Income Tax Tax Policy

More proof that journalists are lobbyists

In the fairfax papers today is another “big companies should pay more tax” article. And like most of these articles, it is just rubbish.

The article states that ASX listed companies have tax rates at less than 30% – even lower than 10% – from analysing their accounts and looking at their tax expense line.

Let me tell you how this happens and you tell me if there is a problem.

I am a successful Australian Company. So successful I list on the ASX and in a few short years get 1/3rd of my income from Australia and the rest from the US. As the US income is taxes at 35% in the US before I bring it back to Australia I don’t pay another 30% Australian tax on top of the 35% I have already paid (the old section 23AJ ITAA36 or the new Division 768 ITAA97).

So as only 1/3rd of my income is taxed in Australia (as the other 2/3rds are taxed at 35% in the US) my effective tax rate is 10% as shown in my AIFRS accounts lodged with the ASX and ASIC.

There is no problem, avoidance, unethical behaviour… at all here. Except lobbyists and journalist knowing they are telling half truths.

UPDATE: Now the tax justice network behind this report are saying they don’t know why the tax rates are less than 30%…. They obviously don’t read this blog.

UPDATE 2: I just realised they included listed property trusts… Trust taxation for the very dummies – unit holders are taxed on their present entitlement, not the trusts. I wonder why the listed trust paid so little tax????? As my seven year old would say – derrrr!

UPDATE 3: I just heard an ABC journalist say to Senator Day “can’t we just make no changes to benefits and pensions and simply recover the $8 billion unpaid company tax by the ASX200 to balance the budget?” You watch how for the next decade “spendies” and their mouthpiece journalists will still claim there is $8 billion in unpaid company taxes. Great way to have a real debate about government revenues.

Income Tax Legislation Planning Idea Rulings

Using imputations credits in an entity that does not have retained earnings

I have been asked a few times about using imputations credits in an entity that does not have retained earnings. Well there are a series of ways to do this. What people often try to do in the small end of town is to drop in some tax free income (often using section 23AJ or AH or whatever the new section 23 AJ division in the ITAA97 is – 768???) or in the big end of town they use the consolidation rules to transfer the imputation credits to a group that has untaxed profits…

But I reckon there is a much easier way….

Revalue assets

A company can pay a franked dividend to its shareholders out of an unrealised capital profit of a permanent character recognised in its accounts that is available for distribution, provided that the company’s net assets exceed its share capital by at least the amount of the dividend, and the dividend is paid in accordance with the company’s constitution and without breaching section 254T or Part 2J.1 of the Corporations Act.

So is there an asset you can revalue? Have a look at this example from TR 2012/5:

74. Upwey Ltd has the following balance sheet:

Assets and Liabilities 
Cash            100
Property, plant and equipment            140
Investment in subsidiary            40
Net assets            280                       

Share capital            190
Accumulated losses            (40)
Permanent and unrealised capital profit reserve            130
Total equity            280

75.  Upwey Ltd is assumed to have a positive franking account balance due to its activities in prior years. Upwey Ltd determines to pay an $80 dividend. To pay the $80 dividend the company makes the following accounting entries:

Dr Permanent and unrealised capital profit reserve                        $80
Cr Cash            $80           

76.  In this example, the company has sourced the distribution from a species of profit account which is ascertained in its accounts, although it does not have any current or retained earnings. The payment of the $80 dividend does not result in net assets being less than share capital either before or after the dividend payment. On this basis, the dividend will be assessable under paragraph 44(1) (a) of the ITAA 1936, and will be a frankable distribution as it will not be sourced indirectly from the share capital account (assuming it satisfies all the other criteria in section 202-45 of the ITAA 1997). However, if Upwey Ltd’s net assets were less than its share capital, either before or after Upwey Ltd makes the distribution from the reserve (on the basis that it is an unrealised capital profit of a permanent character) it may not be frankable as a result of paragraph 202-45(e) of the ITAA 1997 depending on the particular facts and circumstances.

Income Tax Planning Idea

Can a new company pay a fully franked dividend in its first year?

