taxandsuperaustralia.com.au The Taxpayer€¦ · been less online traffic. While most practitioners...

Low value goods and digital products

pp. 4-8

Main residence exemption and death

pp. 9-16

“Central management and control”

pp. 24-29

Top five in tax for December & January

p. 35

February 2017

taxandsuperaustralia.com.au

Practical insights on current tax issues

The Taxpayer

The backpacker tax: A raw deal for employers?

Low value goods and digital products: The new black 4

Main residence exemption and death 9

The backpacker tax: A raw deal for employers? 17

Where is a company’s central management and control? 24

Member interview: In search of a robust super system for clients 34

Top 5 in December and January 35

The Taxpayer is brought to you byTaxpayers Australia Ltd T/A Tax & Super Australia1405 Burke Road Kew East 310203 8851 4555

Editorial TeamLetty Chen Jay HuangAndy NguyenDenys Smerchanskyi

Guest ContributorSimon Dorevitch

Production Manager & Advertising Véronique Kopf03 8851 4514

Graphic Design & TypesettingLeonnie Gleeson

GlossaryIncome Tax Assessment Act 1997: ITAA97Income Tax Assessment Act 1936: ITAA36Fringe Benefits Tax Assessment Act 1986: FBTAAA New Tax System (Goods and Services Tax) Act 1999: GSTAAustralian Taxation Office: ATOCommissioner of Taxation: The CommissionerCapital gains tax: CGTAdministrative Appeals Tribunal: AAT

Contents

Did you know? Around 47% of Australia’s

consumption of goods and

services is subject to GST.

The Taxpayer: February 2017 3

Technology can be a God-send, but when it fails us, it can fail spectacularly.

As most practitioners were eyeing a well-earned break before Christmas, we were stopped in our tracks on December 12 with an unprecedented outage of the ATO website, which included the tax agent portal.

While it wasn’t panic stations, thumbs would have been twiddling in practices nationwide as the ATO worked furiously to restore online services.

Shortly after the outage, the ATO released a statement revealing that the cause was a failure in its storage hardware, which was installed about a year ago by its partner Hewlett Packard Enterprises. The problem was further compounded by the failure of the ATO’s back-up systems to work as planned.

The Commissioner subsequently issued a statement later that week to clarify the events that had transpired, and promised that an investigation will be conducted to ensure that another similar outage is prevented. Further, the public were again reassured that no data had been lost or compromised as a result – an immediate concern in the digital world that we now live in.

Thankfully, the system’s downtime coincided with the Christmas holidays, when there would have been less online traffic. While most practitioners were accommodating, a failure at any other time, particularly during lodgment season, could have been catastrophic.

Commendably, since the system meltdown, the ATO has been forthcoming in its

communications – keeping practitioners in the loop on the stability of the portal and also any upcoming planned outages.

While stability has been restored, what happened during December appears to be emblematic of a worrying trend of government technology failing, and falling short of community expectations. Last year also witnessed the denial-of-service attack on Census night, and the ongoing debacle with data-matched Centrelink debt letters.

Are these events merely coincidental, or part of a broader problem with the federal government’s “digital by default” strategy? Does the reincarnation of the Digital Transformation Agency last October have anything to do with this?

Indeed, the federal government must work with all of its agencies to ensure that IT systems are appropriately financed and resourced, that there is adequate oversight and accountability by those responsible, and that there is adequate skill and expertise in-house without an overreliance on outsourcing.

Clearly, the failure of the ATO system is unacceptable to the community. Let’s hope that lessons have been learnt, and are learnt quickly.

Andy NguyenTax Technical Manager

ATO systems outage: A one-off or the tip of the iceberg?

From the Editorial Team

4 The Taxpayer: February 2017

TAXING THE INTERNET SHOPPER

When the GST Act and Regulations were drafted in 1999, e-commerce was in its infancy – it was not fully envisaged that people wouldprefer to shop from the comfort of their mobiledevices rather than visiting a bricks and mortarshop! Over the years, however, Australianinternet sales have grown rapidly and are nowin excess of $20 billion per annum.

This has caused dismay from Australian businesses who have increasingly complained about an unequal playing field, since Australian consumers are often able to avoid incurring GST on their internet purchases from non-resident businesses. Online video-on-demand provider Netflix is a prime example where a

subscription to their services is currently not subject to GST under existing laws.

In response to these concerns, the government has introduced amendments that extend GST to supplies of digital products, certain services and low value goods imported by consumers.

As a result of these amendments, Australian consumers will soon find themselves paying 10% more for many online purchases. In addition, many overseas suppliers will be required to register and pay GST, though in some cases the GST liability may be shifted to an electronic distribution platform or goods forwarder. To ease the administrative burden, the Commissioner will permit some foreign businesses affected by the amendments to hold a limited GST registration.

Low value goods and digital products: The new black

Simon Dorevitch reviews important changes to GST and cross-border transactions.


EXISTING GST FRAMEWORK

By way of background, GST is payable on “taxable supplies” and “taxable importations”.

Taxable supplies

For a supply to be taxable it must, among other things, be connected with Australia.1

In the context of physical goods brought to Australia, a supply is connected with Australia if the supplier either imports the goods or installs or assembles them in Australia. Therefore, if the consumer imports the goods, the supply will generally not be connected with Australia and will not be a taxable supply.

In the context of supplies other than physical goods or real property (eg digital products and other services), a supply is connected with Australia if:

• the thing is done in Australia

• the supply is made through an enterprisethat is carried on in Australia, or

• the supply is the supply of a right to acquireanother thing that is connected withAustralia.

If the location of performance is not in Australia, a supply by a foreign entity will generally not be connected with Australia and will not be a taxable supply.

Taxable importations

For an importation to be taxable it must be of tangible personal property. Therefore, an importation of digital products or services is not a taxable importation as these are not tangible goods. Furthermore, GST regulations specify that an importation of low-value tangible goods (ie those with a customs value of $1,000 or less) is a non-taxable importation and therefore no GST is payable.

APPLYING GST TO DIGITAL PRODUCTS & OTHER SERVICES

Amendments to the GST Act2, which take effect from 1 July 2017, extend the scope of the GST to digital products and other services imported by Australian consumers.

The media have dubbed the amendments the “Netflix tax” and have focused on their application to digital products such as streaming or downloading of movies, music, apps, games and e-books. However, what may be missed is that the amendments apply equally to supplies of services such as consultancy and professional (eg architectural, legal or educational) services.

Australian consumer

As a result of the amendments, a supply of digital products and other services will be connected with Australia (and therefore potentially a taxable supply) if the recipient of the supply is an “Australian consumer”.

An Australian consumer, in relation to a supply, is an Australian resident (as defined for income tax purposes) who is not entitled to an input tax credit (ITC) in respect of the acquisition. To be entitled to an ITC, a consumer must be registered for GST and the supply must be acquired to some extent for an enterprise they carry on. The amendments are therefore intended to capture private consumption only.

Example:3 Global Movies supplies Fellini with video on demand services. The supply is not performed in Australia and Global Movies does not carry on an enterprise in Australia. Fellini is a resident of Australia, does not carry on an enterprise and is not registered for GST. The supply by Global Movies is connected with Australia as a result of the amendments.Had Fellini not been a resident of Australia, the supply would not have been connected to Australia, even if he was in Australia when the supply was made.

1: The GST Act now refers to the “Indirect Tax Zone” rather than Australia. However, for simplicity, this article will continue use the term Australia.

2: Tax and Superannuation Laws Amendment (2016 Measures No .1) Bill 2016

3: Example 1.1 from Explanatory Memorandum to Tax and Superannuation Laws Amendment (2016 Measures No .1) Bill 2016


Reasonable belief safeguard

It may not always be practical for a supplier to determine if the recipient of a supply is an Australian consumer. Recognising this, the amendments provide a safeguard; if the entity that would be liable for GST takes reasonable steps to establish whether the recipient of a supply is an Australian consumer and, having taken these steps, reasonably believes that the recipient is not an Australian consumer, they may treat the supply as if it had been made to an entity that was not an Australian consumer.

Example:4 Peter, an Australian resident who is not registered for GST, orders a videogame online from a non-resident supplier while visiting family in London. He pays using a credit card from a UK bank and gives the address and phone number of his relatives as contact information. The supplier reasonably believes that Peter is a not an Australian resident and may therefore treat him as not being an Australian consumer and the supply as not connected with Australia.

In some circumstances, the process for making a supply may be largely automated. Such supplies may also be covered by this safeguard if the business systems and processes provide a reasonable basis for identifying if the recipient is an Australian consumer.

Penalties for misrepresentations by customers and extending the reverse charge provisions

Australian consumers may have incentives to avoid GST by misrepresenting their status. To address this, the amendments broaden the existing administrative penalties for making false or misleading statements.

Furthermore, the amendments extend the compulsory reverse charge rules so that they apply where an Australian business has made a wholly private or domestic acquisition but has made representations that it is not an Australian

consumer in respect of the supply. The operation of this reverse charge rule will mean the supply is a taxable supply and the recipient, not the supplier, is liable for GST.

