Taxpayer Alert TA 2008/10: Purported prepayment of service fees designed to postpone tax liability
Date of issue: 23 May 2008
Status: Current


Description: The alert applies to arrangements having the following features: 1. A trading entity purportedly borrows funds from a financial entity that is associated with the promoter of the arrangement. 2. These funds are purportedly used by the trading entity to prepay for services to be provided by a service entity. 3. The purported borrowing and the purported prepayment are made as follows: i. A cheque is drawn in favour of the trading entity by a financial entity associated with the promoter. ii. The cheque is endorsed by the trading entity in favour of the service entity. iii. The service entity further endorses the cheque in favour of the original drawer, the financial entity, for the purported purpose of a 'deposit' with that financial entity. iv. The cheque is to be held by the financial entity well after it becomes a stale instrument, but is never presented or banked for payment. 4. The promoter entity advises the trading entity that three conditions must be attached to the cheque, being that: i. the cheque will not be presented and banked for payment, ii. the cheque will not form the basis of a claim or marked for payment, and iii. the cheque will be retained after it becomes stale. 5. In some cases, the services may not actually be provided by the service entity in the following income year. 6. The trading entity claims a deduction for the amount of the cheque in the first year. 7. The service entity declares the assessable income in the later year. 8. Due to the deferral of tax for each year, the trading entity enters into a subsequent arrangement the following year, with an ever-increasing amount of tax involved. | 1. A trading entity purportedly borrows funds from a financial entity that is associated with the promoter of the arrangement. 2. These funds are purportedly used by the trading entity to prepay for services to be provided by a service entity. 3. The purported borrowing and the purported prepayment are made as follows: i. A cheque is drawn in favour of the trading entity by a financial entity associated with the promoter. ii. The cheque is endorsed by the trading entity in favour of the service entity. iii. The service entity further endorses the cheque in favour of the original drawer, the financial entity, for the purported purpose of a 'deposit' with that financial entity. iv. The cheque is to be held by the financial entity well after it becomes a stale instrument, but is never presented or banked for payment. 4. The promoter entity advises the trading entity that three conditions must be attached to the cheque, being that: i. the cheque will not be presented and banked for payment, ii. the cheque will not form the basis of a claim or marked for payment, and iii. the cheque will be retained after it becomes stale. 5. In some cases, the services may not actually be provided by the service entity in the following income year. 6. The trading entity claims a deduction for the amount of the cheque in the first year. 7. The service entity declares the assessable income in the later year. 8. Due to the deferral of tax for each year, the trading entity enters into a subsequent arrangement the following year, with an ever-increasing amount of tax involved. | i. A cheque is drawn in favour of the trading entity by a financial entity associated with the promoter. ii. The cheque is endorsed by the trading entity in favour of the service entity. iii. The service entity further endorses the cheque in favour of the original drawer, the financial entity, for the purported purpose of a 'deposit' with that financial entity. iv. The cheque is to be held by the financial entity well after it becomes a stale instrument, but is never presented or banked for payment. | i. the cheque will not be presented and banked for payment, ii. the cheque will not form the basis of a claim or marked for payment, and iii. the cheque will be retained after it becomes stale. | Diagram of typical arrangement | FEATURES WHICH CONCERN US | The Tax Office considers that an arrangement of this type gives rise to the following taxation issues that include whether: 1. such an arrangement or certain steps in it may be a sham. 2. the Trading Entity is entitled to a deduction under section 8-1 Income Tax Assessment Act 1997 (ITAA 1997) and in particular, whether the amount purportedly paid to the service entity: i. constituted a loss or outgoing; ii. was to any extent incurred in gaining or producing the trading entity's assessable income; and iii. was to any extent necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. 3. section 82KK Income Tax Assessment Act 1936 (ITAA 1936) applies so that the deduction is not allowable until the services for which it was purportedly incurred are provided by the service entity. 4. the general anti-avoidance rules contained in Part IVA ITAA 1936 operate to disallow the deduction until the services for which it was purportedly incurred are provided by the service entity. 5. any entity involved in the marketing of such an arrangement is a promoter of a tax exploitation scheme for the purposes of Division 290 of Schedule 1 to the Taxation Administration Act 1953 . | 1. such an arrangement or certain steps in it may be a sham. 2. the Trading Entity is entitled to a deduction under section 8-1 Income Tax Assessment Act 1997 (ITAA 1997) and in particular, whether the amount purportedly paid to the service entity: i. constituted a loss or outgoing; ii. was to any extent incurred in gaining or producing the trading entity's assessable income; and iii. was to any extent necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. 3. section 82KK Income Tax Assessment Act 1936 (ITAA 1936) applies so that the deduction is not allowable until the services for which it was purportedly incurred are provided by the service entity. 4. the general anti-avoidance rules contained in Part IVA ITAA 1936 operate to disallow the deduction until the services for which it was purportedly incurred are provided by the service entity. 5. any entity involved in the marketing of such an arrangement is a promoter of a tax exploitation scheme for the purposes of Division 290 of Schedule 1 to the Taxation Administration Act 1953 . | i. constituted a loss or outgoing; ii. was to any extent incurred in gaining or producing the trading entity's assessable income; and iii. was to any extent necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. | The Tax Office has reviewed this arrangement in several cases and has determined that it is not effective because of some or all of the features set out above. Note 1: Penalties of up to 50% of the tax avoided can apply where Part IVA is applied. Reductions in base penalty may be available if the taxpayer makes a voluntary disclosure to the Tax Office. If you have any information about the current arrangement, phone us on 1800 060 062. Tax agents wanting to provide information about people or companies who may be promoting arrangements covered by this Alert should call 13 72 86 (Fast Key Code 3 4 ). Note 2: Penalties of up to 5,000 penalty units for individuals, 25,000 penalty units for bodies corporate or up to twice the amount of consideration received or receivable may apply to promoters of tax exploitation schemes under Division 290 of Schedule 1 to the Taxation Administration Act 1953. The Commissioner can also apply to the Federal Court of Australia for restraining and performance injunctions against promoters where prohibited conduct has occurred, is occurring or is proposed. | Date of amendment Comment 3 May 2024 Updated Tax Agent tip off hotline number 19 January 2024 Updated ATO tip-off hotline numbers | Date of Issue: 23 May 2008 | Date of Effect: 23 May 2008 | Related Practice Statements: PS LA 2005/13 | Subject References: Arrangement Associate Prepayment Endorsed cheque | Legislative References: Income Tax Assessment Act 1936 Section 82KK Part IVA Income Tax Assessment Act 1997 Section 8-1 Taxation Administration Act 1953 Division 290 | Contact Officer: Gary Hammersley Business Line: Aggressive Tax Planning Phone: 08 9268 5691





Related documents: PS LA 2005/13 | Section 82KK | Part IVA | Section 8-1 | Division 290

This Taxpayer Alert describes an arrangement for the prepayment of service fees from a trading entity to an associated service entity in which the dominant purpose of the arrangement was to secure a deduction in the year of alleged payment rather than in the year any services were provided.