Tax Rambling

It has been a while but the Government is back with some new law. Yes I know we had the changes to the personal tax rates, but that was boring (changes to rates and thresholds). Now we have some real meaty changes to digest!

The beautiful named “Treasury Laws Amendment (2019 Tax Integrity and Other Measures No. 1) Bill 2019” has some very interesting changes.

One of my favourites in the SG Act will be changes so that an individual’s salary sacrifice super contributions cannot be used to reduce an employer’s minimum SG contributions. It does this stating an employer must contribute at least 9.5% of an employee’s ordinary time earnings and any amounts sacrificed into superannuation that would have been ordinary time earning if there was no packaging. Interestingly, if an employer has a shortfall, the amount of the shortfall will be calculated by reference to their employee’s salary or wages base, and now any amounts sacrificed into superannuation that would have been salary or wages, but for the salary sacrifice arrangement. These changes start on 1 July 2020.

But you want something meatier? How about the fact that the Bill denies deductions that relate to holding vacant land. Before you scream, this does not apply to where the land is used or held available for use in the course of carrying on a business in order to earn assessable income. It also does not apply to corporate tax entities, superannuation funds (but it does apply to SMSFs, managed investment trusts, public unit trusts or unit trusts or partnerships of which all the members are entities of the these types.

Land is vacant if there is no substantial and permanent building or other structure that is in use or available for use on the land, with an independent purpose that is not incidental to the purpose of another structure or proposed structure on the land.  Have a look at these examples:

Example 3.1: Vacant land
Chelsy owns a block of land. She intends to eventually build a rental property on the land. However, while the block of land is fenced and has a retaining wall, it currently does not contain any substantial and permanent building or other structure with an independent purpose that is not incidental to the purpose of another building or structure. As the block of land does not have a substantial and permanent structure on it, it is vacant land and Chelsy cannot deduct any holding costs she may incur in relation to the land.

Or worse…

Example 3.2: Expenditure for mixed use land
Howard owns one hectare of land in Queensland. He uses one third of the land for carrying on his firewood sales business. He stores all his firewood in the open and there are no structures on the land. Howard has set aside the remainder of the land to construct a rental property. The remaining part of the land is separately fenced off and has been subject to site work including earthworks to clear the land ready for construction.
Howard is eligible to claim losses and outgoings relating to holding the part of the land that he uses for carrying on his firewood business, to the extent that the loss or outgoing is necessarily incurred for the purpose of gaining or producing the assessable income.
The remainder of his land is not used or held available for use in carrying on his firewood business. Further, as there are no structures on Howard’s land, it cannot contain a building or other structure that meets the requirements of these amendments. As a result, Howard is not entitled to claim any deductions relating to the costs of holding this part of the land even though he intended to derive income from it in the future as a rental property.

And now comes the kicker… There is a special rule applies when determining if land that contains residential premises is vacant. The land is treated as remaining vacant for the purposes of these amendments until the residential premises are able to be occupied under the law and leased, hired or licensed or available for lease, hire or licence. IF YOU DON’T HAVE AN OCCUPANCY PERMIT AND HAVE NOT ADVERTISED THE LAND IS VACANT??? Magic, you just made a building disappear and miraculously reappear as soon as you advertised for a buyer! This applies from the start of the first quarterly period commencing after the day of Royal Assent of the Bill.

Not meaty enough… What about the change to prevent the small business CGT concessions from being available for assignments of the income of a partner and other rights or interests in the income or capital of a partnership that are not a membership interest in the partnership.

When capital gains arise from a CGT event that involves the creation, transfer, variation or cessation of a right or interest that entitles an entity to either an amount of the income or capital of a partnership or an amount calculated by reference to the partner’s entitlement to an amount of income or capital of a partnership then we have a new test in the small business CGT concessions. This new test states that these concessions can only be used if the CGT event  make the entity holding the right or interest a partner (including for example, the transfer of all or part of a partner’s share in a partnership to another entity, making that other entity a partner or increasing their existing share in the partnership). So you can transfer the whole interest and not be a partner any more, but you just can’t transfer the income rights.

