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Explanatory Memo (Client Alert in more detail) Tax Planning Put simply, tax planning is the arrangement of a taxpayer’s affairs so as to comply with the tax law at the lowest possible cost. A common mistake is to believe that tax planning is optimised when every opportunity to reduce tax is taken. This is because some opportunities to reduce tax rely on strained interpretations of the law. Therefore, tax planning involves much more than taking the option that at first appears to result in lower tax costs. It involves objectively assessing and actively managing tax risk. Common tax planning techniques include deferring the derivation of assessable income and bringing forward deductions. It is equally important that consideration be given to any pending changes to tax legislation, especially when a proposed amendment will be backdated. Part IVA and tax planning Due to the broad scope of Pt IVA of ITAA 1936 and the consequences of its application, it should form an integral aspect of tax planning rather than exercised as an afterthought. Before the Commissioner exercises his discretion under s 177F of ITAA 1936 to cancel a tax benefit, the requirements of Pt IVA must be satisfied. These requirements are:
The term ‘scheme’ is defined in s 177A(1) of ITAA 1936 and includes any agreement, understanding, promise or undertaking, whether express or implied, and whether legally enforceable or not. Further, a scheme includes a scheme, plan, proposal or course of action, even if unilateral. Whether or not a tax benefit has been obtained in connection with a scheme, it requires the consideration of the eight factors listed in s 177D(b). These factors are:
Exempt income and tax planning Although exempt income is not assessable income, it cannot be ignored for tax planning purposes. For example, the amount of a dependent rebate may be reduced by the separate net income of the dependent, which includes exempt ordinary income. The derivation of exempt income may also reduce or limit deductions. Exempt income may also affect the rate of tax applicable to taxable income. For example, foreign employment income that is exempt under ss 23AF or 23AG of ITAA 1936 is taken into account in determining the rate applicable to other assessable income. Non-assessable non-exempt income Non-assessable non-exempt income is not counted in working out taxable income. That is, non-assessable non-exempt income has no effect on the income tax system. The categories of non-assessable non-exempt are listed in s 11-55 of ITAA 1997. They include:
Deferring Assessable Income The timing of when income is included in the assessable income of a taxpayer will depend on whether it is statutory income or ordinary income. Statutory income is included in assessable income at the time specified in the relevant provisions dealing with that income. Ordinary income is included in assessable income when it is derived unless a specific provision includes the amount in assessable income at some other time. Consideration must be given to the nature of an income, ie revenue or capital, because of the difference in their tax treatment, which ultimately will have an impact on a taxpayer’s tax position. Business income When ordinary income of a business is derived and to be included in assessable income will depend on whether the business returns income on a cash basis or on an accruals basis. Where a business uses the cash basis, ordinary income is, generally, derived in the year in which the business receives the income. Conversely, if the business is reporting income on an accrual basis, ordinary income is derived when a recoverable debt is created such that the taxpayer is not obliged to take any further steps before becoming entitled to payment. Payment received in advance Income received in advance of services being provided is generally not assessable until the services are provided (the Arthur Murray principle). This principle applies regardless of whether a taxpayer is reporting its income on an accrual basis or on a cash basis.
Work in progress In relation to manufacturers, partly manufactured goods that are not ‘finished’ goods are treated as trading stock and it is necessary to determine the difference between the opening and closing value of the trading stock for the income year. (See Trading Stock.)
Income from property Income from property is essentially all income that is not personal exertion income and includes interest, rent, dividends, royalties and trust distributions. The time of when such income is derived for non-business taxpayers is as follows:
Sale of depreciating assets A taxpayer is required to calculate the balancing adjustment amount resulting from the disposal of a depreciating asset. The balancing adjustment amount is calculated by comparing the termination value against the adjustable value. If the termination value is greater than the adjustable value, the difference is included as assessable income of the taxpayer. If the termination value is less than the adjustable value, the difference is a deduction available to the taxpayer. If the disposal of an asset will result in assessable income, a taxpayer may want to consider postponing the disposal to the following income year. However, if it is not possible to delay the disposal, consideration may be given to whether a balancing adjusting rollover relief is available. If the disposal of an asset will result in a deduction, it may be beneficial to bring the disposal forward to the current year. Balancing adjustment rollover relief Balancing
adjustment rollover relief effectively defers a balancing adjustment
until the next balancing adjustment event occurs. Broadly, the
rollover relief will apply automatically if the conditions listed in
An optional rollover relief is available in a partnership scenario if the composition of the partnership changes or when assets are brought into or taken out of the partnership. To defer any balancing adjustments, the existing partners and the new partner can jointly elect for the rollover relief to apply.
