Australia: Balancing the books: The importance of proper "paper" trails for calculation, claiming and audit purposes

Taxpayers should be reminded of keeping up to date and accurate records of their assets, especially when those assets are disposed of. Not only is it an offence to fail to keep accurate records, but keeping these records will assist in calculating your income tax for the financial year as well as potentially off-setting the potential Capital Gains you make which will be relevant in calculating your income. Contemporaneous records are important for claiming deductions, compliance and audit purposes. Contemporaneous records are the strongest evidence in any audit or litigious tax dispute This article will cover three issues that our Taxation Team often encounter and taxpayers should take account of;

1. Record Keeping for Capital Gains Tax and the Consequences for failure to do so;
2. The need for proper documentation for loans to be Division 7A compliant; and
3. Ensuring proper documentation of loan agreements for loans to be recoverable.

Record Keeping for CGT Purposes

What Records must you Keep?

Section 121.20 of the Income Tax Assessment Act 1997 prescribes the records you must keep for every transaction, act, event or circumstances which would reasonably lead to a CGT event. These can/may potentially include:

• Receipts of purchase or transfer;
• Contract of sale/purchase
• Market valuation of the asset;
• Receipts for the costs, rates and land taxes paid for the asset; or
• Receipts for the maintenance and cost of owning the asset.

These records are essential insofar as they will assist you in accurately calculating your assessable income and off-setting any Capital Gains made on other assets you dispose of.

Cost Base

In disposing of your assets, the cost base is an important concept to assess whether you made a capital gains on your asset. Your cost base will usually consist of 5 elements including:

• Acquisition Costs – The purchase price of the asset;
• Incidental Costs – Expenses associated with acquiring the asset (e.g. Stamp duty and conveyancing fees);
• Ownership Costs – Include maintenance fees, land tax and insurance;
• Enhancement/Preservation Costs – Includes the cost of preserving/increasing the value of your asset (e.g. renovation costs); and
• Costs associated with preserving title and rights – Capital expenditure in respect of title or right to the CGT asset.

In calculating whether you made a capital gain, the value you receive for disposing of the asset must be offset by the cost base. Any capital losses incurred can be offset against any future capital gains you make.

How long must you keep records for and consequences of not doing so?

You must keep records until the end of 5 years of the relevant CGT event happening. You must do so regardless of whether you made a capital gain or loss. Failure to do so will result in a fine of 20 penalty units ($3,846.20).

2. Division 7A Compliance

In the context of division 7A, record keeping is essential if taxpayers want to avoid liability for loans made to them by private companies. Under division 7A, loans that are not covered by an exception are to be treated as dividends meaning that they will be part of your assessable income. It must be noted that under the Income Tax Assessment Act 1936, the meaning of loan is wide and includes:

• An advance of money;
• A provision of credit or any other form of financial accommodation;
• A payment of an amount for, on account of, on behalf of or at the request of an entity, if there is an express or implied obligation to repay the amount; and
• A transaction which in substance effects a loan of money.

Further to this, a loan will be treated as a divided if:

• The private company makes a loan to the entity during the current year;
• The loan is not fully repaid before the lodgement day for the current year;
• No exceptions apply; and
• Either:
  • The entity is a shareholder of the private company, or an associate of the shareholder at the time the loan was made; or
  • A reasonable person would conclude that the loan is made because the entity has been such a shareholder or associate at some time.

To ensure that any loans made to shareholders of a private company are not dividends and taxable, taxpayers must ensure that loans made to them are division 7A compliant. This necessarily involves the loan to meet the following requirements:

• The loan agreement is in writing;
• The rate of interest payable on the loan equals or exceeds the benchmark interest rate (8.27% for the income year ending 30 June); and
• The term of the loan does not exceed the maximum term which is either:
  • 25 years if 100% of the value of the land is secured by a mortgage over real property and the value of the real property is at least 100% of the amount of the loan; or
  • 7 years for any other loan.

3. Debt Recovery and Capital Losses

Further to this, proper documentation of loans should also be observed given the implications related to recovery of debts. Usually, debts are recoverable within 6 years from which a cause of action accrues. This occurs when the debt becomes due and payable. Claims outside of the 6 year period are statute barred and unrecoverable. However different implications arise between written and unwritten contracts.

In the case of written loans, the 6 year period starts when the debt becomes due and payable. For example, when an instalment for a debt is due. In the case of unwritten agreements, the court in Young v Queensland Trustees outlined that it is implied that a loan is immediately payable from the moment the loan was provided. This means that the 6 year period starts from when the money for the loan is provider to the borrower.

There are also important implications in regard to whether the loan is a personal or business loan in the circumstances the loan is unrecoverable. In the case of a business loan, at the time when the loan is unrecoverable and you make a loss on this, this is considered to be a capital loss and may be offset against any future capital gains you make. However any capital losses you make through a personal loan must be disregarded and cannot be used to offset any capital gains you make.

Conclusion

For all of the above reasons, please keep all appropriate documentation for these purposes and for transactions between related parties please ensure that you credit the current document to reflect the transaction. If cannot be emphasised how important this is should an audit or dispute arise in the future.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.