How long is a piece of string? Getting the market value right for taxation purposes

The following article originally appeared in the March edition of ‘The Taxpayer’ journal, published by Tax & Super Australia. My apologies for any formatting issues – I could not upload a pdf of the article.

 

A century on from the High Court’s landmark decision in Spencer v Commonwealth[1], Simon Dorevitch sheds light on the term ‘market value’ and its implications for tax purposes.

“Price is what you pay. Value is what you get”

Warren Buffet

Under Australia’s tax laws, taxpayers are frequently required to determine the market value of an asset or liability. The Inspector General of Taxation found that there are “at least 206 different tax provisions that may require a taxpayer to determine an unrealised value of an asset or liability, or an alternative value to a realised asset or liability”.[2]

Examples of these provisions include;

·        The market value substitution rule,[3] which can modify the capital proceeds or cost base in respect of a CGT event happening to a CGT asset where, for example, the parties were not dealing with each other at arm’s length.

·        The first used to produce income rule[4], where a taxpayer is deemed to have acquired their dwelling for its market value for the purposes of determining the extent of tax payable under the main residence exemption.

·        The $6 million net market value asset test,[5] which can determine access to the small business CGT concessions where the taxpayer is not a small business entity.

·        The ‘principal asset test’,[6] which can determine whether a membership interest in an entity is an indirect Australian real property interest and therefore taxable Australian property.

·        The GST margin scheme, which may require the supplier to work out the GST payable by reference to the value of real property at a particular date.[7]

In most cases the market value of an asset will be the price agreed to by parties dealing at arm’s length. The ATO states; “where a market exists for an asset, that market is widely considered to be the best evidence of market value of the asset”.[8] For example, if shares are listed on a stock exchange, the market value will typically equal the listed price.

However, in many other cases it is not so straightforward. It is therefore unfortunate that, despite the ubiquity of the market value concept, the legislation provides scant guidance as to its meaning – leaving taxpayers to look to the courts and ATO to fill the void. Some ATO practical guidance is contained in its publication ‘Market valuation for tax purposes’ (search QC21245).

Legislative Guidance

Subdivision 960-S states that the expression ‘market value’ is often used with its ordinary meaning but may, in some cases, have a meaning that is affected by the subdivision.

The subdivision provides that, when working out market value, taxpayers should;

·        Reduce the value by any input tax credits to which the taxpayer would be entitled if it had acquired the asset for a taxable purpose.[9] This rule attempts to ensure that the market value reflects the real economic outlay to the taxpayer (since they can claim a refund of input tax credits via the Business Activity Statement).

·        Disregard anything that would prevent or restrict conversion of a non-cash benefit to money when working out the market value of a non-cash benefit.[10]

This subdivision, or the Tax Acts elsewhere, does not explain what is the ordinary meaning of market value and so this is where one turns to case law for guidance.

Case Law Guidance

The case of Spencer v Commonwealth is widely accepted as the most important judicial pronouncement on the ordinary meaning of ’market value’. Spencer provides that a valuer is to assume a hypothetical market operating under specific assumptions. The market value is the price that buyers and sellers would negotiate in such a hypothetical market.

Griffith CJ said;

“the test of the value of land is to be determined, not by inquiring what price a man desiring to sell could actually have obtained for it on a given day, i.e. whether there was, in fact, on that day a willing buyer, but by inquiring: What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?”.

Issacs J expanded on this by adding;

“To arrive at the value of the land at that date, we have…to suppose it sold then, not by means of a forced sale, but by voluntary bargaining between the plaintiff and a purchaser, willing to trade, but neither of them so anxious to do so that he would overlook any ordinary business consideration.               We must further support both to be perfectly acquainted with the land, and cognisant of all circumstances which might affect its value”.

This test was also adopted in Abrahams v FC of T[11] where Williams J said that market value is;

“The price which a willing but not anxious vendor could reasonably expect to obtain and a hypothetical willing but not anxious purchaser could reasonably expect to pay … if the vendor and purchaser had got together and agreed on a price in friendly negotiation”.

Where neither party is anxious, both parties are knowledgeable, negotiations are conducted at arm’s length and the other Spencer market assumptions are satisfied, the actual market will align with the hypothetical market and market value will align with the agreed price.

However, applying the test in Spencer is not always straightforward in practice – for example in cases of special value or aggregated disposals.

Special Value

One point of contention is how to determine market value where there is a buyer willing to pay more than an asset’s intrinsic value because it has a particular adaptability or usefulness to them. This may occur where, for example, there a parcel of land that a neighbour wants to acquire. It could also reflect synergistic advantages such as economies of scale or reduction in competition; for example, a business acquiring a supplier or a competitor.

It can be argued that such a special value should be excluded when determining market value, since the buyer could be characterised as being ‘anxious’. The opposing argument is that market value should include this special value since doing so reflects the Spencer assumptions that both parties are ‘cognisant of all circumstances which might affect (the asset’s) value’ and that the hypothetical purchaser will put the land to its highest and best use.

The ATO’s view, as expressed in ‘Market valuation for tax purposes’[12] is that special value is not usually relevant in determining market value. The guide states that where “the special value is known or available to the wider market, this would be reflected in an objective valuation of the asset”. However, “if a special value is known or available only to one potential buyer and not known or available to the wider market, it will not be reflected in the market value”. This appears to reflect the view that a special purchaser would bid just enough to outbid other interested purchasers, rather than making an offer which reflects the complete value to them.

With respect, it appears that the ATO has taken an alternative interpretation. There is strong judicial support for including special value. For example, in Brisbane City Council v Valuer-General (Qld)[13] it was held that “all possible purchasers are to be taken into account, even a purchaser prepared for his own reasons to pay a fancy price”. In a comprehensive and widely cited review of cases that have addressed the question of special value[14], Professor Bernard Marks found that, “on any proper analysis” the proposition that special value be excluded from market value could not be sustained.

Aggregated Disposals

Market value should be assessed at “the highest and best use of the asset as recognised in the market”. However, the highest and best use may depend on whether the asset is considered on a stand-alone basis or in combination with other assets.

