Thinking | 18 July 2018

Talking Tax – Issue 125

Case law

What constitutes an ‘active asset’ for the purposes of the small business CGT concessions: Rus and FCT [2018] AATA 1854

In Rus and FCT [2018] AATA 1854, the Taxpayer was disallowed from challenging a private binding ruling made by the Commissioner which found that her land, of which 90% was vacant, was not an ‘active asset’ for the purposes of the small business capital gains tax (CGT) concessions under the Income Tax Assessment Act 1997 (ITAA 97).

As SME advisors will know, the small business CGT concessions are complex. Also, they are an area where the ATO is constantly undertaking compliance reviews of positions taken by taxpayers. Where the CGT asset involved is land and if the concession is sought to be applied on the basis that the entity disposing of the land is a ‘small business entity’, greater care is warranted.

Taxpayers should be mindful that the Commissioner will carefully consider the nature and extent to which land is used in carrying on a business in determining whether the land is considered an ‘active asset’. It is likely that the Commissioner will refuse to allow the small business CGT concessions in relation to the land if the business activities on the land are minimal or insignificant, or if the majority of the land is vacant.

Section 152-10 of the ITAA 97 provides, among other things, that a capital gain may be reduced or disregarded if the CGT asset to which the capital gain relates is an ‘active asset’ of a small business entity. Under Division 152, an asset is an ‘active asset’ if it has been actively used, or held ready for use, in the course of carrying on the small business, for a specified period of time as defined in the Division. The specified period of time for the purposes of section 152-10 is as follows:

  • if the asset has been owned for 15 years or less, at least half of the period of ownership or
  • if the asset has been owned for more than 15 years, at least 7.5 years.

Furthermore, under Division 152, the capital gain may be completely disregarded where the active asset has been continuously owned by the small business for 15 years and the Taxpayer is aged 55 years or over and is retiring or permanently incapacitated.

In this instance, the Taxpayer owned a small construction company which he operated from the land, however, the shed and office which were used for the business only occupied approximately 10% of the 16 hectare property. The remainder of the business activities of the company were conducted offsite. The Taxpayer contended that, despite this, the particular activities that were carried out on the land were sufficiently important to the functions of the business operations for the land to be considered an active asset of the company.

The Tribunal rejected the arguments of the Taxpayer. The main factors contributing to the decision of the Tribunal were as follows:

  • Only 10% of the land was used
  • The vast majority of the remaining land was vacant and did not produce any income assessable to the Taxpayer (such as through agistment) and
  • Of the 10% of the land that was used, only part comprised buildings used for the business as the land also contained several private dwellings of the Taxpayer and of the Taxpayer’s adult children.

Consequently, the Tribunal found that the land was not an active asset of the small business and duly refused to allow the Taxpayer to apply the CGT concession in section 152-10.

ATO updates

TD 2018/12 Income tax: schemes that limit a taxable presence in Australia under section 177DA of the Income Tax Assessment Act 1936 - meaning of 'directly in connection with'

In TD 2018/12 (Tax Determination), released on 4 July 2018, the ATO has clarified the Commissioner’s view on the meaning of the expression ‘directly in connection with’ in subparagraph 177DA(1)(a)(ii) of the Income Tax Assessment Act 1936 (ITAA 36).

Section 177DA comes within the anti-avoidance provisions of Part IVA of the ITAA 36 and is targeted at schemes that are entered into or carried out to limit a ‘taxable presence in Australia’, where the scheme has the purpose or effect of enabling foreign multinational entity’s to avoid the attribution of business profits in Australia.

A foreign entity may have entered into or carried out a scheme to limit its taxable presence in Australia under section 177DA where:

  • the foreign entity makes a supply to an Australian customer
  • activities are undertaken in Australia ‘directly in connection with’ the supply
  • some or all of those activities are undertaken by an Australian entity who is an associate of, or who is commercially dependent on, the foreign entity and
  • the foreign entity derives ordinary or statutory income from the supply, of which some or all is not attributable to an Australian permanent establishment of the foreign entity.

