Tax Rambling

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.

Go to Wikipedia and look at the list of the verified oldest people and coming in first is Jeanne Calment, who it is claimed was born on 21 February 1875 and passed away on 4 August 1997 at the ripe old age of 122 years, 164 days.

What was the secret of her long life? It appears it may have been tax fraud!

It is now claimed that Mrs Calment died in 1934 and her daughter, Yvonne, then pretended to be her mother from that time. The daughter’s name was put on the death certificate rather than her mother’s name. So why would the family do this?

At the time of the death, Mr and Mrs Calment owned 50% each of a very successful, multi story department store, and if she died in 1934, 50% of the value of the entire business would have been taxed at what was an amazingly high inheritance tax rate of 38%.

In other words, if Mrs Calment did die in 1934, Mr Calment would have been the 100% owner of the business, but he would need to find cash equalling 19% of the business’ value to pay in inheritance tax.

So, it is alleged that to save a great deal of tax, they made sure the correct person died.

I have no idea if this is what happened, as it is denied by the researchers who confirmed her age at her death, but I am pretty sure there are people who would go this far to avoid some tax.

I was reading the 24th Amendment of the United States Constitution on a Saturday night (doesn’t everyone read comparative international tax for a big night out on Saturdays?) and found that Congress and the states cannot stop people voting in elections if they have not paid “a poll tax or other types of tax”.

Southern states run by the Democratic Party adopted these poll taxes voting rules as a measure to prevent African Americans from voting in the first third of the 1900s.

I looked in our Constitution and could not find any equivalent specific rule stopping the Australian government from stopping people who don’t pay their taxes from voting… But why would 21st century Australia want to bring in this type of rule?

If tax is not theft (as some will argue) and it is not a payment for services (which it is hard to argue it is) then it is a payment we make to the government under some form of social contract. We get to vote for who decides how to use the money that we collectively agree we all should pay. And if this is the case, then a rule like this makes sense.

If you don’t make your payments, you don’t get to decide who get to work out how to spend it. Put simply, if you don’t pay your taxes you don’t get to vote. While you have a tax debt of a certain amount you are unable to vote.

But what is the High Court going to say if this law was brought in? To answer this we can look at the felony disenfranchisement rules we have had in Australia – the rule that convicted felons cannot vote.

We have had rules in Australia since 1902 that have denied voting for certain felons (either all felons or longer than 5 years). In 2006 this ban was extended to all prisoners, but in 2007, the High Court of Australia in Roach v Electoral Commissioner found that the Australian constitution enshrined a limited right to vote. Therefore, citizens serving relatively short prison sentences (generally less than three years) cannot be barred from voting.

Chief Justice Murray Gleeson held that the right to vote was constitutionally protected as the constitution states that our politicians will be “directly chosen by the people of the Commonwealth” (sections 7 and 24). But he agreed limitations could be put on this as long as the reasons were worth of such extreme consequences. The law that he was considering stated it wanted to remove the right to vote for serious misconduct. This was acceptable. However, the law identified what was serious criminal misconduct by saying where any prison sentence was given. The Chief Justice stated that short-term sentences could be imposed for arbitrary reasons, such as location or homelessness, that were unrelated to the seriousness and so this rule was not valid. He argued that a term of three years would be appropriate.

What guidance would this give us for our “unpaid tax, no vote rule”? Just like the Roach case, as long as the bar is set high enough, I would expect the High Court to accept it. If the bar was $10,000 of debts, not under a payment agreement and outstanding for 6 months, this may be enough. And what if an individual has not lodge say three years of tax returns?

So how about this as the new tool for the Commissioner to get people to lodge their outstanding returns and pay their tax? An I kidding myself that anyone would care enough about their chance to number some boxes and eat a badly cooked sausage to change their tax practices? Probably…

On 24 May 2018, the Government introduced the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018, proposing a Superannuation Guarantee Amnesty, so that if you let the Commissioner know of any unpaid super all the way back to 1992, and make the payment by 23 May 2019, the payment will be deductible and the $20 per employee per period penalty will not apply.

As at 6 December 2018, our hard working parliamentarian concluded for the year, but they were too busy to enact this Amnesty bill. The Bill had made it to the Senate so all we need is approval from the Senate.

But how many days will the Senate sit before 23 May 2019, when the amnesty runs out? The Senate will sit on 12, 13 and 14 February and then not again until 13, 14, 15 and 16 May.

If you have a client who missed some super, you won’t want to miss this Amnesty, but if the Senators cannot approve the Bill as it is without any changes, it will go back to the House of Reps and return for final approval in mid May.

It looks like you will have 10 days (16 May 2019 to 23 May 2019) to tell the Commissioner of the underpayment and make the payment with certainty of the penalty…

The Commissioner has released a draft Ruling (LCR 2018/D10 Non-arm’s length income – expenditure incurred under a non-arm’s length arrangement) on the proposed amendments to section 295-550 so that the non arms length income rules for super funds will apply to a scheme where a superannuation entity incurs non-arm’s length expenditure, or where expenditure is not incurred.

How will these rules work…

Example 1 – purchase less than market value and no in-specie contribution – NALI

During the 2018-19 income year, Russell, as trustee of his self-managed superannuation fund, purchased listed shares from a related entity for $500,000. The market value of the shares at the time of purchase was $900,000. The terms of the agreement specifies the purchase price as $500,000, rather than $900,000.

The non-arm’s length dealing between Russell’s SMSF and his related entity amounts to a scheme, which has resulted in his superannuation fund incurring capital expenditure that was less than would otherwise be expected if those parties were dealing with each other at arm’s length in relation to the scheme. The capital expenditure was incurred in gaining or producing the dividend income. Any dividend income derived by the superannuation fund from the shares will be NALI.

