Explanatory Memorandum(Circulated by the authority of the Treasurer, the Hon. P.J. Keating, M.P.)
This Bill will implement the proposal, announced on 16 December 1984, to tax each year as it accrues part of the overall yield on discounted and other deferred interest securities, including securities of the indexed capital type, issued after that date. Some modifications of the proposal were announced on 20 December 1985.
Under the existing law, the gain to a taxpayer from investing in these kinds of securities is taxed only at maturity or earlier redemption, i.e., when it is received in cash. This treatment has created tax deferral advantages associated with the use of these securities by comparison with traditional interest-bearing securities. The amendments proposed in this Bill are designed to eliminate those tax deferral advantages. By the amendments, a resident taxpayer holding one of these securities will be taxed annually on that part of the income accruing on the security that is attributable to the period the taxpayer held the security during a year of income. Taxing the accruing income in this way should also ensure that the after-tax effective yield on the types of securities concerned reasonably equates with that from a traditional security having the same nominal yield.
Subject to certain exceptions, parallel treatment is to be accorded in relation to deductions to issuers of these securities for the discount or other "interest" component payable.
Three basic tests will need to be satisfied before a security is affected by the new measures -
- it will need to have been issued after 16 December 1984;
- its expected term will, or is likely to, exceed one year; and
- the sum of all payments (other than payments of periodic interest) under the security will exceed its issue price.
A further basic test is that where the amount of the excess in paragraph (c) can be established at the time a security is issued, e.g., in the case of a zero-coupon discounted security, the new measures will not apply unless the excess is greater than 1.5 per cent of the sum of those payments multiplied by the number of years and part years in the term of the security.
The accruals method is not to apply to prescribed securities within the meaning of section 26C of the Income Tax Assessment Act 1936.
It is expected that in most cases the securities affected will be readily identifiable as such. However, to enable a holder or potential holder of a security who is unaware of its status for purposes of the new measures to determine this fact, the legislation provides for the holder of a security to apply to the issuer for a notice as to whether or not the security is an affected security and, if so, for details of the issue price.
The actual treatment, for income tax purposes, of a security affected by the new measures depends on whether it is to be regarded as a fixed or variable return security. A fixed return security is one where the yield consists of a specified amount or amounts, e.g., a zero-coupon discounted security or where the calculation of the amount or amounts payable under the security does not involve the use of an interest or indexation rate that may vary over its term e.g. a security that pays interest only at maturity or earlier redemption and has a fixed coupon rate or where the security is some combination of these two characteristics. A variable return security is any security that is not a fixed return security. One example is a capital-indexed bond.
For a fixed return security, the holder will be required to calculate a yield to redemption for the security. This yield is, broadly, the compound interest rate per six monthly "notional accrual period" at which the sum of the present values of the payments to be made under the security equal its issue or transfer price, as the case requires. This compound interest rate is then used to gross-up the value of the security for each such period, to calculate the amount to be included in the holder's assessable income as the income accruing under the security for any year of income.
This method will also form the basis generally for determining the annual deductions allowable to the issuer of an affected security in respect of the discount or deferred interest payable under the security. The allowance of deductions to an issuer on an annual accruals basis will not apply, however, in relation to issues of bearer securities. or to offshore issues of affected securities. Relevant deductions will continue to be allowed in these cases only in the year in which the discount or deferred interest is paid.
Where a variable return security is involved, it will not always be possible to calculate in advance the overall yield to redemption under the security. Therefore, it is proposed to have regard to the actual terms of the security to ascertain the income accruing under the security for a year of income, e.g., in the case of a capital-indexed bond, this would be the capital indexation amount for that year, in addition to any interest payments received during that year. If, for any reason, the terms of a security do not enable the amount of the income to be accurately determined for any year, the Commissioner will be able to determine an amount to be included in a taxpayer's assessable income for that year.