In Hustlers case[15] it was necessary to value three adjoining parcels of land. The Court accepted a valuation based on their combined use as a commercial business. A valuation prepared on a stand-alone basis was rejected, as was a valuation based on use as a retail shop (even though it gave the highest value), since there was no evidence of such demand. The principal established, and reaffirmed in other cases such as Collis[16], is that market value reflects the highest and best use, including on a consolidated basis, provided there is actual demand for such a use.

Miley’s Case[17]

This recent and controversial case addressed many of the issues discussed above. The taxpayer was one of three equal shareholders who sold their shares to a single purchaser. The amount paid by the purchaser reflected a premium for control of the company and therefore the proceeds received by Mr Miley included one-third of this premium.

The AAT found that the correct enquiry was directed towards determining the market value of Mr Miley’s 100 shares alone – not as part of a package comprising the entire 300 shares in the company. The Deputy President went on to accept Miley’s argument that the market value of the CGT asset is to be determined by reference to the Spencerhypothesis and is not necessarily equal to the amount actually paid. Accordingly, the control premium was to be deducted from the sale proceeds to arrive at the market value of the shareholding. It should be noted that the ATO have indicated they will appeal this decision.

Syttadel Holdings[18] is another recent case which, like Miley, demonstrates that market value is not always equal to the contract price – even where the parties deal at arm’s length. At issue was the market value of a marina. Interestingly, valuers for the taxpayer and the ATO both agreed that the market value was considerably less ($4.5m and $5.3m respectively) than its $8.9m sale price. In its Decision Impact Statement, the ATO indicated that, while each case must be considered on its merits, it still considers that the sale price of its asset will generally be its market value.

What Should Taxpayers Do?

Where the market value of an asset needs to be ascertained, taxpayers are typically[19] not obliged to obtain a detailed valuation from a qualified valuer. They may compute their own valuation based on reasonably objective and supportable data.[20]

However, the onus is on taxpayers to establish that their valuation is correct. The ATO may challenge valuations where appropriate. Therefore, a taxpayer would be prudent to retain the services of a professional valuer if there is any doubt about the market value. Furthermore, the methodology adopted by the valuer should be one that is in accordance with valuation industry practices.

Taxpayers (or the valuer they appoint) should clearly document the process which was undertaken in reaching the value, to demonstrate that it was done in accordance with sound valuation principles. In the event of a dispute, a failure to keep adequate documentation will likely be fatal to a taxpayer’s position.   The ATO also outlines the various elements of a good valuation in its ‘Market valuation for tax purposes’ publication – one critical aspect is that “a market valuation is a valuation that applies the definition of market value for tax purposes…”.

Avoiding Penalties

The majority of taxpayers who use a qualified valuer will generally not be liable to an administrative penalty, even when the valuation ultimately proves to be deficient, since relying in good faith on an expert’s advice is generally consistent with the taking of reasonable care. However, penalties may still apply where;

·        The taxpayer has not given correct information to the valuer;

·        The taxpayer or their agent should reasonably have known that the information provided by the valuer was incorrect; or

·        The methodology or valuation hypothesis used by a qualified valuer may be based on an unsettled interpretation of a tax law provision or unclear facts.

Appraisals

Mindful of the cost of obtaining a profession valuation, taxpayers often ask whether an appraisal from a local real estate agent will suffice for land valuations. There is no rule preventing the taxpayer from doing this – it is the valuation process undertaken, rather than who conducted it, that governs the acceptability of a valuation. However, caution should be exercised before going down this path.

Where an appraisal is obtained, the valuer may not make reasonable enquiries or provide a definitive opinion on market value (for example, a range is used).  As such it may not be accepted by the ATO. Accordingly, if an appraisal is to be relied upon, it should only be done in the most straightforward of valuations, and preferably where errors will not have a significant impact on tax payable.

Private ruling

Taxpayers seeking certainty can apply to the ATO for a private ruling. They may ask the ATO to provide a valuation or ask the ATO to confirm a valuation that they have obtained. In either case the taxpayer must pay for the work of the ATO’s valuer. Generally, the cost will be less where the ATO is only asked to confirm a valuation. Obtaining a private ruling removes the risk of providing the ATO with a valuation that does not meet its requirements. However, the taxpayer may receive a valuation that they do not agree with but they are not obliged to use the valuation.

Simon Dorevitch is Senior Tax Consultant, A&A Tax Legal Consulting

[1] Spencer v Commonwealth (1907) 5 CLR 418

[2] Inspector-General of Taxation, ‘Review into the Australian Taxation Office’s administration of valuation matters’ p. 13

[3] ss 116-30 & 112-20 ITAA 1997

[4] s 118-192 ITAA 1997

[5] s 152-15 ITAA 1997

[6] s 855-30 ITAA 1997

[7] s 75-10 GST Act

[8] ‘Market valuation for tax purposes’, QC21245

[9] s 960-405 ITAA 1997

[10] s 960-405 ITAA 1997

[11] Abrahams v FC of T (1944) 70 CLR 23

[12] ‘Market valuation for tax purposes’, QC21245

[13] (1978) 140 CLR 41

[14] Bernard Marks, ‘Valuation Principles in the Income Tax Assessment Act’ (1996), Bond Law Review

[15] Hustlers Pty Ltd & Anor v The Valuer-General (1967) 14 LGRA 269

[16] Collis v FC of T (1996) 96 ATC 4831

[17] Miley and Commissioner of Taxation [2016] AATA 73

[18] Syttadel Holdings Pty Ltd v FC of T (2011) AATA 589

[19] Note that where a valuation is required under the GST Margin Scheme, taxpayers must use the services of a professional valuer

[20] CGT Determination TD 10(W)

 

As always I would like to remind readers that

  1. The article does not constitute advice and is not intended to be comprehensive. While I have attempted to ensure the accuracy of the article I do not give any assurances. Please seek your own professional advice.
  2. The views in the article are mine alone and do not necessarily represent those of my employer or Tax  & Superannuation Australia
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Low Value Goods and Digital Products: the New Black

The following article appeared in the February edition of ‘The Taxpayer’ by Tax & Superannuation Australia. Unfortunately I cannot upload a PDF or link to the article so the unformated text below will have to suffice. Please contact me if you would like to discuss anything in this article.

