session 10b: tax issues for distressed times
SESSION 10B: TAX ISSUES FOR DISTRESSED TIMES Evan Last, CTA Deloitte
Teresa Dyson, CTA McCullough Robertson
Tax issues for distressed times Agenda
Preserving debt deductions Franking account health check The forgotten loss recoupment rules Modified COT doesn’t always deliver Good news on the fall-back test?
Preserving debt deductions
Adjusted average debt > Maximum allowable debt = Thinly capitalised
Preserving debt deductions What’s changed from 1 July 2015? Safe harbour debt limit decrease to 1.5:1
WWG ratio decrease to 100%
WWG ratio available to inbound investors
Increase of de-minimis threshold to $2m
Preserving debt deductions What should we do? Forecast the thin cap position well before year end
Other considerations Debt pricing Interest withholding tax
Consider alternative methods
Thin cap approaches Thin cap approaches Worldwide gearing test? •
Alternative valuation Safe harbour test methods? Tax balance sheet?
•
Worldwide • gearing Under test accounting
•
standards Arm’s length debt test • Using special intangible valuation rules
Arm’s length debt test?
Debt in focus Increased ATO focus However there were no changes in the 2016 Budget
Preserving debt deductions The tax balance sheet
Revalue of assets Internally generated intangibles modification Intangible assets with no active market modification
Role of external expert Elections
Preserving debt deductions TA 2016/1 Intangible assets and thin capitalisation ATO focus
1. Inappropriate recognition
Criteria
Exam ples
•
• •
• •
• 2. Inappropriate revaluation
• •
3. No impairing of assets
•
Item cannot be separated from the entity/no contractual or other legal rights; Entity lacks control over the item; or All potential future economic benefits of the item do not flow to the taxpayer.
Applying unsupportable/ questionable management assumptions Double counting of asset value across multiple intangibles Revaluing based on economic benefits that do not accrue to taxpayer
• • • • •
Entities not impairing assets where the fair value has declined, in accordance n/a with AASB 136 Impairment of Assets
Customer relationships/customer loyalty Skilled staff, management/key employees/training Internal policies, internal meeting protocols, procedures and manuals Assets not owned and controlled by the taxpayer. Unrealistic market growth rates Software valuations with a useful life of ≥ 25 years Revaluing generic material e.g. internal policies
Franking account health check
Imputation discourages double taxation
Franking account health check Factors influencing franking account balance Permanent and timing differences Cash tax optimisation projects NANE income Inappropriate transfer pricing arrangements
Franking account health check Corporate tax rate reduction Derived pre-30 June 2016 ($)
In the future…
Pre-tax profits
100.00
100.00
Company tax
30.00
27.50
After tax profit
70.00
72.50
Franking credits
30.00
27.50
Individual marginal tax rate
49%*
49%**
Dividend
70.00
72.50
Dividend paid Maximum franking credit
Trapped franking credit Grossed up dividend
Prior to 1 July
After 1 July
2016
2016
= 70.00 * (30/70)
=70.00 *
= 72.50 *
= 30
(27.5/72.5)
(27.5/72.5)
= 26.55
= 27.50
Nil
3.45
Nil
100.00
96.55
100.00
51.00
49.24
51.00
49%
50.8%
49%
Dividend to individual Cash (net of all taxes after distribution to shareholder) Effective tax rate after distribution to shareholder
Franking account health check
Dividend imputation is arguably the most effective antiavoidance measure introduced into the Australian tax system
Franking account health check International operations Intangible assets Group financing Management fees Domestic and international operations M&A activity Instalment rates Amendment requests Trading stock
The forgotten loss recoupment rules Subdivisions 165-CC and 165-CD Loss integrity provisions Share similar objectives and concepts
Prevent loss duplication/multiplication Subdivision 165-CC limits losses at loss company level Subdivision 165-CD limits losses at shareholder level
The forgotten loss recoupment rules Subdivision 165-CC case study 1 July 20X1
30 June 20X3
$1 $
Alpha
$100
Asset
MV
100
100
Delta
Alpha
$
100%
Beta
$
CB
$ Asset Liabilities Equity
CB
MV
300
300
(200)
(200)
100
100
Asset
CB
MV
100
1
Asset
CB
MV
1
1
100% $ CB
Beta
Asset Liabilities Equity
MV
300
1
(200)
(200)
100
(199)
The forgotten loss recoupment rules Subdivision 165-CC case study continued On 30 June 20X4, Beta sells its assets for $1
Is there a changeover time? What is the unrealised net loss? How much of the capital loss can be recouped? How can the capital loss be recouped?
