Talking Tax – Issue 77

Case law

The Tribunal to confirm an assessment when a taxpayer fails to appear

In Melbourne Home Insulation Pty Ltd v Commissioner of State Revenue (Review and Regulation) [2017] VCAT 654, the Victorian Civil and Administrative Tribunal (VCAT) confirmed the payroll tax reassessments for the relevant tax years issued by the Commissioner of State Revenue (Commissioner) to Melbourne Home Insulation Pty Ltd (Applicant) by reason of the Applicant’s non-appearance at the hearing.

The Applicant sought review from VCAT of the decision made by the Commissioner to disallow its objection to the Commissioner’s reassessments of payroll tax in respect of amounts paid to the employees of and contractors engaged by the Applicant for the years ended 30 June 2009, 2010, 2011 and 2012. However, the Commissioner made a number of concessions in the Statement of Legal Contentions (SLC) filed with VCAT in 2017. If those concessions resulted in reassessments, the primary tax would be reduced.

At the hearing, while the Commissioner was represented, the Applicant did not appear and was not represented. Section 111(2) of the Taxation Administration Act 1997 (Vic) provides that if the taxpayer does not appear, the Tribunal must confirm the assessment or decision. The issue for VCAT was whether it could reduce or vary the assessment to reflect concessions made by the Commissioner in the SLC. Tribunal Member R Tang considered section 111(2) as a mandatory provision, meaning that the confirmation of the assessment which forms the subject matter of the review is required despite any concessions or even a subsequent reassessment on the part of the Commissioner. It was also considered consistent with the interpretation of the equivalent provision in section 51(5) of the Victorian Civil and Administrative Tribunal Act 1998 (Vic).

The Tribunal Member noted there is nothing preventing the Commissioner from reassessing in line with the concessions made in the SLC. Whether or not the Commissioner does so, the Applicant may seek to re-open the case at VCAT.

This matter demonstrates how poor case management of an appeal by the taxpayer will lead to increased legal costs and an unsatisfactory outcome.

ATO updates

Draft Practical Compliance Guideline released on taxation issues associated with cross-border financing

Last year, the Australian Taxation Office (ATO) released a consultation paper dealing with offshore marketing hubs which was discussed in Talking Tax - Issue 45. It has now progressed to a draft Practical Compliance Guideline PCG 2017/D4 (draft PCG) which outlines the compliance approach of the ATO to the taxation outcomes associated with certain ‘related party financing arrangements’.

A related party financing arrangement includes a financing arrangement, or a related transaction or contract, entered into with a cross-border related party. The draft PCG applies to both inbound and outbound financing arrangements entered into with a related party that is not a resident of Australia subject to a number of exceptions including: arrangements undertaken by ADIs, Australian securitisation vehicles, Australian resident entities subject to the ATO’s existing simplified transfer pricing guidelines and Islamic finance.

The draft PCG is particularly concerned with related party financing arrangements that are at risk of not complying with the transfer pricing provisions.

Taxpayers can self-assess the tax risk of their related party financing arrangements in accordance with the risk indicators and framework for financing arrangements provided in the draft PCG.

Comments on the draft PCG may be made on or before 30 June 2017. When finalised, it will apply from 1 July 2017 to existing and newly created financing arrangements, structures and functions.

The draft PCG sets out 11 various qualitative and quantitative risk indicators which are applied to assess the taxpayers’ overall risk level.The related party financing arrangement risk framework is made up of six risk zones:

• White zone - arrangements already reviewed and concluded by the ATO
• Green zone - low risk
• Blue zone - low to moderate risk
• Yellow zone - moderate risk
• Amber zone - high risk
• Red zone - very high risk.

The draft PCG provides that if a taxpayer is in the ‘green zone’, the ATO will generally not apply compliance resources to the arrangements, other than to confirm facts and check eligibility. However, if a taxpayer is outside of the ‘green zone’, the Commissioner will monitor, test and/or verify the taxation outcomes of the related party financing arrangement. The higher the risk rating, the more likely the relevant arrangements will be reviewed as a matter of priority.

Taxpayers are encouraged to assess their tax risks and to “transition” existing arrangements to the ‘green zone’. For a limited period, the Commissioner is willing to remit penalties and interest if certain pre-conditions are met. Taxpayers are also encouraged to engage with the ATO early and discuss their related party financing arrangements.

In light of this draft PCG and the recent Full Federal Court decision in Chevron (see Talking Tax - Issue 75), it is particularly important that taxpayers are proactive to address any issues with their international related party transactions.  If you have any concerns about any financing arrangements you have in place between related parties, please contact one of our tax lawyers and we will assist you in managing your tax risk.

ATO extends due date for 2015-16 SMSF returns

The ATO made an announcement that it will extend the due date for lodgement of self-managed superannuation fund (SMSF) annual returns for the 2015-16 financial year to 30 June 2017 as a result of feedback received from professional and industry representatives.

The SMSF annual return must be lodged once the audit of an SMSF has been finalised. If your SMSF did not have assets in the first year it was registered, it may not need to lodge a return for that year.

More information regarding the lodgement of the SMSF annual tax returns can be found on the ATO website.

This demonstrates the ATO is providing flexibility to practitioners during the peak compliance period and recent budget announcements.

