the report |
explanatory memorandum
July 2005
Super Fund Choice
For further information on ‘super choice’, please review the Federal Government’s information source at:
<www.superchoice.gov.au>.
Assessable Income from Sporting Activities
In the High Court case Commissioner of Taxation v. Stone [2005] HCA 21, it was unanimously held that
amounts received as prize money, grants and sponsorship by an elite sportsperson were assessable income.
Background
The taxpayer was a police officer and also trained as an Olympic javelin thrower. In the income year ended
30 June 1999, the taxpayer received prize money ($93,429), government sporting grants from the Australian
Olympic Committee and Queensland Institute of Sport ($27,900), sponsorships ($12,419) and appearance
fees ($2,700). The Tax Office considered that each of these amounts was assessable income. The taxpayer
objected and the matter was first brought before the Federal Court.
After conceding that the monies derived from sponsorships were assessable income, the taxpayer disputed
the assessability of the remaining receipts.
The Federal Court held that the government sporting grants were not assessable as they did not have the
character of income. However, the court held that the appearance fees and the prize money constituted
assessable income.
The taxpayer appealed against this decision and the matter was brought before the Full Federal Court.
The Full Federal Court overturned the decision in relation to the prize money and held that neither this nor
the government sporting grants were assessable income on the basis that the taxpayer’s sporting exploits did
not represent the carrying on of a business. However, the court agreed that the appearance fees were
assessable.
High Court Appeal
By special leave, the Tax Office appealed to the High Court on the basis that the taxpayer derived the
amounts in the business of being an elite sportsperson. The taxpayer also sought special leave to cross-appeal
against the Full Federal Court’s decision that the appearance fees were assessable. The matter was brought
before the High Court as a test case with all costs paid by the Tax Office.
The Tax Office argued that because the taxpayer was deriving money from her talent as an elite athlete, the
sums received on that account were business income. The taxpayer’s lack of intention to derive business
income from her talent was irrelevant.
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The taxpayer argued that the amounts received could only be deemed assessable if it was found that they
were derived from an act in carrying on business. The taxpayer contended that she was not carrying on a
business and her motivation was solely to excel and represent her country, not to make money. The amounts
received as grants and prize money were a means of helping to defray the large expenses she incurred in
competing. The taxpayer accepted the assessability of the sponsorship receipts, as they were a reward for
services rendered, whereas the other receipts were not.
Decision
The High Court held that since the taxpayer accepted that the sponsorship receipts were assessable income,
the conclusion that the taxpayer had turned her sporting talent to account for money was inevitable. The
taxpayer was able to receive the sponsorship receipts not only to assist in her sporting pursuits, but also
because of her sporting pursuits. This dual aspect rendered it inappropriate to classify one category of
income as ‘business’ (i.e. the sponsorship) and others as ‘sport’ (i.e. the grants and prize money). As a result,
the athletic activities of the taxpayer during 1998/99 were held to constitute the carrying on of a business.
Consequently, the High Court unanimously upheld the Tax Office’s appeal and dismissed the taxpayer’s
cross-appeal. All amounts were declared to be assessable income on the basis that they were rewards from
the conduct of the taxpayer’s business of competing and winning in the athletics arena.
Justice Kirby noted that while some of the amounts in isolation (e.g. intermittent prize money and occasional
special grants) may not meet the ordinary definition of income, the fact that they were all linked to the
taxpayer’s sporting activities resulted in their inclusion as assessable income.
For further information, please review Commissioner of Taxation v. Stone [2005] HCA 21, at
<www.austlii.edu.au/au/cases/cth/HCA/2005/21.html>.
Service Trusts
The Tax Office has recently released Draft Taxation Ruling TR 2005/D5, which discusses deductibility of
service fees paid to associated service entities. It is quite common for professionals, such as accountants,
lawyers, doctors, engineers and others to use service entities (normally a trust) as a means of segregating a
portion of total business income for ultimate distribution to owners and their family members. The service
fees typically cover the use of office space, administrative staff and equipment, all of which are recharged at
a margin.
