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Used the wrong/ trustee’s ABN for a new trust? How to fix …

A common mistake, misstep or omission on setting up a family discretionary trust (FDT) or other kinds of trusts is to use the Australian Business Number (ABN) of the trustee of the trust, typically a proprietary company, rather than to obtain and use a separate ABN after the trust has been established to run a business or enterprise.

Situations where this can happen include:

an ABN application form is completed incorrectly for the company without correctly identifying the FDT as the entity to which the application applies;
early application for the ABN is made by the company for an ABN, say so the company can say, open a bank account before the trust formation; or
the company is already doing other things and has an ABN already.

In each of these situations a client of an accountant can be tempted to use the ABN already to hand for the FDT. A client so tempted may well think – my accountant can sort this out later!

ABN for the wrong entity

It’s a clear mistake as a trust is clearly a separate entity to the company. An entity that can obtain an ABN under the A New Tax System (Australian Business Number) Act 1999 is equivalent to an entity as defined under the companion GST legislation which is:

(1) Entity means any of the following:
(a) an individual;
(b) a body corporate;
(c) a corporation sole;
(d) a body politic;
(e) a partnership;
(f) any other unincorporated association or body of persons;
(g) a trust;
(h) a superannuation fund.
Note: The term entity is used in a number of different but related senses. It covers all kinds of legal persons. It also covers groups of legal persons, and other things, that in practice are treated as having a separate identity in the same way as a legal person does.
sub-section 184-1(1) of the A New Tax System (Goods And Services Tax) Act 1999

which also conforms with other definitions of entity in the Income Tax Assessment Acts (ITAAs). Its clear that a company can have an ABN and a trust with a company as its trustee can and should separately obtain another ABN where the trust is to carry on an enterprise requiring an ABN.

The usual trust implementation

The usual implementation of an asset protected FDT is to set up the FDT with a corporate trustee with limited liability where the company is to be a dormant company. That is the company will have modest nominal share capital so it can register as a proprietary company with the Australian Securities and Investments Commission (ASIC) but the company will not have business or other substantive assets or liabilities on its own behalf as all intended activity of the FDT will be as the trustee of the FDT.

The company must have a right to be indemnified out of the property of the FDT so that the directors will not be personally liable for the debts of the trust under section 197 of the Corporations Act 2001 but, in terms of the balance sheet of the corporate trustee of a FDT, that right and the share capital are about the only few assets the company needs in the role of trustee of a FDT.

Impact of the wrong ABN

But if an ABN for the company is quoted on bank accounts and on invoices then the Australian Taxation Office (ATO) and all others concerned with the business are informed that transactions thought to be made by the FDT for its business are made by the company in its own right. The accountant for the FDT will have little choice but to record the transactions as transactions of the company in its own right and prepare the accounts of the company accordingly. Significant penalties can apply if the company persists with a position that it was quoting the ABN of the company for activity of an entity without an ABN rather than for activity in its own right.

So instead of the accounts of the company being dormant and those of the FDT being active, the business transactions will go to the accounts of the company and nothing will happen on FDT accounts and the implementation of the trust to operate the business will misfire.

If the business is being run under a business name, where the ABN of the company was used to apply for and obtain the business name, then the ATO and all others concerned with the business will view and treat the business name as a business name of the company and not the FDT.

Fixing the problem – reverting to the trust structure

This is one of those problems that can’t be fixed retrospectively without penalty trouble – the ABN has been quoted and relied on, but the problem can be fixed going forward.

Get the right ABN

The FDT can belatedly apply for an ABN. It is possible for an ABN to have retrospective application viz. the ABN can take effect from a date nominated by the applicant some time prior to the time of the application. But the ABN taking earlier effect won’t cure the problem of where the wrong ABN has been quoted since then.

Restore the company balance sheet

The company shouldn’t need to be voluntarily liquidated but a comparable internal process can be done to transfer the assets and liabilities in the accounts of the company to the FDT and to restore the balance sheet of the company to the modest assets described under The usual trust implementation above from a set fix or changeover date. If the problem is picked up early enough – it should be! –significant income tax profit and capital gains tax exposures of transferring assets to the FDT that may require remedy such as the small business restructure rollover in Division 328-G of the ITAA 1997 may not necessarily be needed to reset the company balance sheet.

Coping with the administrative consequences of changeover

If a client of an accountant has put itself into this sort of tangle it is likely that the client will struggle with this remedial action too which presents some administrative challenges as the client is now dealing with, effectively, two discrete businesses before and after the changeover day: The business initially carried on by the company with its ABN and then the business carried on by the FDT with its ABN from the changeover day.

It is important that the accounting and administrative team of the client (the Team) can pinpoint company period transactions before the changeover date and FDT period transactions that happen after the changeover day.

