Velocity Legal (00:03.200)
This is Tax Talks, Australia’s tax news podcast for accountants and tax practitioners. The podcast designed to help you grow your practice.
Velocity Legal (00:12.400)
Well, welcome to Tax Talks, our September episode. I’m your host, Rajan Verma.
I’m your host, Andrew Henshaw.
Today, we’re very fortunate to have Karen Goodfellow of Goodfellow Tax Advisory join us. Welcome, Karen.
Thank you. It’s great to be here.
Karen, why don’t you tell us a bit about your background and your practice?
Sure. I’m a specialist tax adviser, and I run Goodfellow Tax Advisory, as you mentioned. We’re a boutique tax advisory firm.
Most, if not all, of my clients are accountants and other advisers. I don’t really deal directly with taxpayers.
Most of my clients come to me when they’ve got a complex problem that they need help with. They can see there’s a tax issue, but they don’t necessarily have the internal capacity to deal with it, and they realise they need a specialist tax brain involved.
That’s when they might come to me. I’ve carved out a bit of a niche in the small business CGT concessions space, but my work is a lot broader than that.
I do pretty much anything in the private client space. I do a lot of restructuring work, which I’m expecting to really ramp up as a result of the Budget announcements.
I also do a bit of bespoke training, which I really enjoy. I guess you could say I work in that space where an accounting firm, or another kind of adviser, says, “We’re out of our comfort zone here. We need someone else.” That’s where I fit in.
Velocity Legal (02:08.319)
I imagine the latest Budget announcements were right in the sphere of your regular practice. Are you finding that you’re getting a lot of questions from your client base?
I am getting a lot of questions. A lot of my clients are in a bit of a “we don’t need to worry about that now” space. They’ve got a lot of very pressing issues that have to be dealt with today.
Obviously, as all three of us understand, and Andrew, you and I were speaking about it earlier, there’s only so much time you can invest in something that is not yet settled.
A lot of them understand that, but everybody is very concerned. I’m telling them to absolutely be aware, educate themselves and identify the clients who might be affected.
We can start thinking about it, but let’s not panic and let’s not take any action just yet. That’s the space I’m telling them they should play in.
I think that has certainly been the general consensus. The Budget announcements are relatively recent. We’re talking about May, and there has been some discussion since then, but the general feeling has been to hold fire and not take any drastic steps just yet.
Particularly as we wait for legislation and a bit more clarity to come through.
That is probably a good segue into the first item on our agenda today, which is the exposure draft legislation, particularly the trust changes.
Velocity Legal (04:02.000)
The first thing is the trustee minimum tax, the 30% minimum tax. We all knew it was there from the Budget. What we were lacking was the detail, and we’ve got some detail now in the exposure draft.
A lot of detail.
Where do we begin with it?
Just to set the scene, I believe it was 3 September when we received this tranche of Bills, exposure drafts, explanatory memorandums and explainers.
I can’t remember how many there are, but it’s eight or nine. There are a lot of documents, with a consultation window until 18 September.
Very short.
We did put a consultation submission into the first round, before there were exposure drafts, but I’ve seen a lot of discussion on LinkedIn and elsewhere about whether they are even listening at this point.
I don’t know. What’s your take on that, Karen?
I agree entirely. I’ve been discouraged, to put it mildly, by the apparent lack of consultation. It is striking me as consultation in name only.
Two weeks to review, consume, understand and then respond to all those documents you mentioned, Andrew, is simply not adequate. It’s not feasible.
They can’t expect to have received reasonable responses. Then there is the speed at which they’re turning things around.
If you think about the first consultation paper on the 30% minimum tax for trusts, which you said you responded to, the exposure draft was out very soon afterwards.
It’s hard to believe they took much of those responses into account. I completely understand your decision not to devote more resources to responding to the exposure draft.
Velocity Legal (06:18.800)
The funny thing about the timing of the release of the exposure draft is that it happened while The Tax Institute’s Tax Summit was on. Many of us were in Sydney and distracted by that, and then, of course, the weekend was straight afterwards.
I feel like we lost four days because of the particular date on which they dropped it.
At the Tax Summit, the Commissioner of Taxation was there. It’s not like the ATO didn’t know. I mean, it wasn’t the ATO releasing it, it was the government, of course.
It may have been coincidental, but it just seemed a bit funny to me.
I agree, Raj. If I were conspiracy-theory-minded, which I’m not, I would wonder about the coincidence.
