Talking Tax – Issue 130
The High Court in Thomas: franking credit “streaming” ineffective
On Wednesday 8 August 2018, the High Court of Australia unanimously allowed one appeal, partly allowed a second appeal and dismissed two appeals from the Full Federal Court decision in Federal Commissioner of Taxation v Thomas  HCA 31 (Thomas).
The taxpayer sought to use a trust structure to allocate or “stream” income separately from credits available on franked distributions, collecting more than $9 million in franking credits in the process.
The key conclusions relevant to taxpayers and practitioners are as follows:
- it is decided: franking credits are creatures of tax law only and are not income or an asset of a trust
- as such, franking credits cannot be separately allocated disproportionately to the income to which they attach (such as dividends) to achieve an optimal tax position for beneficiaries and
- directions given by State Supreme Courts are effective to issue binding determinations of the rights and facts as they occur between the parties, but cannot determine the operation of federal tax laws to bind the Commissioner.
What is the case about?
In the interests of brevity, those interested in the background of the taxpayer’s colourful scheme can read more in our previous article on the Federal Court decision.
In short, over a number of years, the trustee prepared resolutions which:
- distributed a part of the trust’s income comprising the franked distributions to a corporate beneficiary and to another (notably smaller) part to the taxpayer and
- sought to distribute or “stream” the corresponding franking credits in different proportions to the income.
The assumption that such a manoeuvre was permissible at law was referred to throughout the 7-year litigation as the "Bifurcation Assumption"
The final adjudicator: the High Court of Australia
Surprisingly, the legal basis of the Bifurcation Assumption was no longer an issue to be determined by the High Court of Australia, having been conceded by the Taxpayers in the course of the appeal.
The issues determined by the High Court are outlined below:
Is the Court bound by Executor Trustee1
The principal question in the High Court appeal was whether the Full Federal Court was correct in considering itself bound by the decision in Executor Trustee. Specifically, whether it could be concluded that the directions obtained by the trustee from the Supreme Court of Queensland to conclusively determine the rights of the parties (Directions) were binding on the Court - even though the Directions contained an error of law plainly acknowledged by both sides to the appeal.
Ultimately, the Court found that the Full Federal Court was wrong to conclude that it was bound by the Directions, given the following:
- Executor Trustee is authority for the proposition that the general law rights of trustee and beneficiary, as determined by a competent court as to the facts and rights as between the parties, are binding until set aside
- however, it is not authority for the proposition that the Commissioner is bound as to the actual application of the taxation laws to the determined facts and rights and
- moreover, on the basis of not being a party to the proceedings in which the Directions were made, the Commissioner was not bound (because, as aforementioned, the Directions determine only the rights as between the parties).
The Court also found that, in any event, a question about how the taxation acts operate is not suitable for determination under section 96 of the Trusts Act, which at most could only direct the trustee to protect it from later complaint.
Can the resolutions be constructed in a different way so as to give effect to the franking credit fork?
The alternative submission of the Taxpayers, if the High Court did not accept that that it was bound by Executor Trustee, was that the substitute construction of the resolutions posited by the Full Federal Court should be upheld.
On this view, the franked distributions were "notionally allocated" to match the purported, and separate, distribution of the franking credits. This argument was quickly dismissed by the High Court, which found that this argument was flawed as it was contrary to the terms of the resolutions and the intention of the trustee, as well as to the proper construction of the legislation.
The Taxpayers also attempted to establish alternate arguments around estoppel by convention, rectification of the resolutions and denial of procedural fairness. The Court made some interesting observations on these grounds but did not indulge the Taxpayers.
Travelex successfully challenges ATO approach to delayed tax refunds
In Travelex Limited v Commissioner of Taxation  FCA 1051, the Federal Court ruled that in determining the entitlement to delayed refund interest for GST overpayments in favour of the taxpayer, the relevant date in calculating the interest owing is when the taxpayer’s entitlement to the refund arose. Importantly for the taxpayer, this was an earlier date than when the taxpayer gave the Commissioner notice of the overpayment.
Given the decision was contrary to ATO practice with respect to GST returns lodged prior to 1 July 2012, the decision can still be appealed by the ATO given the wider implications for other taxpayers.
The key issue considered by the Federal Court was the period for which interest was payable. The court considered whether Travelex was required to give the Commissioner notice in relation to the refund as a precondition to an entitlement to interest commencing.
