House of Representatives

Taxation Laws Amendment Bill (No. 2) 1998

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 1 - Denial of certain capital losses

Overview

1.1 Schedule 1 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to deny the ability to offset against capital gains certain capital losses created by an arrangement entered into before 3 pm on 29 April 1997 and to prevent companies using capital losses artificially created through an arrangement entered into after that time.

Summary of the amendments

Purpose of the amendments

1.2 The overall purpose of the amendments is to deny the use of capital losses which do not reflect economic losses actually incurred. Part 1 of Schedule 1 amends the law to deny certain capital losses incurred by a company where an asset has previously been rolled over from a related company under section 160ZZO of the Act.

1.3 Part 2 of Schedule 1 applies the anti-avoidance provisions contained in Part IVA of the Act to the creation of capital losses in the year in which they are incurred, rather than to the amount of loss offset against capital gains in a particular year.

Date of effect

1.4 The amendments made by Part 1 apply to capital losses incurred as a result of arrangements entered into before 3 pm on 29 April 1997. The amendments made by Part 2 apply to capital losses resulting from schemes entered into after 3 pm on 29 April 1997 [item 14] . Where both measures could apply, those in Part 1 would apply before Part 2 (see paragraphs 1.9 and 1.10).

Background to the legislation

1.5 Under the existing law, corporate groups could artificially multiply and group an actual economic capital loss several times over through manipulation of the capital gains tax provisions. In particular, section 160ZZO of the Act is open to manipulation. Section 160ZZO provides that where an asset is transferred from a company to a related company, the general capital gains tax provisions do not apply to the disposal and acquisition. Instead, the company acquiring the asset (the loss company) is considered to have acquired it at the time and for the cost base, indexed cost base or reduced cost base that applied to the company disposing of the asset. If a capital loss is incurred on the subsequent disposal of an asset, the loss is calculated using the asset's reduced cost base. The subsequent disposal of the asset by the acquiring company is generally subject to the normal capital gains tax provisions. A simplified example of this type of arrangement is provided below.

Example: creating capital losses by unbundling group companies in a 'chain' before liquidating that chain.

Assumptions for this example

1.6 There is a group of companies structured as shown below with a $1 billion investment made by the group. The companies in the group are, directly or indirectly, 100% owned by the parent company A. The same $1 billion is passed down the chain by each successive company purchasing shares in the company below. Company C used the $1 billion to acquire an asset (the loss asset).

1.7 A year later, the asset that C owns, which cost $1 billion has a market value of $300 million. Hence, there is an unrealised capital loss of $700 million inherent in the asset held by C.

Market Value 300 million

Approach

·
B transfers its shares in C to A for $300 million (market value). Rollover relief is claimed under section 160ZZO. A is deemed to acquire these shares for a cost base equal to B's reduced cost base on the shares ($1 billion), in determining whether a capital loss arises on the disposal of the shares.
·
C's asset is transferred to A at market value ($300 million). Rollover relief is claimed under section 160ZZO. A is deemed to acquire this asset for C's reduced cost base and, on disposal of the asset, A realises a capital loss of $700 million.
·
The cost bases of A's shares in C and B are each $1 billion, while the market value of each parcel of shares is $300 million represented by the cash received for the transfer of the loss asset by C and the shares B held in C.
·
A liquidates B and C and generates a capital loss of $700 million each on the cancellation of its shares in the companies.
·
These steps generate a total of $2.1 in billion capital losses when the actual economic loss suffered by the group as a whole was $0.7 billion. On the facts of this example, each additional interposed entity in the chain would result in an additional capital loss of $0.7 billion being available.

1.8 At 3 pm on 29 April 1997, the Treasurer announced that the Government would introduce measures to deny taxpayers the ability to offset certain capital losses, artificially created before that time, against subsequent capital gains in the 1996-97 and later years of income. An exception was provided for amounts offset against capital gains in a tax return for the 1996-97 income year, lodged before announcement of the measures, or in previous income years.

Explanation of the amendments

Interaction between Parts 1 and 2 of Schedule 1

1.9 Part 1 is a specific anti-avoidance provision which applies to capital losses incurred in limited circumstances. One criterion for application of Part 1 is that the capital loss in question is incurred in respect of the disposal of an asset which was rolled over, under section 160ZZO, to the company making the disposal. Part 1 does not require that the capital loss be incurred before or after any particular date. However, the rollover of the asset subsequently disposed of must have occurred before 3 pm on 29 April 1997.

