September Update
This month:
ATO take ‘gloves off’ on overseas income
Guidance on home-based businesses
Rental property expenses - what you can and can’t claim
Outrageous deductions rejected
Motor vehicle registries data matching program protocol
Black economy road trip to combat the $11.1bn small business tax shortfall
Common GST errors for importers and exporters
Luxury Car Tax relief for primary producers and tourism operators
Known incorrect ENCC determinations
Are all your SMSF eggs in one basket?
ATO take ‘gloves off’ on overseas income
Five years ago, the Australian Taxation Office (ATO) offered a penalty amnesty on undisclosed foreign income. Five years on, the ATO has again flagged that underreporting of foreign income is an issue but this time the gloves are off.
How you are taxed and what you are taxed on depends on your residency status for tax purposes. As tax residency can be different to your general residency status it’s important to seek clarification. The residency tests don’t necessarily work on ‘common sense.’
For tax purposes:
Australian resident - taxed on worldwide income including money earned overseas (such as employment income, directors fees, consulting fees, income from investments, rental income, and gains from the sale of assets).
Foreign resident - taxed on their Australian sourced income and some capital gains. Unlike Australian resident taxpayers, non-resident taxpayers pay tax on every dollar of taxable income earned in Australia starting at 32.5% although lower rates can apply to some investment income like interest and dividends.
There is no tax-free threshold. Australian sourced income might include Australian rental income and income for work performed in Australia.
Temporary resident – Generally, those who have come to work in Australia on a temporary visa and whose spouse is not a permanent resident or citizen of Australia. Temporary residents are taxed on Australian sourced income but not on foreign sourced income. In addition, gains from non-Australian property are excluded from capital gains tax.
Just because you work outside of Australia for a period of time does not mean you are not a resident for tax purposes during that period. And, for those with international investments, it’s important to understand the tax status of earnings from those assets. Just because the asset might be located overseas does not mean they are safe from Australian tax law, even if the cash stays outside Australia. Don’t assume that just because your foreign income has already been taxed overseas or qualifies for an exemption overseas that it is not taxable in Australia.
How your money is being tracked
A lot of Australians have international dealings in one form or another. The ATO’s analysis shows China, the United Kingdom, Switzerland, Singapore and the United States are popular countries for Australians.
The ATO shares the data of foreign tax residents with over 65 foreign tax jurisdictions. This includes information on account holders, balances, interest and dividend payments, proceeds from the sale of assets, and other income. There is also data obtained from information exchange agreements with foreign jurisdictions.
In addition, the Australian Transaction Reporting and Analysis Centre (AUSTRAC) provides data to the ATO (and the Department of Human Services) on flows of money to identify individuals that are not declaring income or paying their tax.
It’s not uncommon for taxpayers to forget to declare income from a foreign investment like a rental property or a business because they have had it for a long time and deal with it in the local jurisdiction with income earned ‘parked’ in that country. However, problems occur when the taxpayer wants to bring that income to Australia, AUSTRAC or the ATO’s data matching picks up on the transaction and then the taxpayer is contacted about the nature of the income. If the income is identifiable as taxable income (for example, from a property sale or income from a business), you can expect the ATO to look very closely at the details with an assessment and potentially penalties and interest charges following not long after. There is no point telling the ATO the money is a gift if it wasn’t, they can generally find the source of the transaction and will know it’s not from a very generous grandmother - misdirection is only going to annoy them and ensure that there is no leniency.
What you need to declare in your tax return
If you are an Australian resident, you need to declare all worldwide income in your tax return unless a specific exemption applies, although in some cases even exempt income needs to be reported. Income is anything you earn from:
Employment (including consulting fees)
Pensions, annuities and Government payments
Business, partnership or trust income
Crowdfunding
The sharing economy (AirBnB, Uber, AirTasker etc.,)
Foreign income (pensions and annuities, business income, employment income and consulting fees, assets and investment income including offshore bank accounts, and capital gains on overseas assets)
Some prizes and awards (including any gains you made if you won a prize and then sold it for a gain), and
Some insurance or workers compensation payments (generally for loss of income).
