Talking Tax – Issue 136
SRO come up short-sighted: distributions to beneficiaries not viewed as ‘wages’ for payroll tax purposes
In an important win for healthcare clinics, the Supreme Court of Victoria in Commissioner of State Revenue v The Optical Superstore Pty Ltd  VSC 524 dismissed the Commissioner of State Revenue’s appeal and agreed with the Victorian Civil and Administrative Tribunal (VCAT) that trust distributions made to Optometrist Entities were not “wages” within the meaning of Payroll Tax Act 2007 (Vic) (PTA).
By way of background, The Optical Superstore Pty Ltd (Trustee) is the trustee of four related trusts which together carry on a business known as The Optical Superstore. The stores owned by the Trustee (Stores) are either operated by the Trustee or are licensed to other parties (Licensees).
The Trustee and Licensees had entered into contracts either directly with optometrists or with the companies or trusts through which the optometrists operated their respective businesses (collectively, Optometrist Entities) in relation to the provision of optometry services at the Stores (Agreements).
Under the Agreements, the optometrists’ consultation fees (Medicare payments and patient fees) were paid directly to the Trustee to hold that money in one of its four trusts on behalf of the Optometrist Entities (Consultation Fees). The Optometrist Entities would receive a monthly “Reimbursement Amount” from the Trustee based on the number of hours the particular optometrist worked at the Stores (regardless of the actual Consultation Fees earned). Finally, any surplus funds from the Consultation Fees, after paying the Reimbursement Amounts to Optometrist Entities, was retained by the Trustee as an “Occupancy Fee”.
At times the Reimbursement Amounts actually exceeded the Consultation Fees. In this event, the amount by which the Reimbursement Amount exceeded the Consultation Fees were paid to the Optometrist Entity from the Trustee’s own funds, and these excess payments were referred to as “Location Attendance Premiums” (LA Premiums).
Broadly, VCAT had made the following key findings:
- The Agreements were “relevant contracts”, being contracts under which the optometrists supplied services for or in relation to the performance of work.
- The LA Premiums were taxable wages, on the basis that they had a close connection to the performance of services by the optometrists.
- The Reimbursement Amounts were not taxable wages, on the basis that these payments came from the consultation funds held in the express trusts, rather than from the trustee’s own funds and, as such, a return of money from an express trust could not meet the condition of an amount “paid or payable” by the Trustee for the purposes of section 35(1) of the PTA (amounts under relevant contracts taken to be wages).
- The exemption for contractors who provide services to the public generally was applied to some of the optometrists on a case by case basis, based on the activities of the optometrist.
- The 25% penalty rate had been fairly imposed by the Commissioner in relation to any outstanding payroll tax liability.
Issue for the Supreme Court
The principal issue for the Court, in determining whether the Reimbursement Amounts paid to the Optometrist Entities constituted “wages”, was whether the money was “paid or payable” by an employer for or in relation to the performance of work.
The Court held that the meaning of “payments” for the purposes of section 35(1) of the PTA did not extend to the return of money to a contractor where that contractor earned that money from providing services to a third party and directed the fees to be held on trust for the contractor or the contractor’s business. Accordingly, the Court upheld VCAT’s decision that the Reimbursement Amounts paid to the Optometrist Entities were not “paid or payable” by the Trustee for or in relation to the performance of work, and the Reimbursement Amounts were not subject to payroll tax.
Further, Justice Croft made the following observations:
- The use of the trust structure could not alter the essential character of the payments as the return of monies by way of distributions under an express trust. This is to be distinguished from distributions from discretionary trusts or distributions from trusts to employees.
- It was of critical importance that the source of the distribution was the beneficiaries’ own funds – the Optometrist Entities were the beneficiaries of the consultation fees that they had derived.
This decision strengthens the authority of the VCAT decision, and is a significant win for medical practices and similar allied health clinics at a time when revenue authorities are focusing on payroll tax compliance. On the basis of this case, a practice that runs in a similar way to Optical Superstore, which is a common structure, should not be subject to payroll tax on payments ultimately made to practitioners from a pool of the funds accumulated by the practitioners’ consultation fees. This should not be confused with a practice that derives the patient fees itself and pays the professionals a wage from their own funds.
In light of this, unfavourable assessments issued by revenue authorities in the past should be reviewed, and businesses in this industry are encouraged to reassesses their arrangements with contractors.
Avoiding common GST errors
The ATO has warned taxpayers that it has identified five of the most common errors made by taxpayers when reporting GST. These errors comprise over half of the overall corrections made to GST reporting.
While the ATO did not reveal the specific errors made, they provide general advice on avoiding these types of errors when reporting GST. According to the ATO, taxpayers should:
- make sure the timing is correct, and report for the correct tax period;
- check the figures to avoid accidental miscalculations and simple transcription errors;
- ensure claims for GST credits can be substantiated; and
- check there is a creditable purpose so GST is not claimed for goods purchased for personal use.