Taxpayer alerts issued regarding the Research and Development (R&D) Tax Concession

AusIndustry and the ATO have been actively pursuing taxpayers with respect to certain claims made in relation to the Research and Development (R&D) Tax Concession. Specifically, the ATO has recently issued taxpayer alerts identifying companies undertaking activities in the following industries:

• Building and construction (TA 2017/2)
• Software and technology development (TA 2017/5)
• Farming and agriculture (TA 2017/4)

In addition to the industries noted above, the ATO has issued a general alert TA 2017/3 on businesses claiming the R&D Tax Concession where some (or all) of the expenditure that is incurred relates to their ordinary business activities and not to eligible R&D activities.

Broadly, the ATO is concerned that the above entities have been claiming the R&D Tax Concession incorrectly as they did not meet the requisite eligibility criteria under the Industry Research and Development Act 1986 (Cth) and the deductibility criteria in the Income Tax Assessment Act 1997 (Cth) (Relevant Tax Legislation). Recent experience across the country has shown that the ATO and AusIndustry have been working together to identify taxpayers in the above industries, review their R&D Tax Concession claims, undertake a full audit of the qualitative aspect of the claim (undertaken by AusIndustry), undertake an audit of the quantum of the claims (undertaken by the ATO) and, where relevant, the ATO will issue amended assessments. Where there is a shortfall of tax payable by a taxpayer, the shortfall penalties and interest can be quite substantial.

Taxpayers should seek assistance to review their eligibility for the R&D tax concession and manage their risk by:

• critically reviewing the qualitative aspect of the claims for the purpose of determining eligibility under the Relevant Tax Legislation
• considering the quantum of the R&D Tax Concession claimed and, if necessary, prepare the appropriate documentation to substantiate the reasonableness of that quantum and
• if necessary, making a voluntary disclosure and engaging early with the ATO so that the taxpayer is afforded the opportunity to obtain a significant reduction in penalties and interest applying to any tax shortfall.

It is highly recommended that this process is handled in a pro-active manner as it is substantially more difficult to obtain a reduction in shortfall penalties and interest once an ATO audit has commenced.

Draft ruling released on taxation of rights and retail premiums under renounceable rights offers where shares held on capital account

On 10 May 2017, the ATO released Draft Taxation Ruling TR 2017/D3  regarding the taxation of rights granted and retail premiums paid under renounceable rights offers where shares are held on capital account. This draft ruling concerns the tax treatment of eligible shareholders (Australian or New Zealand residents) and ineligible shareholders (foreign residents).

It is proposed that the shareholders covered by this draft ruling will not need to include anything in their assessable income upon the grant of the entitlement. Any retail premium received is treated as the realisation of a capital gains tax (CGT) asset. The draft ruling also outlines the features of offers to which it applies. However, the application of Australia’s tax treaties is not covered by this draft ruling.

When the final ruling is issued, it is proposed to have retrospective effect prior to its date of issue.  If you have issued or have been issued entitlements that may be subject to this draft ruling, please contact for further details about the potential tax treatment.

Part A of the draft ruling: the Australian resident eligible shareholders

The market value of the entitlements, being the rights to be issued shares, of eligible shareholders is non-assessable non-exempt income under section 59-40 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) at the time they are granted.

Each entitlement is a CGT asset. CGT event A1 happens when an entitlement is transferred to a successful bidder under the retail bookbuild process. The retail premium represents capital proceeds from a CGT event. An eligible shareholder will make a capital gain if the capital proceeds exceed the cost base of the entitlement.

An eligible shareholder is taken to have acquired the rights when it acquired the original shares. Therefore, any capital gain may represent a discount capital gain so far as the eligible shareholder’s original shares have been held for 12 months or more.

Retail premiums paid to eligible shareholders are not ordinary income for the purpose of section 6-5 of the ITAA 1997 and are not dividends.

Part B of the draft ruling: Foreign resident ineligible shareholders

The draft ruling considers that the market value of the entitlements of ineligible shareholders is non-assessable non-exempt income under section 59-40 of the ITAA 1997 at the time they are granted.

Each entitlement, being a right to have offered for sale the rights to subscribe for shares which the ineligible shareholder would otherwise have been entitled to be issued, is a CGT asset. CGT event C2 happens when the right to subscribe for the relevant number of shares is allocated to a successful bidder under the retail bookbuild process. The retail premium represents capital proceeds from a CGT event. An ineligible shareholder will make a capital gain if the capital proceeds exceed the cost base of the entitlement.  However, any capital gain is disregarded unless the entitlements constitute taxable Australian property under Division 855 of the ITAA 1997.

Retail premiums paid to ineligible shareholders are neither ordinary income for the purpose of section 6-5 of the ITAA 1997 nor dividends. There is no withholding tax obligation for the company in respect of retail premiums paid to foreign resident ineligible shareholders. Recent experience across the country has shown that the ATO and AusIndustry have been working together to identify taxpayers in the above industries, review their R&D Tax Concession claims, undertake a full audit of the qualitative aspect of the claim (undertaken by AusIndustry), undertake an audit of the quantum of the claims (undertaken by the ATO) and, where relevant, the ATO will issue amended assessments. Where there is a shortfall of tax payable by a taxpayer, the shortfall penalties and interest can be quite substantial.