Simon Dorevitch reviews important changes to GST and cross-border transactions

 

  1. Taxing the internet shopper

When the GST Act and Regulations were drafted in 1999, e-commerce was in its infancy – it was not fully envisaged that people would prefer to shop from the comfort of their mobile devices rather than visiting a bricks and mortar shop! Over the years, however, Australian internet sales have grown rapidly and are now in excess of $20 billion per annum.

This has caused dismay from Australian businesses who have increasingly complained about an unequal playing field, since Australian consumers are often able to avoid incurring GST on their internet purchases from non-resident businesses. Online video-on-demand provider, Netflix is a prime example where a subscription to their services is currently not subject to GST under existing laws.

In response to these concerns, the government has introduced amendments that extend GST to supplies of digital products, certain services and low value goods imported by consumers.

As a result of these amendments, Australian consumers will soon find themselves paying 10% more for many online purchases. In addition, many overseas suppliers will be required to register and pay GST, though in some cases the GST liability may be shifted to an electronic distribution platform or goods forwarder. To ease the administrative burden, the Commissioner will permit some foreign businesses affected by the amendments to hold a limited GST registration.

 

  1. Existing GST framework

By way of background, GST is payable on “taxable supplies” and “taxable importations”.

Taxable supplies

For a supply to be taxable it must, among other things, be connected with Australia.[1]

In the context of physical goods brought to Australia, a supply is connected with Australia if the supplier either imports the goods or installs or assembles them in Australia. Therefore, if the consumer imports the goods, the supply will generally not be connected with Australia and will not be a taxable supply.

In the context of supplies other than physical goods or real property (e.g. digital products and other services), a supply is connected with Australia if:

  • The thing is done in Australia;
  • The supply is made through an enterprise that is carried on in Australia; or
  • The supply is the supply of a right to acquire another thing that is connected with Australia.

If the location of performance is not in Australia, a supply by a foreign entity will generally not be connected with Australia and will not be a taxable supply.

Taxable importations

For an importation to be taxable it must be of tangible personal property. Therefore, an importation of digital products or services is not a taxable importation as these are not tangible goods. Furthermore, GST regulations specify that an importation of low-value tangible goods (i.e. those with a customs value of $1,000 or less) is a non-taxable importation and therefore no GST is payable.

 

  1. Applying GST to Digital Products and Other Services

Amendments to the GST Act[2], which take effect from 1 July 2017, extend the scope of the GST to digital products and other services imported by Australian consumers.

The media have dubbed the amendments the ‘Netflix tax’ and have focused on their application to digital products such as streaming or downloading of movies, music, apps, games and e-books. However, what may be missed is that the amendments apply equally to supplies of services such as consultancy and professional (e.g. architectural, legal or educational) services.

Australian consumer

As a result of the amendments, a supply of digital products and other services will be connected with Australia (and therefore potentially a taxable supply) if the recipient of the supply is an ‘Australian consumer’.

An Australian consumer, in relation to a supply, is an Australian resident (as defined for income tax purposes) who is not entitled to an input tax credit (ITC) in respect of the acquisition. To be entitled to an ITC, a consumer must be registered for GST and the supply must be acquired to some extent for an enterprise they carry on. The amendments are therefore intended to capture private consumption only.

Example: [3]

Global Movies supplies Fellini with video on demand services. The supply is not performed in Australia and Global Movies does not carry on an enterprise in Australia.

Fellini is a resident of Australia, does not carry on an enterprise and is not registered for GST. The supply by Global Movies is connected with Australia as a result of the amendments.

Had Fellini not been a resident of Australia, the supply would not have been connected to Australia, even if he was in Australia when the supply was made.

Reasonable belief safeguard

It may not always be practical for a supplier to determine if the recipient of a supply is an Australian consumer. Recognising this, the amendments provide a safeguard; if the entity that would be liable for GST takes reasonable steps to establish whether the recipient of a supply is an Australian consumer and, having taken these steps, reasonably believes that the recipient is not an Australian consumer, they may treat the supply as if it had been made to an entity that was not an Australian consumer.

Example:[4]

Peter, an Australian resident who is not registered for GST, orders a videogame online from a non-resident supplier while visiting family in London. He pays using a credit card from a UK bank and gives the address and phone number of his relatives as contact information. The supplier reasonably believes that Peter is a not an Australian resident and may therefore treat him as not being an Australian consumer and the supply as not connected with Australia.

In some circumstances, the process for making a supply may be largely automated. Such supplies may also be covered by this safeguard if the business systems and processes provide a reasonable basis for identifying if the recipient is an Australian consumer.

Penalties for misrepresentations by customers and extending the reverse charge provisions

Australian consumers may have incentives to avoid GST by misrepresenting their status. To address this, the amendments broaden the existing administrative penalties for making false or misleading statements.

Furthermore, the amendments extend the compulsory reverse charge rules so that they apply where an Australian business has made a wholly private or domestic acquisition but has made representations that it is not an Australian consumer in respect of the supply. The operation of this reverse charge rule will mean the supply is a taxable supply and the recipient, not the supplier, is liable for GST.

Example:[5]

Leslie, an Australian resident registered for GST, acquires a movie from Online Movie Co (OMC) for a wholly private purpose. She is therefore an Australian consumer in relation to the supply. However, Leslie provides OMCS with her Australian Business Number (ABN) and declares that she is registered for GST. Accordingly, OMC does not charge GST. Under the extended reverse charge provisions, Leslie is obliged to pay the GST.

Electronic Distribution Platforms

Consumers may purchase digital products and services via an electronic distribution platform (EDP). The Apple App Store is an example of an EDP, Amazon is another.

The operators of EDPs are often better resourced and therefore better placed to comply with Australia’s GST laws. On this basis, where supplies are made through an EDP and are connected with Australia under these amendments, responsibility for the GST liability is generally shifted from the supplier to the operator of the EDP. In other circumstances the supplier and operator of the EDP may agree that the operator will be liable for GST on the supply.

Registration and Limited Registration

Supplies that are connected with Australia because they are made to an Australian consumer will generally count towards the GST registration threshold of $75,000. However, these supplies may also be GST free because they are used or enjoyed outside Australia.

