Talking Tax – Issue 128

Case law

Taxpayer denied deductions for share losses and legal fees

In the decision of the Federal Court in Greig v Federal Commissioner of Taxation [2018] FCA 1084, Justice Thawley held that the Taxpayer was not entitled to deductions under section 8-1 of the Income Tax Assessment Act 1997 (Cth) (ITAA 97) for losses incurred in relation to the compulsory transfer of shares in Nexus Energy Limited (Nexus) in the amount of $11.85 million and expenditure of $507,198 in legal fees arising from litigation involving the voluntary administration of Nexus.

The Taxpayer claimed that the share losses and legal fees were deductible under section 8-1 of the ITAA 97 on the basis that they were losses on revenue account incurred in a business or commercial transaction entered into for the purpose of making a profit, consistent with the principles in Myer Emporium.¹

The Commissioner contended that the losses did not fall within section 8-1(1)(a) on the basis that the transactions were not incurred in a business operation or commercial transaction contemplated by Myer Emporium and that the necessary profit-making purpose was absent. The Taxpayer could not be said to be have been carrying on a business and, in any event, even if the losses fell within either section 8-1(1)(a) or (b), those losses would have been on capital account and dealt with under the capital gains tax regime.

The Federal Court dismissed the Taxpayer’s claims and found in favour of the Commissioner. The Court considered that while the Taxpayer intended to make a profit from the shares, he intended to do so as an ordinary investor would - therefore, the fact of seeking to make a profit alone did not justify a finding that the shares were purchased in the course of a “business operation or commercial transaction”. The Taxpayer simply was not carrying on a business. Finally, the Court concluded that the shares were not held on revenue account, as the shares were not dealt with in a “business-like” manner, in the way that might be expected if a business was in fact carried on.

Taxpayers should be aware that the Commissioner will look carefully at the nature and purpose of the activities undertaken, the regularity of the trading, the amount of capital invested and whether the investments are managed in a business-like manner when determining whether shares are truly held as part of a business.

By way of background:

• The Taxpayer held various managerial and senior executive roles within the Bechtel Group which provided construction, project management and engineering services to clients.
• For a period of 6 years, the Taxpayer incurred millions of dollars in expenditure on traded equities, generally based on advice provided by a firm of stockbrokers and financial advisers.
• The Taxpayer incurred a loss of $11.85 million when shares in one particular company were compulsory transferred and cancelled by the administrators of the company (that company having been in financial distress).
• The Taxpayer incurred a further $507,198 in expenditure on legal fees in attempting to challenge the compulsory transfer of the shares.
• The Taxpayer treated all his other share acquisitions and disposals on capital account.

This case is a reminder that where shares are held by a Taxpayer in their capacity as a private investor, losses incurred in relation to the investment will be of a capital nature, and so will be dealt with under the capital gains tax regime. However, where shares are traded as part of a business, such losses may be held on revenue account and offset against global income assessable to the Taxpayer. This treatment is often desirable, as losses of a capital nature are quarantined (and therefore may only be offset against future capital gains).

Land developer liable to pay land tax on land being developed on behalf of the Crown

In Australia Avenue Developments Pty Ltd as trustee for the SOP Site 3 Partner Trust v Chief Commissioner of State Revenue [2018] NSWCATAD 144, the Taxpayer challenged the Chief Commissioner’s assessment as to its liability to land tax pursuant to section 21C of the Land Tax Management Act 1956 (NSW) in relation to land that was the subject of a registered construction lease.

Broadly, section 21C imposes land tax on lessees under Crown leases, thereby shifting the burden that ordinarily rests with the legal owner of real property, for the reason that the Crown is exempt from land tax.

Having regard to the characterisation of the leasing arrangements, Senior Member R L Hamilton QC found in favour of the Chief Commissioner and confirmed the assessments for the 2016 and 2017 land tax years.

By way of background:

• The Taxpayer, who operates a property development business, had entered into a contract with the legal owner to develop a parcel of land at Sydney Olympic Park (Land).
• The legal owner, the Sydney Olympic Park Authority (Land Owner), was a statutory body established for the purposes of administering the Land on behalf of the Crown.
• The contract involved a ‘construction lease’ to enable the development to proceed, which was duly entered into and registered.
• The Taxpayer was consequently assessed to land tax under section 21C for the 2016 and 2017 years and objected to those assessments under section 86 of the Land Tax Administration Act 1996 (NSW).

The Taxpayer’s objection was made principally on the following grounds:

• it is necessary to look beyond the form of the words used in a contract to determine whether the substance of an arrangement constitutes a lease and
• the ‘construction lease’ in question was not in law a lease, given it lacked the essential characteristics of one (for instance, exclusive possession and quiet enjoyment), notwithstanding that it was referred to as a ‘lease’, which provided a grant of exclusive possession.

The Tribunal recognised the significant case law establishing the need to examine all of the relevant factors affecting the rights of the parties to the arrangement to determine what was actually intended.

However, while the Tribunal agreed with the Taxpayer that the required elements of a lease must be present for an arrangement to be classified as such, the Tribunal ultimately found that these elements were present. In particular:

• the Taxpayer was in exclusive possession of the land, as the Land Owner had only limited rights of access to inspect the land and to test materials, which are rights consistent with those of a landlord to a lease and
• the Taxpayer similarly possessed the right of quiet enjoyment under the lease, as it exercised control over the land to the exclusion of the Land Owner.

