Latest income tax developments January and February 2022

ATO UPDATES

ATO releases findings in relation to its Top 1000 Combined Assurance Review

• The ATO has released its findings for the Top 1000 Combined Assurance Review for reviews completed up to June 2021.
• The key findings are as follows: 
  • A decrease in taxpayers receiving low and high assurance levels, with an increase in those receiving medium ratings.
  • A minority of taxpayers receiving "Stage 2" tax risk management and governance assurance ratings, meaning only a minority are considered to have effective and operating frameworks in place.
  • General improvements in risk ratings relating to tax losses, capital allowances, thin capitalisation and R&D, but few taxpayers achieving high assurance ratings for related party transactions.
• When taxpayers are considering which areas may be focus areas for ATO reviews, particular attention should be paid to the implementation of their tax risk management and governance frameworks, as well as any related party debt arrangements.

LEGISLATIVE UPDATES

CCIV Framework and Other Measures Act 2022

• The Act has been passed by both Houses and received assent on 22 February. Its primary purpose is to establish a tax and regulatory framework for Corporate Collective Investment Vehicles (CCIVs), a new type of company limited by shares and used for funds management.
• The goal of this new regime is to make the Australian managed fund industry more attractive to foreign investors, particularly by attracting foreign investors who may not be familiar with traditional Australian unit trust structures. As such, the Act seeks to ensure that CCIVs are taxed consistently with Australian unit trusts (i.e., generally on a flow through basis), and enabling CCIVs to qualify as MITs and AMITs.
• In addition to the CCIV regime, the Act also extends the loss carry back rules by 12 months, removes cessation of employment as a taxing point for tax deferred Employee Share Schemes from 1 July 2022, as well a number of miscellaneous and technical amendments to other Treasury laws.

Treasury Laws Amendment (Tax Concession for Australian Medical Innovations) Bill 2022 (Patent Box Regime)

• The Bill is currently before the House of Representatives, with a second reading being moved on 10 February. It was announced in the 2021-22 Budget and has been subject to consultation prior to release of the Bill.
• It proposes to establish a 'patent box' regime, which would provide concessional tax treatment for ordinary and statutory income derived by a corporate taxpayer from exploiting a medical or biotechnology patent. The Government has not yet made any policy decision regarding expansion of the scheme beyond medical and biotechnology inventions, to low emissions and clean energy technologies.
• This concession will be in the form of an effective income tax rate of 17 per cent, provided that the taxpayer undertakes the R&D underlying that patent in Australia. The regime is elective, prospective only, applies in respect of all the taxpayer's eligible medical and biotechnology patents and the election is irrevocable.
• This regime is designed to encourage innovation in the Australian medical and biotechnology industry.

Treasury Laws Amendment (Enhancing Tax Integrity and Supporting Business Investment) Bill 2022

• The Bill is currently before the House of Representatives, with a second reading being moved on 9 February. It is part of the Digital Economy strategy outlined in the 2021-22 Budget.
• The primary goal of the Bill is to amend the current intangible asset depreciation rules and allow taxpayers the choice to self-assess the effective life of certain intangible depreciating assets, being various patents, registered designs, copyrights (except copyright in a film), licences, a licence relating to a copyright, in-house software, spectrum licences and telecommunications site access rights.
• The Bill also includes a measure allowing the Commissioner to direct taxpayers to complete an approved Record-Keeping course.