Pending legislation The Government introduced Tax Laws Amendment (2009 Measures No 2) Bill 2009 into the House of Representatives on 19 March 2009. The Bill will amend ITAA 1997 to provide an exemption from tax for the Clean-up and Restoration Grants paid to small business and primary producers affected by the Victorian bushfires. At the time of publication, this Bill has not received Royal Assent. Maximising Deductions Deductions are divided into general deductions and specific deductions. General deductions are allowable under s 8-1 of ITAA 1997 whereas specific deductions are those provided for by sections of ITAA 1936 and ITAA 1997. Where an item of expenditure would be a deduction under more than one section, it is deductible under the provision that is most appropriate. Meaning of incurred In Taxation Ruling TR 97/7, the Commissioner states his view on the meaning of ‘incurred’ for the purposes of s 8-1 of ITAA 1997. He states that an outgoing has been incurred when:
The phrase ‘presently existing liability’ means that a taxpayer is definitively committed (or completely subjected) to the outgoing, ie the liability is more than impending, threatened or expected. An outgoing is still incurred even if the amount cannot be quantified precisely, provided it is capable of approximate calculation based on probabilities. If a taxpayer could have claimed a deduction for an outgoing that was incurred but not paid in the particular income year but failed to do so, the taxpayer cannot claim a deduction in the year in which the liability is discharged, as the outgoing has not occurred in that year. The taxpayer is required to seek an amendment of the assessment for the previous year, within the statutory limits.
Managed investment schemes The deductibility of expenses incurred for a managed investment scheme (MIS) was the subject of a Full Federal Court case. In a test case decision, the Full Federal Court has found that two taxpayers’ investments in an almond MIS constituted the carrying on of a business and the outgoings incurred on the schemes were allowable deductions pursuant to s 8-1 of ITAA 1997: Hance & Anor v FCT [2008] FCAFC. The Court also found that there would be no relevant trust interest acquired by the taxpayers in exchange for payment of the relevant deductions and therefore the income to be derived by the taxpayers should not be taxed as trust income. The Commissioner has indicated that the Tax Office will not appeal against the decision of the Full Court. He said that investments in MIS arrangements which are broadly similar to the test case are deductible. He said the arrangements did not involve features like non-recourse or round-robin funding in mass-marketed schemes that were disallowed by the courts in cases such as Howland-Rose & Ors v FCT (2002) 49 ATR 206 and Vincent v FCT (2002) 51 ATR 18. In light of the Court’s decision, the Tax Office has withdrawn its Taxation Ruling TR 2007/8 and Draft GST Ruling GSTR 2008/D1 on managed investment schemes.
Bad debts A debt that is written off as a ‘bad’ in an income year is an allowable deduction under s 25-35 of ITAA 1997, provided:
Taxpayers should review their debtors prior to year-end and assess which debts may be written off as ‘bad’. In Taxation Ruling TR 92/18, the Tax Office sets out the list of circumstances in which a debt may be considered to have become bad. These circumstances include:
Before a debt can be written off as ‘bad’, a taxpayer must have taken the appropriate steps in an attempt to recover the debt. The Tax Office, in TR 92/18, lists the steps to be taken to establish that a debt is bad, which include:
It is important to note that while the above factors are indicative of the circumstances in which a debt is considered bad, ultimately the question of whether the debt is bad is one of fact and will depend on all of the facts and circumstances surrounding the debt.
Additional requirements for companies A company must pass either the continuity of ownership test (the primary test to be applied) or the same business test in addition to satisfying the requirements of s 25-35. Companies that have undergone a change in underlying ownership due to a sale of the business during the year will need to pass the ‘same business test’ to claim a deduction for bad debts. In Lilyvale Hotel Pty Ltd v FCT [2009] FCAFC 21, the Full Federal Court said that the management of a taxpayer’s business at different times in different ways had no bearing upon the characterisation of its business. Therefore, the Court found that the business carried on by the taxpayer was that of ‘owning and operating a hotel to derive revenue from its guests and profits from its operation’ at all relevant times. Accordingly, the Court held that the taxpayer satisfied the same business test.
Additional requirements for trusts Special rules apply to deny trusts a deduction for bad debts unless certain strict tests are passed. The applicable tests will depend on the nature of the trust. (See Trust losses.) Carried forward losses The deductibility of tax losses carried forward from previous income years will depend on the type of entity claiming the losses. Corporate tax entities The entitlement of corporate tax entities to deductions in respect of prior year losses is subject to certain restrictions. An entity needs to satisfy the continuity of ownership test before deducting the prior year losses. If the continuity of ownership test is failed, the entity may still deduct the loss if it satisfies the same business test.
