Wealthy and wise A tax guide for Australia s wealthiest people

Transcription

1 Wealthy and wise A tax guide for Australia s wealthiest people NAT

2 OUR COMMITMENT TO YOU We are committed to providing you with advice and information you can rely on. We make every effort to ensure that our advice and information is correct. If you follow advice in this publication and it turns out to be incorrect, or it is misleading and you make a mistake as a result, we must still apply the law correctly. If that means you owe us money, we must ask you to pay it. However, we will not charge you a penalty or interest if you acted reasonably and in good faith. If you make an honest mistake when you try to follow our advice and you owe us money as a result, we will not charge you a penalty. However, we will ask you to pay the money, and we may also charge you interest. If correcting the mistake means we owe you money, we will pay it to you. We will also pay you any interest you are entitled to. If you feel this publication does not fully cover your circumstances, please seek help from the Tax Office or a professional adviser. The information in this publication is current at March We regularly revise our publications to take account of any changes to the law, so make sure that you have the latest information. If you are unsure, you can check for a more recent version on our website at or contact us. COMMONWEALTH OF AUSTRALIA 2008 This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney-General s Department, Robert Garran Offices, National Circuit, Barton ACT 2600 or posted at PUBLISHED BY Australian Taxation Office Canberra March 2008 JS 7819

3 Foreword This booklet is part of our continuing program to explain how the Tax Office goes about fostering voluntary compliance with Australia s tax laws. It sets out our processes for monitoring compliance by Australia s wealthiest people, the risk factors that draw our attention, and suggestions for these taxpayers to better manage their tax risks. We believe that being open and accountable about our compliance activities encourages voluntary compliance. Our compliance work is as much about helping people comply as it is about dealing firmly with those who don t want to do the right thing. Some businesses see taxation as just another business cost. While entrepreneurship is important to Australia, underpaying tax that is properly payable not only undermines our system and deprives Australia of valuable services, it can also give rise to unfair competition. Wealthy people are behind some of Australia s largest and most successful businesses. They employ many Australians and significantly contribute to our economy and tax revenue. Many take on a great deal of personal risk to build their businesses. Given their positions of influence, it is important that they do not take unacceptable risks when it comes to tax compliance.

4 FOREWORD Most wealthy Australians are not experts in tax law and how it applies to their business and private interests. But, like all taxpayers, they are responsible for what they report in their tax returns, irrespective of who prepares the return and the advice they get. They need to be confident about the quality of advice and the tax positions adopted for themselves and their business groups. This is a good way of exhibiting one s rights and responsibilities as a citizen. This booklet is designed to facilitate a discussion between wealthy people and their tax advisers. Where they are not clear about or comfortable with the advice they are being given, they should get a second opinion or contact the Tax Office to clarify the application of the law. For more than 10 years we have operated a dedicated taskforce to monitor and manage compliance by Australia s wealthiest people. We do this not because wealthy people are necessarily less compliant with their tax obligations, but because of the scale of their activities and the potential impact of their non-compliance on the community. I believe the success of this approach is demonstrated not so much by audit results, but by a progressively improving culture of compliance and governance by this sector and their advisers. With the involvement and assistance of tax advisers to wealthy people, this booklet has been designed to help wealthy citizens and their advisers adopt and maintain high standards of governance and propriety in their tax affairs. Michael D Ascenzo Commissioner of Taxation

5 Contents 01 Introduction 2 The purpose of this booklet, the tax-related characteristics of wealthy people, and how we manage their compliance. 02 Meeting your tax obligations 11 Suggestions to help you manage your tax obligations, including questions to raise with your adviser. 03 What attracts our attention 17 The issues and characteristics that attract our attention and constitute a risk. 04 Our risk reviews and audits 26 How we conduct risk reviews and audits of highly wealthy individuals and their group entities. 05 Our products and processes 44 Key products and processes in our dealings with taxpayers. 06 How we help you to comply 49 Information and support services to help you comply with your tax obligations.

