July's tax developments - in depth

This article is taken from the August issue of Taxation in Australia, the journal for members of The Tax Institute.

Government initiatives 

1. Better targeting the research
and development tax incentive

In a 29 June 2018 joint media release, the
Treasurer and the Minister for Jobs and
Innovation announced the release of draft
legislation (and explanatory material) to
give effect to the 2018-19 Budget proposal
in relation to the research and development
tax incentive (R&DTI).

In the Budget, it was announced that the
R&DTI would be reformed to better target
the program and improve its integrity
and fiscal affordability in response to the
recommendations of the 2016 Review of
the R&D tax incentive. The changes are to
apply for income years starting on or after
1 July 2018.

The Treasurer said that the
government is committed to backing
R&D investment and the economic
opportunities and jobs it generates. At
the same time, it needed to be made
sure that the investment of taxpayers’
money is well targeted by encouraging
companies to do more, and not just
be rewarded for R&D they would have
conducted without an incentive.

2. Stapled structures: integrity

In a 28 June 2018 media release, the
Treasurer announced the release of a
paper for public consultation in relation to
the reform of the tax treatment of stapled
structures and similar arrangements.

The package (which was envisaged in an
announcement on 27 March 2018) ensures
trading income for foreign investors is
taxed at the corporate tax rate, and limits
access to broader concessions for passive
income utilised by foreign governments
and foreign pension funds.

The consultation paper outlines the
conditions stapled entities must comply
with to access the proposed infrastructure
concession and transitional arrangements.
The conditions include:

  • the extension of existing integrity rules
    that apply to managed investment
    trusts (MITs) to ensure that all staples
    are required to set their rent at market
    prices; and 
  • the introduction of statutory caps on
    the amount of cross-staple rent that is
    able to access the concessional rate
    of withholding tax (available under
    the MIT regime) for new and existing
    infrastructure projects during the
    transition or concession period. 

The Commissioner’s

3. Central management and
control: company

The Commissioner has issued a final
ruling which sets out his view on how
the central management and control
test of company residency in s 6(1)
of the Income Tax Assessment Act
1936 (Cth) (ITAA36) operates following
the decision of the High Court in the
Bywater Investments Ltd case (Bywater)
(TR 2018/5).

On the same day as the ruling was issued,
the Commissioner also released a draft
practical compliance guideline which
contains practical guidance to assist
foreign incorporated companies and their
advisers to apply the principles set out in
the central management and control ruling
(PCG 2018/D3).

A company is a resident or a resident of
Australia under the central management
and control test of residency if it:

  • carries on business in Australia; 
  • has its central management and control
    in Australia. 

Some points of interest from the ruling are
noted below.

Does a company carry on business
in Australia? 

It is not necessary for any part of the
actual trading or investment operations
of the business of the company to take
place in Australia. This is because the
central management and control of a
business is factually part of carrying on
that business. A company carrying on
business does so both where its trading
and investment activities take place, and
where the central management and control
of those activities occurs.

What does central management and
control mean? 

Central management and control refers to
the control and direction of a company’s
operations. It does not refer to a physical
location in which the control and direction
of a company is located, and may
ultimately be exercised in more than one

The key element in the control and
direction of a company’s operations is the
making of high-level decisions that set the
company’s general policies, and determine
the direction of its operations and the type
of transactions it will enter.

The control and direction of a company
is different from the day-to-day conduct
and management of its activities and
operations. The day-to-day conduct
and management of a company’s
operations might be an exercise of central
management and control in circumstances
where they are effectively the same.

Merely because a person is a majority
shareholder or has the power to appoint those who control and direct a company’s
operations does not, by itself, mean the
person controls and directs a company’s
operations and activities.

Acts of central management and

Exercising central management and control
of a company can involve:

  • setting investment and operational
  • appointing company officers and agents
    and granting them power to carry on the
    company’s business (and the revocation
    of such appointments and powers); 
  • overseeing and controlling those
    appointed to carry out the day-to-day
    business of the company; and 
  • matters of finance, including
    determining how profits are used and
    the declaration of dividends. 

