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Negative Gearing Equity?

The Government are being hammered for not removing negative gearing as it is not “equitable”. Those saying “equity” seem to have a different definition then the standard tax axioms but when asked what they mean they indicate that the benefit of negative gearing (aka borrowing to buy an income producing asset and claiming a deduction for the borrowing costs) goes to high wealth individuals.

Of course it does… We have a marginal tax system where high wealth individuals pay more tax on each dollar they earn and so get better benefit for their tax deductions. If I earn less than $18,200, negatively gear and pay $1 of interest I get no benefit from the $1 in my tax return as there was already no tax to pay before I even considered my deduction. But if I earn more than $180,000, I get $0.49 of benefit (less tax payable) for the $1 of interest.

So the solutions available if you don’t like this “inequity” include a flat tax rate (not possible, unless you are Ted Cruze or Donald Trump) or limit deductions for everyone. Not just negative gearing deduction, but all deductions as the same inequity applies to all deduction (just as ridiculous).

The reason every tax deduction is not “equitable” is the same reason tax payments are not “equitable”. Because some people pay a much higher rate of tax on each dollar they earn (someone earning $180,000 pays an average tax rate of 32%, someone on $80,000 pays an average tax rate of 22% and someone earring $18,200 pays an average tax rate of 0%) they get a much higher benefit from deductions.

And for the Labor supporters who think their policy is more “equitable”… Under the Labor policy negative gearing deductions on existing properties will still be able to be offset against non salary income. Who has non salary income (dividends, business income…)? High wealth individuals. This will mean even more of the benefit of negative gearing will flow to high wealth individuals. And who will buy the new residential premises that can be negatively geared? Those that can pay the most (high wealth individuals) and those who will get the most benefit from the negative gearing (high wealth individuals). If you believe the current system is a problem, then the Labor proposal will only make it worse.

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Taxpayers ALERT! Taxpayer ALERT!

I love “Taxpayer Alerts” as they sound like some robot warning us of impending danger. But what they really are is a lot more exciting (to me at least).

When the Commissioner finds people acting in ways he thinks are contrary to the tax laws he quickly releases one of these Taxpayer Alerts to say that he knows this is happening, that he is concerned it is happening and he is going to review taxpayers who are acting in this way.

Recently he released four of these alerts on one day (a new record for the Commissioner). And these are great examples of what he uses these Taxpayer Alerts for.

In the first Taxpayer Alert the Commissioner states he has become aware of manipulation of the thin capitalisation rules. This is being done by entities making choices to inappropriately recognise and value (do not comply with the recognition criteria contained in the relevant accounting standards) internally generated intangible items as assets for thin capitalisation purposes. By increasing the value of these assets they increase the equity section of the balance sheet (revaluation reserves) and avoid the thin capitalization provisions applying. Some of the arrangements the Commissioner is focusing on include:

  • Generic material such as internal policies, internal meeting protocols and procedures being valued;
  • The application of unsupportable or questionable management assumptions from an asset revaluation perspective;
  • The double counting of the same value across multiple intangibles items; and
  • Entities not impairing assets where the fair value or the cash generating unit has declined.

In the second Taxpayer Alert the Commissioner raises concerns about “lease in lease out arrangements”. These are where a foreign resident wants to lease substantial equipment into Australia, like a ship. To avoid having a Permanent Establishment in Australia (leasing substantial equipment into Australia will make this happen) they lease the ship to a shell foreign company first and the shell company leases the ship into Australia. Now only the shell company has a PE in Australia.

The Commissioner is concerned this could still leave the initial foreign resident with a PE in Australia. He is also concerned the rates being charged by these related entities may not meet the arms length rule in the Transfer Pricing provisions.

In the third Taxpayer Alert, large businesses are trying some crazy schemes to avoid the new Multinational Anti Avoidance Law. The scheme involves the foreign and Australian entities swapping their roles via contracts. These contracts purport to make the Australian entity the distributor of the products or services and the foreign entity an agent of the Australian entity, collecting the sales revenue from customers on its behalf. This is despite no changes being made to the underlying functions performed by the entities.

