ATO’s Guide for taxpayers – Investigating tax-effective arrangements – How to work out if an arrangement is a tax avoidance scheme
ABOUT THIS GUIDE
Investigating tax-effective arrangements is a guide to help you recognise some of the common types of tax avoidance schemes so you can reject them and avoid the negative consequences associated with them.
You should read this guide if you are considering entering into a tax-effective arrangement that will affect your tax liability.
This guide:
• explains the difference between a tax-effective arrangement and a tax avoidance scheme
• gives examples of the most common types of tax avoidance schemes
• helps you identify a tax avoidance scheme and work out what to do if you are involved in one.
Throughout this guide you will find important notes (look for the and symbols) which will help you with key information.
You will also find ‘more information’ boxes (look for the symbol) which will show any further steps you may need to take or supplementary information you may need to refer to.
We often refer to taxpayer alerts. You can find these on our website at www.ato.gov.au by searching for ‘taxpayer alerts’.
| For more information about how to access our publications and services, see page 15. |
QUICK CHECKLIST
TAX-EFFECTIVE ARRANGEMENTS – WHAT TO CONSIDER
This checklist outlines the steps that can help you when considering a tax-effective arrangement. Each point is covered in more detail later in this guide. If you are still unsure, it is best to check with us.
♦ Always get independent advice from someone not associated with the arrangement.
If you are obtaining advice from a tax agent, check they are a registered tax agent. A list of registered tax agents is available from the Tax Practitioners Board by:
• visiting their website at www.tpb.gov.au
• phone on 1300 362 829
♦ Check that the salesperson selling the arrangement holds an Australian Financial services licence, issued by the Australian securities and Investments Commission (ASIC).
You can check licence details free with ASIC by:
• visiting their website at www.moneysmart.gov.au
• phoning their infoline on 1300 300 630.
♦ Make sure you are given a product disclosure statement (PDS) or a prospectus for the arrangement – this is required by law.
If you haven’t been provided with a current PDS or prospectus you should contact ASIC by:
• email to infoline@asic.gov.au
• phone on 1300 300 630
♦ Check with the ATO for more information.
Our taxpayer alerts provide warnings about some of the tax scheme arrangements you might be offered. You can check alerts on our website at www.ato.gov.au/taxplanning
Many tax-effective arrangements have an ATO product ruling. A product ruling provides you with legally binding assurance that the tax deductions set out in the ruling will be available provided the scheme is carried out as described in the product ruling. You can find out if the scheme has a ruling by contacting us on 1800 177 006 or speaking to an independent tax adviser.
You can also apply for a private ruling to cover your individual circumstances. Refer to Private Ruling Application form (NAT 13742) or phone us on 1300 720 092 to have one sent to you.
GETTING STARTED
BEFORE YOU COMMIT TO AN ARRANGEMENT
You’re entitled to minimise the amount of tax you pay through legal tax planning arrangements. However, under Australia’s self-assessment system the way your tax affairs are structured is your own responsibility. This is regardless of whether you use a tax agent to prepare your tax return. The claims you make are also your own responsibility, so when making decisions that will impact your tax liabilities, it’s important to get independent and impartial advice.
When we identify arrangements where the promised tax benefit isn’t available under the law, the arrangement is deemed to be a tax avoidance scheme. As a result, tax deductions for the arrangement are disallowed and participants face potential penalties.
Tax schemes aren’t limited to the ‘too good to be true’ type of arrangement. They can be more sophisticated than many people realise. Schemes can be complex arrangements that are offered to you by some advisers with claims the availability of tax benefits is confirmed by genuine experts.
HOW YOU CAN PROTECT YOURSELF FROM TAX AVOIDANCE SCHEMES
Before committing to a tax-effective arrangement, make sure you understand the arrangement and are certain that the promised tax benefits are available.
Independent advice
Before you get involved, it’s important to get independent advice from an adviser who has no connection with the seller or the arrangement. Don’t be misled by advisers who are recommended to you by someone involved with the arrangement.
Provider’s licence details
Anyone who offers financial products and advice must be one of the following:
♦ an Australian Financial services (AFS) licence holder
♦ a director or employee of an AFS licence holder
♦ an Authorised representative of an AFS licence holder.
If the person or entity offering you the arrangement doesn’t hold a valid licence issued by the Australian Securities and Investments Commission (ASIC), they could be operating illegally and you may not be protected if things go wrong.
| You can check licence details free of charge and find out more information by referring to the ASIC website at www.moneysmart.gov.au |
Product disclosure statement
A product disclosure statement (PDS) sets out important information about an arrangement. This includes details of fees and commissions, outlining the benefits and risks of the arrangement and other information to help you make an informed decision.
