Super contributions for those 65 and over:12-month work test exemption

Until recently regulated superannuation funds (including self-managed superannuation funds (‘SMSFs’) were prohibited from accepting voluntary superannuation contributions from, or for the benefit of, members aged 65 to 74 unless the member was gainfully employed on a part-time basis during the financial year in which the contributions were made. For this to occur required the member to have been ‘gainfully employed’ (i.e. worked for at least 40 hours within 30 consecutive days) in the relevant financial year (the ‘work test’) (Reg 7.01(3), Reg. 7.04 to Reg. 7.05 of SIS Regulations 1994).

An exemption to the work test was first announced in the 2018-19 Federal Budget as part of the More Choices for a Longer Life package, with the measure implemented on 7 December 2018 by the Treasury Laws Amendment (Work Test Exemption) Regulations 2018.The measures are focused on providing benefits for those with superannuation balances of up to $300,000.

This article considers the operation of the work test exemption, as well as its interaction with the small business capital gains tax (‘CGT’) concessions, and the bring-forward rule for non-concessional contributions. Each of the relevant issues is considered in the context of ‘Sandra’ who:

  • as at 30 June 2019: was 64 years old, had $200,000 in her superannuation fund, and had been gainfully employed during the financial year;
  • ceased to be gainfully employed from 1 July 2019 and will turn 65 on 1 October 2019.

Can Sandra make contributions to her super fund after she turns 65?

As a result of the abovementioned measures, from 1 July 2019, a 12-month exemption from the work test is available for those aged 65 to 74, provided all of the following conditions are met:

  • the member satisfied the work test in the financial year prior to the financial year in which the contributions are made;
  • the member had a total superannuation balance (‘TSB’) of less than $300,000 at the end of the previous financial year; and
  • no contributions have been accepted by a regulated superannuation fund in respect of the member under the work test exemption in the previous year or any other earlier financial year.

Applying this measure to Sandra (who has not previously utilised the exemption), as she was gainfully employed in FY2019 and had a TSB as at 30 June 2019 of less than $300,000, she can rely on the work test exemption and contribute into her superannuation fund in FY2020 after she turns 65, despite not being gainfully employed in that year.

Note: the work test exemption can only be used once, hence if Sandra chooses to apply the exemption for FY2020, she will no longer be able to make super contributions in the future unless she can demonstrate that she is gainfully employed in the relevant year(s). Additionally, if Sandra does not utilise the exemption in the year directly following the year in which she was gainfully employed, she effectively loses the exemption (i.e. if Sandra didn’t make a contribution in FY2020, she would not be able to make a contribution in FY2021 unless she was gainfully employed).

How does the work test exemption interact with Sandra’s contribution caps?

The work test exemption only impacts a member’s ability to contribute an amount into their superannuation fund. Accordingly, a member will still be subject to the annual contribution caps being $25,000 p.a. for concessional contributions (‘CC’) and $100,000 p.a. for non-concessional contributions (‘NCC’).

As Sandra satisfies the work test exemption, she can contribute up to $100,000 of NCC into her superannuation fund in FY2020. Depending on Sandra’s circumstances, she may also be able to make up to $25,000 of CC in that year.

Can Sandra contribute more than the annual NCC contribution cap?

The author notes that when the measures were first announced, it was initially proposed that members applying the work test exemption would not also be able to access bring-forward NCC arrangements. However, the final version of the measures did not have any such restriction. What this means is that if the bring-forward rules for NCC are met, members relying on the work test exemption may make NCC amounting to more than the annual $100,000 NCC cap over a 3 year period.

The bring-forward rules are contained in s.292-85(3) of ITAA 1997 and broadly require that:

  • the individual must be under 65 at any time during a financial year (“first year”);
  • the individual must make a NCC in the first year that exceeds the annual NCC cap; and
  • immediately before the start of the first year, the taxpayer’s total superannuation balance is less than the general transfer balance cap for the year (i.e., $1.6 million for FY2019).

If Sandra does not have a bring-forward period that is currently in operation, and given she turns 65 only on 1 October 2019, Sandra can trigger the bring forward rules in FY2020 (i.e., the first year) by  making  up to 3 years’ worth of NCC in that year. In other words, Sandra can make an additional NCC in FY2020 to bring her up to $300,000 after she turns 65 under the work test exemption rules (as opposed to the previous $100,000 NCC cap as outlined above). Sandra will need to contribute the full $300,000 NCC in the first year (i.e., FY2020) as in the second year, her fund will be unable to accept any contributions from her (as she is over 65, not working and not able to rely on the work test exemption a second time). Note: the ability to utilise the bring-forward rule would not be available to Sandra if she had instead turned 66 on 1 October 2019.

The interaction of the work test exemption rules and super contributions under the small business CGT concessions

According to Reg. 7.04(6A) of the SIS Regulations 1994, regulated superannuation funds may accept contributions that are covered under s.292-100 ITAA 1997 (i.e., super contributions relating to amounts covered by the small business CGT concessions) provided the amount contributed does not exceed a member’s CGT cap amount (for FY2020 the CGT cap amount is $1.515 million) and the superfund is not prevented from accepting the amount as a contribution had it been made to the fund in the financial year in which the CGT event happened (e.g. because the small business CGT concession stakeholder for which the contribution is made was 65 or over and did not satisfy the work test in the CGT event year).

This means for business owners who qualify for the small business 15-year exemption the maximum amount that can contributed is $1.515 million (in FY2020). If the small business 15-year exemption is not available, then the amount that can be contributed is limited to the exempt capital gain under the small business retirement exemption (subject to the relevant individual’s CGT lifetime retirement limit of $500,000).

In the context of the small business CGT concessions, the introduction of the work test exemption now provides greater opportunity for those who were previously prevented from contributing amounts under the small business CGT concessions into their super fund to be able to do so subject to the above conditions for exemption being met.

