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Company tax rate cut comes with compromises
The Business Tax Working Group has released a discussion paper canvassing a number of possible ways in which a cut to the company tax rate could be funded from within the business tax system. The 71-page paper notes that the options canvassed are not recommendations and that, to date, the Working Group has not finalised an assessment of the costs and benefits of the options canvassed.
The Working Group says it “believes thatAustraliashould have an ambition to reduce its company tax rate over the medium term and that achieving a materially lower rate is a worthwhile reform objective”. The Working Group notes the Henry Tax Review’s proposal to cut the rate to 25% over the short to medium term. Further, according to preliminary Treasury estimates, a 25% company tax rate would have revenue implications totalling $26 billion over four years from 2012–2013.
According to the Working Group, a comprehensive tax base that contains minimal special exemptions and deductions for certain investments can result in a more productive mix of different investment options and a broader tax base that will generate greater revenue to fund a lower company tax rate. However, it notes that there may well be circumstances where a departure from a uniform tax base can be justified on economic grounds (such as encouraging activities that give rise to positive social benefits). Further, the Working Group notes that its terms of reference do not allow it to consider changes to the GST.
The Working Group’s consideration of base-broadening options builds upon its recent work on the tax treatment of losses whereby three areas were identified as being worthy of additional analysis:
- interest deductibility (including thin capitalisation rules);
- capital allowances and the treatment of capital expenditure; and
- the research and development (R&D) tax incentive.
The Working Group has been careful to note that the options set out in the paper should not be interpreted as an indication that they will be adopted by the Working Group or the Government. The Working Group is open to suggestions on potential transitional arrangements that could accompany any potential base-broadening options.
The Working Group says it plans to meet with stakeholders during August and September 2012 in relation to the discussion paper. The Working Group intends to release a draft of its final report to the Treasurer in late October 2012, with the final report due to the Treasurer in December 2012.
Submissions are due by 21 September 2012.
The ATO has released details of its 2012–2013 compliance program, highlighting the compliance issues attracting ATO attention and what it is doing to address them. The program covers individuals, micro businesses, SMEs, large businesses, Project Wickenby, tax practitioners, superannuation, promoter penalty laws and non-profit organisations. Focus areas identified by the ATO include:
- Incorrect claims for work-related expenses. In particular, the ATO says it will focus on claims made by plumbers, IT managers and defence force personnel. Taxpayers must keep written records for all their work-related expenses if their claims total more than $300.
- Tax avoidance schemes and tax effective investments. The ATO says it will focus on investments by medical practitioners and other high income individuals, particularly in widely marketed financial products that promise substantial tax benefits.
- Unrecorded and unreported cash transactions in the café and plastering industries. Note, the ATO is stepping up its use of third party information, such as information from suppliers, to identify under-reporting of income.
- GST refund integrity and GST evasion. The ATO says that with the introduction of the Commissioner’s discretion to retain high risk refunds, it may stop a small percentage of BASs for verification where it detects anomalies, discrepancies, unusual behaviour or changes in patterns. It says that in order to minimise the number of businesses having refunds delayed, it may also check some refunds after they have been paid.
- Incorrectly treating employees as contractors, particularly in the construction industry. In addition, the ATO notes that from 1 July 2012, businesses that make payments to contractors in the building and construction industry are required to report the payments to the ATO each year.
- Treatment of private company profits, particularly in relation to loan arrangements.
- Superannuation obligations of employers, with a focus on cafés and restaurants, real estate businesses and carpentry businesses in home building or construction.
- GST business systems in the certain industries. The ATO intends to conduct 500 reviews and audits in the mining, manufacturing, wholesale trade, and financial and insurance services industries in relation to GST business systems.
- Incorrect or contrived application of the consolidation cost-setting rules. The ATO notes that changes to the tax law in 2010 broadened the scope for deductions of the tax cost of certain assets in an unanticipated way. The ATO says it will administer the law as currently enacted in accordance with the administrative treatment published on its website. However, it notes that once legislative amendments have been enacted, it will assist taxpayers to review their claims relating to rights to future income and the residual tax cost-setting rules. The ATO says it is also examining cases where foreign partnerships are being included in consolidated groups for the apparent purpose of creating interest deductions in two countries (double-dipping). In checking whether such deductions are being correctly claimed inAustralia, the ATO says it is exchanging information with foreign tax authorities where appropriate.
