This month's Top 5 Tax & Accounting Q&As live from the Knowledge Shop Help Desk:
- Differences between taxable income and distributable income of a trust
- Can a company transfer its tax / capital losses to another company?
- Extracting profits from a company through liquidation
- The margin scheme and pre-2000 property
- Accessing the small business CGT concessions for disposal of business premises
1. Differences between taxable income and distributable income of a trust
A unit trust deed doesn't define income. This means net income is income according to ordinary concepts. The unit trust's tax net income has been reduced by capital works allowance and small business < $20,000 write off. These deductions would not reduce income according to ordinary concepts. I am currently getting the trust deed amended to allow the trust net income to be tax income.
Hypothetically, if the income definition wasn't amended, would the following work?
Trust resolves to accumulate an amount of net income equal to the capital works deduction and small business write-off, and pool deductions less accounting depreciation. It then distributes the remaining income 50/50 to the unit holders. The unit holders have now only received the tax income, so shouldn't have to adjust the cost base of their units (which was nil in this case).
What happens to the accumulated income in the trust? Is it taxed to the trustee? Does the proportionate approach apply?
There isn't necessarily an easy solution to this. We would generally work through this process as follows.
The starting point is to determine what the distributable income of the trust for the year. In this case I agree that ordinary concepts of income should be used if the trust deed doesn’t contain a definition of income.
The next step would be to check whether the trust deed operates to make the beneficiaries automatically presently entitled to the income of the trust at year-end. Some unit trust deeds do this but many don’t.
If the trustee does not appoint all of the distributable income to the beneficiaries by the end of the year and this doesn’t happen automatically under the trust deed, then this would generally cause the trustee to be assessed on some of the taxable income of the trust. The proportionate approach should apply to determine how much is taxed in the hands of the trustee. For example, if 15% of the distributable income of the trust is not appointed to the unit holders then this would generally cause the trustee to be taxed on 15% of the taxable income of the trust. The trustee would generally be taxed at penalty rates and further adverse implications could arise (e.g., loss of the CGT discount on capital gains taxed in the hands of the trustee etc.).
If the distributable income of the trust exceeds the taxable income of the trust due to things like capital works deductions and accelerated depreciation deductions then this is likely to cause CGT event E4 for the unit holders, even if some of the income is not appointed to the unit holders. Again, this is because the proportionate approach applies. Having said that, the CGT implications for the unit holders should be reduced if the trustee does not appoint all the distributable income to the beneficiaries (assuming this doesn’t happen automatically under the trust deed).
For example, assume the distributable income is $100 and taxable income is $80. If the trustee appoints $50 to the unit holders then:
- They should be assessed on $40;
- CGT event E4 would be triggered for $10;
- The trustee should be assessed on $40 at penalty rates.
CGT event E4 is generally triggered when the actual distribution is more than the assessable amount for the unit holders. They need to reduce the cost base of their units and this can trigger a capital gain if the non-assessable portion exceeds the cost base of the units.
2. Can a company transfer its tax / capital losses to another company?
I have a small Australian Pty Ltd ("A") client that is wholly owned by another Australian Pty Ltd company ("B"). It is not consolidated.
If the owners close business A, can it transfer its losses to B. If so, what are the steps involved?
No, a company cannot generally transfer tax losses or capital losses to another company unless they are part of the same tax consolidated group in which case there are special rules dealing with the transfer and utilisation of losses.
In order for the losses to be transferred from Company A to Company B it would be necessary to form a tax consolidated group, which can be a complex process and there are a range of other issues that would need to be considered. There would then be two additional steps relating to the losses:
- You would need to test whether the losses can be brought into the group with a modified continuity of ownership test / same business test;
- You would need to calculate an 'available fraction' for the losses which would limit the rate at which they can be utilised. In very broad terms, this is the market value of Company A over the market value of the entire group (with some adjustments being made).
While there are some rules in Division 170 which allow losses to be transferred between companies in the same wholly-owned group, the rules are limited to the situation where one of the companies is an Australian branch of a foreign bank. The rules in Division 170 used to apply to all companies in the same wholly-owned group, but they were restricted to this specific scenario when the consolidation provisions were introduced.
3. Extracting profits from a company through liquidation
We have a new client who owns pre-CGT shares in his private company; retained profits are made up of the following:
- Asset revaluation reserve $100,000
- Sale of asset – pre-CGT $195,000 (derived btw 2004 and 2009 from sale of pre CGT business)
- Retained profits ($98,000)
The company has imputation credits of $95,000.
The sole shareholder/director of the company decided to invest the proceeds of the pre-CGT business sales in Units in a listed unit trust around 3 years ago. The investment was around $221,000 and the units are now worth $291,000. The units easily exceed 75% of the market value of the company’s assets. The units are basically the only asset of the company now.
Our client would now like to extract the profits from the company. It is our understanding that if we liquidate the company, CGT event K6 would apply and basically the distributions would be fully taxable?
Fortunately, the company has imputation credits and the client is retiring (no other taxable income) - so, depending on the response to our question, a slow wind down strategy may be best here.
