Senate

New Business Tax System (Miscellaneous) Bill (No. 2) 2000

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
This Memorandum takes account of amendments made by the House of Representatives to this Bill as introduced.

Glossary

The following abbreviations and acronyms are used throughout this Explanatory Memorandum.

Abbreviation Definition
A Platform for Consultation Review of Business Taxation: A Platform for Consultation
A Tax System Redesigned Review of Business Taxation: A Tax System Redesigned
ABN Australian Business Number
AD/RLA accident and disability/residual life assurance
ADF approved deposit fund
ANTS Government's Tax Reform Document: Tax Reform: not a new tax, a new tax system
ASIC Australian Securities and Investments Commission
ATO Australian Taxation Office
BAS business activity statement
Capital Gains Tax Act New Business Tax System (Capital Gains Tax) Act 1999
CFCs controlled foreign companies
CGT capital gains tax
COIN Company and Superannuation Fund Instalment System
Commissioner Commissioner of Taxation
CS/RA complying superannuation/roll-over annuity
EIB eligible insurance business
ETP eligible termination payment
GAAR general anti-avoidance rule
GDP gross domestic product
GIC general interest charge
Income Tax Rates Act No. 1 New Business Tax System (Income Tax Rates) Act (No. 1) 1999
Income Tax Rates Act No. 2 New Business Tax System (Income Tax Rates) Act (No. 2) 1999
Integrity and Other Measures Act New Business Tax System (Integrity and Other Measures) Act 1999
ITAA 1936 Income Tax Assessment Act 1936
ITAA 1997 Income Tax Assessment Act 1997
Life Insurance Act Life Insurance Act 1995
NBTS Miscellaneous Bill 1999 New Business Tax System (Miscellaneous) Bill 1999
NCS non-complying superannuation
PAYG Pay As You Go
PST pooled superannuation trust
RBA running balance account
RSA retirement savings account
TAA 1953 Taxation Administration Act 1953
the Recommendations Review of Business Taxation: A Tax System Redesigned
the Review Review of Business Taxation
Transitional Provisions Act Income Tax (Transitional Provisions) Act 1997

General outline and financial impact

Inter-entity loss multiplication

Schedule 1 to this Bill introduces measures into the ITAA 1997 to prevent multiple recognition of losses of a company where:

there has been a change in ownership or control in the company; or
a liquidator has declared the company's shares to be worthless.

Date of effect : The measures apply where substantial changes of ownership occur after 1 pm, by legal time in the Australian Capital Territory, on 11 November 1999.

Proposal announced :This proposal was announced in Treasurer's Press Release No. 74 of 11 November 1999 (refer to attachment E).

Financial impact :The financial impact of this measure is included in the estimate for measures to prevent inter-entity loss multiplication. The financial impact of these measures is set out in the following table:

2000-2001 2001-2002 2002-2003 2003-2004 2004-2005
$15m $20m $25m $20m $25m

Compliance cost impact: There are compliance costs associated with determining the tax value adjustments to affected equity in debt interests. However, special relief is provided to minimise the costs associated with complying with this measure.

Company losses and bad debts and technical amendments

Schedule 1 to this Bill amends the ITAA 1997 to provide an appropriate link to the inter-entity loss measures by:

amending the continuity of ownership test applying to company losses and bad debts; and
aligning the application date of the unrealised loss measures (contained in the Integrity and Other Measures Act) with that of the inter-entity measures.

This Bill also makes technical amendments to measures dealing with the continuity of ownership test, unrealised losses, excess mining deductions and 13-month prepayments, all of which are contained in the Integrity and Other Measures Act.

Date of effect : Technical refinements to the continuity of ownership tests take effect for losses claimed in an income year ending after 21 September 1999. The other losses measures apply where substantial changes of ownership occur after 1pm by legal time in the Australian Capital Territory on 11 November 1999. Technical amendments to prepayments rules apply in relation to assessments for an income year ending after 21 September 1999. These amendments only apply to expenditure incurred by a taxpayer after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999. The amendment relating to excess mining deductions applies to assessments for the 1999-2000 income year and later.

Proposal announced : The measures linked to the inter-entity measures were announced in Treasurer's Press Release No. 74 of 11 November 1999 (refer to Attachment E). The technical refinements give effect to the measures announced in Treasurer's Press Release No. 58 of 21 September 1999 (refer to Attachment Q).

Financial impact : The financial impact of this measure is included in the estimate for measures to prevent inter-entity loss multiplication.

Compliance cost impact : Reduced compliance costs are expected from linking the continuity of ownership test to the new inter-entity measure, as this will streamline the rules that apply to entities. Reduced compliance costs are also expected in relation to the unrealised loss measures from various rules providing compliance relief. The measures may increase record-keeping requirements regarding the direct and indirect ownership in a loss company.

Losses - amendments to Subdivisions 170-C and 170-D

Schedule 1 to this Bill makes amendments to the following provisions in the ITAA 1997:

Subdivision 170-C, which prevents loss transfers between wholly-owned company groups from being duplicated (loss duplication measures); and
Subdivision 170-D, which defers capital losses or deductions in certain cases (linked group transfer measures).

Date of effect : The amendments clarifying the application of Subdivision 170-C apply from 22 February 1999, the original application date of application of the loss transfer measure.

Amendments to Subdivision 170-D apply to deferral events happening on or after 21 October 1999, the original date of application of the Subdivision.

The amendments restricting cost base uplifts will apply from the date of introduction of this Bill.

Proposal announced : These amendments arise from the loss duplication and linked group transfer measures, announced in Treasurer's Press Release No. 58 of 21 September 1999 (refer to Attachment Q).

Financial impact : The financial impact of this measure is included in the estimates reported under the following measures:

preventing a deduction and a capital loss arising from a single economic loss; and
transfer or creation of assets by companies that are members of linked groups;

dealt with in the Integrity and Other Measures Act.

Compliance cost impact : There are no additional compliance costs associated with amendments to these measures.

Life insurance companies

Schedule 2 to this Bill amends the ITAA 1936 and the ITAA 1997 to:

broaden the tax base for life insurers by largely taxing the various businesses of life insurers on a comparable basis to those types of businesses generally; and
broadly tax the current pension business of superannuation funds consistently with that of life insurers.

Date of effect :1 July 2000.

Proposal announced : This proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 (refer to Attachment N). Measures to provide transitional relief to small superannuation funds were announced in Assistant Treasurer's Press Release No. 28 of 20 June 2000.

Financial impact : The following financial impact includes the impact of Review proposals affecting policyholders, which will be included in a later Bill:

1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005
-$30m $200m $170m $228m $250m $272m

Compliance cost impact : Broadening the tax base for life insurers should reduce ongoing compliance costs by increasing certainty and integrity of the tax base. However, there are some implementation and transitional costs that will arise.

Imputation - PAYG instalments

Part 1 of Schedule 3 to this Bill amends the ITAA 1936 to make consequential amendments to the dividend imputation regime to provide for franking credits and debits to arise for:

the payment and refund of income tax under the PAYG instalments system; and
PAYG rate variation credits.

Date of effect : The amendments to the dividend imputation provisions apply from the 2000-2001 income year.

Proposal announced : This proposal has not previously been announced.

Financial impact : There is no financial impact arising from the introduction of these measures.

Compliance cost impact : If this measure has any impact on compliance costs, it will involve a small increase in those costs.

Imputation - life assurance companies

Part 2 of Schedule 3 to this Bill amends the dividend imputation system of the ITAA 1936 as it applies to life insurers so that:

franking credits and debits arise in relation to tax paid on income actually allocated to shareholders; and
the imputation system applies to virtual PSTs of life insurance companies.

Date of effect : 1 July 2000.

Proposal announced : This proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 (refer to Attachment O).

Financial impact : The financial impact of this measure is included in the overall estimates reported under the measure broadening the tax base for life insurers.

Compliance cost impact : This measure may impose some additional compliance costs on life insurers by requiring calculations that reflect the true underlying circumstances rather than applying an arbitrary rule. However, the application of accepted accounting practices will limit any additional complexity.

Imputation - conversion of franking account balances

Part 3 of Schedule 3 to this Bill amends the ITAA 1936 to ensure that the reduction in the company tax rate from 36% to 34% is correctly reflected in the dividend imputation system in relation to:

life insurance companies;
PAYG instalments payable by early balancing companies; and
estimated debit determinations.

Date of effect : 1 July 2000.

Proposal announced : These measures have not been announced. However, they arise from the proposal to reduce the company tax rate from 36% to 34%. This was announced in Treasurer's Press Release No. 58 of 21 September 1999 (refer to Attachment A).

Financial impact : The financial impact of this measure is included in the overall estimates reported under the measure reducing the company tax rate, dealt with in the Income Tax Rates Act No. 1.

Compliance cost impact : The amendments to the conversion of franking account provisions will cause a small, one-off cost for companies affected by the measure arising from implementing changes to their systems. However, the method adopted in the conversion of franking account provisions minimises ongoing compliance costs.

Imputation - thresholds for franking credit trading rules

Part 4 of Schedule 3 to this Bill amends the franking credit trading provisions in Division 1A of Part IIIAA of ITAA 1936 to increase the threshold for the small shareholder exemption under the holding period rule from $2,000 to $5,000.

Date of effect : This change will apply to assessments for the 1999-2000 income year, and later income years.

Proposal announced : This proposal was announced in Treasurer's Press Release No. 74 of 11 November 1999 (refer to Attachment F).

Financial impact : A minimal loss to revenue.

Compliance cost impact : There is expected to be a reduction in compliance costs mainly arising from individual taxpayers entitled to a franking rebate between $2,000 and $5,000 no longer having to consider the application of the 45 day rule.

CGT: capital payments for trust interests (CGT event E4)

Schedule 4 to this Bill amends the ITAA 1997 so that the cost-base adjustment that is made where a capital payment is received for a trust interest (CGT Event E4) reflects the CGT discount and CGT small business concessions.

Date of effect : The amendments apply to assessments for the income year including 21 September 1999, and later income years.

Proposal announced : This measure was foreshadowed in the explanatory memorandum to the Capital Gains Tax Act, but was otherwise not announced.

Financial impact : The financial impact for these changes is included in the estimates reported under the measures providing small business relief dealt with in the Capital Gains Tax Act.

Compliance cost impact : None.

Scrip for scrip roll-over

Schedule 5 to this Bill amends the scrip for scrip roll-over provisions in the ITAA 1997 by:

clarifying the circumstances in which roll-over can be used;
providing cost base rules for acquired equity; and
limiting the availability of roll-over where both the original and acquiring entities are non-residents.

Date of effect : The amendments generally apply from 10 December 1999. The amendments affecting non-resident companies apply on or after 13 April 2000.

Proposal announced : This proposal has not previously been announced.

Financial impact : The financial impact for these changes is included in the estimates reported under the measures providing scrip for scrip roll-over dealt with in the Capital Gains Tax Act. The amendments in this Bill do not have any further revenue impacts. The changes to the cost base rules and the non-resident roll-over measure are revenue protection measures.

Compliance costs : Negligible.

PAYG instalments: anti-avoidance rules

Schedule 7 to this Bill inserts rules in Part 2-10 of Schedule 1 to the TAA 1953 to support the integrity of the PAYG instalments regime. The rules penalise entities who obtain a tax benefit or tax benefits from a scheme to avoid, defer or reduce PAYG instalments. The rules do this by imposing a penalty by way of the GIC on twice the tax benefit or tax benefits arising from the scheme. The Bill also amends the object of the PAYG instalments regime to clarify the objects and purposes of that regime.

Date of effect : The amendments apply to the 2000-2001 income year and later income years.

Proposal announced : The PAYG system was announced in ANTS and the need for rules to support the integrity of the PAYG instalments regime was identified in the explanatory memorandum to A New Tax System (Pay As You Go) Act 1999.

Financial impact : No gain to revenue. The amendments will protect the PAYG instalments base and prevent significant deferral of instalments.

Compliance cost impact : Taxpayers will need to be aware of how the measures operate. However, taxpayers who are not engaged in tax avoidance activities will not be affected by these measures.

Summary of regulation impact statement

Regulation impact on business

Impact : The measures in this Bill are part of the Government's broad ranging reforms which will give Australia a New Business Tax System. These reforms are based on the Recommendations of the Review that the Government established to consider reforms to Australia's business tax system.

The New Business Tax System is designed to provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings, as well as providing a sustainable revenue base so that the Government can continue to deliver services for the community.

Main points:

The potential compliance, administrative and economic impacts of the measures contained in this Bill have been carefully considered, by both the Review and the business sector. The Review focussed on the economy as a whole and concluded that there would be net gains to business, Government and the community as a whole from business tax reform.
The measures in this Bill will reduce compliance costs as part of providing a more consistent and easily understood business tax system.
Most of the measures in this Bill impact on a particular group of taxpayers (e.g. the life insurers imputation amendments will impact on life insurance companies) or taxpayers that undertake a particular transaction (e.g. technical amendments to the scrip for scrip roll-over provisions apply to companies involved in takeovers undertaken by way of a scheme of arrangement).
Some of the measures have a wider impact (e.g. the measure amending the imputation system to take account of PAYG instalments will affect all entities who make instalments and have franking credits and debits arise under the imputation system).
Most of the measures are expected to decrease compliance costs (e.g. increasing the threshold for the exemption from the franking credit trading rules). In many cases, the only increase in compliance costs is in the transition and implementation of the measure (e.g. broadening the tax base for life insurers).
The administration costs of implementing the measures in this Bill are expected to be minimal.

Chapter 1 - Inter-entity loss multiplication

Outline of Chapter

Object of the Subdivision

1.1 Schedule 1 to this Bill inserts new Subdivision 165-CD into the ITAA 1997. Subdivision 165-CD prevents the duplicate, or multiple, recognition of the realised and unrealised losses of a 'loss company' that has an 'alteration'. An alteration is a change in the company's ownership or control or a declaration by a liquidator that its shares are worthless.

1.2 Duplicate or multiple recognition of losses happens because the company's losses are reflected in the values of interests (e.g. shares or debts) held directly, or indirectly, in it. Where the entity holding the interest is not an individual, this outcome is referred to below as inter-entity loss multiplication.

Application of the Subdivision

1.3 If a loss company has an alteration, the Subdivision prevents inter-entity loss multiplication by reducing tax attributes (reduced cost bases, costs, or deductions) for significant direct and indirect equity and debt interests in that company. Consistent with preventing inter-entity loss multiplication, the Subdivision actually calculates reductions based on the company's losses, as discussed further at paragraphs 1.9 to 1.16.

Tax attributes of 'inter-entity' interests reduced

1.4 The Subdivision applies to 'inter-entity' interests. 'Inter-entity' interests are interests held by entities in other entities. Inter-entity interests represent a significant source of loss multiplication, especially where there are tiers of entities, and entity interests, that reflect the losses of companies 'downstream' of them.

Interests of individuals and certain other entities unaffected

1.5 Interests held by, or solely on behalf of, individuals are not affected by this Subdivision. Also, interests held by certain entities are not subject to reduction under this Subdivision if there are no interests held by others in those entities on which the company's losses can be duplicated. It will be difficult for entities with fixed interests to qualify for this exclusion, but most solvent superannuation funds and non-fixed trusts will be excluded from the Subdivision's operation.

Only significant inter-entity interests affected

1.6 The Subdivision applies only to significant inter-entity interests. Broadly, a significant inter-entity equity interest is a 10% or greater interest (held directly or indirectly) in the loss company, and a significant inter-entity debt interest is a loan of $10,000 or more to the loss company, or to another entity with a significant interest in the loss company. A further requirement is that the entity must have a controlling stake (determined on an associate-inclusive basis) in the loss company.

When are significant inter-entity interests affected

1.7 Ordinarily, only interests held immediately before an alteration time are affected by the Subdivision. This means there is an impact on interests whose disposal triggers the alteration, as well as on interests held by entities 'upstream' or downstream' of the entity that disposed of interests.

1.8 In limited circumstances, interests disposed of before an alteration time may also be affected. Broadly, interests disposed of within 12 months before an alteration time, or under an arrangement involving disposals at, or within 12 months of, that time, can be affected.

Calculating reductions to tax attributes of significant interests - based on realised and unrealised losses of the 'loss company'

1.9 The amounts of reductions to the tax attributes of significant interests are based on realised and unrealised losses of the loss company. Calculating a company's unused realised capital and tax (revenue) losses is generally straightforward. The calculation of unrealised losses on assets can be less straightforward and involves valuing assets. Relieving provisions are contained in the Subdivision to minimise the requirement to value assets.

1.10 This relief will limit the cost of complying with the Subdivision without significantly reducing its contribution to the integrity of the tax system. All entities can benefit from aspects of this relief, and in particular small business will benefit from most aspects of it.

Special relief - calculation of unrealised losses

1.11 To minimise the need to value assets to determine a company's unrealised loss assets, assets acquired for less than $10,000 are disregarded, and, in most cases, items of plant can be valued at their tax written down values.

1.12 Companies and company groups in the small business sector (with net assets (on a related entity basis) of $5 million or less) are fully exempted from calculating unrealised losses.

1.13 In certain cases, companies without realised losses may not have to apply the Subdivision or calculate their unrealised losses if they would reasonably be expected to be in a 'net unrealised gain' position at an alteration time.

1.14 In addition, the Subdivision specifically authorises the Commissioner to provide valuation guidelines to further reduce compliance costs associated with calculating unrealised losses.

Working out the reductions to tax attributes based on the company's losses

1.15 The Subdivision contains a formula to determine reductions to tax attributes based on the company's realised and unrealised losses. This applies in straightforward cases. Another test applies in all other cases, or where the formula does not give a reasonable result.

1.16 In no case will an entity have to make a reduction that is unreasonable in the circumstances.

When the Subdivision applies

1.17 This Subdivision applies if a loss company undergoes an alteration after 1 pm, by legal time in the Australian Capital Territory, on 11 November 1999. This measure was announced in Treasurer's Press Release No. 74 of 1999 of 11 November 1999 (attachment E). The Subdivision prevents the obtaining of deductions and capital losses (that duplicate the company's losses) on inter-entity interests from 11 November 1999.

Context of Reform

1.18 Loss multiplication arises where the taxation system recognises a single economic loss more than once. Inter-entity loss multiplication can occur because losses of a company are reflected in the values of direct or indirect interests (e.g. shares and loans) in that company.

1.19 If entities are interposed between individual shareholders and a loss company, the company's losses may be multiplied on the realisation of 'inter-entity' interests in the loss company. In A Tax System Redesigned, the Review recommended that the same business test be retained following a change in ownership of a loss company, subject to the removal of inter-entity loss multiplication. (Recommendation 6.9(b) on page 256 and discussion on page 257).

1.20 This Subdivision implements that recommendation by requiring appropriate reductions to the tax attributes of significant interests in a loss company that undergoes a change of ownership or control or when a liquidator declares that its shares are worthless.

1.21 This Subdivision balances integrity benefits (the prevention of inter-entity loss multiplication) with the need to contain compliance costs. Firstly, only entities with an (associate-inclusive) controlling stake in the loss company are affected, and they in turn must have a significant equity interest (10% or more) or significant debt interest ($10,000 or more). The Subdivision contains several other relieving provisions that help to contain compliance costs, especially in relation to the calculation of unrealised losses.

Summary of new law

Purpose and application of the Subdivision

1.22 Subdivision 165-CD prevents inter-entity loss multiplication. This is the duplicate or multiple recognition of a company's losses on the realisation of certain equity and debt interests held directly or indirectly in a loss company that has undergone an 'alteration'.

1.23 An alteration involves a change in a company's ownership or control or where a liquidator has declared its shares are worthless.

1.24 Usually, the Subdivision impacts only on interests held immediately before an alteration, but in certain cases can also apply to certain interests disposed of before that time.

1.25 The Subdivision applies only in respect of a change in a loss company's ownership or control, or a liquidator's declaration that its shares are worthless, where these events happen after 1 pm, by legal time in the Australian Capital Territory, on 11 November 1999.

Affected entities

1.26 Entities potentially required to make reductions under this Subdivision ('affected entities') are only those that have (alone or with associates) a controlling stake in the loss company. Also excluded are individuals, entities holding interests solely on behalf of individuals, or entities in which no other entity has held, or holds, an interest on which a capital loss or deduction might be claimed that duplicated, or duplicates, the loss company's losses.

1.27 Affected entities may be required to reduce deductions and reduced cost bases in relation to significant interests they hold in the loss company.

1.28 A significant interest means at least a 10% (direct or indirect) inter-entity equity interest in the loss company or a debt of at least $10,000 owed directly by the loss company or by an entity with a significant interest in the loss company.

Reductions

1.29 In general, reductions are required only for interests held directly or indirectly in the loss company immediately before an alteration time.

1.30 Reductions may also be required for relevant interests disposed of within 12 months before an alteration time; or where the deductions or capital losses would be realised more than 12 months before an alteration time but are part of an arrangement that also involved the disposal of interests at the alteration time or within 12 months of that time. This requirement for reductions ensures that the measures apply appropriately where an interest is disposed of in a number of stages.

1.31 For direct interests in loss companies which have only shares of one class and market value (and have not issued rights or options to acquire shares), or such shares and loans of only one type, a formula is provided to simplify the reductions. In other cases, or where the formula does not provide a reasonable outcome, the measures provide for appropriate reductions based on several factors. In no case will an entity be required to make a reduction that is unreasonable in the circumstances.

1.32 The amount of reduction is based on the total of the company's realised and unrealised losses at the alteration time. However, it is recognised that not all of this amount will always be relevant in determining the reduction required to prevent inter-entity loss multiplication.

Notice requirements

1.33 To assist taxpayers to comply with this measure, an obligation is placed on any entity (other than an individual) that, in its own right, has a controlling stake in the loss company, to provide information to its associates that will assist them to make the reductions required. If more than one entity has such a controlling stake (e.g. in a 'chain' of companies) the entity in which no other entity (excluding individuals) has a controlling stake (e.g. the ultimate parent) is obliged to provide the information. If the ultimate parent is a non-resident, and there is a resident entity that would have been required to provide the notice if the non-resident parent had not existed, the obligation will fall on the resident entity.

1.34 In some cases, the loss company itself may be required to provide information to holders of significant interests in it.

Diagram 1.1:  Scheme of the Subdivision

Comparison of key features of new law and current law

1.35 There is no current law in relation to this measure.

Detailed explanation of new law

Object of Subdivision 165-CD

1.36 The object of Subdivision 165-CD is to prevent the multiplication of a loss company's realised and unrealised losses. The Subdivision is triggered where an alteration time occurs in respect of the company. This usually involves a change in the ownership or control of the loss company, but can also happen where a liquidator of the company declares its shares worthless, or if certain interests are disposed of before an actual alteration time.

1.37 The object of the Subdivision is achieved by requiring appropriate reductions to the values for tax purposes of certain interests (inter-entity interests) held by entities that have a controlling stake in the loss company. [Schedule 1, item 18, section 165-115J]

1.38 Multiplication of losses on inter-entity interests can occur because the company's realised and unrealised losses are reflected in the values of interests (equity and debt) held directly or indirectly in the loss company.

Loss multiplication only - not reduced gains

1.39 This Subdivision only addresses the multiplication of losses by way of deductions or capital losses recognised in relation to these interests. It does not deal with reduced gains recognised on them because the company has made losses.

1.40 Thus, the basis for determining the quantum of reductions to reduced cost bases and deductions for interests in the loss company is the amount of realised and unrealised losses in the loss company. Unrealised gains in that company are not relevant because only 'loss attributes' (reduced cost bases and deductions) of interests in it are reduced or adjusted.

Example 1.1 X Co has a 100% shareholding in Y Co, having capitalised Y Co post-CGT with $10 million. X Co sells its shares to an independent buyer for $7 million. This triggers the operation of the Subdivision.Y Co has a realised loss of $3 million (at the beginning of the income year in which the Subdivision is triggered), an unrealised loss of $1 million on one asset and an unrealised gain of $1 million on another.The reduced cost base of X Co's shares would be reduced by $4 million to $6 million. The cost base of $10 million is unaffected by the Subdivision so no capital gain or capital loss would be made on the sale.If Y Co distributed the unrealised gain asset to X Co before the sale, and sold its shares for $6 million, the Subdivision would again prevent duplication of the company's losses.

Compliance cost saving - unrealised gains recognised in some circumstances

1.41 Although in general, unrealised gains are not taken into account in determining whether, and the extent to which, the Subdivision requires reductions to interests, this is subject to one exception made on compliance cost grounds.

1.42 If an alteration time occurs that is not a 'changeover time' for the purposes of the unrealised loss measures (Subdivision 165-CC), the company does not have any realised losses, and, if the alteration time had been a changeover time it would have been reasonable for the company to conclude that it would not have had an unrealised net loss at that time under section 165-115E, this will not be treated as an alteration time. [Schedule 1, item 18, subsection 165-115K(4)]

1.43 The effect of this is that the Subdivision will not apply. Companies with no realised losses, and no unrealised net loss at the alteration time will not be required to obtain valuations of their unrealised loss assets for the purpose of Subdivision 165-CD at a time when they are not required to do so under Subdivision 165-CC.

1.44 However, if the alteration time coincides with a changeover time, the company will have to obtain valuations of its unrealised loss assets. It already has to do this for Subdivision 165-CC purposes, so there are no additional compliance costs imposed by this requirement under this Subdivision.

Affected entities - not individuals, entities holding interests solely for individuals, or certain other entities

1.45 Subdivision 165-CD does not require reductions to be made by individuals holding interests directly or indirectly in the loss company [Schedule 1, item 18, subsections 165-115X(5) and 165-115Y(6)] . Also excluded are interests held by trustees for individuals absolutely entitled as against them to the interests, and interests held on behalf of individuals by trustees in bankruptcy and by security holders [Schedule 1, item 18, subsections 165-115X(7) and 165-115Y(8)] .

1.46 In the case of partnerships, the 'fractional interest' approach ensures that no special rule is required for CGT provisions where individuals hold interests in partnership in the loss company. However, for the revenue provisions, it is provided that no reduction is made under this Subdivision to interests held by a partnership of individuals. [Schedule 1, item 18, subsections 165-115X(6) and 165-115Y(7)]

1.47 It is appropriate that individuals can effectively realise the underlying net losses of the loss company by disposing of their interests in it. This is recognising only once that company's underlying losses on an interest in the loss company. Following a change in ownership or control of the loss company, such losses may also be available to the loss company, but only if the same business test is satisfied.

1.48 Subdivision 165-CD limits multiplication of these losses by making reductions to the tax attributes of relevant 'inter-entity' interests in the loss company.

1.49 In addition to interests held effectively by individuals, it is appropriate to exclude certain other entities from having interests in relation to which Subdivision 165-CD may require reductions.

1.50 Such an entity is one for which no other entity (including an individual) has obtained, or can obtain, a capital loss or deduction for a direct or indirect equity or debt interest in it that reflects a loss of the underlying loss company [Schedule 1, item 18, subsections 165-115X(3) and (4) and 165-115Y(4) and (5)] . The purpose of describing an entity in this way is to ensure that no entity is excluded from having a relevant interest if there is any possibility that a loss can be duplicated on an interest in that entity.

1.51 This test potentially excludes most superannuation funds and discretionary trusts if neither a capital loss nor a deduction has been, or could be, available, in respect of an entity's interest in the fund or trust.

1.52 However, if the superannuation fund or trust has borrowed (including a borrowing from an arm's length borrower) the existence of a loan in respect of which a capital loss or deduction has been made or could be made by the lender that duplicates a loss of the loss company, will prevent the exclusion from applying.

1.53 The rationale for excluding most superannuation funds and discretionary trusts is that, without the exclusion, the effect of Subdivision 165-CD might be to prevent any recognition of a company's loss in certain cases. For example, if a discretionary trust holds all the shares in a loss company, and it disposes of those shares to an unrelated party, Subdivision 165-CD could operate to prevent a capital loss or deduction arising on their disposal. If the company then fails the same business test, the loss would not be recognised in any way.

Non-application of Subdivision to calculating the attributable income of a CFC

1.54 The Subdivision will not apply when calculating the attributable income of a CFC. [Schedule 1, item 67, proposed paragraph 427(ba) of the ITAA 1936]

1.55 The CFC measures prevent tax deferral by taxing Australian residents on their share of certain types of foreign source income accumulated offshore in a CFC (called attributable income). Broadly, the attributable income of a CFC is calculated as if it were a resident taxpayer. Subdivision 165-CD would therefore apply unless modifications are made to the calculation of attributable income.

1.56 In principle, the Subdivision should apply when calculating the attributable income of a CFC. Applying the measures to CFCs in the same way that they apply to residents would help ensure residents are not advantaged by accumulating amounts offshore in a CFC.

1.57 Subdivision 165-CD, however, would not mesh well in its current form with aspects of the CFC measures and could produce anomalous outcomes or uncertainty in the law. It will therefore not apply to CFCs at present. Its application to CFCs will be considered as part of the review of the CFC measures announced in the New Business Tax System: Stage 2Response (Treasurer's Press Release No. 74 of 11 November 1999). This will allow time to develop cohesive rules that are properly integrated with other measures.

Subdivision 165-CD applies to other CGT events in the same way that it applies to disposals

1.58 In some situations the reductions are made as a result of the 'disposal' of equity or debt interests in a loss company. The Subdivision is not limited to situations where an entity 'disposes' of its interests to another person or entity (as understood in CGT event A1 (section 104-10)).

1.59 Subdivision 165-CD applies to a CGT event other than a disposal happening to a CGT asset in the same way as it applies to a disposal of a CGT asset [Schedule 1, item 18, subsection 165-115K(5)] . So, for example, a cancellation of shares would be covered by the Subdivision. The extension to CGT events other than a disposal also applies where the Subdivision refers to the disposal of assets by the loss company.

1.60 Where a CGT event other than CGT event A1 occurs (i.e. an event other than an actual disposal), a disposal is taken to have occurred for the purposes of Subdivision 165-CD at the time of the CGT event [Schedule 1, item 18, subsection 165-115K(5)] . For an actual disposal, the time of the disposal depends on whether the Subdivision refers to a CGT outcome (e.g. a capital loss) or to a revenue outcome (e.g. a deduction). In the first case, it is the time of the disposal under Parts 3-1 and 3-3 as applicable for CGT event A1 (e.g. the time of the contract of sale). In the second, it is the time of the disposal under the general law (e.g. the time of settlement on sale).

When does Subdivision 165-CD apply?

1.61 Subdivision 165-CD will apply if:

a company has an alteration time;
at the alteration time the company is a loss company; and
one or more entities have relevant equity interests or relevant debt interests in the company immediately before the alteration time.

