• Interaction rules

    Due to the introduction of TOFA, certain consequential amendments were made to provisions in the ITAA 1936 and the ITAA 1997 that deal with matters within the scope of, or affected by, TOFA.

    For example, specific amendments have been made to the consolidation, capital gains tax (CGT) and foreign currency gains and losses provisions. Anti-overlap rules have also been introduced to address specific interaction issues.

    These consequential and interaction amendments generally fall into six categories:

    1. Ordering rules: These rules provide guidance on which tax law provisions will prevail when a financial arrangement falls within the scope of other tax laws outside TOFA (see ordering rules).
    2. Value-setting rules: These rules set the values of financial benefits for the purposes of the tax law, including for TOFA (see value-setting rules).
    3. Recognition of gains and losses: This category of amendments provides rules on whether an amount is assessable or deductible where a financial arrangement within TOFA is involved.
    4. Definitional: Certain definitions in existing tax law have changed due to TOFA.
    5. Referencing: Under these amendments, references to Division 230 have been added in other tax law provisions, and relevant referencing tables in the ITAA 1997 have been updated.
    6. Record keeping: These amendments outline how record-keeping requirements have been modified due to the introduction of TOFA.

    Ordering rules

    There are a number of provisions that may apply to an arrangement that is also a TOFA financial arrangement.

    As a consequence, there are rules to work out which provision should take precedence. Some of these rules are:

    • 12-month prepayment rule: Subdivision H of Division 3 of the ITAA 1936 sets out the timing of the deduction that may be allowable when such expenditure is prepaid. When the prepayment period is more than 12 months, TOFA will take precedence over Subdivision H of Division 3 of the ITAA 1936.
    • Qualifying securities: TOFA will bring to account most of the gains and losses made on discounted and deferred interest securities acquired or issued on or after 1 July 2010, or 1 July 2009 if a relevant entity makes an early-start election.
    • Deductions for returns on debt interests: Where a debt interest (as per Division 974) is also a TOFA financial arrangement, the gains or losses on those debt interests may be brought to account or allowable as a deduction under TOFA.
    • Trading stock: An item of trading stock that is a financial arrangement will be dealt with under TOFA and not Division 70.
    • Superannuation funds: Section 295-85 provides that, where a CGT event happens to a CGT asset that is also a financial arrangement, the relevant gain or loss is generally brought to account under the CGT provisions and not TOFA.

    See also:

    Value-setting rules

    Financial arrangements may be dealt with in circumstances involving dealings with other things. The objective of section 230-505 is to provide appropriate proceeds and cost base interaction rules between the provisions of Division 230 and the rest of the ITAA 1997 and the ITAA 1936. This is to ensure symmetry between TOFA and other provisions of the act, such as the capital gains tax (CGT) regime.

    Specifically, section 230-505 applies if an entity starts or ceases to have a TOFA financial arrangement as consideration for:

    • the provision of a thing
    • the acquisition of a thing
    • the starting to have a thing
    • the ceasing to have a thing
    • providing or receiving services
    • incurring an obligation
    • extinguishing a right or obligation
    • varying a right or obligation.

    Examples of each of these types of circumstances are:

    • Provision of a thing – the entity sells an asset subject to capital gains tax, and instead of receiving capital proceeds upfront, the entity is issued a debt interest under which the proceeds will be paid two years after the asset is sold.
    • Acquisition of a thing – the entity acquires an item of plant that is subject to Division 70, and under the acquisition contract, the entity issues a promissory note as consideration for the acquisition of the plant.
    • Starting to have a thing – the entity enters into a contract is entered into with the purchaser of the business not to operate a similar business in the same town. The contract states that $20,000 was paid for this four years after the contract date.
    • Ceasing to have a thing – a right the entity has comes to an end, and the entity will receive consideration for the ending of the asset in instalments over a ten-year period.
    • Incurring an obligation – an entity creates an obligation in itself, and in consideration for this starts to hold a bond.

    The effect of section 230-505 is to reset the tax cost of the thing, service, obligation or right. The amount provided or received in order to acquire or assume the thing, service, right or obligation is deemed to not equal the amount actually provided or received to acquire or assume the thing, but instead to equal the market value of that thing, service, right or obligation at the time when it was actually acquired or assumed.

    The effect of section 230-505, in the context of these examples, may be to reset the following:

    • the capital proceeds from a CGT event that occurs when the asset is sold to equal the market value of the asset when it was sold
    • the cost base of the depreciating asset to equal the market value of the asset when it was acquired
    • the proceeds from entering into the contract to equal the market value of the contract when it was entered into
    • the proceeds from the ending of the right to equal the market value of the asset when it ended
    • the amount provided to acquire the asset to equal the market value of that asset when it was created
    • the amount received as consideration for agreeing to vary the lease to equal the market value of the varied right under the lease when it was varied.

