Talking Tax – Issue 166

Distributions from foreign trusts assessable under section 99B

The Federal Commissioner of Taxation (Commissioner) has had a recent win in the case of Campbell v Commissioner of Taxation [2019] AATA 2043. In this case, Ms Catherine Campbell (Taxpayer) had received distributions from a New Zealand-based trust estate totalling $463,200 across the 2013 and 2014 income years.

The Taxpayer failed to return these amounts as income and the Administrative Appeals Tribunal (Tribunal) held that the Taxpayer was in receipt of distributions from a foreign trust that are assessable pursuant to section 99B(1) of the Income Tax Assessment Act 1936 (Cth) (1936 Act).

This case provides three important reminders:

  • Distributions of income received from foreign trusts are assessable pursuant to section 99B of the 1936 Act and should be disclosed. This includes amounts of capital referrable to accumulated prior year income.
  • Those seeking to claim that a distribution represents ‘corpus’ of the trust must ensure that these distributions are accurately recorded in the trustee minutes and trust accounts. Particular care needs to be taken when communicating with advisers for non-resident entities to ensure that accounts are prepared accurately and consistently.
  • AUSTRAC and the ATO (and other government authorities) will readily share information about international and domestic transactions. Taxpayers should expect that any income received from oversees will come to the attention of the ATO and may be queried.

Receipt of the payments was brought to the ATO’s attention by AUSTRAC and despite repeated requests, the Taxpayer failed to provide tax returns for the relevant income years.

The Commissioner issued default assessments for the 2013 and 2014 income years, including the distributions as assessable income of the taxpayer pursuant to section 99B(1) of the 1936 Act. A 75% penalty (standard for default assessments) was also imposed on the Taxpayer for failing to provide the requested tax returns.

The Taxpayer objected to the assessments by claiming that the amounts received represented the corpus of the trust estate, which is exempt from being included in her assessable income under section 99B(2)(a) of the 1936 Act.

The Tribunal ultimately disagreed with the Taxpayer, upholding the Commissioner’s decision. Relevantly:

  • The Taxpayer provided two different sets of trust accounts for the relevant years. One set showed a negative capital balance, which would indicate there was no corpus to distribute, while the other showed a net positive capital balance and distributions of capital to the Taxpayer. The Taxpayer claimed that the differences were necessary in order to accommodate the Australian accounting standards but could provide no evidence to substantiate this claim.
  • There was no record of the trustee ever resolving to distribute any corpus of the trust in the relevant years. The trustee distribution minutes for the relevant years reflected a decision to accumulate all trust income and not make any distributions of income or capital.

Ultimately, the Tribunal concluded that the trust accounts and the trust minutes were unreliable as evidence due to their inconsistency, and the Taxpayer was unable to establish that the distributions received were in fact the corpus of the trust.

As the default assessments were held to be reasonable and enforceable against the Taxpayer, the 75% administrative penalty was also upheld.

Div 7A and failure to comply: What is an ‘inadvertent omission’?

In the case of Howard v Commissioner of Taxation [2019] AATA 1910, the Tribunal found in favour of the Commissioner, concluding that a loan made to a beneficiary (Taxpayer) of a trust constituted a deemed dividend provided by an interposed entity under Subdivision E of Division 7A of the Income Tax Assessment Act 1936 (Cth) (1936 Act).

Excluding penalties and interest, the primary issues considered by the Tribunal included whether the:

  • relevant loan was made in the 2009 or 2010 income year;
  • Commissioner should exercise his discretion under section 109RB of the 1936 Act to disregard any deemed dividends or, alternatively, to frank it to the maximum amount possible; and
  • discretion to make a determination under section 109W(1) of the 1936 Act should be exercised, and if so, how.

This case highlights the importance of contemporaneous and accurate documentation when dealing with transactions impacted by Division 7A of the 1936 Act. Specifically, the findings make it clear that while it is possible for a written loan agreement to document a loan that has already been made, the precise terms of that loan agreement and the surrounding circumstances (including when monies were advanced) are of vital importance.

Any interpretation that this case narrows the circumstances in which the Commissioner may exercise a discretion under section 109RB of the 1936 Act should be considered with caution.

In particular, any suggestion that the discretion in section 109RB of the 1936 Act may not be exercised:

  • where professional advice has been obtained by a taxpayer; or
  • there has been a failure to properly secure a Division 7A loan by registered mortgage,

are unsupported.

It is clear the findings in this case in relation to section 109RB of the 1936 Act were coloured by the Taxpayer's lack of evidence, and the unavoidable inconsistencies in the evidence provided.

The Taxpayer was a beneficiary of the BJ Howard Finance Trust (Finance Trust) and the owner and operator of a cargo handling business known as Bulk Cargo Services Pty Ltd (Services Company). BJ Howard Finance Pty Ltd was the trustee of the Finance Trust and also a shareholder in the Services Company.

