House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Rt. Hon. Harold Holt.)

General Introduction

The main purposes of this Bill are -

1.

To specify limits to the deductibility in 1960-61 of interest incurred by companies in excess of the interest payable at 15th November, 1960, or the interest paid in 1959-60.

2.

To discontinue the deduction for interest incurred by companies on convertible notes issued after 15th November, 1960, except where the terms of issue of the notes were announced on or before that date or the company was, on or before that date, bound by agreement to borrow the money represented by the convertible notes.

Each clause of the Bill is explained in the following notes.

Notes On Clauses:

Clause 1: Short Title and Citation.

This clause formally provides for the short title and citation of the Amending Act and of the Principal Act as amended.

Clause 2: Commencement.

Section 5(1A.) of the Acts Interpretation Act 1901-1957 provides that every Act shall come into operation on the twenty-eighth day after the day on which the Act receives the Royal Assent, unless the contrary intention appears in the Act.

By this clause, it is proposed that the Income Tax and Social Services Contribution Assessment Act (No. 3) 1960 shall come into operation on the day it receives the Royal Assent.

Clause 3: Definitions.

By this clause it is proposed to include in section 6 of the Principal Act a provision providing that the term "shares" shall also include stock.

This amendment is being made because of the proposed new section 51AB (see clause 4) relating to interest paid on notes convertible into shares or stock. The introduction of the definition proposed by clause 3 will enable the word "shares" to be read as including also stock issued or to be issued by a company.

The amendment will apply for the 1960-61 income year and subsequent years.

Clause 4: Deductions for Interest Paid by Companies.

By clause 4, it is proposed to insert in the Principal Act two new provisions - section 51AA and section 51AB - relating to interest incurred by companies.

Section 51AA.

Introductory Note

Section 51AA, which will apply only in the case of companies, is designed to place a limit upon the amount of the deductions available for interest incurred by companies during the year of income ending on 30th June, 1961 (or substituted accounting period), in gaining or producing assessable income. The new section has no application to subsequent years.

The limitation of deductions will not, however, apply to interest paid or payable by a company to a bank, a declared pastoral finance company or dealer in the short-term money market or to companies accepted as building societies. Similarly, there will be no disturbance of the present allowance for interest paid or payable to, or guaranteed by -

The Commonwealth.

An Australian State or Territory.

A public authority of the Commonwealth or of an Australian State or Territory.

The categories of interest mentioned are being defined as "excepted interest".

The new section will not curtail the amount of the deductions available for excepted interest.

A further feature is that the new provisions will not, apart from special cases to which sub-section (5.) or (6.) applies, reduce the amount of the deductions available for other interest below an amount of XX10,000.

The provisions being included in the law will not place a limit upon the amount of the deductions permitted for interest paid by -

a bank,

a declared pastoral finance company,

a declared dealer in the short-term money market,

a company or body accepted as a building society,

a company whose principal business is to supply and distribute water, gas or electricity by a reticulation system.

Subject to the qualifications mentioned, the plan of the section 51AA is to restrict the allowance for interest (other than excepted interest) incurred by a company to the greater of -

the amount of interest deductible from the company's assessable income of the 1959-60 income year;

the amount demonstrated by the company to be its annual interest commitment as at 15th November, 1960 on borrowings used in earning assessable income.

Stated broadly, the overall effect of section 51AA will be -

1.

Deductions for all excepted interest incurred in gaining or producing assessable income will not be disturbed.

2.

In the generality of cases, there will be no curtailment of the deductions available for other interest that does not exceed XX10,000.

3.

The new provisions will not limit deductions for other interest up to the amount of the interest deductible for 1959-60 or, if the company so elects, the annual amount of non-excepted interest payable as at 15th November, 1960, whichever is the greater.

4.

Where the excepted interest for the income year 1960-61 is less than -

(a)

the excepted interest for 1959-60; or

(b)

if the company has made the appropriate election, the annual amount of excepted interest as at 15th November, 1960,

the deduction otherwise available is increased by the amount of the difference - see notes relating to sub-section (7.).

