Tax residence – is it administrable after Pike?

passportsIn the recent case of Pike v Commissioner of Taxation [2019] FCA 2185 Federal Court judge Logan J. noted:

This is the third in a succession of taxation appeals in the original jurisdiction entailing a taxation residence issue, the others being Stockton v Commissioner of Taxation [2019] FCA 1679 (Stockton) and Addy v Commissioner of Taxation [2019] FCA 1768 (Addy), which have fallen for determination by me since the Full Court’s judgment in Harding v Commissioner of Taxation (2019) 365 ALR 286 (Harding).

The Commissioner’s losses

In each of the cases, the Federal Court overturned decisions of the Commissioner of Taxation that each of the protagonists were residents of Australia for tax purposes, and found that they were non-residents. Addy and Stockton were “working holiday” cases. In Pike too Logan J. overturned an objection decision of the Commissioner that Mr. Pike was a resident for the 2009 to 2014 income years but the Pike case raises wider questions about the income tax residence rules and indeed, Pike differs from the Full Federal Court decision (special leave to appeal to the High Court refused) in Harding too as it concerned a taxpayer whose spouse and children lived in Australia during the income years in dispute and was especially borderline. How that perhaps perplexing outcome could come about is the concern of this post.

Dissatisfaction with the residency rules already

In 2016 the Board of Taxation initiated a review into income tax residence rules which considered:

  • whether the existing Australian individual income tax residency rules that are largely unchanged since enactment in 1930:
    • are sufficiently robust to meet the requirements of the modern workforce;
    • address the policy criteria of simplicity, efficiency, equity (fairness) and integrity;
  • integrity concerns;
  • the increase in litigation relating to the residency rules since 2009; and
  • any changes that could be adopted to improve the residency rules.

The Board reported a core finding that the current individual tax residency rules are no longer appropriate and require modernisation and simplification but the Board also noted that any change has inherent integrity risks such that high net worth individuals in particular could become citizens of nowhere.

Pike – applying the existing tests

The curious and complex aspects of the existing Australian individual income tax residency rules where comprehensively considered and applied by Logan J. in Pike. Mr. Pike, even in the submission of the Commissioner, was a dual resident of Australia and Thailand during the relevant years. This meant that Logan. J needed to look to the “tie-breaker” provisions in the Australia Thailand Double Tax Agreement (the DTA) to determine which of Australia or Thailand could treat Mr. Pike as a tax resident of their jurisdiction during those years.

The domicile test

In the residency tests in the definition of “resident” or “resident of Australia” in sub-section 6(1) of the Income Tax Assessment Act (ITAA) 1936 there is an interplay between ordinary residence with the test in paragraph (a)(i) where the “domicile” of the taxpayer is relevant. Under that definition in the ITAA a “resident” or “resident of Australia”means:

(a)  a person, other than a company, who resides in Australia and includes a person:

(i)  whose domicile is in Australia, unless the Commissioner is satisfied that the person’s permanent place of abode is outside Australia; …

And so Logan J. needed to consider the evidence in Pike to understand whether Mr. Pike had a domicile in Australia during the relevant years.

Principal facts relating to the domicile test in Pike

In the context of Mr. Pike’s domicile the principal facts in Pike were:

  1. Mr. Pike was a native of Zimbabwe.
  2. Mr. Pike and his de facto, Ms. Thornicroft, with whom Mr. Pike had children, left Zimbabwe. Ms. Thornicroft obtained a position with Ernst & Young in Brisbane however Mr. Pike’s skills and career were in the tobacco industry and he had to relocate elsewhere. In the event he relocated alone to Thailand, and after 2014, to Tanzania and to the United Arab Emirates to use his skills and pursue his career in the tobacco industry.
  3. Ms. Thornicroft and their children became Australian citizens in 2010. Mr Pike applied to become an Australian citizen in 2013 and, initially, he was rejected presumably with the Department of Immigration taking into account the paucity of time Mr Pike was physically in Australia and his Thailand connections:
Income year Days spent in Australia Percentage of time spent in Australia
2008 76 20%
2009 155 42%
2010 97 27%
2011 109 30%
2012 102 28%
2013 86 23%
2014 123 33%
(2015) 32 8%
(2016) 44 12%
(2017) 77 21%
  1. Despite those Mr. Pike did eventually become an Australian citizen in 2014.

These principal facts are but a snapshot and simplification of the factual matrix in Pike all of which beared on, in varying degrees, the questions of residence and domicile at issue in the case. Resolution of these questions based on these facts plainly justified the full remittance of penalties by the Commissioner which the Commissioner conceded to Mr. Pike at the objection stage.

Domicile of origin of Mr. Pike

Logan J. observed that Mr. Pike had sought to become and became an Australian citizen though somewhat as a matter of convenience to overcome the complications for an international businessman travelling on a Zimbabwean passport. Logan J. found that Mr. Pike clearly had a domicile of origin in Zimbabwe and applied legal reasoning and learning to understand when Mr. Pike may have acquired Australian domicile as a domicile of choice. Even though the evidence was far from conclusive Logan J. stated that there were sufficient signals from Mr. Pike’s activity to conclude that Mr. Pike did not have a domicile of choice in Australia before 2014.

Thus Logan J. found that Mr. Pike was not a “resident of Australia” due to the operation of the domicile test in paragraph (a)(i) of the definition in sub-section 6(1) even should the Commissioner have reason not be satisfied that Mr. Pike had a permanent place of abode in Thailand.

Dual resident

Logan J. explained with reference to applicable authority including Dixon J. in Gregory v D.F.C.T. (W.A.) [1937] HCA 57; 57 CLR 774 at p.777-778 that an individual can be ordinarily resident in two places. In Pike further principal facts relating to Mr. Pike’s ordinary residence included:

  1. Ms. Thornicroft and their children opted not to move to Thailand so that the children’s schooling could be in Australia and could continue undisrupted.
  2. Despite their living apart the Federal Court was impressed by Mr. Pike’s commitment to his de facto, children and his wider family including his full economic support of Ms. Thornicroft and the children after Ms. Thornicroft ceased earning an income from her employment in 2011 after sustaining an injury.
  3. Although Mr. Pike and Ms. Thornicroft had purchased a vacant block in Brisbane in the hope of building a home, the block was sold undeveloped for a loss in 2014. Ms. Thornicroft, the children, and Mr. Pike when in Australia, thus always occupied rental accommodation in Australia.
  4. Mr. Pike too rented a succession of apartments and cottages in Chaing Mai, Thailand which accommodated the family when Ms. Thornicroft and their children visited Mr. Pike in Thailand; and
  5. Mr. Pike was keen on sports, both as a participant as a spectator and was a member of a number of sports clubs in Thailand. Logan. J. accepted evidence of Mr. Pike and Ms. Thornicroft that Mr. Pike had his own “life abroad” for the long periods he was present in Thailand for his work commitments.

As stated, the Commissioner too had accepted that Mr. Pike was an ordinary resident of both Australia and Thailand. Thus the Federal Court needed to apply the “tie-breaker” tests in the DTA.

The paramount DTA

Logan J. explained how the DTA is paramount over the ITAA  in cases where the DTA applies. Thus an individual who is, or could be a resident of, Australia under the ITAA definition in sub-section 6(1) could nevertheless come to be treated as a resident of Thailand and not a resident of Australia under the DTA. That is the outcome under sections 5 and 4 of the International Tax Agreements Act 1953 if, under the DTA, the “tie-breaker” provisions of the DTA apply to treat a dual resident as a resident of Thailand.

The DTA tie-breakers

However like with the domicile test considered above, the tie breaker tests in the DTA were not so readily capable of application to resolve Mr. Pike’s circumstances.

The first tie-breaker under Article 4.3(a) of the DTA is:

the person shall be deemed to be a resident solely of the Contracting State in which a permanent home is available to the person;

Based on relevant authorities and OECD commentary Logan J. found that a rented home, albeit a family home occupied as such for the foreseeable future, is not a permanent home in this context. Similarly Mr. Pike’s various accommodations in Thailand also did not amount to any permanent home. So this tie-break was of no assistance to the Federal Court to resolve the question of Mr. Pike’s tax residence.

The second tie-breaker is in Article 4.3(b) of the DTA:

if a permanent home is available to the person in both Contracting States, or in neither of them, the person shall be deemed to be a resident solely of the Contracting State in which the person has a habitual abode;

which also turns on the availability of a permanent home to Mr. Pike was similarly to no avail.

The third tie-breaker in Article 4.3(c) of the DTA is:

if the person has a habitual abode in both Contracting States, or in neither of them, the person shall be deemed to be a resident solely of the Contracting State with which the person’s personal and economic relations are closer.

was applied by Logan J. Logan J. analysed Mr. Pike personal relations to Australia which included the presence of his de facto wife and children in Australia and the availability of a not so permanent home which he occupied in Australia when he was living with his family. Those were clearly of greater significance, as personal relations, than his sporting and social activity in Thailand to him in his personal space. Against that Logan J. considered Mr. Pike’s economic relations to Thailand which gave rise to all of his income which, from 2011, was the income which sustained both Mr. Pike and his family in Australia.

Although Mr. Pike spent considerably more days each year between 2009 and 2014 in Thailand due to work than in Australia Logan J. stated:

I do not accept Mr Pike’s submission that habitual abode ought to be determined just by length of residence such that Mr Pike’s greater length of residence in Thailand in each year meant that, between the 2009 and 2014 income years, only in Thailand could be said to have a habitual abode.

