Latest income tax developments - March 2022

ATO News

ATO Issues Decision Impact Statement on Clough Limited v Commissioner of Taxation

• The ATO has issued a decision impact statement in response to the Full Federal Court decision in Clough Limited v Commissioner of Taxation [2021] FCAFC 197. At issue in the case was the correct tax treatment of payments made by Clough Limited for the cancellation of employee entitlements under an employee option plan and employee incentive scheme in the context of a takeover by an entity with a 61.6% shareholding in Clough Limited. Specifically at issue was whether the primary judge erred in concluding that the payments were not deductible under s 8-1 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).
• The Court unanimously held that the payments were not a working expense. Rather, they were part of an activity required to complete a necessary step in the takeover; the acquisition of the minority shareholding. Consequently, the Court held that the payments did not satisfy the positive limbs of s 8-1 of the ITAA 1997 and were on capital account.
• The ATO views the decision as an application of well-settled principles to the facts and consistent with the reasoning of the Commissioner in Taxation Ruling IT 2656.
• The ATO has acknowledged that whether a payment for the cancellation of employee entitlements in the context of a merger or acquisition is deductible under section 8-1 of ITAA 1997 will be fact and circumstance specific. However, the decision "provides authority for the proper characterisation of outgoings in comparable arrangements".
• The question of whether the provisions in s 40-880 of ITAA 1997 applied was not considered by the Court. Before the hearing, the Commissioner had agreed that s 40-880 applied. Based on additional facts, the Commissioner was satisfied that the relevant nexus requirement between the outgoings and the business as stated in TR 2011/6 was met. The Commissioner does not consider that this decision has any precedential value on the application of s 40-880 to the cancellation of employee entitlements, given the concession made before hearing.

ATO Issues Decision Impact Statement on Virgin Australia Regional Airlines Case

• The ATO has issued a decision impact statement outlining the ATO's response to the Full Federal Court decision in Federal Commissioner of Taxation v Virgin Australia Regional Airlines Pty Ltd [2021] FCAFC 209. The Full Court allowed the Commissioner’s appeal from the primary decision (Virgin Australia Airlines Pty Ltd v Federal Commissioner of Taxation (2021) 113 ATR 152; [2021] FCA 523).
• The case concerned the interpretation of the phrase "primary place of employment" in s 136(1) of the Fringe Benefits Tax Assessment Act 1986 (Cth) (FBTAA). The Full Court held that fringe benefits tax (FBT) applied in respect of the provision of car parking facilities by Virgin to its Flight and Cabin Crew employees as it was decided that the employees' "primary place of employment" was their home base airport terminal. The Enterprise Agreements regulating the Flight Crew's conditions of employment were relevant as employees were allocated a "Home Base".
• The ATO believes that the decision is consistent with the Commissioner’s application of s 39A of the FBTAA, which specifies when the provision of parking facilities to employees will be taken to constitute a benefit provided to the employee in respect of their employment. In relation to the definition of "primary place of employment" in s 136(1), the ATO views the decision as consistent with the Commissioner's interpretation of s 136(1)(c), and the ATO accepts the Full Court's view on the application of s 136(1)(d).

• TR 2021/2 will be updated to include further guidance on what is meant by "primary place of employment" in light of the decision and Chapter 16 of Fringe benefits tax – a guide for employers will also be updated.

ATO Issues Online Guidance on the tax implications of inter-bank offered rate reform

• The ATO released online guidance on the tax implications for businesses where changes are made to existing financial arrangements, and that change is driven by inter-bank offered rate (IBOR) reform. The guidance follows on from a discussion paper issued by the ATO last year (TDP 2021/1 "Tax implications of Inter-bank Offered Rate reform").
• The guidance applies to businesses that change the contractual terms of a financial arrangement due to IBOR reform. Examples include businesses that implement market conventions to a risk free rate or replacement rate in contracts, or make incidental variations to contracts as a direct consequence of IBOR reform. The focus of the guidance is on financial arrangements subject to the taxation of financial arrangements (TOFA) regime in Division 230 of the ITAA 1997.
• Specifically, the guidance outlines the ATO's understanding of:
  
  • the affect on London Inter-Bank Offered Rate (LIBOR) settings and Australian dollar key interest rate benchmarks;
  • general income tax implications of amending or creating contracts; and
  • implications for transfer pricing when a cross-border financial arrangement is amended to transition.

