This year’s Federal Budget (Budget) is the Coalition Government’s third since coming to power in 2013. The key Budget numbers are:
- the 2016/17 underlying cash deficit is forecast to be in the order of $37.1 billion; and
- the underlying cash deficit is expected to fall to $6 billion in 2019-20.
In this special Gilbert + Tobin Tax publication, we explore the key tax measures which have emerged in the Budget focussing on business taxpayers and those measures which have been announced for the first time on Budget night. The key themes emerging from the Budget are:
- an increased focus (following on from last year’s Federal Budget) on targeting multinational enterprises (MNEs) with various measures, including the introduction of a diverted profits tax (DPT) and hybrid mismatch measures. These measures highlight the Government’s continued focus on ensuring that Australia takes a leading role in the evolution of international tax policy, particularly, base erosion;
- providing a pathway for reduced corporate tax rates for a broader range of corporate taxpayers but with a particular focus initially on small business – it would appear that the Government has a view that reductions in corporate tax rates will encourage investment decisions in a low inflation, low growth economic environment;
- a tightening of superannuation concessions; and
- continuing to encourage the use of Australia as an investment hub through the introduction of a collective investment vehicle (CIV) tax and regulatory regime.
It is also interesting to observe what the Budget has not disturbed. For example:
- there is no apparent intention to attack negative gearing or capital gains tax concessions;
- the Government has confirmed that the 2% temporary Budget deficit levy (applicable to incomes exceeding $180,000 per annum) would cease on 30 June 2017 (in accordance with the existing legislation); and
- there has been no reduction to the thin capitalisation safe harbour ratio from 60% to 50%, as was foreshadowed by some several days before the Budget.
With an unprecedented reduction in interest rates by the Reserve Bank to 1.75% and continuing global and domestic economic uncertainty, the Budget will be closely scrutinised by economists, opposition politicians and the public alike, as Australia moves towards “election mode”.
Key topics include:
In the 12 months since the handing down of the 2015 Federal Budget, the focus on multinational tax avoidance has continued unabated by governments around the world and in the press.
In particular, Treasury, the Australian Taxation Office (ATO) and the Foreign Investment Review Board (FIRB) have been displaying a coordinated approach in dealing with the myriad issues associated with multinational profit shifting.
Further, the Multinational Anti-Avoidance Legislation (MAAL), designed to counter the use of artificial and contrived arrangements to avoid Australian taxation, received Royal Assent and commenced on 11 December 2015 and applies to schemes entered into on or after 1 January 2016. The MAAL targets global groups with an annual turnover of AUD$1 billion or more which, in broad terms, structure their affairs such that revenue from sales to Australian customers are recorded substantially offshore in low/no tax jurisdictions but where the activities of an Australian entity are instrumental to the sale transaction with the Australian customer.
Treasury also announced on 22 February 2016 that FIRB approvals would become subject to additional conditions aimed at tax compliance. Specifically, the conditions include undertakings to comply with tax laws, pay tax debts, provide full disclosure about tax planning, and, for higher risk transactions, to compulsorily seek tax clearances from the tax authority.
On 26 April 2016, the ATO also published four Taxpayer Alerts dealing with emerging profit-shifting arrangements that may lead to tax avoidance, being arrangements where companies have been:
- inappropriately recognising (or over valuing) internally generated intangible assets in order to raise their maximum allowable debt levels under Australia’s thin capitalisation rules (TA 2016/1);
- implementing arrangements to avoid the operation of the MAAL (TA 2016/2);
- using related party financing arrangements to create an alleged need to swap currencies and periodical payments designed to increase the cost of borrowing and/or avoid interest withholding tax in Australia (TA 2016/3); and
- using cross-border leasing arrangements involving mobile assets to gain favourable tax treaty outcomes (TA 2016/4).
These developments continue the trend set by the Government in last year’s Federal Budget of focusing on multinational corporate tax avoidance, and in its 2016/17 Budget the Government has announced additional new measures focussing on multinational tax avoidance. These specific Budget measures are set out below.
A new DPT to be introduced
The Government has announced a 40% DPT aimed at MNEs that artificially divert profits from Australia. The rules are proposed to apply to income years commencing on or after 1 July 2017.