A loan for $3.6 million was made to the Taxpayer from the Finance Trust and secured by a second ranking mortgage over a residential property  (Loan). The Commissioner made a determination that the Loan constituted a deemed dividend under Subdivision E on the basis that the Services Company was the relevant private company, the Finance Trust was an interposed entity and the Taxpayer was the ‘target’.

Timing of the loan

Before reaching a conclusion on the application of section 109RB, the Tribunal had to consider the evidentiary matter of whether the Loan arose in either 2009 or 2010. The Taxpayer claimed that the loan was granted on 30 June 2009 but was unable to provide any plausible explanation as to why there was an 11-month delay between granting the loan and signing the loan agreement.

A lack of contemporaneous evidence in support of the Taxpayer’s claim that the loan was made by way of set-off on 30 June 2009 caused the Tribunal to conclude that the Loan in fact arose in May 2010, and not in the 2009 income year as claimed by the taxpayer.

The section 109RB discretion

While the Taxpayer initially asserted that no deemed dividend had arisen, these arguments were not raised at hearing. Instead, the Taxpayer asserted that the Commissioner ought to have exercised his discretion under section 109RB to disregard the deemed dividend.

The Commissioner may exercise his discretion under section 109RB if the deemed dividend arose because of an honest mistake or inadvertent omission by the relevant taxpayer, private company, or interposed entity.

The Taxpayer asserted that the relevant ‘inadvertent omission was their failure to comply with the requirements of section 109N of the 1936 Act, which provides that loans will not be treated as dividends if certain requirements are met.

Claims by the taxpayer that this was due to an ‘inadvertent omission’ by the taxpayer’s accountant were flatly rejected. The Tribunal noted the Taxpayer’s lack of consistent evidence, and the fact that the taxpayer had been receiving professional advice.

Accordingly, the Tribunal was not satisfied that the failure to comply with section 109N was due to honest mistake or inadvertent omission.

Determination under section 109(1)

In the final submissions of the case, the taxpayer raised the argument that section 109W of the 1936 Act must be read in the context of section 109X.

Section 109W of the 1936 Act prescribes the method by which the Commissioner is able to determine the notional loan amount being provided by a private company through an interposed entity. Section 109X of the 1936 Act specifies that the relevant notional loan amount provided to a target entity via an interposed entity is to be included in the assessable income of the interposed entity.

The taxpayer asserted that because an amount was brought to tax in the hands of another entity, this was something the Commissioner should have taken into account when determining the notional loan amount under section 109W.

This argument was ultimately rejected by the Tribunal which concluded that, taking into account the factors the Commissioner must consider under section 109W(2), it was reasonably clear that the arguments raised by the taxpayer were not relevant considerations.

Much needed clarity on the meaning of ‘core R&D activities’

On 25 July 2019, Justices Davies, Moshinsky and Steward of the Federal Court of Australia Full Court (Court) delivered a joint judgment in favour of the Taxpayer in Moreton Resources Limited v Innovation and Science Australia [2019] FCAFC 120, overturning the trial decision and remitting the matter to the Tribunal for determination.

In its decision the Court clarified that activities involving the application of existing technology to previously untested sites may come within the meaning of the words ‘core R&D activities’ in the R&D tax concession provisions of Division 355 of the Income Tax Assessment Act 1997 (Cth) (1997 Act).

You can read more about the trial decision in Talking Tax Edition 134.

While there may be more to learn once the Tribunal has considered the matters returned to it for determination, it appears the judgment may be of benefit to taxpayers in a broad range of industries beyond that of the taxpayer’s.

The Taxpayer in this case was an Australian resources company seeking to develop an underground coal gasification (UCG) facility in Queensland where cleaned and stabilised gas could be produced and used to generate electricity. Before establishing a commercial scale plant, the Taxpayer established a pilot project using existing UCG technology to see if it was suitable for use at the previously untested Queensland site.

The Taxpayer sought to demonstrate that some of its activities should be registered as R&D activities and consequently, that they should be able to access the R&D concessions.
Innovation and Science Australia initially determined that the Taxpayer’s activities were not sufficient to be deemed R&D activities, and therefore the Taxpayer was not entitled to the R&D tax concessions. This decision was upheld by the Tribunal, which concluded that none of the activities were core R&D activities within the meaning of that term.

The Tribunal took a narrow interpretation of ‘core R&D activities’, which the Court held was in error. In this regard the Court held:

  • the Tribunal misconstrued the words 'experimental activities' in the opening line of section 355-25(1) of the 1997 Act by treating these words as not covering activities having the purpose of generating new knowledge with respect to the application of an existing technology at a new site;
  • the words ‘experimental activities’ in the opening line of subsection 355-25(1) of the 1997 Act have very little, if any, work to do beyond reflecting the type of activities described in paragraphs (a) and (b) of the subsection; and
  • subject to the relevant circumstances, the R&D provisions are capable of applying to activities that are conducted for the purpose of generating new knowledge with respect to the application of an existing technology at a new site.

This article was written with the assistance of Charlie Renney, Lawyer.

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