Laura, a partner in a partnership, makes an equitable assignment of half her partnership interest to Dominic, her spouse. This entitles Dominic to half of any amounts Laura receives as a partner, but does not make Dominic a partner.
The assignment results in Laura having a CGT event. The CGT event involves both the variation of Laura’s partnership interest and the creation of a right in the hands of Dominic. The partnership interest held by Laura and the equitable interest held by Dominic must be membership interests for the new additional basic condition to be satisfied in relation to the CGT event.
The partnership interest held by Laura is a membership interest of Laura’s in the partnership and satisfies the condition. The equitable interest held by Dominic is not a membership interest of Dominic’s and cannot satisfy the condition.
As Dominic’s interest does not satisfy the new additional basic condition, the small business CGT concessions are not available to Laura in relation to the CGT event.

This applies from May 2018.

I feel like a salad now…

The Commissioner has shown us his ability to bend and twist in relation to the FBT exemption that applies to taxi travel by an employee beginning or ending at the employee’s place of work.

He states that the exemption is limited to travel in a vehicle licensed by the relevant state or territory to operate as a taxi. It does not extend to ride-sourcing services provided in a vehicle that is not licensed to operate as a taxi. Have a look at this…

The Commissioner says nothing to explain why the term “taxi” in the FBTAA does not include an Uber, but the term “taxi” in the GST Act does include an Uber so that Uber drivers have to register for GST for their first trip, rather than when their turnover in over $75,000.

Would it possibly be that the Commissioner interprets the term “taxi” in two contradictory ways in two different Acts so that they both end up in his favour (he gets more FBT and more GST)????

This is an important question, primarily for the small business entity concessions which require the entity to be carrying on a business. It is also important for applying the lower company tax rate before 1 July 2017, when a company had to be carrying on a business to get the lower rate as the rate was linked to being a small business entity.

Therefore, probably 3 years after we lodged our first company return in July 2016 where we could claim the lower company tax rate, the Commissioner has provided some guidance to this question.

In Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? he answers the question. But only for companies. But only for the small business entity rules and the lower company tax rate rules. He seriously says that the word “business” in Division 328 mean what this ruling says but we cannot use this where the word “business” is in other places in the tax acts. And he seriously says it does not apply to understanding if a trust or an individual is carrying on a trust.

What does he say? He states that the key indicia considered by the courts in determining whether the activities carried on by an entity amount to the carrying on of a business are:

• Whether the person intends to carry on a business;
• The nature of the activities, particularly whether they have a profit-making purpose;
• Whether the activities are repeated and regular and organised in a business-like manner, including the keeping of books, records and the use of a system;
• The size and scale of a company’s activities including the amount of capital employed in them; and
• Whether the activity is better described as a hobby, or recreation.

That is all well, but it is how he applies these criteria that is awesome for us.

“However, where a limited (including a proprietary limited) or NL company is established and maintained to make a profit for its shareholders, and invests its assets in gainful activities that have both a purpose and prospect of profit, it will normally be carrying on a business in a general sense.”

“A limited (including a proprietary limited) or NL company engaged in gainful activities may be able to establish that it is not carrying on a business in limited circumstances. The most common situations are where it can be shown, on the facts, that the company has no purpose or prospect of profit, and its activities lack a commercial character.”

And look at what he says about our bucket companies…

“Most corporate beneficiaries of family discretionary trusts are formed and appointed beneficiaries of trusts, with the clear expectation of being made entitled to any trust income that exceeds the amounts the trustee will appoint to individuals in the family. They are usually appointed income, often repeatedly. They either reinvest the income in the trust, by way of a formal loan, by leaving the income uncalled for, or invest it in other ways that give rise to an entitlement to a return of profits. These companies are carrying on a business to profit in connection with the trust. This conclusion is stronger for companies investing in widely held or fixed trusts.”