1.10 Part 2 amends the general anti-avoidance provisions of the Act and therefore has much broader application than Part 1 . As a matter of statutory interpretation, the general anti-avoidance provisions are known as 'residual' provisions. That is, they apply after any other relevant provisions in the Act have been applied. Therefore if new section 160ZPA could apply to a capital loss and, in addition, the loss was incurred under a scheme which had been entered into after 3 pm on 29 April 1997, new section 160ZPA would be applied. Part IVA would only apply to the extent that the company obtained a tax benefit that would not be within new section 160ZPA .

Part 1

1.11 Part 1 of Schedule 1 inserts new section 160ZPA , which denies the use of certain capital losses incurred by a company. Part 1 applies where an eligible loss, described in new subsection 160ZPA(4) has been incurred and that loss was not offset against subsequent gains as described in new subsection 160ZPA(6) . Part 1 does not apply if the company is a small business or the asset rolled over is plant, machinery, or a building used for specified periods in manufacturing businesses. [New subsection 160ZPA(5)] Part 1 only applies to a company with net capital losses in the particular year of income. [New paragraphs 160ZPA(2)(a) and (4)(c) and (d)] In any other case, the company will have used up any eligible rollover losses it incurred prior to the date of announcement.

How to calculate an eligible rollover loss

1.12 New subsection 160ZPA(4) provides that a company incurs an eligible capital loss if it makes a capital loss on the disposal of an asset in the circumstances set out below.

1.13 Firstly, the asset disposed of should have been acquired from a related company and section 160ZZO of the Act should have applied to the acquisition of the asset from the related company (referred to as a rollover disposal). [New paragraph 160ZPA(4)(a)] For this provision to apply, the rollover disposal must have occurred before 3 pm on 29 April 1997. [New paragraph 160ZPA(4)(f)] For a rollover disposal to occur, the companies must be related companies. A company is related to another company where that company owns directly or indirectly 100% of the shares in the other company or there is a company which owns 100% of both, either directly or through subsidiaries.

1.14 The provisions will not apply to deny a capital loss if the loss asset is not disposed of by the loss company until after 5 years from its being rolled over to the loss company by another company in the group. [New paragraph 160ZPA(4)(g)] Generally, the longer the period between the rollover and the disposal of the rolled over asset, the smaller the likelihood that the rollover was part of an arrangement designed to artificially duplicate a capital loss. A period of five years is considered sufficient to ensure that the rollover and subsequent disposal are not part of such an arrangement. Also, the longer the period between the rollover and the disposal of the rolled over asset, the more likely it is that any loss on disposal of the loss asset may be unrelated to any loss realised in relation to the transferor of the loss asset or in relation to any indirect interests in the transferor.

1.15 New paragraph 160ZPA(4)(b) provides that for an eligible rollover loss to have been incurred, the transactions must be such that if section 160ZZO had not applied to the rollover of the asset, there would have been no capital loss or a smaller capital loss. Therefore, if the transactions did not create or increase the value of capital losses incurred by the loss company, new section 160ZPA will not apply to the transactions.

1.16 The loss company must have rights in relation to the company rolling over the asset (the transferor). [New paragraph 160ZPA(4)(c)] The right may be:

·
an interest in the transferor held either directly or indirectly through interests in interposed companies; or [New subparagraph 160ZPA(4)(c)(i)]
·
the right to recover a debt from, or acquire shares in, the transferor company; or [New subparagraph 160ZPA(4)(c)(ii)]
·
an interest in a company, partnership or trust, held either directly or indirectly through interposed companies, which has the right to recover a debt from, or acquire shares in the transferor. [New subparagraph 160ZPA(4)(c)(iii)]

1.17 An interest is defined in new subsection 160ZPA(7) to mean a share in a company or an interest in the income or capital of a partnership or trust. An example showing the connection between the transferee and transferor is set out below.

The connection between the transferee and the transferor

1.18 In the above example, A holds a direct interest in companies B, D and E and has an indirect interest in Company C. Company B holds a direct interest in Company C, an indirect interest in Company D and rights in relation to Company E.

1.19 The loss company must have acquired the right after 19 September 1985. [New paragraph 160ZPA(4)(d)] That is the date on which the capital gains tax provisions became effective. This condition has the same application whether the company actually acquired the asset after that date or was deemed to have acquired it on that date by another CGT provision. If any of the rights linking the loss company to the transferor were acquired after 19 September 1985 or a direct right was acquired after that date, new section 160ZPA will apply.

