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Medicare Levy Surcharge The Tax Laws Amendment (Medicare Levy Surcharge Thresholds) Bill (No. 2) 2008 received Royal Assent on 31 October 2008. The Bill, after the Senate’s amendments, increased the Medicare levy surcharge threshold:
Note that the individual threshold and the family threshold initially proposed in the Bill were $75,000 and $150,000 respectively. The Medicare levy surcharge thresholds applicable from 1 July 2008 are as follows:
Transitional provision A transitional provision operates to ensure that an individual (including his or her dependants) is taken to be covered by private hospital policy for the period 1 July 2008 to 31 December 2008 if:
If the transitional provision applies, the individual will avoid the levy surcharge for that period. Date of effect The increase to the Medicare levy surcharge thresholds applies from 1 July 2008. Lifetime health cover Professional advisers and their clients should consider the potential loading for private hospital policy under the Lifetime Health Cover (LHC) prior to terminating a policy. Broadly, the LHC provisions penalise individuals who take out private hospital cover later in their life. Under the provisions, if an individual does not have private hospital cover on the 1st of July following his or her 31st birthday, the individual will pay a 2% LHC loading on top of his or her private health insurance premiums for each year he or she remains without cover. However, the LHC loading does not apply to people who were born on or before 1 July 1934. Note that special rules apply to certain groups of people including:
The LHC loading will only be removed after an individual has held an appropriate private hospital cover for a continuous period of 10 years. Deductibility of Legal Expenses In a majority decision (4:1) handed down on 12 November 2008, the High Court upheld the Full Federal Court’s decision that legal expenses incurred by a taxpayer were deductible. In doing so, the Court rejected the Commissioner’s contention that the expenses were incurred in defending charges extraneous to the performance of the taxpayer’s income producing activities and therefore did not satisfy the requirements of subsection 8–1(1)(a) of ITAA 1997. Background The taxpayer was a former customs officer. He incurred legal expenses in defending charges made against him under the now repealed Public Service Act 1922, which alleged that he engaged in improper conduct as an officer and failed to fulfil his duty as an officer. The first charge related to the activities of the taxpayer in attempting to secure information regarding the issue of a search warrant over his property and that of another person. The second charge related to inaccurate recording of attendance records in connection with his employment. The inquiry officer for the charges found the charges to be proven and directed that $400 be deducted from the taxpayer’s salary. The taxpayer appealed to the Disciplinary Appeal Committee and was unsuccessful. In the process of his appeal, the taxpayer incurred $220 of legal expenses. The third charge related to the taxpayer failing to fulfil his duty as an officer which arose as a result of a joint criminal investigation between the Australian Federal Police and the Internal Affairs Unit of Customs. The investigation involved phone taps of the taxpayer’s private and work phones. The taxpayer commenced legal action on the basis that the telephone interceptions were unlawful, which was eventually dismissed by the High Court. The taxpayer had incurred legal expenses over two income years (2001/02 and 2002/03) relating to the third charge. The case was first heard by the Federal Court as an appeal against a decision by the Commissioner on an objection by the taxpayer against an assessment to tax for the year ended 30 June 2002. The Federal Court held that the legal expenses incurred by the taxpayer in defending the charges were partially deductible under section 8–1 of ITAA 1997. The taxpayer was denied a deduction for legal expenses relating to the first charge because he was not able to prove that a nexus existed between the expenses and in carrying out his duties as a customs officer. The taxpayer was allowed a deduction for legal expenses relating to the second charge because the Court held that it was incurred by the taxpayer in carrying out his duties. For legal expenses incurred in defending the third charge, the Court found that an insufficient nexus existed between the expenses and the carrying out of the taxpayer’s duties. However, the Court held that the Commissioner was estopped from denying a deduction for those expenses on the basis of an order of the Federal Court in December 2003 that legal expenses incurred in the 2001/02 tax year in relation to the third charge were deductible. Since the legal expenses incurred in the 2002/03 tax year related to the same matter, the Court held that the Commissioner was