As part of the Budget announcement, the Treasury has released a discussion paper outlining how the DPT would apply in the Australian context. Submissions in relation to the discussion paper are due by 17 June 2016.
Background to the proposed DPT
The Treasury has stated in its discussion paper that the design of the proposed DPT for Australia will be broadly based on the second limb of UK’s DPT which prevents companies from creating tax advantages by using transactions or entities that lack economic substance.
The proposed 40% DPT follows the introduction of the MAAL.
Main features of Australia’s DPT
Key features of the proposed DPT include the following:
- The DPT will impose a tax rate of 40% on profits transferred offshore through related party transactions, where the transaction has given rise to an ‘effective tax mismatch’ and where the transaction has ‘insufficient economic substance’ (as defined below)
- ‘Effective tax mismatch’ will exist in circumstances where an Australian taxpayer has a cross-border transaction with a related party, and as a result, the increased tax liability of the related party attributable to the transaction is less than 80% of the corresponding reduction in the Australian company’s tax liability;
- Determination of whether there is ‘insufficient economic substance’ will be based upon whether it is reasonable to conclude based on information available at the time to the ATO that the transaction(s) was designed to secure the tax reduction. The determination should be assisted by recent introduction of information exchange regimes between tax authorities in different jurisdiction (as well as the country-by-country reporting) which provide the ATO a greater access to information to assist with its determination.
- The measure will apply to large companies with global revenue of $1 billion or more. However, a de minimis threshold will apply to exempt entities with Australian turnover of less than $25 million, except whether income is artificially booked offshore rather than in Australia.
- An offset will be allowed for any Australian taxes paid on the diverted profits (e.g. Australian withholding taxes and Australian tax paid under the CFC regime could be credited)
- The DPT itself will not be deductible or creditable for income tax purposes. A franking credit will be allowed for DPT paid but will be limited to the company tax rate applicable to the entity.
- A DPT liability will only arise from an assessment issued by the ATO (unlike the UK DPT, the taxpayer will not be required to disclose upfront that they have transactions which could give rise to a DPT liability).
- Taxpayers that are issued with an assessment under the DPT rules will be required to make an upfront payment of any DPT liability, which can only be adjusted following a successful review of the assessment. This places the onus on the taxpayers to provide relevant and timely information to prove why the DPT should not apply.
Implementing the OECD hybrid mismatch arrangement rules
The Government intends to implement the OECD rules to eliminate hybrid mismatch arrangements taking into account the recommendations made by the Board of Taxation in its report on the Australian implementation of those rules.
As part of this measure, the Government has asked the Board of Taxation to undertake additional work on the manner in which to best implement these rules in relation to regulatory capital.
This measure is directed to ensuring that MNEs cannot exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions and targets the situation where tax is either deferred or not paid at all. The measure is intended to apply from the later of 1 January 2018 or 6 months following the date of royal assent of the enabling legislation.
A typical example of a hybrid mismatch occurs where a loan from one member of a group to its subsidiary might be treated as equity under one country’s tax law and debt under the tax law of another. Absent the proposed changes, the subsidiary would have been permitted to claim a deduction for interest payments but the parent company might not pay tax on those payments. Another example would be where a limited partnership which is taxed as a corporate in one jurisdiction but as a “pass through” in another might be entitled to a deduction in respect of the same interest outgoing in more than one jurisdiction. That is, the limited partnership might be entitled to an interest deduction in Australia as it is treated as a company but the partners would also receive the benefit of the tax deduction on interest in their home jurisdiction.
Transfer pricing rules to implement OECD recommendations
It is proposed that the transfer pricing law will be amended to give effect to the 2015 OECD transfer pricing recommendations, which amended the OECD guidelines.
Broadly, the amendments ensure that the transfer pricing of MNEs better aligns the taxation of profits with economic activity, and enhance guidance on intellectual property and hard-to-value-intangibles.
Australia’s transfer pricing legislation currently specify that the rules are to be interpreted to ensure it is applied consistent with OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations as last updated in 2010.
The amendment will apply from 1 July 2016.
Administrative penalties for significant global entities to be increased
From 1 July 2017, it is proposed that the Government will increase the administrative penalties for those companies with a global revenue of $1 billion or more for failure to adhere to tax disclosure obligations.