The following notes provide explanations of each of the sub-sections in the proposed section 51AA.

Sub-section (1.) contains definitions designed to facilitate drafting and to clarify the meaning of the new section.

"Excepted interest" is defined to mean interest paid or payable by a company to a bank, a declared pastoral finance company, a declared dealer in the short-term money market, a body registered as a building society or co-operative housing society or a registered co-operative company the principal business of which is the provision of housing or finance for housing. Interest paid to, or the payment of which is guaranteed by, the Commonwealth, a State, a Territory of the Commonwealth or a public authority of the Commonwealth or a State or a Territory of the Commonwealth is also included in this definition.

The pastoral finance companies and dealers in the short-term money market, to which the definition is intended to relate, will be declared by the Treasurer after consultation with the Reserve Bank Board.

It will be noted that, under sub-paragraph (iii) of the definition, "excepted interest" extends to interest paid to building societies and co-operative housing societies registered under a State law or under a law of a Territory of the Commonwealth.

There are, however, co-operative companies engaged principally in the business of providing housing or finance for housing. Although these co-operative companies are not registered as co-operative housing societies, interest paid to them will also be "excepted interest" by virtue of sub-paragraph (iv) of the definition, if they are registered as co-operative companies under a State or Commonwealth law.

The definition of "excepted outgoings" is a drafting provision and the term will mean outgoings incurred by a company consisting of excepted interest. The definition facilitates reference in succeeding provisions to interest in respect of which deductions are not being limited.

"Excepted outgoings of the 1959-60 year" means excepted interest of the year of income ended 30th June, 1960 while the term "excepted outgoings of the 1960-61 year" means excepted interest of the income year ending on 30th June, 1961. The two definitions have been included in order to facilitate the drafting of succeeding provisions in section 51AA.

"Interest" will, for the purposes of the new section, include interest in respect of -

(a)

money lent, advanced or deposited;

(b)

credit given; or

(c)

any other form of debt or liability.

Payments in the nature of interest are also being brought within the compass of the definition. If, for example, a discount or premium, not of a capital nature, is allowed or paid by a company, the amount involved will fall within the definition of interest. Discounts and premiums of a capital nature are not deductible under the existing law and there is accordingly no need for them to be brought within the scope of the new provisions.

The reference, in the definition of "interest", to interest paid on shares in co-operative companies will ensure that the new provision does not disturb an allowance that has, over a long period, been authorised in the case of co-operative companies that conduct not less than 90% of specified classes of business with members.

"Outgoings of the 1959-60 year" is a further drafting provision and means interest, other than excepted interest, incurred by a company during the income year ended 30th June, 1960 in earning its assessable income.

"Outgoings of the 1960-61 year" is also included as an aid to drafting and means interest, other than excepted interest, that a company incurs during the year of income ending on 30th June, 1961 in earning its assessable income.

"Outgoings to which this section applies" will, broadly stated, mean outgoings consisting of interest incurred by a company in the course of earning its assessable income or which is necessarily incurred in carrying on a business for the purpose of earning such income.

The expression is, however, defined so as to exclude interest on convertible notes if that interest is excluded from the allowable deductions under the proposed section 51AB. The provisions of that proposed section are explained in this memorandum.

Sub-section (2.) will have the effect of excluding from the operation of the section all interest paid or payable by specified categories of companies. In consequence, there will be no change in the existing basis upon which these companies are entitled to deductions for interest.

The classes of companies specified for this purpose are -

banks;

declared pastoral finance companies;

declared dealers in the short-term money market;

registered building or housing societies;

companies whose principal business is the provision of housing or finance for housing and are registered under a law relating to co-operative companies;

companies carrying on, as their principal business, the supply and distribution by means of a reticulation system of water, gas or electricity.

Sub-section (3.) is a drafting measure to ensure that "excepted interest" does not include interest paid to a bank or other company or body in the capacity of a trustee or on account of a customer or other person.

