at this time Jure started to think that the Canberra commercial office property market was becoming overheated and formed the view that it was the right time to sell. However, Ivan was reluctant to sell as his business philosophy was that he preferred investments in property rather than cash, particularly where the property had leases from which to generate rent. Ivan eventually agreed particularly after Mirvac offered the Doma Group the opportunity to acquire three commercial properties from Mirvac as part of the selling price. As the Group was attracted to this type of deal, it rejected a subsequent higher offer of $77 million. The contracts for sale of the four properties were exchanged between Mirvac and JIPL in June and July 2007 with settlement taking place on 19 July 2007. As the Glasshouse has been held by JIPL for more than 12 months, the CGT 50% discount was applied to reduce the gain. The gain from the sale of the Glasshouse was purported to be distributed to Ivan through an intermediate trust who then declared the gain in his 2008 tax return and paid tax on it. The Commissioner argued that the gain was a revenue gain and should have been returned as ordinary income without the application of the 50% discount and amended Ivan's assessment for the 2008 year. A 50% penalty for recklessness was imposed. Brown Wright Stein Lawyers © 2016 page 19 Monthly tax training – July 2016 Ivan objected to the amended assessment, and when his objection was disallowed, applied for review by the Tribunal. Issues Was the profit from the sale of the property ordinary income or a capital gain? Decision Frost DP noted that the following propositions apply in determining whether a profit from the sale of property is assessable as ordinary income or is capital gain: 1. a distinction is drawn between the mere realisation of a capital asset, and an act done in the carrying on, or carrying out, of a business. Profits derived in a business operation or commercial transaction carrying out any profit-making scheme are income, whereas the proceeds of a mere realisation or change of investment or from an enhancement of capital are not income; 2. unless a sale of property is made in an operation of business, the resulting profit will not be income according to the ordinary concepts and usages of mankind; 3. if the sale in question is a business operation, carried out in the course of the business of profitmaking, the profit arising on the sale will be of an income character; 4. a profit or gain made as a result of an isolated venture or a ‘one-off’ transaction will constitute income if the property generating a profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit; and 5. where a transaction occurs outside the scope of ordinary business activities, it will be necessary to find, not merely that the transaction is ‘commercial’ but also that there was, at the time it was entered into, the intention or purpose of making a relevant profit; and Transaction undertaken in the ordinary course of business? In considering this question Frost DP referred to authorities that provided that ‘the identification and characterisation of the business carried on by the taxpayer is the essential task’: London Australia Investment Company Limited v Commissioner of Taxation [1977] HCA 50 (Jacobs J) Frost DP noted that the activities of the Doma Group over the years have been: 1. the acquisition, development and sale of residential properties; 2. the acquisition and development of residential properties to hold as capital assets for the purpose of the derivation of rental income; 3. the acquisition, development and sale of commercial properties; 4. the acquisition of commercial properties to hold as capital assets for the purpose of the derivation of rental income; and 5. the acquisition and development of commercial properties to hold as capital assets for the purpose of the derivation of rental income. Frost DP emphasised that such activities were conducted in a discrete manner as properties were generally earmarked by the Group specifically for one of the above activities. For this reason, Frost DP rejected the Commissioner’s submissions that an appropriate characterisation of the activities was the carrying on ‘a business of the acquisition, development and disposal of properties or, alternatively, a business which included investing in property assets. Frost DP concluded that the transaction by which the Glasshouse was disposed of was not a transaction undertaken in the ordinary course of the Doma Group’s business activities. Profit-making intention? As an alternative, the Commissioner argued that Carpark was part of a profit-making scheme; namely, it was a commercial acquisition and JIPL acquired it with a profit-making intention which included not only Brown Wright Stein Lawyers © 2016 page 20 Monthly tax training – July 2016 the receipt of lease income, but other possibilities, including development and sale, as ultimately occurred with the Glasshouse. Frost DP rejected this argument, stating as follows: The ‘possibilities’ to which the Commissioner refers are remote, and not at all contemplated. It is, of course, always possible that the owner of an asset will sell it, but to elevate that possibility here into an intention to make a profit by selling the property is to draw a long bow indeed. The Commissioner ran a similar argument in Westfield, and it was rejected by the Full Court: The fact is, in the case before me, that circumstances presented themselves