    Section 230-505 will also apply where the starting or ceasing to have the TOFA financial arrangement is not consideration for one of the circumstances outlined above, but rather where the starting or ceasing is, in substance or effect, done for one of those circumstances. For example, an entity that is a tenant under a lease, satisfies the obligation to pay rentals as consideration for its tenancy by issuing promissory notes.

    Additionally, the market value of the thing, service right or obligation will also be used in calculating the gains and losses the entity makes from the financial arrangement it started or ceased to have in consideration for the acquisition or assumption of the thing, service right or obligation.

    Example: Applying section 230-505 to a sale of an office block

    Nick Co acquired an office block for $500,000 in 2004.

    On 1 July 2012, Nick Co signs a contract to sell the office block to Vinnie Co. The contract includes:

    • a sale price of $1,100,000 to be paid in full on 1 July 2014
    • transfer of ownership of the office block to occur on 1 July 2012 – the market value at this time is $1,000,000.

    Nominal gain

    Overall, Nick Co makes a $600,000 gain – that is, $1,100,000 payment received, less $500,000 acquisition cost.

    Tax consequences before the operation of TOFA

    CGT event A1 happens on 1 July 2012 and Nick Co makes a capital gain of $600,000 – that is, $1,100,000 (proceeds) less $500,000 (cost base).

    Tax consequences after the enactment of TOFA

    TOFA applies on a mandatory basis to Nick Co as Nick Co's assets meet the threshold requirements.

    The substance of the arrangement is Nick Co is providing finance to Vinnie Co for the period between delivery of the building (on 1 July 2012) and the payment date of 1 July 2014, in addition to the transfer of the office block. This results in a gain to Nick Co (and a loss to Vinnie Co), which TOFA also seeks to tax.

    As Nick Co starts to have a financial arrangement as consideration for providing a CGT asset (the office block), for CGT purposes, section 230-505 will modify the capital proceeds amount in respect of the CGT event A1 happening.

    The tax consequences of this arrangement for Nick Co are as follows:

    (i)TOFA gain or loss from the financial arrangement
    A financial arrangement comes into existence (the right for Nick Co to be paid $1,100,000 by Vinnie Co) when ownership of the office block is transferred on 1 July 2012. This is because at this time, there are only cash settlable rights and obligations between Nick Co and Vinnie Co; that is, payment of the $1,100,000.
    The amount that Nick Co is taken to have obtained for providing the office block is $1,000,000, which is its market value at the time Nick Co provided it. This means Nick Co received capital proceeds of $1,000,000 for the office block (subsection 230-505(2)).
    Nick Co's gain on the financial arrangement is worked out as the difference between:
    • the cost of the financial arrangement, which is taken to be the market value of the building at the time the building was provided – that is, $1,000,000
    • the total amount it received under the contract – that is, the payment of $1,100,000.

    Accordingly, Nick Co made a $100,000 gain on the financial arrangement.

    (ii) Capital gain or loss on disposal of office block

    CGT event A1 happens at the contract date. The capital gain is calculated as follows:
    • $1,000,000 capital proceeds:
    • $500,000 less cost base

    $500,000 Nick Co's capital gain.

    End of example

    See also:

    Consolidation interactions – assets

    When a consolidated group acquires a company, the shares in the acquired company cease to be recognised for taxation purposes and the acquired company’s assets effectively become assets of the head company. Broadly, the tax costs of those assets are set at their tax cost-setting amounts.

    In essence, section 701-55 sets the tax cost of an asset (being its tax cost-setting amount) to be used when applying other provisions of the income tax law to that asset.

    Subsections 701-55(5A) and (5B) apply to an asset that is a financial arrangement and specifies the use of the tax cost-setting amount for the purposes of applying TOFA and section 701-61.

    See also:

    Subsection 701-55(5A)

    If subsection 701-55(5A) applies then the asset will be deemed to be acquired:

    • if the accruals/realisation or hedging method in TOFA is to apply in relation to the asset – at the asset’s tax cost-setting amount
    • if the fair value, retranslation or reliance on financial reports method in TOFA is to apply in relation to the asset – at the asset’s accounting value at the joining time.

    The effect of subsection 701-55(5A), in conjunction with section 715-378, is that the deemed acquisition amount (be it the tax cost-setting amount or accounting value at the joining time) can be taken into account when working out the gains or losses the head company makes from the financial arrangement asset.

    Example 1: Applying subsection 701-55(5A) at the joining time

    A joining entity brings into a consolidated group a forward asset worth $100. The tax cost-setting amount of the asset is $90. When the forward ends, the head company receives $120 in respect of the ending.

    Assume that subsection 701-55(5A) applies at the joining time.

    If accruals/realisation is to apply to the asset, the effect of subsection 701-55(5A) applying is that the $90 tax cost-setting amount can be taken account of when working out the gain or loss the head company makes from the forward. In this case, the head company would make a $30 gain.