It would be unnecessary for foreign suppliers to register for GST if the only supplies they make that are connected to Australia is also GST-free. Therefore, the amendments ensure such supplies are only included in GST turnover if the supply is made through an enterprise carried on in Australia.

Some entities that are required to register under these amendments will not have any other connection with Australia. These entities will have no claim to ITCs and will therefore not need to claim GST refunds.

To ease the administrative burden on such entities, the Commissioner will allow them to opt to be a ‘limited registration entity’. Such entities will only be required to provide minimal information when registering for GST and lodging business activity statements. Limited registration entitles are not entitled to claim ITCs or to have an ABN. They will report quarterly.

 

  1. Applying GST to Low Value Imported Goods

The government has also released draft legislation[6] to amend the GST Act to ensure that GST is payable on certain supplies of low value goods that are purchased by consumers and imported into Australia. This amendment again is intended to level the playing field between local and overseas businesses.

The changes, if passed, will also apply from 1 July 2017.

Supplies of low value goods that are connected with Australia

As a result of the amendments, a supply of goods will be connected with Australia if:

  • The supply involves the goods being brought to Australia with the assistance of the supplier;
  • The goods are low value goods; and
  • The recipient acquires the supply as a consumer.

Bringing goods to Australia with the assistance of the supplier

The supplier provides assistance where it makes arrangements with third parties for the transport of the goods or facilitates the consumer making such arrangements. However, if a supplier merely makes the goods available for collection or provides contact information to unrelated transport companies it will not be providing such assistance.

Low value goods

Broadly, a low value good is tangible personal property that has a customs value of $1,000 or less at the time of supply.

If multiple goods are supplied and each is individually below $1,000 but the total is above the threshold, the supply is a supply of low value goods unless it would be unreasonable to treat each good as a separate supply (for example the supply of 100 floor tiles). A supply that involves both low value and other goods is treated as two or more separate supplies.

Acquired as a consumer

A recipient, who may not be the person to whom the goods are delivered, is a consumer in relation to a supply if they are not entitled to an ITCs for the acquisition.

A business can confirm that a recipient is not a consumer by requesting their ABN and a declaration that they do not acquire the goods for an enterprise they carry on in Australia. Unlike the amendments relating to digital products and other services, there is no requirement that the consumer be an Australian resident.

Example:[7]

Wei, a resident of Hong Kong purchases artwork valued at $700 in Vietnam and arranges for the seller to deliver it to his niece in Australia. The supply is connected with Australia, despite the fact that Wei is not a resident and outside of Australia when the purchase is made.

Supplies not connected with Australia

A supply that satisfies each of these three requirements will not be connected to Australia if the supplier reasonably believes that the goods will be imported as a taxable importation and the goods are imported as a taxable importation. If the supplier’s reasonable belief turns out to be incorrect, they will include the additional GST payable on their next Business Activity Statement and no penalties will apply.

Electronic distribution platforms

Where low value goods are supplied through an EDP, the GST liability will generally shift from the supplier to the operator of the platform. This is consistent with the EDP rules applying to cross-border supplies of digital products and other services – discussed above.

Goods forwarders

Goods forwarders may help arrange a purchase, take delivery of the goods and/or arrange for their pick-up, make storage arrangements and deliver, or arrange delivery of the goods to the consumer.

In contrast, entities that merely deliver goods to Australia are not treated as goods forwarders. If a supply to a consumer involves goods being delivered outside of Australia and brought to Australia with the assistance of a goods forwarder, then the supply will be connected with Australia and the goods forwarder will generally be treated as the supplier.

Example:

Sam is an Australian resident who is not registered for GST. Sam purchases a hockey stick valued at $300 from a US store. Sam instructs the store to send his purchase to a mail forwarding service (MailMe). MailMe then sends the hockey stick to Australia and delivers it to Sam. MailMe, and not the US store, is treated as making the supply and will need to register if it has a GST turnover of $75,000 or more.

Limited Registration

The amendments allow non-resident suppliers (including operators of EDPs treated as suppliers) and non-resident goods forwarders of low value goods to be limited registration entities

Simon Dorevitch is Senior Tax Consultant

A&A Tax Legal Consulting

 

As always I would like to remind readers that

  1. The article does not constitute advice and is not intended to be comprehensive. While I have attempted to ensure the accuracy of the article I do not give any assurances. Please seek your own professional advice.
  2. The views in the article are mine alone and do not necessarily represent those of my employer or Tax  & Superannuation Australia

 

[1] The GST Act now refers to the “Indirect Tax Zone” rather than Australia. However, for simplicity, this article will continue use the term Australia.

[2] Tax and Superannuation Laws Amendment (2016 Measures No .1) Bill 2016

[3] Example 1.1 from Explanatory Memorandum to Tax and Superannuation Laws Amendment (2016 Measures No .1) Bill 2016

[4] Example 1.4 from Explanatory Memorandum to Tax and Superannuation Laws Amendment (2016 Measures No .1) Bill 2016

[5] Example 1.5 from Explanatory Memorandum to Tax and Superannuation Laws Amendment (2016 Measures No .1) Bill 2016

[6] Treasury Laws Amendment (2017 Measures No. 1) Bill 2017

[7] Example 1.5 from Explanatory Memorandum to Treasury Laws Amendment (2017 Measures No. 1) Bill 2017

“Hotel, Motel, Holiday Inn” – Deriving Rent and the small business CGT concessions

The following article appeared in the December edition of ‘The Taxpayer’ by Tax & Superannuation Australia. Unfortunately I cannot upload a PDF or link to the article so the unformated text below will have to suffice. Please contact me if you would like to discuss anything in this article.

 

“Hotel, Motel, Holiday Inn”[1] – Deriving Rent and Accessing the Small Business CGT Concessions

Simon Dorevitch examines the pitfalls of satisfying the active asset test for assets which are used to derive rent.

Back to basics: The active asset test

To access the small business CGT concessions, certain conditions must first be satisfied. One such condition is that the CGT asset satisfies the active asset test. Satisfying this test requires the asset to be an active asset of the taxpayer for the lesser of 7.5 years and half of the relevant ownership period.