1.20 Immediately after the rollover disposal, the market value of the loss company's rights in the transferor must be less than its reduced cost base or what would be its reduced cost base if the right were an asset to whose disposal the general capital gains tax provisions applied. [New paragraph 160ZPA(4)(e)]

1.21 In the case of a right held indirectly through a company subsidiary to the loss company, the direct interest held by the subsidiary may have been acquired on or before 19 September 1985 (see paragraph 1.19). In that case, the capital gains tax provisions would not provide a cost base in relation to the subsidiary's direct interest. In the example in paragraph 1.17 above, Company A has an indirect right in Company C, acquired after 19 September 1985, although B's direct right in C was acquired before that date. New paragraph 160ZPA(4)(e) provides that, in that case, the shares in Company C are considered to have the cost base they would have had if the CGT provisions did provide a cost base.

1.22 The rollover disposal must have occurred before 3 pm on 29 April 1997. [New paragraph 160ZPA(4)(f)] This provision and its interaction with the amendments made by Part 2 are discussed in paragraphs 1.9 to 1.10 above.

Unused amount of the eligible rollover loss

1.23 New subsection 160ZPA(6) provides for the calculation of the 'unused amount' (that is, the amount of an eligible rollover loss that is not taken to have been offset by a realised capital gain) which is denied under either new subsection 160ZPA(1) or (2) . The unused amount of an eligible rollover loss is calculated in the test year, which is either the year in which a company incurs the eligible rollover loss or a later year. If the test year is a later year, the unused amount is recalculated in each subsequent year, unless the company's net capital loss is nil. [New paragraph 160ZPA(6)(a)] If a company does not have a net capital loss, then the company has used all its capital losses, including eligible rollover losses, to reduce capital gains.

1.24 In the year in which an eligible rollover loss is incurred, the unused amount of that loss is calculated as the company's net capital loss minus the amount that would have been the net capital loss if section 160ZZO had not applied to any of the rollover disposals concerned. [New paragraph 160ZPA(6)(b)] If the loss company would not have incurred a capital loss but for the arrangement, the amount of net capital loss the company would have incurred is taken to be nil.

1.25 In the example provided in paragraphs 1.6 to 1.7 above, the net capital loss is $2.1 billion. If section 160ZZO had not applied to the rollover disposals, company C could realise a capital loss of $700 million. C's loss could have been transferred to A under section 160ZP. In this case, A's unused amount would equal:

$2.1 billion less $0.7 billion = $1.4 billion.

1.26 If A did not accrue capital gains during the year of income and therefore C was unable to transfer the losses to A, then those losses would be extinguished when C was liquidated. A could make a loss of $700 million on the liquidation of B. In this case, the unused amount would equal:

$2.1 billion less $0.7 billion = $1.4 billion.

1.27 In a year after that in which a company incurred an eligible rollover loss, the unused amount of that loss is calculated as set out in new paragraph 160ZPA(6)(c) . If the company accrues no capital gains in a test year, the unused amount will be equal to the unused amount for the previous year as the amount of the reduction will always be nil. If a company accrues capital gains or transfers the whole or part of a net capital loss to a related company under section 160ZP (as described in new subsection 160ZPA(8)) , the unused amount is reduced. New subsection 160ZPA(9) describes a loss or part of a loss transferred to a related company under section 160ZP, which can reduce unused amounts in the same way as capital gains. An example is provided in paragraph 1.28 below.

1.28 If a company with net capital losses for the previous year of income of $2,500, including an unused amount of $2,000, accrued a capital gain of $500 and transferred $500 in net capital losses to a related company under section 160ZP, the unused amount for the company's test year would be calculated as follows:

2,000-(500+500)*2000/2,500 = $1,200

1.29 The unused amount is calculated separately in respect of each eligible rollover loss incurred by a company. The sum of eligible rollover losses in a year of income becomes one unused amount in subsequent years of income. Each unused amount is calculated separately and the sum of any unused amounts is denied under new subsection 160ZPA(1) or (2).

When a capital loss is denied - the usual case

1.30 The treatment of unused amounts varies depending on whether the company has lodged its income tax return for the 1996-97 year of income before 3 pm on 29 April 1997. Most companies would not meet this condition. Therefore, most eligible rollover losses will be denied in the 1996-97 and later years of income by new subsection 160ZPA(1).

