Category Archives: Technical Knowledge

GST on options over real property

Developers often use options as a means of mitigating risk by optioning a property so as to lock in a property at a set price whilst giving them give them time within which to obtain the necessary approvals  without having to actually acquire the property – saving carrying costs such as interest as well as delaying stamp duty.

The GST implications of options broadly follow the GST treatment of the underlying property/ies subject to the option, that is, if the supply of the underlying property on exercise of the option would be an input taxed supply of (non-new) residential premises, then the option itself will not be subject to GST.

It is common for some option holders to acquire the option with a view to obtaining the necessary approvals before effectively ‘on-selling’ the option rather than exercising it and carrying out the development itself. This is done by way of nomination under the option agreement. However, developers acquiring an option by way of nomination, whereby they pay a premium representing the difference between the amount payable for the property under the option and the market value of the underlying property following the development approval process must understand the GST implications this will have downstream when it subsequently re-develops the property and seeks to sell-off individual titles. Specifically, how acquiring property in this way, as opposed to purchasing land directly, impacts on the calculation of the margin scheme on eventual disposal.

These issues should be carefully determined as part of any meaningful feasibility study from the outset.

For a detailed explanation and helpful diagrams, see GST on Options over Real Property

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Disclaimer – this article and the contents of any links herein do not constitute specific advice and cannot be relied upon as such.

GST adjustments for property developers

Introduction

This article discusses the adjustment provisions in Div 129 of the GST Act. These provisions often apply in the context of property developers who lease out stock to generate income to offset holding costs during downturns in the market. Failing to adjust can result in inadvertent shortfalls, penalties and interest. Therefore, it is critical for developers and their advisers to have a working knowledge of the adjustment regime to avoid any nasty surprises.

Background

Where a registered taxpayer makes a wholly creditable acquisition, they are entitled to 100% of the GST embedded in the relevant good or service in the form of input tax credits. The extent to which an acquisition is creditable is based on the taxpayer’s intention as at the acquisition time regarding the use to which that acquisition will be put. That is, if it will be used to make fully taxable supplies, it will be a fully creditable acquisition. Difficulties arise, however, when an acquisition is made which, based on the intention of the taxpayer as at the acquisition time, was fully creditable but, due to a subsequent change of intention/use, the acquisition will no longer be used in making taxable, or fully taxable supplies, such as where the acquisition will now be used to make GST-free supplies.

What is a GST adjustment?

An adjustment for present purposes arises for an acquisition in an “adjustment period” where:

  1. there is a difference between the actual application and the planned (or intended) application of the relevant “thing”; or
  2. there is a difference between the actual application of the thing up to the end of 1 adjustment period and the actual application of the thing up to the end of the previous adjustment period.

When does a taxpayer have to start adjusting?

A taxpayer’s first adjustment period following a change of intention/use is the first tax period that starts at least 12 months after the end of the tax period to which the acquisition is attributable and ends on 30 June. For example, if a creditable acquisition was made on 30 September 2010, the first adjustment period would be 30 June 2012, that is:

  1. the December 2011 Quarter is the first tax period to commence at least 1 year after the end of the September 2010 Quarter; and
  2. the June 2012 Quarter is the first tax period to commence after at least 1 year after the end of the September 2010 Quarter that ends on 30 June.

For how long do taxpayers have to adjust?

The number of adjustment periods is determined by reference to the GST-exclusive value of the relevant acquisition to which they relate, that is:

GST-exclusive value of acquisitionAdjustment periods
Under $1,000No adjustment required
$1,001 to $5,0002
$5,001 to $499,9995
$500,000+10

What is the relevant “thing” subject to adjustment?

Division 129 of the GST Act applies in relation to a “thing”, for example, as outlined by the Commissioner in GST Ruling GSTR 2009/4, under a periodic payment contract for building services; this is likely to be the individual instalment payments rather than the underlying items to which they relate (concrete, bricks, trusses, windows, etc).

Example 1

X Co is a property developer. In 2010, X Co acquired a block of land for $100,000 from a private individual (no GST embedded in the sale price and X Co will apply the margin scheme on eventual disposal of the re-developed lots).

X Co incurred $550,000 (incl. GST) in expenses re-developing the property and therefore, claimed 1/11th of the total cost, or $50,000, in GST input tax credits.

The development was completed in September 2010 after which, the original property was subdivided into 2 lots. Each lot was valued at $750,000 each. X Co marketed the properties but due to a downturn in the property market, they sat on the market for 12 months.

To defray the holding costs pending sale, from September 2011, X Co decided to lease out the properties to arm’s length third parties. The properties were continually marketed for sale however, and an agreement was struck with tenants that in return for a lower rent, they required only 10 days notice to vacate if the property was sold. Each lot is leased at $3,500 per month and the market values of the properties have been revised down to $700,000 each.

The progress payments during construction were as follows:

  1. 30 May 2010 – $220,000;
  2. 30 June 2010 – $110,000
  3. 30 July 2010 – $110,000;
  4. 30 September 2010 – $110,000

Therefore, the first adjustment period for all payments is 30 June 2012.

Between September 2011 and June 2012, each property derived $35,000 in rent ($70,000 in total). Therefore, the GST adjustments are as follows:

Current market value/(Current market value + Rent)
= $700,000/($700,000 + $35,000)
= 95.24%

This is the actual application of the “thing” (that is, each progress payment). Therefore, X Co has an increasing adjustment as it overclaimed GST originally on account of the actual application of the thing. The increasing adjustment is as follows:

GST paid x (100% – 95.24%)
= $50,000 x (4.76%)
= $2,380

Example 2

Where, unlike in Example 1, X Co decided to take the properties off the market and hold them both long term for rental income. As such, the properties are leased at $4,000 per month each as there is no discounting for the short notice to vacate period as in Example 1.

Where the relevant “thing” was initially acquired for a wholly creditable purpose, but subsequently the thing was put to a wholly non-taxable purpose, it is appropriate to adjust on a time basis. That is:

[Period held for creditable purpose/Total Period] x 100%

On these facts, the first instalment payment was for a creditable purpose from 30 May 2010 to 1 September 2011 (16 months) and the total period between 30 May 2010 and 30 June 2012 is 25 months. Therefore, the adjustment is as follows:

16/25 x 100% = 64%

This is the actual application of the thing resulting in an increasing adjustment as follows:

$20,000 (GST paid on first instalment payment) x (100% – 64%)
= $20,000 x 36%
= $7,200

This process must be repeated in relation to each instalment payment.

Conclusion

The purpose of this article was to highlight the operation of the adjustment regime in Div 129 of the GST Act. The most important thing for developers and their advisers to remember is that whenever a developed lot is held or is being used for any purpose other than for sale, including to derive rental income and whether or not the property is still being marketed for sale, the GST Act operates to claw-back over-claimed input tax credits and the developer must adjust accordingly.

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Note – this article was published in the October 2012 edition of inTax Magazine (a Thomson Reuters publication).

Disclaimer – this article does not constitute specific advice and cannot be relied upon as such.

Are you a developer or investor?

Key points

  1. certain taxpayers can access the 50% CGT discount on capital assets;
  2. if you have a history of development (directly or indirectly through interposed entities), other things being equal there is a higher evidentiary burden in seeking to hold property on capital account;
  3. holding revenue and capital assets in separate entities may assist, however, ultimately it depends on all the relevant facts and circumstances of the case, that is:
    1. what you told your financiers, surveyors, real estate agents, local council authorities etc;
    2. whether you subsequent actions objectively support your previously stated intention;
    3. whether any specific event(s) gave arise to a change of intention and if so, was that change appropriately reflected for, income tax purposes, CGT and/or GST purposes in the relevant income year?