If a variable return security is issued at a discount, e.g., a Treasury capital-indexed bond, the amount of that discount is to be included in the assessable income of the purchaser on a straight-line basis over the period the taxpayer holds the security. The amount to be so included for the first purchaser is to be calculated by reference to the term of the security. For example, if a capital-indexed security with a term of 10 years and a face value on issue of $1,000 is issued for $950, in addition to the proportion of the overall yield on the security that is to be included in assessable income for each year under the procedures outlined in the previous paragraph (i.e., any interest payments received and the capital indexation amount for that year), the taxpayer will be required to include $5 per year as the accrual of the issue discount. Similarly, if a taxpayer acquires, otherwise than on issue, a variable return security for less than its accrued value, the taxpayer will be required to include the "purchase discount" on a straight-line basis over the remaining term of the security. As noted earlier, the exclusion from the new measures of securities issued with an annual discount yield not exceeding 1.5 per cent will not apply to a variable return security.
Should a taxpayer sell or otherwise dispose of either a fixed or variable return security, adjustments are to be made where the realised gain from the security does not equal the sum of the amounts included in the taxpayer's assessable income under the accruals method. Where the gain from the sale exceeds the accrual amounts already included in the taxpayer's assessable income in previous years, that excess is to be assessed in the year the security is transferred. Conversely, where the gain is less than the sum of the accrual amounts previously assessed, that deficiency is to be an allowable deduction in the year of transfer. Similar provisions exist where the security is redeemed or partially redeemed.
In the case of a purchaser of a fixed return security on the secondary market, it has already been indicated that the purchase or transfer price paid will form the basis for determining the purchaser's yield to redemption and thus the amount to be included in assessable income each year under the accruals basis of assessment. On the other hand, a purchaser of a variable return security on the secondary market will be required to include any purchase discount, i.e., the excess of the security's accrued value over the purchase price as assessable income and will be entitled to an allowable deduction for any purchase premium.
The amendments proposed in this Bill are designed to only affect securities issued after 16 December 1984. However, as an anti-avoidance measure, provision exists for subjecting a security issued on or before that date to the accruals method if its terms are so varied after 22 May 1986 so that. if the security was issued on those terms on the date the variation took place, it would be subject to the proposed amendments. A variation that will trigger the operation of this provision is one that has the effect of transforming the security into a discounted or other deferred interest security or one that has the opposite effect. In both cases, the security is to be treated as having been issued as varied on the date its terms were altered.
One assumption underlying the arrangements for taxing each year the accruing income on an affected security is that this income will eventually be received by the holder of the security at redemption. This may not always be the case. Where it becomes clear that the issuer will be unable to meet its liability under the security because, for example, the issuer becomes insolvent, the holder of the security will be able to claim, as a bad debt, a deduction for the sum of the amounts previously included in assessable income under the accruals method and written-off as a bad debt, even though the payment of the accrued interest may not be then due. Where the allowance if such a deduction gives rise to a carry- forward loss, the usual tests for deductibility of losses will apply.
The application of the annual accruals method of assessing the gain on an affected security in the case of a private company raises particular implications when determining the company's distributable income for the year for the purposes of calculating its liability or otherwise for undistributed profits tax under Division 7 of Part III of the Income Tax Assessment Act 1936. If the accrued income included in the company's taxable income for the year is included in the distributable income calculation the company would not only be required to finance the primary tax payable on the accrued income out of its other resources (a feature common to all holders of affected securities), but might also be required to fund a dividend in respect of the after-tax component of the income out of these other resources if Division 7 tax were to be avoided. The company would, therefore, be disadvantaged by the accruals method compared with other taxpayers. For this reason, the accrued income included in a private company's taxable income for a year of income is to be excluded from the distributable income of the private company for Division 7 tax calculation purposes until such time as the security is sold by the company or is redeemed. At that time, given that the income will have been received in cash, the accruals amounts excluded in prior years are to be then added to the distributable income of the company for Division 7 tax calculation purposes.
The amendments contained in the Bill also cover "stripped securities", such as DINGO Bonds and similar securities. These securities separately market the entitlements to principal and interest on another security, usually a Commonwealth bond. The amendments deal with two types of these securities - the one where the interest coupons are physically separated from the principal component and both are sold singularly; the other where the holder of the "underlying security" creates new securities to match the timing and face value of the interest entitlements and the principal entitlement of the underlying security.
