Thinking | 11 August 2017
Talking Tax – Issue 89
Federal Court disallows Taxpayer’s deductions in relation to a carbon emissions scheme
On 3 August 2017, the Federal Court of Australia (FCA) in Academy Cleaning & Security Pty Ltd v Deputy Commissioner of Taxation  FCA 875 dismissed a Taxpayer’s appeal against the objection decision of the Deputy Commissioner of Taxation (Commissioner) to disallow the Taxpayer from claiming deductions in respect of an emission reduction purchase agreement it had entered into under the general deduction provision in section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).
Broadly, the Taxpayer agreed to purchase carbon credits at a cost of $420,000 which was to be paid in two instalments: firstly, a deposit on execution of the scheme, and the balance once certain conditions were met (including, the requirement that sufficient carbon credits had been generated by certain projects expected to be undertaken) (Agreement).
Justice Rares of the FCA found that the Taxpayer was not entitled to deduct this amount, either because:
- the expense was not ‘incurred’ as it was contingent on certain conditions being met
- the purchase of carbon credits was not connected to the carrying on of the Taxpayer’s business or
- it was a scheme for the purposes of the anti-avoidance provisions and was contrived to achieve an immediate tax deduction.
This case serves as yet another reminder to taxpayers that schemes which are orchestrated to enable taxpayers to claim excessive deductions and that are unrelated to their ordinary business activities are likely to be rejected by the Commissioner and the courts.
Taxpayers should also take care with conditional contracts to ensure that they identify the correct point in time that an expense is incurred for tax purposes and therefore deductible.
In this case, the Taxpayer was a company which provided, among other things, security and cleaning services to a number of corporations.
The emission reduction purchase agreement
In 2009, the Taxpayer entered into the Agreement under which it agreed to acquire carbon credits at a cost of $420,000 (Purchase Price) from BR Redd Ltd (BR Redd), which in turn had contracted to acquire the carbon credits from Carbon Strategic Pty Ltd (Carbon Strategic) which was expected to generate carbon credits through a number of overseas projects.
Under the Agreement:
- the Taxpayer was required to pay a non-refundable deposit of $63,000 upon execution of the Agreement, and the balance of $357,000, once sufficient carbon credits had been generated by Carbon Strategic and certain other conditions were met (including, receiving a delivery notice from the BR Redd) and
- if the Taxpayer had not received a delivery notice within three years of the date of the Agreement, it could terminate the Agreement, but could not recover the deposit.
- The Taxpayer included a $420,000 deduction in respect of the Agreement in its 2009 tax return - which included the deposit and the balance payable when the other conditions were met.
Lead up to proceedings
The Commissioner issued the Taxpayer an amended assessment in respect of the 2009 income year disallowing the $420,000 deduction. The Commissioner also imposed a shortfall penalty of 75% in the amount of $94,000.
The Commissioner dismissed the Taxpayer’s objection to the amended assessment on the grounds that the Purchase Price:
- was not deductible under either limb of section 8-1 of the ITAA 1997; and, even if it was
- it was part of a scheme to reduce income tax under the anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936).
Was the expense ‘incurred’ in the relevant year?
The FCA found that the Taxpayer did not incur a loss or outgoing within the meaning of section 8-1(1)(a) of the ITAA 1997 to pay the balance of the Purchase Price in the 2009 income year because the liability to pay for the carbon credits was contingent on the carbon credits coming into existence at an uncertain future time. The FCA concluded that no reasonable business person in the Taxpayer’s position would have understood that by entering into the Agreement, the Taxpayer had ‘completely subjected itself’ to pay the second instalment as required in order to ‘incur’ losses in the relevant income year.
The business purpose issue
The FCA also found the Purchase Price failed section 8-1(1)(b) of the ITAA 1997 on the basis that the expenditure was not appropriate and adapted for carrying on that business and had no real or sufficient connection to the Taxpayer’s business. In reaching this conclusion, the FCA took into account the following considerations:
- the investment in the Agreement was considerably out of the nature and character of the Taxpayer’s business activities and was excessive, as the cost was about 10 times the taxable profit that the Taxpayer would have made in the 2009 income year
- the only actions that the sole director took after entering the Agreement were to promote the company environmental credentials to its existing and potential clientele and
- the Taxpayer had never thought of, or inquired about, when the projects that Carbon Strategic was supposed to be pursuing would be brought to fruition. This was highlighted by the fact that the sole director of the Taxpayer was unaware that Carbon Strategic had been wound up in 2015.
Part IVA issue
The FCA found that the dominant purpose of the Taxpayer was to enable it to obtain a tax benefit (namely, to be able to claim a significant deduction) in connection with that scheme within the meaning of section 177D of the ITAA 1936.
The FCA considered that the scheme was contrived to achieve an immediate tax deduction of twice the value of the deposit payable using a grossly inflated price per tonne of carbon dioxide equivalent in contract lots that did not reflect any reasonable or commercial relationship to any market in which carbon credits were being traded.
Tribunal finds preparation of plans for performance of building works is not ‘building works’ for the purposes of the building boost grant
The Queensland Civil and Administrative Tribunal Appeals (Appeals Tribunal) in Commissioner of State Revenue v Gundachar  QCATA 79 recently found that the preparation of plans for performance of building work does not constitute ‘building work’ for the purposes of section 14(f) of the Building Boost Grant Act 2011 (Qld) (BBGA). Rather, ‘building work’ is limited to the physical construction of a home and the Taxpayer was unable to broaden the definition by relying on the same words from different legislation where there was no cross-references in the legislation.