Example:5 Leslie, an Australian resident registered for GST, acquires a movie from Online Movie Co (OMC) for a wholly private purpose. She is therefore an Australian consumer in relation to the supply. However, Leslie provides OMCS with her Australian Business Number (ABN) and declares that she is registered for GST. Accordingly, OMC does not charge GST. Under the extended reverse charge provisions, Leslie is obliged to pay the GST.

Electronic distribution platforms

Consumers may purchase digital products and services via an electronic distribution platform (EDP). The Apple App Store is an example of an EDP, Amazon is another.

The operators of EDPs are often better resourced and therefore better placed to comply with Australia’s GST laws. On this basis, where supplies are made through an EDP and are connected with Australia under these amendments, responsibility for the GST liability is generally shifted from the supplier to the operator of the EDP. In other circumstances the supplier and operator of the EDP may agree that the operator will be liable for GST on the supply.

Registration and limited registration

Supplies that are connected with Australia because they are made to an Australian consumer will generally count towards the GST registration threshold of $75,000. However, these supplies may also be GST free because they are used or enjoyed outside Australia.

It would be unnecessary for foreign suppliers to register for GST if the only supplies they

4: Example 1.4 from Explanatory Memorandum to Tax and Superannuation Laws Amendment (2016 Measures No.1) Bill 20165: Example 1.5 from Explanatory Memorandum to Tax and Superannuation Laws Amendment (2016 Measures No.1) Bill 2016

Low value goods and digital products: The new black (continued)


make that are connected to Australia is also GST-free. Therefore, the amendments ensure such supplies are only included in GST turnover if the supply is made through an enterprise carried on in Australia.

Some entities that are required to register under these amendments will not have any other connection with Australia. These entities will have no claim to ITCs and will therefore not need to claim GST refunds.

To ease the administrative burden on such entities, the Commissioner will allow them to opt to be a ‘limited registration entity’. Such entities will only be required to provide minimal information when registering for GST and lodging business activity statements. Limited registration entitles are not entitled to claim ITCs or to have an ABN. They will report quarterly.

APPLYING GST TO LOW VALUE IMPORTED GOODS

The government has also released draft legislation6 to amend the GST Act to ensure that GST is payable on certain supplies of low value goods that are purchased by consumers and imported into Australia. This amendment again is intended to level the playing field between local and overseas businesses.

The changes, if passed, will also apply from 1 July 2017.

Supplies of low value goods that are connected with Australia

As a result of the amendments, a supply of goods will be connected with Australia if:

• the supply involves the goods being brought to Australia with the assistance ofthe supplier

• the goods are low value goods, and

• the recipient acquires the supply as aconsumer.

Bringing goods to Australia with the assistance of the supplier

The supplier provides assistance where it makes arrangements with third parties for the transport of the goods or facilitates the consumer making such arrangements. However, if a supplier merely makes the goods available for collection or provides contact information to unrelated transport companies it will not be providing such assistance.

Low value goods

Broadly, a low value good is tangible personal property that has a customs value of $1,000 or less at the time of supply.

If multiple goods are supplied and each is individually below $1,000 but the total is above the threshold, the supply is a supply of low value goods unless it would be unreasonable to treat each good as a separate supply (for example the supply of 100 floor tiles). A supply that involves both low value and other goods is treated as two or more separate supplies.

6: Treasury Laws Amendment (2017 Measures No. 1) Bill 20177: Example 1.5 from Explanatory Memorandum to Treasury Laws Amendment (2017 Measures No. 1) Bill 2017

‘‘

‘‘

Supplies that are connected with Australia because they are made to an Australian consumer will generally count towards the GST registration threshold of $75,000.


Acquired as a consumer

A recipient, who may not be the person to whom the goods are delivered, is a consumer in relation to a supply if they are not entitled to an ITCs for the acquisition.

A business can confirm that a recipient is not a consumer by requesting their ABN and a declaration that they do not acquire the goods for an enterprise they carry on in Australia. Unlike the amendments relating to digital products and other services, there is no requirement that the consumer be an Australian resident.

Example:7 Wei, a resident of Hong Kong purchases artwork valued at $700 in Vietnam and arranges for the seller to deliver it to his niece in Australia. The supply is connected with Australia, despite the fact that Wei is not a resident and outside of Australia when the purchase is made.

Supplies not connected with Australia

A supply that satisfies each of these three requirements will not be connected to Australia if the supplier reasonably believes that the goods will be imported as a taxable importation and the goods are imported as a taxable importation. If the supplier’s reasonable belief turns out to be incorrect, they will include the additional GST payable on their next Business Activity Statement and no penalties will apply.

Electronic distribution platforms

Where low value goods are supplied through an EDP, the GST liability will generally shift from the supplier to the operator of the platform. This is consistent with the EDP rules applying to cross-border supplies of digital products and other services – discussed above.

Goods forwarders

Goods forwarders may help arrange a purchase, take delivery of the goods and/or arrange for their pick-up, make storage arrangements and deliver, or arrange delivery of the goods to the consumer.

In contrast, entities that merely deliver goods to Australia are not treated as goods forwarders. If a supply to a consumer involves goods being delivered outside of Australia and brought to Australia with the assistance of a goods forwarder, then the supply will be connected with Australia and the goods forwarder will generally be treated as the supplier.

Example: Sam is an Australian resident who is not registered for GST. Sam purchases a hockey stick valued at $300 from a US store. Sam instructs the store to send his purchase to a mail forwarding service (MailMe). MailMe then sends the hockey stick to Australia and delivers it to Sam. MailMe, and not the US store, is treated as making the supply and will need to register if it has a GST turnover of $75,000 or more.

Limited registration

The amendments allow non-resident suppliers (including operators of EDPs treated as suppliers) and non-resident goods forwarders of low value goods to be limited registration entities.

Low value goods and digital products: The new black (continued)

Simon Dorevitch is Senior

Tax Consultant, A&A Tax

Legal Consulting


Main residence exemption and death

Legislative references relate to the ITAA97.

Andy Nguyen explains how CGT can be minimised on the family home upon the death of an owner.

Death can often be a topic that is difficult to discuss. Where it involves the family home, who that asset will or should go to, and its impact on loved ones, warrants consideration. The CGT implications are equally of relevance, particularly since the family home is often the taxpayer’s most valuable asset.

DEATH AND CGT

When a taxpayer dies, the deceased’s ownership interest in a property will devolve to their “legal personal representative” (LPR) or pass to a beneficiary of their estate. The term LPR describes a person who administers the estate of a deceased person as executor or as a court-appointed administrator.

Broadly, the approach taken by Division 128 is to ignore any capital gain or loss that may arise as a result of property passing from the deceased to the LPR or a beneficiary as a result of death. In order to correctly deal with the CGT implications arising from the transfer of a dwelling, it is necessary to identify the type of ownership interest that is given up upon death.


OWNERSHIP INTERESTS

Ownership of a dwelling (which constitutes a taxpayer’s main residence) may be by way of:

• joint tenancy

• tenancy in common, or

• sole ownership.

Where a property is owned by multiple parties as joint tenants (typically by spouses), each party holds an equal and undivided interest in the property. Upon the death of a joint tenant, the interest of the deceased passes to the other joint tenant (or tenants) without becoming an asset of the deceased’s estate.

For CGT purposes, the interest of a joint tenant in property is considered to be a separate asset, as if it were an interest as a tenant in common (s108-7).

In the case of ownership by way of tenancy in common, each party holds a separately identifiable interest in the property, which constitutes a CGT asset.

The relevant CGT implications for each form of ownership are summarised in the table opposite.

THE MAIN RESIDENCE EXEMPTION

The main residence exemption rules are contained in Subdivision 118-B. Under the rules, any capital gain or loss on the disposal of a dwelling is disregarded. Where the exemption is not wholly available it may be available in part.

The main residence exemption, pursuant to s118-110, applies to the extent that the following basic conditions are met:

• the taxpayer is an individual (or is abeneficiary who has an absolute right to aproperty as against a trustee)

• the dwelling is the taxpayer’s “mainresidence” throughout the “ownershipperiod”1 and the dwelling was not passedto the individual taxpayer either as abeneficiary or as a trustee of a deceasedestate (although in these circumstancesother exemptions may apply), and

• specified CGT events apply to the disposal,including CGT event A1.

THE ABSENCE RULE

There are certain circumstances where the main residence exemption may remain fully available although the taxpayer is no longer residing in the dwelling. One instance is referred to as the “absence rule” (s118-145).

Under this rule, an absent taxpayer can make a choice to continue to treat a dwelling as their main residence for CGT purposes provided, among other things, that they do not treat any other property as their main residence.

Depending on whether the dwelling is used for an income producing purpose, the timeframe in which the property can be treated as a main residence is as follows:

• If the dwelling is used for incomeproducing purposes during the absenceperiod: A maximum period of six yearswill be available during which the taxpayermay retain full access to the main residenceexemption; thereafter only a partialexemption would be available (note:taxpayers could take advantage of multiplesix year absence periods, provided residencyof the dwelling is resumed within six yearsfor each time that the dwelling is used forincome producing purposes).