Matters of company administration are
not acts of central management and
control. Examples of these are keeping a
company’s share register and keeping and
adopting a company’s accounts.

A starting point 

Normally, where a company is run by
its directors in accordance with its
constitution and the company law rules
applicable to that company, which give
its directors the power to manage the
company, the company’s directors will
control and direct its operations. It follows
that ordinarily it is a company’s directors
who exercise its central management and

However, the actions of a company’s
directors, or others with the legal power
and authority to control and manage the
company, are not the end of the enquiry as
to who exercises central management and
control. There is no presumption that the
directors of a company will always exercise
its central management and control.

When determining who exercises a
company’s central management and
control, all the relevant facts and
circumstances must be considered.

Mere legal power or authority 

A person who has legal power or authority
to control and direct a company, but
does not use it, does not exercise central
management and control. For example,
in Bywater, the court disregarded the
role of those directors who were formally
appointed but did not play any real role in
the affairs of the company.

Tacit control 

A person may control and direct a
company without actively intervening in
the company’s affairs on an ongoing basis
provided they:

  • have appointed agents or managers
    whom they tacitly control to conduct
    the company’s day-to-day business; 
  • tacitly control and regularly exercise
    oversight of the affairs of the company,
    including monitoring the company’s
    performance; and 
  • do not need to actively intervene
    because the company’s affairs are
    running smoothly and in the manner
    they desire. 

Where is central management and
control exercised? 

A company will be controlled and directed
where those making its high-level
decisions do so as a matter of fact and
substance. It is not where they are merely
recorded and formalised, or where the
company’s constitution, bylaws or articles
of association require it be controlled and
directed, if, in reality, it occurs elsewhere.
This will not necessarily be the place where
those who control and direct a company

Control and direction of a company may
be undertaken by those controlling a
company in multiple places. This means
a company’s central management and
control may be divided between more
than one place. However, a company’s
central management and control will only
be exercised in a place for the purpose
of the central management and control
test if it is exercised in that place to a
substantial degree, sufficient to conclude
the company is really carrying on business

Relevance of a company’s activities 

Central management and control of a
company is not necessarily exercised
where the trading or investment activities of
the company are carried on. However, the
nature of a company’s business activities
may dictate where its key decisions must
be made as a matter of practice.

Residence of directors vs residence
of a company 

Where a company’s central management
and control is exercised is not determined
by where the directors, or other persons,
who control and manage it, are resident or
live. What matters is where they actually
perform the activities to control and direct
the company.

4. Part IVA: restructures of hybrid
mismatch arrangements 

A draft practical compliance guideline has
been released which sets out the ATO’s
compliance approach with respect to the
general anti-avoidance provisions (Pt IVA
ITAA36) and certain restructures that
have the effect of preserving Australian
tax benefits that would otherwise be
disallowed under the hybrid mismatch
rules (proposed Div 832 of the Income
Tax Assessment Act 1997 (Cth) (ITAA97)
which are being enacted by the Treasury
Laws Amendment (Tax Integrity and Other
Measures No. 2) Bill 2018 (PCG 2018/D4).

The hybrid mismatch rules will implement
into Australian taxation law the
recommendations of the Organisation for
Economic Co-operation and Development.
The rules are intended to deter the use of
certain hybrid arrangements that exploit
differences in the tax treatment of an entity
or financial instrument under the income
tax laws of two or more countries.

The rules are to have a 1 January 2019
commencement which is intended to allow
taxpayers time to review their existing
hybrid arrangements and to unwind or
restructure out of such arrangements in
advance of the rules, if they so choose.

The draft practical compliance guideline
states that concerns have been raised
about the potential for the Commissioner to
apply the general anti-avoidance provisions
(Pt IVA) to cancel all or part of a tax benefit
where a taxpayer restructures an existing
hybrid arrangement to avoid the potential
application of the hybrid mismatch rules.
This may involve, for example, replacing
a hybrid financing instrument with a debt
instrument to eliminate tax benefits in
another country but preserve tax benefits,
in the form of deductible debt, in Australia.