All potential retail investors must be given a PDS or prospectus when an arrangement is recommended or offered. This document must give enough information about the arrangement for you or your adviser to make an informed decision.
INFORMATION AVAILABLE FROM US
We have information available to help you make informed decisions.
Taxpayer Alerts
You can check our taxpayer alerts to see if the arrangement you are considering, or one with similar characteristics, is listed as having potential negative tax consequences. Alerts are early warnings to taxpayers either when we have concerns about particular arrangements that we believe are high-risk, or when we are in the process of assessing them. An alert provides the name of the arrangement and a brief description, highlighting the features we have concerns about.
If an alert hasn’t been issued for the type of arrangement you are considering, this doesn’t mean the arrangement is legitimate. You can apply for a private ruling to provide certainty of the tax consequences for your particular circumstances.
| For more information, refer to Taxpayer alerts at www.ato.gov.au |
Product rulings
When you’re considering a tax-effective arrangement you should check if a product ruling has been issued for it. If the arrangement is covered by a product ruling it provides you with certainty of the tax consequences, as long as the arrangement is implemented exactly as it has been outlined in the ruling.
It’s important to make sure the product ruling is valid. It must be current and also needs to apply to that particular arrangement, in that particular year. If there is a financing or loan element of the product you’re considering, then it should be described in the product ruling. You are not covered by product rulings for similar arrangements – the ruling must apply to the exact arrangement you are considering.
You should also check that the tax benefits the arrangement promises you are consistent with what is outlined in the product ruling otherwise they may not apply.
If the arrangement you’re considering doesn’t have a product ruling there is no certainty that the promised tax benefits are available. In this situation you could apply for a private ruling to cover your particular circumstances.
A product ruling is not a guarantee of the commercial or financial viability of the product.
| For more information, refer to The facts about product rulings available on our website at www.ato.gov.au |
Private rulings
A private ruling sets out our view about the way a tax law applies, or would apply, to you in your particular circumstances.
A private ruling relates only to you and your individual situation. It will provide you with certainty of the tax consequences of an arrangement as long as you provide us with all the facts and the circumstances do not change.
To obtain a private ruling you must complete an application form and forward it to us. You can use the Private Ruling Application form (NAT 13742) or call 1300 720 092 to have one sent to you.
Private ruling requests can be lodged via the Tax Agent Portal or the Business Portal, if you have access to them.
| For more information, refer to How to apply for a private ruling on our website at www.ato.gov.au |
RECOGNISING TAX AVOIDANCE SCHEMES
WHAT MAKES AN ARRANGEMENT A TAX SCHEME?
A tax scheme is an arrangement where the intention is to avoid or defer tax obligations. There are many different types of tax schemes and these vary from the mass-marketed arrangements that you might see advertised to the general public, to specialist financial arrangements offered directly to experienced investors.
Many of these arrangements use a series of complex transactions, moving funds through several entities such as trusts. The aim is to avoid or minimise tax which would otherwise be payable.
Schemes may also involve distorting the way funds are being used to incorrectly claim tax deductions or structuring arrangements to exploit concessional tax rates such as those applied to superannuation (super) funds. Some schemes even offer ways to release super funds early.
The person or entity behind a scheme is known as a promoter. A promoter is someone who has a vested interest in securing your involvement in the arrangement. Scheme promoters are generally quite active in marketing the arrangement, charge substantial fees and receive a payment, including commissions, from your investment.
WHAT TO LOOK OUT FOR
Some arrangements have characteristics that make them seem like an obvious tax scheme to experienced investors. However there are many less obvious features that can also indicate a potential illegal scheme.
Advice and documentation
You should be wary of arrangements that:
• offer zero-risk guarantees
• do not have a product disclosure statement or prospectus
• refer you to a particular adviser or expert who they claim has specific knowledge about the arrangement and the promised tax benefits
• ask you to maintain secrecy to protect the arrangement from rival firms and discourage you from obtaining independent advice.
Finance
Many tax schemes are promoted with mechanisms to help you finance your involvement. The following are examples of ‘red flags’ that should prompt you to investigate further before getting involved.
• ‘Round robin’ financing where the funds are passed through various entities and usually back to the initial entity. This may take the form of the entity offering the arrangement lending you the money to invest in their product.
• Non-recourse loans that you don’t have to repay if the investment goes bad.
• Complex financing arrangements involving limited recourse loans, where your liability is limited to your share in the investment.
• Investments that are primarily funded through tax deductions – for example, including substantial interest prepayments in a financial year.
Structure
The way an arrangement is structured can indicate whether it is a tax scheme. Arrangements with the following features should be carefully investigated.