I’ve been telling people the story. I was in one of the sessions. It dropped, I think, at about 3.00 pm on the Thursday afternoon, which couldn’t have been closer to the middle of the conference if you tried.
It was a Wednesday, Thursday and Friday event, as you know. I really felt for the poor fellow who was presenting.
It was in a large theatre, and all of a sudden there was all this whispering. It was like a high school classroom when somebody has worked out that so-and-so is going out with someone else.
Everybody was whispering about it, and people even got up and left. I spoke to the fellow who was presenting afterwards because I know him slightly.
I said to him, “You must have wondered what was going on.”
He said that, in the middle of it, he thought, “I can’t be doing that badly.”
He could just feel the energy or the attention drain out of the room, which was really unfortunate.
Then, of course, the whole direction of the conference somewhat changed because this is such a far-reaching change.
Even presentations that weren’t directly on point inevitably touched on it because it touches so many things. Everybody who was scheduled to present afterwards had to somehow bring it in.
That’s right. It was tough going.
I’m glad I wasn’t presenting at the conference.
I did present, but thankfully mine was done on the Wednesday, so I got away with it.
Velocity Legal (08:53.519)
Let’s get stuck into the architecture and what is actually proposed.
The starting point is Division 6. We deal with it all the time. It’s broken, some would say, and it’s complicated.
What this seems to do is start by adding the minimum tax in certain situations.
For example, if the trust has retained income and has already been assessed at the top rate, then it has no work to do.
The exposure drafts do not rebuild Division 6. They add another layer on top of it, so that in certain situations the trustee is going to have to pay this 30% minimum tax.
It is adding complexity on top of complexity.
To be honest, I think there was a real opportunity here to rewrite Division 6 into the 1997 Act instead of adding more provisions within Division 6. That was a bit of a shame.
Generally, the way it works is to identify the circumstances in which the 30% tax applies.
If there’s already a trustee assessment, there’s no work to do.
If there are certain types of income, such as farming or primary production income, those are taken out.
Then you have the overarching question of whether you have a minimum tax trust to begin with.
That’s a good place to start. The exposure draft goes through what is excluded. We knew these things already, but we’ve now got more detail.
What’s excluded? A fixed trust, a special disability trust and certain testamentary trusts, for example.
There’s probably not too much controversy over those things. “Controversy” is probably not the right word, but there’s a lot of detail about what a fixed trust is.
The proposed definition is broader than we’ve had before. The thing with fixed trusts is that all these provisions in the tax legislation pick up the definition of a fixed trust.
You go to Schedule 2F, and the case law tells us that a fixed trust is actually a fairly narrow concept.
This gives us something broader, which I think is a good thing overall, because it would then flow through to the other provisions that are relevant to fixed trusts. That’s my reading of it, at least.
Velocity Legal (11:37.680)
My understanding is that they are changing the definition of a fixed trust in Schedule 2F.
The existing definition has requirements around the price at which redemptions and unit issues can occur. Valuations need to be undertaken in a certain manner, broadly in accordance with accounting concepts.
The point has often been made that a lot of trusts you would think are fixed, such as unit trusts, don’t actually meet that definition because they may have more open-ended issue and redemption powers and valuation procedures.
My reading is that they will amend the definition of a fixed trust, perhaps to make it not quite as tight as it was before.
Because they’re amending that definition, it will affect the entire tax legislation, not just this regime.
That’s my understanding as well. They are amending the core definition, which will affect any provisions that draw on it.
You’re right. I’ve always said to people that you would struggle to find a truly fixed trust.
A lot of my clients are under the misconception that unit trusts are fixed trusts just because they’re unitised. We all know that is not necessarily the case and is probably highly unlikely to be the case.
We’ve got that practice statement where the Commissioner sets out the circumstances in which he is willing to treat a trust that is not, in fact, fixed as if it were fixed.
That’s unsatisfactory because it is only an administrative position.
My problem with the proposed definition is that, yes, it broadens the definition, which is welcome, but I expect it to introduce a great deal of uncertainty.
In particular, what does “material discretionary elements” actually mean?
That isn’t a phrase we’ve seen before. It’s different from a term such as “vested and indefeasible”, which appears in the existing definition and around which we have a lot of settled law.
“Material discretionary elements” is an interesting phrase because it’s peppered throughout these provisions.
They also use it in the context of companies that can be nominated beneficiaries, provided they don’t have material discretionary elements.
You’re right. It comes up every so often, and I’ve wondered what it actually means.
What is material compared with immaterial? Where is the line?
