Talking Tax – Issue 40

Case law

High Court refuses leave to appeal in legal professional privilege case

The High Court has refused the taxpayer special leave to appeal against the decision of the Full Federal Court in FC of T v Donoghue 2015 ATC 20-551.

The special leave disposition noted that an appeal would involve no question of principle, and that there was no reason to doubt the correctness of the Full Court’s decision.

We previously reported on the details of the Full Federal Court decision in Issue 18 of Talking Tax, where the Full Federal Court unanimously upheld default assessments that were based partly on privileged documents obtained from an ATO informant. In that case, the Full Federal Court concluded that as an act of maladministration (a breach of privilege) was not found, there could not be conscious maladministration on the part of the Commissioner.

The Full Federal Court decision and recent refused leave to appeal confirm that the scope of legal professional privilege only applies to documents the Commissioner wishes to obtain, and not documents the Commissioner already has.

ATO updates

ATO Guidance – Are you in business or is your activity just a hobby?

The ATO has released further guidance to help taxpayers determine whether they’re in business or are simply pursuing a hobby. The ATO in this Guidance makes the distinction between a hobby, being a spare-time activity pursued for recreation and a business which is run with the intention of making a profit and has basic reporting requirements, such as declaring income and claiming expenses. This distinction becomes important as there are no additional tax or reporting obligations if activities can be classified as a hobby.

The ATO has produced a list of indicators that can help taxpayers determine whether they are carrying on a business, including registration of business names, profit making intention, repetition of similar activities and whether the activity is carried out in a business-like manner. Whilst the ATO has not given a reason for the updated guidance, it does point artists and other creative goods makers to use its online hobby or business tool.

ATO Guidance – Refund of franking credits information 2015–16

With the end of financial year having just passed, the ATO has provided guidance in relation to franking credits.

Franking credits generally arise for shareholders when certain Australian-resident companies pay income tax on their taxable income and distribute their after-tax profits by way of franked dividends. However, they can also occur as a result of an entitlement to a franked distribution, such as when the organisation is a beneficiary of a trust. The ATO also pointed out that whilst New Zealand franked credits cannot be claimed, New Zealand companies can distribute a dividend with Australian franking credits attached to it and in such a case these can be claimed. In this regard the ATO have sought to clarify an issue which has caused confusion to taxpayers – the treatment of dividends paid by New Zealand companies, with Australian franking credits attached to the dividend.

Franking credits paid to an organisation are refundable provided certain eligibility criteria are met and the organisation is any of the following:

• a charity registered with the ACNC and endorsed by the ATO as exempt from income tax
• an income tax exempt deductible gift recipient (DGR) endorsed in its own right or listed by name in the tax law
• an income tax exempt relief fund declared by the Treasurer to be a developing country relief fund
• an otherwise prescribed income tax exempt entity eligible for a refund.

For tax agents and advisors, it is important to be aware of how the franking credit rules apply especially in the context of income tax or DGR entities. We have experience in assisting not for profits work through franking credit issues – please contact a member of our Public and Private Philanthropy team for more information.

PCG 2016/9 – ATO Practical Compliance Guideline – Complying with MIT rules in 2016/17

Previously we released an update that explained the new tax regime that will apply to those managed investment trusts (MIT) (from 1 July 2016) that qualify as Attribution Managed Investment Trusts (AMIT).

The ATO has issued Practical Compliance Guideline PCG 2016/9 which sets out its administrative approach to the requirement that in order to be an AMIT, the constituent documents of a trust must, by 1 July 2016, clearly define its members’ rights to income and capital. The Practical Compliance Guideline also states that if appropriate changes to the constituent documents are made between 1 July 2016 and 31 October 2016, and other specified conditions are met, the ATO will treat the trust as being compliant in respect of the 2016/17 income year.

Practical compliance guidelines provide taxpayers with broad administration guidance and set out the Commissioner’s administrative approach to various issues, particularly regarding the assessment of tax compliance risk on that matter. It is likely that we will see such guidelines used more frequently to administer general guidance, as opposed to other forms of rulings which the Commissioner will use for more contentious areas of the tax law.

Law Companion Guidelines

The ATO has released a series of Law Companion Guidelines relating to the new foreign resident capital gains withholding regime. We have previously covered the foreign resident withholding regime in a number of articles. Since it has only been 6 days since the introduction of these new rules and given its wide reaching effect, we expect that a range of scenarios will arise where it will not be clear as to how these new laws will apply. Therefore the law companion guidelines will be a way for the Commissioner to address these issues as and when they arise, in the form of a public ruling.

These new law companion guidelines include:

LCG 2016/5 – Foreign resident capital gains withholding regime: the Commissioner’s variation power

Guideline (LCG 2016/5) describes how the Commissioner will apply section 14-235 of Schedule 1 of the Taxation Administration Act 1953 (TAA). This Guideline indicates that the regime will apply to:

• acquisitions of assets that are ‘taxable Australian real property’ (TARP), an ‘indirect Australian real property interest’, or an option or right to acquire such property or interest
• transactions entered into on or after 1 July 2016, where the vendor of the asset is a relevant foreign resident.

