Trending Tax Topics: Current and Topical Issues in Income Tax - - PowerPoint PPT Presentation

Trending Tax Topics: Current and Topical Issues in Income Tax

Presented by: Professor Michael Dirkis University of Sydney Law School

Focus of f presentation

• 1. 2018-2019 Budget Measures:
• Denial deductions for vacant land
• Taxation of income for an individual’s fame or image
• Revisiting the taxation of team sportspersons
• 2. 2017-2018 Budget Measure: removal the entitlement to

the CGT main residence exemption for foreign residents

• Individual residency revisited

1.1 .1 Denial deductions for vacant land [1 [1]

• Budget Paper No 2 states that from 1 July 2019 deductions for

expenses associated with holding vacant land, such as interest costs, will be disallows where the land is not genuinely held for the purpose of earning assessable income.

• As well aimed at addressing concerns that deductions are being

improperly claimed it is also intended to reduce tax incentives for land banking

• Denied deductions will not be able to be carried forward for use

in later income years, but may be included in the cost base of the asset for capital gains tax (CGT) purposes when sold (eg borrowing expenses and council rates)

1.1 .1 Denial deductions for vacant land [2 [2]

• This measure will not apply to expenses associated with holding

land that are incurred after:

• a property has been constructed on the land, it has received

approval to be occupied and is available for rent; or

• the land is being used by the owner to carry on a business,

including a business of primary production.

• Budget Paper No 2 concludes by stating that this measure will

apply to land held for residential or commercial purposes, however, the ‘carrying on a business’ test will generally exclude land held for commercial development.

1.1 .1 Scope of f change

The scope of the change is unclear

• Farmers are expressly okay
• Okay if a property developer as land is trading stock under s 70-10 (ie

acquired & held for the purposes of sale or exchange in the ordinary course of business): FCT v St Hubert’s Island Pty Ltd (in liq) (1978)

• For land owners with land used for agistment the expenses will be

denied

• What about land acquired as part of a ‘profit making scheme or

undertaking’? If not a business in itself the expenses are denied

• The target of these changes appears to be cases like Steele v DCT,

where interest was incurred in a period prior to the derivation of relevant assessable income (Commissioner’s attempts to limit Steele in Taxation Ruling TR 2004/4 appear to have failed)

1.1 .1 Recap: Steele v DFCT [1 [1999] HCA 7

Facts: Steele bought a 7 hectare racehorse training & agistment centre in 1980 for $1m to redevelop as a motel & townhouse complex to be run personally. In late 1981 a development application was refused but after selling half of her interest to a business associate, a 2nd development application was approved in early 1982. In 1986, following litigation, the Steele acquired the associate's half-

• interest. In 1987, she again sold half of her interest & in 1988 she

sold her remaining interest. While she held the property, it was only used for agisting horses from which she derived $29,000

1.1 .1 Recap Steele v DFCT [1 [1999] HCA 7 [2 [2]

Issue was whether the $909,000 of interest incurred by the taxpayer on the unpaid purchase price, on borrowings from a finance company & later a bank on the security of the property was deductible. High Court allowed the interest deduction. It noted: ‘Having regard to the original purpose for which she acquired the land, Carr J said, any profit on a resale would have constituted assessable income. He considered that from the time the appellant acquired the land she had embarked on a profit-making undertaking or scheme. In those circumstances, the appellant's

• perations, were, in his view, sufficiently linked to the derivation of

assessable income.’

1.2 .2 Taxation of income for an individual’s fame or image [1 [1]

There appears to wider agenda of revisiting the law and the ATO’s practice in respect of profit splitting through assignments, the use

• f service trusts, etc.

On 19 July 2017 the ATO released a Draft Practical Compliance Guideline PCG 2017/D11: Tax treatment of payments for use and exploitation of a professional sportsperson’s ‘public fame’ or ‘image’. It offers a safe harbour where by up to 10% payments to professional sportsperson can be treated as referable to the use and exploitation of the professional sportsperson’s ‘public fame’ or ‘image’ under the associated resident third-party’s licence and are therefore can be treated as the income of the associated resident third-party.

1.2 .2 Taxation of income for an individual’s fame or image [2 [2]

This safe harbour is to be superseded by Government announcing in the 2018-2019 budget that from 1 July 2019 high profile individuals are no longer able to take advantage

• f lower tax rates by licencing their fame or image to another

entity. Budget paper No 2 states that the ‘measure will ensure that all remuneration (including payments and non cash benefits) provided for the commercial exploitation of a person’s fame

• r image will be included in the assessable income of that

individual.’