Following the introduction of self-assessment for GST effective from 1 July 2012, the appropriate period for interest commencing on GST overpayments would ordinarily be when the request for an amended assessment is lodged with the Commissioner.
However, for tax periods prior to this date, the court determined that there was no provision in the tax legislation which required Travelex to give the Commissioner notification of the refund amount for the purposes of the delayed refund interest provisions.
ATO Draft Property and Construction Website Guidance
On 9 July 2018, the ATO released its ‘Draft Property and Construction Website Guidance’ (Guidance). The Guidance provides the ATO’s draft view on the capital and revenue distinction in the context of property developments.
The Guidance outlines the factors taken into account by the ATO when assessing whether the proceeds of a land development are on capital or revenue account, and provides examples of how the ATO views certain factual scenarios.
The consultation period for the Guidance ended on 17 August 2018, and the ATO intends to release a summary of the comments it has received by the end of August 2018. It is hoped that in reviewing the commentary it has received and when finalising the Guidance, the ATO will provide an explanation of how its views align with the applicable authorities.
While it is understandable that ATO website guidance would not ordinarily include significant reference to case authorities, the level of weight to be given to the Guidance at this stage is questionable. Particularly as, in some instances, the ATO appears to place more weight on the terms of the development agreement than the actual development that has taken place.
Further, the fact that the ATO’s conclusions can turn on a single factor in otherwise parallel circumstances, such as the terms of a property development agreement, provides little safe harbour for taxpayers.
The factors and the applicable law
Whether an agreement to develop and sell land is more than a ‘mere realisation’
The Guidance states that the ATO will consider whether an agreement to develop and sell land is:
- a ‘mere realisation’ or
- a disposal:
- in the course of a business or
- as part of a profit making undertaking or plan.
That is, there are three broad categories of dealings in land contemplated by the ATO.
Where a realisation of land is a ‘mere realisation’, the proceeds will be capital receipts, and not assessable as income according to ordinary concepts. On the other hand, where land is disposed of in the course of a business, or as part of a profit making undertaking or plan, the proceeds will be revenue receipts, and assessable as income according to ordinary concepts.
The distinction between capital and revenue
The Guidance lists 21 factors that are relevant to whether a sale of land will be a capital or revenue receipt. The ATO makes it clear in the Guidance that the factors are not to be ‘tallied’, and that some are more significant than others.
The table below categorises the factors:
|Landowner’s conduct||Whether the landowner has held the land for a considerable period prior to the development and sale|
|Whether the landowner has conducted farming, or other non-development business activities, on the land prior to beginning the process of developing and selling the land|
|Whether the landowner originally acquired the property as a private residence or for recreational purposes|
|Whether the landowner originally acquired the property as an investment, such as for long term capital appreciation or to derive rental income|
|The landowner has a history of buying and profitably selling developed land or land for development|
|The landowner has changed its use of the land from one activity to another (e.g. farming to property development)|
|Location and zone of the land||Whether the land has been acquired near the urban fringe of a major city or town|
|Where the property has recently been rezoned, whether the landowner actively sought rezoning|
|The landowner applies for rezoning and planning approvals around the time or sometime after acquisition of the property, but before undertaking further steps that might lead to a profitable sale or entering into development arrangements|
|The market for the land||A potential buyer of the property made an offer to the landowner before the landowner entered into a development arrangement|
|The landowner was unable to find a buyer for the land without subdivision|
|Whether the landowner is registered for GST||The landowner has registered for GST on the basis that they are carrying on an enterprise in relation to developing the land|
|The landowner has registered a related entity for GST that will participate in (or undertake) the development of the land|
|The conduct of the development||The operations are planned, organised and carried on in a businesslike manner|
|The scope, scale, duration and degree of complexity of any development|
|Who initiated the proposal to develop the land for resale|
|The sophistication of any development or other pre-sale arrangements|
|The level of active involvement of the landowner in any development activities|
|The level of legal and financial control maintained by the landowner in a development arrangement|
|The level of financial risk borne by the landowner in acquiring, holding and/or developing the land|
|The value of the development or other preparatory costs relative to the value of the land|
It is clear that the ATO is concerned with the conduct of the landowner, and the manner in which the development is conducted. In the ATO’s view, developments managed in a ‘business-like’ way are more likely to give rise to proceeds on revenue account.