The forgotten loss recoupment rules Subdivision 165-CD case study 1 July 20X1
30 June 20X3 $400
$ Asset
$
CB
MV
1000
1000
Zeta
Eta Asset
CB
MV
1000
400
Lota
Zeta
30%
70%
Theta
Eta
30%
70%
$ C/fwd capital loss
400
Unrealised capital loss
100
Theta
The forgotten loss recoupment rules Subdivision 165-CD continued On 30 June 20X3, Zeta sells its shares in Theta for $400
Is there an alteration time? Is there a loss company? Is there a relevant entity? Are there any notice requirements?
The forgotten loss recoupment rules Subdivisions 165-CC and 165-CD loss calculations Trading stock Consumables Computers Furniture Fittings Motor vehicles Heavy equipment Land Buildings
Cost base 12,000 6,500 8,500 32,000 81,500 54,950 115,000 258,000 118,950
Market value 14,000 6,000 6,000 8,000 70,000 32,500 98,000 275,000 125,000
Modified COT doesn’t always deliver Loss recoupment case study LossCo is an ASX listed mining company At 30 June 20X1, LossCo has carried forward tax losses of $10m During the 30 June 20X2 income year, BuyerCo acquires 99% of the shares in LossCo LossCo is immediately delisted In the 30 June 20X2 income year, LossCo has taxable income of $3m
Modified COT doesn’t always deliver Loss recoupment case study continued
Division 165 test period Loss year
Intervening period
Income year
Ownership test period
Division 166 test period Loss year
End of each income year / end of each corporate change Test period
Income year
Modified COT doesn’t always deliver Loss recoupment case study continued
A company is eligible for the modified COT if it is widely held or an eligible Division 166 company for the income year in which it seeks to deduct a tax loss. Companies that are neither widely held nor eligible Division 166 companies continue to use Division 165 to determine whether they satisfy the COT.
Good news on the fall-back test? What’s changing? Losses incurred after 1 July 2015 can be carried forward using the more relaxed similar business test
Intended to help businesses take sensible risks to get back in the black
Deriving income from a “new business” or a “new transaction” will not automatically cause a failure of the similar business test
Good news on the fall-back test? Proposed law Current law Companies can only access prior year losses if they pass: •
the continuity of ownership test (COT), or
•
if the COT is failed, the same business test (SBT).
SBT is supplemented with a more flexible “similar business test”. The new test gives regard to: •
The extent to which the assets (including goodwill) that are used in current business to generate assessable income were also used in the former business
•
The extent to which the sources from which the current business generates assessable income were also the sources from which the former business generated assessable income
•
Whether any changes to the former business are changes that would reasonably be expected to have been made to a similarly placed business
Good news on the fall-back test? Similar business test case study (example 1.2 of exposure draft EM) RePoly converts algae into a biodegradable plastic Significant carried forward loss balances, predominantly arising from R&D RePoly introduces a new investor Additional equity issued to the new investor causes COT to be breached
Good news on the fall-back test? Similar business test case study continued RePoly subsequently discover algae can be used for production of teeth whitening products Sales of teeth whitening product become a small part of RePoly business income RePoly returns to profit and seek to apply carried forward losses
Good news on the fall-back test? Similar business test case study (example 1.4 of exposure draft EM) Bob’s homewares business is on a main street and is highly reputable It has been trading at a loss for a number of years Mary buys the business causing a failure of COT Mary decides to sell high-end stationery instead of homewares
Good news on the fall-back test? Similar business test case study continued Mary returns the business to profits by:
Negotiating favourable supply contracts using her contacts Capitalising on the shop exposure on the main street Continuing to use the brand name and logo of the homewares store
Mary seeks to apply the prior year losses against the profit
© Evan Last, CTA and Teresa Dyson, CTA 2016 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this presentation and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.