The Tax Determination states that the phrase ‘directly in connection with’ is intended to be broadly construed on its ordinary meaning. While the question of whether the requisite connection exists will depend on the facts and circumstances of each particular case, in essence, the meaning of this phrase in relation to section 177DA is as follows:

  • the activities undertaken in Australia must have a connection or factual relationship with the supply made by a foreign entity to an Australian customer and
  • this connection or relationship must be ‘direct’, in the sense that the connection is sufficiently close and not indirect or merely incidental.

The Tax Determination provides the following examples of situations in which activities will be directly connected to a supply, such as where the activities:

  • contribute to the entering in of the contract for the supply
  • attract new customers or maintain existing customer relationships
  • relate to the ability to supply the goods or service in the manner in which it is supplied
  • support the ongoing execution of a supply under an existing supply arrangement or
  • actively procure demand for sales.

Ultimately, it is necessary to examine the circumstances surrounding the supply in the context of the entire supply chain.

The Tax Determination will apply retrospectively, but will not apply to taxpayers to the extent to which it conflicts with the terms of a settlement of a dispute with the ATO agreed to before the date of publication on 4 July 2018. For more information about how section 177DA applies to you or your clients, please contact us.

TR 2018/D1 Income tax: the 'in Australia' requirement for certain deductible gift recipients and income tax exempt entities

The ATO has released draft Taxation Ruling TR 2018/D1 (Draft Ruling) clarifying the Commissioner’s view on the provisions of the Income Tax Assessment Act 1997 (ITAA 1997) that require certain charities which are endorsed for income tax exemption, or which are deductible gift recipients (DGRs), to have a connection to Australia in order for their income to be exempt or for tax deductible donations to be made.

In 2008, the High Court in Commissioner of Taxation of the Commonwealth of Australia v Word Investments Limited [2008] HCA 55 determined that a charity may be pursuing their objects principally ‘in Australia’, even where they merely pass funds within Australia to another charitable organisation that conducts its activities overseas.

Following this, the Federal Government announced in its 2009-10 Budget that it would tighten up the ‘in Australia’ requirements of Division 50 of the ITAA 1997, to limit the effect of the High Court’s decision, in terms of charities carrying out overseas activities.

Following several rounds of public consultation and exposure draft legislation, the Government released the Tax Laws Amendment (Special Conditions for Non-for-profit Concessions) Bill 2012 (Bill). The Bill sought to restate the ‘in Australia’ rules for income tax exempt charities and codify the ‘in Australia’ rules for DGRs.

The Bill was ultimately set aside by the Assistant Treasurer due to significant public opposition to the measures, which were seen by many as giving rise to an unreasonable restriction on DGRs conducting legitimate activities outside Australia, such as visits to foreign medical institutions or participating in international cultural or sporting events.

Instead, the ‘in Australia’ requirement would be dealt with through an administrative response, from both the ACNC and the ATO.

The ACNC has responded with its governance and compliance guidelines for charities conducting activities and operations overseas (see:  https://www.acnc.gov.au/ACNC/FTS/Charities_operating_overseas.aspx)

The Draft Ruling represents the ATO’s response and has been drafted with the intent of addressing the Government’s concerns surrounding the ‘in Australia’ requirements.

The Draft Ruling deals with the following provisions of the ITAA 1997:

  • the condition that certain DGRs be 'in Australia' before a gift or contribution to them is tax deductible (DGR Australia Condition) in paragraph (a) of column 4 in item 1 of the table in section 30-15
  • the condition that certain entities have a 'physical presence in Australia' and to that extent, incur its expenditure in Australia and pursue its objectives in Australia before their income is exempt from tax (ITEC Australia Condition) in paragraphs 50-50(1)(a), 50-55(1)(a) and 50-70(1)(a) and
  • the condition that a registered charity or DGR have a 'physical presence in Australia' before they qualify for a refund of franking credits (Franking Credit Condition) in section 207-117.

DGR Australia Condition

  • A DGR will satisfy this condition if it is established or legally recognised in Australia and operates in Australia.

