House of Representatives

Tax and Superannuation Laws Amendment (2015 Measures No. 2) Bill 2015

Replacement Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Chapter 3 - Income tax look-through treatment for instalment warrants and similar arrangements

Outline of chapter

3.1 Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide income tax look-through treatment for instalment warrants and instalment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds. This look-through treatment ensures that most income tax consequences associated with the underlying asset of the trust flow through to the investor, and not the trustee.

3.2 All references are to the ITAA 1997, unless otherwise stated.

Context of amendments

What are instalment warrants and receipts?

3.3 Instalment warrants are financial products that entail borrowing to acquire an asset, such as a share. The asset is held on trust during the life of the loan to provide security for the lender. The investor is required to pay one or more instalments to repay any outstanding amounts before taking legal ownership of the asset. Nevertheless the investor is entitled to the benefit of any income flowing from the asset (for example, dividends) while it is held on trust. It is common but not necessary (unless the investor is a trustee of a regulated superannuation fund) for the borrowing under these arrangements to be limited recourse in nature, meaning investors can 'walk away' from the investment rather than pay any outstanding instalments.

3.4 Instalment receipts are similar to instalment warrants, although the key difference is that there is no 'borrowing'. Rather, there is a provision of credit to acquire an asset that is held on trust until the purchase price of the asset is fully paid by the investor.

What is the taxation treatment?

3.5 The long-standing industry practice for certain types of instalment warrant and instalment receipt arrangements has been to ignore the trust and treat the investor as the owner of the asset for capital gains tax (CGT) purposes. On the basis of this long-standing practice, a significant market for instalment warrants and instalment receipts has developed.

3.6 The types of arrangements within this market have evolved over time and become more complex. Further, the superannuation law was amended in 2007 to allow regulated superannuation funds to invest in instalment warrants. As a result, these amendments seek to remove any uncertainty about how the income tax law applies and confirm the industry practice for these types of arrangements. This avoids any potential disruption to the significant market that developed on the basis of the long-standing industry practice.

Summary of new law

3.7 These amendments provide income tax look-through treatment for instalment warrants and instalment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds. In particular, look-through treatment is provided:

to investors, for instalment warrant and instalment receipt arrangements over certain assets (broadly, direct and indirect interests in listed securities as well as unlisted securities in widely held entities); and
to regulated superannuation funds, for any limited recourse borrowing arrangement that satisfies the relevant requirements of the Superannuation Industry (Supervision) Act 1993 (SIS Act).

Comparison of key features of new law and current law

New law Current law
The investor holding the instalment warrant or instalment receipt over certain assets, rather than the trustee, is treated as the owner of the asset for income tax purposes (with some exceptions). This means that the trust is effectively ignored (and 'looked through') and anything that happens to or results from being the owner of the asset, such as receiving franked dividends, affects the investor and not the trustee. Uncertainty has arisen about whether the trust relationship over an asset arising in an instalment warrant or instalment receipt arrangement can be ignored for income tax purposes. However, the long-standing practice has been to ignore the existence of the instalment trust for CGT purposes.
For an investor that is a trustee of a regulated superannuation fund, look-through treatment is provided in respect of assets acquired under a limited recourse borrowing arrangement that satisfies the requirements of the SIS Act.

The trust is effectively ignored and anything that happens to or results from being the owner of the asset, such as receiving franked dividends, affects the investor (a trustee of the regulated superannuation fund) and not the trustee of the instalment trust.

Uncertainty has arisen about whether the trust relationship over an asset that arises in a limited recourse borrowing arrangement of a trustee of a regulated superannuation fund, can be ignored for income tax purposes. However, the long-standing practice has been to ignore the existence of the trust for CGT purposes.

Detailed explanation of new law

3.8 These amendments provide income tax look-through treatment for instalment warrants and instalment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds. [Schedule 3, item 1, sections 235-1 and 235-805]

3.9 Look-through treatment for most income tax purposes is achieved by:

treating the investor, and not the trustee, as the owner of the assets of the instalment trust;
treating any acts done by the trustee in relation to the assets of the instalment trust as if they had been done by the investor, instead of by the trustee;
treating the investor as having the assets in the same circumstances as the investor actually has the interest in the trust; and
ensuring any consequence arising under the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) for the trustee, is taken to have arisen for the investor.

[Schedule 3, item 1, section 235-820]

What arrangements receive look-through treatment?