A CGT asset is an active asset at a time if it is used, or held ready for use, in the course of carrying on a business by the taxpayer, their affiliate or an entity connected with them (relevant entities).

However, certain assets are specifically excluded from being an active asset. One such exclusion applies to assets whose 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 and to treat any use by their affiliate or entity connected with them as their own use.

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 by the taxpayer or a relevant entity. There is no conclusive test for determining whether a business is being carried on. However, in Tax Ruling TR 97/11, the ATO has enumerated several indicators of a business 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
  • The expectation, and likelihood, of a profit

It is highly likely that the operator of a hotel would be conducting a business. In contrast, most residential rental activities are a form of investment and do not amount to carrying on a business. However, the following examples indicate that it is possible to conduct a rental property business.

Example 1 – Taxpayer was conducting rental property business[2]

The taxpayers owned eight houses and three apartment blocks (each comprising six residential units), making a total of 26 properties. They actively managed the properties, devoting a significant amount of time (an average of 25 hours per week) to them. The ATO concluded that the taxpayers were carrying on a business.

Example 2 – Taxpayer was conducting rental property business [3]

The taxpayer owned nine rental properties. Although they were managed by an agent, the taxpayer spent considerable time undertaking tasks in connection with the properties. Despite finding that the taxpayer’s methods were unsophisticated and un-business-like, the AAT concluded that the taxpayer was carrying on a business.

TIP – PASSIVE ASSETS USED IN THE BUSINESS OF AN AFFILIATE OR CONNECTED ENTITY

The Small Business CGT Concessions may still be available where the taxpayer (i.e. owner of the asset) is not carrying on a business. This would be the case, for example, where the CGT asset is used in a business carried on by the taxpayer’s affiliate or connected entity and this other entity is a ‘small business entity’ (broadly one with a turnover less than $2m).

Deriving rent

An asset whose main use by the taxpayer is to derive rent cannot be an active asset (unless this main use was only temporary).

It has been argued that this exception does not apply to properties where the taxpayer carries on a business of leasing properties, but rather only to passive investment assets. The AAT rejected this argument, stating clearly that it does not matter if the taxpayer is in the business of leasing properties or not. [4]

There is no statutory definition of 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.

Example 3 – Payments for use of a commercial storage facility were not rent[5]

Christine carries on a business of providing commercial storage space. Each space is available for hire periods of 1 week or more. She provides office facilities, on-site security, cleaning and various items of equipment for sale or loan. The agreements provide that in certain circumstances Christine can relocate the client to another space or enter the space without consent and that the client cannot assign the rights under the agreement. Having regard to all the circumstances, the ATO concluded that the amounts received by Christine were not rent.

Example 4 – Payments for occupancy of boarding house were not rent[6]

David operates an 8-bedroom boarding house. The average length of stay is 4-6 weeks. Visitors are required to leave the premises by a certain time and David retains the right to enter the rooms. David 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 by David were not rent.

Example 5 – Payments for occupancy of holiday apartments were not rent[7]

Linda owns a complex of 6 holiday apartments, advertised collectively as a motel. Each is booked for periods not exceeding 1 month, with most bookings being for less than 1 week. Guests do not have exclusive possession of their apartment, but rather only a right to occupy on certain conditions. Clean linen, meal facilities and cleaning are provided to guests. The ATO found that Linda’s income was not rent.

Example 6 – Payments for short stays in a caravan park were not rent[8]

The taxpayer owned and operated a caravan park that consisted of fully-furnished self-contained cabins, caravans set up on blocks and sites for guests with their own caravans. Guests also had access to a shared amenities block. The ATO ruled that short-term guests (those staying less than 3 months) did not pay rent while long-term guests (3 months or longer) did.

Example 7 – Payments for occupancy of mobile home park were rent[9]

The taxpayer owned and operated a mobile home park that consisted of 77 sites and a ‘community hall’ with shared facilities such as a kitchen, toilet and recreation area. In reaching the conclusion that the payments for use of the park were rent, the AAT found that the following factors were relevant; the park owner agreed to give vacant possession to a resident on a certain date, the resident was granted exclusive possession and had the right of quiet enjoyment, and the residential site was occupied as the resident’s ‘principal place of residence’.

Example 8 – Payments for short stays in holiday unit were rent[10]

The taxpayer owned a holiday home that was used to provide short term tourist accommodation (i.e. stays of about one to two weeks). Crockery, cutlery and linen were provided but cleaning was done only after the occupants departed. The AAT found there to be little doubt that the occupants regarded themselves as having rented the unit for the period of their stay and as having exclusive possession. Therefore, the payments did constitute rent.

What is the main use?

Where a CGT asset is used partly to derive rent and partly in the business of the taxpayer or relevant entity, it will be necessary to determine the ‘main use’ of the asset. This is because an asset whose main use by the taxpayer is to derive rent cannot be an active asset (unless the main use for deriving rent was only temporary).

The term main use is not defined in Division 152 (which contains the small business CGT reliefs). Tax Determination TD 2006/78 states that no single factor will necessarily be determinative and resolving the matter is likely to involve a consideration of factors such as;

  • The comparative areas of use of the premises,
  • The comparative times of use of the asset and, most importantly.
  • The comparative level of income derived from the different uses of the asset.

Example 9 – Mixed use[11]

Mick 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 the total income, while the income derived from leasing the other sheds is only 20% of the income. Having regard to all the circumstances, the ATO considers that the main use of Mick’s land is not to derive rent.

Example 10 – Mixed use[12]

The taxpayer owned a shopping centre. Most the shops (constituting 73% of the floor space) were rented by unrelated shopkeepers but some (27% of the floor space) were used by the taxpayer to conduct business. Despite this, the ATO ruled that the main use of the shopping centre was not to derive rent because the majority (63%) of the income generated from the asset was from the business and only 27% was generated from rent.

In a recent AAT case[13], the taxpayer argued that the word ‘use’ in ‘main use’ could include non-physical uses such as holding a property for the purposes of capital appreciation. This argument was rejected, with the AAT finding that the concept of use was a reference only to physical use.

Treat use by affiliate/connected entity as taxpayer’s own

When determining the main use of the asset the taxpayer is instructed to treat any use by a relevant entity as their own use.

