Category Archives: Technical Knowledge

Taxation of Children’s Bank Accounts

Tax pitfalls of “Children’s” Saver Accounts

The ATO recently released TD 2017/11 to provide guidance on the taxation of interest derived on interest bearing bank accounts. In consolidating a number of previous ATO releases dealing with the topic, the new ruling aims to clear the air and better define the taxpayer who is assessed on interest income generated by bank accounts held by minors.

Background:

It’s been a number of years since it was genuinely advantageous to maintain an investment in the name of a child or “minor. Unless certain criteria are met (e.g. excepted income), passive income derived by minors will be assessed at aggressive rates of tax.

These penal rates of tax, especially in light of the ATO’s data matching capabilities, require careful planning for parents in the establishment of bank accounts for their children so as to avoid any unwanted tax positions.

Legislation and Ruling:

In determining who is assessable on interest income according to TD 2017/11, the ATO focuses on “Beneficial Ownership”. The ruling confirms that:

“Interest income on a bank account is assessable to the person or persons who beneficially own the money in the account”[1]

and specifically in relation to children’s savings accounts:

“Where a parent operates an account on behalf of a child, but the Commissioner is satisfied that the child beneficially owns the money in the account, the parent can nonetheless show the interest in a tax return lodged for a child…”[2]

Guidance:

Parents are generally required by financial institutions to be a signatory to a child’s bank account and thereby retain legal title. However, the broad concept of “Beneficial Ownership” used by the ATO refers to the ultimate rights of use and control under equity law[3].

To explain, TD 2017/11 provides a clear example of Beneficial Ownership:

“Raymond, aged 14, has accumulated $7,000 over the years from birthdays and other special occasions. Raymond’s mother has placed the money into a bank account in his name, which she operates on his behalf. Raymond’s mother does not use the money in the account for herself or others. Raymond earns $490 in interest during an income year.”[4]

In this example, Raymond has beneficial ownership of the money in the account; therefore, he will be assessed on the interest income received at his penal rates as a minor.

If however, Raymond’s mother used the account to pay for school fees or pay Raymond “pocket money”, she would be deemed the beneficial owner as she has operated the account as her own. The ATO would assess the interest income on her marginal rates.

Practical Application:

With interest rates for savings accounts at the lowest seen in recent times, perspective is key. As an example, your child would need to have at least $13,500 in their bank account at 3% interest for the year to be assessed at penal rates.

There are still a number of practical considerations to make when dealing with children’s bank accounts:

Whose money is it?

As above, the ATO focuses on “beneficial ownership” rather than legal title of the bank account.

It’s therefore important to clearly determine the purpose of the bank account up-front and retain that purpose.

Is the account for:

The child to accumulate savings, generate interest and eventually take control of; or
For the Adult to control the funds in the account to benefit the child?

A clear distinction will confirm to both you and the ATO (should they ask) who is to be assessed on the interest generated by the bank account.

You should lodge a return for your child if necessary.

When should I apply for a Child’s Tax File Number (TFN)?

There is no minimum age for a child to apply for a TFN, nevertheless, they are still eligible to apply at any age. It may therefore be a proactive idea on the parents’ behalf to apply for a TFN for their child so as avoid over-withholding (sometimes at 46.5% or above) in the event of:

TFN non-disclosure where the bank account held by the child generates more than $416 of interest in a year; or
PAYG Withholding when the child is old enough to commence part-time/casual employment.

Be thankful but wary of large sums of money as “birthday gifts”

Whilst “gifts” are not taxable in the hands of the child who receives them, the child may be assessed on the interest (or other income) generated as a result. Large sums of money may quickly accumulate in a bank account held solely for the child, so parents should be careful to ensure penal rates of tax don’t apply to the interest received.

Consideration should also be made with regard to the impact of eligibility on the recipient or donor of large gifts to government entitlements.

Children in receipt of other income

Although special concessions may apply to certain income received by a child, the penal rates of tax may outweigh the benefit of having your child receive income from other sources (i.e. a family trust distribution).

Care should be taken to ensure investments for children are not held to the detriment of the income being received.

[1] TD 2017/11 para 2

[2] TD 2017/11 para 5

[3]http://www.treasury.gov.au/~/media/Treasury/Consultations%20and%20Reviews/Consultations/2017/Beneficial%20ownership%20of%20companies/Key%20Documents/PDF/CP_Increasing_Transparency_of_the_Beneficial_Ownership_of_Companies.ashx

[4] TD 2017/11 para 13

Avoid a common structuring trap when participating in a start-up ESOP

Background

Most people in the Australian start-up world would be broadly aware of the beneficial changes to Australia’s employee share scheme (“ESS”) rules from 1 July 2015 (“2015 Amendments”).

The previous regime gave rise to potential tax and cash flow problems, for example:

by taxing employee participants at vesting in circumstances where their ESS interests (whether shares or options/rights) were (or related to) minor shareholdings in highly illiquid companies;

given the high failure rate of start-up companies, value was often ephemeral and employee participants were commonly taxed on income account (at up to 45% + levies) at vesting only for those companies to subsequently fall over such that participants derived no benefit whatsoever and yet were heavily taxed under the ESS rules; and

specifically in relation to employee share option plans (“ESOPs”), employee participants had to exercise their vested options and hold the underlying shares for at least 12 months (“12-Month Holding Period Rule”) in order to access the 50% CGT discount in the event of an exit (and if an offer came out of nowhere, many employees with vested but unexercised options were caught short in this regard).

2015 Amendments

To combat the deficiencies outlined above, the 2015 Amendments introduced an eligible start-up concession which, in relation to ESOPs and subject to meeting various conditions, resulted in employee participants not being taxed up-front, at vesting or at exercise, but generally only on the eventual disposal of the underlying shares post-exercise (“Start-Up ESOP”).

In relation to shares acquired following the exercise of options granted under a Start-Up ESOP, the holding period of the option itself counts towards the holding period of the underlying shares post- exercise for the purposes of the 12-Month Holding Period Rule. That is, unlike under the general CGT rules, whereby the start-date for the purposes of the 12-Month Holding Period Rule effectively resets on the exercise of an option and the grant of the underlying share, they are effectively treated as a single asset in this regard.

Participating in an ESOP via a family trust

It is common to hold assets in a family trust to take advantage of both their asset protection and tax benefits. Under the ESS regime, where an associate of an employee participant (including the trustee of a family trust) acquires an ESS interest in relation to the employee’s employment, those ESS interests are treated as being acquired by the individual employee for the purposes of Division 83A of the Income Tax Assessment Act 1997.

This is known as the ‘Associate Rule’.

If the Start-Up ESOP rules apply, the family trust is effectively ignored in accordance with Associate Rule and there is no amount that is included in the individual employee’s assessable income.

However, this is not the end of the matter. If the relevant options under a Start-Up ESOP are held by a family trust and they vest, are subsequently exercised and the trustee wishes to dispose of the underlying shares, an issue arises as to the acquisition date of the shares for the purposes of the 12-Month Holding Period Rule.

Exception to general acquisition rules and interaction with Associate Rule

The acquisition rules under the CGT regime state, amongst other things, that shares an acquirer acquires by exercising ESS interests (including options or rights under an ESS) where the Start-Up ESOP rules applied to reduce the amount to be included in the acquirer’s assessable income are taken to be acquired when the acquirer acquired those interests (options or rights).

The complexity surrounds the meaning of an ‘acquirer’ and its interaction with the Associate Rule, that is, by virtue of the Associate Rule, it is only the individual employee participant whose tax liability may be reduced under the Start-Up ESOP rules. Therefore, even though the Start-Up ESOP rules may operate to reduce the individual employee participant’s liability under the ESS tax regime, unless the options are issued to the individual employee participant, the special acquisition rules in relation to shares derived from Start-Up ESOP options will not apply, leaving the general acquisition rules to apply whereby the shares must be held for at least 12 months post-exercise in order to satisfy the 12-Month Holding Period Rule.

Conclusion

The Start-Up ESOP rules can be very beneficial in terms facilitating access to discount capital gains on shares acquired following the exercise of options granted under an ESS. However, given that an exit may come along at any time in a start-up context, clients must be careful to ensure that they fall within the special acquisition rules in relation to their shares otherwise, they may miss out on discount capital gains tax treatment on exit.

If you or your clients need any assistance in relation to the design of your ESS and the tax consequences of same, feel free to get in touch!