Instalment warrants

3.10 An instalment warrant is a derivative based investment product that involves an investor borrowing against an asset (such as a share or a unit in a unit trust) and repaying that loan in instalments over the life of the warrant. The asset is held on trust to secure the repayment of the loan, with the benefits of ownership of the asset (such as dividends and franking credits) flowing through to the investor. After the final payment is made, the investor obtains legal ownership of the asset. [Schedule 3, item 1, section 235-830]

3.11 Income tax look-through treatment is specifically provided for a trustee of a regulated superannuation fund that acquires an asset or assets through a limited recourse borrowing arrangement permitted under the SIS Act (see paragraphs 4.43 to 4.49). To ensure the look-through treatment provided in relation to these arrangements entered into by the trustee of a regulated superannuation fund are limited only to those permitted under the SIS Act, such a trustee is expressly excluded from the more general provisions that provide look-through treatment for instalment warrant arrangements. [Schedule 3, item 1, paragraph 235-825(1)(b), subsection 235-830(2) and section 235-840]

Types of instalment warrants

3.12 There are broadly three different situations in which an investor acquires an instalment warrant (described below). Providing the relevant conditions are satisfied in these amendments, look-through treatment is available under each arrangement.

'Cash applicants' pay an upfront amount for an instalment warrant over a 'new' asset - that is, they have not previously owned the underlying asset or an instalment warrant over the underlying asset.
'Share applicants' effectively convert an asset they already own into an instalment warrant over that asset (which becomes the underlying asset). The applicant receives cash from the provider of the instalment warrant, reflecting the outstanding instalments the investor must pay to regain legal ownership of the asset (less fees and borrowing costs).
'Roll-over applicants' already hold an instalment warrant over the underlying asset, and instead of paying the outstanding instalment(s) at the maturity date, the applicant rolls the asset over into another instalment warrant. The investor may pay additional money or receive money back, in order to maintain an agreed leverage ratio.

[Schedule 3, item 1, sections 235-820, 235-825 and 235-830]

Instalment receipts

3.13 Instalment receipts are similar to instalment warrants, although the key difference is that there is no 'borrowing'. Rather, the investor is provided with credit for the acquisition of the asset, with the payment of the purchase price being made in instalments over the life of the instalment receipt. [Schedule 3, item 1, section 235-830]

3.14 While trustees of a regulated superannuation fund are expressly excluded from accessing the instalment warrant provisions, (as discussed at paragraph 4.11 above) they are not excluded from the provision that provides income tax look-through treatment for instalment receipts because that exclusion only applies where the arrangement entered into by the trustee of the regulated superannuation fund includes a borrowing. [Schedule 3, item 1, subsections 235-830(1) and (2)]

Secured financing arrangements generally

3.15 These amendments also cover secured financing arrangements that are structured in the same way as an instalment warrant or instalment receipt arrangement but are not necessarily so named, for example, certain limited recourse loan facilities. Provided the prescribed criteria in these amendments are satisfied, look-through treatment also applies to these types of arrangements. [Schedule 3, item 1, section 235-820, paragraph 235-825(1)(a) and section 235-830]

Regulated superannuation funds

3.16 These amendments provide income tax look-through treatment for a regulated superannuation fund in respect of assets acquired under a relevant limited recourse borrowing arrangement. For these cases, income tax look-through treatment applies if the rules specific to regulated superannuation funds are satisfied (see paragraphs 4.43 to 4.49, rather than 4.17 to 4.42). Where a regulated superannuation fund invests under an instalment receipt arrangement, income tax look-through treatment applies if the conditions described below are satisfied (see paragraph 4.50 describing the rationale for this requirement). [Schedule 3, item 1, sections 235-830 and 235-840]

What criteria do the arrangements need to satisfy to receive look-through treatment?

3.17 Broadly, for income tax look-through treatment to apply, the arrangement must satisfy the following criteria:

A trustee must acquire an asset or assets to either secure a borrowing made by the investor, or to secure a provision of credit made to the investor to acquire the asset or assets.
The investor must have a beneficial interest in the asset or assets, as the sole beneficiary of the trust, and must be entitled to obtain legal ownership of that asset or those assets on discharging its obligations relating to the borrowing or the provision of credit.
The investor must be entitled to the benefit of all income from that asset or those assets.
The assets must be an asset that is (or is part of) the underlying investment of the trust - broadly, this is a listed or widely held security, or an indirect interest in such a security (referred to below as a 'covered asset' - see paragraphs 4.28 to 4.39).

[Schedule 3, item 1, subsection 235-830(1)]

3.18 The above requirements are explained in more detail below - see paragraphs 4.19 to 4.27.

Borrowing and provision of credit

3.19 The references to 'a borrowing' and 'the borrowing' do not necessarily require all loan amounts under the arrangement to be part of the same loan contract. Where an investor enters into more than one loan contract, provided they are part of one broader arrangement, this criterion is satisfied. [Schedule 3, item 1, paragraphs 235-830(1)(a) and (b)]

3.20 A key feature of an instalment receipt is that the investor is not required to pay the full purchase price of the asset upfront, rather the investor is provided with credit for the acquisition of the asset, with the payment of the purchase price being made in instalments over the life of the instalment receipt. This feature is therefore required for an instalment receipt arrangement to obtain look-through treatment under these amendments. [Schedule 3, item 1, paragraphs 235-830(1)(a) and (d)]