In such circumstances, the amount payable to the Commissioner is generally 10% of the asset’s purchase price, unless the Commissioner exercises the discretion under section 14-235 to vary the amount. Variations can be requested by a purchaser of the CGT asset, the vendor of a CGT asset or an entity that is owed a debt by the vendor and should be applied for as soon as is reasonably practicable in the sale process. Circumstances the ATO considers would support a request to vary withholding amounts include:

• where the vendor will not make a capital gain on the disposal of the CGT asset or a net capital gain for the income year
• same-asset roll-overs
• marriage or relationship breakdown roll-overs
• roll-overs for business restructure
• where the vendor will not have an income tax liability for the income year.

When exercising the variation power, the Commissioner must also consider the creditor’s right to recover a debt, which ensures the withholding provisions do not give the Commissioner a preferential position over other creditors.

LCG 2016/6 – Foreign resident capital gains withholding regime: amount payable to the Commissioner

Guideline (LCG 2016/6) explains how to work out the amount to be paid to the Commissioner under the foreign resident capital gains withholding regime in Subdivision 14-D of Schedule 1 to the TAA. It extends to how the purchaser can determine the amount to withhold in circumstances where the value of the asset differs from the contract price, or the contract price relates to more than one asset.

The amount payable to the Commissioner is equal to 10% of the first element of the CGT asset’s cost base to the purchaser. The first element of the cost base is the total consideration given to acquire the CGT asset, which is usually the money paid, plus the market value (worked out at the time of the acquisition) of any property given to acquire the asset. In arm’s length transactions this is generally the purchase price of the asset. However, the cost base can differ from the purchase price in the following circumstances:

• where the vendor and purchaser are not dealing at arm’s length (a market value substitution will apply)
• where the contract deals with the disposal of a number of CGT assets for a lump sum, and only some of the assets are subject to the withholding obligation, the purchaser needs to work out the correct amount to withhold (the parties can dissect the purchase price by using the proportionate market value of each asset).

LCG 2016/7 – Foreign resident capital gains withholding regime: options

Following on from LCG 2016/6, the ATO has released Guideline (LCG 2016/7) which discusses when a purchaser that becomes the owner of:

• an option to acquire TARP or an ‘indirect Australian real property interest’
• TARP or an indirect Australian real property interest as a result of exercising an option, is required to pay an amount to the Commissioner under section 14-200 of the TAA.

When a foreign resident grants an option over TARP or an indirect Australian real property interest, this may trigger a withholding obligation for the grantee (purchaser) as an option to acquire property is a CGT asset. If the withholding obligation arises, the purchaser must withhold from the vendor, and pay to the Commissioner, an amount equal to 10% of the option’s cost base which is generally 10% of the option fee.

However on exercise of the option, any withholding obligations will take into account the amount withheld previously on grant of the option by reducing the amount on which the 10% withholding is applied by any payments the purchaser made and the market value of any property that the purchaser gave for the option. This payment should be made on or before the day the purchaser becomes the owner of the option. The purchaser does not have to withhold an amount if the vendor is not a foreign resident at the time the option is granted.

It is worth noting that the withholding obligation does not apply to acquisitions of TARP, or indirect Australian real property interests giving rise to company title interests, where the asset has a market value of less than $2 million. However the $2 million threshold does not apply to options.

Finally subparagraph 14-200(3)(a)(ii) of the TAA ensures that when an asset is acquired as a result of exercising an option, the withholding obligation does not apply to the option fee twice.

Legislation and government policy

Legislative Instrument – PAYG withholding variation for foreign resident capital gains withholding payments – acquisitions from multiple entities

The Commissioner has issued a legislative instrument to ensure that the correct amount of foreign resident CGT withholding tax is withheld on a sale of Australian property by multiple sellers and one of them is an Australian resident and at least one is a foreign resident. The PAYG amount must be based on the proportion of the acquisition cost and the market value of the financial benefit attributable to foreign resident entities.

The instrument commences on 1 July 2016.

We expect that more guidelines, publications and legislative instruments like this will be released in the next few months, as the application of the new foreign resident withholding rules is worked through and applied to specific taxpayer circumstances by agents and advisors.

Government policy – Coalition to spend $50 million to modernise myGov

The Coalition has announced that it will invest $50 million if it is re-elected in order to modernise the myGov portal. This modernisation is part of the general movement of government services to a digital environment, streamlining the way that taxpayers interact with government. The myGov portal allows individuals to engage with government services including Medicare, the Department of Veterans’ Affairs, Centrelink and the ATO (including myTax). This announcement follows previous news from the ATO that they had retired eTax and had replaced it with an “upgraded and improved” myTax effective 1 July 2016.