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ATO Attack on Rental Property Expense Claims

We have recently helped a number of taxpayers who have had their rental property deduction claims queried, and often disallowed, by the ATO.

The property is usually in a ‘holiday town’ and is advertised as being available for rent all year but is also occasionally used by the taxpayer and their family to stay in. The taxpayer’s use is usually only a couple of weeks each year.

The ATO argues that the taxpayer is only allowed to claim deductions for interest etc. up to an amount equal to the actual income derived. So if the property is actually only rented out for 6 weeks and derives rent of $3,000 then the ATO says the taxpayer is only allowed to claim deductions of $3,000. This is despite the fact that the property was available for rent for 50 weeks of the year (the taxpayer staying in it the other two weeks).

The ATO argues that the property was not genuinely available for rent even though it has been advertised on the internet and listed with a real estate agent. The ATO tends to rely on very old Board of Review and Administrative Appeals Tribunal cases that have different facts to support its view. But other, more recent cases, indicate that provided the property is available for rent (e.g. listed with a real estate agent for rental) then the expenses incurred can be claimed for that period as well as for the period the property was actually rented out.

We believe the ATO is taking too harsher stance in these circumstances. The cases the ATO relies on arose in the pre-internet era. We reject the ATO’s view that advertising a property on the internet is not sufficient for the property to be genuinely available for rent. Hopefully there will be a test case in the near future.

 

If you or your clients need help in challenging the ATO’s disallowance of expenses, or in responding to the ATO’s position paper, please contact Rob Warnock or Patrick Cussen on 1300 267 529.

 

Below is a link to the ATO’s website page ‘Focus on holiday home rentals’

https://www.ato.gov.au/media-centre/focus-on-holiday-home-rentals/

 

By |June 6th, 2018|Uncategorised|0 Comments

Changes to Small Business CGT Concessions

A bill containing changes to the Small Business CGT Concessions (‘SBC’) has now been introduced into Parliament. It is Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018 (Cth) (‘the Bill’). According to the Bill, when passed, the changes will apply in relation to CGT events happening on or after 1 July 2017. That is, the changes are retrospective.

The first thing to note is that the changes only apply where the asset being sold, or in respect of which the CGT event happens, is a share in a company or an interest in a trust (e.g. a unit in a unit trust). If the CGT event happens in relation to some other type of asset the changes do not apply.

The changes were introduced to stop taxpayers accessing the SBC in certain unintended circumstances. Below you will find examples demonstrating the operation of these changes.

 

Example 1:

Bob owns 20% of the shares in Bigit Pty Ltd, a private company that develops and sells special IT systems to banks. The company’s market value is $50,000,000 and so Bob’s shares are worth $10,000,000. Bob does not work in Bigit Pty Ltd, he simply invested in it when a few friends started it up and has seen his investment grow. If Bob sells his shares he will make a very large capital gain. He would not be entitled to the SBC as he would not be able to satisfy the basic conditions.

 

Example 2:

Bob is an accountant employed at a mid-sized accounting firm. Bob decides he wants to run his own practice and, so, buys a small accounting practice which has an annual turnover of $300,000. 8 months later Bob sells his shares in Bigit Pty Ltd and makes a $10,000,000 capital gain. Under the current rules Bob can now apply the SBC to this gain. Bob is a small business entity under section 152-10(1)(c)(i) of the Income Tax Assessment Act 1997 (Cth) (‘the ITA Act’). The shares satisfy the active asset test because at all times the 80% test in section 152-40(3) of the ITA Act was satisfied. Bob is a CGT concession stakeholder in Bigit Pty Ltd and so the additional basic condition in section 152-10(2) of the ITA Act is satisfied.

 

Under the changes in the Bill, section 152-10(2) of the ITA Act is being replaced so that where shares or units are sold additional conditions must be satisfied before the taxpayer can access the SBC. In addition to the current requirements the following applies:

  • a modified active asset test must be satisfied;
  • if the taxpayer does not satisfy the maximum net asset value test then the taxpayer must be carrying on a business just before the CGT event; and
  • the object entity (i.e. the company or unit trust in which the taxpayer owns shares or units) must also satisfy a modified MNAV test or small business entity test.

Thus, in the above example, as Bigit Pty Ltd is not a small business entity and cannot satisfy the MNAV test, Bob will not be eligible to apply the SBC to the gain made on the sale of his shares.

 

Unfortunately the changes will deny some taxpayers from applying the SBC in circumstances in which arguably they should be allowed to apply them. For example, where a shareholder owns 25% of the shares in a company that has a net value of $10,000,000 and a turnover of $3,000,000, and that shareholder wishes to sell their shares.

So, if a taxpayer now wishes to sell shares in a company or an interest in a trust and apply the SBC, the proposed changes must be carefully worked through to see if the new additional conditions can be satisfied.

 

Should you require assistance or advice regarding these proposed changes, please contact Rob Warnock or Patrick Cussen.

By |May 24th, 2018|Uncategorised|0 Comments

The ATO’s concern over SMSFs using reserves

The recent release of regulatory bulletin SMSFRB 2018/1 highlights what will spark the ATO’s interest where an SMSF is using reserves. The bulletin was issued in light of the 2017 super reform and the ATO’s concern that some SMSFs are implementing reserving strategies designed to circumvent restrictions imposed under the new law.

