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  • Business structure

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    Consolidation

    Consolidation allows wholly-owned corporate groups to operate as a single entity for income tax purposes. Issues that attract our attention include:

    CGT consequences

    We focus on the reporting of capital gains or losses related to consolidation.

    Situations that attract our attention include:

    • corporate groups that restructure and have one or more consolidated groups within a private group
    • where multiple entities join or leave the consolidated group
    • incorrectly reporting capital gains or losses arising from the allocable cost amount (ACA) and allocation process on joining or leaving the consolidated group. For example, a head company has not reported a capital gain when a negative ACA occurred from an entity leaving the group.

    See also:

    Cost-setting rules

    We focus on the:

    • allocable cost amount (ACA) calculation
    • allocation on joining or leaving a consolidated group.

    Situations that attract our attention include:

    • restructuring that may affect the ACA calculation, before joining, forming or leaving a consolidated group
    • on joining a group        
      • miscalculating or overstating the ACA, for example, relating to the costs of membership interests or the accounting liabilities of the joining entity
      • inappropriately including or excluding assets before allocating the ACA to assets
      • incorrectly allocating the ACA to assets which results in increased revenue deductions or cost bases of CGT assets – examples include using inappropriate market values or incorrectly making relevant adjustments 
    • on leaving a group        
      • incorrectly calculating the ACA, for example by excluding or understating liabilities
      • incorrectly allocating the ACA to the membership interests and treatment of pre-CGT shares (if any). 

    Membership

    We focus on the formation of a consolidated group and the eligibility of members.

    Situations that attract our attention include:

    • the incorrect formation of a consolidated group
    • incorrectly including or excluding an entity as a member of a consolidated group
    • late notifications of entries or exits from a consolidated group.

    Losses

    We focus on whether losses have been correctly transferred, the available fraction has been correctly calculated and losses correctly used.

    Situations that attract our attention include:

    • incorrectly including or excluding an entity as a member of a consolidated group, where it may cause unintended tax benefits
    • incorrectly transferring or using losses
    • high available fractions that, if incorrect, would allow a consolidated group to use transferred losses at an inappropriate rate
    • failing to adjust the available fraction as required.

    Demergers

    A demerger involves the restructuring of a corporate group by splitting its operations into two or more entities or groups. When a demerger happens, the shareholders of the head entity of the group acquire a direct interest in the demerged entity.

    The demerger provisions offer CGT and income tax relief at both the entity and shareholder level. This tax relief is intended for genuine demergers that offer business benefits through restructuring. Demergers should not be undertaken to achieve a tax benefit.

    Situations that attract our attention include:

    • disposing of the demerged entity or business after the demerger event
    • shareholders acquiring more than their share of the new interests in the demerged entity
    • schemes aiming to inappropriately obtain CGT rollover concessions through a corporate restructure that does not satisfy the demerger requirements
    • demergers that appear to have been undertaken to obtain a tax benefit rather than to improve business efficiency
    • demergers that eliminate or significantly reduce assessable capital gains or dividends.

    See also:

    International transactions

    International transactions that attract our attention include:

    Capital gains withholding

    Foreign resident capital gains withholding applies to disposals of certain taxable Australian property under contracts entered into from 1 July 2016.

    Situations attract our attention where there is a disposal of:

    • real property with a market value of at least $750,000 and both        
      • the foreign resident vendor did not apply for a clearance certificate or a withholding variation
      • the purchaser has not paid a withholding amount. 
    • membership interests in an Australian entity that owns substantial real property assets and the foreign resident vendor held a material ownership interest in the entity.

    See also:

    Characterisation of inbound foreign funds

    We review cross-border arrangements that mischaracterise inbound foreign funds provided by non-residents to Australian taxpayers.

    We are concerned with whether the correct tax characterisation has been adopted for funds received into Australia.

    Inbound foreign funds need to comply with relevant tax laws, applicable tax treaties and the factual circumstances such as the underlying transaction, the structure used and the relationship between the relevant parties.

    We are concerned that such arrangements may be contrived and unnecessarily complex so as to reduce or disguise the amount of income tax or withholding tax payable.