Velocity Legal (14:16.480)
We then have sections in the exposure draft that remove certain components of income.
Regardless of the status of the trust, those types of income are not subject to the 30% rate.
The big-ticket item is primary production income. We then need a definition of what that is.
It sounds obvious, but it is really income derived from primary production, rather than passive income or something else.
From what I’ve seen in tax returns, they have a section for primary production income and non-primary production income.
I imagine it probably follows that. Whatever you would have included in that section of the return would be primary production income for the purposes of these rules.
There are a number of exemptions around distributions to DGRs and income paid to non-residents where withholding tax applies.
It’s a bit like Swiss cheese, with a number of holes in it.
If this does go ahead, you’re going to ask, firstly, what type of trust am I dealing with and, secondly, what type of income am I dealing with?
You will get more questions as you go, but those are the first two questions in determining whether the 30% tax will apply.
It’s like everything. Once you try to categorise something, you’re always going to end up with arguments at the margin.
Think about primary production income. As I understand it, the rules draw on the existing definition.
Even then, you can get into arguments about whether adjustment income is primary production income.
The other thing that has been pointed out to me is that capital gains are not primary production income.
If a farmer sells the land from which they are farming, the gain will not necessarily be excluded.
A farmer might think, “I don’t have to worry about this because all I earn is primary production income.” That may not necessarily be the case.
Velocity Legal (16:59.199)
There are mechanisms around the crediting system and how that is going to work. We know a bit more about that now.
This is the 30% offset. The trustee pays the tax and the beneficiary receives an offset.
Nothing has changed with the overall system, including the issue for companies.
That’s right. It’s a non-refundable offset, and companies are not eligible for it.
That means you wouldn’t distribute from a minimum tax trust to a company beneficiary because it would effectively result in double taxation.
I’d hoped that the submissions following the consultation paper would encourage them to think about that in a little more detail.
The consultation paper seemed to say, “We propose to deny it in full because it’s simple,” but my reading was that they were open to other ideas.
The policy they wanted to achieve was to avoid allowing a franking credit to be refunded in a way that resulted in less than 30% tax overall.
It seemed to me that they were open to another approach that would avoid double taxation while ensuring that, when the bucket company declared a dividend in the future, the overall rate could never fall below 30%.
Unfortunately, there is no engagement with that in this material.
You could think of ways to achieve it. For example, if the distribution goes from a trust to a company, the credit could be made non-refundable and unavailable for any other purpose.
You could have done it through the system, but we don’t have any of that.
We’ve got a section that provides the 30% offset, but a company doesn’t receive it.
Velocity Legal (19:26.320)
Let’s move on to the two other big items in the 30% tax proposal. One is entirely new, and the other is something we knew about previously.
Let’s start with the entirely new one, the EET, or whatever acronym people are using for it.
This came from left field.
The underlying issue was largely a stamp duty issue. If you are introducing the 30% tax and pushing people to restructure, what happens with stamp duty? What about the states? Will there be relief?
There are other costs as well.
I think the government listened to that concern and decided it needed to do something else.
It came up with a way in which a trust might not need to restructure but could make an election and be treated as essentially fixed.
I’m giving the government credit here, but that seems to be the policy behind the EET system.
When I first read it, I thought, “What is this?”
It’s another thing on top of what already exists. What were your thoughts before we unpack it?
So many. It was, as you say, Andrew, out of left field, to say the least. It’s nothing like anything we’ve seen before.
It gives you a ticket out of the 30% minimum tax, but you really have to make a bargain with the devil to get it.
It is an irrevocable bargain.
If you accidentally or intentionally extract yourself from the system, the consequence is significant.
It’s enormously restrictive.
Velocity Legal (22:13.280)
There was immediately a lot of discussion about how it interacts with trust law and whether it fetters the trustee’s discretion.
I don’t believe that to be the case, but I’m not an equity and trusts lawyer. There were issues being raised there.
Then you think about what it means if you’re fixing your distributions today.
You may have children you wouldn’t distribute to at the moment because they’re children, and unearned income of children is punitively taxed.
Soon enough, however, they will be of an age where it becomes more sensible to distribute to them. How does that work?
There was also an article in this morning’s Australian Financial Review about distributing to charities.
If you want to distribute to a charity, you have to include that charity in the election.
That is inconsistent with how people ordinarily make donations. Are people going to stop making donations, and are charities going to suffer?
There are lots of unintended consequences as soon as you start scratching the surface.
Taking a step back, as I understand this EET, there has to be an upfront election about how the income and capital will be distributed.
