2018 FBT: Half Yearly Update

With the 2018 FBT year already more than half over, it is time to review some of the most significant areas of FBT changes over the period 1 April 2017 to 30 September 2017.

 

Draft Tax Ruling on employees’ travel expenses

The Commissioner has issued Draft Taxation Ruling TR 2017/D6 which sets out the ATO’s views on general principles for determining whether an employee can deduct travel expenses under s 8-1 of the ITAA 1997. When the final ruling is issued, it is proposed to apply both before and after its date of issue.

 

A travel expense is an expense relating to:

  • Transport by airline, train, car, bus or other vehicle, or
  • Accommodation, meal and incidental expenses of an employee when they travel away from home for work.

 

The draft ruling sets out general principals as well as particular issues relating to (ordinary home to work travel, special demands travel, co-existing work locations travel and relocation travel.

The ruling contains many examples to illustrate how to determine the deductibility of travel expenses in a range of situations.

 

FBT technical discussion paper on taxis

The ATO has issued a technical discussion paper TDP 2017/2 on the definition of “taxi” under the FBT Act. under s 58Z of the Act, taxi travel undertaken by an employee to or from work or due to illness is exempt. At present a “taxi” only covers vehicles licensed by the relevant state or territory to operate as a taxi. The ATO is reviewing this definition in light of the Uber B.V. v FC of T decision (which dealt with the definition of taxi in the context of GST).

 

New occupational clothing guidelines

The government has issued new approved occupational clothing guidelines, replacing the 2006 version. These set out the criteria that designs of non-compulsory uniforms must meet if the designs are to be entered on the Register of Approved Occupational Clothing which is maintained by AusIndustry. One of the ways to ensure that employee expenditure on uniforms is eligible as a tax deduction is for the design to be entered on this Register.

Draft ruling on employee remuneration trusts

The ATO has issued Draft Taxation Ruling TR 2017/D5 which sets its views on how the taxation laws apply to an employee remuneration trust (ERT) arrangement that operates outside of Div 83A of the ITAA 1997.

 

An ERT arrangement involves a trust being established to facilitate the provision of payments and/or other benefits to employees. The ruling considers the consequences for the employer, particularly when contributions will be deductible. It also deals with the consequences for employees in terms of when they may be assessed on contributions or deemed dividends.

 

The draft ruling replaces Draft Taxation Ruling TR 2014/D1. When the final ruling is issued, it is proposed to apply both before and after its date of issue.

 

 

FBT car parking threshold for 2017/18

The ATO released Taxation Determination TD 2017/14, which states that the car parking threshold for the FBT year commencing on 1 April 2017 is $8.66. This is up from $8.48 for the previous FBT.

 

ATO guidance withdrawn

The ATO has withdrawn numerous Tax Rulings, Determinations and Interpretative Decisions of relevance to FBT. These include:

  • ATO ID 2002/616 dealing with deductibility of accommodation expenses for a person who lives a long distance from their work place, and
  • ATO ID 2002/807 dealing with deductions on meal expenses while on overnight business travel.
  • ATO ID 2001/120 Fringe benefits tax “otherwise deductible’” rule
  • ATO ID 2010/178 Deductibility of income protection premiums.
  • ATO ID 2002/616 dealing with deductibility of accommodation expenses for a person who lives a long distance from their work place, and
  • ATO ID 2002/807 dealing with deductions on meal expenses while on overnight business travel.
  • Various Tax Determinations (TDs) setting out rates and thresholds for the 2012 FBT year
  • IT 112 Income tax: Deductibility of travelling expenses between residence and place of employment or business.
  • IT 113 Income tax: Computer consultant — travelling expenses between home and place of employment.
  • MT 2030 Fringe benefits tax: living-away-from-home allowance benefits.
  • TD 93/113 Income tax: are the costs incurred by teachers when travelling between their home and their regular school to attend Parent and Teacher meetings, sports and other school functions allowable as a deduction under subsection 51(1) of the Income Tax Assessment Act 1936?
  • TD 93/174 Income tax: does the receipt of a travel allowance automatically entitle an employee to a deduction for travel expenses under section 8-1of the Income Tax Assessment Act 1997?
  • TD 96/7 Fringe benefits tax: is fringe benefits tax (FBT) payable on meals and accommodation provided to employees who work at remote construction sites, where the accommodation is not the usual place of residence of the employee?

 

Class rulings issued

The ATO has issued numerous class rulings. I suggest you visit law.ato.gov.au to view the full list.

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Permanent Establishments 2.0

This article originally appeared in the September edition of The Taxpayer

https://www.taxandsuperaustralia.com.au/TSA/Products_Services/Publications/The_Taxpayer/TSA/Publications/The_Taxpayer.aspx

 

The 1997 Assessment Act states that, if you are a foreign resident, your assessable income includes the ordinary income you derive from Australian sources (e.g. from sales to Australian customers). In practice, however, it can be difficult for Australia to tax many non-residents on their Australian income. This is because it can be difficult for the ATO to detect business income which has a source in Australia and, where detected, challenging to collect the tax on that income.

In recognition of these difficulties, Australia will not tax the Australian-sourced income of our treaty partners, unless the non-resident has a sufficient presence in Australia. This sufficient presence is referred to as a ‘permanent establishment’ (PE). Practically, this means that a non-resident will likely need to lodge an Australian return if it has a PE in Australia.

What if the non-resident is not from a treaty country?

