Impact of the Federal Budget 2014 on Independent Contractors

The Federal Government has confirmed its commitments to independent contractors and criticised government agencies for an attack on the self-employed (The Coalition’s Policy for Small Business (August 2013); Australian Financial Review 23 September 2013, ATO told to end ‘attack’ on self-employed; Australian Institute of Company Directors Magazine 1 February 2014 Q & A with Bruce Billson).

However, there is increasing inconsistency in the taxation, administration and agency supervision of the independent contractor industry generally, and as a result of the Federal Budget 2014.

The Federal Budget 2014 confirmed the reduction of the corporate tax rate to 28.5% from 1 July 2015 and announced a 2% temporary budget repair levy on individuals’ taxable income in excess of $180,000 per annum for the 2015 to 2017 tax years (Federal Budget 2014 at 15).

The increased divergence of corporate and personal progressive tax rates, the repeal of the corporate sufficient distribution regime and the refund of imputation credits encourage income diversion to companies, retention of profits at the corporate rate and deferral of distributions to non-corporate shareholders in subsequent low tax years to reduce personal progressive tax rates (Board of Taxation, ‘Post Implementation Review of Division 7A…’, 20/12/2012 at [2.21]).

The increased divergence of corporate and personal progressive tax rates will likely increase pressure on the personal services income regimes and the private company constructive dividend regime particularly in the independent contractor industry (Div. 86 ITAA 1997; Part IVA 1936; Div. 7A ITAA 1936).

The Board of Taxation has reviewed the personal service income regime and is reviewing Div.7A  and emphasises the objectives of equity, efficiency, simplicity, transparency and tax neutrality on reform(‘Post-implementation Review into the Alienation of Personal Services Income Rules’, 31/10/2009; ‘Post Implementation Review of Division 7A…’, 25/03/2014).  Those objectives and the post implementation reviews are undermined by the Federal Budget 2014.

These increasing inconsistencies will need to be addressed in the Taxation White Paper to restore equity, efficiency, simplicity, transparency and tax neutrality to the taxation, administration and agency supervision of the independent contractor industry.

Trusts Reform

The Federal Budget 2014 has deferred the start date of the managed investment trust regime until 1 July 2015 (at 19). Draft legislation for the managed investment trust reforms is scheduled for release in June 2014.

The Federal Government has previously announced reforms to the taxation of trust income (Assistant Treasurer MR 25/2010), fixed trusts (Assistant Treasurer MR 80/2012), bare trusts (Assistant Treasure MR 122/2012), investment manager regime (Johnson Report 15/01/2010) and collective investment vehicles (Board of Taxation Report 17/12/2010).

Steven Ciobo MP announced that the reform of the taxation of trusts will be examined in the context of the Taxation White Paper (TTI 29th National Convention, Hobart, 28/03/2014; The Coalition’s Policy for Small Business at [21] (August 2013)).

The Taxation White Paper is to be issued prior to the next Federal election which must be held on or before 14 January 2017 ((2013) 39 WTB [1681]) with any reforms scheduled for the Federal Government’s second term in office.  The consultation process has not been announced.

The previous timing of the trust reforms and managed investment trust reforms no longer appears to be aligned, which may create some disconformities.

Unfortunately, tax practitioners appear to have another 3-4 years of continuing uncertainty regarding the taxation of trust.

2nd BOT Discussion Paper on Div. 7A Reform

Div. 7A ITAA 1936 private company deemed dividends is a commonly encountered problem area for practitioners, which is difficult to construe and apply, often misunderstood by clients and practitioners and results in high compliance costs and frequent and unintended breaches.

On 25 March 2014, the Board of Taxation (BOT) issued the 2nd BOT Discussion Paper and proposed a new ‘transfer of value model’ for reforming Div. 7A.  The model has much to commend it.

