Talking Tax – Issue 44

Case law

High Court grants special leave to ElecNet to appeal Full Federal Court decision

The High Court has granted special leave to the taxpayer to appeal the decision of the Full Federal Court in FCT v ElecNet (Aust) Pty Ltd (Trustee for the electrical industry severance scheme) [2015] FCAFC 178.

The taxpayer in the matter is ElecNet Pty Ltd (Taxpayer), as trustee of the Electrical Industry Severance Scheme (EISS). The EISS provides benefits to workers, being severance or redundancy payments, who leave or change their employment in circumstances set out in the Consolidated Deed of Trust Electrical Industry Severance Scheme (Deed).

In December 2012, the Taxpayer applied to the Commissioner of Taxation (Commissioner) for a private ruling supporting that the EISS was a unit trust, that is, a public unit trust and a public trading trust for the purposes of Division 6C of Part III of the Income Tax Assessment Act 1936 (ITAA 1936). The Commissioner ruled that the EISS was not a unit trust for Division 6C purposes as the workers did not have any units in the trust in any meaningful sense.

The Taxpayer appealed the private ruling and the Federal Court at first instance held that the EISS was a unit trust for the purposes of Division 6C. The Court’s reasoning in this decision was twofold:

• relying on the definition of ‘unit’ in section 102M of the ITAA 1936, the concept of a unit trust was that of a trust in which the beneficial interest in property or income of the trust is widely held, whether or not the interest is described as a ‘unit’, and whether or not the trust is described as a ‘unit trust’
• under the Deed, each worker has a discrete proprietary interest in the contributions paid in respect of their work into the trust fund (notwithstanding that they did not have a present right to any immediate payment) and this interest constituted a beneficial interest in the property of the trust estate within the meaning of ‘unit’ in section 102M of the ITAA 1936.

The Commissioner appealed this decision to the Full Federal Court and was successful. The Full Federal Court emphasised the need for a close examination of the particular trust deed, being the EISS Deed, to determine whether the functional nature of the trust operates as a unit trust. Its decision rested upon the existence of a number of discretions of the trustee, in relation to the provision of benefits to workers, which were provided for in the Deed. In the Full Court’s view, the existence of these discretions had the effect that any interest that a worker had under the Deed was not capable of being described functionally as an interest under a unit trust, and that this was the case regardless of whether the workers were properly considered to have a beneficial interest in the trust. Accordingly, the Commissioner’s appeal was allowed.

It is appealing to know that in an age of such complexity in commerce, and tax in particular, the High Court is prepared to give time to consider the meaning of a simple word such as ‘unit’, in the context of a ‘unit trust’, just as it did in the Bamford¹ case in 2012, where it considered the meaning of ‘share’ in the context of a ‘share of net income of a trust estate’.

Appeal to the Federal Court - Rowntree v Federal Commissioner of Taxation [2016] AATA 420

The taxpayer (a solicitor) has decided to appeal the original AAT decision in Rowntree v Federal Commissioner of Taxation to the Federal Court.

This case concerned three distinct purported loan arrangements entered into from 2009 to 2012 where various companies limited by guarantee loaned money to its shareholder (the taxpayer). As a result of the loan arrangements the taxpayer claimed that as at June 2014 he owed one participant $2,240,000 (1^st and 2^nd loan arrangements) and another participant $1,700,000. The taxpayer claimed to have commenced loan repayments around 30 June 2014. The taxpayer had previously given an Enforceable Voluntary Undertaking (EVU) to the Commissioner in August 2011 assuring he would not promote any ‘company limited by guarantee arrangement’.

The Commissioner issued the taxpayer with amended assessments purporting to assess the taxpayer on the income received from the companies limited by guarantee. The taxpayer claimed the assessments were excessive and that the amounts received were loans. The taxpayer said loan agreements were in place at the relevant time that payments were made, and that such payments were made pursuant to those loan agreements - even though they were not documented in writing until after the income year. The taxpayer appealed to the Administrative Appeals Tribunal (AAT) to determine whether the amounts received by the taxpayer could be characterised as loan funds as opposed to income.

The AAT decided against the taxpayer and held that the payments (aside from a $1,000,000 and $80,000 payment) could not be characterised as loan funds. The AAT found that the taxpayer produced insufficient evidence to support the existence of the alleged loans. Of critical importance was that the loan agreements post-dated the payments and that no repayments were made until after the taxpayer became aware that the Commissioner was carefully reviewing such arrangements.

In regards to the post-dated documentary evidence of the loans, the taxpayer relied on Division 7A and in particular section 109N of the ITAA 1936. The taxpayer claimed that section 109N specifically allowed a loan agreement to be reduced to writing after the relevant year of income had concluded. The taxpayer also placed heavy reliance on the EVU suggesting that it showed that the Commissioner had accepted the loans existed.

The AAT held that section 109N said nothing about what was required to objectively establish the existence of the loan and that the EVU did not preclude the Commissioner from denying that the loans existed upon a deeper analysis.

It is worth highlighting that the taxpayer failed because he could not provide substantial documentary evidence that the loans existed at the time the payments were made. This scenario could have easily been avoided if loan agreements were created and properly documented contemporaneously before any payments were made to the taxpayer.