Further, the introduction of the exemption creates additional considerations for members regarding the timing of contributions as while contributions that qualify for the small business CGT concessions are not treated as NCC, they are still counted as part of a member’s TSB. What this means is that if a contribution covered under the small business CGT concessions was made for the benefit of Sandra (e.g., because she was a CGT concession stakeholder in FY2019), it could cause her TSB to exceed the $300,000 threshold at the end of FY2019. In that case, Sandra will need to meet the work test criteria in order to be eligible to make a NCC after she turns 65 as she is no longer able to meet the requirements to access the work test exemption. If the super contribution covered by the small business CGT concessions was delayed until after 30 June 2019, Sandra will be able to apply the work test exemption for FY2020 (assuming she was gainfully employed in FY2019).

Conclusion

In conclusion, the work test exemption in conjunction with existing rules provide ample scope and opportunities notably for those turning 65 to plan their retirement strategies. For others who are in the 65 to 74 age bracket, the work test exemption allows for additional NCC to be made in the year following their retirement provided the requirements for exemption are met.

This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

Director penalties and GST – some matters to know

It is proposed to extend the existing director penalty regime to enable the Commissioner to recover unremitted GST from directors. Presently, the regime allows the Commissioner to take recovery action against directors of non-complying companies for unpaid PAYG withholding and SG charge. Further, it is proposed that the Commissioner’s tax estimate collection power, which currently allows him to make and recover estimates of an entity’s PAYG withholding and superannuation guarantee (SG) charge, will be extended to GST liabilities.

The proposed changes are contained in the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019. The Bill also makes some other far-reaching changes to the Corporations Act 2001 that potentially extend a director’s liability for permitting the company to make creditor defeating dispositions.

This article explains the proposed changes to the Tax law.

Extension of the Commissioner’s power to make estimates of GST — Div. 268 of Sch. 1 to the TAA

The Commissioner will have the power to make and recover an estimate of a net amount of GST for a tax period (estimated GST). The Commissioner will be able to issue estimates to any taxpayer registered/required to be registered for GST, not just to a company.

The liability of a taxpayer to pay an estimate is created by the Commissioner issuing a notice to the taxpayer. It is a liability separate from the underlying liability to pay assessed GST. However, payment of an estimate will correspondingly be a payment of the underlying liability for GST and vice versa.

Extension of the director penalty regime to unpaid GST – Div. 269 of Sch. 1 to the TAA

The director penalty regime will be extended to allow the Commissioner to recover a company’s liability to pay net amounts of GST for a tax period (assessed GST), estimated GST, and instalments of GST from the company’s directors. The regime applies to companies registered under the Corporations Act 2001 and, more specifically, to ‘directors’ within the meaning of that Act.

Existing and intending directors should understand their obligations under the Tax law and the personal risks that they incur if they do not take appropriate timely action in circumstances where the company of which they are a director fails to comply with its obligations to account to the Commissioner for GST (or the other taxes to which Div. 269 Sch. 1 TAA applies). A ‘director’ includes persons who act in the position of director even though not validly appointed as such and a person in accordance with whose wishes the conventional directors are accustomed to act.

Persons who were directors on/after the last day of a tax period (the initial day) and were not ‘new directors’ (discussed below) will be personally liable, by way of a penalty, for the net amount of GST payable in respect of that tax period where the company has not paid the GST on/before the day on which payment is required under the GST Act (due day). The penalty arises automatically unless the company has gone into administration or liquidation on/before the due day.

Similarly, where a GST instalment for a quarter has not been paid on/before the day required by the GST Act (also ‘the due day’) and the company has not gone into administration/liquidation on/before that due day, a person who was a director on the last day of the GST instalment quarter (also the ‘ initial day’) and is not a new director incurs a penalty in the amount of the instalment.
A separate director penalty in the amount of the Commissioner’s estimate arises where:

  • a person is a director of the company on the last day of a tax period (also the ‘initial day’) and is not a new director;
  • the company has been given a notice of an estimate of GST for that tax period under Div. 268; and
  • the company has not paid the estimate by the end of day on which the notice was given (also the ‘due day’) or gone into administration/liquidation by that time. (Note that s. 268-15(4) provides that a notice ‘is taken to be given at the time the Commissioner leaves it or posts it’.)

A director penalty for an estimated amount in relation to a tax period can co-exist with a director penalty for an assessed amount in relation the same tax period, as the Commissioner can make an estimate ‘to the extent that the net amount has not been assessed before the Commissioner makes the estimate’ (proposed s. 268-10(1)(c)). Payment in respect of one penalty will reduce the other (s. 269-40 and s. 268-20).

‘New directors’ are persons who become directors after the due day. New directors incur a director penalty for the company’s outstanding liability to remit GST (or, as the case may be, a director penalty for previously estimated GST) if the company does not pay the relevant amount or go into administration/liquidation within thirty days of the person becoming a director.

In effect, under the proposed changes, a company’s directors are giving a personal guarantee that their company will remit GST to the Commissioner.

Resignation as a director after the initial day does not relieve a director of liability. Note also that the Bill includes separate amendments that will prevent directors from backdating resignations or leaving a company without a director.

Understanding what is required of directors

The time-frames for taking action

Directors need to be aware of the statutory time-frames for action which leads to relief from personal liability for assessed GST/estimated GST for a tax period. If they await receipt of a director penalty notice (DPN), they may be out of time to obtain relief.

Broadly speaking and subject to one qualification described below, where the director penalty is for the net amount of GST payable in relation to a tax period, the level of relief for directors depends on whether the company:

  1. goes into administration/ liquidation before the earlier of: (i) the expiration three months after the due day and (ii) the expiration of 21 days after the issue of the DPN; or
  2. has actually lodged its BAS within that three-month period and has gone in to administration/ liquidation before or within 21 days after the issue of the DPN.