Introduction

Subject to meeting various conditions, most notably holding an asset for at least 12 months prior to its disposal, individuals and trusts (but not companies) are eligible for the 50% CGT discount. That is, they can halve the capital gain before including it in their assessable income – the other half is completely tax-free!

This significant benefit creates a tax bias or distortion in favour of holding assets on capital account compared ordinary business assets (trading stock) or otherwise on revenue account – taxpayers would be prefer to pay 50% less tax.

However, the classification of an asset as either trading stock or revenue assets on the one hand, or capital assets on the other, can be a very grey area of the law.Think of it as a spectrum with “Trading stock/revenue asset” on one side and “Capital asset” on the other. Where the particular facts clearly support one conclusion or the other, it is very straightforward, however, as you head towards the middle, it becomes more a matter of arguing by way of analogy based on common factors with the decided cases as to where the relevant taxpayer sits and why.

In recent years, certain taxpayers have pushed the boundaries to create vehicles purportedly limited to holding assets on capital account yet all other facts and circumstances pointing towards the opposite end of the spectrum.

This paper is not intended to canvass the relevant case law as to the revenue /capital distinction. Rather, it is intended to provide some practical guidance as to the Commissioner’s current compliance activity and practical evidentiary issues required in order satisfy the Commissioner that an property was held on capital account.

Ultimately, the practical reality is that taxpayers generally have the burden of proving that a tax assessment is excessive, therefore, the taxpayer’s intention with regard to the relevant assets will be determined based on myriad factors including:

  1. the taxpayers history of development (if any);
  2. how long the assets were held;and
  3. whether what the taxpayer says to the Commissioner as to their/its intention accords with what the taxpayer told their financiers, real estate agents, the local council etc at the outset.

The reality is, in the face of the Commissioner’s compliance activity and recent case law in this area, those taxpayers with a history of property development (whether directly or indirectly through interposed entities) will face a higher evidentiary burden in satisfying the Commissioner of its intention to hold assets on capital account and this must be kept in mind from the very beginning so as to ensure that contemporaneous documentation is maintained and activities are strictly referable to same.

The Commissioner’s views

The Commissioner released Taxpayer Alert TA 2014/1, ‘Trusts mischaracterising property development receipts as capital gains’ (“Alert”) on 28 July 2014. However, the Alert does little more than mirror the recent Full Court of the Federal Court decision in August v Commissioner of Taxation [2013] FCAFC 85 (“August”) insofar as the critical importance of:

  1. objective evidence of the taxpayer’s intention; and
  1. activity referable to, and in accordance with, that intention,

in seeking to satisfy the Commissioner that an asset was held on capital account.

Neither the contents of the Alert, nor the observations (and outcome) of the court in August should come as a surprise to practitioners. Taxpayers always have the onus of proving that an assessment is excessive and therefore, in advising clients on the structure of a property transaction, great care should be taken to stress that the Commissioner (and a court for that matter), will gauge subjective intention from objective material and subsequent actions. Further, the evidentiary requirement will be especially important for those taxpayers with a history of development and/or hold the property for ‘dual purposes’, that is, for sale or lease.

The Alert focuses on a particular set of facts broadly described as follows:

  1. an entity with experience in developing/selling property or otherwise involved in the property or construction industry establishes a new trust to acquire property for development and sale;
  1. the trust deed may or may not state that the purpose of the trust is to hold the developed property as a capital asset;
  1. activity is undertaken at odds with the stated purpose of treating the property on capital account, for example:
    1. financing documents refer to sales and repayment within a specified timeframe;
    2. correspondence with planning authorities refer to development for sale;
    3. correspondence with and/or engagement of real estate agents early in the development process (i.e. off-the-plan sales).
  1. the property is sold soon after completion (as little as 13 months after), with the trustee claiming the 50% CGT discount in relation to the disposal.

The ATO’s concerns include whether the underlying property constitutes trading stock (see Division 70 of the Income Tax Assessment Act 1997 [“ITAA 1997”]) or the proceeds of sale constitute ordinary income under section 6-5 of the ITAA 1997.

The decision in August

In the recent decision in August, at issue was the character of the profit derived from the sale of various parcels of land, that is, on income or capital account.

Mr August met and befriended a property developer whose modus operandi was to develop industrial/commercial property, lease it up and sell it off. Mr August was advised that there was a good opportunity to make some profit by acquiring various contingent lots, spending some money renovating/developing, leasing it up and selling.

Mr August established a unit trust and began acquiring various contingent lots in November 1997. The unit trust continued to acquire lots and develop some of those lots.

In or about mid-2005, fully developed and leased up, the court found that Mr August had commenced discussions with real estate agents with a view to sale (a finding of fact based on the court’s assessment of the available evidence).

In early 2007, the properties were sold in one line.

The unit trust returned the profit as a capital gain. The ATO argued that it was on revenue account. On appeal, the court found that Mr August’s evidence was unreliable and that his purpose was to emulate the business model of his developer friend, that is, to acquire a run-down shopping centre, rejuvenate and develop the complex, leased it up and sell for a substantial profit.

Separate to the above, Mr August’s unit trust was also a party to a 50/50 joint venture with his developer friend in relation to another property. The joint venture agreement provided for maximum flexibility in terms of the relevant investment strategy and said nothing at all in terms of holding assets for long-term investment.

Mr August argued that there was an Addendum to the joint venture agreement which stated that:

  1. the strategy was to create a long-term investment portfolio of commercial and industrial properties;
  1. use the income and equity generated from investments to reinvest and build assets; and
  1. restrict the sale of assets unless absolutely necessary.

However, the court found that the objective evidence showed:

  1. the surveyors report in relation to the proposed development of the property stated that it was to be subdivided into 6 smaller lots to be sold individually (which was the topic of discussion at various meetings with the relevant Territory Government Authority);
  1. signs were erected on the property advertising subdivided lots “For Sale or Lease”; and
  1. neither Mr August or his other joint venture participant’s evidence was reliable and that there had been highly improper collusion between them with regard to the existence of the Addendum after the fact.

On this basis, the property was taken to be held by the joint venture participants on revenue account.

As can be seen from both R&D Holdings and August, contemporaneous objective evidence as to intention is critical, and all activities should be consistent with that intention. The bar is be higher in terms of the evidentiary burden applicable to those with a history of development, but it is not the case that just because an entity (or its directing mind) has developed in the past, and continues to do so, that it is not capable of holding assets on capital account under any circumstances.

Trading stock and dual purposes?

It is clear from the decision in August (relying on the decision of Finn J in R & D Holdings Pty Ltd v FCT [2006] FCA 981 [“R&D Holdings”]) that in circumstances where a client is “keeping their options open” with regard to the sale or lease of a property, it will be trading stock. That is, where a dual purpose exists, the decisions in August and R&D Holdings appear to introduce a judicial gloss inserting a tie-breaker test in favour of trading stock (as opposed to capital account) akin to that under the debt/equity rules in Division 974 of the ITAA 1997.

Whether this is correct, that is, where even the slightest intention to sell triggers this de facto tie-breaker or a dominant purpose test is more appropriate in seeking to characterise the relevant assets as either trading stock or capital assets at any particular time, is beyond the scope of this paper. However, the practical reality is that in almost every instance, even taxpayers who clearly hold an asset on capital account are “open” to the prospect of a sale and this, of itself, cannot be sufficient to render the asset trading stock (or otherwise on revenue account).

