However, this week s announcement particularly in regards to big business audits includes a growing focus on the following areas:

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1 Issue 5, August 2003 Briefly in Tax Taxation Specialists - Business Advisors THIS ISSUE ATO Spotlight is Bigger and Brighter for Areas under the spotlight with the ATO are expanding once again, according to Tax Commissioner Michael Carmody this week when he outlined the ATO s newest target list. Earlier this year we highlighted key ATO focus areas including: Work related expenses Rental property claims Capital gains DIY Super Undeclared income Tax schemes However, this week s announcement particularly in regards to big business audits includes a growing focus on the following areas: GST compliance with 1 in 2 large corporates expected to be audited this year Tax compliance audits in both the large and medium corporate sectors Shareholder loan audits in small and medium business Tax evasion and fraud focusing on the cash economy and tax file numbers High wealth individual audits International tax avoidance including high risk cases in tax havens and tax avoidance by non residents or foreign nationals working in Australia Review of transfer pricing arrangements Medical Expense Threshold Increased A revised amount of $1500 effective from 1 July 2003 has now been passed increasing the threshold for the 20% tax offset on net medical expenses by $250. This new threshold amount must be used when preparing tax returns for the year ended 30 June 2003 onwards. ATO Spotlight is Bigger and Brighter for Medical Expense Threshold Increased Consolidations: Market Valuations Anti-Avoidance and Personal Services Income Self Managed Super Funds: Traders or Investors? Common BAS mistakes Traps in Salary Sacrificing Testamentary Trusts for Asset Protection 1

2 Consolidations: Market Valuations The tax consolidation legislation requires market valuation of assets and subsidiary entities in a number of instances. In undertaking post consolidation compliance reviews this year, the ATO has indicated that market valuations will be a key focus. In particular, audits will focus on group s experiencing a favourable tax outcome for example, utilisation of tax losses or a significant increase in depreciation deductions. Market valuations determined in a transparent way and commissioned from independent and qualified valuers will be considered more favourably but a number of factors listed in an ATO risk matrix (provided in the ATO s Consolidation Reference Manual) will provide the overall basis for investigation including: - quality of a taxpayers market valuation processes and documentation, including the qualifications and independence of valuers; - use of valuation short cut options for example, to lower risk profile; - complexity and size of business for example, intangibles are seen as high risk; - appropriateness and reasonableness of methodologies and assumptions; - use of existing valuations and documentation as to relevance and changes; and - tax outcomes of consolidation process. The ATO Consolidations Reference Manual offers comprehensive guidance on points to consider when obtaining a valuation including who can do them, what documentation should be obtained and factors which will increase ATO questioning a particular valuation. It is advisable that these factors are taken into consideration and that companies undertake a range of calculations to determine the optimal mix of combined transitional and standard rules when determining the market value of assets. Call Marc Worley to further discuss market valuations in your business. Anti- Avoidance and Personal Services Income Anti-avoidance provisions of the income tax law otherwise known as Part IVA only apply if there is a scheme entered into or carried out for a dominant purpose of obtaining a tax benefit. You may be affected by anti-avoidance rules where you earn personal services income through your company, trust or partnership. Personal services income is income which is earned mainly as a result of personal efforts or skills rather than through income producing assets or a business. You may also be affected if you are classified as carrying on a personal services business and are therefore not affected by the alienation of personal services income legislation. Personal services businesses earn personal services income and not business income for income tax purposes. 2

3 Part IVA may apply in the following situations: - where personal services income is alienated (for example, contracted through your company, trust or partnership) and is taxed at a lower rate than if you had received income yourself particularly where remuneration is not commensurate with the value of your services; - where you split personal services income with an associated person, or with an entity associated with you, particularly in the case of a family trust or company splitting personal services income with a family member and you reduce your income tax liability; - where you are conducting a personal services business and the dominant purpose of the relevant arrangement was to obtain a tax benefit. There are steps however to ensure that you are not affected by Part IVA provisions including: - if you operate through a company and there is no income splitting and no retention of profits in the company; - if operating through a trust, you receive personal services income that is commensurate with your duties and responsibilities or be the sole beneficiary of the trust in relation to that income; - if operating through a partnership and you conduct that business with your spouse through a genuine partnership. Please speak to us to ensure that you will not be affected by these provisions. Self Managed Super Funds: Traders or Investors? In its July 2003 superannuation newsletter, the ATO has indicated its views as to whether Self Managed Superannuation Funds (SMSFs) can be share traders. The distinction between a share investor and a share trader is important for tax purposes. Broadly, gains or losses made by share investors are held to be on capital account and are considered for capital gains tax purposes. Capital gains may be eligible for concessional tax treatment. Net capital losses must be carried forward and can only be applied against future capital gains. Shares held by share traders are normally treated as trading stock. Expenses associated with the purchase and disposal of shares are allowable deductions. Any net gain from share trading is assessable income and any net loss can be used to offset other taxable income. There are a number of tests that may be used to determine whether a taxpayer holding shares is a share trader or share investor. The ATO considers that SMSFs are unlikely to meet the tests necessary to be share traders for tax purposes. However, each case is assessed on its own merits. The following criteria will generally be considered by the ATO in determining whether a taxpayer is a share investor or a share trader: 3