When contracts are amended, the changes will either vary the original contract or rescind the original contract and create a new contract. The parties' intentions as reflected in the amendments, and the significance of the amendments are important when characterising the amendment. The ATO expects that when parties to the contract agree to the change "for the sole purpose of responding to the withdrawal of LIBOR" it would be characterised as a variation of the original contract. Ultimately, the characterisation of amendments is to be determined by reference to all facts and circumstances in a case.

Where the original contract is varied and the contract is subject to the TOFA regime, the ATO states that there "may be an assessable gain or deductible loss for tax purposes" depending on the applicable TOFA tax-timing methods. However, where the original contract is rescinded and a new one is created, a balancing adjustment under s 230-G of the TOFA regime will arise and, if the arrangement is not subject to the TOFA regime the tax implications in ss 26BB, 70B, or Div 16E of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) must be considered.

Additionally, a transfer pricing benefit may arise when a cross-border financial arrangement between related parties is amended to transition from LIBOR. To determine if the benefit arises, consideration must be given to whether the amended arrangement is consistent with what arm's length parties would do.

Taxpayers who are amending arrangements in response to IBOR reform should consider the impact of those changes for tax purposes.

Draft Guidance Released on the Application of s 100A of the Income Tax Assessment Act 1936 (Cth )

• The Commissioner has released Draft Taxation Ruling TR 2022/D1 setting out the Commissioner's preliminary guidance on the application of s 100A of the ITAA 1936 concerning trust reimbursement agreements. The Commissioner has also issued Draft Practical Compliance Guideline PCG 2022/D1, which outlines how the Commissioner differentiates risk for trust reimbursement agreements to which s 100A may apply.
• Broadly, section 100A applies where a beneficiary of a trust estate is presently entitled to a share of the income of the trust estate which arises out of, or in connection with, a reimbursement agreement.
• A beneficiary's present entitlement to a share of trust income arises out of, or in connection with, a reimbursement agreement, where there is an arrangement involving the provision of a benefit to another person intended to have the result of reducing someone's tax liability and entered into outside the course of ordinary family or commercial dealing. The provision is aimed at arrangements pursuant to which a low tax rate beneficiary or a beneficiary with tax losses is made entitled to trust income but the benefit of the trust income is passed to another, usually high tax rate, person.
• If section 100A applies, the beneficiary is deemed to be not presently entitled to the trust income, resulting in the trustee being taxed on that share of the net income at the top marginal tax rate.
• TR 2022/D1 outlines the Commissioner's views on the four basic requirements that must be satisfied for s 100A to apply. First, to satisfy the "connection" requirement, there needs to be a relevant connection between:
  
  • a legally-effective entitlement, payment or application giving rise to an actual or deemed present entitlement to a share of the income of a trust estate; and
  • an agreement that meets the requirements to be a reimbursement agreement under s 100A.
• To establish an "agreement", an exact understanding of the nature and extent of the agreement is not required between all parties and the agreement can be a plan comprising steps undertaken individually or collectively over a period of time. A causal connection between the entitlement and the agreement is not needed. It is sufficient for the entitlement to have arisen from another act, transaction or circumstance that occurred "in connection with" or "as a result of" the agreement.
• Second, the "benefit to another" requirement will be satisfied if the agreement provides for the payment of money, transfer of property to or provision of services or other benefits for one or more persons other than the beneficiary. For example, an agreement would provide for the provision of benefits to another if it includes that a beneficiary will not demand payment of an amount to which they are presently entitled.
• Third, the "tax reduction purpose" requirement will be satisfied when one or more of the parties entered the agreement for a purpose of ensuring that a person would be liable to pay less tax in an income year than they otherwise would have be liable to pay in respect of that income year.
• Fourth, agreements "entered into in the course of ordinary family or commercial dealing" are not reimbursement agreements for the purposes of s 100A. For the exception to apply, the whole dealing in the course of which the agreement is entered into must have the quality of an "ordinary, family or commercial dealing". Whether the agreement was entered into in the course of ordinary dealing is to be assessed objectively. However, this assessment is to be at least principally addressed from the perspective of persons whose purposes are relevant to the operation of s 100A.
• PCG 2022/D1 contains a table outlining four risk zones for a range of trust reimbursement arrangements and their corresponding compliance approaches:
  
