Australian Tax Focus

DEBT FORGIVENESS

The Australian government has made an announcement in their Federal Budget to amend the Income Tax Assessment Act, whereby deductions for bad debts will be denied between related parties that are not members of the same consolidated group  where the bad debt written off will not be included as part of the debtor’s income.

It is proposed that in such situations the creditor will have a capital loss rather than a deduction for income tax purposes. This situation will arise where for example the creditor is resident in Australia and the debtor is resident in New Zealand. This has not yet been enacted, but once done it will be back dated to 8th of May 2012.

This will add further layer of complexity to the already complex rules. For example, there is already a tax adjustment when a debt is forgiven: the beneficiary of the forgiveness loses (in descending order) tax losses, capital losses, the tax cost of depreciating assets and the cost base of capital assets up to the extent of the amount forgiven. Related parties can currently choose to forego the losses and the tax consequences.

ATO’s COMPLIANCE PROGRAM

ATO’s annual compliance program was released in July 2012. It identifies areas of compliance risk where ATO’s focus will be directed. Namely:

  • Taxation of Financial Arrangements (TOFA):
    • Validity of elections made for the purposes of TOFA
    • Correct application of tax timing methods
  • Profit shifting  between jurisdictions,
    • Transfer pricing and thin capitalisation
    • Entities with significant asset revaluations that may not be able to meet the safe harbour debt values without these revaluations
  •  Corporate restructuring
    • Mergers and acquisitions
    • Complex and unusual financial arrangements
    • Pre-restructuring activities
    • Changes to the effective ownership and control where the result may be deferral or avoidance of taxation
  • Consolidations
    • Inclusion of foreign partnerships in consolidated groups aimed at achieving a deduction of interest  in two jurisdictions
  • Further Audit activity will be in areas of:
    • GST
    • Research & Development

 

Deduction of Shareholder Employee’s Salary of an LTC

Recently we have been asked whether a shareholder employee’s salary is deductible for a LTC (Look Through Company) and whether it can be paid without having to deduct PAYE.

There are two parts to the question one being the deductibility of the shareholder employee’s salary and another being the PAYE withholding.

  • SHAREHOLDER SALARY
    • The LTC is allowed a deduction for the shareholder salary, insofar as the shareholder is a working owner employed by a LTC.
    • There must be an employment contract pursuant to which salary is paid for services performed by the working owner.
    • The employment contract must specify the amount of salary to be paid and terms and services to be performed by the working owner.
    • The available deduction is limited to the salary payments authorised by the contract of employment. A bonus is also deductible even if not specifically provided for in the employment contract.
    • The working owner status is not achieved if the LTC is wholly or mainly engaged in investing, holding or dealing in shares, securities or land.  The LTC must derive an active as opposed to passive income.
    • The working owner providing services to the LTC is therefore classified as an employee.
  • PAYE
    • PAYE has to be deducted from the salary paid to the working owner.
    • The definition of a PAYE income payment includes salary, wages, extra pay, etc (this would cover bonuses as well)
    • The term salary and wages specifically includes payments to the working owner of a LTC

In Summary:

  • The LTC is allowed a deduction for salaries, wages and bonuses paid to the working owner pursuant to the employment contract.
  • PAYE must be deducted.

 

Keeping you up to date

We wanted to share with you how our ongoing review of our services is coming along.

When you became our client we made a commitment to you to provide a high quality service that you value. That the work we undertake for you is consistent with your priorities both now and in the future.

As part of this commitment we will regularly take the opportunity to reflect on the services we provide our clients. Are we effectively communicating how we can be of service and that all our work meets the standard we set ourselves? To this end we felt our Website, and our direct communications to you, such as newsletters and brochures were not reflecting where we have now positioned ourselves.

As a result we:

  • Updated our website look and moved over to a Word Press environment. When you have an opportunity, take a look around the website and let us know what you think. You will find us at www.covisory.com .
  • Re-branded our newsletter. You will find previous editions on our Download page or use the following link: https://covisory.com/info-centre/
  • have made it easier for you to join on to our mailing lists. Our sign up form is on the right hand side bar of all our website pages.
  • Have put together a Private Client and a Consulting brochure that provide an overview of the range of services we can help you with. You would have receive a copy of the brochure in the mail; for a softcopy version, the following link will take you to our downloads page: https://covisory.com/info-centre/

If you would like to make an appointment to talk with us about any of our services, please call us on 09 307 1777 or email Nigel on nigel@covisory.com or Martina on martina@covisory.com .