Other taxpayers The
method for deducting earlier tax losses incurred by other taxpayers
is governed by s 36-15 of
Depreciation (Capital allowances) A deduction may be available on the disposal of a depreciating asset if a taxpayer stops using and expects never to use it again. Therefore, asset registers may need to be reviewed for any assets that fits this category. The effective life of an asset can be recalculated at any time after the end of the first income year for which depreciation is claimed by a taxpayer, if it is no longer accurate because of changed circumstances relating to the nature of use of the asset. Therefore, consideration may be given to the use of an asset to determine whether its effective life can be recalculated, which may result in an increased or decreased rate of depreciation. Immediate deduction Non-business taxpayers Non-business taxpayers are entitled to an immediate deduction for assets costing $300 or less, provided:
Small business entities A small business entity (see Small business entities) that chooses to apply the capital allowance rules contained in Div 328 of ITAA 1997 is eligible for an outright deduction for the taxable purpose proportion of the adjustable value of a depreciating asset in the income year it first starts to use the asset or installs it for a taxable purpose if:
The entity is also entitled to an immediate deduction for any addition to a low cost asset, provided the cost of the addition is less than $1,000. Where an asset costs more than $1,000, the entity is required to pool the asset into either a general pool or a long-life pool depending on the effective life of the asset. Business taxpayers For business taxpayers that are not small business entities, all capital items must be written off over their effective life under Div 40 of ITAA 1997, regardless of the cost (including low-value items). However, the Tax Office has adopted an administrative practice allowing an outright deduction for low-cost capital assets in certain cases. Broadly, an expenditure of $100 or less (inclusive of GST) incurred by a taxpayer to acquire a capital asset in the ordinary course of carrying on a business will be assumed to be revenue in nature and therefore deductible in the year of the expenditure. It is important to note that because the threshold includes GST, for a business registered for GST, the threshold is effectively $90.91. This administrative practice does not apply to expenditure incurred by a taxpayer on:
Pooling Certain depreciating assets can be pooled, with the result that the decline in value is calculated for the pool instead of the individual assets. For a small business entity, two pools are available: a general pool for assets with an effective life of less than 25 years, and a long-life pool for assets with an effective life of more than 25 years. If the cost of the asset is less than $1,000, the small business entity is entitled to an outright deduction. For other taxpayers, there is the option of pooling ‘low-cost’ and ‘low-value’ assets to a low-value pool. A ‘low-cost’ asset is a depreciating asset that costs less than $1,000. A ‘low-value’ asset is a depreciating asset that has been depreciated using the diminishing value method, has an opening adjusted value of less than $1,000 in an income year, and is not a ‘low-cost’ asset. If a taxpayer sets up a low-value pool, all low-cost assets have to be allocated to the pool. However, low-value assets do not need to be allocated to the pool.
Donations A taxpayer may make a written election to spread the deduction for a donation made over a period of five years if:
If a taxpayer is anticipated to have an increase in assessable income in the coming income years, consideration may be given to spread the deductibility of the donation over five years.
Donations to the Victorian bushfires Tax Laws Amendment (2008 Measures No 6) Act 2009 amended ITAA 1997 to specifically list the 2009 Victorian Bushfire Appeal Trust Account as a deductible gift recipient in Div 30 of ITAA 1997. A donation to the Trust Account will be a deduction if the donation is made after 7 February 2009 and before 6 February 2014. On 27 March 2009, the Treasurer and Assistant Treasurer declared the recent Victorian bushfires a disaster for the purposes of establishing the Australian disaster relief funds, effective from 29 January 2009. The declaration is made pursuant to amendments to the ITAA 1997 by the Tax Laws Amendment (2008 Measures No 6) Act 2009. The Treasurer and Assistant Treasurer say the declaration ensures that qualifying existing and new funds established for the relief of people in communities affected by the bushfires can receive tax deductible donations. Donations to Australian disaster relief funds established to provide relief in the aftermath of the bushfires will be tax deductible for a period of 2 years from 29 January 2009. At the time of publication, the Government has not released further details about the declaration. Tax Office media release In Media Release 2009/10, the Tax Office stated that individuals who donated to the Victorian bushfires and Northern Queensland floods through ‘bucket donations’ can claim a tax deduction equal to their contribution of up to $10 in their 2008/09 tax return without the usual need to keep a receipt. It also stated that where individuals have made a donation over $10 using the Internet, the telephone or through third parties (eg banks and retail outlets), the internet receipt or the credit card statements will suffice in lieu of a receipt. Legal expenses It is impossible to formulate an all-encompassing ‘rule’ as to the deductibility of