You have to nominate beneficiaries and agree to the proportions.
It has to be the same proportion of income and capital. You can’t have some beneficiaries receiving income and others receiving capital.
It is locked in. This is how you will distribute, and you have to stick to that.
If you deviate from it in any way, you have effectively revoked the election.
My reading is that it’s a once-off election for trusts existing before 1 July 2028.
The trustee can lodge a form stating, “I intend to distribute in this manner.”
If the trustee does that, the 30% minimum tax won’t apply.
If the trustee deviates from it, the election will be revoked for that year, the trustee will be taxed at the top marginal rate and, thereafter, the trust will become subject to the ordinary 30% minimum tax rules.
As I understand it, the election is not limited to individual beneficiaries. You can nominate companies.
You can’t nominate superannuation funds or other minimum tax trusts.
Companies are possible, provided they don’t have material discretionary elements.
That’s correct.
There is also a look-through to the shareholders of that company. If there are changes there, that can affect the election.
In theory, you could nominate a company owned 100% by mum and dad as the 100% income and capital beneficiary.
They are obviously targeting companies with different share classes, dividend access shares and similar arrangements.
Velocity Legal (25:40.000)
What the draft doesn’t address, although I assume the final legislation will, is whether that corporate beneficiary can itself be owned by a discretionary trust.
As the draft legislation reads at the moment, I think it can.
That cannot be what they intend.
I had the same question when I read it. My reading was also that it could be owned by another discretionary trust.
Of course, that discretionary trust would then have to grapple with the 30% minimum tax anyway.
But the company could choose when it declared a dividend, so you would have more control over the timing.
This is what happens when you make policy on the run. I’m not trying to be overly critical. I’m just trying to read it as it is.
As you said, Karen, after one minute you start scratching and find an issue. After two minutes, there’s another issue. After three minutes, there’s another one.
That’s what happens when things have not been properly considered and haven’t gone through a proper process.
There are questions about beneficiary rights and how the election affects those rights.
It’s probably just not a good idea. I don’t think it’s a good idea.
I agree. I don’t think it’s a good idea either.
Practically, I thought, “Who would make this election?”
When I think about clients I’ve advised, the only trusts for which I might at least consider it are very small trusts.
They are trusts so small that you might argue they shouldn’t have been established in the first place.
For example, a trust might hold one property producing $20,000 of income.
It might be mum and dad, both with no other income and self-funded in retirement.
In that type of situation, you might say, “Yes, it’s probably okay. Just make it 50–50 between mum and dad.”
Outside those very small trusts, why would you ever do it?
That would certainly need to be the approach if this goes ahead. You would be very reluctant because you’re making a decision that could bind the trust in a long-term way.
That goes against the purpose of a trust. You generally want a degree of asset protection.
If you make one of these elections and establish a pattern of distributions, you could start creating expectations and entitlements.
That could have flow-on consequences in bankruptcy law, family law, wills and estates.
There are very broad consequences to something like this that we may not fully understand for many years.
Velocity Legal (28:24.000)
A judge could make a decision in the future that nobody had previously considered.
The fact that people are already arguing about it is enough to suggest there is probably an issue, or at least something that needs to be resolved.
The family law issue is interesting.
If this was being considered in the Family Court, there would be an election stating that distributions were to be made in particular proportions.
If I were the judge, I might assume that those proportions represented the interests the beneficiaries effectively owned, or at least the minimum interest each person should be treated as having.
Neither of us is a family lawyer, but you can see how that argument could be made, particularly if the distribution pattern had been followed for many years.
The other interesting thing is that we now have more clarity about when revocation of the election will happen.
It’s not only where the trustee distributes in a manner that doesn’t comply with the fixed proportions.
It can also happen if there has been a change involving one of the beneficiaries.
For example, if a company is an elected beneficiary and the shares in that company change, or the company is wound up, that can affect the election.
That could make the company, or at least the shares in the company, essentially untradeable.
Absolutely. It certainly could.
If you ever wanted to rationalise or clean up the structure, it would be very difficult to do so without a significant tax impost.
Indeed.
Velocity Legal (30:11.360)
Maybe we move to the trust rollover.
It is proposed to be Subdivision 126-C.
We already have Subdivision 328-G, the small business restructure rollover, the other CGT rollovers and the small business concessions.
Now we have this proposed trust rollover, which will sit in its own subdivision outside those other regimes, although it clearly borrows some of their concepts.
This is the thing that led to the whole EET proposal because this is an income tax rollover, not a duty rollover.
