Edited version of your written advice

Authorisation Number: 1051391318289

Date of advice: 29 June 2018

Ruling

Subject: Record keeping – section 262A of the Income Tax Assessment Act 1936

Question

Will the taxpayer and associated entities comply with the record keeping requirements in section 262A of the Income Tax Assessment Act 1936 (ITAA 1936) in relation to the recording of financial transactions between the related entities under the proposed arrangement to take effect from 1 July 20xx?

Answer

Yes. If the Special Purpose Vehicle creates and keeps records as prescribed in Taxation Rulings TR 96/7 and TR 2018/2 it will be taken to comply with the requirements of section 262A of the ITAA 1936.

This ruling applies for the following period:

1 July 2018 to 30 June 2021

Relevant facts and circumstances

Special Purpose Vehicle

● A Special Purpose Vehicle ("SPV") has been proposed, to be established, which has arisen out of the administrative difficulty in maintaining a loan matrix;

● Currently, funds are transferred between entities on an "as needs" basis from whichever entity has funds available;

● The SPV will be a trust, and it is yet to be determined whether the trust will be a discretionary trust or a unit trust;

● The SPV will hold all future surplus funds for the Group and provide funding to the entities in the Group, where required;

● The SPV will act as a "financier" to the Group, by maintaining the only active operating bank account. For example, the SPV will be responsible for collecting group entity income (e.g. rental income) and paying third party suppliers;

● Records will be kept via spreadsheet, with a separate tab representing each entity to record all the transactions. The spreadsheet will also take into consideration GST collected and paid, and could potentially form a GST worksheet. The preliminary/head sheet will act as a control worksheet;

● The SPV will pay interest on group entity deposits and receive interest on group entity loans, with rates set via a benchmark.

● There is an intention to have the proposed Trust established prior to 1 July 2018. Accordingly a private ruling application is required to be expedited to assist in the timely establishment of the SPV.

Background information

● By way of background, the taxpayer has been in the construction industry for at least twenty (20) years. Immediately after finishing high school, the taxpayer studied at TAFE and on completion became eligible to acquire a Relevant licence. The taxpayer later joined their parent in the business, who eventually phased out of the business due to illness.

● The taxpayer’s role is latterly very hands-on and assumes many of the roles in the business including, managing the finances, paying suppliers and subcontractors and property management.

● The Group's business is predominately property development with some construction business.

Understanding the tax losses

● The entities have always been heavily geared, through funding from financial institutions and third parties. Initially, there were no assets to borrow against, giving rise to large borrowings from relatives and unrelated parties. The agreements were "handshake" agreements, which have resulted in high financing expenses, contributing to the losses.

For some time now the taxpayers have been providing and /or receiving inter-entity loans, from one to the other, in order to support internal group funding arrangements for each entity, as the funding arrangement or requirement arises. Such arrangements lead to the need to maintain and reconcile inter-entity balances (especially at year end).

To overcome the plethora of inter-entity loan accounts and to streamline all future arrangements, preferably from 1 July 2018, it is proposed that a special purpose entity be established. The entity will have a stand-alone trustee company of a standalone discretionary trust. This special entity (called ‘SPV’ for the purposes of this application) will act as a depository for all funds received by the taxpayers from third parties. At the end of each month it is proposed that interest that is received from the financial institution, with whom the SPV is established, will pass on that interest to each relevant taxpayer holding a credit balance with the SPV, less an administrative charge, to the said taxpayers that have deposited funds with the SPV.

The SPV will provide funds for taxpayers on an ‘as needs’ basis. To the extent that any taxpayer has a net debit with the SPV, the SPV will charge at the end of the month an amount of interest which will exceed the deposit rate (minus the above mentioned administration charge). No taxpayer will be allowed to draw funds in excess of a pre-approved credit limit, which might be revised from time to time, depending on the circumstances. Approved credit limits will be documented via a directors’ resolution of the SPV and the gist of the resolution conveyed to the taxpayer requiring access to group funds.

From 1 July 2018 each taxpayer will cease to use a separate bank account and the SPV bank account will operate as ‘banker and/or financier’ to the taxpayers.

We expect that the books and records that are required to be kept for compliance with section 262A of the Income Tax Assessment Act 1936 (‘ITAA 1936’) will comprise excel spreadsheet accounting, whereby:

● There will be a control sheet for the SPV that will account for every receipt and every payment into and out of the SPV’s bank account;

● There will be entity sub-sheets of the SPV that will account for every receipt and payment made on behalf of each taxpayer, such that any GST received or paid (as the case may be) will likewise be accounted for in the entity sub-sheet. GST record keeping will, thus, appear in the sub-sheets.