The Real cost of adding to your Owners Corporation

When I first started in strata 25 years ago there weren’t many urban renewal projects going on. In fact newly registered strata plan numbers were only in the 50,000’s.

With the recent NSW changes to the rules for collective sale, many Owners Corporations – who may not want to leave their homes entirely – have been sparked into thinking about adding to, or changing the existing buildings for the benefit of all owners.

They may be:

seeking to create more of a community than merely a vertical housing structure, or
they may be looking for monetary benefit without selling up and moving from their current home.

It would seem a building upgrade, or addition to create modern facilities, reducing the carbon footprint or generation of income for the lot owners is a reasonable option to consider.

It’s important to remember that there may be costs you haven’t considered when undertaking such projects

An Example

Let’s say the Owners Corporation is looking to add to the existing structure in order to make some money whilst the property market is booming. The owners have been throwing around the idea of converting an existing top floor plant room into an additional lot which can be sold and the proceeds returned to the owners. They don’t have the funds now, but they are looking at raising a special levy to fund the project.

The physical building works will include:

extending the lift shaft,
relocating the existing plant and equipment room; and
creating the new lot in the plan.

This newly formed lot could then be sold with the proceeds of the sale being returned to the owners.

So the owners create a sub committee to investigate the costs to complete the project. They have a fair idea of what the lot will sell for, but what is the cost?

Working out the Cost

A detailed project is created and they start breaking down all the expenses which will be incurred in the project. Quotes are requested, and estimates are collated for the cost of consultancy and application fees, project management and building costs.

Tax implications

The subcommittee must remember to consider the tax implications for both the Owners Corporation, and the lot owners individually. Tax is complex; there could be an unexpected tax liability or some deductions which were not considered when budgeting for the project. The subcommittee should take into account things such as:

Capital Gains Tax: construction and sale of the new lot for the Owners’ Corporation;
GST: What are the implications for the Owners Corporation of undertaking the project?
Personal tax: What are the implications on the Lot Owners’ personal tax if a special levy is raised to fund the works? Would there be a difference to the Lot Owners if the funds were raised to the Administrative or Capital Works Fund for the project? What are the tax implications for Lot Owners once the proceeds are returned after the sale of the lot?

A Private Ruling

The subcommittee may want to recommend the owner’s corporation apply for a private ruling which is binding advice provided by the ATO that sets out how a tax law applies in relation to a specific scheme or circumstance. Of course there are professional costs associated with lodging the ruling.

What should you do?

There can often be significant financial benefit to individuals when undertaking these types of works, but remember to consider all tax implications.

At the Economos Group we are experienced tax advisors for all individuals, and businesses including Owners Corporations. We’ve done this before and we can do it for you. We get it done.

Landbanking and the primary production exemption: NSW OSR hosed down

On 10 February 2017, the Supreme Court of NSW (Court of Appeal) handed down its decision in Chief Commissioner of State Revenue v Metricon Qld Pty Ltd [2017] NSWCA 11 (“Metricon”). The decision followed the Supreme Court of NSW’s recent decision in Leppington, which was the subject of a previous post by the author.

At issue was whether the Chief Commissioner’s continued attack on ‘landbanking’, of itself, as a relevant current use in determining eligibility for the NSW primary production exemption from land tax was sustainable.

The central issue before the court was:[1]

“whether “intangible use” (such as “land banking use” or “land development use” in the sense already mentioned), as distinct from “physical use” (such as cattle grazing or some other physical activity pursued on the ground) is relevant for the purposes of s10AA and, if so, whether such an intangible use was, at relevant times, the “dominant use” of the land in question.”

Core meaning of ‘use’

After carefully canvassing the relevant authorities, both as to the construction of the word, “use” generally[2] and in the context of s10AA specifically,[3] Barrett AJA concluded as to the core meaning of use:[4]

“Decided cases are replete with statements that “use” is a word of variable meaning and that the construction of one statutory provision concerning “use” of land may well be an unreliable guide to the correct construction of another such provision. For that reason, approaches taken in cases about different statutory contexts in which the word “use” is employed with respect to land must be treated with caution. It must nevertheless be accepted that “use”, in relation to land, has a core meaning independent of statutory context. In the recent Berrima Gaol land claim case (New South Wales Aboriginal Land Council v Minister Administering the Crown Lands Act [2016] HCA 50, French CJ, Kiefel, Bell and Keane JJ said (at [34]):

“True it is that the words ‘used’ and ‘occupied’ might be said to take much of their meaning from context. But that is not to say that they are devoid of a commonly understood meaning in ordinary parlance. They require an examination of activities undertaken upon the land in question and, in the case of ‘occupied’, factors such as continuous physical possession must be taken into account.”

Examination of “activities undertaken upon the land in question” is thus central to identification of “use”, according to the commonly understood meaning of the expression; and, as Allsop P pointed out in the Leda Manorstead case, the inquiry is not limited to activities producing beneficial or commercial return. Furthermore, past activity may be indicative of present use even if the activity is for the time being not continuing. This is because the absence of activity on the land at a given time may be part of a scheme of calculated and continuing utilisation that stems from past activity and remains in course of implementation without discernible activity at the time in question.”

‘Use’ under section 10AA of the Land Tax Management Act 1956

Barrett AJA held that:

the primary production exemption focused on “use” at large rather than use by an “owner” (that is, it included the use of the land by those other than the owner);

“dominant use” must be “for” the purposes of primary production and the activities listed in subsection 10AA(3) of the LTMA require “deliberate physical acts in relation to the land”;

hypothetically, if there were a lessor leasing to a lessee that carried on primary production activities:
1. if the focus is on physical activity, then the objective observer would conclude that the lessee’s agricultural use was the only use; and
2. if the focus is on the exploitation of ownership rights, the lessor’s use by leasing would be the only use;

it is difficult to compare and contrast those two uses as they have “intrinsically different qualities” and where each is fully deploying their rights, neither use would be dominant;

it must follow that section 10AA of the LTMA is referring to the physical use of the land and therefore:[5]

“the hypothetical case under discussion would be resolved by holding that there is, for s 10AA purposes, only one use, being the agricultural use by way of physical deployment undertaken by the tenant; and that it is not necessary to address any question of comparison with any use by the lessor (or any question of relative quantification).

inactivity cannot be a relevant current use[6] unless an intentional, actual and present advantage is derived by virtue of that inactivity.[7]

Conclusion

Barrett AJA concluded:[8]

“. . . the concept of “use” relevant to s 10AA as a whole (and s 10AA(3) in particular) – a concept in which the preposition “for” plays a central role – is one of physical deployment of Isaacs J’s “concrete physical mass”^[22] in pursuance of a particular purpose of obtaining present benefit or advantage from it, with deployment understood as including not only activity but also inactivity deliberately adopted as a means of obtaining such actual and present advantage from the land; and with purpose understood as objectively ascertained purpose. There is no requirement that immediate productive return be achieved, as long as some benefit or advantage accrues. In a s 10AA(3) case, each “use” considered in the search for “dominant use” must be of the character I have described.”

And further:[9]

“In saying this, I respectfully depart from the approach that commended itself to the primary judge and which his Honour confirmed in his later decisions on s 10AA in Bellbird Ridge Pty Ltd v Chief Commissioner of State Revenue [2016] NSWSC 1637 and Leppington Pastoral Co Pty Ltd v Chief Commissioner of State Revenue [2017] NSWSC 9. His Honour there confirmed the view that the possible uses to be considered for the purpose of determining what is the dominant use of land are not necessarily confined to physical uses of the land. That view should not be accepted.”

[Emphasis added]

Specifically as to landbanking, Barrett AJA held:[10]

“If “land banking” is understood as merely accumulating and holding a stock of land with a view to its future development, such “land banking” cannot be regarded as being, of itself, use of the land. Inactivity in the form of mere holding, although accompanied by a present intention to subdivide and sell at some future point, is not the source of present benefit or advantage and therefore does not constitute a use for the purposes of s10AA(3). What is required is some physical activity that causes the land to be raised out of a state of non-use into one of actual deployment in pursuance of the purpose of deriving advantage through subdivision and sale.”

Takeaway points

This is a big win for taxpayers. Not only did Metricon win, but the apparent expansion of relevant uses identified and accepted in Leppington (i.e. intangible use) was rejected in favour of a physical use test.