It’s interesting because there is a mechanism dealing with how the rollover has to be applied.
It is not an asset-by-asset rollover. You can’t simply cherry-pick the assets you want to move out of the trust.
There are, however, some excluded assets that can be left behind.
For example, if you had primary production assets mixed with other investment assets, you could move the investment assets and leave the primary production assets behind.
There are carve-outs like that.
Otherwise, it’s everything. You have to transfer every relevant asset out.
I imagine that would also apply to real estate assets.
One strategy someone might otherwise consider would be to leave the land where it is, perhaps to avoid duty, at least in Victoria, and move everything else.
That would not be an option, as I understand it.
It’s really all or nothing. You have to transfer everything.
You also have to transfer the assets to a fixed entity, such as a fixed trust or company.
Again, I think this has the “no material discretionary elements” concept.
It does.
Those concepts are all bouncing around my head.
Again, what does that mean?
It’s interesting. On the one hand, this feels like a very broad rollover.
Unlike most of the other rollovers we are used to, it covers all assets.
It isn’t only a CGT rollover. Subdivision 328-G is the only other example of that.
It will cover trading stock and depreciating assets, but, as you say, Raj, you have to take across all assets.
Velocity Legal (33:06.720)
I wondered whether you might be able to use it as an opportunity to tidy up structures that you wished had been structured differently if you’d had a magic wand.
For example, could you separate the trading operations from the premises or land and buildings?
I don’t believe that’s what is intended.
I think they want a one-to-one restructure.
Unfortunately, I was disappointed by that.
The other upside, which we don’t have under Subdivision 328-G, is that this rollover is not confined to active business assets.
A discretionary trust that only holds investment shares and property can potentially use this rollover.
From that point of view, it may be an opportunity in some cases.
It’s something we will need to work through. There are so many different options available. You’ve got all the existing concessions and rollovers, and then you’ve got this on top.
I’m going to throw up a scenario that was bubbling away in my head. I don’t know the answer.
When you move assets into a company, you’ve got the issue of how you are ever going to get the value out again without tax.
Let’s say you bought a business for $100,000 and then transferred it from a discretionary trust to a company using this rollover.
The company has the rolled-over cost base.
You then sell the business for $100,000. There’s no capital gain in the company, but how does the company get that money out to the shareholders?
I don’t know the answer. I don’t think there is an easy way to get it out.
You may end up dealing with tax at that level, and it could be a trap.
Earlier in my career, when I was learning about tax, this was before Subdivision 328-G and we had the general rollovers that are still in the legislation.
Someone pointed out to me that all the rollovers get you into companies, but they don’t get you out.
Once you’re in the company environment, you can’t get the money out easily.
The discretionary elements are gone, the CGT discount is gone and you need to deal with Division 7A.
That’s where I get to raise the flag for the Division 152 small business concessions.
They are not a rollover. They’re concessions.
If your client is in that space and can access them, they have just taken another step up in terms of their appeal and value.
Absolutely.
For a long time, I was worried that the small business concessions might be abolished or pared back.
If one good thing has come out of these changes, it looks like they are very much here to stay.
At least the government appears to be saying, “Those concessions are still there. We’re not turning our back on small business.”
If you can access them, they’re now even more valuable.
Velocity Legal (36:18.000)
Before we move on, there are a few other interesting things about this rollover.
The original cost base effectively transfers across, but there are also provisions dealing with the small business concessions.
If you use the rollover, elections made under the former structure are preserved.
That might be relevant to something such as the small business rollover, where you are required to acquire replacement active assets.
I think it also preserves your 15-year holding period.
It does. It also deals with CGT events J2, J5 and J6, which roll across as well.
But I think it has the same issue as the small business restructure rollover.
What about the equity in the company you’ve just incorporated? That equity doesn’t have a 15-year holding period.
If you sell the shares in the company in the future, I don’t think there is any ability to treat those shares as having been held for that earlier period.
It may preserve the period for the business or the transferred asset itself, but not for the equity created in the new company.
The next item is the innovative business CGT concession.
To explain what this is intended to be, it is essentially a 50% CGT concession in certain situations.
This was announced as a form of damage control.
When the Budget announcements first came out, there wasn’t really anything. There was a comment that the government would consult on the effect on startups, but there wasn’t much detail.
We gradually received more information, and now we have exposure draft legislation that was open for consultation in September.
The concession was needed because of the move to an indexation model.
Indexation is useful if you have a cost base to index, but people investing in startups often don’t.
