Can I have the real estate in my SMSF?

Real estate can be provided in kind to a member as a superannuation benefit. Prohibitions can apply to acquisitions of real estate from members but this prohibition does not apply going the other way. That is: from a fund to a member on a payment out of the fund as a superannuation benefit.

Still a condition of release needs to be met before a superannuation benefit is provided by a SMSF. Let us say that the fund is in pension mode and the member is over the age of sixty-five so a condition of release is met for a benefit to come from the member’s superannuation balance in the fund to the member.

Difficulties providing a real estate benefit from a SMSF in an income stream

A SMSF in pension mode must face these difficulties before releasing a benefit in the form of real estate:

the Australian Taxation Office (ATO), if not the superannuation laws unequivocally, require that a pension (a superannuation income stream) benefit must be paid in money and not in kind;
the benefit can take the SMSF out of pension mode, where the income of the SMSF is tax exempt on its earnings; and in to accumulation mode, where the fund is taxable at 15% on its earnings; depending on how the commutation of pension is done. This could inadvertently cause the capital gain, the SMSF makes on the disposal of the real estate as a benefit, to be taxable to the SMSF; and
the SMSF may not have paid a minimum annual pension payment for the year as required by the superannuation income stream regulations.

Partial commutation solution

A partial commutation of a pension is a work around for these difficulties. A partial commutation of a pension is a commutation of less than the member’s pension balance in the fund as a lump sum. That is the member needs to have remaining member pension balance after the commutation. The ATO has indicated that a partial commutation:

being a lump sum benefit, as opposed to a pension benefit, can be paid in kind. In other words, by payment of the property of the superannuation fund;
does not lead to a cessation of the pension and so the SMSF can remain in pension mode and exempt from tax on its earnings including on capital gains; and
can count towards meeting the minimum annual pension payment for the year: Self Managed Superannuation Funds Determination SMSFD 2013/2 but only up to 1 July 2017. The member will thus need to have a sufficient remaining pension balance in the fund to meet the minimum pension benefit from that date.

Doing it

There are a number of traps to implementing this solution:

The governing rules of the SMSF must allow for partial commutations of pensions, the trustee must have a power under the governing rules to pay benefits in kind and the pension arrangements or agreement with the member must reflect this.
The member needs to trigger the partial commutation and the benefit in kind in accordance with the pension arrangements or agreement.
The trustee of the SMSF must value the real estate to ascertain the amount of the lump sum benefit being paid to debit to the member’s account.
The member getting the real estate benefit must have a sufficient member account balance remaining after the debit to treat the satisfaction of the benefit in kind as a partial commutation of the pension.
The fund and conveyancing documentation needs to be prepared on an arms length basis as required under superannuation law.

Although there is no capital gains tax if the fund remains exempt from tax in pension mode, other taxes and duties on a transfer of real estate can still apply.

For instance:

GST can apply to the transfer of commercial premises or new residential premises from a SMSF where the fund is registered or is required to be registered for GST.
Stamp duty liabilities vary significantly from state to state. Victoria has concessions on the transfer of dutiable property to a beneficiary of a trust. In New South Wales there is generally no relief from full ad valorem duty. A concession which applies in New South Wales on the transfer of dutiable property to a superannuation fund as a contribution does not apply to a transfer out the other way as a benefit.

Thus, to recap our disclaimer, partial commutation of a pension to provide real estate from a SMSF should be considered case by case and specific advice should be taken in relation to the above general comments.

Managing the GIC in settling an income tax dispute – Caratti

A general interest charge (GIC), which accrues and compounds daily, applies to compensate the revenue for the time value of unpaid tax debts. That is where a taxpayer has the use and enjoyment of money which should have been paid in tax for a period of time.

Opportunity to dispute GIC

The GIC is imposed on and follows a tax debt and, for a taxpayer, it is difficult to establish a basis in the objection and appeal process upon which the GIC applicable to a tax debt should be dealt with separately and reduced and remitted.

Resolution of a tax dispute by agreement with the Australian Taxation Office is one opportunity where the GIC can be revisited and reduced so long as the Australian Taxation Office is agreeable. By the time this point is reached significant GIC can have accrued if the taxpayer has not opted to provisionally pay a tax debt that is contention.

Dealing with GIC in an agreement with the ATO

So it was, in the Federal Court in Caratti v Commissioner of Taxation [2017] FCA 70, where $1,145,639.03 had accrued since 7 August 2015 on a tax debt of $10,948,507.45 which included GIC up to 10 February 2017.

