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Explanatory Memo (Client Alert in more detail)
October 2004

Interposed Entity Elections

Where the trustee of an elected family trust confers a present entitlement to income or capital of the trust to a beneficiary that is outside of a defined family group, family trust distribution tax applies at the top marginal tax rate. Therefore, once a trustee has made a family trust election (FTE), other companies and trusts which receive distributions from the family trust would need to make an interposed entity election (IEE) in order to avoid family trust distribution tax.

Broadly, the family group is defined in sections 272–90 and 272–95 of Schedule 2F of ITAA 1936 to include the following:

• parents, grandparents, brothers, sisters, nephews, nieces, children and grandchildren of the test individual or the test individual’s spouse;
• the spouse of the test individual or another family member;
• trusts covered by an FTE specifying the same test individual;
• entities covered by IEE’s;
• entities which are wholly owned by the family group; and
• certain tax-exempt bodies and tax deductible gift recipients.

Once an IEE has been made, the entity making the election is limited in relation to distributions of income and capital to the same defined family group. Otherwise, family trust distribution tax applies under sections 271–20, 271–25 and 271–30 of Schedule 2F of ITAA 1936.

Although an IEE involves all of the same distribution restrictions that an FTE imposes, and has the same risk of incurring family trust distribution tax, an IEE does not provide similar benefits when made by a trust. Specifically, the following is noted:

• The making of an IEE does not exclude a trust from the various tests under the trust loss rules (a trust which has made an IEE is not an excepted trust under section 272–100 of Schedule 2F of ITAA 1936). Therefore, although the trustee of a discretionary trust may make an IEE, that trust would still be subject to the pattern of distributions test, the 50% stake test and the control test in order to utilise its own losses.
• An IEE does not result in concessional modifications to the income injection test. These modifications, which make the test easier to satisfy due to the softer ‘outsider’ definition, only apply when a family trust election is made, rather than an IEE.
• An IEE does not assist in recouping tax losses of companies owned by trusts but a family trust election does, as discussed in our August edition.
• An IEE does not assist beneficiaries in utilising franking credits in the way that an FTE does. A discretionary trust beneficiary may not be able to access franking credits on shares acquired after 31 December 1997 unless an FTE is made.

In light of the above, whenever a trust makes an IEE to be included in the family group in relation to an elected family trust, the interposed trust would be well advised to make a family trust election, as well. This will not result in additional restrictions, but will give rise to significant benefits under the rules discussed above concerning tax losses and franking credits.

GST Treatment of Tax Law Partnerships

The Tax Office’s ruling GSTR 2004/6 explains the application of the GST Act to transactions carried out by tax law partnerships (TLPs). The ruling focuses on the leasing of co-owned properties by TLPs and the GST implications for the individual partners.

A TLP is an association of natural persons in receipt of ordinary or statutory income jointly, but not through the carrying on of business as partners. Where partners are in receipt of ordinary or statutory income jointly through the carrying on of a business, a general law partnership exists. TLPs are not recognised at general law and exist only for tax purposes. However, the GST laws apply to TLPs to the same extent as to general law partnerships.

A TLP is a GST entity and may carry on an enterprise and make supplies or acquisitions and have assets and liabilities.

A TLP is formed from the time that the persons jointly commence an activity from which income is, or will be, received jointly. For example, where two non-registered individuals jointly purchase a property with the intention of leasing it, a TLP is formed when the partners enter the agreement to acquire the property. Where an existing jointly owned property is converted for an income producing purpose, a TLP is established at the time the co-owners agree to undertake the conversion of the property.

For further information please review GSTR 2004/6 — Goods and services tax: tax law partnerships and co-owners of property at:

< http://law.ato.gov.au/atolaw/print.htm?find=%22gstr%202004%2F6%22&docid=GST/GSTR20046/NAT/ATO/00001>

Superannuation Tax Reduction Strategies

The Tax Office has recently issued ‘Guidance on re-contributions to superannuation’. For further information please review ATO Media Release — Nat 04/058 at:

< http://www.ato.gov.au/corporate/content.a sp?doc=/content/mr2004058.htm>

Taxpayer’s Redundancy not Bona Fide

The Administrative Appeals Tribunal (AAT) has found that payments received by a taxpayer upon retirement were assessable in full, as the amounts were not paid in respect of a bona fide redundancy.

To the extent that a bona fide redundancy payment does not exceed the tax-free amount, it is not a component of an Eligible Termination Payment (ETP). Under section 27CB, this amount is tax-free. For the income year ending 30 June 2004, the tax-free amount is $5,882 plus $2,941 for each year of service to which the payment relates. Any excess over the tax-free amount becomes a component of an ETP and is taxed accordingly.

Broadly, a termination payment will be classified as a bona fide redundancy payment where it has resulted in the termination of the position, not the person. In addition, redundancy usually occurs where an employee’s dismissal is not connected with the employee’s performance in carrying out the requirements of the position.