Although it was something of an oranges versus apples comparison Logan J. broadly found that Mr. Pike’s relations (in the main, economic) to Thailand were closer than Mr. Pikes relations (in the main, personal) to Australia.

Hence Logan J. found that, under the DTA tie breaker in Article 4.3(c), Mr. Pike was a resident of Thailand and a non-resident of Australia between the 2009 and 2014 income years.

How then to change the residency rules?

At the outset of this post I raised the Board of Taxation’s recommendation that the residency rules should be modernised and simplified. In the context of Pike and how that case ultimately turned it is not so easy to formulate how the residency rules could be changed to avoid the perhaps arbitrary application of overly simple and ineffective DTA tie-breakers based on OECD settled model provisions which change may put Australia out of alignment with international norms.

Or is Pike too unusual to worry about?

That said the facts in Pike seem exceptional to the wisdom that tax residence will generally be at the habitual place of abode a taxpayer has with his or her spouse and children. In Pike the following factors, which were somewhat unusual, appear to have given rise to a different outcome:

  • Mr. Pike had a foreign history and never seemed to really settle with his family in Australia before 2014;
  • Mr. Pike and Ms. Thornicroft never purchased a home in Australia and the family lived in a succession of rented homes; and
  • Mr. Pike and Ms. Thornicroft were unusually credible and convincing witnesses who were able to establish to the Federal Court that they really had reasons for and had a believable distance though stable family relationship.

Commissioner hamstrung by equivocal residency rules

Still unusual residential arrangements abound and, for many taxpayers, this means wide surveys of their facts and background of their residency will need to be undertaken and presented to the Commissioner. The Commissioner does not have the benefit of laws fit for purpose to assist the Commissioner to administer the law and clearly resolve the question of tax residence even when fully appraised of assiduously supplied facts. This ultimately can lead to administration challenges for the Commissioner and to expensive disputes with taxpayers over tax residency which will be as impenetrable as Pike was to resolve.

Closely held trusts, “family trusts” and circular trust distributions – a tax net nuanced again for the compliance burden

trusts guardrail

In Australia the income taxation of trusts is based on the trust being a conduit with look-through to beneficiaries of the trust who are presently entitled to the income of the trust. In the standard case of an adult resident beneficiary of a trust, the beneficiary is taxed on trust income and the trust is broadly treated as a transparent entity and isn’t taxed.

Even where a beneficiary is:

  • not an adult; or
  • not a tax resident;

the trustee of the trust pays tax though ostensibly on behalf of the beneficiary entitled to trust income at the rate applicable to the beneficiary and the beneficiary is entitled to a credit for tax paid on that income should the beneficiary file his, her or its own tax return.

Tax capture when no beneficiary entitled to the income

Look-through taxation of income doesn’t work when there is no beneficiary presently entitled to income of the trust to look through to. Under the Australian system, in these cases, the trustee of a trust pays tax at the highest marginal rate on income plus applicable levies including medicare levy. That is where no beneficiary is presently entitled to the income of a trust under section 99A of the Income Tax Assessment Act 1936.

The trustee beneficiary complication

Trusts can be beneficiaries of other trusts. These beneficiaries are “trustee beneficiaries” of a trust.

Example

  • The trustee of trust B is a beneficiary and so is a trustee beneficiary of trust A.
  • C, a beneficiary of trust B, takes (is presently entitled to) a share of the income of trust A.
  • C may be an individual or a company, viz. an ultimate beneficiary, or may be a further trust – a further trustee beneficiary.

It is then necessary to trace trust income of trust A through trustee beneficiaries to find if there is an ultimate individual or company beneficiary entitled to that income. There may be no ultimate beneficiary entitled to income and the case of a “circular” trust distribution is a case in point.

The circular trust distribution by trusts

A definitive example of a circular trust distribution of income is where:

  • trust X distributes income of trust X to trust Y; and
  • trust Y distributes its income (back) to trust X.

There is thus no ultimate individual or company beneficiary. The income is in a state of flux.  Nonetheless it is clear no beneficiary is presently entitled to the income and the highest marginal rate and applicable levies imposed under section 99A should be applicable to a circular trust distribution of income under the regime so far described.

That is a fair point in principle but a circular trust distribution, or any distribution to a trustee beneficiary that isn’t on-distributed to an ultimate beneficiary, is not necessarily readily traceable and identifiable as income to which no beneficiary is entitled. That is especially so where a labyrinthine structure of numerous trusts is used to conceal who is entitled to trust income and that there is no ultimate beneficiary who is not a trustee beneficiary entitled to trust income.

The legislative countermeasures

Countermeasures in the below legislation apply to support the integrity of flow through taxation of trusts. These countermeasures were introduced in Division 6D of Part III of the Income Tax Assessment Act 1936 which has lead to these new taxes:

  • firstly, the ultimate beneficiary non-disclosure tax when introduced with the A New Tax System (Closely Held Trusts) Act 1999 (see below); and
  • currently the trustee beneficiary non-disclosure tax as introduced to reform the ultimate beneficiary non-disclosure tax under the Taxation (Trustee Beneficiary Non-disclosure Tax) Act (No. 1) 2007 and the Taxation (Trustee Beneficiary Non-disclosure Tax) Act (No. 2) 2007.

These taxes were or are in substance proxies for tax on the trustee under section 99A for presumed lack of present entitlement of an ultimate beneficiary to ensure that income of a trust does not escape income tax either:

  • for want of an ultimate beneficiary entitled to the income; or
  • because of the opaque lack of an ultimate beneficiary where a trustee beneficiary may seem to be an ultimate beneficiary in the tax return of the trust.

Like the rate that applies under section 99A the rate of trustee beneficiary non-disclosure tax is the highest marginal rate plus applicable levies including the medicare levy.

The countermeasures also include a concept of “trustee” group which expands liability for trustee beneficiary non-disclosure tax to corporate directors of trustees of closely held trusts personally: an impost beyond the section 99A impost for falling under the purview of these anti-avoidance provisions.

A New Tax System (Closely Held Trusts) Act 1999

The first legislation to grapple with the tracing problem was in the A New Tax System (Closely Held Trusts) Act 1999 which introduced a wide and indiscriminate ultimate beneficiary statement reporting obligation on all closely held trusts.

Closely held trusts

A trust is a closely held trust if it:

  • is a discretionary trust, or
  • has up to 20 individuals who, between them, directly or indirectly, and for their own benefit, have fixed entitlements to a 75% or more share of the income or a 75% or more share of the capital of the trust;

where the trust is not an excluded trust. Examples of excluded trusts are complying superannuation funds and, for their first five years, deceased estates.

Reset of the closely held trust compliance burden

In response to sustained complaints from many trustees of trusts which did not distribute to trustee beneficiaries and their advisers, the federal government came to amend the regime in 2007 so that only trustees of closely held trusts which distribute income to:

  • trustee beneficiaries;
  • where the distribution includes an “untaxed part”;

have reporting obligations to file a trustee beneficiary (TB) statement. TB statements need to be filed with a tax return and, in the case of resident trustee beneficiaries, need to disclose the following about the trustee beneficiary:

  • name,
  • tax file number,
  • the untaxed part of their share of trust income; and
  • their share of tax preferred amounts;

and to withhold trustee beneficiary non-disclosure tax and to pay it to the Commissioner of Taxation where the relevant trustee beneficiary fails to provide the information for the TB statement when it is sought by the (distributor) closely held trust.

This more nuanced or targeted solution imposes a less onerous compliance burden on closely held trusts than the 1999 measures did.

Further, in accord with policy to treat “family trusts” viz. trusts that have

  • a valid family trust election; or
  • a valid interposed entity election;

in force or that otherwise forms part of a “family group” less onerously, family trusts were excluded trusts to which the closely held trusts regime did not apply following the 2007 reform.

2018-19 Budget changes to closely held trusts

Following an announcement in the 2018-19 Federal Budget, the closely held trust arrangements have been further tweaked by the Treasury Laws Amendment (2019 Tax Integrity and Other Measures No. 1) Act 2019. Under these changes it is still the case that family trusts still do not have to comply with the TB statement reporting requirements however family trusts are no longer excluded trusts.

That means that a family trust that is a closely held trust (which will often be the case) must now comply with the closely held trust obligations but a family trust remains relieved from the obligation to file TB statements and pay trustee beneficiary non-disclosure tax on omission to file a TB statement. Despite that a family trust is now liable for trustee beneficiary non-disclosure tax on circular trust distributions under section 102UM of the Income Tax Assessment Act 1936 but not on distributions received from other trusts (which are not circular and to which section 102UM does not apply).

How will compliance with the changes work?

It is perhaps unusual that the changed closely held trusts regime relieves a family trust, no longer an excluded trust and that distributes income to a trustee beneficiary, from filing a TB statement. The Commissioner of Taxation will have no TB statement to aid detection of a taxable circular distribution back to the family trust. Further, in the case of family trusts, the Commissioner won’t obtain TB statement level information about distributions by family trusts to trustee beneficiaries that are not circular or the opportunity to impose the trustee beneficiary non-disclosure tax on those distributions as a matter of course on the omission to file a TB statement.

Nevertheless the Commissioner of Taxation will have trustee beneficiary contact details and perhaps a tax file number, or will be alerted by the absence of a tax file number; from the tax return of a closely held trust family trust. The Commissioner can trace a distribution and ascertain when a circular trust distribution by a family trust occurs by investigative activity. Further, risk of family trust distributions tax liability under Schedule 2F of the Income Tax Assessment Act 1936 makes it less likely that a family trust will make a distribution liable to that tax, particularly a distribution of a tax preferred amount, to a trustee beneficiary that is:

  • outside of the family group; and
  • where that trustee beneficiary’s tax file number is not known by the trustee of the trust and reported in the trust tax return.