Indexation wasn’t going to help them. They could have ended up with enormous capital gains and little or no cost base.
That’s right. You can index zero for as long as you like, and you still have zero.
Velocity Legal (38:53.680)
There have been some changes from what was previously proposed, and we now have a lot more detail.
Previously, the shares had to be held for five years and there was a cap, which I think was $10 million.
The $10 million cap has now been removed, and the holding period is three years.
It is slightly more flexible.
It is still confirmed that the concession applies to equity being issued rather than equity being transferred.
In my experience in the private market, you are often dealing with equity transfers, not new equity issues. That leaves the same problem.
There are a lot of conditions. I don’t think there is an easy way to summarise them.
They are similar to the early stage innovation company rules, but also different.
The interest has to be equity, and it has to be at risk.
There is a concept similar to the delta requirements in the franking credit rules, although it isn’t quite as complicated.
The interest has to remain at risk, so you can’t have a hedge arrangement.
The company also has to be less than 15 years old and have turnover of less than $50 million.
Then there is a whole tranche of innovation eligibility criteria.
When I read those provisions, they look similar to the ESIC requirements. They deal with matters such as scalability and related factors.
There is also an entire registration regime.
My reading is that registration has to occur. You do not receive the status without registration.
Registration doesn’t have to happen on day one, but nobody gets the status until the company is registered.
There is a reporting body, and reporting has to occur annually.
The exposure draft material even contains an entire system for private rulings about the status.
It seems to be creating a very complicated system for what is essentially a 50% discount.
Velocity Legal (41:32.319)
Have you applied for a private ruling lately, Karen?
Yes. I’ve just finalised one in the small business concessions space. We’ve only just lodged it, so I don’t know where it’s going.
Clients ask me all the time, “How long will this take?”
That was going to be our next question. How long do they take?
How long is a piece of string?
I always say to allow at least two months. It could be longer or it could be less, but it’s not likely to be less.
It really depends. There is no way to provide the taxpayer with certainty, which is unsatisfactory for them.
It’s like one of those Magic 8 Ball toys. You shake it, and an answer comes up on the top.
I don’t know what you say. How long do you tell people it might take?
Six months or more.
Six months?
Yes.
Maybe I should increase my estimate.
I miss the old days when you could get one within 28 days.
It has been a long time since that happened.
I raised it because you mentioned private rulings. I don’t know whether this will be the same kind of private ruling process.
I think it is.
Oh dear.
Velocity Legal (43:01.440)
There are other conditions I haven’t mentioned. They deal with having enough activity in Australia.
At least 50% of the assets by value need to be in Australia, including tangible and intangible assets.
At least 50% of the people engaged in the business must also be undertaking their activities primarily in Australia.
The reference to people engaged is presumably broader than employees and would cover contractors and other workers.
The company has to be relatively new and below the turnover thresholds.
It has to satisfy the innovation criteria, which are highly subjective.
There are the 50% thresholds for asset value and where people undertake their activities.
There are a lot of conditions.
There are also a lot of exclusions. Not every activity can qualify.
It’s quite a long list.
Property development is excluded, as is banking.
Anything involving gambling or vaping is excluded.
Construction is also on the list.
Those are excluded activities unless the business is developing technology relating to one of those industries.
It’s very complicated to work out the status.
One question I had, and I don’t quite know the answer, concerns what happens if the company loses the status.
It doesn’t appear to be enough to qualify when the equity is first issued. The status may need to be maintained until the realisation event.
That could become a problem. You might satisfy the requirements when the qualifying interest is issued but fail them at some later stage.
I think there was a draft provision dealing with a 20-year look-back.
It appeared to say that, provided the business had qualified over the previous 20 years, it would not fail.
Twenty years?
That’s a long time.
Velocity Legal (45:36.319)
I don’t know the answer either, and I wasn’t aware of the 20-year look-back.
One of the concerns I’ve seen raised is how you will know whether the innovation criteria will be satisfied when the CGT event eventually happens.
What if the business is innovative for part of the period but not the whole period?
I don’t know how they have dealt with that, but my understanding is that there is considerable concern around it.
You mentioned that the company has to be under a certain age.
They are apparently going to start that clock from when the company, or any connected entity, first began carrying on an enterprise.
“Connected” draws on the rules in Division 328, which can involve a 40% control threshold.
There are concerns around that as well.
There is still more water to go under the bridge.
There is also the practical issue that the person claiming the concession will be the shareholder or equity holder, but it is the company that has to maintain the conditions.