A question I get asked regularly is can a new company pay a fully franked dividend in its first year, even if it has never paid a tax bill yet as it has not yet lodged its first tax return and so has not paid any PAYGI?

The answer is a big YES without any penalty. But let me explain why.

  1. The payment of the franked dividend will create a franking deficit tax liability may arise.
  2. But the Franking Deficit Tax can be offset against the company’s income tax bill that will be paid when they pay the first tax bill when the first return is lodged.
  3. However, this is where people get worried as they know that where the deficit at the end of the year is more than 10% of all the franking credits that arose during the year, which in this year was $0, the company’s franking deficit tax offset is reduced by 30%. But the 30% offset reduction does not apply in the first income year in which a private company has an income tax liability if all the conditions of subsection 205-70(5) are met. The main concern in this subsection is that the amount of the income tax liability for the relevant year is at least 90% of the amount of the deficit in the company’s franking account at the end of the relevant year. So be careful.
GST Legislation Rulings

“Excess GST”, “passed on”, “reimbursed”…

One of the best amendments to the GST Act ever was inserting a new Division, Division 142. This Division applies to tax periods starting on or after 31 May 2014.

The object of Division 142 is to ensure that excess GST is not refunded if this would give an entity a windfall gain.

In summary, the Division operates so that an entity is not entitled to a refund of an amount of excess GST where the entity has passed on the GST to another entity, and has not reimbursed the recipient for the passed-on GST.

Yes, I know you are asking me what is “excess GST”, “passed on” and “reimbursed”. To help, the Commissioner has released Draft GST Ruling GSTR 2014/D4. This is titled:

Goods and services tax: the meaning of the terms ‘passed on’ and ‘reimburse’ for the purposes of Division 142 of the A New Tax System (Goods and Services Tax) Act 1999

But first, an example if you have never seen Division 142 before…

Joshua sells his widgets to a Canadian company and incorrectly charges GST (excess GST). The Canadian company pays the $100 on the invoice that states there has been $10 of GST (GST passed on). Under Division 142, the supply Joshua made is a taxable supply and is not a GST-free export until Joshua refunds (reimburses) the $10 to the Canadian company. Once this amount is refunded Joshua can amend their BAS and reclaim the excess $10.

Excess GST is pretty simple…

Excess GST can arise by incorrectly treating something which is not a supply as a taxable supply, miscalculating a GST liability under the GST law, incorrectly reporting an amount of GST on a GST return or incorrectly treating a GST-free or input taxed supply as a taxable supply.

Notice this is not where you find addition input tax credits but only where the GST has been too high.

Has the GST has been passed on…

The Draft Ruling says look at the following factors to assess if the GST has benn passed on:

  • The manner in which the excess GST arose
  • The entity’s pricing policy and practice
  • The documentary evidence surrounding the transaction, and
  • Any other relevant circumstances.

In relation to the manner to which the excess GST arose, the Draft Ruling states that where an error occurs after the transaction has taken place, for example through a simple transcription error, this may point towards a finding that excess GST has not been passed on. Where the excess GST arises as a result of an error made before setting the price, this error will generally flow through to the sale price paid by the recipient and is likely to point towards a finding that excess GST has been passed on.

For example:

Diana provides personal aquatic survival skills courses and swimming lessons. She holds qualifications issued by a relevant accrediting association. Diana’s supply of the personal aquatic survival skills course is a GST-free supply of an education course under section 38-85 and Diana issues each student of this course with a tax invoice showing the amount of GST on the supply as nil.

When preparing her GST return, Diana mistakenly reports supplies of personal aquatic survival skills course as taxable and remits GST on each course.

As the excess GST arose when Diana filled out her GST return and she had issued tax invoices showing the amount of GST as nil, this would indicate that Diana has not passed on the excess GST.

In relation to pricing and policy the Commissioner states you need to consider if GST was included in working out what to charge for the supply. If it was, then the GST has been passed on.

