Philanthropy is a highly desirable trait in any society. Making gifts of money or goods to charities is a very worthwhile thing to do. One never knows when one might be in need of a little charity oneself!
Governments have long recognised the worth on encouraging people to make such gifts and there have been provisions in the tax law for many years that encourage this. We all know about deductions for gifts made to many charities.
However, every now and then, a scheme comes along that “pushes the envelope” in terms of complying with the tax law. The Tax Commissioner has recently alerted people to an arrangement he is concerned about.
The Commissioner has warned about arrangements promoting a tax deduction for gifts of pharmaceutical items to charities for use overseas. Pharmaceuticals are often in short supply in some poor overseas countries, so the attractiveness of making such gifts is obvious.
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According to the Tax Office, the taxpayer provides cash for a vendor (seller) to purchase the pharmaceuticals from a low-cost overseas supplier, and they are then valued for gifting purposes at a much higher cost. This inflates any tax deduction claimed.
The Commissioner said the difference in these amounts is covered by what appears to be an unsecured, long-term, low-interest loan purportedly funded by the vendor. The pharmaceuticals are apparently made available to the charity through an overseas bonded warehouse.
The Commissioner said that, under this arrangement, the taxpayer claims a deduction for a donation and related costs that is much greater than the actual amount outlaid.
The ATO said its initial view is that the arrangements are not effective at law, and it has concerns about the value of the pharmaceuticals and when they are actually received by the charity.
The Commissioner noted that although the taxpayer gets a receipt for the donation, it is the seller of the pharmaceuticals, and not the charity, that sets the value of the pharmaceuticals. He said the ATO had seen examples where, for deposits of around $2,000, taxpayers were claiming $20,000 in deductions. This presents a fraud on the revenue.
The Commissioner said the ATO is contacting approximately 100 people involved in these arrangements asking them to review their circumstances and to make a voluntary disclosure before January 31, 2011. By making such a disclosure, they can receive a reduction in any tax penalties.
The ATO will also write to the people who are marketing such arrangements and to certain charities who are involved requesting they stop seeking such donations from the community, and warning them that the promoter penalty laws may apply. These laws were designed to deter the promotion of schemes that exploit the tax system and the tax laws by tax avoidance or evasion.
The arrangements of concern
The arrangements involve a number of steps. Broadly speaking, they run something like this:
An Australian taxpayer enters into an agreement to purchase pharmaceuticals for donation to a Deductible Gift Recipient (these are organisations that are eligible to receive tax deductible gifts). Under the agreement, the taxpayer makes a cash payment of an amount comprising: (i) a payment to become a member of a facilitating entity (the promoter or an associated entity); (ii) a cash donation to the nominated Deductible Gift Recipient; (iii) an interest prepayment in respect of a purported long-term, low-interest loan alleged to fund the payment of pharmaceuticals; and (iv) a deposit (generally of 7.5% or less) of the nominated amount to be paid for the pharmaceuticals.
• The agreement relies on a loan that the ATO says does not appear to be on normal commercial terms, because:
- the period of the loan for the pharmaceuticals is unusually long, in some cases up to 50 years;
- the rates of interest are unusually low (generally less than 1% per annum), even though this interest is allegedly prepaid;
- there is no security offered in respect of the principal amount; and
- payment will not be required in certain circumstances (such as the death of the participant), meaning there is no certainty of repayment – especially considering the unusually long-term of the loan.
Under the agreement, the promoter deals exclusively with the vendor and any pharmaceuticals are purchased from a low-cost overseas supplier and alleged to be delivered to the Deductible Gift Recipient entirely outside Australia.
Under the agreement, the taxpayer receives: (i) a supply note from the Deductible Gift Recipient describing the pharmaceuticals; (ii) an invoice from the vendor for the pharmaceuticals assigning a domestic value rather than the cash amount actually paid to the overseas supplier, to match the cash deposit and the amount of the loan; and (iii) a receipt from the Deductible Gift Recipient for any cash donation component.
On the basis of the agreement, the taxpayer:
- claims a tax deduction for the gift of the pharmaceuticals to the Deductible Gift Recipient, for the purported value of the pharmaceuticals (ie. the amount nominated by the vendor) at the date of the agreement; and
- purportedly receives a reduction in tax payable that significantly exceeds the total cash amount actually outlaid under the agreement.
The ATO considers that arrangements like this give rise to a number of tax issues including whether there is any tax deductible gift of property at all, and whether various anti-avoidance provisions in the tax law might apply.
One might have reasonably thought that getting a tax deduction for around 10 times the amount outlaid would have raised some alarm bells, but that cannot be assumed. We’ve heard it before, but if a tax deduction looks too good to be true, it probably is!
This is my last column for 2010. I would like to take this opportunity to wish all SmartCompany readers a very Happy Christmas and a prosperous New Year!
Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions .
For more Terry Hayes features, click here.