Australian Taxation Office targets investors seeking to adopt capital gains tax treatment on sale of shares

The recent Australian Administrative Appeals Tribunal (“AAT“) decision in Ransley v Commissioner of Taxation [2018] AATA 4359 has shown the willingness of the Australian Taxation Office (“ATO“) to target investors seeking to adopt capital gains tax treatment on the sale of shares. The AAT also upheld the 50% penalty applied by the ATO.

Please click here to read a briefing which discusses the AAT’s decision and some troubling implications arising from it for Australian taxpayers.

TAXING PRIVATE TRUSTS IN AUSTRALIA – A MOVING TARGET

The Australian revenue authorities have been very active recently issuing judgments, making pronouncements and intensifying enforcement activity, all directed to the way the tax system operates in relation to income made from, and gains arising on transactions with, assets that are held on trust.

Please click here for some highlights of the effects of some of the more important developments affecting private trusts.

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Circular trust resolutions – family trusts to be taxed at 47% by Australian Government

Following on from the Australian Government’s announcement in the 2018-19 Budget, an Exposure Draft entitled Treasury Laws Amendment (Measures for a Later Sitting) Bill 2018 has been released which proposes to impose trustee beneficiary non-disclosure tax (currently, 47%) on the untaxed part of a circular trust distribution to which the trustee of a family trust becomes presently entitled.

Please see below to read more on the impact of the Exposure Draft on family groups.

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Australian tax law bites trust law on franking credits

The High Court of Australia has restored sanity in a long running saga in which a trustee purported to separate franking credits from the underlying dividends in allocations to beneficiaries. The Court held (as the parties now accepted) that this was not possible and that a contrary decision of the Supreme Court of Queensland in its trusts jurisdiction to which the Commissioner of Taxation was not party did not bind the Commissioner. To find out more, please read below.

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Corporate tax rate cut – passive income exclusion

As part of the Australian Government’s Enterprise Tax Plan, the corporate tax rate has been reduced to 27.5 per cent for entities that satisfy the annual turnover threshold requirement, which applies progressively from $10 million in the 2016-17 income year to $50 million in the 2018-19 income year.

The Government released for consultation on 18 September 2017 exposure draft legislation aimed at excluding entities with predominantly passive income from access to the lower 27.5 per cent rate. That is, entities with ‘base rate entity passive income’ that is 80 per cent or more of their assessable income in an income year would continue to pay corporate tax at 30 per cent despite being under the annual turnover threshold. This proposal, once legislated, will apply retrospectively to restrict the application of the rate reduction from the 2016-17 income year.

The usual items such as dividends, interests, royalties, rent (including a flow through of these items through trusts and partnerships) will be included in the proposed definition of ‘base rate entity passive income’. The proposed definition will also take into account capital gains as defined by the Act. However, this fails to reflect that:

  • gains on the disposal of assets such as trading stock and other assets held on revenue account prima facie give rise to capital gains, as defined, but for CGT purposes are then subsequently disregarded to prevent double counting of the gain;
  • capital gains on the disposal of assets in an income year are reduced by capital losses made during that year, as well as carried forward capital losses; and
  • most importantly, capital gains are often realised on the disposal of active assets that are used to carry on a business (for example goodwill).

The current drafting would often result in genuine active business income being incorrectly classified as passive. We expect this is a drafting error, and not the intended policy behind this proposed amendment.  However, this will need to be confirmed through the consultation process.

It is surprising that the exposure draft did not mirror other provisions in the Act that identify net gains on passive assets, such as the controlled foreign company rules in Part X of the 1936 Act or the active foreign business asset rules in Subdivision 768-G of the 1997 Act.

This may not be all bad news. Where an entity has predominantly Australian resident shareholders and routinely distributes all of its profits to shareholders, consistently having passive income of 80 per cent or more may enable them to avoid complexities and simply continue to pay tax at 30 per cent and frank their distributions at 30 per cent. This could be a more favourable outcome when compared to an entity that from year to year is just under 80 per cent and then just over 80 per cent, resulting in different tax and franking rates from one year to the next.

These issues relating to the current exposure draft are in addition to the franking credit issues previously identified in relation to the corporate tax rate reduction measure in general, as listed below.

  • The reduction in corporate tax rate will increase cash flow to shareholders. However, the lower corporate tax rate also means that less franking credits will be available to shareholders. This may result in more tax being paid at the shareholder level where the shareholder is an Australian resident individual; and
  • The potential mismatch between an entity’s applicable ‘corporate tax rate’, which is determined based on the aggregated turnover and passive income amount for the current year, and ‘corporate tax rate for imputation purposes’, which is calculated by reference to an entity’s aggregated turnover and passive income for the previous income year. This can result in a discrepancy for imputation and corporate tax purposes and the potential for franking credits to be trapped in a corporate entity where the entity moves from 30% to a lower tax rate.

Our previous post explains these franking credit issues in greater detail.

We will be making a submission to the Treasury on the draft legislation, which is due on 29 September 2017.

Andrew White
Andrew White
Director
+61 2 9225 5984

Narelle McBride
Narelle McBride
Director
+61 3 9288 1715

Lica Shi
Lica Shi
Senior Associate
+61 3 9288 1985

 

Labor’s Family Trust Distribution Tax

In an audacious move to target income splitting, if elected, the Australian Labor Party (ALP) has announced that it will introduce a minimum standard 30 per cent tax rate on all discretionary trust distributions made to beneficiaries over the age of 18 from 1 July 2019. Touted to tackle income inequality and enforce “fair taxation”, the proposed changes have been described as meddling with “off-limits tax territory”.

How will a discretionary trust distribution tax work?