ITEC Australia Condition

  • An entity will have a ‘physical presence’ where it conducts its physical operations, whether as a separate legal entity or through a branch/division.
  • All of the operations and objectives of the entity must be identified and then compared to the extent to which the entity operates in Australia (ie wholly or partly through a branch/division).
  • An entity will be found to pursue its objectives and incur its expenditure in Australia if it is the type of entity that incurs expenditure in that way. This involves considering past, present and future activities of the entity.

Franking Credit Condition

  • ‘Physical presence’ takes the same meaning as discussed in relation to the ITEC Australia Condition.

Submissions for the Draft Ruling are open until 10 August 2018.

Australia joins international alliance to fight global tax crime

The ATO has announced that the leaders of tax enforcement authorities from Australia, Canada, the Netherlands, the United Kingdom and the United States have established a joint operational alliance, the Joint Chiefs of Global Tax Enforcement (J5), to increase collaboration in the fight against international and transnational tax crime and money laundering.  The focus areas of the J5 will be cybercrime and virtual currencies, enablers of offshore tax crime, and data platforms.

This is yet another example of the ATO’s commitment over the past few years to combat global tax avoidance.

Updates on J5 initiatives are expected in late 2018. More information on the J5 is available on the IRS website.

Transacting with cryptocurrency: updated information on the ATO website

On 29 June 2018, the ATO updated the information on its website dealing with the taxation of transactions involving cryptocurrency. By way of context, the ATO has previously determined that cryptocurrency is a CGT asset for the purposes of the Capital Gains Tax (CGT) regime.

The ATO website now provides guidance about each of the following topics on a separate webpage:

  • transacting with cryptocurrency
  • cryptocurrency in business
  • record keeping and
  • additional information.

While the additional guidance from the ATO is likely to be welcomed by taxpayers and the cryptocurrency community, a number of concerns remain.

Specifically, the ATO appears to have taken a binary view of the taxation of cryptocurrency which largely ignores taxpayers who have acquired cryptocurrency as part of a profit making undertaking or plan. That is, the ATO provides limited commentary on the circumstances in which cryptocurrency will be held in the course of carrying on a business (and therefore as trading stock), or as part of a profit making undertaking or plan (and therefore as a revenue asset, although possibly not trading stock).

Given that few mainstream cryptocurrencies offer a periodic return, as well as the recent meteoric rise and fall in prices, a question arises as to the circumstances in which it can be said that a taxpayer who has acquired cryptocurrency in recent times has not done so solely for speculative gain.

The ATO also appears to be taking a more narrow interpretation of the personal use asset exemption.

Transacting with cryptocurrency

The ATO states that taxpayers who acquire cryptocurrency as an ‘investment’ may make a capital gain on disposal. The ATO does not elaborate on the meaning of ‘investment’, or whether a cryptocurrency which does not offer a periodic return can be held as an ‘investment’.

In any event, the ATO website states that a CGT event will occur when a person disposes of their cryptocurrency, which would include the following situations:

  • selling or gifting cryptocurrency
  • trading or exchanging cryptocurrency for another item or for another cryptocurrency (for instance, trading Bitcoin for Ethereum)
  • converting cryptocurrency into a fiat currency (such as Australian dollars) or
  • using cryptocurrency to purchase goods or services.

A separate CGT event will occur on each occasion that a taxpayer deals with cryptocurrency in one of the above ways, or in any other way that would amount to a disposal of cryptocurrency for CGT purposes.

If the cryptocurrency is traded for another cryptocurrency or for another item that cannot be valued, the capital proceeds of the disposal are worked out using the market value of the cryptocurrency being disposed of at the time of the transaction.

The ATO website also elaborates on the tax treatment of the following situations which may arise in relation to cryptocurrency, where it is held as an ‘investment’:

  • where new cryptocurrency received as a result of a chain split (also known as a ‘fork’ - such as Bitcoin Cash being received by Bitcoin holders), taxpayers do not derive ordinary income or make a capital gain at that time; rather, a capital gain will arise when it is disposed of (see above). In this case, the new cryptocurrency will have a nil cost base; or
  • the taxpayer loses their cryptocurrency private key or loses their cryptocurrency due to theft, the taxpayer may be able to claim a capital loss if they have sufficient evidence to establish their ownership.