If you leave the company but retain the equity, how do you know, when you later dispose of the interest, whether the company has continued to satisfy the conditions?
I imagine there must be ongoing reporting obligations.
There are reporting obligations, and there is a register.
It’s interesting to contrast it with the ESIC rules.
The ESIC rules are also prescriptive at the start, but once the qualifying status is obtained, you are generally in the regime.
Under this proposal, the status appears to need to be maintained continuously.
It will be interesting to see how that plays out.
It is a significant benefit. It’s 50%.
I imagine we’ll all receive questions from people asking, “Can I get this? Do I qualify?”
If the ATO reviews the position, the taxpayer will have to prove all these things.
They may need evidence going back a long way, so it will be important to get their ducks in a row if they intend to rely on the concession.
There are also provisions dealing with companies incorporated before 1 July 2027, including transitional rules.
But, Karen, to your earlier point, you’re advising on problems that exist now rather than future problems. You’re probably not receiving many questions about this, and I’m not either.
The difficulty is that what you do now could affect something in the future, even though we don’t yet know what the final rules will be.
What do you do? You do your best and see what happens.
That’s all we can do. Do our best.
Velocity Legal (48:49.119)
We’ve got some cases.
The first is the significant Part IVA decision involving Hilton Hotels.
As with most Part IVA cases involving large corporate groups, the facts are very complicated.
Without the benefit of a whiteboard, it would be hard to illustrate the situation and all the relevant companies and trusts.
As I understand it, the Hilton group undertook a restructure in 2014 and 2015.
It effectively moved some companies around within the group.
The case concerned a particular arm, involving a company I think was called Admiral Holdings or something similar, which was later sold.
The restructure moved entities from one company in the group to the Admiral group.
That resulted in a significant intragroup debt.
More recently, Admiral was sold to a third party.
The third party paid around $20 million or $25 million to Admiral.
I think the total price was around $200 million.
The remainder was used to pay off the intragroup debt.
It was effectively treated as a direct payment.
For tax purposes, I think only the $20 million component was declared, rather than the rest of the amount that went towards paying off the debt.
The Commissioner took exception to that treatment.
As I understand the outcome, Part IVA applied.
Yes. It was a single-judge decision.
To your point, Rajan, these cases are extremely complicated.
Even getting across and explaining the facts is very detailed.
Think about the other Part IVA cases in recent times, such as Minerva, Hicks and, to some extent, PepsiCo.
There are hundreds of pages dealing just with the evidence.
Velocity Legal (51:13.000)
There is a lot of Part IVA jurisprudence saying that you don’t have to undertake a transaction in the way that produces the most tax.
But you still have to assess the purpose of what is being done.
That can be difficult. You may be drawing on commercial evidence about what other parties would have accepted.
One thing that struck me as interesting here was that there was apparently an objective said to be crucial to the Part IVA defence, but that objective was not recorded in the contemporaneous documents.
My reading is that the taxpayer was saying, “This was one of the reasons we did this,” in an attempt to address the Part IVA risk.
But the contemporaneous documents didn’t support it. It wasn’t really mentioned.
It comes back to the age-old question: what do the contemporaneous documents say, and how do they line up with the position now being put forward?
It is a difficult one because the overarching scheme included a restructure that happened more than 10 years earlier.
You might expect a large corporate group to retain documents relating to a major restructure.
But Part IVA doesn’t apply only to large corporate groups. It also applies to private individuals and other taxpayers.
The further back you have to go, the more difficult it can be.
Think about restructures using the small business concessions.
If you restructure using those concessions and there is a sale later, the same law potentially applies.
You may not be Hilton, and the transaction may not be worth $200 million, but the same provisions can still be relevant.
That is exactly where my brain goes.
To me, this is about restructuring in preparation for a sale.
At what point can that become a Part IVA risk, even at the smaller end of the market?
Velocity Legal (53:30.000)
It’s a difficult question.
Pre-sale restructures are not uncommon.
The thinking has often been that the earlier you do it, and the further it is from the ultimate transaction, the less likely the restructure and sale are to be connected.
This decision makes me wonder how far back the Commissioner might look.
That’s exactly right.
Other examples come to mind, such as cleaning up dividend access shares so that you have a controlling individual for small business concession purposes.
Should you do that now, or as soon as possible, assuming the share isn’t being used and is only there for some legacy purpose?
You don’t want to be seen as doing it immediately before the transaction.
If that is the timing, could the change be regarded as having been undertaken for the dominant purpose of obtaining a tax benefit?