Sub-section (4.) is the operative provision that may limit the amount of the deduction available for interest, other than excepted interest, incurred by a company during the 1960-61 income year. The sub-section will not generally have application unless that interest (other than excepted interest) exceeds XX10,000. Notes relating to sub-sections (5.) and (6.) explain the circumstances in which this general rule may not apply.

Where sub-section (4.) applies, the deduction for the interest (other than excepted interest) incurred in the 1960-61 year is limited to the amount of the deduction allowed to the company for interest (other than excepted interest) incurred during the income year 1959-60. There are, however, subsequent sub-sections that may authorise a greater deduction - for example, sub-section (10.) which entitles a company to elect that its deduction for interest (other than excepted interest) shall be based upon its annual interest commitment as at 15th November, 1960.

The following example illustrates the effect of sub-section (4.) in cases in which an election is not made under sub-section (10.)

Sub-section (5.) is designed for application where the Commissioner of Taxation is satisfied that a company incorporated after 15th November, 1960 has been formed with a view to the affairs of that company and another company being arranged so that section 51AA will apply more favourably than if the arrangements had not been made.

For example, a company paying interest may be in a position to incorporate several subsidiary companies each of which would be entitled to deductions of up to Pd10,000 for interest paid. If, on the facts of any case, the Commissioner is satisfied that a company has been incorporated after 15th November, 1960 for such a purpose, interest (other than excepted interest) incurred by the company in 1960-61 will not be deductible.

Sub-section (6.) is supplementary to sub-section (5.). It will apply where the Commissioner is satisfied that, after 15th November, 1960, changes in the control of a company or in the ownership of its shares have been effected with a view to the affairs of that company and another company being arranged so that section 51AA will apply more favourably than if the changes in control or ownership of the shares had not taken place.

The practical effect of sub-section (6.) will, in these circumstances, be to limit the deduction for interest (other than excepted interest) to the amount of the 1959-60 deduction for interest (other than excepted interest). If that amount is less than Pd10,000, a deduction of up to Pd10,000 for 1960-61 will not be available. The company, if it makes an election under sub-section (10.), will be entitled to substitute the annual interest liability as at 15th November 1960 for the amount of the 1959-60 interest deduction.

Sub-section (6.) will not curtail the deduction for excepted interest incurred in the 1960-61 income year.

The application of sub-section (6.) may be illustrated by the case of a company whose deduction for interest (other than excepted interest) was Pd6,000 for 1959-60 and whose annual interest liability (other than excepted interest) was Pd7,000 as at 15th November, 1960. If, in the circumstances described, the company comes under the control or ownership of another company, the maximum deduction for interest incurred in 1960-61 will be Pd7,000 so long as the company elects under sub-section (10.) to base its deduction on its annual interest liability as at 15th November, 1960. A deduction of Pd10,000 will not be available even if the company, in 1960-61, incurs interest in excess of that amount.

Should a company request that the application of either sub-section (5.) or (6.) be referred to a Taxation Board of Review, the Board will be free to substitute its determination on the applicability of either provision for that of the Commissioner.

Sub-section (7.) will operate where the excepted interest for 1960-61 is less than the excepted interest incurred in 1959-60. The sub-section is designed so as, in those circumstances, to reduce the amount of interest that would otherwise be excluded from the allowable deductions for 1960-61.

But for sub-section (5.) the amount to be disallowed would be Pd2,000. As, however, the excepted interest in 1960-61 is Pd500 lower than the excepted interest in 1959-60, the disallowed interest is reduced from Pd2,000 to Pd1,500.

A further example illustrates the operation of sub-section (7.) in different circumstances.

The amount to be disallowed under sub-section (4.) would, apart from sub-section (7.), be Pd2,000 and the 1960-61 deduction for interest would accordingly be Pd35,000. As, however, the excepted interest for 1960-61 is Pd4,000 less than the 1959-60 excepted interest, sub-section (7.) enables the deduction to be increased to an amount greater than Pd35,000.