legal expenses because each expense must be considered on its own merits. In FCT v Day (2008) 70 ATR 14, the High Court held that legal expenses incurred by a public servant in relation to charges under the Public Service Act 1922 (Cth) of having failed to fulfil his duty as an officer were deductible under s 8-1 . The Court said that the consequences to the taxpayer of internal disciplinary proceedings, in relation the continuation or termination of his employment, formed part of what was productive of his assessable income as a public servant. Accordingly, the ‘occasion’ of the legal expenses was to be found in his position as a public servant and therefore the expenses were deductible. Non-commercial losses An individual taxpayer should consider whether a loss from his or her business activity (whether carried on alone or in partnership) will be deferred under the non-commercial loss rules, which are contained in Div 35 of ITAA 1997. This is because the individual’s overall tax position will be impacted when the loss is deferred. In essence, an individual may only offset a loss arising from a business activity against other income derived in the same income year if the business activity satisfies at least one of the four commerciality tests – the assessable income, profits, real property, and other assets tests. If the individual does not satisfy at least one of the tests, the loss is carried forward and applied in a future income year against assessable income from the particular activity. The Commissioner has the discretion to override the provisions of Div 35. Further, an exemption is available for individuals who carry on a primary production or professional arts business and whose assessable income for the year from other sources (eg salary and wages) does not exceed $40,000.
Prepayments One of the simplest methods to accelerate deductions is the prepayment of deductible expenses. Excluded expenditure The prepayment rules do not apply to ‘excluded expenditure’, ie a taxpayer is able to claim an outright deduction. Excluded expenditure is defined as:
Small business entities and non-business individuals Small business entities and non-business individuals are able to access the 12-month prepayment rule. If the prepaid expenditure is not excluded expenditure, it is deductible outright in the income year it is incurred, subject to two provisos: the eligible service period does not exceed 12 months, and ends in the expenditure year or the income year immediately following. If the prepayment has an eligible service period of greater than 12 months, the expenditure will be apportioned over the relevant period (on a daily basis) up to a maximum of ten years. The eligible service period is the period over which the relevant services are to be provided. Other taxpayers If the eligible service period covers only one income year, the expenditure will be deductible in that particular year. If the eligible service period covers more than one income year, the expenditure is apportioned (on a daily basis) over those years up to a maximum of 10 years in accordance with the formula:
Speculators and losses from shares Generally, speculators are denied a revenue deduction for any losses arising for the disposal of shares unless a speculator is carrying on a business in relation to the shares. By way of example, in AATA Case 6297 (1990) 21 ATR 3747, the Tribunal concluded that a taxpayer’s share activities did not amount to carrying on a business and that, as a result, the taxpayer was not entitled to a deduction for losses arising from the disposal of his shares. Furthermore, in ATO ID 2002/951 the Commissioner ruled that a speculator was not entitled to a revenue deduction for losses under s 25-40 of ITAA 1997 on the sales of post-CGT shares. Interestingly, the Commissioner did not discuss the deductibility of the losses under s 8-1 of ITAA 1997, nor whether the losses were capital in nature. Trading stock The tax treatment of trading stock, which is contained in Div 70 of ITAA 1997, impacts on year-end tax planning. This is because a taxpayer is required to either include in or deduct from its assessable income for an income year the difference between the opening and closing value of the trading stock. Valuation of trading stock A taxpayer can elect to use the cost, market selling value or replacement value to value each item of trading stock-on-hand. However, this does not apply to obsolete stock or certain taxpayers. There is no requirement to adopt permanently any one of the three methods of value.
Small business entities If a small business entity elects to apply the trading stock concession under Div 328, it is permitted to ignore the difference between the opening and closing value of trading stock if the difference between the opening value of stock on hand and a reasonable estimate of stock on hand at the end of that year does not exceed $5,000. The effect of electing this concession is that the value of the entity’s stock on hand at the beginning of the income year is the same as the value taken into account at the end of the previous income year. However, a taxpayer could choose to account for changes in the value of trading stock even if the reasonably estimated difference between opening and closing values was less than $5,000.
Other business taxpayers It is a requirement to value each item of trading stock at the end of an income year at its cost, market value or replacement value. There is no requirement to permanently adopt any one of the three methods of valuation. Further, there is no compulsion for a taxpayer to use the same method across all items of trading stock.