On 23 September 2015 the taxpayer had entered into a deed of agreement with the Commissioner of Taxation under which the Commissioner refrained to recover the “Taxation Debt” defined in the deed as:

the amount of $10,948,507.45, which is comprised of Tax-Related Liability and applicable GIC due and payable by the Taxpayer as at 7 August 2015, subject to any adjustment to those amounts by virtue of the Determination of the Objection Process

However the deed also stated that:

The Taxation Debt will continue to accrue GIC daily from the due date for payment in accordance with and at the rate as may be applied from time to time under the TAA 1953.

So the taxpayer could assert that the “Taxation Debt” was a variable and, further, that that interpretation is sensible as the GIC that accrued after 7 August 2015 related to the same underlying debt or “Tax-Related Liability” which the deed made irrecoverable. Although the deed stated that the “Taxation Debt” will continue to accrue GIC the taxpayer asserted that, as the GIC was a part of the “Taxation Debt”, the deed also made that accrual irrecoverable. The Commissioner contended that the Taxation Debt was $10,948,507.45, as the Taxation Debt was expressly stated to be, and that this figure was the irrecoverable total or ceiling and not just a snapshot in time of the figure.

There were other provisions and context in the deed which supported the position of the Commissioner hence Robertson J. found for the Commissioner in the Federal Court.

Equivocal term in the deed gave the ATO a GIC recovery problem

Moving liabilities like the GIC cause difficulties. $1,145,639.03 was put at stake due to the inadvertent and equivocal use of Taxation Debt (capitalised as a defined term) in the formulation of the term in the deed dealing with the further accrual of GIC. A Federal Court challenge to the ATO might have been avoided by the Commissioner if it had been clear in the deed that the amount of the Taxation Debt (as at 7 August 2015) would continue to accrue GIC as a taxation debt which, in turn, was not part of the Taxation Debt made unrecoverable by the deed.

Sluggish anti-money laundering reform in Australia

Australia has resiliently protected its revenue base. Under Australian law and administration it is risky for Australian tax residents to have involvements in tax havens. Australia is a firm committer to a comprehensive series of double tax agreements and is rarely thought of as a tax haven.

Financial Secrecy Index ranking

In its Financial Secrecy Index (2015), the Tax Justice Network noted that “Australia accounts for less than 1 per cent of the global market for offshore financial services, making it a tiny player compared with other secrecy jurisdictions…. Australia has taken significant steps to address tax evasion and tax avoidance, especially as it relates to revenue loss from Australia. However, its record of helping other countries combat tax evasion and money laundering is somewhat mixed.” Australia was given a 44 rating in this study, which is better than Switzerland (1), USA (3), Great Britain (15) and the Netherlands (41). Still, this middling rating does reflect sluggish progress by Australia with anti-money laundering measures.

Extent of scrutiny of money flows

In 2006, the Anti-Money Laundering and Counter-Terrorism Financing Act and Rules were introduced empowering AUSTRAC to track money flows through providers of banking, remittance and gambling services. In 2007 the Australian Government announced measures to extend the regime to non-financial businesses and professions including the legal, accounting and real estate professions. Now it is 2017 and the extended measures are yet to be implemented. Various lobbies and sectional interests have successfully pressed successive governments to delay and reconsider the extended measures.

Is that scrutiny enough?

Although the 2006 measures appear to be functioning successfully there is growing concern that a vast amount of illicit foreign money, particularly from China, has eluded AUSTRAC scrutiny and has found its way into the very buoyant Australian real estate market.

According to the Financial Action Task Force and the Asia/Pacific Group Mutual Evaluation Report of April 2015 Australia has strong legal, law enforcement and operational measures for combating money laundering and terrorism financing, but the report says important improvements are needed in a number of key areas and an underlying concern remains that Australian authorities are overly focussed on predicate crime rather than on money laundering risks.

Australia could achieve an improved Financial Secrecy ranking by commencement of the extended money laundering measures.

Preparing to change land ownership from a company to a trust

A company controlled by X owns land. X would prefer it if the land was held by a trust or in an individual name such as X or Y, X’s spouse.

Significant capital gains tax (“CGT”) on the transfer of the land is not expected by X and Y. Is a transfer of the land to a trust or to X or Y or both worthwhile? Here are some tax implications X may want to think about:

Capital gains tax

If the land has increased in value X will want to consider CGT more closely:

If the land is not an active asset, or if the small business CGT concessions or the new small business restructure roll-over, can’t apply for some other reason, the value of the land, when disposed of, will be taken into account in determining CGT. i.e. the market value substitution rule will apply in the event of an undervalue transfer of the land. An undervalue transfer of the land is rarely likely to be effective under tax rules.