6 Introduction This chapter sets out the purpose of this booklet, the tax-related characteristics of wealthy individuals and our approach to managing their compliance. 01

7 INTRODUCTION Purpose of this booklet The Tax Office s mission is to promote a culture of voluntary compliance with Australia s tax and superannuation laws. To succeed in this we need to be open and accountable about our compliance activities. All taxpayers, whatever their role in the nation s social and economic life, need to be aware of their rights and obligations and of the compliance issues that may affect them. More broadly, maintaining public confidence in the tax system requires us to keep the community informed on how we manage compliance with the tax law and ensure that all taxpayers are treated fairly. This publication describes the strategies the Tax Office employs to ensure the compliance of the highly wealthy that is, Australian residents who, together with associates, effectively control $30 million or more in net wealth. However, it also has application to wealthy individuals more generally. It outlines the characteristics of these taxpayers that influence how we collect information and respond to compliance risks. It sets out the factors we will review and our compliance processes, and suggests ways that wealthy people can better manage their tax affairs to reduce the risk of non-compliance. Our aim is to help wealthy people and their advisers understand how we work, to provide a basis for an open working relationship with the Tax Office. The publication also sets out, for Tax Office staff, our compliance approach and guidelines for the conduct of their work. It encompasses the philosophy and principles outlined in the Cooperative compliance model booklet, issued in November Where an economic group has a combined turnover of $250 million or more, it is classified as a large business and the compliance processes outlined in the publication Large business and tax compliance apply. However, where such a group is owned or controlled by an individual, we monitor their tax affairs using the information collection methods developed for wealthy individuals. Wealthy and wise 3

8 INTRODUCTION What do we mean by highly wealthy? When we describe someone as highly wealthy we mean an Australian resident who, together with associates, effectively controls $30 million or more in net wealth. The Tax Office s compliance effort is driven by tax risk, which informs how we allocate our limited resources. We also have a responsibility to the Australian people to ensure everyone pays the right amount of tax in accordance with the law. For Australia s wealthiest citizens, this means providing us with detailed information on their often inherently-complex business and private interests so that we can determine whether there is a tax risk. The definition of high wealth is for the purposes of tax administration only. Apart from the requirement to respond to our requests for information, there are no special tax obligations on wealthy individuals over and above those that apply to taxpayers generally. We sometimes apply the processes set out in this publication to wealthy individuals and their groups under the $30 million threshold, such as those whose wealth has dropped below the threshold but who continue to concern us with their level of compliance. Under such circumstances, we may also apply these processes to close associates of these individuals. Residency These processes are applied to the tax affairs of wealthy people who, for tax purposes, are residents of Australia. Where a non-resident conducts business in Australia through a permanent establishment or subsidiary, we manage the compliance of these entities in the same way as other like entities. Control The definition of high wealth is based on effective control rather than strict legal ownership. In monitoring a wealthy individual s compliance we need to include all entities in which the person has a key decision-making role. Net wealth While accounting standards define what net assets are and how legal groups should report their financial data, this is only a start in determining net wealth. We look at the links between the individuals and entities, use market values for assets, and try to ensure that underlying assets are counted only once. We use all possible sources of information to make a reasonable estimate of net wealth. 4 Wealthy and wise

9 INTRODUCTION Characteristics of wealthy individuals and their groups We have identified around 1,200 individuals who fall within the definition of highly wealthy. These people are associated with approximately 25,000 entities. The individual Wealthy individuals tend to have complex business arrangements, with their wealth spread across a group of closely-held companies and trusts, each of which is a separate taxpayer entity (except where wholly-owned entities have been consolidated for income tax purposes). Some wealthy individuals are significant philanthropists, in some cases setting up related entities for charitable purposes. A wealthy person s tax compliance can often only be appreciated when their group as a whole is considered. The group The group is typically controlled by the wealthy person, a family member or associate. This level of control and ownership means that the group may be willing to assume risks (both economic and tax) that a public company may not, and those in control may be able to access funds from the group. They may also be able to use the assets owned by group entities without personally acquiring them. Family members will often hold positions within the group and have access to the same opportunities. The family nature of these groups also means that personal events such as death or divorce can have tax consequences, for example by triggering a capital gains tax event. Groups controlled by wealthy people typically comprise many different entity types, each serving a unique place in the business organisation because of its tax and business attributes. Many of these entities are relatively small, and it is only when the group s assets as a whole are counted that significant wealth is apparent. These groups typically contain the family business and significant real estate (both commercial and private). Private and business interests are often mixed. In many cases their wealth is the legacy of generations of business success, with significant long-term assets acquired before the introduction of capital gains tax (CGT). Typically, business structures across the population of groups owned or controlled by wealthy individuals are less homogenous than among publicly-owned groups, making industry-by-industry comparisons for the purposes of compliance monitoring more difficult. A single legal entity can be the vehicle for multiple commercial operations or a single commercial operation can be spread across several different legal entities, with a high volume of intra-group transactions that complicate financial analysis. Often, the only consolidated information available is that provided for financiers; though even this may cover only the main operating entities, leaving out many of the smaller entities or offshore structures. In groups where an individual ultimately has 100% control, there is no need to define the core business, unlike a public company, which must inform its large and sometimes diverse shareholder base of the business s direction and philosophy. Accessing wealth Wealthy people may maintain expensive lifestyles without relying on income in a conventional taxable form. Wealth can be accessed in a variety of ways such as through the sale of pre-cgt assets, distributions of unrealised gains, loans and the use of lifestyle assets owned by the group. Wealthy and wise 5