Obsolete stock A deduction may be available for obsolete stock. Therefore, a taxpayer should review its closing stock to identify whether any obsolete stock exists. In Taxation Ruling TR 93/23 the Tax Office states that obsolete stock is either:
When valuing obsolete stock, a taxpayer does not need to use any of the prescribed methods (ie cost, market value or replacement value). Rather, provided adequate documentation is maintained, the Tax Office will accept any fair and reasonable value which is calculated taking into account the appropriate factors: see s 70-50 of ITAA 1997. Repairs and maintenance A
deduction is available for repairs to premises, part of premises or a
depreciating asset (including plant) held or used by a taxpayer
solely for the purpose of producing assessable income: see s 25-10(1)
of A common issue that arises is the distinction between restoration of an item to its former condition (deductible) and improvement of the item (capital and therefore not deductible). It is important to realise the mere fact that different materials from those replaced are used will not of itself cause the work to be classified as an improvement, particularly in circumstances where the previous materials are no longer in current use. If the change is merely incidental to the operation of the repair, the deduction, generally, will be allowed. Initial repairs, the replacement of the entire item, and improvements are not deductible, but may qualify for a periodic write-off under the capital allowance provisions. In addition, the expenditure may form part of the cost base of an asset for capital gains tax purposes.
Superannuation contributions Deductions for employer contributions Employers are entitled to a tax deduction for contributions made to a complying superannuation fund or a retirement savings account (RSA) for the purpose of providing superannuation benefits for an employee. Any contributions made are only deductible for the year in which the contributions are made: see s 290-60(3) of ITAA 1997. To maximise the deductions available, employers should ensure that the contributions are paid to their employees’ superannuation funds or RSAs before 30 June.
Superannuation guarantee charge The superannuation guarantee charge (SGC) is imposed if an employer does not make sufficient quarterly superannuation contributions for each employee by the relevant quarter due date. The SGC is also imposed where the employer pays the contributions after the due date, albeit there is no shortfall for the quarter. Employers who have made a contribution for an employee after the due date for a quarter and have an outstanding SGC for the employee for that quarter may elect (using the approved form) to use the late payment offset to reduce part of their SGC liability. Since 24 June 2008, employers can elect to use the late payment offset to reduce their SGC liability for a year (rather than a quarter) which becomes payable after that date. The offset provisions were amended by Tax Laws Amendment (2008 Measures No 6) Act 2009. From 26 March 2009, an employer will be eligible to use the offset to reduce its SGC liability where:
Personal superannuation deductions The self-employed and other eligible persons are entitled to a deduction for personal superannuation contributions is available if less than 10% of a taxpayer’s total assessable income and reportable fringe benefits for an income year is attributable to activities that result in the taxpayer being treated as an employee for superannuation guarantee purposes. The contribution is only deductible for the year in which it is made. Further, the contribution is deductible in full, subject to the restriction that the maximum amount that is deductible is the amount stated in the notice of intention to claim a deduction, which is given to the trustee of a superannuation fund. However, excess contributions tax may apply for contributions above the contributions cap (see Tax Rates and Figures).
Pending developments Small business and general business tax break On 19 March 2009, the Government introduced the Tax Laws Amendment (Small Business and General Business Tax Break) Bill 2009 into the House of Representatives, which seeks to provide a once-off bonus deduction for new investment in tangible depreciating assets undertaken between 13 December 2008 and 31 December 2009 (inclusive). Key details of the bonus deduction follow.
There are a number of important changes from the Exposure Draft Bill that was released on 25 February 2009. These changes include:
The amendments will apply to assessments for the 2008/09, 2009/10, 2010/11 and 2011/12 income years.
Common deductions The table below lists the common deductions. Note that the table is not exhaustive.
