Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 5 - Regulation impact statement
5.1 This bill is the first instalment of the Government's legislative programme implementing the package of reforms following the review of international taxation arrangements.
5.2 The outcomes of the review will improve the competitiveness of Australian companies with offshore operations. In particular the reforms will reduce the commercial constraints and compliance costs arising from the CFC rules, reduce tax on foreign 'active' business income, and effectively reduce foreign taxes by modernising Australia's tax treaties. The reforms will also enhance the competitiveness and reduce the compliance costs of Australian based managed funds.
5.3 Changes to the FIF rules are designed to reduce compliance costs for affected taxpayers and better target the FIF rules to entities most likely to engage in avoidance activities.
5.4 The change to the IWT rules is designed to reduce the cost of obtaining offshore finance for certain unit trusts operating in Australia. This change will ensure the same tax treatment is given to debentures issued by these trusts as is given to companies.
5.5 The change to the CFC rules is designed to reduce the cost of complying with the CFC rules, and complements changes that are to be made to the Income Tax Regulations 1936.
5.6 Note, this bill also contains an amendment that was not part of the review of international taxation arrangements. This amendment ensures royalty payments are not subject to double taxation to the extent that the transfer pricing rules have disallowed a deduction to the payer of the royalty. Due to its minor nature no regulation impact statement is required for this amendment.
5.7 The measures addressed in this regulation impact statement arise directly from the review of international taxation arrangements. Those recommendations were the subject of extensive consultation. The implementation options for these measures can be found in the Board of Taxation's report, International Taxation - A Report to the Treasurer (the Board's Report) and the Treasury's consultation paper, Review of International Taxation Arrangements (Consultation Paper). Table 5.1 shows where the measures, and principles underlying them, are discussed in these publications.
|Measure||The Board's Report||Consultation Paper|
|Exempting complying superannuation entities from the FIF rules.||Recommendation 4.4, pages 121 and 122||Option 4.4, pages 64 and 65|
|Increasing the balanced portfolio FIF exemption threshold from 5% to 10%.||Recommendation 4.2, pages 119 to 121||Option 4.2, pages 61 to 63|
|Removing 'management of funds' from the non-eligible activities in the FIF rules.||Recommendation 4.5, page 122||Option 4.5, pages 65 and 66|
|IWT exemption for certain unit trusts.||Recommendation 4.8C, pages 129 and 130||Not applicable|
|Paring back attributable income of CFCs resident in broad-exemption listed countries.||Recommendation 3, page 82||Pages 33 to 37|
5.8 Where the Board's Report and the Consultation Paper do not address details in this bill, the implementation options are set out in Table 5.2.
|Exempt fixed trusts from the FIF rules where the beneficiaries of the trust are complying superannuation entities.||Superannuation funds typically invest offshore through trusts. The measure ensures that such trusts can also receive the FIF exemption. The exemption will also apply to a chain of trusts. In the absence of the latter rule, the measure would have a more limited application.|
|IWT exemption for certain unit trusts.||The measure ensures that certain unit trusts that operate in Australia are eligible for an IWT exemption on widely offered debentures.
The Board's Report recommended that the exemption be available to widely held unit trusts. The primary example of such trusts are public unit trusts.
The exemption is extended to unit trusts that are not widely held but have all their units held by eligible unit holders (which are themselves widely held). Trusts with these characteristics are a commonly adopted structure in the investment industry that borrow to fund investments.
5.9 The Government, the Board of Taxation and the business sector have carefully considered the potential compliance, administrative and economic impacts of the measures in this bill.