Strangely, Finn J himself in R&D Holdings accepted on the evidence that the relevant entity’s dominant purpose was the sale of strata lots, even though, in relying the authority of John v FCT (1989) 166 CLR 417, the trading stock regime did not employ a sole or dominant purpose test. Similarly, the Commissioner himself in TR 93/26 (partially withdrawn) referred to a dominant purpose requirement in a trading stock context (specifically, the circumstances in which horses would be live-stock, and therefore trading stock, rather than plant – see paragraph 18 of TR 93/26).

Further, there is UK case law authority for the proposition that assets can change their character (as between trading stock and capital assets), but cannot have a dual character at the same time (see Simmons (as liquidator of Lionel Simmons properties) v Inland Revenue Commissioners [1980] 2 All ER 798, as cited by the Commissioner in MT 2006/1 in the context of carrying on a business and obtaining an ABN). This is not binding authority in Australia, but should be persuasive.

Practical observations and conclusions

For those practitioners advising clients on property transactions, it is necessary to carefully consider the following:

  1. what are the client’s stated intentions?
  1. does the client, or the directing mind of the client (i.e. directors, trustees or directors of corporate trustees) have a history of property development or sales?
  1. on what basis has the client obtained bank finance? For example:
    1. is it a construction/development loan?
    2. is it an ordinary residential loan?
    3. if it is a construction/development loan, is it to be repaid from:
      1. sales; or
      2. refinanced on completion and replaced by an ordinary residential loan?
    4. what has the client told various stakeholders as to its plans, including:
      1. the financier?
      2. surveyors?
      3. real estate agents?
      4. the local council?
  2. is the client ‘keeping their options open’? If so, there is considerable risk based on the above that the underlying assets will be treated as trading stock (and although this may not be technically correct, the Commissioner’s views do present a clear compliance risk in this regard);
  1. if the client’s intention changes, ensure it is properly reflected both in the accounts and for tax purposes (e.g. from capital account to trading stock – section 70-30 of the ITAA 1997; TD 92/124; section 104-220 of the ITAA 1997 [CGT event K4]; from trading stock to capital account – section 70-100 of the ITAA 1997).

Finally, in many cases practitioners are required to advise on joint ventures between multiple parties. Further, it is often the case that joint venture participants wish to sell some end-product and retain others.

Clearly, issues arise as to ‘dual purpose’, however, provided that the evidence clearly supports the disposal of particular properties and the retention of others, there is no dual purpose with regard to a single property and therefore, a clear distinction could be maintained between those that are trading stock, and those on capital account.

For example, A Co and B Trust enter into a joint venture to develop and partition 8 apartments. A Co is to take away 6 apartments and sell them for its exclusive benefit. B Trust is to take away 2 apartments and wishes to sell one (“Apartment 7”) and retain one (“Apartment 8”).

If the evidence clearly supports, from the outset and throughout the entire development process, B Trust’s intention to retain Apartment 8, then the issues outlined above should not arise, despite the fact that Apartment 7 is clearly trading stock.

Of course, any taxpayer, particularly those with a history of development or property sales, who maintain a property was held on capital account which is sold very soon after the expiration of the 12 month holding period (facilitating access to the 50% CGT discount) will come under particular scrutiny.

Broadly, in the absence of special circumstances, such as a rapid decline in the taxpayer’s financial circumstances forcing a sale, it would increasingly difficult to discharge the taxpayer’s burden of proof in seeking to prevent the Commissioner from treating it as trading stock (or otherwise on revenue account) the shorter the holding period.

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Note – this article was published in the August 2013 edition of inTax Magazine.

Disclaimer – this article does not constitute specific advice and cannot be relied upon as such.

Cross border employee share scheme issues: issues for inbound employees

Introduction

 The taxation of employee share schemes (“ESS”) has undergone significant amendments under successive Governments over the last decade.  The current rules under Division 83A of the Income Tax Assessment Act 1997 (“ITAA 1997”) have applied since 1 July 2009 (although significant amendments were introduced with effect from 1 July 2015).

This paper highlights the general operation of the ESS rules and particular issues in relation to foreign-resident employees coming to Australia as ESS participants subject to ongoing vesting conditions (e.g. continuing employment for the relevant company/corporate group).

The starting point – upfront or deferred taxation?

First principles

An ESS is a scheme under which ‘ESS interests’ in a company are provided to employees, or associates of employees, of the company or a subsidiary.[1]

In turn, an ESS interest in a company is either:

  1. a share in the company; or
  1. a right to acquire a share in the company (e.g.an option).[2]

Relevantly, it is important to note that for ESS purposes:

  1. the rules extend not only to ‘employees’ as defined at common law,[3] but also to certain relationships similar to employment;[4] and
  1. where an employee participant participates in an ESS indirectly via an associate, the associate is effectively ignored and any actions of the associate attributed to the employee participant in determining the tax implications under the ESS rules.[5]

Upfront taxation

The starting point is that a taxpayer includes in their assessable income any ‘discount’ provided in relation to an ESS interest in the income year it is acquired.[6] The discount is the difference between the market value of the ESS interest granted and the consideration provided by the employee participant (if any).

Despite the general position outlined above, special rules may apply to reduce (including to nil) the discount  otherwise assessable in the hands of an employee participant where:

  1. the ESS is operated by an eligible start-up company in relation to eligible employees;[7] or
  1. amongst other things, the employee participants have adjusted taxable income of no more than $180,000 (up to a maximum $1,000 reduction).[8]

Deferred taxation

Subject to meeting certain conditions (which differ depending on whether the ESS relates to shares or rights in relation to shares),[9] employee participants are not taxed upfront and are instead taxed at the ‘deferred taxing point’.

Some of the critical conditions for deferred taxation are:

  1. in relation to an ESS involving shares, either:[10]
    1. the shares are subject to a real risk of forfeiture; or
    2. part of a salary sacrifice arrangement (subject to a maximum $5,000 limit);
  1. in relation to an ESS involving rights to shares, either:[11]
    1. the rights are subject to a real risk of forfeiture; or
    2. the ESS plan rules genuinely restrict participants from immediately disposing of the right and expressly states that Subdivision 83A of the ITAA 1997 applies; and
  1. in relation to either type of ESS, it involves either ordinary shares or rights in relation to ordinary shares only.[12]

Where deferred taxation is available, the employee participant includes the market value of the ESS interest (less the cost base of those interests) in their assessable income for the income year in which the deferred taxing point occurs.[13]

The ‘deferred taxing point’ is generally the earlier to occur of various events, which differ depending on whether the ESS relates to shares[14] or rights in relation to shares,[15] that is

For SharesFor Rights (incl. Options)
No longer real risk of forfeiture or (if applicable) restriction on disposal of the shareYou have not exercised the right, no longer real risk of forfeiture and (if applicable) no longer any restriction on disposing of the right
Cessation of employment to which ESS interest relatesCessation of employment to which ESS interest relates
15th anniversary of grant date15th anniversary of grant date
–You have exercised the right, no longer real risk of forfeiture and (if applicable) no longer any restriction on disposal of the underlying share

Cross-border ESS issues

Overview

The global mobility of the workforce can give rise to complications where foreign-resident participants in a deferred tax ESS are seconded or relocate to Australia. In this regard, variables include:

  1. the type of ESS (as determined under Division 83A of the ITAA 1997);
  1. if it is a deferred tax plan, whether the ESS interests have fully vested prior to arriving in Australia; and
  1. whether the foreign-resident participant:
    1. became an Australian resident at any stage?
    2. if so, whether they qualified as a temporary resident for Australian tax purposes?
    3. is (or at some stage was) tax-resident of a country with which Australia has a Double Tax Agreement (“DTA”)?
    4. if so, the impact of the DTA (which overrides domestic Australian tax law to the extent of any inconsistency save for anti-avoidance considerations under Part IVA of the Income Tax Assessment Act 1936).