The case demonstrates that parties should be properly advised on land tax implications prior to entering into leasing arrangements. The Tribunal will not be quick to undo or defeat the commercial relationship for land tax purposes when parties have agreed to set out terms of a lease and have sought registration of such documentation.

ATO updates

TD 2018/13: Do the interposed entity rules apply to transactions made on commercial terms?

On 18 July 2018, the ATO released Tax Determination TD 2018/13 (Tax Determination), which outlines the Commissioner’s position regarding the question of whether, in the context of the interposed entity rules, section 109T of the Income Tax Assessment Act 1936 (Cth) (ITAA 36) applies to payments or loans made by a private company as part of an ordinary commercial transaction.

In short, the Commissioner’s view is that section 109T applies even where a transaction is on commercial terms where a reasonable person would conclude, with regard to the particular circumstances, that the payment or loan is made solely or mainly for the purposes of on-lending that money to a shareholder or their associate in circumstances where Division 7A would apply.

Division 7A of the ITAA 36 codifies an integrity measure designed to ensure that private companies cannot make disguised or informal distributions of profits to a shareholder, or their associate, in the form of payments, loans or forgiven debts. Generally, unless one of the exceptions in Division 7A applies, where a private company makes such a payment and the money is not repaid by the company’s lodgement date, the company is deemed under Division 7A to have paid a dividend.

Section 109T of the ITAA 36 operates to extend the scope of Division 7A to include payments of the kind described above which are made via one or more interposed entities, where the target entity is a shareholder or their associate.

The Tax Determination confirms that section 109T will apply to transactions involving interposed entities notwithstanding that they are made on commercial terms.

The Tax Determination also contains a range of practical examples of situations that would trigger the application of section 109T. Taxpayers should be mindful of the interposed entity rules to ensure they do not unwittingly issue a dividend to a shareholder or their associate which would be assessable to the recipient.

ATO Decision Impact Statement: MSAUS v Commissioner

On 26 July 2018, the ATO released a Decision Impact Statement (DIS) on the decision in MSAUS Pty Ltd as the Trustee for the Melissa Trust & Anor v FCT [2017] AATA 1408(MSAUS), where certain purchasers of residential premises in a property development did not have increasing adjustments under Division 135 of the A New Tax System (Goods and Services Tax) Act 1999 (Cth) (GST Act), despite the Full Federal Court making a finding to the contrary in the earlier case of South Steyne².

By way of background, in MSAUS, the Tribunal found on appeal that it was not bound by South Steyne and held that the special conditions in the contract were effective to apply the margin scheme, and that there was no increasing adjustment for the purchaser. Furthermore, the Tribunal made incidental comments about the 'deeds of rectification'.

The reason for the ATO releasing this DIS is largely to address the confusion which has arisen from the seemingly inconsistent application of the law to almost identical fact scenarios.

The primary difference between the various cases and MSAUS is that, in MSAUS, the vendor and purchaser subsequently entered into ‘deeds of rectification’ to retrospectively remove the ‘going concern’ clause from the contract of sale.

The view of the ATO with respect to MSAUS can be summarised as follows:

• despite the tension between the various cases, “the broader public interest is not served by an appeal seeking clarification of how the special conditions in the sale contract at issue in MSAUS operated”
• the use of 'rectification by deed' for the purpose of changing how the tax law has applied to an earlier transaction is not established as a general principle
• where parties subsequently try to vary a contract in such a way, the Commissioner is not bound to accept at face value a deed of this kind executed by private parties in absence of Court orders to the same effect and
• (in the absence of such Court orders), the public interest does not compel the Commissioner to unilaterally change how the tax law has already applied to an earlier transaction.

The decision in MSAUS itself is discussed in detail in Issue 94 of Talking Tax.

The ATO is accepting comments in relation to this DIS to raise consequences not identified. Please contact us if you would like to prepare a submission in respect of this DIS.

Stapled structures: Federal Government releases second tranche of draft taxation legislation

On 26 July 2018, the Government released for public consultation the second stage of exposure draft legislation and accompanying explanatory materials. These propose to give effect to the package of integrity measures designed to address the risks to the corporate tax base posed by stapled structures, by neutralising the tax benefits and concessional treatment currently available to foreign investors.

The stapled structures integrity measures were initially announced on 27 March 2018, and this second iteration of the draft legislation reflects feedback received in relation to the first tranche of draft legislation released on 17 May 2018. The exposure draft also includes additional features designed to close an unintended tax loophole which currently allows foreign investors from accessing concessional MIT tax rates on agricultural land, as well as the following measures:

• subjecting converted trading income to MIT withholding at the top corporate tax rate
• amending the thin capitalisation rules to prevent foreign investors ‘double gearing’ their investments
• limiting the foreign pension fund withholding tax exemption for interest and dividends to portfolio investments
• creating a legislative framework for a tax exemption for foreign governments, on their passive income from portfolio investments and
• ensuring investments in residential property (other than affordable housing) are subject to MIT withholding at the corporate tax rate.

Broadly, the MIT regime exists largely to provide tax concessions to foreign investors to encourage investment into Australia. While the draft legislation released to date reflects an intention to tighten the rules, the final version (when passed) should provide some certainty for foreign investors looking to invest within our shores.

The consultation period for those interested in providing feedback on the exposure draft legislation closes on 10 August 2018.

¹Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199.
²South Steyne Hotel Pty Ltd v Commissioner of Taxation [2009] FCA 13