Teresa Dyson, CTA McCullough Robertson
Tax issues for distressed times Agenda
Preserving debt deductions Franking account health check The forgotten loss recoupment rules Modified COT doesn’t always deliver Good news on the fall-back test?
Preserving debt deductions
Adjusted average debt > Maximum allowable debt = Thinly capitalised
Preserving debt deductions What’s changed from 1 July 2015? Safe harbour debt limit decrease to 1.5:1
WWG ratio decrease to 100%
WWG ratio available to inbound investors
Increase of de-minimis threshold to $2m
Preserving debt deductions What should we do? Forecast the thin cap position well before year end
Other considerations Debt pricing Interest withholding tax
Consider alternative methods
Thin cap approaches Thin cap approaches Worldwide gearing test? •
Alternative valuation Safe harbour test methods? Tax balance sheet?
•
Worldwide • gearing Under test accounting
•
standards Arm’s length debt test • Using special intangible valuation rules
Arm’s length debt test?
Debt in focus Increased ATO focus However there were no changes in the 2016 Budget
Preserving debt deductions The tax balance sheet
Revalue of assets Internally generated intangibles modification Intangible assets with no active market modification
Role of external expert Elections
Preserving debt deductions TA 2016/1 Intangible assets and thin capitalisation ATO focus
1. Inappropriate recognition
Criteria
Exam ples
•
• •
• •
• 2. Inappropriate revaluation
• •
3. No impairing of assets
•
Item cannot be separated from the entity/no contractual or other legal rights; Entity lacks control over the item; or All potential future economic benefits of the item do not flow to the taxpayer.
Applying unsupportable/ questionable management assumptions Double counting of asset value across multiple intangibles Revaluing based on economic benefits that do not accrue to taxpayer
• • • • •
Entities not impairing assets where the fair value has declined, in accordance n/a with AASB 136 Impairment of Assets
Customer relationships/customer loyalty Skilled staff, management/key employees/training Internal policies, internal meeting protocols, procedures and manuals Assets not owned and controlled by the taxpayer. Unrealistic market growth rates Software valuations with a useful life of ≥ 25 years Revaluing generic material e.g. internal policies
Franking account health check
Imputation discourages double taxation
Franking account health check Factors influencing franking account balance Permanent and timing differences Cash tax optimisation projects NANE income Inappropriate transfer pricing arrangements
Franking account health check Corporate tax rate reduction Derived pre-30 June 2016 ($)
In the future…
Pre-tax profits
100.00
100.00
Company tax
30.00
27.50
After tax profit
70.00
72.50
Franking credits
30.00
27.50
Individual marginal tax rate
49%*
49%**
Dividend
70.00
72.50
Dividend paid Maximum franking credit
Trapped franking credit Grossed up dividend
Prior to 1 July
After 1 July
2016
2016
= 70.00 * (30/70)
=70.00 *
= 72.50 *
= 30
(27.5/72.5)
(27.5/72.5)
= 26.55
= 27.50
Nil
3.45
Nil
100.00
96.55
100.00
51.00
49.24
51.00
49%
50.8%
49%
Dividend to individual Cash (net of all taxes after distribution to shareholder) Effective tax rate after distribution to shareholder
Franking account health check
Dividend imputation is arguably the most effective antiavoidance measure introduced into the Australian tax system
Franking account health check International operations Intangible assets Group financing Management fees Domestic and international operations M&A activity Instalment rates Amendment requests Trading stock
The forgotten loss recoupment rules Subdivisions 165-CC and 165-CD Loss integrity provisions Share similar objectives and concepts
Prevent loss duplication/multiplication Subdivision 165-CC limits losses at loss company level Subdivision 165-CD limits losses at shareholder level
The forgotten loss recoupment rules Subdivision 165-CC case study 1 July 20X1
30 June 20X3
$1 $
Alpha
$100
Asset
MV
100
100
Delta
Alpha
$
100%
Beta
$
CB
$ Asset Liabilities Equity
CB
MV
300
300
(200)
(200)
100
100
Asset
CB
MV
100
1
Asset
CB
MV
1
1
100% $ CB
Beta
Asset Liabilities Equity
MV
300
1
(200)
(200)
100
(199)
The forgotten loss recoupment rules Subdivision 165-CC case study continued On 30 June 20X4, Beta sells its assets for $1
Is there a changeover time? What is the unrealised net loss? How much of the capital loss can be recouped? How can the capital loss be recouped?