This seems simple but can get very messy… Have a look at how the Commissioner see this change applying to work done by the Trustee/Member of the SMSF in relation to the assets of the fund…

Lucky the Commissioner like accountants…

Example 4 – Internal arrangement within an SMSF – trustee provides services to the fund

Leonie is a trustee of an SMSF of which she is the sole member. She is a chartered accountant and also runs an accounting business. Leonie in her capacity as trustee, prepares the accounts and annual return for the fund. As she performs these duties or services as trustee of the SMSF, she does not charge the fund for this work.[18] The NALI provisions do not apply as the duties or services performed by Leonie are in her capacity as trustee rather than under an arrangement in which parties are dealing with one another on a non-arm’s length basis.

Example 5 – SMSF trustee carrying out duties in their personal capacity

Sharon is a trustee of an SMSF of which she is the sole member. She is a licensed real estate agent and runs a real estate business which includes property management services for rental properties. The SMSF holds a residential property which it leases for a commercial rate of rent. Sharon provides property management services in her personal capacity to the SMSF with respect to the residential property. She charges the SMSF 50% of the price for her services that she would otherwise charge a non-related party.

For the purposes of subsection 295-550(1), the scheme involves the SMSF obtaining the services from Sharon and deriving the rental income. The price Sharon charges the SMSF constitutes a non-arm’s length dealing between the SMSF and Sharon, which resulted in the SMSF incurring expenditure in gaining or producing rental income that was less than would otherwise be expected if those parties were dealing with each other at arm’s length in relation to the scheme. The rental income derived from the residential property is therefore NALI.

It is not all bad news. In this draft Ruling the Commissioner states how we can overcome some of these non arms length expense issues when buying assets by treating the difference as an in-species contribution…

Example 3 – part purchase/part in-specie contribution at market value – not NALI

During the 2018-19 income year, Nadia owns commercial premises that she leases to a third party which use the premises to carry on a business. The commercial premises have a market value of $500,000. Nadia would like to transfer it to her SMSF but her fund only has $400,000 in cash. Nadia’s SMSF purchases 50% of the commercial premises under a contract from Nadia for $250,000. Nadia makes an in-specie non-concessional contribution of the remaining 50% interest in the commercial premises (valued at $250,000). The acceptance of the in-specie contribution by Nadia as trustee of the SMSF is recorded by her in writing and the market value of the in-specie contribution is reported in the fund’s accounts. The SMSF reports the non-concessional contribution to the ATO.

Nadia’s SMSF continues to lease the commercial premises to the third party at a commercial rate of rent. As the commercial premises were acquired by the SMSF at market value and a commercial rate of rent was charged, the rental income derived by the SMSF is not considered to be NALI. Any capital gain that might arise from the disposal of the factory will also not be NALI.

Lastly, remember that where a superannuation fund acquires a CGT asset at less than its market value, the market value substitution rule will apply, and modify the cost base of the asset. The superannuation fund, when determining the cost base of its CGT asset, is treated as having acquired the asset at market value. This affects the amount of any capital gain that may arise from a later CGT event, but does not affect the application of the NALI provisions in determining whether the asset was acquired by the fund at market value.

Therefore, any capital gain that the fund makes from a subsequent CGT event happening in relation to the asset (such as a disposal of the CGT asset) will be Non Arms Length Income.

Example 7 – market value substitution rules (CGT consequences for the transferor and the fund)

Continuing with Example 1 above, Russell’s SMSF sells the shares it acquired for $500,000 for $1 million two years later.

When calculating the capital gain for the fund on disposal of the shares, the cost base of the shares will be modified by the market value substitution rule in section 112-20[20] as the parties did not deal with each other at arm’s length in relation to the acquisition.

This means that the cost base for the shares will be their market value at the time of acquisition by Russell’s SMSF, which was $900,000. The SMSF has therefore realised a gross capital gain of $100,000 ($1 million sale proceeds less deemed cost base of $900,000).

The $100,000 capital gain derived by the superannuation fund is NALI. This is because the amount of expenditure incurred by the superannuation fund in acquiring the asset was less than what the superannuation fund might have been expected to incur if the parties were dealing with each other at arm’s length.

Ouch!

I doubt there are any, but if there are any regular readers of this crazy blog, they will know I have for many years screamed at the argument that Australia can fix its public finances if only those evil big businesses paid their fair share of tax.

And yes, I have been gloating that this argument started to crumble when the Commissioner early last year stated that the underpayment of tax by these businesses was only $2.4 billion a year. Remember that the underpayment of tax by salary and wage earners due to dodgy deductions or undeclared cash payments is $8.7 billion a year.

But it just keeps getting better…

Remember that the “large corporate group income tax gap” is the difference between the total amount of income tax collected and the amount the Commissioner estimates he would have been collected if every one of these taxpayers was fully compliant. And while the tax gap for salary and wage earners is mostly dodgy deductions ($7.3 billion a year underpayment of tax due to these), the “large corporate group income tax gap” primarily reflects differences in the interpretation of complex areas of tax law.

Have a look at what has been happening to this gap, while the salary and wage earner gap just keeps increasing…

The income tax gap for these large corporates is going down. And there is no wonder why. The multinational anti avoidance law, the diverted profits tax, country by country reporting, hybrid changes…

But watch the number of lobbyists and politicians, wanting money from a new government after the May election, saying that it all can be funded by making those evil big businesses pay their fair share of tax, which they already do…

But no one will dream about addressing the issue that is almost 500% bigger – salary and wage earners and their dodgy deductions.

If you want more analysis of the Treasury’s proposed changes to Division 7A in its October 2018 paper, and lots of complaints about how they have handled the process and the outcomes, I have written a paper on it that can be downloaded by clicking on the link below. Enjoy.

Division 7A to change