• If the dwelling is not used for incomeproducing purposes: The taxpayer cantreat the property as their main residenceindefinitely (i.e. no time limit is imposed).

1: Where land or a dwelling is acquired under a contract, the ownership interest commences when legal ownership is obtained (by settling a purchase contract) or if a right to occupy the dwelling is obtained from an earlier date, that earlier date.

Main residence exemption and death (continued)

The term “main residence” is not defined in taxation law. The ATO has set out its views as to when a dwelling will be a main residence in the online publication titled “Is the dwelling your main residence?” (QC 17184).


CG

T IM

PL

ICA

TIO

NS U

PO

N D

EA

TH

Joint tenancy –

uponthe deathof a jointtenant

The deceased’s ownership interest in the dwelling transfers automatically to the surviving joint tenant(s), however a C

GT event is taken to have

occurred as a result (ie. CG

T event A1) The survivor’s cost base as a consequence of the asset transfer is as follows:•

if the interest in the dwelling w

as a pre-CG

T asset of the deceased: The interest is taken to have been acquired by the survivingjoint tenant on the day that the individual died, with a cost base equal to its m

arket value as at the date of death•

if the interest in the dwelling w

as a post-CG

T asset of the deceased: The deceased’s cost base transfers to the surviving jointtenant

The surviving joint tenant is taken to hold two separate interests with a separate cost base for each interest in the asset (i.e. their own and the interest transferred from

the deceased).

Tenancy in com

mon

–upon

the deathof a jointtenant

The deceased’s separate interest in the asset devolves to the legal personal representative of their estateThe cost base of the interest acquired by the estate is as follows:•

If the deceased’s interest in the asset was acquired pre-C

GT: The cost base in the interest obtained by the estate is its m

arket valueat the tim

e of the deceased’s death, or•

If the deceased’s interest in the asset was acquired post-C

GT and w

as being used for income producing purposes

imm

ediately prior to death1: The cost base of the interest obtained by the estate is the deceased’s cost base at the tim

e of their death•

If the deceased’s interest in the asset was acquired post-C

GT and w

as not being used for an income-producing purpose

imm

ediately prior to death2: The cost base of the interest obtained by the estate is its m

arket value at the time of deceased’s death

If the deceased’s interest passes from their estate to a beneficiary in accordance with their will, any capital gain arising as a result of the

disposal by the estate to the beneficiary is ignored and the beneficiary will obtain the cost base of the estate. The beneficiary will have a separate cost base for each of their respective interests in the asset (ie their original interest and interest acquired under the deceased’s will).

Sole ow

nership –

upondeath ofa soleow

ner

The deceased’s interest in the asset devolves to the legal personal representative of their estate.The cost base acquired by the estate is as follows:•

If the dwelling is a pre-C

GT asset of the deceased: The cost base obtained by the estate is the m

arket value of the dwelling at thetim

e of the deceased’s death•

If the dwelling is a post-C

GT asset of the deceased and w

as not being used for an income producing purpose im

mediately

prior to death:The cost base obtained by the estate is the market value of the dwelling at the tim

e of death•

If the deceased’s interest however passes from the estate to a beneficiary in accordance with the deceased’s will, any capital gain arising

as a result of the disposal by the estate to the beneficiary is ignored. The beneficiary will obtain as its cost base that of the estate.

1: For example, the taxpayer had used part of the dw

elling as a doctor’s surgery prior to death or as a rental property.2: C

orrectly adopting the absence rule (see later in this article) can ensure that a dwelling could be incom

e producing and still satisfy these requirements.


INTERACTION BETWEEN AN INHERITED INTEREST AND THE MAIN RESIDENCE EXEMPTION

The main residence exemption is extended when a dwelling is acquired from a deceased estate under s118-195.

Specifically, if an individual disposes of the interest that they have inherited as a beneficiary of a deceased estate, or obtained by operation of the law as a result of the death of a joint tenant, any capital gain or loss upon disposal is typically disregarded to the extent that:

(i) If the interest was a pre-CGT assetof the deceased:

• The beneficiary’s ownership interest in thedwelling is disposed of within two years ofthe deceased’s death, or

• The dwelling was, from the deceased’sdeath until the ownership interest ends, themain residence of one or more of:

- the spouse of the deceased immediatelybefore death (except a spouse who was permanently living separately and apart from the deceased)

- an individual who has the right to occupy the dwelling under the deceased’s will, or

- the individual disposing of the dwelling who obtained the interest as a beneficiary.

(ii) If the interest was a post-CGT assetof the deceased, the dwelling was thedeceased’s main residence just beforedeath, and was not being used to produceassessable income2:

• The beneficiary’s ownership interest in thedwelling is disposed of within two years ofthe deceased’s death, or

• The dwelling was, from the deceased’sdeath until the beneficiary’s ownershipinterest ends, the main residence of one ormore of:

- the spouse of the deceased immediatelybefore death (except a spouse living permanently and separately apart from the deceased)

- an individual who has the right to occupy the dwelling under the deceased’s will, or

- the individual disposing of the dwelling who obtained the interest as a beneficiary.

It is important to note that the above rules also extend to individuals who own a dwelling as joint tenants (s118-197). The main residence provisions are taken to apply to these individuals as if the interest had passed to them as a beneficiary in a deceased estate.

For the main residence exemption to be available there is no need for a pre-CGT property to have been the deceased’s main residence immediately prior to death. It is therefore possible that this exemption becomes available to beneficiaries in respect of multiple investment or vacant properties owned by the deceased at the date of death, provided that they are all pre-CGT assets of the deceased.

2: Correct use of the absence rule could result in this exemption being available notwithstanding that the dwelling was being used to produce assessable income immediately prior to the date of death; for example, a taxpayer’s residence being used to generate rental income at a time the individual has entered into a nursing home.

Main residence exemption and death (continued)


For the purposes of the main residence exemption, an “ownership interest” ends when a sale contract is settled so that legal ownership changes.

THE “FIRST USED TO PRODUCE INCOME” RULE

A special rule contained in s118-192 applies where a taxpayer’s main residence is first used for income producing purposes. Subject to certain conditions being satisfied, the taxpayer is taken to have acquired the dwelling for its market value on the day that it was first used for that purpose.

The relevant conditions include:

• the taxpayer would only receive a partialexemption under the main residence rulesin respect of a CGT event happening to thedwelling (or an interest in it) because thedwelling was used for income producingpurposes during the taxpayer’s ownershipperiod

• that use occurred for the first time after7.30pm (by legal time in the ACT) on20 August 1996, and

• the taxpayer would get a full main residenceexemption if the CGT event happened justbefore the dwelling was used for incomeproducing purposes during the taxpayer’sownership period.

In addition, if the ownership interest in the dwelling passed to the taxpayer as a beneficiary

in a deceased estate or as a trustee of a deceased estate after 20 August 1996, and the CGT event happens after two years from the deceased’s death, then the taxpayer is:

• treated as having acquired the interest asif they are an individual (rather than as abeneficiary or as a trustee of the estate), and

• the formula for apportioning the extent ofany capital gain as a result of a partialexemption is adjusted to include daysin which the property was not the mainresidence of certain individuals (includingthe deceased’s spouse, someone who hadthe right to occupy the dwelling under thedeceased’s will, or a beneficiary).

Note that a full exemption would be available under s118-195 if the dwelling is disposed of within two years.

Also be aware that the “first used to produce income” rule under s118-192 does not apply if the taxpayer is entitled to a full main residence exemption because a choice has been made to apply the “absence rule” under s118-145. This is a consequence of a partial exemption not having had applied to the taxpayer because of the choice being made – one of the conditions in s118-192 (see ATO Interpretative Decision ATO ID 2003/1113).

!


Richard and Linda Jones purchased a property in May 1987, which they lived in as their main residence. They had purchased the property as joint tenants. For CGT purposes, the cost base of the property was $100,000.

In June 2016, Linda dies and her interest in the property passes to Richard (and not to Linda’s estate).

The property was Linda’s main residence until the date of her death. At the time of her death, the property had a market value of $600,000.

In September 2016, due to health issues, Richard relocates to a nursing home and rents out the property.

In September 2017, Richard decides to sell the property. The property was sold for $650,000.

ISSUES

1. What are the CGT implications uponLinda’s death?

2. What are the CGT implications forRichard upon vacating the property andits subsequent disposal?

1. CGT IMPLICATIONS ON LINDA’SDEATH

Upon Linda’s death, her interest in the property passes to Richard as the surviving joint tenant. The interest of the deceased is not an asset of the deceased estate. Any capital gain or loss arising from the passing of the property interest to Richard is disregarded. Richard is considered to have acquired Linda’s interest in the property at the date of her death.

As the interest is a post-CGT interest, the cost base to Richard is Linda’s original cost base with respect to her interest (ie. $50,000); s128-50 ITAA97.

