Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 1 - Amendments relating to certain prepayments and non-commercial losses
1.1 This chapter explains:
- the new 12 month rule that is to apply to the timing of deductibility of certain expenditure incurred by investors in plantation forestry managed agreements; and
- the associated rule requiring the bring-forward of the assessable income from this expenditure in the hands of the recipient.
1.2 This chapter also explains the technical amendments to the non-commercial losses rules in the ITAA 1997 that will ensure the Commissioners discretion (to allow a loss in the income year in which the loss arises) is able to be exercised as intended, particularly for the forestry plantation industry.
1.3 Subdivision H of Division 3 of Part III of the ITAA 1936 permits an immediate deduction for a prepayment of expenditure that is deductible under the general deduction provision, section 8-1 of the ITAA 1997, where:
- the prepayment is made by an STS taxpayer or is deductible non-business expenditure by an individual;
- the eligible service period for the expenditure incurred is no longer than 12 months and ends no later than the last day of the income year following the year of expenditure (the 12 month rule); and
- the prepayment is not under a tax shelter arrangement, or one of the exceptions to the tax shelter rules applies.
1.4 Where these requirements are not met and the expenditure is not excluded expenditure as described in subsection 82KZL(1) of the ITAA 1936, the prepayment deduction must be spread over the eligible service period, as provided for in section 82KZMF (tax shelter arrangements), section 82KZM (STS and non-business taxpayers) and sections 82KZMB and 82KZMD (other taxpayers).
1.5 For individuals, Division 35 of the ITAA 1997 operates to defer losses from non-commercial business activities where the business activity does not satisfy any of the tests contained in this Division. In addition, the Commissioner has the discretion to allow the loss in the income year in which the loss arises where particular circumstances prevent the activity from satisfying one of the tests in that year.
1.6 In particular, paragraph 35-55(1)(b) allows for the exercise of the Commissioners discretion for those activities which:
- because of their nature, are not able to meet a test in the income year in which the loss arises; and
- are expected to meet a test or produce a profit after a period that is commercially viable for the particular industry.
1.7 Subsection 35-55(2) prevents the exercise of this arm of the discretion after the first occasion on which the business activity produces a profit or meets one of the tests, even for earlier income years, even though the period that is commercially viable may still be in course. This rule prevents the exercise of the discretion in income years in which losses arise following a one-off profit made from thinning out a plantation (a sound forestry management activity) and selling the cut timber.
1.8 The amendments exclude certain prepaid expenditure from the application of the prepayment rules (thereby providing an immediate deduction). A prepayment is excluded from the operation of these rules where the following conditions are satisfied:
- the expenditure is for seasonally dependent agronomic activities carried on under a plantation forestry managed agreement during the plantations establishment period;
- the activities for which the expenditure is made are undertaken within 12 months of the prepayment being made or the activity commencing,whicheveris the later; and
- the activities must be completed by the end of the income year following the income year in which the expenditure was incurred.
1.9 The amendments will also require that managers of plantation forestry managed agreements will need to include the relevant amounts in their assessable income in the year in which the investor is able to claim a deduction.
1.10 The amendments ensure the Commissioners discretion can be appropriately exercised for any income year or years within the period that is commercially viable for the business activity.
|New law||Current law|
A 12 month rule, similar to that applying to STS and non-business taxpayers, will apply where the expenditure is:
This new rule will apply to all taxpayers investing in plantation forestry managed agreements regardless of whether they are STS or non-STS business taxpayers.
The existing rules continue to apply to all other prepayments of expenditure.
Prepayments of expenditure by investors in plantation forestry managed agreements are subject to the rules in sections 82KZM to 82KZMF.
Where a tax shelter prepayment is made, any deductions are apportioned over the income years in which the goods or services are provided.
For STS and non-business taxpayers, where the expenditure is incurred after 25 May 1988 and the period over which the goods or services are to be provided:
the 12 month rule will apply. That is, the whole deduction is claimable in the income year in which the expenditure is incurred.
Where these conditions are not met, the deduction must be apportioned across the income years in which the goods or services are provided.