5.10 The measures in this bill specifically impact on those taxpayers identified in Table 5.3.
|Exempting complying superannuation entities from the FIF rules.||Qualifying superannuation entities such as complying superannuation funds, complying approved deposit funds, PSTs and virtual PSTs of life companies. Fixed trusts where the beneficiaries are complying superannuation entities.|
|Increasing the balanced portfolio FIF exemption threshold from 5% to 10%.||Around 180 entities are currently paying tax due to the application of the FIF rules. However, due to the practice of selling down and because many taxpayers do not have attributable income (though they must still perform steps to determine this conclusion), many more entities than 180 will be affected by this change. A significant number of these entities are domestic managed funds.|
|Removing 'management of funds' from non-eligible activities in the FIF rules.||Due to the practice of 'selling down' (described in paragraph 5.15) and because many taxpayers do not have attributable income, an indeterminate number of entities (though many more than 180) will be affected by this change. A significant number of these entities are domestic managed funds.|
|IWT exemption for certain unit trusts.||Trusts taxed like companies, other public unit trusts and unit trusts with all beneficial interests held by prescribed unit holders. This measure will apply to approximately 600 unit trusts.|
|Paring back attributable income of CFCs in broad-exemption listed countries.||Around 2,000 taxpayers, predominantly companies, have reported interests in CFCs. This equates to around 5,000 CFCs (and controlled foreign trusts) resident in broad-exemption listed countries.|
5.11 Exempting complying superannuation entities from the FIF rules will ensure that such entities do not have to comply with the FIF rules. There will be a significant reduction in compliance costs for such entities as they will no longer need to classify their FIF investments, determine accrual income or maintain attribution accounts. Also, they will not need to undertake the practice of 'selling down' (as described below).
5.12 However, there is insufficient data to produce worthwhile estimates of the magnitude of these compliance cost impacts.
5.13 The balanced portfolio exemption was initially introduced so that taxpayers do not incur substantial compliance costs where non-FIF exempt activities are a minor part of their FIF investments. Increasing the threshold from 5% to 10% will ensure that more taxpayers are exempted from the FIF rules. This will reduce compliance costs for such taxpayers as they will not have to determine attributed income or maintain attribution accounts. However, taxpayers will still have to classify their FIF interests to determine whether their non-exempt FIF interests are no greater than 10%.
5.14 There are particular compliance cost savings for the managed fund industry. When the FIF rules were developed in the early 1990s, it was considered that a managed fund generally would have less than 5% of their FIF investments in non-FIF exempt activities. Since then companies that hold financial assets, which broadly constitute non-exempt FIF investments, now comprise a greater proportion of the global investment market. Anecdotal evidence now suggests that managed funds generally hold between 5% and 10% of their FIF investments in non-FIF exempt activities.
5.15 In order to qualify for the balanced portfolio exemption, managed funds 'sell down' their non-exempt FIF interests at the end of the income year to ensure that they meet the 5% threshold and repurchase those interests at the commencement of the new income year. This involves substantial transactional compliance costs. Increasing the balanced portfolio exemption from 5% to 10% will reduce the need for managed funds to sell down, thus reducing compliance costs.
5.16 There is insufficient data to produce worthwhile estimates of the magnitude of these compliance cost impacts.
5.17 Removing 'management of funds' from the list of non-eligible business activities will reduce the scope of non-exempt FIF investments of taxpayers. This will reduce the compliance costs associated with determining accrual income and maintaining attribution accounts for these investments.
5.18 There is insufficient data to produce worthwhile estimates of the magnitude of these compliance cost impacts.
5.19 The extension of the IWT exemption to certain unit trusts is expected to eliminate compliance costs for these trusts. Currently special purpose companies may be created by unit trusts in order to access the existing IWT exemption, but in some cases this may involve prohibitive costs.
5.20 There is insufficient data to produce worthwhile estimates of the magnitude of these compliance cost impacts.
5.21 The CFC measure will reduce the compliance costs for taxpayers with relevant interests in CFCs resident in broad-exemption listed countries. A taxpayer will not be required to obtain information from a CFC as to whether it derives certain foreign source amounts, except those, if any, identified in the regulations.
