Current Issues

Service Entities

Tax ruling 2006/2 The deductibility of service fees paid by associated service entities.

The ruling outlines the commissioner position in relation to service fees paid to associates entities. This ruling has lead to a significant change in the way professional firms are structured. Should your firm have not considered this ruling in respect of your service fee arrangements you should do so immediately.

The ruling allows affected taxpayers up to 30 April 2007 to alter such returns. Should your firm have not reviewed its service entity arrangements we recommend you contact our office immediately.

Transfer Pricing

Transfer pricing is the policy of valuing transactions of goods or services provided to customers or related parties across international borders. These transactions can move the tax base of your company profits in or out of Australia. Transfer pricing policy requires that all transactions are completed at 'Arms Length'. A business who fails to develop policies and records for these transactions can be double taxed (i.e. in Australian and the country which your company trades with).

• What does the arms length policy mean?
• Which valuation methods available to your business?
• What documentation do we need to complete and keep?
• How do we prevent double taxation of these transactions?

High Court allows Commissioner's appeal regarding St George Bank sell back rights

The High Court (Gummow ACJ, Hayne, Heydon and Crennan JJ, Callinan J dissenting) has allowed the Commissioner's appeal in Commissioner of Taxation v McNeil [2007] HCA 5 (22 February 2007), finding the grant of St George sell back rights was assessable to the taxpayer as ordinary income.

Case overview
The taxpayer, an individual shareholder in St George Bank Ltd (SGL) received an amount of $576.64 from SGL in 2001 in connection with the granting of sell back rights by SGL. The sell back rights were essentially put options under which each shareholder could require SGL to buy back 5% of their shares at a price of $16.50, which was above the market value of the shares at that time. On this basis, the parties agreed that the market value of one sell back right was $1.89, so that the market value of the taxpayer's 272 sell back rights at the listing date was $514. (The balance of the $576.64 received by the taxpayer represented the appreciation in value of the sell back rights between their issue and subsequent sale. It was common ground that this difference represented a capital gain).

The sell back rights were issued by SGL to St George Custodial Pty Ltd ("Custodial") as trustee for the shareholder in February 2001. In broad terms, SGL shareholders could give a direction to Custodial just prior to the grant of the sell back rights to obtain legal title to their sell-back rights so they could sell their shares back to SGL at $16.50 or dispose of the sell back rights on the market (the sell back rights could be traded on the ASX for a period). However, the taxpayer gave no direction which meant that her sell back rights were held by Custodial as trustee until those rights were required to be dealt with by a merchant bank that could trade or exercise the sell back rights and return the proceeds to Custodial as trustee for the taxpayer.

The majority agreed with the Commissioner's primary submission that at the time of the grant of the sell back rights by SGL to Custodial "for the absolute benefit" of the taxpayer under the Sell Back Right Deed Poll, there was a derivation of income according to ordinary concepts of $514. This made it unnecessary to consider the capital gains tax provisions.

The majority observed that the character of the receipt in the hands of the recipient was decisive (and not from SGL's viewpoint as being connected with the share buy-back) and found that the sell back rights "did not represent any portion of her rights as a shareholder" (para 21).

Implications
The ATO have already released an interim form of a Decision Impact Statement on the case, which is not surprising given that the Commissioner considers that more than 80,000 taxpayers are affected. It includes a statement that the ATO will work with St George Bank to contact affected shareholders. It also says that objections lodged by some shareholders against inclusion of the amounts as income in their tax returns will be finalised.

The ATO had issued a class ruling, CR 2001/75, back in December 2001 which concluded that the amount was assessable as ordinary income. St George initially funded litigation for Ms McNeil on behalf of shareholders to challenge this ruling. However, it was a condition of the granting of special leave to appeal to the High Court that the Commissioner pay the costs of the appeal (as a test case) and not disturb previous awards as to costs.

The press release issued by St George in response to the decision includes the following statement:
"At the time the ATO issued its Class Ruling, St.George advised shareholders to act in accordance with the Ruling, by including the market value of the sell-back rights as assessable income in their 2001 income tax return, pending a final court decision. If shareholders followed that advice, they would not be required to do anything further as a result of the High Court's decision today".

Source: Institute of Chartered Accountants in Australia