1.31 If a company incurred a net capital loss in the 1995-96 year of income and that loss included one or more unused amounts of eligible rollover losses then, subject to new subsection 160ZPA(3), (see paragraphs 1.38 to 1.56 below) the net capital loss which is available to be offset against future capital gains is reduced by the unused amount.

1.32 A company's net capital loss in a year of income is determined by section 160ZC as, broadly, the sum of the company's net capital losses incurred in that year and previous years, reduced by any amounts offset against net capital gains accrued in the year of income. A company's net capital loss is also reduced if it makes an agreement to transfer all or part of a net capital loss to a related company under section 160ZP. In calculating the net capital loss for the purposes of new section 160ZPA, a transfer of a loss under section 160ZP will only be taken into account if that transfer occurred before 3 pm on 29 April 1997. [New subsection 160ZPA(8)]

1.33 If:

·
a rollover disposal occurred before 3 pm on 29 April 1997; and
·
an eligible rollover loss was incurred in the 1996-97 or a later year of income; and
·
the company did not lodge its income tax return for the relevant year of income before 3 pm on 29 April 1997; and
·
the eligible rollover loss was created or increased because of the application of section 160ZZO;
then, subject to new subsection 160ZPA(3), that eligible rollover loss is denied. The loss cannot be offset against subsequent capital gains, whether they are incurred in the same year of income or a later year.

When a capital loss is denied 1996-97 income tax return lodged before 3 pm on 29 April 1997

1.34 If a company was an early balancing company which had incurred an eligible rollover loss and had lodged its income tax return for the 1996-97 year of income before 3 pm on 29 April 1997, then subsection 160ZPA(2) could apply to prevent that loss being carried forward into the 1997-98 year of income.

1.35 New subsection 160ZPA(2) applies, subject to new subsection 160ZPA(3) , where the company has a net capital loss at the end of the 1996-97 year of income. That net capital loss is reduced, for the purposes of the 1997-98 and all subsequent years of income, by the sum of the company's unused amounts as at the end of the 1996-97 year of income.

1.36 If a company had incurred the eligible rollover loss in the 1996-97 year of income, new paragraph 160ZPA(2)(d) would apply to deny the unused amount of the loss to the extent there is a net capital loss for that year. The unused amount would be calculated under new paragraph 160ZPA(6)(b) as the entire amount of the eligible rollover loss.

1.37 If a company had incurred eligible rollover losses in or before the 1995-96 year of income, and also in the 1996-97 year of income, the amounts to be denied would be calculated separately for each case. To the extent that the company incurred a net capital loss, the eligible rollover losses in respect of both years would be denied. The separate calculations for the two years of income are necessary because section 160ZC of the Act, which sets out the calculation for net capital gains and losses, applies differently to the two years. Up until the 1995-96 year of income, net capital losses are calculated cumulatively, so that a company's net capital loss in a year of income includes any net capital losses carried forward. From 1996-97 onwards, a company's net capital losses are calculated separately in each year of income.

Commissioner to reduce the amount of the capital loss denied

1.38 The Commissioner is required to reduce the amount of the capital loss otherwise denied under either new subsection 160ZPA(1) or (2) , if requested to do so by the company which incurred the loss (ie. the loss company), where it is fair and reasonable to do so having regard to certain listed, and any relevant, criteria. [New subsection 160ZPA(3)]

Factors to be considered by the Commissioner

1.39 The factors to be considered by the Commissioner in deciding whether, or by how much, it is fair and reasonable to reduce the amount of the capital loss that would otherwise be denied are listed in new paragraph 160ZPA(3)(b) .

Any other disposals by the loss company

1.40 The Commissioner is to have regard to whether the loss company has disposed of, or is likely to dispose of, the interest, right or debt mentioned in new paragraph 160ZPA(4)(c) . [New subparagraph 160ZPA(3)(b)(i)] An eligible rollover loss cannot be artificially multiplied by a company group without there being a disposal by the company group of an interest in the company that originally rolled over the loss asset to the loss company. The existence, or otherwise, of such a disposal is an important consideration in determining the correct amount of an eligible rollover loss to be denied. However, it is also necessary to have regard to the extent to which the loss company could dispose of such an interest in the future. The greater the chance of such a disposal occurring, the greater the opportunity to artificially multiply a capital loss in the future.