estopped from arguing that these legal expenses were not allowed. As a consequence of the Federal Court’s decisions, the Commissioner appealed against the application of issue estoppel in respect of the legal expenses with the third charges to the Full Federal Court. The taxpayer cross-appealed against the finding that the legal expenses in association with the first and third charges were not deductible. Only the first and third charges were subjected to the Full Court hearing. Further, the Commissioner did not press the appeal in relation to the legal expenses, which related to the second charge. The Full Court found that the Federal Court had erred in holding that the Commissioner was estopped concerning the deductibility of the legal expenses regarding the third charge. This was because neither deductibility of the legal expenses incurred in the 2002 year, nor their connection with the gaining or producing of assessable income, was discussed in the Federal Court order in December 2003. Therefore, there was no estoppel in relation to the issues raised in the current proceeding. It ordered that the Commissioner’s appeal and the taxpayer’s cross-appeal be allowed. Following the Full Federal Court’s decision, the Commissioner appealed to the High Court. In particular, the focus of the appeal was the requirement for deductibility of expenses in subsection 8–1(1)(a) of ITAA 1997. Decision In reaching its decision, the Court referred to judgments handed down in cases relating to the deductibility of expenses. These cases included FCT v. Payne (2001) 46 ATR 228, Amalgamated Zinc (De Bavay’s) Ltd v. FCT (1935) 54 CLR 296 and FCT v. Cooper (1991) 21 ATR 1616. The Court considered the expression ‘in the course of’ as contained in subsection 8–1(1)(a). It was of the view that the expression did not require a direct connection between an expenditure and the activity which produced the assessable income. Rather, the requisite connection could be direct or indirect, provided the connection was not too remote. The Court also considered the expression ‘incidental and relevant’ which was stated in subsection 8–1(1)(a). It said that the expression should not be thought to add more to the meaning of the section or to narrow its operation. It proceeded to say that the expression ‘should be taken to describe an attribute of an expenditure in a particular case, rather than being an exhaustive test for ascertaining the limits of the operation of the provision’. It further said that due to the language and breadth of subsection 8–1(1)(a), a formula capable of application to the circumstances of each case would be difficult. It noted that while previous judgments were helpful, the judgments might not always explain how the search for a requisite connection was to be undertaken. The Court stated that the deductibility of the expense incurred by the taxpayer depended on the determination of what was the productive of assessable income, which might take into account the positive and negative duties to be performed or observed by the taxpayer. It also stated that the deductibility also depended upon the employment and the duties imposed on the taxpayer which arose from his occupation. The Court noted that the Public Service Act imposed an obligation to observe standards of conduct, breach of which might entail disciplinary charges. Therefore, it found that a nexus existed between the legal expenses incurred by the taxpayer and the deriving of his assessable income. In conclusion, it held that the legal expenses were allowable deductions. It also concluded that the expenses cannot be view as private or domestic in nature. GST and Cancellation Fees The Tax Office has released Draft GST Ruling GSTR 2008/D4 in which it states the Commissioner’s preliminary view on GST consequences resulting from payments made when an arrangement under which a particular supply was intended to be made does not proceed or does not proceed in the manner originally contemplated. The Draft refers to these payments as ‘cancellation fees’. The Draft focuses on arrangements that are cancelled by a ‘customer’. It also focuses on cancellations made by a supplier in relation to a ticketed arrangement for the supply of performances, events or similar arrangements. In particular, it examines whether a cancellation fee relates to the provision of a ‘supply’ and whether consideration is provided for the supply. The Draft states that supply can be for consideration if the consideration is in connection with the supply. Further, it states that the supply will be a taxable supply if the requirements of section 9–5 of A New Tax System (Goods and Services Tax) Act 1999 (the GST Act) are satisfied. However, it notes that the GST characteristic of the supply is not necessarily determined by the GST status of the intended supply. According to the Draft, a supply to be provided for the cancellation fee can be either the intended supply or a different supply (e.g. a release