As the financial year draws to a close, it is time to start thinking about whether your year-end tax planning is in order.
Tax planning requires consideration of income and deductions for the year as well as whether compliance requirements have been met (e.g. appropriate elections have been made on a timely basis and other appropriate documentation prepared). This bulletin sets out a number of key considerations for this 30 June.
The new thin capitalisation provisions
The new thin capitalisation rules apply from 1 July 2023. Entities that are foreign controlled or majority foreign owned or have foreign investments may be subject to new rules that limit annual net debt deductions to 30% of the entity’s tax EBITDA (carried forward for up to 15 years). Distributions from entities in which a 10% interest is held are excluded from tax EBITDA which may have a significant impact on entities that borrowed to hold equity investments or receive trust distributions. Entities that only use third party borrowings may be able to elect to apply the third-party debt test to preserve their interest deductions.
The new rules are a fundamental change to the earlier balance sheet approach. Entities that may have been able to deduct all their interest in prior years may now find they have material denials under the new earnings-based test. It is imperative that you consider the application of the new rules, including whether an election can be made to use the alternative third-party debt test to claim all debt deductions in respect of certain third-party debt. However, the restrictive drafting of the provisions may deny the use of the third-party debt test in many circumstances. Accordingly, it will be crucial to examine the legal agreements involving both the borrower and any ‘obligor’ in respect of the borrowings (including entities that have provided credit support).
Consider the impact of the new debt deductions creation rules
From 1 July 2024, taxpayers may also be subject to the new debt deduction creation rules (“DDCR”). These rules can apply to entities that are subject to thin capitalisation as well as those entities excluded from the thin capitalisation provisions due to the 90% Australian asset test.
The provisions are drafted such that they can apply to historical transactions (no matter how far they date back) that still exist on 1 July 2024. For example, where associate debt has been used to fund (either directly or indirectly) a distribution of income or capital to a beneficiary or shareholder, the interest expense on such debt can potentially be wholly non-deductible under the DDCR from 1 July 2024. This type of scenario may exist in a simple case where there are Division 7A loans in the group.
The ATO has not provided any guidance on the DDCR but is due to release guidance later this year (including in relation to the scope of the provisions and what may be regarded as acceptable restructures of debt). The DDCR is expected to have a material impact on associate entity debt within a privately owned group that comes within the scope of the provisions. The provisions can result in material non-deductible amounts. There are also specific anti-avoidance provisions that can apply where debt funding is restructured that otherwise overcomes the application of the DDCR. As the provisions have a blunt effect (i.e. 100% denial of interest deductions), it is critical that taxpayers begin considering the potential application of these provisions at year end and in the new financial year.
Corporate tax entities – tax and franking rates
A corporate tax entity will be taxed at the lower corporate tax rate of 25% (rather than 30%) if it is a base rate entity. That is, if its aggregated turnover is less than $50 million and no more than 80% of the entity’s assessable income is Base Rate Entity Passive Income (“BREPI”). The rate used in calculating franking credits to be attached to a frankable dividend is 25% if the entity satisfies these two conditions but assessed by reference to turnover of the previous year. In addition, the rate for franking purposes is 25% if the entity did not exist in the previous year.
The Commissioner has confirmed[1] that a corporate tax entity whose assessable income and aggregated turnover for an income year are both nil, should qualify for the 25% reduced corporate tax rate. However, the applicable franking rate for dividends paid in that year would be 30% if, for example, its only income for the previous year was a small amount of bank interest.
As an entity’s tax rate and franking rate are determined by reference to different years, the tax rate for an income year may be different to the franking rate applicable to dividends paid in that year. Corporate tax entities should ensure that the correct franking rate is used in calculating the franking credit attached to a frankable dividend.
Division 7A matters
Transactions involving a company and an associated entity (individual, trust or partnership) to which Division 7A might apply (e.g. a payment, a loan, forgiveness of a debt or use of the company’s assets) should be carefully considered to determine whether a deemed dividend arises and, if so, what action could be taken to avoid that consequence.