You do not need to declare prizes such as lotto or game show prizes, or ad-hoc gifts.
Do I need to declare money from family overseas?
A gift of money is generally not taxable but there are limits to what is considered a gift and what is income. If the ‘gift’ is from an entity (such as a distribution from a company or trust), if it is regular and supports your lifestyle, or is in exchange for your services, then the ATO may not consider this money to be a genuine gift.
I have overseas assets that I have not declared
Your only two choices are to do nothing (and be prepared to face the full weight of the law) or work with the ATO to make a voluntary disclosure. Disclosing undeclared assets and income will often significantly reduce penalties and interest charges, particularly where the oversight is a genuine mistake.
How to repatriate income or assets
Before moving funds out of an overseas account, company or trust it is important to ensure that you seek advice on the implications in Australia and the other country involved. This is a complex area and the interaction between the tax laws of different countries requires careful consideration to avoid unexpected consequences.
If you need to clarify your residency status for tax purposes or are uncertain about the tax treatment of income, please contact us today
Guidance on home-based businesses
The ATO has released some specific guidance in relation to home-based businesses. The guidance deals with the issues that arise in the context of a range of different business structures, including where the business is operated by a sole trader or as partners in a partnership as well as through entities such as companies and trusts.
For businesses operated as a sole trader or in partnership, the guidance outlines the circumstances in which it is possible to claim part of the occupancy expenses (i.e., rent, mortgage interest etc) for the home. There is also information on claiming running expenses and the methods that may be used in determining an appropriate business use percentage (including guidance on specific costs). This really just clarifies the ATO’s existing guidance in this area.
When it comes to businesses operating through companies or trusts, the ATO guide states:
“If you run your home-based business as a company or trust, your business should have a genuine, market-rate rental contract (or similar agreement) with the owner of the property.”
Unfortunately, the ATO doesn’t really expand on this and explain why a market-rate rental agreement needs to be put in place or the implications for the parties if this does not occur. At a high level, if the business entity pays more than market value rent then this could trigger Division 7A or other adverse tax implications. Alternatively, if the owner of the property is charging less than a market rate of rent then this could impact on their ability to claim deductions in relation to the property (e.g., holding costs).
The ATO also warns that where someone is an employee of the business entity and it pays or reimburses the owner for expenses associated with running a business from home, then this could trigger FBT issues for the business entity.
Rental property expenses - what you can and can’t claim
It’s not uncommon for landlords to be confused about what they can and can’t claim for their rental properties. What often seems to make perfect sense in the real world does not always make sense for the Australian Tax Office (ATO).
In general, deductions can only be claimed if they were incurred in the period that you rented the property or during the period the property was genuinely available for rent. This means a tenant needs to be in the property or you are actively looking for a tenant. If, for example, you keep the property vacant while you are renovating it, then you might not be able to claim the expenses during the renovation period if it was not rented or available for rent during this time (there are some exceptions to this general rule). There needs to be a relationship between the money you make and the deductions you claim.
Here are a few common problem areas:
Interest on bank loans
Only the interest on repayments for investment property loans, and bank charges, are deductible - not the actual loan itself. Also, if a loan facility is used for multiple purposes then only some of the interest expenses might be deductible. For example, if some of the loan is used to acquire or renovate a rental property but further funds are drawn down to pay for a holiday then this is a mixed purpose loan and an apportionment needs to be undertaken.
Repairs or maintenance?
Deductions claimed for repairs and maintenance is an area that the ATO is looking very closely at so it’s important to understand the rules. An area of major confusion is the difference between repairs and maintenance, and capital works. While repairs and maintenance can often be claimed immediately, the deduction for capital works is generally spread over a number of years.
Repairs must relate directly to the wear and tear resulting from the property being rented out. This generally involves restoring a worn out or broken part - for example, replacing damaged palings of a fence or fixing a broken toilet. The following expenses will not qualify as deductible repairs, but are capital:
Replacement of an entire asset (for example, a complete fence, a new hot water system, oven, etc.)