• Deferring income so the tax is paid in a later period than it should be.
• Not declaring income or hiding income (for example, in an offshore location such as a tax haven).
• Changing the nature of the income so less tax is paid, for example changing capital expenses into revenue expenses.
• Changing private expenses into business expenses so they can be claimed against income.
• Creating an entitlement to a tax offset or credit which wouldn’t have otherwise been available.
• Arrangements that are set up for the sole purpose of obtaining tax benefits and have no underlying business purpose.
• Moving the income around to a trust or partnership for no other reason than to split the income amongst people in a lower tax bracket so less tax is paid.
• Inflating or artificially creating deductions.
• Moving taxable income to a tax exempt or lower tax rate entity, such as a charity, company or super account.
COMMON TYPES OF TAX SCHEMES MARKETED TO INDIVIDUALS
‘MORTGAGE MANAGEMENT’ PLANS
In this arrangement, a tax scheme promoter offers you a means of creating deductible interest payments, equivalent to your home loan interest payments, using the existing equity in your home to obtain additional loans for the purpose of claiming investment deductions.
This is achieved by re-financing your existing home loan through a financial institution. The amount financed under the new loan is made up of the outstanding balance on your previous home loan (Loan A) as well as additional funds, namely an interest only investment loan (Loan B). Both Loan A and Loan B are secured over your home (often to the maximum debt level that you could be lent to by a financial institution).
You make principal and interest repayments on Loan A and invest the amount of Loan B by purchasing shares in companies controlled by the promoter who in turn undertakes to pay the interest on Loan B on your behalf. The promoter also lends you additional funds (Loan C) to supplement your investment in promoter controlled companies. This loan is either non-recourse or recourse limited to the shares in the promoter controlled company. This means that you either do not have to repay the loan or your liability is otherwise limited to the shares you have purchased.
Generally, you do not derive any dividend income from the share investments and in all cases it appears you are unlikely to do so in the future. However you claim large deductions for the interest paid on Loan B and supposedly paid on Loan C.
This is a scheme because there is no real investment and the dominant purpose of the arrangement is to reduce your assessable income by claiming deductions you are not entitled to.
There are significant commercial risks if you enter into these types of arrangements. Shares in the promoter company may not deliver a reasonable return or be worth far less than you anticipate. The promoter may also cease making repayments on Loan B.
| For more information, refer to Taxpayer Alert TA 2009/20 – Interest deduction generators involving promoter controlled companies. |
Case study
In one arrangement, home owners were sold a ‘mortgage management’ plan that turned into a very expensive failure. Investors in the scheme were promised a way of paying off their mortgage faster by using the existing equity in their home to obtain additional loans for the purpose of claiming investment deductions, equivalent to their home loan interest payments.
As well as being falsely told the scheme had ATO approval, investors were asked to maintain confidentiality about the arrangement to protect it from rival firms and therefore discouraged from seeking independent advice.
The arrangement was revealed to be a tax avoidance scheme, as the sole purpose of the ‘investments’ was to claim tax deductions that would not otherwise be available. The company offering the arrangement was wound up and investors lost hundreds of thousands of dollars. Many are now faced with the possibility of having to sell their homes to pay money owed.
ILLEGAL EARLY RELEASE OF SUPER SCHEMES
In this arrangement, a promoter claims they can ‘unlock’ your super before you reach your retirement age.
The promoter arranges for you to roll over your super into a self-managed super fund (SMSF). This might sound tempting to anyone wanting to use the money for personal expenses such as a holiday or car.
The promoter withdraws the amount from the SMSF and pays it to you minus their fee. This is a scheme as it is illegal to release your super early, except in very limited circumstances.
Anyone entering this type of arrangement will not only lose money to the promoter for their fee, which in some instances has been as high as 30% of the super savings, but could also face prosecution and pay extra tax and penalties.
| For more information, refer to Taxpayer Alert TA 2009/1 – Superannuation Illegal Early Release Arrangements. |
Case study
In one arrangement, a number of people agreed to pay 30% of their super account balances in exchange for the early release of their benefits. They were promised they could use the money however they liked and were told that the 30% was to cover relevant ‘taxes’ however this money was never remitted to us.
This arrangement was illegal as there were no legitimate circumstances for withdrawing the super benefits early. People who had already lost 30% of their super savings were required to pay additional taxes and penalties for the amounts they had accessed early from super. The promoter offering the arrangement was prosecuted and sentenced to jail.