Guidance and compliance on Diverted Profits Tax
On 26 September 2018, the ATO released Law Companion Ruling LCR2018/6 and Practical Compliance Guideline PCG 2018/5 on the Diverted Profits Tax (DPT). The DPT rules in Part IVA of the Income Tax Assessment Act 1936 aim to ensure that significant global entities cannot reduce their Australian tax by diverting profits offshore through arrangements with related parties.
By way of background, Australia’s DPT legislation applies to significant global entities (broadly, groups with annual global income of AUD$1 billion or more) for income years commencing on or after 1 July 2017 in circumstances where the amount of Australian tax paid is reduced by diverting profits offshore through related-party arrangements and certain other conditions are satisfied.
Where the rules apply and the Commissioner decides to make a DPT assessment, a 40% tax is imposed on the diverted profit.
The ATO’s position on DPT serves as a reminder that all taxpayers with cross-border related party dealings are encouraged to assess the potential application of the DPT. This will start with the preliminary consideration of whether the taxpayer is a significant global entity that has, in broad terms, Australian income in excess of AUD $25 million and then specific consideration of particular transactions within the DPT framework.
Taxpayers should undertake a process to evaluate their risks and supporting documentation for the more complicated areas of DPT law, namely the principal purpose test and whether it could be concluded that an Australian tax benefit exists.
1. Law Companion Ruling LCR 2018/6
LCR 2018/6 discusses the rules around which the DPT operates – primarily the principal purpose test and the 11 matters considered by the Commissioner in applying this test (section 177). The ruling notes that the same test applies for the purposes of the multinational anti avoidance law, except the relevant matters considered by the Commissioner are different.
Quantifiable non-tax financial benefits
If a scheme that limits a taxable presence in Australia results in significant quantifiable non-tax financial benefits, this may provide a strong indication that the scheme was not entered into for a principal purpose of obtaining a tax benefit. Quantification of the non-tax financial benefits that will or may reasonably be expected to result from the scheme will generally be based on the outcomes that were anticipated at the time of entry into the scheme, provided that those outcomes were based on reasonable commercial assumptions.
Sufficient foreign tax test
Foreign tax liability is determined by quantifying the total of the increases in the amount of foreign income tax that is liable to be paid as a result of the scheme.
The definition of foreign income tax is intended to cover taxes that are substantially equivalent to Australian income tax.
Sufficient economic substance test
This test in section 177M of the Income Tax Assessment Act 1936 is an exception to the application of the DPT. The test is satisfied where the profit made as a result of a scheme by each relevant entity reasonably reflects the economic substance of the entity’s activities in connection with the scheme.
The term ‘profit’ in section 177M is used in a more general sense than ‘taxable income’.
Profit and economic substance
LCR 2018/6 also explains that it is a question of fact whether the profit made by an entity as a result of a scheme reasonably reflects the entity’s activities in connection with the scheme. In determining this, it is necessary to have regard to:
- the relative economic significance of the functions performed by the entity in connection with the scheme; and
- the entity’s relative contribution within the context of the overall value chain, to generating the total profit made as a result of the scheme.
In applying the test, it is the economic substance of the entity’s activities in connection with the scheme that is relevant, not the overall economic substance of the entity itself.
For the purposes of the DPT, it will be necessary to examine the functions, assets and risks not only of the relevant Australia taxpayer, but also other entities connected to the scheme.
2. Practical Compliance Guideline PCG 2018/5
PCG 2018/5 sets out the ATO’s taxpayer engagement framework for the DPT and outlines the ATO’s approach to risk assessment and compliance activity when the DPT is identified as a potential area of concern.
ATO compliance approach
A DPT risk will typically be identified by the ATO in the course of its ordinary compliance activities. While the ATO’s decision-making process will be guided by the circumstances of the particular case, it will generally prioritise its resources to address arrangements it considers pose the highest risk.
Once a DPT risk is identified, the ATO’s compliance approach may include ongoing monitoring of the risk or active consideration as part of a review. The ATO will consider information available to it and may request further information from the taxpayer. Even where the ATO considers a DPT risk to be low, it says it may continue to monitor the arrangement having regard to any additional information that becomes available.
Risk assessment framework
The ATO generally expects affected taxpayers to initially undertake their own risk assessment, having regard to the “framing questions” set out in PCG 2018/5. These framing questions cover:
- preliminary matters;
- transaction-specific issues;
- the principal purpose test ; and
- the sufficient economic substance test. Appendix 2 to PCG 2018/5 contains a series of high and low risk scenarios in relation to this test.
The ATO stresses that these framing questions are intended to serve as a general guide only and should not be viewed as an exhaustive list of the issues it may consider.
If taxpayers believe there is a potential DPT risk associated with their arrangements, the ATO expects them to engage with it. Taxpayers seeking greater certainty from the ATO can apply for a private ruling, seek entry to the APA program or contact the ATO’s DPT specialist team.
While there are no specific record-keeping requirements for the DPT, the ATO expects taxpayers to keep appropriate records of their arrangements and transactions in the normal way. In order to aid taxpayers to do this, PCG 2018/5 outlines the kinds of documentation the ATO may have regard to when considering the application of the DPT. These documents include:
- lodged Australian income tax returns and notices of assessment;
- international dealings schedules and working papers;
- Country-by-Country reporting data and other information obtained via exchange of information processes;
- a general submission by the taxpayer outlining its views on the application of the DPT (including the basis for satisfying any exemptions);
- annual reports or general purpose financial statements;
- contemporaneous transfer pricing documentation; and
- intercompany agreements and policies regarding such dealings.