Taxation of Foreign Superannuation

NZ tax residents who have interests in foreign superannuation are often presented with the headache of taxation. There are different tax rules that can be applied to foreign superannuation.

Depending on which set of rules apply, the foreign superannuation may be taxed either on the change in the value of the investment in NZ$ on an annual basis under the FIF rules or at the time the individual receives income (i.e. lump sum, regular pension payment, withdrawal or transfer to another scheme). This creates complexity and uncertainty for the tax payers.

An issue paper was released in July 2012 by the NZ Inland Revenue Department in which new simple taxation rules were proposed. It is proposed that the FIF rules will no longer apply to the foreign superannuation and that the liability to taxation be determined at the time the pension payment or a lump sum is received or when the foreign superannuation is transferred to another scheme.

In simple terms it is proposed that a foreign pension payment will be taxed at the time it is received at the recipient’s marginal tax rate (ranging 10.5% to 33%). A lump sum withdrawal or a transfer from a foreign superannuation will be apportioned, based on how long the person has been in New Zealand before a withdrawal or a transfer was made, and taxed accordingly. This means that a lump sum withdrawal and a transfer will be apportioned and only a certain portion of the amount will be taxable in New Zealand. The longer the person spent in New Zealand the greater the proportion of the amount that will be included in the taxable income.  The proportion of the lump sum that will be included in the taxable income will range from 0% (in first two years) to 100% (after 25 years).

The effect of these proposals on Transitional Residents & Australian Superannuation:

Transitional Residents

  • There will be no adverse effect on Transitional residents, as their foreign superannuation, including withdrawals or transfers are not taxed while they are Transitional Residents, which is basically 4 years from when they first become a transitional resident.

Transfers from Australian Superannuation Scheme to NZ

  • An interest in Australian superannuation scheme, in general, would not be taxable under the FIF rules.
  • For the purposes of New Zealand / Australia Double Tax Agreement, lump sum payments received from Australian retirement benefit schemes are not taxable in New Zealand. Therefore a person would not be taxable in New Zealand under the new rules.
  • Should the New Zealand/ Australia Double Tax Agreement not apply to the individual, transfers from Australian superannuation scheme to a NZ Kiwisaver scheme may still be tax free under the agreement on the portability of savings between New Zealand and Australia (which should come into effect shortly).

The new rules are to apply to income received from a foreign superannuation scheme including pension payments, withdrawals and transfers to another scheme) on or after 01 April 2011. FIF rules will continue to apply if foreign superannuation was taxed under the FIF rules in 2010/11 income year. Special rules may apply to transfers or withdrawals of foreign superannuation made between 01 Jan 2000 – 31 Mar 2011

IRD releases statement on Repairs and Maintenance

The IRD recently released an interpretation statement on the topic of R & M, IS 12/03.  Overall there is nothing ground breaking in what it states, with one exception.  It is however a very good summary of the issues to be addressed in considering whether R & M expenditure is deductible or not.  With the removal of depreciation on buildings, there is now even more pressure to claim costs as being deductible.

The one exception is that the IRD has released some guidance on leaky building repair claims which is very welcome and long overdue.

The R&M Deductibility Process

Step 1
  • What is the asset?
  • Need to identify it
  • Is it the whole or a part
Step 2
  • Nature and extent of the work done
  • Repair or replacement, improved materials
  • Part or whole
  • Does it improve the asset
Step 3
  • Specific issues
  • Purchase of dilapidated assets
  • Accumulation of repairs effected at once

 

While we do not intend to cover the detail of the 53 page paper in full, we consider it is an accurate summary of the law, and how small changes in facts can alter the answer with often two apparently identical cases giving opposing answers/decisions.

Leaky Building Claims

The lack of assistance by the IRD to date has been very concerning.  The paper does however set out some examples which are more than useful in at least confirming that decided case law is still the correct basis to determining the question of deductibility for leaky building claims.

