Explanatory Memorandum(Circulated by authority of the Acting Treasurer, the Hon. Chris Hurford, M.P.)
The main features of the Bills are as follows:
The Bill proposes a limitation on the income tax deductibility of interest associated with the "negative gearing" of rental property investments made after 17 July 1985 (the date of announcement of the proposal). Negative gearing occurs where, in a particular year, interest on borrowings used to finance rental property investments exceeds net rental income (i.e., after accounting for other relevant deductions) from such investments. Under the existing law, the excess is set off against income from other sources.
Amendments proposed by this Bill will have the effect that the aggregate amount of interest incurred in a year of income on borrowings financing rental property investments made after 17 July 1985 is deductible only from the aggregate net rental income derived in the year from all such investments - that is, from the gross rental income and any taxable profit on disposal of such investments, less all allowable deductions in respect of that income other than interest and any "depreciation" deductions in respect of capital expenditure on income-producing buildings. Where those other allowable deductions exceed gross rental income, that excess will remain deductible from assessable income from other sources. Where the interest exceeds the net rental income in any year, the excess will be carried forward and allowed as a deduction against net rental income of later years, without any limit on the carry-forward period.
An investment will be treated as having been made after 17 July 1985 if the relevant property is acquired under a contract entered into after that date. The construction of a relevant building or improvement will be treated as an investment made after 17 July 1985 where construction commences after that date unless either -
- the construction is pursuant to a contract entered into on or before 17 July 1985; or
- both of the following circumstances exist -
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- the taxpayer's interest in the land on which the building or improvement is constructed was held, or was acquired by the taxpayer under a contract entered into, on or before 17 July 1985; and
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- construction was financed by borrowings wholly raised pursuant to a contract or contracts entered into on or before that date.
For the purpose of ascertaining the interest deduction limit, the Bill provides for the aggregation of the income and deductions in respect of two broad classes of investment -
- investments in real property from which rental income is derived at any time during the year of income or which is held ready for use for rent-producing purposes at any time during the year of income; and
- investments (both equity and loan) in rental property companies, partnerships and trust estates.
A company, partnership or trust estate will be a rental property company, partnership or trust estate in relation to a year of income if it has 75% or more of its net worth on the last day of its year of income in investments (either direct or through interposed companies, partnerships or trust estates) in real property that is, or is held ready for use for, rent-producing. Interposed companies, partnerships or trust estates do not themselves have to be rental property companies, partnerships or trust estates as defined and it is the value of the entity's ultimate investment in the real property - not the investment in the interposed entity - that is taken into account in the application of the 75% test. An investor will be treated as having made an investment in a rental property company, partnership or trust estate if the investment is made at any time during the year of income. The Bill ensures that investments in partnerships and trust estates are not within its scope unless the partnership or trust estate is a rental property partnership or trust estate by providing that the interest of a partner or beneficiary in real property owned by a partnership or the trustee of a trust estate is not itself treated as a rental property investment of the partner or beneficiary.
Where the investment is in real property, interest on borrowings is brought within the scope of the interest deduction limitation rule to the extent that the real property is used or held ready for use for rent-producing purposes. The proposed amendments will therefore apply, for example, to interest incurred in respect of a period of such use even if paid in advance. Where the investment is in a rental property company, partnership or trust estate, the whole of the investor's income from that investment is treated as gross rental income and the whole of any interest on borrowings financing the investment is subject to the deduction limitation rule.
A specific exemption is provided in the Bill for investments by employers in residential accommodation leased to their employees at or adjacent to a site of mining (including petroleum mining) operations or in or adjacent to a timber felling area, where capital expenditure on the accommodation may be written off periodically as deductions under the existing income tax law. The Bill also provides that property acquired by reason of the death of another person will be treated as having been acquired on or before 17 July 1985 if the deceased person had acquired the property on or before that date.
Under the Bill the rental income derived from a particular investment made after 17 July 1985, together with any related deductions, will be included in the calculation of the aggregate interest deduction limit notwithstanding that no interest is incurred in the year of income in respect of that investment, whether because no borrowings were used to finance the investment or because any such borrowings have since been repaid.
The Bill provides for all or part of an amount of interest in excess of the deduction limit to be transferred between companies in a wholly-owned company group on a similar basis to that which applies to ordinary losses. An amount may only be transferred to the extent that it can be absorbed by any net rental income of the transferee company from post-17 July 1985 investments remaining after deducting any related interest incurred by that company.
Where a change of 50% or more occurs after 25 September 1985 in the beneficial ownership of rental property acquired on or before 17 July 1985, the Bill provides that the investment will then become subject to the new provisions. The change could be in the beneficial ownership of company shares or one that occurs upon the formation, dissolution or variation of a partnership or trust. However, a change in beneficial ownership on account of death will not be treated as an investment to which the new measure applies. On the other hand, the measure will apply even where the partial property ownership change is less than 50% if the total borrowings financing the investment are increased in the course of the ownership change.