10 INTRODUCTION Limited information is available The publicly-available information on wealthy people is often limited in scope and quality. Their entities generally consist of private companies and trusts, not subject to the stock exchange disclosure requirements on public companies and not overly affected by Australian Securities and Investments Commission requirements. Some people do not disclose their offshore structures even to their domestic advisers. Because there is much less publicly available information, the Tax Office s information-gathering techniques and compliance approaches, include the use of detailed questionnaires, expanded returns, and other tailored information requests. With large public companies, by contrast, we can undertake significant analysis early in the compliance assurance process, without contacting the taxpayer, using their annual report and other publicly available shareholder information. How much tax do the wealthy pay? When determining whether a wealthy individual has paid the right amount of tax in accordance with the law, we don t look at them in isolation. We need to assess their entire group, as wealthy people do not always receive significant assessable income in their own right. Our experience is that most groups owned or controlled by wealthy individuals do pay significant and reasonable amounts of tax. EXAMPLE: Tax inconsistent with group s economic performance A group paid average annual tax of $27 million for the five years to 30 June While this is a significant amount, it was inconsistent with the group s economic performance. Our intelligence and risk assessment activities suggested that we should review the group. A subsequent audit resulted in a substantial increase in tax, and the imposition of penalties, for seven income years. Since 2001, the group has paid an average of about $45 million in tax each year. Their adviser now seeks clarification from the Tax Office on issues that might attract our attention. EXAMPLE: Tax reflects group s economic performance One particular group has paid around $20 million in tax per year over the last 10 years with very little variation between years. The amount paid is in line with the economic performance of the group. Accordingly the group is considered low risk. Figure 1 shows the growth in tax payable on filed tax returns for the highly wealthy and their associated entities from 1995 to It does not include subsequent amendments made by the Tax Office. The consumer price index (CPI), gross domestic product (GDP) and gross operating surplus (GOS) over the same period are provided for comparison. FIGURE 1: Growth in tax payable by the highly wealthy ( ) Index 1995= Year CPI GOS GDP TAX PAID 6 Wealthy and wise

11 INTRODUCTION How we review compliance of wealthy individuals The Tax Office formed a High Wealth Individuals (HWI) Taskforce in May 1996 following preliminary reviews of about 100 wealthy people that revealed some were paying little or no income tax, even as their wealth expanded. The taskforce was set up to improve our understanding of these individuals and their groups, identify their tax planning techniques, improve voluntary compliance, contribute to tax reform and build community confidence in the tax system. In May 2006 the Government provided additional funding for compliance work. This funding recognised that the number of wealthy individuals had grown. Since the taskforce was established, we have collected additional revenue of $1,766 million (table 1) and disallowed losses of $1,712 million (table 2) as a result of active compliance activities (such as audits) of highly wealthy individuals and their associated entities. TABLE 1: Additional revenue collected ( ) Year of collection Direct revenue ($m) Total TABLE 2: Disallowed losses ( ) Year of adjustment Reduction in revenue losses ($m) Reduction in capital losses ($m) Total Identifying wealthy individuals Currently, wealthy individuals are identified from tax return information, publicly-available information including media reports, and intelligence sources. With additional resources, we plan to strengthen our information collection to more effectively identify wealthy individuals. In particular, we will be making earlier and more extensive use of third party data that identifies individuals and entities connected with large financial transactions or capital holdings. These data sources include: state land titles offices property sales databases Australian Securities Exchange and commercial share registry data annual investment income reports from investment institutions overseas revenue authorities and financial institutions state government registration authorities and insurance companies, and other federal agencies including AUSTRAC, the Australian Securities and Investments Commission and the Department of Immigration and Citizenship. To more effectively analyse this information we are developing programs that retrieve, collate and interrogate data, and tools that map relationships and identify groups of connected individuals, entities and transactions. In addition, we are exploring different and easier ways for advisers to supply information to the Tax Office, including greater use of electronic channels. Wealthy and wise 7