    Situations that attract our attention include:

    • cross-border arrangements mischaracterising the structure used by foreign investors to invest directly into Australian businesses and typically display one or more of the following features  
      • The Australian resident entities are unable to obtain capital from traditional external debt finance sources on normal terms.
      • The foreign investor either already participates in the management, control or capital of the Australian entity at the time of investment, or starts to participate in the management, control or capital as part of the investment.
      • Financial dealings between resident and foreign resident related parties that do not intend to create legally enforceable obligations or proceed on the basis indicated by the form of the arrangement.
      • The investment has features not consistent with commercial debt or equity investments.
      • The investment may provide the foreign investor with direct exposure to the economic return from a particular Australian business or asset portfolio (whether via trading activities or from the proceeds on disposal).
    • where there is insufficient substantiation and mischaracterisation of funds received from offshore family and related parties in the form of loans or gifts.

    See also

    • TA 2020/2 Mischaracterised arrangements and schemes connected with foreign investment into Australian entities
    • Division 974 ITAA 1997 Debt and Equity interests

    Foreign residents and taxable Australian property

    Foreign residents (except beneficiaries of resident non-fixed trusts) can disregard a capital gain or loss from a CGT event (such as a disposal), unless that CGT asset is taxable Australian property (TAP).

    TAP comprises:

    • taxable Australian real property (TARP)
    • indirect Australian real property interests
    • assets used in carrying on a business through a permanent establishment in Australia
    • an option, or right, to acquire any of the above assets.

    Foreign residents disposing of TAP are expected to lodge returns advising of any gain or loss.

    Foreign residents attract our attention if they:

    • hold significant direct or indirect interests in TAP assets – for example, shares in mining companies and interests in commercial properties
    • dispose of TARP or indirect interests but do not meet their CGT obligations in relation to the disposal
    • characterise or value assets in a way to come within the CGT exclusion
    • enter into a series of transactions such as 'staggered sell-down' arrangements that attempt to come within the CGT exclusion
    • lodge returns that are not in accordance with new associate inclusive test in determining total participation interests
    • fail the principal asset test by inappropriately allocating significant market value to non-TARP assets
    • are unlikely to have sufficient funds or assets remaining in Australia to meet their tax obligation relating to a disposal of a TARP.

    See also:

    Hybrid mismatch rules

    Enacted in 2018, the hybrid mismatch rules aim to prevent multinational companies from gaining an unfair competitive advantage by avoiding income tax or obtaining double tax benefits through hybrid mismatch arrangements. These arrangements exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions.

    The hybrid mismatch rules apply to payments that result in hybrid mismatch outcomes such as where:

    • a payment is deductible in one jurisdiction and non-assessable in the other jurisdiction
    • one payment qualifies for a tax deduction in two jurisdictions
    • a payment indirectly funds a hybrid mismatch in another jurisdiction.

    These rules will neutralise hybrid mismatches by cancelling deductions or including amounts in assessable income.

    Although most of these rules will only apply to income years commencing on or after 1 January 2019, you may want to review your arrangements. Practical Compliance Guideline PCG 2018/7 Part IVA of the Income Tax Assessment Act 1936 and restructures of hybrid mismatch arrangements provides guidance on when restructures may attract our attention.

    See also:

    Intangible assets

    We review international arrangements that incorrectly characterise either intangible assets, or activities or conditions connected with intangible assets.

    Taxpayers may engage in operations that require the use or enjoyment of intangible assets developed, maintained, protected or owned in a foreign jurisdiction. We are concerned when these taxpayers fail to pay, or recognise payment of, a royalty under Australia’s tax treaties and laws. We are also concerned with migration of intangible assets. Migration refers to any transaction(s) that allows an offshore party to access, hold, use, transfer, or obtain benefits in connection with, Australian intangible assets or associated rights.

    In these circumstances, there is typically a significant mismatch between the substance of the relevant parties' operations and the form of their legal agreements. There is also generally an incorrect characterisation of the relevant assets and activities performed in connection with such assets.

    In particular, we are concerned that:

    • parties to arrangements of this type may not comply with Australian royalty withholding tax obligations associated with consideration for the use of intangible assets, under Subdivision 12-F of Schedule 1 to the Taxation Administration Act 1953
    • the analysis or methodology used to determine the arm's length conditions or profits connected with these arrangements may result in parties obtaining a transfer pricing benefit for the purposes of Division 815 of the ITAA 1997
    • the Australian entity disposes of their intangible assets to the offshore related party for low consideration on non-arm’s length terms, thereby minimising its CGT liability – the Australian entity may have also inappropriately utilised other CGT concessions, such as the rollover in subdivision 126-B ITAA 1997
    • such arrangements may be entered into or carried out for the dominant or principal purpose of obtaining a tax benefit – this may attract the application of Part IVA of the ITAA 1936 or the diverted profits tax or both
    • intellectual property arrangements involving inadequate reward for either  
      • value contributed by the Australian entity
      • non-arm's length migration of rights in property created by the Australian entity.