Broadly, the proposal is:

  • legislative drafting based on the distinction between ‘temporary transfers’ (loans and use of assets) and ‘permanent transfers’ (payments, debt forgiveness and asset transfers) and between ‘passive assets’ and ‘active assets’;
  • annual testing and progressive deemed dividends over the life of temporary transfers based on a revised ‘distributable surplus’ methodology that exclude unrealised gains that are not related to permanent transfers;
  • a single 10 year loan at the Reserve Bank of Australia small business indicator interest rate (e.g. 10%) with prescribed maximum loan balances at year 3 (75%), at year 5 (55%), at year 8 (25%) and the balance at year 10 and interest at least payable at these dates (‘Rule of 78 Loan’);
  • UPEs to and loans from a private company beneficiary constituting a temporary transfer, unless the trust ‘ticks-the-box’ to forego the CGT discount (other than on goodwill); and
  • self-assessed corrective action mechanisms.

Rule of 78 Loans

The standardisation of the 7 year (unsecured) and 25 year (secured) principal and interest complying loans and the 7 year (unsecured) and 10 year (unsecured) interest only UPE investment agreements to a single 10 year ‘Rule of 78 loan’ will no doubt have winners and losers.

Broadly, The Rule of 78 apportions the total interest payable under a loan in accordance with an arithmetic progression.  Under the rule the early instalments include larger interest components than the later ones, generally for loans of less than 18 months (Ruling TR 93/16).

Particularly, one would like to forecast the extent of any consequential impact on the taxpayer and the property market of shortening the 25 year loan used to acquire long term real property.

Tick-the-Box Trust Elections

As a compromise, the ‘tick the box’ option has significant appeal, providing a practical and simple solution to the UPE problem, whilst balancing the policy considerations.  However, the compromise is not necessarily consistent with policy.

The tick-the-box approach does not adequately recognise that the CGT discount can be indirectly obtained by a sale of shares in the Trading Company P/L.  Since the opportunity to sell shares in, rather than the business of, Trading Company P/L is market driven and not policy driven, the entrenching of a restrictive policy position over a more favourable policy position is harsh.

Small businesses are likely to elect to tick-the-box where the CGT small business concessions would shelter the capital gain despite the loss of the CGT discount.  The loss of the CGT discount for taxpayers that do not qualify for the CGT small business concessions may require restructuring to preserve the CGT discount.

Self-corrective action

Self-corrective action is an imperative reform.

It is unclear why there should be a culpability threshold (objectively not deliberately ignored or attempted to circumvent Div. 7A) for corrective action.  Effective corrective action removes the previous tax benefits.  Effective corrective action would be encouraged if corrective action has been commenced or completed before notification of an audit or review and after commencement of an audit or review was not susceptible to a penalty reduction for voluntary disclosure or permitted without the approval of the Commissioner.

Conclusion

Detailed consultation on the 2nd BOT Discussion Paper proposal will no-doubt fill in needed detail and refine the proposal, but implementation would seem a long way off in the future.

In the interim, clients and practitioners must manage the current Div. 7A difficulties and attempt to ensure that any structuring will not have adverse consequences arising from the reform of Div. 7A.

29th National Convention 26-28 March 2014

The Tax Institute is holding the 29th National Convention in Hobart on 26-28 March 2014.

Papers of particular interest are:

  • The Commissioner’s address
  • Alexis Kokkinos: Trusts - State of Play
  • Paul Sokolowski: Penalty Provisions
  • Gordon Cooper: CGT Discount and Non-Residents
  • David Marks: Part IVA - How’s your Postulate?
  • Tony Underhill: Establishing Residence in the Global Village.

On 27 March 2014, I presented on Division 7A - The Contortionist.  The paper discusses the Board of Taxation’s 2nd Discussion Paper on Div. 7A reform published on 25 March 2014 and its impact on structures and restructures to address Div. 7A.

2013 Tasmanian State Taxation Convention - 17 October 2013

The Tax Institute will hold the Tasmanian State Conference in Launceston on 17-18 October 2013.