The forgotten loss recoupment rules Subdivision 165-CD case study 1 July 20X1
30 June 20X3 $400
$ Asset
$
CB
MV
1000
1000
Zeta
Eta Asset
CB
MV
1000
400
Lota
Zeta
30%
70%
Theta
Eta
30%
70%
$ C/fwd capital loss
400
Unrealised capital loss
100
Theta
The forgotten loss recoupment rules Subdivision 165-CD continued On 30 June 20X3, Zeta sells its shares in Theta for $400
Is there an alteration time? Is there a loss company? Is there a relevant entity? Are there any notice requirements?
The forgotten loss recoupment rules Subdivisions 165-CC and 165-CD loss calculations Trading stock Consumables Computers Furniture Fittings Motor vehicles Heavy equipment Land Buildings
Cost base 12,000 6,500 8,500 32,000 81,500 54,950 115,000 258,000 118,950
Market value 14,000 6,000 6,000 8,000 70,000 32,500 98,000 275,000 125,000
Modified COT doesn’t always deliver Loss recoupment case study LossCo is an ASX listed mining company At 30 June 20X1, LossCo has carried forward tax losses of $10m During the 30 June 20X2 income year, BuyerCo acquires 99% of the shares in LossCo LossCo is immediately delisted In the 30 June 20X2 income year, LossCo has taxable income of $3m
Modified COT doesn’t always deliver Loss recoupment case study continued
Division 165 test period Loss year
Intervening period
Income year
Ownership test period
Division 166 test period Loss year
End of each income year / end of each corporate change Test period
Income year
Modified COT doesn’t always deliver Loss recoupment case study continued
A company is eligible for the modified COT if it is widely held or an eligible Division 166 company for the income year in which it seeks to deduct a tax loss. Companies that are neither widely held nor eligible Division 166 companies continue to use Division 165 to determine whether they satisfy the COT.
Good news on the fall-back test? What’s changing? Losses incurred after 1 July 2015 can be carried forward using the more relaxed similar business test
Intended to help businesses take sensible risks to get back in the black
Deriving income from a “new business” or a “new transaction” will not automatically cause a failure of the similar business test
Good news on the fall-back test? Proposed law Current law Companies can only access prior year losses if they pass: •
the continuity of ownership test (COT), or
•
if the COT is failed, the same business test (SBT).
SBT is supplemented with a more flexible “similar business test”. The new test gives regard to: •
The extent to which the assets (including goodwill) that are used in current business to generate assessable income were also used in the former business
•
The extent to which the sources from which the current business generates assessable income were also the sources from which the former business generated assessable income
•
Whether any changes to the former business are changes that would reasonably be expected to have been made to a similarly placed business
Good news on the fall-back test? Similar business test case study (example 1.2 of exposure draft EM) RePoly converts algae into a biodegradable plastic Significant carried forward loss balances, predominantly arising from R&D RePoly introduces a new investor Additional equity issued to the new investor causes COT to be breached
Good news on the fall-back test? Similar business test case study continued RePoly subsequently discover algae can be used for production of teeth whitening products Sales of teeth whitening product become a small part of RePoly business income RePoly returns to profit and seek to apply carried forward losses
Good news on the fall-back test? Similar business test case study (example 1.4 of exposure draft EM) Bob’s homewares business is on a main street and is highly reputable It has been trading at a loss for a number of years Mary buys the business causing a failure of COT Mary decides to sell high-end stationery instead of homewares
Good news on the fall-back test? Similar business test case study continued Mary returns the business to profits by:
Negotiating favourable supply contracts using her contacts Capitalising on the shop exposure on the main street Continuing to use the brand name and logo of the homewares store
Mary seeks to apply the prior year losses against the profit
© Evan Last, CTA and Teresa Dyson, CTA 2016 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this presentation and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.