For prepayments by non-STS business taxpayers, the deduction must be apportioned over the income years in which the goods or services are provided. Limited transitional arrangements apply, ending in the 2002-2003 income year.
|A recipient of an amount which satisfies the new rule (i.e. the manager of the plantation forestry agreement) will be required to include that amount in their assessable income in the year in which the investor is first able to claim a deduction.||The recipient would include the amounts in assessable income in the year when the service was provided.|
|New law||Current law|
|For an activity which, because of its nature, is not able to meet a test in the income year in which the loss arises, the Commissioner can, at any time, exercise his discretion for all relevant income years within the period that is commercially viable for the business activity.||The Commissioner cannot exercise discretion at a time after the first time the business activity is expected to produce a profit or pass one of the tests.|
1.11 The amendments introduce section 82KZMG to Subdivision H of the ITAA 1936 . The section explains how investors in plantation forestry managed agreements should determine the extent to which a prepaid deductible amount may be claimed in the year of expenditure or in a future income year.
1.12 Subsection 82KZMG(1) excludes prepaid expenditure from the prepayment rules provided in sections 82KZMB, 82KZMD and 82KZMF, to the extent that the prepaid amount satisfies the requirements of subsections 82KZMG(2) to (4). Where a part of a prepaid expenditure amount does not meet these requirements, the timing of the deductibility of this residual amount remains subject to the other prepayment provisions. [Schedule 1, item 1, subsection 82KZMG(1)]
Example 1.1 A large business investor makes a prepaid investment of $10,000 in a plantation forestry managed agreement on 30 June 2003. The prepaid activities are carried out within 12 months, and span into the next income year but not beyond the end of that year. $2,000 of the prepayment is for seasonally dependent agronomic activities that occur within the establishment period. This component of the prepayment meets the requirements of subsections 82KZMG(2) to (4), is excluded from the timing rules in sections 82KZMB, 82KZMD and 82KZMF and is fully deductible in the year ending 30 June 2003. As the agreement also satisfies section 82KZME, which relates to tax shelter arrangements, the remaining $8,000 continues to be subject to these provisions, and will need to be apportioned between the 2 years.
1.13 Subsection 82KZMG(2) sets out the requirements that must be satisfied for the relevant prepaid expenditure to be excluded under subsection 82KZMG(1). In particular:
- the expenditure is in relation to an activity that is not wholly completed within the income year in which the expenditure was incurred [Schedule 1, item 1, paragraph 82KZMG(2)(c)] ;
- the expenditure must be incurred on or after 2 October 2001, under an agreement [Schedule 1, item 1, paragraph 82KZMG(2)(a)] ; and
- the eligible service period must be 12 months or less and the thing to be done under the agreement must be completed by the end of the income year following the income year in which the expenditure was incurred [Schedule 1, item 1, paragraph 82KZMG(2)(b)] .
1.14 Subsection 82KZMG(3) limits the application of the new provision to agreements satisfying the following requirements:
- the agreement is for the planting and tending of trees for felling [Schedule 1, item 1, paragraph 82KZMG(3)(a)] . Work preparatory to the actual planting, such as ripping and mounding would be integral to the planting and would therefore satisfy this criterion;
- the taxpayer must not have day to day control over the operations arising out of the agreement. However, the right to be consulted or give directions does not equate to having day to day control and will not result in this requirement not being satisfied [Schedule 1, item 1, paragraph 82KZMG(3)(b)] ; and
- there is more than one participant in the agreement in the same capacity as the taxpayer [Schedule 1, item 1, subparagraph 82KZMG(3)(c)(i)] . That is, there are 2 or more investors; or
- the manager must manage, arrange or promote similar agreements for other taxpayers. Alternatively, an associate of the manager must provide these services, via similar agreements, to other taxpayers [Schedule 1, item 1, subparagraph 82KZMG(3)(c)(ii)] .
