The key findings found in the Next 5,000 population were that most had informally documented tax governance-like processes and controls in place. The ATO is now increasingly focusing on the next ‘gen’ and tax issues arising from succession planning within a private group.

The ATO will select cases by using data analysis and risk profiling, to identify emerging risks affecting private groups and tax issues relating to the Next 5,000 key priority areas. Taxpayers who were previously reviewed and provided with feedback for improvement or had issues may be subject to a new round of ATO review. 

About the Next 5,000 program 

The Next 5,000 program was introduced to instil the community’s confidence that Australia’s largest and most complex private groups are compliant with their tax obligations.

This tax performance program considers Australian resident individuals who, along with their associates, control net wealth exceeding $50 million. Approximately 7,300 private groups fall under this population.

Comprehensive risk reviews (CRR) 

Whilst most taxpayers within this population will continue to be engaged through a streamlined assurance review (SAR), the ATO has recently advised that comprehensive risk reviews (CRR) will be undertaken for taxpayers identified:

• Through risk profiling of key emerging risks and tax issues affecting private groups, or
• In a previous SAR where the taxpayer had insufficient documented governance controls

How does the ATO engage?

A SAR typically involves request for information relating to the last two income years where tax returns were lodged, and for entities within the group with significant activities, events, and transactions. Where the ATO is satisfied that the four pillars of Justified Trust are achieved, future reviews will examine significant changes to the private group, and/or issues that were not considered/assured in the SAR.

In contrast, a CRR would encompass all entities within the private group and a substantially broader scope.

Click here for our previous coverage of Justified Trust and effective tax governance.

ATO focus for the 23/24 income year 

The ATO has identified taxpayers in the Next 5,000 population with the following behaviours and transactions as their focus for the 23/24 income year:  

• Tax governance framework not fit for purpose in supporting the expansion of the group 
• International expansion and cross-border transactions with related parties
• Entering into intra-group arrangements resulting in an ‘inappropriate’ transfer of wealth
• Re-structuring of the group for the purpose of intergenerational transfer of wealth
• Wealth extraction through private equity funds. 

Common tax issues observed in prior year reviews

Common tax issues that the ATO identified from the completed reviews, of which some were escalated to an audit, included: 

• Tax governance framework not fit for purpose in supporting the expansion of the group  
• International expansion and cross-border transactions with related parties 
• Entering into intra-group arrangements resulting in an ‘inappropriate’ transfer of wealth 
• Re-structuring of the group for the purpose of intergenerational transfer of wealth 
• Wealth extraction through private equity funds.  

Key Takeaways

The main observations made by the ATO regarding the Next 5,000 population reviewed to date are that although majority had tax governance-like processes and controls in place, most are not formally documented. The lack of or insufficient governance frameworks has a strong correlation with disclosure errors on ITRs/BASs and taxpayers not recognising tax risks or adopting correct tax treatments. 

Noting the program commenced on and around the in the 2020 income year and, taxpayers who were previously reviewed and provided with feedback for improvement, / had issues or unassured /transactions could not assured may be subject to a new round of ATO review. With the aging of the controlling individual/head, it also appears that the ATO is now increasingly focusing on the next ‘gen’ and tax issues arising from succession planning within a private group.

How SW can help

Reach out to us to discuss your tax governance issues, ATO reviews or other related matters.

Contributors

Antony Cheung

Shu En Hwang

The post ATO updates on Next 5,000 Program for private groups appeared first on SW Accountants & Advisors.

The Taxpayer Alert notes that participants in, and promoters of these types of arrangements, may be subject to penalties, including promotor penalties under Div 290 of Sch 1 to the Taxation Administration Act 1953.

Background on Division 7A

Division 7A (Div 7A) is a far reaching set of provisions the essential purpose of which is to treat certain payments and non-commercial loans made by private companies to shareholders or their associates as a distribution of profits and therefore a deemed (unfranked) dividend.

For a deemed dividend to arise, the relevant private company must have what is referred to in the legislation as a ‘distributable surplus’ (which is very broadly profits, reserves or surplus funds from which a dividend could theoretically be declared).

What types of arrangements is the ATO looking at?

Arrangements that are flagged by Taxpayer Alert TA 2023/1 as being high risk and in the crosshairs of the Commissioner are arrangements along the following lines:

• An individual who is a shareholder and director of a private company with retained profits.
• The individual disposes of their shares in the private company to an interposed holding company (set up by the individual) and receives shares in the interposed holding company in return.
• The value of the shares received in the interposed holding company equate to the net asset value of the private company, with the result that the interposed company has no ‘distributable surplus’ available for distribution.
• The individual applies CGT roll-over to disregard, for tax purposes, any capital gain arising on the disposal of the shares in the private company.
• The private company declares a franked dividend to the interposed holding company. Whilst the TA does not explicitly state this, it is expected that the dividend received by the interposed holding company (being a dividend received from pre-acquisition profits of the private company) would be recorded for accounting purposes as a reduction in the book value of the asset, rather than a receipt of profit. 
• The private company discharges its liability to pay the dividend by ways such as cash, cheque or promissory note.
• The individual receives a loan from the interposed holding company, financed by the dividend received from the private company. The terms of the loan do not comply with Division 7A (which requires loans to meet criteria such as a minimum interest rate and maximum term).
• Whilst the loan is not on complying Division 7A terms, taxpayers are taking the position that Division 7A would not apply due to the absence of a distributable surplus in both the private company and the interposed holding company. 

TA 2023/1 also indicates that the Commissioner would be equally concerned should a similar arrangement be entered into where the relevant shareholder is a trust, rather than an individual.  

Grounds to challenge

On the basis that arrangements such as the above exhibit a high degree of contrivance and would appear to be motivated by an objective of avoiding the application of Division 7A, TA 2023/1 notes that the Commissioner would be likely to challenge the arrangement on the following alternative bases:

• the Commissioner may assert that the loan is not a genuine loan, but a payment that is assessable as an unfranked dividend under the deemed dividend rules in Division 7A
• the arrangement may be challenged as a ‘dividend stripping’ scheme resulting in the loan amount being included in assessable income of the original shareholder and the franking credit on the dividend paid to the interposed holding company being cancelled
• under the general anti avoidance rules in Part IVA.

How SW can help

While the circumstances at which TA 2023/1 are directed are quite specific and may not affect many of our clients, the Taxpayer Alert highlights the efforts that the ATO are applying to enforce Division 7A.

Should you have any queries in relation to this Taxpayer Alert or Division 7A more generally, please reach out to your SW contact or Key Contacts here.

Contributors

Tanya Bester

The post ATO targets Division 7A avoidance scheme appeared first on SW Accountants & Advisors.