Legislative intent

In the context of foreign employment, the Explanatory Memorandum to the Tax Laws Amendment (2009 Measures No. 2) Bill 2009 (“EM”) states:[16]

“Under the core rules of the Australian income tax system, an Australian resident taxpayer is subject to income tax on their worldwide income. A foreign resident taxpayer is only subject to Australian income tax on their Australian sourced income.

Under the existing law, this outcome is achieved by excluding discounts from interests acquired under employee share schemes from tax under the employee share scheme tax rules, to the extent that they relate to foreign service of a taxpayer.

This mechanism operates in a manner inconsistent with core rules. The new rules use the core rules to achieve the desired outcome. The new rules instead include source rules and rely on the core rules to the exclude foreign sourced income of foreign residents from Australian income tax. That is, the employee share scheme rules attribute a source to discounts received on securities acquired under employee share schemes.”

And further:[17]

“Australian resident taxpayers are subject to Australian income tax on all discounts they receive under employee share schemes regardless of whether they received it in relation to employment in Australia or outside Australia. However, this may be affected by Australia’s double tax treaties and the temporary residents rules.”

Therefore, if a foreign-resident ESS participant becomes an Australian resident whilst subject to ongoing vesting criteria such as continued employment and remain Australian resident as at the deferred taxing point, they will be fully taxable in Australia (unless they qualify as temporary residents or benefit under an applicable DTA).

Temporary resident rules

The temporary resident rules[18] provide for concessional tax treatment of foreign-resident individuals that become Australian residents for tax purposes where they meet certain eligibility criteria (including holding certain temporary visas).[19]

The relevant rules limit Australia’s taxing rights to Australian source income only (except for foreign source employment income derived whilst a temporary resident such as where a temporary resident was sent overseas for work for 4 weeks before returning to Australia).[20]

Foreign-resident ESS participant fully vested prior to Australian residence

Where a foreign-resident’s ESS interests fully vest prior to arriving in Australia, whether under an upfront scheme or a deferred tax scheme, there will be no Australian tax implications under Division 83A of the ITAA 1997 (although there may be CGT implications going forward in relation to any shares or options held).[21]

In this regard, practitioners must carefully review the relevant ESS plan documents to determine the tax implications accordingly. For example, a critical distinction is maintained between vesting periods and mere ‘blocking periods’.

In this regard, the OECD Commentary on the Model Tax Convention states:[22]

“as a general rule, an employee stock-option should not be considered to relate to any services rendered after the period of employment that is required as a condition for the employee to acquire the right to exercise that option.

. . .

In applying the above principle, however, it is important to distinguish between a period of employment that is required to obtain the right to exercise an employee stock-option and a period of time that is merely a delay before such option may be exercised (a blocking period). Thus, for example, an option that is granted to an employee on the condition that he remains employed by the same employer (or an associated enterprise) during a period of three years can be considered to be derived from the services performed during these three years while an option that is granted, without any condition of subsequent employment, to an employee on a given date but which, under its terms and conditions, can only be exercised after a delay of three years, should not be considered to relate to the employment performed during these years as the benefit of such an option would accrue to its recipient even if he were to leave his employment immediately after receiving it and waited the required three years before exercising it.”

If a foreign-resident individual arrives in Australia with fully vested ESS interests subject to an ongoing blocking period, they will still fall outside Division U83A of the ITAA 1997 (although again, there may be CGT implications going forward).

Foreign income tax offsets

Where Australia has taxing rights in relation to ESS interests, an issue arises as to the grant of double tax relief (either domestically or under an applicable DTA).

Domestically, Australia provides foreign income tax offsets to Australian residents taxed overseas on a source basis.[23]

Under Australia’s DTA’s, employment income (including income derived under an ESS) is only assessable in the individual’s country of residence unless the employment is performed in the other country).[24] However, the source country has no taxing rights at all where:[25]

  1. the foreign resident individual is present in the source State for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the income year concerned; and
  1. the remuneration is paid by, or on behalf of, an employer who is not a resident of the source State, and
  1. the remuneration is not borne by a permanent establishment which the employer has in the source State.

If the default position applies, then the foreign-resident individual will be taxed in Australia to the extent of the Australian source only (and the residence country will be required to provide a foreign tax credit for the Australian tax paid).[26]

If the exception applies, the foreign-resident individual will not be taxed in Australia at all.

Table of common outcomes

The following table assumes that a foreign-resident individual arrives in Australia as a participant in a deferred tax ESS (that is, after the grant but before the deferred taxing point).

The table summarises some common outcomes in these circumstances, however, the specific tax consequences of a particular client depend on all the relevant facts and circumstances of the individual taxpayer and ESS plan documentation:

Australian Resident (Domestic)DTADTA Residency Tie-breakerDoes DTA Exemption apply?Temporary Resident?Credit for foreign tax paidTax Outcome
NoNoN/AN/AN/AN/ATaxed on Australian source portion

at DTP*

NoYesN/AYesN/AN/ANot taxed in Australia
NoYesN/ANoN/AN/ATaxed on Australian source portion

at DTP*

YesNoN/AN/AYesN/ATaxed on Australian source portion

at DTP*

YesNoN/AN/ANoYesTaxed on entire amount less FITO** at DTP*

*       DTP = Deferred Taxing Point

** FITO = Foreign Income Tax Offset

[1] Subsection 83A-10(2) of the ITAA 1997

[2] Subsection 83A-10(1) of the ITAA 1997

[3] See Hollis v Vabu Pty Ltd [2001] HCA 44

[4] Section 83A-325 of the ITAA 1997

[5] See section 83A-305 of the ITAA 1997

[6] Subsection 83A-25(1) of the ITAA 1997

[7] See section 83A-33 of the ITAA 1997

[8] See section 83A-35 of the ITAA 1997

[9] See section 83A-105 of the ITAA 1997

[10] See paragraph 83A-105(1)(c)(ii) of the ITAA 1997

[11] See paragraph 83A-105(1)(d) of the ITAA 1997

[12] See paragraph 83A-105(1)(b) of the ITAA 1997, subsection 83A-45(2) of the ITAA 1997 and  Norman v. Norman (1990) 19 NSWLR 314

[13] Subsection 83A-110(1) of the ITAA 1997

[14] See section 83A-115 of the ITAA 1997

[15] See section 83A-120 of the ITAA 1997

[16] At paragraph 1.347 – 1.350

[17] At paragraph 1.355

[18] See Division 768-R of the ITAA 1997

[19] See section 995-1 of the ITAA 1997

[20] See section 768-910 of the ITAA 1997

[21] See, for example, sections 855-45 (market value cost base uplift of CGT assets (other than ‘taxable Australian property’ or pre-CGT assets) for individuals that become Australian residents) and 768-950 of the ITAA 1997 (market value cost base uplift where temporary resident ceases to be a temporary resident but remains an Australian resident) or under an applicable Double Tax Agreement

[22] At paragraph 12.7 – 12.8

[23] See Division 770 of the ITAA 1997

[24] See Article 15(1) of the OECD Model Tax Convention

[25] See Article 15(2) of the OECD Model Tax Convention

[26] See Article 23B of the OECD Model Tax Convention

*   *   *   *   *

Note – This article was published in the April 2016 edition of inTax Magazine (a Thomson Reuters publication)

Disclaimer – This article does not constitute specific advice and cannot be relied upon as such.