The bulk of Australia’s trade and investment involves countries with which Australia has entered into a Double Taxation Treaty (DTT). Furthermore, Treasury is frequently negotiating new treaties – for example a treaty was signed with Chile in April 2010. Nevertheless, there are still many countries, from Afghanistan to Zimbabwe, where no such agreement is in place. Where there is no DTT in place, Australia does not require non-residents to have Australia to have a PE before it will tax them on their Australian business profits.

Where a non-resident business has a PE in Australia, our DTTs only allow Australia to tax the profits that are attributable to that PE. When calculating which profits to attribute to a PE, the ‘functionally separate entity’ approach is applied. Broadly, this means that the PE will be taxed on the profits it might be expected to make if it were a separate and independent enterprise, dealing with other parts of the enterprise at arm’s length.

 

The OECD Model

Australia’s tax treaties generally closely match the OECD’s Model Tax Convention (model treaty) and therefore this article focuses upon the clauses of this model convention and its official commentary[2]. Under the model convention, there are broadly three types of PEs that can be construed:

  • A fixed place of business PE (Article 5(1)),
  • A construction or project PE (Article 5(3)), and
  • An agency PE (Article 5 (5-6)).

Each of these are discussed in detail below.

 

The BEPS Project

The permanent establishment concept has been around for many years – it dates back to the 1800s and the Austro-Hungarian empire. The OECD’s model treaty can trace its origins to the League of Nations. As you can imagine, international business has grown enormously, and undergone substantial changes during the intervening years.

The OECD’s BEPS (Base Erosion and Profit Shifting) project represents the most significant attempt to address the challenges of a modern, complex global economy in decades. The project is divided into 15 ‘actions’, with Action 7 focusing on permanent establishments. Broadly, the OECD is proposing to expand the definition of a permanent establishment to counter multinational enterprises that seek to avoid PE status via what it sees as artificial arrangements.

The OECD’s specific proposals, contained in the final report on Action 7, are discussed in detail below. It is expected that, over the coming 18 months or so, the countries involved (including Australia) will amend their bilateral tax treaties (via a multilateral instrument) to reflect the proposed changes.

 

The general definition

Paragraph 1 in Article 5 of the model treaty contains the general definition of the term “permanent establishment”. It states:

“For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.”

A PE therefore has three elements:

  • There must be “a place of business”,
  • That place of business must be “fixed”, and
  • The business of the enterprise must be carried on “through” that fixed place

Place of business

The OECD commentary explains that the term place of business covers premises, facilities or installations, whether or not they are used exclusively in carrying on the business of the enterprise. Furthermore, a place of business may exist where an enterprise merely has a certain amount of space at its disposal (i.e. even if this space is not owned or rented by the enterprise).

Determining when a facility is at the disposal of an enterprise can be a difficult and contentious issue. Clearly the mere presence of a representative of an enterprise at a location does not necessarily mean that the location is at the disposal of that enterprise. However, where an employee of a company is permitted to use an office at the premises of another company (e.g. a subsidiary) for an extended period of time, that office can be said to be at the disposal of the former company. It appears that the extent of the presence at a location, the activities performed at a location and the effective power to use a location may be relevant.

 

Fixed

The commentary explains that there must be a stable link between the place of business and a specific geographic point. Furthermore, the business must have a certain degree of temporal permanency. The ATO has ruled[1], and the OECD has suggested, that, as a guide, six months or more is sufficiently ‘permanent’. However, this is not a hard and fast rule – each case is a question of fact and degree. A place of business may constitute a PE even though it exists for a very short period of time, due to the nature of the business.

Through

The commentary advises that the word ‘through which’ must be given a wide meaning “so as to apply to any situation where business activities are carried on at a particular location that is at the disposal of the enterprise for that purpose”.

 

The listed examples

Paragraph 2 provides specific examples of a PE. It states that the term includes especially:

“a) a place of management;

  1. b) a branch;
  2. c) an office;
  3. d) a factory;
  4. e) a workshop, and
  5. f) a mine, an oil or gas well, a quarry or any other place of extraction of natural

resources.”

These examples are by no means exhaustive and are to be seen against the background of the general definition.

 

Building sites etc

Paragraph 3 of the model treaty states:

“A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months.”

 

The term ‘building site or construction or installation project’ includes not only the construction of buildings but also the construction or renovations of roads, bridges or canals, the laying of pipelines and excavating and dredging.

 

The twelve-month requirement applies to each individual site or project. The commentary explains that the period commences when the contractor begins work, including preparatory work, in the country where the construction is to be established. Seasonal or other temporary interruptions should be included.

 

The BEPS project identified that some multinational enterprises have split-up contracts between closely related parties in order to abuse the twelve-month requirement and artificially avoid permanent establishment status. To address these concerns, a principal purpose test will be added to the model treaty. The commentary will be updated to explain that, where it would be reasonable to conclude that one of the principal purposes for the conclusion of separate contracts was to obtain the benefit of the exclusion in paragraph 3, it would not be appropriate to grant that benefit. Some states may wish to expressly provide for the time periods of separate contracts between closely related enterprises to be combined.

 

Specific activity exemptions

 

Article 5(4) lists a number of business activities that are not permanent establishments, even if they satisfy a definition contained in one of the earlier paragraph (e.g. even if they are carried on through a fixed place of business). The common feature of these activities is that they are, in general, preparatory or auxiliary activities.

 

The exemptions listed in paragraph 4 are:

  • The use of facilities solely[2] for the purpose of storage, display or delivery of goods

or merchandise belonging to the enterprise;

  • The maintenance of a stock of goods or merchandise belonging to the enterprise solely for:
    • The purpose of storage, display or delivery; or
    • The purpose of processing by another enterprise;
  • The maintenance of a fixed place of business solely for the purpose of;
    • Purchasing goods or merchandise or of collecting information, for the enterprise;
    • Carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;

 

An exemption is also available for any combination of activities mentioned above, provided that the overall activity is of a preparatory or auxiliary character.  While not defined in the model treaty, a preparatory activity can be understood as one that is carried on in contemplation of carrying on the essential and significant part of the activity of the enterprise as a whole. An auxiliary activity is one that is carried to support or supplement, without being part of, the essential and significant part of the activity of the enterprise as a whole.

