Alienation of Income

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1 Alienation of Income Marc Romaldi FTIA Kelly & Co. Lawyers Introduction Alienation of income Strategies in relation to: Leases and Licensing Improvements to property Current use of service trusts Assignments of income and trust arrangements Disposal of (a right to) sale proceeds Partnerships and co-ownerships Taxation consequences 1

2 Leases Leases are flexible, binding agreements between landlord and tenant and are a proprietary interest Can assign the property OR assign income from the property separate taxation implications for each Usually a leasehold interest (possession through contract) is distinct from proprietary rights in land Taxation of lease income (rent) Attributable to the person who granted the lease Inalienable 7 year requirement Concurrent Leases Concurrent leases Lease between owner and Tenant 2 Lease of landlord's reversionary interest (not possessory) When and why would a concurrent lease be created? Taxation of concurrent lease income Diversion of income from owner as Tenant 2 becomes landlord to Tenant 1 Unlikely that Div 6A applies as not mere assignment of rental income 2

3 Concurrent Leases Case study 1 leases land Trust A B pays rent Typical leasing scenario Concurrent Leases Case study 1 (cont) Trust A 1. leases land 2. concurrent lease B 2. rent under concurrent lease C 1. rent 3

4 Concurrent Leases Case study 1 (cont) Concurrent lease granted by Trust A to C C becomes B s landlord Assessability of rent on concurrent lease CGT issues from concurrent lease Market value substitution rule? Stamp duty Licensing A licence is gratuitous permission given by the owner for another person to be on the land or to use property that: is attached to the proprietary interest; takes on the character of the relevant property interest; is contractual but with certain implied rights; and can be withdrawn at any time. The granting of a licence (contractual right) attracts CGT Event D1 4

5 Licensing Case study 2 A Trust owns and operates a business A Trust wants to alienate business income to: - cap tax at 30% on business income - avoid TR 2010/3 - asset protection (business subject to litigation risk) Licensing Case study 2 (cont) Licence business to ABC Pty Ltd Setting the licence fee IVS rules CGT issues Event D1 Market value substitution rule Stamp duty GST 5

6 Licensing Potentially impacted by Sturt Football Club decision Sale of tangible assets and licence of IP and goodwill Decision - a sale of business assets should include the value of the goodwill licensed Goodwill is inseparable from the business Same principles arguably follow for licensing Improvements to Property Repairs, maintenance & other general land improvements Capital Improvements (e.g. Buildings) Capital improvements can be: separate assets to the land, OR merely increase land value. Fixtures in common law, in equity and in tax law Unseverable capital assets usually seen as being owned by landholder for taxation law purposes: CGT Event A1 on disposal assessable for income arising from fixture itself 6

7 Improvements to Property Case study 3 A owns vacant land worth $1m A has no $$ to fund building and can t/won t borrow A Trust has $$ to fund $2m development What structure would help alienate income arising from planned future capital improvements to land through the addition of fixtures (in this case, a building)? Improvements to Property Case study 3 (cont) A and A Trust enter into an unincorporated Joint Venture (JV) structure JV created between two parties, each funding a portion of the capital development (in kind and cash) Property law principles what is fixed to the land forms part of the land JV agreement addresses rights of A Trust 7

8 Improvements to Property Case study 3 (cont) How is JV product share interest determined? Cost plus method? Market valuation method value of trust contribution as a proportion to land value at commencement Market valuation method value of trust contribution as a proportion to value of completed project as a whole Benefit of capital growth from development Improvements to Property Case study 3 (cont) How is A Trust re-paid its contribution/product share? Grant of concurrent lease Right to call for payment Right to call for transfer of asset Entitlement to a percentage interest of sale proceeds 8

9 Improvements to Property Case study 4 Same factual scenario as Case study 3 BUT Land owner is an SMSF... SMSF doesn t have $$ to develop vacant land Can SMSF enter into JV with A Trust?? Improvements to Property Case study 4 (cont) WHY WOULD the SMSF enter into the JV? SMSF can t borrow to improve Contributions maxed excess taxed at highest rate Transfer of land to the Trust incurs stamp duty Keep rental stream taxed at 15% 9

10 Improvements to Property Case study 4 (cont) CAN the SMSF enter into the JV? The intention behind A Trust s contribution is to help pay for the capital works Sole purpose test Non-arm s length transactions Attracts highest tax rate to the SMSF Improvements to Property Case study 4 (cont) How is SMSF re-paid its contribution/product share? Any different than A Trust as land owner? Avoid classification as a loan Impact on SMSF financials 10

11 Current Use of Service Trusts Two-tiered structure: 1) Principal practice enters into a service agreement with a service entity (a service trust or company) 2) The service entity provides various services to the principal Effect of this structuring enables the principal to: reduce the taxable income of the principal by alienating income to the service trust; and overcome any professional industry legislative hurdles to income alienation. Current Use of Service Trusts Not a lot has changed in the past few years ATO still in audit phase Taxpayers generally put affairs in order after issue of TR 2006/2 and the ATO Guide Mark-ups and supporting/verifiable information is the key 11