Papers of particular interest are:

  • Ali Noroozi (IGOT), Observations on Tax Administration in Australia by the Inspector General of Taxation;
  • Michael Hine (KPMG), Div. 7A One Step Forward – How Many Backwards?;
  • Michael Parker (H&W), A Review of Major Tax Development 2013;
  • Rob Warnock (M+K), Small Business CGT Concessions – Keeping Out of Harm’s Way;
  • Elen Seymour (Uni WA), Tax and Social Networking; and
  • Allan Swan (Swann & Yii), Tax Issues in Business Succession Planning and Second Generation Control Issues Workshop.

The Convention Dinner is at Josef Chromy Wines with the Winemaker Jeremy Dineen speaking.

A great program by the Organising Committee of Craig Leighton, Ken Davey, Matthew Pawson and Tania Triffitt.

 

TEN – 1st Annual Trusts Taxation Symposium – 16 September 2013

On 16 September 2013, I presented ‘Trust Resolutions: The Devil is in the Drafting’ for the Television Education Network’s 1st Annual Trusts Taxation Symposium being held on 16 & 17 September 2013.

Preparing trust distribution resolutions in a busy practice is an unenviable task.

There are continuing uncertainties regarding the taxation of trusts and a risk approach must be adopted regarding how to address the uncertainties when preparing trust distribution resolutions.

A methodical approach to training staff and undertaking work will assist to address these risks and to improve the quality of trust distribution resolutions.

The paper discussed:

  • approaches to drafting trust distribution resolutions;
  • determining distributable income;
  • allocating expenses and losses;
  • differentially streaming income and capital gains;
  • managing non-resident beneficiary distributions;
  • example trust distribution resolutions; and
  • the consequences of invalid trust distributions and additional amended assessment income.

This paper addresses the practical drafting aspects of preparing trust distribution resolutions and adopts a functional approach to trust distribution resolutions.  The paper refers to illustrative trust instrument clauses and trust distribution resolutions.

The Tax Institute – Breakfast Club – 29 August 2013

I recently presented on Tax Advocacy: Writing to Win, which discussed my tips, traps and examples for preparing more effective written advocacy.  

The paper provided simple examples of objections and penalty and GIC remission requests.  

More effective written advocacy should improve the persuasiveness of the client’s case and the prospects of achieving the desired result

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13th Annual States’ Taxation Conference

The Tax Institute will hold the States’ Taxation Conference in Adelaide on 25-26 July 2013.

Anticipated highlights of the convention in program order include: 

  • the Commissioner’s audit and investigation powers;
  • managing the duty implications of takeovers;
  • exemptions and concessions in Landholder duty
  • payroll tax employment agency provisions; and
  • the aggregation of dutiable transaction.

All the revenue authorities are very well represented.

 

Differential Streaming of Trust Income

Legislative amendments effective 1 July 2010 permit differential streaming of capital gains and franked dividends by a trust.  However, the effectiveness of streaming other classes of income remains unsettled as a result of FCT v Bamford and FCT v Greenhatch  and Treasury failing to publish a view.

The better view is that a trustee can differentially stream all classes of income (other than income under the foreign tax credit provisions).  The entitlement to differentially stream under the foreign tax credit provisions remains unclear and legislative amendments similar to those effected for franked distributions should be made.

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Greenhatch v FCT - CGT Streaming Appeal

On 10 May 2013, the High Court of Australia refused the taxpayer special leave to appeal FCT v Greenhatch [2012] FCAFC 84; [2011] AATA 479.

Accordingly, prior to 1 July 2010 and the amendments made by TLAM No 5 2011, differential streaming of capital gains between trust beneficiaries was ineffective. The beneficiaries of any trust that has differently streamed capital gains will have an exposure to audit activity, amended assessments and penalties.

The FCT will not be undertaking active compliance for the 2009/10 and earlier income years to correct differential capital streaming, unless there is a deliberate attempt to exploit Division 6 ITAA 1936 or the matter is otherwise selected for audit.

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FCT v Greenhatch - CGT Streaming Appeal

The taxpayer’s High Court Special Leave Application in FCT v Greenhatch [2012] FCAFC 84; [2011] AATA 479 is to be heard on 10 May 2013.