RECENT CASES

Singapore Telecom Australia Investments Pty Ltd v FC of T [2021] FCA 1957

• This case involved an Australian resident company entering into a Loan Note Issuance Agreement (LNIA) with a related Singaporean company in connection with the acquisition of shares in SingTel Optus from another related entity.
• The applicable interest rate under the LNIA was amended three times, raising it from an initial rate of the BBSW + 1% to a final rate of 13.2575% and also involved an interest-free period followed by a period where there was a premium to the interest rate. In the 2016 tax year, the Commissioner denied interest deductions of $895 million and issued amended assessments in respect of the years ended 31 March 2011, 2012 and 2013. The taxpayer appealed the Commissioner's assessment.
• The main issue was whether the taxpayer obtained a “transfer pricing benefit” under section 815-15(1) of the ITAA 1997 (and the former provisions under the ITAA 1936), and whether the arrangement under the LNIA differed in conditions from an arrangement that would be expected between two independent parties at arm's length. The Court considered that in determining whether a transfer pricing benefit arose, it was necessary to construct a hypothetical which had the characteristics and attributes of the actual enterprises in question – being, in this case, that the taxpayer was part of a multinational corporate group, where the loan notes were issued as part of the acquisition of a company, with a tenor of 10 years (less one day).
• The Court denied the taxpayer's appeal. The Court found that arm's length parties would not have amended the arrangement represented by the original terms of the loan notes (i.e., at an interest rate of BBSW + 1%). Consequently, the Court held that the Commissioner was correct in assessing the taxpayer as if the amendments to the LNIA had never been made.
• This case reflects the ATO's ongoing focus on transfer pricing issues, and taxpayers should review existing international related party arrangements, as well as carefully consider any new arrangements, to ensure that those arrangements (including aspects that may form part of an assumed hypothetical, such as parental guarantees) are appropriately documented and priced.

Guardian AIT Pty Ltd ATF Australian Investment Trust v FCT

• Arrangements involving distributions of trust income to a corporate beneficiary, which in turn distributed dividends back to the trust, have been found by the Federal Court to not constitute a "reimbursement agreement" for the purposes of section 100A of the ITAA 1936. The arrangements were instead part of ordinary family or commercial dealings.
• The arrangements in question involved a discretionary trust making distributions to a company which was specifically incorporated to be a beneficiary of the trust.
• The distributions were initially not paid, resulting in an unpaid present entitlement (UPE). The company (having paid tax on the amount to which it was made presently entitled) then declared a fully-franked dividend which was payable to the trust, which was paid by reducing the UPE (i.e. debt owed to the company by the trust) to zero. The trustee subsequently distributed the fully franked dividend to a foreign natural person beneficiary. This process had the effect of ensuring the company (as beneficiary) was presently entitled to trust income (and paid tax at 30%), and the fully franked dividends (received by the trust) were then distributed to a non-resident natural person beneficiary without a further tax impost, whereas a higher rate of tax would have arisen in the absence of the distribution to the company.
• The Commissioner considered the arrangement gave rise to a "reimbursement agreement" for the purposes of section 100A of the ITAA 1936. However, the Federal Court disagreed, with Logan J finding that there was no such agreement on or before the present entitlement arising (with this timing being a required aspect of there being a reimbursement agreement), and further that any agreement was entered into in the course of "ordinary family or commercial dealings" (in this case, asset protection) and was therefore excluded from the definition of "agreement" in subsection 100A(13).
• The Commissioner has appealed this decision and has released Draft Taxation Ruling TR 2022/D1, Practical Compliance Guideline PCG 2022/D1 and Taxpayer Alert TA 2022/1 in relation to s 100A, as well as draft Taxation Determination TD 2022/D1 concerning unpaid present entitlements and Division 7A. These will be covered in our March Bulletin.

Peter Greensill Family Co Pty Ltd (Trustee) v Commissioner of Taxation [2021] FCAFC 99

• The High Court has refused the taxpayer special leave to appeal against the Full Federal Court's decision.
• The case concerned whether non-resident beneficiaries of a resident trust estate were subject to tax on distributed gains which were made by the trust on assets that were non-taxable Australian property for the purposes of Div 855 of ITAA 1997. The trust was not a fixed trust. The Full Federal Court upheld the Commissioner's view that these gains were in fact taxable.