It is proposed that penalties relating to:
- lodgment of tax documents to the ATO will be increased by a factor of 100. The maximum penalty will therefore be raised from $4,500 to $450,000; and
- making false and misleading statement to the ATO will be doubled.
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The key change to corporate taxation announced in the Budget relates to the phased reduction in the corporate tax rate over a period of 11 years. However, Treasury also announced some minor amendments to the application of the income tax consolidation rules (which will have potential application to M&A transactions), and the simplification of certain complex tax rules which will be of significant benefit to small business and private groups.
A turnover-based phased reduction in the company tax rate
The Federal Government announced plans to reduce the company tax rate to 25% over the next 11 income years.
These measures will be phased in, commencing with a reduction in the company tax rate from 28.5% to 27.5% for small business entities (those with turnover of less than $10 million) starting from the 2016-17 income year. The reduced rate will then apply to progressively increasing turnover thresholds, such that by the 2023-24 income year all companies should be paying 27.5% tax, reducing further to 25% by the 2026-27 income year. The below graph provided on the Budget website helpfully explains the phased approach:
The Budget Papers contemplate that “franking credits will be able to be distributed in line with the rate of tax paid by the company making the distribution”, which could be expected to complicate franking account compliance. “Top up” tax will likely be required to be paid by Australian companies in receipt of franked dividends paid by lower tax rate companies, and in the inverse, corporate shareholders may potentially receive dividends franked to a higher rate than they are immediately able to pass on to their shareholders.
These measures are estimated to have a $2.7 billion cost to the revenue over the forward estimates period.
Potential amendments to the deemed dividend rules in Division 7A
Division 7A of the Income Tax Assessment Act 1936 contains measures that apply to treat certain benefits (such as low /no interest rate loans, forgiveness of debts and certain payments) provided to shareholders in private companies as though they were assessable unfranked dividends. Under the banner “Less red tape for business”, the Government announced that they would make targeted amendments to these complex rules.
With a proposed commencement date of 1 July 2018, and an unquantifiable cost to the revenue over the forward estimates period, the Government announced they will consult with stakeholders to develop targeted changes to simplify Division 7A, with the stated intention of including:
- a self-correction mechanism providing taxpayers whose arrangements have inadvertently triggered Division 7A with the opportunity to voluntarily correct their arrangements without penalty;
- new safe harbour rules, such as for use of assets, to provide certainty and simplify compliance for taxpayers;
- amended rules, with appropriate transitional arrangements, regarding complying Division 7A loans, including having a single compliant loan duration of ten years and better aligning calculation of the minimum interest rate with commercial transactions; and
- technical amendments to improve the overall operation of Division 7A.
These changes draw on numerous recommendations made by the Board of Taxation review into Division 7A. Any changes to provide greater certainty in relation to Division 7A will be welcomed by private company groups, which often struggle with the complexity of the law in the context of many ordinary commercial transactions.
Income tax consolidation treatment of deductible liabilities
In the 2013-14 Federal Budget, the then Government announced measures aimed at “closing a loophole” relating to the double counting of liabilities that could give rise to a future income tax deduction by deeming an amount of assessable income to the head company of the joined group. Broadly, Treasury was concerned that taxpayers were able to double count deductible liabilities, as the accounting value of the deductible liability was both partially included in the cost base of acquired assets, and also gave rise to an income tax deduction when paid. The most common example of a deductible liability is employee related liabilities (eg, annual leave and long service leave).
Taxpayers (and their advisers) were quick to point out that in the majority of arm’s length transaction scenarios there was no specific double benefit being obtained by the joined group, as typically any tax cost base benefit resulting from the deductible liabilities was allocated to goodwill – which is not amortisable for income tax purposes and is usually only of benefit in calculating capital gains on an ultimate disposal of the entire business.
Treasury seems to have (at least partially) heeded the call from industry participants, as the start date for the measures has been deferred from 14 May 2013 to 1 July 2016, and they have been amended in their ultimate operation. Instead of recognising deemed assessable income over the first 4 years after acquiring an entity with deductible liabilities, the modified approach involves denying the inclusion of the deductible liabilities in the cost base of assets.