So a further element of the fix proposed here is to change the name of the company and for the Team to be meticulous about changing processes and stationery etc. to the new company name once the changeover day happens and the FDT period is underway.

There is an ASIC cost to change the name of the company and stationery etc., and time of the Team to manage all of this, but that cost should be considered in the context of alternatives that are costlier such as to voluntarily liquidate the company, to start afresh with an entirely new business structure to get the ABN process right or to abandon plans to use the FDT structure altogether.

A common technique for a name change for a company running a business, when a name change isn’t really wanted for public facing reasons; is to change NameOfCompany Pty. Ltd. to say NameOfCompany (Aust.) Pty. Ltd. This can help the Team and its customers to apply the right ABN and to get the accounting right (e.g. sales put through the right books of the two distinct entities NameOfCompany Pty. Ltd. to NameOfCompany (Aust.) Pty. Ltd (as trustee for the FDT) in this example for before and after changeover day transactions.

Unless something like this is done the Team and customers of the business might get very confused and might not manage the transition to the FDT as sought all along.

Impact of name change on the appointed FDT trustee

Unlike a liquidation of the company, after which a new trustee of the trust would need to be set up and appointed, a name change won’t affect the position of the company as the trustee of the trust.

The tax burden of handing over business assets to trust beneficiaries

Bigstock Hand With A Car Key - Rent A Car Key@seekpng.com — https://www.seekpng.com/png/detail/47-478269_bigstock-hand-with-a-car-key-rent-a.png

Business assets of GST registered entities, including business assets of a business carried on in a trust, attract significant tax concessions and advantages including:

income tax deductibility – generally either in the income year when they cost money: notably on purchase, or across their effective life in the case of depreciation; and
goods and services tax (GST) credits on GST creditable acquisitions.

It is to be expected that there are clawbacks under the taxation law when a business asset, that has attracted concessions and advantages under the taxation system in anticipation of its productive business use, is transferred to a beneficiary of a business trust that owns the asset for the beneficiary’s private use.

Trading stock taken out of a business for private use

It can be seen with business trading stock, for example, that a strictly market value disposition is taken to occur for income tax purposes when trading stock is taken for private use without regard to the money that may have changed hands. This treatment contrasts with the more flexible choice of actual cost, replacement cost and market selling value that is allowed to a business in determining trading stock on hand: section 70-45 of the Income Tax Assessment Act (ITAA) 1997.

Section 70-90 of the ITAA 1997 includes the market value of trading stock in income assessable to income tax when it is disposed of outside of the ordinary course of business. Section 70-100 can also include the market value of trading stock in the same income where the item, though not disposed of, has ceased to be trading stock.

Handing over depreciable equipment

The balancing charge or adjustment which is assessable to income tax on the disposal of an item of depreciable plant and equipment, such as a car used in the business of a trust, is determined based on its termination value. Where a business (taxpayer) stops holding the item under a non-arm’s length dealing for less than market value, then the item’s termination value is taken to be the market value of the item just before that dealing under item 6 in the table in section 40-300 of the ITAA 1997.

Where business equipment being depreciated by a trust is used privately by a beneficiary of the trust without being disposed of to the beneficiary the item will precipitate a non-deductible private use proportion of use of the equipment. When the item is eventually sold or otherwise disposed of for more than its cost, a capital gain under CGT event K7 attributable to the private use component can arise to the trustee of the trust.

Taxable GST supply without consideration

Generally a supply of property, goods or services by a business that is registered or required to be registered for GST for consideration is a taxable supply. Under section 72-5 of the A New Tax System (Goods And Services Tax) Act 1999 a supply to an associate:

not registered or required to be registered for GST; or
where the associate acquires the thing supplied otherwise than for a solely creditable purpose;

is treated as taxable supply even when there is no consideration for the supply. The value of a section 72-5 taxable supply without consideration (a price) is the GST exclusive market value of the supply: section 72-10.

Not worth the tax and accounting trouble

It can be seen from the above that taxation consistently based on market value substitution applies to non-arm’s length provision of business assets to beneficiaries of business trusts for the beneficiary’s private use.

The in specie distribution of a business asset of a GST registered trust to a trust beneficiary for no consideration, or an inadequate consideration, (price) is thus discouraged by the clawbacks. There is no apparent tax advantage to a trust in giving an asset to a beneficiary of the trust when the gift is compared to a sale of the asset. A sale raises far fewer tax compliance challenges!

How getting the business asset to the beneficiary might be done?

A less problematic way to achieve the same thing would be for the trustee to simply sell the business asset in the ordinary course of its business to the beneficiary for its market value (plus GST in the case of a sale by a GST registered business trust) and, concurrently make a capital distribution to the beneficiary to cover the price. Then the clawbacks would not need to be endured.

Avoiding the igloo – land sold for a GST-inclusive or GST-exclusive price?

