Tax Rambling

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.

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…