Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello MP)
Chapter 7 - Technical amendments and corrections
7.1 Schedule 7 to this Bill corrects a defect in the definitions of 'exempt entity' in the Income Tax Assessment Act 1997 (ITAA 1997) and 'excepted trust' in the Income Tax Assessment Act 1936 (ITAA 1936).
7.2 The income tax law defines exempt entity to be an entity whose income is exempted by Division 50 of the ITAA 1997 or by another Commonwealth (non-income tax) law. Some Commonwealth, state and territory bodies are exempted otherwise than because of Division 50 or another Commonwealth law, so are not included within the definition of exempt entity.
7.3 This causes problems with some provisions that refer to exempt entities. One example is the provision recently added to the income tax law to exempt from tax those funds established solely to provide money to certain entities that are themselves exempt entities. Such a fund that provides money to a Commonwealth, state or territory body (eg, a state library or the National Portrait Gallery) that is exempt from income tax but not an exempt entity within the definition would lose its own exempt status.
7.4 A similar problem arises in Schedule 2F to the ITAA 1936, which requires trusts to satisfy particular tests before they can access their tax losses. It does not impose these requirements on 'excepted trusts'. 'Excepted trusts' include those where all the capital is beneficially owned by entities exempt under Division 50 of the ITAA 1997. If a trust's beneficiaries include an exempt state or territory body, the trust might not be an excepted trust and would have to satisfy the relevant tests before it could access its losses.
7.5 Schedule 7 changes the definition of exempt entity in the ITAA 1997 so that it includes any entity if all of its income is exempted by any Commonwealth legislation or if it is an untaxable Commonwealth entity. It also changes the definition of excepted trust in Schedule 2F to the ITAA 1936, so that it requires all of its income and capital to be owned by exempt entities.
|New law||Current law|
|'Exempt entity' includes all entities whose income is exempt under any Commonwealth law and all untaxable Commonwealth entities.||'Exempt entity' does not include all state and territory bodies that are exempt under Division 1AB of Part III of the ITAA 1936 or Commonwealth bodies that are not liable to taxation.|
|'Excepted trust' includes any trust if all the interests in it are held by exempt entities.||'Excepted trust' in Schedule 2F to the ITAA 1936 does not include all trusts that have interests held by state and territory bodies that are exempt under Division 1AB of Part III of the ITAA 1936.|
The definition of exempt entity and excepted trust
7.6 The income tax law defines exempt entity in a way that does not include all entities whose income is exempt from tax. The definition includes entities that are exempt under Division 50 of the ITAA 1997 but does not include state and territory bodies whose income is only exempt under Division 1AB of Part III of the ITAA 1936. Nor does it include Commonwealth bodies that are not liable to taxation. This result was not intended.
7.7 An example of a problem this causes occurs for some public ancillary funds and prescribed private funds. In 2005, these funds were made exempt if they distributed all their money to exempt entities. These funds would lose that income tax exemption if they distributed money to a state or territory body (eg, a state library) that is exempted under Division 1AB but not under Division 50 or to a Commonwealth body (eg, the National Portrait Gallery) that is not liable to taxation but is not exempted under any law.
7.8 A similar problem occurs in the trust loss provisions in Schedule 2F to the ITAA 1936. Those provisions require a trust to pass certain tests (eg, that there is no change in its ownership) before it can access its tax losses. However, that requirement is not imposed on an 'excepted trust'. Section 272-100 defines excepted trust to mean a trust that (among other things) has all its income and capital beneficially owned by entities exempt under Division 50 of the ITAA 1997. If any of its income or capital were owned by a state or territory body that is exempt from tax but not under Division 50, the trust would not be an excepted trust and would have to satisfy the normal tests before it could access its tax losses.
7.9 These amendments replace the definition of 'exempt entity' with one that makes any entity an exempt entity if all its income (regardless of what kind of income it is) is exempt from income tax under any Commonwealth law or it is an untaxable Commonwealth entity. [Schedule 7, item 14, subsection 995 - 1(1) of the ITAA 1997, definition of 'exempt entity']
7.10 These amendments ensure that state and territory bodies exempted by Division 1AB of Part III of the ITAA 1936 and untaxable Commonwealth entities are treated consistently with entities exempted by Division 50 of the ITAA 1997.
7.11 Requiring that an entity is an exempt entity only if all of its income must be exempt from income tax clarifies that an entity is not an exempt entity merely because some of its income is exempt from tax or because in a particular year it happens to only earn exempt income. Instead, an entity will only be an exempt entity if a provision of a law exempts all income the entity could earn. Untaxable Commonwealth entities
7.12 An untaxable Commonwealth entity is an agency (eg, a department), or an authority, that cannot be made liable to taxation by a Commonwealth law because, for example, it is necessarily immune to taxation or because it has no separate legal personality. The expression is defined in subsection 177-1(5) of the A New Tax System (Goods and Services Tax) Act 1999 .
7.13 The amendments also alter the definition of 'excepted trust' in section 272-100 of Schedule 2F to the ITAA 1936 so that it requires all the interests in the income and capital of the trust to be held by 'exempt entities'. [Schedule 7, item 1, paragraph 272 - 100(d) in Schedule 2F to the ITAA 1936]
7.14 Again, this ensures that state and territory bodies exempted by Division 1AB of Part III of the ITAA 1936 are treated consistently with entities exempted by Division 50 of the ITAA 1997.