Entitlement to the benefit of all income

3.21 Where dividends paid in respect of the underlying asset are applied to reduce the outstanding loan balance under the arrangement, the investor is considered to have satisfied the condition required under these amendments that the investor benefits from all of the income from the asset (unless circumstances exist that suggest otherwise). Further, under some arrangements the investor may, for example, swap its dividend return on the underlying asset for a fixed return. Such an arrangement may not necessarily cause the investor to fail the requirement to be entitled to the benefit of all income from the asset. However, this is an objective test determined according to the facts and circumstances of each case. [Schedule 3, item 1, paragraph 235-830(1)(e)]

Obligations relating to the borrowing or provision of credit

3.22 The requirement for the investor to be entitled to acquire legal ownership of the asset on discharge of its obligations relating to the borrowing or the provision of credit makes it clear that that the only impediment to the investor having the right to acquire ownership of the asset are those obligations relating to the borrowing or provision of credit. [Schedule 3, item 1, paragraph 235-830(1)(f)]

3.23 The investor's obligations relating to the borrowing or provision of credit may include amounts that are directly or indirectly related to the borrowing or provision of credit, such as interest, outstanding tax file number (TFN) withholding amounts (or any other withholding amounts) that relate to, or are in respect of, the borrowing or provision of credit. [Schedule 3, item 1, paragraphs 235-830(1)(a), (b) and (f)]

3.24 Look-through treatment only applies if the asset is not subject to any other charge, security or encumbrance. Any charge that arises in relation to the investor's borrowing against the asset, or the provision of credit to acquire the asset, does not infringe this rule. The effect of this restriction is to ensure that the investor's obligations relating to the borrowing, or provision of credit, are the only impediments to the investor taking legal ownership of the asset. [Schedule 3, item 1, subsection 235-830(3)]

Sole beneficiary and joint holders of an interest in a trust

3.25 Consistent with the notion that the trust relationship in an instalment receipt or warrant arrangement exists to secure a borrowing made by, or credit provided to, the investor, look-through treatment only applies if the investor is the sole beneficiary of the trust. Therefore, look-through treatment is denied if the trust has more than one beneficiary. [Schedule 3, item 1, paragraph 235-830(1)(c)]

3.26 However, where the interest in the instalment trust is held by entities as joint tenants or tenants in common, these amendments apply in the same way to those joint holders as they do to a single owner. This allows joint holders, to together satisfy each of the instalment trust criteria (see paragraph 4.17), despite these criteria being phrased in the singular. Therefore, joint holders must together enter into the loan, or be provided credit together to acquire the asset jointly, to satisfy the relevant criteria. Further, joint holders must together be entitled to benefit from all income from the underlying asset and together be entitled to acquire legal ownership of the underlying asset on discharge of all their obligations under the arrangement. [Schedule 3, item 1, paragraph 235-815(1)(a), subsections 235-815(3), 235-820(1) and 235-830(1)]

3.27 In particular, a joint holding does not infringe the rule that the investor must be the sole beneficiary of the trust. For example, if two entities jointly take out an instalment warrant over an asset and therefore jointly hold an interest in the trust holding the asset, the sole beneficiary rule is treated as being satisfied. [Schedule 3, item 1, paragraph 235-815(1)(a), subsections 235-815(3) and 235-820(1) and paragraph 235-830(1)(c)]

What assets of the trust are covered by the look-through treatment?

3.28 These amendments provide look-through treatment for instalment warrant and instalment receipt arrangements over listed securities and unlisted securities in widely held entities that are held either directly or indirectly by the security trustee. Note there are special rules for certain situations where there is a temporary breach of this widely held requirement (see paragraphs 4.32 to 4.33). These amendments cover such assets, given the policy rationale is to reduce the uncertainty about how the income tax law applies to the significant established market for these products. [Schedule 3, item 1, sections 235-830 and 235-835]

Assets held directly by the trustee of the instalment warrant or instalment receipt trust

3.29 These amendments cover the same types of assets as are covered by Division 247 (capital protected borrowing rules). This is because a significant market developed for instalment warrants and instalment receipts over these types of assets. Therefore, in the cases where the trustee owns shares, units in a unit trust or stapled securities directly (ie Division 247 types of assets), look-through treatment is provided so that the investor in the instalment warrant or instalment receipt arrangement is treated as owning those assets instead of the trustee for most income tax purposes. [Schedule 3, item 1, section 235-820 and subsection 235-835(1)]

3.30 This treatment is only provided in respect of shares, units in unit trusts or stapled securities that are either listed on an approved stock exchange (as defined in subsection 995-1(1) of the ITAA 1997) or where the company or unit trust invested in is a widely held entity. 'Widely held' takes the same meaning as used in Division 247, thus the 'widely held company' dictionary definition in subsection 995 1(1) must be satisfied. For a unit trust, the 'widely held unit trust' definition in section 272-105 in Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) must be satisfied. [Schedule 3, item 1, subsection 235-835(1)]