Heading to the US? Flow chart for Aussie ex pats

Introduction

Whenever an individual relocates overseas, there are a number of potential tax issues to consider from both a home country and destination country perspective and critically, the interactions between the two (if any).

Australia’s “exit tax” and the making of “exit elections”

Clients are often surprised to learn that Australia has an “exit tax”, that is, in relation to all assets other than a limited class of assets including Australian real property, an individual is deemed to dispose of their CGT assets on the date they cease to be an Australian resident for their market value on that date.

Individuals do, however, have the option to defer taxation until actual disposal, however, whether or not this “exit election” should be made depends on variables such as:

  1. the level of unrealised gain;
  2. whether there are any capital or tax losses available; and
  3. the expected future performance of the asset.

Another key consideration is that the “exit election” in an all-or-nothing election, meaning that you cannot pick and choose on an individual asset basis which will trigger the exit tax and which will be subject to the exit election.

Disdvantage of making an “exit election” – impact on 50% CGT discount

If an individual decides to make an “exit election”, then with limited exceptions under particular Double Tax Agreements (such as with the US and UK), the relevant assets will forever remain within the Australian tax net.

Ordinarily,where an individual holds a CGT for at least 12 months, they are generally entitled to the 50% CGT discount, meaning that they halve a capital gain before including it in their assessable income (the other half being completely tax-free!).

However, from 8 May 2012, foreign residents have been ineligible for the 50% CGT discount and in the context of individuals that are both Australian resident and foreign resident at different times over the ownership period of the asset, the maximum 50% CGT discount rate is reduced to the extent of foreign residence.

This is another critical factor which feeds into the decision as to whether or not to make an exit election (although again, special overriding rules can apply under specific Double Tax Agreements in particular circumstances).

Impact on controlled entities

When an individual ceases to be an Australian resident, it may have a cascading effect on the residence of entities that they control. For example:

Companies

Under Australian domestic tax law, a company that is incorporated in Australia is always a resident of Australia for tax purposes, however, if you remain the directing mind of the company and the country you move to has a ‘central management and control test’ for corporate tax residency purposes, the company may also be a tax resident there.

In this situation, if Australia has a Double Tax Agreement with that other country with a corporate residency tie-breaker rule, it would generally assign sole tax residence to the country in which central management and control resides.

Australia and the US do not have corporate tie-breaker rules under the Double Tax Agreement and this can give rise to complications.

Trusts

Broadly, a trust is an Australian resident trust if the trustee is resident in Australia. If you are the sole trustee of a family trust and you relocate overseas ceasing to be an Australian resident, then although there may be a time lag between you ceasing to be a resident and the trust ceasing to a resident, unlike individuals, when a trust ceases to be an Australian resident it triggers an “exit tax” and there is no scope to make an “exit election” as they are only open to individuals.

SMSF’s

The concessional superannuation environment means that SMSFs are a popular and ever-growing retirement vehicle. However, with the global mobility of the workforce, many people live and work overseas for extended periods of time.

One of the critical conditions of complying fund status (which is required to maintain access to the relevant tax concessions) is that the fund’s central management and control is ordinarily in Australia.

There is a special concession where ‘central management and control’ is temporarily outside Australia for up to 2 years, however, if an individual departs Australia indefinitely or intends to remain outside for more than 2 years then they cannot take advantage of this concession even if they actually return to Australia within the 2 year time limit.

If the central management and control test cannot be satisfied, then there is a significant risk of ceasing to be a complying fund which means that both the current year income and capital value of the fund (other than certain contributions) is subject to tax at 45%!

There are a number of options to ensure that an SMSF retains complying fund status around the central management and control issue. Which particular strategy to implement depends on your particular circumstances although any such strategy must be in place prior to your departure!

It is also important to recognise that the US does not recognise the special nature of an SMSF and therefore, in certain circumstances, the income of an SMSF can be taxed to an individual personally in the US.

US grantor trust rules

The US have extremely broad-reaching rules known as the grantor trust rules that can operate to tax an individual that has settled money or otherwise provided a benefit to the trust within 5 years of becoming a US resident.

For example, assume an Australian resident individual establishes an Australian family trust. The individual’s lawyer or accountant gifts the usual $10 settlement sum to establish the trust and then the individual subsequently settles $100,000 on the trust in order for it to make various investments. The individual is the trustee or the sole director of the corporate trustee.

Three years later the individual takes up a business or employment opportunity in the US and becomes a US tax resident. The US grantor trust rules can apply to tax the individual personally in the US on the income of the trust regardless of where the trustee actually distributes the income.

Forward planning

The process of determining the tax implications of ceasing to be an Australian resident is known as “pre-departure planning”.

On the other side of the equation, the tax implications of becoming a foreign resident in the particular jurisdiction is known as “pre-arrival planning”.

Ensuring that your pre-departure planning strategies dovetail with your pre-arrival planning strategies is the key to ensuring that you are able to make fully informed decisions and avoid any nasty surprises.

Through our international affiliate network (www.primeglobal.net), we can help you seamlessly transition anywhere around the world.

Specifically in relation to the particular pre-departure and pre-arrival planning issues to consider when relocating to the US, please see our link below:

 Are you relocating to US

*   *   *   *   *

international

Disclaimer – This article does not constitute specific advice and cannot be relied upon as such.

Heading to the UK? Flow chart for Aussie ex pats

Introduction

Whenever an individual relocates overseas, there are a number of potential tax issues to consider from both a home country and destination country perspective and critically, the interactions between the two (if any).

Australia’s “exit tax” and the making of “exit elections”

Clients are often surprised to learn that Australia has an “exit tax”, that is, in relation to all assets other than a limited class of assets including Australian real property, an individual is deemed to dispose of their CGT assets on the date they cease to be an Australian resident for their market value on that date.

Individuals do, however, have the option to defer taxation until actual disposal, however, whether or not this “exit election” should be made depends on variables such as:

  1. the level of unrealised gain;
  2. whether there are any capital or tax losses available; and
  3. the expected future performance of the asset.

Another key consideration is that the “exit election” in an all-or-nothing election, meaning that you cannot pick and choose on an individual asset basis which will trigger the exit tax and which will be subject to the exit election.

Disdvantage of making an “exit election” – impact on 50% CGT discount

If an individual decides to make an “exit election”, then with limited exceptions under particular Double Tax Agreements (such as with the UK and US), the relevant assets will forever remain within the Australian tax net.

Ordinarily,where an individual holds a CGT for at least 12 months, they are generally entitled to the 50% CGT discount, meaning that they halve a capital gain before including it in their assessable income (the other half being completely tax-free!).

However, from 8 May 2012, foreign residents have been ineligible for the 50% CGT discount and in the context of individuals that are both Australian resident and foreign resident at different times over the ownership period of the asset, the maximum 50% CGT discount rate is reduced to the extent of foreign residence.

This is another critical factor which feeds into the decision as to whether or not to make an exit election (although again, special overriding rules can apply under specific Double Tax Agreements in particular circumstances).