1.15 The expenditure must be paid for seasonally dependent agronomic activities that are carried out during the establishment period. Seasonally dependent agronomic activities include such activities as ripping and mounding a plantation site, applying fertiliser, tending the seedlings prior to planting and the actual planting. The amount charged to, and paid by, the investor would include a reasonable profit margin for carrying out such activities. The investor has paid the amount for the seasonally dependent agronomic activity and would obtain the deduction for that amount. A non-agronomic activity would include the administrative activities carried out by the manager of the agreement. [Schedule 1, item 1, subsection 82KZMG(4)]
1.16 The establishment period, for the purposes of section 82KZMG, is defined as commencing at the time that the first seasonally dependent agronomic activity is performed in relation to a specific planting of trees and concluding with the planting of the trees. If it is necessary to apply a fertiliser or herbicide to the trees at the same time as planting then those activities fall within the establishment period. Planting of trees refers to the main planting of the particular plantation and expressly excludes specific planting to replace existing seedlings that have not survived (i.e. infilling) . [Schedule 1, item 1, subsection 82KZMG(5)]
1.17 A plantation manager may plan to undertake a herbicide spraying as soon as all the seedlings are planted. However, due to weather conditions that spraying may be postponed until the next practicable time, for example, one week. When that spraying is finally undertaken it is still in conjunction with that planting. However if, as part of a later infilling program, another herbicide spraying is undertaken that later spraying is clearly not in conjunction with the planting.
1.18 Section 15-45 of the ITAA 1997 explains that when a manager of an agreement receives an amount from an investor and all the requirements of section 82KZMG are satisfied, the amount must be included in the managers assessable income in the year in which the investor is first able to claim the corresponding deduction [Schedule 1, item 3, section 15-45] . A transitional arrangement allows the initial impact of this measure to be spread over 2 years (see paragraph 1.22).
Example 1.2 A manager of an agreement receives a payment of $3,000 for the ripping and mounding of a timber lot on 20 June 2005 and the activity is carried out in August 2005. The remaining requirements of section 82KZMG are met. The manager must account for this amount as income in the year ending 30 June 2005 because that is the year in which the taxpayer would first be able to claim the deduction.
1.19 Paragraph 35-55(1)(b) of the ITAA 1997 is amended to ensure that the Commissioner is able to exercise the discretion for a number of income years. [Schedule 1, items 5 and 6]
1.20 Subsection 35-55(2) which prevents the exercise of the discretion after the first time a test is met or a profit produced, is repealed. This ensures that the discretion can be exercised where the requirements of paragraph 35-55(1)(b) are satisfied, for all the relevant income years, even though the business activity may, on a one-off basis, meet a test or produce a profit. This can occur, for example, as a consequence of a thinning operation in a forestry plantation. [Schedule 1, item 7]
1.21 The amendments will apply to expenditure incurred on or after 2 October 2001. [Schedule 1, item 9]
1.22 Where deductions are first able to be claimed under section 82KZMG in either the 2001-2002 or 2002-2003 income years (whichever is the first year of use) the manager receiving the payments has a choice to spread the assessment of that income from the first year of use equally between that year and the following year. [Schedule 1, item 4]
Example 1.3 The first income year of use is 2001-2002, and the manager receives eligible amounts of $2 million in the 2001-2002 income year and $3 million in the 2002-2003 income year. If the manager chooses to utilise the transitional arrangements, his assessable income for those years will be $1 million in 2001-2002 and $4 million in 2002-2003 (comprising $1 million deferred from 2001-2002 and $3 million received in 2002-2003). In this example, the deferral arrangement will not apply to income received in 2002-2003 as it is not the first year of use.
Example 1.4 The first income year of use is 2002-2003, and the manager receives eligible amounts of $4 million in the 2002-2003 income year and $5 million in the 2003-2004 income year. If the manager chooses to utilise the transitional arrangements, his assessable income for those years will be $2 million in 2002-2003 and $7 million in 2003-2004 (comprising $2 million deferred from 2002-2003 and $5 million received in 2003-2004). This deferral arrangement does not apply to payments received after 2002-2003.
1.23 The amendments will have effect from the commencement of Division 35, being for the 2000-2001 income year. No transitional provisions are required. [Schedule 1, item 9]
1.24 Division 10 of the ITAA 1997 identifies particular types of assessable income. Section 10-5 is amended to include assessable income under a forestry agreement, specifically where section 82KZMG of the ITAA 1936 applies. [Schedule 1, item 2]
1.25 The amendments repeal references in section 82KZMG to section 82KZMB, effective as of the end of the income year which includes 21 September 2002. Section 82KZMB will be repealed from this time and will therefore not have to be affected by section 82KZMG. [Schedule 1, items 8 and 9]