 

The key criterion, therefore, is whether the activity forms an essential and significant part of the enterprise as a whole. In practice, it is often difficult to distinguish between activities which have a preparatory or auxiliary character and those which are the core or main activities of the business. As a guide, an activity that requires a significant proportion of the assets or employees of the enterprise is less likely to be preparatory or auxiliary.

 

The changing nature of international business means that activities which were previously considered to be merely preparatory or auxiliary may nowadays constitute core business activities. Therefore, some enterprises have been able to artificially avoid PE status via the specific activity exemptions, beyond the intend application of paragraph 4.

 

 

 

Accordingly, most of the countries involved in the BEPS project have agreed to amend the paragraph, so that it explicitly provides that an activity will only excluded where the overall activity of the fixed place of business is of a preparatory or auxiliary character. Therefore, the listed activities will become simply common examples of activities that are covered by the paragraph, not those that automatically qualify for an exemption.

 

Dependent agents

 

In some circumstances, an entity will be treated as having a permanent establishment if it has a dependant agent (e.g. an employee) acting on its behalf in a contracting state, even if it does not have a fixed place of business in that state. As it currently stands, paragraph 5 states that a permanent establishment exists where a dependent agent “has, and habitually exercises, an authority to conclude contracts in the name of the enterprise”.

 

The commentary explains the importance of looking beyond legal formalities.

“Lack of active involvement by an enterprise in a transactions may be indicative of a grant of authority to an agent. For example, an agent may be considered to possess actual authority to conclude contracts where he solicits and receives (but does not formally finalise) orders which are sent directly to a warehouse from which goods are delivered and where a foreign enterprise routinely approves the transactions.”

 

The OECD has expressed concern that it has sometimes been possible to artificially avoid having a PE under article 5(5) through commissionaire arrangements. Broadly, a commissionaire is a person who acts in his or her own name for the account of a principal. Under a typical arrangement the commissionaire sells products in a State in its own name but on behalf of a principal. That principal is contractually bound to deliver (through the commissionaire) the goods sold to the customer, while the commissionaire is contractually bound to collect the proceeds and remit it to the principal (in exchange for a commission). Importantly, no relationship is created between the customer and the principal. Under civil law jurisdictions, the activities of a commissionaire are not attributed to the principal and therefore, through such an arrangement a foreign enterprise is able to sell its products in another state without creating a taxable presence.

 

Similar strategies that seek to avoid the application of article 5(5) involve situations where contracts are substantially negotiated in a State, but finalised abroad.

 

To address these concerns, paragraph 5 will be amended to state that a permanent establishment will exist where a dependent agent is acting in a contracting state on behalf of an enterprise and:

 

“in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are:

  1. in the name of the enterprise, or
  2. for the transfer of ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or
  3. for the provision of services by the enterprise”

 

 

 

The principal role leading to the conclusion of a contract will typically be played by the person who convinced the third party to enter into a contract with the enterprise (e.g. where the conclusion of a contract directly results from the actions of that person). The phrase would not apply where a person merely promotes and markets the goods or services of an enterprise in a way that does not directly result in the conclusion of contracts.

 

Independent agents

 

Paragraph 5 will not apply where the agent is performing their activities in the course of an independent business.

 

As it presently stands, paragraph 6 states that:

“an enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business”

 

An independent agent will typically be responsible to the principal for the results of their work, will not be not subject to significant control with respect to the manner in which that work is carried out and will often represent numerous principals. The distinction between dependent and independent agents is therefore akin to the distinction between employees and contractors for PAYG withholding purposes.

 

There is concern among OECD countries that some agents are being inappropriately being classified as independent, despite being closely related to the foreign enterprise on behalf of which they are acting. To address these concerns, paragraph 6 will be amended to include the proviso that:

“Where, however, a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent”.

 

A person is closely related to an enterprise if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same person or enterprises. The new paragraph 6 will expressly provide that a person will also be closely related to an enterprise where:

  • Either one possesses, directly or indirectly, more than 50% of the beneficial interests in the other; or
  • A third person possesses, directly or indirectly, more than 50% of the beneficial interests in both the person and the enterprise

 

 

Taxing Issues for Departing Taxpayers

The following article originally appeared in the November 2016 edition of The Taxpayer (professional journal of Tax & Super Australia https://www.taxandsuperaustralia.com.au/TSA/Products_Services/Publications/The_Taxpayer/TSA/Publications/The_Taxpayer.aspx)

 

Simon Dorevitch explains the potential tax issues that taxpayers encounter when relocating overseas.

It is estimated that approximately 5% of Australian citizens live outside of Australia, with
Europe and Asia the most popular destinations. If your client has made the decision to relocate to another country (whether permanently or for an extended period), they should be aware of two potential tax issues:
1. When a taxpayer becomes a non-resident of Australia, they are deemed to have sold
their non-Australian assets for market value (CGT event I1). However, such taxpayers
may make an election to disregard any capital gain and thereby defer any tax payable.

2. Thanks to recent changes, Australians living abroad must now report their income
and make repayments towards their HELP (university) and TSL (apprenticeship) debts
if their income exceeds a certain threshold. These changes have effectively brought the
repayment obligations of Australians living overseas in line with those living in Australia.