Example 11 – Use by affiliate[14]

John rents 80% of a property to his affiliate Peter and uses the remaining 20% in his business. Peter uses 60% of the area rented to him in his business and rents the remaining 40% to an unrelated party. 32% of the property (80% x 40%) is being treated as being used to derive rent. However, the remaining 68% is either actually used in John’s business (20%) or is treated as being used in his business (48%, being 80% x 60%). Therefore, the main use of the property is not to derive rent.

 

Ignore private use

When determining the main use of the asset the taxpayer is also instructed to disregard their own personal use or enjoyment of the asset. This point can be illustrated by the following example;

Example 12 – Private use disregarded[15]

Neil rents 60% of a property to his affiliate Andrea, uses 15% in his business and the remaining 25% for his own personal use.  Because personal use by the owner or relevant entity is ignored in determining the property’s main use, the above proportions must be adjusted. Following the adjustments Neil rents 80% (60% x (100/75)) of the property to Andrea and uses 20% (15% x 100/75) in his business.

Is the main use only temporary?

Finally, a CGT asset whose main use is to derive rent will not be precluded from being an active asset if this main use is only temporary. There is scarce guidance regarding what is  considered temporary in this context. However, in the context of whether a share in a company or interest in a trust is an active asset, an example in the explanatory memorandum[16] indicates that a failure to satisfy the 80% look-through test for two weeks would be of a temporary nature only and therefore would not prevent the share or interest from being an active asset.

 

As always I would like to remind readers that

  1. The article does not constitute advice and is not intended to be comprehensive. While I have attempted to ensure the accuracy of the article I do not give any assurances. Please seek your own professional advice.
  2. The views in the article are mine alone and do not necessarily represent those of my employer or Tax  & Superannuation Australia

[1] Rapper’s Delight by Sugar Hill Gang, 1979

[2] ATO’s Guide for rental property owners (NAT 1729-06.2016)

[3] YPFD and Commissioner of Taxation [20-14] AATA 9

[4] Jakjoy Pty Ltd v FACT [2013] AATA 526

[5] Example 2 of Tax Determination TD 2006/78

[6] Example 3 of Tax Determination TD 2006/78

[7] Example 4 of Tax Determination TD 2006/78

[8] PBR 1012886042948

[9] Tingari Village North Pty Ltd and Commissioner of Taxation [2010] AATA 233

[10] Carson and Commissioner of Taxation [2008] AATA 156

[11] Example 5 of Tax Determination TD 2006/78

[12] PBR 70707

[13] The Executors of the Estate of the late Peter Fowler v FCT [2016] AATA 416

[14] Example 2.13 of Explanatory Memorandum to Tax Laws Amendment (2009 Measures No. 2) Act 2009

[15] Example 2.14 of Explanatory Memorandum to Tax Laws Amendment (2009 Measures No. 2) Act 2009

[16] Example 1.12 of Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 7) Act 2007

 

Taxing issues for departing taxpayers

The following article originally appeared in the November 2016 issue of The Taxpayer. This is the monthly journal of Tax & Super Australia (formerly Taxpayers Australia).

taxing-issues-for-departing-taxpayers

If you have any questions abou the issues raised in the article, please don’t hesitate to leave a comment, send me an email or contact me via LinkedIn.

There are a number of excellent articles in the magazine and I encourage you to get hold of a copy.

I will be contributing regularly to The Taxpayer. My next article will appear in December and will be on rental income and the small business CGT concessions.

Simon

Australia’s national innovation agenda – what does it mean in terms of business and tax incentives?

The following article originally appeared in the December 2015 edition of WTS Tax News Australia. I encourage you to read it and other useful articles in previous editions at the WTS Australia website.  The article should be read in conjunction with the disclaimers published on this website and the WTS Australia website. 

Prime Minister Malcolm Turnbull and Innovation Minister Christopher Pyne recently announced the flagship National Science and Innovation Agenda (Agenda), which is made up of a suite of business and
tax initiatives targeting innovation.
The Agenda, which is made up of a suite of proposed initiatives, represents perhaps the most significant policy announcement thus far of the new Turnbull Government. This article will briefly outline the initiatives that are of most relevance to entrepreneurs and investors.
Increasing access to company losses
Currently, in order to claim prior year tax losses, companies must satisfy either the ‘same business test’ or ‘continuity of ownership test’. The government proposes to relax the same business test, replacing it with a ‘predominantly similar business test’ that companies will be able to satisfy where their business, while not the same, uses similar assets and generates assets from similar sources. It is hoped that this will allow loss making companies to pivot and seek out new business opportunities to return to profitability. Legislation is expected to be introduced in the first half of 2016 and will apply to losses made in the current and future income years.
Insolvency reform
The government is proposing to change insolvency laws by reducing the bankruptcy period from three years to one, introducing a safe harbour for directors from personal liability for insolvent trading if they appoint a restructuring adviser and by making ‘ipso facto’ clauses unenforceable if a company is undertaking a restructure. An ipso facto clause allows contracts to be terminated solely due to an insolvency event. The government will release a proposal paper in the first half of 2016 with a view to the introduction of legislation in mid-2017.
Reforms to employee share schemes (ESS)
Earlier this year the government introduced tax concessions for ESS interests issued by start-ups (broadly those companies with an aggregated turnover not exceeding $50 million and incorporated for less than 10 years). Now it intends to pass a new law to limit the potential for disclosure documents given to employees under an ESS plan to be made available to the public (and therefore competitors). While ASIC has already published class orders providing partial relief from disclosure requirements, these do not apply in all circumstances. The legislation is expected to be introduced in the first half of 2016.
Intangible asset depreciation
Businesses will be provided the option to self-assess the effective life of acquired intangible assets (currently fixed by statute), thereby bringing the treatment of statutory intangible assets in line with tangible assets. It is hoped that this will decrease the cost of investment in these assets and enable smaller innovative companies to better market their intellectual property. The new arrangements will apply to intangible assets acquired from 1 July 2016
Tax incentives for early stage investors
New tax concessions will be provided for investors in unlisted companies that: undertake an eligible business (to be determined), were incorporated in the last three years and have expenditure and income of less than $1 million and $200,000 respectively. Where the investment qualifies, the investor will be eligible for a 20% non-refundable tax offset on investments, capped at $200,000 per investor per year, and a 10 year exemption on capital gains tax, provided investments are held for three years. The scheme is modelled on the UK’s Seed Enterprise Investment Scheme. The new arrangements are expected to apply from 1 July 2016.
Making it easier to access crowd-sourced equity funding (CSEF)
New laws will be introduced to enable companies to access crowd-sourced equity funding. Unlisted Australian public companies with turnover and gross assets of less than $5 million will be able to raise funds online (up to $5 million per year) from a large number of individuals. Companies that become public to access CSEF will receive up to a five year exemption from obligations to hold Annual General Meetings, produce audited financial statements and provide an annual report to shareholders. It is hoped that this will provide small innovative businesses with a more diverse range of funding options.
New arrangements for early stage venture capital limited partnerships
(ESVCLPs)
ESVCLPs are tax-effective investment vehicles in innovative companies at the early & growth stages of the start-up life-cycle. Under new arrangements, partners in new ESVCLPs will receive a 10% non-refundable tax offset on capital invested during the year. Furthermore, the maximum fund size for new ESVCLPs will be
doubled to $200 million and ESVCLPs will no longer be required to divest from a company when its value exceeds $250 million. It is hoped that this will make ESVCLPs more competitive internationally and attract greater levels of venture capital investment. The new arrangements are expected to commence from 1 July 2016.