1.41 Although this provision only refers to disposals by the loss company itself, new subparagraphs 160ZPA(3)(b)(ii) and (iii) (see below) give the Commissioner express authority to take into account losses created by the disposal of other companies in the group.

Other losses incurred by companies in the group

1.42 The Commissioner is to have regard to the extent to which the eligible rollover loss or losses are related to losses incurred, and losses which could potentially be incurred, by other companies in the group. [New subparagraph 160ZPA(3)(b)(ii)]

The amount of any loss incurred by other members of the group

1.43 The Commissioner is to have regard to the individual and cumulative amounts of those losses referred to in new subparagraph 160ZPA(3)(b)(ii) . [New subparagraph 160ZPA(3)(b)(iii)]

Example 1

1. 45 The Commissioner would take into account the fact that:

A has made additional losses of $1.4 billion from disposing of the shares in B and C, of which $700 million is an eligible rollover loss (the loss on the disposal of the shares in C which had been rolled over to A by B);

the $1.4 billion loss from disposing of these shares is directly related to the unrealised loss on the loss asset at the time of the rollover;

A makes a loss of $800 million from the disposal of the loss asset which is an eligible rollover loss;

$100 million of the loss from the disposal of the loss asset arose from a decrease in the value of the loss asset after the roll over. This decrease in value of the rolled over asset was not reflected in the losses arising from disposal of the shares in B and C.

1.46 In this situation the Commissioner may decide that it is fair and reasonable to reduce the amount to be denied under new subsections 160ZPA(1) and (2) by $100 million.

Example 2

1.47 This example illustrates the application of new subsection 160ZPA(3) where the Commissioner takes into account only the three factors discussed above in the context of a situation where the value of the loss asset increases after rollover to the loss company. For the purposes of this example the facts are as in Example (i) with the following modifications:

After the loss asset is transferred from C to A , its market value increases from $300 million to $950 million. Upon disposal of the asset, A realises a capital loss (an eligible rollover loss) of only $50 million.

1.44 This example illustrates the application of new subsection 160ZPA(3) where the Commissioner takes into account only the three factors discussed in paragraphs 1.38 to 1.41 above, in the context of a situation where the value of the loss asset decreases after rollover to the loss company. For the purposes of this example the facts are:

·
There is a group of companies structured as shown below with a $1 billion investment made by the group. The companies in the group are, directly or indirectly, 100% owned by the parent company A. The same $1 billion is passed down the chain by each successive company purchasing shares in the company below. Company C used the $1 billion to acquire an asset (the loss asset).
·
A year later, the asset that C owns, which cost $1 billion has a market value of $300 million. Hence, there is an unrealised capital loss of $700 million inherent in the asset held by C .
·
C 's asset is transferred to A for consideration equal to market value ($300 million). Rollover relief is claimed under section 160ZZO. A is deemed to acquire this asset for C 's reduced cost base ($1 billion).
·
After the loss asset is transferred from C to A , its market value decreases from $300 million to $200 million. On disposal of the asset, A realises a capital loss (an eligible rollover loss) of $800 million.
·
B transfers its shares in C to A for $300 million (their market value). Rollover relief is claimed under section 160ZZO. A is deemed to acquire these shares for a cost base equal to B 's reduced cost base on the shares ($1 billion), in determining whether a capital loss arises on the disposal of the shares.
·
The cost bases of A's shares in C and B are each $1 billion, while the market value of each parcel of shares is $300 million represented by the cash received for the transfer of the loss asset by C and the shares B held in C .

Market Value 300 million

·
A liquidates B and C and generates a capital loss of $700 million on the cancellation of its shares in each of the companies, generating a total loss on the shares of $1.4 billion.
·
In the absence of new section 160ZPA company A would generate capital losses of $2.2 billion as a result of these transactions. This amount would include two eligible rollover losses: $700 million from the disposal of A 's interests in C and $800 million from A 's disposal of the original loss asset. Of this amount, $1.5 billion of losses would be denied under either new subsection 160ZPA(1) or (2) on the basis that none of these losses have previously been used to offset a capital gain.
·
A requests that the Commissioner decide whether it would be fair and reasonable to reduce the amount of the loss denied by $100 million to $1.4 billion.

