The ATO has recently issued taxpayer alert TA 2021/2, which relates to arrangements where an Australian tax resident's foreign income is disguised as gifts or loans from related offshore entities. Taxpayers who have entered into these arrangements should expect an ATO review or audit.
What are the 'arrangements' the ATO is concerned about?
Australian tax residents are taxed on their worldwide income, including foreign income. The ATO is targeting arrangements where taxpayers are aware of their residency status but attempt to evade paying tax on their assessable foreign income by concealing the true nature of funds coming into Australia. Those funds are commonly disguised as gifts or loans from a related overseas entity.
The details of the arrangements targeted by the ATO include the following.
An Australian resident taxpayer derives foreign assessable income and doesn't declare it in their return. That assessable income may be:
- actual foreign assessable income - e.g. income from employment, interest or dividend income, or capital gains
- deemed foreign assessable income - e.g. amounts assessable under the controlled foreign company provisions
- amounts that are otherwise assessable - e.g. distributions of capital from foreign trusts that are assessable under section 99B.
- The foreign income is transferred to the Australian taxpayer or their associate. The ATO's experience is that often a related entity or a family member overseas will transfer the funds to the taxpayer or their associate.
- The income is then mischaracterised as a loan or gift from the related overseas entity.
- As a further variation, if the Australian resident taxpayer has used a loan for the purposes of gaining or producing assessable income, the taxpayer claims a deduction on account of interest, but does not pay interest or principal to the related overseas entity.
How can I prove to the ATO that I received a genuine gift or loan?
In any tax dispute, the taxpayer has the burden of proving the correct position. The taxpayer will need to provide evidence that an amount was received as a genuine gift or loan.
In TA 2021/2, the ATO considers that a genuine loan or gift is one that:
- is supported by appropriate documentation, which includes:
- for gifts, depending on the size of the gift and the nature of the relationship, a deed of gift, evidence of the donor's (the entity making the gift) capacity to extend the gift from their own resources and financial records showing the transfer
- for loans, a validly signed loan agreement and financial records evidencing the advance of the loan and the repayment
- is consistent with the parties' behaviour - e.g. the borrower has made repayments under any loan agreement
- involves amounts that are sourced from funds genuinely independent of the taxpayer - which may include obtaining evidence from the lender or donor about how they sourced the funds advanced.
It is important for taxpayers to keep evidence of their arrangements. Take the following example:
Maple is an Australian tax resident and has recently moved back to Australia after living in London with her stepbrother Haibo. Haibo is a UK citizen and still lives in London. Haibo won the lottery shortly after Maple left London and decided to share his winnings with Maple. He transferred half of his winnings to Maple's Australian bank account.
Evidence that Maple can keep to substantiate that the amount Haibo transferred is a gift includes: a deed of gift, Haibo's receipt from the lottery win, bank account statements showing the deposit of Haibo's winnings into his bank account and the subsequent transfer to Maple.
Obtaining this information may be more difficult in certain circumstances. For example, an adult child studying in Australia may receive a gift from his parents overseas to assist with his university fees and living expenses. His parents may not be prepared to disclose to the adult child the original source of the funds. The adult child will need to consider what other evidence he could provide to prove the gifted funds are not his assessable income.
What should I do if I have received a genuine gift or loan from family but have no documents?
The best documentary evidence is contemporaneous evidence - a deed of gift or loan agreement entered into at the time of the transfer of the funds.
If there was no formal written documentation at the time of the transfer, taxpayers should gather the documents that do exist. This might include simple emails or text messages discussing the gift or loan with their family members.
Taxpayers should then consider whether to sign a deed of confirmation, which confirms that the funds were received by way of loan or gift and any continuing obligations - e.g. for loans, an obligation to repay the principal together with any interest.
What should I do if I think TA 2021/2 applies to me?
Taxpayers who have not declared foreign income in their income tax returns should urgently review their circumstances. Significant penalties (in some cases up to 90% of any tax shortfall) may apply and taxpayers may be at risk of criminal sanctions. Making a voluntary disclosure may reduce the penalties that would otherwise apply.
Cooper Grace Ward is a leading Australian law firm based in Brisbane.
This publication is for information only and is not legal advice. You should obtain advice that is specific to your circumstances and not rely on this publication as legal advice. If there are any issues you would like us to advise you on arising from this publication, please contact Cooper Grace Ward Lawyers.