Capital Gains Tax A taxpayer may consider crystallising any unrealised capital gains and losses in order to improve his or her overall tax position for an income year. For example, if the taxpayer is anticipating a significant capital gain in an income year, consideration may be given to reducing the gain by crystallising a capital loss in the same income year. However, consideration must be given to the Commissioner’s view on wash sales contained in Taxation Ruling TR 2008/1, particularly if a taxpayer reacquires the assets being disposed or identical assets, or somehow retains dominion or control over the original assets. Small business CGT concessions Broadly, the small business CGT provisions contained in Div 152 of ITAA 1997 provide a range of concessions for a capital gain made on a CGT asset that has been used in a business if certain conditions are met. These concessions are:
Pending changes to the small business CGT concessions The Government has introduced Tax Laws Amendment (2009 Measures No 2) Bill 2009 in which it will amend ITAA 1997 the law to increase access to the small business CGT concessions. These amendments include:
At the time of publication, the Bill has not received Royal Assent. Rollover relief Rollover relief is available to provide taxpayers with the option to defer the consequences of a CGT event. Apart from disregarding any capital gains or capital losses that would otherwise arise from a CGT event, a rollover usually places the transferee under the rearrangement in the same CGT position as the transferor was before the event occurred. Some of the rollover reliefs will apply automatically while some will require taxpayers to elect the use of the reliefs, which is indicated by the way their tax returns are prepared. Two types of rollovers are available: the replacement asset rollover and the same asset rollover. A replacement asset rollover allows the deferral of a capital gain or loss until a later CGT event happens to the replacement asset. A same asset rollover allows the deferral of a capital gain or loss arising from the disposal of the asset until the later disposal of the asset by the successor entity. The table below sets out the common rollover reliefs that may be considered for tax planning purposes:
Quick reference tables Availability of CGT discount and indexation
CGT discount
Companies The tax treatment of companies will depend on their classification, that is, a private company or a public company. For example, only a private company is subject to the operation of Div 7A of ITAA 1936. Companies are subject to a flat rate of tax (currently 30%) on the entirety of their taxable income. This rate applies whether the company is public, private, resident or non-resident. Franking account It is a requirement that every entity that is (or has ever been) a corporate tax entity has a franking account. The franking account is recorded on a ‘tax paid’ basis and operates on a rolling balance basis. Franking of distributions All distributions are frankable unless specifically deemed unfrankable. Unfrankable distributions include:
Benchmark rule The benchmark rule requires all frankable distributions made by an entity during its franking period to be franked to the same extent (the ‘benchmark franking percentage’). It should be noted that a corporate tax entity would incur an over-franking tax if the franking percentage for a distribution exceeds the benchmark percentage, or a franking debit (for under-franking) if the franking percentage is less than the benchmark rate. (Certain concessions to this rule may apply to public companies.) If the benchmark percentage varies by more than 20% from the last frankable distribution in the last franking period, an entity must notify the Commissioner in writing. Franking period The franking period of a corporate tax entity will depend on whether is it a public company or a private company. The franking period of a private company is the same as its income year. Generally, a public company has a six-month franking period. Distribution statements Entities that make frankable distributions must provide their shareholders with a distribution statement. (Note that the information that must be disclosed on the statement is prescribed in s 202-80 of ITAA 1997.) For entities that are private companies, the distribution statement must be given to their shareholders within four months after the end of the income year in which the distribution was made, or such further time as the Commissioner allows. If this statement is not received, the shareholder will not be able to claim a franking credit tax offset.
Franking account balance A company’s franking account should be reviewed to ensure that the company is not liable for franking deficit tax. If the company is liable for franking deficit tax, it must be paid within a month of the end of the franking period. Franking deficit tax is not a penalty but an early payment of income tax that is offset against future tax obligations. Concession for private companies A private company generating profit in its first income year is prevented from making a franked distribution to its shareholders because of insufficient franking credits. However, a concession, which allows the company to make a franked distribution to its shareholders, exists if the following conditions are satisfied:
Private company and Div 7A The broad thrust of Div 7A of ITAA 1936 is to deem certain loans, payments and debt forgivenesses by private companies to their shareholders and associates to be assessable unfranked dividends to the extent that there are realised or unrealised profits of the company. Managing your Div 7A risk To minimise any adverse Div 7A consequences, taxpayers must consider the following:
Trusts and Div 7A If a private company beneficiary of a trust has an unpaid present entitlement to an amount of the net income of the trust, and the trustee subsequently makes a loan, payment or debt forgiveness to a (non-corporate) shareholder or associate of the private company, it is important to consider the application of Div 7A. Had the actual transaction (a loan, payment or forgiveness) been done by the private company and the shareholder or associate, a deemed dividend would arise here. Whether the company’s unpaid present entitlement arises before or after the transaction is immaterial. The amount of the deemed dividend is the lesser of:
