Are you taking ‘reasonable steps’ to ensure your company is compliant?
In Deputy Commissioner of Taxation v Thomas Wilson  NSWDC 302, the New South Wales District Court rejected a director’s (Director) defences to a Director Penalty Notice (DPN) for $111,798, comprising the Pay-As-You-Go withholding (PAYGW) debts of the corporate taxpayer.
The DPN was upheld by the Court on the grounds that the Director had failed to take all reasonable steps to ensure the company complied with its PAYGW obligations, or had sought to have an administrator appointed or have the company wound up.
The Court stated that the Director of the corporate taxpayer had a duty to ensure that an appropriate system was in place to manage its tax liabilities. The Court considered that it was not reasonable for the Director to delegate such responsibilities or to simply not inform themselves of these matters.
Further, the Court noted that the Director’s attempt to appoint a liquidator was insufficient to demonstrate that he had taken all reasonable steps, as there should have been appropriate steps taken prior to such action including calling an additional board meeting and applying for leave to wind up the company.
This case shows the difficulty for directors in demonstrating that they have taken all reasonable steps to ensure that the company complies with its taxation obligations, and the need to stay informed of all the company’s dealings regardless of the degree of the director’s actual involvement with the day-to-day operations of the company.
Comprehensive review of the ATO’s fraud control management
The outgoing Inspector-General of Taxation, Mr Ali Noroozi, has released his report into the ATO’s fraud control management. This review arose due to concerns surrounding the ATO’s Operation Elbrus, including allegations of tax fraud that may be associated to abuse of position by a public official.
The report announced that the ATO has sound systems for managing internal fraud risks. However, the review uncovered a number of areas requiring improvement.
One of the areas identified for improvement concerns the ATO’s identification and management of conflicts of interest. The report suggested that, in determining whether conflicts of interest have occurred, the ATO should consider the nature of the interest, such as the closeness of the personal relationship giving rise to a potential conflict, the seniority of the officers’ roles and the nature of the official duties, such as relevant transactions or other responsibilities.
Another issue identified relates to senior ATO officer intervention in individual cases. The report particularly considered the ATO’s controls with respect to medium to high risk roles. The report makes recommendations to improve the transparency of such interventions by clearly specifying when they may occur, requiring appropriate documentation of all resulting actions in an accessible form and periodically reviewing compliance with such policies.
The review also examined aspects of the ATO’s management of the risks posed by external parties who seek to exploit the tax system and commit fraud against the Commonwealth, in particular those attracting criminal sanctions.
Another area of particular focus in this review was the ATO’s response to alleged fraud in the precious metals industry, where $2.5 billion was estimated to be at risk due to weaknesses in the GST regime. The report found that there were lessons to be learnt from this experience such as identifying risks early and taking prompt action to prevent the propagation of fraud.
The report provides a total of 13 recommendations to bolster the ATO’s management of fraud and corruption risks. The ATO has agreed to implement all of the recommendations.
ATO compliance on restructures out of existing hybrid arrangements
On 25 October 2018, the ATO issued Practical Compliance Guideline PCG 2018/7 – Part IVA of the Income Tax Assessment Act 1936 and restructures of hybrid mismatch arrangements (PCG 2018/7). PCG 2018/7 sets out the ATO’s compliance approach to restructures out of existing hybrid arrangements to avoid the potential application of hybrid mismatch rules, and certain restructures that have the effect of preserving Australian tax benefits that would otherwise be disallowed.
PCG 2018/7 sets out factors that the Commissioner would expect to be present in order for him to consider a restructure to be ‘low risk’. It also provides six restructuring scenarios to which the Commissioner would not seek to apply the hybrid mismatch rules. Broadly, each scenario illustrates a straightforward restructure which removes the hybrid element of the existing arrangements whilst the surrounding facts and circumstances remain unchanged.
Legislation and government policy
Proposed Division 7A changes
On October 2 2018, the Government released a Consultation Paper regarding proposed amendments to Division 7A of the Income Tax Assessment Act 1936. Division 7A contains integrity rules designed to prevent shareholders from inappropriately obtaining the benefit of private company profits without paying tax at their applicable marginal tax rates.
