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March 2017

The dangers of income splitting

 

Now and then the ATO issues warnings on how its general anti-avoidance legislation can apply to professional firms that allocate profits to individual professional practitioners with proprietorship in the firm.

           

 

Firms potentially affected include those providing services in the accounting, architectural, engineering, financial services, legal and medical professions.

Professional firms can be structured in a range of ways, depending on the choices made by the owners, but the ATO has warned that in some cases the way a business is structured “can be used in ways that give rise to different tax consequences and resulting tax compliance risks”. 

Its concerns about tax compliance in these instances are based on where arrangements are set up so that a practice’s income is treated as being derived from the business itself, even though the source of that income is actually the provision of professional services by individuals.

The ATO says this is particularly the case where: 

  • the level of income received by the practitioner, whether by way of salary, distribution of partnership or trust profit, dividend or any combination of them, does not reflect their contribution to the business and is not otherwise explicable by the commercial circumstances of the business
  • tax paid by the practitioner and/or associated entities on profits of the practice entity is less than that which would have been paid if the amounts were assessed in the hands of the practitioner directly
  • the practitioner is, in substance, being remunerated through arrangements with their associates, and
  • the structure does not provide the practitioner with advantages, such as limited liability or asset protection.

The danger here is that the ATO may commence compliance activity, including audits, of practitioners for any given income year. The ATO’s approach could include: 

  • an individual professional practitioner provides professional services to clients of the firm, or is actively involved in the management of the firm and, in either case, the practitioner and/or associated entities have a legal or beneficial interest in the firm
  • the firm operates by way of a legally effective partnership, trust or company, and
  • the income of the firm is not personal services income.

High and low risk

The ATO says taxpayers will be rated as low risk and not subject to compliance action if they meet one of the following guidelines regarding income from the firm (including salary, partnership or trust distributions, distributions from service entities or dividends from associated entities): 

  • the practitioner receives assessable income from the firm in their own hands as an appropriate return for the services they provide to the firm. The benchmark for an appropriate level of income will be the remuneration paid to the highest band of professional employees providing equivalent services to the firm, or to a comparable firm
  • 50% or more of the income to which the practitioner and their associated entities are collectively entitled (whether directly or indirectly through interposed entities) in the relevant year is assessable in the hands of the practitioner
  • the practitioner, and their associated entities, both have an effective tax rate of 30% or higher on the income received from the firm.

Where none of these guidelines are satisfied, the ATO says the practitioner’s arrangement will be considered higher risk, with increased chance of compliance action. The lower the effective tax rate of an arrangement, the higher the ATO may rank the compliance risk.

Tax & Super Australia 
www.taxandsuperaustralia.com.au

 

 

Online Selling

 

The Australian Taxation Office (ATO) continues to increase their surveillance activity and utilize the electronic data bases of on-line sellers.

           

 

Data will be acquired relating to registrants who sold goods and services to an annual value of $12,000 or more during the 2015–2016, 2016–2017 and 2017–2018 financial years. 

Data will be sought from eBay for these three years and on an ongoing basis.  The data will be used to identify those apparently operating a business but failing to meet their registration and/or lodgment obligations.  It is estimated that between 20,000 and 30,000 records will be obtained.  Uber and Airbnb records are also provided.

 

AcctWeb

Borrowed money to pay a business tax debt? Is the interest deductible?

 

It was about 1990 when the ATO was asked about the tax deductibility of interest on a loan a business may have taken out to repay a tax debt. 

         

 

It was the third time, according to ATO records, that the matter was raised. Of the two previous requests for clarification, one was made as far back as 1951 and the other even further back in time, in 1921.

The 1990 query resulted in the ATO issuing a taxation ruling to put the matter to bed, which has stood ever since. There are however curly caveats and conditions attached.

By way of background, the ATO admitted in its ruling that there were, and are, a number of “practical difficulties” associated with denying such a specific deduction for taxpayers carrying on a business. The difficulty goes right to the heart of the Income Tax Assessment Act 1997 (ITAA97), although at the time of the ruling’s issue some of the relevant sections were still in the Income Tax Assessment Act 1936.

Specifically, subsection 8-1(1) ITAA97 says: “You can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income or it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income, except to the extent to which it is a loss or outgoing of capital, or of a capital, private or domestic nature, or incurred in relation to the gaining or production of exempt income.”

The “difficulties” the ATO refers to come about due to the fact that paying a tax debt is neither of a capital nature nor done to gain “exempt” income. 

The above tax ruling says: “Where a taxpayer carries on a business for the purpose of gaining or producing assessable income and, in connection with the carrying on of that business, borrows money to pay income tax (whether to preserve the assets of the business, maximise the return on them, retain sufficient money to fund the business or otherwise) then it is considered that the interest incurred on those borrowings is a normal incident of conducting that business.”

