Tax Rambling

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

The Government has promised a series of changes to Division 7A and we have finally got an idea of what these changes will be. 

Remember this is just a discussion paper, but I am confident these all will occur.

Change 1 – Simplified Loans

The biggest change is that the current 7 year and 25 year loan models will be replaced by a single loan model which has the following features:

1. A 10 year loan begins at the end of the income year in which the advance is made.
2. The taxpayer is still given until the lodgment day of the private company’s income tax return to repay the loan or put it on complying loan terms.
3. The annual benchmark interest rate will be the Small business; Variable; Other; Overdraft Indicator Lending rate most recently published by the Reserve Bank of Australia prior to the start of each income year.
4. There will be no requirement for a formal written loan agreement, however written or electronic evidence showing that the loan was entered into must exist by the lodgment day of the private company’s income tax return.
5. The minimum yearly repayment amount consists of both principal and interest, BUT the principal component is a series of equal annual payments over the term of the loan. The interest component is the interest calculated on the opening balance of the loan each year using the benchmark interest rate.
6. Interest is calculated for the full income year, regardless of when the repayment is made during the year (except Year 1). If the loan is paid out early, that is before Year 10, interest will not be charged for the remaining years of the loan.
7. Repayments of the loan made after the end of the income year but before the lodgment day for the first income year are counted as a reduction of the amount owing even if they are made prior to the loan agreement being finalised. Interest for Year 1 is calculated for the full income year on the balance of the loan outstanding at lodgment day.

Here is the Government’s example of how this will work…

Example: Calculation of the deemed dividend

Bert is the sole director and shareholder of Sesame Pty Ltd.

On 1 August 2019, Bert withdraws $100,000 from Sesame Pty Ltd to pay for the renovation of his house. Bert does not have the funds to pay back Sesame Pty Ltd by the lodgment day of Sesame Pty Ltd’s income tax return, 15 May 2021.  To avoid the $100,000 being treated as if it were a dividend paid from Sesame Pty Ltd, Bert decides to put in place a complying Division 7A loan agreement.

The repayments that Bert would be required to make according to the new loan model would be as follows:

Year	Interest Rate*	Opening Balance $	Interest Amount $	Principal Amount $	Minimum Repayment $	Closing Balance $
2020-21	8.50%	100,000	8,500	10,000	18,500	90,000
2021-22	7.00%	90,000	6,300	10,000	16,300	80,000
2022-23	6.50%	80,000	5,200	10,000	15,200	70,000
2023-24	8.00%	70,000	5,600	10,000	15,600	60,000
2024-25	9.00%	60,000	5,400	10,000	15,400	50,000
2025-26	8.25%	50,000	4,125	10,000	14,125	40,000
2026-27	7.90%	40,000	3,160	10,000	13,160	30,000
2027-28	8.00%	30,000	2,400	10,000	12,400	20,000
2028-29	9.20%	20,000	1,840	10,000	11,840	10,000
2029-30	7.50%	10,000	750	10,000	10,750	0

*Interest rates shown are for illustrative purposes only

The interest paid by Bert each year will be taxed as income to Sesame Pty Ltd at its corporate tax rate.

• If the repayment actually made in the income year is less than the required minimum yearly repayment, a deemed dividend will arise for the amount of the shortfall between the minimum yearly repayment and the actual repayment made for that income year.

For example, the minimum yearly repayment in the above loan model example for the 2022-23 income year would be $15,200. If the actual repayment made in the 2022-23 income year was $12,200, the deemed dividend would be $3,000. Bert will include this $3,000 as income for the year, and pay tax at his marginal tax rate.

Change 2 – Self-correct without telling the Commissioner

Under the proposed changes, qualifying taxpayers will also be permitted to self-assess their eligibility for relief from the consequences of Division 7A. To qualify for self-correction, the taxpayer will need to meet eligibility criteria in relation to the benefit that gave rise to the breach. The eligibility criteria will require that:

• The breach of Division 7A was an inadvertent breach;
• Appropriate steps have been taken as soon as practicable; and
• The taxpayer has taken, or is taking, reasonable steps to identify and address any other breaches of Division 7A.

Under this approach, in order to self-correct an eligible taxpayer must:

• Convert the benefit into a complying loan agreement, on the same terms that would have applied had the loan agreement been entered into when it should have been; and
• Make catch-up payments of the principal and interest that would have been payable as prior minimum yearly repayments had the taxpayer complied with Division 7A when it should have. The interest component of the catch-up payment will be compounded to reflect prior year non repayments. This compounded interest should be declared as assessable income in the private company’s income tax return for the income year in which the catch-up payment is made.

 So now when you get the new client with heaps of Div7A issues you can clearly tell them how to fix it up. 

Change 3 – Distributable surplus

The third major change is to the concept of distributable surplus – actually it is the total removal of the concept of distributable surplus.

This will align the treatment of dividends with section 254T of the Corporations Act 2001 which allows dividends to be paid out of both profits and capital.

And let’s be honest, if a certain amount is ‘distributed’ to the shareholder, then tax should be paid on the entire amount, and it should not be arbitrarily limited.

Change 4 – UPE argument over 

After eight years of arguing with the Commissioner on whether UPE’s fall within Div 7A the argument is over as the law will be changed to say they are.

Under the proposed chnages, where a UPE remains unpaid at the lodgment day of the private company’s income tax return, the UPE will be a deemed dividend from the company to the trust or the UPE can be put on ‘complying loan terms’ under which principal and interest payments are required to be made.

All UPEs arising on, or after 16 December 2009 and on, or before, 30 June 2019, that have not already been put on complying loan terms or deemed to be a dividend, will need to be put on complying terms by 30 June 2020. The first repayment for such loans would be due in the 2019-20 income year. Any amounts outstanding that have not been put on complying loan terms by the end of the 2019-20 income year will result in a deemed dividend for the outstanding amount of the UPE.

All UPEs that arise on, or after, 1 July 2019 will need to be either paid to the private company or put on complying loan terms under the new 10 year loan model prior to the private company’s lodgment day, otherwise they will be a deemed a dividend.

Effectively, from 1 July 2019 there will be no argument… a UPE is the same as a loan.

Summary

There are lots of other proposed changes that will not be as relevant as these four changes and we can consider these later. But from these four main changes…

From 1 July 2019:

1. If you find a Div 7A problem, you just fix it by paying what you missed;
2. I don’t need written loan agreements;
3. You don’t need to do distributable surplus calculations;
4. UPEs to corporate beneficiaries are just treated like loans from the company to the trust;
5. I pay the same principal off each year, 1/10^thof the initial loan;
6. The interest is just the Small business; Variable; Other; Overdraft Indicator Lending rate most recently published by the Reserve Bank of Australia prior to the start of each income year; and
7. I pay off the loan over 10 years in every case.

Not as massive a change as we hoped, but a good start.