Assuming that sufficient primary production activities are being carried out on the relevant property in the first place, developers can expect to qualify for the land tax exemption until that critical point in time where, on all the relevant facts, a property development venture has crossed over from preparatory activities (even substantial preparatory activities such as planning and consultation) to the physical use of the land by means of subdivision and sale.

It is important to monitor the situation going forward to confirm whether:

the NSW OSR will appeal the decision; or
even if it does not appeal, legislative changes will follow to correct a perceived deficiency in the law.

If you or your clients need any assistance as to where the dividing line falls on the authority of Metricon, or for all your property development structuring needs, feel free to get in touch!

[1] Barrett AJA at paragraph 17 (with whom Macfarlan and Ward JA agreed)

[2] See Council of the City of Newcastle v Royal Newcastle Hospital (1957) 96 CLR 493; Ryde Municipal Council v Macquarie University (1978) 138 CLR 633; Minister Administering Crown Lands Act v NSW Aboriginal Land Council (2008) 237 CLR 285; Blacktown City Council v Fitzpatrick Investments Pty Ltd [2001] NSWCA 259; Ferella v Chief Commissioner of State Revenue [2014] NSWCA 378; Thomason v Chief Executive, Department of the Lands [1995] QLAC 4; The Council of the Town of Gladstone v The Gladstone Harbour Board [1964] Qd R 505

[3] See Leda Manorstead Pty Ltd v Chief Commissioner of State Revenue [2011] NSWCA 366

[4] At paragraph 45

[5] At paragraph 56

[6] Gladstone (above)

[7] Royal Newcastle (above)

[8] At paragraph 61

[9] At paragraph 62

[10] At paragraph 67

NSW OSR attacks land banking (again!) and what it means for developers

Introduction

On 30 January 2017, the NSW Supreme Court handed down its decision in Leppington Pastoral Co Pty Ltd v Chief Commissioner of State Revenue (“Leppington“).[1]

The issue at hand was whether a large parcel of land was eligible for the primary production exemption from NSW land tax.[2] The case is significant for three reasons:

the OSR repeated its position in Metricon Qld Pty Limited v Chief Commissioner of State Revenue (No. 2)[3] (“Metricon“) that “land banking”, of itself, constituted a relevant ‘use’ in determining eligibility for the primary production exemption, that is, land banking was a relevant current use rather than a excluded intended future use;
the manner in which the OSR’s case was argued – the OSR submitted (amongst other things):
1. Government policy guidance on the relevant legislation gave rise to an un-sustainably broad intention to narrow the scope of the exemption;
2. based on an equally un-sustainable interpretation of relevant statutory interpretation principles, the court was required to give effect to this apparent legislative intent;
Metricon is currently on appeal, if the Commissioner succeeds therein (or the likely appeal in Leppington), this will have significant implications for both developers and the broader property market in relation to green field sites, that is:
1. developers will have to factor in these additional cost inputs into any meaningful feasibility study of new acquisitions going forward;
2. developers currently land banking may need to seek additional finance to meet the increased land tax liabilities going forward; and
3. developers are unlikely to absorb these additional holding costs and simply pass them onto the market (in whole or in part), adding to the estimated $130,000 in State and Federal taxes already embedded in the price of a green fields ‘house and land’ package[4] (at a time when the freshly minted NSW Premier has described housing affordability as our “biggest issue”).

The facts

The decision involved rather complex facts whereby the landowner (“LPC“), which at all relevant times carried on one of the largest dairy farming businesses in Australia on the relevant land and elsewhere, granted a Call Option in favour of, then subsequently entered into a Development Rights Agreement (“DRA“) with, a related party (“GDC“).

Broadly, the effect of these agreements was that:

the development of the “Project Land” would be carried out in stages;
until the Project Land was disposed of by LPC, farming operations could continue at LPCs discretion;
GDC could enter into commercial arrangements with third parties to develop the Project Land and negotiate planning consents;
GDC could carry out these activities without first having to acquire the Project Land from LPC under the Call Option; and
GDC was required to fund the development of the Project Land and was entitled to any income derived from the development thereof, including sales contracts.

The Project Land was split into two categories:

the Development Land – being that part of the Project Land being developed from time to time; and
the Farmland – being that part of the Project Land not currently being developed and in relation to which, LPC, at its discretion, could continue its dairy farming operations under the relevant agreements.

Most, but not all, of the Project Land was not zoned rural land and as such, LPC had to satisfy the various requirements in subsection 10AA(2) of the Land Tax Management Act 1956 in order to qualify for the primary production exemption.

The legislation

The primary production exemption is extracted below:[5]

“10AA Exemption for land used for primary production

Land that is rural land is exempt from taxation if it is land used for primary production;
Land that is not rural land is exempt from tax if it is land used for primary production and that use the land:
1. has a significant and substantial commercial purpose or character; and
2. is engaged in for the purpose of profit on a continuous or repetitive basis (whether or not a profit is actually made);
For the purposes of this section, land used for primary production means land the dominant use of which is for:
1. cultivation, for the purpose of selling the produce of the cultivation; or
2. the maintenance of animals (including birds), whether wild or domesticated, for the purpose of selling them or their natural increase or bodily produce; or
3. commercial fishing (including preparation for that fishing and the storage or preparation of fish or fishing gear) or the commercial farming of fish, molluscs, crustaceans or other aquatic animals; or
4. the keeping of bees, for the purpose of selling their honey; or
5. a commercial plant nursery, but not a nursery at which the principal cultivation is the maintenance of plants pending their sale to the general public; or
6. the propagation for sale of mushrooms, orchids or flowers;
For the purposes of this section, land is rural land if:
1. the land is zoned rural, rural residential, non-urban or large lot residential under a planning instrument; or
2. the land has another zoning under a planning instrument, and the zone is a type of rural zone under the standard instrument prescribed under section 33A (1) of the Environmental Planning and Assessment Act 1979; or
3. the land is not within a zone under a planning instrument but the Chief Commissioner is satisfied the land is rural land.”

The issues

There were various issues raised in argument, that is:

who was using the land – LPC or GDC?
what was use of the land?
what was the dominant use of the land in each relevant year?

The OSR’s argument

Preliminary findings

White J held that use was limited to a current use rather than a contemplated future use.

His Honour then concluded that it was necessary to consider the nature, extent and intensity of the various current uses of the land, the extent of the land used for different purposes and the time, labour and resources spent in using the land each purpose.[6]

As to the scale and intensity of the relevant primary production activities, His Honour concluded that certain evidence presented on behalf of LPC in this regard was honest but ultimately unreliable, which affected LPCs ability to discharge its onus of proof.

OSR’s identification of uses

The OSR argued that the competing current uses to the primary production use of the Farmland were as follows:

earthworks use on the Farmland for the development of adjacent Development Land;
consultant use for existing and future development;
intangible use of the land by reason of the DRA; and
LPC was using the Farmland as a land bank.

In addition, the OSR submitted that on account of the Minister’s Second Reading Speech (“Speech“) to the State Revenue Further Amendment Bill 2005 (“Bill“), Parliamentary intent was clear and effectively, the court was required to torture the wording of the legislation to deliver the intended outcome.

Minister’s Second Reading Speech

The Speech in relation to the Bill states:

“… It is important to put on the record that we make no apology for closing tax avoidance measures … Land tax for rural lands for genuine farm purposes is important. We are closing the loophole that has emerged. A developer buys a parcel of rural land from a genuine farmer and organises rezoning to allow subdivision for residential, commercial or industrial use. Under the current legislation all he or she has to do to retain the land tax exemption that applied previously to the land is to ensure that it is fenced, run some farm animals, periodically sell some of them and buys some replacements. The land is then subdivided in stages. Fences are moved back so that the remaining area of subdivided land can continue to be used for primary production. This process continues until all of the land is subdivided and sold.

The only parcels of land on which land tax is ever paid by the subdivider are the subdivided blocks created during the year that have not been sold on 31 December. The amendments will require that the dominant use of the land is primary production. This will allow the portion of the revenue generated from the land from sale of subdivided lots compared to the revenue generated from the sale of animals to be taken into account. The primary production use of the land will have to have significant and substantial commercial purposes, which must be engaged in for the purpose of a profit or on a continuous and repetitive basis. Running a few head of cattle or sheep to attract a land tax exemption rather than to make profits will no longer suffice.”