Case (a) leads to full relief. Basically, Case (b) provides relief to the extent that the corporate liability for the net amount for the tax period has been disclosed to the Commissioner in the three-month period.

The qualification mentioned earlier arises where a person becomes a director within the specified three-month period. In lieu of that three-month period, there is a substituted a period of three months after the day the person became a director. However, action prior to the earlier of expiration of the substituted period and expiration of 21 days after issue of the DPN to the later-appointed director will only protect the later-appointed director. The other directors must rely on action within the primary period.

Again broadly speaking and subject to a qualification corresponding to the one above, where the director penalty is for estimated GST referable to a tax period, relief from the penalty depends on whether the company goes into administration/ liquidation before the earlier of: (i) expiration of three months after the date on which the BAS for the underlying GST should have been lodged and (ii) expiration of 21 days after the issue of the DPN. Where the company meets the requirement, directors obtain full relief from liability from estimated GST.

The expression in point (i) summarises the formulation in the Bill. Effectively, it aligns the three-month action window for estimated GST with the three-month action window applicable in each of Cases (a) and (b) for assessed GST. Forward planning should be considered, as the window may have closed prior to the notice of estimate being issued.

It will be noted that relief from a director penalty for estimated GST is prima facie less generous (absence of a counterpart to Case (b)) than relief from a director penalty in relation to the underlying liability for assessed GST. However, a director actually avoids a penalty for an estimate through the company’s timely lodgment of a BAS. Lodging a BAS for the tax period creates a deemed assessment of GST and proposed s. 268-10(1)(c) denies the Commissioner power to make an estimate to the extent of an assessment.

It follows from the foregoing, that lodging a BAS on time, even if payment is not made, gives a director a period of 21 days after issue of DPN in which to place the company in administration/liquidation in order to be relieved of penalty for both assessed GST and estimated GST to a potentially significant extent.

In relation to director penalties with respect to GST instalments, full relief is available provided the company goes into administration/liquidation before or within 21 days after the Commissioner gives the director penalty notice.

Although Div. 269 provides some defences to director penalties, these have limited scope.

Due diligence before becoming a director

Clients often ask their accountants and other professional advisers to become directors of their investment/trading companies and corporate trustees (professional directors). This includes companies which are passive investors, which have not been subject to taxes within the existing ambit of Divs. 268 and 269.

Professional directors may be alert to the prospect of personal liability as a director of an active corporate client, especially where there are employees. However, with the extension of Div. 269 to GST, directors of passive investors will also need to pay closer attention to their company’s day-to-day affairs, as distinct from merely ensuring compliance with the more general rule against insolvent corporate trading.

In the course of treating trusts as taxable/accounting entities, there is a tendency to overlook the principles that the trustee is the legal entity liable to pay the tax and the ATO recognises (e.g. see PS LA 2012/2 at para. 41) that Div. 269 applies to directors of corporate trustees. Directors of retiring corporate trustees, being dependent on the incoming trustee meeting any outstanding BAS lodgment/payment obligations, will especially need to monitor incoming trustee compliance.

Professional directors should consider how they will approach the prospect of a future imposition of director penalty, particularly where there may be Board tensions with shareholders/beneficiary directors being more willing to accept the risk of a director penalty ‘guarantee’ in view of their expectation of ultimate commercial benefits that will not be derived by the professional director. With a vested interest in the continuity of the company, shareholder/beneficiary directors may resist a professional director’s desire to avoid personal liability by placing a solvent company (with a short-term cash flow impediment precluding immediate payment of GST) in administration/liquidation.

Apart from close consideration of the ‘reasonableness’ defence, this might include consideration of reaching an upfront understanding with the other directors and which would enable the professional relationship to continue in the aftermath of DPN circumstances arising.

A practical approach

Persons contemplating becoming a director need to be aware of the desirability of undertaking due diligence with respect to GST before accepting appointment. It seems preferable to have the choice of declining appointment where there are outstanding GST obligations for which they may become personally liable rather than having to rely on relatively tight windows within which the company has to go into administration/liquidation.

All directors will need to be aware of their potential liability and the need to monitor their company’s GST compliance in a timely way. In the absence of tailored information flow, it is to be expected non-executive directors will be especially vulnerable.

Directors will require understanding of when GST is payable in their company’s circumstances, timely notice of any anticipated problem, and timely receipt of advice on actual non-compliance. All directors will need to ensure management alerts them immediately to any receipt of a notice of GST estimate, as its receipt indicates an existing problem as well as giving rise to a director penalty in its own right.

While the extension of Div. 269 to include GST will expand the set of companies/corporate trustees that need advice in relation to director penalties, advisers may want to take the opportunity to review the sufficiency of arrangements for director oversight of all taxes within the ambit of Div. 269. For instance, it is anticipated that the relatively recent expansion of Single Touch Payroll will intensify ATO scrutiny of timely payment of superannuation contributions and directors need to be aware of the stringent time-frames within which to obtain relief from director penalties for superannuation guarantee charges.

All taxpayers, and not just companies and their directors, need to be aware that estimate notices require immediate attention. The Commissioner is able to take court proceedings against taxpayers to recover the estimate. (Where a director is not relieved from the relevant director penalty, the Commissioner can also take proceedings to recover the estimate from the director following the elapse of 21 days after issue of the DPN.) Unpaid estimates attract GIC, although payment of this GIC also reduces GIC on the underlying unpaid assessed GST (and vice versa).

As estimates will be based on limited information available to the Commissioner, it is to be expected that these will be inaccurate. However, inaccuracy does not preclude recovery action. Div. 268 prescribes time-frames and processes for correcting an inaccuracy. Because the processes require statements on oath, access to reliable business transaction records will be critical.

As a further practical observation, all taxpayers should be mindful that the Commissioner’s estimation power appears to enable an estimate to be raised where he considers there is a shortfall in disclosure of GST in a BAS.