The small business CGT concessions and the new small business restructure roll-over don’t apply if the asset is not an active asset. The land won’t be an active asset if it is mainly used by the company, and related parties of the company, to earn rent. As the land is held in a company, the 50% CGT discount is not available to the company on the transfer of the land.

Problems with a gift or an undervalue transfer

If full value is not payable to the company for the land then, without more, a transfer of the land could be treated as a dividend taxable in full to the transferee as a shareholder of the company, as a deemed dividend taxable to the transferee as an associate of the shareholders of the company, or may possibly be taxable to the company as a fringe benefit. Further if the company has taken the approach of gift there may be difficulties establishing that the company was legally entitled to give the land away to the transferee if that is what is done. Indications of a gift might give a creditor of the company additional rights to pursue the transferee for the value of the land that belonged to the company especially if the stance of the company is that the transfer was not any sort of dividend or remuneration to X or Y.

A sale of the land by the company for full value is more defensible. The sale can be on terms rather than for cash payable on settlement. If the transferee doesn’t follow through, and pay the value in cash or on the agreed terms, then the sale for value can be treated as a sham and the consequences of undervalue transfer can then follow.

So defensible transfers of the land include:

sales at full value on (genuine) terms; and
distribution of the value of the land to the shareholders of the company (not in the form of cash) on the voluntary liquidation of the company.

CGT event A1 – but watch out for CGT event E2 if a transfer to a trust

Usually CGT event A1 is attracted when land is transferred from one beneficial owner to another. CGT event A1 is taken to occur at the time of (in the income year of) the disposal, that is, the time of the transfer unless the transfer is made under a contract. If the transfer occurs under a contract and CGT event A1 applies, CGT event A1 is taken to occur at the time of making of the contract.

This can be significant where a contract and settlement straddle the end of an income year, with the time of the contract bringing forward the capital gain into the earlier income year if CGT event A1 applies. If the transferee is a related trust of the vendor then CGT event E2 can apply rather than CGT event A1. CGT event E2 though, unlike CGT event A1, does not bring forward the time of the CGT event to the time of the contract so, if CGT event E2 applies, the capital gain will be made in the later income year.

Stamp duty on a transfer

Stamp duty varies from state to state but generally applies to acquisitions of land based on the market value of the land, not the price to the transferee/purchaser. Very generally speaking it is usually charged at around 5% of the land value. The states offer limited stamp duty relief when acquisitions occur without a change in ultimate beneficial or economic ownership of the land. For instance, in New South Wales and Victoria relief exists in the form of corporate reconstruction concessions. These concessions are generally not available where the acquisition is by a trust or an individual. Thus stamp duty would need to be budgeted for by X as a further cost of transferring the land.

Goods and services tax

If the company is registered or ought to be registered for the goods and service tax and the land in used in an enterprise carried on by the company then the company may be obliged to charge 10% GST to the transferee on the transfer (taxable supply) of the land. If the transferee is also registered for GST, and will use the land in the transferee’s enterprise, then the transferee can obtain an input tax credit/refund of the GST charged to the transferee. The company and the transferee, if registered for GST, may also:

be able to claim the GST going concern exemption if they take the necessary steps for the exemption; or
be members of a GST group;

which would relieve the company of the obligation to charge GST to the transferee.

Why setting up offshore companies for Australians is a tricky business

Suppliers of offshore companies often supply companies to international clients with the promise that the company will give rise to no or little income tax. What they might really mean is the tax that applies in the offshore place of incorporation or the offshore place of operation of the company. The promise may not be informative about income tax implications in the place of tax residence of the client of taking on the offshore company.

It is useful for Australians looking to acquire an offshore company, and for offshore company suppliers who may supply an offshore company to them, to know about how offshore companies may be treated for Australian income tax purposes. And the involvement of the offshore company supplier in the company may be significant to what that treatment may be.

When offshore companies are controlled foreign corporations

Australia has had a controlled foreign corporations (“CFCs”) regime since 1990 which applies to treat an offshore company controlled by Australian tax residents (“AUTRs”) as a CFC. Like with other CFC regimes, the CFC itself is not, by virtue of being a CFC, treated as a tax resident of Australia generally subject to Australian income tax on its worldwide income; nonetheless the regime functions by attributing offshore income of the CFC to its AUTR controllers. So, although tax may be low on the company in the country of operation of the company, the AUTR faces Australian income tax on the income of the CFC even where the income of the CFC remains unrepatriated from the CFC.

