By Ross Higgins, Partner and Andrew Spalding, Partner
We comment on three welcome tax measures announced in the Federal Budget last night to assist business:
1. Temporary Instant Asset Write-off measures
- New business asset investments made after 7:30 pm on 6 October 2020 (Budget night) and first used or installed by 30 June 2022, may be immediately written-off for tax purposes for all businesses with an aggregated annual turnover of less than $5 billion. There is no cap on the size of the investment!
- Second-hand business asset investments:
- For businesses with aggregated annual turnover of less than $50 million, full expensing also applies to second-hand assets, within that time frame;
- For businesses with aggregated annual turnover between $50 million and $500 million, they can still deduct the full cost of eligible second-hand assets costing less than $150,000 that are purchased by 31 December 2020 under the enhanced Instant Asset Write-off;
- Businesses that hold assets eligible for the enhanced $150,000 Instant Asset Write-off will have an extra six months, until 30 June 2021, to first use or install those assets; and
- Small businesses can deduct the balance of their simplified depreciation pool at the end of the income year while full expensing applies. The five-year limitation period where a small business entity opts out of this regime continues to remain suspended.
This provides an excellent short term opportunity for substantial new business asset investment. There will be issues of cash flow, external financing (e.g. traditional loans or chattel mortgages) and payback on investment. The value of the write-off is of course in the tax deduction, being the ability to lower PAYG instalment payments and pay less tax on assessment or receive larger refunds. If substantial deductions are taken it could put the business in a loss position or increase losses and the ability to utilise those losses will be key and depend on the particular circumstances. Tax losses arising may be able to be carried back against earlier year taxable income under the loss carry-back measure (see below). Care must be taken not to create substantial tax losses prior to a change in ownership if this may put the recoupment of tax losses in jeopardy. Planning will be important.
Hopefully the legislation will be passed quickly to enable decisions on asset investments to be made.
2. Temporary Loss carry-back
This measure applies to companies only and business losses. It will allow companies with an aggregated annual turnover of less than $5 billion that have tax losses in the 2020, 2021 or 2022 income years to carry back those losses to the 2019, 2020 or 2021 income years to reduce taxable incomes in those years.
There is no monetary cap on the relief but the carry-back must not must not be more than the earlier taxed profits and must not generate a franking account deficit.
Tax losses that are carried back against a taxed profit from a previous income year will generate a refundable tax offset in the year in which the loss is made. Eligible companies can elect to claim the tax refund when they lodge their 2021 and 2022 tax returns. Any losses not carried-back can otherwise be carried forward under the existing rules.
This measure will enable struggling businesses to utilise tax losses they are incurring during the current recession and beyond, against previous year taxable incomes. There is no need to show that current losses are caused by covid-19 economic impacts as such.
Care should be taken to limit the payment of franked dividends if the company wants to be able to utilise the loss carry-back measures. An immediate review of the taxable income position for the 2019 year and the current franking position should be undertaken to determine the potential for loss carry-back. Note that the franking account is kept in tax terms, so a franking account balance of $1m for a 30% taxpayer would enable a potential loss carry-back of $3.33m. Companies that may be planning franked dividends to offsets loans for Division 7A purposes may wish to consider alternative strategies.
3. Tax residence of foreign incorporated companies
Ruling TR 2004/15 stated that for a foreign incorporate company to be regarded as a tax resident, it was necessary that the company must be both carrying on business in Australia and as a separate requirement have its central management and control (CMAC) in Australia.
However, since the High Court’s decision in the Bywater case in 2016, the ATO’s interpretation of the corporate residency rules has changed. On 15 March 2017, the ATO withdrew TR 2004/15 and replaced it with Taxation Ruling TR 2018/5 in which the ATO took the view that a company that has its CMAC in Australia will be regarded as carrying on business in Australia, so that the residence test is really just based on CMAC. This has led to widespread concern about the tax residence of overseas companies and whether having Australian directors on boards of foreign companies would cause issues with CMAC, particularly where companies utilise technology to hold virtual board meetings (and may have no choice during the pandemic!).
The Government has announced that a company that is incorporated offshore will only be treated as an Australian resident for tax purposes if it has a ‘significant economic connection to Australia’. This test will be satisfied only where the company’s:
- Core commercial activities are undertaken in Australia; and
- CMAC is in Australia.
This measure will apply from the first income year after Royal Assent of enabling legislation but with the option to apply the new law from 15 March 2017. For existing structures the option should generally be taken up in all cases. In the meantime the usual care around CMAC issues should be maintained until the passing of the new law.