Have a look at these examples he gives.

Example 1 – inactive company with retained profits

InactiveCo is a company incorporated in Australia. InactiveCo carried on a trading business that was wound up in the 2015-16 income year. InactiveCo has $400,000 of retained earnings which it holds in a bank account.

 In the 2016-17 and later income years, the company’s income has consisted solely of interest of $12,000 a year. InactiveCo has no intention of resuming its trading business. InactiveCo pays an annual company review fee of $254 to ASIC[84]. The company’s income is consistently greater than its expenses. As a result, the company has made a profit in each income year from 2016-17.

 InactiveCo’s activities have both a purpose and prospect of profit. InactiveCo is carrying on a business.

Example 2 – company is engaged in preliminary activities invests its assets in producing income

 Future Co is a newly incorporated company. Its activities consist of investigating whether it would be viable to carry on a particular business in the future and investing its $300,000 in share capital in income producing bank accounts. No decision has been made to carry on the business under investigation. However, it derives $9,000 a year in interest from its bank accounts. While Future Co’s activities of investigating the potential business may be preliminary in nature and not a business, it nonetheless carries on a business as a result of its activity of investing for profit.

Example 4 – share investment company

ShareCo is a company incorporated in Australia. ShareCo holds a portfolio of listed shares worth $400,000. The shares generate $20,000 in income a year, after expenses. ShareCo was formed for the purpose of investing in shares with the intention of earning income from dividends. Its share portfolio was selected with this in mind.

ShareCo has applied its assets in ongoing activities that have both a purpose and a prospect of profit. ShareCo has also invested a substantial amount of capital, and the dividend income is received by way of periodic payments.

If ShareCo does not engage a third party to manage its portfolio of shares. ShareCo carries on a business.

If Share Co engages a professional investment advisor and manager to manage its investment portfolio. ShareCo carries on a business.

But just so you don’t get too excited, on the same day he released this Ruling he released Draft Taxation Determination TD 2019/D4 Income tax: can a company that carries on a business in a general sense as described in TR 2019/1 but whose only activity is renting out an investment property claim the CGT small business concessions in relation to that investment property? So does this new understanding of business increase our access to the small business CGT concessions… No.

Example: property investment company

InveproCo is a company incorporated in Australia. InveproCo owns a commercial property, which it has rented to third parties at market rates on normal commercial terms since its inception. InveproCo provides no other services in relation to the property and conducts no other activities. InveproCo has produced a profit in each of the income years it has rented out the property. InveproCo is engaged in ongoing activities that have a purpose and prospect of profit, including letting out the property.

In this situation, the company has derived rental income from the leasing of a property. Accordingly, the company carries on a business in a general sense described in TR 2019/1. However, the main (only) use of the property is to derive rent and it is therefore excluded from being an active asset under paragraph 152-40(4)(e) regardless of whether the activities constitute the carrying on of a business in a general sense. Therefore, the investment property would not satisfy the active asset test in section 152-35 and InveproCo would not meet the requirement in paragraph 152-10(1)(d) to be eligible for the CGT small business concessions in Division 152 in relation to the disposal of the investment property.

In a new Bill before Parliament (Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019) the Commissioner gets some new powers.

First, this Bill will allow the Commissioner to retain tax refunds where a taxpayer has failed to lodge a return or provide other information that may affect the amount the Commissioner refunds. The Commissioner may retain the refund until the return or other information is provided, or an assessment is made.

And second, this Bill allows the Commissioner to collect estimates of anticipated GST liabilities. Yes he can guess what your GST on the future might be and ask you to pay it!

But neither of these methods comes close to the way the German’s do it… Pay your tax or we will take your dog! From the BBC…

I know, I know… This is a stupid idea as you lose the CGT discount…

But remember that the discount could be 25%, not 50%, if there is a change in Government in May. And the highest marginal tax rate goes to 49% if there is a change in Government. And some companies will have a tax rate of as little as 25% in a few years time…

So, if all this happens will it ever be better to buy shares in a company than in your own name?