- The self managed superannuation fund (SMSF) sector. The ATO has indicated a greater compliance focus on SMSFs. Focus areas for 2012–2013 include:
– new trustees, to ensure they can operate their SMSF and are not seeking to illegally access their retirement benefits;
– lodgment of fund annual returns to improve timeliness and, in the case of new funds, to also ensure they are entitled to receive their notice of compliance;
– irregularities in exempt current pension income (ECPI) and non-arm’s length transactions. The ATO says it will contact 3,000 funds in respect of their ECPI claim. It will also audit and review 100 SMSFs to ensure assets reflect their true market value;
– re-reporting of contributions and compliance with excess contributions tax release authorities; and
– breaches of trustee obligations reported to the ATO by approved auditors.
- Fraudulent phoenix activities. The ATO intends to conduct 200 reviews and audits targeting fraudulent phoenix activity. It will also increasingly use legal collection processes against phoenix company directors, including director penalties, garnishees and security bond demand notices.
- Trusts. The ATO says it will contact around 1,000 trustees and beneficiaries regarding a range of issues including lodgment, correct reporting of trust distributions and compliance with trust TFN withholding rules. It says it also expects to undertake around 30 reviews and at least 15 audits of aggressive trust arrangements.
- Project Wickenby. The ATO says around 300 audits and reviews will be progressed in relation to Project Wickenby. The ATO says it will also continue to “send strong messages” to those at risk of involvement in secrecy jurisdiction schemes. The ATO notes that since 2007–2008, there has been a reduction of funds flowing to 13 high-risk secrecy jurisdictions of approximately $12 billion.
Extended compliance focus areas
In addition to the key areas of focus addressed in the compliance program for 2012–2013, the ATO has also released details of its extended compliance focus areas as at 11 July 2012. Some of the key areas include business structure schemes, trust schemes, private company deemed dividend avoidance schemes and aggressive employee remuneration schemes.
In a recent speech, the Commissioner of Taxation discussed the ATO’s use of the small business benchmarks. The Commissioner said ATO statistics indicate that approximately 90% of small businesses in benchmarked industries fall within a benchmark ratio. However, he said around 76,000 businesses have reported income that is significantly below those benchmarks.
To address this issue, Mr D’Ascenzo said the ATO wrote to around 30,000 small businesses regarding the benchmarks in 2010–2011. He said around 17% (or over 5,000) of the businesses have since started reporting income commensurate with the benchmarks, thereby lowering their risk profile with the ATO. Mr D’Ascenzo said the small business benchmarks, together with other available information, will continue to inform the ATO’s compliance activities.
Other topics discussed by the Commissioner include:
- Information matching. The Commissioner said the ATO’s information matching program is expected to match over 600 million transactions in the current year (up from 538 million transactions in the 2011–2012 income year).
- Compliance and prosecution. The Commissioner said in the prior year, the ATO’s compliance activities in the small business sector yielded around $1.97 billion in additional taxes collected. In the last financial year, the Commissioner said the ATO prosecuted 1,430 entities (both individuals and companies) in the small business market for a range of offences including non-lodgment of tax returns and BASs, failure to comply with formal notices for information and making false and misleading statements.
- Future improvements for small businesses. The Commissioner also outlined some future technological improvements to the interactions of small businesses with the ATO. He said the ATO is aiming to allow small businesses to access and update their obligations online by 2013. Mr D’Ascenzo said the ATO aims to allow small businesses to complete obligations using a mobile device and track their dealings online by 2014. Finally, he said the ATO will aim to have integrated payment services, personalised options and cross-channel authorisation solutions for small businesses by 2015.
The ATO has issued Taxpayer Alert TA 2012/4 warning taxpayers about arrangements where accumulated profits of a private company are distributed substantially tax-free to an entity associated with the ordinary shareholders of the private company.