1.2 .2 Recap: Personal service sports businesses [1 [1]

Traditionally sportspersons engaged in team sports were considered employees (eg, in FCT v Maddalena (1971) the High Court concluded that ‘Mr Maddalena's contract with the rugby league club was a contract of employment’). For sportspersons engaged in non-team sports, such as swimmer or track & field athlete the question did not arise as they were generally not renumerated as they were amateurs (ie, the Courts recognised that times had changed from the days when ‘[s]port was the antithesis of work’ and when, for a well-known amateur golfer to lend his name for reward to advertise a commercial product, would be conduct unworthy of his amateur status). But with the growth in professional sports it was recognised that professional athletes in non-team sports were carrying on a business

• f sport (see FCT v Stone [2005] HCA 2)

1.2 .2 Recap: Personal service sports businesses [2 [2]

The business can arise from:

• the sport becoming a sportsperson’s ‘vocation or calling’ (s 995-1

‘business’ definition), but is not an employee

• a sportsperson ‘commercial exploitation of skills developed and

used in the pursuit of sporting excellence’ (TR 1999/17 & Stone) or

• a sportsperson’s ‘commercially exploiting their sporting prowess

and associated celebrity’ (Spriggs v FCT; Riddell v FCT [2009] HCA 22) This can occur despite some of the usual indicators of a business being absent (ie a sportsperson’s ‘motives are idealistic rather than mercenary’).

1.2 .2 Recap: Personal service sports businesses [3 [3]

 In Spriggs & Riddell the High Court’s allowed two professional footballers deductions for costs associated with obtaining football club employment contracts, on the basis that obtaining & performing such employment contracts was part of the business of being a professional footballer.  Although each taxpayer had a playing contract, it was not solely a contract of employment between the taxpayers and their

• clubs. Rather, the contract was a tripartite contract involving

their respective clubs, football leagues & their player rules, which allowed for the taxpayers to receive income from non- playing activities.

1.2 .2 Recap: Personal service sports businesses [4 [4]

The taxpayers were ‘engaged in the business of commercially exploiting their sporting prowess and associated celebrity.’ The High Court noted that it is possible to obtain & perform an employment contract as part of, & during the course of, running a business (Cof T(Vict) v Phillips [1936] HCA 11). Neither the decision in Maddalena , nor the definition of ‘business’ in s 995-1 required the conclusion that employment activities could not form part of the carrying on of a business for the purposes of s 8-1(1)(a).  The Court did accept that a person, as in Maddalena, is not conducting a business merely because the person earns income under an employment contract

Developments in the taxation of f team sportspersons

Justice Edmonds commenting on the Spriggs & Riddell noted that: ‘What the decision of the High Court illustrates, some may say reinforces, is that outgoings by taxpayers in carrying on a business will be afforded more favourable tax treatment in terms

• f deductibility under the general provisions if the Assessment

Acts, than the same outgoings incurred by taxpayers who are not carrying on a business. That may be a natural consequence of the operation of s 8-1… & the proper construction of those provisions. But whether it accords with one’s notion of fairness may be open to doubt.’

2 2 Loss of f the CGT main residence exemption for foreign residents

Treasury Laws Amendment (Reducing Pressure on Housing Affordability No. 2) Bill 2018, Schedule 1, currently before the Senate removes the entitlement to the CGT main residence exemption for foreign residents from 7.30pm on 9 May 2017 (the application time) Individuals who are foreign residents at the time a CGT event occurs to a dwelling (or for a compulsory acquisition a part of a dwelling) in which they have an ownership interest are not entitled to the CGT main residence exemption (ss 118-110(3) & 118-245(3))

2 2 Deceased estates

A trustee of a deceased estate is not entitled to the CGT main residence exemption in respect of an ownership interest in a dwelling of a deceased individual if the deceased was a foreign resident at the time of death (s 118-155(5)) A beneficiary of a deceased estate is not entitled to the portion of the CGT main residence exemption in respect of an ownership interest in a dwelling of a deceased individual if the deceased was a foreign resident at the time of death (s 118-195(1A)).

2 2 Special disability trusts

The main residence exemption no longer applies if:

• at the time a CGT event occurs to the ownership interest in a

dwelling of a special disability trust, the principal beneficiary

• f that trust was a foreign resident; or
• CGT event occurs to a dwelling while it is held by the trustee
• f the special disability trust after the death of the principal

beneficiary and at the time of death the principal beneficiary was a foreign resident (para 118-218(1)(d) & s 118-225(5))

2 2 CGT events I1 I1 or I2 I2

Main residence exemption will now not apply if CGT events I1

• r I2 occur to an ownership interest in a dwelling.

