Talking Tax – Issue 121

Insights5 June 2018

In Hart v FCT [2018] FCAFC 61, the Full Federal Court unanimously dismissed an appeal against a Part IVA determination that had the effect of including part of the earnings of a law firm in the Taxpayer’s assessable income.

Case law

A slight diversion!

In Hart v FCT [2018] FCAFC 61, the Full Federal Court unanimously dismissed an appeal against a Part IVA determination that had the effect of including part of the earnings of a law firm in the Taxpayer’s assessable income. The Taxpayer entered into two arrangements with others called the ‘New Venture Income Scheme’ (NVI Scheme). The effect of the scheme was to divert two classes of earnings away from the Taxpayer, or entities he controlled, and into the hands of a company with carried forward tax losses. Then, following a series of gifts and subscriptions for capital, the earnings were paid to the Taxpayer in the form of loans. The Commissioner assessed the earnings as taxable income in the Taxpayer’s hands.

The Court concluded that at first instance, Justice Bromwich was correct to conclude the amount beneficially derived by the Taxpayer was a distribution to the Taxpayer and assessable as such. The Taxpayer failed to show that what was paid to him was not income according to ordinary concepts.

In respect to the Part IVA assessments, the Taxpayer argued that the Commissioner’s counterfactual was not reasonable, being that there was no possibility that he would have ever received past income, and it would always have gone elsewhere. The Full Court found that the Taxpayer not only failed to establish that the Commissioner’s counterfactual was unreasonable, but he also had failed to adduce evidence of his own counterfactual. A 50% penalty imposed upon the Taxpayer was also upheld.

A discussion of the trial decision of the Federal Court is provided in our earlier publication Talking Tax – Issue 81.

ATO updates

Assessing the risk: allocation of profits within professional firms

The ATO has recently conducted a review into its Guidelines on the risks surrounding the allocation of profits within professional firms and the use of Everett Assignments (Guidelines) following the initial suspension of the Guidelines in December 2017.

When the ATO first suspended the Guidelines, they noted that they were aware the Guidelines were being misinterpreted in relation to arrangements that went beyond their scope. The only specific examples given by the ATO at the time were the use of related-party financing and self-managed super funds.

The ATO has now set out a list of specific concerns following its review of the Guidelines, which are listed below:

Lack of any meaningful commercial purpose regarding arrangements including, but not limited to:
- disposal of an equity interest through multiple assignments;
- the creation of new discretionary entitlements such as Dividend Access Shares; and
- utilising amortisation leading to differences between tax and accounting income.
Disregard for CGT consequences and inappropriate use of CGT concessions.
Assignments where profit sharing is not directly proportionate to the equity interest held.
The creation of artificial debt deductions.
Undertaking an assignment to dispose of an equity interest to a self-managed super fund.
Assignments where the arrangement is not on all fours with the principles of the Everett and Galland cases.

Since the suspension of the Guidelines, the ATO has been consulting with industry with a view to publishing draft guidance prior to 30 June 2018. Submissions can be made by email here.

The ATO website currently states:

Those who have entered into arrangements before 14 December 2017 which comply with the Guidelines and do not exhibit high risk factors can rely on those Guidelines.

Arrangements entered into prior to 14 December 2017 exhibiting any of the high risk factors may be subject to review.

You have been warned! – ‘what attracts our attention’ has been updated

The Commissioner has updated the “What attracts our attention” webpage, which lists behaviours and characteristics that attract the ATO’s attention in privately owned or wealthy groups.

Some of these behaviours and characteristics include:

Tax or economic performance is not comparable to similar businesses.
Low transparency of your tax affairs.
Large, one-off or unusual transactions, including the transfer or shifting of wealth.
Aggressive tax planning.
Tax outcomes inconsistent with the intent of the tax law.
Choosing not to comply or regularly taking controversial interpretations of the law, without engaging with us.
Lifestyle not supported by after-tax income.
Accessing business assets for tax-free private use.
Poor governance and risk-management systems.

Legislation and government policy

Exposure Draft – Treasury Laws Amendment (Stapled Structures and Other Measures) Bill 2018

Treasury has released Exposure Draft of Treasury Laws Amendment (Stapled Structures and Other Measures) Bill 2018 (Exposure Draft) which proposes to amend the ITAA 1936, ITAA 1997 and TAA 1953 to improve the integrity of the income tax law by:

increasing the managed investment trust (MIT) withholding rate on income attributable to trading business
modifying the thin capitalisation rules to prevent double gearing structures
limiting the withholding tax exemption for superannuation funds for foreign residents to limit access to tax concessions for foreign investors and
codifying and limiting the scope of the sovereign immunity tax exemption.

Stapled Structure

Under the Exposure Draft, fund payments made by a MIT to a foreign investor are subject to MIT withholding tax at the top corporate tax rate to the extent that they are attributable to non-concessional MIT income. The MIT withholding tax provisions are modified so that, to the extent that a fund payment reflects amounts of income derived by a MIT that is non-concessional MIT income, the amounts are subject to withholding tax at the top corporate tax rate (currently 30%), rather than 15%.

Thin capitalisation

For income years commencing on or after 1 July 2018, the Exposure Draft proposes to amend the thin capitalisation associate entity test. For the purposes of determining associate entity debt, associate entity equity and the associate entity excess amount under the thin capitalisation provisions, a trust (other than a public trading trust) or partnership will be an associate entity of another entity if that other entity holds an associate interest of 10 per cent or more in that trust or partnership. In addition, in determining the arm’s length debt amount, an entity must consider the debt to equity ratios in entities that are relevant to the considerations of an independent lender or borrower.

Under the current law, for the purposes of determining associate entity debt, associate entity equity and the associate entity excess amount under the thin capitalisation provisions, a trust or partnership is an associate entity of another entity if that other entity holds an associate interest of 50 per cent or more in that trust or partnership.

Superannuation funds for foreign residents withholding tax exemption

Under the Exposure Draft, a superannuation fund for foreign residents will be liable to pay withholding tax on payments of interest, dividends or non-share dividends from an entity if the foreign superannuation fund has a portfolio-like interest in the entity making the payment.

Under the current law, a superannuation fund for foreign residents is not liable to pay withholding tax on payments of interest, dividends or non-share dividends from an entity.

Sovereign Immunity

The Exposure Draft proposes that a sovereign entity will not be liable to tax on amounts paid by another entity if the sovereign entity has, broadly, a portfolio-like interest in the entity making the payment and the payment is not derived from a commercial activity.

Treasury Laws Amendment (Personal Income Tax Plan) Bill 2018

On 9 May 2018 the Treasury Laws Amendment (Personal Income Tax Plan) Bill 2018 was introduced to the House of Representatives. This Bill seeks to amend the ITAA 1936, ITAA 1997 and TAA 1953 to:

Introduce a low and middle income tax offset for the income years ending 30 June 2019 to 30 June 2022.
Merge the existing low income tax offset and the new low and middle income offset into a new low income tax offset from the year ending 30 June 2023 onward.

This Bill also seeks to amend the Income Tax Rates Act 1986 (Cth) to progressively increase the income tax rate thresholds in the 2018-19, 2022-23 and 2024-25 income years, and Income Tax Assessment (1936 Act) Regulation 2015 (Cth) and five other Acts to make consequential amendments. These changes were announced in the Federal Government’s 2018-19 Budget.

For a detailed explanation of these changes and other 2018-19 Budget measures, please see our earlier publication 2018 Australian Federal Budget insight.