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  • Transactions and taxes

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    Bad debts

    We focus on deductions claimed for bad debts, in particular:

    • the genuine nature of bad debts
    • whether it is correct to treat the debt as bad
    • arm's length treatment of debts within closely held groups
    • the treatment, by related entities, of income reflecting the debt
    • the documentation and evidence supporting the claims.

    We also look at the correct application of the deduction rules, in particular:

    • the period when the debts were written off
    • the amount being claimed
    • whether there is a lending business or the debt is included in income
    • the rules being used for individuals, companies and trusts.

    See also:

    Capital gains tax

    Capital gains tax (CGT) issues that attract our attention include:

    Capital losses

    Situations that attract our attention include:

    • losses that appear to be excessive, incorrect or misclassified
    • changes to the company in the year the loss occurred and whether there was a change in either
      • the ownership of the company (may fail the continuity of ownership test)
      • the nature of the business (may fail the same business test)
       
    • capital losses artificially generated to offset capital gains, including  
      • non-arm’s length transactions used to manipulate cost base
      • capital losses realised solely to offset capital gains through wash sales
       
    • entities that incorrectly apply capital losses
    • entities that reclassify capital losses as revenue losses to offset taxable income
    • mismatches between the tax return and the CGT schedule.

    Capital gains tax – disposal

    Situations that attract our attention include:

    • capital gains reported is less than what it should be, based on our estimates using external data sources
    • entities that fail to meet their CGT schedule lodgment obligations
    • companies (other than life insurance companies) claiming a CGT discount
    • entities that received cash (or other ineligible consideration) through a partial scrip for scrip rollover
    • entities that disposed of high value assets but returned small capital gains or claimed unsubstantiated capital losses
    • entities that inappropriately access the small business CGT concessions.

    See also:

    Commercial debt forgiveness

    Situations that attract our attention include entities that have:

    • had a debt forgiven (whether formally or informally)
    • a commercial debt forgiven, but the gain it represents for the debtor has not been recorded correctly in the tax return.
    • had a deemed forgiveness that takes place when a debt is assigned to a party related to the debtor
    • entered into a debt for equity swap and failed to adjust their loss claims.

    See also:

    Deductions

    Situations that attract our attention include:

    • incorrectly claiming deductions that decrease taxable income including from
      • failing to add back non-deductible expenses in the reconciliation statement
      • inappropriately valuing closing stock at below cost or replacement value
       
    • undefined expenses
    • using the trading stock election rules to lower the valuation of closing stock.

    See also:

    Excise equivalent goods

    We focus on the risks associated with:

    • licence and permission obligations
    • record keeping
    • releasing goods without the proper authority to deal
    • tobacco duty. We also working closely with the Department of Home Affairs on the Taxing Tobacco at the Border initiative.

    See also:

    Franking credits

    Situations that attract our attention include:

    • entities incorrectly claiming franking credits or not applying appropriate governance to their franking credit balance
    • a substantial increase in, or refund of, franking credits
    • arrangements to access franking credits through an entity with a concessional tax rate, such as a superannuation fund.

    See also:

    Fringe benefits tax

    Some fringe benefits tax issues we look out for are:

    Motor vehicles

    We look out for situations where an employer provides a motor vehicle to an employee who uses it for private travel, or has it available to use privately.

    Both the actual private use of a motor vehicle and its availability for private travel are fringe benefits. This means that the employer may have a fringe benefits tax liability.

    Situations that concern us include when employers:

    • fail to identify or report these fringe benefits
    • incorrectly apply exemption provisions
      • for vehicles that are not eligible
      • by treating all travel as business
       
    • incorrectly claim reductions for these benefits without the appropriate records to support the reduction.

    See also:

    Employee contributions

    The general effect of an employee contribution to benefits is that it:

    • reduces the amount of fringe benefits tax payable
    • is included in the employer's income.

    We look out for mismatches between the amount reported as an employee contribution on the fringe benefits tax return and the income amounts on the employer's tax return.

    See also:

    Entertainment

    If you provide your employees or their associates with food and drink, gifts or leisure activities (such as Christmas parties and business lunches) you may have a fringe benefits tax liability.