supply or a facilitation supply). Cancellation fees for an intended supply The Draft states that any payment for an intended supply remains consideration for that supply. It also states that a cancellation fee is consideration for the intended supply if it represents payment for work done by a supplier in making the intended supply. Cancellation fees for a different supply Generally, the Draft notes that where the cancellation fees relate to a different supply, the fee may be consideration for that different supply. It also notes that a cancellation fee paid for a release supply may not be consideration for the supply if the fee has a sufficient nexus with an earlier supply. Damages, penalties or compensation The Commissioner states that the determination of whether an amount payable is consideration for a supply does not depend on its classification (i.e. damages, penalties or compensation). Rather, he states that all relevant factors surrounding the amount must be taken into account before making a determination. Ex gratia payments It is the Commissioner’s view that if a customer makes an ex gratia payment, the payment does not constitute consideration for a supply as there is no connection between the ex gratia payment and any supply. Security deposits The Draft states that if a security deposit is forfeited under a clause of a contract, the deposit is treated as consideration for a supply under Division 99 of the GST Act. It also considers the High Court’s decision in Reliance Carpet v. FCT [2008] HCA 22. While the Commissioner notes that the decision was made in the context of a contract for the sale of land, he considers the decision to be applicable to situations where a security deposit is forfeited under a cancellation clause provided for in a contract. Examples The Draft contains examples to demonstrate the application of the principles to common factual situations involving cancellation fees. These situations include:
Date of effect When finalised, the Ruling will apply to all GST tax periods. Refunds, payments and credits for indirect taxes The Tax Office has also released Draft Miscellaneous Taxation Ruling MT 2008/D4 in which it sets out the Commissioner’s views on what constitutes ‘notification’ by an entity to the Commissioner under section 105–55 of Schedule 1 to Taxation Administration Act 1953. Section 105–55 provides a four-year time limit for entitlements to refunds, other payments or credits in relation to GST, luxury car tax, wine tax and fuel tax in respect of a tax period or importation. However, the four year time limit does not apply if within the required period:
The Draft states that there is no specific form which is required for a notification for the purposes of section 105–55. However, the notification must be in writing. It further states that the following constitutes valid notification for the purposes of section 105–55:
Furthermore, the notification need not quantify the amount of the entitlement, provided that the entitlement is clearly identified However, the Draft provides that correspondence will not meet the notification requirements if it is speculative in nature, in the sense that it is directed at reserving an entity’s rights in relation to possible future claim(s), rather than being directed at one or more particular entitlements. Nevertheless, if the entity subsequently provides further information it may then be sufficient to meet the requirements of a valid notification, but the notification will only be valid from the date the further information is received. Requirements for a valid notice For a notification to be valid, the Draft states that the notification must:
The Draft also states that the absence of a specific amount to which an entity is entitled will not invalid a notification, provided all other requirements are satisfied. It further states that the notification may be lodged on behalf of more than one entity, provided the person lodging the notification has the authority to act on behalf of those entities. However, the notification must explain how the relevant entitlement relates to each entity. Date of effect When finalised, the Ruling will apply to all tax periods. Allowances and Foreign Earnings In ATO ID 2008/143, the Tax Office discusses whether allowances received by an Australian resident taxpayer to cover various expenses related to their employment in a foreign country are assessable income under subsection 6–5(2) of ITAA 1936. The ID says the part of the allowances received by the Australian resident taxpayer in respect of expenses that are attributable to the period that the taxpayer is engaged in foreign service is not assessable under subsection 6–5(2). It is exempt under subsection 23AG(1) of ITAA 1936 as it is foreign earnings derived from foreign service. However, the ID says the part of the allowances received by the taxpayer in respect of expenses that are attributable to a period prior to the commencement or after the completion of