ATO updates

ATO releases tax determinations clarifying the availability of business-related deductions

Deduction for airport lounge membership fee

In Taxation Determination TD 2016/15, which will apply to income years both before and after its date of issue, the ATO says that an employer is entitled to a deduction under section 8-1 of Income Tax Assessment Act 1997 (ITAA 1997) for annual fees incurred on an airport lounge membership for use by its employees. This expense is deductible where it is provided as part of the employment relationship, and in this respect it can be considered incidental and relevant to the taxpayer’s business.

The ATO clarified that the deduction will not be allowable if the annual fees were incurred in relation to the gaining or producing of exempt income or non-assessable non-exempt income, or if section 26-45 of the ITAA 1997 (recreational club expenses) or section 32-5 of the ITAA 1997 (entertainment expenses) applies.

Further, the ATO stated that the deduction will still be allowable where there is a substantial private use of the lounge membership, so long as the link to employment is satisfied. To the extent that the airport lounge membership fee could be considered an expense payment benefit or a property benefit under the Fringe Benefits Tax Assessment Act 1986, it is exempt from fringe benefits tax.

Deductibility of gifts to clients

In Taxation Determination TD 2016/14, the ATO says that a taxpayer may claim a deduction for a gift made to a former or current client, where the gift is made for the purpose of producing future assessable income, regardless of whether it actually does produce assessable income. For the same reason as above, this expense is deductible on the basis that it can be considered incidental and relevant to the taxpayer’s business.

The expense is not deductible, however, where it is of a capital nature, relates to producing exempt or non-assessable non-exempt income or, more importantly, is of a private or domestic nature.

Legislation and government policy

The Council of Financial Regulators release Brexit report

On 7 July 2016, the Council of Financial Regulators (CFR) released a report on the implications of the United Kingdom’s vote in favour of exiting the European Union (Brexit). The CFR is of the view that the impacts of Brexit will be concentrated predominantly in the UK economy as well as Europe more generally, particularly if it triggers exit movements by other nations within the EU.

In terms of the key tax implications of Brexit, the CFR’s report highlighted the following:

• the UK Chancellor has signalled that it is likely to implement corporate tax cuts in response to reductions in UK GDP, in an effort to support the economy through this period
• extended exit agreement negotiations may challenge the capacity of the UK and EU from engaging efficiently in international fora, which may disrupt international cooperation on key global economic issues, such as international taxation.

It should be noted, however, that Brexit is unlikely to have a significant impact on Australia, as it is believed that Australia is well placed to manage what is expected to be only a minimal effect on its economy and financial sector.

Other news

OECD Secretary–General releases tax report to G20 Finance Ministers

The OECD Secretary-General has released his July 2016 Tax Report to G20 Finance Ministers. The report provides an update since April 2016 on key global tax issues, focusing on the following key items:

OECD Base Erosion and Profit Shifting (BEPS) Project

The OECD’s BEPS project remains a priority, with the establishment of the G20/OECD Inclusive Framework which held its first meeting on June 2016. Further progress towards the implementation of the BEPS package has also taken place, including the following developments:

• over 50 countries have now taken serious steps towards the implementation of Country by Country Reporting
• the European Union adopted an Anti-Tax Avoidance Directive which provides for the implementation of measures relating to Action 2 (Hybrid Mismatches), Action 3 (Strengthen controlled foreign company rules), and Action 4 (Interest deductions) of the BEPS package
• a fourth round of negotiations took place in relation to the tax treaty-related BEPS actions in the Multilateral Instrument on BEPS implementation, the signing of which by the 96 negotiating countries could lead to the amendment of more than 2,000 bilateral tax treaties.

In the Australian context, one of the threshold matters for consideration in relation to the Country by Country reporting obligations will be whether a resident taxpayer is a ‘significant global entity’ within the meaning of section 960-555(2) of the Income Tax Assessment Act 1997. Generally, an entity is a significant global entity if it is:

• a global parent entity with an annual global income of A$1 billion or more, or
• a member of a group of entities consolidated for accounting purposes and one of the other group members is a global parent entity with an annual global income of A$1 billion or more.

The Country by Country measures affect income years commencing on or after 1 January 2016.

Contact the Hall & Wilcox tax team for further information regarding the potential impact of these new measures.

Tax Transparency

Since June 2016, three countries have signed the multilateral Convention on Mutual Administrative Assistance in Tax Matters, bringing the total to almost 100 countries and jurisdictions.

Objective criteria have been established to identify non-co-operative jurisdictions. Specifically, for a jurisdiction to be considered co-operative with respect to international tax transparency, it would need to meet two of the following criteria:

• implementation of the Exchange of Information on Request standard
• implementation of the Automatic Exchange of Information standard
• joining the multilateral Convention on Mutual Administrative Assistance in Tax Matters.

Work of the Global Forum

The Global Forum on Transparency and Exchange of Information for Tax Purposes (Global Forum) is the world’s leading multilateral body working in the area of transparency and exchange of information for tax purposes. Since the call for further tax transparency by the G20 Finance Ministers in April this year, the Global Forum has improved its work, producing a number of important results, including:

• five more countries have committed to implement the Common Reporting Standard
• three countries have signed the multilateral Convention on Mutual Administrative Assistance in Tax Matters
• progress has been made in relation to jurisdictions with unsatisfactory ratings
• proposals on the implementation of international standards on transparency are under discussion.

This article was written with the assistance of Comeron Forsyth, Law Graduate and Tim Hutton, Paralegal.

¹FCT v Bamford and Others (2010) 264 ALR 436; [2010] HCA 10.