Assets held indirectly by the trustee of the instalment warrant or instalment receipt trust

3.31 In some cases, a trustee may hold the assets described above indirectly through another entity, such as an interposed fixed trust. Consistent with Division 247, these amendments ensure that where the trustee of the instalment warrant or instalment receipt trust holds an interest in an entity, such as an interposed fixed trust, the investor is treated as owning the interest in that trust. This treatment applies where the interposed fixed trust holds shares, units or stapled securities each of which is either listed or in a widely held entity. [Schedule 3, item 1, subparagraph 235-835(1)(a)(ii) and paragraph 235-835(1)(b)]

Example 3.1 Matt, an Australian resident investor, acquires for his own benefit an instalment warrant over an interest in Clefton Fixed Trust. That is, Matt has an interest in an instalment warrant trust (Instalment Trust) and the trustee of Instalment Trust has an interest in Clefton Fixed Trust (which is not a unit trust).The trustee of Clefton Fixed Trust holds shares and units in a variety of listed and widely held companies and unit trusts. Therefore, look-through treatment is provided in respect of the Instalment Trust such that Matt is taken to own the interest in Clefton Fixed Trust.

Temporary breaches of the widely held requirements

3.32 Where the widely held requirements are failed on a temporary basis and the circumstances that resulted in this failure were outside the control of the investor, the widely held requirements are taken to be satisfied. This rule provides certainty to taxpayers as it avoids the potential for arrangements fluctuating in and out of income tax look-through treatment. If this fluctuation is not avoided, the investor or the trustee would be subject to a CGT taxing point each time the income tax treatment changes. [Schedule 3, item 1, subsection 235-835(2)]

3.33 Whether a breach of the widely held requirements is temporary or not, is to be determined according to the circumstances of each case. However, breaches of the widely held requirements as a result of an entity being in a start-up or wind-down phase are generally considered temporary in nature. [Schedule 3, item 1, subsection 235-835(2)]

Bonus interests

3.34 Where the trustee of an instalment warrant or receipt trust acquires a new asset relating to the underlying covered asset (for example, a bonus right as part of a corporate restructure), the covered asset requirements do not need to be satisfied in respect of that new asset in all circumstances. This exclusion from the covered asset rules recognises that investors may inadvertently breach the widely held requirement due to corporate actions, which may be outside the investor's control. For consistency with the widely held rules, any right, option or similar interest to acquire a share or a unit in a trust, must be in respect of a company or unit trust that meets the widely held requirement described in paragraph 4.30. [Schedule 3, item 1, subsection 235-835(3)]

3.35 In cases where the new asset that is issued is a share, unit trust, or stapled security, the normal widely held rules as described above in paragraph 4.30 apply. [Schedule 3, item 1, section 235-835]

Assets held as part of a bundle or basket arrangement

3.36 Traditionally, instalment warrant and instalment receipt arrangements involved a single covered asset held in a trust with only that asset. These arrangements evolved such that arrangements involved bundles of identical assets and baskets of different assets. In order to provide look-through treatment for these arrangements involving bundles and baskets of assets, the covered asset rules described above do not restrict cases where the trust contains multiple covered assets. [Schedule 3, item 1, subsection 235-825(2), paragraph 235-830(1)(b) and section 235-835]

3.37 In the case of an instalment warrant bundle, this is a commercial term to describe multiple assets of the same type being held in the instalment warrant trust. For example, the trustee holds multiple XYZ Limited shares. In comparison, an instalment warrant basket refers to a basket of different widely held shares and units being held in the instalment warrant trust. For example, the trustee holds shares in ABC Limited, DEF Limited and XYZ Limited.

3.38 These amendments cover such arrangements where the bundle or basket of underlying assets consists of listed units or shares (held directly or indirectly by the trustee) or unlisted but widely held units or shares. [Schedule 3, item 1, section 235-835]

Replacement assets

3.39 The trustee of the instalment trust may hold assets that are replaced during the life of the agreement, for example, due to a corporate restructure where a share in one company is replaced with a share in another company. Therefore, providing both the original and replacement asset is a covered asset, this would mean that these amendments treat the investor as owning both the original and replacement asset. As the investor is taken to own both assets, CGT roll-over may then be available to defer any CGT liability arising from the change in ownership of the assets (providing relevant roll-over conditions are satisfied). [Schedule 3, item 1, section 235-835]

What if an asset that is held in the trust is not a covered asset?

3.40 Where an asset acquired by the security trustee secures the borrowing or the provision of credit (ie it is part of the underlying investment of the trust) and that asset is not a covered asset, then look-through treatment is not provided for any of the assets that make up the underlying investment. This may happen, for example, where the instalment warrant trust owns a closely held share or unit. [Schedule 3, item 1, sections 235-830 and 235-835]

What if an asset that is held in the trust does not secure the borrowing or the provision of credit?