“Just make it happen”

The OSR submitted that on account of the above, the legislative ‘target’ was clear and the court was obliged to make it happen.[7]

However, the authority cited in support of that submission is more limited than the authority suggests. To follow the relevant line of interconnected authority:

where the legislation is clear, a court cannot legitimately construe the words in a tortured and unrealistic manner;[8] however
where the legislative intent is clear, a court may be justified in giving a provision a ‘strained interpretation’;[9] however
where a literal approach to statutory interpretation gives rise to ambiguity or inconsistency, a purposive approach is to be adopted and an interpretation consistent with legislative purpose is to be preferred to one that does not;[10]
this common law position is codified in various jurisdictions, including NSW[11] and the Commonwealth;[12] and
the Commonwealth provision was discussed by the Full Court of the Federal Court in R v L, where it was held:[13]

“The requirement . . . that one construction be preferred to another can have meaning not only where two constructions are otherwise open, and . . . is not a warrant for re-drafting legislation nearer to an assumed desire of the legislature“[14]

[Emphasis added]

It is clear from the Speech that the legislation was targeted at a particular scheme whereby portions of land were fenced off and the vendors ran “some” farm animals to access the exemption.

The Minister was referring to cases where the exemption was claimed in circumstances where the relevant primary production activities were de minimis. The Minister was referring to circumstances in which the comparative scale or intensity of the relevant primary production use was low and it was in this context that he added that “[t]he amendments will require that the dominant use of the land is primary production.”

If land tax is assessed based on the use, or dominant use, of land from year to year, it stands to reason that land banking, which may not involve any use for many years (despite it being earmarked for future development) can only be weighed against any competing current use in that year.

How would taxpayer’s even determine the dominant use of a parcel of land where land banking was a current use with zero activity or expenses incurred on development activities? Would the future stages of actual development somehow relate-back to the earlier years as the relevant land was earmarked for development all along?

The scheme identified in the Speech was of narrow import involving de minimis primary production activities. It did not give rise to a broad-based intention to remove the exemption in relation to land banking regardless of the particular current uses from year to year. If it did, the legislature could (and should) have made this clear.

The OSR not only sought to argue that the policy identified in the Speech was of far broader scope than it actually was in narrowing the availability of the exemption, it then sought to apply an equally expansive view of relevant statutory interpretation principles to argue that the court was bound to deliver that apparently intended outcome.

The outcome

After comparing the current development uses versus the relevant primary production use of the Farmland in each year, White J concluded as follows:

in relation to 2011 – the OSR’s assessment was confirmed;
in relation to 2012 – the OSR’s assessment was revoked;
in relation to 2013 – the OSR’s assessment was revoked; and
in relation to 2014 – the OSR’s assessment was confirmed.

Comments and conclusion

The takeaway from Leppington is that the OSR is pushing to:

expand the apparent policy intent of the relevant legislation, thereby narrowing the availability of the primary production exemption; and
employ statutory interpretation principles to force the court to “make it so”.

Metricon is on appeal and the OSR raised the same argument in Leppington so as to preserve its rights on appeal in this regard.

Even if the OSR does not get up on appeal, in the absence of a determination by the High Court, it may still agitate to litigate on this point, which in itself presents a compliance risk for smaller taxpayers that simply do not have the resources to put up a fight.

Next steps

In light of the above, developers should:

review their circumstances;
identify the current uses of the relevant land;
if there is more than one current use, compare and contrast those uses in terms of scale and intensity;
be cognisant of the timing of certain activities and the impact it may have on eligibility for the primary production exemption (if any);
based on the timing of certain activities over the project period:
1. work out any anticipated land tax liability into the feasibility study from the outset; or
2. conservatively estimate its impact (on the high side) so as to more accurately estimate:
  1. holding costs;
  2. finance costs; and
  3. return on investment.

* * * * *

[1] [2017] NSWSC 9

[2] Section 10AA of the Land Tax Management Act 1956

[3] [2016] NSWSC 332 per White J

[4] See http://cms.3rdgen.info/3rdgen_sites/186/resourc/Senate%20Housing%20Affordability%20Submission.pdf

[5] Note 2 (above)

[6] Citing Thomason v Chief Executive, Department of Lands [1995] QLAC 4

[7] Citing Kingston v Keprose Pty Ltd (1987) 11 NSWLR 404

[8] Newcastle City Council v GIO General Ltd (1997) 191 CLR 85 at 113 per McHugh J

[9] See Note 7 (above); Sutherland Publishing Co Ltd v Caxton Publishing Co Ltd [1938] 1 Ch 174

[10] Mills v Meeking (1990) 169 CLR 214 at 235 per Dawson J

[11] Section 33 of the Interpretation Act 1987 (NSW)

[12] Section 15AA of the Acts Interpretation Act 1901

[13] (1994) 49 FCR 534 at 538 per Burchett, Miles and Ryan JJ

[14] Citing Trevisan v FCT (1991) 29 FCR 157 at 162

Moving to Australia? Pre-arrival planning questionnaire

Relocating to Australia gives rise to myriad potential tax issues from both a pre-departure, pre-arrival and ongoing perspective.

Check out our questionnaire on some of the key issues to consider and understand in making the transition.

Economos Pre-Arrival Questionnnaire

If you or your clients need any assistance in answering these questions and devising a pre-arrival plan, feel free to get in touch!

Using Contractors

If you are a small / medium business using contractors, you must make sure they are independent contractors to claim exemption from certain liabilities.

Contractors are a key area of compliance with the Australian Taxation Office.

If your contractors are not independent they will be classified as employees and your business will be liable for their:

Superannuation
Workers Compensation
PAYG Withholding Tax
Payroll Tax (State based tax)
Fringe Benefits Tax (where applicable)

The following statutory bodies:

Australian Taxation Office (superannuation and PAYG WHT),
Workcover (Workers Compensation), and
the various Offices of State Revenue (Payroll Tax)

are the bodies authorised to go back 4 years and review payments your business made to your “contractors” to make sure they are independent for liability purposes.

This is especially important in the building and construction industry. This industry is of particular interest to the various authorities.

Two important facts about contractors:

Just because a contractor has an ABN does NOT make them an independent contractor.
A contractor who uses a PTY LTD company will always be an independent contractor.

The following guide has been provided by the ATO in determining the status of your contractors.

An employee…..	A contractor…..
Works in your business and is part of your business	Runs their own business and provides a service to your business
Cannot sub-contract or delegate	Is free to sub-contract or delegate work
Is paid for time worked, price per item or paid a commission	Is paid for a result based on a quote provided

Is provided tools for the job – or is re-imbursed for the cost of equipment	Provides their own tools and equipment and does not receive an allowance or reimbursement
Has no commercial risk. You are responsible for their work.	Has all commercial risk and is liable for rectifications and defects
Your business has control over the work	Contractor has the freedom in the way the work is done – subject to prior contractual agreements

You may have hidden liabilities.

Please contact me if you need assistance in determining the independence of your contractors and assessing any potential hidden liability to these authorities.

Links

The ATO: Employee or Contractor: What’s The Difference?

Principal Contractor Issues: New South Wales Workcover

Contractors: Office of State Revenue NSW

Helicopter Guide to ESS

Overview

With limited exceptions (most notably in relation to eligible start-up schemes), the ESS rules are aimed at ensuring that ESS interests (shares or options rights over shares issued by a company employer or the holding company of the relevant employer) are subject to tax as ordinary income rather than concessionally-taxed capital.

The ESS rules achieve this by taxing any discount to the market value of the relevant ESS interest. However, the timing of when the relevant discount is calculated, either up-front or at the deferred taxing point depends on whether or not the particular ESS interests are eligible for deferral.

Preliminary issues

It is important to understand that:

the ESS rules can apply to relationships broader than the ordinary employer/employee relationship;

the ESS rules apply to the individual employee even if the relevant ESS interest are actually issued to another entity such as a family trust;

the ESS rules only apply to shares or options/rights over shares in companies – they do not apply to units in unit trusts;

ESS give rise to State/Territory-based payroll taxes;

where up-front taxation arises, subject to meeting certain conditions, employees may be able to reduce the amount included in their assessable income by up to $1,000; and

in relation to an ESS involving unlisted options (even if over listed shares), employees may be able to take advantage of the concessional ‘Table Valuations’ under the ESS regulations.

Taxed up-front schemes

The starting point under the ESS rules is that any discount is taxed up-front in the income year in which the relevant shares or options/rights are granted.

Where an individual is taxed up-front, the relevant discount is included in their assessable income in the ordinary course subject to the possible $1,000 reduction.

Example 1

Annabelle is a key employee of Tech Co. Tech Co issues Annabelle with shares in the company worth $25,000 in 2017.