    If the fair value or reliance on financial reports method is to apply in relation to the asset, the effect of subsection 701-55(5A) applying is that the $100 accounting value would be taken into account in working out the gain or loss the head company made from the asset. As a result, there would be a $20 gain made from the forward (assuming that the fair value or reliance on financial reports method has not already brought this amount to account due to the fluctuation in value that occurred after the joining time).

    End of example

    Note that generally speaking, there are no special rules that apply for working out the amount of the tax cost-setting amount for assets in relation to which TOFA applies. Subsection 701-55(5A) only specifies how the tax cost-setting amount is to be taken account of under TOFA or section 701-61. It does not specify the amount of the tax cost-setting amount.

    There is, however, one exception to this. As per subsection 705-25(5) of the prospective-rules period (as defined in Schedule 3 to Tax Laws Amendment (2012 Measures No. 2) Act 2012), a retained cost-base asset includes a right to future income. A right to future income can include many types of assets, some of which may be financial arrangements: subsection 701-63(5) of the prospective-rules period. There is a carve-out in the definition of rights to future income for rights that are either a TOFA financial arrangement, or a part of a TOFA financial arrangement.

    This leads to the following consequences:

    • If the TOFA carve-out applies, then the asset may be a retained cost-base asset (provided the other elements of the definition are satisfied).
    • If the TOFA carve-out does not apply, then the asset may be a reset cost-base asset (unless it is a retained cost-base asset under one of the other definitions of retained cost-base asset).

    See also:

    Section 701-61

    Where the fair value, retranslation or reliance on financial reports method applies, there is a special adjustment rule provided for under section 701-61. The difference between the asset’s tax cost-setting amount at the joining time and the accounting value of the asset at the joining time is to be:

    • where the accounting value exceeds the tax cost-setting amount – included in the head company’s assessable income, equally spread over the income year in which the joining time occurs, and the following three income years
    • where the accounting value is less than the tax cost-setting amount – allowed as a deduction from the head company’s assessable income, equally spread over the income year in which the joining time occurs, and the following three income years.

    This adjustment should not be confused with the transitional balancing adjustment – this is a completely different process calculated under a different set of provisions.

    Example 2: Applying the section 701-61 special adjustment rule

    Following on from example 1, if the fair value or reliance on financial reports method is to apply in relation to the asset, section 701-61 would have brought to account the difference between the $100 accounting value at the joining time and the $90 tax cost-setting amount at the joining time, and spread the difference over four income years from the joining time.

    End of example

    See also:

    Consolidation interactions – liabilities

    Under section 715-375, where a joining entity brings a liability into a consolidated group in relation to which TOFA applies, the liability will be deemed by subsection 715-375(2) to have been assumed at the joining time for (broadly) receiving the liability’s accounting value at the joining time.

    This is similar to the tax cost-resetting process for assets in that it deems an assumption of the liability for an amount. The difference between the cost-setting rule for liabilities is that the quantification of the cost of the liability is simply its accounting value. The cost-setting process for liabilities does not involve a push-down process.

    Example 1: Joining entity brings a derivative liability into the consolidated group

    A joining entity enters into a derivative on 1 July 2010 for $0.

    On 1 July 2011, the entity joins a consolidated group. At the joining time the value of the derivative liability is –$100.

    On 1 July 2012, the liability is discharged for –$120.

    The outcome under this scenario is that the head company will only be entitled to a loss of $20 – being the difference between the accounting value at the joining time and its value at the time when it is discharged. This arises because, as per the liability cost-setting rule, TOFA is to apply as though the liability is assumed at the joining time for receiving $100. As a result, because of the deemed receipt of $100, and the payment of $120, a net loss of $20 is allowed under TOFA.

    The precise timing and character of this deduction will depend upon the application of the TOFA tax-timing methods.

    Example 2: Joining entity brings a loan liability into the consolidated group

    A joining entity lends US$1,000,000 on 1 July 2010. The value of the amount lent, translated into Australian dollars as at 1 July 2010, is A$1,000,000.

    On 1 July 2011, the entity joins a consolidated group. At the joining time the value of the loan liability is now A$900,000.

    On 1 July 2012, the liability is discharged for A$850,000 equivalent.

    The outcome under this scenario is that the head company will only include $50,000 in its assessable income – being the difference between the accounting value at the joining time and its value at the time when it is discharged. This arises because, as per the liability cost-setting rule, TOFA is to apply as though the liability is assumed at the joining time for receiving $900,000. As a result, because of the deemed receipt of $900,000, and the payment of $850,000, a net gain of $50,000 is included in the head company’s assessable income under TOFA.

    The precise timing and character of this deduction will depend upon the application of the TOFA tax-timing methods.