7.15 The amendments make some minor technical corrections to Division 58 of the ITAA 1997. None of them change the intended operation of the law.
7.16 In the ITAA 1997, defined terms are marked by an asterisk (eg, ' * exempt entity') so that readers can readily identify them. The amendments add a missing asterisk. [Schedule 7, item 2, paragraph 58 - 5(2)(a) of the ITAA 1997] References to 'person'
7.17 Division 58 deals with the income tax treatment of assets previously owned by exempt entities. Some of its provisions refer to future actions taken by 'the purchaser or another person'. In the ITAA 1936, the term 'person' is often used to cover all types of entity to which the law applies (ie, as a synonym for 'taxpayer'). However, in the ITAA 1997, the preferred way to describe the widest category of entities is to use the term 'entity' itself. Therefore, the amendments replace all Division 58 references to a 'person' with references to an 'entity'. [Schedule 7, items 7 to 11, subparagraphs 58 - 10(2)(b)(i) to (iii), and paragraphs 58 - 10(1)(a ), ( 2)(a) and (2)(c)]
7.18 The amendment to the definition of 'exempt entity' applies from 1 July 2005. This ensures that the amendment applies from the same time as the amendment made by the Tax Laws Amendment (2005 Measures No. 3) Act 2005 to exempt public ancillary funds and prescribed private funds that provide money to other exempt entities. Aligning the application of the amendments ensures that those funds retain their tax-exempt status back to 1 July 2005 even if they later donated money to a Commonwealth, state or territory body that was exempt from tax but not technically an 'exempt entity'. [Subclause 2(1), item 4 in the table]
7.19 The amendment to the definition of 'excepted trust' applies from Royal Assent. [Subclause 2(1), item 3 in the table]
7.20 Although the amendment to the definition of 'exempt entity' applies from 1 July 2005, transitional provisions prevent the amendment applying to:
- entitlements to the research and development (R & D) tax offset affected by subsection 73J(2) of the ITAA 1936 until the first income year starting after Royal Assent [Schedule 7, item 15, and subclause 2(1), item 5 in the table] ; and
- entitlements to input tax credits affected by subsection 69-5(4) of the A New Tax System (Goods and Services Tax) Act 1999 in relation to net amounts for tax periods starting before Royal Assent [Schedule 7, item 16, and subclause 2(1), item 5 in the table] .
R & D tax offset
7.21 The R & D provisions encourage R & D activities by providing an accelerated rate of deduction for R & D expenditure. As many R & D companies do not have a positive cash flow in their starting years, the benefit of the deduction would be deferred. So, in 2001, the law was amended to allow small and medium businesses to choose a refundable tax offset instead, so that the benefit could be accessed immediately in the form of a cash payment.
7.22 However, the choice of a tax offset was not allowed to R & D companies that were at least 25 per cent controlled by 'exempt entities'. This was to prevent exempt entities obtaining the benefit of the R & D tax offset.
7.23 This amendment ensures that the offset is not available to R & D companies at least 25 per cent owned by entities all of whose income is exempted from tax. A transitional provision ensures that the amendment does not apply retrospectively to deny tax offsets already claimed by R & D companies.
Goods and services tax
7.24 The goods and services tax law works by charging GST on supplies an enterprise makes but allowing input tax credits for GST the enterprise pays on inputs to make those supplies. In effect, the enterprise only pays GST on the value it adds.
7.25 The GST law denies input tax credits for a range of expenses that are denied deductibility under the income tax law (eg, entertainment expenses). The reasons for denying the input tax credits are the same as those for denying the income tax deductions.
7.26 Because they have no deductions to deny, the GST law expressly extends the denial of input tax credits for those expenses to 'exempt entities' (see subsection 69-5(4) of the A New Tax System (Goods and Services Tax) Act 1999 ). This ensures that exempt entities are treated in the same way as other enterprises.
7.27 This amendment ensures that all entities exempted from income tax are denied input tax credits. A transitional provision ensures that the amendment does not apply retrospectively to deny input tax credits that might already have been claimed.
7.28 There is a separate definition of 'exempt entity' for the purposes of Division 58 of the ITAA 1997 (about the tax treatment of an exempt entity's depreciating assets when the entity or the assets are sold). That separate definition is substantially the same as the general definition but also includes 'exempt Australian government agencies'. Most things covered by that term would be 'exempt entities' within the proposed new definition. The exceptions are the Commonwealth, the States and the Territories, which are exempt Australian government agencies but not necessarily exempt entities.
7.29 The ITAA 1997 generally aims to have only one definition for each defined term. So, instead of maintaining the separate definition of 'exempt entity' for Division 58, the amendments add references to the Commonwealth, the States and the Territories, in each of the relevant places in Division 58. That preserves both the existing operation of Division 58 and the drafting preference for only defining each term in one way. [Schedule 7, items 3 to 9 and 11 to 13, subparagraph 58 - 10(2)(b)(i), paragraphs 58 - 5(4)(a) and (b), 58 - 5(5)(a), 58 - 10(1)(a), 58 - 10(2)(a) and (c) and 58 - 85(1)(a) and subsection 58 - 10(1) of the ITAA 1997]
7.30 The consequential amendments commence on 1 July 2005, to match the commencement of the new definition of 'exempt entity'. [Subclause 2(1), item 4 in the table]