The ATO website also clarifies that, as a CGT asset, cryptocurrency will be subject to the other rules affecting CGT assets. For instance, taxpayers may be entitled to the CGT discount for assets held as an ‘investment’ for 12 months or more.

In respect of the personal use asset exemption, the ATO has taken the view that both ‘the period of holding and the nature of the subsequent transaction will be relevant to whether your cryptocurrency is a personal use asset’. The ATO has also stated that ‘the longer the period of time that a cryptocurrency is held, the less likely it is that it will be a personal use asset’.

This appears to reflect a more narrow interpretation from the ATO, and perhaps a departure from the views expressed by the Commissioner of Taxation in a number of private binding rulings on the topic.

Cryptocurrency in business

The ATO website commentary relating to cryptocurrency used in business is largely unchanged.

However, the ATO provides limited commentary on the circumstances in which cryptocurrency will be held in the course of carrying on a business (and therefore as trading stock), or as part of a profit making undertaking or plan (and therefore as a revenue asset, although possibly not trading stock).

In fact, the ATO website appears to suggest that taxpayers who have acquired cryptocurrency with an intention to make a profit (or with a genuine belief that they will do so), will hold their cryptocurrency as trading stock.

Record keeping

Prudently, the ATO recommends that taxpayers keep records of all transactions involving cryptocurrency, whether they are using cryptocurrency as an investment, for personal use or in business.

Additional information

This page provides links to previously released Tax Determinations which relate to cryptocurrency and bitcoin.

Legislation and government policy

Productivity Commission delivers report on the effect of Horizontal Fiscal Equalisation on the economy

The Productivity Commission (Commission) has released its report into the effect of Horizontal Fiscal Equalisation (HFE) on productivity, efficiency and economic growth, which will inform changes to the way in which the revenue collected from the GST is shared between the states and territories.

In response to Commission’s report, the Treasurer, the Hon Scott Morrison MP, said that the Federal Government will introduce changes to reinforce and protect the ‘fair go’ system used to distribute GST, which provides protection to smaller states and removes the volatility in how GST revenue is distributed by removing the impact of significant economic events such as the mining boom.

12-month pilot to extent the ATO Independent Review service

From 1 July 2018, the ATO is running a 12-month pilot in Victoria and South Australia to assess the viability of extending the existing pre-assessment technical merits case review (Independent Review) to small business taxpayers with income of less than $10 million who have audits undertaken by the ATO.

Since 2013, Independent Review has been offered to taxpayers in Public Groups and International (PGI) (i.e. those with income of more than $250 million). Independent Review allows eligible taxpayers to have the results of an initial ATO audit referred to an independent technical officer from outside the audit area, together with the position of the taxpayer, prior to issuing notice of assessment or amended assessment.

The Independent Review pilot for small business will initially target small business audit cases involving issues identified as high priority and will be based on the same design and principles as the existing Independent Review for PGI, and will follow the following process:

  • eligible taxpayers will be invited to participate in the pilot by their audit case officer
  • taxpayers invited to participate must email the ATO within 30 days of the date of the audit finalisation letter with a clear outline of the specific issues in the audit decision they dispute
  • a Review and Dispute Resolution officer will contact the taxpayer to discuss the request for Independent Review and
  • if approved, the request for Independent Review will be referred to an independent reviewer.

Disputes relating to GST, superannuation, fringe benefits tax, fraud and evasion findings, and penalties and interest are excluded from the scope of the pilot. It would be surprising if the pilot for small business does not also exclude disputes relating to areas that have or will be considered by the General Anti-Avoidance Rules Panel in relation to Part IVA of the Income Tax Assessment Act 1936, which is currently excluded by the existing Independent Review regime available in PGI.

The pilot does not affect the rights of taxpayers who do not wish to seek an Independent Review, who are excluded from the pilot or who are ineligible from lodging an objection to any amended assessments or notices issued following the finalisation of an audit.

In our experience, Independent Review has been a useful mechanism to resolve issues with the ATO, and we would generally recommend that taxpayers accept an offer to participate in the pilot.

Contact

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