Improvements and extensions where you are going beyond the work that is required to restore the property back to its former state
Also remember that any repairs and maintenance undertaken to fix problems that existed at the time the property was purchased are not deductible, even if you didn’t find out about the problem until later.
The sharing economy
The deductions you can claim for ‘sharing’ a room or an entire house are similar to rental properties. You can claim tax deductions for expenses such as the interest on your home loan, professional cleaning, fees charged by the facilitator, council rates, insurance, etc. But, these deductions need to be in proportion to how much and how long you rent your home out. For example, if you rent your home for two months of the financial year, then you can only claim up to 1/6th of expenses such as interest on your home loan as a deduction. This would need to be further reduced if you only rented out a specific portion of the home.
Friends, family and holiday homes
If you have a rental property in a known holiday location, the ATO is likely to be looking closely at what you are claiming. If you rent out your holiday home, you can only claim expenses for the property based on the time the property was rented out or genuinely available for rent and only if the property was not actually being used for private purposes at that time.
If you, friends or relatives use the property for free or at a reduced rent, it is unlikely to be genuinely available for rent and as a result, this may reduce the deductions available. It’s a tricky balance particularly when you are only allowing friends or relatives to use the property in the down time when renting it out is unlikely.
A property is more likely to be considered unavailable if it is not advertised widely, is located somewhere unappealing or difficult to access, and the rental conditions - price, no children clause, references for short terms stays, etc., - make it unappealing and uncompetitive.
"Outrageous" deductions rejected
The ATO has published some of the most unusual claims that they disallowed last financial year.
Nearly 700,000 taxpayers claimed almost $2 billion of ‘other’ expenses, but the ATO's systematic review of claims had found, and disallowed, some very unusual expenses, including:
claims for Lego sets bought as gifts for children, and sporting equipment or membership fees for their child athletes;
claims for dental expenses ("believing a nice smile was essential to finding a job");
some taxpayers tried to claim the purchase of a brand new car (in excess of $20,000 each!), with one "particularly charitable" taxpayer trying to claim for a car purchased as a gift for their mother;
one taxpayer made a claim for "the cost of raising twins", while another claimed for the "cost of raising three children" (and another taxpayer was obviously shocked at the cost of having children, simply stating "New born baby expensive" when making their claim);
other taxpayers claimed child support payments, private school fees, school uniforms, before school care and other school expenses, as well as health insurance costs and medical expenses; and
one taxpayer decided to claim the cost of their wedding reception.
The ‘other’ deductions section of the tax return is for expenses incurred in earning income that don’t appear elsewhere on the return — such as income protection and sickness insurance premiums.
The ATO is reminding taxpayers that, in order to claim an ‘other’ deduction, the expenses must be directly related to earning income and they need to have a receipt or record of the expense.
Motor vehicle registries data matching program protocol
The ATO will match the data provided by the State and Territory motor vehicle registering authorities against the ATO’s taxpayer records with the objective of identifying those who may not be meeting their registration, reporting, lodgment and payment obligations.
Details will be requested where records indicate a vehicle has been transferred or newly registered during the 2016/17, 2017/18 and 2018/19 financial years where the purchase price or market value is equal to or exceeds $10,000 (approximately 2 million transactional records a year).
This data will allow compliance checks on luxury car tax, FBT and fuel schemes, as well as identifying higher risk taxpayers with outstanding taxation lodgments, and those with undeclared income or concealing the real accumulation of wealth.
The ATO hits the road to combat the $11.1bn small business tax shortfall
Last month, the ATO released statistics showing small business is responsible for 12.5% ($11.1 billion) of the total estimated ‘tax gap’.
These new figures give visibility to tax compliance issues within the small business sector and indicate where we can expect ATO resources to be focussed now and in the future.
The tax gap estimates the difference between the tax collected and the amount that would have been collected if everyone was fully compliant with the law.
Australia’s small business community is doing comparatively well with international figures showing gaps in this same sector of between 9% and 30%.
