AMK:lg
13 September 2022
Pitcher Partners Advisors Proprietary Ltd ABN 80 052 920 206
Level 13, 664 Collins Street Docklands VIC 3008
Level 1, 80 Monash Drive Dandenong South VIC 3175
Postal Address GPO Box 5193 Melbourne VIC 3001 p. +61 3 8610 5000
Director, Tax Administration Unit Individuals and Indirect Tax Division, Treasury Langton Cres PARKES ACT 2600
By Email: taxadministrationconsultation@treasury.gov.au
Dear Sir/Madam
PROPOSED EXCLUSIONS FROM SHORTER PERIOD OF REVIEW FOR SMALL AND MEDIUM ENTITIES
1. Thank you for the opportunity to provide comments to the Exposure Draft legislation Income Tax Assessment (1936 Act) Amendment (Period of Review) Regulations 2022 (“ED”) and accompanying draft explanatory materials (“EM”).
2. Pitcher Partners specialises in advising taxpayers in what is commonly referred to as the middle market. Accordingly, we service many clients that would be impacted by the measures proposed in the ED.
3. We welcome the proposed modifications to the regulations that will provide a limited period of review for small taxpayers.
4. However, we are concerned that the proposed regulations inappropriately extend to small entities and other non-business entities with simple tax affairs, beyond the intended policy scope.
5. On its consultation webpage,1 Treasury states that the proposed further limitations on the two-year period of review (“POR”) are based on the previous Government’s 2020-21 Budget announcement. That announcement proposed to extend the shorter two-year POR from 1 July 2021 for entities with up to $50m aggregated turnover, except those with “significant international tax dealings or particularly complex affairs”.2
https://treasury.gov.au/consultation/c2022-298165
Budget Paper No. 2, Budget Measures 2020-21, page 16.
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6. However, while the ED provides for this concession announced in the Budget, it also removes access to the shorter POR for entities that otherwise qualified prior to the recent changes that extended this to medium business entities.
7. That is, small business entities (those with less than $10m aggregated turnover) and entities that do not carry on a business at all would be inappropriately affected by this measure as they may be subject to a longer POR than that which applied to them prior to the 1 July 2021 changes which were supposed to be concessionary in nature.
8. The shortened POR is an important feature of the tax system, providing certainty to taxpayers. It was introduced in 2005 after the Report on Aspects of Income Tax Self Assessment to “reduce uncertainty and compliance costs for taxpayers, while preserving the Australian Tax Office’s (“ATO”) capacity to collect legitimate income tax liabilities.”3
9. Therefore, any changes proposed in the ED that remove existing concessions should only apply to entities that are medium business entities and not small business entities (i.e., those new entities brought into the shorter POR rules) so as not to adversely affect entities that otherwise did not benefit from the recent expansion of two-year POR. The ED would result in increased compliance costs and increased uncertainty for these smaller taxpayers that is contrary to the stated policy with respect to the shorter POR.
10. Furthermore, given that the ED is not consistent with the Budget announcement, the removal of these concessions for small business entities would result in a retrospective amendment for those taxpayers.
11. Our submission also contains further specific comments in relation to particular items in the ED which are contained in the Appendix.
If you would like to discuss any aspect of this submission, please contact either Leo Gouzenfiter on (03) 8612 9674 or me on (03) 8610 5170.
Yours sincerely A M KOKKINOS Executive DirectorAPPENDIX – DETAILED COMMENTS
Item 1 – related party dealings
12. We do not consider that the proposed amendment is required.
13. The existing Regulations4 already cover non-arm’s length dealings. There should not be any need to extend the exclusion to cover all transactions involving associates even where the parties were dealing at arm’s length.
14. If as part of the ATO’s investigations they conclude that parties were dealing at arm’s length, there should be no necessary adjustments to make and therefore no need for an extra two years to review.
15. Moreover, the Budget announcement sought to exclude from the expansion entities with significant international dealings and particularly complex affairs. That is, complex affairs of entities with $10m to $50m of aggregated turnover. The parameters of what is considered “particularly complex” should be determined through that lens. In the context of businesses with between $10m and $50m aggregated turnover, $50,000 is not an accurate indicator of a complex or significant transaction, and is likely to have the effect that most, if not all, entities in that group would fall within scope.