Conclusion and implementation date

In conclusion, as a stand out practical matter, directors will likely need to act without awaiting the issue of a DPN – it may be too late to seek relief when a DPN issues. It is also worth emphasising that the Commissioner considers that the director penalty regime extends to directors of corporate trustees.

The proposed changes are scheduled to commence from the beginning of the first quarter (1 January; 1 April, 1 July or 1 October) to occur after the relevant Bill receives Royal Assent. In the circumstances, it might be prudent to anticipate the Bill will be passed and the changes operative from 1 October 2019.

The changes will not have retrospective effect. They apply (Item 22 Sch. 3 of the Bill) to ‘net amounts and assessed net amounts for tax periods that start on or after’ the specified commencement date and to ‘GST instalments for GST instalment quarters that start on or after’ that date.

Editor’s Note: Webb Martin Consulting Pty Ltd is able to assist you in relation to your preparation of advice that alerts clients to the proposed director liability for GST and/or director liability for taxes already within Div. 269 and to practical protective action that should be taken.

This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

The active asset test and vacant land used partially for business – where should the line be drawn?

Practitioners would be well aware that in order for taxpayers to be able to access the small business capital gains tax (“SBCGT”) concessions, they must first satisfy the basic conditions under Division 152 of the Income Tax Assessment Act 1997 (“ITAA 1997”). One of these basic conditions requires that the subject CGT asset passes the active asset test, that is, the asset is an active asset for a specified period of time. Pursuant to section 152-40, an asset will qualify as an active asset where it is used, or held ready for use, in the course of carrying on a business (whether alone or in partnership) by the taxpayer, their affiliate (a defined term) or their connected entity (also a defined term). The phrase “used in the course of carrying on a business” is not defined.

In relation to land, particularly in relation to otherwise vacant land that has had some business use,  a query arises over the degree of connection required between the activities conducted on the land and the business in order for the land to qualify as an active asset. The Commissioner’s long held view is that whilst section 152-40 does not require an exclusive use of the asset for business purpose, the degree of connection required under section 152-40 is expressed by the words “in the course of” which mean “integral to the process by which the business is carried on”. In other words, the activities conducted on the land must have a direct connection that is not merely incidental with the business operations. Historically, the Administrative Appeals Tribunal (“AAT”) has also been found to hold this view.

This view was first manifest in the AAT hearing Karapanagiotidis and Commissioner of Taxation [2007] AATA 1961; (2007) 68 ATR 348; 2007 ATC 2746 (16 November 2007). In this decision, the taxpayer was seeking to apply the SBCGT concession to the sale of land they owned that was partially used to store old records of a business. The relevant business was operated not by the taxpayer, but by a company which the taxpayer owned and controlled. The Tribunal found that passively storing old records in containers placed on the property was insufficient to be regarded as integral to the carrying on of a business and, therefore, section 152-40 could not be satisfied.

A similar decision was handed down by the AAT in Rus and Commissioner of Taxation (Taxation) [2018] AATA 1854 (14 May 2018). In that decision, a home office was established to conduct the plastering/housing construction business operated by a company controlled by the taxpayer, and that home office was manned by two full time staff. A shed was constructed on the land and used to store tools, plant and equipment and three motor vehicles for that business. Additionally, there were two containers outside the shed containing material supplies, the property had been used as the postal address for the business and the company’s website lists the property as the operations office. However, the AAT found that, as less than 10% of the total land was used in carrying on the business (with the balance of the land being vacant), the land was not being sufficiently ‘used’ for the purposes of the active asset test. In reaching its decision, the AAT considered it was necessary to form a view on whether the asset as a whole could be said to have been used in carrying on the relevant business. As the nature of the company business did not call for a level of activity on the land than the use of a very small proportion of it, the land could not be considered integral to the business.

However, the recent AAT decision in Eichmann and Commissioner of Taxation (Taxation) [2019] AATA 162 (15 February 2019) appears to indicate a shift in this long-held view. In this decision, whilst the AAT agreed that minimal or incidental use of an asset would not be sufficient to cause the asset to satisfy the active asset test, the AAT rejected the Commissioner’s contention that the phrase “in the course of” requires the use to be integral to the process by which the business is carried on. The AAT said the legislature could easily have used the word “necessary,” “integral” or “essential” in order to further limit the availability of the concession should it so desire. It did not do so.

The AAT also restated one of the key principles of statutory construction from the High Court decision of FCT v Consolidated Media Holdings Ltd (2012) 250 CLR 503 and was that

…the task of statutory construction must begin with a consideration of the [statutory] text…in its context… Legislative history and extrinsic materials cannot displace the meaning of the statutory text [emphasis].

The factual circumstances in Eichmann were to an extent similar to those in Rus. The taxpayer carried on a business of building, bricklaying and paving through a trust that they controlled. The subject land was adjacent to the land that contained the taxpayers’ main residence and had two 4m x 3m sheds, a 2-metre-high brick wall and a gate to secure the property. Similar to the Rus case, there was no business signage on the subject land. The two sheds were used for the storage of work tools, equipment and materials. The open space on the subject land was used to store materials that need not be stored under cover, including bricks, blocks pavers, mixers, wheelbarrows, drums, scaffolding and iron. Work vehicles and trailers were also parked on the property. Tools and items were collected on a daily basis. In some cases, the property would be visited a number of times in a day between jobs depending on what tools each job required. The property was mainly for storage as work would be done on work sites although, on occasion, some preparatory work was done at the property in a limited capacity.

Considering the above, the AAT was satisfied that the extent of the use of the land was far from minimal or incidental to the carrying on of the business. In particular, the AAT determined that the use of the land contributed to the efficiency of the business and was not trivial or insignificant, finding that the taxpayer did not merely hold the land passively as an investment.

