No more deductions for non-compliant payments

The government recently released exposure draft legislation that removes the ability of taxpayers to deduct certain payments – including payment of wages and payments to contractors – if the entity making the payment fails to comply with its obligations to withhold and report information to the ATO.

If the PAYG withholding regime applied to the following payments, and the payer did not withhold the amount from the payment as required or did not notify the Commissioner when required, then the amendment to legislation (intended to apply from 1 July 2019) would not allow a deduction in relation to the following payments:

• Salary, wages, commissions, bonuses or allowances to an employee;
• Directors’ fees;
• Religious practitioner;
• Labour hire arrangement; or
• For a supply of services — excluding supplies of goods and supplies of real property — where the payee has not quoted its ABN.

The explanatory memorandum (EM) to the draft legislation explains that the amendment is intended to create a financial disincentive to businesses making payments to those operating in the black economy by disallowing deductions that would normally be available. “The disincentive created by denying the deduction will complement existing penalties for failures to withhold amounts under the PAYG system.”

Note however that the deduction is only denied where no amount has been withheld at all or no notification is made to the Commissioner. Withholding an incorrect amount or notifying an incorrect amount will not affect the entitlement to a deduction.

A deduction is also denied in relation to a non-cash benefit provided in lieu of a cash payment.

Exemptions
Where an employer that makes a payment to an employee that they believe to be a contractor, they will not be denied a deduction if, had the employer been correct in characterising the employee as a contractor, the employer would not have been required to withhold and the person provides an ABN.

Example from the EM: Super Express Deliveries Pty Ltd carries on a business as a bicycle courier service. Super Express Deliveries has engaged around 30 bicycle couriers to enable it to fulfil orders from its customers.

Super Express Deliveries seeks legal advice about the engagement of the bicycle couriers. The advice concluded the bicycle couriers were independent contractors and were not employees. It placed significant emphasis on the couriers’ use of their own bicycles. To this end, Super Express Deliveries required each of its bicycle couriers to obtain an ABN and provide it to the company. Super Express Deliveries concluded that it did not have to withhold any amounts from the payments it made to couriers.

The Commissioner conducts an audit of Super Express Deliveries and decides that the bicycle couriers are employees of Super Express Deliveries. After considering the Commissioner’s reasons and legal authorities, Super Express Deliveries does not dispute this conclusion and agrees to begin fulfilling its withholding obligations on this basis.

The deduction available to Super Express Deliveries for its previous payments to bicycle couriers is not affected by its failure to withhold.

Under the second exemption, a deduction that would otherwise be denied is restored if the taxpayer voluntarily notifies the Commissioner of their mistake before the Commissioner commences an audit or other compliance activity.

Example 2: Caleb carries on a business as a mechanic. Caleb does not have any employees until he hires an apprentice, Bianca, in May 2020. Caleb is not aware that he must withhold an amount from Bianca’s wages and pay it to the Commissioner.

Caleb visits his accountant in September 2020 to prepare his 2019-20 income tax return. He mentions his expenditure to pay Bianca’s wages. Caleb’s accountant advises Caleb he should have been withholding from the wage payments.

Caleb notifies the Commissioner of his mistake and enters into an arrangement to pay the Commissioner the penalties associated with his failure to withhold. However he is entitled to claim the deduction for the cost of Bianca’s wages in his 2019-20 income tax return.

New guideline on deceased estate tax debt and legal personal representatives

One of the major concerns for taxpayers in taking on the role of a legal personal representative is that the Tax Commissioner may treat legal personal representatives (LPRs) as having a personal liability for a tax debt where assets of a deceased estate have been distributed and there is still outstanding amounts owed to the ATO.

In a recently released practical compliance guideline (PCG 2018/4), the ATO spells out when an LPR of smaller and less complex estates can be personally liable for tax debts. The PCG also provides a safe harbour arrangement to ensure the Tax Commissioner does not seek to recover the deceased’s outstanding tax liabilities from the LPR’s own assets. (Note however that there are some limitations on the PCG’s application, see below).