    See also:

    • TA 2018/2 Mischaracterisation of activities or payments in connection with intangible assets
    • TA 2020/1 Non-arm’s length arrangements and schemes connected with the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets

    International dealings schedule – non-lodgment

    We focus on tax returns and other information indicating that an international dealings schedule may be required but has not been lodged.

    See also:

    Non or under-reporting attributable foreign income

    We focus on Australian entities that have failed to report or incorrectly reported attributable foreign income. This includes Australian corporate tax entities with offshore activities that have repatriated their income as a foreign equity distribution that is non-assessable non-exempt income (NANE) (see section 768-5 of the ITAA 1997).

    Situations that attract our attention include where:

    • the controlled foreign company (CFC) or transferor trust (TT) is located in an unlisted country
    • the income being generated through a CFC is tainted
    • fund movements are contrary to where the CFC or TT is located
    • there is a sudden drop in attributable foreign income without a change in the number of CFCs or TTs
    • the amount of NANE income reported has increased from the previous year but no attributable foreign income has been reported for the current and prior years
    • entities that have large claims for deductions, under section  25-90 of the ITAA 1997, for outgoings incurred in deriving NANE income.

    See also:

    Non-resident withholding tax – interest, dividend or royalty

    We focus on:

    • Interest, dividend or royalty withholding tax that has not been withheld or paid
    • an incorrect amount of withholding tax is paid
    • deductions for interest or royalty payments to an offshore entity being incorrectly claimed or misclassified on tax returns
    • situations where an entity pays interest, dividends or a royalty to a non-resident and fails to lodge the PAYG withholding from interest, dividend and royalty payments paid to non-residents annual report.
    • situations where entities defer their interest to avoid or defer withholding tax and claim deductions on an accruals basis
    • arrangements where offshore related entities are used to facilitate the avoidance of interest withholding tax in relation to interest expenses deducted against Australian-sourced income and paid to non-residents
    • situations where there are discrepancies between the amounts  
      • claimed as deductions for interest or royalty payments on the tax return
      • reported as withheld and paid on the activity statement or annual report.

    See also:

    Significant global entities

    Certain measures only apply to entities that meet the definition of a significant global entity (SGE). Subdivision 960-U of ITAA 1997 currently defines SGE as a global parent entity or member of that global parent entity’s group with annual global income of A$1 billion or more. The SGE concept is not limited to entities that are members of a multinational group. An SGE can also be an entity in a group that only operates in Australia.

    Amendments to the law in 2020 extended the definition of SGE to include:

    • groups headed by individuals
    • trusts
    • partnerships
    • private companies.

    The amendments apply in relation to income years or periods commencing on or after 1 July 2019 with penalties applying from 1 July 2020 to entities that were not previously SGEs. SGE’s may be subject to increased penalties and compliance measures including:

    We focus on entities that:

    • meet the SGE definition but do not identify as one on their tax returns
    • fail to lodge relevant and complete documentation as required.

    See also:

    Country-by-country (CBC) reporting

    The revised SGE definition also includes changes to CBC reporting requirements. CBC reporting entities are a subset of SGEs that are required to provide CBC reports and general purpose financial statements (GPFS) to us if they have not been filed with ASIC.

    We focus on CBC entities that:

    • meet the CBC definition but do not identify as such on their tax returns
    • fail to lodge relevant and complete documentation as required.

    Note: Some SGEs may still have CBC and GPFS reporting obligations under the law that applied before the amendments mentioned above. Entities should check their status to ensure that any returns that may be due are provided as required.

    See also:

    Residency

    We focus on individuals, companies and trusts shifting their tax residency to another jurisdiction before or during restructures or asset disposals within their family group with the aim of:

    • avoiding an Australian tax liability
    • obtaining tax benefits on the disposal of CGT assets
    • making tax-free distributions to associates.

    Other situations that attract our attention include when tax has not been paid on:

    • an entity's assets when ceasing to be an Australian resident
    • a resident entity's worldwide income.