3.41 Where an asset acquired by the trustee does not secure the borrowing or the provision of credit (ie it is not part of the underlying investment of the instalment warrant or instalment receipt trust), then that asset is not tested under these amendments and is not eligible for look-through treatment. As this asset is not tested under these amendments, it does not impact on whether the asset that is part of the underlying investment of the trust receives look-through treatment. [Schedule 3, item 1, sections 235-830 and 235-835]

Employee share schemes

3.42 Consistent with Division 247, no look-through treatment is provided for instalment warrant or instalment receipt trusts where part (or all) of the underlying investment is an employee share scheme interest, as defined in subsection 83A-10(1). Providing look-through treatment could inappropriately extend the scope of the employee share scheme provisions, as it would allow employers to satisfy the employee share scheme requirements by offering instalment warrants. [Schedule 3, item 1, subsection 235-835(4)]

Superannuation funds - Limited recourse borrowing arrangements

3.43 The SIS Act prohibits superannuation fund trustees from borrowing, or maintaining a borrowing of, money, subject to limited exceptions. This is to minimise assets of the fund being put at risk in the event of default on the loan.

3.44 One exception, contained in subsection 67A(1) of that Act (and its predecessor, former subsection 67(4A) of that Act) permits a trustee of a regulated superannuation fund to borrow money, or maintain a borrowing of money, on a limited recourse basis in certain circumstances to acquire assets that the fund would otherwise be permitted to acquire directly.

3.45 In order to prevent superannuation funds from being disadvantaged compared with other entities outside the superannuation system, this measure provides look-through treatment for a regulated superannuation fund in respect of an asset acquired under a limited recourse borrowing arrangement that, until the borrowing is fully repaid, is covered by subsection 67A(1) or former subsection 67(4A) of the SIS Act. [Schedule 3, item 1, sections 235-820 and 235-840]

3.46 Those provisions require regulated superannuation funds to use a trust to hold the asset or assets acquired using a limited recourse borrowing arrangement, which consequently may subject the regulated superannuation fund to a CGT taxing point on repayment of the borrowing. Such restrictions are not imposed on entities outside of superannuation. Therefore, by providing regulated superannuation funds with look-through treatment for any limited recourse borrowing arrangement that satisfies subsection 67A(1) or former subsection 67A(4A) of the SIS Act, this disadvantage is removed. [Schedule 3, item 1, sections 235-820 and 235-840]

3.47 This income tax look-through treatment continues to apply, provided all eligibility criteria continue to be satisfied, after the borrowing is fully repaid until the instalment trust comes to an end (such as where the asset is transferred either to the investor or to a third party). [Schedule 3, item 1, section 235-820 and paragraph 235-840(b)]

3.48 While look-through treatment is provided for instalment warrant arrangements involving baskets of covered assets (see discussion above at paragraphs 4.36 to 4.38), the SIS Act does not now permit regulated superannuation funds to invest in such arrangements. Accordingly, look-through treatment is not provided for regulated superannuation funds that acquire assets under arrangements that are not permitted under the SIS Act. [Schedule 3, item 1, section 235-820 and paragraph 235-840(b)]

3.49 Similarly, these amendments only provide look-through treatment for regulated superannuation funds in respect of replacement assets acquired under a limited recourse borrowing arrangement where the requirements of section 67B of the SIS Act are satisfied. [Schedule 3, item 1, section 235-820 and paragraph 235-840(b)]

Instalment receipts

3.50 Look-through treatment in relation to instalment receipts (which involve a provision of credit to acquire the underlying investment rather than a borrowing) applies in the same circumstances for superannuation fund investors as for non-superannuation fund investors. This is because instalment receipt arrangements are not subject to the requirements in subsection 67A(1) or former subsection 67A(4A) of the SIS Act. [Schedule 3, item 1, sections 235-820, 235-825, 235-830, and 235-835]

How is look-through treatment provided under the income tax provisions?

3.51 By treating the asset as being an asset of the investor and not an asset of the trust, the amendments ensure the investor stands in the shoes of the trustee for most purposes of the income tax law (the key exceptions are discussed in paragraph 4.71). As emphasised by the object clause, this is a broad-based principle providing flow-through treatment of the income tax consequences to the investor. The parenthesised words in the key operative look-through provision, namely 'instead of being an asset of the trust', together with the express application of the Subdivision to the trustee, make it clear that the trust is ignored for most income tax purposes. This means that anything that happens to or results from being the owner of the asset, such as receiving franked dividends, affects the investor and not the trustee. [Schedule 3, item 1, section 235-810 and subsections 235-815(2) and 235-820(1)]

3.52 To complement this broad-based principle, any acts done in relation to the asset by the trustee (such as selling the asset) are taken to have been done by the investor and not by the trustee. [Schedule 3, item 1, section 235-810 and subsection 235-820(2)]