Income from private company investments – the tax scourge of SMSFs

increase

A self managed superannuation fund (SMSF) is generally a low tax entity, particularly when in pension phase where a nil rate can apply and a low 15% rate can apply when not. Still the taxable income of a complying superannuation fund (SF) can be split into a non-arm’s length component and a low tax component under section 295-545 of the Income Tax Assessment Act (ITAA) 1997. The non-arm’s length component is taxed at the highest individual marginal rate which is 45% in the 2019-20 income year.

Non-arm’s length income

The non-arm’s length component for an income year is the complying SF’s “non-arm’s length income” (NALI) for that year less any deductions to the extent that they are attributable to that income.

NALI picked up on audit – even higher tax

The recent case in GYBW v. Commissioner of Taxation [2019] AATA 4262 (GYBW) is a cogent reminder of how NALI taxed at the highest marginal rate can arise in a SMSF. In GYBW a tax shortfall arose as the NALI not returned by the SMSF was detected in an audit by the Commissioner of Taxation. Hence even higher taxes applied including shortfall interest and penalties. There was a reduction in penalties on appeal to the AAT from “reckless” to “failure to take reasonable care” level.

NALI

Section 295-550 is one of a number of superannuation rules designed to protect the integrity of the low tax complying SF regime by combatting income shifting arrangements where income, that might be taxed elsewhere to another type of taxpayer at higher rates, is non-commercially shifted to a complying SF that attracts a low rate of tax.

Section 295-550 is directed at non-arm’s length dealings where complying SFs (and other superannuation entities) earn income from an arrangement which exceeds the income that the complying SF might have been expected to derive from the arrangement if the parties to the arrangement had been dealing with each other at arm’s length.

Where section 295-550 is enlivened all of the income from the arrangement is NALI taxed at the highest rate.

Private companies dividends prone to be NALI

At the forefront of NALI is dividend income from investment by complying SFs in private companies.

In GYBW Senior Member McCabe identified an objective test in sub-section 295-550(2) which looks at a question of fact: is a dividend paid by a private company to a complying SF consistent with an arm’s length dealing? A private company dividend paid to a SMSF is NALI to the SMSF if it is not. This objective test replaced the former provisions in Part IX of the ITAA 1936 under which private company dividends were treated as special income (the forerunner to NALI) as a matter of course. That is, unless the Commissioner exercised a discretion that it was unreasonable to treat the private company dividend as special income where the Commissioner became satisfied that the income was earned at arm’s length.

Sub-section 295-550(3) sets out factors to be considered in applying the objective test.

The facts and findings in GYBW

In GYBW, the SMSF was the SMSF of a partner in an accounting practice with the pseudonym D. His client and connection pseudonym K had volatile and valuable business interests which could earn significant income from Department of Defence contracts.

D retired from his accounting practice to become the chief financial officer of the B Group.

The various partnership and corporate dealings of K are complex and supporting evidence of them before the AAT was “difficult” and incomplete. The AAT did not accept:

  • that the evidence, though involving non-related parties D, K, K’s trust and the other partners and former partners of K; and
  • that legal advice received before the SMSF invested in B Holdings;

supported a finding that the shares in pseudonym B Holdings acquired by D’s SMSF were acquired on terms where dividends would be earned from the shares consistently with an arm’s length dealing.

Senior Member McCabe observed how parties at arm’s length from each other can engage in an non-arm’s length dealing just as non-arm’s length parties can engage in an arm’s length dealing. For instance, in the latter case, a family member of the seller acquiring stock exchange listed shares of the seller on a stock exchange. Section 295-550 is directed to the dealing viz. how the SMSF came to earn the private company dividends it earned, not to the relationship of the parties to the arrangement. The AAT was therefore sceptical about the acquisition by D’s SMSF of ordinary shares in B Holdings on its formation for a nominal sum where B Holdings was also able to obtain and exploit K’s business interests a day later which D contended had negligible value then.

That AAT observed that “Fortune shined on the business” of B Holdings and B Holdings earned more than $10 million over four years which likely explains why it was picked up for an audit by the Commissioner.

Darrelen applicable

After looking at the Explanatory Memorandum with which section 295-550 was introduced Senior Member McCabe concluded that the purpose of the section did not change nor was there any change to the factors to which regard was to be had. Therefore the Full Federal Court decision in Darrelen Pty Ltd v Federal Commissioner of Taxation (2010) 183 FCR 237, which concerned the former provisions in Part IX of the ITAA 1936, remained authoritative in Senior Member McCabe’s view. In Darrelen the court had held that dividends paid by a private company were special income. In the case the SMSF had acquired its four shares in that company for a cost far less than their market value in an earlier year of income notwithstanding that the same dividend amount was paid on all 100 shares in the income year it was paid.

The cost to the SMSF of the shares on which the dividend was paid

The cost to the SMSF of the shares on which dividends were paid is a specific factor that can be taken into account under paragraph 295-550(3)(b) in determining whether their payment is consistent with an arm’s length dealing. In applying the objective test Senior Member McCabe referred to Commissioner of Succession Duties (SA) v Executor Trustee and Agency Co of South Australia Ltd (Clifford’s Case) where the High Court set out its views on how to value shares in a company:

The main items to be taken into account in estimating the value of shares are the earning power of the company and the value of the capital assets in which the shareholder’s money is invested. But a prudent purchaser does not buy shares in a company which is a going concern with a view to winding it up, so that the more important item is the determination of the probable profit which the company may be reasonably expected to make in the future, because dividends can only be paid out of profits and a prudent purchaser would be interested mainly in the future dividends which he could reasonably expect to receive on his investment. Further, a prudent purchaser would reasonably expect to receive dividends which would be commensurate with the risk, so that the more speculative the class of business in which the company is engaged the greater the rate of dividend he would reasonably require. In order to estimate the probable future profits of a company it is necessary to examine its past history, particularly the accounts of those years which are most likely to afford a guide for this purpose. In order to estimate the rate of dividend that a prudent purchaser could reasonably require on his investment it is necessary to examine the nature of the business and the risks involved and to seek the evidence of business men, particularly members of the stock exchange and experienced accountants, who can testify to the appropriate rate from the prices paid for shares in companies carrying on a similar business listed on the stock exchange or from private sales of shares in such companies or from their general business experience.

[1947] HCA 10; (1947) 74 CLR 358 at p.362

and with the benefit of hindsight, and omissions in the evidence supporting D’s SMSF’s case about how the SMSF and B Holdings came to benefit in K’s business interests, the AAT found that dividends were not consistent with arm’s length dealing as they arose from shares acquired for less than their value so evaluated. The AAT found that the dividends received by D’s SMSF from B Holdings were NALI.

NALI rules extended to expenses

The NALI rules have extended to losses, outgoing or expenditures that are less than expected to the complying SF by the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Act 2019 in Schedule 2.

Conclusion

Unless GYBW is overturned on appeal SMSF investment in a private company of a related party or in a private company of the connections of the SMSF seem destined for NALI high tax treatment. So SMSFs should be wary of investment in private companies generally: SMSF investment in a private company carries the suspicion that the investment is an opportunity to shift income from a higher taxed entity to a concessionally taxed SMSF.

It follows that the trustee of a SMSF looking to sustain concessional tax treatment needs to adequately document its dealings with and investment in private companies so the arm’s length character of the investment can be verified and, where need be, independent valuation supporting consistency with arm’s length dealing should be sought.

Changing the trustee of a trust – some elements for success

It is sometimes wrongly assumed that a minute of the current trustee is sufficient to change the trustee of:

  • a family discretionary trust (FDT); or
  • a self managed superannuation fund (SMSF) (which must be a trust with a trustee too – see sub-section 19(2) of the Superannuation Industry (Superannuation) Act (C’th) 1993 (SIS Act));

and that a change of trustee will have no serious tax consequences. The second proposition is more likely to be true, but not always.

FDTs and SMSFs invariably commence with a deed which contains the terms (the trust terms or governing rules – TTOGRs) on which the trust commences. That, in itself, is a reason why I contended in 2009 in Redoing the deed that an instrument or resolution less than a deed to change the trustee is prone to be ineffective even where change by less than or other than a deed is stated to be permitted by the TTOGRs in the trust deed.

Changing trustee relying on ability to change in the trust deed

It is thus to the trust deed that one needs to look to find:

  1. whether there is a power in the TTOGRs to appoint a new trustee or to otherwise change the trustee; and
  2. if, so, what the procedure or formalities are for doing so.

Changing trustee relying on the Trustee Acts

If ability to change trustee is not present, or is derelict, in the TTOGRs then the Trustee Acts in states (and territories) provide options for appointing a new or additional trustee which vary state to state.

Trustee Act – New South Wales

In New South Wales: section 6 of the Trustee Act (NSW) 1925 allows a person nominated for the purpose of appointing trustees in the TTOGRs, a surviving trustee or a continuing trustee to appoint a new trustee in certain specified situations such as where a trustee:

  • has died;
  • is incapable of acting as trustee; or
  • is absent for a specified period out of the state.