which made selling the property a sensible thing to do, despite the desire and intention to retain the property as an income-generating asset, and despite Ivan’s resistance to selling it. The price was simply too good. And it is relevant to note that the three properties acquired on disposal of the Glasshouse are still owned by the Doma Group, almost nine years after the transaction. Frost DP referred to the statement of the High Court in Myer explaining the distinction between mere realisation and a profit making intention as follows: It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction. Frost DP accepted Ivan and Jure's evidence with respect to the intended use of the Glasshouse property and therefore concluded that the property had not been acquired for the purpose of profit-making by sale. Frost DP also noted that the parties had all accepted the distribution to Ivan through the intermediate trust was not correct and that the gain should have flowed directly from the Domazet Family Trust to Ivan and 5 other beneficiaries. Accordingly, for this reason alone the amended assessment would have been excessive. COMMENT – where there is a sale of a property by a person who conducts a business of property development, the profit from the sale will generally, although not necessarily, be a revenue gain. The important factor in this case was that the Doma Group's property activities were not limited to developing and selling properties. For this reason, Frost DP considered that it could not be said that the sale was a transaction undertaken in the ordinary course of the Doma Group’s business activities. Citation FLZY and Commissioner of Taxation [2016] AATA 348 (Beazley P, Ward JA and Simpson JA, Sydney) w http://www.austlii.edu.au/au/cases/cth/AATA/2016/348.html 1.7 Oswal No. 6 –intention to defraud creditors Facts Mrs Oswal was the owner of a property at 72 Philip Road, Dalkeith and a property at 2 Bay View Terrace, Peppermint Grove. Mrs Oswal was also the owner of 35% of the issued shares in Burrup Holdings Limited, now known as Yara Pilbara Holdings Pty Ltd. Sometime before 24 December 2010, Mrs Oswal executed a mortgage over each of the properties in favour of Mercury Services Limited, a company owned and controlled by her brother. The mortgage was Brown Wright Stein Lawyers © 2016 page 21 Monthly tax training – July 2016 not dated by Mrs Oswal and was signed by her in the absence of a witness at a time when she was overseas. Thereafter, Mrs Oswal’s signature was ‘witnessed’ by a person called Ramesh Sodum disclosing an address in the Perth suburb of Nedlands. An immigration search disclosed that Ramesh Sodum was in Australia between 12 November 2010 and 25 December 2010, at which time he departed Australia and then returned on 16 January 2011. At the time execution of the mortgage, Mrs Oswal had executed the following securities in favour of the ANZ Bank: 1. a share mortgage dated 23 December 2009 pursuant to which Mrs Oswal mortgaged to the ANZ the greater of: a. 82,503,106.5 shares in Burrup Holdings registered in Mrs Oswal’s name in her personal capacity from time to time; and b. 7.5% of the total issued share capital in Burrup Holdings registered in Mrs Oswal’s name in her personal capacity from time to time; 2. an Escrow Process Deed, Escrow Agreement and Power of Attorney all dated 1 February 2010, which governed Mrs Oswal’s dealings with the balance (27.5%) of her shares in Burrup Holdings; and 3. a personal guarantee to the extent of US$568 million. In January 2009 the Commissioner commenced a preliminary risk review of Mr Oswal and his connected entities. In 22 February 2011, the Commissioner issued notices of assessment to Mrs Oswal for each of the income years ended 30 June 2007 and 30 June 2010 for income tax, administrative penalties and general interest charges in the total amount of $178,210,810 (tax-related liabilities). At the time the mortgage was executed, Mrs Oswal had not lodged a tax return for the 2007 or 2010 income years. The Commissioner sought declarations that mortgages were void pursuant to s 89(1) of the Property Law Act 1969 (WA) (PLA) as being an alienation of property with intent to defraud her creditors. Section 89 of provides: (1) Except as provided in this section, every alienation of property made, whether before or after the coming into operation of this Act, with intent to defraud creditors is voidable, at the instance of any person thereby prejudiced. (2) This section does not affect the law of bankruptcy for the time being in force. (3) This section does not extend to any estate or interest in property alienated for valuable consideration and in good faith or upon good consideration and in good faith to any person not having, at the time of the alienation, notice of the intent to defraud creditors. Mrs Oswal brought separate proceedings in the Supreme Court of Victoria seeking to have the ANZ securities set aside or declared void on the bases that they were procured by the duress, undue influence or coercion by ANZ, or by misleading conduct, or that they were illegal. For the purpose of these proceedings, the Commissioner accepted that ANZ was not at a material time a creditor of Mrs Oswal. Issue 1. whether Mrs Oswal, in granting the mortgage, did so with intent to defraud her creditors, and 2. whether it was necessary for the Commissioner to prove, for the purpose of s 89(3) of the PLA, that the mortgage was not granted for valuable or good consideration and was not granted in good