Primary Producers Although primary producers are subject to the general rules relating to assessable income and allowable deductions, they receive special concessions under ITAA 1997. These concessions include:
Livestock accounting The value of all livestock on-hand at the beginning of an income year and at the end of the year is taken into account in ascertaining whether or not a taxpayer has a taxable income. Therefore, a deduction is obtained for all losses by death, etc, in the income year. Conversely, the taxpayer’s assessable income is increased by the value of all natural increases on hand at the end of that year. A taxpayer can choose to value livestock at the end of an income year using the livestocks’ cost, market selling value or replacement value. (Note that there are additional options for valuing horse breeding stock.) If livestock acquired by natural increase is valued at cost, a taxpayer may choose either the actual cost of the animal or the cost prescribed by the regulations for each animal in the applicable class of livestock. The actual cost means the full absorption cost of bringing the animal into its current state and location. The prescribed costs are set out as follow:
Disposal of livestock In certain situations where a primary producer makes a profit on the forced disposal or death of livestock (eg the livestock was disposed because pasture or fodder is destroyed by fire, drought or flood), Subdiv 385-E allows the primary producer to elect either to spread the tax profit over five years or, where the profit is mainly used for replacement stock, to defer including the tax profit in assessable income. Where livestock disposed of is replaced by stock of the same species (eg sheep by sheep), in calculating the cost of the replacement animals for income tax purposes the amount applicable to each replacement animal is the amount paid or payable for the purchase of that animal less the reduction amount: see s 385-120(1). The reduction amount is the amount of the tax profit on disposal or death attributed to livestock of the species being replaced, divided by the number of animals of that species that were disposed of or died: see s 385-120(2). Section 385-120(4) limits the reduction amount to the unused tax profit so that a particular purchase cannot reduce it to less than nil. The excess amount is carried forward in the unused tax profit. The right to reduce the cost, and thus absorb the assessable income derived from the original disposal or death until such time as the newly acquired animals are disposed of, extends for a period of five years from the date of the disposal. Where livestock disposed of is replaced by stock of a different species (eg sheep by cattle), s 385-120(3) provides that the reduction amount for the animal is any reasonable amount at least equal to the amount calculated under s 385-120(2). Where the replacement stock is acquired at a price substantially in excess of the replacement cost of the species disposed of, the proportion of the profit on disposal required to reduce for taxation purposes the cost of the new animal is any reasonable amount at least equal to the amount worked out under s 385-120(2), provided that it does not exceed the cost of the new animal. Where the cost of the replacement animal is not substantially in excess of the replacement cost of stock of a similar species to that disposed of, the reduction amount is the amount worked out under s 385-120(2) or the cost of the animal. Where a primary producer makes an election under s 385-110 and replaces the stock disposed of by breeding, the primary producer may elect to include an amount in its assessable income of the income year in which the livestock are replaced: s 385-115. No formula is provided for determining the amount to be included and it is any amount chosen by the taxpayer. The provisions governing trust, which include in whose hands trust income is assessed and the amount assessed, can be complex. A good starting point is always the trust deed. This is because the deed governs the operation of the trust. Trust losses The trust-loss recoupment rules restrict the circumstances in which prior year and current year losses of a trust can be claimed as a deduction when calculating the net income of the trust. The applicable tests that must be satisfied will depend on the type of trust. These tests must also be satisfied when the trust is seeking to claim a bad debt deduction.
Trust distribution minutes The drafting of the distribution minutes needs to take into account the following tax issues:
Trusts and unpaid entitlements to private companies A ‘loan’ from a private company to a trust can generally trigger a Div 7A deemed dividend under s 109D of ITAA 1936 where:
An unpaid present entitlement may result in a s 109D loan where either:
Tax Office view In a recent address at a Taxation Institute of Australia seminar, the Deputy Commissioner of Taxation indicated that s 109D and s 100A of ITAA 1936 may apply to unpaid present entitlements of a private company beneficiary to trust income. The Deputy Commissioner said his comments regarding the application of s 109D reflected the approach being taken by the Tax Office in one of its audit cases. The Deputy Commissioner confirmed that a consensual agreement may arise if a private company's unpaid present entitlements to trust income are credited to a loan account on the trust's balance sheet, and the company acquiesces to or adopts the same accounting treatment. The Deputy Commissioner also confirmed that, if the evidence indicates that an unpaid present entitlement is not a s 109D loan, consideration should still be given to the potential application of s 100A. Section 100A was originally enacted to prevent trust-stripping but has wider scope due to its broad wording. It generally operates to disregard a trust distribution that is diverted away from a presently entitled beneficiary under a reimbursement agreement, and to instead tax the trustee under s 99A.