The amendments in relation to stripped securities have two broad aims. The first is to ensure that, regardless of when the underlying security was issued, where the holder of that security physically separates an interest entitlement or interest entitlements from the principal entitlement and markets them individually after 16 December 1984, the stripped components are to be regarded as having been issued as separate qualifying securities after that date. Therefore, where, as is usual, those stripped components are sold at a discount, they will be subject to the provisions contained in this Bill for taxing the deferred yield on a discounted security.
Secondly, for purposes of determining relevant deductions allowable to the issuer of stripped securities the amendments are designed to allocate the cost of the underlying security across the range of the stripped securities, and not just to the coupon or new security or securities that relate to the entitlement to the principal on the underlying security. This aspect of the amendments is designed to prevent issuers of stripped securities from creating artificial losses where they have unsold interest coupons on hand at the end of a year of income.
The amendments contained in this Bill will give effect to the proposal announced on 14 December 1984 to strengthen the interest withholding tax provisions of the income tax law to prevent a continued loss of revenue through a particular avoidance device and by the use of what may be described as non-traditional methods of finance. The amendments will also clarify the application of the law in relation to certain payments made in respect of bank accepted bills. In general terms the amendments will deal with three situations -
- where a non-resident sells a qualifying security, as defined in the amendments dealing with discounted and other deferred interest securities, to a resident;
- where a resident has entered into or enters into a hire-purchase agreement or finance lease arrangement after 16 December 1984 with a non-resident; and
- where a resident, in relation to a bill of exchange drawn or issued after the amendments become law and accepted and discounted overseas, indemnifies or reimburses the offshore acceptor of the bill in respect of the discount due under the bill at its maturity, with like provisions relating to promissory notes.
In relation to paragraph (a), the avoidance device referred to in the announcement of 14 December 1984 was one where a non- resident sold a discounted or other deferred interest security to a resident and no part of any profit derived by the non-resident from the sale was subject to Australian tax. This was in direct contrast to the situation where the non-resident held the security until maturity. In the latter instance, the non-resident was liable to withholding tax on the discount or deferred interest element of the redemption payment. Further, as these sales were arranged so as to give the profit an ex-Australian source, the non-resident was not able to be taxed on the profit by assessment.
By the amendments contained in this Bill, the profit on these transfers to residents by non-residents is to be deemed to be income that consists of interest. As such, the profit will be subject to withholding tax under the existing provisions of Division 11A of Part III of the Income Tax Assessment Act.
The proposed amendments will apply to relevant transfer payments made in respect of affected securities issued after 16 December 1984 but will not affect payments made on or before the date on which those amendments become law.
The profit to be subject to withholding tax is to be calculated, primarily, by reference to the security's issue price and the sale or transfer price. Where a non-resident acquired the security other than on its issue, i.e., by purchasing it from another person, no account is to be taken of the purchase price that the non-resident paid for the security unless he or she can show that it was purchased directly from a resident. In that case, the non-resident will be able to obtain from the Commissioner of Taxation a certificate which will show, among other things, the price paid for the security by the non-resident. By presenting the certificate to a resident transferee before the sale, the deemed interest on the sale is to be calculated as if the purchase price specified in the certificate was the security's issue price. The certificate must be presented to the resident transferee at the time of transfer to be effective. Otherwise the resident transferee would be required to withhold from the transfer price withholding tax on the difference between that price and the issue price of the security. To enable the orderly issue of these certificates, a non-resident may apply to the Commissioner at any time after he or she buys the security.
The certificate will also be effective should the security be redeemed in the hands of the non-resident. If an issuer is given one of these certificates at redemption, the issuer will be able to substitute the purchase price specified in the notice for the security's issue price for purposes of determining the non-resident's liability for withholding tax.
