By Muhunthan Kanagaratnam, Partner, Mark Goldsmith, Special Counsel and Julian Cheng, Partner, Gilbert + Tobin.
While we have seen state and federal governments announcing a variety of stimulus measures to assist business in these uncertain times, there are still numerous conventional tax planning strategies which business should be mindful of as a supplement to the government response.
As cash management becomes critical to the survival of many businesses, it is a useful time for all businesses to reconsider possible tax planning ideas that may reduce their tax burden. Where any of these ideas result in a reduction to the tax payable of a business for a year of income, the benefit of such reduction may be realised through variations to Pay As You Go (PAYG) instalments instead of having to wait until lodgement of the tax return. In this regard, the Australian Taxation Office (ATO) has announced that businesses can vary PAYG instalments for the 2019/20 year without incurring penalties or interest and may also be able to claim a refund of previous instalments paid for that year.
The purpose of this brief guide is to firstly, act as a reminder to business of these various strategies which are typically employed as part of ongoing year-end tax planning and secondly, to explore some less conventional ideas which may in particular cases be of interest.
1. Deferring the tax recognition of income
There are some unique features associated with our tax system which may allow for the deferral of income which would not otherwise be permissible at least from an accounting and business perspective.
In this regard, for service orientated businesses, typically the timing of recognition of services income arises at the time a recoverable debt is created. This is generally when an invoice is issued although the terms of the contract with customers or clients may mean a recoverable debt arises at other times. Therefore, delaying the timing of issue of invoices may delay the recognition of income for tax purposes, for example, if an invoice is to be issued in June, but the expectation is that it will not be paid until July or later, then consideration could be given to delaying the issue of such invoices. Equally, if the view is that there may be a low prospect of payment given the financial position of the service recipient then again thought could be given to delaying the issue of the invoice until after year end. These matters need to be considered having regard to the terms of the relevant contract governing the timing of issue of an invoice, as well as the requirement under the GST law for the party making the taxable supply (assuming it is one) to which the payment relates, to issue a “tax invoice” within 28 days after receipt of such a request.
Of course, this tax planning idea needs to be balanced with the commercial realities of the actual timing of the payment of your invoice, the likelihood of payment and the terms of the contract itself. Clearly, if the impact of such a strategy to delay the tax recognition of that income will have an adverse impact on your cash flow, then that is a significant factor that may outweigh the benefits of employment of this particular strategy.
2. Utilisation of trading stock election
The Tax Act provides for various methods of recognising the value of trading stock. In most cases, the default position adopted by business is to effectively recognise trading stock for tax generally at cost. However, in circumstances where the value of closing stock (or a particular item of stock) has materially declined such that the market value of the stock is less than the cost, then a taxpayer can adopt the market selling value basis for valuing that closing stock. Alternatively, closing stock can be valued by adopting the replacement value of the closing stock on hand. In both of these cases, the effect of adopting a lower stock valuation method, whether it be market selling value or replacement value is to effectively value your closing stock at an amount less than cost and as the closing stock is treated as assessable income, this will effectively generate a deduction for the difference between the cost and the alternative value adopted.
An example of a situation where market selling value may be adopted could be in respect of obsolete stock, on the basis that the market selling value of that stock given its obsolescence is less than the cost of the stock. Typically, from an accounting perspective the impact of this value obsolescence will be reflected through the creation of a provision for obsolescence, which in the ordinary course is not deductible. If this is the case, a deduction can effectively be obtained for that provision by revaluing for tax purposes the obsolete stock using the market selling value.
Some businesses may have also modified their return policies in response to COVID-19. For example, returns may have been placed on hold to prevent the spread of the virus or businesses that have been forced to close may have extended the time frame for returns to enable customers to return goods once they reopen. Depending on the terms of the contract, returns may be assessable to the purchaser and deductible to the seller.
3. Foreign exchange movements
Recently, we have witnessed a significant devaluation in the Australian dollar. The effect of this adverse Australian dollar movement in circumstances where arrangements have been put in place to hedge the Australian dollar (say against the US dollar) will be that there is potentially a significant unrealised foreign exchange gain to be recognised in respect of such a hedged position. The tax treatment of such an unrealised gain, or for that matter, a realised gain, will depend on the method chosen to recognise such forex movements under the Taxation of Financial Arrangements (TOFA) rules where those apply.
In this respect, the default method, under TOFA, unless a taxpayer has elected otherwise, will be the “realisation method”. Meaning that it is not until the gain is realised that it will be recognised for tax purposes. In the case of most hedge arrangements this will be the point in time when the hedge expires or is closed out.
Where a taxpayer is likely to realise a hedge gain prior to year end, strategies could be explored to defer the recognition of such a gain until after year end. The ease with which this can be achieved will largely depend upon the specific form of hedge arrangement employed and the terms of that arrangement.