Big-mart sells a range of food and retail products. Big-mart sets its prices at a level that is lower than its competitors for equivalent products. Big-mart contends that GST was not factored into its pricing methodology, despite the fact that it sets prices then adds GST at the end.

Big-mart realises that one of its products is GST-free, but has been treated as taxable. Big-mart immediately reduces the price of the product by 1/11th. The price reduction points towards a finding that the excess GST has been passed on.

The documentary evidence is basically what the tax invoice says. While it is not a 100% certainty, if there is a tax invoice with GST on it that has been paid by the customer, Division 142 will generally apply.

Taylor Co and David Co enter into an agreement for David Co to purchase Taylor Co’s business as a GST-free supply of a going concern. All the requirements of section 38-325 are met and the contract of sale is clear that the supply is a GST-free supply.

As Taylor Co regularly makes taxable supplies, Taylor Co’s new accounts manager does not realise that the supply of the business is a GST-free supply. The accounts manager issues a tax invoice to David Co showing an amount of GST payable, and includes the GST on the GST return.

Even though Taylor Co has issued a tax invoice for the supply showing an amount of GST payable, it has other documentary evidence including the contract of sale and other written correspondence with David Co which indicate that the excess GST has not been passed on.

However, excess GST may have been passed on even if there is no tax invoice, if the evidence suggests it was included in the price.

When is the GST reimbursed?

There are only two real issues here as what is a reimbursement will generally be obvious.

The first is when I cannot identify my customers? Bad luck…

Gavin Co is a large retailer that has introduced a new stock item, supplies of which it treated as taxable. Tax invoices were issued to customers showing an amount of GST on these supplies. Gavin Co later discovers that the supplies should have been treated as GST-free.

Gavin Co has an excess GST amount of $135,000 which was passed on to its customers.

In order to claim a refund of the excess GST that was passed on, Gavin Co must reimburse the excess GST that was passed on to its customers. However, Gavin Co is not able to identify those customers and so is unable to reimburse them.

Section 142-10 applies so that the excess GST is treated as always having been payable. Accordingly, Gavin Co is not entitled to a refund of the excess GST

The other issue is what if you don’t reimburse the whole amount, specifically as you decide to keep an administration fee. No luck again.

Patel Co is registered for GST and makes a supply to Kim which it believes to be taxable. Kim pays $3,300 for the supply which includes GST of $300 and receives a tax invoice. Kim is not registered or required to be registered for GST.

In its quarterly GST return, Patel Co includes GST payable of $300 for the supply to Kim. The $300 is taken into account in Patel Co’s net amount for the relevant tax period.

Subsequently Patel Co realises that the supply was not taxable and that the $300 is excess GST. The excess GST is taken to have always been payable until Patel Co reimburses Kim. However, Patel Co decides that it will only reimburse Kim if he agrees to pay a $30 administration fee which can be offset against the amount of excess GST to be reimbursed. Kim agrees to pay the fee and Patel Co only reimburses Kim $270 of the excess GST Kim paid.

Consequently, Patel Co is only entitled to a refund of $270. The remaining $30 (being the difference between the excess GST and what has been reimbursed) is taken to have always been payable under section 142-10. Patel Co is entitled to a decreasing adjustment of $270 in the tax period in which it became aware of the adjustment.

So in summary, your GST scheme where the supplier recovers all the GST is over if the GST was passed on to the customer – as it will in almost all sitiuations…

Income Tax Rulings

Employee Share Schemes – 4 simple rules…

The Commissioner has released a draft taxation determination on employee share schemes. While this draft determination relates a to employees who get a beneficial interest in a share subject to shareholder approval (this does not come within the employee share scheme rules) it is a great time to summarise the employee share scheme rules.

Simply, if you get shares or rights under an employee share scheme and these shares or rights are provided to you at less than their market value, then step through these rules:

Rule 1: The discount on the shares or right is included in your assessable income in the year you get the shares or rights.

Rule 2: If the scheme is available to 75% of the employees who have been at the employer for 3 years and the shares you get make up less than 5% of the share capital voting rights and there is no real risk in losing the shares or rights, you can reduce the discount by up to $1,000.