To cover the situation where a non-resident fails to produce such a certificate to a resident purchaser and the original issue price is not known or evident to the purchaser, or it is not apparent that the security is affected by the proposed amendments, the legislation proposes that the holder of a security may apply to the issuer for a notice as to whether or not the security is a qualifying security for those purposes, and, if so, for details of its issue price.
As indicated in the notes which follow on the Income Tax (Securities and Agreements) (Withholding Tax Recoupment) Bill 1986, provision is made for a resident who purchases an affected security from a non-resident to be liable for extra withholding tax, formally imposed by that Bill, where the Commissioner is satisfied that the parties were not dealing with each other at arm's length and that the resulting withholding tax liability is less than the withholding tax that would have been payable under an arm's length dealing.
The changes proposed by this Bill as they affect bank accepted bills of exchange are designed to ensure that offshore acceptors of the bills are exposed to liability for withholding tax in respect of the bill discount where, under an indemnification agreement or otherwise, a resident reimburses or indemnifies the non-resident acceptor for the amount of the face value of the bill at its maturity. A common arrangement is for a resident to draw a bill for acceptance by an offshore bank which may then either discount the bill itself or sell it on the open market. At the same time, the bank enters into an arrangement (be it formal or informal) with the drawer whereby the drawer agrees to either have sufficient funds on deposit with the bank to meet the bill or to reimburse the bank after it has paid the bill.
To remove any possible doubt as to whether withholding tax is payable on these reimbursement type payments - even though, if the resident drawer had met the bill directly, withholding tax would have been payable on the discount element of the bill - the amendments will specify that withholding tax is payable on that part of any reimbursement amount or amounts that constitute the discount or interest component of the bill of exchange.
Similar provisions are contained in this Bill in relation to promissory notes and the amendments concerned will apply in relation to relevant payments made in respect of bills of exchange and promissory notes issued or drawn after the date the amendments proposed by this Bill become law.
The Bill also contains provisions designed to subject to withholding tax the charges paid by a resident under hire-purchase and similar agreements, such as "terms purchase" and "lease with option to purchase" arrangements. These arrangements are becoming more common as alternative means of financing the purchase of plant or equipment from overseas. The charges under these arrangements have not been classed as interest for withholding tax purposes, although, in reality, the charges are a return for the provision of finance.
The amendments proposed by this Bill will both deem the charges under these arrangements to be interest for withholding tax purposes and provide the formula for allocating a portion of the interest to each payment under the contract. To avoid complexity and enable the "interest" component of each payment to be readily determined, the formula is based broadly on the so-called Rule of 78 that is well known in commercial circles. It assumes, of course, an even payment flow over the term of the contract. However, the situation could arise where the amount of a payment is less than the amount of interest attributed to that payment. This could arise because of a fluctuating payment stream or simply a low level of payments. In such cases, the formula specified in the legislation assumes that the interest is paid first, i.e., the whole of the payment will be taken to consist of interest and any "excess" interest is to be carried forward to the following payment. The amount of interest deemed to be payable in the succeeding payment will thus be the sum of the interest attributed to that payment by the formula and any excess interest brought forward from the preceding payment.
When the extension of the interest withholding tax provisions to hire purchase and similar arrangements was announced, it was pointed out that the interest component under the contract was to be regarded as the amount by which the sum of the payments exceeds the cost price of the item of plant or equipment. For the purposes of the amendments, this cost price is to be the market value of the property at the time the agreement commences or commenced to apply to that item of property.
The amendments also cover variations to the contract as well as situations where the contract is extended for any reason.
While securities and contracts issued or entered into after 16 December 1984 are affected by the proposed amendments, withholding tax is only to be deducted from relevant payments made or liable to be made after the date the amendments come into operation.
The Bill proposes amendments of section 160AA of the Income Tax Assessment Act 1936 - which applies to limit the rate of tax payable in respect of certain payments made on termination of employment - to remove an unintended effect.