    We also focus on wealthy individuals who change their Australian residency status commensurate with a significant income event occurring in their personal lives or in relation to their family group.

    See also:

    • TR 2018/5 Income tax: central management and control test of residency
    • PCG 2018/9 Central management and control test of residency: identifying where a company's central management and control is located
    • Working out your residency

    Section 23AH non-assessable non-exempt income

    We focus on an Australian company’s overseas branch or permanent establishment income that has been incorrectly recognised as non-assessable non-exempt (NANE) branch income under section 23AH of the ITAA 1936. We also focus on the deductions being claimed to have been incurred by the Australian company in deriving section 23AH NANE branch income, for which no deduction is available.

    Situations that attract our attention include:

    • there is no permanent establishment but section 23AH NANE income is declared
    • a permanent establishment may not have passed the active income test and the income is both        
      • adjusted tainted income
      • eligible designated concession income (this applies to permanent establishments in listed countries only 
    • there are low non-deductible expenses but section 23AH NANE income is declared.

    See also:

    Thin capitalisation

    We focus on Australian and foreign entities that have multinational investments and whose debts exceed 60% of the net value of their Australian investments.

    An entity attracts our attention if it has:

    • failed to lodge the international dealings schedule when required
    • reported a large amount of overseas interest expense on the tax return and has not completed the thin capitalisation section
    • failed the safe harbour debt test, arm’s length debt test or worldwide gearing test (based on the international dealings schedule) and has not declared the debt deduction disallowed.
    • relied on the arm’s length debt test without due consideration of the Commissioner’s view in TR 2020/4 Income Tax: Thin Capitalisation - the arm's length debt test
    • determined the value of its assets and liabilities inappropriately for thin capitalisation purposes
    • revalued assets for thin capitalisation purposes.

    See also:

    Transfer pricing – related party dealings

    We focus on income or profits generated in Australia that are not being subjected to domestic tax due to non-arm's length conditions of international related party dealings.

    Situations that attract our attention include entities entering into financing arrangements with international parties on non-commercial terms that generate excessive interest deductions or non-recognition of income in Australia. We will focus on financing arrangements that are not consistent with loan conditions typical of independent borrowers and lenders dealing wholly independently with one another in comparable circumstances (including interest free loans). The Commissioner has released PCG 2017/4 ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions which provides a risk assessment framework for cross-border related party financing.

    Other situations include:

    • paying non-arm’s length prices on related party service arrangements and tangible goods to generate excessive losses or expenses domestically while shifting gains or revenue outside the jurisdiction
    • offshore hubs that derive high profits from marketing or procuring goods or services for Australian operations
    • business restructures that shift Australian assets or operations offshore without arm's length compensation or appropriate recognition for their inherent underlying commercial value.

    See also:

    Lower company tax rate

    The lower company tax rate applies to a company that is a base rate entity (BRE). The company tax rate of 30% applies to all other companies.

    We recognise that the majority of companies will apply the correct tax rate. However, situations that attract our attention include:

    • entities not eligible to be a BRE claiming the concessional tax rate
    • artificial or contrived arrangements to change the company tax rate, such as arrangements where groups  
      • restructure to reduce their aggregated turnover
      • shift the derivation of non-passive income to companies who derive only passive income
      • shift passive income to companies deriving non-passive income.

    See also:

    Professional firms

    In 2017, we reviewed the:

    The review found the guidelines are being misinterpreted for arrangements that go beyond the scope of the guidelines.

    Examples of arrangements with high risk factors that concern us include those that:

    • lack any meaningful commercial purpose for the  
      • disposal of an equity interest through multiple assignments
      • creation of new discretionary entitlements (such as dividend access shares)
      • use of amortisation leading to differences between tax and accounting income
    • disregard CGT consequences or inappropriately access CGT concessions
    • involve assignments where profit sharing is not directly proportionate to the equity interest held
    • create artificial debt deductions
    • undertake an assignment to dispose of an equity interest to a self-managed super fund
    • involve assignments where the arrangement is not 'on all fours' with the principles of Everett and Gulland.

    In light of these concerns, we suspended the application of the guidelines and Everett Assignment web material as of 14 December 2017. Individual professional practitioners thinking of entering into new arrangements should engage with us through Early engagement or contact us via Professionalpdts@ato.gov.au.