1.45 The Commissioner would take into account the fact that:

·
A has made additional losses of $1.4 billion from disposing of the shares in B and C , of which $700 million is an eligible rollover loss (the loss on the disposal of the shares in C which had been rolled over to A by B );
·
the $1.4 billion loss from disposing of these shares is directly related to the unrealised loss on the loss asset at the time of the rollover;
·
A makes a loss of $800 million from the disposal of the loss asset which is an eligible rollover loss;
·
$100 million of the loss from the disposal of the loss asset arose from a decrease in the value of the loss asset after the roll over. This decrease in value of the rolled over asset was not reflected in the losses arising from disposal of the shares in B and C .

1.46 In this situation the Commissioner may decide that it is fair and reasonable to reduce the amount to be denied under new subsections 160ZPA(1) and (2) by $100 million.

Example 2

1.47 This example illustrates the application of new subsection 160ZPA(3) where the Commissioner takes into account only the three factors discussed above in the context of a situation where the value of the loss asset increases after rollover to the loss company. For the purposes of this example the facts are as in Example (i) with the following modifications:

·
After the loss asset is transferred from C to A , its market value increases from $300 million to $950 million. Upon disposal of the asset, A realises a capital loss (an eligible rollover loss) of only $50 million.
·
A satisfies the Commissioner that it has no intention of disposing of C and hence will not realise the losses inherent in its interests in C . In addition, it can establish that it will only dispose of 50% of its interests in B .
·
A requests that the Commissioner decide whether it would be fair and reasonable to reduce the amount of the loss that would otherwise be denied under new subsection 160ZPA(1) or (2) by 50%, from $50 million to $25 million.

1.48 The Commissioner would take into account the facts that:

·
A is unlikely to realise any of its losses inherent in its interests in C ;
·
A is also unlikely to realise more than 50% of the losses inherent in its interests in B ;
·
the duplication of losses is not limited to $25 million as A will be able to generate a total of $400 million of losses (the $50 million eligible rollover loss and $350 million of other capital losses (ie. 50% of $700 million)) even if it only disposes of 50% of its interests in B ;
·
the company group has only suffered an economic loss of $50 million.

1.49 The Commissioner is unlikely to reduce the amount of the loss that would otherwise be denied under new subsection 160ZPA(1) or (2) .

Example 3

1.50 This example illustrates the application of new subsection 160ZPA(3) where the Commissioner takes into account only the three factors discussed above in the context of a situation where a number of companies in the group have incurred (or have the potential to incur) capital losses as a result of the rollover of a loss asset. For the purposes of this example the facts are as in Example 1 with the following modifications:

·
Company A invests $800 million in Company B and $200 million in Company C . B invests the $800 million in C . Consequently, A owns 100% of B and 20% of Company C , and B owns the other 80% of C .
·
B does not transfer its shares in C to A . A disposes of the loss asset transferred from C , thereby realising an eligible rollover loss of $700 million. Subsequently, both A and B dispose of their interests in C for market value. As a result, A realises another capital loss of $140 million (20% of $700 million) and B realise a capital loss of $560 million (80% of $700 million). The company group has a total of $1.4 billion capital losses as a result of these transactions.
·
A requests that the Commissioner decide whether it would be fair and reasonable to reduce the amount of the loss to be denied from $700 million to $140 million. The basis for the application is that A , itself, has only duplicated $140 million of capital losses.

1.51 The Commissioner would take into account the fact that:

·
the cumulative capital losses available to the group (actual and potential) is $1.4 billion compared to the group's economic loss of $700 million;
·
the only eligible rollover loss (which is the maximum amount which could be denied under new subsection 160ZPA(1) or (2) ) is the $700 million loss from the disposal by A of the loss asset;
·
although A has only generated $140 million of capital losses by disposing of the shares in B , the company group has generated capital losses of $1.4 billion in total, of which only $700 million are economic losses.

1.52 Because the group as a whole has $700 million of artificial losses, the Commissioner is unlikely to decide to reduce the amount of loss otherwise disallowed under new subsection 160ZPA(1) or (2).

The content and timing of information provided to the Commissioner

1.53 The Commissioner may have regard to the content and time of any disclosure of information by the company making the application (usually the loss company) for the Commissioner to determine whether, or by how much, to reduce the amount of the capital loss denied. This factor would allow the Commissioner to have regard to such things as:

·
the loss company's failure to provide information to the ATO on the arrangements which resulted in the eligible rollover loss being created; or
·
the provision of information only after an audit had been commenced by the ATO.

