LATITUDE LINK 33

When is a Gift Not a Gift?

The Tax Commissioner successfully argued that over $1.6 million deposited into a couple’s bank account was assessable income—not a gift or loan from friends.

A Case Fit for a Telemovie: Rusanova vs. Commissioner of Taxation

This case is enough for a telemovie plot: an Australian resident Russian couple ‘gifted’ over $1.6 million in unexplained bank deposits, over $67,000 in interest, a Russian father-in-law seafood exporter, a series of Australian companies, and a friend generously loaning money in $20,000 tranches.

The Crux of the Matter

Before the Federal Court, the question was whether the couple could prove to the Australian Tax Office (ATO) that unexplained deposits should be treated as gifts or loans. What happens when the Tax Commissioner thinks otherwise? If the Commissioner suspects the deposits are income, a default tax assessment can be issued, and it’s then up to the taxpayer to prove the Commissioner wrong.

The Unexplained Deposits

Between 2012 and 2016, an Australian resident husband and wife had around $1,636,000 deposited into their bank accounts. The ATO became suspicious when neither spouse lodged tax returns, mistakenly believing they had not earned any income.

The couple claimed the deposits were gifts from the wife’s father, thus not assessable income. However, no records supported the deposits, nor was there a single text or email confirming the money’s remittance or receipt.

Additionally, a friend of the couple deposited money into the husband’s account, including a series of $20,000 transactions over a week. These were said to be interest-free loans with no agreed terms, only an expectation of repayment. However, there were no loan documents, emails, or texts to support this claim. At the same time, there was evidence of the husband ‘repaying’ amounts exceeding what had been lent, and he also transferred a Porsche Cayenne to his friend in Russia as repayment.

Further complicating matters, the husband held directorships in four Australian companies, none of which had lodged tax returns. One company was a seafood wholesaler, distributing his father-in-law’s products. The son-in-law claimed he was merely trying to develop the business without remuneration.

Contesting the Tax Commissioner

In 2017, a covert tax audit utilized entries in the couple’s bank accounts to assess their income tax liability. The ATO issued a default assessment based on the unexplained deposits and expenses. The couple objected to the assessment, and while the objection was partly allowed, a second assessment was issued, which they again contested before the Administrative Appeals Tribunal (AAT).

Can the Tax Commissioner Really Decide Your Tax?

The Tax Commissioner has the power to issue a ‘default assessment’ for overdue tax returns or activity statements based on what he believes is owed, not what has been declared.

The problem with a default assessment isn’t just the Tax Commissioner deciding your tax—it’s the potential 75% administrative penalty of the tax-related liability for each default assessment, which may increase to 95% for taxpayers with a pattern of non-compliance.

Here’s the issue for the couple: while genuine gifts of money are not taxable, the burden of proof lies on the taxpayer to show that the gift is truly a gift, if asked by the ATO. The AAT held that, “absent any reliable evidence…, there is no proper basis to make any findings as to whether the deposits constitute part of the applicants’ taxable income or not.”

The couple’s claims that the deposits were gifts from the father or loans from a friend were rejected by the AAT, despite an affidavit from the wife’s father stating that the amounts were gifts. The couple couldn’t prove their income or substantiate the gifts. The Federal Court dismissed their appeal with costs, leaving the default tax assessment and penalties in place.

Avoiding the Gift Tax Trap

Generally, a gift of money or assets isn’t taxed if given voluntarily, with nothing expected in return, and without any material benefit to the giver.

Gifts from a Foreign Trust

If you’re an Australian tax resident and a beneficiary of a foreign trust, some amounts paid to you (or applied for your benefit) may need to be declared in your tax return. This applies even if the gift came indirectly via a family member.

Inheritances

Inheriting money or property is often not taxed, but Capital Gains Tax (CGT) may apply when disposing of an inherited asset. For example, CGT generally doesn’t apply if:

• The property was your parents’ main residence
• Your parents were Australian residents for tax purposes
• You sell the property within 2 years

However, CGT likely applies if:

• You sell your parents’ former main residence more than 2 years after inheriting it
• The property wasn’t their main residence
• Your parents weren’t Australian tax residents at their time of death

Managing the tax consequences of an inheritance can quickly become complex. Contact us for assistance in estate planning to maximize outcomes for your beneficiaries or managing the tax implications of an inheritance. These issues are often overlooked when drafting or updating a will.

Gifting an Asset Doesn’t Avoid Tax

Gifting an asset doesn’t avoid CGT. If you receive nothing or less than the asset’s market value, the market value substitution rule may apply, treating you as having received the market value for CGT calculation.