4 - volume, frequency and scale of activities, such as multiple transactions occurring on a daily basis; - existence of a systematic course of buying and selling for the purpose of producing profits; and - intention of the trustee (having regard to what is already their fiduciary duty). Where the activities of a SMSF constitute that of share trading, it must also be demonstrated that other regulatory requirements have been met. For example, any share trading must be undertaken in accordance with an appropriate investment strategy for the SMSF. Common BAS Mistakes A number of mistakes have been identified as being common in the preparation and lodgement of BAS including: GST Registration ensure you are completing your BAS on the same basis you nominated when registering for GST (for example cash or accrual basis). Record Keeping where cash takings are used to pay expenses, this must be included when calculating GST liability Payment of GST remember to lodge your BAS form even if you have already paid the amount owing to ATO Trade-Ins if you claim input tax credits on the purchase of a capital asset, remember to recognise the sale or trade-in of the asset as a taxable supply Input Tax Credits overstating private use of assets, incorrectly including wages and superannuation in calculation of input tax credits, incorrectly claiming 1/11th of total insurance premiums, incorrectly claiming input tax credits or not calculating GST on assets that have changed purpose Hire Purchase if lodging under accruals system, the whole of input tax credit for hire purchase items may be claimed but if using cash basis, claims must be made progressively Leases input tax credits may only be claimed progressively, irrespective of method used to prepare BAS We would be happy to review your company BAS please speak to us for assistance or to arrange a review. 4

5 Traps in Salary Sacrificing Salary sacrificing into super can be a very effective retirement savings strategy, given the significant entitlement to make tax deductible super contributions at a concessional tax rate. However, there are traps that one should be aware of including the potential liability to pay 15 per cent superannuation surcharge on contributions. Another consideration is the potential reduction to long service leave entitlement where significant salary sacrificing has occurred in the year ending employment. Long service leave entitlement is calculated based on an employee s ordinary rate of pay. However, a number of factors are not included in the definition of ordinary rate of pay including overtime and allowances and any salary sacrificed amounts. Hence, if large amounts of pay are salary sacrificed in the year of long service leave payment, the entitlement will be calculated on a much reduced amount, rather than the total remuneration package. Testamentary Trusts for Asset Protection Testamentary trusts are proving ever more popular with increasing onus on professionals to ensure adequate asset protection following continuing claims from corporate regulators and creditors. This type of trust provides significant asset protection because no individual legally owns trust held assets. Instead, these trusts come into existence upon a benefactor s death and act to ensure that no financially vulnerable person inherits the assets. Testamentary trusts provide a lifetime of asset protection because there is limited risk that the assets will fall back into the hands of creditors or other claimants. Instead, assets can be distributed to children in the form of regular income or assets can be distributed at a specified age. This is important to consider, where assets are initially granted to a wife for example, however if she dies and the assets are not directed to the children via a testamentary trust, they will be immediately redirected back to the husband and become exposed to creditors again. Testamentary trusts can also be set up to skip a generation for example assets can be passed onto grandchildren of the benefactors and not first generation children who may be in a financially vulnerable position. Income in the trust can be distributed on a discretionary basis and is subject to normal tax provisions. This allows the income to be available for certain tax planning strategies including access to the $6000 tax free threshold, even for minors. Income can be distributed at the trustee s discretion and can be allocated to beneficiaries with little or no other income or those in a highly favourable tax position. Flexibility of testamentary trusts is also a positive factor. These trusts can borrow and invest funds and are not limited to investment of initial assets only. They can be set up more equitably as a series of separate trusts distributing to single beneficiaries. Speak to us about estate planning and asset protection. 5

6 Enquiries If you would like further information regarding any of the tax topics discussed in this newsletter, please contact: KD Johns & Co 15 Ord Street WEST PERTH WA 6005 Ph: (08) Fax: (08) Website: Disclaimer Material contained in this publication is intended for information purposes only and not for advice. Readers should not act or rely upon any matter or information contained in, or implied by this publication without taking appropriate professional advice, relating specifically to their particular circumstances. 6