The post-June 1983 component of a lump sum superannuation or kindred termination payment is subject to a maximum rate of tax of 30% and, where the taxpayer is aged 55 or more, the first $55,000 is taxed at a maximum rate of 15%. Where the tax that would otherwise be payable at normal rates exceeds the tax at these maximum rates, section 160AA applies to allow an offsetting rebate of tax. Similarly, the section limits to 30% the rate of tax payable in respect of lump sum employment termination payments made in lieu of accrued annual leave and/or long service leave entitlements.
However, because of a technical deficiency in section 160AA, the full benefit of the rebate may not be provided, in certain limited circumstances, where some part of the relevant termination payments is subject to tax at the lowest marginal rate (25% for 1985-86 and 26.67% for 1984-85). That defect is to be remedied by this Bill. The proposed amendments, to first apply in respect of income tax assessments for the 1984-85 year of income, will ensure that the appropriate rebate of tax is available to recipients of the relevant termination payments.
The Bill will also admit the Pearl Watson Foundation Limited to those provisions of the Income Tax Assessment Act 1936 that authorise income tax deductions for gifts of the value of $2 or more made to certain specified organisations. Gifts made to the Foundation after 22 May 1986 will qualify for deduction.
The Bill will also amend the secrecy provisions of the Income Tax Assessment Act 1936 to allow the Commissioner of Taxation to communicate information to the Secretary to the Department of the Treasury, or to the prescribed holder of an office established under Commonwealth law, for purposes related to the supervision or regulation of superannuation funds, approved deposit funds or other similar funds.
This Bill will exempt from tax certain components of the Formal Training Allowance payable to qualifying trainees from 1 January 1986 by the Commonwealth Department of Employment and Industrial Relations. The basic allowance comprises a living component, a training component and other additional components, where necessary to cover costs such as living away from home. These amounts are income on ordinary concepts and form part of the trainee's assessable income. The living component of the allowance is equivalent to the social security pension or benefit entitlement for which a trainee may otherwise have qualified, and may include payments of mother's/guardian's allowance, additional assistance for a dependent child, rent assistance or a remote area allowance. Other payments are also made to cover additional costs such as travel expenses, fees and tutorial assistance, but these do not form part of assessable income.
Social security pensioners or beneficiaries in receipt of the mother's/guardian's allowance, additional assistance for a dependent child, rent assistance or a remote area allowance are currently exempt from tax on those payments in accordance with the provisions of section 23AD of the Principal Act. The amendments proposed by the Bill will exempt from tax those components of the Formal Training Allowance corresponding to the exempt social security pension or benefit entitlements. The assessable component of the allowance will be subject to tax instalment deductions under the pay-as-you-earn system.
Subdivision F of Division 3 (Ed Note: the reference 'Division III' appeared in the original text) of Part III of the Principal Act contains rules for the substantiation of employment-related expenses and certain car and travel expenses. These rules require, as from 1 July 1986, that receipts, invoices or similar documentary evidence be obtained by a taxpayer as proof of expenses for which deductions are claimed, and that the documentary evidence so obtained be signed and supplied by or on behalf of the person or business that supplied the relevant goods or services. The Bill proposes to remove the requirement that the receipt be signed by the supplier.
On 16 October 1985, the Veterans' Entitlements Bill 1985 (the main Bill) and the Veterans' Entitlements (Transitional Provisions and Consequential Amendments) Bill 1985 (the transitional Bill) were introduced into the Parliament.
The main Bill was designed to rationalise and simplify the burgeoning body of Repatriation legislation by replacing various Repatriation statutes with one consolidated Act - the Veterans' Entitlements Act 1985. The transitional Bill was to provide arrangements for the transition from the Repatriation Act 1920 and other supplementary legislation to the main Bill.
Originally it was expected that both the main Bill and the transitional Bill would come into operation on 5 December 1985. However, the passage of the Bills through the Parliament was delayed following amendments of the main Bill in the Senate. The amended Bills have recently passed through the Parliament and received the Royal Assent. It is expected that the Acts - the Veterans' Entitlements Act 1986 and the Veterans' Entitlements (Transitional Provisions and Consequential Amendments) Act 1986 will operate on and from 22 May 1986.