CGT event I1 & I2 did occur to dwellings that are a unit of accommodation that is a caravan, houseboat or other mobile home, but did not apply to dwellings that are TARP (real property situated in Australia (including leases of land)). Without this change, the main residence exemption would be available for a mobile home at the time the owner changes their residency (as CGT events I1 or I2 occur at this time), but not for real property in the same circumstances (as no CGT event occurs at this time).

2 2 Delayed application date

Although the amendments broadly apply from application time to ensure that taxpayers are not adversely affected by a retrospective change, the amendments to the main residence exemption do not apply for certain dwellings held before the application time. The amendments do not apply to a capital gain or loss from a CGT event that occurs to a dwelling if the CGT event occurs on or before 30 June 2019 if:

• an individual, or trustee of a special disability trust held an
• wnership interest in the dwelling to which the CGT event relates

at all times from immediately before the application time until immediately before the CGT event happens; or

2 2 Delayed application date [2 [2]

• an individual acquired the property as a beneficiary of a

deceased estate and at all times from immediately before the application time until immediately before the CGT event happens to the dwelling, that individual; the deceased person; the trustee of the deceased estate of the deceased person; the trustee of a special disability trust on behalf of a principal beneficiary; or a combination of these entities held the ownership interest in the dwelling (s 118 110 of the Income Tax (Transitional Provisions) Act 1997)

2 2 Delayed application date [3 [3]

Example 1.9 Samantha acquired her main residence on 13 April 2013. She residing there until 15 September 2016 when she moved to Bahrain on 16 September 2016 and becoming a foreign resident. It was rented until it was sold by a contract signed 10 January 2019 & settlement occurring on 7 February 2019. CGT event A1 for the sale of the dwelling occurs when the contract for sale was signed, that is 10 January 2019. As Samantha held her ownership interest in the dwelling on or before 9 May 2017, she continued to own it until it was sold and as it was sold before 1 July 2019 she is entitled to the main residence exemption under the transitional rule.

This change reinforces why is residence important

Residence determines:

• Tax rate
• Whether CGT applies to assets (s 855-10), soon the

availability of principal residence exemption (from 9.5.17) & 50% CGT (removed for non-residents & temporary residents

• n capital gains accrued after 8.5.12: ss 115-105 & 115-115)
• Entitlement to tax treaty relief
• Application of withholding tax in respect of interest,

dividends, royalties, & AMIT & MIT distributions (ITAA36 Divs 11A & 13A; Divs 275, 276 & 840)

Why is residence important [2 [2]

Entitlement to franking credits exemption of certain income of foreign resident individuals, eg visiting experts, representatives of foreign governments, etc (Div 842) imposition of thin capitalisation rules (which impose limits

• n their debt/equity ratios) on non-residents with

investments in Australia (Div 820); setting aside or varying of transactions that have the effect

• f shifting profits (transfer pricing arrangements) (ITAA97

SubDivs 815-A & 815-B to D).

In Increase in information fl flows [1 [1]

 Information flows set to increase due to the:

• Multilateral Convention on Mutual Administrative Assistance in

Tax Matters (MCMAA) signed on 3.11.2011 (111 jurisdictions have now signed up), and

• OECD Common Reporting Standard (CRS). Under CRS the ATO is

required obtain information from its financial institutions relating to non-resident financial accounts. Financial institution reporting is based on a calendar year with lodgment due with the ATO by the following 31 July. However, the first ‘calendar’ year is the 6 months (1.7.2017 to 31.12.2017) due to be lodged with the ATO by 31.7.2018.

In Increase in information fl flows [2 [2]

• Exchange is based on existing provisions in DTAs, TIEAs & the

MCMAA

• For bilateral exchange there must be an agreement between the two

Competent Authorities &here Australia has signed on the OECD’s Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information (CRS MCAA) (signed on 3.6.2015) that forms a basis for these agreements.

• Exchanges are required by 30 September in the year the reports are

lodged with the Commissioner. There are 58 exchanging jurisdictions for 2018.

• There is no monetary threshold for due diligence on new accounts &

there is a $250,000 threshold for existing entity accounts & transitional arrangements for individual accounts.