In this case, the taxpayer was an officer in the Tax Office legal division for over 35 years. Due to an imminent internal restructuring of his division and changes in his position description, the taxpayer believed his skills would not be utilised effectively and he chose not to apply for a new position following the restructure.

The taxpayer sought to take advantage of the concessional tax treatment of bona fide redundancy payments and therefore instigated proceedings with his superiors to be offered a severance payment (package).

Under clause 76 of the taxpayer’s employment agreement, an employee would be offered a severance package where the employee’s skills were excess to the requirements of the office or organisation. The Commissioner of Taxation provided the taxpayer with formal notification that clause 76 did not apply to his situation as he was not an ‘excess employee’. However under clause 75, an employee may be offered voluntary redundancy in the event that their services cannot be effectively used. The taxpayer applied this clause to his situation and argued that he was in fact made redundant on the basis that he was an employee whose services could not be effectively used.

The Commissioner of Taxation argued that there was a continuing role for the taxpayer in the restructured division had he not retired. The respondent formally offered the taxpayer retirement under clause 75 and the taxpayer accepted, knowing that he still had a job at the Tax Office.

The AAT held that as the taxpayer had initiated his termination, there was no involuntary dismissal (or constructive dismissal) by his employer, and consequently the requirements of the redundancy provisions were not satisfied. Accordingly, the AAT rejected the taxpayer’s appeal on the grounds that the taxpayer’s termination of employment was due to his intention to retire and not because his position or his skills were redundant due to the restructure.

For further information please review Marriott and Commissioner of Taxation [2004] AATA 806 (30 July 2004) at:

< http://www.a ustlii.edu.au/au/cases/cth/aat/2004/806.html>

Taxpayer Challenge Successful

The Federal Court has held in favour of a taxpayer who successfully challenged the validity of her amended income tax assessments on the basis that they were excessive.

The taxpayer did not lodge income tax returns for the years ending 30 June 1995, 30 June 1996, 30 June 1998 and 30 June 1999. The taxpayer did lodge a return for 30 June 1997, declaring income of $5,920. In 1999, the Tax Office performed a tax audit and issued notices of assessment and amended assessment for the relevant years.

Between 1994 and 1999, the taxpayer was involved in a series of complex property and investment transactions with her de facto partner. The taxpayer transferred money to her de facto partner, who invested the monies on trust into his private investment company, Battleship Holdings. With each amount transferred by the taxpayer, she received written documentation that the principal would be repaid by a specified date and that an annual fixed return of 13% would be paid to her.

For each relevant year, the tax audit calculated the total amounts gained by the taxpayer from her de facto partner in excess of the amounts transferred by the taxpayer and deemed each receipt to be assessable income. The respondent acknowledged that the accuracy of its audit might have been hampered by incomplete source documents.

Upon receiving the assessments, the taxpayer appealed that the amounts were excessive on the basis that the receipts were not solely made up of investment returns. Closer inspection of the assessed income showed that the taxpayer was in receipt of other non-assessable payments. These included domestic allowance payments from her de facto partner and maintenance payments for her son from her ex-husband.

For each year, the Court calculated the taxpayer’s principal investment amount and the resulting income based upon the fixed rate of return. Any amounts in excess of the return were taken to be contributions to domestic and social expenses.

The Court supported the taxpayer’s evidence that the assessments were excessive and subsequently ordered that each assessment be set aside and re-calculated accordingly.

For further information please review Kimche v. Commissioner of Taxation [2004] FCA 1108 (26 August 2004) at:

< http://www.austlii.edu.au/cgi-bin/disp.pl/au/cases/cth/federal%5fct/2004/1108.html?query=kimche>

CGT a Major Focus for ATO in 2004/05

The Tax Office has made it clear to taxpayers that capital gains tax (CGT) will be a major area of focus in its 2004/05 compliance program. All taxpayers, from individuals to small and large businesses, stand to be affected by this increased scrutiny of CGT compliance.

Major areas of increased CGT scrutiny include:

The Tax Office plans to conduct 2,500 highly targeted audits in this area, and will write to a further 3,800 people regarding the possible inclusion of capital gains in future income tax returns.

Data matching for real property transactions is currently in action and the Tax Office plans to expand its operations with several state revenue offices in order to ensure that capital gains are being correctly disclosed by property sellers. In addition, other techniques to be used to ensure the correct amount of capital gain disclosure may involve the use of off-the-plan sales records in high capital growth areas, use of the Australian Stock Exchange Share Registry and data reported by managed funds.

The Tax Office will examine the sale of ‘high value/high growth’ properties where signs of deliberate evasion may be present.

For further information regarding the Tax Office’s 2004/05 compliance program, please review Media Release — Nat 04/061 ‘Tax Office expands compliance work’ at:

< http://www.ato.gov.au/corporate/content.asp?doc=/content/mr2004061.htm>