  • White (low risk) zone which applies to arrangements entered into in income years ending prior to 1 July 2014.
  • Green (low risk) zone, which includes arrangements falling into three scenarios: distribution to individuals (members of a family), examples described in TR 2022/D1 as being an ordinary dealing, and retention of funds by the trustee.
  • Blue (medium risk) zone, which applies to arrangements that do not fall within any other zone. For example, those that involve the retention of funds by trustees but do not fall into the green zone because they have one or more of the features listed in paragraph 26 of the Draft PCG.
  • Red (high risk) zone, which includes arrangements where the beneficiaries' entitlements appear to be motivated by sheltering the trust's net income from higher tax rates, or those involving contrived elements directed at enabling someone other than the presently entitled beneficiary to have use and enjoyment of the economic benefits referable to the trust's net income.
• The Draft PCG provides that the ATO will not dedicate new compliance resources when considering the application of s 100A to arrangements falling within the white and green zones. Persons with arrangements falling within the blue or red zone will likely be contacted by the ATO so that the arrangement can be understood.
• The final Ruling is proposed to apply to arrangements before and after its issue. However, it will not apply to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue. The final Guideline will apply to present entitlements to income of a trust estate conferred before or after its date of issue. The Commissioner will follow the administrative position in Trust Taxation – reimbursement agreement to the extent it is more favourable to the taxpayer's circumstances for entitlements conferred before 1 July 2022. The guidance may also be impacted by the outcome of the appeal to the Full Federal Court from the decision in Guardian AIT Pty Ltd ATF Australian Investment Trust v Commissioner of Taxation [2021] FCA 1619, discussed in our previous Bulletin.

ATO releases Draft Determination on when an unpaid present entitlement or amount held on sub-trust will become the provision of 'financial accommodation'

• The ATO has released Draft Determination TD 2022/D1, which considers the application of Division 7A of the ITAA 1936 in relation to private companies that have unpaid present entitlements (UPEs) and amounts held on a sub-trust for the benefit of a private company.
• The Draft provides the Commissioner's revised views on when a private company beneficiary provides "financial accommodation" to the trustee or a shareholder for the purposes of Division 7A. The Commissioner ruled that "financial accommodation" in s 109D(3)(b) of ITAA 1936 has a wide meaning. The consequence of establishing the provision of financial accommodation is that there will be a Division 7A loan.
• In the context of a UPE, a private company beneficiary with a UPE, with knowledge of the UPE and which does not demand payment will be taken to have consented to the trustee retaining the amount and using it for trust purposes. This constitutes the provision of financial accommodation to the trustee.
• In the context of a sub-trust, a choice by the company not to exercise its right to call for payment of the sub-trust does not constitute financial accommodation in favour of the trustee as the sub-trust fund is held for the sole benefit of the company. When the private company's shareholder or associate uses all or part of the sub-trust fund with the knowledge of the private company, the private company will be taken to have consented to the sub-trustee allowing the funds to be used by either entity. This will constitute the company providing financial accommodation to the entity using the sub-trust fund. This will be the case hether or not the use of the sub-trust fund is on commercial terms whereby return is paid to the sub-trust fund.
• The Division 7A loan is made when the financial accommodation is provided, which is the point when the company has knowledge of the use of an amount of the sub-trust fund and does not call for payment of that part by its shareholder or associate. Similarly, it is when the company has knowledge of the UPE and does not demand payment.
• The Commissioner explained that the private company beneficiary will be taken to have the requisite knowledge (at the requisite time) if the company and trustee "have the same directing mind and will".
• The final Determination is proposed to apply to trust entitlements arising on or after 1 July 2022. The ATO proposes to withdraw TR 2010/3 and Law Administration Practice Statement PS LA 2010/4 with effect from 1 July 2022. This is because the ATO no longer agrees with the view that where there is a sub-trust "but the funds representing the UPE remain intermingled in the main trust as a consequence of an investment back by the sub-trust, the private company does not provide any financial accommodation" (provided that the investment by the sub-trust is on terms that entitles the sub trust to "all the benefits from use of those funds and a repayment of the principal of the investment").

Other

Federal Budget 2022-23: Tax Measures

On 29 March 2022, Josh Frydenberg handed down the Federal Budget (the Budget). The relevant tax measures are summaries in our special budget Tax Bulletin.