    We look out for situations where employers are providing entertainment activities to their employees and the expenses are:

    • claimed as deductions in their tax return without correctly reporting and paying fringe benefits tax
    • classified as sponsorship or advertising where there is an entertainment aspect to the activity.

    See also

    Car parking valuation

    You must:

    • get a valuation to support the calculation of car parking fringe benefits from a suitably qualified valuer
    • detail the basis the valuation was determined on.

    Situations that concern us include when the calculation is based on:

    • market valuations that appear to be significantly discounted
    • parking rates that are not representative of commercial parking in the area
    • parking rates that are not supported by evidence.

    See also:

    Private assets or private pursuits in business

    We focus on assets and private pursuits that generate deductions or are misrepresented as business activities. These deductions reduce profits from other enterprises or income within the same private group structure.

    We also look at assets or pursuits that are not accounted for under Division 7A or fringe benefits tax.

    Situations that attract our attention include:

    • private aircraft ownership or activities
    • art ownership and dealings
    • car or motor bike racing activities
    • luxury and charter boat activities
    • enthusiast or luxury motor vehicles
    • grape growing and other farming pursuits
    • horse breeding, racing and training activities
    • holiday homes and luxury accommodation provision
    • sporting clubs and other activities involving participation of the principals of private groups or their associates.

    We address the following tax risks:

    • income tax
      • an entity which has claimed deductions, against other income, for the conduct of private pursuits or assets that are private in nature. This is a tax risk if the entity is not carrying on a business relating to those assets or pursuits
      • incorrectly apportioning deductions where the assets have been used for income producing and private purposes or are not available for rent or hire
      • entities that have disposed of assets but have not reported revenue income or capital gains.
       
    • fringe benefits tax – entities that have purchased assets through their businesses but have used them for the personal enjoyment of an employee or associate
    • GST – entities that have claimed input tax credits for expenditures for private pursuits
    • superannuation – self-managed super funds (SMSFs) that have acquired assets and used them for the benefit of the fund's trustees or beneficiaries.

    Private company benefits

    We focus on arrangements that enable the extraction of wealth from private companies while avoiding the appropriate amount of tax. These may include:

    • excessive or non-arm's length payments
    • potential application of anti-avoidance rules.

    Private company benefits that may attract our attention include:

    Director loans

    We focus on:

    • directors who are shareholders of private companies and who report low levels of salary and wages with minimal other sources of income
    • whether shareholders and their associates are maintaining a lifestyle that cannot be supported by the level of income reported to us.

    See also:

    Dividend access share schemes

    Situations that attract our attention include:

    • using dividend access share schemes as dividend stripping schemes
    • arrangements that involve the use of 'dividend access shares' to distribute accumulated profits of a company in a tax-free (or lower tax) form to an associate of the ordinary shareholders of the company.

    We encourage taxpayers to review their affairs if they have entered into such arrangements.

    See also:

    • TA 2012/4 Accessing private company profits through a dividend access share arrangement attempting to circumvent taxation laws
    • Taxation Determination TD 2014/1 Income tax: is the 'dividend access share' arrangement of the type described in this Taxation Determination a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E of Part IVA of the Income Tax Assessment Act 1936?

    Division 7A – deemed dividend

    A Division 7A dividend is a payment or other benefit provided by a private company to a shareholder or their associate. It can be treated as a dividend for income tax purposes even if the participants treat it as some other form of transaction, such as a loan, advance, gift or writing off a debt. It should be included in the assessable income of the shareholder or their associate.

    The use of company funds or assets for private purposes by shareholders or their associates may result in a deemed dividend under Division 7A Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

    Our attention is attracted when:

    • amounts are taken from a company and not repaid
    • a complying loan agreement has not been put in place
    • minimum yearly repayments on a loan are not paid
    • income from interest on a loan is not declared
    • a company asset is used for private purposes
    • there are arrangements designed to avoid the application of Division 7A.

    See also:

    Transactions through interposed entities

    Division 7A will apply if a reasonable person would conclude that a private company made a payment or loan to an interposed entity (as part of an arrangement involving a payment or loan to a target entity).