The three examples they set out are as follows:

Example 12 – leaky home repairs (no change in character or substantial reconstruction, replacement or renewal) Cath and Simon own a residential rental property. A few years ago they added a two room extension to the property. The extension has been leaking. The timber framing within the extension is rotten and needs replacing. To make the repairs the cladding and windows need to be removed from the extension and refitted. The cost of the repairs is revenue in nature. The work done to the house does not amount to a reconstruction, replacement or renewal of substantially the whole of the house. Nor do the repairs change the character of the house.

 

Example 13 – leaky home improvements (change in character) Cath and Simon are unlucky and have discovered that another of the rental properties they own is a “leaky home”. In this case the solution is not as straightforward as in Example 12 above and the remedial work required is extensive. Cath and Simon decide to re-clad all the house’s exterior walls using a superior concrete block construction system rather than the equivalent substitute cladding system. While the concrete block construction system is more expensive, it should be more durable, and require less maintenance. The cost of repairs will be capital expenditure. The work done goes beyond repairing the house and the character of the house is changed. This is the outcome in this case regardless of whether the work done results in the reconstruction, replacement or renewal of the house or substantially the whole of the house.

 

Example 14 – major repairs to leaky building (substantial reconstruction) Stuart owns a stand-alone single-storey commercial building in Onehunga that he leases to a small manufacturing business. The building has been leaking badly and the walls and timber framing are extensively damaged. To rectify the damage and prevent it recurring, extensive work is undertaken. All the exterior wall cladding is removed and replaced with an equivalent recommended product. Large sections of the buildings framing are  replaced with treated timber.  Also, damaged sections of the floor are replaced.  New flashings are installed around the windows, and portions of the interior walls are relined.  The cost of the work done to the building is significant.  The cost is capital expenditure.  This is because the remedial work done is so extensive it has resulted in the reconstruction of substantially the whole of the building.

In summary therefore for a rental asset:

1. If the repairs are to make good the leaky building issues, but not to improve the building, then it will be a deductible repair.

2. If there are new or better components (eg double glazing over single, additional rooms added), there will be capital costs.

3. If the repair is so extensive that the asset is significantly replaced, even if not improved, this will be capital as it is no longer a repair but a replacement.

As always it will be a question of degree, but at least we have some points to measure it against.

Refer www.ird.govt.nz – key word IS 12/03

IRD continues to focus on mixed use personal assets.

While the IRD has been busy reviewing submissions on its discussion paper on Mixed Use Assets, its audit division has embarked on a major new initiative this year by either risk reviewing or auditing a large number of taxpayers.

The typical scenario involves the claiming of expenses or losses arising from mixed use assets like baches, boats and planes.  The mixed use arises from these assets being made available for third parties to rent, as well as being used by the “owner” (often the asset will have been owned in a look through company, loss attributing qualifying company (LAQC) or a trust) for private purposes.

While the IRD discussion document is more focused around the issue of apportionment of costs between private and third party use, the audits and risk reviews are focused more around disallowing some or all of the losses that usually arise.

In effect the IRD is saying that to the extent that a loss arises, the portion of the loss that relates to the private use percentage should be disallowed.  This applies even where the owners have paid full arms length market rates on their use of the asset.  This argument is based on a Taxation Review Authority (TRA) decision that found a taxpayer who bought their own family home in an LAQC and rented it off them, and claimed the resulting loss (interest and depreciation costs exceeded market rents) against other taxable income.  The IRD is applying the TRA decision logic to the partial use of assets, with the loss being reduced by the private use percentage.

Naturally, there is always the additional problem that the IRD will also seek to impose shortfall penalties of at least 20% but often 100% plus interest!

In some cases the IRD is going one step further, and arguing that there is no actual business and that in reality the limited third party use is really just an adjunct to the private ownership or use of the asset.  The consequence of this is that the IRD then sets out to deny the whole of the loss that arises, while again looking for shortfall penalties and interest.  GST may also be more of an issue in such cases, as usually the IRD will also seek to retrospectively deregister the activity for GST.