The ATO also considers that a development of significant scale, complexity, duration will be less likely to be a mere realisation of land. Similarly, a development in which the landowner is ‘significantly involved’ and bears the financial risk, will be more likely to give rise to proceeds on revenue account.
While many of the factors listed in the Guidance are taken from related case authorities, the ATO has provided no authority to support its conclusions regarding when any particular factor, or combination of factors, will determine that a development is more than a mere realisation of an investment.
Income tax implications of trust vesting and vesting dates: ATO releases Taxation Ruling and Compendium
Taxation Ruling TR 2018/6 (Ruling), issued on 15 August 2018 alongside the Ruling Compendium TR 2018/6EC, sets out the ATO’s final views with respect to the immediate income tax consequences of a trust vesting having regard to the powers of a trustee under the deed including the ability to amend the vesting date.
The Ruling also discusses the tax implications arising where the trustee mistakenly purports to exercise their discretionary power of appointment after the vesting date is reached.
Specifically, the Ruling provides guidance in relation to the matters outlined below.
- a trust deed typically specifies the date on which the interests in the trust vest and the consequence of that date being reached, as required by the rule against perpetuities (Vesting Date)
- prior to the Vesting Date and subject to the trust deed or court order, it may be possible for the trustee to postpone the vesting of the trust by nominating a later date (and doing so through a valid amendment prior to vesting should not give rise to CGT event E1)
- however, once the Vesting Date has passed, it is no longer possible for a trustee to change or postpone vesting with the result that the interests in the trust property become fixed at law and
- neither a mistaken assumption that discretionary powers of appointment continue to apply after the Vesting Date nor ignorance of the Vesting Date having been passed can alter the legal and equitable rights of parties that are established by the terms of the trust on vesting (which, from the moment of vesting, are fixed).
Trust law consequences of a trust vesting
- once the trust has vested, all of the interests in the trust as to income and capital become fixed beneficial interests of the residual beneficiaries specified in the trust deed
- if the trust is a discretionary trust, the trustee will no longer have any discretionary power to appoint the income or capital of the trust; rather, the trustee will hold the trust property for the absolute benefit of the residual beneficiaries
- vesting does not ordinarily cause the trust to come to an end nor cause a new trust to arise, nor is there a requirement that trust property be transferred to the residual beneficiaries on the Vesting Date and
- moreover, where the trustee continues to hold property, it is held pursuant to the same trust as existed prior to vesting (although the nature of the trust relationship will have changed).
Vesting Dates and CGT consequences
- broadly, whether a CGT event has occurred requires a close consideration of the relevant trust deed, and the subsequent conduct of the parties
- CGT event E1 may arise where the parties to a trust relationship subsequently act in a manner which creates a new trust e.g. declaration or settlement
- CGT event E5 may arise where the vesting of the trust results in the residual beneficiaries becoming absolutely entitled against the trustee to CGT assets of the trust and
- CGT event E7 may arise where CGT assets are distributed to beneficiaries post-vesting (but not to the extent to which beneficiaries are already absolutely entitled to those assets).
ATO updates Practical Compliance Guideline PCG 2017/13: unpaid present entitlements under sub-trust arrangements
On 15 August 2018, the ATO released an updated version of Practical Guidance Guideline PCG 2017/13 (Guideline) which deals with unpaid present entitlements under sub-trust arrangements in Division 7A of the Income Tax Assessment Act 1936.
The Guideline applies to a private company (or trustee) beneficiary of a trust and sub-trust where the trustee has (in accordance with Option 1 of Practice Statement PS LA 2010/4):
- validly placed funds representing an unpaid present entitlement under a sub-trust arrangement before 30 June 2012 on a 7-year interest only loan with the main trust and
- does not repay the principal of the loan when it matures in the 2017, 2018 or 2019 income years.
The original form of the Guideline issued in July 2017, applied to arrangements of this nature that mature in the 2017 or 2018 income years. The updated Guideline extends the scope to cover loans that mature in the 2019 income year.
Broadly, where the loan is not repaid in full or put on complying terms before the company’s lodgement day, any unpaid principal of the loan will be treated by the Commissioner as the provision of financial accommodation and therefore a Division 7A loan giving rise to a deemed dividend at the end of the income year in which the loan matures.
