Thinking | 10 February 2017
Talking Tax – Issue 64
Taxpayer Alert 2017/1(TA 2017/1): Re-characterisation of income from trading business
The ATO are reviewing arrangements that attempt to fragment integrated trading businesses to re-characterise trading income as passive income which is favourably taxed. Where these arrangements are entered into, the general anti-avoidance rules in Part IVA of the Income Tax Assessment Act 1936 (Cth) may be triggered.
Commonly, re-characterisation arrangements will involve the diversion of trading income to a ‘flow-through trust’ where, on distribution from the trust, the trading income will be subject to no or low tax. In the absence of such an arrangement, the trading income would ordinarily be assessable to the relevant trading entity at the corporate tax rate.
The ATO has identified that stapled structures are often used in such re-characterisation arrangements, and they have highlighted four primary stapled structures which are used:
- finance staples
- synthetic equity staples
- royalty staples and
- rental staples.
The ATO is of the view that these arrangements may be used to promote investment by overseas investors seeking advantageous tax treatment in Australia, ultimately resulting in an erosion of the corporate tax base. In particular, the ATO appears to be fixated on taxpayers in the infrastructure space.
Taxpayers using a stapled structure, or seeking to implement comparable structures, should consider the ATO’s warning lest they be found to be in breach of the Part IVA general anti-avoidance rules.
Please contact the Hall & Wilcox tax team for further information.
Base Erosion and Profit Shifting (BEPS) update
The theme of preventing Base Erosion and Profit Shifting (BEPS) continues, with the recent OECD release of key peer review documents which will form the basis of the peer review of Action 13 (Country-by-Country Reporting) and Action 5 (transparency framework).
The Action Plan on BEPS, developed in the context of the OECD and G20 BEPS Project, identified 15 actions to address BEPS in a comprehensive manner. The Action Plan is intended to equip governments with domestic and international instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created.
In accordance with Actions 5 (transparency framework) and 13 (Country-by-Country Reporting) of the BEPS minimum standards, the OECD has now released for assessment peer review terms of reference and methodology documents.
The methodology for each of the Actions provides guidance to entities about:
- the information that should be used to conduct the review
- the timeline and significance of each stage of the review
- the data gathering and review process
- the structure of the annual report addressing the implementation of the reporting or framework and
- the discussion and approval of the annual report.
The peer review of Action 13 will be undertaken by an Ad Hoc Working Party.
Action 5 – Transparency framework
Action 5 revamps the work on harmful tax practices with a focus on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for preferential regimes, such as IP regimes. The peer review of Action 5 will be undertaken by the Forum on Harmful Practices.
Action 13 – Country-by-Country Reporting
Country-by-Country Reporting provides a template for multinational enterprises to report annually for each tax jurisdiction in which they do business. This report is called the Country-by-Country (CbC) Report. The objective of the CbC report is to provide tax administrations with a high level overview of the operations and tax risk profile of the largest multinational enterprise groups.
Vakiloroaya v Federal Commissioner of Taxation  AATA 95
The AAT has found against the taxpayer in Vakiloroaya v Federal Commissioner of Taxation  AATA 95, disallowing deductions for motor vehicle and self-education expenses.
The Taxpayer appealed to the Tribunal after the Commissioner had disallowed the deductions and issued the Taxpayer with an administrative penalty of 25% of the tax shortfall for failure to take reasonable care.
The Tribunal considered two issues:
- whether the Taxpayer was entitled to deductions for motor vehicle expenses in the amount of $3,250, self-education expenses in the amount of $47,311; and other work-related expenses in the amount of $5,653 and
- whether the administrative penalty was correct.
This case highlights the importance of carefully considering the nature of employment related expense claims in light of the ATO’s continued scrutiny in this area.
The self-education deductions in dispute in the proceedings included amounts for ‘control and measuring instruments’, invoices from patent attorneys to patent his inventions and costs associated with attending an awards function in relation to this invention as part of his PhD university studies. The Tribunal held that these expenses did not possess the requisite connection between the ‘self-education’ expenses and any income producing activity. The expenses were not connected with the taxpayer’s employment, and the taxpayer was not required to produce or patent an invention as part of his university studies. The Taxpayer had incurred these expenses producing his own invention for the purpose of commercialisation in the future. Accordingly, the Tribunal held that most of the $47,311 related to self-education expenses could not be deducted.