 

A SILENT TAXING POINT: CGT EVENT I1

Generally, the assessable income of taxpayers who are tax residents of Australia includes
income from all sources, whether in or out of Australia. In contrast, the assessable income of foreign residents generally only includes income with an Australian source.
In the context of CGT, this means that foreign residents disregard capital gains or losses that happen in relation to a CGT asset that is not taxable Australian property (TAP)
Broadly, TAP includes:

• taxable Australian real property (TARP) – eg land or buildings situated in Australia
(including a lease of land if the land is situated in Australia). It can also include
mining rights.

• indirect Australian real property Interests – ie a membership interest in another entity,
where the interest is a non-portfolio interest (10% or more) and the entity passes the
principal asset test (market value of TARP assets exceeds market value of non-TARP
assets)

• A CGT asset used in carrying on a business through an Australian permanent establishment, and

• An option or right to acquire one of the above assets.

Where a taxpayer ceases to be an Australian resident those assets that are not TAP are taken outside the remit of the Australian tax system. As you might imagine, the government does not like this, so CGT Events I1 and I2 were included in the legislation to tax these assets before they fell out of Treasury’s grip.

 

WHEN DOES CGT EVENT I1 HAPPEN?
CGT event I1 happens when an individual or company stops being an Australian resident. For an individual taxpayer, this will occur when they no longer satisfy any of the four tests of residency – the resides test, the domicile test, the 183-day test and the superannuation test.

In certain situations, it may be difficult to pinpoint precisely when a taxpayer ceases to
be a resident (or even if they ceased being a resident at all). Where such timing could have a significant impact on the taxpayer’s liability it may be prudent to seek a private ruling from the ATO.

WHAT ARE THE CONSEQUENCES OF CGT EVENT I1 HAPPENING?

The taxpayer is deemed to have disposed of their non-TAP assets, and also their indirect
Australian real property interests, for their market value at the time. Therefore, they make a capital gain if the market value is more than their cost base and a capital loss if the market value is less than the reduced cost base.

There are, however, exceptions:
• A capital gain or loss is disregarded if theasset was acquired before 20 September 1985 (ie before the introduction of CGT).
• If the taxpayer is an individual, they may choose to disregard the capital gain or
loss. This choice is evidenced by how the taxpayer prepares their tax return (ie whether
the gain is included or excluded). Note that the choice is all in or all out – it cannot be
made per CGT asset.

 

The ATO has published a fact sheet that contains a rough “rule of thumb” to assist
emigrating taxpayers. Below is an extract from this fact sheet:

If you go overseas temporarily and do not set up a permanent home in another
country…then you may continue to be treated as an Australian resident for tax
purposes.

If you leave Australia permanently…then you will generally not be considered an Australian resident for tax purposes, from the date of departure.

 

WHAT ARE THE CONSEQUENCES OF MAKING THIS CHOICE?

If a taxpayer makes a choice to disregard the capital gain, the assets are taken to be TAP until the taxpayer disposes of the asset or becomes an Australian resident once more. Effectively, the assets are kept within the Australian tax system.
Note, however, that this may be overridden by a Double Taxation Agreement (DTA).

How the ATO will become aware of a foreign resident disposing of non-TAP assets is unclear, though it is noted that data-sharing between tax authorities has increased in recent years.
WHEN SHOULD THE CHOICE TO DISREGARD CGT EVENT I1 BE MADE?

In some cases the taxpayer will simply not have the cash to fund the CGT liability (since, being a deemed disposal, they have not actually received any capital proceeds). In those situations the choice to disregard any capital gain is clear.

In other cases, knowing whether it is in a taxpayer’s interests to make the choice requires a consideration of numerous factors and, ideally, a well-functioning crystal ball! The time between the CGT event and the lodging of the return is an important consideration (see table).

Keep in mind also that non-residents are subject to non-resident rates of tax and no longer have access to the CGT discount. This makes it more likely that the taxpayer will face higher taxation on the future capital gain if a choice is made to disregard the deemed gain.

It may be more favourable to make the choice where

 

It may be less favourable to make the choice where

 

The taxpayer’s taxable income is higher than it is expected to be in the year of disposal (since CGT is applied at marginal tax rates)

 

The taxpayer’s taxable income is lower than it is expected to be in the year of disposal (since CGT is applied at marginal tax rates)

 

The asset is expected to fall in value (and therefore the capital gain in the future will be lower)

 

The asset is expected to rise in value (and therefore the capital gain in the future will be greater)

 

Being able to defer payment to a later date is important

 

The taxpayer intends to return to Australia (and the market value is expected to rise whilst they are away)
The subsequent disposal will not be taxable in Australia (e.g. because of a DTA)  

Keep in mind also that non-residents are subject to non-resident rates of tax and no longer have access to the CGT discount. This makes it more likely that the taxpayer will face higher taxation on the future capital gain if a choice is made to disregard the deemed gain.

What if the taxpayer becomes a resident again?

On becoming a resident, a taxpayer is deemed to have acquired their non-TAP assets for market value. Therefore, a former resident, having not made the choice to disregard a capital gain from CGT event I1, who returns to Australia (and becomes a resident once more) receives an uplift in the cost base of their non-TAP assets. For CGT discount purposes, the date of regaining residency (and not the original date of actual acquisition) is used to determine whether the asset has been held for 12 months.

Example

In June 2016 James decides he has had enough of Australia and emigrates to France, vowing never to return. He is considered to have terminated his Australian residency at this time. Upon departure James owns the following assets:

·         A home in Toorak

·         An investment property in the United States

·         50% of the shares in Gemba Pty Ltd, a company whose major asset is a farm in NSW

When James’ Australian residency ends, CGT Event I1 happens. He is deemed to have disposed of his investment property and shares for their market value, triggering a capital gain.