However an appointment of a new trustee in these situations must be effected by registered deed: sub-section 6(1) That is the deed of appointment must be registered with the general registry kept by the NSW Registrar-General, which is publicly searchable, and the applicable fee to so register the deed must be paid to NSW Land Registry Services for the appointment to take effect.

It is apparent from sub-section 6(13) that registration of a deed of appointment is not required where ability to appoint a new trustee is in the TTOGRs where the TTOGRs express a contrary intention; that is: where the TTOGRs expressly and effectively allow an appointment to be effected without a registered deed.

Trustee Act – Victoria

In Victoria there is a comparable capability for a person nominated for the purpose of appointing trustees in the TTOGRs, a surviving trustee or a continuing trustee to appoint a new trustee in writing in certain specified situations such as where a trustee:

  • has died;
  • is incapable of acting as trustee; or
  • is absent for a specified period out of the state;

under section 41 of the Trustee Act (Vic.) 1958. However this Victorian law does not impose any requirement that the required instrument of appointment in writing must be registered.

Changing trustee by obtaining a court order

The supreme courts of the states and territories are also given a residual statutory capability to appoint trustees under the respective Trustee Acts. However applying to a supreme court for an order to change a trustee of a FDT or a SMSF with sufficient supporting grounds is an option of last resort given likely significant costs and uncertainties of obtaining the order.

Changing trustee by deed

The TTOGRs in a trust deed of a FDT or a SMSF will frequently require that an appointment of a new trustee may or must be effected by a deed. It is desirable that it should do so to ensure the appointment of a new trustee does not become of a matter of uncertainty and difficulty for the reasons I have described in Redoing the deed.

Tax consequences of a change of trustee

As a change of trustee without more generally does not change beneficial entitlements under a trust, the tax consequences are usually benign:

For capital gains tax (CGT), assurance that changing trustee does not give rise to a CGT event for all of the CGT assets held in a trust is diffuse under the Income Tax Assessment Act (C’th) (ITAA) 1997:

Sub-section 104-10(2) concerning CGT event A1 states:

(2) You dispose of a * CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event A1 will not happen merely because of a change in the trustee.

Sub-section 960-100(2) with the Notes below it in fact say:

(2) The trustee of a trust, of a superannuation fund or of an approved deposit fund is taken to be an entity consisting of the person who is the trustee, or the persons who are the trustees, at any given time.

Note 1: This is because a right or obligation cannot be conferred or imposed on an entity that is not a legal person.

Note 2: The entity that is the trustee of a trust or fund does not change merely because of a change in the person who is the trustee of the trust or fund, or persons who are the trustees of the trust or fund.

Similarly sections 104-55 and 104-60 of the ITAA 1997 which concern:

• Creating a trust over a CGT asset: CGT event E1

• Transferring a CGT asset to a trust: CGT event E2

each restate the above Note: viz.

Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event E… will not happen merely because of a change in the trustee.

Stamp duty

A change of trustee can have stamp duty consequences where the trust holds dutiable property such as real estate.

Duty – NSW

Concessional stamp duty on the transfer of the dutiable property of the trust to the new trustee can be denied in NSW to a FDT unless the trust deed of the trust limits who can be a beneficiary, for anti-avoidance reasons: see sub-section 54(3) of the Duties Act (NSW) 1997.

Indeed Revenue NSW withholds the requisite satisfaction in sub-section 54(3) unless the TTOGRs provide or have been varied in such a way so that an appointed new trustee or a continuing trustee irrevocably cannot participate as a beneficiary of the trust. Contentiously satisfaction is withheld by Revenue NSW unless a variation to a FDT to so limit the beneficiaries is “irrevocable“ : see paragraph 6 of Revenue Ruling DUT 037, even though that variation may not be plausible or permissible under the TTOGRs of the FDT.

This hard line is taken by Revenue NSW to defeat schemes where someone, who might otherwise be a purchaser of dutiable property who would pay full duty on purchase of the property from the trust, becomes both a trustee and beneficiary able to control and beneficially own the property who is thus able to contrive liability only for concessional duty and avoid full duty,

Duty – Victoria

Although the Duties Act (Vic.) 2000 contains anti-avoidance provisions addressed at this kind of anti-avoidance arrangement, there is no comparable hard line to that in NSW in sub-section 33(3) of the Duties Act (Vic.) 2000 so that the transfer of dutiable property, including real estate, on changing trustee is more readily exempt from stamp duty.

Other requirements

A prominent requirement on changing trustee of a SMSF is notification to the Australian Taxation Office, as the regulator of SMSFs, within twenty-eight days of the change: see Changes to your SMSF at the ATO website.

Where changing trustee involves a corporate trustee then there may also be an obligation to inform the Australian Securities and Investments Commission of changes to details of directors of the corporate trustee, if any. There may be further matters to be addressed if any new or continuing directors are or will become non-residents of Australia and, with SMSFs, the general requirement in section 17A of the SIS Act that the parity between members of the fund on the one hand and trustees, or directors of the corporate trustee on the other, needs to borne in mind and, if need be, addressed.

Taking out tax when superannuation death benefits are paid to deceased estates and testamentary trusts

Confusion-Blue

Who pays tax and how much when a superannuation fund pays out death benefits to a deceased estate or to a testamentary trust is not intuitive. The two technical concepts of “dependant” and “taxable component” in particular are a source of confusion.

Dependant

There are two relevant kinds of dependant. The SIS Act kind of dependant (a spouse of the person, any child of the person and any person with whom the person has an interdependency relationship – section 10 of the Superannuation Industry (Supervision) Act 1993) notably differs from a death benefits dependant under section 302-195 of the Income Tax Assessment 1997 , a subset of (SIS Act) dependant, as a death benefits dependant excludes adult children who are not disabled or in an interdependency relationship. Such an independent adult child can be a (SIS Act) dependant in receipt of a death benefit from a superannuation fund but is not a (section 302-195 of the ITAA 1997) death benefits dependant.

Taxable component

For tax purposes a death benefit is split into a taxable component and a tax fee component. The tax free component is tax free to any dependant but the taxable component is a misnomer when paid to a death benefits dependant (DBD): it’s tax free too! So of the four permutations (tax free to DBD, tax free to Non-DBD, taxable to DBD, taxable to Non-DBD) it is when a death benefits dependant receives a death benefit comprising taxable component that the benefit becomes taxable.

Re-contribution

Superannuation benefits can be paid prior to death if a member has satisfied a condition of release such as reaching the age of 65 years. This can be a way of reducing the taxable component of a death benefit that might be taxable to a dependant when paid after the member’s death. Member benefits, viz. benefits withdrawn by a member during his or her lifetime, are generally not taxable to the member where the member has reached aged 60.  It is permissible to re-contribute withdrawn benefits as non-concessional contributions back into superannuation, which become tax free component, when later paid out by the superannuation fund as death benefits.

Non-concessional limits and caps on re-contribution

However the member must be within non-concessional contribution limits to re-contribute back into superannuation in this way. At over age 65 that involves meeting the work test and being within the non-concessional caps. That is being under:

  • annual non-concessional contributions of $100,000 p.a. (no bring forward allowed for over age 65s); and
  • a total superannuation balance of $1.6m.
A look at how a taxable death benefit is taxed

A payment of death benefit that flows to a beneficiary of a deceased estate is something of a three stage event. The tax system looks through to the ultimate dependant in receipt of the death benefit (the third stage) even though the trustee of the superannuation fund may simply be paying death benefits to the legal personal representative of the deceased member who is an allowable (SIS Act) dependant (the first stage).

Non-death benefits dependants only get lump sum death benefits

Only lump sum death benefits can be paid to a dependant who is not a death benefits dependant, such as an independent adult child, so ordinarily we are looking at tax at 15% on a “taxed element” (the usual source [element] of benefits from a SMSF) but other rates can apply: see this table of rates at the ATO website https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?page=12

A curiosity is that taxable lump sum death benefits received by the trustee of a deceased estate are not subject to the medicare levy. Taxable lump sum death benefits viz. taxable component received directly by a non-death benefits dependant from the trustee of a superannuation fund, that is, not indirectly from the fund via a legal personal representative deceased estate dependant, is subject to medicare levy and PAYG withholding.

No PAYG withholding on lump sum death benefit paid by the trustee of the superannuation fund

The ATO also confirms that a lump sum death benefit is not subject to PAYG withholding where it is paid to:

  • a death benefit dependant (tax free); or
  • the trustee of a deceased estate – this amount is taxed within the deceased estate broadly in the same way it would be taxed if it was paid directly to the beneficiary.

https://www.ato.gov.au/super/apra-regulated-funds/paying-benefits/taxation-of-super-benefits/?default

The trustee of the superannuation fund is obliged to provide a PAYG payment summary – superannuation lump sum form (NAT 70947) to the trustee of the deceased estate within fourteen days of the payment though.

Obligations of the trustee of the deceased estate

According to the 2018 trust tax return instructions at the ATO website https://www.ato.gov.au/forms/trust-tax-return-instructions-2018/?page=43

A superannuation death benefit paid to a trustee is taxed in the hands of the trustee in the same way that it would be taxed if paid directly to a beneficiary, that is, the portions of the payment are subject to tax to the extent the beneficiary is a dependant or a non-dependant of the deceased. There is no tax payable to the extent that the payment is made to dependants or eligible non-dependants of the deceased.

At stage two, the trustee returns the taxable portions applicable to the non death benefits dependants in the trust return so that the ATO can assess the tax payable by the trustee as if the estate beneficiary/non-death benefits dependant was being directly taxed (with the taxed element generally capped to 15%).