This arrangement purports to result in no supply being made by the foreign entity and, potentially, the foreign entity becoming a permanent establishment of the Australian entity in the foreign entity’s jurisdiction, which opens an opportunity to argue that income from the Australian sales should continue to be returned in the foreign tax jurisdiction.

Good try.

The final of the four Taxpayer Alerts… well lets just say it is complex and I was not surprised that at the bottom of a Taxpayer Alert that covers “related party foreign currency denominated finance with related party cross currency interest rate swaps” is the name of the Deputy Commissioner who is, in my simple opinion, the best person in tax in this country.

 

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Where have the bills gone?

I went looking for a Bill on the aph.gov.au website. And it was not there. And after a bit of looking around I discovered something weird was happening.

In March, the Prime Minister wrote to the Governor-General to ask him to prorogue Parliament on Friday 15 April and summon Parliament to sit again on Monday 18 April 2016. He did this so they had to discuss the ABCC legislation and not exciting tax and super Bills.

Proroguing a Parliament essentially terminates the current session of Parliament and with it all the current Bills working their way through the Parliament are ended. That means they need to be reintroduced and start the process again.

So this means the innovation tax changes in the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, the GST changes (including the “Netflix” tax) in the Tax and Superannuation Laws Amendment (2016 Measures No 1) Bill 2016 and the Commissioner’s discretion in Tax and Superannuation Laws Amendment (2016 Measures No 2) Bill 2016 are all dead.

Given the next sitting day is 3 May and the Prime Minister has announced he will call an election on 11 May it is unlikely any of these Bills will get through Parliament before the election (which would see them die again).

So easy of these changes may not see the light of day for some time to come…

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Super Budget Changes

It is pretty clear that the Government will decrease the threshold for Div 293 tax to $180,000 in the upcoming budget. This will mean an effective rate of 30% contributions tax for those earning more than $180,000.

But the other rumour that just won’t die is that contribution caps will get reduced…

His first budget might also tighten the generous caps on how much high earners can contribute to super out of concessionally taxed funds. At present $30,000 for most taxpayers, and $35,000 for those over the age of 50, the annual caps might be cut to nearer $20,000.

The problem with $20,000 is that some taxpayers will be forced to make excess concessional contributions.

The SGC maximum super contribution base goes to $51,620 a quarter from 1 July 2016. This threshold is used to determine the maximum limit on any individual employee’s earnings base for each quarter of any financial year for SGC purposes. If an employer pays more than this $51,620 in a quarter the employer is only required to pay 9.5% on $51,620 and not the higher ordinary time earnings.

As an example, if I earn $206,480 (4 x $51,620) and you earn $1,000,000 salary a year, our employers are only required by law to pay $19,615.60 in SG Contributions on these amounts – 9.5% up to the maximum super contribution base.

Now $19,615.60 is less than $20,000 (and leaves us with a massive $384.40 that we can recommend high earners salary package). But from 1 July 2017 this base will get indexed again and if it goes up by the average increase of previous years, the SGC maximum super contribution will get above $52,631.58 a quarter, which is where an employer is required to pay more than $20,000 in SG contributions.

So if the concessional cap is reduced to $20,000, every employee earning more that $210,526.31 would breach the concessional contributions cap as their employer would be required by law to put more than $20,000 into super.

Simple solution if you want to reduce the concessional cap to $20,000… Link the SGC maximum super contribution cap to the concessional contribution cap. The SGC maximum super contribution cap should be the concessional cap divided by the SGC rate divided by the number of quarters (4). This would be:

$20,000 / 9.5% / 4 = $52,631.58

 

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A quiz… What does the average tax agent charge to prepare an individual income tax return?

In the 2013/14 year the average tax deduction claimed for managing their tax affairs by the 6 million individual taxpayers who used a tax agent to lodge their return was $372.

Was that your guess?

