The tax office doesn't always interperet laws reasonably when it comes to maximising revenue.
ONE of the main features of the tax system is the role of the Tax Office in telling taxpayers how to conduct their tax affairs. It does this by issuing draft or final determinations on how it interprets tax and other legislation.
It can be extremely helpful when the Tax Office interprets legislation reasonably, but there have been many cases where the original intent of the legislators is ignored and fairness is sacrificed to maximise tax revenue.
Interpreting tax legislation has been made harder for both the Tax Office and tax professionals by the poor quality of legislation produced by Federal Parliament. There have been two recent examples of Tax Office rulings concentrating on maximising revenue while dealing with poorly drafted legislation.
People who invested in tree-farming managed investment schemes, through companies that have subsequently gone into liquidation, have been dealt a blow by a Tax Office interpretation of legislation relating to tax deductions for these investments.
The poor drafting of this legislation is evidenced by the fact that in some cases these investments became Ponzi schemes, and the investors were given no protection from greedy banks, rapacious liquidators, and inept or dishonest managers of the schemes.
The determination issued by the office will disallow a tax deduction to investors for amounts paid where the trees were not planted. This means if the manager of a scheme has used growers' funds to prop up their ailing business, rather than the funds being used for the planting of trees, the growers will have lost money and be denied a tax deduction.
The other example of the Tax Office dealing with badly drafted legislation, and not getting its interpretation correct, was a draft self-managed super fund ruling last week relating to borrowings within a superannuation fund. This draft ruling was issued to correct a previous ruling.
At the heart of the legislation allowing self-managed super funds to borrow to buy an asset were two main requirements, the first being that any loan taken out by a super fund had to be a limited recourse borrowing arrangement in other words the loan could not put at risk any of the other assets of the super fund. The second requirement was that the asset must be owned by a warrant trust.
In the original ruling, the Tax Office said that where a property was situated on several titles, a separate warrant trust had to be set up for each title. This would have led to the ridiculous situation of a super fund that bought an income-producing building on two titles paying to set up two warrant trusts.
In its new ruling, the Tax Office concedes that a single asset can be on several titles and therefore only one warrant trust will be required. It will also allow borrowed funds to be used to repair an asset held by a warrant trust but not to improve or alter the original asset purchased. Though borrowed funds cannot be used to improve or alter an asset bought through a warrant trust, a super fund can use its own cash from contributions or selling other investments to improve it.
Hopefully the Tax Office will also change its ruling on managed investment schemes.
Frequently Asked Questions about this Article…
How does the Tax Office’s interpretation of tax laws affect everyday investors?
The Tax Office issues draft and final determinations on how it interprets tax laws, and when it focuses on maximising revenue this can override legislators’ original intent. That can make outcomes less fair for investors, especially when legislation is poorly drafted and leaves room for broad interpretations.
Why does poorly drafted legislation matter for investors in managed investment schemes?
Poorly drafted legislation makes it harder for the Tax Office and tax professionals to interpret the rules, which can lead to rulings that disadvantage investors. The article highlights tree-farming managed investment schemes as an example where bad drafting led to unexpected tax and legal outcomes for investors.
Can I claim a tax deduction for payments to a tree-farming managed investment scheme if the trees were never planted?
According to the Tax Office determination discussed in the article, deductions will be disallowed for amounts paid where the trees were not planted. If scheme managers used investor funds for other purposes instead of planting, investors may lose both money and the expected tax deductions.
What risks do investors face when a tree-farming scheme goes into liquidation?
The article notes investors in some schemes faced outcomes like Ponzi-style failures, and had little protection from banks, liquidators or dishonest managers. Combined with the Tax Office disallowing deductions for unplanted trees, liquidation can leave investors with financial loss and no tax relief.
What changed in the Tax Office’s ruling on self-managed super fund (SMSF) borrowings?
The Tax Office revised a prior ruling to allow a single warrant trust for an asset that spans several titles, avoiding the need to set up multiple trusts. It also clarified that borrowed funds can be used to repair an asset held in a warrant trust, but not to improve or alter the original asset purchased.
What is a limited recourse borrowing arrangement (LRBA) and why is it important for SMSF property purchases?
An LRBA is a requirement for SMSF borrowings where the loan is limited in recourse—meaning the loan cannot put at risk any of the other assets of the super fund. It’s important because it protects the rest of the fund from being exposed to the debt tied to the purchased asset.
Can an SMSF use borrowed funds to improve a property held in a warrant trust?
No. The Tax Office ruling allows borrowed funds to be used for repairs but not to improve or alter the original asset purchased through a warrant trust. However, the SMSF can use its own cash (from contributions or the sale of other investments) to make improvements.
What should investors do if tax rulings or legislation are unclear or seem unfair?
Because the article highlights ongoing issues with poor drafting and shifting Tax Office rulings, everyday investors should monitor Tax Office determinations and consider seeking advice from a tax professional. The article also expresses hope that the Tax Office will revise rulings on managed investment schemes to better protect investors.
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