FC of T v Shell Energy Holdings Australia Ltd [2022] FCAFC 2

• The Full Federal Court dismissed the Commissioner’s appeal against the decision in Shell Energy Holdings Australia Ltd v FC of T [2021] FCA 496 and allowed the taxpayer’s cross-appeal.
• The case involved a petroleum exploration project entered into by both Shell and Chevron. In August 2012, Shell agreed to purchase Chevron's participating interest in the project in return for cash and various petroleum interests held by Shell. Shell and Chevron agreed an apportionment of the total consideration ($2.3 billion), and the transaction was approved and registered by the relevant statutory authorities.
• Shell claimed that it was entitled to an outright deduction under s 40-80 ITAA 1997 for the cost of acquiring the additional proportional interest in the project on the basis that it was first used for exploration or prospecting. The Commissioner disagreed.
• At first instance Colvin J found in favour of Shell, except in relation to one of the statutory titles as Shell had not demonstrated when "first use" occurred.
• The Commissioner appealed, but this was unanimously dismissed by the Full Court on the grounds that the first instance decision was correct, but allowed the taxpayers cross-appeal and found that Shell had in fact demonstrated when "first use" occurred in relation to all statutory titles. The Commissioner has subsequently sought special leave to appeal to the High Court.

HOT TOPICS

ACNC Releases Impact Statement on Charity Registration Entitlement Case

• The Australian Charities and Not-for-profits Commission (ACNC) has issued an impact statement on the AAT’s decision in Cancer & Bowel Research Australia Ltd v Commissioner of the ACNC [2021] AATA 3875.
• The case concerned three incorporated companies limited by guarantee and primarily controlled by one individual which were involved in raising funds for research into various types of cancer. The applicants had been refused charitable registration by the ACNC on the basis that the companies did not operate for purely charitable purposes as they also provided private benefits to employees.
• The applicants appealed this decision to the AAT, arguing they were in fact eligible for charitable status. However, the tribunal not only affirmed the ACNC's decision, but found the applicants were also ineligible on the basis they had been established to take over the fundraising activities of another charity in order to avoid an existing tax liability to the ATO. This avoidance was found to be an additional "disqualifying purpose".

Determination finalised for forgiveness of debts for reasons of natural love and affection

• The ATO has finalised TD 2022/1, which provides guidance on the exclusion for debts forgiven for reasons of natural love and affection from the commercial debt forgiveness provisions under paragraph 245-40(e) of ITAA 1997.
• Paragraph 245-40(e) requires a direct causal nexus between the forgiveness and the natural love and affection, such that the natural love and affection must arise from ordinary human interaction. This can only occur where the creditor is a natural person. There is no requirement for the debtor to be a natural person, but there is a requirement that the debt is forgiven for reasons of natural love and affection – i.e., the object of that love and affection must be a natural person, but that may be satisfied if (for example) a parent forgives a debt owed by a company that is wholly-owned by the parent's child.
• The ATO also considers that it is possible for a natural person to forgive a debt in their capacity as a trustee of a trust or as a partner in a partnership within the conditions of paragraph 245-40(e).
• The position adopted by the Commissioner is not consistent with an earlier view expressed by the Commissioner in an ATO ID (being ATO ID 2003/589).

Draft Tax Determination for deductibility of expenses incurred in establishing and administering an 'employee share scheme'

• The Commissioner has issued TD 2022/D2, which sets out the Commissioner's preliminary views on the deductibility of expenses incurred by an employer in establishing and administering an 'employee share scheme' (ESS) as part of its remuneration strategy.
• The Commissioner considers three types of expenses in the draft ruling, being 'establishment expenses', 'amendment expenses' and 'ongoing expenses'.
• Establishment expenses may include legal fees incurred when establishing the ESS rules, start-up costs, and registration fees with various authorities. Amendment expenses may include legal fees, and regulatory fees and stamp duty paid to authorities. Expenses incurred in establishing and amending an ESS are considered by the Commissioner to be capital in nature and consequently are not deductible under s 8-1 of the ITAA 1997. However, both establishment and amendment expenses may be deductible under section 40-880 (i.e., in equal proportions over 5 years) to the extent that the person incurring the expenses carries on a business for a taxable purpose, and none of the other limitations apply to deny a deduction under section 40-880.
• Ongoing expenses associated with the administration of an ESS are considered by the Commissioner to be deductible under s 8-1 of the ITAA 1997. Such expenses may include brokerage fees, bank charges, audit fees and making new offers to employees under an existing ESS.
• When issued, the final determination is proposed to apply before and after the date of issue. However, it will not apply to taxpayers to the extent it conflicts with the terms of settlement of a dispute agreed to before the date of issue. 