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More “innovation tax” changes

The next part of the Government “innovation tax changes” has been released in a draft Bill.

This draft Bill implements the announcement last year to supplement the “same business test” with a more flexible “similar business test” to improve access to losses for companies that have changed ownership.

When the announcement was made many of us wondered how the Government would define such a test, especially as the term “similar” is highly subjective.

Well we now know – they just did not define it.

For the second time in relation to these “innovation tax changes” the Government has decided to make assessing if you can use these changes unbelievably hard.

The new “similar business” test, which applies in addition to the same business test, require that to carry forward the loss if you fail the COT , the business carried on throughout the business continuity test period must be “similar” to the business carried on immediately before the test time.

“Similar” is not defined and only three factors, which the law clearly states are not exhaustive, are offered to help us decide what is similar:

  • The extent to which the assets (including goodwill) that are used in its current business to generate assessable income were also used in the company’s former business to generate assessable income;
  • The extent to which the sources from which the current business generates assessable income were also the sources from which the former business generated assessable income; and
  • Whether any changes to the former business are changes that would reasonably be expected to have been made to a similarly placed business.

But don’t think you need to pass all these three factors. The examples in the EM have companies that pass and fail many of these three tests and some can use the “similar” test and others cannot.

From these examples it appears that:

  • An online retail company that sells various household furniture items from established brands that then develops its own mattresses, outsourced the manufacturing to a local factory and sells its own mattresses as well as household furniture items from established brands is undertaking a substantially similar business.
  • A plastic manufacturer who discovers their process to make the plastic can be used to make teeth whitener and so adds this product to their sales is carrying on a substantially similar business.
  • Going from producing, bottling and wholesaling your own iced tea to just bottling someone else’s iced tea is not substantially similar.
  • Changing a homewares shop into a shop selling high-end stationery products and art supplies is not substantially similar.

Once again, taxpayers and advisors will be left uncertain whether they pass this test without getting a private ruling, or the Commissioner clarifying the law in a public ruling (the Government once again outsourcing its detailed policy work to the Commissioner of Taxation?)

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More on the Small Business Rollover

Yes I am way too excited about this… But the Commissioner has produced his first two bits of guidance on using this rollover.

In the first he looks at the consequences of using the rollover. This is all pretty simple stuff (cost base transfer…) but the final example has the trick in it…

Example 6 – Indirect tax consequence – subsequent debt forgiveness

Facts

  1. Dean operates a fishing tour business through a company, where he is the sole director and shareholder. The active assets of the business include a fishing boat, which cost the company $300,000.
  2. In January 2017, a discretionary trust is set up, Dean is one of the beneficiaries and a family trust election is made with Dean as the primary individual. The termination value and adjustable value of the boat is $260,000 at this time.
  3. The company transfers the boat to the trust for $260,000 as consideration, payable within 60 days. Both the company and the trust choose to apply the SBRR.
  4. The trustee does not pay at that time and enters into a written loan agreement that complies with the requirements of section 109N of the ITAA 1936.
  5. In June 2018, the company executes an effective deed to forgive the loan.

Other tax consequences are recognised

  1. A transfer of an asset has no direct income tax consequences, except as provided for under Subdivision 328-G. Related rollover relief for depreciating assets is available under section 40-340.
  2. The subsequent application of Division 7A to the loan, which was created in connection with the transfer of the assets, is an indirect consequence of the transfer and is not turned off by section 328-450. The forgiveness of the loan or failure to make minimum yearly repayments may give rise to a deemed dividend under Division 7A.

So a simple transfer of assets out of a company to a trust can lead to a big DIV 7A issue… But maybe not. Have a look at paragraph 1.65 of the EM to the Bill that introduced the rollover…

1.65 Consistent with the object of allowing small business owners flexibility to change their legal structure, the roll-over does not require that market value consideration, or any consideration, be given in exchange for the transferred assets. A transferor and transferee may, for example, agree to transfer the assets at cost in order to eliminate any future unrealised gains on membership interests held in the transferor entity. Where an asset transfer is made at other than market value, decreases and increases in the market values of any interests that are held in the transferor and transferee can result.