Im Importance reflected in recent litigation

Btw 2010 & 2017 35 cases concerning individual residence litigated compared with only 25 cases in the prior 79 years The issues covered in the litigation included:

• application of the ‘resides’ and ‘domicile tests’
• determination of ‘permanent place of abode’
• application of the ‘half year’ test
• application of ‘superannuation’ test
• treaty tie-breaker test in Article 4(2)
• related matters associated with the onus of proof, the

provision of evidence in the context of residence disputes and application of the former foreign employment income exemption in s 23AG

Im Importance reflected in recent litigation [2 [2]

In 79 years (from 1930 – 2010) only 5 involving companies (with the last being in 1946), Then, between 2010 - 2017 there were 8 company matters heard by the HCA, FCAFC, FCA & AAT

• Is there a problem?

If If so, , why?

• There was no change to the s 6(1) residence rules
• The majority of the recent litigation in respect of individuals

was

• consistent with existing jurisprudence
• not driven by difficulties in interpretation & application
• Corporate litigation outcomes were also consistent with

existing jurisprudence

Recap: Who is an Australian resident?

Section 995-1 defines “Australian resident” to mean “a person who is a resident of Australia for the purposes of the” 1936 Act The principal definitions of when an “individual” or a company is a “resident” or “resident of Australia” are in s 6(1) ITAA36 A “foreign resident” is defined in s 995-1 as someone who is not a resident of Australia under 1936 Act A “non-resident” is defined in s 6(1) of the ITAA36 as a person who is not a resident of Australia

Alternative defi finitions for individuals

As well as four resident ‘tests’ in s 6(1)(a) in relation to individual there are three specific purpose residence definitions used (or intended to be used) in the income tax

• law. They are the terms/definitions:
• ‘ordinarily resident’ (in ss 23AA, 251U(1)(e), &

252A(2A)(b) of ITAA36)

• ‘Territory resident’ (repealed from 30 June 2015)
• ‘temporary resident’ (s 995-1): SubDiv 768-R – treats all

their foreign source income as NANE

Principal defi finitions for individuals

The four resident ‘tests; in s 6(1)(a) consist of a primary test and three secondary tests:

• domicile,
• half year,
• superannuation tests?

Domicile & superannuation tests extend residency to people who do not physically reside in Australia. This statutory definition of ‘resident’ contains a number of words which have been interpreted by the Courts. These words & phrases are ‘resides in Australia’, ‘domicile’, ‘permanent place

• f abode’, and ‘usual place of abode’.

‘Primary’, ‘common law’ or r ‘resides’ test

 Illustrative: Gunawan [2012]

 Is a person actually ‘residing’ in Australia?  Koitaki Para Rubber Estates v FCT per Williams J: ‘[t]he place of residence of an individual is determined, not by the situation of some business or property which he is carrying on or owns, but by reference to where he eats and sleeps and has his settled or usual abode. If he maintains a home or homes he resides in the locality or localities where it or they are situate, but he may also reside where he habitually lives even if this is in hotels or on a yacht or some

• ther place of abode’

Factors assist in in determining residence

• physical presence (Efstathakis -11 yrs, Reid v IRC,

Subrahmanyam, Re Bezuidenhout cf Re Young (1875), Rogers (1879), Joachim (2002), Pickles v Fulsham (1923), Iyengar)

• term of any employment or appointment (Pechey - 4 weeks

insufficient time)

• nature of the person's family (Efstathakis; Re Mynott;

Iyengar; Shord [2015], Hughes [2015])

• business & social ties (Gregory ‘chief & principal place of

business activity & social life’), The Engineering Manager [2014]

Factors assist in in determining residence [2 [2] ]

• frequency & regularity of a person's movements:

Loewenstein v De Salis (1925), Lysaght - attended monthly directors' meetings; Agius [2015]

• intention (purpose) of visit or trip: Levene (trips abroad were

for his health – ‘... none of these purposes was more than a temporary purpose’), Slater v Comms of Taxes [1949]; Re Mackenzie [1941]); Sneddon [2012].

• Nationality: limited importance – Lysaght, Dempsy
• Onus is on the taxpayer - Horrocks [2010]; Murray and FCT

(No 3) [2012]; Mulherin [2013] FCAFC, cf, The Overseas Applicants [2014]

Danger wit ith lis lists of f factors

Although that list gained some later currency in later Tribunal cases, in Re Dempsey and Commissioner of Taxation Justice Logan, Presidential Member Hack and Senior Member Kenny warned: However useful such checklists may be, they are no substitute for the text of the statute and the recollection that ultimate appellate authority dictates that the word “resides” be construed and applied to the facts according to its

• rdinary meaning.