The draft guideline is designed to assist
taxpayers to manage their compliance
risk in these circumstances where their
intention is to eliminate hybrid outcomes.
It does so by outlining restructuring that
the Commissioner considers to be of “low
risk” and to which he would not seek to
apply Pt IVA.

The description of low risk arrangements
is illustrated by scenarios involving
straightforward restructuring that
merely removes the hybrid element of
existing arrangements while keeping the
surrounding facts and circumstances unchanged (for example, relevant nexus to
the derivation of assessable income). The
draft guideline is not intended to provide
more detailed technical guidance on when
Pt IVA could potentially apply to more
complex restructuring scenarios. Such
guidance would be of limited practical
utility given the nature of Pt IVA and
the overriding importance of facts and
circumstances in the particular case.

5. CGT improvement threshold 

For the 2018-19 income year, the indexed
CGT improvement threshold is $150,386
(TD 2018/8).

The improvement threshold is determined
for the purposes of s 108-70 ITAA97 (about
when a capital improvement to a pre-CGT
asset is a separate asset). It is also
determined for the purposes of s 108-75
ITAA97 (about capital improvements to
CGT assets for which a roll-over may be

6. Interest incurred by
discretionary trust beneficiary 

A recent final taxation determination
is to the effect that a beneficiary of a
discretionary trust who borrows money,
and on-lends all or part of that money
to the trustee of the discretionary trust
interest-free, is usually not entitled to a
general deduction (under s 8-1 ITAA97)
for any interest expenditure incurred by
the beneficiary in relation to the borrowed
money on-lent to the trustee (TD 2018/9).

The determination states that it is only

  • the beneficiary is presently entitled to
    income of the trust estate at the time
    the expense is incurred; and  
  • the expense has a nexus with the
    income to which the beneficiary is
    presently entitled, 

that some part of the interest expense
might be deductible. Even then, the interest
expense is likely to have been incurred
in the pursuit of one or more objectives
other than the derivation of assessable
income by the beneficiary and will not be
deductible to the extent of any non-income
producing objective/s.

Although the determination is concerned
only with interest deductibility, the
principles described would also apply to
other expenses incurred by a beneficiary
of a discretionary trust to the extent that
the beneficiary asserts that the expense is
deductible by reason of its connection to
an expected receipt of a trust distribution.

Examples of such expenses might include
motor vehicle expenses, stationery and
telephone expenses.

7. Cross-border related party
financing arrangements 

A recently issued final practical compliance
guideline outlines the ATO’s compliance
approach to the taxation outcomes
associated with a “financing arrangement”,
or a related transaction or contract,
entered into with a cross-border related
party (called a “related party financing
arrangement” (PCG 2017/4).

The ATO uses the framework in the
guideline (and the accompanying
schedules) to assess risk and tailor its
engagement with the taxpayer according to
the features of the related party financing
arrangement, the profile of the parties to
the related party financing arrangement
and the choices and behaviours of the
particular group. The tax risk associated
with a related party financing arrangement
is assessed having regard to a combination
of quantitative and qualitative indicators.

If the related party financing arrangement
is rated as low risk, then it can be expected
that the Commissioner will generally not
apply compliance resources to review the
taxation outcomes other than to fact check
the appropriate risk rating. If the related
party financing arrangement falls outside
the low risk category, it can be expected
that the Commissioner will monitor, test
and/or verify the taxation outcomes. The
higher the risk rating, the more likely an
arrangement will be reviewed as a matter
of priority.

The guideline has effect from 1 July 2017
and applies to existing and newly created
financing arrangements. The guideline
does not cover financing arrangements
characterised as equity in accordance with
Div 974 ITAA97.

8. GST withholding rules 

The Commissioner has issued a law
companion ruling that deals with the
recently enacted GST notification and
withholding requirements for vendors and
purchasers of residential premises and
potential residential land where (broadly)
the contract is entered into on or after
1 July 2018 (LCR 2018/4).