Taxpayers should seek legal advice when any grant relies on the application of strict legal definitions within the policy of the relevant Act. In this case, the Appeals Tribunal heard an appeal by the Commissioner of State Revenue (Commissioner) against the primary tribunal member’s (Tribunal Member) decision to set aside the Commissioner’s decision to refuse to grant a Taxpayer the ‘building boost grant’ under the BBGA.
The case centred on the proper construction of subsection 14(f) of the BBGA and, in particular, the meaning of ‘building work’.
Under the BBGA, a taxpayer is entitled to the building boosting grant where a home purchase contract is an ‘eligible home purchase contract’. For a contract to purchase a new home on a proposed lot on an unregistered plan of subdivision of land to be an eligible home purchase contract, among other things, the building work must start before 1 May 2013 and be completed before 1 March 2015 (or the contract must stipulated that building work is to be completed in accordance with these dates).
At first instance, the Tribunal Member found that the Taxpayer was entitled to the grant on the basis that the term ‘building work’ included the preparation of plans for the performance of building work.
The Commissioner sought to appeal that decision on the basis that the Tribunal Member had erred in law by:
- construing the term ‘building work’ in accordance with the definition of that term in the Queensland Building and Construction Act 1991 (QBCA) and
- construing the term ‘building work’ in the BBGA as including preparation of a building.
Should the term ‘building work’ be construed in accordance with the definition of that term in the QBCA?
The Appeals Tribunal found that the definition of ‘building work’ in the QBCA does not provide a satisfactory basis for interpreting that (undefined) phrase in the BBGA and that the Tribunal Member had therefore made an error in law by doing so. The Appeals Tribunal relied on the fact that there is no similarity of purpose or subject matter between the respective Acts as would warrant the conclusion that the Acts should be comparatively considered.
Should the term ‘building work’ be construed in the BBGA as including the preparation of a building?
The Appeals Tribunal found that the meaning of ‘building work’ in section 14(f) (and elsewhere in the BBGA) is work involving the physical construction of a ‘home’. Importantly, the Appeals Tribunal concluded that the preparation of plans (or specifications) is not building work because it is not work involved in the physical construction of a home.
Legislation and government policy
New regulations under the Taxation Administration Act 1953 to come in force from 1 October 2017
The Government has recently released the Taxation Administration Regulations 2017 (Cth) (Regulations) in exposure draft form to replace the Taxation Administration Regulations 1976 (Cth) (1976 Regulations) which is due to be automatically repealed on 1 October 2017.
The Regulations provide further compliance requirements in the administrative framework for taxation laws, including the collection and recovery of income tax and other liabilities, appeal processes, payments, enforcement and, rulings.
The Regulations are intended to improve the 1976 Regulations by repealing redundant provisions, simplifying language and restructuring provisions for ease of navigation. However, the changes are not intended to affect the substantive meaning or operation of the 1976 Regulations.
The Regulations will commence on 1 October 2017.
The closing date for submissions to The Treasury is Friday, 18 August 2013.
The United States and Australia agree to bilateral CbC report exchange agreement
On 1 August 2017, the US and Australia signed the Competent Authority Arrangement to exchange Country by Country (CbC) Reports. This means that any Australian entity that is a ‘significant global entity’ (and therefore subject to CbC reporting) that has a parent company in the US or is itself the parent company of a US subsidiary, will need to exchange CbC reports for the year starting 1 January 2016.
Hall & Wilcox update
Business & Estate Planning Conference
Andrew presented on passing control of family business and business succession, focusing on how to transfer ownership or control of family assets or structures to the next generations without triggering unnecessary tax liabilities or unravelling asset protection strategies. (A paper on this topic, which was written with the assistance of Raoul D’Cruz, will be available from the Tax Institute shortly).
In a session chaired by Andrew, James Whiley presented on international estate and succession planning issues for families with global assets, covering issues such as conflicts of laws, and Australian and foreign tax and residency.
Employee v Contractor - transport & logistics industry - tax issues presentation on 30 August 2017
On 30 August 2017, Frank Hinoporos and Joni Pirovich will be presenting on "Effective Contractor Management - from a tax perspective" at the Container Transport Alliance Australian forum for Shippers, Forwarders and Container Transporters. Frank and Joni will be highlighting the taxes and penalties that can arise if a contractor is actually an employee, some positive and negative case studies and risk mitigation and management strategies. Taxes and penalties include PAYG-W, Director Penalty Notices, minimum superannuation obligations, superannuation guarantee charge and payroll tax.
Please be in touch with Frank or Joni if you would like further details regarding the presentation or to discuss tax issues arising from the classification of your worker/s as an employee or independent contractor.
To register, or for further information about the forum, please see the following flyer.
You might be also interested in...
Banking & Finance | 15 Aug 2017
Proposed changes to self-reporting of contraventions including new and higher penalties
The Australian Securities and Investments Commission (ASIC) is becoming more proactive, and a recent review proposes expanding the regulator’s powers.
Superannuation | 15 Aug 2017
Changing the trustees of a self-managed superannuation fund (SMSF) is not necessarily a straightforward task, as evidenced by a recent Queensland Supreme Court case.