    We focus on arrangements that seem artificial or lack commerciality.

    See also:

    Unpaid trust entitlements

    An unpaid present entitlement (UPE) is where a private company is a beneficiary of a trust and is presently entitled to an amount of trust income, but does not actually receive payment of that distribution.

    Situations that attract our attention include:

    • private companies, including assessable trust distributions, not receiving payment of the distribution from the trust before the earlier of either
      • the due date for lodgment
      • the date of lodgment of the trust’s tax return for the year in which the present entitlement arose
       
    • a failure to put funds retained by the trustee in a sub-trust for the sole benefit of the private company beneficiary
    • a failure to pay the UPE at the conclusion of the term specified in an investment agreement
    • arrangements releasing the trustee from having to pay the UPE to the private company beneficiary.

    See also:

    Unitisation arrangements

    We focus on arrangements involving private companies acquiring units in a unit trust. These arrangements may involve either:

    • the company making a payment to the unit trust for the units
    • the unit trust issuing the units to satisfy a UPE, debt or other obligation owed to the company.

    We are concerned if the cost of the units is more than what would have been paid had the parties been dealing at arm's length.

    The funds representing the UPE are then either:

    • retained in the unit trust as working capital
    • used to make loans or payments to shareholders or associates of shareholders of the private company.

    These arrangements may involve the application of Division 7A, section 100A or Part IVA of the ITAA 1936.

    See also:

    Revenue losses

    Some revenue loss issues we look out for are:

    Revenue losses incurred

    We focus on entities that inappropriately generate tax losses by over-claiming expenses and reconciliation items in a given year.

    Potential compliance risks include:

    • inflating expenses and creating artificial losses
    • understating, mischaracterising or omitting income
    • misclassifying capital losses as revenue losses.

    Entities with one or more of the following factors in their tax returns attract our attention:

    • high operating loss in a single year
    • significant revenue loss in a single year
    • high negative reconciliation items resulting in low or no taxable income
    • poor profitability over a sustained period.

    See also:

    • TD 2007/2 Income tax: should a taxpayer who has incurred a tax loss or made a net capital loss for an income year retain records relevant to the ascertainment of that loss only for the record retention period prescribed under income tax law?
    • Losses

    Revenue losses used

    We focus on entities that are using or carrying forward tax losses incorrectly.

    Tax losses that attract our attention include those:

    • being used where companies do not satisfy either the continuity of ownership or same business tests
    • deducted in the current year and exceeding the previous year’s carried forward tax losses
    • that cannot be reconciled with relevant labels on the tax return
    • being used by trusts that do not satisfy the relevant trust loss rules.

    See also:

    • TR 1999/9 Income tax: the operation of section 165-13 and 165-210, paragraph 165-35(b), section 165-126 and section 165-132 (same business test)
    • TR 2007/2 Income tax: application of the same business test to consolidated and MEC groups – principally, the interaction between section 165-210 and section 701-1 of the Income Tax Assessment Act 1997
    • TD 2007/2 Income tax: should a taxpayer who has incurred a tax loss or made a net capital loss for an income year retain records relevant to the ascertainment of that loss only for the record retention period prescribed under income tax law?
    • Trust loss provisions

    Taxation of financial arrangements

    The taxation of financial arrangements (TOFA) rules in Division 230 of the ITAA 1936 are often complex and errors can arise.

    TOFA issues that attract our attention include:

    • exceeding a TOFA threshold, but not applying the TOFA rules
    • not reporting TOFA gains and losses correctly on the tax return, which may lead to an incorrect PAYG instalment rate being issued
    • failing to bring to account accrued but unrealised gains on debt-like securities such as discounted bonds. This rule applies to all taxpayers and is not limited to those subject to the TOFA rules
    • failing to use market values for transfers of financial arrangements between related parties
    • improper characterisation of a financial benefit as sufficiently certain for the purposes of the TOFA accruals methods.

    See also:

    Find out about other areas that attract our attention:

    Last modified: 03 Apr 2019QC 58474