The shares are not subject to any vesting conditions.

Annabelle includes the full $25,000 in her assessable income in 2017.

As you can imagine, this can place a significant cash flow constraint on the employee, who must come up with actual cash in order to pay her tax bill on a potentially illiquid asset (shares in a private company).

It was partly for this reason that the relevant start-up ESS concessions were introduced (see below).

Tax deferred schemes

Subject to meeting relevant deferral conditions, which differ for shares versus options/rights (with some overlap), the employee does not calculate the relevant discount as at the grant date but at the earlier of various deferred taxing points.

The critical conditions for deferred taxation include:

the ESS interests must be ordinary shares or options/rights over ordinary shares (and importantly, ordinary shares are effectively any shares other than preference shares);

the ESS interests must be subject to a ‘real risk of forfeiture’, that is, they are subject to vesting conditions such as minimum terms of employment, employee or company-specific KPIs or a combination all of them.

For options/rights granted before 1 July 2015 (even if un-vested as at 1 July 2015), the taxing point is generally vesting with a maximum deferral period of 7 years from the grant date.

For options/rights granted on or after 1 July 2015, the taxing point is generally exercise with a maximum deferral period of 15 years from the grant date.

The downside of deferred taxation is that the discount is calculated at the deferred taxing point so that any increase in the value of the ESS interests up to that point will be taxed in the employees hands as ordinary income.

Example 2

William is lead engineer in a telecommunications company. The company issues William $10,000 worth of options.

Both the company and William satisfy the relevant conditions for deferred taxation and the options vest at the end of 3 years provided that William is still employed by the company and certain company-based KPIs are met.

At the end of 3 years, the options vest. If the options were granted before 1 July 2015 vesting would generally be the taxing point. If the options were granted on or after 1 July 2015 the subsequent exercise of the options will generally be the taxing point.

Either way, however, the increase in the value of options (based on the underlying increase in the company’s share price) between the grant date and the deferred taxing point is assessed to William at the relevant time. For example, if the options were worth $1m on the relevant date William will be taxed at up 45% on the entire discount (excluding levies)!

Eligible start-up concession

In recognition of the difficulties facing start-up companies and their employees, particularly in relation to the latter and the potential for them to be taxed heavily in relation to ESS interests that are highly illiquid and their valuations highly speculative, new rules with effect from 1 July 2015 operate to ensure that, in relation to the issue of options:

eligible start-ups can save the potentially significant costs of:
1. formal legal advice by adopting the Australian Taxation Office template ESS Plan documentation;
2. subject to meeting additional criteria – a formal valuation by adopting the safe harbour valuation methodology (which in effect provides a net tangible assets valuation stripping the company of valuable intangibles);

eligible employees:
1. may be able to obtain shares in the company (via exercising the options) at a significant discount to ‘real’ market value which would generally include valuable intangibles ignored under the safe harbour valuation methodology; and
2. are only taxed on the eventual disposal of the underlying share following vesting and exercise of the relevant options/rights.

In addition, provided that the combined holding period of options and the underlying shares (post-exercise) is more than 12 months, the relevant employee will generally be able to access the general 50% CGT discount (whereas ordinarily, exercising an option ‘re-starts the clock on the 12 month holding period rule in relation to the underlying share).

There are a number of conditions that must be satisfied, however, in order to qualify for an eligible start-up plan, including but not limited to:

the strike price of the option must be at least equal to the underlying share price on the grant date (which, subject to separate eligibility criteria, could be determined using the safe harbour valuation methodology);

the relevant company and all group entities are under 10 years old;

the relevant company and all group members have total turnover of less than $50m;

the options must relate to ordinary shares in the relevant company; and

the particular employee-participant cannot hold more than 10% of shares in the relevant company on a fully diluted basis.

Other ESS plans

If, for whatever reason, the relevant ESS fails to qualify for the eligible start-up concession or none of the other structuring options under the ESS rules are suitable to all relevant stakeholders, other alternatives include:

a limited recourse loan plan – where employees are issued shares in the company but are required to repay the full market value as at the subscription date over time (watch out for deemed dividend and FBT issues);

a partly paid share plan – where employees are issued with share partly paid-up to a certain extent and who pay-up the shares to the full market value as at the subscription date over time (generally should not give rise to deemed dividend or FBT issues); and

a phantom share plan – which isn’t a share plan at all but a right to a cash payment which usually tracks the increase in value of the shares in the company between set dates.

Conclusion

There are numerous issues to consider in relation to the design and implementation of an ESS.

The starting point is achieving the company’s commercial goals of incentivising key employees to kick major goals by tying business levers to individual KPI’s in a meaningful way so that all stakeholders benefit.

Other things being equal, from a tax perspective the start-up concession is the most beneficial to participating employees in that the relevant increase in value will generally be taxed at only half the rate of ordinary income (max. 22.5% instead of max. 45% excluding levies). However, if this is not available, it is a matter of designing a plan that strikes the right balance between achieving the company’s goals and not creating cash flow problems for participating employees.

* * * * *

Disclaimer – this article does not constitute specific advice and cannot be relied upon as such.

Kiwi investing or expanding into Australia?

Introduction

This helicopter guide to inbound Australian tax issues for New Zealand resident individuals and entities is meant to operate as a spring-board for high-level structuring discussions by NZ advisers.

The purpose of this guide is to enable readers to quickly identify the various issues raised by the different structuring options before seeking specific advice (preferably ours!) on the most suitable structuring option for your clients.

This guide is separated into five parts.

Part I highlights the tax issues for NZ-resident investors investing in Australian real property, shares and unit trusts.

Part II outlines the tax issues for NZ-resident employees seconded to Australia.

Part III details the tax issues for NZ-resident entities expanding into Australia (whether by way of branch or subsidiary).

Part IV outlines the basics of Australia’s GST.

Part V highlights Australia’s CGT withholding tax.

PART I – CGT ISSUES FOR NZ RESIDENTS INVESTING INTO AUSTRALIA

Overview

Although still a small market by global standards, Australia’s proximity to NZ and the close ties between the two countries means NZ residents often invest in Australian real property, shares and unit trusts.

Under Australian domestic tax law, the starting point is that Australia taxes foreign-residents on their capital gains from Australian sources.[1]

Australia’s CGT rules operate such that a capital gain or loss is triggered where a CGT event arises.

The most common CGT event is CGT A1 – disposal of a CGT asset.[2]

Where, amongst other things, individuals or trusts (but not companies) hold a CGT asset for at least 12 months prior to disposal, the 50% CGT discount will apply so as to halve the gross capital gain before being included in the taxpayer’s assessable income.[3]

Special rules for foreign-resident investors

The general rules above are subject to a specific statutory exception that operates to limit the taxation of foreign residents on Australian source capital gains to those in relation to a limited class of assets, known as ‘taxable Australian property’ (“TAP”).[4]

That is, a capital gain or loss is disregarded if you are a foreign resident, or the trustee of a foreign trust just before the CGT event (e.g. disposal) and the relevant asset was not TAP.

Relevantly, TAP means:[5]

taxable Australian real property;

an indirect Australian real property interest;

a CGT asset used in carrying on a business through a permanent establishment in Australia;

an option or right to acquire a CGT asset over any of the above; and

a CGT asset subject to an exit election (that is, where a previously Australian-resident individual chose to defer Australian exit tax by electing to pay tax on actual disposal).

Based on the above, where, for example, an NZ resident invests in Australian real property, they will always be subject to CGT in Australia on any capital gain.

However, in relation to the disposal of shares in an Australian company or units in an Australian unit trust, NZ residents will not be subject to CGT in Australia unless those interests qualify as ‘indirect Australian real property interests’ which, amongst other things, requires:[6]

the NZ resident (together with associates) to hold at least 10% of the Australian company or trust; and
the Australian company or trust to pass the ‘principal asset test’,[7] that is, the market value of the entity’s taxable Australian real property assets exceeds the market value of the entity’s non-taxable Australian real property assets (essentially, the company or trust is ‘land-rich’).

Foreign-residents no longer entitled to the 50% CGT discount

As outlined above, where the relevant conditions are met by an eligible taxpayer (individual or trust), the 50% CGT discount applies to reduce the gross capital gain by half before being included in assessable income.

However, from 8 May 2012, foreign-residents are not entitled to the 50% CGT discount, meaning that they will pay tax on the gross capital gain at non-resident rates (currently up to 45%).