The CFC regime has an active income exemption which applies to exclude income earned by a CFC carrying on an active business in an offshore place from attribution to AUTRs. Where the active income exemption can apply to the CFC an offshore company supplier may be better placed to make good on their promise of low income tax to an Australian client.

Another way of making good on the promise, but a way which is not, in any way, legal under Australian laws, including under the associate-inclusive control tests in the CFC rules, is to hide the Australian control of the offshore company from Australian authorities and from others whom it may concern. Offshore company suppliers have been known to do this by providing local-based company directors and nominee shareholders who follow the directions of the client through opaque protocols, which can be in various forms, to give the client the necessary control and assurance that the client’s directions concerning the offshore company will be followed.

Offshore company is an Australian tax resident after all?

A offshore company under covert directions of AUTRs not only faces the risk that its income will be attributed as attributable income taxable in Australia under the CFC regime but also faces possible treatment as an Australian tax resident, itself. In that eventuality Australian tax authorities won’t need to rely on the CFC regime to tax the income of the offshore company in Australia.

When a company will be treated as an Australian tax resident

Under the Australian Income Tax Assessment Act 1936 a company is resident in Australia if:

it is incorporated in Australia or, if not incorporated in Australia, if it carries on business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are residents of Australia

(definition of “resident” or “resident of Australia” in sub-section 6(1))

This is similar to the formulation of tax residence of companies that applies in most OECD countries.

The highest court in Australia, including on tax matters, is the High Court of Australia. In the 1973 case of Esquire Nominees Ltd. v. Federal Commissioner of Taxation, Gibbs J., who lead the High Court in this case, observed that:

“the real business [of a company] is carried on where the central management and control actually abides”; and
“the question where a company is resident is one of fact and degree”.

In Esquire Nominees, the High Court was able to find that a Norfolk Island company was not centrally managed and controlled from Australia despite evidence that Australian-based accountants:

formulated a tax avoidance scheme involving the company acting as the trustee of a number of trusts; and
communicated every aspect of the scheme of the trusts to the directors of the corporate trustee in Norfolk Island including how the scheme was to be carried out.

Gibbs J. was satisfied that the directors of the corporate trustee in Norfolk Island had sufficient independent power in their role, beyond the control of the Australian-based accountants, to support a finding that the central management and control of the company was on Norfolk Island. This was despite what appeared to be the whole reliance of the directors on the communications from the Australian-based accountants. The board of directors of the company did not to have to comply with directions from the Australian-based accountants. Gibbs J. found that the (board of) directors were making the decisions of the company, albeit in line with the strong influence of the Australian-based accountants, and that they met to do so on Norfolk Island.

Bywater Investments Limited v Commissioner of Taxation, Hua Wang Bank Berhad v Commissioner of Taxation

A November 2016 decision of the High Court has shown that:

relevant matters to be taken into account in ascertaining the central management and control of a company include, but are not limited to:
- the location of the company’s registered office;
- the residency of the company’s directors;
- the residency of the company’s shareholders;
- where the company’s meetings, including its directors’ meetings, are held; and
- where the books of the company are kept;
the place where the board of directors meets, in particular, is not sufficient, by itself, to show where the central management and control of a company, and thus the Australian tax resident status of a company is; and
despite the outcome in Esquire Nominees, Australian courts will not always accept, just because a company has a properly appointed and functioning offshore-based board of directors, that the independence or autonomy of those directors can be inferred.

In Bywater Investments Limited v Commissioner of Taxation Hua Wang Bank Berhad v. Commissioner of Taxation [2016] HCA 45 a Sydney accountant (“G”) had complete legal and actual control of Swiss-based and Samoan-based companies despite the considerable lengths taken by G:

to conceal the fact of G’s control of the companies; and
to project apparent control of these companies by boards of directors in Switzerland and Samoa arranged by Swiss-based and Samoan-based offshore company and corporate services providers.

Companies involved were incorporated in the Cayman Islands and in the Bahamas. Only through the course of the Australian investigation and litigation did it become clear that various legal means, including:

in the case of Hua Wang Bank Berhad, the device of an unredeemed secured bearer debenture which operated to suspend the rights of the offshore shareholders of the company to vote or demand a poll; and
in the case of “JA Investments”, another significant company in the structure, appointment of G as “Appointor” with the power to appoint additional members of this company who in turn could remove directors;

had been devised to give G control of the companies.

The abrogation exception

The High Court in Bywater Investments Hua Wang Bank Berhad found that, although the central management and control of a company will ordinarily be where meetings of its board are conducted; a long line of authorities, including Esquire Nominees and the UK House of Lords decision in Unit Construction Co Ltd v Bullock [1960] AC 351, identify a significant exception where a board of directors abrogates its decision-making power in favour of an outsider, and the board operates as a puppet or cypher, effectively doing no more than noting and implementing decisions made by the outsider as if they were, in truth, decisions of the board.