The flipside of this strategy to defer the recognition of foreign exchange gains, is to trigger a realisation of foreign exchange losses prior to year end and in so doing generate a deductible loss. Again, the ease with which this can be achieved really depends upon the method adopted by the taxpayer to recognise foreign exchange gains and losses under TOFA and also the nature of the arrangement underpinning the creation of the forex loss.
4. Depreciating assets
Given the government has introduced a stimulus package which includes an increase in the value of a depreciable asset that can be immediately written off by small businesses to an amount of $150,000, this may incentivise small- to medium-sized businesses to seek to replace existing depreciated assets with new assets. That being the case, it may warrant a review of your existing depreciable asset base to determine the circumstances in which it might be feasible to take advantage of that incentive and replace an existing asset which has a market value significantly below its existing depreciated book value. Where that scenario exists, not only would you be able to generate an immediate deduction on the acquisition of the new asset, but also generate a tax deduction for the loss on disposal of an existing depreciable asset.
Other opportunities in relation to depreciating assets include:
• Reviewing depreciating assets to determine if any can be scrapped or abandoned before year end.• Self-assessing the effective life of depreciating assets that are acquired (where the immediate write-off is not available).
5. Bad debt deductions and impairments
This financial year it will be more important than ever for taxpayers to closely scrutinise their existing outstanding debts to assess their likely recoverability with a view to identifying genuine bad debts which could be written off for tax purposes. In this regard, care would need to be taken in making that assessment, to make sure that the appropriate requirements of the tax law are satisfied that there is little to no prospect of recovery and that the debt is actually written off in the books of the company prior to year end.
Where the TOFA rules apply, a taxpayer may be recognising gains (eg interest) under a financial arrangement such as a loan on an accruals basis where those gains are “sufficiently certain”. However, if a loan is impaired, the taxpayer may be required to reassess whether the accruals method can still apply. The taxpayer may determine that all or part of a gain is no longer sufficiently certain and should only be recognised on a realisation basis. Alternatively, if the taxpayer determines that the accruals method will continue to apply, it is necessary to re-estimate the gain or loss that is accrued. While losses arising from an impairment are not deductible until the debt is written off as bad, a taxpayer should at least review its loans to ensure it is not continuing to accrue gains that are no longer sufficiently certain.
6. Writing back existing debtors
Circumstances may arise where for example a bill is in dispute and the taxpayer should make a serious commercial assessment prior to year end as to whether that bill is likely to be paid or if it is going to remain in dispute on a protracted basis. If the commercial outcome of that evaluation process is that it is in the taxpayer’s best interest for the matter to be settled, an appropriate way of potentially resolving the matter would be to cancel the existing bill and issue another bill for the revised agreed amount. In this way depending on the timing of the reissuance of the bill whether it is prior or post year end, at least the taxpayer would be in a position where the amount upon which they will be assessed prior to year end will be the amount that they actually consider will be recoverable, not an amount in excess of that recoverable amount.
7. Corporate tax rate
Companies with “aggregated turnover” of less than $50m for the year ended 30 June 2020 whose “base rate entity passive income” is less than 80% of total assessable income can apply a lower corporate tax rate of 27.5%.
Aggregated turnover includes the turnover of the company and the turnover of any entity connected with or affiliated with the company. Base rate entity passive income broadly includes amounts of passive income such as dividends (other than where the company holds at least 10% of the voting power in the company paying the dividend), royalties, rent, interest and net capital gains.
Companies should consider whether they expect to fall below the aggregated turnover threshold of $50m, or if there are opportunities to defer the derivation of base rate entity passive income, to allow access to the 27.5% corporate tax rate.
8. Some novel opportunities
Foreign tax offset planning
If you are in a position where you have foreign tax offsets attributable to foreign income it will be important to recognise the fact that your foreign tax offset is only available effectively to the extent of the Australian tax payable in respect of that income. Therefore, putting it simplistically, in the event that no Australian tax is payable in respect of that foreign income, then it will mean that you are no longer entitled to the benefit of that foreign tax offset. In such a case consideration could be given to exercising some of the above-mentioned suggestions in a way which (contrary to our earlier suggestion) will generate income creating a tax liability which could be reduced by the foreign tax offset. Clearly this would only be done in circumstances where the generation of the assessable income was a timing difference and would reverse out in the following period.
Utilisation of franking credits
Thought should be given to whether to pay a franked dividend in circumstances where you envisage a position whereby you may have no profits available at a future point in order to pay a dividend which is capable of being franked. In this context, it must be remembered that from a tax perspective (although this is not the case under corporate law) in order to frank a dividend, that dividend must be paid out of profits.
Other strategies could be employed which may facilitate the payment of a franked dividend at a future point in time by preserving, for example, current year profits and not offsetting those profits against accumulated losses. However, this can be a complex area of the law and if you find yourself in this situation where you are concerned with the company’s ability to actually maintain profits out of which a franked dividend could be paid, we would strongly suggest seeking specific advice.
Another consideration is whether a company may be in a franking deficit and, therefore, liable for franking deficit tax at year end due to refunds it has received of PAYG instalments or downward variations of such instalments.