12 Current Use of Service Trusts Ownership barriers across industries coming down Use of flexible ownership structure has lessened use of traditional service trusts Medical practitioner concession More exotic uses... Current Use of Service Trusts Case study 5 A professional sportsman (A) earns income from his trade Supplemented by significant income from promotion and endorsement opportunities Most income taxed at highest marginal rate of tax How can he/she alienate income? 12

13 Current Use of Service Trusts Case study 5 (cont) Service trust for the endorsement income? Income is earned from use of name, image, likeness, talents, identity, reputation and signature (image) Service trust granted a non-exclusive right/licence to use/exploit sportsperson s image Service trust agrees to employ the sportsperson to perform certain services Current Use of Service Trusts Case study 5 (cont) What services licensed to the service trust? promotional, marketing and advertising activities cooperating with sponsors, suppliers and licensees of the identity's image appearing on television and radio programs giving interviews to television, radio, newspaper, magazines using and endorsing nominated products or services cooperating with media as and when required by the trust 13

14 Current Use of Service Trusts Case study 5 (cont) Is the licence effective at law? Licence enables the trust to use the image in a way that would otherwise enliven a cause of action in any or all of: Defamation Misleading or deceptive conduct Passing off (insinuating relationship) PSI Employment terms market value remuneration? Current Use of Service Trusts Case study 5 (cont) Granting a licence creates a new form of property Service trust has an interest owns the property Vesting of the licence in the service trust is an asset Rights granted to service trust are not assigned - create a contract of services between the service trust and the sportsperson 14

15 Assignments of Income Division 6A applies to receipt of income from certain transferred property If assignment of right to receive income is transferred to: an associate; or any person for no consideration, then transferor will continue to be assessable Rental income from property cannot be assigned Assignments of Income Case study 6 A B 50% Business 50% Typical simple business structure: Simple/smaller businesses Many older professional service structures Inflexible 15

16 Assignments of Income Case study 6 (cont) - Everett assignments back on agenda A B AFT A 10% B 50% 50% 40% 50% Business Business CGT concessions make them viable again A assigns 80% of its 50% share to A Family Trust General law issues Assignments of Income Case study 6 (cont) - Everett assignments back on agenda A B AFT A 10% B 50% 50% 40% 50% Business Business CGT Stamp duty GST 16

17 Disposal of (a Right to) Sale Proceeds Are proceeds ordinary or capital income? Was the: primary purpose of transaction to make a profit? transaction isolated, ordinary income &/or usual business? property purchased pre- or post-september 1985? Is the contract for sale in place prior to disposal? Yes: proceeds can become part of trust estate CGT Events A1 or E1 No: difficulties in quantifying proceeds CGT Events D1 or E9 Disposal of (a Right to) Sale Proceeds Case study 7 Disposes of right to receive proceeds on sale Land Third Party How effective? What if negotiations/contract are on foot? 17

18 Disposal of (a Right to) Sale Proceeds Case study 8 - when derivation doesn t matter... 50% 50% U/T sells property Third Party proceeds by instalments Disposal of (a Right to) Sale Proceeds Case study 8 (cont) 50% 50% U/T Property under contract Assign right to receive proceeds Purchase price owing Third Party 18

19 Disposal of (a Right to) Sale Proceeds Case study 8 (cont) Proceeds payable over time (5-10 years) 15 year exemption 2 year limit for exempt payment Vest the debt to unitholders Stamp duty CGT Event A1 CGT Event E4 Partnerships Income from an interest in real property, not ownership Share held in partnership determines assessable income Calculating capital gain or loss: Apportionment of assignor s expenses for deduction purposes Deductibility attributable to assignor for any partnership loss Timing of assignment Current legal right (legal transaction) versus future right or non-specific interest (equitable transaction) 19

20 Partnerships Case study 9 A A B 50% 50% Contributes land to partnership capital Partnership A contributes land to Partnership capital Agreement recognises land contribution gives A 75% interest in land and B 25% interest Agreement is silent on profit distribution B still derives 50% of income from land CGT on land A assessed on 75% (section 106-5(1)) Co-Ownerships >1 person with concurrent legal interests in the same land Proportion of allocated share in the property determines: Legal interest Division of net income Equitable title (except in very limited circumstances) 20

21 Types of Co-Ownerships Joint Tenants & Tenants in Common Proportion of property ownership interests Legal and equitable interests Rental income from real property Person granting the lease = person deriving income Income assessability for taxation purposes always reflects legal interest for taxation purposes This remains so despite the existence and legal enforceability of any contrary arrangements made between co-owners Co-ownerships Case Study 9 Dad Son 50% 50% Registered title 50/50 Co-owners of Land Family agreement - in practice Dad bears all expenses and Son receives all income Family Agreement irrelevant for tax purposes income and expenses taxed pursuant to title proportions 21

22 Marc Romaldi 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. 22

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