In Bywater Investments Hua Wang Bank Berhad it was found that G was such an outsider in control of companies that made the decisions of each company. These decisions were implemented as decisions of the boards of the Samoan-based and Swiss-based companies and the central management and control of these companies, was with G, the outsider, who was thus carrying on the business of each company in Australia.

Place of effective management of offshore companies

In the case of the Swiss-based companies, where a consideration of the place of effective management was also relevant under the applicable double tax treaty between Switzerland and Australia , the finding viz. that that place of effective management was Australia, was no different. The consequence was that the Swiss-based companies were not entitled to protection from Australian taxation under the double tax treaty.

Demonstrating board autonomy of an offshore company

The company in Esquire Nominees was able to show that it was in the ordinary case, albeit by an indistinct or possibly by a fine margin, in contrast to the boards of directors of the companies in Bywater Investments Hua Wang Bank Berhad which failed to show that they were not puppets or cyphers of its AUTR controller.

The evidence in Bywater Investments Limited Hua Wang Bank Berhad was in stark contrast to the evidence in Esquire Nominees from which the court accepted the contention that the board of the Norfolk Island company had maintained a sufficient autonomy over decision-making by the company. In Bywater Investments Hua Wang Bank Berhad the evidence of the companies unravelled as it was found that:

the documents and evidence produced by directors of the companies where untruthful and falsely contrived to corroborate testimony that the offshore directors operated autonomously;
the offshore directors were a “fake”;
the offshore ownership structure of the companies was a “ruse”; and
the means used by G to conceal that he was the true owner of one of the companies suggested dishonesty. Every decision of consequence for that company was made by G.

It follows that AUTR clients of offshore company suppliers may be challenged to sustain that an offshore company has central management and control in an offshore jurisdiction where the offshore directors are nominees, arranged by offshore company service providers potentially identifiable as “puppets and cyphers” and not directors with real understanding of the affairs of the offshore company who are genuinely involved in the decision-making of the offshore company.

Conclusion

Following Bywater Investments Hua Wang Bank Berhad Australian clients of offshore company suppliers may have reason for concern that an offshore company they procure from an offshore company provider may be an Australian tax resident. Those concerns arise in the absence of real business activity by the company in the offshore place or real autonomy, in relation to the affairs of the company, given to the offshore directors in the offshore place which is evident from a holistic evaluation of the constituent legal documents of the company on which control of the company comes to rely.

Although the appearance of offshore decision-making by the company may initially show that the central management and control of the company is outside of Australia, that conclusion may not withstand a persistent scrutiny should the company be investigated, or more, and forced to produce its constituent legal documents to defend its offshore tax resident status. The outcome may be that the company is dealt with as an Australian tax resident without reliance on the CFC provisions to attribute and tax income of the offshore company to its AUTR controllers.

Are there limits to interest deductions in Australia in participative loan arrangements involving entities in the same economic group?

Question on taxlinked.net members forum about Participative Loan Taxation

Since 1st January 2015 in Spain, interests are (interest is) not tax deductible when the participative loan is agreed to between entities of the same economic group. Is there similar treatment in your countries?

Response to post

Generally not in Australia.

In Australia interest is deductible if incurred on debt finance obtained to earn assessable income or to carry on a business even if debt finance arrangements include entities not dealing with each other at arms length.

These deductibility tests are serious purposive tests so non-arms length transactions attract particular scrutiny and, like in most jurisdictions, the burden of making out either purpose is on the taxpayer. As well as the general construct of sham there are a numerous specific instances where the Australian law denies interest deductions including:

sometimes where deductions are prepaid;
where there is not a sufficient relation between the loan and income received after a “commonsense” or “practical” weighing of the circumstances; and
where deductions are artificial or contrived or have those elements– if specific anti-avoidance rules do not apply.

Australia has a longstanding general anti-avoidance provision that can apply even if the interest deduction was otherwise available under the law. In international outbound financing the deduction can be lost because foreign income can be treated as other than assessable income. International debt/hybrid mismatch rules are being developed in Australia following some taxpayer success resisting anti-avoidance rules and the international experience.

Deductions are also lost if a “loan” is technically found to have characteristics of equity in substance.