James decides not to make the choice to disregard the gain. However, having been out of work since August 2015, James taxable income in the 2016 financial year is very low and therefore low marginal tax rates apply to the capital gain.

Five years later, with his favourite Australian sporting team competing for their fourth-straight premiership, James decides he misses Australia too much and returns permanently. He is deemed to have reacquired his investment property for its market value when he becomes an Australian resident once more. Any increases in value that occurred whilst he was in France will not be subject to Australian tax.

 

 

HELP Debts

In November 2015, the government passed legislation closing a loophole which enabled university graduates living overseas to avoid making student loan repayments. From 1 July 2017, the HELP (Higher Education Loan Program) and TSL (Trade Support Loan) repayment obligations for overseas residents will be brought in line with those who remain in Australia.

From 1 January 2016

Taxpayers with an existing HELP or TSL debt who leave Australia and intend to be overseas for more than six months in any 12-month period will need to need to notify the ATO within seven days of leaving Australia. Those who already live overseas will need to update their details no later than 1 July 2017.

It does not matter whether the taxpayer is overseas for work, study or travel.

Taxpayers should notify the ATO by updating their contact details, including international residential and email addresses, using the ATO’s online services via the myGov website. This means that, if they haven’t already, such taxpayers will need to register for a myGov account. The ATO should also be informed if there are any further changes to a taxpayer’s contact details whilst they reside overseas.

From 1 July 2017

Taxpayers who are living overseas and are not Australian residents for tax purposes will need to self-assess the world-wide income they have received in the 2016-17 financial year and submit details to the ATO via myGov. Foreign income will be translated to Australian dollars using the average exchange rate for the financial year.

They should do this, even if their income is below the threshold (or if they have not worked at all). Income details should be submitted by 31 October each year.

The ATO have indicated that, at this stage, their first priority is to educate taxpayers and encourage self-compliance. However, they have also confirmed that individuals who do not comply with their obligations will potentially be subject to the same range of penalties that apply under broader taxation law.

Taxpayers who remain Australian residents despite being overseas will continue to file tax returns and will therefore not need to report income via myGov.

If the taxpayer’s income for repayment purposes exceeds the minimum repayment threshold, they will be required to make compulsory repayments towards their debt. Non-resident taxpayers will make repayments via myGov.

The repayment income threshold for the 2016-17 financial year is;

Repayment income Repayment rate
Below $54,869 Nil
$54,869 – $61,119 4.0%
$61,120 – $67,368 4.5%
$67,369 – $70,909 5.0%
$70,910 – $76,222 5.5%
$76,223 – $82,550 6.0%
$82,551 – $86,894 6.5%
$86,895 – $95,626 7.0%
$95,627 – $101,899 7.5%
$101,900 and above 8.0%

These rates are identical to those that apply to taxpayers who remain in Australia. As with resident taxpayers, non-resident taxpayers may also make voluntary repayments.

 

 

 

 

 

 

 

 

Small Business Restructure Rollover

The following article originally appeared on the WTS Australia website in March 2016.

 

Introduction

Roll-over relief was previously available for transfers of a CGT asset, or all the assets of a business, from a sole trader or partnership, to a wholly-owned company. The small business restructure roll-over supplements these existing roll-overs by also allowing small business owners to defer gains or losses that they would otherwise make from transfers of business assets from one entity to another as part of a genuine restructure.

It is intended that the roll-over will facilitate flexibility for owners of small business entities by allowing them to restructure their businesses via a change of legal structure. This is in recognition of the fact that the most appropriate structure for a small business may change over time and that restructuring may lead to benefits, both for the small business itself and for the economy as a whole.

The roll-over will apply to transfers of CGT assets, depreciating assets, trading stock or revenue assets on or after 1 July 2016.

 

Availability of the roll-over

The roll-over is available if an asset is transferred to one or more entities and;

  1. The transaction is, or is part of, a genuine restructure of an ongoing business; and
  2. Each party to the transfer is a small business entity (SBE) or alternatively an affiliate of, connected to, or a partner in, an SBE; and
  3. The transaction does not have the effect of materially changing the ultimate economic ownership of the asset; and
  4. The asset is a CGT asset and is, at the time of the transfer, an active asset of the relevant SBE; and
  5. The transferor and transferee(s) are Australian residents; and
  6. The transferor and transferee(s) choose to apply the roll-over.

 

Genuine restructure – safe harbour

The requirement that the transaction be part of a ‘genuine’ restructure is intended to deny the roll-over to artificial or inappropriately tax-driven schemes. Whether a restructure is ‘genuine’ is a question of fact, to be determined having regard to all of the facts and circumstances surrounding the restructure.

To provide certainty, a small business will be taken to satisfy the requirement of a genuine restructure where, for three years following the roll-over;

  • There is no change in the ultimate economic ownership of any of the significant assets of the business (other than trading stock) that were transferred under the transaction;
  • Those significant assets continue to be active assets; and
  • There is no significant or material use of those significant assets for private purposes.

If a business does not meet the requirements of the safe harbour, it can still access the roll-over by satisfying the general principle that the transaction is, or is part of a genuine restructure.

 

Small business entity

An entity is a small business entity if it meets the requirements under Subdivision 328-C ITAA 1997. Broadly, this requires the entity to carry on a business and have a turnover, when combined with affiliates and connected entities, of less than $2m. Previously the bill also required the taxpayer to satisfy the maximum net asset value test. This requirement has been removed.