AvoidIgloo

A local sale of goods or a supply of services by a GST-registered business will usually be:

for a GST-inclusive price/fee; and
accompanied by a tax invoice confirming the GST-inclusive price and the 10% (1/11th) GST included in the price/fee.

When to look out for GST on land sales

The price and GST on a sale of real estate in Australia can be far less clear. Although a majority of sales of residential property are not subject to GST, sales broadly of:

new residential premises (where not tenanted for at least five years);
vacant land that can be used for residential development; and
commercial residential premises;

are generally (GST) taxable supplies at settlement where the sale is by a seller who is either registered or required to be registered (perhaps solely required to register due to the sale). There are some exceptions.

Unanticipated GST and reducing GST with the margin scheme

Sometimes the parties can be caught unaware of a GST liability on the land sale or of an opportunity to apply the margin scheme to a sale of residential land under Division 75 of the A New Tax System (Goods And Services Tax) Act 1999 so a GST rate lower than 10% can be applied. A margin scheme rate lower than the 10% rate (or 1/11th of the GST inclusive price) will suit:

a purchaser:
- not entitled to claim a GST credit (purchaser credits are not available when the margin scheme is applied to the purchase) ; and
- liable for stamp duty calculated ad valorem based on the (lower) purchase price plus GST; and

the vendor who receives a higher nett price.

GST-inclusive or GST-exclusive price in the contract?

Normally a price for land is GST-inclusive under a contract in NSW.

Still, a purchaser should be vigilant when purchasing real estate where GST could apply. The current 2019 Law Society NSW and Real Estate Institute NSW contract of sale of land (the NSW contract) now has a number of checkboxes and GST residential withholding details which should indicate if GST is to apply when a proposed contract is received from the vendor. However where vendor agents and conveyancers are unaware or unsure about whether GST applies these can be left unchecked or incomplete when they should be proposed checked and completed.

The general conditions in the NSW Contract state that:

Normally, if a party must pay the price or any other amount to the other party under this contract, GST is not to be added to the price or amount. (Emphasis added)
General condition 13.2

That normal case thus matches a GST-inclusive price one is used to seeing on a tax invoice for goods or services from a supplier. However beware a contract which reveals that the purchaser must pay the price “plus GST” (so the price is GST-exclusive and general condition 13.2 is thus overridden) in a special condition even where less than obviously so: see Booth v Cityrose Trading Pty Ltd [2011] VCAT 278.

The importance of the terms of the contract, and the imperative to pick up an exceptional GST-exclusive special condition, is apparent from the NSW Court of Appeal decision in Igloo Homes Pty Ltd v Sammut Constructions Pty Ltd [2005] NSWCA 280. In that case a price plus GST (GST exclusive) provision in a 2000 edition NSW contract permitted the vendor to recover an additional amount of $250,000 on account of GST even though a series of misunderstandings (or worse) indicated that:

the vendor had put the properties on the market at a price inclusive of GST;
the purchaser had intended the price it offered to be inclusive of GST;
the selling estate agent had intended the price agreed upon to be inclusive of GST;
the selling estate agent was the vendor’s agent for the purpose of negotiating the sale and the price;
the selling estate agent had given written advice to the vendor of the terms agreed;
the vendor’s directors had intended the price to be the price agreed plus $90,909 on account of GST applying the margin scheme;
neither party had intended the price to be the price agreed plus $250,000 on account of GST;
the vendor had settled the sale even though GST of any amount and other amounts due at settlement hadn’t been paid by the purchaser;
at settlement the vendor had accepted the price agreed and undertook to provide a tax invoice; and
the purchaser’s mistake as to the effect of the contract was induced by the vendor’s agent who knew of and intended that outcome.

Contract could not be rectified

The evidence in the case showed that the purchaser did not understand GST and the margin scheme and had not examined the contract to identify the GST-exclusive special condition. It was found that the vendor’s conveyancer’s and the agent’s conduct described above was not so wrongful that the “rectification” of the contract sought on appeal was justified: a rewriting of the contract by the courts to reset the price as GST-inclusive.

Add the GST inclusive amount in the box to avoid an “Igloo”

The 2019 NSW contract includes a box on the front page:

The price includes GST of: $ _________

however the box is marked “optional”. It is in a purchaser’s interests to ensure this box is completed before contracts are exchanged so a purchaser’s liability for a “plus GST” amount above the agreed contract price can be countered for whatever reason.

The margin scheme and the price

One reason the parties may not complete this box is that the parties do or would seek to apply the margin scheme where GST must be charged. Eligibility for the margin scheme and thus a GST rate lower than 1/11th of the sale price is limited – see Eligibility to use the margin scheme at the ATO website. A GST liability under the margin scheme needs to be calculated by the vendor and the vendor may not have performed the calculation in time for the exchange of contracts. A further requirement of using the margin scheme is that the parties must agree to apply it under their contract (another checkbox on the NSW contract).

