Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 2 - Overview
2.1 The Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 (called 'the Bill' is this Explanatory Memorandum) will insert new Schedule 2Finto the ITAA 1936 to provide new rules that have to be satisfied by trusts before prior and current year losses and debt deductions [F1] can be deducted. [Item1]
2.2 There are also three complementary Bills. Two of these impose a special tax which may become payable under the measures. These are the Family Trust Distribution Tax (Primary Liability) Bill 1997 and the Family Trust Distribution Tax (Secondary Liability) Bill 1997 . The third complementary Bill, the Medicare Levy Consequential Amendment (Trust Loss) Bill 1997 , makes a consequential amendment to the Medicare Levy Act 1986 . Separate Bills are necessary for constitutional reasons.
2.3 The proposed rules will not apply to family trusts that make distributions (broadly defined) only to members of a family group. The income injection test applies to a family trust only where income is injected into it from outside the family group. A family trust is defined for the purposes of these measures.
2.4 The provisions dealing with trust losses are intended to prevent the transfer of the tax benefit of tax losses or other deductions which are incurred by trusts. They mainly do this by looking at whether there is a relevant change in the individuals who will benefit from any deduction for the tax losses or other deductions compared to the individuals who actually incurred and economically suffered the loss or deduction. The deductions affected by the rules specifically include bad debt and certain debt/equity swap deductions. These are called 'debt deductions' in this Explanatory Memorandum. The discussion below outlines in broad terms how the measures will apply. This is followed by a detailed explanation of the proposed amendments.
2.5 The rules that are to apply to trusts will differ from those that apply to companies, reflecting the different characteristics of trusts. Accordingly, the particular rules which apply to a trust will depend on the type of trust. The three basic types of trusts which are dealt with differently in the legislation are fixed trusts (including widely held unit trusts), non-fixed trusts and excepted trusts. Excepted trusts include family trusts.
2.6 The Bill deals with each kind of trust in a different part. While this leads to some repetition of common rules, it means that the reader can see the rules which apply to each kind of trust in one place.
2.7 Each type of trust has to satisfy certain tests relating to ownership or control of the trust in order to be able to deduct prior and current year losses and debt deductions. For prior year loss and debt deduction purposes, if an applicable test is not satisfied, the loss or debt deduction cannot be deducted. For current year loss purposes, if an applicable test is not satisfied, the income year is divided into periods and the net income or tax loss of the trust is calculated for each period.
2.8 The new regime will also contain an income injection test which applies to deny a deduction to the trust for losses and other deductions. In very broad terms, the test will apply where, in connection with a scheme, the losses are used to shelter assessable income from tax.
2.9 The new regime will apply to corporate unit trusts and public trading trusts. The income of these trusts is currently taxed in a manner similar to that of companies under Divisions 6B and 6C of the ITAA 1936.
2.10 Consequential amendments will also be made to the ITAA 1936 and other legislation including the Fringe Benefits Tax Assessment Act 1986 . These will integrate the new measures into the income tax law and other relevant legislation.
2.11 While retaining the basic structure of the trust loss legislation proposed by the previous Government, the Bill contains a number of significant differences to those measures.
2.12 The tables in the Appendix provide a broad overview of the various rules in the trust loss measures.
2.13 Taxpayers may have quite properly lodged tax returns for 1994-95, 1995-96 and 1996-97 without regard to the proposed trust loss measures. However, taxpayers may be obliged to amend their returns for these income years if the commencement date of the trust loss measures affects the validity of deductions claimed in returns for those income years. The Commissioner will not seek to apply penalties and interest against any underpayments of tax provided returns are amended within a reasonable time after the measures become law. If amendments are not made promptly, the normal penalty and interest provisions may apply.
2.14 The income tax law is currently be rewritten as part of the Tax Law Improvement Project (TLIP). The ITAA 1997, which is generally effective from the 1997-98 income year, represents the law that has been rewritten to date. The trust loss provisions are being inserted into the ITAA 1936, rather than the ITAA 1997, because they have a commencement date for most purposes that is before the commencement of the ITAA 1997.
2.15 In many cases the Bill refers to various provisions of the income tax law. Because the general commencement date of the trust loss measures is before the commencement of the ITAA 1997, it has been necessary in many cases to refer to both the old law and equivalent new law provisions when doing this. In many cases, the old law references will be able to be deleted when the trust loss measures are transferred to the ITAA 1997 at a later date.
2.16 The Bill is lengthy, but necessarily so. The trust loss provisions use many presentational aids such as flow charts. Of the approximately 150 pages of legislation, about 14 are for explanatory diagrams and charts, etc. Also, the drafting style contains some repetition. This was a deliberate choice. Once the taxpayer identifies the category into which a particular trust falls, the draft seeks, as much as possible, to describe all the rules applicable to that category of trust. This makes the provisions easier to follow.
2.17 The length of the provisions has been affected significantly by the Government's decision to modify the original provisions, including as announced in the 1996-97 Budget and the 1997-98 Budget. Many of these changes were made in response to representations by tax professionals and taxpayers in order to soften the impact of the provisions or clarify their operation. This has resulted in a trade off between simplicity and equity. Two examples of this are in the categorisation of trusts and the way family trusts are treated.
2.18 There are many different categories of trusts. One way of dealing with trust losses would be to have a few standard rules that apply to all trusts. This would result in the rules themselves being unfair in their impact. Instead, different rules have been applied to the different categories of trusts, depending on their nature. The result is that the size of the legislation increases, but this is matched by an increase in the fairness of treatment.
2.19 For example, four of the categories of trusts are different kinds of widely held unit trusts. They are given concessional treatment in determining the times at which they have to test for changes in ownership. As a result, they do not have to face the compliance burden of constant tests for changes in ownership.
2.20 In the 1996-97 Budget, the Government announced the introduction of a new method for determining which trusts are family trusts. This method allows a trust to elect to be a family trust but will impose a tax on any distributions outside the family group by the family trust or another entity in the family group. This change was made to eliminate the need for trust deeds to be altered with the consequent compliance costs.
2.21 Procedural sections are required to provide for the collection and recovery of the family trust distribution tax. These provisions add many pages to the legislation. However, if such trusts and entities abide by the election they have made, the provisions will never have any application.
2.22 In addition, detailed provisions have been included to ensure that the tax can be collected where it becomes payable by non-resident family trusts and family entities and that information can be gathered about these non-residents. An alternative to including these provisions dealing with non-resident entities is to say that non-resident trusts cannot be family trusts and that non-resident entities cannot be in the family group of a family trust. This would have allowed for much shorter provisions. However, in the interests of fairness, non-resident entities are included but with the stringent anti-avoidance provisions discussed above.
2.23 In the Taxation Laws Amendment Bill (No. 4) 1995 , the family trust provisions were two and a half pages long. With the new method for determining family trust status, together with the associated provisions discussed above, the family trust provisions are approximately 34 pages in length. However, only a few pages of the Bill will be relevant to a trust used to run a small business that elects to be a family trust and abides by the election by not distributing income or capital outside the family group.
2.24 Finally, the provisions have been prepared having regard to the work that is being done on the high wealth individuals project. This has required more attention to the anti-avoidance aspects of the provisions, such as the non-resident entity measures discussed above.