16. Additionally, the ED is drafted so as to refer to transactions “relating to” assets that have a market value of $50,000 or more. This is drafted too broadly and should instead be focused on the size of the transaction instead of the value of the asset. Otherwise, a $500 rental charge in relation to a car valued at $60,000 would seem to satisfy this requirement of “relating to” such an asset.
Item 3 – entities that derive more than $200,000 from foreign sources
17. We do not support this proposed amendment.
18. The EM states that the threshold of $200,000 is the total of amounts of foreign source income derived by the entity and all of its connected entities and affiliates “to prevent structuring arrangements being undertaken to avoid the four-year period of review”.
19. We do not observe taxpayers structuring in such a manner to avoid a longer period of review by splitting foreign source income across multiple related entities.
20. Further, the aggregation of amounts between an entity, its connected entities and affiliates is complex and may significantly increase compliance costs to determine the correct POR. For example, the affiliate test is inherently uncertain and is also unidirectional with respect to trusts.
21. An entity that is a trust may have an affiliate that is a company, but that trust cannot be an affiliate of the company. This could result in a strange outcome whereby the trust is subject to the four-year POR, but the company is not.
22. We believe the integrity of the four-year POR is retained even where income flows through at trust. This is because, for the purpose of those provisions, foreign income
retains its character as such when it flows through a trust to the beneficiary (i.e., see section 6B(2A) of the ITAA36).
23. In addition, as beneficiaries of a trust are subject to a four-year POR (in any event), we do not see the integrity risk with simplifying this rule.
24. Accordingly, we recommend that, for simplicity, this be tested on a standalone-entity basis, with the threshold amount of foreign source income reduced if appropriate.
Resident investment vehicles
25. The existing Regulations provide an exclusion to item 5 for amounts received from a “resident investment vehicle”. Presumably, the underlying policy rationale relates to the strict reporting requirements that apply to investment entities that are subject to annual reporting (which can be data-matched).
26. At a minimum, that exclusion should be extended to the proposed item 5A (if they are to be retained).
27. However, we note that the term “resident investment vehicle” is defined by reference to section 118-510 of the Income Tax Assessment Act 1997 (Cth) (“ITAA97”) (which relates to venture capital entities). This definition does not appear fit for purpose as Subdivision 118-G of the ITAA97 is specifically concerned with foreign resident tax exempt pension funds investing in venture capital equity in entities registered under the Pooled Development Funds Act 1992 (Cth).
28. We would suggest that it may be more appropriate for such an exclusion to be based on an entity receiving income from an “investment body” as defined in section 202D of the Income Tax Assessment Act 1936 (Cth) as it is these entities that are required to lodge an annual investment income report (AIIR) for data matching purposes5
29. Therefore, in addition to adding an exclusion in proposed item 5A for foreign source income from such entities, we suggest that the term “resident investment vehicle” also be replaced in item 5 in the Regulations with the term “investment body” and the definitions updated accordingly.
Item 3 – foreign owned or controlled entities
30. The proposed item 5B is extremely broad and covers all “foreign controlled Australian entities”, but the EM does not provide any explanation as to why such entities are likely to have significant international dealings.
31. For example, an Australian company that is owned by a New Zealand resident individual would result in the company being excluded from the shorter POR for this fact alone, even if it only had an annual turnover of $200,000, no complex transactions and no international dealings whatsoever.
32. Such a restriction on the shorter POR will adversely affect micro enterprises and seems unnecessary and not consistent with the stated policy of dealing with significant international transactions.
5 Under section 393-5 of Schedule 1 to the Tax Administration Act 1953 (Cth) (“TAA”).
33. We suggest instead that the measure be limited to cover specific complex part of the tax law such as the application of Division 820 of the ITAA97 (the thin capitalisation rules) or Division 832 of the ITAA97 (the hybrid mismatch rules).
Item 6 – 10 or more entities
34. We reiterate our comments above in relation to the uncertainty regarding the affiliate concept and the potential for inconsistent outcomes due to its unidirectional nature. At the very least, we recommend that only connected entities and not affiliates are considered as part of this item to remove uncertainty and increase compliance costs.