For those NZ residents that held Australian TAP assets as at 8 May 2012, special transitional rules apply and specific advice should be sought in this regard in calculating any capital gain or loss in the future.

For those NZ residents that acquired Australian TAP assets after 8 May 2012, they are not eligible for the 50% CGT discount regardless of how long the asset is held.

PART II – NZ EMPLOYEES SECONDED TO AUSTRALIA

Overview

Under Australian domestic tax law, the starting point is that foreign-resident are taxed on their ordinary income (including salary and wages income) from Australian sources.[8]

Application of the Australia/NZ Double Tax Agreement

The domestic Australian tax position above is reflected in the default position under the Australia/NZ Double Tax Agreement (“DTA”),[9] that is, an NZ-resident is only taxed on employment income in NZ unless the employment is performed in Australia.

However, the default position is subject to an overriding provision such that an NZ resident deriving income from employment exercised in Australia is only taxed in NZ if:[10]

the NZ individual is present in Australia for a period or periods not exceeding in the aggregate 183 days in any 12 month period commencing or ending in the Australian income year; and

the remuneration is paid by, or on behalf of, an employer who is not a resident of Australia, or is borne by or deductible in determining the profits attributable to a permanent establishment which the employer has in NZ; and

the remuneration is neither borne by nor deductible in determining the profits attributable to a permanent establishment which the employer has in Australia.

If these conditions are satisfied, the NZ-resident employee is only taxed in NZ.

Further, even if these conditions cannot be satisfied, remuneration derived by an NZ-resident individual in respect of a secondment to Australia is only taxable in NZ where the individual is present in Australia for a period or periods not exceeding in the aggregate 90 days in any 12 month period.[11]

PART III – NZ BUSINESSES EXPANDING INTO AUSTRALIA

Overview

Most NZ practitioners would be broadly familiar with the structuring options in relation to expanding into Australia (or elsewhere for that matter), that is, branch versus subsidiary.

Again, under Australian domestic tax law, a foreign-resident is taxed in Australia on all Australian-source income.[12]

However, under the DTA, the Australian-source business profits of an NZ-resident are not taxed in Australia unless the NZ-resident has a permanent establishment in Australia.[13]

What is a permanent establishment?

A permanent establishment is a fixed place of business in Australia.

Specific advice should be sought as to whether your operations will trigger a permanent establishment in Australia as the concept relies on the particular facts of each individual case and therefore, although similar cases may provide guidance, different facts may prove decisive in a particular case.

The Australian Taxation Office takes an expansive view as to what triggers a permanent establishment in Australia and has ruled that an NZ company had a permanent establishment in Australia where:[14]

it sold products to 3rd parties in Australia;

sales orders were taken by two Australian-based employees who emailed orders to NZ;

the employees were the Australian contacts of the company;

the employees were provided with a car and office machinery;

the employees operated out of a designated room in their own houses;

the company had an Australian bank account; and

the products were sent directly from New Zealand to Australian customers or via a 3rd party warehousing intermediary.

Based on the above, an individual employees’ home (or even, a single room of their home) may trigger a permanent establishment in Australia.

Branch versus subsidiary (tax issues)

Assuming that the NZ-resident’s Australian operations would give rise to a permanent establishment in Australia, we note that:

in relation to an Australian branch:
1. the profits of the branch will be taxed in Australia at the relevant rate (e.g. NZ-resident companies will be taxed at 30% and NZ-resident individuals at their marginal tax rate up to 45%);
2. Australia does not have branch profits remission tax in moving the profits to NZ;
3. the assets of an Australian permanent establishment are TAP assets and therefore, the NZ-resident will be subject to CGT in Australia if the Australian branch was sold in the future;
in relation to an Australian subsidiary:
1. it will be taxed on its worldwide income at 30%;
2. in relation to dividends paid up to the NZ-resident shareholder(s):
  1. no dividend withholding tax will apply to the extent that the dividend is fully franked;
  2. dividend withholding tax of between 0% and 15% will apply under the DTA to the extent that the dividend is un-franked;
3. the shares in the Australian subsidiary (unless it is ‘land-rich’ with Australian real property) are not TAP and therefore, the NZ-resident entity will not be subject to Australian CGT if the Australian operations are sold in the future by way of share sale (disposal by way of the sale of underlying assets by the Australian subsidiary will be taxed at 30% in the ordinary course giving rise to the taxation of dividends as outlined above).

Choice of structure of foreign tax credits/offsets

Cross border business activities often gives rise to multiple layers of taxation and the inability to claim foreign tax credits so as to push up the effective tax rate on foreign-source profits. However, some business structures facilitate the claiming of full foreign tax credits (up to the maximum tax liability in the home country) such that taxpayers pay no more than the maximum domestic tax rate in their home country.

Understanding the various structuring options available and how they are ultimately taxed in Australia, New Zealand and under the DTA is the key to making a fully informed decision and preventing any nasty surprises. In this regard, structuring options include:

a New Zealand company with an Australian branch (and in turn, whether or not it gives rise to an Australian permanent establishment);

an Australian subsidiary of a New Zealand parent company;

a New Zealand limited partnership operating in Australia (whether or not an Australian permanent establishment arises); and

a New Zealand Look-Through Company operating in Australia (whether or not an Australian permanent establishment arises).

PART IV – GST ISSUES

Australia levies GST on ‘taxable supplies’[15] and ‘taxable importations’[16].

The rate of GST is (currently) 10%.[17]

The registration turnover threshold (above which you are required to be registered) is AUD$75,000, although you may be voluntarily registered if you are under this turnover figure.[18]

There are various supplies that are not subject to GST, that is:

GST-free supplies (such as certain foods, health and education services and supplies of going concerns[19] – similar to zero-rated supplies in NZ; and

input taxed supplies (such as financial supplies, residential rent supplies and residential premises themselves [unless ‘new residential premises][20] – similar to exempt supplies in NZ.

Where an enterprise makes a ‘creditable acquisition’ or ‘creditable importation’, they are entitled to claim the relevant input tax credits.

Broadly, a creditable acquisition is an acquisition (or expense incurred) that had a GST component within it and was incurred in order for you to make taxable supplies or GST-free supplies (but not input taxed supplies – input tax credits are not available in this regard).

You make a creditable importation if goods are imported and they are entered for home consumption (unless specifically non-taxable).

From a cash flow perspective, NZ businesses importing into Australia should consider the ‘deferred GST’ regime, whereby instead of paying GST only to claim it back at the end of the relevant tax period, the liability is deferred and nets off against the refund at the end of the tax period.

PART V – CGT WITHHOLDING TAX

From 1 July 2016, and in similar circumstances to the NZ CGT withholding regime for properties held for less than 2 years, Australia imposes a 10% withholding tax on the purchase price of Australian real property over AUD$2m.

Even if you are caught by the CGT withholding regime, it is possible, in circumstances where there is insufficient equity in the property or the ultimate CGT liability on the property will be less than the 10% withholding amount, to apply to the ATO for a withholding variation (including to nil) as soon as possible after exchanging contracts so as to ensure that the relevant approvals are granted prior to settlement.

CONCLUSION

Economos has significant experience and expertise in assisting foreign investors and business invest or expand into Australia.

This requires an in-depth knowledge of Australian domestic tax laws and the operation of the DTA.

We provide commercially-focussed, complex international tax advice in a simple, easy-to-understand manner so as to enable your clients to make fully-informed decisions and avoid nasty surprises.

Our tax advisory services form a critical part of our broader service offering, including:

tax compliance (income tax, GST, fringe benefits tax, payroll tax etc);

financial reporting; and

audit.

* * * * *

[1] Subsection 6-10(5) of the Income Tax Assessment Act 1997 (“ITAA 1997”)

[2] Section 104-10 of the ITAA 1997

[3] See Subdivision 115-A of the ITAA 1997

[4] See Division 855 of the ITAA 1997

[5] Section 855-15 of the ITAA 1997

[6] Section 855-25 of the ITAA 1997

[7] Section 855-30 of the ITAA 1997

[8] Subsection 6-5(3) of the ITAA 1997

[9] Article 14(1) of the DTA

[10] Article 14(2) of the DTA

[11] Article 14(4) of the DTA

[12] Note 8

[13] See Articles 7 (Business Profits) and 5 (Permanent Establishment) of the DTA

[14] See ATOID 2005/289 (available at https://www.ato.gov.au/law/view/document?docid=AID/AID2005289/00001)

[15] Subsection 7-1(1) and section 9-5 of the A New Tax System (Goods and Services) Tax Act 1999 (“GST Act”)

[16] Subsection 7-1(1) and section 13-5 of the GST Act

[17] Section 9-70 of the GST Act

[18] Section 23-15 of the GST Act and reg 23.15.01 of the A New Tax System (Goods and Services) Regulations 1999 (“GST Regs”)

[19] See Division 38 of the GST Act

[20] See Division 40 of the GST Act

Partitioning real property – what is it and what are the tax implications?

