Ever since its introduction a little more than a decade ago, Division 7A in the Income Tax assessment Act 1936 Act has been an unmitigated ambush for companies and their shareholders.

The intent of the Division was to prevent shareholders extracting company benefits without being subjected to top–up taxation (above the company rate of 30 percent).

Subsequently the stranglehold eased.

Changes were made to allow shareholders to enter into specified loan agreements with the company to avoid the punitive force of the Division.

More recently the law has provided the Commissioner the discretion to ignore the Division in certain circumstances.

Now the pendulum has swung uncomfortably to the far side.

Private companies allowing their shareholders and their associates to use company assets need to tread with caution.

If Div 7A applies the use of the assets will be taken as unfranked dividend paid to shareholders or their associates.

Prior to the recent amendments by the Tax laws Amendment ( 2010 Measures No 2) Act 2010, Div 7A applied only if there was a payment, loan or forgiveness of loan in favour of a shareholder or associate.

The concept of ‘payment’ has now been extended to cover even the use of assets.

According to the amendment, allowing a shareholder or associate to use company buildings and vehicles will be covered by the Division.

However, the fringe benefits tax ‘minor benefits’ exemption available in the case of employees will apply to shareholders and their associates.

There are, however, two ‘dwelling’ exceptions to the application of Division 7A.

Firstly, the Division will not apply if the shareholder or associate uses company dwelling in carrying on a business.

For this, the dwelling must have been acquired before 1 July 2009.

Further the company must have qualified to carry forward its losses, which in practical terms would amount to having no change to its shareholding between the time of purchase of the dwelling and the time of its provision for use by the shareholder or associate.

The second exception can be used in respect of flats or home units owned by the company in a complex (apartments and duplexes).

A single apartment or holiday home will not qualify for the exemption.

The time of purchase of the dwelling in the first exemption (1 July 2009) is not a requirement here.

‘Associate’ is widely defined and may even include entities benefiting under a trust.

All is not lost, you could still enter into a loan agreement with the company before the lodgement date of the company.

This week there was a disturbing piece of news in the Australian Financial Review of 20 July 2010. The caption read “Calls to scrap breaks on family home”.

According to item, the estimated 2009-2010 cost of capital gains tax exemptions for family homes is now the largest tax expenditure measured by Treasury in Tax Expenditures Statement 2009 Chapter 3:

• - Capital gains tax main residence exemption $14.5 billion

• - Capital gains tax main residence exemption- discount component $17 billion

• - Total $31.5 billion

Comparative figures for 2009-2010 are:

• - Small business CGT 50 percent reduction $740 million

• - CGT roll-over for small business $280 million

• - CGT discount for individuals and trusts $5.38 billion

• - Exemption for work related items $25 million

• - Small business CGT exemption for assets held more than 15 years $120 million

• - GST-Food-uncooked, not prepared, not for consumption on premises of sale $5.6 billion

• - GST-Heath, residential care, community care and other care services $1.2 billion

• - GST- Health, medical and other health services $2.7 billion

• - GST- Education $2.55 billion

• - GST- Child care services $510 million

There are opposing views on how removal of the exemption in the future would affect the housing market, increased leveraging by households to invest in housing.

The extension to the exemption for up to six years even if the dwelling ceases to be main residence and is used to produce assessable income (rent) is one feature of the regime that may come under closer scrutiny in the future, especially the extension period of 6 years.

Once exemption has been claimed in respect of a dwelling, further exemption in respect of the next dwelling may be denied until the latter has been held as main residence for the further specified period.

Tax expenditure in respect of family homes is too big to ignore.

Warren Buffet once described derivatives as ‘weeds priced as flowers’ and then they turned more toxic and became ‘financial weapons of mass destruction’.

Contracts for difference (CFD) are a type of derivatives, confusing and curly and according to recent reports are spinning out of control.

CFDs are mostly “over-the –counter” deals and that’s not helpful for disclosure and transparency.

With the recent troubles faced by investors in CFD’s, attention has quickly turned to the adequacy of disclosure in their product disclosure statements.

There’s no excuse for losing money with Sonray

Tax Office wanted Sonray wound up

One area in which adequate information is not given to investors is the taxation consequences of CFD investment.

Providers need to do more to ensure investors understand the risks of CFD trading

The value of a CFD is determined by the price of the stock being traded on the market.

The acquisition of a CFD on a particular stock does not mean that the acquirer gets the stock.

It is only a bet on the price of the underlying stock. If the stock price goes the CFD holder gains and vice versa.

In Taxation Ruling TR 2005/15 the Australian Tax Office (ATO) sets down its position on taxation of gains and losses from CFD’s.

The ATO’s inclination is to treated gains and losses on the revenue and not on the capital account, thus depriving the tax payers of capital gains tax concessions, such as the general discount of 50 percent and small business CGT concessions.

Gains and losses will be treated on the revenue account where the transaction is entered into as an ordinary incident of carrying on a business, or where the profit was obtained in a business operation or commercial transaction for the purpose of profit making.

According to the Ruling, gains or losses are expected most often to be on revenue account, because it is expected that usually they will be entered into with the purpose of profit-making.

If the transaction does not fall within the above circumstances, capital gains tax will apply.

A CFD is a CGT asset.

However if the transaction was entered into for merely recreational purposes in a manner similar to making a bet in a game of chance, no capital gain or loss will arise.

Continuous losses incurred by an Australian subsidiary of a multi-national corporation does not necessarily mean that there is breach of transfer pricing rules.

For the first time in Australia a case involving transfer pricing went up to the Federal Court.

In 2008, the Administrative Appeals Tribunal heard the case of in Roche Products Pty Ltd v Federal Commissioner of Taxation [2008] AATA 639 involving the international pharmaceutical giant Roche.

Here the Commissioner had a partial victory.

In the recent case of SNF (Australia) Pty Ltd v Commissioner of taxation [2010] FCA 635 the Commissioner’s argument that the Australian subsidiary had paid its group companies prices for products which were higher than  comparable prices was rejected.

In support of the argument that the prices paid to the group were high the Commissioner put forward the view that the Australian subsidiary has been continuously incurring losses.

But the Court attributed the losses in Australia to low sales and poor management.

Furthermore, in this case the Commissioner has impliedly accepted that the ‘Associated Enterprise’ Article appearing in almost all Australian double tax agreements does not create a power of assessment in addition to that in the Income Tax Assessment Acts.

In the lingering aftermath of events of the last few days the mining sector has come out strongly claiming credit for the recent political changes.

Tycoons claim credit for a burial

Besides the blinding political manoeuvrings and commercial machinations, isn’t it clear as daylight that tax revenue is failing to meet the increasing demand for social services and that unless governments formulate speedy and efficient schemes to enhance their coffers the prospect is gloomy and almost threatening.

Being thrifty is one way. Europe has decided to hold back on stimulus spending as countries are falling into spiralling debt.

A balance has to be struck between free enterprise with minimal or ideally no state intervention (tax is one such intervention) and the expanding need for government funds to help finance the needs of the community.

The Henry review referred to several areas where increased funding is required in the future due mainly to the demographic changes in Australia.

Health expenditure is projected to increase significantly over the next 40 years, due in part to the ageing of the population, but also because of increased demand for health services in the broader community.

One is reminded of the children’s song, “There’s a hole in the bucket”. The song sounds almost true in economic reality.

Do tax increases impede economic growth  and therefore future tax revenue and vice versa?