This tax is a final tax paid at the trustee of the deceased estate level so no tax at stage three! A trustee of deceased estate should not include taxable elements of a superannuation death benefit lump sum, otherwise returned and directly and finally taxed, in income in its tax return. Then these amounts will not be further taxed at stage three as income say of a resident adult beneficiary.

Declarations of trust and stamp duty on disguised conveyances

declare

Each of the state and territory duty jurisdictions include declarations of trust over dutiable property (typically real estate) as dutiable transactions in one form or another. Without a declaration of trust head of duty, or an apt anti-avoidance provision, conveyancing duties that would by paid on a transfer of the dutiable property to B can be avoided by A declaring that property is held on trust for B though still held legally (on title) by A. Duty on a declaration of trust generally applies at full rates chargeable against the value of the dutiable property and differs from the head of duty which applies to declarations of trust which are not made over dutiable property to which a concessional duty or, in some states and territories, no duty will apply.

Duty eagerly assessed on the mention of a trust

So the Commissioners of State Revenues Australia wide are eager to assess any document to duty which purports to contain a declaration of trust over dutiable property which could be viewed as either:

  • a transfer of beneficial interest in the property in substance; or
  • a disguised transfer.

Integrity of the state revenues

That zeal can be understood in the context of the integrity of state revenues. In New South Wales, where a “declaration of trust” is a dutiable transaction under section 8 of the Duties Act 1997, Revenue NSW will treat documents which foreshadow or even just mention a trust over dutiable property as dutiable. Hence those who have an eye to the duty implications of deeds and documents that impact dutiable property are justifiably cautious about using the expression “on trust” in a deed or document where dutiable conveyance of the beneficial ownership of dutiable property by that document is not intended.

Ambit declaration duty rejected in W.A.

A recent case in Western Australia shows that duty on documents that state that dutiable property is held on trust can be too readily assessed as a declaration of trust by state revenue. The W.A. Court of Appeal in In Rojoda Pty Ltd v. Commissioner of State Revenue (WA) [2018] WASCA 224 decided against the Commissioner where two deeds of dissolution of partnership in that case explicitly stated that a partner, the surviving registered owner of land, held dutiable property on trust for other surviving partners of the partnerships. The Court of Appeal found that the dissolution of two partnerships involving family members, whose business included property ownership and investment, were not declarations of trust and were not dutiable as declarations of trust over dutiable property.

It was determinative in Rojoda that the trusts recited in the deeds were confirmatory of trusts that already existed. It was significant that the Court of Appeal, in overturning a decision by the State Administrative Tribunal, was prepared to examine the equitable implications and the relevant legal and beneficial interests of the partners just before and on the execution of the deeds of dissolution of the partnerships. The Court of Appeal found that the legal and beneficial interests of the partners, just before the deeds were executed, were sufficiently comparable to the interests set out to be on trust in the deeds and thus held the deeds established no new trusts and thus did not declarations of trust in the context of the W.A. head of duty.

Identifiable new trust needed for a dutiable declaration of trust

The land had been used as partnership property of the partnerships. The Court of Appeal found that the wife, who was the surviving registered proprietor of the land, already held the land for the partners, which included the children of the wife and the husband, or their representatives. They thus had specific and fixed beneficial or equitable interests in the partnership properties before the deeds prepared for the dissolution of the partnerships were executed. These interests, reflecting their respective proportionate share of partnership property, were comparable interests to those said to be held on trust in the deeds. Thus the Court of Appeal found the trusts set out in the deeds were not new trusts declared over property dutiable in W.A.

The High Court has granted the Commissioner of State Revenue special leave to appeal in Rojoda. This case will likely inform what amounts to a declaration of trust dutiable in state and territory stamp jury jurisdictions.

Aggregating for dual $6m MNAV tests following 2018 small business CGT concession integrity changes – with the aid of chess!

ChessPieces

Those seeking the small business capital gains tax (CGT) concessions in the 2018 and later income years need to be wary of modified small business CGT concession integrity rules which apply from 8 February 2018 by virtue of Schedule 2 of the Treasury Laws Amendment (Tax Integrity and Other Measures) Act 2018 (TIOMA).

The small business CGT concessions in Division 152 of the Income Tax Assessment Act (ITAA) 1997 may look straight forward but there are subtle complications within the misnamed “basic” conditions for the relief which can be matrixlike. The small business CGT concessions are generous so perhaps it is right that rules to protect their integrity, as ramped up by the TIOMA, are more complicated than the rules that ordinarily impose a CGT liability on sales of small business related CGT assets.

Share or interest sales need to meet additional basic conditions

For CGT events involving sales of shares in companies or interests in trusts “additional” basic conditions have commenced with the TIOMA. The additional basic conditions go further than what I describe here. In this post I wish to focus on the significance of the dual $6m maximum net asset value tests that the TIOMA initiates. So in the below considerations I am going to assume that the other basic conditions for the small business CGT concessions, including the additional basic conditions, such as the dual active asset test, which also needs to be considered following the introduction of the TIOMA, will be met.

The dual MNAV and SBE tests

The dual $6m maximum net asset value (MNAV) tests are alternative tests with the similarly dual small business entity ($2m aggregated turnover) (SBE) tests which apply where the small business CGT relief is sought on a sale of shares in a company or an interest in a trust. The dual MNAV tests and SBE tests separately test both the taxpayer (“you”) and the object entity which is the relevant company or trust in which the shares are or interest is held by the taxpayer as the case may be. To obtain relief under the basic conditions, and under the additional basic conditions set out in sub-section 152-10 as revised by the TIOMA, the dual tests must be separately satisfied to obtain any small business CGT concession relief:

Taxpayer must satisfy AND Object entity must satisfy
MNAV test or SBE test   Modified MNAV test or SBE test and carried on business up to day of sale

When the object entity MNAV test becomes vital

In practice, there is a significant slew of sales of shares or trust interests where the object entity won’t satisfy the SBE test because of:

  • an aggregated annual turnover of the object entity of more than $2 million; or
  • alternatively, the object entity may satisfy that SBE test but paragraph 152-10(2)(a) may apply because the object entity ceased to carry on its business some time before the sale.

In those cases the object entity also needs to satisfy the MNAV test even where the taxpayer has separately satisfied either of the MNAV test or the SBE test or both.

Satisfaction of the MNAV test by the object entity may thus be vital to the availability of the small business CGT concessions to a taxpayer selling shares or a trust interest. Where the object entity, let us say a private company with multiple owners, is worth more than $6m overall, this may well be a problem for minority owners who otherwise are:

  • on or over the 20% significant individual/CGT stakeholder threshold; or
  • with net asset value (NAV) under $6m who sell their shares looking for the small business CGT concessions.

The Explanatory Memorandum with the TIOMA gives the following example:

Example 2.4: Investment in large business

Karen carries on a small consulting business as a sole trader. She is a CGT small business entity (according to the general rules) for the 2019-20 income year. Karen also owns 30 per cent of the shares in Big Pty Ltd, a large private company with annual turnover in excess of $20 million in both the 2018-19 and 2019 CGT assets exceeds $100 million throughout this period. On 1 October 2019, Karen sells her shares in Big Pty Ltd. She would not be eligible to access the Division 152 CGT concessions for any resulting capital gain. Even if Karen satisfies the other basic conditions for relief, she cannot satisfy the new condition. Big Pty Ltd is not a CGT small business entity in the 2019-20 income year. It also does not satisfy the maximum net asset value test in relation to the capital gain, as its net assets exceed $6 million immediately prior to the CGT event happening (being in excess of $100 million for the entire income year).

MNAV test complexities

Like the SBE test with aggregated turnover of the taxpayer, affiliates and their connected entities, compliance with the MNAV test relies on, or more specifically NAV (net asset value) must stay under the relevant $6m limit after, aggregation.

Before aggregation is considered there is a flip side: the exclusions from the MNAV test: The substantial exclusions are confined to individual taxpayers viz. interests in an individual’s main residence, personal use assets, superannuation and insurance: section 152-20 of the ITAA 1997. The other exclusions in this section are largely to prevent accounting anomalies with:

  • accounting provisions; and
  • the double counting of the value of an asset indirectly held in an entity and the value of the stake in the entity including the asset, representing the same value, in NAV.

Liabilities are also excluded from NAV where they relate to assets so the MNAV test can be a maximum net asset value test.

The value of assets that are not excluded are tallied in NAV when applying the MNAV test. Then aggregation must be done. Just like with the complexity of small business CGT concessions integrity more generally, MNAV tests and sometimes qualification for the concessions, involve a hierarchy of constructs which, for the purposes of illustration, can be loosely compared to the pieces on a chessboard one’s opponent in chess may hold:


Chess piece: King

Div 152 construct: The taxpayer

Comment: If the King falls, it’s game over. If either NAV of the taxpayer or (modified) NAV of the object entity exceeds $6m in each required MNAV test the basic condition is failed unless there is a pathway to compliance through the SBE test as described above.

Chess piece: Queen

Div 152 construct: An affiliate

Comment: Although an affiliate is not the taxpayer (or object entity), the NAV of the affiliate also counts/aggregates to the taxpayer (or object entity) when applying the MNAV test to the taxpayer (or object entity), in all directions including NAV aggregated from connected (and Oconnected in the case of an object entity – see below) entities of the affiliate.

