Taxpayer Alert

TA 2010/8

Gift deductions for donation of pharmaceuticals to charities operating overseas

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• An arrangement of the type described in this Taxpayer Alert has been investigated by the ATO. The features of the arrangement and the tax consequences for participants are described in Charity donation schemes
  This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

FOI status: may be released

Overview

This Taxpayer Alert describes an arrangement where a taxpayer claims a gift deduction for pharmaceuticals and other items ('pharmaceuticals') to a charity for use overseas. The taxpayer provides cash for a vendor to purchase the pharmaceuticals from a low cost overseas supplier. They are then valued for gifting purposes at a much higher cost. The difference in these amounts is balanced by what appears to be an unsecured, long term, low interest loan facilitated by the promoter of the arrangement and purportedly funded by the vendor. The pharmaceuticals are apparently made available to the charity through an overseas bonded warehouse.

Under this arrangement, the taxpayer claims a deduction for a donation and related costs that is much greater than the actual amount outlaid, e.g. for a cash outlay of $2,100 the taxpayer claims a gift deduction purportedly valued at $20,000.

Context for the arrangement

Division 30 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) and section 78A of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) deal with deductible gifts or contributions.

Description

The alert applies to arrangements with features substantially equivalent to the following:

1.

An Australian taxpayer (the 'participant') enters an agreement ('the agreement') to purchase pharmaceuticals for donation to a Deductible Gift Recipient (DGR).

2.

Under the agreement, the participant makes a cash payment of an amount comprising:

a)

a payment to become a member of a facilitating entity (the promoter or an associated entity);

b)

a cash donation to the nominated DGR;

c)

an interest prepayment in respect of a purported long term, low interest loan alleged to fund the payment of pharmaceuticals; and

d)

a deposit (generally of 7.5% or less) of the nominated amount to be paid for the pharmaceuticals.

3.

The agreement relies upon a loan that does not appear to be on normal commercial terms, because:

a)

the period of the loan for the pharmaceuticals is unusually long, in some cases up to 50 years,

b)

the rates of interest are unusually low (generally less than 1% per annum), even though this interest is allegedly prepaid,

c)

there is no security offered in respect of the principal amount, which may be a significant sum, and

d)

payment will not be required in certain circumstances (such as death of the participant), meaning that there is no certainty of repayment - especially considering the unusually long term of the loan.

4.

Under the agreement, the promoter or facilitating entity deals exclusively with the vendor and any pharmaceuticals are purchased from a low-cost overseas supplier and alleged to be delivered to the DGR entirely outside Australia.

5.

Under the agreement, the participant receives:

a)

a supply note from the DGR describing the pharmaceuticals

b)

an invoice from the vendor for the pharmaceuticals assigning a domestic value rather than the cash amount actually paid to the overseas supplier, to match the cash deposit and the amount of the loan, and

c)

a receipt from the DGR for any cash donation component.

6.

On the basis of the agreement, the participant:

a)

claims a tax deduction for the gift of the pharmaceuticals to the DGR, for the purported value of the pharmaceuticals (i.e. the amount nominated by the vendor) at the date of the agreement, and

b)

purportedly receives a reduction in tax payable that significantly exceeds the total cash amount actually outlaid under the agreement.

Example of typical arrangement

Features which concern us

The ATO considers that arrangements of this type give rise to the following issues relevant to taxation laws, including whether:

a.

the arrangement or any part of it may be a sham at general law;

b.

there may be any deductible gift of property under Division 30 of the ITAA 1997, including considering:

i.

the question of whether the pharmaceuticals actually exist

ii.

the market value of the pharmaceuticals at relevant times, if they do exist

iii.

who has custody and control of the pharmaceuticals at relevant times, if they do exist, and

iv.

the effect of the long-term low-interest unsecured loan on the arrangement;

c.

the anti-avoidance provisions of section 78A of the ITAA 1936 may operate to limit the availability of deductions claimed;

d.

any amounts may be allowable deductions under section 8-1 of the ITAA 1997, such as any amounts:

i.

paid in cash for the cost of purchasing the pharmaceuticals

ii.

borrowed for the cost of purchasing property, and/or

iii.

associated with such a loan or with deferral of payment of the cost such as interest.

e.

any amounts may be allowable as deductions for borrowing expenses under section 25-25 of the ITAA 1997

f.

any of the transactions may be subject to the transfer pricing provisions in Division 13 of Part III of the ITAA 1936;

g.

the general anti-avoidance rule contained in Part IVA of the ITAA 1936 may allow the cancellation of a tax benefit under all, or some part, of the arrangement

h.

private rulings may be denied to participants under section 359-35 and/or section 357-110 of Taxation Administration Act 1953 (TAA 1953);

i.

any fee, commission or other amount received by the promoter of this arrangement may be assessable income for any income year

j.

any entity involved in the arrangement may be a promoter of a tax exploitation scheme for the purposes of Division 290 of Schedule 1 to the TAA 1953,

k.

any taxation statements made in relation to the arrangement may be false or misleading; and

l.

any criminal offences may have been committed regarding the arrangement.

The ATO is currently reviewing these arrangements, but our initial view is that they are not effective at law.

Date of Issue: 6 December 2010

Date of Effect: 6 December 2010

Related Rulings/Determinations:
TR 2005/13

Related Practice Statements:
PS LA 2005/24
PS LA 2008/15

Subject References:
borrowings & loans
deductible gift recipients
deductions & expenses
gifts and donations
gifts to organisations
interest expenses
material benefits derived from gifts
scheme promoters
schemes & shams

Legislative References:
Income Tax Assessment Act 1936
Part IVA
Section 78A
Income Tax Assessment Act 1997
Division 30
Section 8-1
Taxation Administration Act 1953
Division 290 of Schedule 1

Case References:

AAT Case 12,314 Re Hodges v. FC of T
97 ATC 2158
(1997) 37 ATR 1091

Fletcher v. Federal Commissioner of Taxation
(1991) 173 CLR 1
91 ATC 4950
(1991) 22 ATR 613

Leary v. FC of T
80 ATC 4438
(1980) 11 ATR 145
(1980) 32 ALR 221

Milroy v. Lord
(1862) 45 ER 1185
4 De G F & J 264
[1861-73] All ER Rep 783

Re Rose (dec'd); Rose v. Inland Revenue Commissioners
[1952] 1 All ER 1217

Authorised by:
Tim Dyce
Deputy Commissioner
Aggressive Tax Planning (ATP)