“That is, such an expense is an expense incurred in carrying on that business and hence qualifies for deduction under the second positive limb of subsection 8-1(1) of the act.”

Care needs to be taken however, as the ruling would not apply to interest on borrowings that are not connected with the carrying on of a business for the purpose of producing assessable income. 

Note however that the ruling does not consider situations where individuals borrow to pay off a tax debt.  In these cases, interest incurred by an individual on a loan to pay off a tax debt is not deductible.

 

Tax & Super Australia 
www.taxandsuperaustralia.com.au

 

 

 

 

ATO issues further taxpayer alerts on key focus areas

 

The ATO is continuing to crack down on the incorrect use of the Research & Development Tax Incentive program, issuing an additional two taxpayer alerts.

         

 

The ATO, together with the Department of Industry, Innovation and Science (DIIS), is continuing to crack down on the incorrect use of the Research & Development (R&D) Tax Incentive program. 

On 9 February the ATO issued TA 2017/2 and TA 2017/3 to warn those seeking to deliberately exploit the R&D Tax Incentive program, but seemingly it wasn’t enough.

On 20 February the ATO issued two further taxpayer alerts on the topic, TA 2017/4 and TA 2017/5.

While the original two alerts focused on specific concerns within the building and construction industry, the new alerts relate to behaviours noticed in the agricultural, software and IT industries, according to the ATO deputy commissioner Michael Cranston.

Mr Cranston said they are seeing businesses in the agricultural, software and IT industries incorrectly claim ordinary business activities as R&D activities and R&D expenditure.

“These taxpayer alerts are a continuation of our efforts to work with industries involved in R&D to ensure their claims are valid, and through compliance activities and legal actions, address businesses and advisors deliberately doing the wrong thing,” Mr Cranston said.

“We acknowledge that the vast majority of people claiming this tax incentive are doing the right thing. We are focusing our efforts on the small number of people who are deliberately trying to exploit the system.”

 

LARA BULLOCK
Wednesday, 22 February 2017
www.accountantsdaily.com.au

Active vs passive assets and the small business CGT concession

 

The small business capital gains tax concessions are extremely valuable, and for small business owners who need to dispose of assets that have risen in value during the time they have owned them, accessing these concessions can mean greatly reducing any consequent tax liability, even to zero.

           

 

But to access the CGT concessions some conditions must first be satisfied, such as having an aggregated annual turnover of less then $2 million, and net assets not exceeding $6 million. One of the small business CGT concessions, the 50% asset reduction, comes with one particular condition — that the CGT asset satisfies the active asset test. 

A CGT asset is an “active asset” if it is used, or held ready for use, in the course of carrying on a business by the taxpayer (or their affiliate or an entity connected with them, known as relevant entities). For example, a bricks-and-mortar shop held and used by a green grocer to sell fruit and vegetables is an example of an active asset. 

Another condition to satisfy this test is that the asset must be an active asset of the taxpayer for the lesser of 7.5 years or half of the relevant ownership period.

However, certain assets are specifically excluded from being an active asset, with one such exclusion applying to assets where the main use by the taxpayer is to derive rent (unless the main use for deriving rent was only temporary). When determining the main use of the asset, the taxpayer is instructed to disregard any personal use or enjoyment of the asset by them (which includes use by affiliates and connected entities). 

Carrying on a business

To qualify as an active asset, a tangible CGT asset must be used or held ready for use in the course of carrying on a business, but there is no black-and-white test for determining whether a business is being carried on. However the ATO has enumerated several indicators that may be relevant, including;

  • the size, scale and permanency of the activity
  • repetition and regularity of the activity 
  • whether the activity is planned, organised and carried on in a systematic and businesslike manner, and
  • the expectation, and likelihood, of a profit.

It can be assumed that the operator of a motel is conducting a business, however most residential rental activities are a form of investment, and do not amount to carrying on a business. 

Notwithstanding this, it is possible to conduct a rental property business. To take a real example from the ATO’s case files, it so happened that a taxpayer owned eight houses and three apartment blocks (each comprising six residential units), making a total of 26 properties. The taxpayer actively managed the properties, devoting a significant amount of time to this (an average of 25 hours per week). The ATO concluded this taxpayer was carrying on a business. 

So while an asset whose main use is “to derive rent” cannot be an active asset, it has been argued that this exception should not apply to properties where the taxpayer carries on a business of leasing properties (but rather only to passive investments). There have however been legal cases where the courts rejected this argument, stating clearly that it does not matter if the taxpayer is in the business of leasing properties or not. 

There is no statutory definition of the word rent that is relevant in this context, so the term takes on its common law meaning. 

