Tax Avoidance Chapter 23 PDF

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Chapter 23 Text book Q & A and summary ...

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23. Tax Avoidance Difficulty distinguishing between tax planning and tax avoidance Taxpayers are not in general obliged to structure transactions in a way as to attract greater tax liability: Fletcher v FCT 1991  Exceptions are not available to taxpayers with an adjusted taxable income of $250,000 or more: s 35-10(2E) – integrity measure  Does not apply to losses incurred in primary production or professional arts businesses provided the taxpayers assessable income (excluding net capital gain) from other sources in the income year is less than $40,000: s 35-10(4)

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General anti-avoidance provision: Part IVA Key elements     

Must be a scheme as defined in s 177A ITAA 1936 Must obtain from the scheme a tax benefit as defined in s 177C Person must enter into the scheme for the sole purpose/dominant purpose of enabling the tax payer to obtain a tax benefit: s 177D When all elements are satisfied, commissioner is empowered to cancel the tax benefit by for example including the amount in assessable income or denying the deduction of the amount: s 177F Amendments applied to schemes retrospectively on/after 16 November 2012. P722

Scheme    

Defined in s 177A(1) – proposal, arrangement, course of action, understanding etc May be unilateral and does not require more than one person: s 177A(3) First, applies if a person enters a scheme for a dominant purpose of obtaining a tax benefit: s 177D Tax benefit must arise in connection with the scheme: s 177D(a) ITAA 1936

Tax Benefit   

Defined in ss 177C and 177CA Amount not being included in the assessable income of the taxpayer, where in absence of the scheme it would have been reasonably expected to be included Determine tax benefit: o Comparison between what taxpayer did and what would have been done o Conduct that would have occurred but for the scheme: counterfactual; Commissioner of Taxation v Lenzo 2008, or an alternative postulate; FCT v Hart 2004

Dominant Purpose  

Subjective purpose of taxpayer is irrelevant: Eastern Nitrogen Ltd v FCT 2001 Objective purpose determined using s 177D ITAA 36 o Manner in which scheme was entered into/carried out o Form and substance of the scheme o Timing at which scheme was entered into and the length of the period during which the scheme was carried out o Result that would have been achieved by the scheme o o o

Change in the financial position of the relevant taxpayer Change in financial position of any person connected to the taxpayer Any other consequence for the relevant taxpayer and any person connected with the taxpayer

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o Nature of the connection between the taxpayer and the person connected to the taxpayer Dominant purpose: ‘ruling, prevailing, or most influential purpose’ FCT v Spotless Services 1996

High Court Cases on Part IVA    

Value shifting step involved getting a tax benefit: FCT v Peabody 1994 Genuine commercial purpose with tax benefit. No reasonable person would go through the complex procedures so secure a low interest rate in the absence of tax benefit: FCT v Spotless Services 1996 Dominant purpose was to gain a tax benefit from an interest deduction, and hired a professional advisor: FCT v Consolidated Press Holdings Ltd 2001 Commercial purpose, but dominant purpose was tax benefit: Hart v FCT 2004

177D SCHEMES TO WHICH PART APPLIES This Part applies to any scheme that has been … entered into after 27 May 1981, where- (a) … the “relevant taxpayer” … has obtained … a tax benefit in connection with the scheme; and (b) having regard to [8 matters], it would be concluded that the person … who entered into … the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme … 8 Matters Listed in s.177D(b) ITAA 1936 Need to consider all, but not necessary to refer to in a judgment a “global assessment of purpose” is acceptable: Consolidated Press (i) the manner in which the scheme was entered into …; (ii) the form and substance of the scheme; (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (iv) the result in relation to the operation of this Act that … would be achieved by the scheme; (v) any change in the financial position of the relevant taxpayer …; (vi) any change in the financial position of any person who has … any connection (whether of a business, family or other nature) with the relevant taxpayer …; (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi) …; and (viii) the nature of any connection … between the relevant taxpayer and any person referred to in subparagraph (vi)