Ensure that minimum yearly repayments (“MYRs”) are made before 30 June in respect of complying Division 7A loans made in prior years. Where dividends need to be declared by 30 June to enable MYRs to be made, ensure necessary resolutions are made and offset agreements entered into before year end. Consideration should also be given to whether the requirements of the qualified person rules[2] to ensure franking credits are accessible. A risk of not satisfying the qualified person rules may exist where the recipient of the dividend is a discretionary trust that has not made a Family Trust Election and the dividend is then distributed to the individual needing to make the MYR.
From 1 July 2022, the ATO treat unpaid present entitlements (“UPEs”) to companies as constituting loans for Division 7A purposes[3]. For UPEs arising in the 2021-22 and earlier years that were placed on investment agreements, ensure that appropriate amounts of interest have been recorded and that the interest has been paid in cash.
Bad debt write-offs
A business entity may be entitled to a deduction for bad and doubtful debts provided the debt is ‘written off’ prior to 30 June. This means that the debt needs to be appropriately authorised as being written off in the books (authorised journal entries) by 30 June or supported by a minute or director’s resolution that is similarly authorised by that date.
However, deductions may be denied if the relevant continuity of ownership and control tests are not satisfied. Crucially, the relevant tests for trusts do not provide an equivalent to the similar business test available to preserve deductions for companies that fail the continuity of ownership test.
If you have bad debts or are planning to claim a bad debt deduction, ensure you have considered the applicable tests at the necessary times before deducting any unrecovered amounts.
Non-accrual loans
Entities that hold loans that either have a high chance of, or are currently in, default, may have the ability to ‘turn off’ accruing the interest income during the year from an income tax perspective. The ability to do so will depend on whether certain criteria are satisfied (as set out in the Taxation of Financial Arrangements (“TOFA”) regime for entities subject to it, or, more generally, the non-accrual loan requirements outlined in Taxation Ruling TR 94/32).
This is an important part of year-end planning, as non-accrual loans (loans where the interest income does not accrue) do not require complex continuity of ownership testing and may help to minimise the differences between tax and accounting amounts where such amounts are also not recorded in the financial statements.
Intra-group charges
Where there are charges between group entities, you should ensure that agreements and other relevant paperwork that determine that the amount of the intragroup charge is ‘due and payable’ at 30 June 2024 (and thus incurred at 30 June 2024) is in place to substantiate deductibility. Intragroup charges can include items such as management fees, service charges and interest on loans.
You should ensure that the amounts are commercially justifiable, are not in excess of arm’s length amounts, and that they are not being charged and paid simply because losses or other deductions are otherwise available to the recipient.
Where trusts and companies are involved, you should ensure that you have appropriately considered the income injection rules that can apply to deny deductions in certain circumstances.
Trust considerations
When distributing income at year end, there are a number of considerations that the trustee needs to make. We have released a separate bulletin (link) which provides for a fuller discussion on these matters.
In addition to ensuring the requirements of the trust deed and the constitution of the corporate trustee, where relevant, are satisfied in respect of the distribution, trustees need to also ensure that they have considered the implications of the Owies decision and the ATO guidance in relation to reimbursement agreements.
Instant asset write-off
At the date of writing, legislation to implement the Government’s May 2024 Budget announcement to temporarily extend the instant asset write-off threshold for assets first used or installed ready for use between 1 July 2023 to 30 June 2024 remains stalled in Parliament. The Government proposal would increase the threshold for small business entities (i.e. those with aggregated turnover of less than $10 million) to eligible assets costing less than $20,000. The Senate agreed to increase the threshold to $30,000 and extend its application to medium business entities (i.e. those with aggregated turnover of less than $50 million). The House of Representatives has so far refused to agree to the amendment while the Senate has insisted. While we expect that the legislation will be passed allowing a $20,000 deduction limit, if you are relying on claiming a deduction under these provisions, you should closely monitor the status of the legislation over the next few weeks.