The basic set-up involves a service entity providing an associate entity (the taxpayer) with staff, equipment
and office space for a fee. The fees received by the service entity may then be ultimately distributed to the
taxpayer and/or its associates. The fees paid by the taxpayer are treated as deductible. The Tax Office is
concerned that some taxpayers may be paying artificially high fees across to the service entity in order to
increase tax benefits.
TR 2005/D5 is designed to supplement IT 276, which was issued in response to the Federal Court’s decision
in Phillips v. FCT 77 ATC 4169. The draft ruling states that while the Tax Office continues to accept the
decision in Phillips, taxpayers cannot automatically rely on the service fee mark-ups used in that case. In
order for service fees to be deductible, the amounts are required to be commercially realistic.
The Tax Office will investigate instances where:
the fees are excessive in relation to the benefits provided;
the fees are calculated using fixed mark-ups that are not commercially justified; or
the fees generate profits in the service entity and there is no clear separation of business activities
between the service entity and the taxpayer.
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TR 2005/D5 also outlines the Tax Office’s approach in applying Part IVA of ITAA 1936 to a service
arrangement. For Part IVA to apply, the identified scheme must have been entered into or carried out in a
particular way for the dominant purpose of enabling a taxpayer to obtain a tax benefit in connection with the
scheme. An example of such a scheme would involve a service entity charging grossly excessive fees to a
partnership. Part IVA considerations include:
the manner in which the arrangement was entered into and the presence of non-commercial aspects;
any divergence between the form of the arrangement and the substance; and
the impact of the arrangement on the ongoing profitability and business condition of the taxpayer.
Part IVA would not apply where the taxpayer can show that the arrangement makes business sense, the
service entity actually performs its contractual duties and the service fees and charges are commercially
realistic.
For further information and detailed examples of different structures, please review TR 2005/D5 — Income
tax: deductibility of service fees paid to associated service entities: Phillips arrangements, at
<http://law.ato.gov.au/atolaw/view.htm?docid=DTR/TR2005D5/NAT/ATO/00001>.
Capital Allowances
The Tax Office has clarified the following situations:
If deductions are available but a business ceases within the five-year deduction period, the taxpayer is
unable to claim an immediate deduction for the balance of the undeducted expenditure in the year of
business cessation. The taxpayer’s entitlement to deductions over five years continues even if no
business or income-producing activities are carried on.
A single capital payment including eligible and non-eligible amounts can be apportioned to allow
eligible costs to be deducted over the five-year period.
Costs incurred either directly or indirectly in winding up a business are eligible for the deduction even if
the costs may serve another purpose including, for example, the winding up of a deceased estate.
For further information please review:
ATO ID 2005/106 — Capital Allowances: business related costs — amount you can deduct, at
<http://law.ato.gov.au/atolaw/view.htm?docid=AID/AID2005106/00001>;
ATO ID 2005/107 — Capital Allowances: business related costs — costs to stop carrying on your
business — apportionment of single payment, at <http://law.ato.gov.au/atolaw/view.htm?docid=AID/
AID2005107/00001>; and
ATO ID 2005/108 — Capital Allowances: business related costs — to stop carrying on your business —
purpose of expenditure, at <http://law.ato.gov.au/atolaw/view.htm?docid=AID/AID2005108/00001>.
Tax Losses Deduction Denied
In the High Court case Commissioner of Taxation v. Linter Textiles Australia Ltd (In Liquidation) [2005]
HCA 20, it was unanimously held that the taxpayer was unable to deduct prior year and transferred tax losses
on the basis that the appointment of a liquidator to the taxpayer’s parent company caused the taxpayer’s
ultimate controller to lose control of voting power. This meant the taxpayer failed to satisfy the control
requirement of section 80A(3) of the Income Tax Assessment Act 1936 (ITAA 1936), and the continuity of
ownership test was not satisfied.