[Schedule 1, item 18, subsection 165-115K(1)]

1.62 By focussing on interests held immediately before the alteration time the Subdivision ensures that reductions are also made to the interests that trigger the alteration in ownership or control of the loss company. [Schedule 1, item 18, paragraph 165-115K(1)(c)]

1.63 Subdivision 165-CD may also apply to interests in the loss company that an entity disposed of within a 12 month period before the alteration time, if the entity had a significant equity or debt interest in the loss company immediately before the alteration time, or would have had such an interest but for certain disposals. [Schedule 1, item 18, section 165-115P]

1.64 The Subdivision may also apply to interests that are disposed of under an arrangement that commenced before the 12 month period (but not before the commencement time of the Subdivision) and involved the disposal of interests at the alteration time or within the 12 months before that time. [Schedule 1, item 18, section 165-115Q]

1.65 These provisions prevent an entity disposing of, or recognising losses on, interests in more than one transaction to maximise loss multiplication and prevent the ordinary application of the Subdivision.

1.66 Subdivision 165-CD may also apply to interests that are trading stock of the entity immediately before an alteration time but not where deductions or reductions in value were recognised in an income year ending more than 12 months before the alteration time. [Schedule 1, item 18, subsections 165-115ZA(5) and (6)]

What is an alteration time for a company?

1.67 An alteration time for a company is usually one where, broadly, there is a failure of the same persons to maintain a majority interest in the voting power, rights to dividends, and rights to capital in the loss company. [Schedule 1, item 18, section 165-115L] .

Change of ownership

1.68 The new tests (discussed in Chapter 2) for determining whether there has been a continuity of ownership are used in Subdivision 165-CD. The changes in the continuity of ownership are measured by reference to a time that cannot be earlier than 1.00 pm by legal time in the Australian Capital Territory, on 11 November 1999. The special tracing rules for listed public companies are used in the usual way. The 'saving provision' which refers to circumstances where less than 50% of the loss company's losses have been duplicated, does not generally apply for the purposes of applying Subdivision 165-CD.

1.69 However, the 'saving provision' that applies where the same persons have maintained a majority interest in the voting power, rights to dividends and rights to capital though they hold that interest in a different form, and less than 50% of the loss company's unrealised net loss has been duplicated, has a particular application in this Subdivision.

1.70 If a company:

has an alteration time which is not a changeover time under Subdivision 165-CC (e.g. where the saving provision applied);
has no realised tax losses or net capital losses; and
can reasonably conclude that the total unrealised gains on CGT assets it owns would be greater than or equal to the total unrealised losses on its CGT assets,

the alteration time is taken not to have occurred. This results in the Subdivision not applying in relation to the company at that time [Schedule 1, item 18, subsection 165-115K(4)] . This operates as a compliance cost saving measure, because companies will not have to obtain valuations of assets in these circumstances.

Change of control

1.71 An alteration time for a company may also happen where there is a change in its control. [Schedule 1, item 18, section 165-115M] Changes in control are measured by reference to a time that cannot be earlier than 1 pm by legal time in the Australian Capital Territory, on 11 November 1999.

Declaration by a liquidator - CGT event G3 triggered

1.72 An alteration time for a company is also taken to include a situation where a liquidator of a company makes a declaration and shareholders can obtain capital losses in respect of their shares before the company is dissolved and the shares are cancelled. [Schedule 1, item 18, section 165-115N]

1.73 Were CGT event G3 not to trigger the application of Subdivision 165-CD, liquidators' declarations could be used to bypass the anti-loss multiplication reductions the Subdivision is designed to achieve.

What is a 'notional alteration time' for a company?

1.74 A company has a notional alteration time if:

it is a loss company at an alteration time;
an entity has a relevant equity or debt interest in the company immediately before the alteration time (or would have had a relevant equity or debt interest if it had not disposed of equity or debt at any previous notional alteration times);
the entity disposed of a direct or indirect equity or debt interest in the company in the 12 month period before the alteration time, or disposed of equity or debt outside the 12 month period as part of an arrangement under which equity or debt was also disposed of within the 12 month period or at the alteration time; and
immediately before the disposal the equity or debt had been part of a relevant equity or debt interest (or part of an interest that would have been a relevant equity or debt interest if other equity or debt had not been disposed of at any previous notional alteration times) held by the entity in the loss company.

[Schedule 1, item 18, subsections 165-115P(1) and 165-115Q(1)]

1.75 An 'arrangement' for these purposes would not include the normal repayment of a debt consistent with its terms of issue. A notional alteration time [Schedule 1, item 18, subsections 165-115P(3) and 115Q(3)] is also not an alteration time for the purposes of these sections [Schedule 1, item 18, paragraphs 165-115P(1)(a) or 165-115Q(1)(a)] so the 12 month period is not successively activated.

1.76 There is no notional alteration time if the disposal was before 1 pm, legal time in the Australian Capital Territory, on 11 November 1999. [Schedule 1, item 18, paragraphs 165-115P(1)(b) and 165-115Q(1)(b)]

1.77 Where the requirements in paragraph 1.76 are met the company's notional alteration time is taken to be immediately before the disposal of the equity or debt [Schedule 1, item 18, subsections 165-115P(3) and 165-115Q(3)] . The equity and debt disposed of are taken to be relevant equity and debt interests of the entity immediately before the notional alteration time [Schedule 1, item 18, subsections 165-115P(4) and 165-115Q(4)] . Subdivision 165-CD then operates as it would for any other alteration time in relation to those specified equity and debt interests.

1.78 Importantly, all other equity and debt interests held by the entity in the loss company at the notional alteration time are taken not to be relevant debt or equity interests [Schedule 1, item 18, subsections 165-115P(4) and 165-115Q(4)] . This ensures that the Subdivision only affects the equity and debt disposed of. The relevant equity and debt interests of other entities will not be affected by the notional alteration time [Schedule 1, item 18, subsections 165-115P(5) and 165-115Q(5)] .

1.79 When Subdivision 165-CD applies to the loss company at a future alteration time, a notional alteration time is taken not to have occurred [Schedule 1, item 18, subsections 165-115P(6) and 165-115Q(6)] . This ensures that the reductions made to the values for tax purposes of relevant equity and debt interests held at the actual alteration time are not affected by any reductions made because of the notional alteration time.

1.80 The purpose of these provisions is to prevent an entity maximising loss multiplication or preventing the application of the Subdivision by disposing of debt and equity interests in a series of steps involving an arrangement, or within a short period of time. This could occur, for example, if an entity acquires 100% of the relevant equity interests in a company before the company starts making losses. Without these provisions the entity could sell 49% of its equity in the loss company just before selling the remaining 51% and Subdivision 165-CD would not apply to the disposal of the first 49%.

1.81 These rules do not have a purpose test or a tax avoidance motive test. They operate automatically if the disposals occur within a 12 month period or under an arrangement. An arrangement is as defined by section 995-1 to be any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings. What constitutes an arrangement in a particular situation will be a question of fact in that case.

What is a loss company?

1.82 A loss company is a company which has realised losses or unrealised losses at the alteration time. Different rules exist to determine whether a company is a loss company at the first or only alteration time in an income year, and for a second or later alteration time in the same year. [Schedule 1, item 18, sections 165-115R and 165-115S]

1.83 A company must be a loss company at the alteration time for the Subdivision to apply.

Rules for determining whether a company is a loss company at the first or only alteration time in an income year

1.84 The Subdivision contains rules about when a company is a loss company at the first or only alteration time in an income year [Schedule 1, item 18, section 165-115R] . It also provides the method for calculating the loss company's overall loss at the alteration time. The overall loss is taken into account in making reductions under the Subdivision.

1.85 For the purpose of determining whether a company is a loss company it is assumed that a notional income year starts at the beginning of the income year in which the alteration occurs and ends at the alteration time. [Schedule 1, item 18, subsection 165-115R(2)]

Example 1.2 Company A changes ownership on 1 May 2000. To determine whether A is a loss company, section 165-115R is applied on the basis that the period from the beginning of Company A's income year up to the alteration time, 1 May 2000, is an income year.

1.86 A company will be a loss company at an alteration time where at least one of the following is satisfied at that time:

it has an undeducted tax loss or undeducted tax losses at the beginning of the notional income year for one or more earlier income years;
it has an unapplied net capital loss or unapplied net capital losses at the beginning of the notional income year for one or more earlier income years;
it has a tax loss for the income year;
it has a net capital loss for the income year; or
at the alteration time the company has an adjusted unrealised loss (see paragraphs 1.110 to 1.116).

[Schedule 1, item 18, subsection 165-115R(3)]

1.87 Subdivision 165-B is used to calculate whether a company has a tax loss for the notional income year. It is applied on the basis that there are no full year deductions or full year amounts, and that subsection 165-45(4) is not relevant. Subdivision 165-CB is applied similarly for net capital losses.

1.88 A tax loss that is undeducted or a net capital loss that is unapplied is disregarded if it was used in determining whether the company was a loss company in an earlier income year [Schedule 1, item 18, paragraph 165-115R(4)(a)] . This rule prevents the double counting of such losses.

1.89 Subdivision 170-D is also disregarded in determining whether the company is a loss company [Schedule 1, item 18, paragraph 165-115R(4)(b)] . This ensures that losses deferred under Subdivision 170-D are taken into account at an alteration time. It is appropriate to recognise such deferred amounts because they can be multiplied on the realisation of inter-entity interests.

Rules for determining whether a company is a loss company at a second or later alteration time in an income year

1.90 If there has been a previous alteration time in the same income year, it is assumed that the period from immediately after the last alteration time to the current alteration time is an income year. [Schedule 1, item 18, subsection 115-165S(2)]

Example 1.3 On 1 May 2000 (the first alteration time) Company A undergoes a change in ownership.On 31 May 2000 Company A's ownership changes again (the second alteration time). The income year for the purpose of determining whether it is a loss company at the second alteration time will be from 1 May 2000 (immediately after the previous alteration) until 31 May 2000.

1.91 A company will be a loss company at the second or subsequent alteration time where one of the following is satisfied:

it has a tax loss for the income year;
it has a net capital loss for the income year; or
at the alteration time the company has an adjusted unrealised loss.

[Schedule 1, item 18, subsection 165-115S(3)]

1.92 Subdivision 170-D is disregarded in determining whether the company is a loss company at the second or subsequent alteration time for an income year. [Schedule 1, item 18, paragraph 165-115S(4)]

What is the overall loss for a loss company?

1.93 The overall loss for a loss company at the alteration time is the sum of the amounts of losses taken into account when determining that the company is a loss company [Schedule 1, item 18, subsections 165-115R(5) and 165-115S(5)] . The overall loss is the maximum amount in respect of which reductions are made to prevent multiplication of the company's losses on the disposal of inter-entity interests in the loss company.

1.94 The overall loss generally includes the amount of realised losses of the loss company at the alteration time. It also includes an amount (adjusted unrealised loss) to reflect the company's unrealised losses at that time.

1.95 The amounts reflected in the overall loss can be multiplied on the disposal of inter-entity interests. This occurs where the market values of inter-entity interests are reduced because of the losses in the company. Disposals of these interests can effectively realise the underlying losses of the loss company.

Example 1.4 Hold Co owns all the shares in Sub Co, which it bought for $400,000. On 30 April 2000 (an alteration time) Hold Co sells the shares for their current market value, $100,000. At that date Sub Co has an unapplied net capital loss of $200,000 and an undeducted tax loss of $100,000.Sub Co is a loss company at the alteration time. Its overall loss is $300,000.To ensure that Sub Co's losses are not multiplied when Hold Co sells the shares, the reduced cost bases of Hold Co's shares are reduced by $300,000 (the overall loss in Sub Co) to $100,000. Hold Co makes no capital loss or capital gain from the shares.

Reduction of certain amounts included in a company's overall loss

1.96 Certain losses, or parts of losses, are to be disregarded when considering whether a company is a loss company, and working out the amount of the company's overall loss. Losses are to be disregarded to the extent that they are not an outlay or loss of the economic resources of the company. [Schedule 1, item 18, subsections 165-115R(6) and 165-115S(6)]

1.97 Any part of a loss that is not an outlay or loss of the economic resources of a company does not decrease the market value of the company. An example is a tax deduction for an amount not actually expended by the company (e.g. the additional 25% tax deduction provided for certain Research and Development expenditure). Losses for tax purposes arising from such deductions cannot be multiplied when interests in the company are disposed of. It follows that they should not be included in the overall loss figure on which anti-multiplication reductions are based.

1.98 It is specifically provided that a non-economic loss will include depreciation on an item of plant to the extent that tax recognition of the outlay (via depreciation deductions) happens in advance of economic depreciation or depletion of the plant. These 'timing differences' for plant are to be calculated on an asset by asset basis. It is not necessary to track reversals of the difference.

1.99 Certain realised losses in a loss company's overall loss may also be reduced if a notional revenue loss, notional capital loss or trading stock decrease in respect of an asset was taken into account in determining whether the company was a loss company at an earlier alteration time, and the realised loss reflects these amounts [Schedule 1, item 18, section 165-115T] . The realised loss is reduced by these amounts. This prevents double counting of the same underlying loss.

1.100 No reduction in the overall loss is required if the company did not have an adjusted unrealised loss at an earlier alteration time, or if a notional revenue loss, notional capital loss or trading stock decrease was disregarded at the earlier alteration time under the measures for reducing compliance costs (see paragraphs 1.108, 1.109 and 1.116).

1.101 A realised loss for this purpose is a tax or net capital loss for the income year or an earlier income year. Notional revenue losses, notional capital losses and trading stock decreases are calculated in working out any adjusted unrealised loss. (Paragraphs 1.102 to 1.116 explain 'notional revenue loss', 'notional capital loss', 'trading stock decrease' and 'adjusted unrealised loss').

Example 1.5 In the 2000-2001 income year Manufacturing Co has 2 alteration times. Two assets held by the company have unrealised losses at the first alteration time. In the period between the first and second alteration times these assets are sold. In determining Manufacturing Co's overall loss at the second alteration time, realised losses must be reduced to take account of the notional losses for these assets which were taken into account at the earlier alteration time.

  Alteration time 1 Alteration time 2
Asset 1 Notional revenue loss $300,000. Realised tax loss $200,000.
Asset 2 Notional capital loss $400,000. Realised net capital loss $500,000.
The realised loss ($200,000 tax loss) relating to Asset 1 is reduced to nil because it is less than the notional loss.The realised loss on Asset 2 (that constituted the $500,000 net capital loss) is reduced by an amount equal to the notional loss ($400,000).

Example 1.6 At the first alteration time on 3 January 2001, Prosper Co has a $200,000 undeducted tax loss, which it incurred in 1998. It also has an adjusted unrealised loss of $50,000 consisting of a notional revenue loss on an asset, 'A', that it owns.At this first alteration time, Prosper Co is a loss company, having an overall loss of $250,000.Asset A increases in value and on 1 May 2001 Prosper Co sells it and incurs a loss of only $30,000.Prosper Co has a second alteration time on 31 May 2001. It has a tax loss of $100,000 for the notional income year to 31 May 2001. The tax loss includes the $30,000 loss realised on asset A and $10,000 representing the benefit of a tax incentive.At this second alteration time in the same income year, Prosper Co has an overall loss of $60,000. This is calculated by reducing the $100,000 tax loss by the realised loss on asset A ($30,000) and by the $10,000 tax incentive, which is not a loss of the company's economic resources.

What is a notional loss?

1.102 A notional loss is the loss on a CGT asset that a company would make if it disposed of that asset at an alteration time for its market value. It measures any unrealised fall in the value of a CGT asset that the company still owns. A notional loss can be of a revenue or capital nature. [Schedule 1, item 18, subsection 165-115V(8)]

1.103 Notional losses must be calculated to decide whether a company has an adjusted unrealised loss at an alteration time. This is taken into account in determining whether a company is a loss company and the amount of the overall loss.

1.104 The method of calculating notional losses is, for practical purposes, the same as it is in the unrealised loss provisions [Schedule 1, item 18, section 165-115F of Subdivision 165-CC] . Provision is made for the Commissioner to give guidance or provide advice about valuing assets, with the object of reducing the costs of complying with Subdivision 165-CD. Matters covered in the Commissioner's advice could include the grouping of assets for the purpose of valuation [Schedule 1, item 18, subsection 165-115V(8)] .

What is a trading stock decrease?

1.105 A different way of calculating an 'unrealised loss' on an item of trading stock is required because of the tax accounting used for trading stock generally.

1.106 A trading stock decrease is the extent to which (if any) the market value of an item immediately before an alteration time is less than

its value (under subsection 70-40(1)) at the start of the income year in which the alteration time occurred; or
its cost of acquisition if the item was acquired during the income year.

1.107 If there was an earlier alteration time (or earlier alteration times) in that year, the trading stock decrease is the extent to which (if any) the market value of an item immediately before the alteration time is less than its market value immediately before the latest of the previous alteration times; or if the item was acquired after the latest alteration time, is less than its cost of acquisition. [Schedule 1, item 18, subsection 165-115W(1)] There is also a double counting rule so that the same trading stock decrease is not taken into account more that once.

Special relief measures

1.108 For working out both notional losses and trading stock decreases, there are measures to reduce companies' compliance costs. A notional loss or a trading stock decrease on a CGT asset is disregarded if the loss company acquired the CGT asset for less than $10,000. [Schedule 1, item 18, sections 165-115V(2) and 165-115W(2)]

1.109 A further saving on valuation costs is available on items of plant (not including a building or structure) costing $10,000 or more, but less than $1 million, for which the loss company can claim deductions for depreciation. Providing the loss company can reasonably conclude that the market value of the item of plant would not be less than 80% of its written down value for tax purposes at the alteration time, the company may use the written down value to calculate any notional loss for that plant. [Schedule 1, item 18, subsections 165-115V(6) and (7)]

What is an adjusted unrealised loss?

1.110 In broad terms, the adjusted unrealised loss is the sum of the notional losses on a loss company's CGT assets (other than trading stock) and any decreases in value of items of the loss company's trading stock [Schedule 1, item 18, subsection 165-115U(1)] . If unrealised losses and trading stock decreases were not recognised as part of a loss company's overall loss, loss multiplication could occur to the extent of these losses when inter-entity interests in the company are realised.

1.111 The method statement [Schedule 1, item 18, section 165-115U] for working out whether a loss company has an adjusted unrealised loss at an alteration time adopts a different treatment of trading stock from the corresponding method statement in the unrealised loss measures [Section 165-115E of Subdivision 165-CC] . This is because the method used in the unrealised loss measures does not give appropriate results where more than one alteration time occurs. A different methodology is adopted generally to measure decreases in the value of trading stock for calculating an adjusted unrealised loss for a company.

1.112 To calculate the adjusted unrealised loss the company must first work out the notional revenue loss or notional capital loss (if any) on each CGT asset, other than trading stock, owned at the alteration time. To the extent that this reflects an amount already taken into account at an earlier alteration time, it is not counted again.

1.113 The company must also work out, in respect of each CGT asset that is trading stock of the company, any decrease in value of the asset since the start of the income year in which the alteration time occurs, or since the date of its acquisition if later; or in the case of a second or subsequent alteration time in the same year, any decrease in value of the asset since the previous alteration time, or since the date of its acquisition if later. [Schedule 1, item 18, subsection 165-115U(1), step 1]

1.114 The sum of the company's notional revenue losses and notional capital losses is its nominal unrealised loss at that alteration time. [Schedule 1, item 18, subsection 165-115U(1), step 2]

1.115 The sum of the decreases in value of items of the company's trading stock is the loss company's overall trading stock decrease. The sum of the nominal unrealised loss (if any) and the overall trading stock decrease (if any) is the company's adjusted unrealised loss at the relevant alteration time. [Schedule 1, item 18, subsection 165-115U(1), steps 3 and 4]

Example 1.7 Mineral Co had alteration times in each of three consecutive income years. During these years Mineral Co held a number of CGT assets. Unrealised losses on assets 1 and 2 are determined under the CGT provisions while asset 3 is subject to the revenue provisions.Mineral Co needs to work out its adjusted unrealised loss at each of the alteration times. The assets had the following attributes at the alteration times.[CB = cost base; RCB = reduced cost base; MV = market value]

  1st Alteration time 2nd Alteration time 3rd Alteration time
Asset 1 (CGT only)

CB/RCB: $300,000
MV: $200,000

CB/RCB: $300,000
MV: $100,000

CB/RCB: $300,000
MV: $20,000

Asset 2 (CGT only)

CB/RCB: $600,000
MV: $550,000

CB/RCB: $600,000
MV: $700,000

CB/RCB:$600,000
MV: $500,000

Asset 3 (Revenue asset)

Cost: $1,000,000
MV: $980,000

Cost: $1,000,000
MV: $980,000

Cost: $1,000,000
MV: $1,050,000

Trading stock item 1

Opening value:$900,000
MV: $500,000

Opening value (based on previous closing value):$500,000
MV: $300,000

Opening value (based on previous closing value):$300,000
MV: $150,000

Trading stock item 2

Opening value:$1,500,000
MV: $1,000,000

Opening value (based on previous closing value):$1,500,000
MV: $1,200,000

Opening value (based on previous closing value):$1,500,000
MV: $500,000

Trading stock item 3

Opening value:$600,000
MV: $800,000

Opening value (based on previous closing value):$600,000
MV: $550,000

Opening value (based on previous closing value):$600,000
MV: $400,000

[CB = cost base; RCB = reduced cost base; MV = market value]
Sections 165-115U, 165-115V and 165-115W would apply in the following way to determine Mineral Co's adjusted unrealised loss at each of the alteration times.
  1st Alteration time 2nd Alteration time 3rd Alteration time
Asset 1 (CGT only) Notional capital loss: $100,000 Notional capital loss: $100,000

($200,000 - $100,000)

Notional capital loss: $80,000

($280,000 - $200,000)

Asset 2 (CGT only) Notional capital loss: $50,000 No notional capital loss. Notional capital loss: $50,000

($100,000 - $50,000)

Asset 3 (Revenue asset) Notional revenue loss: $20,000 No notional revenue loss. No notional revenue loss.
Trading stock item 1 Trading stock decrease: $400,000 Trading stock decrease: $200,000 Trading stock decrease: $150,000
Trading stock item 2 Trading stock decrease: $500,000 No trading stock decrease: nil

($300,000 - $500,000)

Trading stock decrease: $500,000

($1,000,000 - $500,000)

Trading stock item 3 No trading stock decrease. Trading stock decrease: $50,000 Trading stock decrease: $150,000

($200,000 - $50,000)

Nominal unrealised loss $170,000 $100,000 $130,000
Overall trading stock decrease $900,000 $250,000 $800,000
Adjusted unrealised loss $1,070,000 $350,000 $930,000

1.116 A loss company is taken not to have an adjusted unrealised loss if it meets the maximum net asset value test (section 152-15); that is, if the net value of its CGT assets, together with the net value of the CGT assets of any connected entities, is $5 million or less. For this purpose the Subdivision adopts the meaning of 'connected entity' used in section 152-30 (in the CGT small business relief provisions). For entities with net assets less than this threshold, any reductions are based on the loss company's realised losses only. [Schedule 1, item 18, subsection 165-115U(2)]

A relevant equity or debt interest

1.117 Reductions are made under Subdivision 165-CD to the values for tax purposes of interests that are part of a relevant equity interest or a relevant debt interest in the loss company.

1.118 In broad terms a relevant equity or debt interest is present where an entity or an entity and its associates have a controllingstake in the loss company and the entity has a minimum equity or debt interest in the loss company. [Schedule 1, item 18, sections 165-115X and 165-115Y]

1.119 Adopting a test which requires an entity to have not only a minimum interest but also a controlling stake ensures that the entity will not have to adjust an interest in a loss company which the entity or the entity and its associates do not control.

1.120 In the Treasurer's Press Release No. 74 (Attachment E) of 11 November 1999 it was announced that the inter-entity measures would apply to equity interests of at least 10% in the loss company and to all debt interests in the loss company.

1.121 Significant concerns were raised about this approach. Compliance costs and other difficulties associated with the proposal were put forward. The position of entities with minority interests in the loss company was of particular concern. Many such entities may have limited access to information relevant to the application of these measures. This could put them at a disadvantage compared to majority holders.

1.122 As a result of these concerns the measures now apply as described above. The significant change is that an entity must have a controlling stake in the loss company before reductions can be made to the tax values of its interests in the company. This overcomes many of the concerns raised.

What is a 'controlling stake'?

1.123 The test for a 'controlling stake' in a company is based on the 'linked group' test found in section 170-260 of Subdivision 170-D. An entity will have a controlling stake in a loss company if the entity or the entity and its associates have a greater than 50% stake in the voting power, rights to dividends, or rights to distributions of capital of the loss company. Control can be direct or indirect through one or more interposed entities. [Schedule 1, item 18, subsection 165-115Z(1)]

1.124 If an entity has a controlling stake in a loss company in its own right, associates of that entity will also have a controlling stake in the loss company irrespective of whether they independently have such a stake.

1.125 'Associate' is defined in section 318 of the ITAA1936. An individual may be an associate in applying the controlling stake test, although the interests of individuals are not adjusted under this Subdivision.

1.126 To prevent double counting, where an entity has an indirect interest in the loss company through an associate which has a direct interest, only the direct interests are to be counted. [Schedule 1, item 18, subsection 165-115Z(2)]

Example 1.8

Example 1.8 What is a 'controlling stake'?

Company A and its associate Company B have a 70% controlling stake in Company C. Company A has both a direct and an indirect interest in Company C.To prevent double counting interests in Company C only direct interests are counted. Company A's indirect interest in Company C, through its shareholding in Company B, is disregarded.

When does an entity have a relevant equity interest in a loss company?

1.127 An entity will have a relevant equity interest at a time if the entity has at that time:

a controlling stake in a loss company; and
equity that gives (directly, or indirectly through one or more interposed entities):

-
control of, or the ability to control 10% or more of the voting power in the loss company; or
-
the right to receive 10% or more either of any dividends or of any distributions of capital that the loss company may pay.

[Schedule 1, item 18, paragraphs 165-115X(1)(a) and (b)]

1.128 The equity must be either:

an interest in the loss company, including a share or shares, or an option or right to acquire a share or shares, in the loss company, or
an interest, including an option or right to acquire an interest, in another entity which has a relevant equity interest or relevant debt interest in the loss company.

[Schedule 1, item 18, paragraph 165-115X(1)(c)]

1.129 Subdivision 165-CD is intended to apply to both direct and indirect equity interests in the loss company. An equity interest for these purposes includes membership interests in entities (e.g. shares or units or interests in fixed trusts) and is extended to include options or rights to acquire such interests.

1.130 The entity's relevant equity interest in the loss company at a particular time is made up of this equity or equities. [Schedule 1, item 18, subsection 165-115X(2)]

1.131 A special rule exists to allow the relevant equity interests of some entities ('the subject entity') to be taken not to be relevant equity interests [Schedule 1, item 18, subsection 165-115X(3)] . Certain trusts and superannuation funds will be covered by this rule.

1.132 The exception will apply where, at the relevant time, no entity (including an individual) with an interest held directly or indirectly in a potentially affected entity could obtain a capital loss or deduction reflecting any part of the loss company's overall loss, and no entity (whether still holding an interest in the potentially affected entity or not at the relevant time), has obtained or becomes entitled to such a capital loss or deduction in respect of an interest in the entity. [Schedule 1, item 18, section 165-115X(3) and (4)]

1.133 If the potentially affected entity can show that no one has obtained or become entitled to a capital loss or deduction that reflects any part of the loss company's overall loss, and no one could make a capital loss or deduction at a later time that reflects it, then that entity will not have a relevant equity interest.

1.134 In relation to the obtaining of a capital loss or a deduction at a later time, it will be enough if the potentially affected entity can show that, for example, the market values of the interests unrealised immediately before the relevant time have never been impacted by the company's losses. For example, a fully secured bank loan owed by the entity, with a market value not less than its face value at the relevant time, may be shown not to have been affected by a company's losses.

1.135 Most potentially affected entities would find it difficult to show that no interest held directly or indirectly in them (at any time) has duplicated, or is capable of duplicating, at any time, the company's losses. However, it is expected that this would be feasible for solvent superannuation funds and non-fixed trusts, and for similar entities without realisable fixed interests.

What is a relevant debt interest in a loss company?

1.136 A relevant debt interest exists at a time if an entity has a controlling stake in the loss company and the entity:

is owed a debt of $10,000 or more, or a number of debts some of which are $10,000 or more by the loss company; or
is owed a debt of $10,000 or more, or a number of debts some of which are $10,000 or more by a debtor entity (not the loss company), and the debtor entity has a relevant equity or debt interest in the loss company.

[Schedule 1, item 18, subsections 165-115Y(1) and 165-115Y(2)]

1.137 The total of the debt or debts of $10,000 or more makes up the entity's relevant debt interest in the loss company. [Schedule 1, item 18, subsection 165-115Y(3)]

1.138 A special rule also exists to allow the relevant debt interests in a loss company held by certain entities to be taken not to be relevant debt interests [Schedule 1, item 18, subsection 165-115Y(4) and (5)] . The rule operates in the same way as it does for relevant equity interests (see paragraphs 1.131 to 1.135).

Example 1.9 Company A owns 60% of Company D (a loss company). Company A also owns 20% of Company B and 80% of Company C. Company C has a $20,000 loan outstanding to Company B and Company D has a $20,000 loan outstanding to Company C. Company B is not an associate of Company A or Company C.

Example 1.9

Company A's shares in Company D are part of a relevant equity interest. This is because Company A has a controlling stake in Company D and the right to more than 10% of any dividends or distributions of capital from Company D.Company C's loan of $20,000 to Company D is a relevant debt interest. This is because the debt is greater than $10,000 and Company C has a controlling stake in Company D (because it is an associate of Company A).Company B does not have a relevant equity or debt interest in Company D. It does not have a controlling stake in Company D (not being an associate of Company A or Company C).Company A's shares in Company C are part of a relevant equity interest. This is because Company A has a controlling stake in Company D and the right to more than 10% of any dividends or distributions of capital by Company D. Company A also has a direct interest in Company C which has a relevant debt interest in Company D.

Making reductions for interests held in the loss company

1.139 Having determined that an affected entity has a relevant equity interest or relevant debt interest (or both) in a loss company that has had an alteration, it is necessary to determine what reductions to the values for tax purposes of those interests are appropriate to prevent loss multiplication.

1.140 What kinds of reductions are required, and when they are required, is set out in one section [Schedule 1, item 18, section 165-115ZA] . The methods for calculating the actual reduction amounts are set out in the following section [Schedule 1, item 18, section 165-115ZB] .