Unless an exclusion applies, the
purchaser’s liability to make a payment to
the Commissioner arises if the purchaser
is the recipient of a taxable supply by
sale or long-term lease of new residential
premises, or potential residential land.
The vendor is then entitled to a credit for
the amount paid to the Commissioner by
the purchaser. The credit arises when the
vendor’s net amount is assessed on their
GST return.

The law companion ruling explains how the
new rules apply, including:

  • the types of supplies for which
    purchasers are required to pay; 
  • when a purchaser is required to pay; 
  • the amount the purchaser is required
    to pay; 
  • the requirement for a vendor to provide
    a notice to the purchaser; and 
  • the penalties that may apply to vendors
    and purchasers. 

Recent case decisions 

9. Small business CGT

The Administrative Appeals Tribunal
(AAT) has affirmed the Commissioner’s
decision that the taxpayer did not satisfy
the maximum net asset value test and,
therefore, was not eligible for the CGT
small business reliefs (Hookey and FCT1

The taxpayer made an assessable capital
gain in the 2008 income year when, by
contracts dated 13 December 2007, he or
entities which he controlled (that is, entities
related to him) sold five child care centre
businesses to ABC Development Learning

For the purpose of applying the maximum
net asset value test, there were six
liabilities in dispute. Two of these are of
some interest.

One liability was the accrued interest on
90% of an RAB Finance Pty Ltd loan.
The loan was taken out by a related entity
predominately for purposes connected
with the asset, secured by a registered
mortgage on the asset, and the asset
was one of the CGT assets on which
the net assets were calculated. Both the
Commissioner and the taxpayer treated
90% of the amount of the principal
borrowed as a relevant liability. Interest
accrued but unpaid on 13 December 2007
was disregarded in the Commissioner’s
calculations and was asserted by the
taxpayer to be a relevant liability. The
taxpayer was a guarantor of the facility,
and so far as he was concerned, the
liability to pay interest (and principal as
well) may properly have been regarded as
a contingent liability. The Commissioner submitted that the liability to pay interest
was only a contingent one, and therefore
to be disregarded. However, so far as the
borrower was concerned, no contingency
affected its liability to pay interest and the
AAT treated 90% of the whole of that loan,
including interest, as a relevant liability.

When addressing a submission by the
Commissioner, the AAT said that the
word “liability” takes its ordinary English
meaning in the ITAA97 which does not
require that moneys be immediately due
and payable, but simply that they be
payable. On that view, interest which has
already accrued would form part of the
liabilities of the entity at the relevant date,
and interest which has not yet accrued
would not do so.

The other liability contended for which
is of interest arose from the family law
arrangements made by the taxpayer with
his former wife. Under court-approved
terms of settlement, the taxpayer was to
pay to the wife the sum of $1,500,000.
By order 2, the wife was to transfer to the
taxpayer a number of assets, including
her interests in the KA Penrith and
KA Warnervale child care centres. Order 2
was not expressed to be the consideration
for order 1. When the transfer document
was entered into, dated 7 November 2007,
no consideration for any particular asset
was specified, no doubt because transfers
under the Family Law Act 1975 (Cth) are
free of stamp duty. The only consideration
expressed was the family law settlement.

The AAT rejected a contention that a
portion of the sum of $1,500,000 should
be allocated to the Penrith and Warnervale
centres. The AAT was not satisfied of that
fact nor that the amount of $1,500,000
was outstanding on 13 December
2007. Whatever values may have been
attributed by either or both of the parties
to those assets did not appear, and more
importantly, contributions may have been
taken into account by the taxpayer or his
wife, or both of them, when calculating the
sum of $1,500,000. The fact that a transfer
document was dated in November did
not suggest that anything was still due in

10. Tax agent deregistration 

The AAT has affirmed a decision of the
Tax Practitioners Board to terminate
the registration of an individual as a tax
agent on the ground that she was not a
“fit and proper” person (Beckett and Tax
Practitioners Board2

The applicant’s current status was that
of a person who had been convicted of
two charges of using false documents to
influence the exercise of a public duty. She
had also publicly acknowledged her guilt
of a further offence of knowingly making a
false statement under oath. She had been
sentenced to imprisonment for a, currently
unexpired, period of 20 months, and was
subject to a good behaviour bond. Those
circumstances were, in the AAT’s view,
incompatible with the applicant currently
being regarded as a person who can
properly be characterised as of “good

The AAT senior member said that he was
conscious of the gravity of the present
proceedings and the potential personal
implications for the applicant, and for
her family, of their adverse resolution.
Nevertheless, on the basis of the material
before the tribunal, he had reached a firm
view of absence of satisfaction that the
applicant was currently a person of either
good fame, or a person of good integrity
and character.