2. CGT IMPLICATIONS ON DISPOSAL

Linda’s interest inherited by Richard:

As Richard inherited Linda’s interest upon her death, the main residence exemption will be available if the interest is disposed of by Richard within two years of her death, or if the dwelling was maintained as Richard’s main residence from the time of her death until the date of disposal.

As the interest acquired from Linda was sold within two years of her death, Richard would be entitled to the main residence exemption.

In addition, provided that Richard invoked the absence rule in September 2016, the interest in the dwelling would also have remained his main residence until it was sold in September 2017. Therefore, the capital gain of $375,000 (ie. $425,000 less $50,000) arising on disposal of the interest would be disregarded.

Note that because there is no partial exemption arising because Richard is entitled to a full exemption, it would not be necessary to consider the application of the “first used to produce income” rule (see ATO ID 2003/1113).

Richard’s interest:

With respect to Richard’s interest, the property was his main residence from the date of acquisition until he sold the property in September 2017 (provided the absence rule was correctly invoked).

Due to the absence rule, Richard may treat the dwelling as his main residence for a maximum period of six years from the time that he vacated the property – provided that he did not have another main residence. In this case, as the property was vacated for one year before being sold, the main residence exemption will apply.

Richard’s capital gain on disposal of his original interest ($375,000) is disregarded. Again, it is unnecessary to consider the “first used to produce income” rule for the reasons noted above.

EXAMPLES

Example 1: Taxpayer dies and leaves post-CGT main residence to spouse


Example 2: Property vacated, not rented out

Continuing with the facts from example 1 above, but instead of the property being rented out when Richard vacates the dwelling, he allows his nephew to live in the property free of charge.

The answer for the above scenario would not change if the property was vacated by Richard and provided to his nephew free of charge.

Instead of a six year time limit, Richard would be able to treat his interest in the dwelling as his main residence indefinitely for as long as the property is not used for income producing purposes.

In respect of the interest inherited by Richard from his deceased spouse, the capital gain would be disregarded as this interest was sold within two years.

Note that the “first used to produce income” rule would not apply as Richard had not used the dwelling for an income producing purpose.

Example 3: Property sold in October 2018

Continuing with the facts from example 1 above, but instead of selling the property in September 2017, the property was sold in October 2018.


As the property is sold outside the two year time period, the main residence exemption would not be available unless the property was the deceased’s spouse’s main residence from the time of their death until the property is sold.

With the benefit of the absence rule, Richard is able to treat the dwelling as his main residence from the time of Linda’s death until he disposes of the property. This applies despite the fact that he has vacated and rented the property (as the permitted six year time period has not been exceeded).

Again, the “first used to produce income” rule is not relevant as Richard is able to avail himself of the full main residence exemption by virtue of invoking the absence rule.

Note that if Richard had not treated the dwelling as his main residence following Linda’s death, then a partial main residence exemption would be available.


The main residence exemption would continue to apply to Richard’s original interest from the date of acquisition until the date of disposal. The period in which he vacated the dwelling satisfies the absence rule (as noted). Therefore, the capital gain on disposal would be disregarded.

Example 4: Property held as tenants in common

Continuing with the facts from example 1 above, but instead of the property being held as joint tenants, the property was held as tenants in common in equal proportions. On this basis, Linda’s will outlines that her interest in the property would pass to Richard via her estate.

CGT IMPLICATIONS UPON LINDA’S DEATH

Upon her death, Linda’s interest in the property becomes an asset of her estate and therefore held on trust to be dealt with in accordance with her will by the executor. In this case, the interest would pass to Richard as the beneficiary without any CGT event being recognised (s128-10).

Richard is considered to have acquired the property at the date of Linda’s death.

As the dwelling was Linda’s main residence just before she died and was not then being used for income producing purposes, the cost base to Richard is the market value of Linda’s interest at the date of death (ie $300,000 – being 50% of $600,000).

EXAMPLES


CGT IMPLICATIONS UPON DISPOSAL


In this case, there would be no difference in the CGT implications to Richard from the sale of his inherited interest in the dwelling as a tenant in common.

Richard would still be able to obtain the main residence exemption as the interest is sold within two years of Linda’s death. However, the capital gain that is disregarded would be different.

A capital gain for the interest of $25,000 (ie. $325,000 less $300,000) would be disregarded.

The “first used for produce income” rule would not be relevant as Richard is entitled to a full main residence exemption (see ATO ID 2003/1113).


In this case, there would be no difference in the CGT implications on Richard’s interest under a joint tenancy or tenants in common scenario.

The capital gain of $275,000 arising from the sale of Richard’s interest in the dwelling would be disregarded under the main residence exemption. Again, the “first used to produce income” rule would not be a relevant consideration.

Example 5: Property was acquired pre-CGT

Continuing with the facts from example 1 above, but instead of the property being acquired in May 1987, the property was acquired in May 1985.

LINDA’S INTEREST INHERITED BY RICHARD:

In this case, Richard is deemed to have acquired Linda’s interest in the property as a joint tenant with a cost base equal to the market value of the interest at the time of her death. This interest would be held by Richard as a post-CGT asset with a cost base of $300,000.

Richard would still be able to obtain the main residence exemption as the interest is sold within two years of Linda’s death. The capital gain of $25,000 would be disregarded.

The “first used for produce income” rule would not be relevant as Richard is entitled to a full main residence exemption (see ATO ID 2003/1113).

RICHARD’S INTEREST:

As Richard’s interest in the dwelling is a pre-CGT asset, his capital gain on disposal of $275,000 is disregarded. The main residence exemption is not required to be relied upon in this case.

EXAMPLES

Easy CPD for Tax ProfessionalsOur webinars let you learn wherever you are. Even if you can’t make the live session, you can access our webinars on-demand, so you can review any part of the content as much as you like.

n The new sharing economy: what are the practical tax issues?

22 February 2017: 11am

This webinar covers key tax issues and obligations for individuals who operate through the sharing economy.

n Taxing intellectual property

15 March 2017: 11am

Learn to identify and define the various forms of intellectualproperty and apply the appropriate income tax treatment.

17 The Taxpayer: February 2017 17

The backpacker tax: A raw deal for employers?

Jay Huang and Andy Nguyen tally the real beneficiaries of the new “backpacker tax”.

HOW THE BACKPACKER TAX CAME TO BEAfter several attempts, the much-debated backpacker tax was enacted before Christmas last year.

Applying from 1 January 2017, the new law taxes those classed as “working holiday makers” at 15% on the first $37,000 earned – with ordinary rates applying to taxable income thereafter. Previously, such workers could avail themselves of the $18,200 tax-free threshold if they were “resident” for tax purposes, while “non-residents” were taxed 32.5% on their first $87,000 earned.

The changes will affect stakeholders in the agricultural and tourism sectors where the work provided is often seasonal and is found in regional areas – fruit picking being a prime example.


When it was initially announced in the 2015 Federal Budget, the government intended that a rate of 32.5% was to apply on the first $37,000 of taxable income from 1 July 2016 – which was consistent with the rate for non-resident individuals. Inevitably, toes were stepped on – with considerable backlash from those in the agricultural and tourism industries, who rely heavily on working holiday makers for their source of labour.

The government ultimately delayed the start date and went back to the drawing board.

After being returned to government following the election, the Treasurer announced in October 2016 that the tax rate would be revised to 19% for the first $37,000 earned from 1 January 2017. To balance the books, it was proposed, among other things, to tax certain “departing Australia superannuation payments” to working holiday makers at 95% and to increase airport departure taxes by $5 to $60 for all outbound international travellers.

To enact these measures, the government introduced a series of bills into the Parliament. These bills stuttered through both houses before being referred to the Senate Economics Legislation Committee for inquiry during November 2016. Some of the bills were subsequently revised by the Senate, with the proposed tax rate revised down from 19% to 15% and the departing Australia superannuation payments tax rate reduced from 95% to 65%.

THE BACKPACKER TAX: IN DETAIL

WHO IS A “WORKING HOLIDAY MAKER”?

As a starting point, it is important to note that the new rates are limited to those who are classed as “working holiday makers”. A working holiday maker for these purposes means an individual holding one of the following temporary visas:

• Subclass 417 (Working Holiday) visa, or

• Subclass 462 (Work and Holiday) visa.

As background, these visas allow young adults aged 18 to 30 from eligible partner countries to work in Australia while having an extended holiday. Work in Australia must not be the main purpose of the visa holder’s visit. Those on 417 and 462 visas can stay and work in Australia for up to 12 months on their first visa. Holders of 417 visas can apply for a second year visa, but to be eligible for this, participants must work for three months in specified industries in regional Australia.

A working holiday maker may also be an individual who holds a bridging visa, permitting the individual to work in Australia if:

• the bridging visa was granted under theMigration Act 1958 in relation to anapplication for one of the visas referred toabove

• the Immigration Minister’s decision on thatapplication is yet to be made, and

• the most recent visa, other than a bridgingvisa, held by the individual was a Subclass417 (Working Holiday) visa or Subclass462 (Work and Holiday) visa.