Kinds of reduction required: CGT and deductions on revenue assets

1.141 Reductions are to be made to:

the reduced cost bases of equity or debt acquired after 19 September 1985 [Schedule 1, item 18, subsection 165-115ZA(3)] ;
deductions the entity is entitled to in respect of the disposal of equity or debt which is not trading stock of the entity [Schedule 1, item 18, subsection 165-115ZB(4)] .

1.142 The first kind of reduction prevents the obtaining of a capital loss that represents a multiplication of the loss in the loss company. The reduction takes effect immediately before the alteration time. The second kind of reduction deals with the disposal of an asset that is not trading stock of the affected entity, but for which a net profit on sale is, or would be, returned as income, and a net loss on sale claimed as a deduction.

Application of the subdivision to equity or debt that is trading stock

1.143 If equity or debt is an item of trading stock of the affected entity immediately before an alteration time the item's cost for the purpose of the provisions of the ITAA 1997 dealing with trading stock may be reduced [Schedule 1, item 18, subsection 165-115ZA(5)] . The way reductions are made for trading stock reflects the fact that deductions are obtained in a different way than for non-trading stock CGT assets. See Appendix 1A. for a detailed discussion of the application of the Subdivision to trading stock.

Reversal of previous reductions, etc. in relation to debts subject to commercial debt forgiveness provisions

1.144 If, in respect of an alteration time, a reduction is required under this Subdivision in respect of a debt owed to a creditor, and there is, at the alteration time, or at a later time, a forgiveness of the debt (or another transaction attracting the commercial debt forgiveness provisions) any reductions required or other consequences that occur to the creditor are taken not to have been required or to have occurred. [Schedule 1, item 18, subsection 165-115ZA(2)]

1.145 An amendment can be made at any time to give effect to this reversal. [Schedule 1, item 66, subsection 170(10AA) of the ITAA 1936]

Example 1.10 X Co capitalised Y Co post-CGT with 2 $1 shares and a $98 loan. Y Co has a $98 carry-forward tax loss and is worth $2. X Co transfers its shares to Z Co (triggering an alteration time) and forgives the debt (worth $2) all in exchange for $2 from Z Co. Under Subdivision 165-CD, the reduced cost base of the debt (and any deductions in respect of its realisation) would be reduced by $96. On its forgiveness, no capital loss or deduction would arise.Under the commercial debt forgiveness provisions, the forgiveness of the debt would usually result in a gross forgiven amount of $96 and a reduction to Y Co's (the debtor's) tax loss by the same amount. However, this tax loss has already been used as the basis of the reductions under Subdivision 165-CD to the tax attributes of the debt. It is not appropriate that Subdivision 165-CD and the commercial debt forgiveness provisions combine in this way.Thus, if the commercial debt forgiveness provisions apply to the debt, the reduction to its reduced cost base and to deductions in respect of its realisation would be taken not to have been made. This means that a capital loss or deduction of $96 would become available to Y Co on the forgiveness of the debt.

Calculation of the reduction

1.146 Loss multiplication is prevented by affected entities making the reductions discussed above. Reductions must be worked out by the affected entity for its relevant debt and equity interests in the loss company. The amounts of the reductions are called adjustment amounts.

1.147 There are 2 methods for working out the adjustment amount. The first method uses a formula. The second method looks at what is the appropriate reduction given several factors. [Schedule 1, item 18, subsections 165-115ZB(3) and 165-115ZB(6)]

1.148 The loss company's overall loss at the alteration time is relevant to both methods. It provides a measure of the maximum level of multiplication that can occur for a relevant debt or equity interest.

1.149 The formula method will apply where immediately before the alteration time the entity:

only has a share or shares (a relevant equity interest) in the loss company and the company's equity consists of shares of one class with the same market value; or
has a share or shares (a relevant equity interest) and a relevant debt interest in the loss company. The company's equity must consist only of shares, and only of one class of shares with equal market value. The debt or debts must be owed by the loss company, and be of the same kind where there are 2 or more debts.

[Schedule 1, item 18, subsection 165-115ZB(2)]

1.150 Debts are of the same kind where, for example, they have broadly the same terms, conditions and rights. Such debts may be said to be of the same class. Because the debts are of the same kind, any fall in value of the company would be likely to affect each debt to the same extent.

1.151 The formula method apportions the overall loss of the loss company over equity and debt of the same kind. If the formula method does not produce a reasonable outcome, bearing in mind the Subdivision's object of preventing loss multiplication, then the entity must use the non-formula method to work out the adjustment amount. The non-formula amount must be used if the formula amount would result in an adjustment amount that is greater or less than would be reasonable in the circumstances. [Schedule 1, item 18, subsection 165-115 ZB(2)]

Example 1.11 Takeover Co has held 15% of the shares in Target Co for some years. On 1 February 2000 it acquires a further 40% of Target's shares for their market value at that time. Target Co has a carried-forward tax loss of $200. On 3 March 2000 (an alteration time) Takeover Co acquires an additional 40% interest in Target Co. At this alteration time Target Co still has an overall loss of $200.Takeover Co has a controlling stake in Target Co immediately before the alteration time. If the formula were applied, the $200 loss would be applied to make equal reductions to the reduced cost bases of each of Takeover Co's existing shares. This would not be appropriate, as the price Takeover Co paid for the 40% interest acquired on 1 February 2000 would already reflect the $200 loss. The non-formula method would be used in this case.

Formula method

1.152 Under this method an entity will calculate the adjustment amount according to the formula:

(The entity's number of shares making up its relevant equity interest immediately before the alteration time / The total number of shares in the loss company immediately before the alteration time) * The amount of the loss company's overall loss at the alteration time

[Schedule 1, item 18, subsection 165-115ZB (3)]

1.153 The adjustment amount is applied equally among the shares making up the equity. Any excess remaining after the reduced cost base or other tax attribute of a share is reduced to nil, is applied equally to other shares to the extent possible [Schedule 1, item 18, subsection 165-115ZB(4)] . If the entity also has a debt or debts owed by the loss company, then any remaining adjustment amount is applied to these [Schedule 1, item 18, paragraph 165-115ZB(3)(b)] . The remaining adjustment amount is the part of the adjustment amount which is not used in reducing the reduced cost bases, deductions or trading stock values of the equity.

Example 1.12 Immediately before an alteration time, Holding Co owned 60% of the 100 shares in Loss Co (the only class of shares). The reduced cost base of Holding Co's shares was $50 (per share). Also, Loss Co had a $15,000 loan outstanding to Holding Co (being the only debt owed by the company). At the alteration time, Loss Co had an overall loss of $20,000.The adjustment amount calculated under the formula method in relation to the shares is as follows:

(60/100) * $20,000 = $12,000 (or $200/share)

As the reduced cost base per share is only $50, the excess of $9,000 (60 $150) is offset against the reduced cost bases of the relevant debt interest as follows:

$15,000 * $9,000 = $6,000

1.154 The tax attributes of equity are adjusted before debt on the basis that losses of the loss company affect the market value of equity before they affect the market value of debt. However, if the reductions that the formula produces are unreasonable having regard to the Subdivision's object of preventing loss multiplication, then the formula does not apply.

1.155 Where there is more than one debt the adjustment amount, or part of it, to be applied to each debt is calculated according to the following formula.

[Schedule 1, item 18, subsection 165-115ZB(5)]

Non-formula method

1.156 This method is to be used in all cases where the formula method cannot apply, or it gives an unreasonable result. The non-formula method asks what is the appropriate reduction taking into account a series of factors . The adjustment amount is to be applied in making reductions to the tax attributes of equity and debt in an appropriate way. [Schedule 1, item 18, subsection 165-115ZB(6)]

1.157 The non-formula method provides a flexible means for dealing with the many different situations which can arise.

1.158 The factors to be considered are:

the objects and purpose of the Subdivision. Reductions are required only to achieve the object and purpose of the Subdivision which is to prevent loss multiplication;
the extent of the entity's relevant equity or debt interests in the loss company immediately before the alteration time;
the time and circumstances of the entity's acquisition of the relevant equity or debt interests. For example, losses arising before the interest was acquired would not normally be capable of being multiplied on realisation of the interest and can be disregarded in determining what is an appropriate reduction;
the loss company's overall loss. This sets the maximum reduction that would be required in respect of any interest;
the extent to which the overall loss has reduced the market values of the equity or debt when that loss was suffered, or components of that loss were suffered, as the case may be. If part or all of the overall loss has not had an impact on the market values of the equity or debt, it follows that losses cannot be multiplied on their realisation; and
the extent of any reductions required by Subdivision 165-CD in respect of another loss company in which the entity has a relevant equity or debt interest. This factor prevents more than one reduction being made to debt or equity in respect of the same realised or unrealised loss. (Example 1.13 gives an illustration of this 'double counting factor').

[Schedule 1, item 18, subsection 165-115ZB(6)]

Example 1.13 Takeover Co acquired 60% of the shares in Target Co in March 1996. In June 1998 it acquired a further 10% of Target Co. Takeover Co sells its 70% interest on 22 February 2000. Takeover Co has a relevant equity interest of 70% in Target Co immediately before the alteration time.At the alteration time Target Co has an overall loss of $300,000 comprising:

1997 tax loss - $100,000; and
1999 net capital loss - $200,000

The price paid by Takeover Co for the shares it acquired in June 1998 reflected the tax loss in Target Co at that time.It would not be reasonable to apply the formula method to Takeover Co's 10% interest acquired in 1998. There would be no multiplication of the 1997 tax loss on disposal of this interest.Having regard to the listed factors in the non-formula method, it would be reasonable to apply the following adjustment amounts to Takeover Co's interests in Target Co:

60% interest acquired in 1996: 60/100 * $300,000 = $180,000; and
10% interest acquired in 1998: 10/100 * $200,000 = $20,000.

1.159 In looking at the effect of the overall loss on the market value of an equity or debt, the effect of other factors on the value of the equity or debt must be removed. The extent of any reduction in the market value of an equity or debt because of the overall loss must be determined as if any other factor had not occurred. [Schedule 1, item 18, subsection 165-115ZB(7)]

Example 1.14 The shares in Little Co had a total market value of $1,000,000 at 1 June 1998. The market value consisted of the value of the company's goodwill ($100,000), statutory licence ($300,000) and cash reserves ($600,000) at that time.During the 1999 income year Little Co traded unprofitably and made a $500,000 economic tax loss for the year. The market values of the goodwill and licence increased by a total of $600,000 over the income year.Little Co has an alteration time on 30 May 2000 when Big Co acquires all of the shares in Little Co. At this time the company had an overall loss of $500,000 (being the tax loss from the previous year).At the alteration time, the market value of Little Co is $1.1 million. This is made up as follows:

goodwill $ 600,000
statutory licence $ 400,000
cash reserves $ 100,000
$1,100,000
It may be argued that as the market value of the shares in Little Co did not decrease over the period in which the tax loss was incurred, there should be no adjustment amount. The overall loss cannot be duplicated.However, when the make-up of the market value of the shares in Little Co is examined it can be seen that the tax loss (reflecting the reduction in cash reserves) has reduced their market value by $500,000. The effect of the increase in values of the goodwill and statutory licence must be removed in applying these provisions.It is appropriate to make reductions to the reduced cost bases of shares in Little Co in these circumstances.

1.160 The double counting factor is to stop the tax attributes of equity or debt being adjusted more than once in respect of the same realised and unrealised losses. Usually, the mechanics of the Subdivision itself will prevent double counting occurring but the double counting factor provides additional protection should this not happen. These points are illustrated in Example 1.15.

Example 1.15

Example 1.15 Non-formula method

Harold Co owns the 2 shares issued in Jack Co, which holds the 2 shares on issue in Loss Co. The shares are held on capital account. The total reduced cost bases for each of Harold Co and Jack Co's holdings of shares is $400,000. Jack Co has no realised losses and Loss Co has a $200,000 realised tax loss.Harold Co sells its shares in Jack Co for their market value of $200,000. This causes an alteration time to occur in respect of both Jack Co and Loss Co.Loss Co is a loss company at the alteration time with a carry-forward tax loss of $200,000. Harold Co and Jack Co both have a relevant equity interest in Loss Co, and the reduced cost base of Jack Co's shares in Loss Co and Harold Co' s shares in Jack Co, would be reduced by $200,000 immediately before the alteration time in respect of Loss Co. Thus, Harold Co would not make a capital loss on its disposal of shares in Jack Co.As noted above, the sale by Harold Co would also trigger an alteration time for Jack Co. As Jack Co has no realised losses, and the only assets it owns are its shares in Loss Co, it would not be a loss company.The unrealised loss of $200,000 (reduced cost base $400,000 less market value $200,000) it had on its shares in Loss Co would have been eliminated immediately before Jack Co's alteration time by the reduced cost base reduction of $200,000 resulting from the alteration time happening to Loss Co (see subsection 165-115ZA(3)). So at Jack Co's alteration time, it is not a loss company, having no adjusted unrealised loss (and no overall loss) at that time.In this case there would not be a further (and inappropriate) reduction to the reduced cost base of Harold Co's shares in Jack Co of $200,000 which would 'double count' the effect of Loss Co's economic loss.In most cases, the mechanics of the Subdivision will prevent the double counting of realised and unrealised losses where there is an alteration time that is the same time for a chain of companies.In general, if companies are taken in order from the lowest tier to the highest tier in determining whether they are loss companies and in making the required reductions, this will eliminate unrealised losses on intra-group interests and either prevent higher tier companies from being loss companies or reduce what would otherwise be their overall loss.However, if there are cases where this approach, and the mechanics of the Subdivision, do not eliminate double counting, a specific factor to eliminate double counting is included in the Subdivision.

[Schedule 1, item 18, paragraph 165-115ZB(6)(f)]

Notices

1.161 If an alteration time occurs in respect of a loss company, a controlling entity (other than an individual) with a controlling stake in its own right in the loss company immediately before the alteration time is required to provide a written notice to its associates who, to its knowledge, have relevant equity or debt interests in the loss company. The information in the notice will assist the associates in making the reductions required by this Subdivision. [Schedule 1, item 18, subsections 165-115ZC(2) and 165-115ZC(4)]

1.162 In determining whether an entity has a controlling stake, direct and indirect interests are to be counted, but those held by associates are to be disregarded.

1.163 If more than one entity has a controlling stake disregarding associates (e.g. the entities are in a 'chain') the entity in which no other entity (except individuals) has a controlling stake is treated as the controlling entity for the purposes of providing notices. However, if a non-resident entity would otherwise be the controlling entity, and there is a resident entity that would (but for the non-resident) be a controlling entity, the resident entity is taken to be the controlling entity. This ensures that in such cases notices are to be provided by the resident holding company. [Schedule 1, item 18, subsection 165-115ZC(2) and subsection 165-115ZC(3)]

1.164 The notices must be provided within 6 months after the later of the alteration time or the day on which the Act containing this requirement receives Royal Assent. There is a penalty of 30 penalty units for failing to comply with the notice requirements.

1.165 The loss company may be required to provide notices to entities which, to its knowledge, have relevant equity or debt interests in it. This requirement applies if the loss company does not receive within 2 months of the alteration time (or, if later, the day on which the Act containing this requirement receives Royal Assent) written advice from a controlling entity that it will give, or has given, the relevant notices (as discussed above). This may occur if there is no controlling entity, or there is such an entity and it fails to notify the loss company of its intention to give the notices. [Schedule 1, item 18, section 165-115ZC(5)]

1.166 The loss company must provide the notices within 4 months of the 2 month period expiring. There is a penalty of 30 penalty units for failing to comply with the notice requirements. [Schedule 1, item 18, subsection 165-115ZC(5)]

1.167 The notice must include the following information:

the alteration time;
the amount of the loss company's overall loss at the alteration time;
the type, amount and income year of each tax and net capital loss in the loss company's overall loss;
the amount of the loss company's adjusted unrealised loss; and
details of relevant equity and debt interests held by other entities and through which the associate holds its relevant equity or debt interests in the loss company. The details must allow the associate to comply with the Subdivision. Sufficient details of the amounts, proportions, and times of acquisition of the relevant equity and debt interests of the other entities must be included.

[Schedule 1, item 18, subsection 165-115ZC(6)]

Example 1.16

Example 1.16 Notice

Company D had an alteration time when Company A and Company C sold their shares in it on 12 December 1999. Company D is a loss company at the alteration time.Company A had a controlling stake in Company D in its own right immediately before the alteration time. As a result, Company A has an obligation to provide certain information to its associates who have relevant equity interests in Company D. Company B and Company C have relevant equity interests in Company D.The overall loss of Company D at the alteration time was:
1997 net capital loss $100,000
1998 tax loss $200,000
adjusted unrealised loss $100,000
$400,000
Company A will need to provide Company B and Company C with notices containing the following information:

alteration time: 12 December 1999;
Company D's overall loss: $400,000; and
a breakdown of the overall loss (as shown above).

In addition, Company A will need to provide Company B with the following details of Company C's shares in Company D, for example:

number of shares: 15;
proportion of shares: 15%; and
time of acquisition: 1 May 1996.

1.168 An entity is not required to provide information it does not know, unless that information could reasonably be expected to be known by the entity and the entity could readily obtain it. [Schedule 1, item 18, subsection 165-115ZC(7)]

1.169 The fact that an entity does not receive a notice from a controlling entity, or from the loss company itself, does not absolve the entity from complying with the requirements of this Subdivision. [Schedule 1, item 18, subsection 165-115ZC(8)]

1.170 A pro-formafor a notice is contained in Appendix 1B.

Detailed example illustrating the operation of the Subdivision

1.171 A detailed example illustrating the operation of this Subdivision in a less straightforward case is included in Appendix 1C.

Application and transitional provisions

1.172 There are no transitional provisions relating to this measure.

Consequential amendments

1.173 A consequential amendment is made to Subdivision 170-C (about cost base and reduced cost base reductions following the transfer of losses within wholly-owned groups of companies) to prevent a double reduction to a reduced cost base under Subdivision 165-CD and Subdivision 170-C if the company's loss on which the Subdivision 165-CD reduction was based, is later transferred. [Schedule 1, items 38 and 49, paragraphs 170-210(3)(ba) and 170-220(3)(ba)]

1.174 The table of modifications to cost base and reduced cost base because of provisions outside the CGT provisions (Parts 3-1 and 3-3 of the ITAA 1997) is updated to include the reductions to reduced cost base required by this Subdivision. [Schedule 1, item 1, section 112-97, new item 12A]

Appendix 1A

Application of the Subdivision to equity or debt that is trading stock

1A.1 If an equity or debt is an item of trading stock of the affected entity immediately before an alteration time, and its cost exceeds its market value at that time (the excess), its cost for Division 70 purposes and any deductions for outlays incurred to acquire the trading stock are reduced by an amount not exceeding the excess [Schedule 1, item 18, subsection 165-115ZA(5)] . The purpose of the restatement is to prevent inter-entity loss duplication where the inter-entity interest is trading stock.

1A.2 The reductions apply only for the purposes of calculating deductions under section 8-1 or deductible or assessable amounts for the purposes of section 70-35 in respect of income years ending after the later of the commencement time and the time 12 months before the relevant alteration time. [Schedule 1, item 18, subsection 165-115ZA(6)]

1A.3 If a company has elected something other than cost as the closing value for an item to which a restatement of cost applies in the period referred to above, the company may re-elect cost [Schedule 1, item 18, subsection 165-115ZA(7)] . This ensures that the company does not have to return an inappropriate amount of assessable income, for example, where the company has previously elected market selling value as its closing value.

1A.4 The reason for the special treatment of trading stock is the way that deductions are obtained on items of trading stock under the ITAA 1997.

1A.5 Broadly, an entity can deduct the outlay to purchase an item of trading stock under section 8-1. If the item falls in value and is sold for less than cost before the end of the year of income, the deduction for the purchase and the assessable income returned effectively allows a 'net deduction' for the 'loss'.

1A.6 If, however, the item is on hand at the end of the year of income, the entity must value it (give it a closing value) for the trading stock provisions. Under those provisions, if the total closing values of items on hand at the end of the income year exceeds the total value of items on hand at the beginning of the year (items bought during the year have a 'nil' opening value), the excess is assessable. If the total value of items at the beginning exceeds the total value of items at the end, the excess can be deducted.

1A.7 Thus, if an entity had one item only of trading stock purchased during the year, and elected to use cost as a closing value, the deduction for the item's purchase price would be offset by the inclusion of assessable income equal to its cost. No 'loss' is claimed up to this point. However, if its market selling value is less than cost, and the entity elects market selling value at the end of the year of income, the entity will effectively recognise the difference (the 'loss') in that year of income.

1A.8 Subdivision 165-CD seeks to disallow recognition of this 'loss' to the extent that it duplicates the underlying losses of the loss company that has had an alteration time. By reducing deductions for the purposes of section 8-1 and by reducing the cost of the trading stock item under Division 70 at all times and in all respects (subject to a further reduction at a later time under this provision), the entity is effectively prevented from 'deducting' the loss.

1A.9 The reductions are taken to occur only for the purposes of determining deductions and differences between total closing stock and opening stock values for years of income ending after 12 months before the alteration time. That is, the reduction applies only for the purposes of determining deductions, and an item's opening or closing value in a year of income that ends within 12 months before the alteration time, or in a year of income after the alteration time.

1A.10 The effect of this is that, if an item of trading stock (consisting of an equity or debt) was valued at cost for a year of income ending less than 12 months before the alteration time, that value is reduced in calculating the item's opening or closing value for that year. This prevents the entity from deducting the duplicated loss. However, if the trading stock (the equity or debt) was valued at its market selling value in an earlier year, the entity has already deducted the duplicated loss or a part of it before the relevant 12 month period and Subdivision 165-CD will not disturb that deduction. This is consistent with the treatment given to non-trading stock assets under this Subdivision.

1A.11 Once an item's cost has been reduced, the reduction continues to apply where the entity chooses 'cost' as its closing value at the end of any later year of income. An entity is also allowed to re-elect cost as a closing value during the period for which the reduction to cost occurs.

Example 1A.1 A 100% equity interest in a loss company that is an item of trading stock is acquired for $10,000 when the overall loss of the loss company is $20,000.The loss company makes a further loss of $6,000 during the next year. An alteration time then occurs, and at the time immediately before the alteration, the stock has a market selling value of $4,000 which fully reflects the further loss.The duplicate (net) deduction of $4,000 could be realised by sale or by adopting a market selling value as a closing value. That is, if the stock's opening value was cost ($10,000) and its closing value for Division 70 purposes were market selling value ($4,000), a (net) deduction of $6,000 ($10,000 - $4,000) would arise which multiplies the loss already recognised in the loss company in respect of this amount.What the measure does is reduce the cost of the item for Division 70 (and its purchase deduction) to $4,000. This effectively reverses a deduction of $6,000 for a duplicate loss.

Example 1A.2 X Co acquired an interest in a loss company being an item of trading stock for $10 million. At the first alteration time in the following income year, it had a market value of $6 million. The decrease in market value reflected the overall loss of the loss company. X Co had elected market selling value of $8 million as its last closing value. At the first alteration time, the company's purchase deduction would be reduced to $6 million under section 8-1. However, unless X Co were able to re-elect its closing value, it would record a (net) income of $2 million for that year [$6 million deduction for purchase and $8 million (difference between closing and opening value (taken to be nil))]. This is inappropriate. X Co is therefore allowed to re-elect cost which ensures that no 'net' income is returned for that year.

Asset becoming an item of trading stock after the alteration time

1A.12 The Subdivision also deals with a case where a relevant debt or equity interest was not an item of trading stock immediately before an alteration time but later becomes one and, had it been trading stock at that time (or an earlier alteration time), its cost would have exceeded its market value. [Schedule 1, item 18, subsection 165-115ZA(9)]

1A.13 Under Division 70, the entity has the option of choosing to bring the asset into the trading stock provisions at either cost or market value. Even though the Subdivision has prevented the multiplication when the asset was not an item of trading stock, the ordinary Division 70 rules would allow the item to be recorded at actual cost, which reflects the multiplied loss.

1A.14 This multiplied amount could then inappropriately be obtained as an effective deduction through the operation of Division 70. It is therefore provided that, for the purposes of Division 70 only, the cost of such an asset is taken to be its market value immediately before the alteration time, or if cost has exceeded market value at more than one time, the smallest of its market values at these times. [Schedule 1, item 18, subsection 165-115 ZA(9)]

Reduction of proceeds of disposal of trading stock

1A.15 This Subdivision prevents the multiplication of a company's losses on inter-entity interests which themselves generate 'losses'. The Subdivision does not address reduced gains on the disposal of such interests even though the company's loss may have impacted on the value of the interests and resulted in a smaller gain on disposal than would otherwise have been the case.

1A.16 In the case of trading stock, it is possible that upon realisation the disposal proceeds may exceed what was, or would have been, the market value of the stock, on which a reduction was based, immediately before an alteration time. That is, a net gain may actually be realised on the realisation of the trading stock relative to the position at the time immediately before the alteration on which the anti-multiplication reduction was based.

1A.17 To ensure that trading stock is not treated differently under this measure from non-trading stock assets, where the proceeds of disposal of the equity or debt exceeds its market value immediately before an alteration time, the proceeds are reduced to the extent of a reduction, or reductions, previously made to its cost under subsection 165-115ZA(5).

1A.18 The reduction to the proceeds is not to exceed the excess of the proceeds of disposal of the equity or debt over its market value immediately before the alteration time, or the greatest excess (if more than one). [Schedule 1, item 18, subsection 165-115ZA(10)]

1A.19 This has the effect of ensuring that assessable income is reduced to the extent that the earlier anti-multiplication reduction is found, on ultimate disposal of the trading stock, to have been excessive.

Example 1A.3 A relevant debt or equity interest that is trading stock immediately before the alteration time has an opening value (based on cost) of $20,000 and a market value of $10,000. The company in which the interest is held has an overall loss of $10,000 which is fully reflected in the market value of the trading stock and duplicates it.The effect of the reduction provisions is that the cost of the trading stock is reduced to $10,000 and its deduction on purchase is reduced to the extent it reflects and duplicates that loss i.e. by $10,000.Sometime later, the trading stock is sold for $20,000. But for the reduction to its deduction, the holder of the trading stock would normally be assessed on $20,000 and, having been allowed a deduction for $20,000 under the trading stock provisions, the net effect would be a nil amount of 'income' or 'gain'.However, because of the reduction, a net amount of $10,000 income would be recognised. This is inappropriate because the trading stock cost $20,000 and was sold for $20,000.A compensating adjustment is required because $10,000 more than the unrealised market value of the stock immediately before the alteration time has ultimately been realised. The sale proceeds are therefore reduced to $10,000.If the stock were sold for $45,000 instead of $20,000, the sale proceeds would also be reduced by $10,000 to $35,000. In net terms, the holder would be appropriately 'assessed' on $25,000.

Appendix 1B

Pro-forma notice satisfying the requirements of section 165-115ZC

Pro-forma notice

Notes:
1.
If the recipient entity holds its relevant equity and/or debt interest directly in the loss company, disregard paragraphs (3) and (4).
2.
If the entity through which the recipient entity holds its relevant equity and/or debt interest (i.e. the interposed entity) does not hold its interest directly in the loss company, then the information in paragraphs (3) and (4) must be provided in relation to each interposed entity.
3.
The 'other relevant information' heading in paragraphs (3) and (4) is for information which needs to be taken into consideration when determining the impact of the losses on the market value of the above equity and debt interests (e.g. dividend rights and priority of debts).
4.
Where the company is a loss company at a second or later alteration time in the same income year, disregard subparagraphs 2(a) and (b).

Appendix 1C

Detailed example

1C.1 Alpha Co was incorporated in 1993. The structure of Alpha Co is as follows:

Beta Co has a 60% ordinary shareholding acquired in 1993 for $6 million. Market value of the shares at 5 September 2000 is $3.6 million.
Gamma Co (with a wide range of investments) has a 60% ordinary shareholding in Beta Co acquired on 1 July 1993 for $4.8 million. Market value of the shares at 5 September 2000 is $2.16 million.
Gamma Co has an 80% ordinary shareholding in Epsilon Co acquired in January 2000 for $7 million. Market value of the shares at 5 September 2000 is $6.5 million.
Epsilon Co (which has a wide range of investments) has a 40% ordinary shareholding in Beta Co acquired in 1995 for $2.304 million. Market value of the shares at 5 September 2000 is $1.44 million.
Epsilon Co also has a 10% ordinary shareholding in Delta Co (an overall profitable company) which it acquired in 1999 for $2 million. Market value of the shares at 5 September 2000 is $4 million.
Delta Co has a 5% ordinary shareholding interest in Alpha Co which it acquired in 1995 for $480,000. Market value of the shares at 5 September 2000 is $300,000.
Gamma (an individual) has a 100% beneficial ordinary shareholding in Gamma Co acquired in 1993 for $17 million. Market value of the shares at 5 September 2000 is $20 million.
Pi (an individual) has a 20% ordinary shareholding in Alpha Co acquired in 1993 for $2 million. Market value of the shares at 5 September 2000 is $1.2 million. Pi is Gamma's brother.
Zeta Co, a sharetrader, acquired a 15% ordinary shareholding interest in Alpha Co on 30 December 1999 for $1.17 million to sell at a profit if Alpha recovers. Market value of the shares at 5 September 2000 is $900,000. Zeta accounts for the trading stock at cost for tax purposes. Gamma is able to direct the activities of Zeta Co through an arrangement he has with the company that controls Zeta Co.

1C.1 flowchart Non-Participating , unbundle life insurance policies, where the liabilities are to be discharge from virtual PST assets

1C.2 All the shares are ordinary shares and 1% = 1 share. There are no inter-company debts.

1C.3 At 5 September 2000 Alpha Co has the following losses:

Table 1C.1
  1994 1997 1998 Current year
Tax losses $400,000 $900,000 ($300,000 of which are non-economic losses)    
Net capital losses     $1,200,000  
Current year tax loss       $1,000,000

1C.4 In addition, Alpha Co has an unrealised loss on an asset of $800,000 at 5 September 2000. This accrued during the notional income year 1 July 2000 to 5 September 2000.

1C.5 Consider what the position would be if on 5 September 2000:

Beta Co transferred its shares in Alpha Co to Gamma Co for their market value;
Beta Co sold the shares for their market value to an unrelated buyer;
Gamma Co transferred its shares in Beta Co to Gamma;
Gamma sells all his shares in Gamma Co to an unrelated buyer; or
What are the notice requirements in each of the above cases?

Beta Co transferred its shares in Alpha Co to Gamma Co for their market value

1C.6 Beta Co acquired the shares for $6 million and would sell them for $3.6 million. Apart from Subdivision 165-CD it would have a capital loss of $2.4 million.

Is there an alteration time?