Under the consideration method for applying the margin scheme, which will usually be the only method applicable to property acquired on or after 1 July 2000, a margin scheme GST is 1/11^th of the margin viz. the margin is the difference between the property’s selling price and the original purchase price. That is, the sale price less the purchase price equals the margin.

The GST residential withholding amount when the margin scheme applies

The margin scheme GST and rate differs from the flat 7% GST residential withholding amount which a purchaser must usually withhold at settlement based on the vendor’s notification that margin scheme GST applies on the contract. GST residential withholding was introduced in 2018 to require a purchaser to withhold an amount to meet the GST on the sale (taxable supply) of residential land at settlement. The GSTRW amount is paid by the purchaser to the Australian Taxation Office at settlement as an approximation of the margin scheme GST with credit given to the vendor for the payment.

The 7% GST residential withholding amount is presently set by sub-sections 14-250(6)-(8) of Schedule 1 to the Taxation Administration Act 1953. Under sub-section 14-250(7) the 7% rate is applied to the “contract price” to determine the amount that must be withheld. It is to be remembered that the 7% is not the GST payable by the purchaser so a calculation treating a notionally GST-exclusive price as the price in the 7% calculation viz.

viz. 6.542056075% of the contract price on a supposed GST-inclusive basis withheld as GST residential withholding is not compliant either with this author’s understanding of sub-sections 14-250(6)-(8) or with the ATO website guidance on withholding on GST at Settlement. It should be 7% x Price.

GST withholding on residential property sales to plug a phoenix hole

The Federal Government, through the Phoenix Task Force involving the Australian Taxation Office (ATO) and other government agencies, has been cracking down on invidious “phoenix” activity through this decade.

The phoenix swindle

The idea behind a phoenix entity is that the entity, usually a company, is set up to undertake and undertakes a money-making activity where a considerable portion of the money made is owed to government, usually as taxes such as PAYG withholding or GST, perhaps after a significant claim of GST input tax credits, or to other agencies or creditors. Before the taxes, or money owed, can be collected, the money made by the entity is stripped from the entity by the controllers of the entity. The controllers can then rise from the ashes, phoenix like, with a new entity which can again make money for the controllers in the same way and can again be stripped of money owed to government, agencies and creditors by them.

Proposed GST withholding by purchasers of residential land

The government is addressing a phoenix trouble spot with property developers by the proposed introduction of a GST withholding from 1 July 2018 under which purchasers must retain one eleventh of the price of the property on or before settlement of sale of residential land for remission to the ATO. The Exposure Draft: Treasury Laws Amendment (2017 Measures No. 9) Bill 2017 has now been released in line with an announcement in the 2017/18 Budget. The withholding requirement in the Exposure Draft Bill would be a short circuit to the usual GST regime which obliges a vendor who is registered or required to be registered for the GST to collect GST on a taxable supply to a purchaser and for the vendor to pay it to the ATO via their BAS.

GST withheld 10% – GST owing less?

If the vendor applies the margin scheme then the purchaser will have withheld too much GST. The withholding rules in the Exposure Draft Bill include a mechanism which allow a vendor, who is not a monthly BAS lodger, to seek an early refund of the overpaid GST when too much GST has been withheld for the vendor by the purchaser.

GST withholding will apply to a taxable supply of land by a vendor who is registered or required to be registered for the GST under the Exposure Draft Bill. Both new residential premises and land that is potentially residential land, though not if it is input taxed as existing residential premises, require GST withholding by the purchaser. In other words the withholding obligation is broadly imposed so that the purchaser does not need to inquire about whether the land is new residential premises for GST purposes to the vendor. Broadly, and subject to exceptions, it is understood that the withholding obligation arises on the purchase of land from a vendor who is registered or required to be registered for the GST as follows:

Purchaser might need to withhold 22.5% for the ATO!

The proposed introduction of the GST withholding regime follows two years after the introduction of the non-resident capital gains tax withholding tax which requires a purchaser to withhold 12.5% of the price unless the vendor produces a ATO clearance certificate to verify that the vendor is not a non-resident: see Australia is now tracking & surcharging foreign buyers of land. These withholding obligations will require focus in conveyancing with enterprises which sell residential or potential residential land in the course of their operations.

Both measures visit responsibility to collect tax on the purchaser because of the some time difficulty of collecting tax from a vendor who departs with the sale money leaving taxes and creditors owed. Potentially both withholding obligations can apply to a purchaser who would then be withholding 22.5% of the price to pay to the ATO. There is no clearance certificate or other relief to relieve a purchaser from GST withholding, as yet, which may mean that one-eleventh GST withholding will have a broad application to buyers of residential land from GST registered property developers and traders should the Exposure Draft Bill become law.

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