As provided for in section 230-15, TOFA only applies to gains and losses made from a financial arrangement.
Subsection 230-15(1) states that an entity's assessable income includes a gain made from a financial arrangement.
Subsection 230-15(2) states that an entity can deduct a loss made from a financial arrangement, but only to the extent that it is either:
- made in gaining or producing your assessable income
- necessarily made in carrying on a business for the purpose of gaining or producing assessable income.
TOFA will not include amounts in taxable income where the gains and losses relate to exempt or non-assessable non-exempt income as provided for under section 230-30. Gains and losses of a private or domestic nature are also generally excluded from the application of TOFA under section 230-35.
In contrast to section 8-1 (general deductions), subsection 230-15(2) does not include an equivalent exclusion for amounts of a capital nature. As a result, gains and losses under TOFA are considered to be on revenue account (except for gains and losses on certain hedging financial arrangements). This treatment simplifies the law by removing the need to determine the revenue or capital nature of such gains or losses.
Under TOFA, the concept of gain or loss is a net concept. A gain or loss is calculated in nominal terms by offsetting the costs against the proceeds from the financial arrangement.
Costs from a financial arrangement include financial benefits that either:
- are provided, or to be provided, under the arrangement
- play an integral role in determining whether an entity will make a gain or loss from the financial arrangement (subsection 230-60(1)).
Proceeds from a financial arrangement include financial benefits that either:
- are received, or to be received, under the arrangement
- play an integral role in determining whether an entity will make a gain or loss from the financial arrangement (subsection 230-60(2)).
A financial benefit could be considered integral to more than one financial arrangement. An example would be where a fixed and indivisible fee will be provided to acquire either one or more financial arrangements. In this circumstance, it will be necessary to apportion on a reasonable basis the actual amount of the financial benefit between the financial arrangements (section 230-65).
The financial benefits provided and received under a financial arrangement are generally taken into account at the value they have at the time they are provided or received – this is not necessarily the contract date.
There are also rules that can deem the amount an entity is taken to have provided or received in certain circumstances (sections 230-505 and 230-510).
Gains and losses may also arise from balancing adjustments that must be made in certain circumstances. The majority of these balancing adjustment provisions are set out in Subdivision 230-G, although there are other provisions under which balancing adjustments must also be made.
Example: calculation of gains or losses under Division 230
Jam Co enters into a contract to sell a truck to Straw Co on 1 July 2011. Under the contract, Jam Co must deliver the truck to Straw Co on 1 September 2011 and Straw Co must make payment of $50,000 on 30 June 2013. The value of the truck is $40,000 on 1 September 2011.
Jam Co starts to have a financial arrangement from 1 September 2011. Before this date, Jam Co had a non-cash settlable obligation (the obligation to provide the truck), which was not insignificant in comparison to the cash settlable right (the right to receive $50,000).
A financial arrangement arises when there is no longer a non-cash settlable non-insignificant obligation – that is, when the obligation to provide the truck is satisfied, which is on 1 September 2011.
Jam Co makes a sufficiently certain gain of $10,000 under the financial arrangement because it:
- receives a financial benefit of $50,000
- provides a financial benefit of $40,000 – the value of the truck on the date of delivery, not the contract date.
For more information, see:
- Section 230-60 – When financial benefit provided or received under financial arrangement
- Section 230-65 – Amount of financial benefit relating to more than one financial arrangement
- Section 230-505 – Financial arrangement as consideration for provision or acquisition of a thing.
Financial benefits that play an integral role
For some financial arrangements there will be financial benefits that, although not part of the financial arrangement, should be taken into account in determining the gain or loss. Where there are financial benefits that play an integral role in determining a gain or loss made from the financial arrangement, they are taken to be relevant rights and obligations under that financial arrangement for the purposes of working out any gain or loss.
What is considered essential or integral will be determined by the nature or purpose of the financial benefit provided or received under the financial arrangement. This can be determined by commercially-accepted principles and the relevant facts and circumstances of each arrangement.
For example, the payment of borrowing costs in relation to a financial arrangement may not be part of the financial arrangement, but may be taken to be an obligation under the financial arrangement pursuant to section 230-60. If so, the borrowing costs would need to be spread over the period to which they relate (and not over the shorter of life or 5 years as per section 25-25).
These rules ensure that an appropriate cost or amount of proceeds is allocated to the cash settlable financial arrangement. These rules operate only for the purpose of assisting in working out any gain or loss from the financial arrangement and are not intended to broaden what constitutes the financial arrangement as determined under sections 230-45 or 230-50.