Rule 3: If there is a real risk of forfeiture then you can delay putting the discount in your assessable income until the earlier of:

  • When the risk of forfeiture ends
  • When your employment ends
  • When 7 years comes up.

Rule 4: And for CGT issues in the future the cost base is the market value at the time you put the discount in your assessable income…

Now that does not sound too hard does it….

Income Tax Legislation Rulings

Gardening leave and personal services income

I never thought I would read the term “gardening leave” in a tax ruling but it is the main issue in draft taxation determination TD 2014/D15.

The issue is whether the payment you get while you are on gardening leave (which if you don’t know is when you are told to go home, work in the garden, don’t come into the office ever again and don’t work for our competitors) is personal services income.

Given that subsection 85-5(1) states “Your *ordinary income or *statutory income, or the ordinary income or statutory income of any other entity, is your personal services income if the income is mainly a reward for your personal efforts or skills (or would mainly be such a reward if it was your income)” it would seem that as gardening leave is not for any personal effort or skill (it is often due to a total lack of skill…) so it is not personal services income… And if this is the case this income could be streamed to a company (30% tax rate) or to a discretionary trust and distributed to a non working spouse.

But that’s not what the draft determination concludes.

The draft first concludes annual leave is due to our personal effort and skill (no question there as I earn it by working) and then says the same applies to retainers (being paid so my personal effort and skill is available so it is PSI – and it is specifically mentioned in the 2000 explanatory memorandum).

From this understanding the draft considers gardening leave. The Commissioner concludes that as the person on leave must remain available to work for those that put them on gardening leave this is simply a retainer. Therefore it is PSI.

Oh well…

And for those who learn through examples…

2. Jim is the sole shareholder/director of Services Coy. Services Coy has a contract with Client Coy to make Jim available to provide his skill and expertise to Client Coy from 1 July 2010 to 30 June 2015 as required by Client Coy. The contractual fee is a flat non-contingent $40,000 per month.

3. Jim has a contract of employment with Services Coy to undertake the services for Client Coy on Service Coy’s behalf.

4. On 29 November 2014 a dispute arises between Jim and the management of Client Coy which results in Jim being directed to stay away from the business premises of Client Coy until further advised. The contract between Client Coy and Services Coy expires on 30 June 2015 without Jim being called upon to resume providing services to Client Coy.

5. During the period from 30 November 2014 to 30 June 2015, Client Coy continues to pay the $40,000 monthly fee to Services Coy. The payments made by Client Coy to Services Coy during this period are Jim’s personal services income within the meaning of subsection 84-5(1) notwithstanding that Client Coy did not call upon Jim to undertake any further services.

Funny Stuff GST Income Tax Rulings

Am I cool if I say Bitcoin?

I live in a town of less than 400,000 people and I just saw a Bitcoin ATM. I don’t know who to use it but how cool am I for living near a Bitcoin ATM…

The Commissioner also is cool as he has released his thoughts on the tax treatment of Bitcoin transaction.

In summary, he thinks Bitcoin is not money (not widely used or general accepted as money) so using Bitcoin is like any barter transaction… For example:

I want to buy a coffee. I could:

1. Go to the coffee shop and use cash or a card to buy the coffee; or

2. I could go to the fruit shop, buy $4 worth of bananas and go to the coffee shop and see if they will swap my $4 of bananas for a coffee (barter); or

3. I could go to a Bitcoin ATM or Bitcoin exchange and buy $4 of Bitcoin (yes I know Bitcoins are worth over $600 – it is just an example) and go to the coffee shop and swap my Bitcoin for a coffee (barter).

There is no difference between example 2 and example 3 – effectively no difference between Bitcoin and bananas. Yes, Bitcoin has a exchange so has a standard value at any time so if you would prefer replace bananas with BHP shares as they have an exchange, the ASX.

The problem with this outcome is a GST issue. In example one the only GST remitted is by the cafe (around 40c) and I don’t claim it back.