Trust is effectively ignored for income tax purposes

3.53 Where all of the assets of the instalment trust are eligible for look-through treatment, this has the effect that the trust does not exist for income tax purposes (apart from the key exceptions discussed in paragraph 4.71). This is because for a trust to exist, trust property must be held by the trustee. Where all the assets are treated as being held directly by the investor, no trust property exists and consequently no trust exists for most income tax purposes. Naturally, this has no effect on the existence of the trust at law. In these cases, where look-through treatment applies to all of the assets, given the trust is taken not to exist for most income tax purposes, the investor's interest in the trust is also ignored. This has the effect that no CGT consequences arise in respect of the investor's actual interest in the trust. [Schedule 3, item 1, sections 235-810, 235-815 and 235-820]

3.54 These amendments apply to the investor and the trustee of the instalment trust only. They do not apply for entities that hold indirect interests in the instalment trust - that is, through the investor. This accords with the purpose of these amendments, which is to 'look through' the instalment trust to the immediate investor (and not beyond). [Schedule 3, item 1, subsection 235-815(1)]

3.55 Importantly, however, these amendments do not operate for certain withholding tax purposes and the tax file number provisions (see paragraph 4.71). [Schedule 3, item 1, section 235-815]

Determining the characteristics of the asset held by the investor

3.56 Where these amendments treat the investor as the owner of the trust assets, the investor is taken to hold those assets on the same basis as the investor holds the interest in the trust at law. This means that all of the characteristics of the investor, such as how the investor entered into the arrangement and with whom the investor holds the interest, are taken to exist in respect of the asset instead. The effect of this is that the assets adopt the same characteristics of the investor's actual interest in the trust, such as whether the asset is held on revenue or capital account or held as joint tenants or tenants in common. [Schedule 3, item 1, subsections 235-820(3) and (4)]

What are the income tax consequences of providing income tax look-through treatment?

Dividends

3.57 Where an investor holds an instalment warrant or instalment receipt over a share, any dividends paid on that share will be paid by the company to the trustee. As a result of the investor being treated as the owner of the share, the investor stands in the shoes of the trustee and the trust is ignored. The effect of this is that the dividend is taken to be received by the investor and not by the trustee for income tax purposes. This enables the dividend assessing provisions to be applied to the investor and not the trustee. [Schedule 3, item 1, subsection 235-820(1)]

Example 3.2 Henry, an Australian resident investor, acquires for his own benefit an instalment warrant over an XYZ share. Under the terms of the instalment warrant, Henry is entitled to the cash amount of the dividends payable on the XYZ share on the record date. As the trustee is the legal shareholder of the XYZ share, it is the trustee that receives the dividend. The terms of the instalment warrant require the trustee to pay the cash amount of the dividends it receives on the XYZ share to Henry as soon as practical after receipt and clearance of those dividends. Any dividend received by the trustee that is not immediately paid on to Henry is held on trust for Henry. The flow of the dividend can be represented diagrammatically as follows.As Henry is deemed to be the owner of the XYZ share, and the trustee is not, Henry is taken to stand in the shoes of the trustee. These amendments mean that Henry is treated as receiving the dividend, as the owner, directly.As the trustee is treated as not being the owner of the XYZ share, it is not capable of being the shareholder. Rather, Henry, as the owner of the XYZ share, standing in the shoes of the trustee, is considered to be the shareholder for the purposes of the dividend assessing provisions, including the definition of 'dividend'.In addition, by treating Henry as the owner of the XYZ share and the trustee not to be the owner, the payment of the cash amount of the dividend from the trustee to Henry is ignored for income tax purposes.As a result, Henry includes the dividends paid on the XYZ share in his assessable income under subparagraph 44(1)(a)(i) of the ITAA 1936.

Franking credits

3.58 Where dividends that are taken to have been received by the investor and not by the trustee are franked, these amendments also have the effect that the franking credits are taken to have flowed directly to the investor (instead of indirectly through the trust). This means that in determining the investor's income tax consequences of receiving franked dividends from the underlying asset, being a share in a company, the investor applies section 207-20 (the general gross-up and offset rule) instead of section 207-35 (which applies for distributions made through trusts). In addition, in determining whether the investor is entitled to the franking credit, the qualified person rules in former Division 1A of Part IIIAA of the ITAA 1936 are applied to the investor directly instead of those rules relevant for trustees and beneficiaries. [Schedule 3, item 1, subsection 235-820(1)]

Capital gains tax

3.59 By treating the investor as the owner of the underlying asset from the time that the investor acquires the interest in the trust, these amendments make it clear that no CGT event, and therefore no CGT taxing point, happens on payment of the final instalment for the trustee or the investor. [Schedule 3, item 1, subsection 235-820(1)]

Example 3.3 Jack, an Australian resident investor, acquires for his own benefit an instalment receipt over an ABC share on 1 July 2014. Under the terms of the instalment receipt arrangement, Jack is required to pay $4.00 (plus interest and transaction costs) upfront and $6.00 on 1 July 2015. The ABC share is held by the trustee of the instalment receipt trust to secure the provision of credit of $6.00. After payment of the $6.00, Jack receives ownership of the ABC share. No CGT event happens on transfer of the ownership of the share from the trustee to Jack as he is taken to have been the owner from the time of acquiring his interest in the instalment receipt trust and therefore there is no change of ownership.