Example 4

1.54 For the purposes of this example the facts are:

·
Company A is an early balancing company which lodged its income tax return for the 1996-97 year of income after 3 pm on 29 April 1997.
·
A incurred an eligible roll over loss in the 1996-97 year of income and did not reduce the loss in its income tax return as required by new subsection 160ZPA(1) .
·
After A came under investigation by the ATO in the 1998-1999 year of income, it notified the Commissioner of the eligible rollover loss and requested the Commissioner to decide whether would be fair and reasonable to reduce the amount of the loss that would otherwise be denied.

1.55 The fact that A failed to notify the Commissioner of its eligible rollover loss until it was under investigation would be one factor which would have to be weighed with all the other factors by the Commissioner in deciding whether it is fair and reasonable to reduce the amount of the loss that would otherwise be denied under new subsection 160ZPA(2) . A failure, in a self assessment environment, to provide relevant information in a timely fashion should be viewed as of at least equal, if not greater, weight to the other factors discussed above.

Other relevant matters

1.56 In addition to being able to take into account the specified factors, the Commissioner may take into account any other factors he considers relevant. [Subparagraph 160ZPA(3)(b)(v)]

Exclusion for small business and manufacturing business assets

1.57 New section 160ZPA does not apply to a company if it would satisfy the requirement in subsection 160ZZPP(4) of the Act at the time it incurred the eligible rollover loss. [New paragraph 160ZPA(5)(a)] The requirement, which is akin to a small business test, is that the sum of:

the total of the net values of the assets of the company; and
the net values of the assets of any entities that are connected with the company; and
if an associate of the company is a partner in a partnership (other than a partnership that is connected with the company) - the share of the associate in the net value of the assets of the partnership;
do not exceed $5 million.

1.58 In addition, new section 160ZPA does not apply where the asset whose disposal would create an eligible rollover loss is plant, machinery or a building and it is used in a manufacturing business both before and after the transfer. [New paragraph 160ZPA(5)(b)] For this exception to apply, the asset must have been used by the transferor in a manufacturing business immediately before the rollover disposal and the loss company must use the asset in a manufacturing business for a period of at least 12 months starting immediately after the date the asset was transferred.

Part 2

1.59 Part 2 of Schedule 1 amends Part IVA of the Act so that it can be applied to the creation of capital losses in the year in which they are incurred, rather than when a capital loss is offset against capital gains in that income year or a later income year. Item 2 amends subsection 177A(1), which defines certain terms for the purposes of Part IVA, to provide that a capital loss has the same meaning as in Part IIIA of the Act.

1.60 Part IVA of the Act contains the general anti-avoidance provision which confers on the Commissioner the power to cancel tax benefits when certain objective criteria set out in the Part are met.

Tax Benefits

1.61 A 'tax benefit' is defined for the purposes of Part IVA in subsection 177C(1). Currently, a 'tax benefit' includes:

·
the non-inclusion in assessable income of an amount that, but for the scheme, might reasonably be expected to have been included; or
·
a deduction being allowable that, but for the scheme, might reasonably be expected not to have been allowable.

1.62 New paragraph 177C(1)(ba) extends the definition of 'tax benefit' to include a capital loss incurred in a year of income where it might reasonably be expected that, but for the scheme, no capital loss would have been incurred. [item 3] Broadly, a capital loss is incurred in a year of income where the reduced cost base of the asset disposed of exceeds the consideration received on its disposal (subsection 160Z(1)). The amount of the tax benefit in such a case is so much of the capital loss as would not have been incurred if the scheme had not been entered into. [New paragraph 177C(1)(e) inserted by item 4]

1.63 Subsection 177C(2) sets out specific exclusions from the definition of a tax benefit to which Part IVA applies. The provision prevents Part IVA from applying to a tax benefit attributable to the making of a declaration, election or selection, giving of a notice or exercising of an option under a provision in the Act. Subsection 177C(2) only applies where the scheme was not entered into for the purpose of creating the conditions necessary for the making of the declaration, election, or selection, or the giving of a notice or exercising of an option.