faith. Decision Intent to defraud creditors Gilmour J noted that the following principles apply to determining whether there is an intent to defraud creditors: Brown Wright Stein Lawyers © 2016 page 22 Monthly tax training – July 2016 1. the expression ‘intent to defraud creditors’ in s 89(1) refers to an intention to hinder or delay creditors; 2. the intention required by the statute is an actual intention, but ordinarily the existence of that fact will be inferred; 3. the determination of whether that intent existed requires a consideration of all relevant circumstances; 4. it is not necessary to prove ‘the actual content of the relevant person's mind’. Proof of an intention to hinder or delay creditors of itself establishes relevant dishonesty; 5. it is not necessary to show that a disponor wanted creditors to suffer a loss, that the disponor had a purpose of causing loss or that the disponor had an ‘awareness that the transaction would have an effect on the ability of [his or her] creditors to recover’; 6. the intention to hinder or delay creditors need not be the sole, or even the predominant or primary purpose of the conveyance or assignment, and it does not matter if the relevant intention was formed because of, or at the instigation of, another; 7. where, all of the facts concerning a disposition are within the knowledge of the disponor and the disponee, a very slight degree of proof should be sufficient to shift that burden to the disponor; and. 8. there are various circumstances in which it is recognised that the Court will move readily to infer the existence of the requisite intention. These include where: a. the ‘natural and probable consequences’ of the disposition is the defeat or delay of creditors b. the alienation is made voluntarily; c. the alienation is made, relevantly, for no consideration by a person in financial difficulties; d. the alienation is made in favour of a family member; and e. the alienation is made in haste or proximately to one or more events indicating financial stress on the part of the disponor. Gilmour J noted that ‘creditors’ in s 89(1) does not refer to any one or more particular creditors of a defendant at the time the impugned alienation occurred. Rather, ‘creditors’ includes present and future creditors, whether individually or collectively. Gilmour J referred to the comments of Young JA in Chen v Marcolongo [2009] NSWCA 326 as follows: ‘The word ‘creditors’ in the section has been held on more than one occasion to mean present or future creditors, so that if a person fears that his or her activities may generate creditors and puts property out of the reach of such possible persons, the transfer of the property can be attacked under the section.’ Accordingly, the fact that the Commissioner had not yet issued an assessment and the Commissioner had accepted, for the purposes of the proceedings, that ANZ was not a creditor of Mrs Oswal, did not prevent Mrs Oswal from having the requisite intention. In applying the principles set out above, Gilmour J noted that the mortgage: 1. was granted when Mrs Oswal believed upon objectively reasonable grounds that she was in parlous financial circumstances; 2. was prepared in haste; 3. was granted without consideration; 4. was granted voluntarily; 5. was granted to Mercury which was owned and controlled by a close family member, namely Mrs Oswal’s brother; and 6. had the effect of alienating Mrs Oswal’s entire real property assets within Australia. Gilmour J also concluded that the time of granting the mortgages Mrs Oswal had actual knowledge of creditors, being the Commissioner. Gilmour J stated as follows: It January 2009 Mrs Oswal knew that the Commissioner was making enquiries as to her tax affairs, which was referred to in correspondence mentioned above, but I also infer that as at February 2009 she knew that her tax agent was of the opinion that she had then no Brown Wright Stein Lawyers © 2016 page 23 Monthly tax training – July 2016 present tax liabilities. This is not to conclude that she then, in fact and law, had no such liabilities. However, I have already mentioned that judgment was entered against Mrs Oswal on 9 August 2011 in respect of tax liabilities in an amount of approximately $186 million in respect of the income years ended 30 June 2007 and 2010. This followed the assessments issued by the Commissioner in February 2011 in respect to those tax years. I infer, in these circumstances, that Mrs Oswal, at the time she executed the Mortgage, would on the balance of probabilities have known that she would have income tax liabilities for at least the financial year ended 30 June 2010 even if she was not aware of the precise amount of that liability at the time she granted the Mortgage. Onus of proof of section 89(3) As noted above, section 89(3) of the PLA provides as follows: This section does not extend to any estate or interest in property alienated for valuable consideration and in good faith or upon good consideration and in good faith to any person not having, at the time of the alienation, notice of the intent to defraud creditors. Mercury argued that, as this section was not a defence, the onus was on the Commissioner to prove that the section did not apply. Gilmour J rejected this submission, finding that Mercury carried the burden of demonstrating, by evidence, that s 89(3) was satisfied. Gilmour J noted that, in any event, there was sufficient evidence to positively conclude that the section was not satisfied as: 1. Mercury