1C.7 As a result of the sale of the shares, an alteration time occurs under section 165-115L. Although Gamma, through Gamma Co, continues to be able to control more than 50% of the voting power in Alpha Co, and to have rights to more than 50% of the company's dividends and capital distributions, he would not exercise that control or those rights through all the same interposed companies. Section 165-165 therefore applies and a change is taken to have occurred in the ownership of Alpha Co.

Is Alpha Co a loss company?

1C.8 Alpha Co is a loss company under section 165-115R, having prior year undeducted tax losses a prior year unapplied net capital loss at the beginning of the income year, a current year tax loss and an unrealised loss at the alteration time that has not been taken into account at a previous alteration time.

Are there relevant equity interests or relevant debt interests?

1C.9 Entities other than individuals had relevant equity interests in Alpha Co immediately before the alteration time. Beta Co had a controlling stake in its own right, since it held more than half of the ordinary shares in Alpha Co. The 60% shareholding it has is a relevant equity interest.

1C.10 Gamma Co is an associate of Beta Co under section 318(2) of the ITAA 1936 by virtue of the 60% of its ordinary shares it holds. Because of this associate relationship, Gamma Co is taken to have a controlling stake in Alpha Co. Through Beta Co it also has a relevant equity interest in Alpha Co, being a 36% indirect interest (60% 60%).

1C.11 Epsilon Co is an associate of Gamma Co, which holds the majority of its shares, under subsection 318(2) and through Gamma Co is also an associate of Beta Co. This gives Epsilon Co a controlling stake. By virtue of its shareholding in Beta Co, Epsilon Co has an interest of 10% or more indirectly in Alpha Co. It has a relevant equity interest in Alpha Co.

1C.12 Zeta Co might reasonably be expected to act in accordance with Gamma's directions and on this basis is associated with Gamma under subsection 318(1). Gamma, as owner of Gamma Co, is in turn an associate of Gamma Co. Because of this association, Zeta Co is also associated with Gamma Co. This gives it a controlling stake. Zeta Co's 15% ordinary shareholding interest in Alpha Co is also a relevant equity interest.

1C.13 Gamma's brother Pi is an associate of Gamma and therefore of Gamma Co. However, as an individual, Pi does not have a relevant equity interest in Alpha Co. Delta Co, having only a 5% interest in Alpha Co also does not have a relevant equity interest.

1C.14 Because there has been an alteration time in respect of the loss company Alpha Co and several entities have relevant equity interests in the company, Subdivision 165-CD applies to adjust the reduced cost bases of those equity interests. In Zeta Co's case, the shares held in Alpha Co are trading stock - their cost for the purposes of Division 70 and deductions in respect of outlays to purchase them are reduced under Subdivision 165-CD.

Adjustments to the values of relevant equity interests

1C.15 The following adjustments would be made in accordance with sections 165-115ZA and 165-115ZB.

Beta Co's 60% shareholding in Alpha Co

1C.16 Since this shareholding was acquired in 1993, all of the losses in Alpha Co were incurred during the period of Beta Co's share ownership. The overall loss in Alpha Co at the alteration time totals $4 million (the $300,000 non-economic loss incurred in 1996-1997 is disregarded because such a loss cannot be duplicated). The $4 million comprises the 1994 tax loss of $400,000, the 1997 tax loss of $600,000 (net of non-economic losses), the 1998 net capital loss of $1.2 million, the current year tax loss of $1 million, and the unrealised loss of $800,000.

1C.17 Applying the formula in subsection 165-115ZB(3), the adjustment amount is:

(60/100) * $4,000,000 = $2,400,000

1C.18 The reduced cost base of each of Beta Co's shares in Alpha Co would be reduced by:

$2,400,000 / 60 = $40,000

1C.19 The amounts are reasonable having regard to the object of the Subdivision, and so the formula result would stand.

Gamma Co's 60% shareholding in Beta Co

1C.20 This shareholding was also held throughout the whole period during which Alpha Co made its losses. The formula approach cannot be used because the interest in Alpha Co is indirect. Subsection 165-115ZB(6) applies in this case. Having regard to the matters listed, the reduced cost bases of Gamma Co's shares in Beta Co should be reduced by a total of:

(60/100) * (60/100) * $40,000,000 = $1,440,000

1C.21 The reduced cost base of each share would be reduced by $24,000.

Gamma Co's 80% shareholding in Epsilon Co

1C.22 The reduced cost bases of these shares must be adjusted because Gamma Co, through its association with Beta Co, also has a controlling stake in the loss company. However, Gamma Co acquired this interest in Epsilon Co in January 2000. Only $1.8 million of Alpha Co's overall loss arose after this acquisition date. The formula approach cannot be used because this is not a direct interest in Alpha and would not, in any case, produce a reasonable reduction. Applying the considerations in subsection 165-115ZB(6), the total adjustment amount is:

(80/100) * (40/100) * (60/100) * $1,800,000 = $345,600

1C.23 The reduced cost base of each share would be reduced by:

$345,600 / 80 = $4,320

Epsilon Co's 40% shareholding in Beta Co

1C.24 Epsilon Co acquired this shareholding in 1995. The adjustment to the reduced cost bases of the shares should not take into account Alpha Co's 1993-1994 tax loss of $400,000. Again the formula approach is not available, and the appropriate adjustment amount under subsection 165-115ZB(6) is:

(40/100) * (60/100) * $3,600,000 = $864,000

1C.25 The reduced cost base of each share would be reduced by:

$864,000 / 40 = $21,600

1C.26 No adjustment is made to the reduced cost bases of Epsilon Co's shares in Delta Co, as Delta Co does not have a relevant equity interest in Alpha Co.

Zeta Co's 15% shareholding in Alpha Co

1C.27 $1.8 million of Alpha Co's losses were incurred after Zeta Co acquired its shareholding. The formula in subsection 165-115ZB(3) should be considered first, but in this case would result in an inappropriate adjustment amount because it takes no account of the fact that not all Alpha Co's losses were made after Zeta Co acquired its shares. Considering then the matters in subsection 165-115ZB(6) an adjustment amount of $270,000 would be determined in respect of these shares. As the shares are trading stock of Zeta Co, the adjustment amount is applied to reduce the cost of the shares, for the purposes of Division 70, by $18,000 per share. Although Zeta Co had claimed a deduction for the $1.17 million purchase price of the stock in the 1999-2000 income year, it will have to reduce that deduction by $270,000 to $900,000. Its closing value for the 1999-2000 year and its opening value for the 2000-2001 years would also be reduced by $270,000 to $900,000.

Note 1: If Zeta Co had used market selling value (e.g. $1 million) as the closing value at the end of the 1999-2000 income year, then its cost would have been reduced by $270,000 to $900,000 as above. Without adjustment, this would cause Zeta Co to have assessable income of $1 million, leaving a net assessable position of Zeta Co of $100,000. This is inappropriate. Zeta Co is able to elect to value trading stock at its cost. Using the cost figure of $900,000 as the closing value, the assessable income of $900,000 offsets the revised cost of $900,000. The duplicate loss (based on a deduction for purchase of $1.17 million and market selling value on 5 September 2000 of $900,000) is eliminated.
Note 2: Subdivision 170-D may also apply to the transfer of Beta Co's shares in Alpha Co to Gamma Co. Subdivision 170-D will only operate if the conditions for its operation exist after making adjustments to the reduced cost bases of the transferred shares under Subdivision 165-CD.

Beta Co sold the shares for their market value to an unrelated buyer

Is there an alteration time?

1C.28 Following the sale of Beta Co's shares to an unassociated entity, Gamma would no longer have more than 50% of the voting power in Alpha Co, or the rights to more than 50% of any dividends or capital distributions Alpha Co might make. An alteration time has therefore occurred under section 165-115L.

Is Alpha Co a loss company?

1C.29 As before, Alpha Co has an overall loss under section 165-115R.

Are there relevant equity interests or relevant debt interests?

1C.30 Relevant equity interests and relevant debt interests are measured immediately before an alteration time. Immediately before the alteration time in this case companies had relevant equity interests in Alpha Co as set out in part (a) of this example. These same interests are adjusted if Beta Co sells its shares in Alpha Co to an unassociated entity.

Adjustments to the values of relevant equity interests

1C.31 The adjustments for this part of the example are the same as in part (a).

Note: Subdivision 170-D does not apply to the transfer of the shares to an unassociated entity, but this does not affect the operation of Subdivision 165-CD.

Gamma Co transferred its shares in Beta Co to Gamma

Is there an alteration time?

1C.32 In this scenario, again, Gamma continues to be able to control more than 50% of the voting power in Alpha Co, and to have rights to more than 50% of the company's dividends and capital distributions. However, the shares that Gamma owns and through which he can control the voting power, and from which the rights to dividends and capital distributions are derived, are now shares in Beta Co rather than shares in Gamma Co. Section 165-165 applies and an alteration time is taken to have occurred.

Is Alpha Co a loss company?

1C.33 As before, Alpha Co has an overall loss under section 165-115R.

Are there relevant equity interests or relevant debt interests?

1C.34 Yes, as previously.

Adjustments to the values of relevant equity interests

1C.35 The adjustments shown in part (a) would be made to the reduced cost bases and other tax values of the equity interests.

Gamma sells all his shares in Gamma Co to an unrelated buyer

Is there an alteration time?

1C.36 Following the sale of his shares in Gamma Co to an unassociated entity, Gamma would no longer have more than 50% of the voting power in Alpha Co, or the rights to more than 50% of any dividends or capital distributions Alpha Co might make. An alteration time has therefore occurred under section 165-115L.

Is Alpha Co a loss company?

1C.37 Yes, as outlined previously.

Are there relevant equity interests or relevant debt interests?

1C.38 Yes, as outlined previously.

Adjustments to the values of relevant equity interests

1C.39 The situation is the same as for the previous scenarios. It should be noted that Subdivision 165-CD does not require any adjustment to be made to the reduced cost bases of Gamma's shares in Gamma Co: as an individual not acting in the capacity of trustee, Gamma does not have a relevant equity interest (as described in section 165-115X) in Alpha Co.

1C.40 Gamma would realise a capital gain on the sale of his shares in Gamma Co. The market value of the shares would reflect the losses incurred by Alpha Co and as a result, the capital gain is less than it might otherwise have been.

1C.41 The adjustments to reduced cost bases and other tax values required under Subdivision 165-CD would apply to any later disposal by Gamma Co, Epsilon Co, Beta Co and Zeta Co of their direct or indirect interests in Alpha Co.

What are the notice requirements in each of the above cases?

1C.42 Section 165-115ZC requires notices to be given by an entity that had a controlling stake in the loss company without taking into account any of its associates' interests. In this case, Gamma Co had a controlling stake in its own right, and no other entity (apart from an individual) has a controlling stake in it. Gamma Co is required to give notices, within 6 months after the alteration time, to each of its associates that had relevant equity interests, containing information sufficient to assist each associate to determine the effect of Subdivision 165-CD on the tax values of its own equity interests. Gamma Co notifies Alpha Co within 2 months after the alteration time that it proposes to give a notice to its associates.

1C.43 Information required to be included in the notices is set out in subsection 165-115ZC(5).

Chapter 2 - Company losses and bad debts and technical amendments

Outline of Chapter

2.1 This Chapter discusses amendments to the ITAA 1997 contained in Schedule 1 to this Bill. These amendments are required as a consequence of the new inter-entity measures (discussed at Chapter 1). The Schedule amends the continuity of ownership test applying to companies' losses and aligns the application date of the unrealised loss measures with that of the inter-entity measures.

2.2 This Chapter also discusses amendments that are mainly of a technical nature to refine and clarify the unrealised loss measures, the excess mining deductions measures and the 13 month prepayment measures as enacted by the Integrity and Other Measures Act.

Context of Reform

2.3 This Bill makes changes to the continuity of ownership test as announced in the Treasurer's Press Release No. 74 of 11 November 1999. The announcement foreshadowed changes to the continuity of ownership test to provide an appropriate link to the new inter-entity measures (discussed at Chapter 1). The proposed inter-entity measure is consistent with the Review of Business Taxation's recommendation No. 6.9(b).

Summary of new law

2.4 The amendments will:

amend the continuity of ownership tests contained in Division 165 of the ITAA 1997 to provide an appropriate link to the new inter-entity measures;
include saving provisions in specific circumstances to enable a loss or deduction to be claimed without being subject to the same business test as though there was continuity of ownership;
refine aspects of the continuity of ownership test as enacted by the Integrity and Other Measures Act;
apply existing tracing rules applicable to certain listed public companies (and their 100% subsidiaries) in relation to the unrealised loss measures and the inter-entity measures;
in relation to the unrealised loss measures:

-
align the application date of the unrealised loss measures enacted in the Integrity and Other Measures Act with the inter-entity measures contained in this Bill;
-
introduce measures to reduce compliance costs associated with the valuation requirement;
-
strengthen the unrealised loss measures to ensure that these rules are not undermined by the transfer of loss assets within a company group;
-
exclude CFCs from the unrealised loss measures; and

make technical corrections in relation to the excess mining deductions measures and the 13 month prepayment rule.

Comparison of key features of new law and current law
New law Current law
In determining whether a condition or circumstance has been satisfied under the continuity of ownership test, only shares and interests that were the same shares or interests and held by the same persons since the start of the relevant test period may be counted. In determining whether a condition has been satisfied, the shares so counted must be the same shares. A change in the way shares are held (e.g. through an interposed entity) does not exclude a share from being counted.
Contains special provisions dealing with unit splits and consolidations. Unit splits and consolidations are not covered.
Modified same share or unit rule applies to 100% owned subsidiary of listed public company. Rules do not extend to 100% owned subsidiaries of a listed public company.
Saving provisions could apply where test is failed because of the same share or unit rule. The Integrity and Other Measures Act does not contain saving provisions.
Unrealised loss measures apply to ownership changes after 1 pm, by legal time in the Australian Capital Territory, on 11 November 1999. Unrealised loss measures apply to ownership changes after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999.
Unrealised loss measures will not apply to small business taxpayers. Unrealised loss measures apply to all corporate taxpayers.
At the taxpayer's choice, assets acquired for less than $10,000 will be ignored for the purposes of working out a company's unrealised net loss. Where the choice is made, losses on such assets will not be subject to the same business test under these measures. All assets owned by a company at changeover time are included for the purposes of working out a company's unrealised net loss. Similarly, losses on all assets (except trading stock) owned at changeover time are subject to the same business test.
In some cases, a company may use the tax-written down value of an item of depreciable plant as a proxy for its market value for the purposes of working out a company's unrealised net loss. A company is required to determine the market value of all assets, including depreciable plant, owned at changeover time when working out its unrealised net loss.
Unrealised loss measures will now effectively apply to losses on all assets including a loss on an item of trading stock held at changeover time. Unrealised loss measures apply to all assets (including trading stock) owned by a company at changeover time. There is, however, no mechanism to allow the same business test to apply because the concept of a trading stock loss does not exist.
Unrealised loss measures will now also apply to a loss asset that the company transferred before changeover time where the loss remains unrealised at changeover time. The amount of the unrealised loss is to be included in the calculation of the unrealised net loss. Unrealised loss measures apply only to assets owned by a company at changeover time.
A listed public company (and its subsidiaries) may rely on special tracing rules in determining whether the continuity of ownership test is satisfied in relation to the unrealised loss measures and the inter-entity measures. Special tracing rules do not apply in relation to unrealised losses. Inter-entity measures do not exist.
Unrealised loss measures will not apply when calculating the attributable income of a CFC. There is nothing to prevent the unrealised loss measures from applying to a CFC

Detailed explanation of new law

2.5 The Integrity and Other Measures Act contained measures that removed defects in the existing continuity of ownership test applying to companies' prior and current year tax losses, net capital losses and bad debts. The Integrity and Other Measures Act also contained measures that apply the amended continuity of ownership test to companies with unrealised net losses.

2.6 It is necessary to amend certain aspects of the continuity of ownership test, both as a consequence of the introduction of the new inter-entity measures in this Bill and in order to refine the new test as enacted in the Integrity and Other Measures Act. Both aspects of the changes to the continuity of ownership test are incorporated in the same provisions of the new Bill, as the test is connected to tax losses, net capital losses, bad debt deductions, unrealised net losses and now to the new inter-entity adjustment provisions.

Changes to the continuity of ownership test consequential upon the new inter-entity measures

Same share or interest rule

2.7 A company may be prevented from deducting a loss or a deduction unless it satisfies the continuity of ownership test and the same control is maintained throughout the relevant test period. Where a company fails to maintain continuity of ownership and control, a loss or deduction will only be available if the same business test is satisfied.

2.8 The Integrity and Other Measures Act inserted changes to rules in section 165-165 of the ITAA 1997 applying to tests to determine whether there has been continuity of ownership in a relevant test period. Essentially, these changes were designed to ensure that a company would fail the continuity of ownership test where the loss has been substantially duplicated by individual shareholders disposing of their shares in a loss company. The company will fail the continuity of ownership test even though the same individual shareholders have reacquired the same shares within the relevant test period.

2.9 Under the changes in the Integrity and Other Measures Act, rights and powers attaching to an individual's share in a company may only be taken into account if the individual owns the same share throughout the relevant period. This is known as the 'same share' rule. It is irrelevant under this rule whether there has been a change in the way a share was held. For example, a share in a loss company initially held by an individual through an interposed company that is then transferred to the individual will be counted for the purposes of the test as having been owned continuously.

2.10 The same share rule is now extended by Schedule 1 to this Bill to direct and indirect equity interests in a company to provide an appropriate link to the inter-entity adjustment rules in new Subdivision 165-CD. Broadly, where any interests (interposed interests) in an entity interposed between an individual and a loss company are to be taken into account for the purposes of the continuity of ownership test, those interests must not only be exactly the same interests, they must be held by the same persons. (A 'person' includes a company or an interposed entity.) If this is not the case, the interposed interests will not be taken into account in determining whether a condition is satisfied, or a changeover time or alteration time has occurred. The extended rule is referred to in this Chapter as the same share or interest rule. [Schedule 1, item 22, subsection 165-165(1)]

2.11 The condition that has to be satisfied as referred to in the new provision may be, for example, a condition listed in section 165-12 (relating to prior year tax losses or net capital losses). The test for determining whether there has been a changeover time is contained in section 165-115C of the ITAA 1997 (the unrealised loss measures). The test for determining whether there has been an alteration time is being inserted as section 165-115L of the ITAA 1997 (the inter-entity measures). Broadly, a changeover time or an alteration time occurs when a company fails to maintain continuity of majority ownership throughout the period from 11 November 1999 (the application date of both the unrealised loss measures and the inter-entity measures). Where there has been a previous failure, a changeover time or an alteration time occurs when the company fails to maintain continuity from the previous changeover time or alteration time.

2.12 Where an individual disposes of a share to an entity interposed between the individual and a loss company, rights and powers attaching to the share will not be taken into account even if it is ultimately owned by the same individual throughout the test period. Similarly, a share previously held indirectly through an interposed entity is not allowed to be taken into account if it is disposed of to another interposed entity. In these circumstances, the share in the loss company cannot be included because the same person (in this case, the same interposed entity) did not hold it throughout the test period.

Example 2.1 Bridget holds 100% of the shares in an interposed company (X Co) that in turn owns all the shares in a loss company. Over the course of several months during the relevant test period, X Co disposes of 60% of its shares in the loss company to Y Co, another interposed entity controlled by Bridget. Y Co then owns a 60% interest in the loss company. Only 40% of the original shares held by X Co in the loss company can be counted for the purposes of determining whether there has been a substantial change in the ownership of the loss company. While Bridget has retained 100% underlying ownership throughout the test period, only the shares held by the same persons (i.e. 40% of the shares held by X Co in the loss company) may be counted.

Share splits and consolidations - same share or interest rule

2.13 The rules relating to share splits and consolidations contained in amended section 165-165 will now also apply to unit splits and consolidations. The amendments prevent a loss company from failing the continuity of ownership test simply because a unit in a unit trust interposed between a person and the loss company is split into 2 or more units or consolidated with other units to form a new unit. The amendments to section 165-165 will enable a company to take into account the rights and powers attached to the split or consolidated units even though the units were not held (and did not exist) from the start of the test period. [Schedule 1, item 22, subsections 165-165(3) and (5)]

2.14 For a new share to be treated as the old share under these rules, each of the shares resulting from a share division must be owned or held throughout the rest of the period after the division occurred by the same person who owned the original shares which were split. A similar rule applies to unit divisions. This is consistent with the existing subsection 165-165(2). In the absence of such a rule, substantial loss duplication could occur without a company failing the continuity of ownership test. Shareholders could dispose of a majority of their divided shares leaving a token number of shares (carrying a small fraction of the power or rights attaching to the original shares) to satisfy the continuity requirements.

2.15 A company could fail the continuity of ownership test simply because a shareholder sold a divided share carrying a small fraction of the powers or rights attaching to the original share. In these circumstances, the relevant saving provision (discussed at paragraphs 2.23 to 2.39) could treat the company as having satisfied the continuity of ownership test.

2.16 The rules relating to share or unit splits and consolidations apply only where a share or unit held at the start of a relevant test period is split or consolidated during the period. In relation to a test period after the test period in which the share or unit split occurred, the split share or unit is treated in the same way as any other share or unit. For example, the requirement that the person (i.e. shareholder) continues to be the beneficial owner of each of the shares or units resulting from the split will be irrelevant in relation to a subsequent testing period. [Schedule 1, item 22, subsections 165-165(2) to (6)]

Application of modified same share or interest rule to 100% subsidiary of listed public company

2.17 Division 166 of the ITAA 1997 contains a modified continuity of ownership test that applies special tracing rules to listed public companies. The rules make it easier for a listed public company to determine whether it satisfies the continuity of ownership test. The tracing rules also apply to 100% subsidiaries of a listed public company. The tracing rules currently applying to a company's tax losses, net capital losses and bad debt deductions will be extended by this Bill to apply for the purposes of the unrealised loss measures and the inter-entity measures(the extension is discussed at paragraphs 2.40 to 2.49 and paragraphs 2.75 and 2.76).

2.18 Schedule 1 introduces a modified same share or interest rule to determine whether a 100% subsidiary satisfies the continuity of ownership test in Division 166. The special tracing rules in Division 166 (including the tracing rules introduced in this Bill in relation to the unrealised loss measures and the inter-entity measures) will now be subject to a modified same share or interest rule when applied in relation to a 100% subsidiary of a listed public company.

2.19 Under this rule, the 100% subsidiary will be treated as not having satisfied a condition or as having experienced a changeover time or alteration time unless:

the shares directly held by a listed public company (the holding company in section 166-10(2)) in the subsidiary that are taken into account in determining whether the condition is satisfied are the same shares held by the same persons throughout the relevant test period; and
any direct or indirect equity interests held by the holding company in an entity interposed between the holding company and the subsidiary that are to be taken into account are exactly the same interests held by the same persons throughout the relevant test period. (A company or an interposed entity is a 'person' for the purposes of this provision.)

[Schedule 1, item 34, subsection 166-170(1) and (2)]

2.20 A share or an interest not allowed to be taken into account under the modified same share or interest rule will not, however, affect the way a subsidiary company's total voting power or rights to capital or dividends are determined [Schedule 1, item 34, subsection 166-170(7)] .

2.21 In effect, the conditions applying to a 100% subsidiary of a listed public company are more stringent than those applying to the listed public company itself. Under the provision, a 100% subsidiary will fail the continuity conditions where, although there is continuity of majority ownership of the listed public company (and therefore the 100% subsidiary), the way in which the listed public company's direct or indirect interest in the subsidiary is held has changed substantially during the test period. Losses in the 100% subsidiary will generally have been substantially duplicated in these circumstances(refer to discussions at paragraphs 2.33 to 2.35 regarding the application of the saving provisions to 100% subsidiaries of a listed public company).

2.22 Rules relating to share or unit splits and consolidations apply to equity interests held directly or indirectly by a listed public company in a 100% subsidiary. The provisions will enable a subsidiary to take into account the rights and powers attached to split or consolidated shares or units in a unit trust in some cases even though the shares or units were not held from the start of the relevant test period. The provisions are similar to the ones discussed above applying to companies generally. [Schedule 1, item 34, subsection 166-170(3) to (6)]

Saving provisions

2.23 Saving provisions are contained in each of the provisions relating to conditions or circumstances operating on tests in relation to tax losses, net capital losses, unrealised net losses and bad debts to offset the effect of the same share or interest rule. The saving provisions will enable a loss or a deduction to be claimed as though the continuity of ownership test was satisfied.

2.24 Subject to certain criteria being satisfied, saving provisions will apply if a company fails the continuity of ownership test while retaining majority underlying ownership throughout the relevant period. A company could fail the test where those majority shareholders no longer hold direct or indirect equity interest in the company in the same way (because of the operation of the same share or interest rule).

2.25 To address this situation, the conditions set out in the relevant provisions may be treated as having been satisfied, or a changeover time (in relation to the unrealised loss measures) is deemed not to have occurred, if:

apart from the operation of the same share or interest rule, the continuity of ownership test would have been satisfied; and
the company proves that less than 50% of the tax loss, unrealised net loss, notional loss or bad debt (whichever is relevant) has been reflected in deductions, capital losses or reduced assessable income that occurred, or could occur in future, because of the happening of any CGT event in relation to any direct or indirect equity interests in the company during the relevant test period.

2.26 An equity interest whose cost base has been adjusted by the inter-entity measures (discussed at Chapter 1) is to be excluded for the purposes of providing the required proof. A loss on the disposal of such an interest that reflects the loss in the company will effectively be prevented under those measures. [Schedule 1, item 3, subsection 165-12(7); item 5, subsection 165-37(4); item 15, subsection 165-115C(4); item 20, subsection 165-123(7)]

2.27 A company will be able to use the saving provisions in relation to a tax loss where the same persons have retained more than 50% of the voting power in the company or rights to more than 50% of the company's dividends or capital distributions throughout the ownership test period. The loss will not be treated as having failed the continuity of ownership test where the loss company can demonstrate, for example, that the only equity interests in the company that were sold during the relevant test period have been subject to the inter-entity measures.

2.28 A company's tax loss, net capital loss, notional loss (for the purposes of the current year loss rules) or bad debt deduction will often result in equity interests being disposed of for an increased loss. There is an increased loss on the sale of equity for the purposes of the saving provision if, for example, the loss that would have arisen on the sale of equity in the absence of the company's tax loss is increased because of the tax loss. The tax loss is reflected in increased losses on the sale of equity to the extent of the increase. Alternatively, a loss on the sale of equity in a company could relate solely to the company's loss or deduction. This is where, for example, the shareholder would not have experienced a loss on the sale of equity but for the company's loss or deduction.

2.29A tax loss, net capital loss, notional loss or bad debt deduction could also result in equity interests being disposed of for a reduced gain. There is a reduced gain if, for example, the gain that would have arisen on the sale of equity in the absence of the company's tax loss is reduced because of the tax loss. The tax loss is reflected in reduced gains on the sale of equity to the extent of the reduction.

2.30 Where a company's tax loss relates not to an economic loss suffered by the company but to a taxation incentive, for example, accelerated depreciation, the tax loss will generally not be reflected in increased losses or reduced gains on the sale of equity.

2.31 The relevant test period in relation to tax losses, net capital losses and bad debt deductions is the ownership test period. In relation to unrealised losses, the relevant test period is the period between the last changeover time (and where there has never been a changeover time before, 11 November 1999) and the current changeover time. The start of the relevant test period is referred to in the law as the reference time. [Schedule 1, item 10, subsection 165-115A(2A)]

2.32 The happening of a CGT event in relation to direct or indirect equity interests in a company that causes the company to experience a changeover time is to be treated as occurring during the relevant test period. This ensures that a loss company must take into account any loss on such an event happening in obtaining the requisite proof under a saving provision. [Schedule 1, item 3, subsection 165-12(8); item 5, subsection 165-37(5); item 15, subsection 165-115C(5); item 20, subsection 165-123(8)]

Saving provision applying to 100% subsidiaries of a listed public company

2.33 A saving provision will apply to prevent a loss or deduction from being subject to the same business test where a continuity of ownership test is failed because of the modified same share or interest rule applying to a 100% subsidiary of a listed public company under Division 166 (discussed at paragraphs 2.17 to 2.22).

2.34 The provision is almost identical to the saving provisions applying generally to other companies, with one important difference. The difference is that in proving that not more than 50% of the loss or deduction of the subsidiary has been reflected in the disposal of direct or indirect equity interests in a 100% subsidiary, the only relevant equity interests are those that have been disposed of either by the holding listed public company or by an entity interposed between the holding company and the subsidiary.

2.35 The saving provision will not, however, apply for the purposes of determining whether there is an alteration time for the purposes of the inter-entity measures. This is consistent with the general rules for determining the alteration time in respect of other companies. [Schedule 1, item 34, subsection 166-170(9)]

New shares or units

2.36A company that issues new shares, for example under a rights issue, or because of the exercise of an option, could fail the continuity of ownership test even though there has been no change in its ownership. This is because only shares held by a particular shareholder throughout the relevant test period may be counted for the purposes of the continuity of ownership test (see discussion at paragraphs 2.7 to 2.12).

2.37 While a person's new share issued during the relevant test period will not be counted as a share held throughout the period, the new share will nevertheless be included for the purpose of working out the total voting power or rights in the company. Amendments have been made to the rules affecting totals of shares, or powers or rights attaching to shares to ensure that this occurs. In effect, section 165-165 will not affect how powers and rights carried by shares are counted for the purpose of determining the total voting power, total dividends or total distributions of capital [Schedule 1, item 23, Heading to section 165-200; Schedule 1, item 24, section 165-200] .

2.38 Similarly, interests in an interposed trust that are ignored under section 165-165 because of the application of the same share or interest rule will nevertheless be taken into account for the purposes of determining a company's total voting power or rights to capital or dividends. [Schedule 1, item 25, subsection 165-200(2)]

2.39 The saving provisions could apply to a company that fails the continuity of ownership test because of the issue of new shares. The company's loss or deduction will be treated as having satisfied the continuity of ownership test where the conditions are satisfied and the necessary proof is obtained.

Example 2.2 At the start of an ownership test period, Alex holds 90% of shares in a company. Brian owns the remaining 10%. The company has issued 100 ordinary shares (i.e. Alex owns 90 shares and Brian owns 10 shares).100 more new shares are issued at some time during the test period. Of these, Alex owns 90 and Brian owns 10. The total share issue is now 200. The original shares held by Alex now only carry 45% of the power and rights in the company (90/200 = 45%). The original shares held by Brian now carry 5%of the power and rights in the company (10/200 = 5%). Due to the operation of the same share rule, only those original shares may be counted for the purposes of determining whether there has been continuity of ownership throughout the period.In the absence of a saving provision, the company would fail the continuity of ownership test because only 50% of the power and rights in the company have been maintained throughout the test period. To satisfy the test, more than 50% continuity must be maintained.Under the saving provision, the company will be treated as though it satisfies the continuity of ownership test if it is able to prove that:

there has been no substantial change in proportionate shareholding between Alex and Brian - throughout the period Alex has maintained a 90% interest and Brian has maintained a 10% interest; and
less than 50% of the loss has been duplicated during the period - neither Alex nor Brian have sold any of their original shares.