Capital gains distribution There are two methods that a trustee can use to distribute the income of the trust: the quantum approach and the proportionate approach. The preferred method is the proportionate approach, based on the volume of case law regarding trust distribution, which distributes the income based on the proportions of the trust income to the beneficiaries. For example, if a beneficiary is presently entitled to 10% of the trust income, he or she will be taken to be presently entitled to 10% of the net income for tax purposes. However, a strict application of the proportionate approach will result in an anomaly if capital gains are derived by the trust, and there are separate and distinct income beneficiaries and capital beneficiaries. This is because under s 97 of ITAA 1936, a beneficiary who is entitled to the ‘income’ would be taxed on all of the ‘taxable income’ (including the capital gains, even though the beneficiary has not received any of the capital distribution). To overcome this anomaly, in Practice Statement PS LA 2005/1 (GA), the Commissioner has stated that he will permit the use of the capital beneficiary approach or the trustee approach. However, for a trust to be able to use either one of these approaches, documentation as discussed must be entered into within two months of year-end. Capital beneficiary approach The capital gain may be assessed to a beneficiary (or a trustee on his or her behalf) if:
A capital beneficiary must agree in writing on the approach to be used, and he or she must prepare his or her tax return in a way that corresponds to the agreement. The agreement must be made within two months after the end of the income year, or such further time as the Deputy Commissioner allows. The trustee resolution allocating the capital gain must also be made by the time the agreement is made. Trustee approach If there is a capital gain that is not to be included in the share of the net income of a beneficiary, the trustee will be assessed under ss 99 or 99A of ITAA 1936. This approach can only be used if the beneficiaries and trustee have agreed in writing to use it. Any agreement must be made within two months after the end of the relevant income year. If a party does not prepare his or her income tax return in accordance with an agreement, the Tax Office will ignore the agreement in assessing the capital gain. Pending developments In a media release dated 31 October 2008, Federal Assistant Treasurer, Mr Chris Bowen, announced that the Government will remove one of the CGT exceptions to CGT events E1 and E2. According to the media release, the Government will abolish the ‘trust cloning’ exception. This exception provides a CGT exemption for capital gains arising from a change in ownership of an asset that typically occurs on the creation of a trust over a CGT asset (CGT event E1) and on transferring a CGT asset to an existing trust (CGT event E2). However, the other exception to CGT events E1 and E2, that is, where an individual is the sole beneficiary of a trust and absolutely entitled to the assets of the trust, and the trust is not a unit trust, will be retained. The media release stated that the amendments will resolve uncertainty surrounding the application of the exception. It also stated that the amendments will remove the possibility of using the trust cloning exception to eliminate tax liabilities on accrued capital gains. At the time of publication, the Government has not released any draft legislation or Bill to implement the proposed changes. Tax Office administrative treatment The Tax Office has said that it would continue to apply the existing law until enactment of the proposed changes. It also said that, if the legislation receives Royal Assent prior to 1 July 2009, taxpayers should ensure the enacted changes are taken into account when completing their income tax returns for the income year ending 30 June 2009. Small Business Entities The small business entity regime replaced the Simplified Tax System (STS) with effect from 1 July 2007. Under the small business entity regime, a taxpayer does not need to elect to enter into the regime. Instead, it will be apparent from a small business entity’s tax return whether it has used the tax concessions. These concessions include:
In addition, a small business entity will be able to access other various concessions (subject to any additional criteria set out in the particular concessions themselves). These are:
Definition of a small business entity An entity will be classified as a small business entity for an income year if:
The aggregated turnover is the annual turnover of the entity’s business plus the annual turnover of any businesses that the entity is connected to or affiliated with. The aggregated rules are similar to the former STS grouping rules. An entity satisfies the aggregated turnover test if:
Personal Services Income Broadly, the personal services income (PSI) rules attribute income derived by an interposed entity to the individual providing services to the entity. This is achieved by ‘forcing’ individuals to include the income generated by their personal skill or efforts in their personal tax returns. The deductions of a taxpayer who receives PSI are generally limited to the amount that he or she would be entitled to deduct if they had received the income as an employee. However, the PSI rules do not apply to individuals or interposed entities if one of the required personal services business (PSB) tests (results test, unrelated clients test, employment test and business premises test) is satisfied. The primary test to be applied is the results test. If this test is met, there is no further requirement to self-assess against the other tests and the PSI rules do not apply. In addition, the Commissioner has the power to grant a determination, which has the effect of exempting a PSB from the PSI regime. Generally, a determination will be granted if unusual circumstances existed that prevented the business from satisfying the tests or the business would have had, but for the unusual circumstances, two or more unrelated clients in the current income year.
General anti-avoidance and PSB It is a common misconception that income earned by a PSB is income from a business structure. The income derived by a PSB is still categorised as PSI for income tax purposes if it is income that is mainly a reward for an individual’s personal efforts or skills. Therefore, the income (as distinct from income from a business structure) that is derived by the PSB may be subject to the application of Pt IVA, if:
However, remuneration paid to an associate (or service trust) for bona fide services related to the earning of PSI will not attract the application of Pt IVA if the amount is reasonable. The Tax Office has stated that Pt IVA will not apply in the following situations: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||