In the context of M&A, the period since 14 May 2013 up to this announcement in the Budget has been relatively uncertain in relation to future deducible liabilities, as the deemed assessable income can often represent a material deal cost (particularly for labour force intensive target companies). The certainty that this measure represents for many already completed deals will no doubt be welcomed, and may potentially result in many groups revisiting past transactions and assumed tax outcomes.
Deferred tax liabilities in income tax consolidation
In September 2012, the Board of Taxation released a Discussion Paper that identified a mismatch between the commercial and tax treatment of deferred tax liabilities under the income tax consolidation rules. According to that Discussion Paper, the “deferred tax liabilities give rise to over taxation for the vendor consolidated group when an entity is sold. Where the deductible liability ceases within the purchaser consolidated group, deferred tax liabilities give rise to under taxation.”
Accordingly, and with application to transactions from the date amending legislation is introduced in Parliament, deferred tax liabilities will no longer be included in income tax consolidation entry and exit tax cost-setting calculations.
Broadening the securitised asset measure
The Government proposes to extend the application of the 2014-15 budget measure Closing Loopholes in the Consolidation Regime – securitised assets to non-financial institutions with securitisation arrangements. This will ensure that the same treatment applies to liabilities arising from securitisation arrangements within both financial and non-financial institutions. These liabilities will be disregarded if the relevant securitised asset is not recognised for tax purposes. The change will apply to arrangements commencing on or after 7.30pm AEST on 3 May 2016 with transitional rules applying to arrangements commencing before this time.
The measure was originally introduced because of unintended consequences which arose as a result of securitisation arrangements under the entry and exit tax consolidation cost setting process. These processes resulted in a double benefit being recognised in respect of securitisation related liabilities on entry of an entity into a tax consolidated group and on exit of an entity from a tax consolidated group, the double recognition of liabilities gave rise to potentially significant tax cost base reductions which did not reflect the economic outcomes for the seller and in some instances could result in material additional tax liabilities.
Taxation and financial arrangements – regulation reform
The Government proposes to reform the taxation and financial arrangements (TOFA) rules to reduce the scope, decrease compliance costs and increase certainty through a redesign of the TOFA framework. The simplified rules are intended to apply to income years on or after 1 January 2018.
The four key components of the proposed measures are as follows:
- A greater alignment with accounting, intended to strengthen and simplify the existing link between tax and accounting in the TOFA rules;
- A simplified version of the accruals and realisation rules which are intended to reduce the number of taxpayers affected by TOFA and reduce the number of arrangements where spreading of gains and losses is required;
- A new tax hedging regime which is easier to access, covers more types of risk management arrangements and removes the direct link to financial accounting; and
- Simplified rules for the taxation of gains and losses on foreign currency to preserve the current tax outcomes but streamline legislation. It is intended that the new framework will remove the majority of taxpayers from the TOFA rules and provide lower compliance costs and greater certainty while reducing the distortions in decision making. In addition to the above the Government intends to legislate certain previously unannounced measures relating to TOFA.
Increasing the small business entity turnover threshold
The Government will increase the small business entity turnover threshold from $2 million to $10 million from 1 July 2016. The $2 million turnover threshold will be retained for access to the small business CGT concessions and access to the unincorporated small business tax discount will be limited to entities with turnovers of less than $5 million.
Increasing the unincorporated small business tax discount
The Government will increase the tax discount for unincorporated small businesses incrementally over 10 years from 5% to 16%. The tax discount will increase to 8% on 1 July 2016 and remain constant at 8% for 8 years but will increase to 10% in 2024-25, 13% in 2025-26 and reach a new permanent discount of 16% in 2026-27. This is designed to coincide with staggered cuts in the corporate tax rate to 25%. The current cap of $1,000 per individual for each income year will be retained.
The tax discount applies to income tax payable on business income received from an unincorporated small business entity. Access to the discount will be extended to individual taxpayers with business income from an unincorporated business that has an aggregated annual turnover of less than $5 million.