Special tracing rules for listed public companies (and their subsidiaries) in relation to the inter-entity measures

2.40 New Subdivision 166-CA applies the special tracing rules in Division 166 to modify the way the inter-entity measures apply to a listed public company and its 100% owned subsidiaries (100% subsidiaries). The rules will make it easier for such a company to determine whether there has been a substantial change of ownership and therefore, whether an alteration time has occurred within the meaning of section 165-115L of the inter-entity measures.

2.41 The rules are to apply at the company's option. There is a presumption that a listed public company and its 100% subsidiaries will rely on the special tracing rules unless the relevant company chooses to apply the inter-entity measures in Subdivision 165-CD without modification. A company must make such a choice on or before the day it lodges its tax return for the income year in which an alteration time (under section 165-115L) has occurred. [Schedule 1, item 30, section 166-90]

2.42 Under the new rules, a listed public company will be taken not to have experienced an alteration time under section 165-115L if there is substantial continuity of ownership:

between the start of the relevant test period (the reference time) and the time immediately after each abnormal trading in shares of the company; and
between the reference time and the end of each income year.

2.43 Broadly, section 166-145 applies to treat a company as having achieved substantial continuity of ownership between 2 specified points in time where the persons who had more than 50% of the voting power, or rights to dividends or capital (whichever is relevant) at one point in time also had more than 50% of the relevant power or right at the other point in time.

2.44An alteration time is taken to have occurred in relation to a company immediately after the time of an abnormal trade in its shares where there is no substantial continuity of ownership between the reference time and the time immediately after the abnormal trade. Where there has not been abnormal trading in the company's shares, an alteration time is taken to have occurred at the end of an income year where there is no substantial continuity of ownership between the reference time and the end of the income year. [Schedule 1, item 30, subsection 166-80(2) and (3)]

2.45 The special tracing rules apply to a company that is a listed public company at all times during the relevant test period [Schedule 1, item 30, paragraph 166-80(3)(a)] . The existing continuity of ownership tests in section 166-145 of the ITAA 1997 will apply in determining whether there is substantial continuity of ownership of a listed public company in terms of voting power and rights to capital and dividends [Schedule 1, item 30, section 166-80] .

2.46 Special tracing rules also apply to a 100% subsidiary of a listed public company where certain conditions are satisfied. The conditions are the same as those applying in relation to the special tracing rules for tax losses, net capital losses and bad debt deductions. To be eligible, the company must have been a 100% subsidiary of a listed public company throughout the relevant test period. [Schedule 1, item 30, subsections 166-85(1) to (3)]

2.47 The relevant test period in this context is the period from and including the reference time (defined at subsection 165-115L(2)) to the test time. [Schedule 1, item 30, subsection 166-85(2)]

2.48 Unless the subsidiary chooses otherwise, the special tracing rules will apply to a 100% subsidiary that satisfies the specified conditions as if the subsidiary were itself a listed public company. Furthermore, any abnormal trading in the holding company's shares will be treated as if it were abnormal trading in the subsidiary's shares. [Schedule 1, item 30, section 166-90 and subsection 166-85(5), paragraph 166-85(2)(a)]

2.49 The provision that a 100% subsidiary will be treated as if it were a listed public company is, however, subject to the limited same share or interest rule applying in respect of the listed public company's equity interest in the subsidiary. The limited same share or interest rule is discussed above at paragraphs 2.17 to 2.22.

Alignment of commencement time as a consequence of the inter-entity measures

2.50 The unrealised loss measures in Subdivision 165-CC of the ITAA 1997 will now only apply to companies that experience a changeover time after 1 pm, by legal time in the Australian Capital Territory, 11 November 1999. This will align the commencement dateof the unrealised loss measures with the inter-entity measures contained in this Bill. The adjustment will minimise the circumstances where companies will be required to determine their unrealised net losses at different times in respect of inter-entity measures and the unrealised loss measures. [Schedule 1, item 9, paragraph 165-115A(2)(a)]

Refinements of the continuity of ownership test as enacted by the Integrity and Other Measures Act

2.51 The Integrity and Other Measures Act contains certain key amendments to the substantive tests contained in section 165-12 (company must maintain the same owners) and section 165-13 (company must carry on the same business in the relevant period). The supporting tests in sections 165-150 to 165-160 for establishing whether the company has maintained the same owners during the test period were accordingly also modified by the Integrity and Other Measures Act.

2.52 Schedule 1 of this Bill will make technical modifications to the tests enacted in the Integrity and Other Measures Act in the following respects:

the words 'rights to' previously omitted from subsection 165-155(1) and subsection 165-160(1) of the ITAA 1997 will be inserted. The amendment will ensure consistency between the listed provisions and the provisions being referred to [Schedule 1, item 21, subsections 165-155(1) and 165-160(1)] ;
the alternative tests forming part of the continuity of ownership test will be amended so that they recognise that shareholders of a company do not have beneficial interests in a company's assets. The relevant provisions as they stand incorrectly imply the contrary [Schedule 1, item 21, subsections 165-150(2), 165-155(2) and 165-160(2)] ; and
the alternative tests relating to voting power will also be amended to exclude trustees from being taken into account when determining the identity of persons with majority ownership [Schedule 1, item 21, subsection 165-150(2)] .

2.53 The modifications with respect to trustees are also made to the tests contained in Subdivision 166-D (tests for finding out whether a listed public company has maintained the same owners) and Subdivision 166-G (special tracing rules for listed public companies). [Schedule 1, item 31, subsections 166-145(2) to (4); item 32, section 166-150; item 35, paragraph 166-265(1)(a); item 36, subsections 166-265(2) and (3)]

2.54 Further technical amendments have been made to the tests incorporated in the Integrity and Other Measures Act:

the Integrity and Other Measures Act referred previously to 'rights to more than 50% of the voting power in the company' for the purposes of the continuity of ownership tests for the deduction of tax losses and bad debts. As it is erroneous to refer to 'rights to voting power', the relevant provisions have been amended to remove the reference [Schedule 1, item 2, subsection 165-12(2) (note); item 19, subsection 165-123(2) (note)] ; and
the alternative test provisions (for the deduction of current year losses in a year) will now be applicable where there has been a company or companies interposed between individual owners and a loss company at the beginning of the ownership test period. Previously the provisions applied the alternative test where a company is interposed at any time during the ownership test period. This amendment is consistent with changes made in the Integrity and Other Measures Act to sections 165-12(6) and 165-23(6) and will apply to net capital losses or tax losses claimed in a return for an income year ending after 21 September 1999. [Schedule 1, item 4, subsection 165-37(3); sub-item 68(2)]

Consequential amendments

Rules affecting the operation of the ownership tests applying to listed public companies

2.55 Division 165 of the ITAA 1997 contains rules which affect the operation of the ownership tests in Subdivision 166-D. Broadly, certain general rules in Division 165 also apply for the purposes of the modified continuity of ownership tests in Subdivision 166-D. As these general rules were amended by the Integrity and Other Measures Act, the provisions applying to the operation of the ownership tests in relation to listed public companies have been amended to ensure that the general rules in Division 165 continue to apply to listed public companies and their subsidiaries. [Schedule 1, item 33, section 166-165]

Rules applying to loss companies owned by non-fixed trusts

2.56 Schedule 9 to the Taxation Laws Amendment Bill (No. 8) 1999 currently before the Parliament will amend the continuity of ownership test applying to companies losses and deductions. This Bill introduces concessional tracing rules to companies that are owned by non-fixed trusts under certain conditions.

2.57 Amendments will be made to the tracing rules as a consequence of the changes contained in the Integrity and Other Measures Act to the continuity of ownership test. These amendments are of a technical nature. They essentially reflect the fact that the relevant test period for applying the continuity of ownership test is now the ownership test period. [Schedule 1, item 26, subsection 165-215(2) and (3); item 27, subsection 165-215(5); item 28, subsection 165-230(2) and (3); item 29, subsection 165-230(5)]

Amendments relating to the unrealised loss measures

2.58 Measures relating to unrealised losses were enacted by the Integrity and Other Measures Act. Broadly, the measures will apply to a company that:

fails the continuity of ownership test; and
at the time of failure (changeover time), has an unrealised net loss in respect of all of the company's assets (changeover assets) held at the time.

2.59 The following are refinements to the recently enacted measures.

Compliance cost saving measures

2.60 Schedule 1 to this Bill contains amendments to the unrealised loss measures directed at reducing the cost of compliance. The amendments are introduced in recognition that the valuation requirement under the measure could impose compliance costs on affected taxpayers. [Schedule 1, item 6, section 165-115]

2.61 The following are the measures directed at reducing compliance costs associated with the valuation requirement:

exclusion of small business taxpayers;
exclusion of low cost assets;
in relation to depreciable plant, the option to use tax written-down value as a proxy for market value where certain conditions are satisfied; and
empowering the Commissioner to give guidance about valuation methods and approaches in relation to the operation of unrealised loss and gain asset calculations.

[Schedule 1, item 17, subsection 165-115F(7)]

Exclusion of small business

2.62 Any company that has a net asset value of $5 million or less (as determined under section 152-15 of the ITAA 1997) at the time of change of ownership or control is exempt from the unrealised loss rules in Subdivision 165-CC. This will assist small businesses with unrealised net losses that would otherwise be prevented from using losses unless the company satisfies the same business test. [Schedule 1, item 7, paragraph 165-115A(1)(d)]

Exclusion of low cost assets

2.63 A company will now be allowed to make an election to exclude from the unrealised loss measures all of its assets acquired for less than $10,000 [Schedule 1, item 8, section 165-115A(1B)] . A company is required to make such an election on or before the day it lodges its income tax return for the income year in which the relevant changeover time occurred [Schedule 1, item 8, section 165-115A(1C)] .

2.64 There are 2 consequences of making such an election. Firstly, losses and gains on assets acquired for less than $10,000 will be excluded when calculating a company's unrealised net loss at changeover time. Secondly, losses on assets held at the changeover time that were acquired for less than $10,000 will be allowed regardless of whether the company satisfies the same business test. Accordingly, a loss company will not have to calculate a notional capital loss, notional revenue loss or trading stock loss in respect of CGT assets acquired for less than this amount.

Market value proxy for depreciable plant

2.65 Special rules may apply in determining the market value of depreciable plant for the purposes of calculating a company's unrealised net loss. A company may choose to use the written down value of depreciable plant at a relevant time instead of the market value at that time, provided that certain conditions in relation to that plant are satisfied. Essentially, the plant must be of a type that is eligible for a depreciation deduction. Further, the expenditure to acquire the plant must be less than $1 million. Finally, it must be reasonable for the company to conclude that the market value of the plant at the relevant time was at least 80% of its written down value at that time. [Schedule 1, item 17, subsections 165-115F(5) and (6)]

Disposal or revaluation of trading stock held at changeover time

2.66 The unrealised loss rules have also been amended to apply the same business test to a loss on an item of trading stock held at changeover time. As with other assets, the same business test will apply to a trading stock loss arising when the item is disposed of, when the item ceases to be trading stock, or when the item is revalued. Broadly, a trading stock loss will have occurred if:

in the case of disposal or cessation as trading stock, the market value at the time of disposal or cessation as trading stock is less than the value of the item chosen for the purposes of Division 70, or in any other case, less than the cost of the item at the time of disposal or ceasing to be trading stock; or
in the case of revaluation, the value under the revaluation is less than the most recently chosen value of the item for the purposes of Division 70, or in any other case, less than its cost at the time of the revaluation.

[Schedule 1, item 7, paragraph 165-115A(1)(c); item 8, subsection 165-115A(1D)]

2.67 If a company makes a trading stock loss after a changeover time and the same business test is not satisfied, the amount of trading stock loss is included in the company's assessable income. A trading stock loss is included in assessable income only to the extent of the company's residual net unrealised loss at the time of disposal or cessation. Any part of a trading stock loss in excess of the residual net unrealised loss is ignored. [Schedule 1, item 15, subsection 165-115BA(1) to (3)]

2.68 There will, however, be no inclusion in the company's assessable income if the company satisfies the same business test in relation to the trading stock loss. Broadly, for the purposes of determining whether the company has satisfied the same business test, section 165-13 must be applied as if the trading stock loss were a net capital loss of the year immediately prior to the year in which a change of ownership or control occurred. The company is treated as having failed to meet the ownership conditions in relation to voting power, rights to dividends and rights to capital distributions at the changeover time and the continuity period is treated as ending at that time. [Schedule 1, item 15, subsections 165-115BA(4) and (5)]

2.69 The provisions of Subdivision 165-CC are generally adjusted to ensure that a company's residual unrealised net loss will now be reduced by trading stock losses that are subject to these rules. After a changeover time, a company is required to calculate its residual net unrealised loss to determine the extent to which the same business test will be applied to subsequently realised losses (including trading stock losses). The residual net unrealised loss is now calculated by subtracting any previous capital losses, deductions or trading stock losses from the amount of the unrealised net loss determined at the relevant time. [Schedule 1, item 11, subsection 165-115B(1); item 12, subsection 165-115B (2); item 13, subsection 165-115B(5) and (6); item 14, subsection 165-115B(8); item 15, subsection 165-115BB(2)]

2.70 Capital losses, deductions and trading stock losses arising in relation to CGT events in respect of CGT assets owned at the changeover time will be subject to the same business test in the order in which the CGT events occurred. [Schedule 1, item 14, subsection 165-115B(7); item 15, subsection 165-115BB(1)]

Transfer of loss assets before changeover time

2.71 The current unrealised loss measures may be undermined by companies transferring their loss assets within a majority-owned group. Broadly, under the recently enacted loss asset transfer measures in Subdivision 170-D of the ITAA 1997, a loss on an asset transferred within a group is quarantined in the transferor company and deferred until the asset is disposed of outside the group. A deferred loss in respect of such an asset will not, however, be subject to the unrealised loss measures where, for example, the loss asset remains within the group but there is a substantial change in the ownership of the group. Under the current unrealised loss measures, the deferred loss is not subject to the same business test because the unrealised loss measures apply only to assets owned by a loss company at changeover time.

2.72 Amendments in this Bill will ensure firstly, that the amount of a capital loss or deduction on a transferred asset (deferred under section 170-270 of the ITAA 1997) will be included in the calculation of a company's unrealised net loss at changeover time. This is appropriate because the loss would have been reflected in the value of the equity of the transferor company and substantially duplicated at changeover time.

2.73 The calculation of the unrealised net loss will only include an amount of capital loss or deduction that remains deferred at the changeover time. Any amount of capital loss or deduction that has been available to the company under section 170-275 before the changeover time will be excluded. Such an amount will already be subject to the continuity of ownership test for realised losses. [Schedule 1, item 16, section 165-115E]

2.74 Secondly, the unrealised loss measures will be extended to apply not only to capital losses and deductions in respect of a company's assets owned at changeover time but also to losses (previously subject to deferral under the loss asset transfer measures) on assets that the company transferred before changeover time. The amendments will ensure that a loss or a deduction on a transferred asset that is eventually allowable to the transferor company (under Section 170-275 Subdivision 170-D of the ITAA 1997) will be subject to the same business test. A loss or deduction is subject to the same business test only to the extent of any residual unrealised net loss as at the time of realisation. A residual unrealised net loss (as defined in section 165-115B) is the amount of any unrealised net loss yet to be reduced by losses or deductions on assets held at changeover time. [Schedule 1, item 8, paragraph 165-115A(1A)(b)]

Special tracing rules for listed public companies (and their subsidiaries) in relation to the unrealised loss measures

2.75 New Subdivision 166-CA applies the special tracing rules in Division 166 to modify the way the unrealised loss measures apply to a listed public company and its 100% subsidiaries. The rules are identical to those applying in relation to the inter-entity measures discussed above. The rules will make it easier for such a company to determine whether there has been a substantial change of ownership and therefore, whether there is a changeover time within the meaning of section 165-115C of the unrealised loss measures.

2.76 In summary, some features of the special tracing rules are as follows:

the rules apply to listed public companies and their 100% subsidiaries that satisfy certain eligibility conditions [Schedule 1, item 30, subsections 166-80(1) and 166-85(1) to (3)] ;
the rules apply at the company's option. A company that chooses to apply the unrealised loss measures in Subdivision 165-CC without modification must make such a choice on or before the day it lodges its tax return for the income year in which a changeover time (under section 165-115C) has occurred [Schedule 1, item 30, section 166-90] ;
a listed public company will be taken not to have experienced a changeover time within the meaning of section 165-115C if there is substantial continuity of ownership of the company between the specified times [Schedule 1, item 30, section 166-80] ;
a 100% subsidiary of a listed public company is subject to the modified same share or interest rule applying in respect of the listed public company's equity interest in the subsidiary (discussed at paragraphs 2.17 to 2.22);
unless the subsidiary chooses not to apply the special tracing rules, the rules will apply to a 100% subsidiary that satisfies the specified conditions as if the subsidiary were itself a listed public company. Also, any abnormal trading in the holding company's shares will effectively be treated as if it were abnormal trading in the subsidiary's shares. [Schedule 1, item 30, paragraph 166-85(2)(a) and subsection 166-85(5)]

Application of the unrealised loss measures to CFCs

2.77 The unrealised loss measures contained in Subdivision 165-CC of the ITAA 1997 will not apply when calculating the attributable income of a CFC. [Schedule 1, item 67, paragraph 427(ba)]

2.78 The CFC measures prevent tax deferral by taxing Australian residents on their share of certain types of foreign source income accumulated offshore in a CFC (called attributable income). Broadly, the attributable income of a CFC is calculated as if it were a resident taxpayer. The unrealised loss measures would therefore apply unless modifications are made to the calculation of attributable income.

2.79 In principle, the unrealised loss measures should apply when calculating the attributable income of a CFC. Applying the rules to CFCs in the same way that they apply to residents would help ensure residents are not advantaged by accumulating amounts offshore in a CFC. The unrealised loss measures, however, would not mesh well in their current form with aspects of the CFC measures and could produce anomalous outcomes or uncertainty in the law. The rules will therefore not apply to CFCs at this time and will be considered as part of the review of the CFC measures announced in the New Business Tax System: Stage 2 Response (Treasurer's Press Release No. 74 of 11 November 1999). This will allow time for the development of cohesive rules that are properly integrated with other measures.

Other technical amendments

2.80 Technical amendments have been made to the provisions of the unrealised loss measures in relation to the time at which a company experiences a change in ownership or control. To ensure consistency with the new inter-entity measures, a changeover time is now referred to as the 'test time' for the purposes of determining the point at which there has been a change in ownership or control of a company. [Schedule 1, item 15, sections 165-115C and 165-115D]

2.81 Further, amendments have been made to replace a reference in the existing law to 'that unrealised net loss' with a reference to 'the residual net loss'. This amendment merely clarifies the existing law. [Schedule 1, item 12, subsection 165-115B(2)]

Technical corrections

Excess mining deductions

2.82 A technical correction has been made to the excess mining deduction measures to replace the reference to Subdivision 300-A and Subdivision 300-C with the reference to Subdivision 330-A and 330-C. [Schedule 6, item 1]

13 month prepayment rule

2.83 A pre-RBT obligation is currently defined as being one that arose 'before' 11.45 am 21 September 1999. Item 1 corrects the definition to specify the time as 'at or before' 11.45 am to ensure that the definition includes obligations at that exact time. [Schedule 8, item 1]

2.84 Subparagraph 82KZM(1)(a)(i) and paragraph 82KZMA refer to a 'small business taxpayer'. Items 2 and 4 correct these provisions to state that the taxpayer is a small business taxpayer 'for the year of income'. [Schedule 8, items 2 and 4]

2.85 Item 3 amends subsection 82KZMA(1) to change the wording of 'income year' to 'year of income'. This ensures that the expression is consistent with that used throughout the ITAA 1936. [Schedule 8, item 3]

2.86 Section 82KZMB provides a code for deducting prepayments of 13 months or less for businesses. For a prepayment made in an income year that was not covered by the table in that section, the part of the prepayment relating to future years would never be deductible. Further, if an income year includes 2 of the 21 Septembers described in the table, the table could be interpreted as allowing a double deduction for part of a prepayment. To rectify this problem items 5, 6 and 7 of Schedule 8 amend each of items 2, 3 and 4 in the table in subsection 82KZMB(5), to refer to the immediately preceding item in the table. [Schedule 8, items 5 to 7]

2.87 Item 8 amends the formula in subsection 82KZMC(5) to ensure that the amount of a prepayment that exceeds the amount which may be deducted in the expenditure year is deductible proportionately over the remainder of the eligible service period. [Schedule 8, item 8]

2.88 Items 9 and 10 amend the heading and application provision to Division 2 of Schedule 7 to the Integrity and Other Measures Act to address substituted accounting periods which may overlap the transitional period for the new rules. [Schedule 8, items 9 and 10]

Application provisions

2.89 The amendments made to the continuity of ownership test in relation to the new same share or interest rule are to apply to tax losses, net capital losses or deductions claimed in relation to an income year ending after 21 September 1999. The new same share or interest rule gives effect to the Government's announcement on 21 September 1999 to remove defects in the continuity of ownership test. The measures are aimed at reducing the scope for substantial loss duplication. As the unrealised loss measures and the inter-entity measures only apply from 11 November 1999, the new same share or interest rule will only apply from that date in relation to those measures. The saving provisions, announced on 11 November 1999, will also apply to tax losses, net capital losses or deductions claimed in relation to an income year ending after 21 September 1999. The new same share or interest rule is detrimental to taxpayers as it increases the likelihood of taxpayers failing the continuity of ownership test. Nevertheless, the saving provision will apply in respect of the same losses or deductions to effectively treat a company as not having failed the test in certain circumstances. [Schedule 1, subitem 68(2)]

2.90 Other refinements to the continuity of ownership rules as enacted by the Integrity and Other Measures Act are to apply in respect of tax losses, net capital losses or deductions claimed in relation to an income year ending after 21 September 1999, the date from which the measures relating to the continuity of ownership test apply [Schedule 1, item 68(2)] . The amendments are of a technical nature and give effect to the original intention underlying the measures as announced on 21 September 1999.

2.91 The measures applying the special tracing rules to listed public companies and their 100% subsidiaries in relation to the unrealised loss measures and the inter-entity measures apply to determine whether there is a changeover time or alteration time after 11 November 1999 being the date of announcement of the inter-entity measures. [Schedule 1, subitem 68(3)] .

2.92 The amendment that prevents the unrealised loss measures from applying in the calculation of the attributable income of a CFC commences at 1 pm, by legal time in the Australian Capital Territory, on 11 November 1999, the time from which the unrealised loss measures apply [Schedule 1, item 68(3)] . The other amendments relating to the unrealised loss measures (discussed at paragraphs 2.58 to 2.81) apply to tax losses, net capital losses or deductions claimed in relation to an income year ending after 11 November 1999 [Schedule 1, subitem 68(1)] .

2.93 The technical correction relating to excess mining deductions applies to assessments for the 1999-2000 income year and later years. [Schedule 6, item 2]

2.94 The technical corrections relating to the 13 month prepayment rule apply to expenditure incurred by a taxpayer after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999, and the taxpayer's assessments for the year of income including that day and for later years of income. [Schedule 8, item 11]

Chapter 3 - Amendments to Subdivision 170-C

Outline of Chapter

3.1 Schedule 1 makes amendments to the provisions of Subdivision 170-C of the ITAA 1997. Subdivision 170-C applies to the transfers of net capital losses or tax losses within wholly-owned company groups. The proposed amendments will:

ensure that in respect of an interest being a debt in a loss company, only its reduced cost base may be reduced following the transfer of a net capital loss;
clarify certain factors considered in making an appropriate adjustment to the cost base or reduced cost base of an interest in a loss company or an income (or gain) company;
ensure there can be no uplift in the cost base and reduced cost base of interests in the income (or gain) company unless there has been a reduction in the reduced cost base of at least one interest in the loss company;
ensure that, in addition to the general limitation that an uplift to a cost base or reduced cost base for any interest in the income (or gain) company cannot exceed its increase in market value because of the economic loss component of a transferred loss, increases may be capped at a yet lower level having regard to the amount of reductions to the cost bases or reduced cost bases of interests in the loss company; and
allow uplifts in the cost base and reduced cost base of interests in the income (or gain) company only to the extent that the loss transferred is an economic loss.

Context of Reform

3.2 The main purpose of Subdivision 170-C is to prevent the duplication of a tax loss or net capital loss transferred between companies in the same wholly-owned group when a direct or indirect interest in the loss company is realised. Loss duplication can occur by the making of a capital loss or by the reduction of a capital gain on the realisation of the interest whose value reflects the loss already used by the group.

3.3 Subdivision 170-C prevents loss duplication by requiring, in certain circumstances, reductions to be made to the cost base and reduced cost base of equity interests, or the reduced cost base of debt interests, held directly, or indirectly, in a loss company. In some cases cost base and reduced cost base increases are also required to interests held directly, or indirectly, in the company to which the loss is transferred (the 'income' or 'gain' company). These increases do not relate to loss duplication or attempt to match loss duplication reductions. The increases relate to, and are always limited by, any increases in the market values of the interests because of the transfer of a tax benefit from the loss company to the income or gain company (net of any payment by the income or gain company for it).

3.4 Following the introduction of Subdivision 170-C, it was recognised that addressing certain issues identified in the process of consultation would enhance the clarity of the law and help to ensure that its purpose is achieved. The following amendments address these issues.

Summary of new law

3.5 Schedule 1 proposes amendments to Subdivision 170-C to ensure that:

in respect of an interest being a debt in a loss company, only its reduced cost base may be reduced following the transfer of a net capital loss;
the factors considered in making an appropriate adjustment to the cost base or reduced cost base of an interest in a loss company or an income (or gain) company are clarified;
there can be no uplift in the cost base and reduced cost base of interests in the income (or gain) company unless there has been a reduction in the reduced cost base of at least one interest in the loss company;
in addition to the general limitation that an uplift to a cost base or reduced cost base for any interest in the income (or gain) company cannot exceed its increase in market value because of the economic loss component of a transferred loss, increases may be capped at a yet lower level having regard to the amount of reductions to the cost bases or reduced cost bases of interests in the loss company; and
uplifts to the cost base and reduced cost base of interests in the income (or gain) company are limited to the extent that the loss transferred is an economic loss.

Comparison of key features of new law and current law
New law Current law
Only the reduced cost base of a debt interest in the loss company may be reduced following the transfer of a net capital loss. Both the cost base and the reduced cost base of a debt interest in the loss company may be reduced following the transfer of a net capital loss.
The object statement is expressly included as a relevant factor to have regard to in making adjustments. The object statement is not expressly included as a factor to have regard to in making adjustments.
It is made clear what is meant by the factor 'the extent to which the loss reduced the market value' of an interest. The law does not elaborate upon the meaning of the expression 'the extent to which the loss reduced the market value' of an interest.
The new law clarifies that no reduction in cost base or reduced cost base of an interest in a loss company is required to the extent that the loss transferred is not an economic loss. The new law clarifies what is meant by an economic loss in this context. The law does not expressly provide that no reduction in cost base or reduced cost base of an interest in a loss company is required to the extent that the loss transferred is not an economic loss.
There can be no uplift in the cost base or reduced cost base of an interest in an income or gain company unless there has been a reduction in the reduced cost base of at least one interest in the loss company. An entitlement to an uplift in the cost base or reduced cost base of an interest in an income or gain company is not linked to any requirement that there has been a reduction in the reduced cost base of at least one interest in the loss company.
In addition to the general limitation that an uplift to a cost base or reduced cost base for any interest in the income (or gain) company cannot exceed its increase in market value because of the economic loss component of a transferred loss, increases may be capped at a yet lower level having regard to the amount of reductions to the cost bases or reduced cost bases of interests in the loss company. The amount of reductions to the cost bases or reduced cost bases of interests in the loss company is not stated as a limiting factor to be taken into account in determining what uplifts are appropriate to the cost bases and reduced cost bases of interests in the income (or gain) company.
Uplifts to the cost base or reduced cost base of interests in the income or gain company are limited to the extent that the loss transferred is an economic loss. An entitlement to an uplift to the cost base or reduced cost base of an interest in an income or gain company is not limited by the extent to which the loss transferred is an economic loss.

Detailed explanation of new law

3.6 Subdivision 170-C was inserted into the ITAA 1997 by the Integrity and Other Measures Act. The changes proposed in Schedule 1 make certain that the Subdivision operates as intended.

Debt interests may have only their reduced cost bases reduced following the transfer of a net capital loss

3.7 Under the current law, both the cost base and the reduced cost base of a debt may be reduced following the transfer of a net capital loss.

3.8 This is to be amended so that only the reduced cost base of a debt may be reduced following the transfer of a net capital loss. The amendment will correct a drafting error in the Integrity and Other Measures Act and achieve consistency with the adjustment rules for tax loss transfers. [Schedule 1, items 46 and 47, subsections 170-220(1), 170-220(2) and 170-220(3)]

Insertion of specific reference to objects clause and related matters in the factors to have regard to in making appropriate cost base and reduced cost base decreases or increases under Subdivision 170-C

3.9 It has been argued that, under the current law, regard may not be had to the statements of the objects of Subdivision 170-C in section 170-205in making appropriate adjustments under the Subdivision because the statements of objects are not specifically referred to as a factor to be considered in the provisions that require the adjustments.

3.10 Although a reading of the legislation as a whole makes such a reference unnecessary, it is proposed to insert in subsections 170-210(3) and 170-220(3) a specific reference to the object of the Subdivision and particularly the objects clause, section 170-205. [Schedule 1, items 37, 43, 48 and 54, paragraphs 170-210(3)(aa), 170-215(3)(aa), 170-220(3)(aa) and 170-225(3)(aa)]

3.11 This puts beyond any doubt that the objects of the Subdivision must be taken into account in determining what adjustments are appropriate in particular cases.

3.12 In addition, to prevent double counting, a reduction in the reduced cost base of an interest made under Subdivision 165-CD is also a factor to be taken into account in determining what reductions are to be made to the reduced cost base (but not to the cost base) of an interest under this Subdivision. [Schedule 1, items 38 and 49, paragraphs 170-210-(3)(ba) and 170-220(3)(aa)]

Extent to which a loss reduces the market value of a share or debt interests in the loss company

3.13 Following a tax loss or net capital loss transfer, one of the factors to be considered in deciding what is an appropriate amount to reduce the cost base or reduced cost base of a share, or the reduced cost base of a debt interest, in the loss company, is the extent to which the loss reduced the market value of the interest.