 

WTS Comment

The proposed measures are encouraging but, as they say, the devil is in the detail.   At the time of writing, the Exposure Draft to the regulation to the CSEF regime (Corporations Amendment (Crowd-sourced Funding) Regulation 2015) only contemplates ‘ordinary shares’ and not other types of share instruments.   This may present a limitation for new economy innovation projects.  WTS will continue to provide updates as more information becomes available.

To read more about the Agenda business and tax incentives click here. (Tax News Australia 2015/6).

 

What expatriate employees should consider salary-sacrificing

A number of my clients have brought over employees from overseas. They want to know if there is anything they can do to pay these employees in a tax-effective manner.

Since October 2012 it has been far more difficult for these employees to be paid a living away from home allowance in a tax-effective manner. This is because, in order to access favourable tax treatment, the employee must now, amongst other requirements, maintain a home in Australia at which they usually reside.

However there are still a number of other tax-effective benefits that such employees can receive. This article will outline some of these benefits which an employer could consider providing.

EXEMPT BENEFITS

Relocation consultant costs

A relocation consultant may provide services such as obtaining removalist quotes, finding accommodation, negotiating leases, providing information about transportation to the new location and providing information about education and community services at the new location.

The costs of such a consultant would be exempt from FBT if they were incurred solely because the employee is relocating, whether temporarily or permanently, their place of residence in order to perform their employment duties

Removal and/or storage of household effects

This exemption covers transport, packing, unpacking and insurance of tangible personal property.

To be exempt from FBT, the costs must occur within 12 months of commencing duties at the new place of employment and must arise solely because the employee is relocating, whether temporarily or permanently, their place of residence in order to perform their employment duties.

Sale or acquisition of dwelling as a result of relocation

This exemption covers things like stamp duty, advertising, legal fees, agent’s services, discharge of a mortgage, borrowing expenses and other similar matters. However it would not include loan repayments, loan service fees, insurance or rates.

To be exempt, the sale of the old dwelling must be within two years of the employee commencing duties and the purchase of the new dwelling must be within four years. Furthermore, the costs must arise solely because the employee is required to change their usual place of residence to perform employment duties.

Connection or re-connection of certain utilities

This covers connection and re-connection of telephone and re-connection of gas or electricity.

These costs must be incurred within 12 months of the employee changing their residence. Furthermore, they must be incurred solely because the employee is required to live away from home or change their usual place of residence in order to perform their employment duties

Relocation transport

This exemption covers transport incurred solely because the employee is required to live away from their usual place of residence to perform their employment duties. It also extends to meals and accommodation on the journey (e.g. stopovers) as well as accident insurance, airport or departure taxes, passenger movement charge, a passport, a visa or a vaccination or any similar matter such as residency application costs and immigration agent fees.

This exemption can be very broad. It covers both the trip to Australia and the return journey. It would also cover a trip to visit Australia in order to find suitable accommodation before the secondment and/or a visit back to the employee’s usual residence to arrange the removal of tenants, making repairs or having utilities reconnected before the employee returns.

Compassionate travel

This exemption is for employees who, unfortunately, have a close relative (a parent, parent-in-law, spouse or child) who is seriously ill or has passed away. The transport, as well as meals and accommodation on the journey, incurred solely because to visit the relative or attend their funeral is exempt from FBT. The exemption applies to employees who are travelling or living away from home in the course of performing their employment duties.

BENEFITS ELIGIBLE FOR A REDUCTION IN TAXABLE VALUE (i.e. LESS FBT WILL BE PAYABLE)

‘Overseas employees’

The following two concessions apply only to overseas employees. This is a defined term that includes somebody whose usual place of residence is outside of Australia but is temporarily posted to Australia for work. It could also include Australian employees posted overseas. In order to access the concessions the overseas posting must be for a period of not less than 28 days

Crucially the benefits are only subject to a reduction in taxable value where they are either;

  • Provided under an industrial agreement i.e. a registered Australian workplace agreement, an award or legislation or
  • It is customary in the employer’s industry to provide the same kind of benefit in similar circumstances. The ATO’s view is that such benefits do not need to be provided to a majority of employees in the industry but nor can it be ‘rare or unusual’.

Holiday transport for overseas employees

This exemption covers transport to the holiday destination, as well as accommodation and meals on route, for the employee, their spouse and children. It also covers accident insurance, airport or departure taxes, passport costs, visa fees, vaccinations or other similar costs in connection with the transport.

Other requirements include; the employee must be on holiday and not performing their employment duties and the holiday must be for three or more days. Note also that remote area holiday transport falls under a different provision.

