Contributed by Associate Professor Justin Dabner, Law School, James Cook University, Cairns and Principal, Tax Resolutions
Much has been made of the personal tax cuts in the 2018/19 Budget. The features of the proposed non-refundable low and middle income tax offset (LMITO) that see it increase from $200 to $530 as incomes increase before phasing out and, then, only available on assessment are unusual to say the least (contrast the low income tax offset, LITO). The substantial broadening of the 32.5% threshold leading to a flatter tax system might remove some disincentive to earn more and mitigate the tyranny of bracket creep but does raise equity concerns. Meanwhile, the logic behind legislating for tax cuts seven years in the future (rather than take the proposal to an election — or two — as policy) is unclear.
Beyond these headline measures are a number of other tax measures that SMEs and many individuals will be interested in. Nine in particular are outlined below, with details of what we know and what we need to look out for when the legislation surfaces.
From 1 July 2019, the concessional tax rates available for minors receiving income from testamentary trusts will be limited to income derived from assets that are transferred from deceased estates or the proceeds of the disposal or investment of those assets. Currently, s 102AG(2)(a) of ITAA 1936 has the effect that income received by minors from testamentary trusts is taxed at normal adult rates rather than the higher tax rates that generally apply to minors.
Some advisers have taken the view that the section permits taxpayers to obtain the benefit of this lower tax rate by injecting assets unrelated to the deceased estate into testamentary trusts. This is notwithstanding s 102AG(4) that would arguably apply to such arrangements and cancel the concessional tax treatment.
The proposed measure is to clarify that minors will be taxed at adult marginal tax rates only in relation to income of a testamentary trust that is generated from assets of a deceased estate (or the proceeds of the disposal or investment of these assets). The fact that this “clarification” will take effect from 1 July 2019 is strange. If it is truly a clarification of the existing law, then it would be expected to have immediate effect. It will be of interest to see whether the resultant amendment will apply to all distributions from testamentary trusts or just to those created from 1 July 2019.
Tax agents and clients
Following the Commissioner’s statement at the Tax Institute conference in Cairns in February that the worst taxpayers for the underpayment of tax were those represented by tax agents, the government will provide $130.8m to the ATO from 1 July 2018 to increase compliance activities targeting individuals and their tax agents. The smart money is on increased auditing by the ATO of work expenses deductions. The ATO has already stated that car expenses are to be a particular item of investigation this year.
$20.1m is also to be provided over four years to the Tax Practitioners Board to assist it in meeting broadened responsibilities to ensure that tax agent services “are provided to the public in accordance with professional and ethical standards”. Practitioners can only speculate as to what this means but can be sure that whatever it entails, further funding is to come from an increase in tax practitioner fees.
High profile taxpayers and rights assignments
From 1 July 2019, high profile individuals will no longer be able to take advantage of income splitting and lower tax rates by licensing their fame or image to another entity. All remuneration provided for the commercial exploitation of a person’s fame or image is to be included in the assessable income of the individual.
Currently, high profile individuals, such as sportspeople or actors, can license their fame or image to a related company or trust and the income derived goes to the entity that holds the licence. In Draft Practical Compliance Guideline PCG 2017/D11 which was issued last July, the ATO had indicated that it would accept up to 10% of lump sum payments for the provision of a professional sportsperson’s services and the exploitation of their public fame under licence as the income of an associated licencee. Will existing such arrangements be grandfathered or will the amendments apply to all licence arrangements regardless of when they were implemented?
In the 2016/17 Federal Budget, the government foreshadowed changes to Div 7A to commence on 1 July 2018. This start date has been deferred to 1 July 2019. In addition, the operation of Div 7A is to be clarified to ensure that unpaid present entitlements (UPEs) come within its scope. This measure will ensure that a UPE is either required to be repaid to the private company over time as a complying loan or is subject to tax as a dividend. It is unclear whether this change will apply only to future UPEs or will also transition to existing arrangements. In particular, UPEs arising on or before 16 December 2009 have effectively been quarantined according to ATO guidance.
As a refresh the 2016/17 Budget proposals included:
- • simplified Div 7A loan arrangements, including having a single compliant loan duration of 10 years and better aligning of the minimum interest rate with commercial transactions
- • safe harbour rules setting appropriate charges for the use of corporate assets, and
- • a self-correction mechanism for inadvertent breaches of Div 7A to allow a voluntary correction without penalty.
The proposals draw on recommendations from the Board of Taxation’s post-implementation review of Div 7A. The Board had developed a model under which loans would be repayable over a 10-year period, have reduced documentation requirements, a fixed interest rate and have greater flexibility in repaying interest and the principal. Complying 25-year loans would be grandfathered while all other pre-existing Div 7A loans would be transitioned to the new 10-year loans.
The model has an additional feature to assist trading trusts wishing to reinvest profits as working capital. An exemption was proposed under which UPEs will not be subject to Div 7A if the trustee makes a once-and-for-all election to forgo the capital gains tax (CGT) discount concession on assets other than goodwill. The logic here is that had the funds been actually distributed to the company, then any capital assets acquired with the funds would not have benefited from a CGT discount. The 2018/19 Budget announcements dealing with UPEs are silent on whether this election will still be made available.
Family trust circular distributions
From 1 July 2019, anti-avoidance rules that apply to other closely held trusts will apply to circular trust distributions to family trusts and be extended to impose tax at the maximum marginal rate of tax (plus Medicare levy). Currently, where family trusts act as beneficiaries of each other in a round robin arrangement, a distribution can ultimately be returned to the original trustee in a way that avoids any tax being paid on that amount.