Question 23.2 George is an accountant with an income of $300,000 per year and he is looking for a tax-effective investment in agriculture. He decides to invest in Hardwood Forests Pty Ltd, the promoter of a scheme for growing trees in northern New South Wales. 49 other investors have already signed for the scheme. The promoter has a private ruling from the Commissioner that the non-commercial loss rules will not apply to the investment. George was supplied with contractual documents that give him the right to be informed of the progress of the venture and the right to remove the promoter and substitute another by majority vote of the investors. On 29 June this income year, George writes out a cheque for $50,000 and hands it to Smith, a director of the promoter, who in turn hands him a cheque for $200,000 made out to George. George endorses the cheque to Hardwood Forests Pty Ltd and hands it back to Smith. The promoter has 50 hectares of land in northern New South Wales and one hectare is allocated to George, but it is not identified by the end of the income year. The clearing and planting of the trees commences on 29 June this income year. No returns are expected from the venture until at least ten years later. Advise if George can claim a tax deduction of $250,000 in this income year. Answer The answer should include the following points:   

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Whether George is regarded as carrying on a business: likely yes: Hance v FCT (2008) 74 ATR 644. Whether the payments are capital in nature: likely no: Hance. Division 394 ITAA97 which is the statutory regime (effective since 2007) stipulating the conditions for investors in forestry managed investment schemes to obtain a deduction for payments made under such schemes, including the general rule of allowing deduction for initial contributions to the scheme provided they hold the interest for at least 4 years. Before the enactment of Div 394, a range of pre-payment rules applied to the deductibility of prepaid expenditure with regard to agricultural schemes, including ss 82KZL to 82KZO, and 82KZMG ITAA36. The possible application of Part IVA, including the concepts of scheme, tax benefit and dominant purpose. It should be noted that the Commissioner now in general accepts that investments in managed investment schemes similar to the one considered in Hance are deductible.

Question 23.3 George is a fund manager with Bathurst Pty Ltd. His strategy is to buy shares in companies that have a low priceearnings ratio, and when the shares rise in price, he switches his investment to different companies. In June 2004 George caused the fund to buy 1 million shares in the Ajax Mining Ltd at $4 per share. In June this income year, Ajax Mining Ltd's shares are listed at $12 each and George decides it is time to sell. The fund also has a parcel of 2 million shares in Hill Ltd which were purchased in the year 2000 for $10 each and are now worth $4 each. On 30 June this income year, George causes the fund to sell the 1 million shares in Ajax Mining Ltd, as well as all the shares in Hill Ltd at $4 each. Two months later, George asks the analysts at the Bathurst Pty Ltd to analyse all financial documents of Hill Ltd including the profit and loss account, the balance sheet and a new prospectus just issued by Hill Ltd. Based on a favourable report concerning the prospects of Hill Ltd, George instructs Bathurst Pty Ltd to purchase 2.5 million shares in Hill Ltd at $4.50 each. Advise the tax implications of the disposal of the shares on 30 June this income year. Answer 23.3 The answer should cover the following issues:     

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CGT event A1 occurs upon the disposal of the shares in Ajax and Hills Capital gain on disposal of Ajax shares = $1M x (12 – 4) = $8M Capital loss on disposal of Hills shares = $2M x (10 – 4) = $12M Assuming no other CGT event for the income year, net capital loss = $4M The possible application of Part IVA, including the issues of a scheme, tax benefit, and whether the dominant purpose of the disposal of Hills shares is for the tax benefit. In particular, s 177C(1)(ba) of ITAA36 includes as a tax benefit a capital loss being incurred by a taxpayer where it might reasonably be expected not to have been incurred if the scheme had not been entered into or carried out. The relevant case being Cumins v FCT (2007) 61 ATR 625, in which the Full Federal Court held that Part IVA applied. TR2008/1 that explains the ATO position on wash sales, in particular paragraph 13 which discusses the factors the Commissioner would take into consideration with respect to the dominant purpose issue.

Question 23.4 Sara Lee entered into a contract in April 2014 to sell part of its business to a Swiss company Roche Holdings Ltd for $60 million. The sale is to be effected in November 2014. In August 2014, the board of directors was advised by Sara Lee's lawyers that the company has made a CGT loss of $6 million in the income year, and the sale of its business to Roche will result in a CGT gain of $8 million. Subsequently Sara Lee and Roche entered into a deed of release in October 2014 whereby the contract of April 2014 was discharged for a consideration of $900,000 payable to Roach. Two hours later after negotiation and change of some contractual terms, Sara Lee entered into a new contract to sell the identical part of the business to Roche holdings for $61 million. The minutes of the director's meeting said that the reason for discharging the earlier contract was that the lawyers advised that the change in consideration meant that the original contract could not be ratified, and that a new contract had to be entered into. The minutes also declared that changes in the redundancy entitlements also meant that discharge and entry into another contract was the safest path to create a binding contract. Advise the tax implications of these transactions and whether Part IVA will apply.

