On 31 October 2008, the Assistant Treasurer and Minister for Competition Policy and Consumer Affairs, the Hon Chris Bowen MP, announced that the Government will abolish the trust cloning exception to CGT events E1 and E2.

Generally, a capital gains tax event happens when an asset is transferred to a new or existing trust. However, under the trust cloning exception no event happens if the asset is transferred to the trust from another trust and the beneficiaries and terms of both trusts are the same.

However the other exceptions will remain and a mere change of trustee of a single trust will continue not to trigger a CGT taxing point.

The Assistant Treasurer indicated that the amendment is aimed at resolving uncertainty surrounding the application of the exception, as well as removing the possibility of using the trust cloning exception to eliminate tax liabilities on accrued capital gains.

The amendments will apply to CGT events happening after 31 October 2008, and legislation is expected to be released shortly.

The ATO has released a draft SMSF Ruling which explains the main issues with respect to the definition of in-house asset as set out in section 71 of the Superannuation Industry (Supervision) Act 1993, as they apply to self-managed superannuation funds.

The draft considers the meaning of a number of key phrases including asset, loan, investment in, lease, and lease arrangement.

Section 71 of the SIS Act provides that an in-house asset is an asset of the fund that is a loan to, or an investment in, a related party of the fund, an investment in a related trust of the fund, or an asset of the fund subject to a lease or lease arrangement between a trustee of the fund and a related party of the fund.

Subject to a number of exclusions which may, superannuation funds are prohibited from acquiring in-house assets where the value of those assets exceed 5% of the total value of the fund's assets.

Section 10(1) of the SIS Act provides that an asset means any form of property and includes money whether Australian currency or foreign currency. The draft explains that the phrase has a very wide meaning and includes every type of right, interest or thing of value that is legally capable of ownership including real property and personal property including any right or interest that is of value and legally capable of ownership.

Section 10(1) of the SIS Act provides that a loan includes the provision of credit or any other form of financial accommodation, whether or not enforceable, or intended to be enforceable, by legal proceedings. The draft explains that it extends to include arrangements that are in substance financing arrangements deferring the payment of an amount, including a loan of money, sale of goods or land on credit, instalment payment arrangements and arrangements for the deferral of payment of debts or entitlements. However, the draft also provides that not every payment deferral is necessarily a loan.

The draft explains that the meaning of the term investment is the asset resulting from applying the assets of the SMSF or entering into a contract for the purpose of gaining interest, income, profit or gain. It explains that where money or assets are provided for the benefit of a related party or related trust for the purpose of receiving income, interest, profit or gain, a sufficiently close connection will be established between the investment and that entity to enable it to be described as an investment "in" that entity.

Argyle Comment:
This draft follows a string of ATO opinion on the application of the SIS Act in connection with SMSF’s. It is increasingly important for advisors to be aware of the application of these provisions, particularly given the onerous obligations imposed on advisors and fund auditors.

In a recent decision the AAT has set aside a notice of non-compliance issued to a self-managed superannuation fund after finding that the Commissioner's notice was invalid and ineffective.

Facts - The Fund was a single member fund established in 1998 with contributions of $12,000, made only on or about the first year. No regulatory return or approved auditor had been lodged or appointed since the fund was established, and no income tax returns for the Fund had been lodged for the 2001 to 2003 income years. In addition, none of the Funds records were in order or even in existence. The trustees argued that meeting the regulatory requirements were too onerous and costly.

In May 2007, trustee was issued with a notice of non-compliance for contravening the SIS Act. The Commissioner concluded that the SMSF had failed the culpability test in s 42(1A) of the SIS Act, in that all members of the fund were directly or indirectly knowingly concerned in, or party to, the contraventions.

Decision - The notice of non-compliance was set aside after the tribunal found that the notice was invalid and ineffective as the Commissioner had incorrectly made its decision under ss 42(1) and s 42(1A) of the SIS Act, instead of the relevant provisions for SMSFs in ss 42A(1) and 42A(5).

More importantly, the Tribunal declined to disregard the Commissioner's technical error and it explained that the Commissioner's intention was based upon what he perceived as serious contraventions of the SIS Act and the failure of the culpability test. It further explained that as the culpability test in s 42(1A) does not apply to SMSFs, the Tribunal considered that the Commissioner may have otherwise refrained from issuing the notice of non-compliance.

The Tribunal ordered that, pursuant to s 262A of the SIS Act, the trustees be provided with an opportunity to furnish a written enforceable undertaking to transfer or roll-over the Fund into a nominated industry, retail or public offer complying superannuation fund, as opposed to being issued with a non-compliance notice. In doing so, it noted that the acceptance of an enforceable undertaking from a trustee is an option available to the Commissioner to deal with a contravention by an SMSF trustee as set out in PS LA 2006/19.

Argyle Comment:
Section 295-325 of the Income Tax Assessment Act 1997 provides that a super fund which loses its complying status is assessed for tax at the rate of 45% of the value of its assets (less any undeducted contributions). It is important to note that until a superannuation fund's complying fund notice is formally revoked under section 40 of the SIS Act, a fund continues to be a complying fund and assessed as such.

In a High Court decision recently, Raftland Pty Ltd as trustee of the Raftland Trust v FCT, the High Court unanimously confirmed that the "trust reimbursement agreement" provisions in s 100A of the ITAA 1936 applied to distributions of some $4m made to a beneficiary of the trust under an arrangement whereby the income was applied for the benefit of other beneficiaries. As a result, it found that the trustee was assessable on the income under s 99A of the ITAA 1936.

In a recent address in Melbourne on 24 July 2008, Mr Kevin Fitzpatrick, Chief Tax Counsel, gave an insight into the ATO’s approach to tax litigation.

In a recent AAT Decision, a taxpayer has succeeded in having penalties reduced from 75% to 25% of the relevant tax shortfall.

In this case, the taxpayer sought to challenge penalties and a tax shortfall of $178,867, derived from a capital gain on the sale of a property.

The taxpayer argued that the property was at all times held in trust for a Mr Scharkosi who was the beneficial owner and occupied the property, made all loan repayments, paid all expenditure relating to the property and according to the taxpayers submissions was entitled to proceeds of any sale of the property.

It was found that there was no documentary evidence of any express or implied trust supporting the taxpayer's primary contention. The taxpayer had included rental income from the property and had claimed deductions relating to the property for the 1996 and 1997 income years.

The Tribunal found that there was no evidence of either the cost of any improvements or the date on which they were made and there was no supporting evidence the transfer of the property was made on a non-arm's length basis.

The Tribunal acknowledged that the amended assessment was issued more than 4 years after the original assessment, it noted that the Commissioner may amend an assessment at any time if there had been an avoidance of tax due to fraud or evasion and it held that on balance, there was an avoidance of tax due to evasion and therefore the amended assessment was valid.

The Tribunal confirmed the Commissioner's decision, but decided to reduce the penalty from 75% to 25% of the tax shortfall.

Argyle Comment:
This case highlights two points. The first is that any legal argument requires firstly substance, and then form. But most importantly any argument that cannot be supported without facts will face difficulty. Secondly, in all cases advisors need to consider whether the application of penalties at the level applied are appropriate.