Broadly, the ATO says the arrangements the Alert applies to have the following (or substantially similar) features:
- a private company has accumulated significant profits that are subject to income tax at the company tax rate;
- the company’s ordinary shares are held by one or more individuals who may also be the company’s directors;
- a tax intermediary then recommends the private company create a new class of shares that has some or all of the following characteristics:
– a right to receive a dividend distribution at the discretion of the company’s directors;
– a lack of any voting rights or rights to participate in surplus assets of the company upon its winding up;
– a right by the company to redeem the new shares within four years of the issue date; and/or
– a right by the company to abolish dividend entitlements on new shares within four years of the shares’ issue date;
- the new shares are then issued at nominal consideration to another entity or entities that are closely associated with the ordinary shareholders in the company;
- significant profits of the company are then distributed as a dividend to the entity or entities, in most instances with franking credits attached;
- a series of transactions is then entered into as a means of transferring the economic benefits of all or some of the dividends to the control of the ordinary shareholders of the private company with a purpose of securing a better tax outcome;
- in some cases, the transactions may be delayed for some time (ie planned to spread over a four-year period) and/or involve the use of promissory notes and/or “round robin” bank facilities;
- in certain arrangements, the dividend received by the entity or entities may be:
– lent to the ordinary shareholders or their associates;
– distributed to a trust, or individual who has carried forward tax losses, which may result in no tax being paid and may generate a refund of franking credits;
– distributed through a series of trusts and companies and may ultimately end up in the hands of, or the control of, the ordinary shareholders and/or their family in a manner that attracts no or minimal additional tax; or
– distributed to a non-resident who is not subject to any Australian tax, with the non-resident then lending a comparable amount back to the private company; and
- the ordinary shareholders and their advisers may indicate that there is a commercial rationale for the arrangement, such as asset protection.
The ATO says a taxing event may generate a capital gain under CGT event K8 for the ordinary shareholders of the private company by virtue of the direct value shifting rules in Div 725 of the Income Tax Assessment Act 1997 (ITAA 1997). It says the arrangements may also be a scheme by way of, or in the nature of, or that has substantially the effect of, dividend stripping under s 177E of the ITAA 1997.
In addition, the ATO says the arrangements may be a scheme to which Pt IVA may apply. Any entity involved with these arrangements may be a promoter of a tax scheme for the purposes of Div 290 of Sch 1 to the Taxation Administration Act 1953, and the ATO says that where the entity involved is also a tax practitioner, they will be referred to the Tax Practitioners Board under the Tax Agent Services Act 2009.
The Federal Court has allowed an appeal by the Commissioner and held that a taxpayer had not in fact discharged the onus of proving that amounts of over $4.75 million deposited in its bank account from an overseas bank were not income, nor that payments made in respect of certain loans were deductible interest.
The taxpayer was one of many companies associated with one of two brothers and their successful manufacturing and property development business. The taxpayer’s financial statements for the 1997 to 2008 income years recorded a loan liability to an overseas bank, and substantial related interest expenses. The taxpayer said the liability amount approximated the total value of the taxpayer’s assets, while the interest expenses approximated its income. The Commissioner argued that the asserted loan liability related to funds that the taxpayer received as assessable, and that none of the asserted interest payments were deductible.
At first instance, in Re Areffco and FCT  AATA 628, the Administrative Appeals Tribunal (AAT) found that the amounts were legitimate loans and that the payments made back to the bank in respect of these loans were legitimate interest deductions. It did so essentially on the basis that there was a sound evidentiary basis for concluding that the receipts were (among other things) loans, that they were from a reputable overseas bank and that the outgoings were for real interest obligations in respect of those loans.
However, the Federal Court found that the AAT had erred in finding that the taxpayer had discharged the onus of proof that the amounts were not income. In particular, it found that the existence of a loan is primarily proved by an obligation of repayment under the terms of a contract under which money is transferred from one party to another, and that in this case there was no evidence before the AAT of any such contract, nor of any obligation on the part of the taxpayer to repay the amounts it received.