3.60 These amendments also ensure that where the underlying asset is sold by the trustee, CGT event A1 happens for the investor instead of the trustee. Therefore, any capital gain or loss made on the sale is taken to have been made by the investor and not the trustee. [Schedule 3, item 1, subsection 235-820(2)]

3.61 For a share applicant, these amendments ensure that no CGT taxing point arises on transferring the asset into an instalment warrant trust. This is because the investor owns the asset prior to its being transferred into the trust, and the investor is treated as owning the asset throughout the term of the instalment warrant. As such, no CGT taxing point arises as there has been no change of ownership under the CGT provisions. Likewise, in applying the CGT discount on selling the asset, the investor retains its original acquisition time of when it acquired the asset. [Schedule 3, item 1, subsections 235-820(1) and (2)]

3.62 Similarly, for a roll-over applicant, these amendments ensure that no CGT taxing point would arise where an investor rolls over an instalment warrant into a new warrant over the same asset. This is because the underlying asset is still treated as being owned by the investor. [Schedule 3, item 1, subsections 235-820(1) and (2)]

Prepayment rules

3.63 By treating the investor as the owner of the underlying asset instead of the trustee, the exception to the apportionment rule for prepaid expenditure in subsection 82KZME(5) of the ITAA 1936 for certain taxpayers can be satisfied, meaning that deductible prepaid expenditure would not be required to be apportioned across income years. That subsection prevents the proportional deduction rule in section 82KZMF from applying where the relevant taxpayer has borrowed money to acquire negatively geared real estate, shares or units in a unit trust which are expected to be income producing. [Schedule 3, item 1, subsection 235-820(1)]

Securities lending arrangements

3.64 Similar to the rule in subsection 26BC(2) of the ITAA 1936 (which concerns a person who is absolutely entitled to an eligible security), these amendments apply for the purposes of applying the securities lending arrangement provisions in section 26BC. This ensures that, for the purposes of applying those provisions, the investor is treated as the owner of the relevant eligible security rather than the trustee and any acts done by the trustee in relation to that eligible security are taken to have instead been done by the investor. [Schedule 3, item 1, subsections 235-820(1) and (2)]

Income tax return

3.65 Section 161 of the ITAA 1936 provides that every person identified by the Commissioner of Taxation must prepare an income tax return. The Commissioner publishes a yearly notice that sets out these requirements (see, for example, Legislative Instrument F2014L00688, in relation to the 2013-14 income year). In relation to a trust, the practice, subject to limited exceptions, has been to require an income tax return where the trustee of a trust estate has derived income, including capital gains. However, as these provisions ignore the trust where the underlying investments by the trust are in covered assets, no income tax return is required to be prepared by the trustee in these circumstances. Any income tax consequences in respect of the assets would be recognised in the investor's income tax return. [Schedule 3, item 1, subsection 235-820(1)]

3.66 In cases where the trust is not ignored because the trustee has invested in non-covered assets (see paragraph 4.40), an income tax return may be required to be lodged (subject to limited exceptions). [Schedule 3, item 1, subsection 235-820(1)]

Interactions with other income tax provisions

3.67 It is not necessary to consider whether the underlying investments of the instalment trust would satisfy the CGT look-through provisions, namely whether a security arrangement exists (section 106-60) or whether there is absolute entitlement (section 106-50). It is unnecessary to consider whether such provisions apply, as these amendments 'look through' the trust for most income tax purposes. That is, they provide a more expansive look-through treatment than the security holding and absolute entitlement provisions, which only apply for CGT purposes. Given that the absolute entitlement rules and security holding rules also provide look-through treatment for CGT purposes, these amendments expressly exclude those provisions in order to give these amendments priority. [Schedule 3, item 1, subsections 235-845(1) and (2)]

3.68 Additionally, Division 247, which isolates the cost of capital protection provided under a capital protected borrowing where it is not explicitly provided by way of a put option, continues to apply to arrangements (where relevant) that are subject to these amendments. [Schedule 3, item 1, subsection 235-845(3)]

Interactions with the GST Act

3.69 No amendments are made to the GST Act. However, to ensure that these amendments, which affect the income tax provisions, interact appropriately with the GST Act, any consequence arising under the GST Act for the trustee as a result of anything done in relation to the underlying asset is taken to have instead arisen for the investor. This is the case even where that consequence would not have arisen if the investor had done that thing instead of the trustee. Given that the investor is taken to stand in the shoes of the trustee, this rule is necessary to ensure that any entitlements or liabilities of the trustee under the GST Act are appropriately taken into account by the investor for income tax purposes. [Schedule 3, item 1, subsection 235-820(5)]

3.70 For example, if the trustee receives a net input tax credit in relation to the instalment trust asset because the trustee has done something in the course of the enterprise of the trust, the impact of this input tax credit on the income tax provisions will flow through to the investor (such as to reduce the investor's cost base for the instalment trust asset). This is despite the fact that the investor may not have received a net input tax credit in similar circumstances if, for example, the investor was not registered for goods and services tax. [Schedule 3, item 1, subsection 235-820(5)]

What income tax provisions do not receive look-through treatment?