The Bill proposes amendments of Division 10D of Part III of the Income Tax Assessment Act 1936 to extend the income tax deductions (commonly referred to as "depreciation" allowances) that are presently available for capital expenditure on the construction of non-residential income-producing buildings, extensions, alterations and improvements to such expenditure on residential income-producing buildings, etc. where construction commenced after 17 July 1985 (the date on which the proposal was announced).
The effect of the amendments will make most new income-producing buildings, etc. eligible for deductions under Division 10D. However, a building or a part of a building will not be eligible for a deduction during any period that -
- it is used for display or exhibition purposes in connection with the sale or lease of any building or part of a building; or
- it is residential accommodation that is used or reserved for use by the taxpayer or by certain persons associated with the taxpayer.
Deductions will be available on broadly the same basis as that presently applying under Division 10D for capital expenditure on non-residential income-producing buildings. A fixed annual deduction of 4% of the construction cost will be allowed over a 25 year period in relation to a qualifying building, extension or alteration used for eligible income-producing purposes during that period. The person who first owns the building, incurs the construction costs and uses the building for income-producing purposes will generally be eligible for the deduction. Where the ownership of a building changes hands, entitlement to deductions will generally pass from the person previously entitled to the new owner. In certain circumstances, a lessee who incurs eligible construction costs will be entitled to the capital expenditure deductions.
For expenditure to qualify for deductions under Division 10D, a building (or a part of a building) commenced to be constructed after 17 July 1985 must, at the time of its completion, be for use, or for disposal to another person for use, for income-producing purposes or for use as residential accommodation. This will mean that a building can first be used as non-income-producing residential accommodation by its owner without excluding it from future eligibility under Division 10D. Deductions will only be allowable, however, in respect of periods during which the building (or part) is used for the purpose of producing assessable income.
Where expenditure on a residential building qualifies for deduction under the existing provisions of the law, such as the special provisions applicable to mining infrastructure, deductions will continue to be available under those provisions. However, Division 10C of the Assessment Act, which authorises deductions for capital expenditure on buildings used as short-term traveller accommodation, will cease to apply to buildings commenced to be constructed after 17 July 1985. These buildings are to be treated in the same way as other residential income-producing buildings.
The construction cost of a building, extension, alteration or improvement for the purposes of existing Division 10D includes such preliminary expenses as architect's fees, engineering fees and the cost of foundation excavation. However, costs associated with the demolition of an existing building for the purposes of erecting an eligible building on the site do not qualify. That position is to remain unchanged. Also, in cases where qualifying expenditure has been incurred in relation to an income-producing building which is destroyed before the expiration of the 25 year period, a balancing deduction will continue to be allowed in appropriate circumstances where the written-down value of the building exceeds any insurance or salvage recoveries.
The Bill will give effect to the proposal, announced on 9 October 1985, to tax consideration received for the transfer to another person of rights to receive income from property where the property is not also transferred and modify existing anti-avoidance provisions relating to the alienation of income for short periods so that they apply only where income is transferred between associated persons for a non-arm's length consideration.
The amendments are intended to counteract the revenue effect of the decision of the Federal Court in FCT v Myer Emporium Ltd, which held that an income flow could effectively be converted to a non-taxable capital amount by assigning the income, for commercial consideration, to an unrelated finance company. For its part, the finance company would be able to offset the amount of the consideration against the (assigned) interest received.
Under the existing law, income from property that is transferred by a person to another person is treated as the income of the transferor for income tax purposes where the transfer (whether for valuable consideration or not) is, or may be, for a period of less than 7 years and the transferor does not also transfer his or her interest in the property that produces the income.
The relevant provisions, in Division 6A of Part III of the Income Tax Assessment Act 1936, are directed basically at transfers between related persons, but are also capable of application to transactions for commercial consideration between parties at arm's length. Under amendments in this Bill their application is to be limited to transfers, for less than 7 years, of rights to future income where the parties to the transfer are associated persons and any consideration in respect of the transfer is less than could be expected under an arm's length transaction.
New provisions will apply to other cases where income rights are transferred for consideration - whether for more or less than 7 years - without the interest in the underlying property also being transferred. In these cases the consideration is to be included in the transferor's assessable income of the income year in which the transfer of income rights occurs.
This Bill will facilitate the implementation of the proposal, announced in the 1985-86 Budget, to introduce a system of self-assessment of income tax returns.
Under the proposed self-assessment system, income tax returns will not generally be subject to technical scrutiny before an assessment is made. There will however be some clerical examination of all returns, mainly to prepare them for computer processing, but also to identify obvious errors and incorrect claims. There will be more post-assessment audits and examination of returns. These audits and examinations will in a number of cases give rise to a need to amend assessments to correct errors thus detected.