The policy proposal of the ALP is scant in detail and leaves a number of questions unanswered. What we do know is that the new tax builds on the existing regime which taxes minor beneficiaries on certain income at the highest marginal tax rate. If the new tax is to follow that model, this would mean that the beneficiary will be assessed at a minimum of 30 per cent, with no tax credits provided.

This approach is confirmed in the policy document. To the extent that the income is distributed to a tax payer with a higher marginal tax rate (>30 per cent), the income would be taxed at that higher rate.

There are, of course, carve outs. The proposed changes will only apply to discretionary trusts. This means other non-discretionary trusts will not be impacted by the change. Further, farm trusts (undefined) and charitable institutions will not be subject to the proposed changes. Similarly, exemptions will be provided for distributions to certain mature beneficiaries, including people with disabilities.

Conceptual issues

At this stage, it is difficult to assess how effective the new policy will be. It is estimated that the policy will only impact 2 per cent of taxpayers and 318,000 discretionary trusts. Yet, the independent Parliamentary Budget Office estimates the policy will raise $4.1 billion over the forward estimates period to 2021-22. Quantitative analysis aside, a number of unanswered policy questions remain, including:

  • how will non-cash distributions made from a discretionary trust be treated? Non-cash distributions can occur through the transfer of property, shares, or units. Presumably, the trustee will need to fund the 30 per cent tax on the distributions from other sources.
  • how will the policy apply to distributions made to non-resident beneficiaries? Non-resident beneficiaries already face a higher marginal tax rate, and are initially taxed at the trustee level. It is not clear whether a credit for the 30 per cent tax will be available to non-residents as is generally the case at the moment.
  • what if adults receive the discretionary trust distributions indirectly via a company? Will a mechanism be introduced to ensure that the franking credits generated at the company level are not refundable in these circumstances?

The ALP has proposed to provide $55 million per year to the ATO to ensure that the intent of the policy is achieved, and also to bolster the ATO’s current trust anti-avoidance activities. The ATO may need to allocate a significant proportion of these funds to managing the administrative complexity that will come with the introduction of this new tax.

What’s next

It is clear that policy makers are starting to turn their attention to tax minimisation created through trust structures. With high-net wealth individuals being a reoccurring feature in the “fair taxation” debate, we can expect more initiatives that will “make the tax system fairer and improve the budget bottom line”.

Andrew White
Andrew White
Director
+61 2 9225 5984

Narelle McBride
Narelle McBride
Director
+61 3 9288 1715

Chris Aboud
Chris Aboud
Senior Associate
+61 2 9225 5954

Stefania Maccarrone
Stefania Maccarrone
Associate
+61 2 9225 5955

 

A severe case of the penalties

The Administrative Appeals Tribunal (AAT) has handed down its decision in Peter Sleiman Investments Pty Limited as Trustee for The Sleiman Family Trust and Commissioner of Taxation (Taxation) [2017] AATA 999 (Sleiman). The decision is a timely reminder of the various powers that the Commissioner has to impose penalties on taxpayers.

The case involved the lodgement of returns not necessary by a family trust which was undertaking a property renting business. The taxpayer submitted that it had lodged returns not necessary for numerous income years on the basis that its expenses exceeded the assessable income in each of these income years.

The Commissioner subsequently issued default assessments to the taxpayer resulting in combined taxable income of $8.04 million and a tax liability of $3.739 million for the income years in which returns not necessary were lodged. As a result, the onus of proof was on the taxpayer to substantiate its deductions or that certain amounts were non-assessable in the default assessment income years.

Unsurprisingly, the AAT found in favour of the Commissioner given that the taxpayer was unable to demonstrate the nexus of its outgoings and its passive property renting business. These deductions included 65 cars (including two cars located in a State which the family trust held no property), fitness equipment and firearms. The taxpayer was also unable to support its treatment of certain amounts as non-assessable.

Following the discovery of the tax shortfall, the Commissioner sought to impose administrative penalties on the taxpayer for failing to lodge income tax returns. The Commissioner imposed a 75% base penalty rate on the shortfall and an additional base penalty rate increase of 20% on the shortfall in the default assessment income years following the initial default assessment. The imposition of these penalties result in the taxpayer paying almost $7 million in tax and penalties on $8 million of undeclared taxable income.

In considering the penalties, the AAT concluded that the 75% administrative penalty was appropriate given the “deliberate and inexplicable” actions taken by not lodging the relevant income tax returns. The taxpayer also contended the 20% uplift should be remitted as the non-lodgement was “one single course of conduct”. However, the AAT rejected this contention and stated that this line of argument was the equivalent of:

“asserting that an armed robber who holds up a bank once a year for each of three years is engaging in just one single course of conduct and should therefore be treated more leniently”.

This case is an important reminder of the various powers that the Commissioner has under Division 274 of the Tax Administration Act 1953 to impose substantial penalties on taxpayers. Generally, the quantum of the penalty imposed will be based on the Commissioner’s view as to whether there were inadvertent errors or purposeful actions. In certain circumstances, the Commissioner is also entitled to further increase the penalty for additional indiscretions (as was the case in Sleiman).

Once the Commissioner decides to impose a penalty, the onus is on the taxpayer to provide reasoning as to why the Commissioner should remit that penalty. Factors such as compliance history, the way in which the tax shortfall is discovered and the taxpayer’s co-cooperativeness are considered by the Commissioner in choosing whether to exercise this discretion.

Based on the broad powers given to the Commissioner under Division 274, generally the only avenue to challenge any denied request for remission is for the taxpayer to refer the matter to the AAT (as was the case in Sleiman) or the Courts.

Andrew White
Andrew White
Director
+61 2 9225 5984

Chris Aboud
Chris Aboud
Senior Associate
+61 2 9225 5954