What are the new tax rates and thresholds?

From 1 January 2017, the relevant tax rates that apply to working holidaymakers are as follows:

Taxable income Tax rate

Less than $37,000 15%

Exceeds $37,000 but less than $87,000 32.5%

Exceeds $87,000 but does not exceed $180,000 37%

Exceeds $180,000* 45%

*The above rates do not include the Temporary BudgetRepair Levy — for 2016-17 this levy is payable at a rate of2% for taxable incomes over $180,000.

The backpacker tax: A raw deal for employers? (continued)


Importantly, these special rates apply to those who are “working holiday makers” irrespective of their Australian tax residency status. Note that these tax rates also apply to non-employment income that may be derived by a working holiday marker while they are in Australia.

Depending on whether the taxpayer is a resident or non-resident for Australian tax purposes1, this separate category of tax rates for working holiday makers has the following implications:

• Resident working holiday makers:These individuals are taxed at 15% fromthe first dollar of income that they earn to$37,000. They can no longer benefit fromthe tax-free threshold (currently $18,200) orpay tax at 19% for taxable income between$18,201 and $37,000. A resident workingholiday maker whose income exceeds$37,000 will now pay $1,978 more taxthan previously (ie. $5,550 compared with$3,572).

• Non-resident working holidaymakers: These individuals are now taxedat 15% from the first dollar of income to$37,000, compared with the non-residentrate of 32.5% for taxable income up to$87,000. As such, working holiday makersin this group benefit from a 17.5% reductionin income tax for their first $37,000 oftaxable income. A non-resident workingholiday maker who has a taxable incomeof $37,000 saves $6,475 in tax for theincome year.

In isolation, crunching the numbers shows some small pain for resident working holiday makers earning up to $37,000 – however, non-resident working holiday makers are the big beneficiaries from the change. The net effect is that government, according to its estimates, will lose revenue to the tune of $420 million over the forward estimates. This revenue loss is recouped by other changes discussed below.

SO WHY DID THE GOVERNMENT DECIDE TO ADOPT SPECIAL RATES FOR ONLY WORKING HOLIDAY MAKERS?

According to the government, recent AAT cases have established that most working holiday makers under existing laws would be classified as non-residents for tax purposes and be subject to a 32.5% tax rate from the first dollar of income. This is due to the transient lifestyle of such individuals. A person who stays in one place and establishes ties with the community is likely to be a resident taxpayer.

This lack of clarity has meant that working holiday makers tended to incorrectly self-assess as being resident taxpayers, thereby erroneously taken advantage of the tax-free threshold.

The introduction of a special set of tax rates seeks to clarify the tax rate for working holiday makers. The lower rate for non-residents, according to the government, will also improve Australia’s international competitiveness for backpackers and improve the supply of seasonal and temporary jobs in the agriculture and tourism sectors.

1: An individual who is non-resident for Australian tax purposes is only taxed on their Australian source income. Conversely, an individual who is an Australian tax resident is taxed on income derived from Australian and worldwide sources. There are four tests in establishing the residency of an individual – refer to the Tax Summary 2017 at 11.120.

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Working holiday makers tended to incorrectly self-assess as being resident taxpayers, meaning they have erroneously taken advantage of the tax-free threshold.



PRACTICAL CONSIDERATIONS

What if the individual is a working holiday maker for only part of the income year?

This scenario typically arises where an individual is a working holiday maker for part of an income year and, for the balance of that income year, holds a different visa that does not qualify them as a working holiday maker.

In these circumstances, the working holiday maker rates of income tax apply only to income derived during the period of the year of income in which the individual qualifies as a working holiday maker. For the balance of the year of income in which they are not a working holiday maker, the individual must assess their residency status, determined on a whole-of-year basis (typically as a non-resident) and the relevant rates of tax will apply.

Consider the following:

Example 1.2 (reproduced from the Explanatory Memorandum)

Fabio is a non-resident for income tax purposes. Fabio earns $50,000 while a working holiday maker in Australia from 1 July 2017 to 31 March 2018 and has $1,000 of deductions that relate to this income. His working holiday taxable income is therefore $49,000. He also earns a $39,000 salary in Australia while holding a different class of visa from 1 April 2018 to 30 June 2018, which does not result in him being a working holiday maker for this period.

Fabio pays tax at the rate of 15% on the working holiday taxable income from $0 to the tax threshold of $37,000 and 32.5% for the remaining $12,000 of his total of $49,000 of working holiday taxable income.

For Fabio’s taxable income of $39,000 that is not working holiday taxable income, he pays income tax at the 32.5% non resident rates for the first $38,000. The remaining $1,000 is taxed at 37%, as his overall income for the year is higher than $87,000 so he moves into the next tax bracket.

Any problems with the 1 January 2017 start date?

Unfortunately, yes. The one major issue with the start date of 1 January 2017 is that there will be two sets of tax rates that apply to working holiday makers if they have been employed throughout the 2016-17 year, as follows:

• for the period from 1 July 2016 to 31December 2016: the ordinary resident ornon-resident tax rates apply (depending onthe working holiday maker’s tax residencystatus for the income year), and

• for the period from 1 Janaury 2017to 30 June 2017: the new tax rates willapply irrespective of the working holidaymaker’s tax residency.

The ATO has indicated that it will automatically calculate the amount of tax payable when a working holiday maker lodges their tax return. Further, to facilitate the preparation of the return, employers of working holiday makers are required to issue two PAYG payment summaries for the 2016-17 year; one for each of the above periods – rather than one payment summary for the entire income year.

Apart from this, there has been minimal guidance from the ATO on the actual disclosures to be made in the individual return or the mechanics of how certain aspects of the law will be applied by the ATO – for example, how will the tax-free threshold be applied for the first half of the year? This aspect has yet to be clarified.


MORE THAN JUST TAX RATE CHANGES…

The introduction of a backpacker tax has broader implications than just merely changes to tax rates and thresholds.

Key measures as part of the government package of bill include:

Additional employer obligations

Generally, employers of working holiday makers were only required to withhold PAYG from payments made to these employees if they were deemed to be a non-resident for tax purposes.

As a consequence of the backpacker tax, employers are now unfortunately lumped with additional obligations by having to register and withhold PAYG for payments made to all working holiday makers.

Registration with the ATO

The ATO is required to maintain a working holiday maker employer register.

Employers of working holiday makers must register with the ATO in order to withhold at 15% from 1 January 2017. Otherwise, employers must withhold using the current non-resident withholding rates at 32.5% for income up to $87,000. The ATO may also impose penalties if employers of working holiday makers fail to register.

Albeit limited, the ATO website now contains information on how to register and includes a registration page.

The steps to ensure compliance with the new requirements are as follows:

• Step 1. Determine employee’s visastatus: Check to determine whether thereare any employees under a visa subclass417 or 462 by using the Department ofImmigration and Border Protection’s VisaEntitlement Verification Online service at:http://www.border.gov.au/Busi/visas-and-migration/visa-entitlement-verification-online-(vevo), and

• Step 2. Register with the ATO if theemploying working holiday makers:Employers who employ working holidaymakers can register online using the ATO’sregistration tool: https://www.ato.gov.au/TWHM/. Note that the employer mustalready be registered for PAYG withholdingand has an ABN or a withholding payernumber; otherwise they will need to registerfor this first.

Note that a registration can be cancelled if the Commissioner is satisfied that the employer is not a fit and proper person. Employers can also choose to cancel their registration – for example, if they no longer employ working holiday makers.

Regardless of whether the employer is registered as a registered working holiday maker employer, the rates of income tax in assessing the working holiday maker’s taxable income are the same. The ATO will refund any excess PAYG withholding amount if the employer is not registered and had withheld at non-resident rates.

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Employers of working holiday makers must register with the ATO in order to withhold at 15% from 1 January 2017.


Determining the amount of withholding

Employers can use Schedule 15: Tax table for working holiday makers (available on ato.gov.au) in working out the amount of withholding.

Relevant aspects to consider include:

• For registered employers, the amount ofwithholding is determined using an Excellook-up table which can be downloaded.

• Unregistered employers are requiredto withhold at foreign resident rates asspecified in the tax tables for weekly,fortnightly or monthly payments.

• If a working holiday fails to provide to theemployer their TFN, then withholding willbe at the top marginal tax rate – currently47%.

Note: see breakout on following page concerning extension to registration date.

PAYG payment summaries

As noted earlier, employers of working holiday makers must issue two PAYG payment summaries if they have employed working holiday makers who have worked throughout the 2016/17 year.

Departing Australia superannuation payments tax

By way of background, temporary residents, including working holiday makers, who work in Australia, and have superannuation contributions paid by their employer, are entitled to claim their superannuation benefits once they leave Australia and their visa expires or is cancelled. This payment is called a departing Australia superannuation payment.

From 1 July 2017 the rate of tax that applies is increased to 65% for certain components of the departing Australia superannuation payment. This rate is a far cry from the 95% that was initially tabled in Parliament – which would not have left temporary residents with not much left over! This was subsequently reduced as a compromise for decreasing the backpacker tax from 19% to 15%.