The amendments draw on some of the recommendations from the Board of Taxation in its 2014 report ‘Post Implementation Review of Division 7A of Part III of the Income Tax Assessment Act 1936’. The proposed legislative amendments include various measures applying from 1 July 2019 with key changes summarised below:
- Simplified single loan model for complying Division 7A loans including a maximum 10-year loan term with minimum yearly repayments comprising an annual principal and interest component.
- The interest component will be charged at the new (higher) annual benchmark interest rate prescribed by the Reserve Bank of Australia reflecting the small business variable overdraft rate.
- Existing 7 and 25-year Division 7A loans will be transitioned into the new regime, rather than being grandfathered, and will both be subject to the new benchmark interest rate from 1 July 2019.
- Existing 7-year unsecured loans will keep their current outstanding term upon transition.
- Existing 25-year secured loans will need to have in place a complying 10-year loan agreement prior to the private company’s lodgment day for the 2021-22 income year.
- An unpaid present entitlement (UPE) will be treated consistently with other payments made by private companies to taxpayers, by requiring the UPE to be repaid over time as a complying loan, with existing arrangements to be on complying terms by 30 June 2020.
- The concept of a ‘distributable surplus’ will be scrapped. The consequence of this will be that a private company’s deemed dividends assessed in an income year will reflect the entire value of the benefit extracted, rather than being capped at an amount equal to the distributable surplus.
- The ATO’s review and amendment period for Division 7A arrangements will be extended to 14 years. As the burden of proof lies with a taxpayer to disprove the Commissioner’s assessments, we anticipate that the proposed review period of this length could cause significant issues for taxpayers.
- A self-correction mechanism to assist taxpayers to promptly rectify breaches of Division 7A rather than having to apply for the discretion of the Commissioner under the current rules.
- The introduction of a safe harbour mechanism for the provision of certain assets by a private company to reduce the compliance burden when applying the arm’s length methodology.
- Other minor technical amendments to improve the integrity of the Division 7A regime.
The outcomes of this consultation will inform the development of legislation required to implement these measures. Submissions in response to the Consultation Paper are due by 21 November 2018.
Stronger penalties for corporate and financial sector misconduct
On 24 October 2018, the Federal Government introduced the Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Bill 2018 that proposes to strengthen criminal and civil penalties for corporate and financial sector misconduct.
The Bill proposes to double the term of imprisonment from 5 years to 10 years for certain criminal offences. Civil penalties will also be increased 10-fold for corporations and 5-fold for individuals. Currently, if a court finds a corporation guilty of making false or misleading statements in relation to charging fees for no service, a criminal penalty of up to $210,000 could be imposed. Under the proposed amendments, the court will be able to impose a penalty of up to $1.26 million for each offence.
The Bill will also expand the range of actions subject to civil penalties, and give the courts the power to seek additional remedies to strip wrongdoers of profits illegally obtained or losses avoided. Currently, if a court finds that a corporation breached its duty to provide financial services efficiently, honesty and fairly by continuing to deduct insurance premiums from members’ accounts after they have died, there is no penalty apart from taking Australian financial services licensing action. Under the proposed changes, depending on the size of the corporation, it could face a maximum penalty of up to $210 million.
Lower taxes for small and medium businesses
On 16 October 2018, the Treasury Laws Amendment (Lower Taxes for Small and Medium Businesses) Bill 2018 received royal assent. This Bill implements the proposal to accelerate the reduction of the corporate tax rate for base rate entities. A base rate entity is a corporate tax entity with an aggregated turnover of less than $50 million and no more than 80% of its income derived is of a passive nature.
Under this Bill, the corporate tax rate for base rate entities will reduce from 27.5% to 26% in the 2020-21 year before being cut to 25% for the 2021-22 income year and subsequent income years (rather than the current 2026-27 year as currently legislated).
Additionally, the Bill proposes to increase the small business income tax offset rate to 13% of an eligible individual’s basic income tax liability relating to their total net small business income for the 2020-21 income year. This rate will then increase to 16% for the 2021-22 income year and subsequent income years.