3.14 The reference to 'loss' is a reference to the outlay by, or loss of economic resources in, the loss company represented by the transferred tax loss. The impact of the loss on the market value of the share or debt interest will have occurred when the loss was suffered by the company, which will often be before the loss was transferred.

3.15 Unless the contrary could be shown, a loss or outlay of the company's economic resources reflected in a tax loss, or a net capital loss would normally be expected to have reduced the market value of interests in the company because the company would have been worth more but for the loss or outgoing.

3.16 In some cases, it can readily be shown that certain interests have not been affected. For example, the market value of preference shares or loans to the company may not be affected by a loss because its impact can be shown to have fallen exclusively on the market value of ordinary shares held in the company.

3.17 It is proposed to clarify the operation of this factor in certain cases. [Schedule 1, items 39 and 50, subsections 170-210(3A) and 170-220(3A)]

3.18 For the avoidance of doubt, in determining the extent to which a loss reduced the market value of a share or loan, that reduction is to be determined as if any other factors (including any benefits accruing to the company as a result of the loss or outlay of economic resources) that may have altered its market value did not occur. [Schedule 1, items 39 and 50, subsections 170-210(3A) and 170-220(3A)]

3.19 The legislation does not require that the market value of the shares must actually have fallen. The question is whether the loss when incurred, considered in isolation, reduced, or would have reduced, the market value of the share or debt.

3.20 The importance of looking at the effect of the loss in isolation is where a tax loss or net capital loss is incurred which results from a loss or outgoing of the company's economic resources but the presence of other factors result in a net increase in the market value of shares in the company.

Example 3.1 A company makes a tax loss of $100. This loss results from a loss or outlay of economic resources of the company. At the same time the company's goodwill increases by $250. The result is an increase in the market value of shares in the company by $150.Despite the overall increase in the market value of the shares, cost base and reduced cost base reductions having regard to the $100 loss would be necessary to prevent loss duplication on realisation of the shares.In this example, if the cost base of the shares were not reduced to reflect the loss, only $150 of the $250 increase in value of the company's goodwill would be captured on the realisation of the shares. The group would inappropriately access the transferred loss twice - once in offsetting income of the transferee, and again, because of reduced value shares, on the disposal of the transferor.

3.21 It is not essential that a realisation of the interest shelters from tax an unrealised accounting gain on assets of the loss company. It is enough that the loss reduced the market value of the interest and that there is asset value in the loss company that would have produced a gain on the interest were it not for the value reduction of the loss transferred.

Example 3.2 Company Y holds $700 of post-CGT equity in a wholly-owned subsidiary, Company X.Company X makes a tax loss of $300. The tax loss represents a loss or outflow of economic resources of the company.Company X transfers the $300 tax loss to Company Y. Company Y offsets the loss against income of $300.Company Y then sells its shares in Company X for $700, being their market value.Although the market value of the shares in Company X has not fallen, cost base and reduced cost base reductions would be required to the shares having regard to the economic loss of $300 transferred. Ignoring indexation, a capital gain of $300 would arise on the disposal of the shares. This result is appropriate because, but for the loss, the value of this asset would have been captured as a capital gain on the disposal of shares in the loss company.

Non-economic losses

3.22 It is not necessary to reduce the cost base or reduced cost base of an interest in a loss company to the extent the loss transferred is not an economic loss. An economic loss is a loss or outlay of a company's economic resources. In contrast a non-economic loss arises where a tax deduction or capital loss exceeds the economic resources outlaid or lost. An example of this is the additional 25% tax deduction provided for certain Research and Development expenditure.

3.23 It is specifically provided that a non-economic loss will include depreciation on an item of plant to the extent that tax recognition of the outlay (via depreciation deductions) happens in advance of economic depreciation or depletion of the plant.

3.24 These 'timing differences' for plant are to be calculated on an asset by asset basis. It is not necessary to track reversals of the difference.

3.25 Although the treatment of a non-economic loss was made clear in the explanatory memorandum to the Integrity and Other Measures Act, an amendment to the legislation puts that treatment beyond doubt. [Schedule 1, item 39 and 50, subsections 170-210(3B) and 170-220(3B)]

3.26 Where a company transfers only part of a loss incurred and the loss comprises both economic and non-economic elements it may choose the extent to which it has transferred the non-economic elements provided it maintains sufficient records to evidence its choice.

Example 3.3 A group company has a tax loss of $225,000 of which $25,000 relates to a deduction 25% greater than Research and Development expenditure actually incurred by the company. If the company transfers an amount of tax loss of $25,000 it may, if it chooses, treat this as relating wholly to the non-economic part of the tax loss provided it makes a record of its choice and the basis for it.

3.27 In circumstances where a loss (e.g. a tax loss for a prior income year) has been offset against income, and it is sought to transfer the remainder of that loss to another group company, the economic and non-economic elements of the loss are decreased proportionately to determine the economic and non-economic elements of the loss available for transfer.

No cost base uplifts unless cost base reductions are made following transfer of tax loss or net capital loss and amount of reductions are a limiting factor for uplifts

3.28 Under the current law, if a payment (a 'subvention payment') is not made by the gain or income company to the loss company for the tax benefit of a transferred tax loss or net capital loss a shift in value may occur from the loss company to the income company equal to the value of the tax benefit transferred (e.g. the corporate tax rate (say 34%) multiplied by the amount of transferred loss). For example, if a loss of $100 is transferred between 'sister' subsidiaries and no subvention payment is made, $34 value may be shifted from the loss company to the income or gain company.

3.29 The uplift under the current law on cost bases and reduced cost bases for interests in the transferee company reflects the value shifted and the fact that interest holders in the transferee would have made a smaller capital gain (or bigger capital loss) on the ultimate sale of their interests if the loss transfer had not occurred and the transferee company had been taxed on the income or gain.

3.30 Subdivision 170-C does not, however, require a reduction to cost bases or reduced cost bases for interests in the loss company to reflect any value shifted out of those interests by the actual transfer of the loss itself, except to the extent that this is indirectly effected by reductions made to remove loss duplication.

3.31 In the absence of loss duplication, and therefore the absence of reductions to cost bases and reduced cost bases for interests in the loss company under Subdivision 170-C to reflect the value shifted from the loss company, no cost base or reduced cost base increase should be made to reflect any value shifted to the income or gain company. This ensures symmetrical treatment.

3.32 It is therefore proposed to ensure that no cost base or reduced cost base uplifts can be made to interests held directly or indirectly in the income or gain company, unless a reduction is appropriate for at least one interest held directly in the loss company. [Schedule 1, items 41, 42, 52, 53, paragraphs 170-215(1)(h), 170-225(1)(g), 170-215(2)(h) and 170-225(2)(h)]

3.33 It is also proposed to ensure that, in addition to the general limitation that an uplift to a cost base or reduced cost base for any interest in the income (or gain) company cannot exceed its increase in market value because of the economic loss component of a transferred tax loss or net capital loss, an increase may be capped at a yet lower level having regard to the amount of reductions to the cost bases or reduced cost bases of interests in the loss company. [Schedule 1, items 43 and 54, paragraph 170-215(3)(ab) and paragraph 170-225(3)(ab)]

3.34 The total reductions made to cost bases or reduced cost bases in respect of interests held directly in the loss company will generally serve as an appropriate further limitation of the uplifts that can be made to cost bases and reduced cost bases of interests held in the income or gain company.

3.35 For example, if the total cost bases and reduced cost bases of direct equity and debt investments in the loss company is only $10, a $10,000 loss (which is an economic loss) is transferred to an income company, and no subvention payment is made by the income company, no increase could be made to any interest in the income company that exceeds $10 multiplied by the relevant corporate tax rate.

3.36 Where paragraph 3.32 refers to an 'appropriate' reduction and paragraph 3.34 refers to reductions 'made' to the cost bases or reduced cost bases of interests in the loss company, it is not required that a 'reduction' has (or reductions have) actually been made at the times required by subsection 170-210(4) or 170-220(4). This occurs immediately before a CGT event happens to the relevant share or debt. It is sufficient that the need for the reduction has been identified. This means, for example, that an uplift will not be denied in the cost base or reduced cost base of an interest in the gain company just because a CGT event has not yet happened to an interest in the loss company.

Cost base uplifts allowed only to the extent that losses transferred are economic losses

3.37 Amendments are also proposed to ensure that cost base or reduced cost base uplifts can be made only to the extent that the loss transferred is an outlay or loss of any of the economic resources of the loss company. [Schedule 1, items 44 and 55, subsections 170-215(4A) and 170-225(4A)]

3.38 If, for example, a $20,000 tax loss were transferred, and $15,000 relates to amounts that do not represent an outlay or loss of any of the economic resources of the loss company, uplifts can only be made in respect of $5,000 of the amount transferred.

3.39 Subject to the requirement of not exceeding the market value increase of any single interest because of the economic loss component of the transferred loss, and assuming that there are cost base and reduced cost base reductions of at least $5,000 to direct interests in the loss company (see paragraph 3.34 above), the maximum total uplift possible for interests held directly in the transferee company would be an amount equal to $5,000 multiplied by the applicable company tax rate. The maximum total uplifts for interests held indirectly in the transferee company could not exceed the total uplifts obtained by the entities in which those particular investments were directly held.

Example: 3.4 A net capital loss of $50,000 is transferred to Gain Co, of which $20,000 is an economic loss. There are reductions of at least $20,000 to the cost bases or reduced cost bases of interests held directly in the transferor loss company. The 500 shares in Gain Co are held 50% (250 shares) by Holding Co 1 and 50% (250 shares) by Holding Co 2. Holding Co 2 owns all 100 shares on issue in Holding Co 1. All the companies are members of the same wholly-owned group.Assuming a relevant company tax rate of 34%, and subject to any increasing adjustment not exceeding an increase in its market value as a result of Gain Co receiving the economic loss component of the loss, the maximum cost base and reduced cost base uplift for an interest (at any tier) in Gain Co, and for the total of those investments (at any tier) is $6,800. That is $20,000 (the economic loss component) x 34% = $6,800.On the facts in this case, each share held directly in Gain Co (a tier of investment) would be expected to have an increased market value (based on the economic loss component) of the transferred loss of $6,800/500 shares = $13.60 per share. Thus, the maximum increase for each of Holding Co 1's 100 shares, and Holding Co 2's 100 shares, in Gain Co would be $13.60The maximum increase for Holding Co 2's shares in Holding Co 1 would be limited to the maximum uplift obtained on Holding Co 1's shares in Gain Co. In this case, this is 250 shares x $13.60 = $3,400. Because Holding Co 2 holds all the shares in Holding Co 1, the maximum uplift on these shares would be $3,400/100 = $34 per share. Again, this does not exceed the increase in market value of any interest because of the (economic loss) component of the transferred loss.

Amendments to notes

3.40 The note after subsection 170-210(4) is repealed and a new note is substituted. The new note alerts readers to the fact that the expression 'deduction year' means the same as it does in the provisions dealing with the actual transfer of the tax loss. The note continues to alert readers to the relevance of subsection 170-210(4) for indexation. [Schedule 1, item 40, section 170-210 notes]

3.41 A note is inserted after section 170-215 to provide a cross-reference to the definition of 'deduction year.' This serves the same purpose as the note discussed in the preceding paragraph. A note is also inserted after section 170-220 to provide a cross-reference to the expression 'applicable year' which has the same meaning as it does in the net capital loss transfer provisions. [Schedule 1, items 45 and 52, sections 170-215 note and 170-220 note 3]

Application and transitional provisions

3.42 The amendments which provide that only the reduced cost base of a debt may be reduced following the transfer of a net capital loss and other clarifications to the making of cost base or reduced cost base adjustments, will apply to tax loss and net capital loss transfer agreements made on or after 22 February 1999, the commencement date for Subdivision 170-C [Schedule 1, subitem 68(4)] . These amendments help to achieve what has always been the intended application of the Subdivision.

3.43 The amendments to deny cost base and reduced cost base uplifts for interests in an income (or gain) company, if there are no cost base or reduced cost base reductions for interests in the loss company, to have regard to reductions as a limiting factor for appropriate increases, and also to limit the uplifts to the extent that a loss transferred is an economic loss, apply to loss transfer agreements made on or after 13 April 2000. [Schedule 1, subitems 68(4A) and 68(5)]

Consequential amendments

3.44 There are no consequential amendments relating to this measure.

Chapter 4 - Amendments to Subdivision 170-D

Outline of Chapter

4.1 Schedule 1 to this Bill amends Subdivision 170-D of the ITAA 1997. Subdivision 170-D defers recognition of a capital loss or deduction which would otherwise be realised on the transfer or creation of a CGT asset between companies in the same linked group or between a company in a linked group and a connected entity (or its associate).

4.2 The amendments introduced in this Bill refine Subdivision 170-D to ensure that it operates as intended.

Context of Reform

4.3 Subdivision 170-D was introduced to address the duplication of losses. This can arise if a 'loss asset' (an asset with an unrealised loss) is transferred or created between companies in the same wholly-owned or majority-owned company group (both a 'linked group') or between such a company and an entity connected with it. Under the previous law, duplication was facilitated by, among other things, the existence of compulsory loss asset roll-over within wholly-owned groups of companies and by rules that allowed companies to realise losses or deductions by 'internal' transactions.

4.4 Subdivision 170-D addresses loss duplication by ensuring that the transfer or creation of a loss asset by one company (the 'originating company') to, or in, another company in the linked group or a connected entity, does not allow a capital loss or deduction that can be immediately realised for taxation purposes. Broadly speaking, recognition of the capital loss or deduction is deferred until the asset, or a majority interest in it, is no longer held by the linked group and connected entities. If the asset, or majority interest in it, is reacquired by certain entities within a 4 year period, the capital loss or deduction may be subject to further deferral.

4.5 Following the introduction of Subdivision 170-D, it became evident that certain minor refinements could be made to the Subdivision that would enhance its operation. The amendments contained in this Bill make these refinements.

Summary of new law

4.6 The amendments proposed by Schedule 1 will ensure that Subdivision 170-D will:

apply to defer a deduction to a non-resident company on the disposal of a CGT asset;
clarify the operation of the 'double counting' rule in the linked group test;
apply appropriately to dealings involving an interest in a CGT asset and clarify that 'asset' means 'CGT asset';
modify the reacquisition rule so it works properly if an entity holding the asset, or a majority interest in the entity, is acquired; and
provide relief from the operation of the reacquisition rule in circumstances where it would be reasonable to conclude that the majority underlying ownership of the originating company has changed from when the capital loss or deduction was deferred.

Comparison of key features of new law and current law
New law Current law
Applies to defer a deduction to a non -resident company on the disposal of a CGT asset Does not apply to defer a deduction to a non-resident company on the disposal of a CGT asset.
Makes it clear that interests of associates are taken into account in the 'double counting' rule for the linked group test. Does not expressly state that associate interests are taken into account in the 'double counting' rule.
Applies the 'interest' concept and 'asset' definition consistently across the Subdivision. Does not apply the 'interest' concept and 'asset' definition consistently across the Subdivision.
Extends the rule for the reacquisition of an asset within 4 years to a situation where an entity holding the asset, or a majority interest in the entity, is reacquired. The reacquisition rules does not include a case where an entity, or a majority interest in an entity, holding the relevant asset is reacquired.
Provides relief from the reacquisition rule where it would be reasonable to conclude that the majority underlying ownership of the originating company has changed from when the capital loss or deduction on the reacquired asset was deferred. There is no relief from the reacquisition rule even though the majority underlying ownership of the originating company has changed since the capital loss or deduction was deferred.

Disposal of a CGT asset leading to a deduction by a non-resident

4.7 Subdivision 170-D is amended so it will apply where:

the originating company is a non-resident at the time of the disposal of the CGT asset; and
the disposal would have resulted in the originating company (or partnership in which it is a partner) becoming entitled to a deduction.

[Schedule 1, items 57,58, subparagraph 170-255(1)(d)(v)]

4.8 Currently, the Subdivision does not apply to defer a deduction on the disposal of an asset held on revenue account by a non-resident company (alone or in partnership), although it may defer a capital loss on the disposal of a CGT asset. The amendment ensures consistent treatment for non-residents.

Clarify the operation of the double counting rule in the linked group and connected entity tests

4.9 In applying the linked group rules, the controlling stake and connected entity tests work on an associate-inclusive basis. Where an interest held by an entity would be double counted, and the interest is both direct and indirect, only the direct interest (of the entity or its associate) is to be counted. [Schedule 1, items 60 and 61, existing subsection 170-260(4) and paragraph 170-265(3)(a)]

4.10 These tests are amended to put beyond doubt that the meaning of the word 'interest' in respect of an entity in the double counting provisions is to be read as including the interests held by its associates. [Schedule 1, items 56 and 57, paragraphs 170-260(4)(a) and 170-265(3)(a)

References to CGT asset and application of the Subdivision to an interest in a CGT asset

4.11 For avoidance of doubt, amendments are made to ensure that 'asset' in this Subdivision 170-D means a 'CGT asset'. In addition, Subdivision 170-D does not currently apply consistently if an interest in a CGT asset, rather than the asset itself, is dealt with.

4.12 Schedule 1 therefore amends subparagraphs 170-255(1)(b)(ii) and (iii), paragraph 170-275(1)(c), subsection 170-280(1) and paragraph 170-280(3)(c) to ensure these outcomes. [Schedule 1, items 56, 59, 62, 64, 65 and 65A, subparagraphs 170-255(1)(b)(ii) and (iii), paragraphs 170-275(1)(c), subsection 170-280(1) and 170-280(3)]

Modifying the reacquisition rule

4.13 Currently, if a deferred capital loss or deduction was recognised by an originating company because of the occurrence of a new event in respect of a CGT asset (as described in section 170-275), that recognition may be undone if within 4 years after the happening of the new event, the asset, or a greater than 50% interest in it is acquired by:

the originating company;
an entity which is a connected entity, or an associate of the connected entity, of the originating company; or
a company that is a member of the same linked group as the originating company.

4.14 Section 170-280 is amended so that these events are now called 'further events'. [Schedule 1, item 64, subsection 170-280(1)]

4.15 The reacquisition rules are modified to include new further events which may give rise to a deferral of a capital loss or deduction. This is because the current law focuses on reacquisition of the asset by a company in the linked group or connected entity, and does not deal with other cases where the asset may be effectively reacquired. [Schedule 1, item 64]

4.16 A capital loss or deduction which has been made is also to be deferred if the following additional further events happen:

a company that owns the asset or a greater than 50% interest in it becomes a member of the same linked group as the originating company [Schedule 1, item 64, paragraph 170-280(1)(b)] ;
the originating company becomes a member of a linked group a member of which owns the asset or a greater than 50% interest in it [Schedule 1, item 64, paragraph 170-280(1)(c)] ; or
an entity that owns the asset or a greater than 50% interest in it becomes:

-
a connected entity of the originating company; or
-
an associate of such a connected entity.

[Schedule 1, item 64, paragraph 170-280(1)(d)]

4.17 The purpose of these amendments is to deny the previous recognition of a capital loss or deduction if the asset is effectively reacquired indirectly.

Example 4.1 Subco and Smallco are owned by Holdco. On 1 December 1999 Subco transfers a loss asset to Smallco. As Subco and Smallco are part of the same linked group, the capital loss that would otherwise have been made on transfer of the asset is deferred.On 1 June 2000 Holdco sells Smallco to an entity unconnected to the linked group. At this time Subco recognises the deferred capital loss.Two years later, on 1 June 2002, Smallco, while still holding the asset, is sold back to Holdco. This is a further event, therefore, the capital loss which has been claimed is taken not to have been made.

Relief from the reacquisition rule if change in underlying ownership of the originating company

4.18 Subdivision 170-D focuses on the originating company and on entities that are part of the same linked group as the originating company or entities connected with the originating company and its associates.

4.19 In limited cases, the originating company may have been sold to a different group of underlying owners such that it would be inappropriate to apply the reacquisition rule if the asset, or a majority interest in it, were acquired by the originating company and related companies and entities.

4.20 A relieving provisionis proposed to be inserted into the reacquisition rule contained in section 170-280. If within 4 years after the new event happens the CGT asset involved is transferred to the originating company and the originating company has information from which it would be reasonable to conclude that the ultimate owners who now have the majority underlying interest in the asset are not the same as the ultimate owners who had a majority underlying interest at the time of the deferral event, then, the further event is considered not to have happened. [Schedule 1, item 64, subsection 170-280(1A)]

Example 4.2 Subco and Smallco are owned by Holdco. On 1 December 1999 Subco transfers a loss asset to Smallco. As Subco and Smallco are part of the same linked group the capital loss, which Subco makes on transfer of the asset, is deferred.On 1 June 2000 Holdco sells Subco to an entity outside the linked group and not connected with the linked group. At this time Subco is able to recognise the deferred loss.Two years later, on 1 June 2002, Smallco sells the asset to Subco. Subco is able to establish that there has been a change in underlying ownership and therefore the further event is considered not to have occurred and the capital loss claimed is not denied.

Application and transitional provisions

4.21 The amendments made by Schedule 1 apply to deferral events happening on or after 21 October 1999. This was the application date for Division 170-D when it was introduced. These amendments make a number of corrections and clarifications to achieve what was intended by that measure. [Schedule 1 , subitem 68(6)]

Consequential amendments

4.22 There are no consequential amendments relating to this measure.

Chapter 5 - Life insurance companies

Outline of Chapter

5.1 This Chapter explains the amendments which insert new Division 320 into the ITAA 1997. New Division 320 will provide a new basis for taxing life insurance companies and will replace Division 8 and Division 8A of the ITAA 1936. The new Division will ensure that life insurance companies are taxed on all their profits including:

all management fees (except for management fees that are exempt from tax under transitional arrangements);
underwriting profit; and
profit on immediate annuity business.

5.2 New Division 320 also enables the segregation of certain assets of a life insurance company into:

'virtual' PST assets - that is, assets relating to complying superannuation business:

-
income generated on those assets is taxed at a rate of 15%; and

segregated exempt assets - that is, assets relating to immediate annuity and current pension business;

-
income generated on those assets is exempt from tax.

5.3 This Chapter also explains amendments to the ITAA 1936 and the ITAA 1997 to:

tax the current pension business of complying superannuation funds and PSTs consistently with the immediate annuity and current pension business of life insurance companies;
change the section 275 transfer mechanism for complying superannuation funds; and
ensure that the CGT provisions that apply to complying superannuation funds apply to the complying superannuation business of life insurance companies.

Context of Reform

5.4 The Government announced in ANTS major reforms to the taxation of the life insurance industry. The details of the proposed reform were developed by the Review and announced as part of the New Business Tax System.

5.5 Existing taxation arrangements for life insurers are very complex with income and expenses being allocated to up to 4 classes of business.

Each class is subject to a different rate of tax.
Some classes include components which are exempt from tax or subject to different rates of tax.
Different calculations are required to determine assessable income for each class of business.
Tax planning opportunities can arise from internal dealings that exploit differences in the taxation rates of each class of business.

5.6 In addition, existing taxation arrangements for life insurers are inconsistent with the treatment of similar activities carried on by other entities.

The income tax base does not include all income.
Similar economic activities are subject to different rates of tax depending on whether the business is carried on by a life insurer or a general insurer. For example:

-
unlike general insurers, life insurers are not taxed on underwriting profit; and
-
management fees embedded in premiums are not included in the assessable income of life insurers. However, all management fees are included in the assessable income of banks, public unit trusts and general insurers.

5.7 The reforms ensure that life insurance companies will be taxed on a more rational basis in line with the treatment of similar activities by other entities.

5.8 Discrepancies in treatment between life insurance companies and other entities are removed so that:

the taxable income from the risk business of life insurance companies is calculated on broadly the same basis as the taxable income of the risk business of general insurers; and
the taxable income of the investment business of life insurance companies is calculated on broadly the same basis that applies to calculate the taxable income of the investment business of other investment entities (other than collective investment vehicles).

5.9 Life insurance companies will be able to maintain their current role in respect of superannuation through the establishment of virtual PSTs.

Summary of new law

5.10 The new provisions ensure that life insurers are taxed in a comparable way to other entities with similar types of income. The provisions contain special rules for working out the taxable income of life insurance companies. Those rules:

include certain amounts in assessable income;
identify certain amounts of exempt income; and
identify specific deductions.

5.11 The taxable income of life insurance companies is divided into 2 classes:

the complying superannuation class - this class contains taxable income that relates to a life insurance company's complying superannuation business and is taxed at the rate of tax that applies to complying superannuation funds; and
the ordinary class - this class contains the rest of the company's taxable income and is taxed at the company tax rate.

5.12 The new provisions also enable the segregation of certain assets of a life insurance company into:

'virtual' PST assets - that is, assets relating to complying superannuation business;

-
income generated on those assets is taxed at a rate of 15%; and

segregated exempt assets - that is, assets relating to immediate annuity and current pension business;

-
income generated on those assets is exempt from tax.

5.13 This Bill also amends the ITAA 1936 and the ITAA 1997 to:

subject to transitional arrangements that apply to self managed superannuation funds and small APRA funds, tax the current pension business of complying superannuation funds consistently with the immediate annuity and current pension business of life insurance companies;
change the section 275 transfer mechanism for complying superannuation funds; and
ensure that the CGT provisions that apply to complying superannuation funds apply to the complying superannuation business of life insurance companies.

Comparison of key features of new law and current law
New law Current law
The taxable income of life insurance companies will be determined under both the general provisions and new Division 320 of the ITAA 1997.

Life insurers will be taxed on all the profit made from their different activities in broadly the same way as activities in other entities that are similar in economic substance. That is:

risk business will be taxed on broadly the same basis as for general insurers;
investment business will be taxed on broadly the same basis as for other investment entities (other than collective investment vehicles); and
complying superannuation business held in a virtual PST will be taxed on broadly the same basis as for PSTs.

The assets relating to the complying superannuation business will be segregated and held in a virtual PST. Ordinary income and statutory income generated on those assets will be taxed at a rate of 15%.

Income derived from immediate annuity and other exempt superannuation business will be exempt from tax if the assets relating to that business are segregated. This will apply only for assets necessary to fund that business.

The remaining business of life companies will be taxed at the company tax rate.

Amounts transferred to and from virtual PST assets and other parts of the life company's business will be taken into account in calculating liability to tax. This will ensure that fees on this business are taxed and will prevent tax planning opportunities arising from internal dealings.

For the same reason, amounts transferred to and from the segregated exempt assets will also be taken into account in calculating liability to tax.

The taxable income of life insurance companies and registered organisations (including friendly societies) is currently determined by applying the provisions in Division 8 and Division 8A of the ITAA 1936 respectively.

These provisions do not include all income in the income tax base. Underwriting profit, profit on immediate annuity business and some management fees are not subject to tax.

Division 8 and Division 8A:

specifies exempt income, assessable income and allowable deductions of life insurance companies; and
allocates income and expenses into 4 classes of business.

Four different rates of tax apply to life insurance companies to reflect the 4 classes of business.

Tax planning opportunities can arise from internal dealings that exploit differences in the taxation rates of each class of business.

Detailed explanation of new law

What is a life insurance company?

5.14 A life insurance company is defined in section 995-1 of the ITAA 1997 to be a company registered under the Life Insurance Act.

5.15 Companies that are registered under the Life Insurance Act include:

life insurance companies;
life reinsurance companies; and
friendly societies that carry on life insurance business.

5.16 The definitions of life insurance entity and SGIO in section 995-1 are being repealed as they are no longer required. New Division 320 does not apply to registered organisations because there are no registered organisations (other than friendly societies) that carry on life insurance business. [Schedule 9, items 29 and 48, subsection 995-1(1)]

What is a life insurance policy?

5.17 A life insurance policy is a policy that is:

a life policy as defined in section 9 of the Life Insurance Act;
a policy that is declared to be part of life insurance business under section 12A or section 12B of the Life Insurance Act; and
a sinking fund policy as defined in the Dictionary in the Schedule to the Life Insurance Act.

[Schedule 9, item 30, subsection 995-1(1)]

5.18 That is, a life insurance policy will be any business that a life insurance company is permitted to carry out as life insurance business under the Life Insurance Act.

5.19 A 'life policy' as defined in section 9 of the Life Insurance Act is:

an insurance contract that provides for the payment of money on the death of a person of the happening of a contingency dependant on the termination or continuance of human life;
an insurance contract that is subject to the payment of premiums for a term dependant on the termination or continuance of human life;
an insurance contract that provides for the payment of an annuity for a term dependant on the termination or continuance of human life;
a contract that provides for the payment of an annuity for a term not dependant on the termination or continuance of human life but exceeding the term prescribed in the Life Insurance Regulations;
a continuous disability policy as defined in section 9A of the Life Insurance Act;
a contract (whether or not it is an insurance contract) that constitutes an investment account contract as defined in section 14 of the Life Insurance Act; and
a contract (whether or not it is an insurance contract) that constitutes an investment-linked contract as defined in section 14 of the Life Insurance Act.

5.20 Policies declared to be part of life insurance business under section 12A or section 12B of the Life Insurance Act are policies which do not clearly fit the explicit definition of a life policy under section 9 of that Act but which are still appropriately undertaken by life insurance companies. Examples of the types of policies which are declared to be life insurance business include:

fixed term annuities that have a term of less than 10 years; and
income bonds and scholarship plans issued by friendly societies.

5.21 A sinking fund policy is a contract under which a life insurance company undertakes to pay money on one or more specified dates that is not dependant on the death or survival of the person to whom the policy is issued or of any other person.

What is the taxable income of life insurance companies?

5.22 Section 4-15 of the ITAA 1997 provides that the taxable income of a taxpayer consists of:

Assessable income - Deductions.

Assessable income

5.23 Section 6-1 provides that assessable income consists of:

ordinary income - that is, income according to ordinary concepts (section 6-5); and
statutory income - that is, amounts included in assessable income by a specific provision of the Act (section 6-10).

5.24 Section 6-25 ensures that:

amounts that are included in assessable income by more than one provision of the Act are included in assessable income only once; and
unless the contrary intention appears, the specific provisions of the Act prevail over the rules about ordinary income.

Deductions

5.25 Division 8 of the ITAA 1997 categorises deductions as:

general deductions - broadly, expenses incurred in carrying on a business for the purpose of gaining or producing assessable income (section 8-1); and
specific deductions - that is, amounts allowed as a deduction by a specific provision of the Act (section 8-5).