As a consequence of, and in anticipation of, the changes proposed by the above-mentioned Bills, several provisions of the Income Tax Assessment Act 1936 (the 'Assessment Act') were amended by the Taxation Laws Amendment Act (No. 4) 1985 (the 'Amending Act') to ensure that references to repealed Repatriation statutes were replaced by references to the statutes, e.g., the Veterans' Entitlements Act 1985. Of course, the references to the Veterans' Entitlements Act 1985 subsequently inserted in the Assessment Act are incorrect as the correct title for that Act is the Veterans' Entitlements Act 1986.
The Bill will amend several provisions of the amending Act to ensure that the Veterans' Entitlements Act 1986 and the Veterans' Entitlements (Transitional Provisions and Consequential Amendments) Act 1986 are correctly cited in the Assessment Act. These amendments are not substantive in nature, will not affect the operation of the relevant provisions of the income tax law and will operate on and from 22 May 1986.
Amendments proposed by this Bill will add to the interpretative provisions contained in the Taxation Administration Act 1953 additional matters that are to be regarded as statements made in connection with the operation of the income tax law. These matters relate to the warranting of information shown on notices and certificates issued to holders of discounted and certain other securities affected by proposed amendments of the Assessment Act relating to the introduction of an accruals basis of assessment and the application of interest withholding tax in relation to those securities.
Under those amendments, the holder of an affected security may apply to the issuer of the security for a notice providing details of the security. The notice concerned will affect the application of the accruals basis of assessment in the case of a resident holder, and the relevant withholding tax liability for a non-resident holder. In addition, certain non-resident purchasers of affected securities may apply to the Commissioner for a certificate evidencing the purchase price paid. That certificate will affect the holder's liability for withholding tax on realisation or redemption of the security concerned.
By virtue of the proposed amendments of the Taxation Administration Act, where a holder of an affected security presents such a notice or certificate to another person, or advises another person of the contents of a notice or certificate, and where an issuer of an affected security gives a notice to the holder, the holder or issuer (as the case may be) shall be regarded as having made a statement in connection with the operation of a taxation law. Accordingly, the issuer or holder concerned will be liable to prosecution action for the making of any false or misleading statement in the notice, certificate or advice.
Amendments also proposed to the penalty provisions of the Assessment Act will ensure that, should a holder or issuer of a notice, or the holder of a certificate, make a false or misleading statement about the notice or certificate or the contents of the notice or certificate, the issuer or holder concerned will be exposed to penalty additional tax.
The second Bill, the Income Tax (Securities and Agreements)(Withholding Tax Recoupment) Bill 1986, will, in certain circumstances, formally impose a liability for interest withholding tax on a resident who buys a qualifying security from a non-resident. The circumstances are those where the Commissioner of Taxation is satisfied that the resident and the non- resident were not dealing with each other at arm's length and the amount of withholding tax that the non-resident was liable to pay in relation to the sale of the security is less than the amount which the non-resident would have been liable for if the parties were dealing with each other in an arm's length manner.
In such cases, by provisions being inspected by the Taxation Laws Amendment Bill (No. 2) 1986, the resident transferee will be liable for the extra withholding tax. This Bill formally imposes this tax - known as the avoided withholding tax amount - and declares the rate of the tax to be equal to the amount of the avoided withholding tax.
The Bill will also impose a liability for IWT on a resident where, as part of an arrangement that has as its sole or dominate purpose the avoidance of withholding tax, parties to an agreement affected by the proposed amendments to the withholding tax provisions agree to the pre-payment of interest attributable to the period of the agreement after the commencement of the amendments. This pre-payment of the interest could occur by either making additional payments to or larger payments than, those required under the contract.
Where these payments have the effect of reducing the amount of withholding tax that would otherwise have been payable on the interest component of the contract, the person making the payment will be liable for the avoided withholding tax amount. This Bill formally imposes the tax on the person making the payments, and declares the rate of tax to be equal to the amount of withholding tax sought to be avoided.
A more detailed explanation of the provisions of the Bills is contained in the following notes.