Chess piece: Bishop

Div 152 construct: Connected entities

Comment: The whole of the NAV of the connected entity (excluding the exclusions described above) counts in the MNAV test. So if a taxpayer, or an affiliate, has a stake of 50% in a connected entity X, all (100%) of X’s net value is aggregated to the taxpayer’s NAV (including NAV relating to the stake in X of minority stakeholders unrelated to the taxpayer or affiliate). If Y is a connected entity of X then aggregate all (100%) of Y’s net value to the taxpayer’s NAV too.

Chess piece: Knight

Div 152 construct: Oconnected entities

Comment: The Oconnected entity (my terminology – I thought of using “controlled entity” which is in contrast to a connected entity which can either control or be controlled by the other entity it is connected to. But controlled entity is misleading for, as we shall see, only a 20% stake, hardly control in any sense, is needed to trigger this link) is a new construct introduced with the additional basic conditions in the TIOMA relating to the object entity.

The NAV of a Oconnected entity is aggregated to the NAV of the object entity but it is look through forward to aggregate and not look through back too (unlike “controlled by the other entity” which can connect too to a connected entity). An example is needed to explain constructs here: So if O, an object entity controls Q an Oconnected entity, due to a 20% or greater stake in Q, and P is another unrelated stakeholder in Q; the value of Q owned by P is included in the NAV of Q aggregated to O (see the outcome of that in the below Example 2.5 drawn from the Explanatory Memorandum) but the NAV of P and its connected entities is excluded from the NAV of O (if they are not separately affiliated/connected to O).

In chess the Knight moves in a weird way so the Knight is the allegory chosen here!

Chess piece: Pawn

Div 152 construct: Asset or investment of the above

Comment: A pawn generally moves one space in chess. $1 in value of an asset or investment owned by a taxpayer or object entity, which is not excluded, counts $1 to the NAV of the taxpayer or an object entity.  $1 in value of an asset or investment owned by affiliates, connected entities and Oconnected entities, which are not excluded, count $1 to the affiliate, connected entity and Oconnected entity, as the case may be, but if that NAV is in an affiliate, a connected entity or a Oconnected entity of the taxpayer or object entity in applying the dual tests, the whole NAV of the relevant entity is aggregated to the taxpayer/object entity, not its proportionate NAV based on percentage stake. i.e. A percentage stake is only used for an interest in an entity where the entity the interest is held in is not an affiliate, connected entity or, in the case of the object entity MNAV test, an Oconnected entity.

I don’t play chess and I accept my chess analogy with the workings of the MNAV tests is far from perfect. My endeavour is to make this consideration of the hierarchical workings of the MNAV tests a little more comprehendible and so, perhaps, if you are still reading by this point I have succeeded? If the comparison with chess conveys:

  • that counts of over $6m by either of the taxpayer NAV or the object entity NAV will generally mean failure of a basic condition for the Division 152 CGT relief so can lead to loss of the game; and
  • that high value pieces accelerate aggregation of NAV to the $6m limit. That is they can move more than one space: every $1 of a stake a taxpayer (or object entity) in a connected entity (or Oconnected entity), and affiliates and their connected entities without needing any stake in the affiliate of the taxpayer (or object entity) will generally aggregate more than $1 to NAV as the value of others’ stakes in these entities will count to the NAV attributed to the taxpayer (or object entity) too.

The modified MNAV test of the object entity & the modified Oconnected entity

The NAV for controlled entities of an object entity is different due to sub-paras 152-10(2)(c)(iii), (iv) & (v) in the TIOMA:

The threshold between unrelated entity, counted simply as an asset or investment (pawn) to NAV and connected entity (bishop) consistent with other tests of control in the ITAA 1936 and the ITAA 1997 is 40% with a discretion given to the Commissioner where:

  • there is 40% or over and under a 50% stake; and
  • it can be established to the Commissioner that some other entity controls the entity that would otherwise be the connected entity.

In practice this means expect the Commissioner to de-connect A from connection with X if A owned 48% of X and B (unconnected to A) owned 52% of X.

When applying the object entity MNAV test, sub-paras 152-10(2)(c)(iii), (iv) & (v) have operation so that the threshold is lowered to a 20% stake in the other entity. That is enough “control” to make the other entity, otherwise an asset or investment, an Oconnected entity (knight). This is apparent from another example in the Explanatory Memorandum with the TIOMA:

Example 2.5: Indirect investment in large business

Tien owns 20 per cent of the shares in Investment Co, a company that carries on an investment business. Investment Co is a CGT small business entity (according to the general rules) for the 2020-21 income year. Investment Co holds 20 per cent of Van Co, a transport company. Van’s assets mean that it is not a CGT small business entity in the 2020-21 income year and does not satisfy the maximum net asset value test at any point during the income year. On 15 May 2021, Tien sells his shares in Investment Co. He is not eligible to access the Division 152 CGT concessions for any resulting capital gain. Even if Tien satisfies the other conditions, he cannot satisfy the new condition requiring the object entity be a CGT small business entity or satisfy the maximum net asset value test due to the modifications that apply when determining this matter for the purposes of this condition. For the purposes of this condition, Investment Co is considered to be connected with Van Co, as Investment Co holds 20 per cent of Van.

As stated in the table above there is no look through back so in a case where an object entity has a stake of 21% of X, the NAV in entities connected to X by virtue of the remaining 79% stakes in X are excluded from the object entity NAV although the NAV of the assets of  X, including that relating to the other stakeholders, counts to the object entity NAV.

The odd way disputes over PAYG deducted from salary are resolved

payday

A recent Federal Court case Price v. Commissioner of Taxation [2019] FCA 543 demonstrates the divergent way a taxpayer must go about contesting a dispute with the Commissioner of Taxation over pay as you go (PAYG) tax withholding amounts taken from salary or wages received by the taxpayer.

Right to object about PAYG credits not available

Although the credit for PAYG withholding amounts is notified on a notice of assessment of income tax the PAYG credit is not one of the matters that can be disputed by objection, or more specifically, an objection under Part IVC of the Taxation Administration Act (C’th) 1953 (“TAA”) as discussed on this blog in: Is an objection needed to amend a tax assessment? https://wp.me/p6T4vg-k.

To formally dispute a PAYG credit, especially where the salary and wages from which the withholding is made are not disputed, court action may need to be taken instead. The proceeding that can be taken by a taxpayer is further limited as the Commissioner’s refusal to allow PAYG credits cannot be challenged under the Administrative Decisions (Judicial Review) Act (C’th) 1977: Perdikaris v Deputy Commissioner of Taxation [2008] FCAFC 186. So in Price, the taxpayer (Robert) sought a declaration from the Federal Court of his entitlement to credit for PAYG withheld by his employers under section 39B of the Judiciary Act (C’th) 1903.

Price v. Commissioner of Taxation

In paragraphs 6 to 8 of the Federal Court decision in Price, Thawley J. outlined the legislative basis of the PAYG withholding regime including in the context of the predecessor PAYE (pay as you earn) regime which operated until 2000. In paragraph 2 Thawley J. confirmed that the taxpayer’s proceeding under section 39B of the Judiciary Act, rather than under Part IVC of the TAA, was correctly instigated.

Why the taxpayer risked heavy costs in the Federal Court

Action in the Federal Court is expensive, and an unsuccessful litigant in the court is generally liable for the legal costs of the successful litigant. Those legal costs are significantly more than the costs of lodging an objection or appealing against an objection decision with which the objector is dissatisfied in the Administrative Appeals Tribunal (AAT) which are costs risked in Part IVC of the TAA disputes. The AAT does not award legal costs.

It follows that considerable PAYG credits need to be in dispute before action against the Commissioner in the Federal Court is worth the risk of legal costs at stake.

In Price, Robert was employed as a truck driver by four entities controlled by his brother Jim from the 2001 to the 2016 income years. Robert claimed PAYG credits for the entire period so considerable PAYG credit entitlements were at stake. Robert hadn’t lodged tax returns returning his salary and wages income until 26 September 2016 when all sixteen income tax returns were lodged together. Robert sought all sixteen years’ worth of tax credits then.

The employer and not the Commissioner is tested

One would think that the Commissioner could easily ascertain PAYG credit from amounts remitted by an employer for a recipient of salary and wages. If amounts withheld from salary and wages haven’t been remitted to the Australian Taxation Office (ATO) then that would seemingly be conclusive or near conclusive.

But the point of remittance of PAYG credits to the ATO is not the point at which the TAA operates to confer a PAYG credit entitlement to a taxpayer. Sub-section 18-15(1) of Schedule 1 of the TAA allows PAYG credit to a taxpayer where there has been withholding by the party with the withholding obligation, viz. the employer in the case of an employer who pays salary and wages, of the amount withheld. Sub-section 18-15(1) necessitates an enquiry into whether or not the amounts claimed for PAYG credit were “withheld” by the employer whether or not the amounts “withheld” were ever remitted to the Commissioner. In the Federal Court, in its original (non-appellate) jurisdiction, whether amounts have been withheld is a matter of fact to be established to the court on the balance of probabilities.

In another Federal Court decision cited with approval in Price, David Cassaniti v Commissioner of Taxation [2010] FCA 641 at paragraphs 163 to 165 Edmonds J. thus focussed on the actions of the employer. Edmonds J. explained and contrasted the evidential value of an employer’s apparent withholding to a (its own) bank account which, on the one hand, “clearly demonstrates” a withholding and an employer’s apparent withholding by book entry, which may be insufficient to demonstrate withholding by the employer depending on the surrounding circumstances, on the other. It was also relevant in David Cassaniti, as it was in Price, that the employer had been a company enabling Edmonds J to accept the books of account of the company as first instance evidence of what the books of account contained in accordance with section 1305 of the Corporations Act 2001.

