When is a gift not a gift?

We are often asked by clients about funds that are being lent to them or gifted by parents to help them buy a house, buy a business, or just because the client is a good person, and so they are to be the recipient of a gift.

The Australian Tax Office won a case handed down by the Federal Court in July 2024. In that case, the Tax Commissioner successfully argued that more than $1.6m deposited in a couple’s bank account was assessable income, not a gift or a loan from friends.

The case of Rusanova and the Commissioner of Taxation is a real-life drama that could easily be the plot of a telemovie. It features an Australian resident Russian couple who received ‘gifts’ of over $1.6m in unexplained bank deposits, over $67,000 in interest, a Russian father-in-law who is a seafood exporter, a series of Australian companies, and a generous friend who loaned money in $20,000 tranches.

The crux of the case before the Federal Court is whether you can prove to the ATO that unexplained deposits should be treated as gifts or loans. However, if the Tax Commissioner suspects the deposits are income, he can issue a default tax assessment and decide what tax should be paid. The burden of proof is then on the taxpayer to prove the Tax Commissioner wrong, underscoring the potentially serious consequences of the ATO’s suspicion.

The unexplained deposits

Between 2012 and 2016, an Australian resident husband and wife had an estimated $1,636,000 deposited into their bank accounts. The ATO became curious when neither spouse had lodged tax returns in the mistaken belief that they had not earned any income.

They said the money deposited was a gift from the wife’s father and, therefore, not assessable income. Curiously, no records were produced to support the deposits, and not a single text or email notified that money had been remitted or acknowledged its receipt.

In addition, a friend of the couple deposited money into the husband’s account, including a series of $20,000 transactions over a week. The friend said these were interest-free loans with no agreed terms but an expectation that they would be repaid. The friend could not remember how he was requested to make the loans, and no loan documents, emails, or texts were disclosed to support the loans. Around the same time the loans were being advanced, there was evidence of the husband ‘repaying’ amounts over what had been lent. In addition, documents show the husband transferred a Porsche Cayenne to his friend in Russia, which was said to be the repayment of the loan.

Compounding the issue were the four directorships of Australian companies held by the husband; they had yet to lodge tax returns. One of the companies was a seafood wholesaler, distributing the product of his father-in-law’s American-registered Russian export company. The dedicated son-in-law stated he was merely trying to develop his father-in-law’s business between 2010 and 2016 without remuneration.

Contesting the Tax Commissioner

In 2017, a covert tax audit used entries in the couple’s bank accounts to assess their income tax liability, and the ATO issued a default assessment based on unexplained deposits and expenses. The couple objected to the assessment, and this objection was partly allowed. A second assessment was then issued, to which the couple again objected before the Administrative Appeals Tribunal (AAT) on the grounds that the assessment was excessive.

Can the Tax Commissioner really decide how much tax you should pay?

The Tax Commissioner has the power to issue a ‘default assessment’ for the amount he believes is owing from overdue tax returns or activity statements. The assessment is the amount the ATO believes is owed, not what has been declared.

The problem with a default assessment is not just the Tax Commissioner deciding how much tax you should pay; it is the potential addition of an administrative penalty of 75% of the tax-related liability for each default assessment issued. This penalty may be increased to 95% of the tax-related liability in certain circumstances for taxpayers with a non-compliance pattern.

But, here is the problem for the couple. While genuine gifts of money are not taxable, the taxpayer must prove that the gift is truly a gift if the ATO asks. The AAT held that, “absent any reliable evidence…, there is no proper basis to make any findings as to whether the deposits constitute part of the applicants’ taxable income or not.”

The Tax Commissioner can rely on a “deficiency of proof”.

The AAT rejected the couple’s stance that the deposits were either gifts from the father or loans from a friend. This is despite an affidavit and evidence from the wife’s father stating that the amounts transferred to them were gifts. The couple did not demonstrate their income to prove the Tax Commissioner’s assessment was unreasonable, and they could not substantiate that the gifts were indeed gifts from a very generous father.

The Federal Court dismissed the couple’s appeal with costs, leaving the Tax Commissioner’s default tax assessment and penalties in place.

Avoiding the gift tax trap

A gift of money or assets from an individual is generally not taxed if given voluntarily; nothing is expected in return, and the gift giver does not materially benefit.

However, there are some circumstances where tax might apply.

Gifts from a foreign trust

If you are a tax resident of Australia and the beneficiary of a foreign trust, at least some of the amounts paid to you (or applied for your benefit) may need to be declared in your tax return. This applies even if you were not the direct beneficiary of the foreign trust; for example, a family member received money from a foreign trust and then gifted it to you. This applies to cash, loans, land, shares, etc.

Inheritances

Money or property you inherit from a deceased estate is often not taxed. However, there are circumstances where capital gain tax (CGT) might apply when you dispose of an asset you inherited. For example, if you inherit your parents’ house, CGT generally does not apply if:

• The property was their main residence, and
• Your parents are Australian residents for tax purposes, and
• You sell the property within two years.

However, CGT is likely to apply if, for example:

• You sell your parents’ former principal residence more than two years after you inherit it or
• The property you inherit was not your parent’s principal residence or
• Your parents were not Australian tax residents at the time of their death.

Managing the tax consequences of an inheritance can become complex quickly. Please get in touch with us for assistance when planning your estate to maximise the outcome for your beneficiaries or managing the tax implications of an inheritance. These issues are often not considered when you draft or update a will.

Gifting an asset does not avoid tax.

Donating or gifting an asset does not avoid CGT. If you receive nothing or less than the asset’s market value, the market value substitution rule might come into play. The market value substitution rule can treat you as having received the market value of the asset you donated or gifted when calculating any CGT liability.

For example, if Mum & Dad buy a block of land and then eventually gift the block of land to their daughter, the ATO will look at the value of the land at the point they gifted it. If the market value of the land is higher than the amount that Mum & Dad paid for it, then this would typically trigger a CGT liability. It does not matter that Mum & Dad did not receive any money for the land. Mum & Dad might have a CGT bill for the land they gifted with nothing in return.

Donations of cryptocurrency might also trigger CGT. If you donate cryptocurrency to a charity, you are likely to be assessed on the market value of the crypto at the point you donated it. You can only claim a tax deduction for the donation if the charity is a deductible gift recipient set up to accept cryptocurrency.

 

If you are not sure about what to do in your situation, please make sure that you contact us so that we can help you review your situation and provide you with the correct advice that also provides the correct processes and documentation to avoid the ATO Gift Tax Trap.