Asset backed financing arrangements
The Government proposes to remove barriers to the use of asset backed financing arrangements which are supported by assets such as deferred payment arrangements and higher purchase arrangements. It is intended that the tax treatment of such arrangements will be clarified so that they are treated in the same way as financing arrangements based on interest bearing loans or investments. The intention is to provide access to more diverse sources of capital in Australia under this measure. The measure is proposed to apply from 1 July 2018.
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New CIV regime
On Budget night the Government announced a new tax and regulatory framework for two new types of CIVs. CIVs permit investors to pool their funds and have them managed by a professional funds manager. For income years starting on or after 1 July 2017 a corporate CIV will be introduced and this will be followed by a limited partnership CIV for income years starting on or after 1 July 2018.
The use of a company structure as a collective investment vehicle has been proposed as it is well suited for offering retail investment products. The Government considers that this will be particularly important in encouraging investment from the Asian region and to take advantage of the Asian region funds passport. The limited partnership collective investment vehicle, on the other hand is commonly used in foreign jurisdictions to facilitate wholesale investments by large investors such as pension funds.
The new CIVs will be required to meet similar eligibility criteria as managed investment trusts such as being widely held and engaging in primarily passive investment. While little detail has been provided about the tax rules relating to those vehicles, it is proposed that, in general, investors will be taxed as if they had invested directly in the underlying assets.
Expanding tax incentives for early stage investors
The Government has amended the Mid-Year Economic and Fiscal Outlook (MYEFO) 2015-16 National Innovation and Science Agenda – tax incentives for angel investors measure to:
- reduce the holding period from 3 years to 12 months for investors to access the 10 year capital gains tax exemption;
- include in the definition of eligible start-ups a time limit on incorporation criteria for determining if the start-up is an innovation company;
- require that the investor and innovation company are non-affiliates; and
- limit the investment amount for non-sophisticated investors to $50,000 or less per income year in order to receive a tax offset.
The purpose of the amendments according to the Government is to ensure that they promote investment in early stage innovation companies in a more targeted fashion.
New arrangements for venture capital limited partnerships (VCLP)
The Government has amended the MYEFO 2015-16 measure National Innovation and Science Agenda – new arrangement for venture capital investment to:
- Add a transitional arrangement that allows conditionally registered funds that become unconditionally registered after 7 December 2015 to access the tax offset if the criteria are met;
- Relax the requirement for very small entities to provide an auditor’s statement of assets;
- Extend the increase in fund size from $100 million to $200 million for new early stage venture capital limited partnerships (ESVCLPs) to also apply to existing ESVCLPs; and
- Ensure that the venture capital tax concessions are available for fin tech, banking and insurance related activities.
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A full suite of changes to the superannuation system
With the stated aim of achieving a more sustainable superannuation system, Treasury announced a full suite of superannuation tax reforms on Budget night.
Structurally, the “objective for superannuation” will be enshrined in a stand-alone Act as “to provide income in retirement to substitute or supplement the Age Pension”. The new Act will also include an accountability mechanism to ensure that any new superannuation legislation will be considered in the context of the objective.
With effect from 1 July 2017 (with the exception of the $500,000 lifetime cap, which applies from Budget night) the superannuation tax concessions will be “retargeted” by:
- introducing a $1.6 million balance cap on the total amount of superannuation that can be transferred into the tax-free retirement phase (estimated gain to the revenue of $2 billion over the forward estimates period);
- lowering the personal income threshold from $300,000 to $250,000 (including concessional contributions) at which the 30% tax rate on contributions applies, and reducing the annual cap on concessional contributions to $25,000 (estimated gain to the revenue of $2.5 billion over the forward estimates period);
- introducing a lifetime cap of $500,000 on non-concessional contributions (estimated gain to the revenue of $550 million over the forward estimates period); and
- introducing the Low Income Superannuation Tax Offset to replace the Low Income Superannuation Contribution when it expires on 30 June 2017 (estimated cost to the revenue of $1.6 billion over the forward estimates period).