Although the difference between the 1959-60 and the 1960-61 excepted interest is Pd4,000, sub-section (7.) authorises an increase in the deductions only in respect of the outgoings by way of interest incurred in 1960-61. In the present example the interest incurred in 1960-61 totals Pd37,000 and the deduction of Pd35,000 permitted after applying sub-section (4.) is increased by sub-section (7.) to Pd37,000. The sub-section would enable the Pd35,000 to be increased by the Pd4,000 mentioned only if the 1960-61 interest amounted to at least Pd39,000.

Sub-section (8.) provides that the deduction allowable to a company for the 1960-61 income year in respect of all interest incurred by it is not to be reduced to an amount that is less than Pd10,000 plus the amount of excepted interest incurred during that year.

As already explained, the new provisions will not place a limit upon the deductions for excepted interest and the deduction for 1960-61 would, apart from sub-section (8.), be -

The effect of sub-section (8.) will be to authorise a deduction for other interest incurred up to Pd10,000. As, in this example, the other interest in 1960-61 exceeds Pd10,000, the total deduction will be Pd12,000, comprising Pd2,000 excepted interest and Pd10,000 other interest.

If the other interest in 1960-61 were, say, Pd7,000, the deduction would be Pd9,000 comprising Pd2,000 excepted interest and Pd7,000 other interest.

Sub-section (9.) will ensure that the liability of a private company to additional tax on its undistributed income is not increased as a result of the operation of the proposed new section. The new provisions will, however, apply to the primary tax of a private company in the same way as they operate in the case of a public company.

A private company is liable to pay undistributed income tax for an income year if, during a twelve months' period commencing two months before the end of that year, it fails to make a sufficient distribution. The rate of undistributed income tax is ten shillings in the Pd.

For practical purposes, the distributable income of a private company is the residue of taxable income after deducting therefrom the tax payable at the primary rates on the taxable income.

The effect of disallowing a proportion of the interest paid by a private company will be to increase the taxable income and, in turn, the distributable income of the company. The new provisions limiting the deductions for interest could accordingly give rise to an increase in the amount of undistributed income tax payable by the company. This result would be inappropriate as the interest paid by the company is not available for distribution to the shareholders of the company as dividends.

It is accordingly proposed by sub-section (9.) that the distributable income of the company be reduced by the amount of the interest disallowed as a deduction under the provisions of the new section.

Sub-section (10.) will entitle any company to elect that the limitation of deductions for interest incurred in 1960-61 be determined by reference to its annual interest liability as at 15th November, 1960 rather than by having regard to the 1959-60 deduction for interest. In other words, a company that makes the appropriate election and satisfies the Commissioner of Taxation as to the amount of its annual interest liability as at 15th November, 1960 will not have the deduction for its 1960-61 interest reduced by the new provisions to an amount less than its annual interest liability as at 15th November, 1960.

In the case of a company that elects to have sub-section (10.) applied, references, in the explanations already given, to 1959-60 interest may be read as references to the annual interest liability of the company as at 15th November, 1960.

In calculating the amount of the annual interest liability of a company it will be necessary to apply to each amount of borrowings or indebtedness of the company as at the 15th November, 1960 (being amounts used by the company in gaining or producing assessable income or in carrying on a business for the purpose of earning such income), the rates of interest which are, at that date, applicable to the various borrowings or indebtedness.

Should a company be dissatisfied with the amount adopted by the Commissioner as its annual interest liability as at 15th November, 1960 the usual rights of objection will be available. On reference to a Taxation Board of Review, it will be open to the Board to substitute its determination for that of the Commissioner.

The practical effect of sub-section (10.) is illustrated by the following example.

Sub-section (11.) relates to a company that has made an election for the purposes of sub-section (10.) and that, as at 15th November, 1960, was bound by agreement to borrow a sum of money specified in the agreement or that, on or before that date, had made an offer to borrow a sum of money specified in the offer.

If these tests are satisfied and the company does borrow money in accordance with the agreement or the offer, the annual amount of interest on the amount borrowed (up to the amount specified in the agreement or offer) will be included for the purposes of sub-section (10.) in the total annual amount of interest.

The sub-section will apply only in relation to interest that if paid, would be incurred in gaining or producing assessable income of the company or necessarily incurred in carrying on a business for the purpose of earning such income.