Overall, the Commissioner considers that the small membership nature of SMSFs means that the need to maintain reserves in SMSFs is distinct from the need to maintain reserves in APRA regulated superannuation funds. Consequently, the Commissioner expects the use of reserves by SMSFs to be extremely limited and, where an SMSF does hold reserves outside of such limited circumstances, the Commissioner will consider whether the trustee is acting in accordance with their obligations under the sole purpose test (section 62 of the Superannuation Industry (Supervision) Act 1993 (SISA)), the investment strategy of the SMSF and the anti-avoidance provisions (Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936)).

 

What arrangements are concerning the ATO?

The types of arrangements concerning the ATO include (but are not limited to) the intentional use of a reserve to reduce:

    • a member’s total superannuation balance:
    • to enable them to make non-concessional contributions without breaching their non-concessional contributions’ cap; or
    • to fall below $500,000 in order to allow the member to access the catch-up concessional contributions arrangements; or
    • to fall below $1.6 million in order to allow the SMSF to use the segregated method to calculate its exempt current pension income; or
    • a member’s transfer balance account to fall below the member’s transfer balance cap to allow the member to allocate a greater amount to retirement phase and thereby having a greater amount of earnings within the SMSF being exempt current pension income.

To help withstand ATO scrutiny, SMSF trustees using reserves should:

    • have a clearly articulated purpose for the reserve;
    • use the reserve in a way that adheres to the sole purpose test (section 62 of the SISA) and the requirement to formulate, review regularly and give effect to a strategy for the prudential management of reserves consistent with the fund’s investment strategy and its capacity to discharge liabilities (section 52B(2)(g) of the SISA and regulation 4.09 of the Superannuation Industry (Supervision) Regulations 1994);
    • not use reserves as a means of circumventing restrictions imposed by the 2017 super reform measures (which were brought in to help ensure the system is not used for wealth accumulation, tax minimisation or as an estate planning vehicle)
    • not use reserves as a step in a scheme to achieve potential tax benefits to which Part IVA of the ITAA 1936 may apply.

 
What reserves are allowed and not allowed by the ATO?

The ATO has provided examples of types of reserves that the Commissioner is prepared to allow and not allow for SMSFs. An SMSF that purports to maintain a reserve not allowed by the ATO may be required to demonstrate that the use of the reserve is not part of a strategy employed for the primary purpose of circumventing restrictions in the law and obtaining a tax advantage to which Part IVA of the ITAA 1936 could apply.

Type of reserve ATO response Further ATO comments
Administration NO This describes a reserve being used to fund future administration and operational expenses.
For an SMSF, administration and operational costs should be met from the net assets of the fund as the costs arise.
Investment NO This describes a reserve being used to smooth the impact of market fluctuations.
Reserves for investment smoothing are considered to be unnecessary in SMSFs as investment gains and losses should be reflected in the members’ accounts in the years they occur.
Operational NO This describes a reserve used to meet a registrable superannuation entity’s Operational Risk Financial Requirement (ORFR) target amount.
Operational risk reserves are not necessary in SMSFs as the trustee is not required to meet the ORFR target amount set by the Australian Prudential Regulatory Authority.
Contributions YES This describes the suspense account used to hold contributions pending their allocation under Division 7.2 of the SISR to an accumulation interest of a member.
SMSF trustees are able to accept contributions to these accounts pending allocation to the relevant member in accordance with Division 7.2 of the SISR
Pension YES SMSF trustees are able to maintain ‘pension reserve accounts’ while the SMSF continues to pay:

  • a complying lifetime pension (described in regulation 1.06(2) of the SISR);
  • a non-complying lifetime/flexi pension (described in regulation 1.06(6) of the SISR); and
  • a complying life expectancy/fixed term pension (described in regulation 1.06(7) of the SISR).

The amounts in these accounts comprise an amount available to the trustee, not the member, to satisfy the trustee’s liability to pay the complying pension.
A pension reserve account cannot be maintained to support an account-based pension (described in regulation 1.06(9A)(a) of the SISR).
Some further concessions exist in relation to flexi-pensions.

Self-insurance NO This describes a reserve used in funds that are permitted to self-insure.
Self-insurance reserve should not be maintained in an SMSF because of the prohibition imposed by regulation 4.07E of the SISR (subject to certain circumstances that had a start date before 1 July 2016).
Insurance cover NO An SMSF trustee should refrain from taking out an insurance policy over a fund member in circumstances where the premiums from the insurance policy are sourced from a reserve and the proceeds from the insurance policy are paid into the reserve.
Anti-detriment NO The anti-detriment deduction is no longer available for lump sums paid on or after 1 July 2019 or where the deceased member died on or after 1 July 2017. As the deduction has been removed, there is no longer a need to create this type of reserve from 1 July 2019.

 

What action should your clients take?