 

Ultimate economic ownership and discretionary trusts

Ultimate economic owners are individuals who, directly or indirectly, beneficially own an asset. Where a non-fixed (e.g. discretionary) trust is involved in the transfer, the requirement will be satisfied where the trust has made a family trust election (FTE) and, the ultimate economic owners of the asset, just before and just after the transfer, are members the trust’s family group.  Before making an FTE consideration should be given to the fact that it effectively limits the beneficiaries eligible to receive distributions to those within the family group.

 

Active asset

The meaning of active asset is given in Subdivision 152-A ITAA 1997. Broadly, an asset is active if it is used, or held ready for use, in the course of carrying on a business or if it is an intangible asset inherently connected with a business. Loans to shareholders of a company are not active assets and therefore the roll-over cannot be used to circumvent the operation of Division 7A.

 

Consequences of the roll-over

 

Consequences for the transferor

The small business restructure roll-over is intended to be tax-neutral with no direct income tax consequences to the transferor. For example, the transfer of an asset by a company to a shareholder will not trigger a capital gains tax liability nor an assessable dividend under section 44 or Division 7A ITAA 1936.

 

Consequences for the transferee

Broadly, the transferee is taken to have acquired each asset for an amount equal to the transferor’s roll-over cost just before the transfer. This is the transferor’s cost such that the transfer would result in no gain or loss for the transferor.

CGT assets are deemed to have been acquired for an amount equal to the cost base of the asset. Pre-CGT assets will retain their pre-CGT status in the hands of the transferee. However, the time period for eligibility for the CGT discount will recommence from the time of the transfer. For the purposes of determining eligibility for the small business 15-year exemption, the transferee will be taken as having acquired the asset when the transferor acquired it.

The transferee of trading stock will inherit the transferor’s cost and other attributes just before the transfer. Therefore, the asset’s roll-over cost will be an amount equal to the cost of the item for the transferor, or, if the transferor held the item as trading stock at the start of the income year, the value of the item for the transferor.

The roll-over cost of revenue assets is the amount that would result in the transferor not making a profit or loss on the transfer.

Where deprecating assets are transferred the transferee can deduct the decline in value of the depreciating asset using the same method and effective life (or remaining effective life) as the transferor was using.

 

New membership interests issued as consideration for the transfer

Where membership interests (e.g. shares or units) are issued in consideration for the transfer of a roll-over asset or assets, the cost base of those new membership interests is worked out as follows:

The sum of the roll-over costs, less any liabilities that the transferee undertakes to discharge in respect of those assets  

/

 

 

The number or membership interests

 

 

Membership interests affected by transfers

Where an asset transfer is made at other than market value, decreases and increases in the market value of any interests that are held in the transferor and transferee can result. An integrity concern can arise where the transfer of value from an entity could result in the creation of tax losses on later disposal of the membership interests. A ‘loss denial’ rule is intended to address these concerns. This rule states that a capital loss on any direct or indirect membership interest in the transferor or transferee that is made subsequent to the roll-over will be disregarded, except to the extent that the taxpayer can demonstrate that the loss is reasonably attributed to something other than the roll-over transaction.

 

Comment

The small business restructure roll-over is a generous addition to Australia’s income tax laws. It presents opportunities for small business owners to tax-effectively restructure their affairs.

However, taxpayers should bear in mind the limitations of the roll-over. Specifically, the roll-over;

  • Will not affect a tax liability arising under another Commonwealth tax (for example fringe benefits tax or goods and services tax) or a liability for stamp duty under State legislation
  • Does not prevent the general anti-avoidance provisions of Part IVA from applying
  • Does not extend to exempt entities or a complying superannuation entity.
  • Does not extend non-active assets such as investment assets or Division 7A loans.

Small business owners should contact us to discuss the costs and benefits of a restructure in light of these new amendments.

 

Australia’s Diverted Profits Tax now Law

The following article originally appeared on the FTI Tax website in April 2017.

http://fti.tax/wp/wp-content/uploads/2017/04/AA_2017_DPT_20170434_v_final.pdf

 