Australian courts look at the role of associated entities to understand their purpose and look at transactions holistically. In other words they will focus on the economic units, rather than on juristic entities which seems to happening in Spain from what you say. Hence an interest deduction to an entity can be reduced, for instance, if the debt finance is on-lent to a related entity to earn income palpably less than the deduction.

Australia also has thin capitalisation rules which apply to limit otherwise allowable large cross border interest deductions.

Chevron Australia is involved in the first major transfer pricing case under the new BEPS regime where the Commissioner of Taxation is fighting to contend that interest paid and deducted exceeded the arms length amount based on BEPS arms length principles. The Commissioner won the first stage of the case in 2015.

Is a transfer to a SMSF by a related holding trust, after repayment of a LRBA to purchase residential property, prohibited by s66 of SISA?

Is a transfer to a SMSF by the trustee of a holding trust, who happens to be a related party of the SMSF, after repayment of the borrowing under a limited recourse borrowing arrangement – LRBA, to purchase residential property, prohibited by section 66 of the Superannuation Industry (Supervision) Act 1993 (“SISA”)?

Section 66 of the SISA prohibits a SMSF from acquiring residential property, which is not business real property, from a related party of the fund.

Returning an asset that is already in the SMSF

A similar question arises when a SMSF receives a return of an asset of the fund from a custodian or an investment manager, which incidentally happens to be a related party, which is similarly not covered by any exemption in section 66. Technically the SMSF has acquired the asset from a related party; the legislation could be clearer providing exceptions in section 66 for these cases especially as the scope of acquisition prohibited by section 66 is expressed in very wide terms: see paragraphs 88 to 109 of SMSFR 2010/1.

But an acquisition, being the return or resumption of the asset, not for consideration (value) from a related party, does not really explain the actual transaction happening. In these cases, the SMSF is acquiring or resuming title or legal ownership of an asset it already owns beneficially. So, in the case of a LRBA of residential premises, section 66 would be concerned with who the residential property was originally acquired from, not with the” acquisition” of the asset from the related holding trust once the borrowing is paid out.

As with a custodian or investment manager, the power of the related bare trustee of a holding trust to hold the asset, and the power to transfer the asset back to the trustee of the SMSF, is stated or is implicit in the SISA itself – see sections 67A and 123. As a matter of statutory interpretation those powers should prevail over the prohibition in sub-section 66(1): generalia specialibus non derogant Nevertheless a clearer description of the scope of the acquiring prohibited, and of exceptions, would be preferable to relying on that maxim though SMSFR 2010/1 issued by the Commissioner of Taxation does helpfully state at paragraph 113:

It is therefore necessary to take a holistic approach to the transaction to determine objectively what it is that the trustee or investment manager is actually acquiring. If, for example, something is being purchased by a trustee or investment manager, a relevant question is what is the trustee or investment manager paying money to acquire. While many transactions involve rights, an acquisition is of rights only if the substance of the transaction is rights.

What is the whole LRBA really about?

From a holistic viewpoint the SMSF, which already holds beneficial ownership of the residential property, is, in substance, concluding the acquisition from the original vendor by taking legal title to the residential property by the transfer from the holding trust. It follows that the acquisition of legal title from the related holding trustee is the exercise of a right to acquire legal title which is not the “substance of the transaction”.

The Australian Taxation Office may not necessarily take the same view.

Australia is now tracking & surcharging foreign buyers of land

Turning missing demographics into tax revenue

Hats off to Australian governments who have turned an imperative into a revenue opportunity. The Australian federal government regulator, the Foreign Investment Review Board (the FIRB), has not been well placed to track foreign purchases of real estate to date. The FIRB has been reliant on disclosure, and if prospective foreign buyers didn’t voluntarily disclose their planned land acquisitions, the FIRB has been none the wiser. There has been no register of (foreign) beneficial ownership of buyer entities which the FIRB can go and check even in the case of foreign real estate acquisitions completely prohibited under the foreign acquisitions law: the Foreign Acquisitions and Takeovers Act (C’th) 1975.

That has all changed. Buyers now need to demonstrate that they are not foreign to avoid hiked stamp duty in New South Wales, Victoria and Queensland. Foreigners who buy and sell Australian real estate are now under great scrutiny at both the buyer and seller ends of the land sale especially if the sale is for more than $750,000.

Big city real estate markets are buoyant, prices are high and foreign buyers are not exactly welcome by those looking to buy the same city real estate. The community has been surprised to learn that foreign purchases of Australian land have not been closely monitored. So, politically, it has been an opportune time to introduce these changes. Time will tell if they will be successful. They may well be. They will be a boon to the FIRB, but Australian buyers too will get caught up in the ramp up of imposts on foreign buyers. Why?