AGRIBUSINESS MANAGED INVESTMENT SCHEMES
Managed investment schemes (MIS) are generally mass-marketed arrangements for investment in primary industry. Arrangements usually relate to activities such as forestry, agriculture, horticulture and aquaculture and are for a fixed number of years depending on the nature of the activity. While fee structures for MIS vary, often the investor pays an upfront fee for initial services and may also pay for ongoing services in later years. The upfront fee is typically a large amount and may be financed by a loan, sometimes offered by the MIS provider or a related entity.
While many MIS arrangements don’t constitute a tax scheme, investors should be careful if the arrangement doesn’t have an ATO product ruling confirming the intended tax benefits. Even where a ruling has been issued, it’s important to be aware that having a product ruling isn’t a guarantee of commercial success and that we may withdraw or amend it. This could happen if something changes in the way the arrangement is carried out or the arrangement is terminated or wound up early. In this situation, the promised tax benefits may no longer be available.
HOME LOAN UNIT TRUST ARRANGEMENT
In this arrangement, a promoter claims they can make your home loan interest payments tax deductible.
Using a unit trust the scheme promoter sets you up to borrow funds to purchase a property. You then live in the property and pay rent to the unit trust at market rates which the trust declares as taxable income.
The trust claims associated expenses and interest charges as deductions against the rental income and you claim a tax deduction for the interest payments on the borrowing.
This is a scheme because it involves getting a tax benefit from borrowings for private expenses – your home. You would not be entitled to claim the interest payments as deductions and you risk having to pay penalties and interest.
| For more information, refer to Taxpayer Alert TA 2001/1 – Home Loan Unit Trust Arrangement. The ATO view on this arrangement is set out in Taxation Ruling TR 2002/18. |
INFLATED TAX DEDUCTION FOR DONATION OF GOODS TO CHARITY
In this arrangement a promoter claims you can make a charitable donation of property and obtain a tax deduction for an amount that is significantly greater than the actual cash amount you outlay.
This is done by entering into an agreement to purchase goods for donation to a charity for use overseas. You make an upfront payment for a percentage of the value that the goods are supposedly worth. The balance of the payment for the goods is financed through a loan from either the vendor of the goods or a lender nominated by the promoter. The terms of the loan are unusual in that the loan is for a very long term, is unsecured and interest charges are often minimal. The claimed tax deduction is for the full amount that the goods are supposedly worth – being the upfront payment and the loan amount.
This is a scheme because the dominant purpose is to obtain a scheme benefit. The value of deductions claimed is much larger than the portion of the donation funded with your own money and the additional borrowed funds are provided through a loan which is uncommercial in nature. It is also probable the market value of the goods is much less than the invoiced amount.
| For more information, refer to Taxpayer Alert TA 2010/8 – Gift deductions for donation of pharmaceuticals to charities operating overseas. |
Case study
In one arrangement, taxpayers who claimed big deductions for charitable donations were left with tax bills instead. These donors were told they could buy pharmaceuticals for use by charities overseas and claim deductions for amounts much larger than their actual cash outlay.
The donors entered into contracts to purchase and transfer pharmaceuticals to charities registered as deductible gift recipients. Donors made an initial payment of 7.5% of the purchase price of the pharmaceuticals plus a nominal interest prepayment, with the balance payable up to fifty years later. They were advised they could claim a deduction for the full contracted purchase price of the pharmaceuticals in the year they entered the arrangement.
The arrangement was revealed to be a tax avoidance scheme. Donors who had claimed deductions were advised to voluntarily request an amendment to their income tax assessment. Those who failed to do so had their claim disallowed in full and were charged penalty and interest on the tax shortfall.
SPECIALISED ARRANGEMENTS FOR INDIVIDUALS
HYBRID TRUSTS AND UNCOMMERCIAL USE OF TRUSTS
In this arrangement a promoter claims they can increase your tax deductions using a trust.
The promoter sets up a trust with several beneficiaries and arranges for you to borrow funds to purchase an income producing investment property through the trust. You then claim all of the interest expenses as income tax deductions.
However, either part or all of the income or capital from the investment property is distributed amongst the other trust beneficiaries rather than to you (the original borrower of the funds). Often these beneficiaries are on lower marginal income tax rates.
This arrangement is considered to be a scheme because you are claiming deductions for all of the interest expenses on the borrowing but you haven’t received all the associated benefit in the form of income or capital or both.
| For more information, refer to Taxpayer Alert TA 2008/3 – Uncommercial use of certain trusts. The ATO view on the major issue in this arrangement is set out in Taxation Determination TD 2009/17. |
RETAIL FINANCIAL PRODUCTS
Many banks and other financial institutions offer financial products to investors. Some of these products can be very complex and you should check whether such products have an ATO product ruling. Product rulings offer certainty about the tax consequences of a product, provided the product is implemented exactly as it has been outlined in the ruling.
