Deductions Franchise Tax by swi97464


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No deduction for                        therefore deductible as an               the provision of engineering
franchisee fee                          outgoing of a revenue nature.            services.
                                        The AAT upheld the                       Readers may remember that the
In a recent decision, the
                                        Commissioner’s position.                 PSI rules apply where the income
Administrative Appeals Tribunal         It indicated that there was no           is derived mainly as a reward for
(AAT) disallowed deductions for
                                        business being conducted and the         the individual’s personal efforts or
the payment of an initial upfront       expenses were not incurred in the        skills.
fee to participate in a franchisee      production of assessable income.
arrangement.                                                                     In such circumstances, the income
                                        Instead the AAT held that the
                                        taxpayers had made a capital             represents the individual’s PSI,
A group of taxpayers were                                                        irrespective of whether or not that
involved in an arrangement              investment.
                                                                                 income is derived in another
whereby they would pay an                TIP: Broadly, a tax deduction will     entity, such as a company.
upfront amount to secure franchise          be available where it can be
rights. They also paid legal and            shown that the expense is            The Commissioner attributed the
administration fees in respect of           incurred in carrying on a business   company’s income to the taxpayer
the franchise.                              to produce assessable income,        directly.
                                            as opposed to acquiring a capital
These outgoings were claimed as             or investment asset.                 In his view, the taxpayer was not
a deduction by all taxpayers, in                                                 operating a personal services
their income tax returns.               Personal services                        business and therefore the PSI
                                                                                 rules should apply.
The franchise business involved
marketing financial services to                                                  Broadly, the taxpayer argued the
accounting firms in certain areas       In a recent decision, the
                                                                                 company satisfied two of the four
throughout Australia.                   Administrative Appeals Tribunal
                                                                                 tests required for a personal
                                        (AAT) held that consultancy
                                                                                 services business. These tests
The Commissioner amended the            income derived by a company was
taxpayers’ assessments for the          personal services income (PSI).
periods in question, disallowing        The income was earned by the                the results test — where at
the deductions for the franchise        company for the provision of the             least 75% of the personal
fee and administration fees on the      services of an engineer, who was             services income derived is for
basis they were outgoings of a          also the sole director of the                producing a result; and
capital nature.                         company.
                                                                                    the unrelated clients test —
The taxpayers objected to this          The taxpayer consulted as an                 where a taxpayer derives
decision arguing that the payments      electrical engineer through his              personal services income from
were made in the course of              company. Over several contracts              at least two entities which are
carrying on a business and were         the company derived income for               not associates of each other.

                                                                                                   October 2007
The AAT held that the                             management fee and marketing                       The taxpayer claimed to
Commissioner had correctly                        fee paid as part of their                          misunderstand the advice given
attributed the income of the                      investment, despite the fact that                  to them by the Tax Office and
company to the taxpayer as                        they were largely funded by                        indicated that he did not have an
personal services income and                      limited recourse loans.                            intention to mislead or avoid any
that a personal services business                                                                    payment of GST.
                                                  The Commissioner amended
did not exist in the
                                                  each of the taxpayer’s                             As the relevant law and the
circumstances of the case.
                                                  assessments and applied Part                       calculation of the liability was
                                                  IVA of ITAA 1936 to each                           complex, the AAT held that,
Deductions                                        taxpayer.                                          under the circumstances,
disallowed for                                    He argued that the sole or
                                                                                                     reasonable care was taken by
scheme                                            dominant purpose of entering
                                                                                                     the taxpayer in relation to the
                                                  into the arrangement was to
In a recent decision, the Federal
                                                  obtain a tax benefit. He indicated
Court has upheld the
                                                  that this argument was based on                    Tax Office
Commissioner’s decision to
disallow deductions in relation
                                                  the overall size of the                            Compliance
to management fees, license fees
                                                  management fee paid relative to                    program
                                                  the income earned and the fact
and marketing fees paid by
                                                  that the scheme lacked                             The Tax Office has released
                                                  commercial substance.                              their compliance program for the
A partnership of individuals and                                                                     2007/2008 financial year,
                                                  In conclusion, the Federal Court
a company were established to                                                                        indicating their tax priorities for
                                                  held that the taxpayers had
invest in a business which                                                                           the year include the following
                                                  entered into a scheme for the
provided an information product                                                                      issues:
                                                  sole benefit of obtaining a tax
to travel agents.
                                                  benefit as the deductions                              reviewing whether taxpayers
As part of their involvement in                   claimed were far in excess of                           have correctly accounted for
this business, each partner was                   any funds each of the taxpayers                         CGT on the disposal of
required to pay license fees,                     actually contributed.                                   assets;
management fees and marketing
                                                  Each taxpayer’s deductions were                        work-related expenses,
fees. These fees were largely
                                                  disallowed to the extent that they                      specifically regarding
funded by limited recourse
                                                  exceeded their actual cash                              tourism workers, travel
                                                  outlays.                                                consultants, fitness and
Broadly, under the limited                                                                                sporting industry employees,
recourse loan arrangement, the                     TIP: Taxpayers should be wary                         construction industry
                                                       when entering into
lender only had access to 50% of                       arrangements that involve
                                                                                                          employees, mining
the gross income from exploiting                       limited recourse debt and                          employees and guards and
the licenses in overseas                               should seek advice as to the                       security employees;
territories (after deducting                           availability of deductions.
                                                                                                         company executives with
certain expenses for recovery of
                                                                                                          remuneration in excess of
the loan).                                        Penalties for                                           $1 million who aren’t fully
The Tax Office’s position on                      recklessness in                                         reporting income;
limited recourse finance is that
deductions are only available for
                                                  preparing BAS                                          rental income and expenses
                                                                                                          with a specific focus on
amounts actually paid.                            In a recent decision, the
                                                                                                          unusual patterns of rental
                                                  Administrative Appeals Tribunal
Amounts not ultimately incurred                                                                           claims; and
                                                  (AAT) has set aside a decision
as a result of the limited recourse
                                                  regarding shortfall penalties of                       aggressive tax planning
nature of the loan will not be
                                                  approximately $134,000                                  where taxpayers are creating
                                                  imposed on the taxpayer for                             losses through the
In this instance, the taxpayers                   recklessness in preparing two                           acquisition of prepaid
claimed a deduction for the                       business activity statements                            warrants, and through new
entire amount of the license fee,                 (BASs).                                                 financial products.

Important: This is not advice. Clients should not act solely on the basis of the material contained in this Bulletin. Items herein are general
comments only and do not constitute or convey advice per se. Also changes in legislation may occur quickly. We therefore recommend that
our formal advice be sought before acting in any of the areas. The Bulletin is issued as a helpful guide to clients and for their private
information. Therefore it should be regarded as confidential and not be made available to any person without our prior approval.

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