This months top tax & accounting Q&As live from the Knowledge Shop Help Desk:
- Are management fees for a salary sacrificing arrangement deductible?
- Changing the term of a Division 7A loan agreement
- Applying the rollover rules when restructuring from a sole trader to a company
- Consolidating franking accounts when companies consolidate
- Restrictions on applying the main residence exemption to the sale of a property
1. Are management fees for a salary sacrificing arrangement deductible?
My client salary sacrifices their wage that incurs an administration and management fee each year by the management agency. Can these fees be deducted under related income?
ATO ID 2003/566 indicates that an employee cannot generally claim a deduction for administration costs relating to salary sacrifice arrangements. This is because there is not a sufficient connection between the costs and deriving assessable income. The arrangement generally results in a reduction in assessable income which is replaced with tax-free benefits.
While the ATO ID has been withdrawn, this was only because it was a simple restatement of the law and did not contain an interpretative decision. As a result, the conclusion set out in the ATO ID should still be applicable and is consistent with our understanding of how the rules typically operate.
It may be worth considering whether the administration fees can be included as part of the salary packaging arrangement between the employee and employer.
ATO ID 2001/333 indicates that administrative costs incurred by an employer do not constitute a fringe benefit, even if they are factored into the salary sacrifice arrangement with an employee.
2. Changing the term of a Division 7A loan agreement
My client withdrew money from a private company in 2015 under a 7-year loan agreement. The client now wants to secure the loan against a property.
Can the term of the loan be changed to a 25 year loan by registering a mortgage or is it too late? Is there anything else we should be aware of?
The default position is that a Division 7A loan agreement cannot extend beyond 7 years. However, the maximum loan term can be extended to 25 years in some cases. In order to place a loan under a 25 year loan agreement the following conditions need to be met:
- The full value of the loan from the company must be secured by a mortgage over real property that is registered in accordance with relevant State or Territory law; and
- At the time the loan is made, the market value of the property (less any higher ranking liabilities secured over the property) is at least 110% of the amount of the loan.
The rules also allow you to refinance from an existing 7 year loan to a 25 year loan without triggering the anti-avoidance rules within Division 7A that can apply to refinanced loans (section 109N and section 109R ITAA 1936). However, you would need to reduce the maximum loan term to take into account the period of time already that has already elapsed since the loan was made.
The rules also appear to allow a 7 year loan to be extended to a 25 year loan without being refinanced if the loan is secured by a registered mortgage and the relevant conditions are met. In this case the minimum repayment rules in section 109E appear to treat this loan as having been made just before the start of the year that the loan was extended. However, the maximum loan term should still be based on when the original loan was actually made. See example 1.6 in the Explanatory Memorandum here.
ATO guidance on the refinancing rules can be found here.
3. Applying the rollover rules when restructuring from a sole trader to a company
We have a client who would like to restructure his business from a sole trader to a company. However, the sole shareholder of the company is the trustee of a discretionary trust.
Would it still be possible to satisfy the “Same Ultimate Economic Ownership” requirement for the rollover?
This would be very difficult and it is unlikely that the rules would be available in this case.
In order to access the small business restructure rollover rules in Subdivision 328-G there are a number of conditions that need to be met. One of the conditions is that the transaction must not result in a material change to the individuals who have ultimate economic ownership of the assets being transferred or the percentage interest that they hold in the assets.
In this case it seems very unlikely that the basic condition could be met if you are moving from a sole trader structure to a situation where the assets are held by a company, where all the shares are held by a discretionary trust.
There is a special rule in section 328-440 which can assist in passing this condition when non-fixed trusts are involved, but it does not appear to help in your client's case. At a high level, the section states that you assume there has been no change in ultimate economic ownership of the asset if:
- The asset is included in the property of a non-fixed trust just after the transaction takes place;
- The trust has made a family trust election;
- Every individual who had ultimate economic ownership of the asset just before the transaction was a member of the family group for that trust; and
- Every individual who had ultimate economic ownership of the asset just after the transaction was a member of the family group for that trust.
Unfortunately, it doesn't look like these special rules would be met because the assets are being transferred from an individual to a company (i.e. they are not being transferred to or from a discretionary trust).
It might be worth exploring whether the small business CGT concessions in Division 152 could apply in conjunction with the CGT discount to reduce the capital gain that arises as a result of the restructure.
4. Consolidating franking accounts when companies consolidate
We have three companies (all with franking accounts) who are forming a consolidated group, with one tax return to be lodged. What will happen with the franking accounts of the individual companies upon consolidation? How does this process work in respect of the payment of dividends by the head company?
Division 709 ITAA 1997 outlines the process when this occurs. Basically the franking credits of the subsidiary members of the group are transferred to the head company at the time the consolidated group starts, or the members join the group. The head company then maintains a single franking account for the entire group.
If the subsidiary companies pay dividends to the head company while they are part of the same consolidated group, then this is basically ignored for tax purposes so there is no need to attach credits to the dividends.
When the head company pays dividends, it can attach the credits in its account which could include balances that were transferred from the subsidiary companies.
5. Restrictions on applying the main residence exemption to the sale of a property
My client acquired a block of vacant land jointly with his now ex-partner with the intention of constructing their main residence.
During the brief ownership period both parties did not treat another property as their main residence (i.e. they rented a place to reside in).
Before a building contract was entered into, the relationship broke down. As part of the breakdown the vacant land has been disposed of.
Can the main residence exemption apply in this instance based on an intention (and no actual) to construct a main residence?
Unfortunately, it is not generally possible to apply the main residence exemption to the sale of a property unless it contains a dwelling that has actually been established as the client's main residence.
The rules in section 118-150 contain some special provisions dealing with situations where someone is constructing a dwelling, but they can only apply if the taxpayer actually moves into a dwelling on the property and establishes it as their main residence.
See paragraph 3 of TD 51 at the link below which confirms that mere intention to construct a dwelling or to occupy a dwelling as a main residence but without actually doing so, is insufficient to obtain the exemption.