You should be cautious if any complex financial product doesn’t have an ATO product ruling confirming the intended tax benefits. There can be risks associated with financial products if elements of the product are contrary to the law. A product may offer significant tax benefits to investors, for example through franking credits, interest deductions or income sheltering or deferral. However, the tax benefits may be accompanied by little or no commercial purpose and the product may contain features that are artificial or contrived.
Some features to be wary of include:
• claiming deductions for prepaid financing costs (such as interest) which in some instances may not be allowed
• deferring income to later years or substituting it for income from another source
• inappropriately costing the capital protection element where interest rates for borrowings are set above the prescribed benchmark rate
• generating excessive franking credits when compared to the amount of real income received.
| For more information, refer to Taxpayer Alert TA 2012/3 Structured financial products that exploit franking credits and other tax benefits. The ATO view on the operation of the imputation system and section 177EA is discussed in Taxation Ruling TR 2009/3. |
SMSF FUNDS DERIVING INCOME FROM UNCOMMERCIAL TRUSTS
In this arrangement a promoter encourages you to borrow funds to invest in a trust which has, as one of its beneficiaries, an SMSF. The trust uses the funds to buy a rental property.
You then claim all of the borrowing costs as income tax deductions. However, some of the income from the investment is distributed to the SMSF.
This arrangement is considered to be a scheme because you are claiming deductions for all of the interest expenses on the borrowing but the borrowing has also been used to derive income for other beneficiaries of the trust such as an SMS F which is ordinarily taxed at the concessional rate. However, as the income distribution from the trust to the SMS F may be considered non arm’s-length income, it may in fact be taxable at a higher rate.
| For more information, refer to Taxpayer Alert TA 2008/4 – Self-managed superannuation funds deriving income from certain uncommercial trusts. The ATO view on the major issue in this arrangement is set out in Taxation Ruling TR 2006/7. |
UNCOMMERCIAL OFFSHORE SUPER TRUSTS
Arrangement 1
In this arrangement, an overseas resident (an individual) seeks to avoid paying income tax on money they want to bring into Australia. The individual establishes an offshore trust which is claimed to be an offshore super fund. This fund usually has a trustee situated in a tax haven.
The individual sets up an employer entity also located in a tax haven. The individual becomes a primary shareholder and director of the employer entity. The employer entity does not have any apparent business function other than to make contributions to the offshore trust fund prior to the individual becoming an Australian resident. The offshore trust fund may invest the contributions to derive income, which is accumulated in the fund.
After a number of years the funds are moved to Australia and claimed to be retirement benefits or contributions to a complying super fund.
This is a scheme because the arrangement may avoid payment of tax in Australia under Australia’s foreign source income attribution rules on the accrued income held in the offshore trust fund.
Arrangement 2
In this arrangement, an Australian resident (an individual) working overseas seeks to avoid paying tax on their overseas income. The individual establishes an offshore trust fund which is claimed to be an offshore super fund. The trustee of the fund is usually a resident in a tax haven.
The individual performs work or services for an offshore entity which in turn pays contributions to the offshore trust fund as super contributions.
The offshore trust fund invests these contributions by making loans on less than commercial terms to Australian resident entities related to the individual or by acquiring shares or units in Australian resident entities owned and controlled by the individual.
After a number of years both the capital amounts and investment earnings are transferred to Australia and claimed to be retirement payments.
This is a scheme because the arrangement may avoid payment of tax in Australia under Australia’s foreign source income attribution rules on the accrued income held in the offshore trust fund.
| For more information, refer to Taxpayer Alert TA 2009/19 – Uncommercial offshore superannuation trusts. |
ARRANGEMENTS TARGETING BUSINESSES
AVOIDANCE OF CAPITAL GAINS TAX USING A TRUST STRUCTURE
Using this arrangement, an entity (either an individual, partnership or trust but not a company) seeks to avoid paying capital gains tax (CGT) on the sale of an asset it intends to dispose of.
The entity establishes a trust (Trust 1) within its structure. It also establishes a special purpose company (SPC) to act as trustee for Trust 1. The entity then transfers the asset to Trust 1 and claims CGT rollover relief on the transfer. The cost base value of the asset also transfers to Trust 1.
A second trust (Trust 2) is established which acquires the asset from Trust 1 for a nominal amount. The entity claims that due to the CGT provisions the acquisition by Trust 2 was at market value. Trust 2 then disposes of the asset to a third party for its market value. This is the same amount paid when the asset was acquired from Trust 1.