must have known that Mrs Oswal had no legal or other obligation to grant to it the mortgages, and that in so doing she would be putting the properties beyond the reach of her creditors; 2. Mercury, by its owner Mr Gupta, Mrs Oswal’s brother, knew of the demands made against Mr Oswal, Burrup Holdings and Burrup Fertilisers; and 3. it is reasonable to infer that Mr Gupta would also likely have learned of the demands against his sister directly from her. Accordingly, Gilmour J declared the mortgages void on the basis that they were entered into with the intent to defraud creditors. COMMENT – there is an equivalent provision to section 89 in NSW being section 37A of the Conveyancing Act 1919 (NSW). TRAP – the case reinforces that that the question of whether a transaction is entered into with the intend to defraud creditors has broad application. Although it was not necessary in this case, the requisite intent can be found many years before a person has, or becomes aware of, any financial difficulties. Citation Commissioner of Taxation v Oswal (No 6) [2016] FCA 762 (Gilmour J, Perth) w http://www.austlii.edu.au/au/cases/cth/FCA/2016/762.html Brown Wright Stein Lawyers © 2016 page 24 Monthly tax training – July 2016 2 Legislation 2.1 Progress of legislation There are currently no Bills before Parliament due to the Federal election. 2.2 Foreign resident CGT withholding As set out in prior editions of our Tax Training Notes, from 1 July 2016 a 10% withholding obligation is imposed on buyers in relation to direct and indirect acquisitions of Australian real property. The obligation will apply to the acquisition of an asset that is: 1. Taxable Australian Real Property (TARP); 2. an indirect Australian real property interest; or 3. an option or right to acquire such property or such an interest. There are exemptions to the withholding obligations as follows:: 1. transactions involving TARP and certain indirect Australian real property interests, valued less than $2 million; 2. a transaction that is conducted through a stock exchange or a crossing system; 3. an arrangement that is already subject to an existing withholding obligation; 4. a securities lending arrangement; or 5. transactions involving vendors who are subject to formal insolvency or bankruptcy proceedings. Further, there will be no obligation to withhold where: 1. in the case of TARP and certain indirect Australian real property interests, the vendor obtains a clearance certificate from the Commissioner; or 2. in the case of property other than TARP: a. the vendor has made a declaration that they are an Australian resident for income tax purposes; or b. if the CGT asset acquired is a membership interest, the vendor has made a declaration that the interest is not an indirect Australian real property interest. The Commissioner also has discretion to vary the particular amount otherwise payable by the purchaser under the withholding provisions. The Commissioner's stated approach to the exercise of this discretion is discussed later in these notes. 2.3 NSW State Budget 2016-17 On 21 June 2016 the New South Wales Treasurer delivered the 2016-17 State Budget. The initiatives announced in the Budget included the following: 1. The government will introduce surcharges for foreign investors in residential real estate: a. A transfer duty surcharge of 4 per cent will apply to new purchases; b. A land tax surcharge will also apply at a rate of 0.75 per cent from the 2017 land tax year, with no tax free threshold, including on a principal place of residence. 2. The government will restructure the Jobs Action Plan from 31 July 2016, to focus on businesses with 50 or fewer full time equivalent employees and with the payroll tax rebate increased from $5,000 to $6,000. The NSW Budget also confirmed the abolition of mortgage duty, share transfer duty and non-real property transfer duty from 1 July 2016. Brown Wright Stein Lawyers © 2016 page 25 Monthly tax training – July 2016 3 Rulings 3.1 Foreign CGT withholding: ATO's variation power LCG 2016/5 sets out the principles that the Commissioner will apply in considering whether to exercise his discretion to vary the amount payable by purchasers under the foreign resident capital gains withholding regime that came into effect from 1 July 2016. The Commissioner considers that the following factors support an exercise of the discretion to vary: 1. where the vendor will not make a capital gain on the disposal of the CGT asset or a net capital gain for the income year; 2. where the vendor is not expected to have an income tax liability for the income year, 3. in the case of an application by a secured or unsecured creditor, where the payment of the full withholding amount jeopardises the creditor's ability to recover a debt from the vendor. The withholding provisions do not give the Commissioner a preferential position over other creditors. The Commissioner notes that the fact that purchaser is giving non-cash consideration will not generally be a basis on which to vary the amount payable under the withholding provisions. In such circumstances, the purchaser must pay the withholding amount to the Commissioner from a source other than the consideration payable to the vendor. However, the Commissioner may consider a variation in such circumstances where the vendor is able to provide security to the Commissioner for their ultimate CGT liability in disposing of the asset. LCG 2016/5 notes that the following persons can make an application to the Commissioner