12 INTRODUCTION Monitoring compliance at the taxpayer level We profile and assess the risk of all groups associated with these highly wealthy people. This involves compiling a tax history of the individual and their group, together with information on business structures, financial and offshore arrangements and family connections, as well as details of specific transactions. Understanding the compliance behaviour of this sector requires a holistic approach, which brings all associated entities, both business and private, into the analysis. If our intelligence and a preliminary risk review identifies a problem we will conduct a comprehensive risk review. If some risks cannot be satisfactorily explained during the review, we may need to conduct to an audit. The HWI Taskforce is currently developing systems that will enable us to monitor tax affairs in real time and automate what was previously a highly-manual process. Where wealthy individuals have a history of aggressive tax behaviour whether through tax planning to avoid the intent of the law, lack of proper attention, or weaknesses in their administrative systems we maintain an intense compliance focus until we are confident that a more reliable approach has developed. Risk identification is often undertaken in real time or near real time. For example, we may make enquiries about the nature and tax treatment of major transactions before a tax return is lodged. The outcomes of this analysis are compared to the tax return once it is lodged. If material tax risks are brought to our attention early enough, we may be able to resolve them before tax returns are lodged. This can avoid subsequent amendments, penalties and interest. We also track tax payments in real time to follow up missed registration, lodgment and payment deadlines. Monitoring trends at the macro level Analysis of taxpayer returns, payments and refunds allows us to monitor commercial, economic and tax revenue trends. For example, when there is a significant lift in commodity exports or capital acquisitions, we examine tax payments and refunds at various levels to check they reflect these trade and investment trends. At the macro level our responses to risk can include: help and education for taxpayers tax rulings and determinations referring matters to the Treasury where the tax law is inconsistent with policy, or produces unintended consequences or significant compliance costs, and targeted compliance activities, as guided by our compliance model (see next page). 8 Wealthy and wise

13 INTRODUCTION How we work with wealthy individuals The taxpayers charter The guiding principles underpinning our approach to working with taxpayers are reflected in the taxpayers charter and our compliance model. This involves mutual respect and a professional relationship based on a shared understanding of the tax law in identifying and evaluating compliance, and the taxpayer s business environment and perspective. The compliance model The Tax Office s broad approach to verifying compliance is encapsulated in our compliance model (see figure 2). This is a structured way of understanding compliance behaviour, and helps us respond according to: the nature and level of risk we identify the causes of non-compliance, and the level of cooperation we receive. It reflects our judgment that Australia generally has a culture of high voluntary compliance and most taxpayers are willing to do the right thing. However, to remain so they require a degree of confidence that there is a level playing field. Consultative arrangements In the spirit of openness and accountability that underpins voluntary compliance, we aim to provide taxpayers with the greatest possible certainty around their tax obligations. One way we do this is to consult with taxpayers through their advisers, so we understand any legitimate concerns they may have about tax administration. We want to find solutions that make it easier for taxpayers to voluntarily comply with their obligations. We have recently established a formal consultative forum with major accounting firms and legal advisers to discuss compliance risks in relation to wealthy people. In this publication we detail our core business processes, from initial risk analysis to detailed risk reviews and audits, and how these apply to wealthy individuals. We welcome comment and feedback from advisers and others about the relevance and impact of our strategies on compliance risks and tax administration, along with suggestions for minimising the costs of compliance. FIGURE 2: The compliance model Our approach to certainty A tax administration that operates in accordance with the rule of law promotes certainty for taxpayers. Our approach to tax law is to apply the words of the relevant Act in light of the history and the object of each of its provisions. In legal terms this is referred to as a purposive approach. Where the law is clear, we have a duty to apply it, even if it produces inconvenient outcomes for government revenue or for taxpayers. For example, the law may give rise to unintended consequences, anomalies, or significant compliance costs inconsistent with policy intent. In such circumstances, our responsibility is to advise Government (usually through the Treasury) of the outcome, irrespective of whether the existing law favours taxpayers or revenue. Through this, Government has the opportunity to consider legislative change. Wealthy and wise 9

14 INTRODUCTION There are times when the words in the Act are ambiguous or open to a number of interpretations. In these cases, we adopt the interpretation that best promotes the policy intent. If more than one interpretation supports the policy intent, we will have regard to taxpayer compliance costs in determining the interpretation to be adopted. Of course, these are merely rules of construction and an alternative interpretation is sometimes reasonably arguable. On important matters, our view of the tax law is communicated to taxpayers and their advisers through public rulings. We may also issue taxpayer alerts where we have concerns about how the law is being interpreted. Increasingly we are producing specialised guides such as this one with information tailored to the specific needs of the audience. To further reduce uncertainty, taxpayers can seek private and reviewable rulings from us (see chapter 6 for more information about our advice products). In this way taxpayers can ask to be assessed in relation to an existing or proposed transaction. Where appropriate, this could take the form of a private ruling on the application of general anti-avoidance provisions. Security of information The Tax Office recognises the sensitivity of the information provided by wealthy people, who are invariably the subject of media scrutiny and have consequent privacy concerns. Much of the information we gather from them is generally not available to the public, and some individuals go to great lengths to keep their total group structure private, occasionally even using different advisers for different parts of the group. Like other taxpayers, wealthy people are entitled to expect that the information they provide the Tax Office will be kept secure and made available only to staff who have a legitimate reason to access it. Because of the greater risks associated with information on highly wealthy individuals we have developed a purpose-built information system, which limits access by our staff to information on these taxpayers. Any new systems will provide the same level of security. 10 Wealthy and wise