Consistency of f recent cases wit ith existing la law

The litigation reinforced the existing understanding of Australia’s residence rules

• Taxpayers, with strong family ties to Australia who undertook

employment contracts in the Middle East, not surprisingly, were found to be residents of Australia, while those that did not have family ties in Australia (Iyengar, Shord, Hughes, Landy) or had severed attachment to Australia by establishing a permanent place of abode outside Australia (Re Mynott) were found to be non-residents

• If not married & estranged (Dempsey) or divorced

(Engineering Manager, Agius) not residents

But the 'continuity of association’ test

Hafza v Director-General of Social Security [1985] FCA 164, Wilcox J: 14.… a person does not necessarily cease to be resident there because he or she is physically absent. The test is whether the person has retained a continuity of association with the place … together with an intention to return to that place and an attitude that that place remains "home”… the application of the general concept of residence to any particular case must depend upon the wording, and underlying purposes, of the particular statute in relation to which the question arises. But, where the general concept is applicable, it is

But the 'continuity of association’ test [2 [2]

• bvious that, as residence of a place in which a person is not

physically present depends upon an intention to return and to continue to treat that place as ‘home’, a change of intention may be decisive of the question whether residence in a particular place has been maintained (stuff in red not focused upon by ATO).

But the 'continuity of association’ test [3 [3]

The test has adopted by ATO staff in their assessment of the residency status of taxpayers, be it without being formally adopted by the ATO in its public rulings or its practice statements and been used by AAT (see Shord, Pillay, Murray [2013], Guissouma) Concerns about its application by the ATO – Mayhew and Commissioner of Taxation

Domicile Test

Conditional on no permanent place of abode elsewhere Domicile: general common law concept modified by uniform state & federal legislation (Domicile Acts).  Is a legal relationship between a person and a country by which persons are able to invoke the country's laws as their

• wn (ie, a person's ‘permanent’ home rather than where

they reside). Two types: domicile of origin and domicile of choice

Domicile Test

Applegate, Taxation Ruling IT 2650, Re Boer [2012]; Sully [2012]; Ellwood [2012]; Re Pillay [2013]; Boyd [2013]; ZKBN [2013]; The Engineering Manager [2014]; Landy [2016]

• cf Mayhew [2013]; Re Dempsey [2014]; Murray [2013]

More than half year test

presence for more than half a tax year (so-called “183 day” test). This test is conditional on no usual place of abode outside Australia and intention not to take up residency The use of the word ‘usual’ rather than ‘permanent’ to qualify the words ‘place of abode’ does seem to imply that the exclusionary test is less stringent than that under the domicile test. Thus, ‘usual’ in this context connotes that the ‘place of abode’ be that ‘[…] in ordinary use, current, prevalent, habitual, customary].

More than half year test [2 [2]

Subrahmanyam (sick); Groves [2011]; Guissouma [2013] (no usual place of abode outside Australia); Re Koustrup [2015]; Re Jaczenko [2015]; Re Clemens [2015]; (usual place of abode

• utside Australia)

Government response: from 1.1.2017 a 19% tax rate on income up to $37,000 earned by an individual holding a subclass 417 (Working Holiday) visa or subclass 462 (Work and Holiday) visa or related bridging visa: s 3A(1) of the Income Tax Rates Act 1986. Ordinary tax rates for taxable income exceeding this amount.

Do numbers = complexity & la lack of f cla larity

 Most of the recent litigation was:

• consistent with existing jurisprudence;
• not driven by the difficulties of interpretation & application;
• driven by the 2009 decision to remove for most taxpayers

entitlement to the foreign employment income exemption  The number of cases litigated post 2009 was also inflated by:

• the ATO’s adoption of a mechanical 'continuity of association

with the place’ test, which resulted in some cases being argued that should not have been litigated; and

• a failure to ensuring compliance with s 23AG from 1987 to 2009,

which resulted in s 23AG issues being litigated over 20 years later than they should have been

Reasons for company litigation

Increased audit focus driven by initially by Project Wickenby and then Base Erosion and Profit Shifting (BEPS).

Reform?

2016/17: Board of Taxation residency project - ‘High wealth individuals and residency’ Project Is 2013 UK model the solution? UK model: statutory definition that removes all subjectivity (equity) & replaces it with 159 sections of complex legislation consisting of detailed definitions & extensive specific anti-avoidance rules The attempt to convert a complex policy into a certain

• utcome comes at a cost of complexity & a loss of equity

Questions