Top private group tax developments of 2023

Top 500 & Next 5,000 Review

The Australian Taxation Office (ATO) continued its reviews of the Top 500 and Next 5,000 largest privately owned groups in Australia. Both programs involve tailored one-to-one-engagements to build a comprehensive understanding of a private group’s tax affairs, aiming to detect any historic tax risks and increase forward-looking compliance. These reviews can result in tax audits or a voluntary disclosure having to be made, so care is required in the way a Top 500 or Next 5,000 response is managed.

A particular theme we have noticed throughout these reviews is an emphasis on tax governance and wealth extraction. The ATO has a strong preference for a written tax governance framework to be implemented regardless of the scale of operations undertaken by the private group – although the sophistication of that governance framework will vary according to the group’s needs and activities.

In its most recent annual report, the ATO has identified that the approximate income tax gap (the difference between the total theoretical tax that should have been collected against the actual amount received) for High Wealth taxpayers was 7.1% for the 2020-21 income year. While this figure is broadly in line with the overall net tax gap (which was 7%), it is higher than all most of the other segments. While the tax gap analysis for the 2021-22 income year is yet to be reported, the 2020-21 figures indicate that greater ATO attention will be drawn to High Wealth taxpayers as the Commissioner of Taxation (Commissioner) seeks to continue the trend of reducing the average net gap. The Commissioner’s overview of the report can be found here.

Find out more by visiting our dedicated Tax Disputes Portal for private groups here.

UPEs and Division 7A

On 28 September 2023, Deputy President F D O’Loughlin KC and Senior Member K James of the Administrative Appeals Tribunal handed down their decision in Bendel and Commissioner of Taxation (Taxation) [2023] AATA 3074 (Bendel). The case was primarily concerned with whether an unpaid present entitlement (UPE) (as to income or capital) owing to a corporate beneficiary was a ‘loan’ under Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936). As the name suggests, a UPE occurs when a trustee declares a distribution of trust income (or capital) to a beneficiary which is left unpaid or the beneficiary does not call for payment.

The Tribunal found that outstanding or unpaid entitlements of a corporate beneficiary of a trust, whether held on a separate trust or otherwise, do not constitute a loan to the trust. When making their decision, the Tribunal considered the structure of ITAA 1936, alongside the purpose of Division 7A to prevent enjoyment of corporate profits without declaring a dividend.

This is seemingly a win for taxpayers. However, the decision goes against the Commissioner’s longstanding view that a subsisting UPE is a form of ‘financial accommodation’ or an ‘in-substance loan’, and the Commissioner appears to be maintaining this longstanding view. Thus, the positions of the ATO and the AAT are currently in direct conflict.

The Bendel decision has been appealed to the Federal Court and is expected to be heard some time in the 2024 calendar year.

Residency test for individuals – Release of TR 2023/1

In June 2023, the ATO released the long-awaited ‘one-stop shop’ tax ruling to assist individuals assess their residency for Australian tax purposes. Taxation Ruling TR 2023/1 consolidates several income tax rulings dating back to 1998 and provides more contemporary and consolidated guidance that better reflects modern global work practices and recent court decisions.

TR 2023/1 provides detailed guidance on each of the following residency tests for individuals:

• the ordinary concepts test;
• the domicile test; and
• the 183-day test.

The ruling further explains how residency is about your “connection” to Australia and how you can be a resident for tax purposes of more than one country at a time.

The ruling applies both before and after its date of publication and is solely concerned with the current law and does not consider the recommendations made by the Board of Taxation (Board) in its 2019 report. That report recommended that the Government replace the current rules with an improved and simplified residency test based on a simple bright-line test followed by a detailed analysis for more complex cases.

Spotlight on section 100A

The Full Federal Court shed further light on section 100A of the ITAA 1936 in Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3 (Guardian) and B&F Investments Pty Ltd atf Illuka Park Trust v Commissioner of Taxation [2023] FCAFC 89 (BBlood).