The decision of the AAT contains a
comprehensive overview of the principles
that are relevant to a “fit and proper
person” analysis.

11. Onus not discharged 

The Federal Court (Steward J) has
dismissed appeals by a taxpayer
against objection decisions made by
the Commissioner involving amended
assessments for eight income years which
increased the taxpayer’s taxable income
for those income years by a total of $2.86m
and imposed penalties of $2.08m (Bosanac
v FCT3

His Honour held that the taxpayer had failed
in relation to each income year in dispute
to demonstrate that any of the amended
assessments issued to him were excessive.
That was because, in addition to rejecting
his evidence concerning the nature of the
deposits into his bank accounts (other
than in relation to a car), the taxpayer
failed to positively adduce evidence as to
the quantum and nature of his foreign and
domestic earnings in each income year in
dispute. The taxpayer needed to go further
than his attack on the basis on which the
Commissioner had issued the amended
assessments to him, and positively prove
what his taxable income was in each year.
He needed to lead evidence constituting
a wide survey and exact scrutiny of his
business activities. This he never did.

Steward J said that the word “excessive”
in the onus of proof provisions, might
not, as the High Court observed in
McAndrew v FCT,
have been a “good
choice”, and certainly extended to the
existence or non-existence of a condition
for the exercise of power in a relevant
case. But in the usual case, it directs
attention to a number, being the difference
between taxable income as assessed,
and the taxable income contended for
by the taxpayer. That number can only
be adequately identified on the taxpayer
proving — or otherwise demonstrating —
what its taxable income was in any given
income year.


Steward J also upheld the imposition
of intentional disregard administrative
penalties at the rate of 75%, increased
by 20% for obstruction.

12. Residence: individual

The Federal Court (Derrington J) has held
that, on the facts, a taxpayer who had an
Australian domicile but worked overseas
did not have a place of abode outside
Australia and, therefore, was a resident of
Australia for income tax purposes for the
2011 income year and was assessable on
income derived from ex-Australian sources
during that income year (Harding v FCT5).

As with most cases involving the question
of whether an individual is a resident, there
were quite a range of facts that the court
needed to take into account.

Derrington J first found that the taxpayer
was not resident in Australia within the
ordinary concept of that term. It followed
from a consideration of the objective facts
surrounding the taxpayer’s circumstances
that, in 2009, he left Australia and went to
the Middle East with the intention of staying
there indefinitely and with no intention to
return to Australia and to continue to treat
it as “home”. His absence from Australia
and his formed intention not to return was
sufficient to terminate his residency here
to the extent that is determined by the
ordinary concepts of residency.

However, the taxpayer was a resident
under the domicile test in the definition of
“resident” in s 6(1) ITAA36. The taxpayer
conceded that his domicile was in Australia
but failed to establish that his permanent
place of abode was outside Australia.
On this issue, Derrington J concluded:

“It follows that in the relevant income year
Mr Harding [the taxpayer] did not establish a permanent place of abode in Bahrain. By its
character it was a type of premises used for
temporary or transitory accommodation and
Mr Harding used it as such. By Mr Harding’s own
acknowledgements in his affidavit, his presence
in that accommodation in that year was temporary
and only intended to continue until he was joined
by his wife and youngest son at which time they
would have acquired permanent accommodation.” 

The taxpayer has lodged an appeal to the
Full Federal Court from the decision of
Derrington J.

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1 [2018] AATA 1509.
2 [2018] AATA 1860.
3 [2018] FCA 946.
4 [1956] HCA 62.
5 [2018] FCA 837.


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