The details are scant but presumably the anti-avoidance rule at issue is s 100A of the ITAA 1936 which deals with reimbursement agreements. If so, this already applies to family trusts (although not genuine family or commercial arrangements according to the ATO) so it is unclear why the amendment would be needed.
Deductions for holding vacant land
From 1 July 2019, deductions are to be disallowed for expenses (eg interest and rates) associated with holding vacant land where the land is not “genuinely” held for the purpose of earning assessable income. The rationale is to reduce the tax incentives for land banking which limits the availability of land for housing. How “genuinely” will be defined will clearly be of interest. If an owner is waiting for market conditions to improve and has no intention of commencing construction in the short-term will this be “genuine”?
Where the denial applies, expenses associated with holding land will become deductible once rentable premises have been constructed on the land or the land is being used by the owner to carry on a business. According to the Budget papers, the “carrying on a business” exclusion should ensure that deductions remain available for land held for a commercial development. This seems to be a generous interpretation of carrying on a business.
Disallowed deductions will not be able to be carried forward for use in later income years. Expenses for which deductions will be denied could be included in the cost base if they would ordinarily be a cost base element.
In a further attack on Everett assignments (and maybe the coup de gras), a partner that assigns a right to their share of the future income of a partnership will no longer be able to access the small business CGT concessions in relation to this CGT event. This measure applies from 7.30 pm (AEST) on 8 May 2018.
It might be recalled that back in the 1980s, the Commissioner had ruled that Everett assignments would not be caught by Pt IVA. However, with the introduction of the CGT, such assignments potentially generated large capital gains as the market value substitution rule applied to determine the deemed capital proceeds. Over time, strategies were developed in an attempt to avoid the CGT implications. With the enactment of the small business CGT concessions, a particular opportunity arose. Now, this is to be removed.
In any event, in 2015, the Commissioner reversed the ruling that Pt IVA could not apply. However, guidelines indicating an acceptable level of income splitting were negotiated with the professions and Everett assignments remained viable. Then in December 2017, the Commissioner suspended these guidelines with the announcement that they had been abused and new guidelines would be issued by 30 June 2018.
For ATO advice on their concerns, see www.ato.gov.au/business/income-and-deductions-for-business/in-detail/professional-firms/assessing-the-risk–allocation-of-profits-within-professional-firms/?page=1#Recent_consultation_on_the_guidelines.
Non-compliant PAYG and contractor payments
Commencing 1 July 2019, employers will not be able to claim deductions for wages where they have not withheld any amount of pay as you go (PAYG) from these payments as required. Query whether this measure will apply where a business has inadvertently identified a person as a contractor rather than an employee and not withheld (or withheld the wrong amount) or whether it is restricted to blatant failures to withhold?
As a similar measure, there will be no deductions for payments made by businesses to contractors where the contractor does not provide an Australian Business Number (ABN) and the business does not withhold any amount of PAYG.
Cash payments limit
From 1 July 2019, there will be a limit of $10,000 for cash payments made to businesses for goods and services. This will require transactions over the threshold to be made through an electronic payment system or by cheque. The rules will not apply to transactions with financial institutions (presumably because of the existing AUSTRAC reporting requirements) or consumer-to-consumer non-business transactions.
It will be interesting to see how this rule will be enforced. Clearly, there will need to be some aggregation rule as otherwise transactions might be readily broken up to fall under the threshold. The emphasis would seem to be on consumer to business payments given the incentive on businesses to record such payments presented by the income tax deduction and GST input credit rules.
Presumably, those who have hoarded $50 and $100 notes can now breathe a sigh of relief that the government is introducing this measure in lieu (probably) of following the November 2016 Indian precedent of cancelling 500 and 1000 rupee notes.
Of course, there is no certainty that any of these measures will end up as law in the form proposed. Furthermore, if the opposition wins government at an election later this year, SMEs and individuals will face a whole new set of tax proposals. Of these particular ones of interest are:
- • Company tax rate cuts are not supported for companies with turnovers $25m and above. However, from 1 July 2018, the threshold for access to the lower company tax rate is legislated to extend from $25m to $50m. Would a Labor Government repeal this extension? If so, presumably the 30% company tax rate for affected entities would only be reinstated prospectively.
- • $3,000 cap on an individual’s deduction relating to the management of their tax affairs. Presumably, such an expense will remain deductible to an entity other than an individual. This might present an opportunity to circumvent any such rule. Alternatively, tax advisers might be encouraged to rebadge their advice.
- • Investment guarantee allowing businesses to immediately deduct 20% of the value of investment in eligible depreciating assets, with the balance depreciated in line with normal depreciation schedules from the first year. Will the $20,000 immediate write-off threshold be retained as well?
- • Minimum 30% tax rate for discretionary trust distributions to individual beneficiaries aged 18 years and over. What will be the carve outs? Will a beneficiary subject to a legal disability be excluded? There are a multitude of questions here.
- • No cash refunds of excess franking credits for individuals and superannuation funds. Pensioners have won an exemption the ultimate scope of which will be of interest.
- • Reduce the CGT discount for individuals to 25%. From what date now that 1 July 2017 has passed? What about the CGT small business concessions?
- • Reform negative gearing by limiting it to new housing investment. Again, from what date?