On 4 April 2017, the Diverted Profits Tax Bills received Royal Assent and became Australian Acts No. 21 and 27 of 2017. The new law applies to income years commencing 1 July 2017 (whether or not a relevant transaction entered into before that date) and targets ‘significant global entities’ that have a global income of more than A$1 billion and an Australian income of more than A$25 million and provides for 40% tax on diverted profits; 30% franking; payment of tax to object; 12 months to supply documents in defence; and with limited rights of appeal.
Background
The Diverted Profits Tax (DPT), first announced in the 2016-17 Federal Budget, is the latest in a raft of measures (including the Multinational Anti-Avoidance Law (MAAL)) designed to combat multinational tax avoidance.
The Australian Treasury indicates there are approximately 1,600 taxpayers with income sufficiently large to potentially fall within the scope of the new law, though it is expected that the DPT will apply in only very limited circumstances. Treasury estimates that the tax will raise A$100 miilion in each of the 2018-19 and 2019-20 financial years.
When will DPT apply
The DPT will apply to an entity if, broadly:
• It is reasonable to conclude that a scheme (or any part of a scheme) was carried out for a principal purpose of, or for more than one principal purpose that includes, enabling a taxpayer (the relevant taxpayer) to obtain a tax benefit. This ‘principal purpose’ threshold is lower than the ‘sole or dominant purpose’ threshold that applies for Part IVA anti-avoidance purposes (Australia’s GAAR). Taxpayers may however provide evidence to support the non-tax financial benefits of the scheme;
• The relevant taxpayer is a ‘significant global entity’ (i.e. it has annual global income of A$1 billion or more being either a global parent entity or member of a group of entities consolidated for accounting purposes) for theincome year in which it would obtain the tax benefit;
• A foreign entity that is an associate of the relevant taxpayer entered into, carried out or is otherwise connected to the scheme or part of it. Therefore, the DPT will not apply to a scheme with which only Australian entities are connected; and
• The relevant taxpayer obtains a tax benefit (as defined for Part IVA purposes) in connection with the scheme.
When will DPT not apply
The DPT will only apply if it is reasonable to conclude that none of the following tests are satisfied:
The $25 million turnover test
The DPT does not apply where it is reasonable to conclude that the Australian turnover of the relevant taxpayer and other entities that are members of the same global group does not exceed A$25 million. This test has been broadened to take into account the Australian assessable income of foreign entities (not just Australian entities) that are part of the same global group.
The sufficient foreign tax test
The DPT does not apply where it is reasonable to conclude that, in relation to the scheme, the increase in foreign tax liability is equal to or exceeds 80% of the corresponding reduction in the Australian tax liability. To work out the amount of the increased foreign tax liability, it is necessary to consider any specific tax relief provided by a foreign country to relation to the scheme. Where the tax benefit is an allowable deduction and the taxpayer must withhold an amount in respect of withholding tax, the Australian tax liability is reduced by the amount withheld.
We note that many countries currently have a corporate tax rate that is equal to or less than 24% (i.e. 80% of Australia’s 30% rate). These include the United Kingdom, Russia, Croatia, Sweden, Hungary, the Czech Republic, Singapore and Hong Kong. The United States will be added to this list if President Trump’s tax policies are enacted.
The sufficient economic substance test
The DPT does not apply where it is reasonable to conclude that the profits derived, received or made as a result of the scheme reasonably reflects the economic substance of the entity’s activities in connection with the scheme, having regard to the functions, assets used and risks assumed by the entity. For the purposes of applying this test, consideration should be given to the OECD transfer pricing guidelines.
A carve-out has also been created for managed investment trusts, foreign collective vehicles with a wide membership, foreign entities owned by a foreign government, complying superannuation entities and foreign person funds.
Interaction with the thin capitalisation and CFC provisions
The DPT’s interaction with the thin capitalisation and controlled foreign company (CFC) provisions have been clarified. In particular;
•If a taxpayer is subject to the thin capitalisation provisions and the DPT tax benefit includes a debt deduction, when calculating the DPT tax benefit, the rate is to be applied to the debt interest actually issued (rather than to the debt interest that would have existed if the scheme had not been carried out).
• In relation to the CFC provisions, where an amount of attributable income is included in the assessable income of the relevant taxpayer or their associate, it should be excluded from the taxpayer’s DPT tax benefit.
If DPT applies
If the DPT applies to a taxpayer, the Commissioner may make a DPT assessment and issue it to the relevant taxpayer. The ATO will establish a DPT panel (similar to the existing General Anti-Avoidance Rule (GAAR) panel) and will generally seek
endorsement from this panel before issuing an assessment.
Tax is payable on the amount of diverted profits at a penalty rate of 40% . Furthermore, the DPT due and payable will not be reduced by the amount of foreign tax paid on the diverted profits. The DPT assessment will also include an interest charge.
The DPT will only give rise to franking credits at 30% and not the 40% penalty rate.
The assessment and review process
If the Commissioner considers that a taxpayer is in scope of the DPT, he may make a DPT assessment at any time within 7 years of first serving a notice of assessment on the taxpayer for an income year. In practice, the Commissioner would only do this after communication with the relevant taxpayer had failed to reach an agreement about the correct amount of tax that should be paid.
The relevant taxpayer must then pay the amount set out in the DPT assessment no later than 21 days after the Commissioner gives the notice of assessment.If the Commissioner gives an entity a notice of a DPT assessment, a period of review will generally apply. This
review period gives the taxpayer the opportunity to provide additional documents and information relating to the DPT assessment to the Commissioner.
This review period will typically end 12 months after the DPT assessment is given but can be shortened (for example if the taxpayer considers that it has provided the Commissioner with all relevant information and documents) or extended (for example where the entity provides information close to the end of the 12 month period and the Commissioner needs additional time to properly examine the material).
As a result of receiving additional information, the Commissioner may conclude that the DPT assessment is excessive or that the liability should be increased. He may then make an amended DPT assessment. Where an amended DPT assessment is made, interest will be payable (by the Commissioner on the refund where the liability is reduced or by the taxpayer on the additional amount payable where the liability is increased).
Objections to DPT assessments
The relevant taxpayer may object to the DPT assessment by appealing to the Federal Court within 60 days of the end of the period of review. Previously under the draft legislation this period was 30 days. However, any information or documents that were not provided to the Commissioner during the period of review, or that the Commissioner did not already have prior to the period of review, will not be admissible without either
the Commissioner’s consent or the leave of the court.
What should businesses be considering with regards to potential DPT exposure?
Businesses should first review existing and proposed arrangements, having regard to the the following DPT threshold questions:
1. Is the Australian company (or permanent establishment) a significant global entity (being a member of a group with annual global income of AU$1 billion or more)?
2. Is it reasonable to conclude that annual Australian income is less than AU$25 million (though this includes any DPT benefit)?
3. Is it reasonable to conclude that sufficient foreign tax (effectively over a 24% rate) has not been paid/imposed in all jurisdictions directly or indirectly relevant to the
supply chain into Australia?
4. Is it is reasonable to conclude that the sufficient economic substance test is not satisfied? The taxpayer must prove the arrangement reasonably reflects the economic substance of the entity’s activities. In most cases, this will require a ‘two-sided analysis’, applying an Australian transfer pricing examination to the functions, assets and risks of the activities carried out in Australia and those activities carried out in one or more other overseas jurisdictions; and/or
5. Was obtaining a tax benefit a principal purpose (or one of the principal purposes) behind the taxpayer carrying out the scheme? This is a lower threshold than the existing
Part IVA/GAAR, which requires a ‘dominant purpose’ of obtaining a tax benefit.
We expect that ATO transfer pricing reviews and compulsory Country By Country Reporting may signal to the ATO the existence of potential DPT arrangements. Therefore it is incumbent upon affected taxpayers to review and understand their positions and have in place robust documentation.
Further, the DPT may also encourage multinational taxpayers to engage in a dialog with the ATO in relation to their cross-border activities such that they may consider Advance Pricing Agreements (APAs) to provide greater certainty with respect to their international arrangements and transfer pricing.
The ATO has significant power to raise DPT assessments and taxpayers should be prepared.