15 Meeting your tax obligations This chapter provides suggestions to help you manage your tax obligations, including questions to raise with your adviser. 02

16 MEETING YOUR TAX OBLIGATIONS Understanding your tax obligations Irrespective of the business and tax advice they get, taxpayers are responsible for their own tax affairs. This chapter sets out some questions you can raise with your advisers so you can understand where tax risks may occur and ensure they are properly managed. Wealthy people often enter into large and complex transactions that may carry inherent risks for tax compliance. When business and private interests are entwined, tax issues can arise that would not be present in a publicly-owned group. Since the HWI Taskforce was set up, the Tax Office has continued to make large adjustments to taxable income and carry-forward losses of wealthy individuals. This highlights the need for you to remain vigilant about your tax compliance. From a risk management perspective, wealthy people should know where they stand on the application of the tax laws to the complex and sometimes unique transactions that occur in a global environment. You and your advisers also need to understand how the Tax Office identifies tax risk and what we will challenge. You need to have in place appropriate governance processes to ensure the integrity of transactions or events that may give rise to tax issues. It is also important that you have appropriate documentation or evidence to explain and support the tax treatment. Good record keeping is important. If there is inadequate documentation when we review your tax affairs, you may have problems defending the position you or your advisers have adopted. We suggest that you: make an effort to understand the tax consequences of material issues ensure that valuations are undertaken in good faith and that they stand up to independent scrutiny become aware of any potential problem areas in relation to your tax affairs ensure your advisers act within the law, and seek advice or clarification when there is some doubt about the application of the law. Given that you are ultimately responsible for your tax affairs, you need to be sure of the integrity and likely tax consequences of the advice you receive. Non-compliance carries risks to your financial position (the costs of dealing with intensive auditing and litigation, and paying interest and penalties). You also risk prosecution, and damage to your reputation and standing in the wider community. Non-compliance also undermines community confidence in Australia s tax system and short-changes other citizens. Risks over the business life cycle The types of risk we encounter tend to vary according to where the taxpayer is in the business life cycle, that is: creating, building or obtaining wealth maintaining wealth, or passing on wealth and control to future generations. Creating, building or obtaining wealth Some people inherit wealth and find that the group they now control was established and modelled according to the views of an earlier generation. Some individuals do not share the earlier generation s views on tax compliance. We have seen cases where voluntary disclosures have been made, for example to, bring offshore investments back into Australia and put compliance on a proper footing. Sometimes people have created wealth very rapidly by selling an idea or concept. This can result in very large transactions with significant tax consequences. Sometimes advice was obtained from internal and external advisers appointed when the business operations were far simpler. In these situations you will need to ask whether the level of advice you are getting is commensurate with the sophistication and significance of your current operations. Entrepreneurs sometimes can create wealth very quickly by assuming high levels of business risk. It is not uncommon for such people to enter into transactions and move money around without thinking how to document and explain these dealings for tax purposes. We have encountered situations where such dealings could not be adequately explained, giving rise to significant tax liabilities and penalties. 12 Wealthy and wise