35. Further, we highlight that most trusts are established with a special purpose corporate trustee. As such, both the trustee and the trust are likely to be controlled and connected with a common entity. In effect, a group of five or more trusts is likely to fall within this item if they each have a separate corporate trustee (as each of the trusts and corporate trustee would count as a separate entity). We suggest that this may not be particularly complex for entities who have an aggregated turnover of between $10m and $50m.
36. We recommend that this item be amended to exclude entities who have no assessable income or deductions in the relevant year so that entities such as corporate trustees and other dormant or legacy entities do not count towards the 10 or more required to result in a four-year POR.
Item 6 – Roll-overs
37. We recommend that this item be amended to exclude taxpayers who are covered by a class ruling (i.e., a public ruling that applies to a class of entities in accordance with section 358-5 of Schedule 1 to the TAA). Such
38. As drafted, the ED would apply to “mum and dad investors” who may hold some listed shares in a company which interposes a new holding company or undertakes a demerger. Typically, these listed entities will get a class ruling for all their shareholders such that there is no risk that requires an extra two-year POR. For example, a small investor may hold $500 worth of shares in an ASX top 20 company that demerges a subsidiary. Despite having no attributes that suggest a tax risk, the small investor may have a longer (four-year) POR under the ED.
39. Further, we suggest that the phrasing “may be applicable” is inherently uncertain and note that the ES suggests that the four-year POR apply to entities that “claim” roll-over relief. As such, this item should only apply to those entities that choose to obtain roll-over under the relevant Division or Subdivision.
Item 6 – Division 855
40. Similar to the above, the phrasing that a capital gain or capital loss “may be disregarded” under section 855-10 of the ITAA97 is too vague and uncertain.
41. Many foreign residents would have simple and minor transactions that result in capital gains or losses that are commonly disregarded. For example, the sale of 1 share in a foreign listed entity by a foreign resident in their home country for $1USD technically results in a capital gains tax (“CGT”) event, the gain or loss from which is generally disregarded under section 855-10 of the ITAA97. Assuming the foreign resident was required to lodge an income tax return for some other reason, they would be subject to
a longer four-year POR for no other reason that their $1 sales proceeds being disregarded.
42. We recommend that this item is phrased it such that the capital gain or loss is “not disregarded” under section 855-10 of the ITAA97. In this way, it only extends the POR to situations in which the Commissioner needs more time to conduct analysis of Division 855. If it turns out that section 855-10 does apply to disregard the gain or loss, then the Commissioner loses nothing by going beyond the two years if it is ultimately the case that there is no tax consequence from the CGT event.
Item 7 – Application provision
43. The amendments in the ED have an element of retrospectivity in that they will apply to events occurring before the commencement of the law and the release of the ED. Further, some taxpayers will be worse off depending on the precise date they lodge their 2021-22 tax return.
44. Regulations should typically contain no element of retrospectivity as required under section 12 of the Legislative Instruments Act 2003 (Cth). We therefore recommend that the regulation commences for income years beginning on or after 1 July 2022.
Broader amendments following Yazbek
45. We highlight that the decision in Yazbek v FCT [2013] FCA 39 and the ATO’s decision impact statement following the case continue to provide inappropriate outcomes for many taxpayers.6
46. The result of this case is that almost all taxpayers are already subject to the four-year POR as all that is required is for the taxpayer to be a potential beneficiary of some trust somewhere in the world (that is itself not a small business or medium business entity). This overly broad application of section 170 of the ITAA36, in our view, goes beyond the purpose of the shorter POR as there is no risk to revenue if a taxpayer is merely an object or potential beneficiary of a trust.
47. Further, the result of the decision means that in large part, the proposed changes in the 2020-21 Budget and the ED are irrelevant if all such taxpayers were already subject to a four-year POR.
48. We acknowledge that section 170 of the ITAA36 cannot be amended by regulation. We therefore urge Treasury to consider introducing a legislative amendment to appropriately deal with the case so as to limit the provision to only apply the four-year POR where the beneficiary actually has a present entitlement to a share of income during the income year of a trust that is not a small business entity or medium business entity (and is also not an investment body within the meaning of section 202 of the ITAA36).
49. This would ensure that section 170 of the ITAA36 operates in an appropriate and targeted manner.
https://www.ato.gov.au/law/view/document?DocID=LIT/ICD/NSD1471of2012/00001