Where there is a question of whether the amount paid constitutes “rent”, a key factor to consider is whether the occupier has a right to “exclusive possession” of the property. If such a right exists, the payments involved are likely to be rent. Conversely, if the arrangement allows the occupier only to enter and use the premises for certain purposes, and does not amount to a lease granting exclusive possession, the payments involved are unlikely to be rent. 

Other relevant factors include the degree of control retained by the owner, the extent of any services performed by the owner (such as room cleaning, provision of meals, supply of linen and shared amenities) and the length of the arrangement. 

By way of example, the ATO looked at the operator an eight-bedroom boarding house. The average length of stay was four to six weeks. Visitors were required to leave the premises by a certain time and the proprietor retains the right to enter the rooms. He pays for all utilities and provides cleaning and maintenance, linen and towels and common areas such as a lounge room, kitchen and recreation area. The ATO concluded that the amounts received were not rent. 

What is main use?

The term “main use” is not defined in the relevant laws. Therefore resolving the matter in regard to the mixed use of assets is likely to involve a consideration of various factors, however most important will be the comparative level of income derived from the different uses of the asset.

By way of example, consider a taxpayer who owns land on which there are several industrial sheds. He uses one shed (45% of the land area) to conduct a motorcycle repair business and leases the other sheds (55% of the land by area) to unrelated third parties. The income derived from the repair business is 80% of total income, with the rest derived from leasing the other sheds. Having regard to all the circumstances, the ATO considered that the “main use” of the taxpayer’s land is not to derive rent. 

Tax & Super Australia 
www.taxandsuperaustralia.com.au

Primary Producer Income Tax Averaging

Legislation has been introduced in Parliament that proposes to allow primary producers to return to income tax averaging 10 income years after choosing to opt out, instead of the opt-out choice being permanent. 

           

 

The Federal Government says this will assist primary producers, as averaging only recommences when it is to their benefit (i.e. they receive a tax offset) and they can still opt out if averaging no longer suits their circumstances. The changes are proposed to apply for the 2016–2017 income year and later income years.

Primary producers have to meet basic conditions to be eligible for income averaging. 

 

AcctWeb

SMSF related-party borrowing arrangements

Will a borrowing arrangement by a SMSF pass the smell test?

         

 

The Australian Taxation Office (ATO) has issued a taxation determination concerning non-arm’s length income (NALI) of a self managed super fund (SMSF) when the parties to a scheme have entered into a limited recourse borrowing arrangement (LRBA) on terms which are not at arm’s length.  If you fail this smell test the tax rate becomes 47%.

The ATO has also updated a practical compliance guideline which sets out the Commissioner’s “safe harbour” terms for LRBAs. If an LRBA is structured in accordance with the guideline, the ATO will accept that the LRBA is consistent with an arm’s length dealing and the NALI provisions (47% tax) will not apply. 

Trustees who do not meet the safe harbour terms will need to otherwise demonstrate that their LRBA was entered into and maintained consistent with arm’s length terms.

 

AcctWeb

Impending GST changes good news for SMEs

 

Two mid-tier partners have said that the changes to GST introduced to Parliament last week is a good first step in helping Australian SMEs compete with overseas entities.

             

 

Changes to Goods and Services Tax (GST) collection online were introduced to the Parliament last week, which will see GST applied to low-value imported goods up to $1,000. 

“The government understands Australians are increasingly shopping online from overseas vendors who are able to offer items without tax,” Small Business Minister Michael McCormack said.

“This means goods they provide can be cheaper than those offered by Australian businesses, giving an unfair advantage to foreign businesses. For many Australian small businesses, this has an impact on competitiveness as consumers flock to purchase cheaper imports.”

The legislation will require overseas vendors, electronic distribution platforms and goods forwarders with an Australian turnover of $75,000 or more to register for, collect and remit GST for low-value goods supplied to consumers in Australia.

The legislation will come into effect on 1 July 2017.

Bentleys’ Perth taxation and small business director, Ross Prosper, told Accountants Daily that the changes are a “great start” in helping SMEs succeed.

“Introducing the GST will mean those higher valued goods, $500 to $1,000, will look to the consumer to be more price-competitive now in Australia so ideally, they'll be spending more of their Australian dollars with Australian businesses,” Mr Prosper said.

“It’s going someway to leveling the playing field between Australian-domiciled entities and overseas entities.”

BDO tax partner Fady Abi Abdallah also said that the changes are positive, but has concerns over compliance.

“These changes represent the latest measure in the government’s efforts to modernise the GST regime by ensuring that revenue collection remains in line with how the consumers of today buy goods, while at the same time attempt to address Australian business concerns dealing with offshore suppliers having a competitive advantage,” Mr Abdallah said.

“The real test is just how cooperative offshore suppliers will be in complying with these amendments.”

LARA BULLOCK
Wednesday, 22 February 2017
www.accountantsdaily.com.au