17 MEETING YOUR TAX OBLIGATIONS Maintaining wealth When a person has built up a level of wealth they often become more conservative in their approach to tax risk. However, a major event such as a new venture or group reorganisation may still arise, with significant tax implications. With these big events outside business as usual you need to be confident that the correct amount of tax is being paid. We have seen cases where, despite the taxpayer having a very healthy attitude to their tax obligations, an adviser or employee has engaged in behaviour that contravenes their employer s views, with very serious compliance consequences. It is important to be sure that those who operate on your behalf do so in a way that is consistent with your views, as you will ultimately bear the consequences. Passing on wealth At some point, people decide to retire and either sell up their business or pass control and wealth on to the next generation. Such high-profile events attract our attention. As well as checking that the right amount of tax has been paid on the business transfer, we are also interested in the next generation s approach to tax compliance. Both generations need to ensure they have the best possible tax advice. Getting the right advice It is important that you have open and frank discussions with your advisers and that they operate as objective professionals. You should ask whether their advice is: likely to result in significant amounts of back taxes, penalties and interest, or only reasonably arguable (which may operate to mitigate penalties only). In such cases you should ask yourself whether you should take the risk, given our extensive coverage of high wealth individuals. You also need to ensure that the advice you are getting is commensurate with the complexity of your business dealings. Where there is ambiguity or confusion about particular matters you could suggest that your advisers seek a second opinion from an independent advisor or a private ruling from the Tax Office for the sake of certainty. Characteristics of low risk Characteristics of low risk groups include: effective tax rates that are reasonably in line with statutory rates having regard to the law explainable differences between accounting profit outcomes and taxable income a history of appropriate payment of taxes adequate and explainable documentation of the history of tax losses and business transactions commercially-explainable group structures and transactions appropriate capital gains tax outcomes on major transactions, and income tax payments that reflect industry and business performance. Asking the right questions Wealthy people often provide guidance and direction to large and complex business groups without being involved in the day-to-day running of the business. They will not necessarily be familiar with the tax law, relying on employees or external advisers for advice on tax, legal and financial matters. In some matters these advisers may be the decision maker, or signatory for legal purposes. Irrespective of this, it will be you or your taxpaying entity who bears the ultimate costs and benefits, including the tax outcomes (which may include significant tax, penalties and interest where poor advice is given). Most importantly, your reputation and that of your group could be severely damaged in the eyes of the wider Australian community. We suggest that you: ensure your group meets the routine obligations that come with doing business that is, be fully registered, lodge returns and documents, and pay the required tax on time, and be aware of any strategic and significant business decisions and be comfortable that the group s interaction with the tax system is reflected in correct tax outcomes. The following questions (table 3) are intended to help you assess broadly whether your group s tax obligations are being managed appropriately. Where the answer is yes you should have little difficulty in explaining the level of tax paid when contacted by the Tax Office. Where the answer is no or I don t know, you should review the issue with your adviser. You can also seek a private ruling from the Tax Office to clarify your position. If you discover any errors or non-compliance with the tax law, we encourage you to make a voluntary disclosure at the earliest possible opportunity. Making a voluntary disclosure can save you significant amounts of penalties and interest. Wealthy and wise 13

18 MEETING YOUR TAX OBLIGATIONS TABLE 3: Assessing your group s tax management General obligations and conduct 1 Are your advisers aware of all of the entities you control both in Australia and overseas? 2 Have you registered all of the entities you control with the relevant revenue authorities? 3 Have you disclosed to the Tax Office all of the entities you control including overseas entities? 4 Does your group have a history of lodging accurate returns and paying the required taxes, on time? 5 Are you confident that the advice you are being given is professional and balanced? 6 Do you meet regularly with your advisers to discuss key tax decisions? Yes No 7 Is the tax paid over a period of time consistent with your group s economic performance and any change in your level of wealth? 8 If your group is consistently making losses, are these real economic losses that can be satisfactorily explained in terms of the group s overall performance? 9 If there are any major disagreements between your group and the Tax Office, are you satisfied with how they are being handled? 10 Are your personal tax returns accurate and lodged on time? Record keeping Maintaining adequate records of taxable events and transactions can help you defend your tax position. 1 Are you confident that you and your group have the appropriate records to document your routine business? 2 Are you confident that decisions affecting business and tax outcomes are accurately recorded at the time they are made? 3 If the Tax Office reviews you and your group, are you confident you have the necessary records to support and explain your tax position? 4 Have you made the appropriate records available to your advisers? Choice of business structure 1 Is the number, use and structure of entities in your group appropriate to your business, that is, not overly complex? 2 Do all of your entities serve a commercial purpose? Yes No I don t know 3 Are your overseas entities in places where you have legitimate business operations or interests? 4 If you have any entities, investments or interests in countries that are tax havens, have banking secrecy laws or a relatively low level of tax; are you confident they have been treated correctly for Australian tax purposes? 5 Where you have private or family interests in your entities, is there proper separation of business and private matters for tax purposes? 6 If you have any entities other than companies, partnerships or trusts (such as anstalts or stichtings) in your structure, do you understand what they are being used for? 7 Where there are transactions between your related entities, are they consistent with transactions that would occur between two unrelated parties? That is, are you confident that the related entities aren t being used to reduce income or inflate losses or in other ways reduce the amount of tax properly payable? 14 Wealthy and wise

