A number of recent Full Federal Court decisions have exposed a number of weaknesses in the ‘tax benefit’ concept of Part IVA of the Income Tax Assessment Act 1936 (‘ITAA 1936′). Part IVA contains the general anti-avoidance rules which aim to counter tax avoidance arrangements. The exposure of weaknesses in the legislation have raised concern about the reduced effectiveness of the provisions in combating tax avoidance arrangements. As such, the Federal Government has introduced a number of reforms to Part IVA as part of the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013. The Government has estimated that the reforms will prevent a loss of $1 billion in revenue each year.
- Part IVA was enacted in 1981 to be an effective measure against tax avoidance measures which are “blatant, artificial or contrived” (Explanatory Memorandum. Income Tax Laws Amendment Bill (No 2) 1981).
- Upon its introduction, it was emphasised that Part IVA was not intended to unecessarily inhibit the normal commercial transactions by which taxpayers legitimately taking advantage of opportunities available for the arrangement of their affairs. As such, a clear distinction was drawn between tax avoidance and legitimate commerciala and family arrangements.
- Amend the general anti-avoidance rules in Part IVA of ITAA 1936 (i.e. to counter arrangements that when viewed objectively, are carried out with the sole and dominant purpose of securing a tax advantage for a taxpayer).
- In particular, the amendments aim to enhance the way that s 177C interacts with s 177D of the ITAA 1936.
Rationale for reform:
- To clearly define the two alternative limbs for determining whether a person has obtained a tax benefit from a scheme
- To ensure that the first limb (i.e. what “would have” happened but for the scheme) is determined based solely on the events and circumstances that actually happened or existed, other than those things that formed part of the scheme itself.
- To ensure that the second limb (i.e. what “might reasonably be expected” to have happened but for the scheme) is determined on the basis of an alternative that is reasonable, having particular regard to the substance of the scheme and its effect for the taxpayer but, importantly, disregarding any income tax costs of that alternative
- To emphasise the “dominant purpose” element of Part IVA
Proposed new laws
- The first three rationales are achieved under new section 177CB (which clarifies s 177C from the Exposure Draft and addresses discrepancies between the Exposure Draft and its Explanatory Memorandum)
- To address the fourth rationale, Part IVA has been amended to require a single inquiry of whether the person participated in the scheme for the sole or dominant purpose of securing a particular tax benefit. This change is reflected in sections 177D and 177F(1) of the Bill.
- Note that it has been suggested that this method may not be practically feasible, considering that the inquiry consists of three definite and separately defined limbs.
- Under the proposed new section 177CB the Commissioner of Taxation will essentially have two alternative bases with which to approach transactions entered into by taxpayers:Annihilation approach (subsection 177CB(2))
- Generally used when the scheme in question does not produce any material non-tax results for the taxpayer.
- A decision that a tax effect ‘would have ‘occurred if the scheme had not been entered into or carried out must be made solely on the basis of a postulate comprising all of the events or circumstances that actually happened or existed, other than those that form part of the scheme.
- When determining what would have occurred in the absence of the scheme, the scheme must be assumed not to have happened (i.e. annihilated/deleted).
Reconstruction approach (subsection 177CB(3) and (4))
- Used when the annihilation approach is unsuccessful (i.e. where annihilating the scheme would be inconsistent with the non-tax results and consequences sought for the taxpayer by the participants in the scheme).
- E.g. an income scheme or withholding tax scheme which produces and shelters economic gains.
- Also could be useful where the resulting tax advantage from the scheme is: a deduction benefit, a capital loss benefit, a foreign tax offset benefit or withholding tax benefit (s 177CB(1)(b)-(e)).
- A decision that a tax effect ‘might reasonably be expected to have’ occurred if a scheme had not been entered into or carried out must be made on the basis of a postulate that is a reasonable alternative to the scheme.
- Note that if the scheme is part of a broader transaction, the alternative postulate would be considered reasonable if it performed the same role as part of the broader transaction as the scheme itself did. However if the scheme is integral to the broader transaction, it would be more appropriate for the alternative postulate to involve a reconstruction of the transaction itself.