The Court also found the “reality and substance of the matter” was that the payments only represented some form of transfer of funds, rather than the making of loans, as evidenced by the fact that:
- there was no evidence of any obligation of repayment to the bank, ie there was no agreement, either in writing or oral, imposing an obligation of repayment;
- the lender was not prepared to have any of its officers give evidence in the proceedings, apart from furnishing the taxpayer with documents that went into evidence but that, in any event, did not establish any obligation of repayment;
- there was no evidence that the taxpayer or any other entity, affiliated or not, gave security for the transfer of funds whether by way of charge, lien, set-off or surety – which was consistent with the alternative explanation of the funds being the taxpayer’s funds;
- the taxpayer had no assets inAustralianor any apparent capacity to repay the alleged loans; and
- no withholding tax was withheld from the alleged interest payments, at least until the transactions fell under the scrutiny of the Commissioner.
Accordingly, the Court concluded that the taxpayer had not established that the funds transferred to its Australian bank account in 1997 were loans made to it by the overseas bank and that it had not therefore discharged the onus of showing the assessments were excessive.
The taxpayer has lodged a notice of appeal to the Full Federal Court against the decision.
FCT v Rawson Finances Pty Ltd  FCA 753
In an interlocutory matter the AAT has found that a taxpayer was at all relevant times a beneficiary of a trust estate and that an amended assessment issued in April 2010 for the 2005 tax year was issued within time – that is, within four years pursuant to Item 4 of s 170(1) of the Income Tax Assessment Act 1936.
The taxpayer lodged his 2005 tax return in April 2006, disclosing a nil amount under the Label “Distributions from trusts”. The original assessment was issued on 18 April 2006. However, on 12 April 2010, the Commissioner issued an amended assessment that included an additional $2.1 million for the 2005 tax year.
The AAT noted that during the 2005 tax year, a distribution of trust income was allocated to the taxpayer’s wife with the remainder allocated to a company, but none was allocated to the taxpayer. The AAT also noted the trust deed defined “Father” in the “Eligible Classes” to mean the taxpayer.
The taxpayer argued that, as he had received no distributions in relation to the 2005 tax year, he was not a beneficiary of the trust estate at any time in that year and therefore the amended assessment was out of time.
Essentially, the taxpayer made arguments about the ordinary legal meaning of the word “beneficiary” and proposed a narrower construction of the concept in the context of qualification (d) of Item 1 of s 170(1); broadly, it was argued the qualification requires the beneficiary to have “received” an entitlement. The taxpayer also argued that s 170 imposes “a special, more rigorous or penal tax regime” and should be read down in favour of the taxpayer. Further, the taxpayer contended that the construction of s 170 advanced by the Commissioner would produce “unlikely, improbable and surprising, if not anomalous, outcomes” and therefore should not be preferred.
The Commissioner contended that, as the taxpayer was a member of the Eligible Class, the taxpayer was a beneficiary of the trust estate during the whole of the 2005 tax year, and accordingly, the amended assessment was within time.
The issue for determination was whether the taxpayer was “a beneficiary of a trust estate at any time” in the 2005 tax year as those words are used in qualification (d) of Item 1 of s 170(1). If so, the Commissioner’s power to issue amended assessments can be extended from two years to four years by Item 4. The AAT rejected the arguments raised by the taxpayer. It found that the taxpayer was at all relevant times a beneficiary under the trust, and that the amended assessment was timely by operation of Item 4 of s 170(1).
Re Yazbek and FCT  AATA 477
The Minister for Superannuation has announced that the Government will introduce penalties to deter promoters of illegal early release superannuation schemes. Mr Shorten said these promoters have in the past exploited vulnerable people by encouraging applications for rollover of superannuation balances. In these situations, he said the promoters have taken fees of up to 50% of the member’s superannuation balance.
Mr Shorten said promoters of these schemes generally target non-English speaking communities and take advantage of those who may not be fully aware of the rules regarding access to superannuation benefits. According to Mr Shorten, some schemes have facilitated up to $8 million in illegal release of superannuation benefits and generated millions in commissions for promoters. In some cases, promoters have gone further and exploited identity data for other criminal purposes or actually stolen the entire balance.
The Minister said legislation giving effect to the penalties is being progressed and will take effect when Royal Assent is received.