1.64 New paragraph 177C(2)(c) is inserted by item 6 to extend this provision so that the incurring of a capital loss which is the result of the making of a declaration, election, or selection, or the giving of a notice or exercising of an option under a provision in the Act will not in itself constitute a tax benefit. New paragraph 177C(2)(c) only applies if the scheme was not entered into for the purpose of creating the conditions necessary for the declaration, election, etc., to be made. [New subparagraph 177C(2)(c)(ii)] Additionally, the protection offered by new paragraph 177C(2)(c) is not available where an asset is rolled over under section 160ZZO or a loss is transferred under section 160ZP.

1.65 As all or part of a capital loss may reduce a capital gain and thus reduce assessable income, paragraph 177C(2)(a) may apply to a capital loss to which new paragraph 177C(2)(c) also applies. Consequently, item 5 amends subparagraph 177C(2)(a)(i) so that it will not apply to an amount which has not been included in assessable income, where that benefit is attributable to a declaration, election or selection, giving of a notice or exercising of an option that was made under section 160ZP or 160ZZO.

1.66 The lack of protection under subsection 177C(2) to loss transfers or rollovers under sections 160ZP and 160ZZO could result in Part IVA cancelling the benefit granted by these provisions in 'normal' or 'ordinary' rollover situations. To avoid this occurring, new subsection 177C(2A) is inserted to provide that the making of an agreement under section 160ZP or an election under section 160ZZO does not itself constitute a scheme for the purposes of Part IVA. [Item 7] New paragraph 177C(2A)(a) applies to a tax benefit relating to a reduction of assessable income, and new paragraph 177C(2A)(b) applies to a tax benefit in relation to a capital loss being incurred. Consequently, Part IVA could only apply in such cases if the making of the agreement or election was part of a wider scheme which had as its sole or dominant purpose the creation of a capital loss which would not have existed if the wider scheme had not been entered into.

1.67 Subsection 177C(3) deems the non-inclusion of an amount in assessable income or the allowance of a deduction to be expressly attributed to a declaration, election or selection, giving of a notice or exercising of an option if, but for it, the amount would have been included in assessable income or the deduction not allowed. Item 8 repeals and replaces it with a new subsection 177C(3) which applies not only to the non-inclusion of income or the allowance of a deduction, but provides that the incurring of a capital loss will be attributable to a declaration, election or selection, giving of a notice or exercising of an option if the capital loss would not have been incurred if the declaration, election or selection, giving of a notice or exercising of an option had not been made.

Cancelling of Tax Benefits

1.68 If a scheme has been entered into for the sole or dominant purpose of obtaining a tax benefit then the Commissioner is authorised by subsection 177F(1) to cancel the whole or a part of the tax benefit. The Commissioner may also make compensating adjustments in favour of any taxpayer if it is fair and reasonable to do so (subsection 177F(3)). The power to make a compensating adjustment is given to the Commissioner in case a tax benefit is denied in accordance with Part IVA but, if the scheme had not been entered into, a different tax benefit would have arisen.

1.69 Item 9 inserts new paragraph 177F(1)(c) to authorise the Commissioner to cancel a tax benefit which is referable, in whole or part, to a capital loss. Where the Commissioner has made a determination under new subsection 177F(1)(c) , he or she is also authorised, by virtue of new subsection 177F(3)(c) , to make a compensating adjustment in favour of a taxpayer, in case the need should arise. [Item 13] That is, the Commissioner is given the power to make an adjustment if the Commissioner is of the opinion that the person concerned would have incurred a capital loss, but for the scheme, and that it is fair and reasonable that the taxpayer be allowed to incur either the whole or part of that capital loss.

1.70 Subsections 177F(2B) to (2G) deal with determinations in relation to withholding tax arrangements. Subsections 177F(2B) and (2C) require the Commissioner to provide written notification of a tax determination to the taxpayer. Items 10 and 11 amend subsections 177F(2B) and (2C) to require the Commissioner to provide a notice of a determination to cancel a tax benefit under new paragraph 177F(1)(c) .

1.71 A taxpayer is able to object against a determination relating to assessable income or allowable deductions, as the determination will be reflected in the relevant notice of assessment or amended assessment. A determination in relation to withholding tax or a capital loss is not reflected in a notice of assessment or amended assessment and therefore a taxpayer does not have that right of review. Subsection 177F(2G) provides that, if the taxpayer is dissatisfied with a determination, he or she may object against it, as set out in Part IVC of the Taxation Administration Act 1953 . Item 12 amends subsection 177F(2G) to provide that taxpayer may also object against a determination in relation to the cancellation of a capital loss.


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