for a variation: 1. the purchaser of the CGT asset; 2. the vendor of the CGT asset (including the grantor of an option that has not yet been exercised), or 3. an entity that is owed a debt by the vendor. ATO reference LCG 2016/5 w https://www.ato.gov.au/law/view/view.htm?docid=%22COG%2FLCG20165%2FNAT%2FATO%2F00001 %22 3.2 Foreign resident CGT withholding: amount payable to ATO LCG 2016/6 sets out the Commissioner's guidance on working out the amount to be paid to the Commissioner under the foreign resident capital gains withholding regime. The amount payable to the Commissioner under the foreign resident capital gains withholding regime is equal to 10% of the first element of the CGT asset's cost base to the purchaser, which will usually be the money paid, plus the market value of any property given, to acquire the asset. LCG 2016/6 notes that the first element of the cost base of a CGT asset may differ from the contract or purchase price where: 1. the first element of the cost base has been modified under the CGT cost base modification provisions; or 2. the purchaser acquires more than one asset under the contract for an undissected lump sum, and not all of the assets are subject to the withholding obligation. Market value substitution rule LCG 2016/6 provides that where the market value substitution rule applies the approaches to determine the amount payable are as follows: Brown Wright Stein Lawyers © 2016 page 26 Monthly tax training – July 2016 1. where it is a normal arm's-length dealing – the purchaser can rely on the values assigned to work out whether the withholding obligation applies, and how much they must pay; 2. where it is a non-arm’s length dealing – the purchaser may seek an independent valuation to determine the market value of the asset. The Commissioner notes that the ATO does not proscribe who may undertake the valuation, the valuation must be reliable and use an appropriate valuation methodology. Dissection of contract price The Commissioner notes that where the parties to the contract are dealing at arm's length, they may dissect the purchase price by using the proportionate market value of each asset by taking any appropriate steps to determine the value of the assets, and apportion the contract price on a reasonable basis. This could either be by: 1. obtaining an independent valuation of each asset; or 2. choosing to value the assets and apportion the contract price themselves, if they are able to justify the values they have assigned to each asset. LCG 2016/6 contains a number of examples, and we have extracted two of them below: Example 1 - Contract price substituted for market value 21. Peta purchases a residential property from an associate who she knows is a foreign resident. The purchase price is $3 million under a contract executed on 1 July 2016, with a settlement date of 2 August 2016. Peta and her associate did not deal at arm's length. Shortly before the purchase, Peta obtained an independent market valuation report that valued the property at $4 million. 22. As the parties did not deal at arm's length, the market value substitution rule applies. Therefore, the $4 million market value becomes the first element of Peta's cost base of the property. 23. All the conditions for the application of subsection 14-200(1) are met, so Peta remits $400,000 to the Commissioner on 2 August 2016. Example 2 - Dissection of contract price 24. On 10 July 2016, Afonso, a foreign resident, enters a contract to sell assets used in his Australian business to Relic Co. The transaction is at arm's length. 25. The contract sets out total consideration of $5 million with a settlement date of 30 September 2016. Relic Co obtains an independent valuation of the assets at the time of sale which sets out the following values: (a)Land $2.1 m, (b)Commercial building $2 m, (c)Plant and equipment $0.9 m 28. The land and commercial building are TARP, and are therefore subject to the withholding obligation in section 14-200. The plant and equipment, which is not a fixture, is outside the scope of the withholding obligation. 27. The total market value of the assets in the independent valuation report is equal to the contract price ($5 million). Relic Co apportions the contract price between the assets according to the market value of each asset. The first element of Relic Co's cost base of the land and commercial building is $4.1 million. All the conditions for the application of subsection 14-200(1) are met, so Relic Co withholds and remits $410,000 to the Commissioner on 30 September 2016. Brown Wright Stein Lawyers © 2016 page 27 Monthly tax training – July 2016 TIP – the foreign CGT withholding regime only applies to ‘acquisitions’ that occur on or after 1 July 2016. The amending Act makes it clear that in determining when an asset is ‘acquired’ it is its acquisition date for CGT purposes. Thus, if a property is acquired under a pre-1 July 2016 contract there will generally be no withholding obligation (but this will depend upon the actual CGT event). ATO reference LCG 2016/6 w https://www.ato.gov.au/law/view/view.htm?docid=%22COG%2FLCG20166%2FNAT%2FATO%2F00001 %22 3.3 Foreign resident CGT withholding regime: options LCG 2016/7 considers the application of foreign resident capital gains withholding regime in relation to options to acquire interests in TARP noting that such an obligation may arise on acquiring option to acquire TARP or an 'indirect Australian real property interest' or as a result of exercising such an option. Grant