Legislation and government policy
NSW Stamp Duty Ruling: GST withheld by purchasers to form part of the dutiable value of the property
On 1 August 2018, the NSW Chief Commissioner of State Revenue, Stephen Brady (Commissioner), released Revenue Ruling No. DUT 047 (Ruling). The Ruling clarifies the Commissioner’s view with respect to the calculation of the dutiable value of where the property in question is a taxable supply of new residential premises or residential land that is subject to the new GST Withholding regime.
By way of background, it is generally accepted as settled law that the GST component of the purchase price for the sale of land that is a taxable supply forms part of the dutiable value of the property and that, therefore, duty is payable on the GST-inclusive price.
In certain circumstances, the new GST Withholding regime requires the purchaser to withhold the GST component of the purchase price and remit this amount directly to the ATO (or to the vendor via a bank cheque made out to the Commissioner of Taxation). The regime was introduced as an integrity measure to facilitate collection of GST revenue.
This Ruling states that the amount of GST withheld under the new regime will form part of the dutiable value of the property, and so will be subject to stamp duty in the same way as if the GST was collected by the vendor.
Ombudsman calls to extend the $20,000 instant asset write-off to $100,000
On 7 August 2018, the Australian Small Business and Family Enterprise Ombudsman, Kate Carnell, called for the $20,000 instant asset write-off to be increased to $100,000. The scheme is currently available to small business entities with a turnover of less than $10 million.
Appearing before the House of Representatives Standing Committee on Economics, the Ombudsman made the recommendation alongside calls for other measures aimed at alleviating key impediments to business investment, such as onerous red tape and regulation and confusion around core pieces of legislation such as the Fair Work Act.
The proposed extension of the instant asset write-off would enable eligible entities to deduct the entire cost (up to $100,000) of key equipment in the year in which the expenditure is incurred, rather than over the course of its usable life under the regular asset depreciation rules. For smaller businesses, this has obvious benefits in the form of providing an immediate deduction for purchases.
Northern Territory offers payroll tax exemption for employers taking on NT residents
The Revenue Legislation Amendment Act 2018 (NT) (Act) makes a number of amendments following the recent Budget announcements
Specifically, the Act amends the Payroll Tax Act 2009 (NT) with effect from 1 May 2018 to introduce a new payroll tax exemption for employers that hire Northern Territory residents. The exemption is available for up to the first two continuous years of employment of either:
- a new employee who is a resident of the Northern Territory or
- an existing employee who becomes (for instance, by relocation), or is replaced by, a Northern Territory resident.
provided the new hiring or residency occurs by 30 June 2020.
The Act also amends the Stamp Duty Act 1978 (NT) to:
- remove the exemption for transfers of onshore and coastal petroleum and pipeline interests
- provide an exemption from motor duty for vehicles registered in the Northern Territory as a result of the closure of the Federal Interstate Registration Scheme and
- extend the stamp duty Senior, Pensioner and Carer Concession to the new Northern Territory Concession Scheme.
These amendments are made alongside other changes, including amendments to the Mineral Royalty Act 1982 (NT).
Government releases draft legislation to tackle illegal phoenixing activity
On 16 August 2018, the Minister for Revenue, the Hon. Kelly O’Dwyer MP released Exposure Draft legislation aimed at combatting illegal phoenixing activity. Phoenixing occurs when the controllers of a company strip a company’s assets and transfer them to another entity to avoid paying the company’s debts, which is estimated to cost the Australian economy between $2.85 billion and $5.13 billion annually.
The Exposure Draft implements four measures to combat illegal phoenixing that were originally announced in the 2018 Federal Budget:
- Schedule 1 introduces new offences to prohibit creditor-defeating dispositions of company property, penalise those who engage in or facilitate such dispositions, and allow liquidators and ASIC to recover such property
- Schedule 2 ensures directors are held accountable for misconduct by preventing directors from improperly backdating resignations or ceasing to be a director when this would leave the company with no directors
- Schedule 3 allows the Commissioner to collect estimates of anticipated GST liabilities and make company directors personally liable for their company’s GST liabilities in certain circumstances and
- Schedule 4 authorises the Commissioner to retain tax refunds where a taxpayer has failed to lodge a return or provide other information that may affect the amount the Commissioner refunds, ensuring taxpayers satisfy their tax obligations and pay outstanding amounts of tax before being entitled to a tax refund.
Submissions in response to the Exposure Draft are due on 27 September 2018.
1Executor Trustee & Agency Company of South Australia Ltd v Deputy Federal Commissioner of Taxes (SA)  HCA 35
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