The ATO cautions that the documentation outlined in PCG 2018/5 is intended as a general guide only and should not be viewed as an exhaustive list of the kinds of documentation the ATO may take into account.
Where there is a risk that the DPT may apply to an arrangement covered by a proposed settlement, the ATO says it will generally seek to resolve the matter before proceeding with the settlement. The ATO may, at the taxpayer’s request, include a clause relating to the DPT in the settlement deed.
Legislation and government policy
Australia reinforces its commitment to prevention of base erosion and profit sharing
On 28 September 2018, Australia ratified the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Sharing (Multilateral Instrument). The Multilateral Instrument is a multilateral treaty that enables jurisdictions to swiftly modify their bilateral tax treaties to implement measures designed to better address multinational tax avoidance.
The Multilateral Instrument will enter into force in Australia on 1 January 2019.
The extent to which the Multilateral Instrument will modify Australia’s bilateral tax treaties will depend on the final adoption positions taken by other countries but the following are some main features of the multilateral instrument:
Article 3 – Transparent entities
Treaty benefits will be granted for income derived through fiscally transparent entities but only where one of the two countries treats the income as income of one of its residents under its domestic law.
Article 6 – Purpose of a covered tax agreement
A new treaty preamble will clarify that tax treaties are not intended to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty-shopping arrangements.
Article 7 – Prevention of treaty abuse
New anti-abuse rules will enable tax administrations to deny treaty benefits in certain circumstances: the Principal Purpose Test (PPT) and the Simplified Limitation on Benefits (S-LOB) rule.
Article 8 – Dividend transfer transactions
Shares must be held for 365 days before any non-portfolio intercorporate dividends payable on those shares become eligible for reduced tax rates under tax treaties. This holding period will be added to bilateral treaties that do not already include a minimum holding period and replace any existing holding periods in treaties.
Article 9 – Capital gains from alienation of shares or interests of entities deriving their value principally from immovable property
Countries will be able to tax capital gains derived by foreign residents from the disposal of shares or other interests in ‘land-rich’ entities (where the underlying property is located in that country) if the entity was land-rich at any time during the 365 days preceding the disposal.
Article 13 – Artificial avoidance of permanent establishment status through the specific activity exemptions
Most tax treaties include a list of exceptions to the definition of permanent establishment where a place of business is used solely for specifically listed activities such as warehousing or purchasing goods.
Only genuine preparatory or auxiliary activities will be excluded from the definition of permanent establishment. In addition, related entities will be prevented from fragmenting their activities in order to qualify for this exclusion.
Article 14 – Splitting-up of contracts
Most tax treaties include rules that deem building or construction projects that exceed a specified period (e.g. 12 months) to constitute a permanent establishment.
Related entities will be prevented from avoiding the application of the specified period by splitting building or construction-related contracts into several parts.
Article 16 – Mutual agreement procedure
New rules will ensure the consistent and proper implementation of tax treaties, including the resolution of disputes regarding their interpretation or application. This will provide taxpayers with a more effective tax treaty-based dispute resolution procedure.
Article 17 – Corresponding adjustments
Transfer pricing adjustments can result in double taxation when one country makes an adjustment to an entity’s profits and the other country does not make a compensating adjustment to the profits of the relevant related entity.
A country will be required to make a downward adjustment to the profits of a resident entity, as a result of an upward adjustment by the other country to the profits of an associated entity which is a resident of that other country (provided both countries agree that the upward adjustment is justified).
GST: Waiver of adjustment note requirement
On 27 September 2018, the Government released the Goods and Services Tax: Waiver of Adjustment Note Requirement (Corporate Card Statements) Determination 2018 (Determination). The Determination repeals and replaces the Goods and Services Tax: Waiver of Adjustment Note Requirement (Corporate Card Statements) Legislative Instrument (No. 1) 2008, and allows corporate card holders to claim a decreasing adjustment without holding an adjustment note in certain circumstances.
Requirement for relief from holding an adjustment note
At the time the cardholder gives its GST return/Business Activity Statement for the tax period to the Commissioner, the cardholder must:
- hold a corporate card statement that records a transaction which includes the decreasing adjustment and certain information to enable details of the cardholder to be ascertained; and
- have in place an effectively regulated corporate policy for determining the amount of decreasing adjustments relating to acquisitions made on the corporate card.
GST: Waiver of Tax Invoice Requirement
On 27 September 2018, the Government released the Goods and Services Tax: Waiver of Tax Invoice Requirement (Visa Purchasing Card) Determination 2018 (the Determination). The Determination repeals and replaces the Goods and Services Tax: Waiver of Tax Invoice Requirement (Visa Purchasing Card) Legislative Instrument (No. 2) 2008, and provides greater flexibility to card providers by allowing specified entities other than Visa International to collate the required GST information that is included in the electronic data files.
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