Buyers of Australian land

This is the bit for the FIRB. The New South Wales, Victorian and Queensland governments have just introduced hefty stamp duty and land tax surcharges on foreigners. From 21 June, 2016 a sworn Purchaser Declaration (“PD”) is now required from buyers, whether foreign or not, buying real estate in New South Wales. The PD is required along with stamp duty at the band the PD establishes that the buyer should pay to complete the conveyancing of a land sale. If the buyer of land in New South Wales is a foreign person (entity):

a 8% SURCHARGE (for the 2018 tax year, it was 4% for the 2017 tax year) on the stamp duty (i.e. extra) applies (it’s a 7% surcharge in Victoria);
the buyer is not entitled to the 12 month deferral for the payment of stamp duty for off-the-plan purchases of residential property; and
the buyer faces 2% SURCHARGE (for the 2018 tax year, it was 0.75% for the 2017 tax year) on land tax (i.e. extra).

It’s plain on the PD that the information is going to the ATO – it asks for the FIRB application number for the purchase. This will let the Australian Taxation Office (“ATO”) and the FIRB gather comprehensive data on foreign land acquisitions. Coupled with significantly increased penalties for breach of the foreign acquisitions rules, the availability of this information to the ATO and to the FIRB will give the federal government real capability to penalise unlawful real property acquisitions by foreigners.

Where an Australian buyer will be caught out too – example of a buyer that is an Australian-based family discretionary trust

It is notable that the PD doesn’t seek the confidential tax file number (understandable as the ATO can’t get the States to collect those) or the Australian Business Number (if any) of a buyer trust. It relies on the name of the buyer trust and a copy of the trust deed of the buyer trust with all amendments must be included with the PD.

If a foreign individual, company or trust is a potential beneficiary of the usual style of Australian family discretionary trust that is a New South Wales land buyer then, usually, the trustee can distribute 20% or more (Victoria – more than 50%) of the income and capital to that foreign person. That gives the foreign person a “significant interest” in the trust enough to cause the trust to be a foreign trust under these rules to whom the foreign stamp duty and land tax surcharges apply.

So if the copy trust deed supplied with the PD indicates that a remoter family member, who is not an Australian citizen or an Australian permanent resident, but is a foreigner who is a potential beneficiary of an (otherwise) Australian family discretionary trust ABLE to receive 20% of income or capital (more than 50% in Victoria), even if that remoter family member/foreigner may not have:

any current or past entitlement to income or capital of the trust; nor
any strong likelihood of participating in income or capital of the trust;

his or her eligibility under the trust deed exposes the trust to foreign trust/person status and liability for the stamp duty and land tax surcharges under these rules accordingly.

Sellers of Australian land

The ATO has had a problem collecting capital gains tax from sellers who are offshore after the sale of Australian land. Under tax treaties worldwide rights to tax interests in land are almost universally reserved to the governments where the land is. As other forms of assets and activity are moveable and relocatable taxation based on place is not so reserved because it is less effective than taxation based on residence and/or makes less sense.

So, frequently, when a non-resident sells land and makes a capital gain taxable in Australia, the ATO has no interaction with the non-resident, aside from due to their Australian landholding. This has often left the ATO with little leverage to assist them to collect tax debts arising from CGT on disposals of Australian land by non-residents ceasing investment in land in Australia.

The solution is the tried and trusted withholding tax model. From 1 July, 2016, the non-resident capital gains tax withholding tax (“NCGTWHT”) is an obligation on the buyer (statistically likely to be a resident) to pay a non-final withholding tax to cover capital gains tax (likely to be) owing by the non-resident seller.

The NCGTWHT broadly applies as a non-final tax on sales of land worth more than $750,000 (from 1 July 2017, was $2m from 1 July 2016 to 30 June 2017). If the buyer does not receive an ATO clearance certificate from the seller then the buyer must withhold 12.5% (from 1 July 2017, was 10% from 1 July 2016 to 30 June 2017) of the value of the property (so 12.5% of the price for the land if it is an arms length sale, 12.5% of the “first element of the cost base” of the land to the acquirer if a CGT market value substitution rule applies in a non-arms length transaction).

Where an Australian seller will be caught out too – a non-final 12.5% tax

It is of no consequence that the seller is, or might be, an Australian resident/tax resident and the buyer is assured of this. There is no “reason to believe the seller is an Australian resident” exception for sales of freehold interests in land. Even the seller could be wrong – tax residence can a vexed question which is frequently litigated in tax cases.