Introduction

This article is relevant for developers, investors and even those looking to break into the first-home buyer’s market at a discount to market value.

In relation to the latter, even at historically low interest rates, many people are simply shut out of the property market as the cost of entry is beyond their financial reach. For some, the problem is exacerbated in boom times where the market may increase in value well beyond the rate of their capacity to save.

Increasingly, as a means of entering the market, friends and family members are pooling their financial resources. Commonly, this involves the straightforward purchase of an existing dwelling to live in or rent out, however, an increasingly popular option is to undertake small-scale development projects, such as a duplex.

Such projects can be attractive in a variety of circumstances, including:

parents seeking to acquire an investment property and adult children wanting to enter the first-home buyer’s market (parents take one dwelling and the children take the other(s));

parents seeking to down-size and adult children wanting an investment property (parents live in one dwelling and adult children rent out the other(s)); or

siblings and/or friends seeking a first-home and/or investment property (one party takes one dwelling and the other party takes the other).

There is no denying that such projects give rise to complexities, however, provided that participants carefully consider all the relevant issues and weigh the particular risks prior to entering into any arrangement, they can be very worthwhile.

Increasingly, project home builders have standardised duplex/triplex/townhouse designs available so as streamline the construction process (and although participants pay a premium for the service compared to project managing themselves, in the writer’s experience, project home building is a very competitive industry with very reasonable base prices and if you can source options and extras from external sources rather than the project builder, there are considerable savings to be made).

For present purposes, assume that by pooling their resources, two parties are able to save $100,000 each, that is, an attached duplex which would cost $850,000 on market costs $750,000 to develop. This may not only be the difference between buying in a preferred suburb or elsewhere, but over the life of the loan this will save a very significant amount of interest.

From a planning perspective, individuals need to be aware of the rules governing the development of a potential property before purchasing. Unfortunately, each local government area is different so it will be a matter of participants either:

sifting through the relevant provisions of the applicable Local Environmental Plan, Development Control Plan and any statutory overlays personally; or

engaging the services of an experienced town planner in their local government area, who for a small fee will summarise precisely what can and cannot be done with the property prior to you moving forward.

In the writer’s experience, wherever possible, going down the path of ‘complying development’, that is, purchasing a property that is effectively ‘pre-approved’ by the local government authority for the desired project (subject to meeting designated criteria such as minimum lot frontage, minimum lot area, maximum height and maximum floor-space-ratio) effectively eliminates the risk of not getting approval. However, there are also other risks to carefully consider before deciding to proceed, including finance risk and construction risk.

From a tax perspective, these projects give rise to issues as to:

the income/capital distinction;

income tax;

capital gains tax (“CGT”);

goods and services tax (“GST”);

stamp duty; and

the availability of any relevant concessions/exemptions.

Interaction between planning regulations and finance

One critical issue to consider is finance, which is in part a function of valuation. Generally, ordinary residential mortgage lenders will lend 80% of the valuation of the end product without mortgage insurance.

The potential problem with this is that in relation to attached duplexes and triplexes, local council regulations generally dictate that subdivision (whereby a single legal lot is split into two or more separate legal titles) is the very last step in the entire construction process. Therefore, ordinary residential mortgage lenders will often only lend on the value of the amalgamated (un-subdivided) property. Consider the following:

Example

Annabelle and William are siblings and wish to construct two, three-bedroom attached duplexes. Based on comparable sales, the end value of each duplex post-subdivision will be $850,000 ($1,700,000 in total). However, the lender can only value the existing, un-subdivided block based on the plans provided as a single, six bedroom home valued at $1,200,000. Therefore, Annabelle and William can borrow 80% of $1,200,000 ($960,000) without mortgage insurance, not 80% of $1,700,000 ($1,360,000).

Some participants may simply accept that mortgage insurance is the cost of getting started and of course, there may be better financing options out there, although in the writer’s experience, borrowing on the anticipated end value of a project (post-subdivision) involves commercial forms of finance which is generally more expensive. Ultimately, if the numbers work, perhaps commercial forms of finance is the answer to get the project off the ground before re-financing to an ordinary residential mortgage on completion (a finance broker should be able to assist you in this regard).

What happens on subdivision?

If two participants acquire a property as tenants-in-common in equal shares and intend to construct a duplex, whether as developers, investors or a private arrangement with the duplexes to serve as their respective main residences, then returning to the example above, on subdivision:

Annabelle owns 50% of Lot A and 50% Lot B; and

William owns 50% of Lot A and 50% Lot B.

The purpose of the project is to ensure that Annabelle owns 100% of Lot A and William owns 100% of Lot B. This is critical as to the extent that one party wishes to use their dwelling as their main residence, they must hold 100% of the property in order to claim the full main residence CGT exemption on disposal. Separately, a partition is critical if the parties are seeking to carry out a joint venture as opposed to a partnership (and therefore avoid joint and several liability), as the hallmark of a joint venture is the sharing of product rather than profit.

Returning to the example above, if Annabelle treated Lot A as her main residence and there was no partition, the eventual disposal of Lot A would only be exempt as to 50%, with the remaining 50% assessed in the usual manner in the hands of William (who will be ineligible to claim the main residence CGT exemption in relation to Lot A as his main residence is Lot B).

In order to achieve the desired result:

Annabelle will need to transfer her 50% share of Lot B to William; and

William will need to transfer his 50% share of Lot A to Annabelle.

This is known as a ‘partition’.

As outlined below, depending on whether the relevant participant holds their interest on capital account, trading stock or otherwise on revenue account, various tax consequences arise on partition.

Tax issues for participants

The income/capital distinction

Participants must consider their intention or purpose in entering into the project. If participants intend to live in their dwelling as their main residence, or to rent out one of the dwellings, they are likely to be taken to hold the property as a capital asset. Conversely, if a participant is entering into the project to sell one or more of the dwellings, they will be taken to hold the relevant “for sale” dwelling(s) as trading stock (or otherwise on revenue account).

So what is the difference?

If a participant holds the property on capital account, they will be subject to the CGT regime. Capital assets give rise to capital gains or losses and for individuals (or individual beneficiaries of a trust), the maximum tax payable on a long-term capital gain (a gain on an asset held for at last 12 months) is 22.5% (excluding levies).

This is known as the “50% CGT discount”.

Further, in the present context, special exemptions may apply in the context of partitions (see below).

If participants hold the property as trading stock (or otherwise on revenue account), they will be subject to tax at their ordinary marginal tax rates on disposal (currently up to 45% excluding levies).

Note, the income/capital distinction can be a very grey area and the ATO is certainly alive to the pointy practice of taxpayers purporting to hold assets on capital account rather than as trading stock (or otherwise on revenue account) and claiming the 50% CGT discount on disposal soon after the 12 month holding period ticks over.

In the context of an ATO review, it is insufficient to highlight the taxpayer’s subjective intention or purpose in entering into the project unless such intention is corroborated by objective evidence and as recent case law highlights, this extends to evidence as to:

what participants told their lender(s) when seeking finance as to their purpose;

what participants told any real estate(s) agent as to their purpose and whether they were engaged to generate pre-sales;

what participants told the local government area as to their purpose in seeking approvals (if applicable); and

whether and how the property/ies were marketed (i.e. for sale, for rent or ‘for sale or rent’).

At the risk of over-simplifying, all objective evidence must support the taxpayer’s stated subjective purpose and participants can expect that, in the absence of specific circumstances (such as serious illness, unexpected relocation etc), the shorter the time period between completion of the project and disposal, the higher the scrutiny they are likely to come under from the ATO in seeking to claim discount CGT treatment.

This article assumes that participants are on capital account.

CGT issues

A partition gives rise to a partial disposal, that is, returning to the example above, Annabelle disposes of her 50% interest in Lot B to William as consideration for the transfer of William’s 50% interest in Lot A.