Impact on controlled entities

When an individual ceases to be an Australian resident, it may have a cascading effect on the residence of entities that they control. For example:

Companies

Under Australian domestic tax law, a company that is incorporated in Australia is always a resident of Australia for tax purposes, however, if you remain the directing mind of the company and the country you move to has a ‘central management and control test’ for corporate tax residency purposes, the company may also be a tax resident there.

In this situation, if Australia has a Double Tax Agreement with that other country with a corporate residency tie-breaker rule, it would generally assign sole tax residence to the country in which central management and control resides.

Trusts

Broadly, a trust is an Australian resident trust if the trustee is resident in Australia. If you are the sole trustee of a family trust and you relocate overseas ceasing to be an Australian resident, then although there may be a time lag between you ceasing to be a resident and the trust ceasing to a resident, unlike individuals, when a trust ceases to be an Australian resident it triggers an “exit tax” and there is no scope to make an “exit election” as they are only open to individuals.

SMSF’s

The concessional superannuation environment means that SMSFs are a popular and ever-growing retirement vehicle. However, with the global mobility of the workforce, many people live and work overseas for extended periods of time.

One of the critical conditions of complying fund status (which is required to maintain access to the relevant tax concessions) is that the fund’s central management and control is ordinarily in Australia.

There is a special concession where ‘central management and control’ is temporarily outside Australia for up to 2 years, however, if an individual departs Australia indefinitely or intends to remain outside for more than 2 years then they cannot take advantage of this concession even if they actually return to Australia within the 2 year time limit.

If the central management and control test cannot be satisfied, then there is a significant risk of ceasing to be a complying fund which means that both the current year income and capital value of the fund (other than certain contributions) is subject to tax at 45%!

There are a number of options to ensure that an SMSF retains complying fund status around the central management and control issue. Which particular strategy to implement depends on your particular circumstances although any such strategy must be in place prior to your departure!

Forward planning

The process of determining the tax implications of ceasing to be an Australian resident is known as “pre-departure planning”.

On the other side of the equation, the tax implications of becoming a foreign resident in the particular jurisdiction is known as “pre-arrival planning”.

Ensuring that your pre-departure planning strategies dovetail with your pre-arrival planning strategies is the key to ensuring that you are able to make fully informed decisions and avoid any nasty surprises.

Through our international affiliate network (www.primeglobal.net), we can help you seamlessly transition anywhere around the world.

Specifically in relation to the particular pre-departure and pre-arrival planning issues to consider when relocating to the UK, please see our link below:

Heading to the UK Flow Chart

*   *   *   *   *

international

Disclaimer – This article does not constitute specific advice and cannot be relied upon as such.

Relocating to the UK? Tax issues for Aussie ex pats

Introduction

With uncertainty surrounding the fallout from the UK’s decision to leave to European Union, it is reasonable to assume that the steady stream of Australians heading to the UK is likely to slow (at least temporarily) and those living in the UK may even return. However, the UK generally, and the city of London specifically, will continue to attract working Australians in a variety of industries.

Whenever an Australian relocates to another country it is critical that they carefully consider:

  1. whether they will cease to be an Australian resident for tax purposes;
  1. if so, whether they will be subject to Australia’s ‘Exit Tax’;
  1. if so, whether they should make an ‘Exit Election’ to defer the taxing point until actual disposal;
  1. if an exit election is made, the impact foreign-residence has on eligibility for the full 50% CGT discount;
  1. whether they qualify as a UK-resident non-domiciliary (“Non-Dom”) such that they are only taxed in the UK on:
    1. UK-source income; and
    2. foreign (non-UK) source that is remitted to the UK (which has a particular definition in relation to which specific advice should be sought);
  1. whether there are any pre-departure planning strategies to consider (from an Australian perspective);
  1. whether there are any pre-arrival planning strategies to consider (from a UK perspective);
  1. the operation of the Australia-UK Double Tax Agreement (“DTA”) in the event that:
    1. Australian source income (such as dividends, interest or royalties):
      1. is remitted to the UK (to be assessed in the UK); or
      2. is not remitted to the UK (and therefore, not subject to tax in the UK);
    2. Australian source capital gains from assets subject to an exit election are disposed of whilst remaining a Non-Dom and:
      1. is remitted to the UK (to be assessed in the UK); or
      2. is not remitted to the UK (and therefore, not subject to tax in the UK).

This article focuses on the interaction between the Australian domestic tax system and the provisions of the DTA in circumstances where the relevant Australian source is or is not remitted to the UK. It is assumed that the relevant individual ceases to be an Australian resident under Australian domestic tax law so as to trigger the Exit Tax or the making of an Exit Election.

Australia’s ‘Exit Tax’

CGT event I1 happens if an Australian-resident individual or company ceases to be a resident of Australia (s104-160(1) ITAA 1997). The timing of the event is when the individual or company ceases to be Australian tax-resident (s104-160(2) ITAA 1997).

A capital gain is derived if the market value of each relevant CGT asset is more than their respective cost base and a capital loss is incurred to the extent that the market value of each CGT asset is less than their respective cost base (s104-160(4) ITAA 1997).

Are all CGT assets subject to Exit Tax?

Not all CGT assets are subject to Exit Tax. That is, the class of CGT assets known as ‘taxable Australian property’ (“TAP”) (s855-15 ITAA 1997) are not subject to CGT event I1 (s104-160(3) ITAA 1997).

The most common form of TAP is Australian real property (s855-20 ITAA 1997) and indirect Australian real property interests (s855-25 ITAA 1997).

The policy driver of the Exit Tax is to prevent Australian-residents with unrealised capital gains ceasing to be Australian-residents and taking advantage of Australia’s CGT exemption for foreign-residents. That is, Australia only taxes foreign residents on Australian source capital gains from TAP assets, therefore, for example, if an Australian-resident individual with unrealised capital gains in shares in an Australian company (not being an indirect Australian real property interest) ceased to be an Australian resident then sold those shares the next day, but for the Exit Tax, they would not be taxed in Australia at all. The Exit Tax captures unrealised capital gains of Australian residents before those unrealised gains fall outside the Australian tax net altogether.

As TAP is always in the Australian tax net (even for foreigners that never step foot in the country), there is no need for an Exit Tax on these assets. Further, it is important to recognise that the Exit Tax:

  1. applies to all CGT assets other than TAP, including foreign CGT assets of a departing Australian-resident individual (such as shares in foreign companies); and
  1. only applies to CGT assets acquired after the introduction of Australia’s CGT regime on 20 September 1985 (s104-160(5) ITAA 1997).

Exception to Exit Tax: individuals may make Exit Election

Despite the Exit Tax rules above, individuals (but not companies) may choose to disregard any capital gain or loss on the deemed disposal of assets under CGT event I1 (s104-165(1) ITAA 1997) and the legislative mechanism by which this is achieved is to convert the previous non-TAP CGT assets into TAP assets going forward (item 5, s855-15 ITAA 1997).

To elect or not to elect: that is the question

Whether or not to make an Exit Election (which is an ‘all-or-nothing’ election in relation to all non-TAP assets rather than on an asset-by-asset basis) depends on variables, including:

  1. the particular facts of the case (e.g. whether, on an overall basis, there would be a net capital gain);
  1. the tax profile of the taxpayer (e.g. their income from other sources, the availability of tax and/or capital losses); and
  1. the anticipated holding period and future performance of the asset.