    End of example

    See also:

    Consolidation interactions – transitional aspects

    Special rules apply to financial arrangement assets and liabilities brought into consolidated groups as a result of an entity joining the head company's consolidated group where the joining time occurred before TOFA started to apply to the head company, and that were still on hand when TOFA started for the head company, where the head company made a transitional election.

    Broadly, the effect of these changes are to require, for the purposes of TOFA and the TOFA transitional balancing adjustment, that the cost-setting rules for both assets and liabilities in subsection 701-55(5A) and 715-375(2) respectively be applied for the purposes of calculating the amount of the transitional balancing adjustment and gains and losses the head company makes under TOFA.

    In relation to assets, an additional adjustment also applies where the fair value, retranslation or financial reports method is to apply in relation to the asset (see sub-item 104B(2) of Schedule 1 to the TOFA Act). This adjustment mirrors section 701-61, except it applies transitionally.

    The effect of the special transitional rules is essentially to replicate what subsection 701-55(5A) working with section 701-61 and subsection 715-375(2) would have done, had the rules applied at the joining time. They achieve this effect by deeming application of the rules for the purposes of the transitional balancing adjustment and TOFA.

    This has two important implications:

    • When calculating the transitional balancing adjustment, an entity should have regard only to things that occurred after the joining time, but before the start of TOFA. Things that occurred before the joining time must be disregarded.
    • An entity needs to apply the transitional balancing adjustment and TOFA on the assumption that the deemed acquisition/assumption value as provided for in subsection 701-55(5A) or subsection 715-375(2) actually did occur at the joining time (despite the fact that at the joining time these provisions were not in existence).

    Example 1: Entity joins the consolidated group with a derivative asset before TOFA started to apply to the head company

    On 1 July 2008 a derivative asset is entered into for $0.

    On 1 July 2009, the entity joined a consolidated group. At the joining time, the asset’s:

    • accounting value was $100
    • tax cost-setting amount was $90.

    As at the start of TOFA on 1 July 2010, the accounting value of the asset is $120.

    On 30 June 2011, the asset is disposed of for $150.

    If the accruals/realisation method applied in relation to the asset, then:

    • the asset would be deemed to have been acquired for its $90 tax cost-setting amount
    • when the asset is disposed of, there would be a $60 gain under TOFA.

    If the hedging method applied in relation to the asset, then the:

    • asset would be deemed to have been acquired for its $90 tax cost-setting amount
    • $60 gain that arose upon disposal would be brought to account in accordance with the determination under section 230-360, and its character would be determined in accordance with subsections 230-310(3) or (4).

    If the fair value or financial reports method applies in relation to the asset, then (assuming that the asset is fair valued through profit or loss) the:

    • asset would be deemed to have been acquired for its accounting value at the joining time of $100
    • difference between the tax cost-setting amount and accounting value at the joining time of $10 would be included in the head company’s assessable income under sub-item 104(7) and spread over four income years from the start of TOFA
    • difference between the accounting value at the joining time and the accounting value at the start of TOFA of $20 would be included in the head company’s assessable income as a transitional balancing adjustment gain and spread over four income years from the start of TOFA.

    The difference between the accounting value at the start of TOFA and the amount received in respect of the disposal of $30 would be included in the head company’s assessable income as a Subdivision 230-G balancing adjustment gain.

    Example 2: Entity joins the consolidated group with a derivative liability before TOFA started to apply to the head company

    On 1 July 2008 a derivative liability is entered into for $0.

    On 1 July 2009, the entity joined a consolidated group. At the joining time, the liability’s accounting value was –$100.

    As at the start of TOFA on 1 July 2010, the accounting value of the liability is –$120.

    On 30 June 2011, the liability is discharged for –$150.

    If the accruals/realisation method applied in relation to the liability, then:

    • the asset would be deemed to have been assumed for its –$100 accounting value
    • when the liability is discharged, there would be a $50 loss under TOFA.

    If the hedging method applied in relation to the liability, then the:

    • asset would be deemed to have been assumed for its –$100 accounting value
    • $50 loss that arose upon discharge would be brought to account in accordance with the determination under section 230-360, and its character would be determined in accordance with subsections 230-310(3) or (4).

    If the fair value or financial reports method applies in relation to the liability, then (assuming that the liability is fair valued through profit or loss):

    • the liability would be deemed to have been assumed for its accounting value at the joining time of –$100
    • the difference between the accounting value at the joining time and the accounting value at the start of TOFA of –$20 would be allowed as a deduction from the head company’s assessable income as a transitional balancing adjustment loss and spread over four income years from the start of TOFA.

    The difference between the accounting value at the start of TOFA and the amount provided in respect of the discharge of $30 would be allowed as a deduction from the head company’s assessable income as a Subdivision 230-G balancing adjustment loss.

    End of example
      Last modified: 10 Jun 2016QC 27222