For example, if parents buy land and later gift it to their daughter, the ATO will assess the land’s value at the time of gifting. If the market value is higher than the original purchase price, this could trigger a CGT liability, even though the parents received no payment. Similarly, donations of cryptocurrency might also trigger CGT.

Divorce, You, and Your Business

Divorce can create emotional and financial turmoil, along with a host of issues that need resolution.

What Happens When There’s a Family Company?

If a couple’s assets are tied up in a company, the tax consequences of settlements paid from the company must be assessed. Settlements paid out by a corporate entity can sometimes be treated as taxable dividends, taxed at the relevant spouse’s marginal tax rate.

Understanding the tax implications of receiving assets from a corporate entity is essential before settlement, or a sizeable portion could go to the ATO. Business owners must stay focused on keeping the business running efficiently, even amid personal turmoil.

What Happens to Your Superannuation in a Divorce?

A spouse’s superannuation interest is a marital asset and can be split as part of the breakdown agreement. However, superannuation cannot be paid directly to a spouse unless eligible to receive it. Instead, it can be rolled over into the spouse’s fund until eligible. Laws prevent CGT from being triggered when superannuation assets are transferred, especially important when super funds hold property.

A Court order or Superannuation Agreement is required to effect the agreed split in SMSF assets or execute a rollover eligible for the CGT rollover concession. If both spouses are SMSF members, it’s vital to get advice to ensure all administrative issues are handled appropriately. If a divorce isn’t amicable, remember the SMSF trustee must act in the fund and beneficiaries’ best interests.

Can You Protect Both Parties from Divorce?

In a divorce, assets are split based on earning capacity, child maintenance, and pre-marriage assets. Couples often don’t have an equal view of asset and income attribution until something goes wrong. Evening out income and topping up a lower-earning spouse’s super can have real financial benefits, as superannuation has preferential tax rates. Strategic planning can make a significant difference.

Changes to How Tax Practitioners Work with Clients

The Government has amended legislation guiding registered tax practitioners, introducing compulsory reporting of material uncorrected errors to the Tax Commissioner.

The reforms, driven by a Senate inquiry into PwC and the consulting industry, placed additional requirements on registered tax practitioners. The inquiry revealed flaws in tax practitioner service regulation and the investigative powers of the Tax Practitioners Board (TPB).

We are now obligated to advise clients on: checking our registration as tax practitioners; accessing the complaints process for registered practitioners; and our obligation to report material uncorrected errors and omissions to the Tax Commissioner.

Tax Practitioner Registration

The TPB registers and regulates tax practitioners in Australia. Only licensed practitioners can provide tax or BAS services. Check the public register here: https://www.tpb.gov.au/public-register

Correcting Errors and Omissions

We are prohibited from making false or misleading statements to the Tax Commissioner or other agencies. If we become aware of a materially incorrect statement, we must either correct it or advise you to do so. If not corrected, we are obligated to report this to the Tax Commissioner.

The Rise in Business Bankruptcy

ASIC’s annual insolvency data shows corporate business failures are up 39% compared to last financial year, with construction, accommodation, and food services at the top of the list.

Restructuring appointments grew by over 200% in 2023-24. Small business restructuring allows eligible companies to retain control while developing a restructuring plan with creditors, guided by a restructuring practitioner.

Of the 573 companies that entered restructuring after January 2021 and completed their plan by June 2024, 89.4% remain registered, 5.4% have gone into liquidation, and 5.2% were deregistered.

In a recent statement, Reserve Bank of Australia’s Michelle Bull noted signs of pressure in the business sector and a less rosy outlook. Productivity is lagging, and managers need to stay on top of their numbers to avoid potential problems. If you don’t know your business’s key drivers, now is the time to find out.

Top Three Reasons Companies Fail:

• Poor strategic management
• Inadequate cashflow or high cash use
• Trading losses

It’s easy to miss warning signs and rely on optimism to get past a slump. Common problem areas include:

• Significant below-budget performance
• Increases in fixed costs without revenue growth
• Falling gross profit margins
• Funding primarily from debt rather than equity finance
• Falling sales
• Delaying payment to creditors
• Overspending in excess of cashflow
• Poor financial reporting systems
• Growing too quickly
• Substantial bad debts or ‘dead’ stock

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Note: The material and contents provided in this publication are informative in nature only.  It is not intended to be advice and you should not act specifically on the basis of this information alone.  If expert assistance is required, professional advice should be obtained.

Publication date: August 2024