Sub-section (12.) provides that interest payable by a company under convertible notes -

(a)

the terms of issue of which were announced on or before the 15th November, 1960, or

(b)

that the company was, in pursuance of an agreement made on or before the 15th November, 1960 bound to issue after that date,

is to be included in the annual interest liability of the company as at 15th November, 1960, if the company makes an election under sub-section (10.)

The proposed new section 51AB will not exclude from the allowable deductions the interest paid on convertible notes issued in the circumstances mentioned, and sub-section (12.) will ensure that there is no discrimination as between interest on those notes and other interest incurred by the company.

Sub-section (13.) is designed to ensure that a company making an election for the purposes of sub-section (10.) is not adversely affected thereby.

At the time of making an election a company may not be in a position to determine the precise effect of the election. There may accordingly be isolated cases in which an election would result in the tax payable being greater than if the election had not been made, e.g. if the company is unable to establish that its annual interest liability as at 15th November, 1960 is in excess of the 1959-60 deduction for interest.

If that situation should arise, sub-section (13.) will authorise the allowance of a rebate ensuring that the company is not called upon to pay a greater amount of tax than if it had not made the election.

Sub-section (14.) also relates to elections under sub-section (10.). An election under that provision will be effective if it is made in writing by or on behalf of a company and is delivered to the Commissioner of Taxation on or before the last day for the furnishing of the return of income for the 1960-61 income year, or within such further time as the Commissioner allows.

Section 51AA will apply only in relation to assessments for the income year ending 30th June, 1961, or for a substituted accounting period.

Section 51AB.

Introductory Note

This section relates to the interest incurred by companies on borrowings and indebtedness that may, directly or indirectly, be converted into, or redeemed by, the issue of shares or stock in a company. It will be convenient in these explanations to refer to instruments attaching rights to acquire shares or stock as "convertible notes". That term is defined in the proposed legislation.

Broadly stated, the new section will provide that interest incurred by a company on convertible notes will not be deductible from the assessable income of the company if the notes are issued after 15th November, 1960. If, however, the terms of issue of the notes were announced by the company on or before 15th November, 1960, or the company was bound by an agreement made on or before that date to issue the notes, the new provisions enacted by section 51AB will not apply to the interest on those notes.

It is also proposed that expenses incurred in borrowing money by way of convertible notes to which the section applies shall not be an allowable deduction.

Sub-section (1.) of section 51AB contains a number of definitions for the more convenient interpretation of the section.

The definition of convertible note and the ancillary definitions are designed to indicate the types of loans that may ultimately be converted into shares or stock of a company.

Sub-section (2.) provides for the situation that might arise if a company entered into two or more separate arrangements for the raising of loans which, in effect, constitute the issue of convertible notes. For example, a company might raise money by the issue of ordinary debentures and may also issue to each debenture-holder a separate certificate entitling the holder to obtain the issue of shares in the company at some future date. The sub-section provides that, where two or more related instruments have the same effect or operation as a convertible note, they shall be treated as a convertible note for the purposes of the section.

Sub-section (3.) will apply where a company issues a note that does not directly entitle the holder to an issue of shares, but gives a right under a further instrument or series of instruments to obtain an issue of shares. If the overall effect of the note and the series of instruments is the same as that of a convertible note (as defined), the note and each of the instruments will be treated as a convertible note.

In this context an "instrument" includes a debenture, bond, certificate, receipt or any other document in writing, and a "note" means a note or other instrument issued by a company, that evidences, acknowledges, creates or relates to a loan to the company.

Sub-section (4.) makes provision for the case where a company has made an issue of convertible notes and, under the terms of that issue, a person who was entitled to have a convertible note issued to him did not receive it until a later date. In these circumstances, the company is deemed to have issued the note on the date on which that person first became entitled to receive it.

This will ensure that a company will not be denied a deduction for interest paid on convertible notes that were due to be issued on or before 15th November, 1960, merely because of an inadvertent delay in the formal issuing process.