But in examples 2 and 3 the cafe still remits its 40c but the Bitcoin ATM owner also remits about 40c on the sale of the bit coin it make to me. As I am not registered for GST, and even if I was it is unlikely either acquiring the bit coin or the coffee are a part of my enterprise, I can’t claim either of the GST amounts back.

Now I am off to get a selfie of me and the Bitcoin ATM…

Tax Policy

Julia Gillard’s tax legacy

This is a policy rant so if you care about what the current tax law is, and don’t care what it could have been, then save yourself some time and don’t read this… 

This week we have both the release of former Prime Minister Julia Gillard’s biography telling us about her valuable legacy and her appearing before a Royal Commission where there have been specific allegations of fraud against her. The battle lines are drawn and both sides are going to be fighting all week about what history should say about her three years as prime minister…

But what about looking at the way the former prime minister handled taxation to get an idea of the legacy she should be afforded. For in my almost two decades of tax policy interest I have never seen anything quite like how Julia Gillard handled the mining tax.

Given this tax was repealed this week I thought we should remember her handling of this major tax reform… in the hope nothing like this ever happens again. I don’t mean a tax like this never happens again but rather a prime minister never stuffs up tax reform this badly again.

Yes I accept that Wayne Swan’s initial handling of the Mining Tax under the Kevin Rudd presidency (come on, he never thought he was just a Prime Minister) was poor. However, what happened under Julia Gillard was much worse.

The great policy developer, consensus maker and hard negotiator, Julia Gillard, had a problem. She had rolled a first term prime minister and her poll numbers did not look that solid. What’s more, she had promised to “fix the mining tax” – which was political speak for stopping some low budget, poorly made ads on TV by the miners.

So the new Prime Minister decided it was time for her negotiation skills to shine. She gathered her Treasurer Wayne Swan and her Resources Minister Martin Ferguson and the heads of Australia’s three big mining companies: BHP Billiton, Rio Tinto and Xstrata.

She decided that that was all they needed. The mining companies who had studied the mining tax proposal backward and forward, against three pollies not famous for their intelligence (check out their university records – very bright but not quite Rhode Scholars). 300 metres down the road sat the 200 staff in the Treasury who specifically work in tax policy and some of who wrote the actual tax – but none were allowed in… Craig Emerson who was in the Gillard Ministry had written academic papers (quite good ones actually) on the use of resource rent taxes but even he was not in the room. The prime minister decided that she did not need help from the experts – she could handle it all on her own… And what happened?

A tax that was to bring in tens of billions of dollars each year, enough to fund both the gonski reforms and the NDIS with cash to spare, was changed so that, when you take into account collection and marketing costs, collected pretty much nothing. A tax that raised no revenue. It almost does not fall within the dictionary definition of what is a tax.

The 1½ page agreement signed that night replaced the 40% resource super profits tax with a 22.5% tax only applying to coal and iron ore rather than all mining.

Worse still, the agreement allowed “all state and territory royalties” to be deducted from the tax. So Western Australia promptly lifted its iron ore royalty from 5.6% to 7.5% effectively just taking money from the Federal Government – smart move by WA, pure stupidity by Julia Gillard and Wayne Swan.

Also, (its hard to believe it could get worse) they increased the profits the miners could earn before paying any tax (long term bond rate plus 7% so need to be making upwards of 10% profits before any tax is paid) and allowed profits to be calculated after revaluing assets to market value… Crazy.

Mining taxes have seen some countries change themselves dramatically. Spend some time looking at what the Norwegians have done with their petroleum sovereign wealth fund and you will start to cry when you think what might have been…

Fortunately in countries like Norway who have a resource rent tax (aka a mining tax) their leaders do not do either of the following:

  1. Put their politics before their people (assuming Gillard and Swan knew what they where doing and gave up the revenue from the tax to stop a bad advertising campaign against them so they could win – just – an election); or
  1. Think they are some amazing policy developer, consensus maker and hard negotiator who does not need anyone’s help when they are really just an average industrial lawyer (and industrial lawyers rank not much above workers compensation lawyers in the intelligence stakes).

