Date posted: 25/05/2020 7 min read

How COVID-19 changes your tax year-end client discussions

Financial year end issues to consider in COVID-19 times.

In normal times, CAs in public practice and in commerce may by now be close to getting outstanding 2019 tax returns lodged and turning their minds to year end planning issues.

But these are not normal times.

Many businesses – particularly SMEs – are focussed on surviving and know they’ll have tax losses (in fact, tax loss utilisation will be an enduring topic of interest because of COVID-19).

For these businesses cash management will likely be top of the agenda. This recent article from KordaMentha has some excellent discussion points and ideas.

Hopefully CAs will have less impacted clients for whom the usual year-end tax planning discussion points remain as valid and important as ever. There could also be clients looking for your advice on investment opportunities, operating as solo opportunists or as participants in vulture funds.

But regardless of your clients’ situation there’ll be issues – some old, many new – which now have a unique ‘COVID-19 angle’.

CA ANZ has initiated a dialogue with the ATO on year end issues in a COVID-19 world and we hope officials can find some capacity to provide guidance where needed. Division 7A minimum loan repayment obligations are a particularly pressing issue which the ATO tell us they’re working on.

In the meantime, here is my initial attempt at a list. Those of you working at the coalface can probably think of a lot more.

What happens when COVID-19 stimulus reduces or stops?

Nobody has a crystal ball, but this question is critical to the success of your clients (and your accounting practice).

Weaning Australian businesses off COVID-19 stimulus won’t be easy. There are obvious business planning, cashflow forecasting and restructuring discussion points. The business acumen of CAs will be needed to help set new strategic directions for business clients.

Older CAs like me might favour old fashioned tools like a SWOT analysis. Young Turks may scoff, but this simple methodology engages clients.

On a more positive note, there could be new post COVID-19 ‘road to recovery’ measures to advise on with changes to the tax system and general business regulatory environment already on the agenda in Canberra and at State and Territory level.

Reporting and audit issues

Preparing 2020 accounts will throw up some unique challenges. My CA ANZ colleague Amir Ghandar has already written about some of the reporting and audit implications of COVID-19, and he is engaging with relevant regulators.

CAs may encounter a range of unusual and one-off transactions which will take additional time to work through to get the financial reporting and tax (book to tax) positions right. Unexpected accruals and provisioning could occur.

Those who work with audit colleagues on tax provision calculations should start the dialogue early (noting that auditors too are under enormous fee pressure from clients because of COVID-19).

In no particular order, some of the tax-relevant issues include accounting for:

  • COVID-19 grants (e.g. gross revenue vs offset against related expenses vs cost reduction of capital assets)
  • CashBoost and JobKeeper payments (e.g. gross revenue vs offset expenses; CashBoost not tax effected)
  • Rent relief lease accounting
  • Negotiated changes to business loan terms and conditions
  • Quarantining accounting profits from current year losses (e.g. future dividend capability and franking), and
  • Whether Deferred Tax Asset (losses) should be recognised.

How are client COVID-19 related business records looking?

Readers don’t need reminding about the hectic pace experienced of late, determining eligibility and applying for COVID-19 measures. Yes, there have been assurances around tolerating honest mistakes, reasonable care and using best estimates, but regulators are empowered to seek documents and check entitlements using 20-20 hindsight. Be prepared by doing year end documentation reviews.

The ‘I missed out’ client

It may not be too late to access COVID-19 benefits overlooked to date. Regulators may have discretion to accept late applications in some situations.

Hard to sell trading stock on hand

Reducing year-end trading stock values is tax planning 101.

But what to do when consumer demand is COVID-19 impacted such that stocktake sales are a fizzer? Attention is likely to focus on year end stock valuation alternatives such as market selling value. Determining market value in this environment will be tricky.

Decommissioning depreciating assets still held

With some businesses in “hibernation” and unsure if they will ever re-start, COVID-19 will focus attention on the balancing adjustment event that occurs when a business stops using a depreciating asset, or stops having it installed ready for use, and expects never to use it or have it installed ready for use.

The chances of actually selling second hand depreciating assets in the current economic environment could be pretty slim. Watch out for non-arm’s length sales.

$150,000 instant asset write-off

The government announced on 9 June 2020 that it will extend the exceptionally generous $150,000 instant asset write-off for eligible businesses for a further six months to 31 December 2020. Clients now will have more time to access the enhanced instant asset write-off.

For clients able to open their wallets by 30 June 2020 however, the total write-offs on an asset by asset basis could be huge and ATO scrutiny is highly likely. For example, expect some tension around distinguishing qualifying from non-qualifying assets. Intangible assets (including in-house software claimed outside of the software pooling rules in Subdiv 40-E ITAA 1997) are prima facie eligible and have long been seen within ATO circles as a key risk area.

The fine detail for this incentive is found in Subdiv 40-BA in the Income Tax (Transitional Provisions) Act 1997 and accompanying EM – both can be found in the enabling legislation, Coronavirus Economic Response Package Omnibus Act 2020. Compulsory reading for those advising on this topic.

Where’s the depreciating assets the client ordered?