The table below compares the current and new rates for departing Australia superannuation payments tax.

The 65% rate applies to departing Australia superannuation payments made from 1 July 2017 that relate to superannuation contributions that were made when the person was a working holiday maker.


Component Current rate New rate

The tax-free component of the payment (generally, after tax contributions)

0% 0%

The element taxed in the fund of the taxable component of the payment

38% 65%

The element untaxed in the fund of the taxable component of the payment

47% 65%

The amount of the element that is not an excess untaxed roll-over amount

47% 65%

The amount of the element that is an excess untaxed roll-over amount

0% 0%

CURRENT AND PROPOSED RATES FOR DEPARTING AUSTRALIA SUPERANNUATION PAYMENTS TAX


Other changes

Other changes to the law include:

• reducing the visa application charge forSubclass 417 (Working Holiday) visas andSubclass 462 (Work and Holiday) visasfrom $440 to $390 from 1 July 2017 –again, this is intended to make Australia anattractive destination for working holidaymakers

• increasing the passenger movement chargefrom $55 to $60 from 1 July 2017– alloutbound travellers from Australia toanother overseas destination will besubsidising part of the backpacker tax, and

• as a consequence of maintain a workingholiday maker employer register, furtherchanges include:

- allowing the Commissioner to discloseinformation from the register of employers that is relevant to ensuring an entity’s compliance with the Fair Work Act 2009 to the Fair Work Ombudsman, and

- requiring the Commissioner to give to the Treasurer, for presentation to the Parliament, a report on working holiday makers, which includes statistics and information derived from the working holiday maker employer register.

FINAL COMMENTS

No doubt there will be interest as to whether the backpacker tax and its related changes will achieve the government’s objective of making Australia an attractive destination for working holiday makers (apart from Australia’s other appealing attributes!). For some small employers, there may be challenges with complying with the law – particularly for those who may not have previously been required to withhold PAYG from payments to their working holiday maker employees. The Commissioner’s mandatory report to the Treasurer on working holiday makers should make for some interesting reading as to whether the government’s objectives are achieved.

Existing employers of working holiday makers were required to register with the ATO by 31 January, and withhold using the new tax table. This deadline has now passed. Employers that failed to register on time may now face penalties. Unregistered employers must withhold at normal foreign resident withholding rates, which start at 32.5%.

An employer that currently does not employ working holiday makers, but does so in the future, must register before making the first payment to the working holiday maker.

For ATO guidance on registration, search for “QC 50741” on www.ato.gov.au.

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Where is a company’s central management and control?The High Court recently settled a three-year judicial battle between a multinational group and the Commissioner on the issue of tax residency for companies.

Letty Chen explains the High Court’s recent ruling on the “central management and control” limb of the residency test.

What is the Bywater decision about?

In Bywater Investments Limited v Commissioner of Taxation; Hua Wang Bank Berhad v Commissioner of Taxation [2016] HCA 45 (Bywater), the High Court unanimously decided that the four companies in question were all Australian tax residents. Therefore, they were liable to Australian taxation for the relevant years.

Specifically, the High Court found that the central management and control (CM&C) of each of the companies were effectively in Australia, notwithstanding that the companies were structured so that the strategic decision-making was purportedly exercised overseas. See the panel on page 25 for the statutory meaning of a “resident” company for Australian tax purposes.


What are the facts in Bywater?

There were four corporate taxpayers involved in the dispute with the Commissioner:

• Bywater Investments Limited (Bywater)

• Chemical Trustee Limited (Chemical Trustee)

• Derrin Brothers Properties Limited (Derrin)

• Hua Wang Bank Berhad (HWB).

In August 2010, the Commissioner issued assessments to each of the taxpayers in respect of profits derived from share trading. The taxpayers objected to the assessments, claiming that they were not Australian tax residents and therefore not subject to Australian taxation on the income.

The taxpayers’ objections were subsequently disallowed by the Commissioner and the taxpayers appealed to the Federal Court. The taxpayers lost both that appeal (Hua Wang Bank Berhad v Commissioner of Taxation [2014] FCA 1392) and their subsequent appeal to the Full Federal Court (Bywater Investments Limited v Commissioner of Taxation [2015] FCAFC 176). The taxpayers were granted special leave to appeal to the High Court.

What were the findings of the Full Court?

The Full Court found that the CM&C of each company was located in Australia (Sydney, where the companies’ accountant Vanda Gould operated). Because the non-resident directors of the companies never did more than mechanically carry out Gould’s directions,

the place of CM&C was, as a matter of fact, in Sydney, where Gould made the substantive decisions. Therefore, each company was resident in Australia for tax purposes.

The table on the following page sets out key facts about each company and the relevant findings of the Full Court.

What was the issue before the High Court?

The substantive issue before the High Court was whether the taxpayers were residents for Australian tax purposes. Specifically, the High Court looked at whether the CM&C for each of the taxpayers was being exercised in Australia.

What did the High Court say?

The High Court concluded that all of the corporate taxpayers are Australian tax residents on the basis that the CM&C of each company is exercised in Australia.

A company’s CM&C is located at the place where the company’s operations are controlled and directed. The question of where a company’s operations are controlled and directed is invariably a question of fact to be determined, not according to the construction of the company’s constitution, but upon a scrutiny of the course of business and trading.

There is a long line of authority that makes clear that a company has its CM&C where the CM&C of the company actually abides, that being a question of fact and degree to be determined according to the facts and circumstances of each case.

When is a company an Australian tax resident?

A company is an Australian tax resident if it meets one of three statutory tests (s6(1) ITAA36):

• the company is incorporated in Australia; or

• the company is not incorporated in Australia, but it carries on business in Australia andit has its central management and control in Australia; or

• the company is not incorporated in Australia, but it carries on business in Australia andits voting power is controlled by shareholders who are residents of Australia.

The Bywater decision focuses on the “central management and control” aspect of the second test.


Key facts and findings by the Full Court for each company

Company Key facts – ownership Key facts – management Full Court – key findings

Chemical Trustee

Incorporated in the UK.All shares held by Guardheath, a nominee company owned by a UK firm of accountants.Guardheath held the shares as nominee for JA Investments, a Cayman Islands company.

Sole director and shareholder of JA Investments – Peter Borgas.Directors of Chemical Trustee – Peter Borgas, Winny Borgas,Timothy Borgas.Minutes of meetings of directors record that meetings took place in Switzerland and were attended by Peter and Winny Borgas.

Vanda Gould of NSW beneficially owned and controlled JA Investments.Gould micromanaged and took responsibility for Chemical Trustee’s affairs.Gould made decisions of Chemical Trustee without the involvement of Borgas.The apparent ownership and directorial structure was fake.

CM&C was in Australia.

Derrin Incorporated in the UK.Shareholders:• Guardheath as nominee

for JA Investments• Lordhall Securities Ltd

as nominee for JAInvestments

• Lordhall as nomineefor MH Investments Ltd(Cayman Islands).

Peter Borgas and Winny Borgas.Minutes of meetings of directors record that meetings took place in Switzerland and were attended by Peter and Winny Borgas.

Position was largely the same as that of Chemical Trustee.Gould was the ultimate beneficial owner and controller.The entire ownership and directorial structure was a façade to conceal Gould’s role.


Bywater Incorporated in the Bahamas.Shares held by Anglore SARL, a service entity based in Switzerland, as nominee for MH Investments.

Peter Borgas, Winny Borgas and NTW Directors Inc of Nassau in the Bahamas.No directors’ meetings or annual general meetings.

Owned by Vanda Gould through MH Investments.Roles of Gould and Borgas were the same as in relation to Chemical Trustee and Derrin.


HWB Incorporated in Samoa.Shares held by Pacific Securities Inc, incorporated in Samoa.Registered secured debenture which effectively placed control in the hands of JA Investments.

Register of directors and secretaries recorded the names of several individuals and two companies. All but one of the individuals was employed by a Samoan-based international trustee and service provider.

Controlled by JA Investments as one of Gould’s ‘disguised entities’.Predominant business was receiving money from Gould or his clients and then remitting it to their related entities in the form of purported loans.Gould owned and controlled HWB and the directors of HWB acted on his instructions.


^Peter and Winny Borgas resided and operated in Switzerland.


Ordinarily, the board of directors of a company makes the higher-level decisions that set the policy and determine the direction of operations and transactions of the company. Therefore, it will usually be found that a company is resident where the meetings of its board are conducted. However, it does not follow that the result should be the same where the real decision-making power is held by an outsider and the board of directors merely 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 this regard, the High Court concluded that the fact that the boards of the companies were located abroad was not sufficient to locate the residence of the taxpayers abroad. The boards of directors had abrogated their decision-making in favour of Gould and only met to “mechanically implement or rubber-stamp decisions” made by him in Australia.

The High Court held that the taxpayers could not escape liability for Australian income tax on the basis that they were non-residents.