Trust 1 has made a capital gain as the asset’s value at the time of disposal is greater than its value when initially acquired. Trust 1 appoints additional beneficiaries, chosen for their tax exempt status or availability of tax losses and distributes the capital gain to those beneficiaries.
This is a scheme because the sole purpose of the arrangement is to avoid CGT on disposal of the asset.
| For more information, refer to Taxpayer Alert TA 2003/3 – Avoidance of Capital Gains Tax Utilising a Trust Structure. The ATO considers that this arrangement is a variation of the reduction arrangements discussed in Taxation Determination TD 2003/03 and the discussion of the application of Part IVA in that Determination applies equally. |
FOREIGN TRUST ARRANGEMENT
In this arrangement, a business uses an artificial arrangement to claim tax deductions for funds sent offshore, seemingly as payment for services to the business. In reality the funds are available to be used by the business.
Through a tax scheme promoter, the business establishes an overseas based foreign discretionary trust with a nominated Australian representative. The trust provides services, often at an inflated cost, to an Australian resident business. The Australian business claims the inflated service fee costs as a tax deduction, however, the business has access to these funds through the trust’s Australian appointed representative.
This is a scheme because it is an artificial arrangement to avoid tax and claim deductions for the inflated service fees.
| For more information, refer to Taxpayer Alert TA 2012/2 New Zealand Foreign Trust arrangements. You can also read Taxpayer Alert TA 2004/4 – New Zealand Foreign Trust. The ATO view on this arrangement is set out in Taxation Ruling TR 2005/14. |
PROFIT WASHING SCHEME USING A TRUST AND LOSS ENTITY
In this type of arrangement, a tax scheme promoter offers a way for businesses to offset their income, to minimise tax liability.
The business purchases an unrelated entity in a tax loss situation. The business transfers their income through a chain of trusts until it reaches the purchased entity. The income is offset against the loss, meaning that tax is never paid on the income.
This is a scheme because it is a contrived arrangement where the sole intention is to offset the business income.
| For more information, refer to Taxpayer Alert TA 2008/15 – Profit washing scheme using a trust and a loss entity. |
DISTRIBUTION TO SUPER FUND FROM INTERPOSED FIXED TRUST
In this arrangement, a promoter offers the owners of a business a way to take advantage of the concessional super tax rate to reduce the tax payable by their business on its income.
An existing business is restructured, or a new business is structured, to operate through an operating trust. This operating trust distributes income from the business to an interposed fixed trust which in turn makes an equivalent distribution of income to a super fund. The super fund pays tax at the concessional rate of 15%.
This is a scheme because it artificially reduces the amount of tax payable on the business’ earnings as well as avoiding income tax liabilities which would otherwise have been payable by the SMSF members had they received income directly from the operating trust.
| For more information, refer to Taxpayer Alert TA 2003/1 – Distribution to Superannuation Fund from Interposed Fixed Trust. The ATO view on this arrangement was first set out in ATO Interpretative Decision 2003/230 and is now set out in TR 2006/7. |
EMPLOYEE BENEFIT TRUST ARRANGEMENTS
In this type of arrangement, a business sets up an Employee Benefit Trust (EBT), supposedly to provide benefits to employees.
The employer makes a contribution to the EBT on behalf of a group of employees – for example, the principals of the business. The employees participate by receiving a loan from the trust to purchase units in the same trust, or are nominated as beneficiaries of the trust. The contributed funds may be loaned back to the employer or invested in property. Generally the contributed funds remain in control of the employer and/or the principals.
This is a scheme because the contribution is not a business expense but a distribution of profit to the principals (it is capital in nature). The business is not able to claim deductions for a capital expense. Where the employees are not principals, then the business may have obtained a tax benefit, being the deduction claimed. The arrangement has also avoided fringe benefits tax on the contribution.
| For more information, refer to Taxpayer Alert TA 2007/2 – Employee Entitlement Fund. |
EMPLOYEE SHARE TRUST ARRANGEMENTS
In this type of arrangement an employee share trust (EST) is established in an attempt to convert salary or wages income into a capital gain for employees.
Employees participate in the arrangement by entering into an agreement with the employer to contribute salary or bonus income to the EST. The employer then makes a contribution to the EST which is subsequently loaned to employees to purchase units in the trust. Employees may also be issued with bonus units which typically equal the amounts previously contributed.
This is a scheme because the employees can defer being assessed on their salary and wages while accessing their sacrificed amounts through non taxable loans. When exiting the arrangement, employees also receive concessional treatment on their deferred salary and wages as they are incorrectly treated as capital gains.
| For more information, refer to Taxpayer Alert TA 2008/13 – Employee Savings Plans. The ATO view on this arrangement is set out in TD 2010/10. |
| A variation to the above EST arrangement involves the employee entering into a salary sacrifice agreement with their employer to forego part of their future salary, wages or bonus, in return for a benefit of similar value. This benefit is provided by the employer without regard to the application of fringe benefits tax.