The PCG states that LPRs may be personally liable if they already have notice of the tax amount when they distribute the assets. While this may seem a question of fact, the PCG goes ahead and sets out the situations when the Commissioner will consider that such notice has occurred.

For example, an LPR will be deemed to “have notice” of an amount that the deceased owed to the ATO at the date of their death if, for example, an income tax return had been lodged by the deceased person, but this had not been assessed at the time of the person’s death.

As an LPR is required to lodge all income tax returns that the deceased person has not already lodged, they will have notice of any liability arising from assessments relating to these returns. The LPR will also have notice of liabilities that may arise from reviews and audits.

An LPR will not have notice of any further tax claims relating to returns that have been lodged if:

• the LPR acted reasonably in lodging all of the deceased person’s outstanding returns; and
• the Commissioner has not given the LPR notice that it intends to examine the deceased person’s taxation affairs within six months from the lodgement of the last of the outstanding return by the LPR.

The LPR may become aware of a material irregularity in an income tax return lodged by the deceased. The Commissioner will treat the LPR as not having notice of any tax relating to that irregularity if the LPR brings it to the attention of the Commissioner in writing and the Commissioner does not, within six months, issue an amended assessment or indicate that the ATO intends to review the matter.

The PCG also states that if further assets come in after what is thought to be the completion of the estate’s administration, the LPR will be treated as having notice of a claim to the extent there are taxes on those further assets.

To explain and illustrate further, the PCG offers the following examples:

Example 1 – straightforward small estate

Alfred died on 1 June 2017. Bill was appointed executor of Alfred’s will. He obtained probate in July 2017. Alfred’s estate consists of his main residence, shares in publicly listed companies and money in a bank account. The collective value of the estate is less than $1 million. Up until his death, Alfred had been receiving a pension. Alfred had advised the ATO in 2012 that he was not required to lodge further returns.

Based on all of the information available to him, Bill determines that no return is necessary for the period from 1 July 2016 to 1 June 2017. Bill lodged a Return Not Necessary (RNN) advice with the ATO on 31 October 2017. If the ATO did not notify Bill that it intended to review Alfred’s tax affairs by 30 April 2018 (six months from the time Bill lodged his RNN advice), the ATO will treat Bill as not having notice of any claim relating to Alfred’s estate. Bill can distribute the estate to beneficiaries without risk of personal liability.

Example 2 – small estate – material tax irregularity identified by the LPR

Peter died on 12 December 2016. Jill was appointed executrix of his will. She obtained probate in January 2017.

In the course of discharging her duties as executrix, Jill confirmed with the ATO that Peter had lodged all of his income tax returns other than the returns for the 2015-16 year and the final period to Peter’s date of death.

In preparing those returns, Jill discovered that Peter had never returned rental income from a property that he had owned in Sydney since 2010. Jill included rental income from that property in the returns for the 2016 income year ($20,000) and the period to Peter’s date of death ($10,000). She lodged both returns on 3 March 2017. Jill did not seek to amend any of Peter’s earlier year assessments or otherwise bring the irregularities to the ATO’s attention.

On 4 April 2017, the ATO issued notices of assessment relating to the returns that Jill had lodged. Jill paid those assessments out of the estate’s assets.

On 1 July 2017, Jill published a Notice of Intended Distribution (under state succession laws) for claims to be made within 30 days. On 4 August 2017, Jill distributed the remaining assets of the estate.

On 20 October 2017, the ATO wrote to Jill advising that Peter’s assessments for the 2014 and 2015 years were being reviewed because of the non-reporting of rental income.

Jill had become aware of a material irregularity for those income years because she had discovered that Peter had not included rental income in his returns. Jill will be personally liable for any outstanding tax liabilities resulting from the amendment of Peter’s 2014 and 2015 income tax assessments. Jill cannot avoid liability on the basis that she had no notice of it.