Employers were wound up companies

In the Cassaniti line of cases, which also included the Full Federal Court decision in Commissioner of Taxation v Cassaniti [2018] FCAFC 212, relevant company records of the employers were thus sufficient to establish to the Federal Court that amounts had been withheld by the party with the withholding obligation. As in Price, in which the Cassanitis were also involved, the relevant employer companies had been wound up but nevertheless, by virtue of section 1305 of the Corporations Act 2001, the financial records of these companies in the (earlier) Cassaniti cases were sufficient evidence to show that the companies had made the relevant withholdings despite no record of remittance to the ATO. Robert’s case in Price relied on PAYG payment summaries produced from accounting records of the employer companies being accepted as financial records of the companies.

Robert was unsuccessful. The tax returns and PAYG payment summaries were produced from MYOB in September 2016 after the employers were wound up so the court refused to accept the PAYG payment summaries as financial records of the wound up companies. Thus the PAYG payment summaries were not first instance evidence of the PAYG withholdings asserted in them. In paragraph 87 Thawley J. listed findings showing that withholdings were not made for Robert:

  • the absence of any records from the ATO to that effect or supporting inferences of withholding;
  • the absence of any contemporaneous record of any person or entity who paid Robert evidencing withholding;
  • the fact that every year or thereabouts Robert asked for but was not provided any PAYG payment summary;
  • the fact that no superannuation was paid by any of the employer companies for Robert;
  • the fact that Allyma Transport Services did prepare PAYG payment summaries for other employees; and
  • the fact that the bank records suggest a number of different entities paid the weekly amounts into Robert’s account (including NT TPT Pty Ltd, PMG Transport, CJN Transport) and that at least one of those entities (PMG Transport) probably treated the payments to Robert on the basis that he (or a partnership of which he was a partner) was a subcontractor rather than an employee.

The unremitted PAYG no man’s land

Cases such as the Cassaniti cases and Price are relatively rare.  In that context we can observe that it is precarious to be in the position of an employer, or of a director of an employer, obligated to withhold PAYG amounts from employees’ salary and wages where those amounts have not been remitted to the ATO. The employer and, in the case of a company, its directors personally where director penalty notices issue to the directors and trigger personal liability under Division 269 of Schedule 1 of the TAA, are liable to the Commissioner for these amounts. Further failure to remit PAYG withholding on salary and wages is a strict liability offence under Division 16 of Schedule 1 of the TAA.

The pursuit of unremitted salary and wage PAYG withholdings from the Commissioner can potentially be a fraud against the revenue where employers and their directors have overtly arranged their affairs so that they are not exposed to the above liabilities and prosecution for failure to remit. Confinement of salary and wage earner remedy to proceedings under section 39B of the Judiciary Act does operate as a bulwark against that type of fraud.

It is to be hoped that reporting of and liability for PAYG withholding on salary and wages can be reformed and streamlined so that employees can better monitor withholding for them in real time and opportunities for “phoenix” PAYG credit frauds on the revenue can be reduced.

Small business now has its own dedicated taxation division of the AAT

To give effect to a bi-partisan initiative, changes aimed at making it easier, cheaper and quicker for small businesses to appeal to the Administrative Appeals Tribunal (AAT) against decisions by the Australian Taxation Office (ATO) commenced on 1 March 2019. Small business taxpayers contemplating a tax appeal to the AAT with scant legal knowledge or representation will benefit most from the changes. Represented small business taxpayers too can benefit from the easier, cheaper and quicker AAT tax appeals and may improve their prospects of obtaining funding by the ATO of legal representation costs of their appeal.

Under the changes small business taxpayers can appeal adverse tax objection decisions to the new Small Business Taxation Division (SBTD) of the AAT. The Small Business Concierge Service (SBCS) within the office of the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) also commenced on 1 March 2019 to assist small business taxpayers with appeals to the SBTD.

Tax and related review by the AAT

The AAT can review decisions on objections against tax assessments and other specified decisions made by the Australian Taxation Office (ATO) in the ATO domain on appeal under the Taxation Administration Act (C’th) 1953 viz decisions on:

  1. Commonwealth taxes: income tax, goods and services tax, excise, fringe benefits tax, luxury car tax, resource rent taxes (petroleum and minerals) and wine equalisation tax;
  2. Australian Business Numbers, fuel schemes, fuel tax credits, the ATO’s superannuation administration; and
  3. penalties and interest relating to a. and b.

The SBTD can review these decisions where the taxpayer/applicant is a small business entity under section 328-110 of the Income Tax Assessment Act (C’th) 1997.  A small business entity is an entity carrying on business with an aggregated turnover of less than $10 million in the current income year.

Cheaper – fees for AAT review

The ordinary filing fee for review of (appeal against) a reviewable decision by the ATO in the Taxation & Commercial Division of the AAT is $920 as at 1 March 2019. A single fee can apply if there are related multiple decisions in relation to the same appellant. A concessional fee of $91 applies for disadvantaged appellants: https://is.gd/1s5Vtt

The ordinary filing fee for review by the SBTD is a reduced $500. AAT regulations apply so that a SBTD taxpayer/applicant who the AAT finds is not a small business entity must pay an uplift to the ordinary $920 fee and their appeal will transfer to the Taxation & Commercial Division of the AAT.

Easier – Small Business Concierge Service

The SBCS of the ASBFEO assists a small business taxpayer with the SBTD appeal process and with advice about the appeal or prospective appeal to the SBTD the small business taxpayer plans. Although the SBCS is within the office of the ASBFEO and does not itself give legal advice, the SBCS:

  • offers a one hour consultation with an experienced small business tax lawyer to an unrepresented small business taxpayer prior to the appeal so the lawyer can review the facts pertaining to the ATO decision and provide advice on prospects of success of the appeal. In arranging a pre-appeal consultation the taxpayer needs to be aware of the 60 day time limit that generally applies for making appeals to the AAT on these decisions. A co-payment of $100 for the consultation is required from the small business taxpayer and the balance of the small business tax lawyer’s fee for the consultation is paid by ASBFEO;
  • assigns an ASBFEO case manager (not to be confused with the AAT case manager who will manage the appeals for the AAT) to help the small business to compile the relevant documents to maximise the benefit of the one hour pre-appeal legal consultation;
  • assists with the appeal to the SBTD if the small business chooses to go ahead with the appeal. The ASBFEO case manager assists with the applications and submissions to the SBTD and with engagement by the small business taxpayer with the AAT process; and
  • offers a second one hour consultation with an experienced small business tax lawyer to an unrepresented small business taxpayer after the appeal commences with the cost of the second consultation met by the ASBFEO without a co-payment.

Even if an unrepresented small business taxpayer utilises both hours of consultation with the assistance of the ASBFEO case manager it is still cheaper for the small business taxpayer to commence their appeal to the AAT for $600 in the SBTD, including the $100 co-payment, than to commence for $920 in the Taxation & Commercial Division.

Quicker – 28 day turnaround of reasons for decision

Decisions of the SBTD are to be “fast tracked” so that reasons for decisions will be given to the small business taxpayer usually within twenty-eight days of the hearing where the appeal goes that far. Where practicable an oral decision is to be given at the end of SBTD hearings.

Cheaper – further support for legal costs for SBTD appellants

Although the AAT, and the SBTD and the Taxation & Commercial Division in particular:

  • is not a court;
  • does not make cost orders;
  • isn’t bound by the legal rules of evidence; and
  • of itself, imposes no imperative to have legal representation;

the reality is that, where significant tax is in dispute in an appeal to the AAT, most informed appellants are legally represented and present their case in conformity with rules of evidence as if the AAT was a court. The ATO, too, selectively attends the AAT with external legal representation and, if not, ATO officers who conduct cases and appear at the AAT for the ATO are likely to have legal skills and experience. AAT decisions are reported/published and are used as legal precedent. Appellants can, though, more readily request and obtain anonymity from the AAT in tax cases than they can in courts which operate on the principle that justice is to be done in public.

The SBTD initiative partly synchronises the legal representation choice of a small business taxpayer and the ATO in a SBTD case. The ATO has transparent policy positions on when the ATO will use external legal representation in the AAT. The ATO’s position generally is that the ATO will use external legal representation where the case has high legal or factual complexity or where the case has implications for other taxpayers. Where the ATO is to engage legal representation in the SBTD then the ATO:

  • must inform the appellant that it proposes to engage external legal representation; and;
  • may meet the legal costs of the legal representation of the small business appellant that do not exceed the ATO’s legal costs of its own external legal representation. That is a possibly contentious integer as the ATO has and uses its leverage, which a small business doesn’t have, to negotiate lower fees from legal counsel with expectation of more ATO briefs.

Cheaper – greater opportunity for ATO litigation funding

This opportunity for a small business taxpayer to obtain the assistance of the ATO with their costs of legal representation in the SBTD dovetails with the test case funding policy of the ATO. Like under that policy the decision to assist a small business taxpayer with its legal costs of a SBTD appeal is with the ATO. Where the case has implications for other taxpayers then it is more likely that the ATO will both seek its own external representation and will fund the small business taxpayer’s legal costs up to the same level. Although time will tell, a small business taxpayer appears to be in an enhanced position to obtain ATO assistance with their legal representation costs in the SBTD as compared to taxpayers generally who appeal to the Taxation & Commercial Division of the AAT or who appeal directly to the Federal Court which involves significantly greater costs.