For more information, refer to Taxpayer Alert TA 2011/5 -FBT Avoidance through an arrangement where an employer repays an employee’s loan from a purported employee share trust. The ATO view on this arrangement is set out in ATO ID 2011/54. |
RESEARCH AND DEVELOPMENT OFFSETS
In this arrangement a promoter offers you a way to claim a large tax offset for research and development (R&D) with a minimal outlay.
The promoter helps you to set up a company with a small amount of paid-up capital and enter into an R&D services agreement with a registered research agency (RRA) for the provision of R&D services. This arrangement is often entered into within the last month of a financial year and for a period of up to 13 months. Sometimes funding arrangements are provided by the RRA.
The RRA issues a tax invoice up to the maximum amount of expenditure that can be claimed for R&D ($2 million) for the provision of future R&D services. The RRA engages sub-contractors, often associated with the company, to perform the work required under the agreement. However, no work is commenced in that financial year, no payments are made by the company and the entire amount is said to have accrued.
The company lodges a business activity statement (BAS) to claim the input tax credit relating to the invoice. The company then lodges the tax return, electing to receive the R&D tax offset rather than claiming a deduction. The tax offset funds and GST refund are then applied against the balance owing under the agreement with the RRA.
This is a scheme because it is a contrived arrangement where the sole purpose is to claim a large tax offset without the necessary expenditure.
| For more information, refer to Taxpayer Alert TA 2009/21 – R&D tax offset abuse through registered research agencies. |
LABOUR HIRE ARRANGEMENTS USING A DISCRETIONARY TRUST TO SPLIT INCOME
In this type of arrangement, a labour hire firm makes a discretionary trust structure available to you for the purpose of splitting the income earned from work or services you performed, between you and other beneficiaries such as your spouse or associates.
Payment for work performed or services provided are paid by the labour hire firm via the discretionary trust. The discretionary trust makes payment on a regular basis to any one of, or a combination of, the beneficiaries.
This is a scheme because it attempts to avoid tax by splitting income to beneficiaries who may be taxed at lower rates.
| For more information, refer to Taxpayer Alert TA 2011/2 – Certain labour hire arrangements utilising a discretionary trust to split income. |
LOANS TO MEMBERS OF COMPANIES LIMITED BY GUARANTEE
In this type of arrangement a corporate structure is used to minimise the tax liability on the distribution of profits to shareholders and their associates.
The promoter sets up a company limited by guarantee (an unlisted public company) and interposes it into an established corporate structure. The company limited by guarantee is the recipient of profit distributions from the other entities within the structure. These profits have been previously taxed at the corporate rate.
The funds are subsequently loaned by the company limited by guarantee to its members or their associates. These loans are generally provided at minimal or interest free rates.
This arrangement is considered to be a scheme as the dominant purpose for the existence of the company limited by guarantee is to obtain a scheme benefit in the form of reduced tax liability arising on the profit distributions to shareholders or their associates. There is no apparent commercial purpose behind the company limited by guarantee.
| For more information, refer to Taxpayer Alert TA 2011/1 – Loans to members of companies limited by guarantee and the operation of Division 7A. |
ARRANGEMENTS TARGETING SELF-MANAGED SUPER FUNDS
USING AN UNRELATED TRUST TO CIRCUMVENT SUPER LENDING RESTRICTIONS
Under this arrangement an organiser sets up a supposedly unrelated trust. A self-managed super fund (SMSF) invests in the trust with the promise of a fixed return. The trust then on lends the same or substantially similar amount of money to a member or a relative of the member of the SMSF. Interest paid by the SMSF member or relative flows through the trust, back to the SMSF as a return on investment minus a fee for the organiser.
This arrangement is of concern mainly because, under super law, SMSF trustees are prohibited from using the resources of the fund to lend money or provide financial assistance to a member of the fund or a relative of a member of the fund. The provision of a loan or financial assistance through another entity may also contravene these laws.
| For more information, refer to Taxpayer Alert TA 2010/5 – The use of an unrelated trust to circumvent superannuation lending restrictions. The ATO view regarding giving financial assistance to members or relatives of members of a self-managed super fund is outlined in SMSFR 2008/1. |
CIRCUMVENTION OF IN-HOUSE ASSET RULES USING RELATED PARTY AGREEMENTS
In this type of arrangement, an organiser sets up a joint venture agreement between a self-managed super fund (SMSF) and a related trust to obtain certain taxation and super benefits.