The liability to the ATO is on the buyer unless the seller can obtain and provide a clearance certificate from the ATO to the buyer no later than settlement of the land sale so, if the seller does not return and pay the CGT on the seller for the sale, the NCGTWHT paid by the buyer on the seller’s behalf won’t be refunded.

Template contracts for the sale of land across Australia have been hastily adjusted to include conditions confirming that, where the land is worth more than $750,000:

the buyer can contractually withhold the NCGTWHT from the price if the clearance certificate is not provided; and
the seller can be assured that the NCGTWHT will be paid immediately by the buyer to the ATO to the credit of the seller.

Are electronic records OK for tax?

They’re OK.

It’s clear on the ATO website that electronic storage of paper records is acceptable:

This article from Addisons explains the big picture:

including in the context of record keeping obligations of companies under the Corporations Act 2001; and
refers to the general requirement that taxpayers keep their (Commonwealth) tax related documents for five years.

ATO record keeping requirements in detail are in Practice Statement Law Administration PS LA 2005/2. PS LA 2005/2 shows that the period for keeping records referred to in the article can be longer than five years in certain cases. Records of documents going back to when an asset was acquired, even if prior to the introduction of capital gains tax in 1985, need to be kept for five years after the CGT asset is disposed of. It is also apparent under PS LA 2005/2 that the ATO can impose a range of penalties for failure to keep records including referring cases for criminal prosecution to the DPP where they perceive deliberate falsifications of records.

The article shows how ATO record keeping requirements reflect the Electronic Transactions Act (C’th) 1999. In essence, section 12 states that electronic records of paper documents required to be kept under Commonwealth law are OK if the electronic system is capable of conveniently and adequately reproducing the paper record. That section is referred to and is in line with Taxation Ruling TR 2005/9 Income tax: record keeping – electronic records.

Implementing electronic tax records

A taxpayer fails these requirements, and risks penalty, if electronic records are lost. Using a backup system is critical whatever electronic system is being used. Moreover electronic records have ease of duplication and filing advantages that make electronic records preferable to paper records.

There are other risks of loss of electronic records that should be borne in mind. Export to other formats from legacy or crippleware systems is an imperative when the records can no longer be retrieved from computer software say because the software becomes, over time, no longer licensed, no longer runs in the taxpayer’s operating system environment or the software itself has inherent restraints on its archiving capability. Many modern bookkeeping systems have easy to use export features which can be worthwhile using as a failsafe to ensure compliance with record keeping obligations.

Is a tax invoice that is only electronic OK?

The position with tax invoices is clear. In para 12 of Goods and Services Tax Ruling 2013/1 the ATO states:

Tax invoices in electronic form

A document in electronic form that meets the requirements of subsection 29-70(1) (and if applicable, subsections 48-57(1) and 54-50(1)), will be in the approved form for a tax invoice. [Footnote 9 – This record must be in English or readily accessible and easily convertible to English as required by subsection 382-5(8) of Schedule 1 to the TAA 1953.]

Using Twitter in tax practice

David Garde presented to the Chartered Accountants Australia + New Zealand Tax Discussion Group No. 15 on “Using Twitter in tax practice” on 7 June 2016.

During and following the presentation David was asked how to get started on Twitter and are there Twitter users he can suggest for a new Twitter user in the tax space:

Getting started on Twitter

The 8 minute youtube video How to Use Twitter on Your iPhone, for Seniors is a helpful getting started step by step guide.

Twitter can also be easily set up from the Twitter website or even by selecting:

the icons at this site to follow @TheTaxObjection;
the similar icon/link at other sites; or
any of the below links to Twitter users.

If you have not joined Twitter then you will be prompted/taken to join Twitter before you can the follow the Twitter user you try to follow.

Microblogging about tax

As mentioned in the presentation there is a huge amount of information microblogged on tax with an emphasis on tax comments on what Twitter users find interesting and worth tweeting about.

It is probably better to follow the feed of interesting users/conversations for a while before posting/making tweets until you are comfortable with the Twitter platform. Lots of Twitter users don’t post tweets at all and so just use Twitter as an information service in quiet moments conveniently on their phone. It’s easy to follow users, and to unfollow them if you don’t want to see them in your Twitter feed (timeline) any more.

Some users to follow who tweet about tax

Views about what is interesting are personal and vary with the type of tax work you do. Some Twitter users tax practitioners could follow are:

Other

and, of course,

CharteredAcctsANZ – @Chartered_Accts

Following conversations

and you can join conversations too like

#austax

#capitalgainstax

#TDGNo15

Once set up why not tweet “#TDGNo15 I am on Twitter” so we can see it on the #TDGNo15 conversation?