The practical difficulty is that this is usually when the clean-up happens.
It isn’t until someone looks at the structure that the issue is identified.
I couldn’t agree more.
That’s the problem.
Velocity Legal (55:07.440)
The final case we’ve got here is Quy, I think, Q-U-Y.
This is a case that has been before several courts and tribunals over several years.
It concerns tax residency.
The taxpayer was an engineer who worked in Dubai for almost seven years but retained a number of Australian connections.
He had family in Australia, a house in Australia, spent some time in Australia and maintained other connections.
The question was whether he remained an Australian resident.
I think this is the last of the decisions.
There was initially an AAT decision. Then there was a Federal Court decision saying the AAT had made an error.
The Federal Court did not make its own decision. It sent the matter back to be decided again.
It then went back to what is now the Administrative Review Tribunal.
The Tribunal remade the decision and found that the taxpayer was an Australian resident.
That was not because he resided in Australia under ordinary concepts.
It was because the Tribunal was not satisfied that he had established a permanent place of abode outside Australia for the purposes of the domicile test.
The latest Federal Court decision essentially found that there was no error in the Tribunal’s approach and that the decision was open to it.
It’s an interesting case.
When I deal with residency matters, if a person’s spouse remains in Australia, they have a home here, they are paid in Australia, they have substantial assets here and their young children remain here, I would have thought they were likely to be a resident under the ordinary concepts test.
I’m a little surprised he received a favourable finding on that test.
It didn’t help him under the domicile test.
Velocity Legal (57:06.240)
His issue under the domicile test was that he needed to demonstrate a permanent place of abode outside Australia.
He was living in employer-provided accommodation.
He didn’t necessarily need to own a property to satisfy the test, but he needed to establish a place of his own, and that appeared to be the difficulty.
I always say, when I’m advising on residency matters, that it is very hard to sever your residency with Australia.
It’s very difficult to do.
Even if you are not a resident under ordinary concepts, the domicile test may still bring you back within Australian residency.
I agree with you in this case. I would also have thought he was a resident under ordinary concepts.
If your family remains here, it can be very difficult to argue otherwise.
One notable thing about this case, because we’ve discussed other residency cases in previous episodes, is that Australia does not have a tax treaty with the United Arab Emirates.
In other cases, there is the position under Australian domestic law and then the position under the treaty.
A treaty tiebreaker may apply, and a person can be a resident under Australian domestic law while the treaty allocates taxing rights differently for certain income.
There is no double tax agreement with the United Arab Emirates, so that question is irrelevant in this situation.
There is no residency tiebreaker test or allocation of taxing rights to consider.
I presume he probably didn’t pay tax in the United Arab Emirates either, so there may not have been any foreign income tax offsets to consider.
Velocity Legal (59:04.000)
I don’t know about you, Karen, but are you receiving more enquiries about residency given the current tax landscape?
I’m certainly fielding a few more, but, as you said, it isn’t easy.
It isn’t.
There is a popular narrative at the moment, driven by some cynicism about the current tax environment in Australia.
People are threatening, and perhaps in some cases actually deciding, to relocate.
They may not fully realise that relocating may not be sufficient to sever their tax residency ties with Australia.
You can also see a connection with the Hilton Hotels discussion.
In that case, the Commissioner looked back around 10 years before the later event.
In a residency situation, the ATO might look back over several years and ask whether the taxpayer really severed their residency or whether the overseas move was only a two- or three-year arrangement, viewed with the benefit of hindsight.
That’s often how these matters arise.
People who decide they are no longer residents often stop lodging tax returns in Australia.
That means no amendment period starts running, and the period never closes off.
I’ve seen people identified and assessed for seven, eight, nine or 10 earlier years because they never started the clock.
That’s a good point.
The other important issue when severing residency is CGT events I1 and I2.
Someone may think, “I don’t like the tax landscape, so I’ll leave.”
But there could be a very significant amount of tax on the way out if the consequences are not considered carefully.
That’s exactly right. It’s a really good point.
Velocity Legal (01:00:57.760)
I guess that closes off the agenda for the September session.
No state tax cases this time.
No state tax cases.
There may have been some website updates about focus areas and similar matters.
But anyone who practises in state taxes will know that they are focusing on everything, so I don’t think that’s really news.
Otherwise, I think we can leave it there.
Karen, thank you so much for being part of this episode.
It’s been an absolute pleasure. I’ve enjoyed it very much.
We hope to see you back again.
Thanks so much, Karen.
That’s our September update.