If Jill had brought the prior year irregularities to the ATO’s attention when she lodged the outstanding returns, Jill would not be personally liable because the ATO did not advise her within six months that it was intending to review the assessments.

Limitations
Note that this ATO guideline only applies where, in the four years before the person’s death, the deceased:

• did not carry on a business;
• was not assessable on a share of the net income of a discretionary trust; and
• was not a member of an SMSF.

For this guideline to apply, the estate assets can consist only of:

• public company shares or other interests in widely-held entities;
• death benefit superannuation;
• Australian real property; and
• cash and personal assets such as cars and jewellery.

Finally, the total market value of the estate assets at the date of death must have been less than $5 million and none of the estate assets are intended to pass to a foreign resident, a tax-exempt entity or a complying superannuation entity.

Main residence CGT exemption about to slip through foreign owners’ fingers

As most readers will know, prior to 1985 Australia had no general tax on capital gains. But after the capital gains tax (CGT) regime was introduced in that year (September 19 specifically), the main residence exemption has been a feature ever since.

While there have been a number of changes and clarifications to the specifics of the exemption, the high-level principle has largely remained the same—namely that a dwelling used as a principal place of residence is ignored for CGT purposes.

But a measure was announced in the 2017-18 Federal Budget that will make a significant change to the CGT regime. The government announced that foreign residents will no longer be entitled to claim the exemption when they sell a property in Australia (this change however is not yet law at the time of writing, and is subject to the usual parliamentary processes).

If or when passed, the change will apply to foreign owners of property as follows:

• for property held before 7:30pm (AEST) on 9 May 2017, the exemption will only be able to be claimed for disposals that happen up until 30 June 2019 and only if they meet the requirements for the exemption. For disposals that happen from 1 July 2019 they will no longer be entitled to the exemption
• for property acquired at or after 7:30pm (AEST) 9 May 2017, the exemption will no longer apply to disposals from that date.

This change will only apply if you are not an Australian resident at the time of the disposal (contract date).

The government’s intent on introducing this measure, as stated in Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018, was to “… stop foreign tax residents from claiming the main residence capital gains tax (CGT) exemption when they sell property in Australia from Budget night 2017,” then Treasurer Scott Morrison said. “Foreign tax residents who hold property on Budget night can continue to claim the exemption until 30 June 2019. The legislation will also modify the CGT principal asset test to apply on an associate inclusive basis. This will ensure that foreign tax residents cannot avoid a CGT liability by disaggregating indirect interests in Australian real property.”

Administratively, the ATO has stated that it will accept tax returns as lodged during the period up until the proposed law change is passed by parliament. It has also committed to not reviewing past year assessments until the outcome of the proposed amendment is known.

No tax shortfall penalties will be applied and any interest accrued will be remitted to the base interest rate up to the date of enactment of the law change. In addition, any interest in excess of the base rate accruing after the date of enactment will be remitted where taxpayers actively seek to amend assessments within a reasonable timeframe after enactment.

Possible implications
A number of outcomes have been flagged since the measure was announced and subsequently digested. Among them is the possibility that an Australian residing overseas may inadvertently overstay and be therefore deemed to be a foreign resident for tax purposes. They would therefore find that a quite significant tax obligation accrues from the sale of their main Australian residence.

Also there is a possible implication with the interaction of the absence rule, with foreign residents potentially being put in a position of no longer having access. However previous Australian residents who resume residency will hopefully have access to the absence rule even over the time they were not residents. If you have a client in this position, applying for an ATO ruling may be prudent.

Another implication is that employees offered an extended offshore assignment by their employer may need to consider if their tax obligations may be negatively affected by the new rules. Either their main residence may need to be sold before they become non-residents for tax purposes, or the sale may need to be delayed until they return (assuming the absence rule, mentioned above, will still have relevance). Indeed the subsequent tax position may be an important factor in their decision to take up the offer of an offshore assignment or not.

Another outcome in the above situation could involve cost reimbursement implications for an employer, should an employee find themselves with greatly increased tax obligations brought about by selling a property while assigned overseas.