The ATO has reported that it will not apply compliance resources to review arrangements entered into by SMSFs before 1 July 2017 provided that the reserve:

      • was permitted by the law (section 115 SISA);
      • was permitted by the governing rules of the SMSF; and
      • was not used as a means to circumvent the 2017 super reform (this will be determined according to the facts and circumstances of each case).

Additionally, the ATO will continue to monitor the use of reserves by SMSFs.  Any unexplained increases in new or existing reserves or the allocation of amounts from a reserve directly into the retirement phase will likely attract scrutiny from the ATO.

An amount allocated from a reserve before and after 1 July 2017 will generally be counted as a concessional contribution unless otherwise excluded because certain conditions are met. If existing reserve levels need to be progressively distributed to members, careful consideration should be given to the concessional contributions rules.

 

If you or your clients require any assistance in dealing with SMSF reserves, please contact Thalia Dardamanis or Patrick Cussen on 1300 267 529.

By Thalia Dardamanis

By |March 19th, 2018|Uncategorised|0 Comments

When is a Memorandum of Understanding or a Heads of Agreement Legally Binding?

We often see matters where clients have negotiated the terms of a business deal with another person and the parties then sign a short form document (usually called a Heads of Agreement or Memorandum of Understanding) that embodies the terms of the deal with the intention of executing a more formal agreement later.

What happens if the parties cannot agree on the terms of the formal agreement?  Can a party that wants to proceed with the deal force the other party to go ahead? Or can the party that doesn’t want to proceed walk away?

The answer to this question is the lawyer’s standard answer: “It depends”.

The document needs to be clear about the parties’ intentions as that will determine the issue.

 

Masters v Cameron

The leading decision in this area is the High Court case of Masters v Cameron (1954) 91 CLR 353.

That case established that there are 3 possible scenarios:

  • The parties have reached agreement and intend to be immediately bound. However, the parties propose to have the terms restated in a form which will be fuller or more precise but not different in effect.
  • The parties have completely agreed on the terms of their bargain and intend no departure from or addition to those terms. However, the parties have made performance of one or more of the terms conditional on the execution of a formal document.
  • The intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract.

The High Court then identified that determining which scenario applies depends on “the intention disclosed by the language the parties have employed, and no special form of words is essential to be used in order that there shall be no contract binding upon the parties before the execution of their agreement in its ultimate shape”.

Later cases have established a fourth category – that is, cases where the parties are content to be bound immediately and exclusively by the terms on which they have agreed, while expecting to make a further contract in substitution for the first contract containing additional terms.

 

Cahill v Kiversun

A recent case that considered a Masters v Cameron scenario was the Supreme Court case of Cahill v Kiversun Pty Ltd; Molonglo Group (Australia) Pty Ltd v Cahill [2017] VSC 641.

Kiversun owned property in Collingwood.  Cahill and Molonglo were both property developers.

On 15 July 2016 Kiversun and Cahill signed a document headed “Agreement to Purchase”.  This document contemplated that there would be a formal contract prepared, but did not clearly state whether the parties intended the Agreement to Purchase to be legally binding.

On 29 July 2016, Kiversun signed a second document agreeing to sell the property to Molonglo for $10.15 million.

On 31 July 2016, Kiversun’s solicitors provided a formal contract to Cahill (this contract was prepared by Molonglo’s solicitors).  Under the Agreement to Purchase, Cahill had 5 days to accept the terms of the contract provided to it or Kiversun had a right to “withdraw from the sale”.  This contract included terms that Molonglo and Kiversun knew Cahill would not accept.

On 4 August 2016, Kiversun and Molonglo signed a formal contract by which Molonglo agreed to purchase the property.  This contract was conditional on Cahill failing to sign the other contract.

When Cahill did not return the signed contract with the deposit by 8 August 2016, Kiversun indicated that unless Cahill returned the signed contract by close of business, Kiversun would withdraw from the sale.  Cahill lodged a caveat over the property that day.

Molonglo lodged a caveat over the property the following day.

The court held that the Agreement to Purchase between Kiversun and Cahill was a binding contract.

Kiversun and Molonglo argued that the Agreement to Purchase was not a binding agreement.  Their major argument was that the document included the words “[t]his offer is conditional upon the purchaser’s solicitor’s approval of the final contract of sale and [s 32 statement]”.  They submitted that the use of the word “offer” indicated that there was no binding agreement.  However, the court held that the fact that Kiversun had a right to “withdraw from the sale” if the documents were not returned within 5 days was inconsistent with the claim that the document was only an offer rather than an agreement.

Molonglo has appealed to the Victorian Court of Appeal in this case.  Interestingly, Kiversun has not appealed.

This case highlights that it is extremely important that if:

  • someone has negotiated a deal but does not want to be legally bound until some other event has occurred or a formal document is prepared; or
  • someone has negotiated a deal and wants the other party to be legally bound

that any document that is signed reflects the desired outcome.

Ideally, the document should clearly state whether or not the document is intended to be binding.

 

Contact Patrick Cussen, Nicole Wilson or Konnie Lontos if you or a client are about to sign a Heads of Agreement or Memorandum of Understanding and you want advice about the legal effect of the document.

By Patrick Cussen

By |March 19th, 2018|Uncategorised|0 Comments