- Limitations in determining whether a postulate is reasonable (s 177CB(4)):
- Firstly, regard must be had to the substance of the scheme and any result/consequence for the taxpayer that is or would be achieved by the scheme (these are the same matters which must be considered under s 177D)
- Secondly, the tax outcomes of the alternative must be disregarded such that it’s not possible to argue that the alternative would be unreasonable on the grounds that the tax costs associated with it were too high
Under both approaches a taxpayer will be deemed to have obtained a tax benefit in connection with a scheme if it can be demonstrated that a relevant tax effect would have flowed from the application of the taxation law to the facts remaining once the scheme is assumed away (annihilation approach), or to the alternative postulate (reconstruction approach)
If passed, the legislation will apply to schemes that commenced to be carried out on or after 16 November 2012.
Below is a summary of tax ruling TR 2013/2, which was recently released by the Commissioner of Taxation.
TR 2013/2 concerns the way in which s 30-15 and Item 2.1.10 of the table in sub-s 30/25(1) of the Income Tax Assessment Act 1997 (‘ITAA 1997’) apply to persons who make a gift or contribution to a public fund which purports to be a school building or fund.
The relevant issues discussed in this tax ruling are as follows:
- What is a ‘school or college’ for the purposes of Item 2.1.10?
- Whether a building is ‘used as a school or college’ by an entity specified in Item 2.1.10
- Whether a fund has been established and is being maintained solely for providing money for the acquisition, construction or maintenance of a building used a school or college
A gift or contribution to a school building fund is deductible under section 30-15 if:
- the gift is money or property of the kind covered by column 2 of item 1 of the table in subsection 30-15(1);
- the value of the gift is $2 or more;
- the fund is in Australia;
- if the property is to be valued by the Commissioner – the requirements in section 30-212 are satisfied;
- the fund, the entity that legally owns the fund, or the government body constituted by the persons who control the fund, is endorsed under Subdivision 30-BA; and
- the fund satisfies the requirements of Item 2.1.10 of the table in subsection 30-25(1).
The key requirements of Item 2.1.10 considered in this Ruling are as follows:
- there must be a school;
- there must be a building;
- the building must be used as a school;
- the building must be used as a school by a qualifying body;
- there must be acquisition, construction or maintenance; and
- the fund must be established and maintained for the requisite purpose.
Issue #1: What is a school or college for the purposes of Item 2.1.10?
For the purposes of Item 2.1.10, the word ‘school’ is taken to have its ordinary meaning. That is, it must be both a place of assembly and an educational organisation.
Place of assembly
As per the definition of ‘school’ in Item 2.1.10. there must be one or more buildings where people come together in order to be instructed in an area of knowledge.
In order to satisfy the definition of ‘school’ in Item 2.1.10, there must also be an educational organisation which:
- has a distinct identity; and
- provides regular, ongoing and systematic instruction in a course of non-recreational education
Distinct identity encompasses the following characteristics when pertaining to an educational organisation:
- is established for the promotion, pursuit and achievement of one of more defined purposes;
- has a quality of permanence; and
- has a governing body which controls its affairs
Regular, ongoing and systematic instruction in a course of non-recreational education is indicated by the presence of the following:
- a set curriculum;
- instruction or training provided by suitably qualified persons;
- the enrolment of students;
- some form of assessment and correction; and
- the creation of a qualification or status which is recognised outside of the organisation
Issue #2: Whether a building is ‘used as a school or college’ by an entity specified in Item 2.1.10
For the purposes of Item 2.1.10, the word ‘building’ carries its ordinary meaning. That is, a building is defined as a permanent structure, roofed and usually with walls and flooring (though not necessarily), that provides protection from the elements. The structure must be fixed to the ground and have a roof.
A building is also said to include fixtures which become a permanent addition to the building, for the purposes of Item 2.1.10.
A building is ‘used as a school’ for the purposes of Item 2.1.10 where:
- it is used to provide instruction (as described in paragraphs 5-9)
- the extent and character of that use is such that the building can be described as ‘used as a school’ as a matter of ordinary language.
A building is also considered to be ‘used as a school’ for the purposes of Item 2.1.10 where its use is incidental to provisions of instruction in ‘a building’ as described above (see below).
Other factors which are relevant to determining whether a building is used as a school include:
- the amount of time the building is put to school use relative to the amount of time it is put to non-school use;
- the number of people involved in the school use of the building relative to the number involved in its non-school use;
- the physical area of the building put to school use relative to the physical area put to non-school use; and
- the extent to which the building has been adapted or modified in order to accommodate its school or non-school use.