Section 100A is an integrity measure concerning reimbursement agreements, which operates to deem a beneficiary to have never been presently entitled to the income of the trust for a particular year, resulting in the trustee being assessed at the top marginal tax rate.

Guardian concerned an arrangement over several years whereby a trust made a corporate beneficiary presently entitled to trust income, the present entitlement was set-off when franked dividends were paid to the trust, after which, in turn, the dividends were streamed to a non-resident beneficiary. Holding that section 100A did not apply, the Court found there was no reimbursement agreement involving the payment of the dividend and rejected an invitation by the Commissioner to attribute the tax advisors’ intention to the taxpayers. Importantly, the Court observed that the mere introduction of a corporate beneficiary would not be sufficient to demonstrate that a dealing was not ‘an ordinary or commercial dealing’, one of the limited defences to section 100A.

However, while the Full Court found the arrangement was initially the product of evolving circumstances, the arrangement was a scheme carried out for the dominant purpose of obtaining a tax benefit in the subsequent year, attracting the application of the general anti-avoidance provisions in Part IVA of the ITAA 1936.

In BBlood, the Commissioner sought to apply section 100A to a series of steps, including a share buy-back, that resulted in a corporate beneficiary paying the tax on a fully franked dividend, while the benefit of that dividend remained with the trust. The Full Court held that section 100A applied in the circumstances, in part because the taxpayer’s advisers, acting with the knowledge and assent of the taxpayer, had implemented the arrangement for the purpose of reducing tax payable.

The cases provided much needed guidance on the application of section 100A, a provision which is attracting considerable attention from the Commissioner and one where very limited guidance has traditionally been in place.

ATO focus shifts to Family Trust Elections

We have seen an increase in ATO audits and reviews scrutinising ‘family trust’ and ‘interposed entity’ elections and revocations over the past year. The ATO has been seeking to apply the 47% Family Trust Distribution Tax where family trust and interposed entity elections, revocations and variations have been improperly made resulting in entities distributing funds outside the family group of the test individual. If any of the Family Trust Distribution Tax which a person is liable to pay remains unpaid 60 days after the day by which it is due to be paid, the person will be liable to pay the general interest charge, which can potentially exceed the actual tax payable.

While family trust and interposed entity elections afford various benefits to family groups, the regime is complex and mistakes are easy to make but hard to identify. Broadly, a family trust election must specify an individual who acts as the reference point for the family group, and can only be made if the trust passes the “family control test” at the end of the specified income year. The members of the specified individual’s “family group” who can ultimately receive benefits include, but are not limited to, the specified individual, their parents, grandparents, spouse, siblings, children, nieces and nephews, the lineal descendants of these people, other family trusts with the same individual specified in the family trust election, as well as entities that have made an interposed entity election to bring them within the “family group”. There are a range of criteria that must be met before an election can validly be made, varied, or revoked. Importantly, there are only a narrow range of scenarios in which an election can be varied or revoked.

Changes to Thin Capitalisation Rules

On 29 November 2023, the Senate moved further changes to the controversial Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Bill 2023 (Bill) which sets out the Federal Government announced changes to the Australian thin capitalisation rules in the 2022-23 October Budget. The Bill has been referred to the Senate Economics Legislation Committee (Committee) for the second time with the Committee due to provide its second report by 5 February 2024.

The Bill is designed to address ‘risks to the domestic tax base arising from the excessive use of debt deductions, which amount to base erosion or profit shifting arrangements’. The proposed amendments seek to align Australia's thin capitalisation rules more closely with OECD recommendations and draw parallels with analogous regimes in the UK and the US. The proposed amendments will come into effect retroactively from 1 July 2023.

The proposed measures will introduce new earnings-based thresholds, and a new arm’s length debt test, targeted at ‘general class investors’ – a singular concept referring to each of the following entities under the existing regime: an ‘outward investor (general)’, ‘inward investment vehicle (general)’ and ‘inward investor (general)’. These new rules will disallow an entity’s debt deductions based on the entity’s earnings or profits for the income year, rather than the historical approach which centred on debt-equity gearing ratios.