If the travel is the most direct practicable route between the overseas employment place and the employee’s home country then the taxable value is reduced by 50%. If the travel does not meet the above conditions (e.g. it is not a trip home) then it is reduced by the lesser of 50% and the benchmark travel amount – broadly the usual cost of return travel between the overseas employment place and the employee’s usual place of residence (e.g. a return economy air fare).

Education of children of ‘overseas employees’

This includes school, college or university fees, additional tuition costs and other costs (e.g. a car fringe benefit) that are in respect of the full-time education of the employee’s child. The child must be under 25 years and if the the benefit is a property (e.g. a computer) or residual fringe benefit it must be solely for their education.

The taxable value is reduced to the extent that it relates to the period of the overseas posting or the academic period.

Like the exemption for holiday transport the education of children must be provided under an industrial agreement or is customary in the industry.

Temporary accommodation relating to relocation and temporary accommodation meals

This covers temporary accommodation and leasing of furniture and household goods in relation to such accommodation. Temporary accommodation may be a hotel, motel or guesthouse. It must be paid solely because the employee is required to change their usual place of residence to perform their employment duties

The temporary accommodation can be at the former locality because the employee’s home becomes unavailable or unsuitable (e.g. due to furniture removal, storage or other arrangements). In this case the taxable value is reduced to extent that it is attributable to the 21 day period leading up to the employee commencing work at the new locality

The temporary accommodation can also be at the new locality. To be eligible the employee must commence sustained and reasonable efforts to find long-term accommodation as soon as reasonably practicable. A reduction in taxable value is not available if the employee does not occupy a long-term home within four months of commencing work or does not give their employer a declaration that they are making sustained and reasonable efforts to purchase or lease long-term accommodation

Meals consumed at time when employee and their family were in temporary accommodation are only subject to FBT on the first $2 of each meal (adults and children 12 or over) or the first $1 (children under 12).

Disclaimer

This article is intended to be a general introduction to the topic for information purposes only. It does not constitute advice. I strongly urge you to seek professional advice that is tailored to your personal circumstances.

A Beginner’s Introduction to Superannuation in Australia

Superannuation is a way to save for retirement. Money is contributed to a superannuation fund (fund), either by a member of the fund or their employer. The fund then invests these contributions and, hopefully, the balance of the fund’s assets accumulates over time. Once a fund member retires or reaches a certain age they can access this money without incurring penalties.

Employer Contributions

Employers are required to contribute 9.5% of an employee’s salary into the employee’s nominated fund. This is known as Superannuation Guarantee (SG). These contributions are taxed in the fund at the rate of 15%, rather than in the employee’s own name at their personal tax rate. Employers are entitled to claim a tax-deduction for these contributions.

An employee may agree to sacrifice additional amounts of salary in order to receive greater superannuation contributions. To be effective, the agreement should be entered into before the employee’s services are provided.

Personal Contributions

A fund member may contribute their own money to their superannuation fund. In certain cases they will be entitled to a tax-deduction for the contribution. Broadly, a deduction is available to people who receive less than 10% of their income from employment activities. Examples of such people are the self-employed and those who receive more than 90% of their income from investments.

If the member is between 65 and 75 years of age they must be gainfully employed on at least a part time basis (this is known as satisfying the ‘work-test’). Once the member is 75 or older they can no longer make personal contributions to their fund.

Contributions Caps

The maximum amount that can be contributed to superannuation in a given year depends on the type of contribution and the age of the member.

The concessional contributions cap is $30,000 or $35,000 for those aged 49 years or over on 30 June 2015. Concessional contributions are also known as before-tax contributions. Examples of concessional contributions are employer contributions (whether SG or salary-sacrifice) and personal contributions where the member is entitled to claim a tax deduction.

The non-concessional contributions cap is $180,000, regardless of the age of the member. However, under a ‘bring-forward’ rule, three years worth of caps (i.e. $540,000) may be utilised in the one income year.

These caps are indexed periodically.

Excess Contributions Tax

There may be additional tax for those who exceed their contributions caps.

If the concessional, or before-tax, contributions cap is exceeded any contributions made above the cap, along with an interest charge, is included in the member’s assessable income. Members can choose to withdraw some of their excess concessional contributions to pay the additional tax.

If the non-concessional, or after tax, contributions cap is exceeded the member can choose to withdraw the excess non-concessional contributions, plus the earnings on those contributions. The earnings are then included in the member’s assessable income. If the member does not chose to withdraw the excess contributions they will be taxed at the top marginal tax rate.

Tax in the Superfund

Generally, the income of a superannuation fund is taxed at 15%. However, after-tax (non-concessional) contributions are not subject to any further tax in the fund. Furthermore, non-complying funds and special types of income are taxed at 47%.

Withdrawing the money

Generally, super cannot be accessed (without incurring severe penalties) until the member reaches their ‘preservation age’ (between 55 and 60, depending on their date of birth). Those under 65 who have not permanently retired may only be permitted to withdraw a portion of their entitlement each year. Superannuation may also be permitted to be withdrawn in cases of sever financial hardship, compassionate grounds, family law disputes and temporary residents departing Australia.

Superannuation for those on high-incomes

An employer’s SG obligations are limited to 9.5% of $50,810 per quarter. Therefore, an employee on an annual salary of $300,000 would be entitled to contributions of $19,308 (being 9.5% of $203,240) rather than $28,500 (being 9.5% of $300,000). This ‘maximum contributions base’ is indexed annually.

Taxpayer’s on higher-income levels may also subject to an additional charge, known as Division 293 tax. Division 293 tax is calculated by adding the value of before-tax (concessional) contributions to the taxpayer’s income. The portion of contributions above a $300,000 threshold is subject to 15% tax, in addition to the tax that applies to the superannuation fund.

Superannuation for those on low-incomes

Individuals on low-incomes may be eligible for a government contribution to help them boost their superannuation savings.

Those earning $37,000 or less may receive a low Income superannuation contribution (LISC) of up to $500 directly into their superannuation fund.

Those earning $50,454 or less may receive a government co-contribution. The federal government will add 50c to every dollar of after-tax (non-concessional) contributions made to the fund, up to a maximum amount of $500.

Disclaimer

This information is intended to be an introductory guide for general information purposes only. It does not constitute advice. Readers are strongly advised to seek professional advice that is tailored to their particular circumstances.