Answer The following points should be discussed in the answer: 

CGT event A1 is triggered by the disposal of the business, and the timing of the event is the contract date.

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Sara Lee would have made a capital gain of $8M in the 2013-14 income year under the original contract.

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The new contract would mean that effectively the timing of the A1 event would be deferred to the next income year, and as a result, the $8M capital gain could be partially offset by the $6M capital loss made in that income year.

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The possible application of Part IVA, including the concept of a scheme, tax benefit and dominant purpose. In particular, the discharge of the original contract is likely to be regarded as a blatant step taken solely or predominantly for the tax benefit.

Question 23.5 Jessica is a financial accountant working in the finance department of an engineering consulting firm. The firm recently reviewed their internal operations and decided that the finance department should be outsourced to independent third party contractors, with existing staff being made redundant. The firm was however keen to retain Jessica due to her intricate industry knowledge. To achieve this, the following steps were undertaken: 1. Jessica incorporated a company with the registered name of Jessica’s Accountancy Services Pty Ltd (‘JAS’). Jessica is the sole director and shareholder of JAS. 2. The firm and JAS entered into a ‘Services Contract’ for the provision of accountancy services for an annual sum of $130,000. This annual sum is equivalent to what would have been Jessica’s annual salary. Jessica is required to attend the premises of the engineering firm during normal business hours each working day. A bungalow located at the rear of Jessica’s home, which is separate to her house, is dedicated to Jessica to undertake any JAS business matters. JAS also employs her son at an annual salary of $30,000 to undertake administrative tasks. Advise Jessica and JAS of the tax implications of the annual sum of $130,000 and the salary of $30,000 paid to her son. Answer The answer should include the following points with regard to the personal services income (“PSI”) regime:   

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The $130,000 is personal services income as defined in s 84-5 ITAA97. If the PSI regime applies, the $130,000 service fee derived by JAS would be deemed to be Jessica’s assessable income, unless the amount is paid promptly to Jessica as salaries: s 86-15 ITAA97. The regime will not apply if JAS is carrying on a personal services business under one of the four tests stipulated in Div 87 ITAA97, namely, results test; unrelated clients test; employment test; and business premises test. Results test (see [23.200] for detail): Whether this test is satisfied depends on the exact circumstances and arrangements between JAS and the firm. It is likely that JAS will fail to satisfy this test if Jessica’s work conditions and responsibilities are basically the same as her employment before: Re Scimitar Systems Pty Ltd and DCT (2004) 56 ATR 1162. If JAS fails this test, it cannot rely on the other three tests if at least 80% of its personal services income is derived from the firm: s 87-15(3). Assuming JAS fails the results test but derives more than 20% of its personal services income from sources other than the firm, it can escape the PSI regime if it satisfies any of the three remaining tests. Unrelated clients test (see [23.210] for detail): JAS would have satisfy this test if for example it advertises to

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the public for the provision of accounting services. Employment test (see [23.220] for detail): The employment of Jessica’s son is unlikely to meet this test, as the son is an associate of Jessica. Also, this test will not be met if her son performs only auxiliary activities such as typing, cleaning and filing; Business premises test (see [23.230] for detail): As JAS has exclusive use of the bungalow which is physically separate from Jessica’s home, it is likely that this test is satisfied. PSI determination: even if JAS fails to satisfy any of the four tests, it may apply for a PSI determination under which, if successful, it would be deemed to be carrying on a personal services business and thus not subject to the PSI regime. However, it is unlikely that the Commissioner would issue the determination to JAS as there is no unusual circumstance that has prevented JAS from satisfying the tests: s 87-60 ITAA97. Deduction of the $30,000 salary paid to Jessica’s son: it is unlikely to be deductible, as the payment is made to an associate in relation to the production of personal services income and the son does not perform the principle work that generates the personal services income: s 85-20 ITAA97....