Double tax agreements: Place of effective management

The taxpayers put forward a secondary argument that, if they were Australian tax residents under domestic law, then they could rely on relevant double taxation agreements (DTAs) to avoid liability, on the ground that their “place of effective management” was other than in Australia.

Each of Australia’s DTAs contains a residency tie-breaker provision. Where a taxpayer is considered to be a tax resident of both treaty countries under their respective domestic laws, the tie-breaker rules are applied to determine

which country shall be the taxpayer’s sole country of residence for the purposes of the DTA.

Chemical Trustee and Derrin were incorporated in the UK. They are tax residents of the UK under UK domestic tax laws. The Australian courts have determined that the companies are Australian residents under Australian law. As the companies are residents of both countries, it is necessary to consider the residency tie-breaker test in the DTA between Australia and the UK.

Under Article 4 of the DTA, the company is deemed to be a resident only of the country “in which its place of effective management is situated”. If the place of effective management is in the UK, the company would be considered a resident only of the UK and not of Australia and therefore entitled to relief from Australian taxation.

The High Court held that the “place of effective management” of each of Chemical Trustee and Derrin is in Australia and not in the UK. In the opinion of the court, the express terms of that phrase impose a requirement that in order to identify the place of effective management, the inquiry must go beyond the mere formalities of where the formal organs of a company might be located. The key management and commercial decisions were made by Vanda Gould in Australia, and on that basis, the place of effective management is in Australia.

For various factual reasons, the DTA between Australia and Switzerland also applied to Bywater, Chemical Trustee and Derrin. The High Court examined the tie-breaker provision in that DTA and concluded that the place of effective management for each company is in Australia and not in Switzerland.

The practical outcome of the High Court’s decision is that, under the relevant DTAs, Australia retains its taxing rights over the companies’ worldwide income.

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The High Court concluded that the fact that the boards of the companies were located abroad was not sufficient to locate the residence of the taxpayers abroad.


Spotlight on “central management and control”

The High Court decision that all of the company taxpayers are Australian tax residents turned on whether the CM&C of each company is in Australia.

By way of background, CM&C focuses on management and control decisions that guide and control the company’s business activities. Management and control involves consideration of the high level decision making processes, including activities involving high level company matters such as general policies and strategy, major agreements and significant financial matters. It also includes activities such as monitoring of the company’s overall financial performance and the review of strategic recommendations made in light of the company’s performance.

The High Court relied on a body of case law in arriving at its conclusion. This information is available in a table (“Leading case authorities”) which is included from page 30. This table contains useful guidance for tax advisers who need to decide the location of a company’s CM&C. Note that while the information relates specifically to the s6(1) ITAA36 definition of resident, it may also provide assistance in applying the “place of effective management” tie-breaker rule in DTAs.

The ATO perspective

Taxation Ruling TR 2004/15 sets out the views of the ATO in relation to the residence of companies that are not incorporated in Australia.

The ruling discusses the two requirements for such companies to be a resident of Australia under the second statutory test of residency (see page 25):

1. the company must carry on business in Australia

2. the company’s CM&C must be located in Australia.

If no business is carried on in Australia, the company cannot meet the requirements of the second statutory test and there is no need to determine the location of the company’s CM&C.

There are situations where the nature of the business or the level of control over the business requires the exercise of CM&C at the place where the business is carried on. Where a company’s business is management of its investment assets and it undertakes only minor operational activities, the factors determining where a company is carrying on a business may be similar to those determining where it is exercising CM&C. In these situations the location of CM&C is indicative of where the company carries on business and vice versa.

Carries on business in Australia

• A company that has major operational activities relative to the whole of its business carries on business wherever those activities take place and not necessarily where its CM&C is likely to be located.

• A company with income earning outcomes that are largely dependent on the investment decisions made in respect of its assets, carries on its business where these decisions are made.

Central management and control

• This level of management and control involves the high level decision making processes, including activities involving high level company matters such as general policies and strategic directions, major agreements and significant financial matters. It also includes activities such as the monitoring of the company’s overall corporate performance and the review of strategic recommendations made in the light of the company’s performance.

• Possession of the mere legal right to exercise CM&C of a company is not, of itself, sufficient to constitute CM&C of the company.


In order to reduce uncertainty, the Commissioner as a matter of practical compliance will accept for those companies whose CM&C is exercised by a board of directors at board meetings that the CM&C is in Australia if the majority of the board meetings are held in Australia. The exception to this is cases where the circumstances indicate an artificial or contrived CM&C outcome.

Key takeaways

The following will assist practitioners in determining whether CM&C is in Australia:

• If the majority of board meetings areheld in Australia, the ATO will, as an administrative rule of thumb, generally accept that CM&C is in Australia – unless it suspects that the arrangement has been structured for a contrived outcome. Keep minutes of meetings, evidence of transactions resulting from board decisions made in Australia and other evidence that the directors are the bona fide decision-makers of the company.

• The courts (and the ATO) will look throughthe legal ownership and directorshipstructure of the company to see who in factcontrols the decision-making, and fromwhere.

• The fact that the directors, or the majority of directors, live in a particular country and hold board meetings in that country does not mean that the CM&C of the company is located in that particular country.

• If the board of directors in reality merelyimplements or rubber-stamps decisionsmade by another party, and effectivelyacts as the other party’s puppet, the courtswill not consider the location of the boardmeetings to be the place of CM&C.

• CM&C involves consideration of the highlevel decision making processes andcompany matters, such as policies, strategy,major agreements, significant financialmatters and monitoring of financialperformance.

• Where a party possesses a legal right toexercise CM&C of a company, that aloneis not sufficient to constitute CM&C. Actualexercise of CM&C is required.

• If the company is a tax resident of Australiaand another country under respectivedomestic laws, the ‘place of effectivemanagement’ tie-breaker rule in therelevant DTA will need to be considered.Each DTA is different so check whetherthere are specific provisions in the tie-breaker clause to help decide the countryof residence.

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The courts (and the ATO) will look through the legal ownership and directorship structure of the company to see who in fact controls the decision-making, and from where.


Leading case authorities

Cases Key facts Key findings / principles

Cesena Sulphur Company v Nicholson (1876) 1 Ex D 428

Manufacturing operations were carried on in Italy.

Directors conversed in English, where they conducted the administrative operations.

The companies were resident in England because the directors who comprised the governing body of each company met in England and there actually made the decisions concerning the “acts of highest importance” affecting the operations of the company.

De Beers Consolidated Mines Ltd v Howe [1906] AC 455

South Africa: head office, general meetings, profits out of diamonds raised and sold there, some directors and life governors lived there.

England: majority of directors and life governors lived there.

A company resides for income tax purposes “where its real business is carried on”; that “the real business is carried on where the central management and control actually abides”; and that the question of where CM&C actually abides is “a pure question of fact to be determined, not according to the construction of this or that regulation or bye-law, but upon a scrutiny of the course of business and trading”.

The company was resident in England because the majority of directors and life governors lived in England and the real control of the company was exercised in practically all the important business of the company, except the specifics of its mining operations, at meetings of directors in London.

Koitaki Para Rubber Estates Ltd v Federal Commissioner of Taxation [1941] HCA 13

The company was a resident of Australia. The issue was whether the company was also a resident of Papua by virtue of the rubber plantations it maintained there.

The Papuan plantations were managed by a Papuan resident officer of the company acting under a power of attorney authorising him to manage, carry on and conduct in Papua the company’s property, affairs and business, and conferring on him ample powers to that end.

Although it was possible for a company to reside for tax purposes in more than one place, the better view was that such a finding should not be made unless the control of the general affairs of the company is not centred in one country, but is in fact divided or distributed among multiple countries.

The CM&C of the company was not divided between Sydney and Papua because, although the company carried on the activities of growing, treating, packing and exporting rubber in Papua, and the manager in Papua had full authority over those processes, he was subject in those matters to close supervision from Sydney and his authority did not extend to the control of the general or corporate affairs of the company or to matters of policy or finance.

Control of all important matters was centred in Sydney.

Where is a company’s central management and control?




North Australian Pastoral Co Ltd v Federal Commissioner of Taxation [1946] HCA 17

The company was incorporated in the Northern Territory and carried on a business of breeding, purchasing, depasturing and selling cattle on and from its cattle station, Alexandria, in the Northern Territory. At relevant times its registered office was at Alexandria but, under a power in its articles, it had established a branch office in Brisbane.

Financial activities originated in both locations.

Business transacted on the company’s behalf at Alexandria consisted of things necessarily done by an agent, such as buying a truck and a lighting plant, buying bulls, effecting insurances and interviewing authorities about renewal of leases. The manager made most of the more important decisions concerning the management of the station but some of the directors made visits to Alexandria on occasion in order to make policy decisions in conjunction with the manager.

The company was resident in the Northern Territory.

The determinative factor was that the company carried on its substantial business in the place of its incorporation.

Waterloo Pastoral Co Ltd v Federal Commissioner of Taxation [1946] HCA 30

The company was incorporated in, and operated its business from, the Northern Territory. Its managing directors were resident in Sydney and the board of directors, which was empowered by the articles of association to require that decisions be subject to its confirmation, met mostly in Sydney.