of Option LCG 2016/7 notes that where a purchaser acquires an option or right to acquire TARP or an indirect Australian real property interest from a foreign resident, the purchaser must pay the Commissioner an amount equal to 10% of the first element of the option's cost base. The purchaser does not have to withhold an amount if the vendor is not a relevant foreign resident at the time the option is granted. The vendor is not a relevant foreign resident if: 1. before the purchaser pays an amount to the Commissioner, the vendor gives the purchaser a valid declaration stating that they are an Australian resident, and 2. the purchaser does not know the declaration is false. Options, however, are not subject to the $2 million threshold. A purchaser that pays an option fee to a vendor that is a relevant foreign resident must withhold, even if the option is over an asset that has a market value of less than $2 million. Exercise of Option LCG 2016/7 explains that when an asset is acquired as a result of exercising an option, subparagraph 14-200(3)(a)(ii) avoids double counting of the option fee by reducing the amount to which the 10% withholding is applied by any payments the purchaser made, and the market value of any property the purchaser gave, for the option (or for its renewal or extension). In limited circumstances, subparagraph 14-200(3)(a)(ii) reduces the amount of withholding even where there was no withholding on the granting of the option. This may be the case, for example, if the option was acquired from an entity that was not a relevant foreign resident at the time the option was granted (see Example 3 below), or if the option was granted before 1 July 2016. Where the vendor and purchaser: 1. deal with each other at arm's length, the purchase price of the asset may be used as a proxy for the market value of the asset at the time the option is exercised; or 2. are not dealing at arm's length, the purchaser will have to determine the market value of the asset to work out whether they have a withholding obligation. The purchaser may seek an independent valuation to determine the market value of the asset. LCG 2016/7 contains a number of examples, and we have extracted two of them below: Example 3 - Option not subject to withholding Brown Wright Stein Lawyers © 2016 page 28 Monthly tax training – July 2016 27. On 1 January 2017 Numbat Co acquires an option from Vendor Co, enabling Numbat Co to purchase a commercial property in Australia for $65 million within 18 months of acquiring the option. Both Numbat Co and Vendor Co are Australian residents. 28. Numbat Co pays Vendor Co an option fee of $5 million for the option. 29. Numbat Co considers subsection 14-210(1), and, thinking that Vendor Co is a foreign resident, intends to withhold from the option fee. However, Vendor Co provides Numbat Co with a written declaration of its Australian residency and, consequently, Numbat Co does not need to withhold under section 14-200. The declaration is stated to be valid for 6 months from the date it is made. 30. In October 2017 Vendor Co becomes a foreign resident. 31. In February 2018, Numbat Co exercises the option and acquires the property for $65 million. At this time, all the conditions are met for the withholding obligation under subsection 14-200(1) to apply. The first element of the cost base of the property when the option is exercised is $70 million (being the $65 million paid on exercise plus the $5 million option fee). 32. The amount to which the 10% withholding applies is reduced by the $5 million option fee, despite the fact that there was no withholding at the time the option was granted. Accordingly, Numbat Co is only required to withhold from $65 million (being $70 million less the $5 million that was paid for the option) and remits $6.5 million (being 10% of $65 million) to the Commissioner on the day of settlement. Example 7 - Option fee paid in instalments 56. On 1 January 2017, Possum Co, an Australian resident, enters an agreement with Forco, a foreign resident, under which Possum Co will acquire the right but not the obligation to purchase a commercial property in Australia for $2 million within 10 months of acquiring the option. 57. Possum Co must pay Forco an option fee of $10,000, which is payable in 5 equal instalments of $2,000. Under the terms of the agreement, the option will be granted upon payment of the final instalment. 58. For CGT purposes, Possum Co acquires the option when the option is granted.[22] It is only when Possum Co acquires the option that it will be subject to the withholding obligation in section 14-200. 59. The withholding amount is calculated based on the first element of the option's cost base, which is $10,000. Possum Co withholds $1,000 (being 10% of $10,000) from the final instalment and pays the amount to the Commissioner on the day the option is granted. 