The TOFA reforms were first announced in the 1992 budget and were later taken up by the Review of Business Taxation. The review's final report - A Tax System Redesigned (the Ralph report) - made various recommendations about the taxation of financial arrangements.
Several concepts proposed in the Ralph report have been implemented progressively over the years. Stages one and two of these reforms were introduced in 2001 and 2003 respectively. The recently introduced Division 230 implements stages three and four of the TOFA reforms.
TOFA aims to reduce the influence of tax considerations on how financial arrangements are structured, emphasising other factors, such as risk, when making financing decisions.
Although TOFA provides a comprehensive and overarching framework to address the economic substance of arrangements, it is not an exclusive code for the taxation of gains and losses from financial arrangements.
Unless otherwise specified, other provisions of the Income Tax Assessment Act 1936 (ITAA 1936) or the Income Tax Assessment Act 1997 (ITAA 1997) still deal with gains or losses from financial arrangements where TOFA does not.
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Legislative references in this guide are to provisions of the ITAA 1997 unless otherwise specified.
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Applying tax law to financial arrangements - past problems
Before the TOFA reforms, the income tax law emphasised legal form rather than economic substance in the context of financial arrangements. This led to inconsistencies between the tax treatments of different transactions with similar economic substance. The inflexible, form-based rules did not keep pace with financial innovation, creating opportunities for tax deferral and tax arbitrage.
Income and deductions from financial arrangements were often dealt with on a realisation basis, although some were dealt with on an accruals basis. Income tax law did not adequately take into account the time value of money or provide for an appropriate allocation of income over time.
Further, the way tax law applied to financial arrangements resulted in tax-timing and tax-classification mismatches. The law did not address the tax-timing treatment of emerging hybrid instruments or new structured products, including those with fixed and contingent returns.
The piecemeal approach to amending the law to address a new product or fix a problem resulted in complex law that was a combination of both general and specific provisions.
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Last Modified: Friday, 15 March 2013