Background
The taxpayer, Linter Textiles Australia Ltd (Linter Textiles) was a wholly owned subsidiary of Linter Group
Ltd (parent). The ultimate holding company was Pochette Nominees Pty Ltd, which was effectively
controlled by the Goldberg family.
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In early 1991, the Supreme Court of NSW made an order to wind up the group and consequently wind up the
taxpayer. A liquidator was appointed to the taxpayer in early 1992. Under the statutory scheme for the
winding up of a company, the liquidator ‘shall take into his custody or under his control all the property to
which [Linter Group] is or appears to be entitled’.
In 1999, the Tax Office issued the taxpayer an assessment for the income year ended 30 June 1992. The
taxpayer had derived assessable income totalling $10,163,773 and sought to apply certain carry-forward
losses to this amount. In the income year ended 30 June 1990, the group incurred a tax loss of $9,929,676,
which was transferred to the taxpayer under group loss transfer rules contained in section 80G of ITAA
1936. The taxpayer also had tax losses of $10,393,871 incurred in prior years, which were available to be
offset against remaining taxable income.
The issue was whether the winding up orders caused the taxpayer to fail the conditions allowing prior year
losses to be utilised, particularly section 80A(1) and section 80A(3) in relation to continuity of ownership.
The matter was first heard in the Federal Court where the taxpayer was successful in obtaining a favourable
judgment. The Tax Office appealed to the Full Federal Court and again the taxpayer was successful. Special
leave was granted to the Tax Office and the matter was brought before the High Court.
Beneficial Ownership
In the previous instances, the Federal Court and the Full Federal Court held that regardless of the
appointment of a liquidator the taxpayer continued to satisfy the beneficial ownership requirements whereby
the parent has the right to vote and receive dividends or capital distributions (section 80A(1)), and the control
requirement, whereby the parent had control of voting power (section 80A(3)). Consequently, in both
judgments, the Tax Office was directed to allow the taxpayer to utilise the losses.
Broadly, under section 80A(1) a tax loss of a previous year could not be deducted unless the taxpayer could
satisfy the Commissioner that at all times during the year of income the shares in the taxpayer, carrying
between them:
the right to exercise more than one-half of the voting power in the taxpayer;
the right to receive more than one-half of any dividends that may be paid by the taxpayer; and
the right to receive more than one-half of any distribution of capital of the company;
were beneficially owned by persons who at all times during the year in which the loss was incurred
beneficially owned the shares.
In the High Court appeal, the Tax Office argued that since the winding up order was issued in early 1992, it
could not be said that the beneficial ownership requirement in section 80A(1) had been satisfied at all times
in the 1991/92 income year due to the appointment of a liquidator. The Tax Office also argued that if the
parent ‘beneficially owned’ the taxpayer, it would have the ability to use its shares in the taxpayer for its own
benefit, by selling them and using the proceeds as it wished. However, as the liquidator was bound to apply
the proceeds of sale to creditors, it could not be said that the parent beneficially owned the shares in the
taxpayer at all times in 1991/92.
The High Court rejected the Tax Office’s argument and agreed with the findings of both Federal Courts on
the basis that section 80A(1) turns on the requirement of beneficial ownership and the mere appointment of a
liquidator did not reduce or compromise the beneficial ownership of shares in the taxpayer by the parent.
Control Criteria
The Tax Office further argued that the taxpayer didn’t meet the ‘control’ criteria of paragraph 80A(3)(a). It
stated that as a consequence of the original wind up order of the Linter Group (early 1991), the voting power
in the taxpayer was no longer controlled or capable of being controlled by the ultimate holder (i.e. the
Goldberg family), as only the liquidator of the group could vote and control the voting of its shares in the
taxpayer.