It would appear the decision in Eichmann was aided by the fact that tools and items were collected from the property on a daily basis and the property would be visited a number of times in a day between jobs.  While Eichmann provides some authority for the argument that a taxpayer can use land outside the main function of their business (in this case, as storage of equipment etc used in a business necessarily carried on at other locations) and still be able to pass the active asset test in respect of the land, it is the author’s view the nature of the activities undertaken on the land and their frequency are also key elements to the decision making process. Unfortunately, it is not clear from the Eichmann case what proportion of the land used for business purposes. Based on Rus case, a use in the business of 10% or less would not be sufficient to pass the active asset test. Nonetheless, the question still remains as to where should the line be drawn – would use of more than 10% but less than 50% of a parcel land that would otherwise be vacant land be sufficient, or some other percentage?

Ultimately, whether a taxpayer will be able to satisfy the active asset test in relation to otherwise vacant land will be a question of fact and depend on all the circumstances of the case. However, following Eichmann case, arguably the test should be viewed more broadly. It will be interesting to understand how the law will be interpreted and administered by the ATO in the future.

This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

The cost of doing business worldwide with the click of a button

With the advent of technology such as the internet, smart logistics, smaller lead times etc., markets once only accessible to big business are now increasingly open and available to small and micro businesses.

However, this has also led to an increase in the taxation compliance burdens for such business, with taxation regimes once considered to only affect the “big end of town” potentially now having ramifications for small to medium businesses, sometimes without their knowledge. Additionally, Governments around the world are recognising the tax leaks that can arise from multinational business and are constantly seeking to introduce new legislation to close or manage any perceived tax gaps. The OECD also now can impact domestic taxation laws through its global recommendations and policies.

Accordingly, where business previously only had to consider the tax implications of regimes such as withholding tax, transfer pricing, permanent establishments and thin capitalisation, they now have potential exposures to the full suite of compliance regimes, such as Country-by-Country reporting, and the foreign hybrid mismatch rules.

More often than not, many of these regimes need to be considered together – for example a loan may have implications under the withholding tax, transfer pricing, international dealings schedule, thin capitalisation and foreign hybrid mismatch rules.

This article provides a reminder of some of the key components and objectives of these  regimes and the potential impact they can have for entities of all sizes dealing internationally.

Withholding Tax

The withholding tax rules in Division 128 of the Income Tax Assessment Act 1936 (“ITAA 1936”) are one of the most common international-related tax regimes taxpayers will encounter.

Broadly, these rules require an Australian payer to withhold a flat rate of tax from certain payments of dividends, interest and royalties to a non-resident. As the income is then treated as non-assessable non-exempt income for the non-resident recipient, the withholding tax is a final tax.

While these provisions are generally well understood, complexities still arise particularly in relation to what constitutes a royalty, as well as the interplay of the Australian domestic withholding tax rules and any Double Tax Agreements between Australia and the non-resident recipient’s country.

Residency

The question of an entity’s tax residency is core to the function of each country’s tax system, as it is determinative of a country’s taxing rights in relation to that entity. However, it is a question that is becoming more, not less, complex to answer with time, particularly due to the constant movement of individuals across borders.  

The complexity of this area for individuals has recently been highlighted in the Full Federal Court case, Harding v Commissioner of Taxation [2019] FCAFC 29, where the taxpayer was unanimously found to not be an Australian tax resident (the Commissioner has since sought special leave to appeal); and for companies via the Commissioner’s ruling TR 2018/5, which provided his view on when a foreign-incorporated company’s central management and control would be in Australia such that it would qualify as an Australian tax resident.

This complexity is only increased as entities are required to consider not only domestic tax residency rules, but also those in the double tax agreements (“DTA”) between countries (refer below), particularly where two countries may try to claim residency status for that entity.  

Permanent Establishments

Whether it is an Australian business expanding overseas, or a foreign business expanding into Australia, consideration will need to be given to whether the entity’s activities comprise a permanent establishment (“PE”). An entity that has a PE in another country is exposed to tax obligations in that country.

The question of what constitutes a PE can be a complex one that often depends on the specific domestic tax laws of the relevant country, interplayed with the definition of a PE under any applicable DTA. Depending on the specific definitions involved, having a single person complete contracts could be sufficient to constitute a PE for one business, but for others it may require a staffed office.

The existence of a PE can have both income tax and Goods and Services Tax/Value Added Tax consequences, depending on the country involved.

Double Tax Agreements

Broadly, DTAs are formal bilateral agreements between two countries that aim to prevent double taxation and fiscal evasion, as well as providing clarity for countries regarding which country has taxing rights of income derived cross-border.

How a DTA will apply to a taxpayer will depend on their residency status, what activities the taxpayer is undertaking, and what type of income is being derived.

DTAs can be key to providing double taxation relief and need to be consulted where cross-border transactions and investments arise.

Australia currently has DTAs with around 40 countries. Broadly, however, these DTAs only deal with income tax matters (as opposed to indirect taxes such as Goods and Services Tax/Value Added Tax).

Goods and Services Tax/Value Added Tax

Many countries have a Goods and Services Tax (“GST”) or Value Added Tax (“VAT”), which is an indirect or consumption tax that applies to most goods and services sold or consumed in the relevant country.

Businesses providing goods and services in Australia need to consider whether they are required to be GST-registered and pay GST on their taxable supplies.

The reach of the GST in recent years has been increased, with the Government introducing rules such as the “Netflix tax”, which can add GST to digital services to Australian consumers by foreign providers (such as Netflix, Stan and iTunes). 