Clients with cash to buy depreciating assets who want to access the enhanced instant asset write-off by 30 June 2020 may find that the disruption to supply chains means the ordered equipment isn’t delivered in time to qualify (i.e. the taxpayer must ‘hold’ the asset in the year it is first used or installed ready for use for a taxable purpose: s40-82 ITAA 1997).

The problem is most severe for imported equipment but could also arise in a domestic context where Australian suppliers are COVID-19 impacted or transport companies are flat out.

The backing business investment \ accelerate depreciation measure is not as time critical, being available for the 2019–20 and 2020–21 income years.

Empty the pool

As a result of the Coronavirus Economic Response Package Omnibus Act 2020, if the balance of an eligible SME’s general small business pool is less than $150,000 at the end of an income year that ends on or after 12 March 2020 but before 1 July 2020, the taxpayer can claim a deduction for the entire balance of the pool.

It’s obvious some debts are bad, right?

Does COVID-19 impact ATO thinking in TR 92/18 about the reasonable commercial efforts needed to show that a debt is indeed bad before it is actually written off by 30 June? Some businesses may feel the adverse economic circumstances created by COVID-19 is proof enough to warrant claiming the deduction.

Forex risk heightened

COVID-19 has caused some sizeable movements in exchange rates this financial year. Remember, forex gains and losses are on revenue account (for tax) and the volatility could impact asset valuations and tax calculations.

International stuff

Thin capitalisation positions will require close attention because, whether inbound or outbound, group financing is under the pump.

Ditto transfer pricing positions in light of market turmoil, contract variations etc.

The ATO has already announced some helpful approaches on these two topics.

Tax loss utilisation

Tough economic times sometimes result in tax losses being ‘stranded’ in the wrong entity. In unconsolidated structures, using intra-group or related party transactions to move them about raises tax risk. COVID-19 may entice some unconsolidated groups to elect to consolidate so that losses are housed in the head entity (assuming relevant consolidation loss transfer tests can be satisfied).

COVID-19 related takeovers and restructures in 2019-20 may attract current-year loss rules. Rejigged business models post any change of ownership will focus attention on the carrying on a similar business test. Back your judgment based on ATO pre-COVID-19 guidance, or apply for an ATO private ruling with supporting information?

Trusts too may have COVID-19 triggered loss carry-forward rules to consider. Advising on trust distributions this year end will be more problematic than usual.

Commercial debt forgiveness

Has COVID-19 triggered forgiveness of commercial debts, thereby eroding (sequentially) prior year tax losses, net capital losses, certain deductions and cost bases?

Franking account in deficit?

Franking deficit tax exposure is never welcome, but especially when there’s little or no cash to rectify the franking account.

The ATO has already advised that the Commissioner can’t waive or remit FDT arising where COVID-19 PAYG instalment refunds have resulted in a negative franking account balance at the end of the 2019–20 financial year.

At best the ATO will, on request, consider deferring the liability till 30 September 2020.

Flushing out franking credits

Hard times can hinder an Australian company’s ability to flow franking credits to shareholders hungry for dividends.

The ATO’s Taxpayer Alert 2015/2 warns against an obvious capital raising strategy which seeks to address this problem.

Borrowing to pay dividends is possible using Roberts & Smith planning (mindful of ATO ruling TR 95/25), but lenders could be tight-fisted due to COVID-19.

This tax issue should form part of a much broader capital management discussion.

Clients who’ve tried to profit during COVID-19

There are ASIC reports that COVID-19 has triggered a substantial increase in retail activity across the securities market, as well as greater exposure to risk: “…retail investors are engaging in short term trading strategies unsuccessfully attempting to time price trends”.

Such behaviour in your client base triggers all manner of issues, ranging from the nature of the asset (CGT, trading stock?) through to year-end balancing of positions (watch for wash sales: TR 2008/1). Hopefully there are records for all those tax calculations you’ll need to do.

What’s the company tax rate?

It’s just a personal opinion, but I reckon there’d be more than a few Australian companies applying the wrong company tax rate, such are the intricacies of our base rate entity rules. Those rules become even more problematic when aggregated turnover declines because of COVID-19, and 2020-21 looms with a legislated decline in the rate from 27.5% to 26%. A 1.5% tax rate cut will influence year end thinking in some quarters.

Big companies remain hitched to 30% and it’s unclear whether federal politicians will change their stance on their rate as part of a broader ‘road to recovery’ strategy.

Directors’ personal exposure

Finally, it’s more important than ever for CAs to zero in on client directors’ and business operator personal risk.

In a tax context for example, the ATO’s director penalty notice regime was revamped with effect from 1 April 2020, and now extends to GST debts and the less frequently encountered Wine Equalisation Tax and Luxury Car Tax. DPNs already covered debts relating to PAYG withholding and Superannuation Guarantee obligations.

COVID-19 has also heightened risks of recovery action where the Fair Entitlements Guarantee scheme has applied to unpaid employee entitlements for employees who’ve lost their jobs due to the insolvency of their employers. Fair Work has seen a COVID-19 spike in employee complaints.

There are many other non-tax risks in running a business which have been heightened by COVID-19.

My point is that it would be useful to approach year-end discussions with some clients equipped with a working knowledge of insolvency, and particularly the expiry of temporary measures on insolvent trading.

Chin-up fellow CAs.

Your 2020 year end conversations will not be easy.