The disposal of a CGT asset generally gives rise to a capital gain or loss. However, a special exemption applies where:

you own land on which there is a building; and

you subdivide the building into stratum units; and

you transfer each unit to the entity who had the right to occupy it just before the subdivision,

a capital gain or loss you make from transferring the unit is disregarded.

There is a corresponding CGT exemption for the receipt of the relevant strata unit in these circumstances. However, specific advice should be sought and the relevant partition agreement between the parties must be appropriately documented so as to ensure that each participant has a right to occupy a particular dwelling so as to fall within the particular exemptions.

Note that this only applies to strata title properties and does not apply to other forms of land title, including Torrens title.

In relation to Torrens title land (and other forms of land title), the ATO takes the view that a partition agreement, even if entered into at the very outset between the relevant parties, will trigger an ordinary disposal for CGT purposes.

Some commentators take the view that if the relevant parties enter into an arrangement at the outset whereby Annabelle acquires half of her 50% legal interest in the property as trustee for William and vice versa that the subsequent transfers of those shares by the respective trustees on partition are ignored for CGT purposes under the absolute entitlement rules.

However, the ATO takes the view (in a draft Taxation Ruling that has remained in draft form for near 12 years now) that two or more individuals cannot be absolutely entitled to a single parcel of real property and therefore, the absolute entitlement rules do not apply to prevent triggering CGT in these circumstances.

At the very least, this differential treatment for Torrens title versus strata title property appears to infringe the principle of horizontal equity, in so far as taxpayers with similar assets (although clearly legally distinct) being subject to different tax rules, that is, partitions of Torrens title property triggers liability to CGT whilst partitions of strata title property being disregarded for CGT purposes. However, the CGT concession for strata title property has its genesis in the conversion of older systems of title to strata title following its introduction. The question remains, however, as to why there is not a broad-based CGT rollover for partitions of all real property, regardless of its system of title as it only serves to trigger liability to tax in the absence of the actual receipt of funds with which to pay it (unless the relevant asset is liquidated).

Stamp duty issues

Ordinarily, transfers pursuant to a partition would trigger liability to duty. However, in NSW (and other States/Territories), special concessions may apply to limit duty to the extent of any ‘overs’. Returning to the example above, in NSW, if Annabelle and William have an interest in the post subdivision (pre-partition) dwellings worth $850,000 each, and post-partition they each hold 100% of a single property worth $850,000, concessional duty of only $50 is payable.

However, if the post subdivision (pre-partition) value was $850,000 each, but Lot A was worth $900,000 based on superior fixtures, fittings and aspect, then Annabelle, as transferee, would be subject to duty on her $50,000 up-interest, or approximately $765.

Please note that other States/Territories offer various partition concessions however, they can operate differently to the NSW provisions and specific advice should be sought in this regard.

GST issues

Generally, the supply of residential premises is input taxed, meaning that the supplier (vendor) does not charge GST on the supply and cannot claim any GST credits on expenses in relation to the property.

There is an exception to the general rule, however, in relation to the supply of ‘new residential premises’. Broadly, new residential premises are residential premises that:

have not previously been sold as residential premises (other than commercial residential premises) or the subject of a long-term lease (generally 50 years);

have been credited through substantial renovations; or

have been built, or contain a building that has been built, to replace demolished premises on the same land).

New residential premises are subject to GST if all the relevant conditions of a ‘taxable supply’ are met.

An entity makes a taxable supply where, among other things, they carry on an ‘enterprise’ and they are registered, or required to be registered for GST.

The term, ‘enterprise’ is broader than that of ‘business’ and includes, for example, an enterprise of leasing residential property. However, activities of a private or domestic nature fall outside the scope of an enterprise.

Broadly, if a participant is seeking to construct a dwelling to act as their main residence, it will be considered private or domestic and therefore, they will not be required to be registered for GST (and if they are registered for required to be registered for other reasons, for example, they are a sole trader, then these activities would fall outside the scope of their enterprise).

However, if a participant is seeking to rent out their dwelling, they will be carrying on an enterprise of residential leasing and therefore, they will be required to be registered if they will have turnover of more than $75,000.

Returning to the example above, if Annabelle intended to use Lot A as her main residence and William wanted to rent out Lot B, then as the value of William’s supply of 50% of Lot A to Annabelle on partition will exceed the $75,000 registration threshold, William will be subject to GST on the partial disposal of new residential premises.

Conversely, this means that William will be entitled to GST input tax credits equal to 50% of the GST component of his eligible input costs in carrying out the project. In this regard, specific advice should be sought as to the availability of the margin scheme.

Conclusion

Partitioning is common amongst developers engaged in joint ventures (whether between arm’s length third parties or ‘internal’ joint ventures between a company [intending to sell] and a trust [intending to hold for investment] within a single family group).

Increasingly, partitioning is being used by family and friends to break into the property market or deliver an instant ‘equity boost’ to the participant’s respective property portfolios.

Of course, there are myriad issues to consider and costs to factor in in conducting a feasibility study so as to determine whether it is worthwhile and what participants can expect to save compared to buying equivalent end-product ‘on market’.

Any feasibility study must include as relevant expenses the tax, duty and GST implications of the proposed transaction so as to get an accurate idea of the relevant savings, which will ultimately assist in determining whether the project is worth the effort.

Again, specific advice is absolutely critical in this regard as generalisations are apt to mislead, however, as a rough ‘ready reckoner’, please see the table below:

Purpose	Main Residence	Investment Property
Duty on acquisition	Yes	Yes
GST credits on (non-land) costs	No	Yes (as apportioned)
GST payable on partition	No	Yes
Will margin scheme apply?	N/A	Yes (if conditions satisfied)
NSW duty on partition	Concessional (unless ‘overs’ arise)	Concessional (unless ‘overs’ arise)
CGT on partition	Yes (unless strata exemption applies)	Yes (unless strata exemption applies)

Many people are surprised by the fact that tax and GST issues can arise on partition as they are not ‘cashing out’ but rather, taking a preliminary step in putting the properties in the individual names of the relevant participants so as to facilitate, for example, access to the CGT main residence exemption on eventual disposal. However, in the absence of any specific concession, the general tax rules apply to assess participants as outlined above (except insofar as a specific concession or exemption applies) and these costs must be factored into any meaningful feasibility study.

* * * * *

Disclaimer – this article does not constitute specific advice and cannot be relied upon as such.

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Tax pitfalls of “Children’s” Saver Accounts

Background:

Legislation and Ruling:

Guidance:

Practical Application:

Background

2015 Amendments

Participating in an ESOP via a family trust

Exception to general acquisition rules and interaction with Associate Rule

Conclusion

When I first started in strata 25 years ago there weren’t many urban renewal projects going on. In fact newly registered strata plan numbers were only in the 50,000’s.

Working out the Cost

Tax implications

A Private Ruling

What should you do?

Core meaning of ‘use’

‘Use’ under section 10AA of the Land Tax Management Act 1956

Conclusion

Takeaway points

Introduction

The facts

The legislation

The issues

The OSR’s argument

Preliminary findings

OSR’s identification of uses

Minister’s Second Reading Speech

“Just make it happen”

The outcome

Comments and conclusion

Next steps

Relocating to Australia gives rise to myriad potential tax issues from both a pre-departure, pre-arrival and ongoing perspective.

If you are a small / medium business using contractors, you must make sure they are independent contractors to claim exemption from certain liabilities.

Two important facts about contractors:

The following guide has been provided by the ATO in determining the status of your contractors.

Links

Overview

Preliminary issues

Taxed up-front schemes

Tax deferred schemes

Eligible start-up concession

Other ESS plans

Conclusion

Introduction

PART I – CGT ISSUES FOR NZ RESIDENTS INVESTING INTO AUSTRALIA

Overview

Special rules for foreign-resident investors

Foreign-residents no longer entitled to the 50% CGT discount

PART II – NZ EMPLOYEES SECONDED TO AUSTRALIA

Overview

Application of the Australia/NZ Double Tax Agreement

PART III – NZ BUSINESSES EXPANDING INTO AUSTRALIA

Overview

What is a permanent establishment?

Branch versus subsidiary (tax issues)

Choice of structure of foreign tax credits/offsets

PART IV – GST ISSUES

PART V – CGT WITHHOLDING TAX

CONCLUSION

Introduction

Interaction between planning regulations and finance

What happens on subdivision?

Tax issues for participants

The income/capital distinction

So what is the difference?

CGT issues

Stamp duty issues

GST issues

Conclusion