In relation to the example above, Jam Co's obligation to deliver the truck to Straw Co is not part of the financial arrangement. This is because the financial arrangement does not arise until there is no longer a non-cash settlable non-insignificant obligation (the obligation to deliver the truck). However, as the truck is integral to determining the gain or loss on the financial arrangement, as it is the cost of the financial arrangement to Jam Co, it will be taken to be a financial benefit provided under the financial arrangement (subsection 230-60(1)).
Example: bonds and integral financial benefits
Frost Co acquires a bond that consists of the following rights and obligations:
- the right to receive the redemption price of the bond
- the right to receive interest coupons under the bond
- the obligation to pay a penalty if the bond is redeemed early (under the agreement)
- the right to receive a bonus for redeeming the bond late (under the agreement).
All of these rights and obligations are cash settlable and form a financial arrangement (section 230-45).
The obligation to provide the cost price of the bond is not part of the financial arrangement as it is not an obligation under the bond. However, as the cost price of the bond plays an integral role in determining whether there is a gain or loss (or the amount of the gain or loss) on the bond, it is taken to be a financial benefit under the financial arrangement (subsection 230-60(1)).
Another example of a financial benefit that is not part of the bond financial arrangement but is integral to determining the gain or loss, is the fee paid to brokers for completing applications and paperwork.
Examples of financial benefits that are unlikely to be integral to the gain or loss include:
- fees paid for investment advice in relation to the bond
- fees paid to an accounting firm to determine the accounting treatment of the financial arrangement
- salary and wages paid to full time employees relating to time spent in relation to establishing the investment
- a reasonable allocation of administration costs that relate to the entity's investments.
Example: loans and integral financial benefits
Trader Co, a wholly owned subsidiary of Finance Co, borrows $10 million from AZ Bank. The term is 5 years and the interest rate is 9% payable annually in arrears. Trader Co also pays a loan establishment fee at the commencement of the loan.
Trader Co has a financial arrangement consisting of the right to receive $10 million and the obligation to make interest payments. The obligation to provide the establishment fee is not part of the financial arrangement because it is not an obligation under the financial arrangement.
The establishment fee plays an integral role in determining the amount of the gain or loss on the loan and will therefore be taken to be a financial benefit under the financial arrangement (subsection 230-60(1)).End of example
Apart from some specific rules for determining a gain or loss on a financial arrangement where there is a change of residence during an income year (sections 230-485 and 230-490), TOFA does not affect the general rules relating to foreign residents. These rules ensure that non-residents are only taxed on their gains from financial arrangements that have an Australian source.
Sections 230-20 and 230-25 ensure that a gain or loss from a financial arrangement that is, or will be, taken into account under TOFA, and any associated financial benefits making up the calculation of that gain or loss, are not:
- taken into account more than once under TOFA
- included in assessable income or allowable as a deduction under a provision of the ITAA 1936 or the ITAA 1997 outside of TOFA.
These anti-overlap rules ensure that:
- gains and losses from financial arrangements are recognised only once for tax purposes
- the extent to which a gain or loss from a financial arrangement is assessable or deductible under TOFA, TOFA will take priority over other provisions
- to the extent TOFA does not deal with a gain or loss from a financial arrangement, other provisions of the ITAA 1936 or the ITAA 1997 will have residual operation, unless otherwise specified.
For more information, see:
- Section 230-20 – Gain or loss to be taken into account only once under this Act
- Section 230-25 – Associated financial benefits to be taken into account only once under this Act.
TOFA provides for a number of tax-timing methods that can be applied to work out when gains or losses that an entity makes from a financial arrangement should be brought to account for tax purposes.
If eligible, an entity can apply one or more of the elective tax-timing methods. If no elective tax-timing method applies to a financial arrangement, then the default methods apply.
Although more than one tax-timing method can apply to a financial arrangement, the priority rules in section 230-40 apply when working out which tax-timing method takes priority when calculating gains and losses.
If an entity ceases to have, or disposes of, a financial arrangement, a balancing adjustment must be calculated.
Example: hierarchy of tax-timing methods under TOFA
Example: application of the hierarchy of tax-timing methods
Steel Co entered into a hedging financial arrangement and elected to apply the hedging financial arrangements method.
In applying the priority rules, as the hedging financial arrangements method applies to the gains or losses made from the hedging financial arrangement, the other methods will not apply.
If the hedging financial arrangements method did not apply to the hedging financial arrangement (for example, the entity did not make the hedging financial arrangements election), Steel Co would have to consider whether any other elective tax-timing methods apply. As no other elective tax-timing method elections had been made, the default methods would apply.End of example