5.26 The Bill inserts new Division 320 into the ITAA 1997. [Schedule 2, item 84, Division 320]

5.27 The Division contains special rules for working out the taxable income of life insurance companies. Those rules:

include certain amounts in assessable income;
identify certain amounts of exempt income; and
identify specific deductions of life insurance business.

5.28 The Division divides the taxable income of life insurance companies into 2 classes:

the ordinary class of taxable income - which is taxed at the company tax rate; and
the complying superannuation class of taxable income - which is taxed at a rate of 15%.

5.29 The Division also contains rules for segregating the assets of life insurance companies:

assets that relate to complying superannuation business that are held in a virtual PST; and
assets that relate to immediate annuity and other exempt business.

[Schedule 2, item 84, section 320-1]

What is the object of new Division 320?

5.30 The object of new Division 320 is to ensure that life insurance companies are taxed in a broadly comparable way to other entities that derive similar kinds of income. [Schedule 2, item 84, section 320-5]

What is included in the assessable income of a life insurance company?

5.31 New subsection 320-15 specifically includes additional amounts in the assessable income of life insurance companies. [Schedule 2, item 84, section 320-15]

5.32 The assessable income of a life insurance company will include:

life insurance premiums paid to the company in the income year;

-
a life insurance premium is any amount paid by a policyholder for a life insurance policy and includes the amount paid to purchase an annuity (including a deferred annuity) [Schedule 9, item 31, subsection 995-1(1)] ;

amounts received under a contract of reinsurance to the extent that they relate to the risk components of claims paid under a reinsurance policy;

-
for this purpose a contract of reinsurance does not include a reinsurance contract in respect of life insurance policies that are held in the virtual PST or in the segregated exempt assets of the reinsurance company [Schedule 9, item 12, subsection 995-1(1)] ;
-
the risk component of claims paid under a reinsurance policy is that part of the claim that is allowed as a deduction to the reinsurer under new section 320-80;
-
the investment component of claims paid are currently assessable under section 26AH of the ITAA 1936;

refunds, or amounts in the nature of refunds, of reinsurance premiums paid under a contract of reinsurance;
amounts received under a profit-sharing arrangement under a contract of reinsurance;
the amount included in assessable income under section 320-200 where an asset other than money is transferred:

-
from or to a virtual PST under new subsection 320-180(1) or (2);
-
to a virtual PST under new section 320-185; or
-
from a virtual PST under new subsection 320-195(2) or (3);

the transfer value of assets transferred from segregated exempt assets under new subsection 320-235(1) or subsection 320-250(2);

-
the transfer value of an asset is the amount that could be expected to be received from the disposal of the asset in an open market after deducting any costs expected to be incurred in respect of the disposal [Schedule 9, item 60, subsection 995-1(1)] ;
-
if the asset transferred from segregated exempt assets is money, the transfer value is the amount of the money [Schedule 2, item 84, paragraph 320-170(7)(b)] ;

the amount included in assessable income under section 320-255 where an asset other than money is transferred to the segregated exempt assets under new subsection 320-235(2) or section 320-240;
amounts representing a decrease in the value of the net risk components of risk policy liabilities worked out under new subsection 320-85;
section 275 transfers;

-
section 275 transfers are taxable contributions transferred from a complying superannuation fund or complying ADF under section 275;
-
taxable contributions are, generally, employer and tax deductible member contributions made to a complying superannuation fund that are included in the fund's assessable income under section 274 of the ITAA 1936 [Schedule 9, item 53, subsection 995-1(1)] ;

specified roll-over amounts;

-
specified roll-over amounts are the untaxed element of the post-June 83 component of an ETP rolled-over to purchase a deferred annuity or an immediate annuity [Schedule 9, item 51, subsection 995-1(1)] ;

fees and charges imposed on life insurance policies that are not otherwise included in assessable income; and
taxable contributions made to RSAs provided by the company.

[Schedule 2, item 84, section 320-15]

5.33 The assessable income of a life insurance company also includes amounts that are assessable under the other provisions of the income tax law (such as the ordinary income provisions and the capital gain tax provisions).

Management fees included in assessable income

5.34 The assessable income of a life insurance company will include all explicit and implicit fees charged by life insurance companies.

5.35 Examples of management fees that will be included in assessable income are premium based fees, establishment fees, time based account fees, asset fees, switching fees, surrender penalties, buy/sell margins, exit fees and interest on overdue premiums.

5.36 All premium-based fees, regardless of their type, will be taxed in the period the premiums are paid - this arises as a consequence of including total premiums in assessable income and allowing deductions for certain components of those premiums based on the entitlement of the policyholders.

5.37 For example, surrender fees and exit fees designed to recover acquisition costs will be recognised in the year the premium is received and those fees are reflected in the termination value of the policy.

5.38 Fees derived on life insurance policies held in a virtual PST or in segregated exempt assets will be included in assessable income and taxed at the company tax rate. This is a consequence of provisions relating the amount of segregated assets to liability values that reflect the policyholders' entitlements, the provisions relating to the transfer of amounts from the segregated assets and the mechanism for working out the virtual PST component of assessable income.

Amounts transferred from a virtual PST to its segregated exempt assets

5.39 If an asset other than money that was transferred from a company's virtual PST to its segregated exempt assets under new subsection 320-195(1) is disposed of by the company, the assessable income of the company includes the lesser of:

the amount (if any) that would have been included in assessable income if the asset had been disposed of by the company at the time of transfer of the asset to the segregated exempt assets if section 320-255 applied at that time; and
the amount (if any) that would have been included in assessable income if the asset were an asset of the virtual PST at the time of disposal.

[Schedule 2, item 84, section 320-20]

5.40 Similarly, if an asset other than money that was transferred from a company's virtual PST to its segregated exempt assets under new subsection 320-195(1) is transferred from those segregated exempt assets under subsection 320-235(1) or section 320-250, the assessable income of the company includes the lesser of:

the amount (if any) that would have been included in assessable income if the asset had been disposed of by the company at the time of transfer of the asset to the segregated exempt assets if section 320-255 applied at that time; and
the amount (if any) that would have been included in assessable income because of section 320-255 if the asset had been an asset of the virtual PST at the time of its transfer from the segregated exempt assets.

[Schedule 2, item 84, section 320-25]

Decrease in the value of policy liabilities for continuous disability policies

5.41 New section 320-85 allows a deduction to life insurance companies for the increase in the value of risk policy liabilities. The section specifies that the Valuation Standard is to be used as the basis for valuing risk policy liabilities relating to long term policies, including continuous disability policies. Life insurance companies currently work out the profit made on disability business, including continuous disability business, based on the change in the value of policy liabilities calculated using the Solvency Standard or some similar basis. A decrease in the value of policy liabilities is included in assessable income under new paragraph 320-15(h).

5.42 As the value of liabilities calculated using the Solvency Standard is usually higher than the value of liabilities calculated using the Valuation Standard, the change in basis of calculating policy liabilities for continuous disability policies will result in a significant amount being included in assessable income for the income year in which 1 July 2000 occurs.[F1]

5.43 Therefore, as a transitional measure, one fifth of the amount representing the difference in the value of policy liabilities for continuous disability policies will be included in assessable income each year for a period of 5 years. This will spread the impact of the change in the basis for calculating risk policy liabilities on continuous disability policies over a period of 5 years. [Schedule 2, item 84, section 320-30]

What income is exempt income of life insurance companies?

5.44 New sections 320-35 and 320-40 specify the exempt income of life insurance companies.

5.45 Life insurance companies will be exempt from tax on:

amounts of ordinary income and statutory income accrued before 1 July 1988 on assets that have become virtual PST assets;

-
this ensures that income derived before 1 July 1988 on assets supporting complying superannuation business is exempt from tax;

amounts of ordinary income and statutory income derived on segregated exempt assets;

-
segregated exempt assets are assets that support immediate annuity and current pension business and business from constitutionally protected superannuation funds;
-
capital gains derived from this business are exempt from tax under new section 118-315 [Schedule 2, item 81, section 118-315] ;

amounts of ordinary income and statutory income received from the disposal of units in a PST;

-
capital gains derived from the disposal of units in a PST are exempt from tax under section 118-350;

the non-resident portion of foreign source income derived by an Australian/overseas fund or an overseas fund that is attributable to policies issued by foreign permanent establishments;

-
the non-resident proportion of foreign establishment amounts is worked out using the formula in subsection 320-35(2);

amounts that are credited to an RSA that is paying out an immediate annuity; and
income derived by friendly societies that is:

-
received before 1 July 2001 and is exempt from tax under section 50-1; or
-
received after 30 June 2001 and is attributable to income bonds, funeral policies and scholarship plans issued by friendly societies before 1 December 1999.

[Schedule 2, item 84, section 320-35]

Exemption of specified management fees

5.46 As a transitional rule, life insurance companies will be exempt from tax on one-third of specified management fees on certain life insurance policies taken out before 1 July 2000. The exemption will cease to apply from 30 June 2005.

5.47 The rationale for the transitional relief is that, currently, a full tax deduction is not allowed for policy acquisition expenses to the extent that associated management fees are not taxed at the company tax rate. These acquisition expenses are recovered from fees charged on the policy in its initial years - fees that will now be taxed at the company tax rate. Consequently, any income that is exempt under this transitional arrangement is treated as assessable income for the purpose of claiming deductions under section 8-1 of the ITAA 1997.

5.48 Broadly, transitional relief will apply to exempt from tax one-third of:

all fees on complying superannuation policies held in a virtual PST;
all fees on immediate annuity policies held in segregated exempt assets; and
premium-based fees and other fees that are currently exempt from tax on other policies.

5.49 Transitional relief does not apply to management fees in respect of life insurance policies that, as at 30 June 2000, are:

policies under which benefits are payable only on the death or disability of a person; or
policies that provide for participating benefits or discretionary benefits that are not held in a virtual PST or in segregated exempt assets.

5.50 Specified management fees are the fees and charges made by the company (being fees and charges the company was entitled to make under the terms of policies as at 30 June 2000) being the sum of:

for virtual PST life insurance policies - the total amount transferred from the virtual PST in the income year under subsection 320-180(1) or subsection 320-195(3) less:

-
the total amount transferred to the virtual PST under subsection 320-180(2) or subsection 320-185(1); and
-
any amount of those premiums that relate to the company's liability to pay amounts on the death or disability of the person;

for exempt life insurance policies held in the segregated exempt assets - the total amount transferred from the segregated exempt assets in the income year under subsection 320-235(1) or subsection 320-250(2) less the total amount transferred to the segregated exempt assets under subsection 320-235(2) or subsection 320-240(1);
for other policies - the sum of premiums received in respect of those policies in the income year less the total of:

-
the amount deductible under section 320-75; and
-
the risk component of the claims paid under those policies.

5.51 The amount calculated under any one of subsections 320-40(5), (6) or (7) cannot be negative.

5.52 A policy will be regarded as having been taken out before 1 July 2000 if the contract is entered into with the company before that date. If a policy is restructured or if the terms of the policy change after that date to change the fee structure of the policy, the policy will be considered to be a new policy that does not qualify for transitional relief. An example of a policy that is restructured is a policy that is converted to a different policy table (such as converting from a whole-of-life policy to an endowment policy).

[Schedule 2, item 84, section 320-40]

What specific deductions will be allowed to life insurance companies?

5.53 Life insurance companies will be entitled to specific deductions for:

certain components of life insurance premiums;
the risk component of claims paid under life insurance policies;
the increase in the value of risk policy liabilities;
certain amounts where assets are transferred to or from the virtual PST;
reinsurance premiums;
amounts transferred to segregated exempt assets; and
amounts paid after 30 June 2001 by friendly societies to holders of income bonds issued after 30 November 1999.

Premiums transferred to virtual PSTs

5.54 New subsection 320-55 allows a deduction for the part of the life insurance premiums transferred to a virtual PST.

5.55 The amount allowed as a deduction is the amount of the premium received that is transferred to the virtual PST less the death and disability component of the premiums.

5.56 The death and disability component of the premium is:

if the policy specifies the death and disability component of the premium - the amount specified; or
if the policy does not specify the death and disability component of the premium and:

-
if the policy provides participating benefits or discretionary benefits - nil;
-
if the policy is an endowment policy - 10% of the premium;
-
if the policy is a whole-of-life policy - 30% of the premium; or
-
otherwise - so much of the premium that an actuary determines to be the death and disability component of the premium.

[Schedule 2, item 84, section 320-55]

Premiums transferred to segregated exempt assets

5.57 A deduction is allowed for the amount of a premium that is transferred to segregated exempt assets. Segregated exempt assets are primarily assets to support immediate annuity and current pension business of life insurance companies. [Schedule 2, item 84, section 320-60]

Premiums in respect of policies that provide participating or discretionary benefits

5.58 A deduction is allowed for premiums in respect of policies (other than virtual PST policies or exempt life insurance policies which are covered by other sections) that provide participating or discretionary benefits. [Schedule 2, item 84, section 320-65]

5.59 Policies that provide participating benefits are policies that provide benefits that are not non-participating benefits as defined in section 15 of the Life Insurance Act [Schedule 9, item 40, subsection 995-1(1)] . Generally, participating benefits are benefits that include a share in the profits or surplus of a life insurance company - such as benefits provided under traditional whole-of-life and endowment policies.

5.60 Non-participating benefits are defined in section 15 of the Life Insurance Act to mean, generally, benefits that are set out in a policy document that do not include a share in profits or surplus. Investment-linked policies and some investment account policies are examples of policies that provide non-participating benefits .

5.61 Discretionary benefits are investment account benefits (as defined in section 14 of the Life Insurance Act) that are regarded as non-participating benefits for the purposes of the Life Insurance Act solely because of the operation of Prudential Rules No. 22 of that Act [Schedule 9, item 17, subsection 995-1(1)] . These policies are credited interest according to a prescribed formula but with an element of discretion or smoothing over time that generally requires the establishment and maintenance of a smoothing reserve. The actuarial management of this business is undertaken on bases similar to those for participating business.

5.62 The deductibility of premiums on policies that provide participating or discretionary benefits recognises that the structure and administration of existing life insurance business has not required the separate identification of the capital, risk and fee components of premiums or benefits.

5.63 Therefore, the deductible component of the premium for policies that provide participating benefits or discretionary benefits is the whole of the premium paid by the policyholder. This recognises that under these policies, policyholders are entitled to share in the profits of the business, including underwriting and expense profits. Therefore, the component of the premiums attributable to risk and expenses is part of the entitlement of policyholders until the profit (or, more particularly, the share of that profit allocated to shareholders) is determined.

Premiums in respect of policies that provide benefits only on death or disability

5.64 A deduction is not allowed for any part of premiums in respect of policies that provide benefits only on death or disability, except where those policies are participating or discretionary policies. [Schedule 2, item 84, section 320-70]

Premiums in respect of other policies

5.65 New section 320-75 allows a deduction for a component of premiums in respect of ordinary non-participating investment policies -that is, life insurance policies other than:

premiums that are transferred to a virtual PST;
premiums that are transferred to segregated exempt assets;
premiums in respect of policies that provide participating or discretionary benefits; and
premiums in respect of policies that provide benefits only on death or disability.

5.66 If the policy is taken out after 30 June 2001, the amount allowed as a deduction is the lesser of:

the amount specified in the policy to be the capital component of the premium adjusted for any part of the premium that is reinsured;

-
the capital component of the premium is that part of the premium that is to be returned to the policyholder when a benefit is paid. The amount specified under the terms of the policy could be a fixed dollar amount or an amount capable of calculation by a formula - such as a fixed percentage of the premium or, in the case of a group policy, a fixed amount for each member of the group covered by the policy; and

the sum of the net premiums less the amount that an actuary determines (having regard to the change over the income year in the sum of the net current termination values of the policies and the movements in those values during the year) to be attributable to fees and charges.

5.67 If the policy is taken out before 1 July 2001, the amount allowed as a deduction is the sum of the net premiums less the amount that an actuary determines (having regard to the change over the income year in the sum of the net current termination values of the policies and the movements in those values during the year) to be attributable to fees and charges. [Schedule 2, item 84, section 320-75]

5.68 Net premiums are the amount of the premium reduced by any part of the premium that is reinsured. [Schedule 9, item 34, subsection 995-1(1)]

5.69 Net current termination value is the current termination value that relates to that part of the policy that is not reinsured. [Schedule 9, item 33, subsection 995-1(1)]

5.70 Current termination value is the current termination value as defined in the Solvency Standard that relates to that part of the policy that is not reinsured. [Schedule 9, item 14, subsection 995-1(1)]

5.71 Generally, the change over the income year in the sum of the net current termination values of the policies is the sum of those values at the end of the income year reduced by the sum of those values at the start of the income year.

5.72 In this regard the change in the sum of the net current termination values of the policies should be considered in the context of other cash flows which have occurred during the income year.

The risk component of claims paid

5.73 As the risk component of life insurance premiums is included in assessable income, a specific deduction is allowed for the risk component of claims paid under life insurance policies (including claims paid by reinsurers). [Schedule 2, item 84, section 320-80]

5.74 The risk component of a claim paid under a policy is:

if the policy is a pure death or disability policy that does not provide participating benefits or discretionary benefits and is not an exempt life insurance policy - the whole of the amount paid under the policy;
if the policy provides for participating benefits or discretionary benefits - nil;

-
the risk component of claims paid for policies that provide for participating benefits or discretionary benefits (such as traditional whole-of-life and endowment policies) is nil because an appropriate deduction is effectively allowed through the calculation of the deduction for the premium component of these policies. The deduction for the premium component and risk component of these policies is combined because of the practical difficulty in breaking the premium into its separate elements;

if the policy is an exempt life insurance policy - nil; or
otherwise - the amount paid under the policy on the death or disability of the insured reduced by the current termination value of the policy (calculated by an actuary) immediately before the death, or the occurrence of the disability, of the insured person.

[Schedule 2, item 84, subsection 320-80(2)]

5.75 The risk component of claims paid can never exceed the total claim paid - that is, for taxation purposes the risk component of claims paid can not be a negative amount.

5.76 A deduction is not allowed for claims paid in any other circumstances for the investment component of the claim as the life insurance company pays tax on investment income. The policyholder is compensated for that tax by the rebate available on policies taken out before 1 July 2001 and by the imputation system on policies taken out after 30 June 2001. [Schedule 2, item 84, subsection 320-80(3)]

Increases in the value of liabilities under the net risk component of policies

5.77 New section 320-85 allows a specific deduction for increases in the value of liabilities under the net risk component of policies over an income year. If there is a decrease in the value of liabilities under the net risk component of policies over the income year, the decrease is included in the assessable income of the company under new paragraph 320-15(h). [Schedule 2, item 84, section 320-85]

5.78 The net risk component of a life insurance policy is the risk component of the policy in respect of that part of the policy that is not reinsured. [Schedule 9, item 35, subsection 995-1(1)]

5.79 The change in the value of risk policy liabilities is relevant for working out the profit or loss made on the risk component of a life insurance company's business - that is, its underwriting profit or loss - and its appropriate release over the life of the policy.

5.80 A deduction is not allowed for increases in the value of risk policy liabilities if the company is not entitled to claim a deduction for the risk component of claims paid under new section 320-80. That is, if the risk component of a claim paid under a policy is nil, the risk component of the policy (and the liability in respect of that component) is also taken to be nil. This is because an appropriate deduction is effectively allowed through the calculation of the deduction for the premium component for these policies. The deduction for the premium component and risk component of these policies is combined because of the practical difficulty in breaking the premium into its separate elements. [Schedule 2, item 84, subsection 320-85(2)]

5.81 Generally, the value of liabilities of the risk component of the policies will be the sum of the policy liabilities (as defined in the Valuation Standard) in respect of the net risk component of policies less the sum of any cumulative losses for the net risk component of policies. [Schedule 2, item 84, subsection 320-85(4)]

5.82 Policy liabilities for this purpose will include appropriate amounts for outstanding claims and claims incurred but not reported.

5.83 However, if the policy is a disability policy (other than a continuous disability policy) the value of liabilities of the risk component of the policy will be the current termination value as defined in the Solvency Standard of the policy (calculated by an actuary). [Schedule 2, item 84, subsection 320-85(3)]

5.84 As a transitional rule, the value of policy liabilities for disability policies (other than continuous disability policies) as at 30 June 2000 will be the value of liabilities actually used for taxation purposes as at the end of 30 June 2000. The value of policy liabilities for all other risk policies as at 30 June 2000 will be the value of those liabilities as at the end of 30 June 2000 as calculated under subsection 320-85(4) of the ITAA 1997. [Schedule 2, item 87, section 320-85 of the Transitional Provisions Act]

5.85 A disability policy (which includes a trauma policy) is a policy under which a benefit is payable in the event of:

the death, by accident or by some other cause stated in the contract, of the person whose life is insured;
injury to, or disability of, the insured as the result of accident or sickness; or
the insured being found to have a stated condition or disease.

[Schedule 9, item 16, subsection 995-1(1)]

5.86 A continuous disability policy has the same meaning given by section 9A of the Life Insurance Act. That is, a continuous disability policy is, broadly, a disability policy that by its terms, is to be of more than 3 years duration and either:

the terms do not permit alteration, at the instance of the life insurance company concerned, of the benefits provided by the contract or the premiums payable under the contract; or
if the terms permit alteration, at the instance of the life company concerned, of the benefits provided by the contract, the only alterations that are permitted to be made are alterations that improve the benefits and are made following an offer made by the life company that is accepted by the owner of the policy; or
if the terms permit alteration, at the instance of the life company concerned, of the premiums payable under the contract, and the terms of all contracts of the same kind as the contract, only permit such alterations if they are made on a simultaneous and consistent basis.

5.87 A contract of insurance that is, by its terms, to be of a duration of not more that 3 years is taken to be of more than 3 years duration if:

contracts of insurance of the same kind as the contract are usually of more than 3 years duration; and
the contract is of a lesser duration only because of the age of the owner of the policy at the time when it was entered into.

5.88 A continuous disability policy does not include a contract of consumer credit insurance within the meaning of the Insurance Contracts Act 1984 or a contract of insurance entered into in the course of carrying on health insurance business. [Schedule 9, item 11, subsection 995-1(1)]

5.89 The difference in the basis of valuing risk policy liabilities for disability policies (other than continuous disability policies) and all other policies relates to the impact of the different valuation methods on the spreading of acquisition costs in relation to the policies.

5.90 The policy liability, which is used as the value of risk policy liabilities for policies that are long term in nature, appropriately spreads the acquisition expenses over the life of the policies.

5.91 The current termination value, which is used as the value of risk policy liabilities for policies that are short term disability policies (that is, disability policies that are not continuous disability policies), appropriately allows acquisition expenses to be written off in the year that the policy is written.

5.92 It needs to be recognised that the valuation of policy liabilities may result in a minimal liability in relation to some regular premium risk policies when those policies are first issued because, at that time, the expected cash outflows from the policy are greater than inflows - that is, the acquisition and other expense payments exceed the premium inflows. This results in a decrease in the value of policy liabilities that should appropriately be included in assessable income. However, the position reverses over time once the present value of future claim and expense outflows exceeds the present value of premium inflows.

Assets transferred to or from the virtual PST

5.93 The company can deduct any amount that is deductible under section 320-200 as a consequence of the deemed disposal of an asset where an asset other than money is transferred:

from or to a virtual PST under new subsection 320-180(1) or (2);
to a virtual PST under new section 320-185; or
from a virtual PST under new subsection 320-195(2) or (3).

[Schedule 2, item 84, section 320-87]

5.94 The deduction can be claimed only when:

the asset ceases to exist; or
the asset, or a greater than 50% interest in it, is acquired by an entity other than an entity that is an associate of the company immediately after the transfer.

[Schedule 2, item 84, subsection 320-200(3)]

Assets transferred from the virtual PST to segregated exempt assets

5.95 If an asset other than money that was transferred from a company's virtual PST to its segregated exempt assets under new subsection 320-195(1) is disposed of by the company, the company can deduct the lesser of:

the amount (if any) that could have been deducted if section 320-255 applied at the time of transfer; or
the amount (if any) that could have been deducted if the asset were an asset of the virtual PST at the time of disposal.

[Schedule 2, item 84, section 320-90]

5.96 Similarly, if an asset other than money that was transferred from a company's virtual PST to its segregated exempt assets under new subsection 320-195(1) is transferred from those segregated exempt assets under subsection 320-235(1) or section 320-250, the company can deduct the lesser of:

the amount (if any) that could have been deducted if section 320-255 applied at the time of transfer to the segregated exempt assets; or
the amount (if any) that could have been deducted because of section 320-255 if the asset had been an asset of the virtual PST at the time of its transfer from the segregated exempt assets.

[Schedule 2, item 84, section 320-95]

Reinsurance premiums

5.97 A life insurance company will be entitled to a deduction for premiums paid under contracts of reinsurance. [Schedule 2, item 84, section 320-100]

5.98 A contract of reinsurance does not include a reinsurance contract in respect of liabilities that are held in a virtual PST or in segregated exempt assets. [Schedule 9, item 12, subsection 995-1(1)]

5.99 A deduction is allowed for premiums paid under reinsurance contracts only if the contract provides for the transfer of risk of loss from the occurrence of contingent insured events. The transfer of risk is made through the indemnity to the life insurance company that enters into the reinsurance contract in respect of losses that it suffers as a consequence of carrying on risk business.

5.100 If the arrangement does not transfer the risk to a reinsurer (such as under a financial reinsurance contract), the premiums paid are not deductible as the arrangement is not considered to be a reinsurance contract.

Transfers to segregated exempt assets

5.101 A life insurance company will be entitled to a deduction for the transfer value of assets transferred to segregated exempt assets under subsection 320-235(2) or subsection 320-240(1). [Schedule 2, item 84, subsection 320-105(1)]

5.102 The transfer value of an asset is the amount that could be expected to be received from the disposal of the asset in an open market after deducting any costs expected to be incurred in respect of the disposal. [Schedule 9, item 60, subsection 995-1(1)]

5.103 In addition, if an asset (other than money) is transferred to the company's segregated exempt assets under subsection 320-235(2) or section 320-240, the company can deduct the amount (if any) that it can deduct because of section 320-255. [Schedule 2, item 84, subsection 320-105(2)]

Amounts credited by friendly societies to income bonds

5.104 The investment income derived by friendly societies on income bonds issued after 30 November 1999 will be included in assessable income from 1 July 2001.

5.105 An income bond is a life insurance policy issued by a friendly society under which bonuses are regularly distributed. [Schedule 9, item 27, subsection 995-1(1)]

5.106 Therefore, friendly societies will be allowed a deduction for the amounts credited after 30 June 2001 to income bonds issued after 30 November 1999 where the interest accrued after 30 June 2001. [Schedule 2, item 84, section 320-110]

No deduction for amounts credited to RSAs

5.107 A life insurance company is not entitled to a deduction for any amounts credited to RSAs. [Schedule 2, item 84, section 320-115]

Two classes of taxable income for life insurance companies

5.108 From 1 July 2000 the taxable income of a life insurance company will be calculated on broadly the same basis as for other taxpayers. However, a life insurance company's taxable income will be divided into 2 classes:

the ordinary class which is taxed at the company tax rate; and
the complying superannuation class which is taxed at a rate of 15%.

[Schedule 2, item 84, section 320-135]

What is the ordinary class of taxable income?

5.109 The ordinary class of taxable income of a life insurance company will be the total taxable income less the complying superannuation class of taxable income. [Schedule 2, item 84, section 320-140]

5.110 Any capital losses on ordinary assets - that is, assets that are not virtual PST assets or segregated exempt asset - can only be applied against capital gains from ordinary assets. [Schedule 2, item 84, section 320-120]

What is the complying superannuation class of taxable income?

5.111 The complying superannuation class of taxable income of a life insurance company includes:

the RSA component;
the virtual PST component; and
the specified roll-over component.

[Schedule 2, item 84, section 320-145]

The RSA component of the complying superannuation class

5.112 The RSA component of the complying superannuation class of taxable income relates to the RSA business of a life insurance company.

5.113 An RSA is defined in section 995-1 of the ITAA 1997 to have the same meaning given by the Retirement Savings Accounts Act 1997.

5.114 The assessable income of a life insurance company that is an RSA provider includes all taxable contributions made during the year of income to RSAs provided by the company (see new paragraph 320-15(l)). Investment income derived by RSA providers is included in the RSA provider's assessable income under the ordinary provisions of the income tax law.

Taxable income allocated to the RSA component

5.115 The taxable income allocated to the RSA component of the complying superannuation class is the sum of all amounts (other than contributions that are not taxable contributions) credited to RSAs during the income year less amounts (other than benefits) debited to RSAs during the income year.

5.116 In calculating this amount:

any amount of tax paid in respect of an RSA is taken not to be an amount paid from the RSA; and
any amount credited to an RSA in respect of a period during which the RSA is paying out an immediate annuity is taken not to have been credited to the RSA as it is exempt from tax under new paragraph 320-35(1)(e).

[Schedule 2, item 84, section 320-155]

Preventing losses from being applied to reduce the RSA component

5.117 New section 320-160 operates to ensure that a life insurance company that is an RSA provider cannot offset losses against RSA income. [Schedule 2, item 84, section 320-160]

5.118 This section applies if:

the life insurance company has no taxable income;
the life insurance company has no complying superannuation class of taxable income; or
the complying superannuation class of taxable income is less than the RSA component.

5.119 New subsection 320-160(2) applies if the life insurance company has no taxable income or the complying superannuation class of taxable income is less than the RSA component. In these circumstances:

the life insurance company is taken to have both a taxable income and a tax loss for the year of income;
the taxable income is equal to the RSA component;
the tax loss is taken to be the amount that would have been the company's tax loss if the RSA component were not income derived by the company;
the complying superannuation class is taken to be equal to the RSA component; and
the ordinary class is taken to be nil.

5.120 New subsection 320-160(3) applies if the company's taxable income is equal to or greater than the RSA component. In these circumstances:

the complying superannuation class is taken to be equal to the RSA component; and
the difference between the RSA component and that amount would, but for new subsection 320-160(3), have been the complying superannuation class is applied in reducing the ordinary class of taxable income.

[Schedule 2, item 84, section 320-160]

The virtual PST component of the complying superannuation class

Establishment of a virtual PST

5.121 Life insurance companies will be able to segregate assets to be used for the sole purpose of discharging virtual PST liabilities on or after 1 July 2000. Except as provided for under the transitional arrangements in new section 320-170 of the TransitionalProvisionsAct, an asset can be included in the segregated assets only if the whole of the asset is segregated. The segregated assets will be known as a virtual PST. [Schedule 2, item 84, subsections 320-170(1), (1A) and (6)]

5.122 A virtual PST will effectively be treated as a separate entity within a life insurance company. The taxable income of virtual PSTs will be determined consistently with the taxable income of PSTs and will be taxed at the rate of 15%.