Legislative references are to the Income Tax Assessment Act 1936 (ITAA 1936), the Income Tax Assessment Act 1997 (ITAA 1997) and the Taxation Laws Amendments (2011 Measures No. 5) Act 2011 (TLAM No 5 2011).

There is uncertainty whether a trust could differentially stream capital gains to beneficiaries before 1 July 2010 (amendments made by TLAM No 5 2011) (Improving the Taxation of Trust Income - Discussion Paper 4 March 2011 at [3.2]).

Broadly, in dispute is:

  • whether the assessable income of a beneficiary includes a ‘blended’ amount of all classes of income and capital gains of a trust’s taxable income (sec. 97 ITAA 1936; FCT v Bamford [2010] HCA 10); and
  • whether the part of the trust amount attributed to a trust gain is given a share/proportionate or causative amount construction (sec. 115-215(3)(b) ITAA 1997 ).

Appearing for the taxpayer are A. H. Slater QC and M. Y. Bearman instructed by Harwood Andrews Lawyers.

Director PAYG Penalty Program

On 17 April 2013, the ATO announced a program to contact directors regarding outstanding pay as you go (PAYG) liabilities as part of the Strengthening Director Obligations initiative.

Legislative references are to the Taxation Administration Act 1953 (TAA 1953) and the Superannuation Guarantee (Administration) Act 1992 (SGAA 1992).

A company is liable to a penalty to the extent the company fails to withhold or pay:

  • PAYG amounts (Div. 12 TAA 1953 – remuneration, voluntary agreements, labour hire, TFN or ABN non-quotation, dividend, interest & royalty, foreign resident, natural resources, and managed investment trust payments);
  • alienated personal services payments (Div. 13 TAA 1953);
  • non-cash benefits (Div. 14 TAA 1953);
  • adequate superannuation (Div 12 SGAA 1992); or
  • a PAYG or superannuation guarantee charge (SG Charge) estimate (Div. 268 TAA 1953).

A director is liable to pay a concurrent penalty if the company has not withheld the amount on the initial day for withholding or liability and has not paid the amount by the relevant month, quarter or annual due date (sec. 269-20 TAA 1953).  The director may be relieved of liability if the penalty is remitted because the company pays the amount, an administrator is appointed or the company begins voluntary winding up (sec. 269-30 TAA 1953) or the director establishes a relevant defence (sec. 269-35 TAA 1953).

The program is expressly limited to PAYG liabilities.  It is common for companies with PAYG liabilities to have other withholding or SG Charge liabilities.  If a taxpayer may be at risk, it may be appropriate to review all withholding and superannuation obligations and make a voluntary disclosure of any shortfall to obtain a reduction in penalties (PSLA 2003/11 – remission of PAYG penalty; PSLA 2006/6 – remission of SG Charge).

Director Penalty Notice

A director has limited opportunity to avoid personal liability under a director penalty notice (DPN) issued on or after 30 June 2012 for pre-30 June 2012 PAYG Withholding liabilities under the  Tax Laws Amendment (2012 Measures No. 2) Act 2012  amendments.

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Tax, the way ahead

Commissioner Jordan’s speech to the TTI 28th National Convention, Perth, 14 March 2013 foreshadowed under his leadership:

  • greater emphasis by the ATO on effectiveness (not merely efficiency);
  • earlier, more effective and more solution oriented consultation with stakeholders and consultants for tax policy and law design;
  • implementation of streamlined and independent internal review of disputes and earlier and more timely, transparent and conciliatory dispute resolution; and
  • restructuring of the private and class ruing systems processes to facilitate timely, transparent and responsive guidance but possibly with a fee-for-service arrangement if external independent advice is necessary.

This focus may be seen as responsive to aspects of stakeholder submissions and the Inspector General of Taxation reports on the:

  • Review into the ATO’s use of early and alternative dispute resolution (released 31 July 2012); and
  • Review of aspects of the ATO’s administration of private binding rulings (released 24 November 2010); and
  • Review into the ATO’s administration of class rulings (released 14 March 2012).

While laudable, implementation will be challenging in such a large organisation and improvements are likely to be incremental only.