Majority rules to make over tax laws in 2005

As the 2005 financial year draws to a close, it is timely to consider the new and proposed changes to tax law that will affect taxpayers this year and in future years.

Many of the noteworthy changes will affect how taxpayers treat and administer their investments.

Perhaps the major tax issue for employers and employees in the next few months is superannuation fund choice, a change that is already receiving plenty of attention.

However, there are at least five less publicised issues that also demand scrutiny.

Senate majority

As a result of the October 2004 federal election, the Government will have a majority in the Senate from July 1, 2005. This means that many proposed changes that have previously been rejected or delayed in the Senate may now be passed.

In particular, there are two tax measures that may come under review.

First, the Government may decide to examine the superannuation surcharge. This is an additional tax on superannuation contributions made on behalf of high-income earners. It applies at a rate of up to 12.5 per cent for the 2005 year — reducing to 10 per cent for the 2006 year.

The Government previously attempted to significantly reduce the rate at which the superannuation surcharge applied. The staged reduction in rates to 10 per cent was achieved only after negotiations with minor parties in the Senate. It will be interesting to see whether the Government uses its majority to pass further reductions in the surcharge rate.

Next, the structure of the tax system, especially the taxation of trusts, may come under review. The Government has for some time been keen to review the entire structure of the taxation system, especially with respect to the perceived abuse by high wealth individuals of trust structures.

While proposals to deal with this perceived abuse have never been introduced into Federal Parliament, the Government’s majority in the upper house may make it reconsider some of these, such as the proposal to tax trusts as companies.

Private company loans

Since late 1997, loans made by a private company to shareholders in the company (or associates of the shareholders) have been subject to anti-avoidance provisions — referred to as the Division 7A rules.

These rules deem such loans to be dividends unless:

n the loan is repaid by the end of the financial year in which it was made; or n the loan was made under a written loan agreement that specified a minimum interest rate and maximum term (usually seven years). The loan agreement had to be signed before the money was advanced to the shareholder in order to take effect.

New legislation has been proposed that applies from the 2005 financial year that extends both of the exceptions listed above.

The proposed legislation allows a loan from a private company to be repaid, or put on a commercial footing, before the earlier of the due date for lodgement or the date of lodgement of the private company’s income tax return for the income year in which the loan is made.

This means that, in order to avoid a loan made during this financial year being treated as a deemed dividend, the repayment or documentation need not be in place by June 30, 2005.

At-call loans

Under the debt and equity rules, funds contributed to private companies as at-call loans (that is, loans without a fixed term), with no interest payable, are deemed to be equity (or shares) and not debt.

Most family-owned companies that carry on business are funded in this way by their shareholders and associated entities. In recognition of this, the Government has passed legislation to suspend the application of the debt and equity rules to at-call loans until July 1, 2005. After this date, at-call loans will be deemed to be equity, unless changes are made to their terms.

The Government is considering the possibility of granting an exemption from the debt and equity rules to small businesses from July 1, 2005. However, no draft legislation has been released yet.

The major problem for the makers of at-call loans, if their loans are deemed to be equity, is that upon any repayment of the loan principle, an analysis of the capital benefit anti-avoidance provisions needs to be undertaken. These provisions can deem such repayments to be dividends, where the company has undistributed profits — whether those profits are realised or unrealised.

Holders of at-call loans in companies should consider their position before June 30, 2005.

GST margin scheme

Because of the property boom, a large number of former property investors have become property developers. When calculating their goods and services tax (GST) liability on land developments, these people very often use a method called the ‘margin scheme’.

Under this scheme, the developer only pays GST based upon the difference between what they sell the property for and (usually) what they purchased it for.

On March 17, 2005, the Government announced amendments to the margin scheme to overcome a number of perceived defects in its operation.

Most of the amendments (once passed) will apply to supplies made on or after March 17, 2005. The one exception to this is noted below. In the context of GST law, this means the new rules apply to any sale of property that settled on March 17, 2005, or later.

The most significant amendments to the margin scheme are as follows. First, in order for the margin scheme to apply, there must be a written agreement to that effect between the supplier and the acquirer. The written agreement must be entered into on or before the date of the supply (that is, usually settlement).

This amendment only applies to supplies made on or after the day that the bill receives Royal Assent. Because it is difficult to know when this will be, sellers of land who want to apply the margin scheme should implement written agreements with the purchasers under all outstanding contracts, as well as new contracts entered into.

Second, the calculation of the margin is varied from that applying under the current legislation where the land was acquired under a supply that was GST-free (because of the GST going concern exemption or the farm land exemption).

In these circumstances, the margin is calculated by reference to its value on July 1, 2000, and not its cost, regardless of the number of intervening sales since July 1, 2000. This will significantly increase the amount of GST that developers in this situation have to remit.

Property developers who are registered for GST need to review their outstanding contracts immediately.

Self-assessment review

Looking further into the future, a significant change could be made to the administration of the Australian tax system.

Currently, a ‘self assessment’ regime applies. Under this system, taxpayers are responsible for reporting the correct amount of income and deductions in their tax return. The Australian Taxation Office (ATO) calculates how much tax is payable based on these figures. However, the ATO reserves the right to audit taxpayers to ensure that the figures were correct.

The Department of Treasury has recently completed a review of the self assessment system.

One of the most important recommendations to come out of that review will increase the number of individual taxpayers who qualify for a “shorter period of review”. In the case of these taxpayers, unless the ATO can prove tax fraud or tax evasion, it will only have two years to audit and amend their assessments, rather than the usual four years.

The 2005-06 tax year promises to provide interesting times for taxpayers.

Mark Molesworth is manager, tax consulting, at BDO Kendalls .