60. Note 1: If Possum Co exercises the option, it would be subject to a further withholding obligation on the purchase of the commercial property as the market value of the property is taken to be $2 million at this time. 61. Note 2: If, under the terms of the agreement, the option is granted before the final instalment is paid, Possum Co must still pay the amount to the Commissioner on or before the day the option is granted. Possum Co should withhold the amount payable to the Commissioner from the first or subsequent instalments that are to be paid to Forco. ATO reference LCG 2016/7 w http://law.ato.gov.au/atolaw/view.htm?DocID=COG/LCG20167/NAT/ATO/00001&PiT=99991231235958 Brown Wright Stein Lawyers © 2016 page 29 Monthly tax training – July 2016 4 Determinations 4.1 Division 7A benchmark interest rate On 29 June 2016 the ATO issued Tax Determination 2016/11 to set the benchmark interest rate applicable for the purposes of Division 7A with respect to the year of income that commenced on 1 July 2016. This Tax Determination provides that for the income year that commenced on 1 July 2016, the benchmark interest rate is 5.40% per annum. TRAP – this is the benchmark rate only for companies with a 1 July to 30 June income year. For other companies it is the relevant RBA indicator lending rate for the day prior to the beginning of the income year. ATO reference TD 2016/11 w https://www.ato.gov.au/law/view/view.htm?docid=%22TXD%2FTD201611%2FNAT%2FATO%2F00001% 22 4.2 Improvement threshold The ATO has issued Taxation Determination 2016/12 which provides that the improvement threshold for capital gains tax purposes is $145,401 for the income year ending 30 June 2017. The improvement threshold is relevant for the purposes of determining when a capital improvement to a pre-CGT asset is a separate asset and when a rollover may be available in respect of capital improvements to CGT assets. ATO reference TD 2016/12 w https://www.ato.gov.au/law/view/view.htm?docid=%22TXD%2FTD201612%2FNAT%2FATO%2F00001% 22 4.3 Refunds of increasing adjustments The ATO has issued Goods and Services Tax Determination 2016/2 which provides that in some circumstances a refund of an increasing adjustment for a supply may be prevented under Division 142 of the GST Act. Adjustments under Division 19 can arise because of adjustment events. An adjustment event is any event which has the effect of: 1. cancelling a supply or acquisition 2. changing the consideration for a supply or acquisition, or 3. causing a supply or acquisition to become, or stop being, a taxable supply or creditable acquisition. When an adjustment event occurs in relation to a supply, the supplier may have to make one of the following types of adjustments: 1. an increasing adjustment - where the 'corrected GST amount' is greater than the 'previously attributed GST amount', or 2. a decreasing adjustment - where the 'corrected GST amount' is less than the 'previously attributed GST amount'. Excess GST arises if a supplier's assessed net amount for a tax period takes into account an amount of GST exceeding that which is payable. In such cases, the supplier is entitled to refund of the excess GST. However, section 142-5(2) provides that excess GST does not include an amount of GST that was correctly payable and attributable to the tax period, but which later becomes the subject of a decreasing Brown Wright Stein Lawyers © 2016 page 30 Monthly tax training – July 2016 adjustment – unless this amount was never passed on to the person paying the GST to or reimbursed to the person that paid the GST. The following example sets out the Commissioner's view as to the interaction between increasing adjustments under Division 19 and the entitlement to a refund for excess GST under Division 142 Example 1 - section 19-50 increasing adjustments for supplies to Barry's Biz 2. Jo Wholesale makes a supply of goods to a customer, Barry Biz. Both businesses are GST registered. Jo Wholesale treats the supply of goods as a taxable supply and charges Barry Biz a GST inclusive price of $22,000. Jo Wholesale includes GST of $2,000 on this transaction in its Business Activity Statement (BAS) for the quarter ending 31 March 2015. 3. Some months later, Jo Wholesale discovers that the GST inclusive price charged to Barry Biz for the goods was incorrect and that a higher price should have been charged. Jo Wholesale and Barry Biz agree that a pricing error has occurred. Jo Wholesale issues an adjustment note and Barry Biz pays an additional amount (including GST) of $5,500 that should have been charged for the supply of the goods. 4. Jo Wholesale makes an increasing adjustment of $500 for the supply under section 19-50, representing the extra amount of GST included in the additional amount charged to Barry Biz. The $500 is included in Jo Wholesale's assessed net amount for the quarter ending 31 December 2015. 5. In November 2016, Jo Wholesale discovers that the goods in question are in fact GSTfree. The GST amounts of $2,000 and $500 are excess GST. 6. There are no facts which indicate that the GST amounts of $2,000 and $500 were not passed on to Barry Biz. 7. Jo Wholesale does not reimburse Barry Biz any amount representing the excess GST paid. 8. Division 142 applies to prevent a refund of the $2,000 of excess GST that was included in Jo Wholesale's assessed net amount for the March 2015 quarter, as the excess GST has been passed on but not reimbursed to Barry Biz. 9. Division 142 also applies to prevent a refund to Jo Wholesale of the excess GST arising from the increasing adjustment of $500 included in Jo Wholesale's assessed net amount for the December 2015 quarter, as the excess GST has been passed on but not reimbursed to Barry B. ATO reference GSTD 2016/2 w http://law.ato.gov.au/atolaw/view.htm?docid=%22GSD%2FGSTD20162%2FNAT%2FATO%2F00001%22 Brown Wright Stein Lawyers © 2016 page 31 Monthly tax training – July 2016 5 ATO materials 5.1 Foreign resident CGT withholding forms The ATO have released forms and guidance to obtain: • A foreign resident withholding variation; • A foreign resident withholding purchaser payment notification; and • A foreign