The ruling we seek from the ATO is that the proposed arrangements from 1 July 2018 are considered appropriate and fit for purpose and meet the taxpayer obligations of section 262A of the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1936

Section 262A

Subsection 262A(1)

Subsection 262A(2)

Subsection 262A(3)

Subsection 262A(4)

Subsection 262A(5)

Income Tax Assessment Act 1997

Division 121

Taxation Administration Act 1953

Schedule 1

Subdivision 382-A

Reasons for decision

Taxation Ruling TR 96/7 contains the Commissioner’s guidelines on the application of section 262A of the ITAA 1936 to the income and expenditure of a person carrying on a business. Paragraphs 9 to 11 of the ruling state:

9. Subsection 262A(1) imposes the primary obligation on persons carrying on a business to keep records that record and explain all transactions engaged in by them that are relevant for any purpose of the Act. We consider that a record will 'explain' transactions engaged in by a person if it contains information which will enable ATO staff with accounting skills to understand the essential features of the transactions.

10. Subsection 262A(2) makes it clear that the records to be kept under subsection (1) include documents that are relevant for the purpose of ascertaining a person's income and expenditure. The content of the information needed in a record will depend on the circumstances of each case. Our view, generally, is that the minimum information required by ATO staff with accounting skills to understand the essential features of transactions which relate to the person's income and expenditure is the date, amount and character (e.g., sale, purchase, wages, rental, etc.) of the transactions. In some circumstances, an officer also will need other information about the essential features of transactions, e.g., the purpose of transactions and the relationships between parties to transactions, to understand the relevance of the transactions to the person's income and expenditure.

11. The records that a person must keep under subsection 262A(1) must record every transaction that relates to the person's income and expenditure. However, we consider that to explain the essential features of every transaction, a person does not necessarily have to make a record of each individual transaction. Some records are capable of explaining the essential features of transactions when considered as a group rather than when considered individually. We believe that this is the case where any records of the individual transactions provide no additional information about the essential features of the transactions than does a record of the transactions as a group.

The Commissioner’s views on the application of section 262A of the ITAA 1936 to electronic records are provided in Taxation Ruling TR 2018/2. The ruling states that electronic records must explain all electronic business transactions:

2. Records stored or recorded by means of a computer are recognised as documents for the purposes of Commonwealth legislation, including the record keeping requirements and access powers in the taxation legislation.

3. Computer-generated documents are admissible evidence in taxation matters (subject to relevance and, where necessary, proof of the competence of the computer device)

4. If you are carrying on a business, you must keep records that record and explain all transactions and other acts you engage in that are relevant for any purpose of the income tax legislation. Electronic records must be in a form that we can access and understand in order to ascertain your income tax liability when required.

…

7. Any electronic records are subject to the same record keeping requirements as paper records. This includes encrypted records, e-commerce records and records stored in the cloud.

Record keeping for indirect taxes

Subdivision 382-A of Schedule 1 to the Taxation Administration Act 1953 (TAA) sets out the rules for keeping records of indirect tax transactions such as the goods and services tax (GST).

An entity which makes a taxable supply, GST-free supply, input taxed supply, taxable importation, creditable acquisition or creditable importation is required to keep records that identify and explain all transactions and acts relevant to that supply. Entities must also keep records containing particulars of any elections, choices, estimates, determinations and calculations made under the GST law.

Compliance with the record keeping requirements of section 262A of the ITAA 1936

Subsection 262A(1) of the ITAA 1936 states that:

‘Subject to this section, a person carrying on a business must keep records that record and explain all transactions and other acts engaged in by the person that are relevant for any purpose of this Act.’

An entity in a full self-assessment system is required to keep a record of calculations of amounts specified under section 161AA of the ITAA 1936 in their income tax return.

Subsection 262A(1D) of the ITAA 1936 states that a taxpayer who is a full self-assessment taxpayer must:

‘produce to the Commissioner, when and as required by the Commissioner under this Act, a document containing those particulars.’

Section 262A(2) further explains the types of records that must be kept. These include:

● any document relating to a person’s income and expenditure; and

● any documents relating to any election, choice, estimate, determination or calculation made by the taxpayer under the Act.

Generally, the minimum information required by ATO staff with accounting skills to understand the essential features of transactions which relate to the person's income and expenditure is the date, amount and character (e.g., sale, purchase, wages, rental, etc.) of the transactions.

However, in some circumstances, an officer will need other information about the essential features of transactions, e.g., the purpose of transactions and the relationships between parties to transactions, to understand the relevance of the transactions to the person's income and expenditure.