    For those who have entered into arrangements before 14 December 2017, if you:

    • comply with the guidelines and do not exhibit high risk factors you can rely on those guidelines
    • exhibit any of the high risk factors you may be subject to review.

    If you are uncertain about how the law applies to your existing circumstances, engage with us as soon as possible.

    If you have any questions, email ProfessionalPDTS@ato.gov.au

    See also:

    • TA 2013/3 Purported alienation of income through discretionary trust partners

    Property and construction

    Where entities have conducted property development, we focus on how they include the profit or income from those activities on their tax returns. A particular focus is how the income should be classified, depending on whether the development was:

    • part of a business of property development
    • undertaken for a profit making purpose.

    Situations that attract our attention include:

    • entities that use an SMSF to fund the development and subdivision of properties leading to sale
    • property that has been disposed of shortly after the completion of subdivision where the amount is returned as a capital gain (refer to TD 92/124)
    • where there's a history of property development or renovation sales in the entity’s wider economic group but the current sale is returned as a capital gain
    • an entity that is a land owner and has related entities that undertake a property development (refer to TR 2018/3)
    • claiming inflated deductions for property developments that are not in accordance with the trading stock provisions, or spreading headworks and other costs over the inventory in line with the decision in Federal Commissioner of Taxation v Kurts Development Limited [1998] FCA 1037 (Kurts DevelopmentsExternal Link)
    • an entity that undertakes multi-purpose developments with both revenue and a capital purpose, for example an entity that retains units for rent after development (the entity needs to make sure that costs are applied appropriately).

    Research and development tax incentive

    The ATO and AusIndustry (on behalf of Innovation and Science Australia) jointly administer the Research and Development (R&D) tax incentive. The incentive aims to support companies that undertake eligible R&D activities. AusIndustry administers the registration and compliance of the R&D activities. We are responsible for the R&D expenditure claimed on the tax return.

    We focus on claims:

    • made by entities in particular industries
    • related to particular behaviours.

    Four industries of concern have been identified:

    • agriculture
    • building and construction
    • mining
    • software development.

    Particular behaviours of concern are:

    • claiming the R&D tax offset on business as usual expenses
    • apportionment of overheads between eligible and non-eligible R&D activities
    • payments to associates
    • whether or not expenses have been incurred
    • approaches taken by R&D consultants
    • fraudulent claims
    • failure to keep records.

    See also:

    • Research and development tax incentive
    • TA 2015/3 Accessing the R&D tax incentive for ineligible broadacre farming activities.
    • TA 2017/2 Claiming the Research and Development tax incentive for construction activities
    • TA 2017/3 Claiming the Research and Development tax incentive for the ordinary business activities
    • TA 2017/4 Claiming the Research and Development tax incentive for agricultural activities
    • TA 2017/5 Claiming the Research and Development tax incentive for software development activities

    Self-managed super funds

    With self-managed super funds (SMSFs), we focus on transactions and schemes that aim to inappropriately take advantage of concessional tax rates afforded to complying super funds.

    Our attention is attracted by:

    • schemes in which parties were not dealing with each other at arm's length and non-arm’s length expenditure either has  
      • been incurred in gaining or producing ordinary or statutory income
      • not been incurred but would have been expected to be incurred if the parties were dealing with each other at arm’s length
    • other issues including  
    • issues around valuation of any type of property being indirectly or directly purchased from a private group
    • significant management and administration expenses
    • private company dividends and/or unit trust distributions being diverted to SMSFs
    • illegal early release of superannuation benefits
    • personal services income diverted to SMSFs
    • incorrect calculation of exempt current pension income.

    We know some schemes target Australians planning for their retirement and encourage people to channel money inappropriately through their SMSF.

    The Super Scheme Smart aims to educate individuals and their advisers about these schemes.

    These schemes have some common features. They:

    • are artificially contrived with complex structures, usually connecting with an existing or newly created SMSF
    • involve a significant amount of paper shuffling
    • aim to give a present day tax benefit, often resulting in the individuals involved paying minimal or zero tax, or even receiving a tax refund
    • sound too good to be true and, as such, they generally are.

    See also:

    Trusts

    We are focusing on a number of risks including complex distributions, lodgment of trust and beneficiary tax returns and trust and taxable income mismatches.

    Find out about:

    What Trust issues that attracts our attention:

    Find out about other areas that attract our attention:

    Last modified: 08 Mar 2021QC 58473