3.71 While these amendments provide look-through treatment for the income tax provisions, certain exceptions apply to ensure the income tax law operates appropriately. These exceptions are consistent with the industry practice that has developed. Specifically, these provisions are:

Part VA of the ITAA 1936, which contains the TFN provisions. Precluding these amendments from applying ensures that TFNs can be requested without breaching the TFN offence provisions in Subdivision BA of Division 2 of Part III of the Taxation Administration Act 1953 (TAA 1953).
Subdivision 12-E of Schedule 1 to the TAA 1953, which deals with withholding amounts where an entity invests and has not supplied a TFN or Australian Business Number. The trust is required to be recognised as it is that entity that is legally investing in the investment body, rather than the investor.
Subdivision 12-F in Schedule 1 to the TAA 1953, which deals with withholding tax for dividends, interest and royalty payments made to foreign residents. Recognising the trust ensures that the trustee has the obligation to withhold tax as required.
Subdivision 12-H in Schedule 1 to the TAA 1953, which contains the managed investment trust withholding provisions. Recognising the trust ensures that the trustee has the obligation to withhold tax as required.

[Schedule 3, item 1, subsection 235-815(2)]

How long is look-through treatment provided under the income tax provisions?

3.72 The look-through treatment continues even after the investor pays the final instalment and discharges all their obligations relating to the borrowing or the provision of credit. That is, if the asset is continued to be held in the trust, look-through treatment continues to apply. This ensures that no CGT taxing point arises on legal transfer of the asset from the trustee to the investor after final payment is made. [Schedule 3, item 1, sections 235-820, 235-830, 235-840]

Consequential amendments

3.73 Consequential amendments are made to the ITAA 1997 dictionary, namely inserting the definitions of 'instalment trust', 'instalment trust asset' and 'regulated superannuation fund'. [Schedule 3, item 5, subsection 995-1(1) definition of 'instalment trust', 'instalment trust asset', and 'regulated superannuation fund']

3.74 By introducing a definition of a 'regulated superannuation fund' into the ITAA 1997 dictionary, existing provisions defining the term throughout the tax provisions are redundant. Therefore, consequential amendments are made to remove these redundant provisions. By replacing these redundant provisions with a direct link to the defined term in the ITAA 1997 dictionary, the consequential amendments provide the same outcome as the existing provisions which separately define the term. [Schedule 3, items 2 to 4 and 7, subsections 290-60(4), 290-230(4), section 295-175, subsection 995- 1(1) (definition of 'complying superannuation plan'), and subsection 355-65(3) of Schedule 1 to the TAA 1953].

Application and transitional provisions

3.75 These amendments apply to assets that are acquired by the trustee of an instalment trust in the 2007-08 or later income years. These changes, which are beneficial to taxpayers and confirm the industry practice, are retrospective to broadly align with the application date of the superannuation provisions which allow regulated superannuation funds to enter into certain limited recourse borrowing arrangements. [Schedule 3, item 6, section 235-810 of the Income Tax (Transitional Provisions) Act 1997]

3.76 Applying these amendments from this time removes any uncertainty about how the law applied and ensures that the industry practice of ignoring the instalment warrant and receipt trust can continue to apply. In addition, introduction of these measures does not imply that look-through treatment was not available prior to 2007.

3.77 Consequential amendments related to the insertion of 'regulated superannuation fund' into the ITAA 1997 dictionary commence from the day of royal assent. As identified above in paragraph 4.74, this change simplifies the tax provisions and does not change the operative effect of the existing tax provisions that rely on this definition. [Clause 2]

Amendment of assessments

3.78 The operation of section 170 of the ITAA 1936 (which provides time limits for amending assessments) is modified where an assessment has been made prior to the commencement of these amendments. In these circumstances, these amendments provide that taxpayers are able to seek an amended assessment within two years of these amendments commencing. This ensures that taxpayers are still able to receive the benefit of these changes despite the delay between the application date and passage of these amendments. [Clause 4]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

3.79 This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

3.80 Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 to provide income tax look-through treatment for instalment warrants and instalment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds. This look-through treatment ensures that most income tax consequences associated with the underlying asset of the trust flow through to the investor, and not the trustee.

3.81 This means that the trust is ignored and anything that happens to, or results from, being the owner of the asset, such as receiving dividends and selling the asset, affects the investor and not the trustee.

Human rights implications

3.82 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

3.83 This Schedule is compatible with human rights as it does not raise any human rights issues.


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