the foreign service, is not exempt from tax under subsection 23AG(1) as it is not derived from foreign service. Foreign earnings Foreign earnings derived by an Australian resident taxpayer engaged in service in a foreign country for a continuous period of not fewer than 91 days are exempted from Australian tax under section 23AG, subject to certain exceptions. The term ‘foreign earnings’ is defined in subsection 23AG(7) to mean income consisting of earnings, salary, wages, commission, bonuses or allowances. Foreign earnings also include amounts assessable under the employee share scheme provisions in Division 13A of ITAA 1936 in relation to employee shares and rights acquired on or after 26 June 2005 and employee shares and rights acquired at any time (including before 26 June 2005) by a person who does not become an Australian employee (i.e. employed in Australia) until that or a later day (in such a case, these provisions apply from the date the person becomes an Australian employee). However, the following amounts are specifically excluded from the definition of foreign earnings:
In the ID, the Tax Office referred to the Federal Court’s decision in Chaudhri v. FCT (2001) 47 ATR 126. According to the ID, ‘the foreign earnings need [not] to be received at the time of engaging in a period of foreign service’. It is the Tax Office’s view that the ‘important test is that the foreign earnings need to be attributable to that period of service in a foreign country rather than to a period before or after the period of foreign service’. It is important to note that subsection 23AG(7) defines ‘foreign service’ to mean service in a foreign country. Therefore, an individual’s foreign service period generally cannot begin or end at a time when the taxpayer is not actually in the foreign country where the service will be performed. However, the ID notes that the mere presence of a taxpayer in the foreign country does not mean that the taxpayer is engaged in foreign service. As such, whether the foreign earnings derived will depend on the terms of the taxpayer’s employment. Abolishing Trust Cloning In a media release dated 31 October 2008, the Assistant Treasurer, Chris Bowen, announced that the Government will remove one of the capital gains tax (CGT) exceptions to CGT events E1 and E2. According to the media release, the Government will abolish the ‘trust cloning’ exception. This exception provides a CGT exemption for capital gains arising from a change in ownership of an asset that typically occurs on the creation of a trust over a CGT asset (CGT event E1) and on transferring a CGT asset to an existing trust (CGT event E2). However, the other exception to CGT events E1 and E2 will be retained (see below). The media release stated that the amendments will resolve uncertainty surrounding the application of the exception. It also stated that the amendments will remove the possibility of using the trust cloning exception to eliminate tax liabilities on accrued capital gains. The Assistant Treasurer said legislation giving effect to this measure will be introduced as soon as practicable. He also said that the amendments will apply to CGT events happening after 31 October 2008. The Government is currently inviting interested parties to comment on the policy design of the proposed amendments and subsequently on an exposure draft of the legislation. Trust cloning – CGT events E1 and E2 CGT event E1 — creating trust over asset CGT event E2 deals with transferring a CGT asset to a trust. The event happens if a taxpayer transfers a CGT asset to an existing trust: subsection 104–60(1) of ITAA 1997. Subsection 104–60(5) provides two exceptions to CGT event E2:
In addition, subsection 104–60(6) provides that a capital gain or capital loss is disregarded for trusts created over assets acquired before 20 September 1985. Trust cloning The two common reasons that the practice of trust cloning is used are:
For the trust cloning exception to apply, strict requirements must be satisfied. In Taxation Ruling TR 2006/4, the Tax Office states that the beneficiaries and terms of the original trust and the new trust must be the same for the exception to apply. It also states that these requirements must be met at the time the asset is transferred. Broadly, the following terms of the original trust and the net trust must be the same:
However, it is not necessary for the following to be the same:
It is important to note that the requirements for the exceptions to apply must be adhered. However, practical difficulties often arise, in particular when cloning discretionary trusts whether the original trust and the new trust are the same. While the proposed amendments will apply from 1 November 2008, the Government has not announced any transitional provisions. In addition, the Government has yet to release an exposure draft of the legislation. Therefore, professional advisers and their clients face a degree of uncertainty regarding trust cloning. |