We would only look at CGT event K6 after considering whether the client would be taxed on revenue account first.
1. When a company is liquidated and distributions are made to the shareholder it is necessary to check whether some or all of the distribution would be taxed as a dividend. Section 47 ITAA 1936 basically ensures that distributions made by a liquidator upon winding up a company are treated as a dividend unless:
- The distribution is sourced from paid-up share capital of the company; or
- The distribution is sourced from an exempt capital gains made by the company (e.g., on sale of pre-CGT assets).
If some or all of the distribution is taxed as a dividend then it should generally possible to attach franking credits to the dividend to reduce the tax impact for the shareholder.
2. If some or all of the distribution is not taxed as a dividend then it would generally be used in determining whether a capital gain or loss arises on cancellation of the shares in the company. As you are aware, while capital gains made in relation to pre-CGT assets are generally disregarded, CGT event K6 can potentially give rise to a taxable gain when the CGT event happens to pre-CGT shares in a company.
It is worth referring to the ATO’s comments in TR 2004/18 which provides detailed guidance on the application of CGT event K6. I have extracted the most relevant comments below:
“Can CGT event K6 happen when pre-CGT shares end under CGT event C2 on deregistration of a company in liquidation following its winding up?
48. Although CGT event K6 is theoretically capable of happening, it is most unlikely that the company would have any property of the kind referred to in subsection 104-230(2) just before the time CGT event C2 happens. That is, the company is highly likely to be a 'shell' at that stage.
49. In the unlikely event that CGT event K6 is attracted, section 118-20 of the ITAA 1997 reduces any capital gain under subsection 104-230(6) by the amount (if any) of the liquidator's distribution that is assessed as a dividend.”
Even if a capital gain does arise, the shareholder can potentially apply the CGT discount and/or small business CGT concessions to reduce or eliminate the capital gain if the relevant conditions can be met. It would be necessary to consider whether this would provide a better overall outcome than gradually paying out franked dividends.
4. The margin scheme and pre-2000 property
A client owns a property on capital account which was purchased pre-1985. The property is now being treated as trading stock for the business of land development. The property has been revalued at market value for conversion to trading stock.
Following the sale of the individual lots, and assuming GST applies, is the client able to use the margin scheme. If yes, is the margin based on a cost at revaluation or the original cost?
Assuming the margin scheme is applicable, could the market valuation be applied at the time of conversion to trading stock?
If the property was acquired by the client prior to 1 July 2000 then it should be possible to apply the margin scheme on sale of the property as long as both parties to the transaction agree in writing to apply the margin scheme. Refer to section 75-5 GST Act.
If the property was acquired prior to 1 July 2000, when calculating the margin for GST purposes the client can generally use a valuation of the property at a particular point in time rather than using the original purchase price. If the client was registered for GST on 1 July 2000 then the valuation should reflect the market value of the property on 1 July 2000. If the client registered for GST after 1 July 2000 then the valuation should reflect the market value of the property at the earlier of the date of effect of the GST registration or the day on which the client applied for registration. Refer to section 75-10.
Note that there are very strict rules when it comes to undertaking valuations for the purpose of the GST margin scheme. The ATO has a guide to undertaking valuations for the margin scheme which can be found here.
If the client was not registered for GST at 1 July 2000 and they registered for GST after this date then the valuation should reflect the market value of the property at the earlier of the date of effect of the GST registration or the day on which the client applied for registration. This may or may not be the same as the value when the property started being held as trading stock.
5. Accessing the small business CGT concessions for disposal of business premises
A company has ordinary shares on issue, one to Man A and one to Man B.
The company also has class F shares on issue, one to Lady A and one to Lady B.
Man A and Lady A are married and Man B and Lady B are married.
Man A and Man B own the real estate jointly that the company operated from.
The company has disposed of the business and no CGT small business concessions are available due to the different classes of shares dividend rights.
Assuming the individuals satisfy the $6m net asset test and the company has no value now, are the CGT small business concessions available to Man A and Man B on disposal of the real estate?
The real estate has been owned for 11 years. The first 10 years was active in the company business and for the past year has been leased to the purchaser of the business.
In order for the small business CGT concessions to apply to a capital gain made on sale of the property, the following basic conditions would need to be satisfied:
- The individual would need to pass either the $6m net asset value test or one of the CGT SBE tests in section 152-10 based on a turnover threshold of $2m.
- The individual’s interest in the property would need to pass the active asset test. In order to pass this test the property would need to have been an active asset for at least half of the ownership period. In broad terms, an asset is active if it is used in a business carried on by the owner, a connected entity or affiliate.
In this case, I would probably focus on whether the company was a connected entity of the individuals while it was using the property in its business. In broad terms, a company would be a connected entity of an individual if they hold shares in the company which provide them with the right to at least 40% of voting power, dividend rights or capital distribution rights. For example, if the F class shares have no voting rights and Man A holds shares which carry 50% of the voting rights then it is likely that the company would be a connected entity of him.
If the company was a connected entity of each individual for the 10 year period during which the company was using the property in its business and the property was not mainly being used to derive rent from any other entities during that period then it seems likely that the active asset test would be satisfied.