In addition, from 1 July 2018, the Government extended the GST to apply to sales of low value goods (i.e. less than AUD 1,000) imported by consumers into Australia (as goods above this threshold were already subject to GST and customs on import). Businesses with sales of such goods of over AUD 75,000 now need to register for GST and pay GST on their taxable sales. As such businesses could be the merchants selling goods, electronic digital platform operators or re-deliverers, this has led to a confusion as to who is the relevant entity in the supply chain responsible for collecting and paying the GST (for example, if someone is selling products via Amazon, there is often confusion regarding whether the seller or Amazon is the relevant responsible party).  

Controlled Foreign Company rules

The controlled foreign company (“CFC”) rules can require Australian residents who have substantial interests in Australian-controlled foreign companies (i.e., the CFC) to include a share of the income earned by the CFC in their assessable income on an accruals basis. That is, the Australian resident controller is required to recognise a portion of the income earned by the CFC for the income year in their own tax return, even if the CFC has not paid any dividend or other return to them.

There are different attribution rules depending on whether the CFC is located in a “listed” country (essentially a country with comparable taxation rules) or “unlisted” country (any other country), with less types of income being “attributable” to the controller if the CFC is located in a listed country. Additionally, there are exceptions where the CFC is carrying on an active business and their “passive” income is below a specific threshold.

Exempting entities

The exempting entity rules in Division 208 of the International Tax Assessment Act 1997 (“ITAA 1997”) apply to corporate tax entities that are, or have been, directly or indirectly owned at least 95% by “prescribed persons” (i.e. tax-exempt entity and non-residents), even where residents may ultimately own the corporate tax entity. Under these rules, “franked” distributions paid by an exempting entity or former exempting entity will generally be treated as an unfranked distribution in the hands of the recipient (with certain exceptions).

For non-residents shareholders, there is minimal practical impact of these rules as the distributions generally are still exempt from withholding tax, resulting in the same Australian tax position.

However, for resident shareholders, the tax impact can be significant as the benefit of the franking credits accrued by such a company are essentially lost.  This is something resident shareholders need to be aware of, especially when acquiring an Australian company from non-residents.

Transfer Pricing

For multinational businesses, the transfer pricing rules in Division 815 of the ITAA 1997 are another common international tax regime that is encountered.

These rules apply to cross-border related party transactions (whether in relation to sales, purchases, loans, service fees etc.) and aim to restrict attempts to shift profits of multinational businesses to low-tax jurisdictions through the use of non-arm’s length pricing.

Changes to these rules that began applying from the 2014 income have increased the importance of having supporting evidentiary documentation showing that rates and prices chosen are at arm’s length, as entities without such documentation are at risk of greater penalties should the Commissioner determine a transfer pricing benefit was obtained. Certain entities that satisfy specific eligibility criteria may be able to use simplified transfer pricing documentation, which can provide some relief from ATO reviews in relation to the covered transactions. 

International Dealings Schedule

As many practitioners and taxpayers would be aware, the International Dealings Schedule (“IDS”) is an income tax return schedule that discloses information about related-party international dealings to the ATO.

Generally, the trigger point for needing to complete an IDS is whether or not the entity has international dealings with related parties worth more than AUD 2 million in total (i.e. across all related party dealings).  Care needs to be taken when determining if this threshold is exceeded, as income and expenses need to be aggregated and not set-off. For example, a company with AUD1.1 million of related party income and AUD 1 million of related party expenditure will breach the AUD 2 million threshold and be required to lodge an IDS.

An IDS may also need to be completed if the thin capitalisation provisions (refer below) apply to the entity or if the entity has overseas operations.

Thin Capitalisation

The thin capitalisation provisions in Division 820 of the ITAA 1997 have been around for a number of years and have undergone a number of refinements.

In essence, these rules seek to limit the amount of debt used to fund the Australian operations of both foreign entities investing in Australia and Australian entities investing overseas. Where an entity’s debt-to-equity ratio exceeds certain limits, this will result in a portion of the entity’s debt deductions being disallowed.

While some taxpayers are excluded (for example, where the total debt deductions for the entity and its associate entities do not exceed $2 million), for affected taxpayers, the rules impose an additional yearly compliance burden that can have material tax implications if the ratios are not managed correctly.

Foreign Hybrids

Foreign limited liability partnerships and foreign hybrid companies that are taxed as partnerships in their relevant foreign jurisdictions and whose partners or shareholders have limited liability may be subject to the foreign hybrid rules in Division 830 of the ITAA 1997. Where the rules apply, such entities, which would generally be treated as companies and taxed accordingly for Australia taxation purposes, are instead treated as partnerships for Australian taxation purposes (that is, as a flow-through entity). Further, the rules limit the amount of losses which can be deducted by a partner or shareholder of the foreign hybrid against income from unrelated sources.

As a result of these rules, groups considering investing in limited liability partnerships, or certain foreign companies (such as a US limited liability company), need to consider whether such entities will be treated as companies for Australian tax purposes, or whether the foreign hybrid rules will shift the taxation obligation form the entity to the partners/shareholders.

Foreign Hybrid Mismatch Rules

The foreign hybrid mismatch rules in Division 832 of the ITAA 1997 are relatively new rules that seek to prevent multinational groups from obtaining ‘unfair’ competitive advantages through the exploitation of differences in the tax treatment of an entity or instrument under the laws of multiple jurisdictions.

One impact of these rules is that the knowledge taxpayers and their advisers need to have about the tax impact of an instrument or entity is no longer restricted to Australian domestic tax law – now, at least a rudimentary understanding of how the entity/instrument will be taxed in overseas jurisdictions is required.

While these rules may at first glance appear to be restricted to the bigger end of town, there is a “targeted integrity rule” that can apply to ordinary loans made to Australian entities from overseas parents via interposed foreign entities in low or no tax jurisdictions. Where this targeted integrity rule applies, this can result in the denial of deductions for interest payments to the interposed entity.

An understanding of these rules and how they may impact taxpayers is critical as there is no de minimis rule or materiality threshold and, more importantly, no “grandfathering” for instruments and entities that were in place prior to the start date of these rules.