Sub-section (5.) provides that the new provisions will, with two exceptions, apply in relation to convertible notes issued after 15th November, 1960. The exceptions ensure that the new section will not operate in the case of convertible notes issued after that date if -

(a)

the terms of issue were announced on or before 15th November 1960, or

(b)

the company was, at that date, bound by agreement to issue the notes.

Sub-section (6.) is the operative provision formally enacting that interest, or any payment in the nature of interest, under convertible notes to which section 51AB applies shall not be an allowable deduction from the company's assessable income.

Sub-section (7.) is designed to ensure that section 51AB will have its intended operation where a company pays interest indirectly - for example, by reimbursing some other person who has met the interest charge on behalf of the company. The sub-section accordingly provides that where a person has made a payment (whether under a guarantee or otherwise) which is, in effect, a payment of interest on convertible notes, and the payment is made good by the company, the outgoing incurred by the company shall be deemed to be interest under convertible notes. The amount involved will be treated for income tax purposes, in the same way as if the company had itself paid the interest direct to the noteholder.

Sub-section (8.) provides that a premium paid upon the issue of convertible notes to which section 51AB applies shall be deemed, for the purposes of section 44(2.)(b)(iii) of the Principal Act, to be profit arising from the issue of shares at a premium.

Section 44(2.)(b)(iii) of the Principal Act exempts from tax dividends paid wholly and exclusively out of profits arising from the issue of shares at a premium if the dividends are satisfied by the issue of shares.

Premiums on convertible notes will be treated as premiums on shares only where the interest on the notes fails, by reason of the new provisions, to qualify as an allowable deduction. The non-allowance of the deduction for interest and the treatment of the premium in the same way as a premium on shares are complementary to each other.

Sub-section (9.) states that section 67 of the Principal Act does not apply to expenditure incurred by the company in borrowing money by means of convertible notes.

Section 67 entitles a person who has borrowed money used by him for the purpose of producing assessable income to a deduction for expenditure incurred by him in borrowing the money. The expenditure is deductible over the period for which the money is borrowed, or five years, whichever is the less. A deduction is not authorised for expenses incurred by a company in raising its share capital.

In consequence of sub-section (9.) deductions will not be allowed for expenses incurred in borrowing money under notes convertible into shares, if the new section 51AB applies in relation to the notes. The deduction under section 67 of the Principal Act will not, however, be disturbed in relation to notes issued on or before 15th November, 1960 or where -

(a)

the terms of issue of convertible notes were announced by the company on or before that date; or

(b)

the company was, at that date, bound by agreement to issue the notes.

Sub-section (10.) has the effect of treating interest paid on convertible notes to which the new section applies as dividends for the purposes of calculating a private company's liability in respect of an insufficient distribution of its income.

The sub-section will apply only where the interest is paid on notes that are convertible, directly or indirectly, into shares. The interest on notes to which the new provisions apply will, like dividends, be excluded from the deductions allowable in arriving at the taxable income of the company.

Dividends paid by a private company within a prescribed period are deducted from the distributable income of the company in order to arrive at the undistributed amount upon which additional tax is payable. Sub-section (10.) will ensure that a corresponding procedure is adopted in relation to interest under convertible notes to which the new section applies.

The new provision - section 51AB - will apply to assessments of the income year ending 30th June, 1961 and subsequent years.

Clause 5: Living-away-from-home Allowances.

This clause effects in section 51A of the Principal Act a drafting amendment consequential on the inclusion of the two new provisions - sections 51AA and 51AB.

Section 51A includes a reference to "the last preceding section" which, up to the present, has been section 51. It is appropriate to maintain the reference to that section but, as two new sections are to be interposed between section 51 and section 51A, it is necessary to delete from the latter section the words "the last preceding section" and to insert a specific reference to section 51.

The amendment, which will apply for the 1960-61 income year and subsequent years, will not alter the practical effect of the existing law.

Clause 6: Application of Amendments.

The amendments proposed by the Bill will commence to apply as indicated in this clause. The commencing date for application of each amendment has been stated in the note to the relevant clause.