5.22 There is insufficient data to produce worthwhile estimates of the magnitude of these compliance cost impacts.
5.23 A reduction in the information available to the ATO on the FIF interests of self-managed superannuation funds may require the development of a compliance strategy and the independent collection of information from such entities, in order for the ATO to administer the Superannuation Industry (Supervision) Act 1993.
5.24 There is insufficient data to produce worthwhile estimates of the magnitude of administration cost impacts.
5.25 The administrative cost of this measure is expected to be minimal.
5.26 The administrative cost of this measure is expected to be minimal. There is insufficient data to produce worthwhile estimates of the magnitude of these administration cost impacts.
5.27 Administration costs may increase because a new class of borrowers is eligible for the exemption, subject to certain conditions. Determining whether a trust is an eligible unit trust may involve tracing through certain unit holders. This increase, however, is likely to be negligible because the taxation of the income of these trusts already requires a certain amount of tracing through the relevant unit holders.
5.28 The administration cost of this measure is expected to be minimal. Some ongoing monitoring of broad-exemption listed country tax systems will be required to determine if specific foreign source amounts should be identified in the regulations.
5.29 The financial impact of these measures will be a loss to the revenue over financial years as outlined in Table 5.4.
|Exempting complying superannuation entities from the FIF rules||-$9 million||-$9 million||-$10 million|
|Increasing the balanced portfolio FIF exemption||-$15 million||-$20 million||-$20 million|
|Removing 'management of funds' from the FIF blacklist||*||*||*||*|
|IWT exemption||-$1.5 million||-$3 million||-$3 million|
- Increasing the balanced portfolio FIF exemption: revenue estimates for this measure represent an upper bound estimate of the loss of revenue resulting from the change. This assumes a full-take up of the measure by all entities affected by the FIF rules. Data is not available to provide a reliable estimate of the number of entities that are currently failing to access the balanced portfolio FIF exemption that would qualify for the exemption under the measure.
- As increasing the balanced portfolio FIF exemption represents the upper bound of potentially exempting all FIF income, the costs of this measure and exempting complying superannuation entities from the FIF rules is not additive. The cost to revenue estimates above reflects the cost to revenue if each were separately enacted to the exclusion of the other. In the event that both are enacted the revenue impact for the increasing the balanced portfolio FIF exemption would subsume the exempting complying superannuation entities from the FIF rules costing.
- * a reliable estimate cannot be provided for the measure.
- .. negligible impact.
5.30 By reducing the tax compliance costs of the funds management and superannuation industries the FIF measures and the IWT exemption will improve the international competitiveness of these sectors. Importantly the IWT exemption will also remove a distortion in favour of companies over trusts in relation to offshore borrowing. There is an economic benefit from any compliance cost reduction associated with the CFC measure, to the extent that, where CFCs have foreign source income, CFC consequences (if any) will be more specifically identified in regulations.
5.31 Business, legal and accounting representatives and the ATO have been consulted extensively and have actively assisted in developing these initiatives. This involved the establishment of an advisory group constituted by members of industry and professional peak bodies to help in the design of legislation. Some of the more technical issues, or those that affect a specific interest group, were referred to particular sub-groups. In addition, direct discussions with taxpayers affected by these measures were undertaken as necessary.
5.32 On the IWT exemption measure, consultation substantially shaped the meaning of the unit trusts that would be eligible for the exemption. However, those consulted suggested that the legislation allow investors (e.g. individuals and private companies) other than those prescribed in the law to hold units in the unit trusts (that are not public unit trusts) that may qualify for the exemption. This went beyond the Government's policy in relation to this measure and so was not adopted.
5.33 The measures in this bill are the first instalment of reforms announced following the review of international taxation arrangements. This bill focuses on measures designed to streamline the FIF regime as well as reduce the cost of obtaining offshore finance for certain unit trusts operating in Australia. Reduced compliance costs associated with the FIF and IWT changes, will improve the international competitiveness of Australia's funds management and superannuation sectors. The IWT change will remove a distortion in favour of companies over trusts in relation to offshore borrowing.