Under the existing law there are specified limitations on the power of the Commissioner of Taxation to amend assessments. For example, where a taxpayer has made a full and true disclosure of all material facts necessary for assessment, an amended assessment to increase the liability of the taxpayer may be made within 3 years from when the tax became due under the assessment to correct an error in calculation or mistake of fact, but not to correct an error of law. The amendment of an assessment to decrease a taxpayer's liability is also subject to a 3 year limitation and, similarly, cannot be made to correct an error in law. The limitation prohibiting the amendment of an assessment to correct an error in law is appropriate under the present assessing system as all income tax returns are subject to examination by assessors and errors of law are generally identified and corrected by assessors in the course of making the original assessment.
In order to give effect to the self-assessment system, this Bill will allow the Commissioner of Taxation to make an assessment based on acceptance of information contained in the income tax return of the taxpayer. As the incorrect application of the law by taxpayers will, under the self-assessment system, ordinarily be identified only at post-assessment audit or examination stage, the Bill will authorise the Commissioner to amend assessments to increase or decrease the liability of taxpayers, within the presently specified time limits, to correct errors of law.
The Bill will also provide for payment of interest by taxpayers where an assessment has to be amended to correct an error which resulted in underpayment of tax and where no penalty for a false or misleading statement or other penalty (other than for late lodgment of the return) would apply. This will compensate the revenue for the full amount of tax not having been paid by the due date. The Commissioner will have a power to remit the interest payable by a taxpayer in appropriate circumstances. Where the Commissioner discovers a taxpayer's error which resulted in overpayment of tax, interest will be payable to the taxpayer. In both cases the rate of interest payable will be that applicable from time to time under the Taxation (Interest on Overpayments) Act 1983 (presently 4.026% per annum) where overpaid tax is refunded to a taxpayer following a successful objection or appeal. Any interest paid by a taxpayer will not be tax deductible. Interest payable to a taxpayer will form part of the assessable income of the taxpayer.
The Bill will also give effect to the proposal (announced on 10 December 1985) to admit the Australian Sports Aid Foundation to those provisions of the income tax law that authorise deductions for gifts of the value of $2 or more made to certain specified organisations. Gifts made to the Foundation on or after its date of incorporation - 18 February 1986 - will qualify for deduction.
This agreement is designed to avoid double taxation of income derived from international air transport.
It provides for a reciprocal exemption from tax by the respective countries of profits and revenues derived from the operation of aircraft in international traffic by an enterprise of the other country. That exemption will not apply to profits and revenues derived by an airline of one country from the carriage of passengers, livestock, mail, goods or merchandise solely between places in the other country. The practical effect of the agreement is that Qantas will be exempt from Chinese income taxes on its profits and revenues from international traffic, and China's airline, CAAC, will be exempt from Australian tax on its corresponding profits and revenues. The agreement follows, in all material respects, Australia's other existing airline profits agreements with France, Italy, Greece and India.
The agreement will not enter into force until Australia and the People's Republic of China give written notice to each other of the completion of the procedures required to give the agreement the force of law in the respective countries. Upon entry into force, the agreement is to have effect in respect of relevant profits and revenues derived on or after 1 July 1984.
The Pay-roll Tax (Territories) Assessment Act 1971 will be amended by this Bill to introduce "grouping" provisions into the ACT pay-roll tax law.
ACT pay-roll tax is payable by an employer whose annual wages paid or payable in the ACT, or in respect of services provided in the ACT, exceed the prescribed monetary exemption - presently $170,000. This exemption is reduced by $2 for each $3 by which total wages exceed that prescribed amount, so that when total wages are or exceed $425,000 no part is exempt from pay-roll tax. Because the exemption presently applies to each entity where associated business operations are conducted by separate entities, it is possible to substantially reduce or avoid liability for ACT pay-roll tax.
The proposed grouping provisions will operate in certain circumstances to group together 2 or more employers for pay-roll tax purposes. Where employers are treated as a group, only one member of that group, the designated group employer, will be entitled to benefit from the exemption provided. That exemption will be calculated by reference to the wages paid or payable by all the members of the group.
The remaining group members will each be required to lodge periodic returns (generally monthly) and will be liable for pay-roll tax, at the current rate of 5 per cent, on wages paid or payable by them during that period, unless total group wages will be below the annual exemption level.
Where a group has existed for the whole of a financial year, the pay-roll tax liability for the group will be calculated based on the actual wages paid or payable by the group members during the year. In the event that there has been an overpayment of the tax, that amount will be refunded to the designated group employer. If there is a shortfall between the tax paid by the group members during the financial year and the group's actual tax liability, the group members will be jointly and severally liable for the shortfall. A group which exists for part only of a financial year will have its liability calculated on a proportional basis.
This Bill will formally impose an interest charge, which is technically a tax, in respect of underpayments of income tax. Liability for interest is being established under proposals contained in the Taxation Laws Amendment Bill 1986.
A more detailed explanation of the provisions of the Bills is contained in the following notes.