Work-related motor vehicle expenses
The Taxpayer claimed deductions for work-related motor vehicle expenses on the basis that he was required to carry confidential documents relating to projects at work regularly, that he used his car to transport items during client meetings and site visits and to work from home, and that he used it to travel to university. The Tribunal found that the Taxpayer was not entitled to deduct the amounts as he had not travelled any ‘business kilometres’ in accordance with section 28-25, and could not prove that his travel was work-related rather than private in nature.
Other work-related expenses
The Tribunal also disallowed deductions for mobile phone charges, internet expenses, membership fees to professional societies, engineering reports related to his patent and depreciation of equipment, largely because evidence could not be provided that these amounts were paid. The Tribunal allowed a deduction for an awards entry fee and tickets, as the taxpayers was able to prove that the event was related to his employment (notwithstanding that the invoice was issued to the Taxpayer’s employer and paid by him from his personal account).
The Tribunal was not satisfied that the Commissioner’s decision to impose the penalty was incorrect. The Taxpayer was a knowledgeable and credentialed professional who claimed significant deductions against his assessable income.
The Tribunal stated that the Taxpayer could have sought a second tax opinion, or applied for a private binding ruling to ascertain the Commissioner’s views, before making his claims for deductions for ‘self-education’ expenses. Further, the Tribunal noted that some deductions claimed by the Taxpayer for work-related expenses were entirely unsubstantiated.
Wilson v Federal Commissioner of Taxation  AATA 119
The AAT has handed down a decision that the wages and salary of a Taxpayer were not exempt from income tax in Australia under section 23AF of the Income Tax Assessment Act 1936 (Cth) (Act).
The Taxpayer sought review from the Tribunal of a notice of objection decision issued by the ATO that determined that income earned working for an American company (Employer) as a contractor to the United States Army was assessable in Australia. The taxpayer had not included the amount of $138,465 he earned from his Employer in his assessable income, as he did not lodge a tax return in Australia.
The Tribunal considered:
- whether the amounts received from the Employer were assessable income and
- if so, whether the amounts could be exempt from income tax under section 23AF of the Act.
The Tribunal held that the payments plainly met the definition of assessable income despite being received from the Employer in the USA, as the meaning of assessable income unequivocally includes amounts received from a source outside Australia.
To be exempt under section 23AF, the payments must have been incurred on an ‘approved project’. The Tribunal held that based on the evidence presented, the Taxpayer was not working on an ‘approved project’.
The Tribunal held that the payments were correctly classified by the Commissioner as assessable income not exempt from income tax.
Visy Kraft Holdings Pty Limited v Chief Commissioner of State Revenue (NSW)  NSWSC 8
Taxpayers in NSW seeking to refinance pre-2008 mortgages should be aware that refinance arrangements will be subject to mortgage duty.
The New South Wales Supreme Court has confirmed the assessment of the Commissioner in its decision in Visy Kraft Holdings Pty Limited v Chief Commissioner of State Revenue. The decision confirmed that instruments relating to refinancing arrangements were subject to mortgage duty under section 213 of the Duties Act 1997 (NSW).
The relevant transaction involved the refinancing in 2013 which replicated the original arrangement entered into in 2008 when mortgage duty was not payable. The provisions giving rise to the duty took effect from 1 January 2009. The taxpayer applied for a review of the Commissioner’s decision to assess a Deed of Charge, a Share Mortgage and a Mortgage of Lease entered into in 2008 as giving rise to mortgage duty.
Section 213 states that an advance made under an agreement, understanding or arrangement for which the mortgage is security may be an ‘amount secured’ by the mortgage, even though the advance itself is not ‘recoverable under’ the mortgage. The Commissioner’s assessment of the Taxpayer for mortgage duty on the refinancing instruments as they were captured by section 213 was confirmed by the Court.