Beware dodgy tax schemes

In these tough times, good tax and business planning can help see a business through. But not all tax planning is good – and sometimes, it’s not even legal.

With financial year end approaching, and in times where saving every dollar can make a difference, SMEs need to be wary of dodgy tax schemes. Investing in such schemes can result in loss of the original investment, plus any missing tax will have to be paid back with interest and penalties and often, as the tax office warns, “long after the promoter and your money are gone”.

So, what are dodgy tax schemes and what do they look like? Simple enough questions, but a legitimate scheme is often difficult to tell from a dodgy one. Scheme promoters can be very convincing that a scheme is a good one, using professional marketing tools and attractive sales pitches.

But there are things to be wary of, such as:

• Claims there are no risks or that returns are guaranteed. All gain, no pain – sounds like the perfect investment, but is it?
• Claims that an investment project has a favourable ruling from the tax office should not be accepted at face value. The ruling should be sighted and your accountant or adviser should check it for you.
• Be wary of being asked to sign secrecy agreements.
• Offers to lend money for an investment without credit or asset checks should be very carefully examined. They often sound too good to be true.
• Be wary of claims that even if the investment does not go ahead, you will still make a profit from your tax refund, or that you can get up to 100% tax deductions supported by tax office rulings. Such claims simply beg to be queried and verified.
• Claims that your money will be placed in a tax-free overseas account should ring some alarm bells. Cross-border and international tax avoidance is a major tax office focus these days.
• Similarly, claims that you can run your business through your own offshore company should be treated with care.

None of these warnings are new, and it is always prudent to get good professional advice when investigating whether or not to invest in a scheme.

The tax office has flagged a number of characteristics it considers are signs of tax avoidance schemes. These are yet more pointers for SMEs to be wary of.

They include that the scheme:

• Is contrived or artificial in the way it is carried out.
• Involves a low level of financial risk and a large tax benefit that would not be expected in a commercially driven transaction – rings of “too good to be true”.
• Is aimed at duplicating the tax benefits of a single investment or activity, whether within Australia or between Australia and other jurisdictions.
• Uses complex structures to create tax benefits that are not related to the commercial activity.
• Is based on assumptions, including “blue sky” projections, which can lead to asset valuations that seem excessive or inflated deduction claims.
• Uses tax exempt entities (such as charities), or entities with accumulated tax losses, to wash income.
• Involves a tax haven or bank secrecy country without any sound economic reason – the international focus by many tax administrations around the world sounds a warning note here.
• Includes things such as round robin finance; circular funds movement; non-recourse or limited recourse loans to be paid off by future earnings.
• Contains mechanisms for winding up or exiting an arrangement before net income is generated for investors.
• Is not carried out according to contracts or other legal documents.
• Defers income or accelerates deductions to defer or avoid paying tax altogether.
• May include; large up front deductions, inflated fee prepayment, guaranteed returns, little direct involvement by investors.

Any SME considering investing in a scheme should remember that, in general, people who offer financial products and advice must work for a business that holds an Australian Financial Service Licence issued by the Australian Securities and Investments Commission (ASIC). Licence details can be checked on ASIC’s FIDO website.

It is also sensible to get arm’s length independent advice from an adviser who has no connection with the seller or the investment scheme. Potential investors must also be given either a product disclosure statement or prospectus about the investment.

It is also prudent to check taxpayer alerts, product rulings and class rulings issued by the tax office. They all contain tax office views and warnings about particular schemes or investments and represent a very useful checklist.

Warnings from regulators like the tax office and ASIC that if an investment sounds too good to be true, it probably is, should not be dismissed lightly.

Sound professional advice, not only about the tax consequences, but even the underlying commercial prospects of a proposed investment, is a must.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.