For just a few million dollars in advertising, the big three miners saved themselves billions of dollars every year as they totally and utterly out negotiated our then prime minister.

The chance to have a resource rent tax funding my children’s future, like our Norwegian brothers, is gone, not thanks to Tony Abbott, but thanks to Julia Gillard. It is impossible to defend the mining tax that raised not revenue and was supposed to fund billions of dollars of concessions. Once that agreement was signed there was nothing that was going to save a tax. Once a prime minister’s politics or pride had ripped the heart out of the tax it was never going to survive

And thanks to this debacle no one will have the political courage to take this on again.

But saving that… Remember in 1985 Paul Keating went to his prime minister at the time with his preferred tax reform – not just a capital gains tax, a fringe benefits tax and dividend imputation – a goods and services tax. He argued long and hard for it but Bob Hawke would not have it.

Then in 1993, John Hewson agreed with Keating and ran a campaign on a major GST led tax reform. Keating, knowing it was the best option, and having argued for it for years, ripped it to shreds. When political advantage can be made who cares about the policy (or people).

After Hewson’s loss it seemed like no one would ever touch the GST again – even though it was the best option. Whatever you think of Howard and Costello, you must give them credit for bring the GST to their first attempt at re-election. As someone who has worked in a Labor minister’s office it pains me to say, lets hope there is another John Howard or Peter Costello ion the future who will see that a resource rent tax is very good policy.

End of rant for today… lets go back to reading boring explanatory memoranda.

Cases Income Tax

35-55 and non commercial losses discretion

Given it happens so infrequently, I thought I should mention a case where the AAT has required the Commissioner to exercise his discretion to not apply the non commercial losses rule in Division 35 of the ITAA97.

In AAT Case [2014] AATA 620, Re Bentivoglio v FCT a medical doctor earning over $250,000 (so could not use the four exemptions) wanted to apply losses from his olive business against his other income.

The non commercial losses rules would not let him do this, so he asked the Commissioner to exercise his discretion to not apply these rules (the discretion is in section 35-55) and, like almost always, the Commissioner refused.

The taxpayer went to the AAT and stated the losses were due to the olive lace bug, drought, fire, an olive glut worldwide and the illness of a key worker. The taxpayer said these were special circumstances so the Commissioner should exercise his discretion. And at AAT agreed.

So tick off these issues and it might be worth asking for the 35-55 discretion next time you get stuck with unusable losses due to the rest of Division 35.

Income Tax Planning Stuff Rulings

Divorce and Dividends #2

The Commissioner has released a fact sheet on when a payment or in specie transfer from private company to an individual under matrimonial proceedings can be a dividend or a deemed divided.

I have discussed this before but there are some interesting examples in this fact sheet:

First the simple case…

Tim, Helene and a private company are parties to matrimonial property proceedings before the Family Court. Tim and Helene are both shareholders of the private company. The Family Court makes an order requiring the private company to transfer a rental property with market value of $1,000,000 to Tim.

On 30 April 2014, the private company makes the transfer of the rental property to Tim.

The market value of the rental property ($1,000,000) is an ordinary dividend to Tim for the 2014 tax year.

Now the Division 7A case…

Max, Denise and a private company are parties to matrimonial property proceedings before the Family Court. Denise is the sole shareholder of private company.

The Family Court makes an order for the private company to transfer a rental property with market value of $500,000 to Max. On 30 June 2014, the private company makes the transfer of the rental property to Max.

The market value of the rental property ($500,000) is a deemed dividend to Max for the 2014 tax year.

There are also examples where there is a limited distributable surplus (therefore there is a dividend limited to the distributable surplus), and an example showing these dividends can be franked (remember a Division 7A deemed dividend is franked at the benchmark franking rate or 100% if no other dividends have been paid in the year).

It is worth noting that the fact sheet state where the Family Court requires the private company to pay money to a spouse who is not a shareholder, these rules only apply where the obligation to pay the money was imposed by the Family Court on or after 30 July 2014.

So lets get it right from now on…