The SMSF contributes capital for the acquisition of assets by the trust, such as rental property. The trust uses the funds from the SMSF as well as a borrowed amount to purchase and develop the asset. Any income or benefit received from the investment is split proportionately between the SMSF and the trust, based on the capital invested. All expenses are met by the trust.
This arrangement may breach the in-house asset rules which state that an investment or loan by an SMSF in a related party must not exceed 5% of the total market value of the fund’s assets. Where an SMSF exceeds the 5% limit, the breach must be rectified, usually within 12 months, otherwise the fund may be made non-complying and be subject to a 45% tax rate.
This arrangement may breach rules surrounding intentional acquisition of assets from a related party. It may also breach the sole purpose test which states that an SMSF exists to provide retirement benefits and not present-day entitlements. Income received by the SMSF is also non-arm’s length and therefore subject to a higher rate of tax.
| For more information, refer to Taxpayer Alert TA 2009/16 – Circumvention of in-house asset rules by self-managed superannuation funds using related party agreements. The ATO view on this arrangement is set out in SMSFR 2009/4. |
NON MARKET VALUE ACQUISITION OF SHARES OR SHARE OPTIONS
In this arrangement, a company establishes an employee share scheme (ESS) and invites individuals or their associates (including the trustee of an SMSF) to acquire shares or rights to acquire shares in the company.
The individuals nominate their SMSF as the acquirer of the shares or share options. The trustee of the SMSF pays no consideration or less than market value consideration for the shares or share options.
This arrangement may be of concern because an SMSF cannot intentionally acquire shares or options from related parties. There are exceptions to this rule which include the acquisition of listed shares however these cannot be acquired below market value. Also, the difference between the consideration paid by the SMSF and the market value of the shares may potentially be a contribution which needs to be reported for excess contribution tax purposes.
You may also incur penalties for not appropriately accounting for the discount on the shares or options on your income tax return.
| For more information, refer to Taxpayer Alert TA 2010/3 – Non market value acquisition of shares or share options by a self-managed superannuation fund. |
WHAT TO DO IF YOU’RE INVOLVED IN A SCHEME
WHAT TO DO IF YOU’RE INVOLVED IN A SCHEME
Not only can involvement in a tax scheme risk your original investment, you could also have to pay back any missing tax with interest and penalties.
If you voluntarily tell us about your involvement in a tax scheme, you may be eligible for a reduction in any penalties you incur.
If you think you may have become involved in a tax scheme you can start by talking to your tax agent. You can also call us on 1800 177 006. If you need to request an amendment to your income tax assessment, we can help you.
| For more information about making a voluntary disclosure, refer to Voluntary disclosures – approved form (NAT 72121) available atwww.ato.gov.au |
REPORTING TAX SCHEMES AND TAX SCHEME PROMOTERS
If you come across an arrangement that sounds like a tax scheme, you should let us know. Providing this information to us as early as possible enables us to act quickly to investigate the arrangement. Early detection of schemes can help us take action to prevent other taxpayers from becoming involved.
You can also let us know if you have concerns about a promoter.
Legislation to deter the promotion of tax exploitation schemes was introduced in 2006. The promoter penalty laws protect you from unscrupulous promoters by providing for both civil and administrative penalties for scheme promoters. This means that the Federal Court can impose civil penalties such as fines or grant an injunction.
These laws also cover situations where a scheme has been promoted on the basis that it has an ATO product ruling but has been implemented in a way that is materially different to the conditions described in the ruling, making the product ruling invalid.
| To report a possible tax scheme or a promoter, you can call us on 1800 177 006. |
MORE INFORMATION
• For more detailed and up-to-date information on tax schemes, visit www.ato.gov.au/taxplanning
• For general information on investing and your tax obligations, visit www.ato.gov.au/investment
You can also get other independent advice from:
• ASIC – provides information about investing and financial products. Visit the ASIC website at www.moneysmart.gov.au
• The Australian Competition and Consumer Commission (ACCC) – provides warnings about known investment scams. Visit the SCAMwatch website at www.scamwatch.gov.au
If you do not speak English well and need help from the ATO, phone the Translating and Interpreting Service on 13 14 50.
If you are deaf, or have a hearing or speech impairment, phone the ATO through the National Relay Service (NRS) on the numbers listed below:
• TTY users, phone 13 36 77 and ask for the ATO number you need
• Speak and Listen (speech-to-speech relay) users, phone 1300 555 727 and ask for the ATO number you need
• internet relay users, connect to the NRS on www.relayservice.com.au and ask for the ATO number you need.
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