9. Cash flow considerations
In uncertain times, the ability to maximise cash flow is a critical consideration. While we have earlier referred to some planning strategies to manage the actual tax liability of an entity, there are other measures that the ATO has introduced to help businesses retain cash until the COVID-19 crisis passes. We highlighted earlier that the ATO has issued guidance indicating that businesses who expect their PAYG instalments to exceed their actual tax liability for the 2019/20 income year can vary those instalments downwards without incurring interest or penalties. Quarterly PAYG instalment payers (those with instalment income of less than $20m in the most recent income tax return) can simply amend their PAYG instalment notice for the March 2020 quarter. A monthly PAYG instalment payer with instalment income of no more than $500m in the most recent income tax return must contact the ATO.
It may also be possible to claim refunds for any instalments paid for the September 2019 and December 2019 quarters. The ATO’s position on when any refunded amounts are repayable going forward is unclear. It may be that the benefit of any reduction to taxable income may be recognised by varying the PAYG instalment for the June 2020 quarter or only upon payment of the balance of tax payable for the year ended 30 June 2020.
Other measures announced by the ATO to assist businesses in preserving cash in these uncertain times include:
What you can getIf you …Six-month deferralDeferral of up to 6 months of various tax obligations, including income tax, PAYG instalments, fringe benefits tax and excise payments.Are affected. This is a case-by-case assessment — contact the ATO on 1800 806 218.GST reportingFrom 1 April 2020, you can increase the frequency of GST reporting from quarterly to monthly to get faster access to GST refunds.Are entitled to refunds of GST and your turnover is less than $20m and you are currently reporting quarterly.Note you can only change from the commencement of a GST reporting period — hence, 1 July 2020 being the first effective GST reporting period. Note also that you cannot change back to reporting quarterly for 12 months, so consider whether you will remain in a refund position for that time.Remission of interest and penalties generallyThe ATO will consider remitting interest and penalties incurred after 23 January 2020.All businesses — contact the ATO.Low-interest payment plansPayment plans for existing and ongoing tax liabilities at a low interest rate.All businesses — contact the ATO.
10. GST management issues
GST reporting cycles
During these uncertain times where effective cash management is crucial, one of the simplest GST planning measures is to effectively balance the receipt of GST paid by a recipient (taking into account our comments above regarding issuing tax invoices and deferring the tax recognition of income) and the ability to claim GST credits as early as possible (through the receipt of a tax invoice).
The frequency of the entity’s GST reporting cycle is equally important, after all, it is through an entity’s Business Activity Statement (BAS) where GST is paid and claimed.
As part of the government’s COVID-19 announced measures to assist businesses in preserving cash in these uncertain times, as briefly outlined earlier, from 1 April 2020, entities that are registered for GST and lodge their BAS on a quarterly basis, can elect to increase the frequency of their GST reporting to a monthly basis in order to get faster access to GST refunds.
The election does not affect the requirement of an entity that has a GST turnover of $20m or more to continue to report monthly. However, if an entity currently has a monthly GST reporting period but the impact of COVID-19 is likely to decrease its projected GST turnover below that threshold, under the pre-COVID-19 amendments, rather than being required to change its reporting frequency to quarterly, the amendments mean that the entity can remain reporting its GST on a monthly basis.
This would be particularly useful to an entity who is currently experiencing losses as it would receive its GST refund on a monthly rather than quarterly basis, thereby increasing its cash flow.
However, the election can only apply from the start of a quarter. Therefore, if elected, the change will commence on 1 July 2020. It should also be noted that a change back to quarterly GST reporting cannot be made for a period of 12 months, as such, the entities refund position should be assessed against a 12-month period. It is also worth noting that the change in the entity’s GST reporting frequency does not require a change in its PAYG withholding reporting cycle.
Supplies among related entities
Related entities which make supplies to each other (if they are currently not already grouped), should consider forming a GST group. The advantages of GST grouping include potentially saving compliance costs (as all of the members of the GST group are treated as a single taxpayer and therefore need only submit one BAS), and taxable supplies between such members are disregarded for GST purposes. The latter means that there will be no adverse cash flow timing issues between when the party making the supply has to remit GST to the ATO, and when the party receiving the supply can claim from the ATO GST credits in respect of the acquisition.
Minimising GST leakage
Another GST planning idea would be to carefully consider ways to reduce unrecoverable GST costs. Such a situation would arise, for instance, where an entity makes an input taxed supply (such as leasing residential premises or making a financial supply) and cannot claim GST credits on related expenses.
The ability to reduce the GST leakage on a transaction would depend on the particular circumstances and/or entities involved, but potentially could involve GST grouping or, alternatively, correctly apportioning recoverable GST costs.
Large entities which have an ATO approved “GST recovery percentage” and whose level of business activity will be significantly impacted by COVID-19 in terms of the value of their supplies (ie outputs) and/or acquisitions (ie inputs), should consider varying and agreeing a new percentage with the ATO, which could potentially increase their net GST amount.
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