resident withholding clearance certificate. The variation is discussed above in our notes. The purchaser payment notification is to be completed and lodged on or before the day of settlement. Once completed it should generate a payment reference number. The withholding is due on the day of settlement. The clearance certificate, which will apply in all cases where there is a non-exempt sale of taxable Australian real property, is needed to ensure there is no withholding. The instructions suggest the application is long and complex. w https://www.ato.gov.au/Forms/Foreign-resident-capital-gains-withholding-rate-variation-applicationonline-form-and-instructions/ w https://www.ato.gov.au/Forms/Foreign-resident-capital-gains-withholding-purchaser-paymentnotification-online-form-and-instructions/ w https://www.ato.gov.au/Forms/Foreign-Resident-Capital-Gains-Withholding-clearance-certificateapplication-online-form-and-instructions---for-Australian-residents/ 5.2 Mutuality and taxable income The ATO has updated its guide on mutuality and taxable income. Amounts derived by an unincorporated association, which would ordinarily be income and taxable to the association, will not be taxable where the amounts are covered by the ‘mutuality principle’. The mutuality principle, a well-accepted principle in Australian tax law, provides that contributions to an association by its members will not be income of the association. The mutuality principle typically applies in cases where: 1. an association of persons is not separate to its members under the general law but is separate for tax purposes such that the members have ownership and control of the common fund; and 2. the organisation is carried on for the benefit of their members collectively and the members share a common purpose. The ATO's guide sets out its administrative application of the principle to certain organisations. It should be noted that the guide is merely the ATOs view and is not necessarily determinative of the law but it provides some assistance in determining when the ATO considers that the mutuality principle will apply and which receipts or gains it considers to be non-mutual. w https://www.ato.gov.au/law/view/document?docid=SAV/MUTUAL/00001 5.3 Foreign investment in Australia – Land registration form The ATO has provided information on its website on its new role in maintaining Land Register of purchases, sales and transfers of land and/or properties by foreign persons. Foreign persons must notify the ATO, within 30 days of the event, where they: 1. have acquired an interest in agricultural land or are required to notify as a condition of their approval to purchase residential real estate; Brown Wright Stein Lawyers © 2016 page 32 Monthly tax training – July 2016 2. no longer have an interest in agricultural land; 3. have changed foreign person status, either becoming a foreign person or ceasing to be a foreign person or have changed the land or property type from, or to, agricultural land or residential real estate. Foreign Person A ‘foreign person’ is defined as ‘an individual not ordinarily resident in Australia’. An Australian citizen living permanently overseas may be considered a foreign person as they are not ordinarily residing in Australia and would have to register their holdings on the Agricultural Land Register. Agricultural land A foreign person needs to register their interest in agricultural land if they are the legal owner or if they have a right to occupy the agricultural land under a lease or licence that is likely to exceed five years (including possible extensions or renewals). Agricultural land is land in Australia that is used, or that could reasonably be used, for a primary production business. This includes land which is partially used for a primary production business, or land where only part of the land could reasonably be used for a primary production business. Land that is not being used wholly or predominantly at the time for a primary production business is excluded from being agricultural land if: 1. the land is not currently zoned for a primary production business; 2. an application has been made to re-zone land currently able to be used for primary production to some other use, eg mining; 3. the land is used wholly or predominantly for mining or activities ancillary to mining; 4. an approval of a government authority (that is not a mining or production tenement) is in force allowing a mining operation to be established (or activities ancillary to mining); 5. the land is used for the protection or conservation of the environment; 6. the land is used wholly or predominantly for the purpose of a wildlife sanctuary or for rehabilitating animals; 7. the land is located within an industrial estate; 8. the size of the land is one hectare or less; 9. the land is used for providing facilities for tourism, outdoor education or outdoor recreation to the public; or 10. the only primary production business that the land is or could reasonably be used for relates to submerged plants or animals. Residential real estate Foreign persons who purchase residential real estate are required to register their interest as a condition of Foreign Investment Review Board (FIRB) approval. Residential real estate may include: 1. new dwellings; 2. established dwellings; 3. off-the-plan properties; 4. vacant land zoned for residential living. w https://www.ato.gov.au/General/Foreign-investment-in-Australia/Land-Registration-form/ Brown Wright Stein Lawyers © 2016 page 33