Under the banner of “enhancing flexibility and choice”, Treasury announced that they will:
- lift current restrictions to allow all Australians, under the age of 75, to claim a tax deduction for personal contributions to eligible superannuation funds up to the concessional cap (estimated cost to the revenue of $1 billion over the forward estimates period);
- allow the carry forward of unused concessional caps to enable individuals with superannuation balances below $500,000 to make ‘catch-up’ superannuation contributions (estimated cost to the revenue of $350 million over the forward estimates period);
- extend the eligibility for individuals to claim a tax offset for contributions made to their low income spouse’s superannuation (estimated cost to the revenue of $10 million over the forward estimates period); and
- lift certain restrictions on contributions to superannuation that apply to Australians aged 65 to 74 and instead apply the same contribution acceptance rule for all individuals under 75 (estimated cost to the revenue of $130 million over the forward estimates period).
Treasury also announced measures aimed at reducing the extent to which the superannuation system may be used for tax minimisation and estate planning purposes by:
- taxing the earnings of 'Transition to Retirement Income Streams', to reduce the incentive for them to be used as a vehicle to minimise tax (estimated gain to the revenue of $640 million over the forward estimates period); and
- removing the outdated anti-detriment transitional provisions, which in practical terms, provide a refund of contributions tax paid over a lifetime (estimated gain to the revenue of $350 million over the forward estimates period).
Changes to personal income tax and Medicare levy low income thresholds
The marginal rate of tax on incomes between $80,000 and $87,000 will be reduced from 37% to 32.5%, which is designed to ensure that the average full-time wage earner will not move into the second highest tax bracket in the next three years.
This measure has an estimated cost to the revenue of $4 billion over the forward estimates period.
The Medicare levy low-income threshold for singles will be increased from the current income year from $20,896 in the 2014-15 income year to $21,335, while the individual phase-in limit will be $26,668 for the current income year (up from $26,120 in the 2014-15 income year).
For couples with no children, the family income threshold will be increased to $36,001 (up from $35,261 for the 2014-15 income year), while the additional amount of threshold for each dependent child or student will be increased to $3,306 (up from $3,238).
For single seniors and pensioners eligible for the Senior Australian and Pensioner Tax Offset (SAPTO), the Medicare levy low-income threshold will be increased to $33,738 (up from $33,044 for the 2014-15 income year). The phase-in limit for taxpayers eligible for the SAPTO is $42,172 for 2015-16 (up from $41,305). The threshold for families eligible for SAPTO will be increased to $46,966 for 2015-16 (up from $46,000).
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The GST announcements in this year’s Budget are as follows:
1. The application of GST will be extended to low value (i.e. $1,000 or less) goods imported by Australian consumers with effect from 1 July 2017.
This measure is intended to result in the same GST treatment for goods regardless of whether they are supplied by a domestic or foreign supplier. This means that foreign suppliers that were previously not required to register for, collect and remit GST because they supplied low value goods to Australians consumers, will now be required to do so if their Australian turnover is $75,000 or more.
Implementation of this measure however will require the unanimous agreement of the States and Territories. If this is enacted, the arrangements will also be reviewed after two years “to ensure that they are operating as intended and take account of any international developments”.
2. Changes are proposed to be made to the GST regime to ensure that consumers are no longer subject to “double taxation” when using digital currencies such as bitcoin. Treasury has released a discussion paper on options to reform the GST law to address the double taxation of digital currencies.
Under the current regime, the ATO considers that bitcoin is neither money nor a foreign currency, and the supply of bitcoin is not a financial supply for GST purposes. Its view expressed in public ruling GST 2014/3 is the supply may be taxable on the basis that a supply of bitcoin in exchange for goods and services is to be treated as a barter transaction. This has the consequence that the consumer could potentially bear double GST.
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Establishing the tax avoidance task force
The Government will provide approximately $679 million to the ATO over the forward estimates period to establish a new tax avoidance task force. This will permit the ATO to undertake additional compliance activities targeting multinationals, large public and private groups and high wealth individuals. The Government also intends that the ATO has access to information it requires by enhancing information sharing between the ATO and the Australian Securities and Investments Commission.
Better protecting tax whistle blowers
The Government will introduce arrangements to provide greater protection for individuals who disclose information to the ATO in respect of tax avoidance behaviour and other tax issues. The measure is intended to take effect from 1 July 2018 and will cover individuals including employees, former employees and advisors, who disclose information to the ATO.
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By Peter Feros, Hanh Chau, Andrew Sharp, Adam Musgrave, Grace Ho, Rianne Cheu, Mack Wan