In order for a building to be a school building, its school use must be substantial. This is determined on an objective basis, having regard to all of the surrounding circumstances.
Where a qualifying body carries on a school organisation and also acts in one or more other capacities (for example as a church), it is necessary to have regard to the extent to which the school organisation is able to control the use of the building. While regard must also be had to the actual use of the building, the inability of the school organisation to control the use of the building is an indication that the building is not used as a school.
A building which is not used to provide instruction of the kind above, is also used or to be used as a school where:
- its actual or intended use is incidental to the provision of instruction in one or more school buildings; and
- it can be regarded as being ‘used as a school’ as a matter of ordinary language when considered in conjunction with those buildings
A building is not a school building where its non-school use prevents it from being regarded as being used as a school as a matter of ordinary language.
The building must be used as a school by a qualifying body
This means that the use of the building as a school must be by a government, a public authority, or a society or association which is carried on otherwise than for the purposes of profit or gain to its members.
In order for a qualifying body to use a building as a school the body must:
- carry on the school as an organisation;
- control the use of the building; and
- use the building in the provision of instruction of the kind described in paragraphs 5 to 9.
Issue #3: Whether a fund has been established and is being maintained solely for providing money for the acquisition, construction or maintenance of a building used a school or college
There must be acquisition, construction or maintenance.
In order for Item 2.1.10 to apply an entity must acquire, construct or maintain a building or have an objective intention to do so. For present purposes, the following definitions apply:
- an entity obtains ownership of a legal or equitable interest in a building (including a leasehold interest); and
- that interest is sufficient to enable the entity to control the building’s use.
- Constructed: Where the building is formed or put together. However, an entity must obtain a legal or equitable interest in the building which is sufficient to enable it to control the building’s use.
- Maintained: where action is taken to keep the building in proper or good condition.
Fund must be established and maintained for the requisite purpose – the ‘sole purpose test’
The sole purpose test requires a school building fund to be established and maintained solely to provide money for the acquisition, construction or maintenance of a building used as a school by a qualifying body.
A fund will not satisfy the sole purpose test if it is established or maintained for the purpose of, or for purposes which include, providing money to acquire, construct, or maintain a building:
- that is not used or objectively intended to be used as a school to any extent; or
- that is not used or objectively intended to be used by a qualifying body.
In short, this means a school building fund cannot provide money in respect of acquisition or construction which relates to the building’s non-school use.
The purposes of the fund are determined on an objective basis, having regard to all of the surrounding circumstances – including the constituent documents of the fund and what money is actually provided for. Hence, if the constituent documents indicate that a fund has a purpose other than to provide money for the acquisition, construction or maintenance of a school building for school use, the fund will fail to satisfy the sole purpose test.
Other relevant issues
Where the relevant endorsed entity is not the gift deductible school building fund itself, it must maintain a separate gift fund for donations and contributions to the school building fund.
Payments into a school building fund
A school building fund can only include amounts which are objectively intended to enable or facilitate the provision of money for the acquisition, construction or maintenance of a school building for the purposes of its school use.
Disbursements from a school building fund
A school building fund can only disburse money for the objective purpose of the acquisition, construction or maintenance of a school building for the purposes of its school use.
Please refer to pp. 15-24 of tax ruling TR 2013/2 for examples of the application of the Commissioner’s ruling.
Date of Effect
This Ruling applies to years of income commencing both before and after its date of issue (13 February 2013), though not to the extent that it will conflict with the terms of a settlement of a dispute agreed to before the date of issue of the Ruling.
The test in paragraph 14 of Taxation Ruling TR 96/8 has not been adopted in this Ruling except as follows.
As a result of the test in TR 96/8 no longer applying, where a fund has committed to acquisition or construction arrangements prior to 13 February 2013, they will not be subject to the new ruling. Funds and persons who make gift or contribution to a fund are permitted to apply paragraph 14 of TR 96/8 for the purposes of characterising he provision of money by a fund to maintain a building before 1 July 2013.
I have now incorporated my practice – the new name is PG Gell Legal Services Pty Ltd trading as PGG Legal – and have moved offices to suite 1202, level 12, 83 Mount St North Sydney. PG Gell Legal Services Pty Ltd now has 3 lawyers practising in the areas of taxation advisory, corporate structuring, property and estate planning. The new offices are located in a spacious modern building located close to North Sydney railway station. We look forward to meeting you here!!