So what should you do?  If you do have assets which are used both by you and third parties we recommend that you review whether it is worth continuing to claim all of the resultant losses, or even if you continue to argue it is a business activity at all.  Post Penny & Hooper the IRD has been very aggressive in its audits, and sadly we can’t see that subsiding any time soon.

Australia’s Living Away From Home Allowance Changes

Most New Zealanders working in Australia and receiving living away from home allowances (“LAFHA’s”) will not be eligible to benefit from the LAFHA tax concessions after 1 October 2012.

In May 2012, the Australian Treasurer announced major changes to the tax treatment of LAFHA’s removing most of the tax concessions available. As we predicted, there was significant resistance from large businesses and, after a period of consultation, the Government amended a number of the original proposals.

The principal change to the existing law is to the home which is used as the reference point for entitlement to the benefit. Currently, if your home is New Zealand (regardless of whether you maintain a home there or not) and you are required to live (away from home) in Australia for work purposes, you are entitled to a non-taxable LAFH Allowance. After the changes, you will need to maintain a home in Australia and your work must require you to live away from that Australian home before you can benefit from a LAFHA with no tax consequences.

The main features of the proposals which have now been passed by the House of Representatives are:

  • The new rules will apply from 1 October 2012.
  • There are major carve outs for fly-in fly-out and drive-in drive-out workers.
  • LAFH allowances and benefits will continue to be subject to the FBT system. (The original proposal was to tax the allowances in the hands of the employee.)
  • Employees will need to maintain a home in Australia from which they “live away” in order to qualify for concessions.
  • The ATO will publish LAFHA amounts that it considers to be “reasonable”.  Where LAFHA’s are paid to employees in excess of those ATO amounts, documentation substantiating the amount will be required.
  • The concessions are only available for 12 months for a particular employee in a particular location with a particular employer.
  • Transitional rules will be available until 30 June 2014 for employees with arrangements in place prior to 8 May 2012. Temporary residents and foreign residents must maintain a home in Australia during this period to qualify. Minor change such as a salary reviews or annual adjustment to food component should not affect continuity of the arrangements.

The politicians say that the changes are required to address rorting of the current system. In our opinion, they go much further than is necessary. Along with the removal of the 50% CGT (capital gains) discount for foreign residents, they seem to signal a shift in Australia’s attitude to encouraging foreign investment.

We expect the rules to continue through the Senate and receive Royal Assent. This means that employers with existing LAFHA arrangements need to talk to affected employees and determine their post-1 October 2012 policies.

Update provided by Sydney based Henderson Edelstein & Co partner – Weston Ryan.

http://www.heandco.com.au/

IRD Issues Statement on R&M plus Leaky Buildings

The IRD recently released an interpretation statement on the often vexed issue of what costs are deductible on repairs and maintenance (R&M).  In short the statement is both a good and accurate summary of the New Zealand and international case law on the topic.  It acknowledges that often two cases with almost identical facts can result in opposing answers.

Of particular benefit however is that the IRD at long last considers the significant national issue of leaky building claims.  There is both relevant case law discussion, as well as three very useful examples.

In summary for a rental asset:

1   If the repairs are to make good the leaky building issues, but not to improve the building, then it will be a deductible repair.

2   If there are new or better components (eg double glazing over single, additional rooms added), there will be capital costs.

3   If the repair is so extensive that the asset is significantly replaced, even if not improved, this will be capital as it is no longer a repair but a replacement.

As always it will be a question of degree, but at least we have some points to measure it against.

Refer www.ird.govt.nz – key word IS 12/03

IRD Attack Mixed Use Assets as Tax Avoidance

Following the Penny & Hooper case on tax avoidance the IRD has been far more aggressive on what it now considers to be tax avoidance.  While it has released a discussion document on how the tax rules, and in particular for apportionment of costs, should apply to mixed use assets such as baches, boats and planes, it has also been aggressively auditing or risk reviewing these.

The IRD is focusing on 2 areas:

1    Denying the part of any resulting tax loss that arises from the private use even where market rates have been paid; and

2    Questioning whether the activities constitute a business at all, with any resultant tax loss being denied in total, often also with adverse GST consequences when the IRD then seeks to retrospectively deny GST registration.

In either case the IRD will look for shortfall penalties of at least 20%, but often 100% of the extra tax bill plus use of money interest.