June 2024 Round Up - Family Trust Election problem areas

Over time, family trust elections can become problematic. New guidance from the ATO addresses how the rules should work and where it is all going wrong in practice.

Plus, the ATO’s failed attempt to contest a business valuation pivotal to a taxpayer’s access to CGT concessions.

And, the increase to the instant asset write-off threshold from $1,000 to $20,000 for 2023-24 has passed Parliament just days before the end of the financial year. Read the details here.

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Inside this month Michael Carruthers (Tax Director), Matthew Tse (Tax Adviser) and Lisa Armstrong (MD) bring you:

Managing family trust elections (properly)

Reference: Know your stuff: Family trust elections and interposed entity elections

Many practitioners would be aware that family trust elections can be an effective tool when used correctly. Some of key reasons for making a family trust election include:

• Making it simpler to pass the trust loss tests by ensuring the trust needs to pass only a modified version of the income injection test;
• Helping a company with losses to pass the continuity of ownership test if its shares are held by a discretionary trust; and
• Ensuring beneficiaries of a discretionary trust have better access to franking credits from franked dividends received by the trust by allowing them to be treated as a ‘qualified person’ for the purposes of the 45-day holding period rule.

However, there are some disadvantages to making family trust elections that need to be considered.

When a trust makes a family trust election, the family group is determined by reference to the individual specified in that family trust election. Any distributions made outside the family group of the specified individual are subject to family trust distribution tax. This tax is payable at the top personal marginal rate plus Medicare levy.

This is why the ATO is reminding practitioners and trustees that family trust elections (and interposed entity elections) should be kept on file and be considered carefully, especially when making distribution decisions.

For trusts that have already made an election, the ATO is also encouraging clients to consider if it is actually required, or whether the specified individual is the most suitable.

If not, consideration should be given to whether it is possible to revoke the election or vary the specified individual. Practitioners and trustees still need to approach this carefully because there are timing restrictions as well as other strict conditions that need to be met.

Warning on employer superannuation guarantee obligations

The ATO has set out some simple checks for employer clients to ensure they are meeting their superannuation guarantee (SG) obligations.

First, it is important to consider which workers are eligible to receive SG contributions. Workers who are classified as employees under general principles are normally eligible to receive SG contributions on their salary and wages. However, modified rules can apply to certain workers including employees under 18, private or domestic workers and employees working overseas.

Even though a worker might be a genuine contractor, just be aware this does not always mean that SG doesn’t apply. For example, contractors can be entitled to SG where they perform work under a contract that is wholly or principally for their labor. Also, SG can apply to workers in the sports, entertainment and arts industry even if they aren’t employees under common law.

Another area where the ATO is encouraging checks to be undertaken is around ensuring the correct amount of SG is paid on time and to the right superannuation fund.

When it comes to the right superannuation fund and depending on the circumstances, this will either normally be a superannuation fund of the employee’s choice, the employee’s existing stapled fund or the employer’s default fund.

While the SG rate for the 2024 income year is 11%, this increases to 11.5% from 1 July 2024. It will be important to take this into account to ensure SG contributions are calculated correctly.

In terms of timing, SG contributions must be received by the fund on or before 28 days after the end of each quarter. For the June 2024 quarter, this means superannuation contributions must be received on or before 28 July 2024.

If the payment is late or has been missed, harsh penalties and other obligations will normally be triggered. In these cases, practitioners can assist employers by checking that they’ve lodged a superannuation guarantee charge statement and paid the superannuation guarantee charge to the ATO. Just remember that the superannuation guarantee charge is not deductible to the employer.

Updated guidance on employee v contractor distinction for SG purposes

Reference: TR 2023/4DC1

Following some recent and prominent High Court decisions in this area, many practitioners would be aware that the ATO recently finalised a ruling TR 2023/4 which explains how to determine whether a worker should be classified as an employee for PAYG withholding purposes.

While the ATO historically had a separate ruling which looks at when an individual is considered an employee for SG purposes, this previous ruling SGR 2005/1 has now been withdrawn. Instead, the guidance in this area has been consolidated into TR 2023/4 in draft form.

Importantly, the ATO uses the same approach to determine whether a worker is an employee under common law for both PAYG withholding and superannuation guarantee purposes.