Unlike the Federal Court, the AAT does not order costs. That means that the legal fees and costs of a small business taxpayer running an appeal in the SBTD will only come from the ATO SBDT case funding or ATO test case funding, if not self funded, as legal costs won’t be awarded by the AAT even where the small business taxpayer is successful in a tax appeal case.

ASBFEO already acts as a gateway and assists small businesses to access funding for small business disputes. It is understood that the SBCS will be similarly resourced to act as a gateway to assist small businesses to obtain legal representation funding under both SBTD or ATO test case funding guidelines.

$3,000 deduction cap for managing personal tax affairs – non-millionaires caught in the cross-fire?

Labor’s Fairer Tax System plan

The ALP’s Andrew Leigh and Chris Bowen announced their A Fairer Tax System for Millions, Not Millionaires plan on 13 May 2017. The plan is comprised of a number of laudable and progressive policy announcements including transparency improvements that will impede tax avoidance by wealthy taxpayers and multinationals.

These policies are:

  1. $3,000 cap on deductions for managing their tax affairs for individuals.
  2. Public reporting of country-by-country reports.
  3. Whistleblower protection and rewards.
  4. Mandatory shareholder reporting of tax haven exposure.
  5. Public reporting of Australian Transaction Reports and Analysis Centre (AUSTRAC) data.
  6. Government tenderers must disclose their country of tax domicile.
  7. Develop guidelines for tax haven investment by superannuation funds.
  8. Publicly accessible registry of the beneficial ownership of Australian listed companies.
  9. Australian Taxation Office disclosure of settlements and reporting of aggressive tax minimisation.

The first measure, which this blog post concerns, is a proposed cap of $3,000 on the income tax deduction for managing personal tax affairs. There is no doubt this cap will restrict tax deductibility, which is substantially the funding by other taxpayers, of wealthy taxpayers’ tax professional costs of devising ways to avoid paying Australian tax.

Why an arbitrary $3,000 cap?

Still the $3,000 cap is arbitrary and there is, somehow, a disconnect in the announcement between the proposed cap and the millionaires against whom it is targeted. Why is the cap $3,000 rather than $30,000? My point is that it is not so unusual for ordinary taxpayers, particularly property owners who are not millionaires at whom the Fairer Tax System proposals are directed, to rack up tax professional costs of more than $3,000 for managing their tax affairs in an income year. The $3,000 cap includes tax agent costs for annual tax return preparation and lodgment so the remaining cap to deal with remaining tax difficulties or obligations will be something less than $3,000. So, although the measure will achieve its aim to curb deductibility of these costs to millionaires, there will be taxpayers who are not millionaires who will be collaterally caught with non-deductible tax professional costs in excess of the cap.

It is not so clear that the cap has been designed by someone who has real experience of seriously high individual tax professional costs and of situations where they may happen. Sure, all being well, a salary earner who owns real estate and who engages a tax agent, who charges moderately, will have tax professional costs in an income year comfortably under the cap. However, the salary earner with tax difficulties out of the ordinary may find himself or herself with a need to take a considered custom professional tax advice or to have his or her tax advisor non-prejudicially apply for a binding private ruling to protect himself or herself under the self assessment system.

The self assessment system

Out of the ordinary doesn’t mean tax avoidance is going on. Under the self assessment system a taxpayer is responsible for correct reporting and filing of tax information and severe penalties and interest apply if the taxpayer makes an error and a tax shortfall is assessed. If the taxpayer has an activity or activities where the tax treatment is unclear then it is the taxpayer who must ensure his or her return or other statements to the Australian Taxation Office (ATO) complies with tax law adopting, in the least, a reasonably arguable position on items in the return or statements that are contentious.

Something over $2,000 is not a big budget for obtaining a tax advice letter or a position paper or for professional preparation of an application for a private binding ruling or a complex objection. Often issues an individual can face can take a tax professional a couple of days or more to do thoroughly.

It can be costly just to understand obligations imposed by government

Not so long ago I was briefed to give tax advice to an owner of a heritage building about to enter into a sale of “transferable floor space” in compliance with local government heritage laws. The interaction of the relevant capital gains tax (CGT) and goods and service tax (GST) laws with property, environment and local government laws, cases and public rulings took considerable time to work through even in the absence of any live dispute about these matters with the ATO. $2,000 would have been a fraction of fees for the time needed to give advice so that the client understood the client’s CGT and GST obligations on the sale . The correct application of CGT events and tax rules that apply in this client’s situation are notably unclear and difficult and, in its rulings, the ATO takes positions which some may view as confused and ambiguous. A withering array of laws applied to this heritage building owner.

Each of these laws, considered separately, benefit or aim to benefit government, society and thus other taxpayers by the contribution of taxes, the stimulation of commerce and the preservation of heritage buildings. But is it fair for society to impose such a multitude of obligations on a not necessarily wealthy building owner yet severely reduce society’s contribution to the owner’s costs of compliance with them?

You see much of my work, and the work of many other tax advisors who act for clients who are not necessarily wealthy, is just to advise or explain how the tax law applies to them and what their position is. Generally, as the tax laws have been tweaked and greatly expanded over time, the tax laws do not present exploitative opportunities to ordinary taxpayers for avoidance. There are, of course, exceptions.

The CGT provisions are a good example of tax laws that are necessarily intricate and complex. $2,000 in professional advice costs just to understand a CGT position in an advice from a CGT expert won’t go far. The CGT rules can apply, and severely, to taxpayers who own property, securities and other valuables. If the owner dies or is a non-resident the complexity can ratchet up. Not all of the aforementioned are millionaires.

It can be costly to get a ruling or guidance from the Australian Taxation Office

It is frequently the case that an ordinary taxpayer is unable to articulate, or would be disadvantaged having to personally articulate, a technical capital gains tax problem to the ATO without professional assistance in order to obtain guidance or a binding private ruling from the ATO. So an ordinary taxpayer can be justified in seeking substantial tax professional help applying for a private binding ruling from the ATO. If a binding private ruling adverse to the taxpayer is issued by the ATO the taxpayer may seek to dispute the ruling and still further tax professional help is needed. The taxpayer’s professional tax advisor may need to attend the ATO or prepare an objection or appeal.

The intractability of many tax problems, notably capital gains tax problems, is usually not the fault of the taxpayer but is a feature of complex tax law seeking to impose tax obligations in a wide diversity of situations fairly on the tax paying community.

Costly tax problems not of concern to wealthy taxpayers

A taxpayer of modest means suffers an injury at work and receives an ongoing insurance payout. This taxpayer is the opposite of a millionaire. Still the taxation of the insurance payout gives rise to the income versus capital conundrum on which the Australian income tax system continues to rely. The payouts fall through the cracks of types of insurance payout that are afforded tax exempt status under the Income Assessment Acts 1936 and 1997. If the payouts are capital then capital gains on personal injury payouts are exempt from CGT so there is a lot of tax at stake if the payouts should be treated as capital rather than as assessable income.

Pursuing capital treatment of the payouts is not tax avoidance by the wealthy. Inevitably ruling, objection and appeal costs of disputing that the payouts are not assessable income are likely to be way in excess of $3,000.

These kinds of cases appear often enough in published Administrative Appeals Tribunal reports, and there are plenty below the visible tip of that iceberg to show that they still remain a frequent and expensive kind of tax dispute for injury victims. To deprive injury victims of tax deductibility for costs of their tax dispute to target other less deserving taxpayers is tough indeed on taxpayers affected. It is of no consolation to an ordinary taxpayer who can’t claim most of their seriously high tax professional costs that he or she is one of a number of less than 90,000 taxpayers who incur more than $3,000 in tax professional costs each income year.

Australia’s tax system abounds in these kinds of structural challenges. Whether or not an activity of a taxpayer amounts to “an adventure in the nature of trade” and consequently an enterprise carried on by a taxpayer attracting a GST obligation, is another good example of a tax uncertainty a taxpayer who is not a millionaire may find costly to solve in their case and may not solve without taking valuable professional assistance.

The cap binary and alternatives to better target the cap

So if $3,000 might not be enough of a cap to ensure fair operation of the cap, why impose a binary limitation with such a confidence in the announcement that its impact will be on millionaires?

The small business capital gains tax measures themselves show that the demarcation between “small” and bigger business is not necessarily easily achieved as shown by the unwieldy $6 million net asset test. A demarcation between ordinary and “millionaire” taxpayers to qualify for exemption under the cap may be similarly difficult. But might it be possible to devise a targeted cap which looks at the character of the professional tax costs of a taxpayer of managing their personal tax affairs so that the cap operates more equitably?

For instance could costs of professional tax work just directed at establishing the position of a taxpayer under certain tax laws on non-contrived circumstances be exempted from the cap? Most capital gains tax rules could be within that exemption. If the professional work addressed specific anti-avoidance measures, the general anti-avoidance provisions or exploitative tax planning the professional work could be “tainted” by that consideration and so fall outside of the exemption. One difficulty is that some sort of “chinese wall” solution may be needed so privileged thus confidential tax advice could be considered to verify whether the costs of the professional tax law assistance is exempt from a targeted cap on costs of managing tax affairs.

It may be possible to conveniently go through all of the (many) tax laws and classify those where issues and disputes arising from them are benign, in an avoidance context, as exempt from the cap. Often wealthy taxpayers and their advisers have little interaction with these laws and so exempting them would not give wealthy taxpayers any advantage. That would better achieve the aim of the Fairer Tax System plan.