The crucial test is where the real business of the company is carried on, not in the sense of where it trades, but in the sense of from where its operations are controlled and directed.

The company was resident in the Northern Territory, whether or not it was also resident in Sydney, because the “ultimate operative decisions” were made during visits to the stations in the Northern Territory, whereby tentative decisions made in Sydney would be given effect to or modified on the basis of local conditions assessed “on the spot” at the stations. As such, effective control was exercised from the Territory.




Malayan Shipping Co Ltd v Federal Commissioner of Taxation [1946] HCA 7

Company incorporated in Singapore.

The articles appointed HC Sleigh managing director, who resided in Melbourne, and empowered him to appoint and remove other directors; provided that a resolution of directors was of no force unless first approved by Sleigh; and required that the seal of the company not be affixed without the authority of Sleigh.

The only business done by the company was to charter a ship and to sub-charter it on a number of occasions, that charter being effected in London on instructions cabled from Sleigh in Melbourne, and the sub-charters being organised by Sleigh in Melbourne, where he prepared all the documents before sending them to Singapore for execution.

The CM&C of the company was exercised in Melbourne.

Unit Construction Co Ltd v Bullock [1960] AC 351

Three taxpayer companies were registered in Kenya and each company had a board of directors situated in Kenya.

The directors of the companies did not all have access to all the documents of, or information concerning, the companies of which they were directors.

The real management and control was exercised by the directors of the parent holding company in London, despite that arrangement not being authorised by the memoranda or articles of the Kenyan companies.

It is the actual place of management, not that place in which it ought to be managed, which fixes the residence of a company.

Its residence is determined by the solid facts, not by the terms of its constitution.

Where is a company’s central management and control? (continued)




Esquire Nominees Ltd v Federal Commissioner of Taxation [1973] HCA 67

Board meetings were held on Norfolk Island and substantive decisions were made by the board. Admittedly, the directors complied with the advice of Australian accountants.

The company was a resident of Norfolk Island.

The board of directors in Esquire Nominees did make substantive decisions when electing to adopt the advice of the Australian accountants and it did so on the basis that the advice was considered to be in the best interests of the company.

If they had been advised to do something improper or inadvisable, they would not have acted on the instruction.

This was not a case of a board rubber-stamping decisions made by others.

Wood v Holden [2006] 1 WLR 1393

The only activities of the company in question were to enter into a contract to purchase shares from its parent company to the sum of an amount funded by an interest free loan from the parent company, and then to hold those shares.

The Court of Appeal drew a distinction between cases where CM&C is exercised through a company’s constitutional organs on the basis of external advice or influence, but in fulfilment of the constitutional organ’s functions, and cases where the functions of the company’s constitutional organs are usurped by an outsider who dictates the decisions to be implemented, independently of or without regard to those constitutional organs.

A case of this kind involved different considerations from a case involving the residence of a company with an active continuing business.

The distinction appears to rest on whether the local board actually considers and makes a decision to adopt the parent company’s recommendations as bona fide in the best interests of the subsidiary, or whether the local board just mechanically implements directions from the parent company because it is so directed.


Andrew Leafe works at Nexus Private Wealth Management in Brisbane. He has recently joined Tax & Super Australia (TSA) as a Professional member to fulfil his role of para-planner for the firm. Andrew also found that he tended to take on the mantle of the “go-to” team member when it came to tax technical matters, for which TSA membership seemed an ideal source.

The firm’s 10 member team manages around 200 clients, who Andrew says tend to be from the “mum & dad” side of the pool of wealthier individuals. Most are trustees of their own SMSF.

WHAT DO YOU SEE AS THE FUNDAMENTAL CHALLENGE IN THE SUPER ARENA?

“One of the challenges I consistently battle with is the inherent unpredictability of superannuation. All the laws keep changing, and that can rattle clients more than anything,” he says. “The $1.6 million cap in particular, but also all the caps and limits that seem to keep being ratcheted back.”

He says the recent push for “simpler super” seems to have been abandoned, as the system is anything but simple any more, and is riddled with all sorts of levels of complexity. “Some of the government’s motivations are of course to close perceived loopholes that crop up with legislative measures. But every system, every form of legislation, is not going to be perfect,” Andrew says. Having access to technical support and resources, such as TSA, is an invaluable commodity in this environment.

In search of a robust super system for clients

In the the first of our monthly industry insights from a new member, Steve Burnham chats to Andrew Leafe.

IS THERE AN INEQUALITY IN THE INCUMBENT SYSTEM?

“It seems to be that the middle and upper middle income taxpayer cohort is the one that is taxed more heavily over time, and I do question the equality inherent in the existing system,” he says. “Those relying on government benefits may have contributed less in tax over the long term. For those on middle levels of income, they may naturally expect to have access to at least some form of tax concessions, as they’ve been paying a little more into the system all along.”

WHAT HAVE BEEN SOME OF YOUR CLIENTS’ OVER-RIDING CONCERNS?

“Over some years, I have witnessed many client concerns over the winding back of contribution caps. And it is not just the fact that contribution opportunities are squeezed, but every change may mean that a previously comprehensive investment and wealth plan is made redundant. This is not only annoying but costs real dollars.”

The frustration he says stems from the fact that consumers may have listened to the government’s push for them to plan ahead, which they have diligently gone ahead and done, only to see the system change abruptly.

IS ROBO-ADVICE SOMETHING THAT SMSF PROFESSIONALS NEED TO WORRY ABOUT?

“I’m convinced this area of financial advice is still going to have to have the human touch. If embraced by the industry, robo-advice could actually be a very useful tool — for advisers, not just investors,” he says. “This sort of technological application can put things up for consideration that a planner may not even think of.”


Top five in December 2016 and January 2017…. Here are the top 5 things that happened in tax which you need to know.

5. HIGH COURT: TRUST NOT A “UNIT TRUST”

In Elecnet (Aust) Pty Ltd v Commissioner of Taxation [2016] HCA 51, the High Court of Australia held that the taxpayer was not a unit trust within the meaning of Division 6C of Pt III of ITAA36 because any interest created by the trust deed in favour of employees of the severance scheme could not be characterised as a “unit”. The Court also held that the meaning of “unit trust” in Division 6C accorded with the common usage of “unit trust” (i.e. where the beneficial interest in the trust estate is divided into units as discrete parcels of rights, analogous to shares).

4. TR 2016/13: COMMERCIAL WEBSITECOSTS RULING FINALISED

Taxation Ruling TR 2016/13 sets out the Commissioner’s views on the deductibility of expenditure incurred in acquiring, developing, maintaining or modifying a website for use in carrying on a business, including expenditure relating to domain names.

3. TD 2016/19: UPE WRITTEN OFF AS A BADDEBT IS NOT DEDUCTIBLE

Taxation Determination TD 2016/19 confirms that a beneficiary is not entitled to a deduction under s25-35 ITAA97 for an amount of unpaid present entitlement that the beneficiary purports to write off as a bad debt. This is because the amount of the unpaid entitlement is not included in the beneficiary’s assessable income.The Commissioner considers that the entitlement is used to determine the amount (if any) of the net income of the trust (as determined under subsection 95(1) ITAA36) included in the beneficiary’s assessable income.

2. 2016-17 MID-YEAR ECONOMIC AND FISCALOUTLOOK (MYEFO 2016-17)

On 19 December 2016, the Treasurer released the MYEFO 2016-17. Key tax measures announced include:

• A specific measure will be introducedpreventing the distribution of franking creditswhere a distribution to shareholders isfunded by particular capital raising activities(see Taxpayer Alert TA 2015/2).

• The Commonwealth Penalty Unit will increasefrom $180 to $210 on 1 July 2017, indexedevery three years in line with CPI.

• The ATO will be allowed to disclose toCredit Reporting Bureaus the tax debtinformation of businesses that have notsatisfactorily engaged with it. This willinitially apply to businesses that have anABN and debts of greater than $10,000that is at least 90 days overdue.

1. SIMPLER BAS FOR SMALL BUSINESSDEBUTS

From 19 January 2017, the ATO is providing newly registered small business the option to report less GST information on a simpler BAS. This initiative will extend to existing small businesses from 1 July 2017. Specifically, small businesses will only need to report the following GST information on their BAS:

• GST on sales (1A)

• GST on purchases (1B)

• Total sales (G1)

Other reporting requirements will be removed.Further information is available at ato.gov.au; search using code “QC 48878”.

Tax training 2017 Top up your CPD and keep on top of important tax and SMSF issues with our popular events.

Tax discussion groups

Monthly in Melbourne & Sydney

Super discussion groups

Bi-monthly in Melbourne & Sydney

The new sharing economy: what are the practical tax issues webinar

22 February 2017

FBT and salary packaging seminars

Melbourne: 7 March 2017; Sydney: 8 March 2017

Taxing intellectual property webinar

15 June 2017

taxandsuperaustralia.com.au/events

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