While a range of factors needs to be considered, the key concept is that if the worker and engaging entity have committed to the terms of the relationship in a written contract, the analysis needs to be performed with reference to the legal rights and obligations in that written contract.

The key focus is normally on the terms of the contract. If the contract is not comprehensively committed in writing, the subsequent conduct of the parties can then become relevant to work out the contractual terms that have been agreed to by the parties.

SG obligations aren’t necessarily restricted to workers who are considered common law employees. This is why the draft ruling also provides guidance on when someone could be treated as a deemed employee for SG purposes.

While there are other categories of deemed employees, it is often relevant in practice to consider whether a worker could be treated as a deemed employee under section 12(3). This becomes relevant where they are engaged under a contract which is wholly or principally for their labour.

For this to apply, the ATO in its updated draft ruling confirms the following three conditions need to be met:

• There must be a contract;
• The contract must be wholly or principally for the labour of a person; and
• The person (i.e., an individual) must work under that contract.

Consistent with the ATO’s previous ruling in this area, a worker won’t be considered a deemed employee under section 12(3) if any of the following apply:

• The contract is for a result and the worker is paid for that result (i.e., a results contract);
• The contract is principally for the provision of something other than labour of the person (such as the provision of equipment); or
• The contract contains the right to delegate, subcontract or assign the work to another party.

Together with the draft updated ruling, practitioners should also review PCG 2023/2 when considering whether someone is an employee or deemed employee for SG purposes. This practical compliance guideline explains the ATO’s risk framework and how the ATO will allocate compliance resources when it comes to classifying a worker as an employee or independent contractor, including for SG purposes.

ATO unsuccessfully challenges taxpayer’s valuation

In Moloney v Commissioner of Taxation [2024] AATA 1483, the ATO was unsuccessful in it's challenge to a taxpayer’s valuation of the shares in their trading business.

The taxpayer conducted a freight business that specialised in transporting agricultural products. As part of an internal restructure, one of the steps involved the sale of the shares in the company conducting the freight business to a related entity within the group.

Relying on a valuation undertaken by the taxpayer’s advisors, the taxpayer disclosed a capital gain calculated based on capital proceeds of $3.5 million with the net capital gain subsequently reduced to nil through a combination of the general CGT discount and the small business CGT concessions.

The ATO audited the taxpayer and instead obtained its own separate valuation that valued the shares at around $7 million, which was significantly higher than the taxpayer’s original valuation.

The ATO essentially ran two arguments, with both arguments being dependent on the accuracy of its valuation.

First, the ATO argued that the market value substitution rule in section 116-30 ITAA97 applied to substitute the capital proceeds from the share sale to around $7 million. This was on the basis the related parties weren’t dealing at arm’s length in relation to the transaction.

Also, the ATO considered the taxpayer was not eligible to access the small business CGT concessions. Essentially because the ATO valued the shares at around $7 million, the ATO’s position was that the taxpayer did not satisfy the $6m maximum net asset value test just before the CGT event.

Both the taxpayer and ATO’s substantive arguments at the AAT largely dealt with their approach to valuing the business. The AAT concluded that the taxpayer’s approach was more reasonable, which ultimately meant the taxpayer satisfied the $6m maximum net asset test for the purposes of being eligible to apply the small business CGT concessions.

While acknowledging that both experts were competent and qualified, the AAT favoured the taxpayer’s valuation which discounted the value of an unlisted smaller company on the basis that such businesses are more difficult to sell (compared to a large listed entity). Also, the AAT considered that the taxpayer’s valuation reasonably took account of cyclical factors impacting the agricultural industry which affected the business’s maintainable earnings.

This case highlights that valuations can involve a degree of professional judgment and this is not an area where valuation experts will always necessarily agree on the outcome. While the $6m maximum net asset test is one area where market values are relevant, just be mindful that there are a number of different areas in the tax rules where this is also the case.

Practitioners should be aware that it can be possible to request a private ruling from the ATO to undertake a valuation or confirm a valuation that has already been undertaken by the client. While the ATO will charge the client a fee for the cost of the valuation, the benefit is that this provides a degree of certainty.