ATO Deputy Commissioner Deborah Jenkins says that some small businesses are making mistakes with their tax, but these are often unintentional errors which are easily fixed.
To combat these errors, the ATO have ramped up their ‘visits’ to small businesses to monitor compliance, and educate business operators on compliance expectations with the goal of reducing the black economy (estimated to be 64% of the total small business tax gap). The ATO plans to visit almost 10,000 businesses this financial year.
According to Assistant Commissioner Peter Holt, there are a number of businesses in some areas not registered for GST or PAYG withholding, which can be a sign of the black economy, as well as a number of businesses with overdue tax returns.
Other black economy signs that the ATO looks out for are things like lifestyle and assets far exceeding reported business income, sham contracting, a failure to provide pay slips, reports that employers are paying their workers cash in hand and keeping them off the books, or a lack of merchant payment facilities like EFTPOS.
If the ATO turn up at your business, they may spot check how you are recording your sales and the records for the past day or so. They may also check payroll records to ensure that staff are ‘on the books’ and superannuation entitlements are being met. If something does not look right in an initial assessment, it’s likely the ATO will expand their enquiries to other elements of the business.
Some businesses are more likely than others to get a visit from the ATO, including:
Residential building construction;
Building completion and installation services, and other construction services;
Building cleaning, pest control, and gardening services;
Accommodation;
Pharmaceutical and other store-based retailing;
Automotive repair and maintenance;
Cafes, restaurants, and takeaway food services;
Personal care services;
Legal and accounting services;
Computer system design and related services; and
Adult, community and other education services
The ATO states that the three main drivers of the small business income tax gap are:
Not declaring all income
Failing to account for the private use of business assets or funds, and
Not sufficiently understanding tax obligations.
The small business tax gap estimate is based on a sample of 1,398 randomly selected businesses for the 2015-16 income year (around 0.03% of the small business population). The ATO are looking to expand that sample to 2,000 businesses. However, one of the criticisms of the tax gap analysis has been the size of the sample group, particularly given that ATO resources are allocated on a return on investment basis.
Tips to make your business ATO proof:
Tax reporting is up to date
Systems are in place to manage your business, those systems are set up correctly, and you can explain how those system work
Payroll records are up to date and accurate
You can explain and provide evidence that your invoicing or receipts system works correctly and is well maintained.
Common GST errors for importers and exporters
The ATO has issued guidance looking at common errors found in activity statements relating to imports or exports of goods and services. The errors include:
Incorrectly accounting for on-sold imported goods
The GST treatment when installing and assembling imported goods
Incorrect reporting of warehoused goods by overseas suppliers
Incorrectly classifying exports for GST purposes
If tax agents have clients involved in importing or exporting goods or services then it is important to ensure that the GST treatment of their transactions has been reviewed recently. Also, for entities that have not previously been registered for GST, it is important to check whether there is now a requirement to be registered under the Australian GST system. This is because a number of significant changes have been made in recent years which impact on the GST treatment of cross-border transactions.
If errors are identified, the ATO is urging taxpayers to make a voluntary disclosure as reduced penalties apply if a taxpayer voluntarily disclose errors before compliance activity commences.
Luxury Car Tax relief for primary producers and tourism operators
In the 2019-20 Budget, the Government announced that it would provide further relief to farmers and tourism operators by amending the luxury car tax (LCT) arrangements. Exposure draft legislation and explanatory materials for amendments that would give effect to this Budget announcement have now been released.
Under the proposed new arrangements, eligible primary producers and tourism operators will be able to apply for a refund of any luxury car tax paid, up to a maximum of $10,000, for vehicles acquired on or after 1 July 2019 (this is up from the current limit of 8/33rds of LCT paid up to a $3,000 limit). If the legislation is passed, it is expected that any additional entitlement arising as a result of the amendments will be provided automatically to affected entities based on their original claim (i.e., a claim made before the changes are enacted) and will not require a further application to be made.
The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If you have any queries please contact myself or a member of the Clear Accounting Solutions team
Regards,
Adrian De Vito - CPA