OECD public consultation on nexus and revenue sourcing relating to Pillar One

• By way of background, Pillar One involves the development of new nexus and profit allocation rules that, with respect to certain in-scope entities, assign a greater share of the taxing rights over global business revenue to market jurisdictions (being, in short, the jurisdiction in which the entity or its controlled entities operate).
• Under the proposed rules released for consultation, the nexus test will be satisfied for a period if the revenue of a Group (limited to revenue from third parties) arising in a jurisdiction is equal to or greater than €1 million for jurisdictions with annual Gross Domestic Product (GDP) equal to or greater than €40 billion, and €250,000 for jurisdictions with annual GDP of less than €40 billion. The nexus test applies solely to determine whether a Group may be liable to tax under Pillar One (i.e., it is a threshold question).
• In determining whether revenue arises in a jurisdiction, certain revenue sourcing rules provide indicators as to how this is determined, noting that the source of revenue must be determined on a transaction by transaction basis, and all revenue is required to have a source. For example, revenue arising from services connected to tangible property are deemed to arise in the jurisdiction that is the place of performance of services. The relevant rules can be quite prescriptive – e.g., revenues derived from customer reward programs are deemed to arise in a jurisdiction in proportion to the percentage share of "Active Members" of that customer reward program, with the proportion to be determined by reference to user information, billing addresses, international dialling codes associated with customer phone numbers, or an indicator that is considered to be a "reliable indicator" (which is separately defined).
• It is clear that Pillar One (and, indeed, Pillar Two) will be complex measures requiring detailed consideration by in-scope taxpayers, and will have material impacts on traditional residence and source principles underlying the international tax regime. In-scope taxpayers should continue to monitor developments in this space as further detail is released.

WATCHING BRIEF – TAX GUIDANCE FOR 2022

Taxpayers should be aware of the following expected tax guidance to be published by the Commissioner this year:

• The Privatisation and Infrastructure – Australian Federal Tax Framework. This was previously expected in early 2022, but the ATO has now indicated this is expected in mid 2022. Taxpayers operating in the Infrastructure and Real Estate sectors in particular should be ready to consider any updates to the ATO's views from the draft Framework published back in 2017.
• Taxation Ruling: Income tax: composite items and identifying the depreciating asset for the purposes of working out capital allowances. A draft Taxation Ruling (TR 2017/D1) is expected to be finalised in April 2022, and will be updated to include current ATO views. Taxpayers with material depreciation claims relating to potential composite items should be aware of potential updates in this regard.
• Taxation Ruling: Income tax: application of paragraph 8-1(2)(a) of the Income Tax Assessment Act 1997 to labour costs related to the construction or creation of capital assets. A draft Taxation Ruling (TR 2019/D6) is expected to be finalised in March 2022. The draft Taxation Ruling considered the circumstances where labour costs are on capital account.
• Taxation Ruling: Income tax: royalties – character of receipts in respect of software. A draft Taxation Ruling (TR 2021/D4) is expected to be finalised in Mid 2022, and (as drafted) represented a change in view compared to TR 93/12 and (arguably) OECD Commentary on the royalty article in the Model Tax Convention. The Taxation Ruling is to be updated to consider apportionment issues and also Double Tax Agreements, so taxpayers with material payments for or who develop proprietary software should monitor any changes in the final Taxation Ruling.
• Practical Compliance Guideline: Intangibles Arrangements. This draft PCG is expected to be finalised in March 2022, and taxpayers seeking FIRB or filing Reportable Tax Position Schedules are expected to be required to self-assess certain risks associated with their Intangibles Arrangements.
• Web guidance on determining market values of assets, which is expected to be provided in June 2022. Detailed consideration should be given to any ATO change in approach, particularly with respect to related party transactions.