19 MEETING YOUR TAX OBLIGATIONS Major transactions and aquisitions 1 Where you have sold parts of the business, is the amount of tax paid appropriate? For example, if you sold a portion of your group and made a large profit, have you also paid a significant amount of tax? If you made a loss on a major transaction, does the amount of the loss for tax purposes correspond with this? 2 Where you have restructured or reorganised your business, have you considered any possible tax implications? Yes No 3 Is the transaction carried out in a way that makes commercial sense and not just to achieve a tax advantage? 4 Where valuations are required to calculate the amount of any gain, are they realistic and defendable? Finance 1 Do you understand how any new acquisitions or significant purchases are being financed? 2 Is the form of finance similar to what you would expect for a similar transaction undertaken by another group with an independent financier? 3 Is the financing understandable in that there is not a large number of entities and transactions involved? Tax concessions The tax law provides concessional tax treatment for certain activities such as research and development and investment in films. Concessions are intended as an incentive for these activities, so it is important that they are actually performed and that people do not invest in schemes simply to reduce their tax. The following questions may help you evaluate such investments. 1 Is the activity part of your normal business? 2 Do you understand the commerciality of the proposal? 3 Has the investment been marketed purely on a commercial basis (rather than on promises of significant tax deductions)? 4 Do you understand the proposal and expect to obtain a realistic return on your investment when considering the inherent risk? 5 Are you confident that all of your outlay is being spent on the desired activity? 6 Does the proposal expose you to substantial financial risk? Wealthy and wise 15

20 MEETING YOUR TAX OBLIGATIONS Doing the right thing As a taxpayer, it is never too late for you to ask questions and reorganise your business affairs so you can have confidence that you and your group are complying with your tax obligations. If you have recently increased your wealth (for example, through inheritance, taking over the family business or selling the business or ideas) the following steps will help get your tax affairs on a good footing. Ensure you engage professional advisers. Be open and honest with your advisers and disclose all relevant facts to them. Be aware of the kind of relationship your adviser has with the Tax Office, especially when it comes to tax compliance and planning beyond the intent of the law. Get a broad understanding of the major taxation issues that arise as part of your business. Ask questions when you get advice on tax planning, especially if you suspect that an activity may be designed to improperly minimise tax. If necessary, seek an unbiased second opinion or contact the Tax Office to get clarity and certainty on issues. If you find that your group has inappropriate domestic or overseas investments that may have been tax driven, take steps to clean up the group. Consequences of non-compliance, fraud or evasion When the Tax Office detects non-compliance there can be significant consequences for everyone involved the taxpayer, family members, employees and advisers. Some of the consequences include: significant back taxes substantial penalties and interest, and in the most serious circumstances criminal prosecution. The greatest cost of non-compliance can be the damage done to the individual s reputation and standing in the eyes of the wider Australian community. From 2006 to 2010, the HWI Taskforce will almost triple in size. Together with improvements in technology, this means that the likelihood of a wealthy person s tax affairs being reviewed will increase substantially. 16 Wealthy and wise

21 What attracts our attention This chapter outlines the issues and characteristics that attract our attention and constitute a risk. 03

22 WHAT ATTRACTS OUR ATTENTION How we arrive at a position We acknowledge the right of taxpayers to legally minimise their business costs, protect and maintain their wealth and build their businesses. On the other hand, underpaying tax creates an unfair advantage. The Tax Office seeks to promote a level playing field in accordance with the tax law that fosters competition based on comparative advantage rather than unfair practices. Getting the balance right between legitimately minimising costs (and the associated tax planning) and pushing the interpretation of the law beyond its limit is often difficult. It is not surprising therefore that the Tax Office sometimes takes a different view from the taxpayer or their advisers on the application of tax law. Given the financial impacts of adjustments on tax assessments, we make sure we have a sound position for taking a different view. In making these decisions, we apply all the interpretative and analytical capabilities available to us, including the use of external experts in some cases. Unless there is an immediate risk to the revenue, such as where funds are leaving the country or a business is being liquidated, we will normally discuss the case with the taxpayer before making an adjustment, including making a full and frank disclosure of our position, and attempt to resolve any disputes that arise. A business s tax position must be determined on the basis of the proper application of the law to the facts of the case. The observations made in this publication (and in our public rulings) reflect the Tax Office s view of the law, which in the case of dispute may ultimately need to be reviewed by the Administrative Appeals Tribunal or the courts. The courts are the final arbiters in relation to disputes. 18 Wealthy and wise