Significant Global Entities

A significant global entity (“SGE”) is an entity that has annual global income of AUD 1 billion or more, or a member of a group of entities consolidated for accounting purposes where the global parent entity has annual global income of AUD 1 billion or more.

SGEs are subject to increased compliance and reporting in the form of Country-by-Country reporting (which can require the Australian entity to report information that it may not have or easily access), and the need to lodge General Purpose Financial Statements with the ATO (to the extent they are not already lodged with ASIC). Additionally, SGEs are subject to greater integrity measures in the form of the Multinational Anti-Avoidance Law and the Diverted Profits Tax. Administrative penalties have also increased: administrative statement penalties (e.g. for making a false or misleading statement) have doubled; failure to lodge penalties have been have been multiplied by five hundred (i.e. lodging a document five months late can now cost the taxpayer $525,000 per document).

While many small Australian subsidiaries may not expect these rules to apply to them due to their small size, where they are within a larger group internationally these measures can still apply to the Australian subsidiaries and impose significant and unexpected compliance and financial burdens. 

Conclusion

As can be seen from the above, technological advances have allowed businesses both big and small to access a worldwide market. However, these advances have also resulted in these businesses being exposed to a suite of taxation regimes both domestically and internationally. Where previously such rules were thought only to apply to larger businesses, or multinational groups, increasingly smaller businesses need to understand these exposures, or they risk being subject to potentially excessively punitive, and potentially commercially unviable, penalties.

This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

Is annual leave loading subject to super?

A recent update to the ATO’s website regarding ordinary times earnings (OTE) and annual leave loading (from a superannuation guarantee (SG) perspective) has led to many employers wondering whether they have been adequately meeting their SG obligations, or whether they are at risk of being liable for the SG charge.

The ATO’s long standing position on whether annual leave loading (‘leave loading’) forms part of OTE (and, therefore, is potentially subject to SG) is reflected in SGR 2009/2 (SGR 2009/2 Superannuation Guarantee: meaning of the terms ‘ordinary times earnings’ and ‘salary or wages’).

SGR 2009/2 confirms the ATO’s view that leave loading will qualify as OTE (and, therefore, be subject to SG) unless it is referrable to a lost opportunity to work overtime, as follows:

‘238. By way of exception an annual leave loading that is payable under some awards and industrial agreements is not OTE if it is demonstrably referable to a notional loss of opportunity to work overtime. However, the loading is always included in ‘salary or wages’.’

The question of when this exception applies has led to considerable confusion for employers.

For example, in the circumstance where an employee is subject to an award that provides for leave loading, the award is unlikely to state the reason the entitlement exists. Similarly, for employees that receive leave loading outside of an award, the reason for payment of the loading may not be expressly confirmed.

Additionally, from an administrative perspective, employers may find it difficult to administer the payroll function where SG may potentially only apply to leave loading paid to certain classes of employees.

As a result, many employers have historically adopted a ‘holistic’ view that the rationale for payment of leave loading is the lost opportunity to work overtime across a leave period and, therefore, SG is not applicable (as the payments are not OTE).

Whether such rationale appropriately applies to a leave loading payment to a particular employee (or class employee) is the issue required to be determined.

For many employers, the ATO’s view as originally expressed in the now superseded SGR 94/4 ‘Superannuation Guarantee – Ordinary Times Earnings (SGR 2009/2 replaced SGR 94/4) had supported a ‘holistic’ treatment of leave loading as not being OTE. Specifically, paragraph 19 of that ruling took the view leave loading was paid in respect of employment, not ordinary hours of work and, therefore, was not OTE (unless the parties contracted otherwise).

However, the specific inclusion of paragraph 238 in SGR 2009/2 makes it clear that the ATO’s view changed such that a blanket rule does not apply to leave loading.

The recent changes to the ATO’s website resulted in the ATO acknowledging the difficulties in this area and, in effect, confirming that a blanket approach is not correct.

Of particular relevance are the changes made to the ATO’s website on 12 March 2019 (see QC58207 – Ordinary time earnings – annual leave loading). In updating its views (which haven’t essentially changed), the ATO has provided a concession to employers that may have historically taken the view their leave loading is not OTE, despite a lack of evidence to demonstrate the history/purpose of such entitlement.

As indicated above, employers in this category are potentially at risk of historical superannuation guarantee shortfalls and may be liable for the SG charge. However, in acknowledging the uncertainty and the difficulties regarding what evidence supports the purpose of leave loading entitlements, the ATO has advised:

“For this reason, we won’t apply compliance resources to scrutinising why annual leave loading was paid in historical quarters, where:

  • the employer self-assessed that the annual leave loading was not OTE, with the reasonable position that their annual leave loading was for a notional loss of opportunity to work overtime
  • there is no evidence that is less than five years old (the statutory period employers are expected to keep records relating to their SG affairs) that suggests the entitlement was for something other than overtime”.

However, the ATO confirms that going forward it has the following evidentiary requirements:

“As an entitlement to annual leave loading arises under an award or agreement, we would be satisfied that the entitlement is ‘demonstrably referrable’ to a lost opportunity to work overtime, if there is written evidence related to the entitlement.

This could be satisfied:

  • if the wording in the relevant instrument clarifies the reason for the entitlement
  • by other written evidence (for example, a documented policy) that clarifies the reason for the entitlement, and reflects the mutual understanding of both parties to the agreement that gives rise to the entitlement.

If employers do not have this evidence:

  • we would expect them to ensure they obtain it as soon as practicable, alternatively
  • assess their future entitlements on the basis that their annual leave loading falls within OTE.

Where employers have obtained this evidence as soon as practicable, we won’t apply compliance resources to scrutinising the purpose of the leave loading for quarters before they obtained the evidence”.