In relation to the latter, it was previously more common for outbound Australian residents to make the Exit Election as Australia generally allowed both Australian and foreign-resident individuals to access the 50% CGT discount where, amongst other things, the relevant CGT asset was held for at least 12 months (Subdiv 115-A ITAA 1997).

However, as of 8 May 2012, foreign-residents are no longer entitled to the full 50% CGT discount (s115-105 ITAA 1997). Broadly, the maximum 50% CGT discount is reduced to the extent that the individual is foreign-resident over the holding period of the asset and therefore, whether or not to make an Exit Election now involves balancing the up-front tax cost versus the estimated future tax burden on actual disposal at (higher) foreign-resident tax rates of up to 45% and without the benefit of the full 50% CGT discount.

Impact of the DTA

As Australia and the UK have entered into the DTA, its provisions override those of domestic tax law to the extent of any inconsistency (other than in relation to Australia’s general anti-avoidance rules).

The purpose of the DTA is to allocate taxing rights so as to minimise the impact of double taxation (or double non-taxation).

Non-Doms and remittance-based taxation

Australian source dividends, interest and royalties

Under Australian tax law, the following Australian source income items are subject to Australian withholding tax at the relevant rates:

  1. dividends – 30% (s128B(4) ITAA 1936 and s7 IT(DIRWT)A 1974);
  1. interest – 10% (s128B(5) ITAA 1936 and s7 IT(DIRWT)A 1974); and
  1. royalties – 30% (s128B(5A) ITAA 1936 and s7 IT(DIRWT)A 1974).

Of course, no withholding tax applies to the extent that the dividend is franked (s128B(3)(ga)(i) ITAA 1936).

Under the DTA (which again, overrides domestic Australian tax law to the extent of any inconsistency) these withholding tax rates are reduced as follows:

  1. dividends – 0% – 15% (Article 10 DTA);
  1. interest – max. 10% (Article 11 DTA);
  1. royalties – max. 5% (Article 12 DTA).

However, the DTA limits relief in certain circumstances involving former Australian-residents that are Non-Doms. That is, Article 23(1) DTA states:

“Where under this Convention any income or gains are relieved from tax in a Contracting State [Australia] and, under the law in force in the other Contracting State [UK], a person in respect of that income or those gains is taxed by reference to the amount thereof which is remitted to or received in that other State [UK] and not by reference to the full amount thereof, then the relief to be allowed under this Convention in the first-mentioned State [Australia] shall apply only to so much of the income or gains as is taxed in the other State [UK].”

Based on the above, where a Non-Dom derives Australian source dividends, interest or royalties and:

  1. does not fully remit any of that income to the UK – they will be subject to Australian domestic withholding tax rates (unless the relevant dividends is fully franked such that no dividend withholding tax arises and it does not make a difference from an interest perspective given the same 10% rate arises); and
  1. remits some but not all of that income to the UK – they will be subject to a mixture of both:
    1. Australian domestic withholding tax rates; and
    2. the DTA rates (as apportioned).

Australian source capital gains

Article 13(5) DTA states:

“An individual who elects, under the taxation law of a Contracting State [Australia], to defer taxation on income or gains relating to property which would otherwise be taxed in that State [Australia] upon the individual ceasing to be a resident of that State [Australia] for the purposes of its tax, shall, if the individual is a resident of the other State [UK], be taxable on income or gains from the subsequent alienation of that property only in that other State [UK].”

In terms of the interaction between Australian domestic tax law and the DTA, where an Exit Election is made (to disregard the Exit Tax), even though Australian domestic tax law would continue to treat those assets as TAP and therefore, within the Australian CGT net on actual disposal, if the relevant individual remains a Non-Dom on actual disposal, the DTA will apply to override Australian domestic tax law such that, provided that the capital gain is fully remitted to the UK (Article 23(1) DTA), the  capital gain will be taxed solely in the UK (Article 13(5) DTA).

Conversely, if the capital gain is not remitted to the UK, despite Article 13(5) DTA the operation of Article 23(1) DTA will prevent its application leaving the capital gain to be assessed under Australian domestic tax law (at foreign-resident rates without the benefit of the full 50% CGT discount).

The operation of similar provisions under the UK-Canada Double Tax Agreement were recently confirmed by the Federal Court of Appeal of Canada in Conrad Black v The Queen, 2014 FCA 275 (FCA) November 26, 2014.

Conclusion

Whenever an Australian relocates overseas, there are myriad issues to consider.  For those heading to the UK and becoming a Non-Dom, it is important to understand the tax implications of that status insofar as the relief available under the DTA being dependent on whether or not, and if so, to what extent, they remit Australian source income to the UK.

As an adviser, clients should be made aware of the tax implications of various scenarios to enable them to make fully informed decisions prior to their departure. Of course, at that stage the actual tax implications of future disposals are purely hypothetical and the conversation is more structural, that is:

  1. when will they be taxed;
  1. where will they be taxed; and
  1. how will they be taxed.

As to the interaction between Australian domestic tax law and the DTA with regards to a Non-Dom that made an Exit Election, the position may be summarised as follows:

Type of Australian source incomeAustralian domestic positionDTA position
  If fully remittedIf not remitted
Unfranked Dividends*30% WHT0%-15% WHT30% WHT
Interest10% WHT10% WHT10% WHT
Royalties30% WHT5% WHT30% WHT
Capital GainsTaxed in Australia (foreign-resident rates w/o full 50% CGT discount)Taxed solely in the UK

(Generally at 10%-20%)

Taxed in Australia (foreign-resident rates w/o full 50% CGT discount)

* Fully franked dividends are not subject to dividend WHT in the first place so the DTA is not relevant in this context.

Finally, for a useful pre-departure planning tool for Australians heading to the UK – see our Flow Chart – Are you relocating to the UK? 

*   *   *   *   *

Note – This paper was published in the August 2016 edition of inTAX Magazine (a Thomson Reuters publication).

SMSF and Personal Bankruptcy

Bankruptcy and SMSFs

When an individual suffers bankruptcy, one of the last things they consider is their Self-Managed Superannuation Fund (SMSF).

When a Trustee becomes insolvent or is declared bankrupt, they are classified as a disqualified person. A disqualified person should not be a Trustee of a Superannuation Fund or a Director of a Corporate Trustee. Under Section 126K of the Superannuation Industry Supervision Act 1993 (SIS Act), penalties can apply, if a person continues to act as a Trustee of the SMSF after knowing they are disqualified.

Those who are a member of an SMSF must also be an individual trustee or director of a corporate trustee. A disqualified person cannot be an individual trustee nor director of a company trustee – hence the problem.

So when a trustee becomes a disqualified person, it poses a serious problem to the SMSF and puts the entire fund at risk.

If you are a Director of a Corporate Trustee, you may also have obligations to inform the Australian Securities & Investments Commission (ASIC).

For more information, see the ATO Commissioner Practice Statement on disqualification of the Trustees (PS LA 2006/17).

If you become bankrupt or enter into a personal insolvency agreement, you must:

Remove yourself as a trustee

You must cease being, or acting as a trustee immediately. This must be notified to the tax office within 28 days.

Restructure your SMSF

After removing yourself as a trustee, the SMSF has 6 months to restructure in order to meet the definition of an SMSF. The basic definition of an SMSF is that all members must be trustees and all trustees must be members and there must be more than one and no more than four individuals.