In the attached document I compare buying shares that have a fully franked 6% yield and 3% capital growth where you reinvest the dividends each years for 5 years, first in your own name and then a company… And the company wins… Including paying out the amount to the individual.

I never thought it would be so close.

Idea

In country Victoria, when they get caught for not lodging tax returns, they try (and fail) to avoid having to do so by arguing they do not exist.

Has he ever heard of “Cogito, ergo sum” (I think therefore I am) from René Descartes. Maybe he should have said “Cogito ergo uectigalis” (I think therefore I pay tax. But my Latin is a bit rusty…

Sometimes it is good to remember the basics, especially when the Commissioner is focusing on it. So lets go back to 2001 and have a look at one of my favourite Practice Statements – Practice Statement Law Administration PS LA 2001/6 Verification approaches for home office running expenses and and electronic device expenses.

What I like the most are the examples, primarily because they don’t say that you can just pick a percentage and claim that amount of the cost of your phone and internet costs (and why is it alway 80% that taxpayer guess anyway?).

S0 how do we work out the deduction for the calls and data on or phones and devices? According to this Statement…

Taxpayer’s can calculate their device usage expenses by:

• keeping records and written evidence to determine their work-related proportion of actual expenses, or
• claiming up to $50 in total for all device usage charges (being phone calls, text messages and internet use for all devices) with limited documentation. This approach is appropriate where their device usage is incidental.

There are two options, being only claim $50 for the year and no more or have written evidence and records to justify the claim above $50 – no “I just estimated a percentage” allowed!

Have a look at this example.

Example  internet expenses – time basis

Ben is an employee IT technician who generally works from home three days per week (eight hours per day). In order for Ben to log on to his employer’s network he is required to use his personal home internet connection. This expense is not reimbursed by Ben’s employer.

Considering Ben’s usage is more than incidental he decides to calculate his actual expenses incurred using the ‘time basis’ method.

Ben has determined his time using the internet for work over a representative four-week period as 96 hours (24 hours per week). However, to determine his time using the internet for non-work purposes Ben considers all of the private devices that use the internet connection. This includes his:

• gaming console for online gaming
• smart TV for streaming television and movies, and
• mobile phone to browse the internet.

Ben estimates that he is directly or indirectly (for example, automatic updating) using the internet connection in relation to these devices for four hours per weekday and 16 hours on the weekend. This equates to 144 hours over a representative four- week period. Based on this analysis, Ben is using the internet for a total of 240 hours in a four- week period, of which 96 hours, or 40%, is work-related.

Ben’s wife also uses the internet connection for a similar period of time – that is, 144 hours over a representative four-week period. In this situation, the internet connection is used for a total of 384 hours in a four-week period, of which 96 hours, or 25%, is Ben’s work-related portion.

Internet expenses = 25% of monthly expenses ($60) x 11 months (taking into account Ben’s four weeks annual leave) = $165.00

Either claim $50 or keep a time record of all the use of you and your family of the internet. And to be clear, “but I have to have a connection for work” does not mean you get a 100% deduction.

And a similar but easier analysis is needed for home office expenses. However, you only need work hours.

Example – home office running expenses

Betty is an employee accountant working for a city-based firm that expects her to complete a specified amount of work each day. In order to achieve this, Betty has elected to take some of her work home at night so that she can spend more time with her family. Betty spends an average of two hours per night Monday to Friday working in her home office.

Betty has two options for calculating her home office running expenses. She can calculate the proportion of actual home office running expenses that are work-related, or use the rate of 52 cents per hour. Betty opts to use the rate of 52 cents per hour and keeps a record showing she worked at home for 10 hours per week for 48 weeks in the year. Her deduction is calculated as:

Running expenses = 52c per hour x 10 hours per week x 48 weeks = $249.60

So you should track the time you work from home.