Conclusion

Following from the updates in guidance provided by the ATO, employers who are currently not recognising leave loading in OTE (and, therefore, have not been paying SG on these payments) should review the appropriateness of this treatment and take correct action, if required.

This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

GST, damages and insurance

When entities suffer damage or loss, it is likely that the resulting GST implications are not necessarily top of mind. However, there are some very specific rules that apply that entities need to be aware of.

To provide context, take a simple example where one party causes damage to another entity’s assets, and where we assume both parties are GST-registered and the damages occur while both parties are carrying on activities that relate to carrying on their enterprise. To be specific, take the example where the truck driver employed by the Supplier accidentally breaks a window at the Customer’s premises while delivering goods. The GST-inclusive cost to repair/replace the window is $2,200.

The GST implications arising for this scenario depends on a number of factors including whether the Customer claims compensation directly from the Supplier (i.e. claims damages), or makes an insurance claim.

Damages

Let’s assume the parties resolve this between themselves (that is, no insurance claim is made), with the Customer seeking compensation directly from the Supplier, and the Supplier making a payment directly to the Customer.

Generally for GST purposes, an entity makes a taxable supply where:

  • there is a supply made for consideration;
  • the supply is made in the course or furtherance of carrying on an enterprise;
  • the supply is connected with the indirect tax zone (i.e. Australia); and
  • the supplier is GST-registered or required to be GST-registered.

For this reason (and assuming the supply is in connection with Australia and done in the course of carrying on an enterprise), where an amount of money is paid from one GST-registered entity to another, and this is for a supply being made, the transaction will ordinary be subject to GST. However, the question of the nexus between consideration and supply is the critical issue when considering damages.

The ATO has issued a public ruling setting out its view of the GST implications for out-of-court settlements (GSTR 2001/4), with the question of nexus considered in paragraphs 100 to 114 of that ruling. In particular, paragraphs 110 and 111 state the following in relation to damages for loss:

Damages

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply made by the aggrieved party. If a payment made under a court order is wholly in respect of such a claim, the payment will not be consideration for a supply.

111. If a payment is made under an out-of-court settlement to resolve a damages claim and there is no earlier or current supply, the payment will be treated as payment of the damages claim and will not be consideration for a supply at all, regardless of whether there is an identifiable discontinuance supply under the settlement.

Considering the example provided above, notwithstanding that the Supplier pays an amount of money to the Customer (to cover the loss caused), based on the comments in paragraph 111 that amount will not be treated as consideration for any supply made by the Customer. As such, there is no supply made for consideration, and as one of the conditions for a taxable supply has not been satisfied the amount paid will not be subject to GST.

Where this is the case, the Supplier would only need to compensate the Customer for an amount equal to the Customer’s out-of-pocket expense – in this case, $2,000. Even though the Customer would engage a glazier to repair/replace the window and pay $2,200 (including GST) for such repairs, after claiming a GST credit of $200 the net (after GST) cost to the Customer is $2,000.

Insurance

Let’s now assume the parties were unable to resolve this between themselves, and the matter was dealt with via an insurance claim. Let’s further assume that, as it was the Supplier who caused the damage, the Supplier paid the Glazier directly for the repairs, and the Supplier then made a claim to its Insurer to cover the costs of the damage.

The GST implications of insurance matters are dealt with via special rules contained in Division 78 of the GST law. Division 78 refers to the following entities:

  • insurers – the insurance company;
  • insured entities – in this case the Supplier;
  • third parties – for example, the entity that has suffered the loss (in this case, the Customer); and
  • repairers – in this case the glazier who fixed the broken window for a GST-inclusive amount of $2,200.

Ultimately, the GST treatment of the transaction will be dependent on:

  • the facts of the case (including the nature of any arrangements between the insurer and the repairers);
  • the number and type of parties involved;
  • the method by which the insurers and insured entities settle the claim;
  • whether the insurer is entitled to GST credits for the insurance policy (or not); and
  • whether the insured party was entitled to claim a GST credit for the insurance premium, and whether they notified the insurer of this.

The ATO has general information on its website regarding GST and insurance settlements, and has also issued a specific public ruling, GSTR 2006/10.

Considering the example provided, and assuming the Supplier was entitled to a full GST credit and notified its insurer of this entitlement, the GST implications (based on the above) are as follows:

  • the Insurer makes a taxable supply when supplying the insurance, and therefore the premium paid is subject to GST;
  • assuming the insurance premium charged is $550, the Insurer is liable for GST of $50 and the Supplier would claim a GST credit for $50;
  • the Insured (the Supplier) made a payment to the repairer for $2,200 and claimed a GST credit for $200 – the net cost to the Supplier is $2,000;
  • when the Supplier makes its claim with the Insurer it informs the Insurer of the repair costs;
  • the Insurer only pays the Supplier $2,000:
    • this is because a payment made by an Insurer is ‘not treated as consideration for an acquisition made by the insurer’ [refer to s 78-20(1) of the GST law]; and
    • the amount received is not treated as consideration for a supply made by the entity that was entitled to an input tax credit for the premium paid for the insurance policy’

If, instead of the Supplier agreeing to pay the repairer, the Customer paid the repairer directly and the made a claim against the Supplier, the net cost to the Customer would still be $2,000 (for the reasons outlined above). The Supplier would then refer the Customer’s claim to its Insurer as part of the insurance claim. If the Insurer then paid the Customer directly, such a payment would also not be treated as consideration for a supply between these parties [refer to s 78-65(1)].

Conclusion

The explanation above is not intended to be a detailed account of how GST and insurance interacts, but a summary in the context of the above example.

As can be seen, the GST implications of damages or loss are complex and, as has been highlighted, the facts and actions of the parties are critical. This is of particular relevance when Division 78 (regarding GST and insurance) needs to be considered as there are many extra layers of complexity, and having a clear understanding of the facts is absolutely essential.

This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.

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