Draft legislation released for Federal Government's proposed Digital Games Tax Offset

• The Federal Government has released draft legislation to implement its proposed digital games tax offset announced in last year's Budget, to strengthen the Australian digital games industry, expand employment opportunities in the industry, improve the competitiveness of the industry on an international scale, and promote foreign investment in the industry. The draft legislation for the proposed digital games tax offset would introduce a "30% refundable tax offset for eligible business that spend a minimum of $500,000 on qualifying Australian development expenditure related to the development of eligible games from 1 July 2022". A new Division 378 of the Income Tax Assessment Act 1997 (Cth) would be created to implement the proposed offset.
• Eligible companies are those which have obtained a certificate from the Arts Minister and claimed the offset in its income tax return. The offset is capped at $20m per company per income year. Where the cumulative offset of a claimant company and its related companies exceeds $20m, they must each provide the Commissioner with a notice specifying the amount that will be that company's offset in relation to that income year. The sum of the notices cannot exceed $20m. That is, the $20m annual cap applies across a company and its related companies.
• The certificates that may be issued by the Arts Minister include those for the completion of a new game, the porting of a digital game to a new platform, or one for the ongoing development of existing digital games in one income year.
• Submissions giving feedback and views on the legislation and explanatory memorandum are due to the Treasury by 18 April 2022.

Report released on housing affordability and supply in Australia

• The House of Representatives Standing Committee on Tax and Revenue has released its report entitled 'The Australian Dream: Inquiry into housing affordability and supply in Australia'. In Chapter 6, the report considers the impact of current taxes, charges and regulatory settings at a federal, state and local government level on housing supply.
• The Committee made a number of recommendations relating to tax. These include:
  
  • state and territory governments replace duty with land tax (Recommendation 9);
  • the Australian Government conduct a review into how transitional costs regarding the replacement of stamp duty with land tax could be smoothed (Recommendation 10); and
  • the Australian Government conduct a review into the the build-to-rent (BTR) housing market and how it is affected by current tax policies and regulations (Recommendation 12).
• With respect to the BTR recommendation, the real estate industry has raised concerns over the taxation of returns for certain foreign investors arising through MIT structures (particularly, the application of a 30% rate in contrast to the 15% rate available for other real estate investments, such as commercial office), as well as the GST treatment of BTR.
• The Committee was interested by the evidence it received on BTR. The two key obstacles to BTR's success identified by submitters were land tax (BTR state land taxes are higher than other property asset classes as they are levied on the basis of individual residences rather than entire holding), and GST. In consequence, submitters flagged the need for recognising BTR as a different form of housing in the context of land tax relief and equalising the tax treatment of all forms of commercial residential property.
• The Committee believes that the BTR model has potential to improve housing affordability. However, before any changes to legislation or regulations are made, the Committee recommends that the Australian Government further consider the complex taxation and planning law issues BTR gives rise to.

Cases

Commissioner obtains freezing order against taxpayer prior to an assessment being issued and the taxing event occurring: Deputy Commissioner of Taxation v State Grid International Australia Development Company Limited [2022] FCA 139

• The decision of Perry J in Deputy Commissioner of Taxation v State Grid International Australia Development Company Limited confirms that a taxpayer's assets may be frozen in the absence of a notice of assessment being issued by the Deputy Commissioner when the ATO makes an application to the Court for a freezing order pursuant to rr 7.32, 7.34 and 7.35 of the Federal Court Rules 2011 (Cth).
• This decision is interesting for two key reasons. First, when the application was filed, the ATO had not issued a notice of assessment to State Grid. Second, the CGT event alleged by the Commissioner was to occur the day after the urgent interlocutory hearing for the freezing order.
• The issue giving rise to the proceedings was an alleged CGT event pursuant to s 104-10 of the ITAA 1997, which was the implementation of a scheme of arrangement whereby State Grid would dispose of its shares to Australian Energy Holdings No 4 Pty Ltd. Once the scheme had been implemented, State Grid would have been considered to have had an income tax liability in excess of $220 million. The ATO had not yet issued a notice of assessment or assessed any tax liability (given that the CGT event had not yet occurred) as it was dependent on the scheme of arrangement taking place the day after the hearing.
• The Commissioner was found to have a "good arguable case in the form of a prospective cause of action" (which would accrue once State Grid disposed of its relevant shares and the notice of Special Assessment had been issued to State Grid). For that reason, the Commissioner was qualified to apply for freezing orders. Ultimately, Perry J considered it appropriate to maintain the status quo and make the freezing orders at the conclusion of the hearing.

Authors: Vivian Chang, Partner; Sanjay Wavde, Partner; Ian Kellock, Partner; Bronwyn Kirkwood, Counsel; Steve Whittington, Senior Associate; and James Sainty, Senior Associate.