23 WHAT ATTRACTS OUR ATTENTION What attracts our attention There are several features and characteristics that will attract our attention including: tax performance that varies substantially from business performance significant variations in tax payments that are inconsistent with economic indicators unexplained losses a history of aggressive tax planning by individuals or their advisers weaknesses in compliance structures, processes and approaches tax outcomes that are inconsistent with the intent of newer tax law lifestyle not supported by after-tax income private assets treated as business assets non-disclosure of offshore dealings with overseas entities especially involving tax havens, banking secrecy and low tax jurisdictions complex structures and intra-group transactions used to minimise tax transactions for tax purposes that are at odds with their economic substance distortions and inconsistencies in market valuations. Each of these is discussed more fully in the following pages. Some of the case studies are still subject to litigation and the final outcome is not yet determined. Tax performance that varies substantially from business performance In risk reviewing a taxpayer and their business, we compare tax performance with business performance. Where tax performance appears to be inconsistent with business results, or the effective tax rate is inexplicably low, we will investigate further. This is not an exercise in taxation solely by reference to tax performance, nor a substitute for properly applying the law. We approach our risk reviews openly and objectively. Where we see a lack of correlation between economic and tax performances, we will review this with the taxpayer. It may be that such outcomes can be explained. When reconciling tax paid with business or economic performance, we may examine: the business s internal structures and dealings, such as its financial structure and any loans between related entities that give rise to deductions for interest and bad debts transactions between related parties where it appears there are tax consequences whether the business has properly classified income and expenses for tax purposes whether the business has adopted consistent and appropriate tax accounting practices in treating flows of income and expenses within the group, and in recognising profits and losses in respect of any related party dealings whether costs have been artificially inflated for tax purposes the group structure, and attempt to understand the various entities roles in the wider business. EXAMPLE: Incorrectly classifying profits Our intelligence activity identified a wealthy individual who had sold several properties as part of what appeared to be a successful property development business. When audited, the group s overall level of tax paid was found to be quite low. With each property being held in a separate entity, the taxpayer argued that the sales were of a capital nature and therefore subject to the capital gains regime, which provides for favourable tax treatment through indexation. The Tax Office took the view that given the group s overall structure and conduct the profits were more appropriately categorised as proceeds from the business of property development. The reclassification of profits to revenue account resulted in amendments to taxable income of more than $50 million. EXAMPLE: Non-disclosure of capital gains We observed a large sale of a property. An analysis of tax returns and schedules failed to identify the disclosure of any capital gain. As part of a risk review it was ascertained that the property was properly categorised as being a pre capital gains tax asset and was therefore not subject to tax. No further action was taken. Wealthy and wise 19

24 WHAT ATTRACTS OUR ATTENTION Significant variations in tax payments that are inconsistent with economic indicators The Tax Office monitors the level of tax payments to check they align with economic indicators such as interest and foreign exchange rates and industry trends. Changes in products, services, operating levels and market strategies may also affect the level of tax payments. Where a pattern or trend is inexplicable we may undertake further analysis to understand why. We supplement a detailed systematic analysis with our knowledge of major events such as mergers and acquisitions, demergers, asset sales and capital restructuring. We also follow the pattern of tax payments as legislation changes. For example, since the introduction of income tax consolidation, we have been monitoring payments to ensure they are consistent with the policy intent of the law. EXAMPLE: High sales but low tax The website of a wealthy individual s business, operating in the mining industry stated that worldwide sales had been considerable. However, the group s low effective rate of tax in Australia was not in line with purported sales. A risk review of the group uncovered entities based in tax jurisdictions with low rates of tax. An audit was commenced. Unexplained losses The Tax Office recognises that businesses sometimes incur substantial commercial losses. However, we regard it as out of character for any business to allow large amounts of investment to consistently produce little or no net return, or to diminish in value through a consistent pattern of losses. For a number of years we have focused on specific cases where businesses have been consistently reporting losses or paying little tax. Various arrangements have been detected where deductions have been created despite no real loss having been incurred, or the real loss is much less than the deduction claimed. EXAMPLE: Smoothing of profits Over the last five years, a HWI group has grown substantially while continuing to pay a minimal amount of tax. It appears that losses made in some entities have been transferred through the payment of management fees by the profitable entities. This smoothing of profits has meant that no substantial tax has been paid. While the group may be paying the correct amount of tax, we are looking into the origin and legitimacy of the losses, the arm s length nature of the management fees, and whether any collateral arrangements exist. EXAMPLE: Genuine losses due to market conditions A wealthy individual s business paid no tax over a number of years, as it had significant carry forward losses to offset against its assessable income. An audit undertaken to ascertain the origin of the losses found that they were genuine and had arisen out of changing market conditions. No further action was taken. 20 Wealthy and wise