So if you transfer the assets for no consideration you get no debt to forgive and no Division 7A issues. The accountants scream “how do I account for this???” I say “work it out because if we transfer it at book value to make your accounting easy we have the company making a loan to the trust and that is much worse than your accounting problem!”

So beware of Division 7A traps when transferring out of a company using the rollover – especially as they are very easily fixable (if fixable is a word?).

In the second document the Commissioner considers what is a ‘genuine restructure of an ongoing business’? Remember that if we don’t have one of these genuine restructures we can’t use the rollover. SO what is a genuine restructure?

The following features indicate that a transaction is, or is part of, a ‘genuine restructure of an ongoing business’:

It is a bona fide commercial arrangement undertaken in a real and honest sense to facilitate growth, innovation and diversification, adapt to changed conditions, or reduce administrative burdens, compliance costs and/or cash flow impediments.

It is authentically restructuring the way in which the business is conducted as opposed to a ‘divestment’ or preliminary step to facilitate the economic realisation of assets.

The economic ownership of the business and its restructured assets is maintained.

The small business owners continue to operate the business through a different legal structure. For example, there is continued use of the transferred assets as active assets of the business, continuity of employment of key personnel and continuity of production, supplies, sales, or services.

It results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business.

And if this is too vague (which it definitely is) the law provides a safe harbour rule…

To provide certainty to small businesses using the roll-over, a ‘safe harbour’ rule is included. A small business will be taken to satisfy the requirement that the transaction is, or is a part of, a genuine restructure of an ongoing business where, for three years following the roll-over:

There is no change in the ultimate economic ownership of any of the significant assets of the business (other than trading stock) that were transferred under the transaction;

Those significant assets continue to be active assets; and

There is no significant or material use of those significant assets for private purposes.

But in this document the Commissioner applies this rule to examples. He states that restructures that achieve substantially better asset protection, or allow employees to buy in, or allow new capital, or simplify complex affairs are all genuine restructures

But he goes on to say that transferring assets from a company to an individual and waiting 12 months to get the CGT discount on those assets is not a genuine restructure.

Neither is succession planning where the assets of one company are split into two companies to allow Dad to give a company each to his two sons a genuine restructure (unless Dad meets the safe harbour above by waiting three years).

Finally he states that having a trust that transfers assets to a company to pay of a UPE and then having the company transfer it back at no consideration is not a genuine restructure as it just wipes out the UPE.

Getting the CGT discount and succession planning will come to your mind when planning a small business restructure but it cannot be the main reason you did it!

1 July 2016 is almost here and the Small Business Restructure Rollover is almost available…

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More crazy “innovation” tax changes…

The Government has released the next draft bill on the changes to the tax system to encourage innovation.

This draft bill will allow taxpayers the choice to either self‑assess the effective life of certain intangible depreciating assets or use the statutory effective life. The current law only provides an effective life set by statute.

If you are even slightly interested in this change, here is what I wrote as a part of the consultation…

Hi,

Thanks for all your efforts in this draft law.
I understand that this proposal is “designed to incentivise and reward innovation”.

How does giving a telecommunications company the ability to self assess the effective life of a telecommunications site access right “incentivise and reward innovation”? The same could be asked about datacasting transmitter licences and spectrum licences. Even copyright and in house software need not be innovative but can be exceedingly mundane (merely documenting a standard practice or reengineering an off the shelf software package).

Put simply, buying a right to put a base station on a farmers land is in no way “innovative”.

Shouldn’t this amendment be limited to the intangible assets that are at least in some way related to innovation – like patents – if this is what the changes are supposed to encourage?

As such, this amendment should not apply to all the assets in the table in subsection 40-95(7). It should only apply to the innovative intangible assets, like patents.

Otherwise the proposed law and the purpose of the proposed law do not match. 

I promise the next blog post will be more interesting…