The other trustees or directors of the corporate trustee have the following options:

  • Rollover the bankrupts benefits to another complying superfund e.g. Retail or Industry funds
  • Appoint an approved trustee who has a license from APRA i.e. the SMSF changes from being self managed to being a Small APRA Fund (which becomes managed by someone else);
  • Wind up the fund by rolling all members’ benefits out of the fund and into another appropriate super vehicle.

How to become a trustee of an SMSF again?

A person, who was disqualified due to insolvency/bankruptcy, cannot have their disqualification status waived during the period of administration.

However once they have been discharged from bankruptcy, they are no longer a disqualified person and can become a trustee of an SMSF again.

Disqualification may be a result of a conviction involving dishonesty or a court determination. If a person became a disqualified due to conviction involving dishonesty, they may apply for a declaration to waive their disqualified status. This must be done within 14 days after the date of their conviction. And under a court/regulator disqualification, application must be made to request the court/regulator to revoke the disqualification.

Due to the tight deadlines, restructuring and the highly involved nature with the regulators, we urge any person who may become insolvent or bankrupt and holds an SMSF to contact our office.

CGT 6 year Rule

Extending the main residence exemption to investment properties

In Australian federal tax, one of the advantages of an individual owing their own home is the exemption to Income tax under the Main Residence exemption under Subdivision 118-B of Income Tax Assessment Act 1997.

The Main Residence exemption means when a taxpayer sells their home, any capital gain is exempt from Income Tax.

However, the exemption is not easily applied, as there are many exceptions and rules that need to be considered. This is important given the Australian Taxation Office’s (ATO) increasing audit focus on taxpayers who fail to report the right amount of net capital gains from sale of a dwelling, especially where the gain is not fully exempt.

How does Main Residence Work?

Generally, a dwelling is no longer your main residence once you stop living in it.

In some cases you can choose to treat a dwelling as your main residence for Capital Gains Tax purposes even after you move out of it. This is what is called the ‘temporary absence rule’ (TAR) or the “six year rule”.

How does the Temporary Absence Rule work ?

Some of the basic factors for the TAR are as follows:

  • For any period the dwelling is not used for income producing purposes after the taxpayer ceases living in it, the taxpayer can treat the dwelling as their main residence indefinitely.
  • For any period the dwelling is used for income producing purposes, the taxpayer can treat the dwelling as their main residence for a maximum period of six years;
  • Where a taxpayer makes this choice, they cannot treat any other dwelling as main residence for that period. This is: they cannot purchase another main residence and live there (with certain exeption see below). They of course can rent and access the exemption.
  • A taxpayer cannot cease to use a dwelling as their main residence if the dwelling was never used as their main residence in the first place.

What happens if you rent out a dwelling for more than six years during a period of absence?

The ‘market value rule’ may kick in, which means you are taken to have acquired the dwelling at its market value at the time you first used it to produce income.

In other words, the exemption is not lost.

A partial main residence exemption will apply on its eventual sale instead.

Does the six year rule apply to more than one period of absence?

The answer is yes. If you are absent more than once during the period you own the dwelling, the six year maximum period that you can treat it as your main residence while you use it to produce income applies separately to each period of absence. In other words, the six year rule can apply each time the dwelling again becomes and ceases to be the taxpayer’s main residence. However, for a new six year to kick start, the taxpayer must move back into the property and again treat as their main residence before it becomes income producing again.

Example:

John lives in his home (which he bought in 2001) for the first three years. He then moved to interstate for work purposes and rented his home to tenants for four years. Then he moved back and lived in it for another three years. His home was again rented out for four years before he sold it.

John can choose to treat the dwelling as his main residence for both periods of absence, even if the combined total of both periods is eight years. This is because the six year limitation is calculated separately for each period of absence and the rental period within each period of absence did not exceed six years. As a result, John was exempt from CGT.

What happens if a taxpayer owns more than one dwelling?

A taxpayer can still choose to apply the six year rule to a dwelling they have moved out of even if the taxpayer moves into another dwelling they own. The main residence exemption can only be applied to one dwelling during the overlapping period.

As a general proposition, the main residence exemption should be maximised for the dwelling that is likely to generate the greatest capital gain when it is sold.

Please contact our office if you want to discuss more about the main residence exemption.

Director Penalty Notices

Director Penalty Notices

The Director Penalty regime is contained within Division 269 in Schedule 1 to the Taxation Administration Act 1953 (TAA).

Overview

Directors of Australian companies have a legal responsibility to ensure that their company meets its employee obligations through the

  • pay as you go (PAYG) withholding and
  • Superannuation guarantee charge (SGC) systems.

The director of a company that fails to meet a PAYG withholding or SGC liability by the due date automatically becomes personally liable for a penalty equal to the unpaid amount.

What are Director Penalty Notices (DPNs) ?

When a PAYG withholding or SGC liability remains outstanding, the ATO may issue a director penalty notice (DPN).  Even without issuing a notice, the ATO can collect the penalty by other means, such as withholding a tax refund.

The director penalty regime makes directors of companies that fail to comply with their obligations to pay the amounts under the PAYG withholding regime and the superannuation guarantee charge provisions to the ATO (or fail to pay estimates of those liabilities) personally liable for the amount that the company should have paid, through the imposition of a penalty.

The Commissioner of Taxation (the Commissioner) uses these provisions to pursue directors of companies that fail to meet these obligations.

Recovering Director Penalties

While a director penalty is automatically imposed, the Commissioner must follow a specific procedure before being entitled to commence proceedings to recover that debt. This is expressed in the note to 269-20(2) of the TAA 1953.

The notice is in the form of a DPN. This does not prevent the Commissioner from taking other action such as issuing garnishee notices etc.

What are Garnishee Notices?

Pursuant to s 260-5 TAA, the ATO has the power to issue a third party (ie a bank) who owes the company/director money requiring the party to pay it straight to the ATO. Any money garnisheed by the ATO cannot be recovered in liquidation as an unfair preference. The Notice can ask for a percentage of wages or may seek payment of a lump sum amount. For individuals, that may mean the ATO issues a garnishee notice to your client’s employer or contractor and for businesses, the notice may issue to your client’s financial institution or trade debtor.

How To Avoid Personal Liability For the unpaid PAYG Tax

The ‘Directors Penalty Notice’ provides four options to avoid personal liability for the company’s unpaid PAYG Tax. Remission of the penalty will occur if the director(s) instigate one of four options which are detailed within the ‘Penalty Notice’ within 14 days. These four options are: – The company’s liability has been paid. – An agreement under Section 222ALA of the ITAA to pay the liability has been put in place. – The company is being wound up. – The company is under Administration within the meaning of the Corporations Act, 2001. The director(s) should seek advice on each available option to ensure that they avoid personal liability.

Reporting is important

Directors cannot discharge their DPN by placing their company into administration or liquidation when PAYG or SGC remains unpaid and unreported three months after the due date.

Stated another way, no personal liability if company reports debt on time. Despite recent changes, where the company has reported the liability within 3 months of it becoming due, then the director will still be able to absolve their personal liability by placing the company into administration or liquidation within 21 days of receiving the DPN.

What Should Directors Do?

To avoid the long arm of the ATO directors should:

  • Report on time (BAS and Superannuation Guarantee Charge statements)
  • Ensure ASIC details and records are up-to-date, as DPN’s will be validly served if they are sent to the director’s address set out in the ASIC register;
  • Be proactive and timely in obtaining advice;
  • Remain informed about your PAYG and SG payment obligations.
  • Ensure that ‘contractors’ are correctly classified and that they are not deemed employees;