Where section 262A requires a person to keep records, paragraph 262A(3)(b) of the ITAA 1936 requires that these records are to be kept in a manner that allows the person's liability under the Act to be readily ascertained. The Commissioner considers that the person's liability is readily ascertainable if ATO staff with accounting skills can determine the person's liability quickly and easily with minimal assistance from that person.

Where ATO staff cannot readily ascertain a person's liability from the records, the ATO believes that the person needs to make secondary records which enable transactions to be traced, and verified through the accounting system of the business, from the source of the transactions to the financial accounts. These secondary records, e.g., journals, ledgers and financial accounts, summarise the records that explain the transactions.

Paragraph 48 of the Taxation Ruling TR 96/7 - Income tax: record keeping - section 262A - general principles states that:

48. The case of Re Aarons; ex parte the Bankrupt (1977-78) 19 ALR 633 further supports our view that the word 'keep' means 'make and retain'. The Bankruptcy Act 1966 provides in subsection 150(6) that the Court may exercise its powers under subsection 150(5) where a bankrupt has 'omitted to keep and preserve such books, accounts or records as sufficiently disclose his business transactions and financial position...' It also provides in subsection 270(1) that a bankrupt who 'has not kept such books as are usual and proper in any business carried on by him...' is guilty of an offence. In considering whether a bankrupt had failed to keep proper books under these subsections, Riley J said at 636 that:

"Each provision refers both to the keeping and to the preserving of books, accounts and records. Two of the meanings ascribed by the Concise Oxford Dictionary, 6th ed, to the verb "to keep" are (a) "maintain (diary, accounts, books) by making requisite entries" and (b) "retain possession of, not lose or destroy". It is clear that it is in the former sense that the verb is used in both s150(6)(a) and s270(1).'

Subsection 262A(3) states that a person is required to keep records in the English language or in a form readily accessible and convertible into English and to keep records so as to enable the person's liability under the ITAA 1936 to be readily established.

Clause 42 to the Explanatory Memorandum to the Taxation Laws Amendment Bill (No 5) 1989 that introduced subsection 262A(3) into the ITAA 1936 explains:

‘Subsection 262A(3) obliges a person who is required by the section to keep records, to keep those records:

● by paragraph (a) - in the English language or, if not in written form (e.g., in an electronic medium such as magnetic tape or computer disc), in a form which is readily accessible and convertible into writing in English; and

● by paragraph (b) - so as to enable the person's assessable income and allowable deductions, and any credits to which the person is entitled, to be readily ascertainable.’

Paragraph 262A(4)(a) of the ITAA 1936 further makes it clear that the records which are to be kept under section 262A must be kept for 5 years after the records were prepared or obtained, or the completion of the transactions or acts to which they relate, whichever is the later. An entity carrying on a business is therefore required under the law to retain these records for a period of 5 years and keep them in such a manner so the Commissioner is able to readily ascertain their taxation liability at any time after the completion of the transactions under the Act. This is an ongoing obligation over the retention period.

Other record keeping requirements

In addition to the general record keeping rules set out in section 262A of the ITAA 1936, a number of provisions in both the ITAA 1936 and the ITAA 1997 contain further specific record keeping requirements.

For example, Division 121 of the ITAA 1997 provides that you must keep records of matters that affect the capital gains and losses you make. These records must be retained for 5 years after the last relevant CGT event.

Electronic records

Where records are kept electronically, the following requirements must be met:

● Records must not be altered or manipulated, and must be stored in a way that restricts the information from being altered or manipulated.

● Generally, they must be retained for five years after the records are prepared or obtained, or the transactions are completed, whichever occurs later

● They must be capable of being retrieved and read by the ATO when required.

● They must be in English, or in a form that the ATO can access and easily convert into English.

These requirements ensure the veracity and integrity of electronic records.

Conclusion

Ultimately, the nature and quality of the records kept will decide if an entity complies with section 262A of the ITAA 1936 and subdivision 328-A of the TAA.

Where an entity keeps records in the manner prescribed in TR 96/7 and TR 2018/2 it would be reasonable to conclude that the entity will be compliant or, at least, has made an effort to be compliant.

Therefore, if the Special Purpose Vehicle (SPV) creates and retains records, in the manner described above, for the purposes of recording financial transactions between the related entities, we would conclude that the SPV is compliant with section 262A of the ITAA 1936 and subdivision 328-A of the TAA.

Notwithstanding the proposed arrangement, each entity remains individually responsible for lodgement of its income tax returns and for keeping records which properly reflect its tax position and other dealings.

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