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The High Court agreed with this submission, thereby overturning the Federal Court decisions, on the basis
that the Goldberg family was not capable of exercising control through the liquidator. Even though the
taxpayer had satisfied section 80A(1), it did not meet the criteria set out in section 80A(3)(a) as the parent
was no longer able to control the voting power in the taxpayer. This conclusion was sufficient to be fatal to
the taxpayer’s case and the High Court subsequently allowed the Tax Office’s appeal. Accordingly, the
taxpayer was denied the ability to offset prior year losses against its 1992 assessable income.
For further information, please review Commissioner of Taxation v. Linter Textiles Australia Ltd (In
Liquidation) [2005] HCA 20, at <www.austlii.edu.au/au/cases/cth/HCA/2005/20.html>.
GST: Repairs under Warranty for Non-resident Entities
The Tax Office has released two draft GST determinations dealing with the GST consequences of repair
arrangements for non-resident warranty providers.
The two determinations, GSTD 2005/D3 ‘Does an Australian repairer make a taxable supply when it
supplies repair services under a warranty given by a non-resident manufacturer?’ and GSTD 2005/D2 ‘Is a
payment from a non-resident car manufacturer to an Australian distributor under an offshore warranty
chargeback arrangement subject to GST?’ deal with repairs under a warranty arrangement.
Issues
There seems to be inconsistent treatment between the two determinations. Neither makes reference to
warranties as being financial supplies. Both determinations fail to separate express or implied warranties
under relevant trade practices laws or other consumer laws. The Tax Office rejects the rationale behind
overseas GST case law dealing with similar provisions.
GSTD 2005/D3
GSTD 2005/D3 specifically states that repair services supplied by Australian resident repairers will be
subject to GST where the repair service is provided on behalf of a non-resident supplier who is not registered
for GST and not present in Australia. This applies where the repair service is provided to another entity
(purchaser/consumer) in Australia.
Example
An overseas manufacturer supplies goods in Australia through a resident distributor. Such goods are sold
under warranty. The goods may require repairs in order to make good a manufacturing fault. The Tax Office
takes the view that as the service (the repair) is ultimately made to an Australian entity (the consumer of the
goods), the service is not GST-free (as is the general case when services are provided to a non-resident who
is not in Australia when the service is supplied).
The approach taken by the Tax Office in this draft determination is somewhat controversial given that the
resident repairer is, in essence, making good a warranty provided by a non-resident.
However, if the Tax Office’s draft ruling is released in its current form as a final ruling, a number of
businesses that have entered into arrangements with non-residents may have to increase their prices by
10 per cent to cover their GST obligations. The non-resident may find that their costs have increased by
10 per cent as the non-resident would most likely not be registered for GST and could not recover an input
tax credit.
For further information, please review GSTD 2005/D3: Goods and services tax: does an Australian repairer
make a taxable supply when it supplies repair services under a warranty given by a non-resident
manufacturer? at:
<http://law.ato.gov.au/atolaw/print.htm?docid=DGD/GSTD2005D3/NAT/ATO/00001>.
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GSTD 2005/D2
GSTD 2005/D2 deals with non-resident car manufacturers supplying vehicles in Australia through a
distributor or dealer network and the dealer network receiving a payment from the overseas supplier for
repairs made under warranty. GSTD 2005/D2 provides that the payment received from the non-resident car
manufacturer for warranty repairs undertaken is not subject to GST as there is no taxable supply made by the
non-resident manufacturer to the Australian dealer.
The draft determination should not provide a surprising result for dealer networks as it merely clarifies the
GST position litigated under New Zealand’s GST laws. However, the GST position should extend to other
industries where the overseas manufacturer enters into arrangements to provide payment for warranty repairs
made by the Australian dealer.
For further information, please review GSTD 2005/D2: Goods and services tax: is a payment from a nonresident car manufacturer to an Australian distributor under an offshore warranty chargeback arrangement
subject to GST? at:
<http://law.ato.gov.au/atolaw/view.htm?docid=DGD/GSTD2005D2/NAT/ATO/00001>.
Thomson CPD Would Like to Hear from You
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Publisher — The Report
Thomson Legal & Regulatory Limited ABN 64 058 914 668
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