Key modifications include the replacement of the widely used safe-harbour test with the 'fixed-ratio test,' imposing a cap of 30% of ‘tax EBITDA’ on an entity's debt deductions. Denied debt deductions under this test can be carried forward for up to 15 years to smooth the effect of temporary volatility in earnings and limit distortions on investment decisions where high up-front capital investment is required before earnings are generated. Additionally, the global gearing ratio will be replaced by the 'group-ratio test,' allowing entities within a group to claim debt-related deductions proportional to the worldwide group's debt divided by earnings. The 'arm’s-length debt test' is set to be substituted with the ‘third-party debt test,' restricting deductions to genuine third-party debt costs.

The Bill remains in a draft phase after extensive consultation and numerous concerns expressed by industry experts. This significant overhaul is poised to impact a range of businesses, with particular ramifications for those in the Real Estate and Construction sector, where high capitalisation and low EBITDA are commonplace. Taxpayers and their advisors should proactively engage with the proposed laws given their retroactive effect and seek advice to ensure they won’t be in breach.

State Taxes Update

Distance-based charges on vehicles invalid

On 18 October 2023, the High Court handed down the highly anticipated decision of Vanderstock v State of Victoria [2023] HCA 30 (Vanderstock).

In its landmark decision, the High Court held by a 4:3 majority that the Victorian electric vehicle road user charge (EV charge) is unconstitutional, on the basis that it imposes a ‘duty of excise’ within the meaning of section 90 of the Constitution. Only the Commonwealth, and not the States, can impose an excise.

By extending the scope of an excise to include a ‘tax on goods’, Vanderstock marks a potential shift in the division of taxation powers between States and the Commonwealth and brings into question the validity of other state taxes capable of characterisation as ‘taxes on the consumption of goods’.

Directly, the decision prohibits States and Territories from implementing similar taxes, affecting planned electric vehicle charges in New South Wales and Western Australia. Indirectly, as raised by Justice Edelman in his dissent, the decision calls into question the constitutional validity other State-based taxes more broadly, such as betting taxes, industrial land taxes, gaming machine and waste disposal levies, and motor vehicle duties, where such taxes are capable of characterisation as taxes on consumption of goods within the broad interpretation of an ‘excise’.

The decision undoubtedly brings relief to drivers of electric vehicles in Victoria, with VicRoads announcing that customers are no longer required to pay an upcoming EV charge related invoice, with full refunds available to those customers who have previously made payments of the road-user charge.

Read the full decision here.

Foreign duty and land tax surcharges

In February 2023, Revenue NSW announced that it will no longer impose surcharge duty and land tax on ‘foreign’ owners of land from New Zealand, Finland, Germany, India, Japan, Switzerland, Norway and South Africa. The NSW authorities formed the view that the surcharge was in breach of the non-discrimination article of Australia’s tax treaties with those countries and therefore invalid.

You can read more about the NSW announcement in our article here.

Duty and land tax surcharges for foreign owners of land (or entities deemed to be foreign) have become common across the country in recent years and are a significant cost for investors. They all face the same issue and uncertainty now surrounds their validity.

Shortly after the NSW announcement, Victoria issued a short statement acknowledging that it was ‘considering the implications’ of those issues for its own foreign surcharges. However, nearly one year later, no other states or territories have announced that they are following NSW’s lead.

Federal intervention may be incoming. The Commonwealth Government has announced plans to ensure that foreign investment fees, and similar state and territory property taxes prevail over Australia’s double tax treaties with retrospective effect as part of the 2023-24 mid-year economic and fiscal outlook The measure is in its infancy and details remain scarce.

ABL is actively involved in matters concerning these issues and we should expect to see greater clarity in 2024.