New ATO draft ruling on company tax residence – TR 2017/D2

The following article originally appeared on the A&A/FTI Tax website: http://fti.tax/insights/new-ato-draft-ruling-on-company/

 

On 15 March 2017, the Commissioner of Taxation released Draft Taxation Ruling TR 2017/D2 and withdrew Taxation Ruling 2004/15. These moves came in response to the High Court’s 2016 decision in Bywater Investments.[1] This decision, and the tax rulings, concerned the residence of companies not incorporated in Australia.

Under s 6(1) ITAA 1936 a company, not incorporated in Australia, is resident if it carries on business in Australia and has either its central management and control in Australia or its voting power controlled by Australian resident shareholders.

Bywater Investments

Bywater concerned a foreign-incorporated company that held meetings of its Board of Directors outside of Australia. The taxpayer argued that the court was bound to find that central management and control (CM&C) was exercised abroad. The High Court rejected this approach and held that the location of CM&C of a company was not to be determined by its formal structure, but was rather a question of fact.

The Court found that, as a matter of fact, the real business of the appellant was conducted by an individual from Sydney (Mr Vander Gould), without the involvement of the foreign directors. The directors had abrogated their decision making in favour of Mr Gould and only met to rubber-stamp decisions made by him in Australia.

The situation in Bywater was contrasted with that in Esquire Nominees[2]. In Esquire, a firm of Australian accountants exerted significant influence over the directors. Nevertheless, it was found that CM&C was exercised by the directors, as they would not have acted on the accountants’ instructions had these instructions been improper or inadvisable.

TR 2017/D12 – Income Tax: Foreign Incorporated Companies: Central Management and Control test of residency

This ruling sets out the Commissioner’s preliminary but considered view on how to apply the CM&C test of company residency, following the Bywater decision.

The ruling states that;

“If a company has its central management and control in Australia, and it carries on business, it will carry on business in Australia within the meaning of the central management and control test of residency. It is not necessary for any part of the actual trading or investment operations from which its profits are made to take place in Australia.”

Authority for this proposition can be found in Malayan Shipping.[3]

This position represents a significant change from the view expressed in TR 2004/15 which was that other acts of carrying on a business generally need to exist before the CM&C test is satisfied. TR 2004/15 had argued that only where a company’s business is management of its investment assets and where it undertakes only minor operational activities, will both tests (carrying on a business and CM&C) be satisfied by the same set of facts.

Like TR 2004/15, the draft ruling states that CM&C involves the making of high-level decisions that set the company’s general policies, and determine the direction of its operations and the type of transactions it will enter. This is to be contrasted with day-to-day conduct and management of operational activities. The new ruling adds, in a reference to Bywater, that decision making involves active consideration and does not include the mere implementation of, or rubberstamping of decisions made by others.

Previously, the Commissioner’s view was that CM&C is usually exercised by the company’s board and therefore the place where the board meets is highly relevant in determining where CM&C is located. The new ruling however downgrades the actions of directors to a “useful starting point” and states that “there is no presumption that the directors exercise central management and control unless proved otherwise”. All relevant facts must be considered.

It follows that mere legal power or authority to manage a company is not sufficient to establish exercise of CM&C, particularly where this authority is not used. Furthermore, legal authority is not necessary for a person to exercise CM&C – if an outsider dictates or controls the decisions made by the directors, the outsider will exercise CM&C of the company. The key questions are whether the people with formal decision-making authority actively consider whether to do what they are told or advised to do and make a decision in the best interests of the company and whether they would refuse to follow advice or directions that are improper or inadvisable.

Practical considerations

A common issue is how much influence/control an Australian parent can have over an overseas subsidiary before that subsidiary becomes a resident. To demonstrate that the parent is merely influential and does not itself exercise CM&C, it may be advisable that;

  • The directors of the company have the required skills, experience and qualifications to perform their duties and sufficient knowledge of the business to make informed decisions;
  • The directors actively consider all information and advice before making decisions in the best interests of the company;
  • The directors meet frequently enough to actually exercise CM&C. Ideally these meetings would take place outside of Australia; and
  • Board minutes record, not only what decisions were made, but why the directors made them to evidence that decisions were actually made at the meetings.

The ruling, when finalised, is proposed to apply from 15 March 2017.

[1] Bywater Investments Limited & Ors v. Commissioner of Taxation; Hua Wang Bank Berhad v. Commissioner of Taxation [2016] HCA 45; 2016 ATC 20-589

[2] Esquire Nominees Ltd v. FCT [1973] 129 CLR 177

[3] Malayan Shipping Co Ltd v Federal Commissioner of Taxation [1946] 71 CLR 156