Rental properties and holiday homes
The ATO has flagged rental properties and holiday homes as an area of particular focus for this 30 June 2024 (link).
Include all income
The ATO has a number of data matching programs that enables it to detect under reporting of income (e.g. sharing economy platforms, rental bond agencies and state and territory revenue authorities). Rental property owners should ensure that all income is reported for tax purposes.
Only claim allowable deductions
You should review rental property related losses and outgoings to ensure deductions are not overclaimed.
Interest on loans
Interest on loans may not be fully deductible if the property is not genuinely available for rent, is used for private purposes for part of the year or family or friends are charged a below market rent. Additionally, interest on a loan secured against the property will need to be apportioned if part of the amount borrowed is used for private expenses such as holidays or a new car.
Depreciation
Where the rental property was acquired after 8 May 2017, no deduction will be available in respect of depreciating assets installed in a rental property at the time of acquisition unless the property was a “new residential premises” within the meaning of the GST Act or the taxpayer’s rental activities amount to the carrying on of a business. Where the rental property was acquired before 9 May 2017, no deduction will be available in respect of depreciating assets installed in the property as at 30 June 2017 if no depreciation deduction was available in the year ended 30 June 2017 because, for example, the property was not available for rent at any time during that year.
These rules do not apply to limit depreciation deductions for companies, superannuation entities (other than self-managed superannuation funds) and certain other entities.
Travel expenses
The ATO view is that no deduction is available for travel expenses related to inspecting, maintaining or collecting rent for a rental property unless the expenses were incurred in carrying on a business of providing residential accommodation or were incurred by a company, self-managed superannuation fund or certain other trusts or partnerships.
Record keeping
Adequate records substantiating amounts claimed as deductions and the extent they relate to producing rental income should be retained for five years from the date of lodgment of the tax return. Records of amounts that form part of the CGT cost base of the property should be retained for five years after the disposal of the property.
Working from home deductions
The ATO changed its guidance on the accepted method individuals may use in calculating deductions for working from home expenses as an alternative to the actual expenses method (i.e. calculating the additional expenses actually incurred in working from home).
For 2023-24, taxpayers may use the revised fixed rate of 67 cents per hour which covers additional running expenses, including electricity and gas, phone and internet usage, stationery, and computer consumables. Three conditions must satisfied to use this method: a) the work performed must involve carrying on substantive employment duties or in carrying on business, b) the taxpayer must have incurred deductible additional running expenses and c) the taxpayer meets the record keeping requirement: in particular, taxpayers must keep a record (time sheet or diary entries) of the total number of actual hours worked from home. Details of these conditions are set out in our earlier bulletin (link).
Additional deductions may be claimed for depreciating assets such as office furniture and computer equipment.
Deductions for Superannuation contributions
For an employer to be entitled to a deduction for superannuation contributions, the contribution must be received by the fund on or before 30 June. The SG contribution rate increased to 11.0% of an employee’s ordinary time earnings from 1 July 2023.
Individuals wishing to claim a deduction for personal contributions must provide the fund with a notice of intention to claim the deduction and have that acknowledged by the fund before the earlier of the day the individual’s 2023-24 tax return is lodged and 30 June 2025.
Anti-avoidance rules
Finally, it is worth noting that tax planning should be tempered by an awareness of the many anti-avoidance provisions and integrity rules available to the ATO such as: capital benefits provided in substitution for dividends[4], trust reimbursement agreements[5], “wash sale” arrangements[6] and Part IVA more generally.
What are the next steps?
Clients should contact their Pitcher Partners representative to review their existing arrangements and determine what action is required.
[1] Law Companion Ruling LCR 2019/5.[2] Also referred to as the 45-day holding period rules. [3] TD 2022/11. [4]Section 45B of the Income Tax Assessment Act 1936 (Cth) (“ITAA36”). [5] Section 100A of the ITAA36. (6] Taxation Ruling 2008/1.