5.123 To ensure that the division of assets between the virtual PST and ordinary business is carried out on a fair and equitable basis, the assets that can be placed in the virtual PST on establishment must be a representative sample of all the life insurance company's assets supporting its virtual PST liabilities immediately before the establishment of the virtual PST. [Schedule 2, item 84, subsection 320-170(2)]

5.124 The assets segregated to establish a virtual PST must have a transfer value that does not exceed the sum of:

the company's virtual PST liabilities;
any reasonable provision made by the company in its accounts for deferred tax in relation to unrealised gains on those assets; and
the total amount of any unpaid PAYG instalments relating to the virtual PST component of the complying superannuation class of taxable income.

[Schedule 2, item 84, subsection 320-170(3)]

5.125 The transfer value of an asset is the amount that could be expected to be received from the disposal of the asset in an open market after deducting any costs expected to be incurred in respect of the disposal. [Schedule 9, item 60, subsection 995-1(1)]

5.126 As a transitional rule, if a life insurance company segregates assets in accordance with new section 320-170 between 1 July 2000 and 30 September 2000, the virtual PST will be taken to have been established on 1 July 2000. [Schedule 2, item 84, subsection 320-170(4)] The purpose of this transitional rule is to allow life insurance companies sufficient time to establish a virtual PST.

5.127 The segregated virtual PST assets must be maintained for the sole purpose of discharging the company's virtual PST liabilities. [Schedule 2, item 84, subsection 320-170(5)] This does not prevent the virtual PST assets from being used to pay fees and expenses relating to the carrying on of the virtual PST business.

An asset includes money

5.128 A transfer of an asset to or from a virtual PST includes the transfer of money to or from the virtual PST. If an asset transferred to or from the virtual PST is money, the transfer value of the asset transferred is the amount of the money. [Schedule 2, item 84, subsection 320-170(7)]

Transitional rule for certain assets held as at 1 July 2000

5.129 A segregated asset is an asset that belongs solely to the virtual PST. That is, a part of an asset can not be included in the segregated assets. However, as a transitional rule, segregated assets will include the share of certain existing assets that a life insurance company certifies before 1 October 2000 to be included in the virtual PST. The part of the asset certified will be treated as a separate asset for taxation purposes. This transitional rule will apply to an asset if:

the asset was acquired by the company before 1 July 2000;
the asset is held in an Australian Fund or an Australian/Overseas Fund (as defined in section 74 of the Life Insurance Act) of the company;
the market value of the asset as at 1 July 2000 exceeds the lesser of:

-
$50 million; or
-
the greater of 2% of the value of the Fund in which the asset is held or $5 million.

[Schedule 2, item 87, section 320-170 of the Transitional Provisions Act]

5.130 If part of an asset is certified to be a virtual PST asset, the same proportion of any income or deductible expenses incurred in relation to the asset will be allocated to the virtual PST component. For example, if 75% of an asset is certified to be a virtual PST asset, then 75% of income derived or expenses incurred in relation to the asset will be allocated to the virtual PST income or expenses.

Transitional rule for liabilities held as at 1 July 2000

5.131 The taxation consequences of transfer of assets to the virtual PST assets are disregarded if the life insurance company had a liability before 1 July 2000 under a life insurance policy and that liability is discharged out of the company's virtual PST assets. [Schedule 2, item 87, subsection 320-175(1) of the Transitional Provisions Act]

5.132 For example, when an asset that is included in the virtual PST assets with effect from 1 July 2000 is disposed of by the company, the cost base of the asset will not be adjusted to reflect the transfer value at the time of segregation.

Transitional rule for certain friendly societies

5.133 Some friendly societies currently carry on complying superannuation business directly in a benefit fund of the friendly society rather than indirectly through a complying superannuation fund. This business can be held in the virtual PST of the Friendly Society. However, those friendly societies may wish to transfer that business to a complying superannuation fund which, in turn, will be able to invest in the virtual PST of the friendly society. This will ensure consistent treatment between those friendly societies and other life insurance companies.

5.134 To facilitate the transfer of this business so as not to disadvantage complying superannuation investors, friendly societies will be entitled to CGT and other taxation relief on any taxation consequences arising from the transfer of assets held by the benefit funds for the purpose of providing superannuation benefits to its members to a complying superannuation fund provided that:

the assets are transferred before 1 July 2001; and
the persons who had interests in those assets immediately before the transfer had substantially the same interests in the assets after the transfer.

[Schedule 2, item 87, section 320-5 of the Transitional Provisions Act]

Annual valuation of virtual PST assets

5.135 A life insurance company that establishes a virtual PST must determine the transfer value of the virtual PST assets annually as at the end of the company's income year. The valuation must be made within 60 days of the end of the company's income year. [Schedule 2, item 84, section 320-175]

5.136 As a transitional rule, having regard to the current transitional reporting obligations of friendly societies that carry on life insurance business, friendly societies will have up to 90 days after the end of the 2000-2001 income year to determine the value of the virtual PST assets as at the end of the 2000-2001 income year. [Schedule 2, item 87, subsection 320-175(2) of the Transitional Provisions Act]

Consequences of annual valuation

5.137 If the total transfer value of the virtual PST assets exceeds the sum of:

the value of the company's virtual PST liabilities;
any reasonable provision made by the company in its accounts for deferred tax in relation to unrealised gains on those assets; and
the total amount of any unpaid PAYG instalments relating to the virtual PST component of the complying superannuation class of taxable income,

then assets with a transfer value equal to the excess must be transferred out of the virtual PST within 30 days of the annual valuation. [Schedule 2, item 84, subsection 320-180(1)]

5.138 A transfer of assets under new subsection 320-180(1) will be deemed to have been made in the income year at the end of which the valuation time occurred. [Schedule 2, item 84, subsection 320-180(3)]

5.139 If the total transfer value of the virtual PST assets is less than the sum of:

the value of the company's virtual PST liabilities;
any reasonable provision made by the company in its accounts for deferred tax in relation to unrealised gains on those assets; and
the total amount of any unpaid PAYG instalments relating to the virtual PST component of the complying superannuation class of taxable income,

then assets with a transfer value not exceeding the difference may be transferred to the virtual PST. [Schedule 2, item 84, subsection 320-180(2)]

5.140 A transfer of assets under new subsection 320-180(2) that is made within 30 days of the annual valuationwill be deemed to have been made in the income year at the end of which the valuation was made. [Schedule 2, item 84, subsection 320-180(4)]

Transfer of assets to the virtual PST other than as a result of an annual valuation

5.141 There are 3 circumstances in which a life insurance company can transfer assets to the virtual PST other than as a result of an annual valuation.

5.142 First, if the company determines at a time, other than the annual valuation time, that the total transfer value of the virtual PST assets is less than the sum of:

the value of the company's virtual PST liabilities;
any reasonable provision made by the company in its accounts for deferred tax in relation to unrealised gains on those assets; and
the total amount of any unpaid PAYG instalments relating to the virtual PST component of the complying superannuation class of taxable income,

then assets with a transfer value not exceeding the difference can be transferred to the virtual PST. [Schedule 2, item 84, subsection 320-185(1)]

5.143 Second, the company can at any time transfer assets of any kind to the virtual PST in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. This might occur if, for example, the company holds a parcel of shares outside the virtual PST that is no longer consistent with the investment strategy for that part of its business. The company may wish to transfer the shares to the virtual PST. To save transaction costs, the shares could be transferred to the virtual PST for consideration equal to the transfer value. [Schedule 2, item 84, subsection 320-185(2)]

5.144 Third, the company can transfer to the virtual PST assets of any kind having a total transfer value not exceeding the amount of premiums paid to the company to purchase virtual PST life insurance policies. [Schedule 2, item 84, subsection 320-185(3)]

What is a virtual PST life insurance policy?

5.145 A virtual PST life insurance policy is a life insurance policy (other than an excluded virtual PST life insurance policy) that is:

held by the trustee of a complying superannuation fund, complying ADF or PST;
a deferred annuity policy purchased out of a rolled-over eligible termination payment that is held by an individual;
held by an individual in the benefit fund of a friendly society, where that benefit fund is a regulated superannuation fund under the Superannuation Industry (Supervision) Act 1993; or
held by another life insurance company where the policy is a virtual PST asset of that other company.

[Schedule 9, item 72, subsection 995-1(1)]

5.146 An excluded virtual PST life insurance policy is a life insurance policy that:

provides only for death and disability benefits (other than participating benefits or discretionary benefits) within the meaning of Part IX of the ITAA 1936; or
is an exempt life insurance policy.

[Schedule 9, item 19, subsection 995-1(1)]

5.147 An exempt life insurance policy is a life insurance policy that:

is held by the trustee of a complying superannuation fund and is a segregated current pension asset within the meaning of Part IX of the ITAA 1936;
is held by the trustee of a PST and is a segregated exempt superannuation asset within the meaning of Part IX of the ITAA 1936;
is held by the trustee of a constitutionally protected superannuation fund;
provides for an immediate annuity; or
is held by another life insurance company where the policy is a segregated exempt asset of that other company.

[Schedule 9, item 20, subsection 995-1(1)]

5.148 The virtual PST liabilities are the liabilities of a life insurance company under virtual PST life insurance policies where those liabilities are to be discharged out of virtual PST assets.

5.149 The virtual PST liabilities of a life insurance company are the sum of the following amounts:

for policies that provide for participating benefits or discretionary benefits, the amount determined by an eligible actuary as the sum of:

-
the values of supporting assets as defined in the Valuation Standard for those policies; and
-
policy owners' retained profits for those policies - the policy owner retained profits are the Australian policy owners' retained profits, or overseas policy owners' retained profits (as defined by section 61 of the Life Insurance Act) in relation to the statutory fund (as defined in section 29 of that Act) to which the business of issuing policies relates [Schedule 9, item 41, subsection 995-1(1)] ; and

for all other policies, the sum of the current termination values as defined in the Solvency Standard for those policies.

[Schedule 2, item 84, section 320-190]

5.150 The sum of current termination values includes any provisions for outstanding claims that relate specifically to policies held in the virtual PST.

Transfers of assets and payments of amounts from a virtual PST otherwise than as a result of an annual valuation

5.151 There are 3 circumstances in which an asset can be transferred from a virtual PST other than as a consequence of the annual valuation.

5.152 First, if a policy issued by the company that is held in the company's virtual PST becomes an exempt life insurance policy, then the company can transfer, from the virtual PST to the segregated exempt assets, assets of any kind having a transfer value not exceeding the company's liabilities in respect of the policy plus any reasonable provision made at that time in the company's accounts for liability for tax on unrealised gains that relates to the assets transferred. [Schedule 2, item 84, subsection 320-195(1)]

5.153 An example of when a policy issued by the company that is held in the company's virtual PST becomes an exempt life insurance policy is when a deferred annuity policy becomes an immediate annuity policy.

5.154 Second, the company can at any time transfer assets of any kind from the virtual PST in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. [Schedule 2, item 84, subsection 320-195(2)]

5.155 Third, if the company:

imposes fees or charges in respect of virtual PST assets;
imposes fees or charges in respect of virtual PST life insurance policies other than policies that provide death or disability benefits that are participating benefits;

-
for example, risk rider premiums withdrawn on a regular basis from a policy held in the virtual PST; or

determines, at a time other than the annual valuation time, that there are excess assets in the virtual PST;

-
an example of a situation where a life insurance company would identify excess virtual PST assets at a time other than the annual valuation time would be if the company ceased to carry on business during the income year,

then the company must transfer from the virtual PST assets (at the time fees or charges are imposed or the excess is identified) assets having a total transfer value equal to the fees, charges or excess.

[Schedule 2, item 84, subsection 320-195(3)]

5.156 Amounts will be considered to have been transferred from a virtual PST when fees and charges are imposed or the excess is identified provided they are transferred within a reasonable time having regard to normal business practice.

5.157 In addition, a life insurance company must pay directly from a virtual PST:

any benefits relating to virtual PST liabilities held in the virtual PST at the time the benefit is payable;
any expenses incurred directly in respect of virtual PST assets;

-
examples of expenses incurred directly in respect of virtual PST assets include stamp duty, brokerage costs, expenses relating to a rental property that is a virtual PST asset and joint venture expenses where the interest in the joint venture is a virtual PST asset;
-
an expense can be incurred directly in respect of virtual PST assets even if it is included in an invoice that relates to similar types of expenses incurred by different parts of the company's business; and

the amount of any PAYG instalments relating to the virtual PST component of the complying superannuation class of taxable income.

[Schedule 2, item 84, subsection 320-195(4)]

Consequence of transfer of assets to and from a virtual PST[F2]

5.158 New section 320-200 applies if:

an asset (other than money) is transferred from a virtual PST under new subsection 320-180(1) or new subsection 320-195(2) or (3); or
an asset (other than money) is transferred to a virtual PST under new subsection 320-180(2) or new section 320-185.

[Schedule 2, item 84, subsection 320-200(1)]

5.159 If these provisions apply, then for the purposes of determining whether:

an amount is included in assessable income or is an allowable deduction in respect of the transfer of the asset; or
the company made a capital gain or capital loss in respect of the transfer;

the life insurance company is taken to have:

sold the asset immediately before the transfer for consideration equal to its market value; and
purchased the asset again at the time of transfer for consideration equal to its market value.

[Schedule 2, item 84, subsection 320-200(2)]

5.160 In addition, if a life insurance company could deduct an amount, except an amount that the company can deduct under section 320-55 (that is, for that part of the premium transferred to a virtual PST), or makes a capital loss as a result of the transfer of the asset to or from the virtual PST, the company must disregard the deduction or capital loss until:

the asset ceases to exist; or
the asset, or a greater than 50% interest in it, is acquired by an entity other than an entity that is an associate of the company immediately after the transfer.

[Schedule 2, item 84, subsection 320-200(3)]

Taxable income allocated to the virtual PST component

5.161 The virtual PST component of the complying superannuation class of taxable income is worked out as follows.

Table 5.1 Virtual PST component of the complying superannuation class of taxable income

Assessable income allocated to the virtual PST component   Amounts that reduce the virtual PST component

Ordinary income and statutory income (including net capital gains) derived from the investment of virtual PST assets.
The transfer value of assets transferred to a virtual PST under:

-
subsection 320-180(2) or 320-185(1) to make up a shortfall in virtual PST assets; or
-
subsection 320-185(3) -that is, premiums transferred to the virtual PST.

If an asset other than money is transferred from a virtual PST under subsection 320-180(1) or subsection 320-195(2) or (3), the amount that is included in assessable income because of section 320-200.
Taxable contributions transferred from complying superannuation funds (section 275 transfers) in respect of policies held in the virtual PST.
Specified roll-over amounts included in ETPs used to purchase deferred annuity policies held in the virtual PST.
Amounts included in the company's assessable income under section 320-20 and 320-25.

less

The component of premiums allowed as a deduction under new section 320-55 (i.e. premiums received in respect of virtual PST policies).
Losses (other than capital losses) made during the income year from the investment of virtual PST assets.

-
The transfer value of assets transferred, from a virtual PST under new subsection 320-180(1) or new subsection 320-195(3) to reduce excess virtual PST assets.

If an asset other than money is transferred from a virtual PST under subsection 320-180(1) or subsection 320-195(2) or (3), the amount that is deductible under section 320-87 because of section 320-200.
Expenses paid directly out of the virtual PST that are allowable deductions;

-
examples include stamp duty, brokerage costs and expenses relating to a rental property that is a virtual PST asset and joint venture expenses where the interest in the joint venture is a virtual PST asset.

The proportion of the amount that the company can claim as a deduction under subsection 115-215(6) for the income year that is attributable to capital gains that the company is taken to have under subsection 115-215(3) in respect of virtual PST assets that are interests in trust estates.

    Amounts that the company can deduct under section 320-90 and 320-95.

[Schedule 2, item 84, subsections 320-205(1), (3) and (4)]

Quarantining losses from the virtual PST component

5.162 If the virtual PST assessable income is less than the virtual PST reductions, the life insurance company can only apply the difference to reduce the virtual PST component of the complying superannuation class of taxable income of a later year of income. [Schedule 2, item 84, subsection 320-205(2)]

5.163 Similarly, capital losses from virtual PST assets can only be applied to reduce capital gains from virtual PST assets. [Schedule 2, item 84, section 320-125]

CGT treatment on the disposal of virtual PST assets

5.164 Division 10 of Part IX of the ITAA 1936 applies for the purposes of working out any capital gain or capital loss that arises from a CGT event that involves a virtual PST asset. [Schedule 2, item 84, section 320-45]

5.165 Division 10 of Part IX of the ITAA 1936 provides that CGT rules are the primary code for the treatment of gains and losses unless the asset is a security or the amount is a gain or loss attributable to foreign exchange rate fluctuations.

5.166 In addition, Division 114 and Division 115 of the ITAA 1997 apply to capital gains arising from CGT events involving assets held in a life insurance company's virtual PST in the same way that they apply to complying superannuation funds and PSTs. [Schedule 2, items 77 to 79, section 114-5, section 115-10 and section 115-100]

5.167 The Bill amends the CGT provisions to ensure that life insurance companies are entitled to the concession for discount capital gains from CGT events in respect of CGT assets that are virtual PST assets. [Schedule 2, item 71, section 102-3]

5.168 Section 110-25 allows the company to elect to have capital gains from a CGT event happening after 30 June 2000 in respect of CGT assets that are virtual PST assets to be calculated using a cost base that includes indexation worked out to the end of the September 1999 quarter. [Schedule 2, item 74 and 75, section 110-25]

5.169 Section 115-10 allows the company to make a discount capital gain in relation to a CGT event happening after 30 June 2000 in respect of CGT assets that are virtual PST assets. [Schedule 2, item 78, section 115-10]

5.170 If the company makes a discount capital gain in respect of a CGT asset that is a virtual PST asset, only two-thirds of the capital gain remaining after the application of losses under subsection 102-5(1) is included in the company's net capital gain. [Schedule 2, item 79, section 115-100]

The specified roll-over component of the complying superannuation class

5.171 The specified roll-over component of the complying superannuation class of taxable income consists of specified roll-over amounts included in ETPs rolled-over to purchase immediate annuities. [Schedule 2, item 84, section 320-215]

Segregated exempt assets

Segregation of assets relating to exempt life insurance policies

5.172 Life insurance companies will be able to segregate assets to be used for the sole purpose of discharging its liabilities under exempt life insurance policies on or after 1 July 2000. Except as provided for under the transitional arrangements in new section 320-225 of the TransitionalProvisionsAct, an asset can be included in the segregated assets only if the whole of the asset is segregated. [Schedule 2, item 84, section 320-225] . The segregated assets will be known as segregated exempt assets [Schedule 9, item 47, subsection 995-1(1)] .

5.173 An exempt life insurance policy is a life insurance policy that:

is held by the trustee of a complying superannuation fund and is a segregated current pension asset of the fund within the meaning of Part IX of the ITAA 1936;
is held by the trustee of a PST and is a segregated exempt superannuation asset of the PST within the meaning of Part IX of the ITAA 1936;
is held by the trustee of a constitutionally protected superannuation fund;
provides for an immediate annuity; or
is held by another life insurance company where the policy is a segregated exempt asset of that other company.

[Schedule 9, item 20, subsection 995-1(1)]

5.174 Ordinary income and statutory income derived on the segregated exempt assets will be exempt from tax under new paragraph 320-35(1)(b). Capital gains derived from segregated exempt assets are exempt from tax under new section 118-315.

5.175 The segregated exempt assets at the time of initial segregation must be a representative sample of all the life insurance company's assets supporting its exempt life insurance policies immediately before the segregation of assets. [Schedule 2, item 84, subsection 320-225(2)]

5.176 The total transfer value of the segregated exempt assets must not exceed the sum of:

the company's liabilities under exempt life insurance policies; plus
any reasonable provision made at that time in the company's accounts for liability for tax on unrealised gains that relates to assets transferred from its virtual PST to its segregated exempt assets under subsection 320-195(1).

[Schedule 2, item 84, subsection 320-225(3)]

5.177 As a transitional rule, if a life insurance company segregates exempt assets in accordance with new section 320-225 between 1 July 2000 and 30 September 2000, the company will be taken to have segregated those assets on 1 July 2000. [Schedule 2, item 84, subsection 320-225(4)]

5.178 The purpose of this transitional rule is to allow life insurance companies sufficient time to segregate assets relating to exempt life insurance policies.

5.179 The segregated exempt assets must be maintained for the sole purpose of discharging the company's liabilities under exempt life insurance policies [Schedule 2, item 84, subsection 320-225(5)] . This does not prevent the segregated exempt assets from being used to pay fees and expenses relating to the carrying on of the exempt life insurance business.

An asset includes money

5.180 A transfer of an asset to or from the segregated exempt assets includes the transfer of money to or from those assets. If an asset transferred to or from the segregated exempt assets is money, the transfer value of the asset transferred is the amount of the money. [Schedule 2, item 84, subsection 320-225(6)]

Transitional rule for certain assets held as at 1 July 2000

5.181 A segregated asset is an asset that relates solely to the life insurance company's exempt life insurance policy liabilities. That is, a part of an asset can not be included in the segregated assets. However, as a transitional rule, the segregated assets will include the share of certain existing assets that the company certifies before 1 October 2000 to be included in the segregated exempt assets. The part of the asset certified will be treated as a separate asset for taxation purposes. This transitional rule will apply to an asset if:

the asset was acquired by the company before 1 July 2000;
the asset is held in an Australian Fund or an Australian/Overseas Fund (as defined in section 74 of the Life Insurance Act) of the company; and
the market value of the asset as at 1 July 2000 exceeds the lesser of:

-
$50 million; or
-
the greater of 2% of the value of the Fund in which the asset is held or $5 million.

[Schedule 2, item 87, section 320-225 of the Transitional Provisions Act]

Transitional rule for liabilities held as at 1 July 2000

5.182 The taxation consequences of the transfer of assets to the segregated exempt assets are disregarded if the life insurance company had a liability before 1 July 2000 under a life insurance policy where the income of the company attributable to that liability was exempt from tax prior to that date, and that liability is discharged out of the company's segregated exempt assets. [Schedule 2, item 87, subsection 320-230(1) of the Transitional Provisions Act]

5.183 For example, when an asset that is included in the segregated exempt assets with effect from 1 July 2000 is disposed of by the company, the cost base of the asset will not be adjusted to reflect the transfer value at the time of segregation.

Annual valuation of segregated exempt assets

5.184 A life insurance company that segregates exempt assets must determine the transfer value of the segregated exempt assets annually as at the end of the company's income year. The valuation must be made within 60 days of the end of the company's income year. [Schedule 2, item 84, section 320-230]

5.185 As a transitional rule, having regard to the current transitional reporting obligations of friendly societies that carry on life insurance business, friendly societies will have up to 90 days after the end of the 2000-2001 income year to determine the value of their segregated exempt assets as at the end of the 2000-2001 income year. [Schedule 2, item 87, subsection 320-230(2) of the Transitional Provisions Act]

Consequences of annual valuation

5.186 If the total transfer value of the segregated exempt assets exceeds the sum of:

the company's exempt life insurance policy liabilities; plus
any reasonable provision made at that time in the company's accounts for liability for tax on unrealised gains that relates to assets transferred from its virtual PST to its segregated exempt assets under subsection 320-195(1),

then assets with a transfer value equal to the excess must be transferred out of the segregated exempt assets within 30 days of the annual valuation. [Schedule 2, item 84, subsection 320-235(1)]

5.187 A transfer of assets under new subsection 320-235(1) will be deemed to have been made in the income year at the end of which the valuation time occurred. [Schedule 2, item 84, subsection 320-235(3)]

5.188 If the total transfer value of the segregated exempt assets is less than the sum of:

the company's exempt life insurance policy liabilities; plus
any reasonable provision made at that time in the company's accounts for liability for tax on unrealised gains that relates to assets transferred from its virtual PST to its segregated exempt assets under subsection 320-195(1),

then assets with a transfer value not exceeding the difference may be transferred to the segregated exempt assets. [Schedule 2, item 84, subsection 320-235(2)]

5.189 A transfer of assets under new subsection 320-235(2) made within 30 days of the annual valuation will be deemed to have been made in the income year at the end of which the valuation time occurred. [Schedule 2, item 84, subsection 320-235(4)]

Transfer of assets to the segregated exempt assets other than as a result of an annual valuation

5.190 If a policy issued by a life insurance company that is held in the company's virtual PST becomes an exempt life insurance policy, then the company can transfer assets to its segregated exempt assets [Schedule 2, item 84, subsection 320-195(1)] . Apart from this, there are only 3 circumstances in which a life insurance company can transfer assets to the segregated exempt assets other than as a result of an annual valuation.

5.191 First, if the company determines at a time, other than the annual valuation time, that the total transfer value of the segregated exempt assets is less than the sum of:

its exempt life insurance policy liabilities, plus
any reasonable provision made at that time in the company's accounts for liability for tax on unrealised gains that relates to assets transferred from its virtual PST to its segregated exempt assets under subsection 320-195(1),

then assets with a transfer value not exceeding the difference can be transferred to the segregated exempt assets. [Schedule 2, item 84, subsection 320-240(1)]

5.192 Second, the company can at any time transfer assets of any kind to the segregated exempt assets in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. This might occur if, for example, the company holds a parcel of shares outside the segregated exempt assets which is no longer consistent with the investment strategy for that part of its business. The company may wish to transfer the shares to the segregated exempt assets. To save transaction costs, the shares could be transferred to the segregated exempt assets for consideration equal to the transfer value. [Schedule 2, item 84, subsection 320-240(2)]

5.193 Third, the company can at any time transfer, to the segregated exempt assets, assets of any kind having a total transfer value not exceeding the amount of premiums paid to the company to purchase exempt life insurance policies. [Schedule 2, item 84, subsection 320-240(3)]

What are exempt life insurance policy liabilities?

5.194 The exempt life insurance policy liabilities are the liabilities of a life insurance company under exempt life insurance policies to the extent that those liabilities are to be discharged out of the company's segregated exempt assets.

5.195 The exempt life insurance policy liabilities are the sum of the following amounts (as calculated by an actuary):

for policies that provide allocated benefits (other than participating benefits or discretionary benefits) - the current termination values;
for policies that provide for participating benefits or discretionary benefits - the sum of:

-
the values of supporting assets as defined in the Valuation Standard for those policies; and
-
policy owner's retained profits for those policies;

for all other policies - the policy liabilities as defined in the Valuation Standard for those policies.

[Schedule 2, item 84, subsection 320-245(2)]

5.196 An exempt life insurance policy provides allocated benefits if:

the policy is a segregated current pension asset (as defined in Part IX of the ITAA 1936) of a complying superannuation fund that supports an allocated pension;

-
an allocated pension is a pension that satisfies the requirements of subregulation 1.06(4) of the Superannuation Industry (Supervision) Regulations [Schedule 9, item 3, subsection 995-1(1)] ;

the policy provides for an allocated annuity;

-
an allocated annuity is an immediate annuity that satisfies the requirements of subregulation 1.05(4) of the Superannuation Industry (Supervision) Regulations [Schedule 9, item 2, subsection 995-1(1)] ; or

the policy is a segregated exempt asset of another life insurance company that supports an allocated annuity or an allocated pension.

[Schedule 2, item 84, subsection 320-245(3)]

Transfers of assets and payments of amounts from segregated exempt assets otherwise than as a result of an annual valuation

5.197 There are 2 circumstances in which an asset can be transferred from the segregated exempt assets otherwise than as a result of an annual valuation.

5.198 First, the company can at any time transfer assets of any kind from the segregated exempt assets in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. [Schedule 2, item 84, subsection 320-250(1)]

5.199 Second, if the company:

imposes fees or charges in respect of segregated exempt assets;
imposes fees or charges in respect of exempt life insurance policies; or
determines, at a time other than the annual valuation time, that there are excess assets in the segregated exempt assets;

-
an example of a situation where a life insurance company would identify excess segregated exempt assets at a time other than the annual valuation time would be if the company ceased to carry on segregated exempt insurance business during the income year;

then the company must transfer from the segregated exempt assets (at the time fees or charges are imposed or the excess is identified) assets having a total transfer value equal to the fees, charges or excess.

[Schedule 2, item 84, subsection 320-250(2)]

5.200 Amounts will be considered to have been transferred from the segregated exempt assets when fees and charges are imposed or the excess is identified, provided they are transferred within a reasonable time having regard to normal business practice.

5.201 In addition, a life insurance company must pay directly from the segregated exempt assets:

any annuities or pensions, or any other benefits, relating to exempt life insurance policy liabilities held in the segregated exempt assets at the time the benefit is payable; and
any expenses incurred directly in respect of the segregated exempt assets;

-
examples of expenses incurred directly in respect of the segregated exempt assets include stamp duty, brokerage costs and expenses relating to a rental property that is a segregated exempt asset.

[Schedule 2, item 84, subsection 320-250(3)]

5.202 A life insurance company can also pay directly from the segregated exempt assets any tax liability that relates to realised gains on assets that are transferred to those segregated assets under subsection 320-195(1). [Schedule 2, item 84, subsection 320-250(4)]

Consequence of transfer of assets to and from segregated exempt assets[F3]

5.203 New section 320-255 applies if:

an asset (other than money) is transferred from the segregated exempt assets under new subsection 320-235(1) or new subsection 320-250(1) or (2); or
an asset (other than money) is transferred to the segregated exempt assets under new subsection 320-235(2) or new section 320-240.

[Schedule 2, item 84, subsection 320-255(1)]

5.204 If these provisions apply, then for the purposes of determining whether:

an amount is included in assessable income or is an allowable deduction (other than under the depreciation provisions) in respect of the transfer of the asset; or
the company made a capital gain or capital loss in respect of the transfer;

the life insurance company is taken:

to have sold the asset immediately before the transfer for consideration equal to its market value; and
to have purchased the asset again at the time of transfer for consideration equal to its market value.

[Schedule 2, item 84, subsection 320-255(2)]

5.205 In addition, if a life insurance company could deduct an amount, except an amount that the company can deduct under section 320-60 or subsection 320-105(1), or makes a capital loss as a result of the transfer of the asset to its segregated exempt assets, the company must disregard the deduction or capital loss until:

the asset ceases to exist; or
the asset, or a greater than 50% interest in it, is acquired by an entity other than an entity that is an associate of the company immediately after the transfer.

[Schedule 2, item 84, subsection 320-255(3)]

5.206 A life insurance company cannot deduct an amount or apply a capital loss as a result of the transfer of an asset from its segregated exempt assets. [Schedule 2, item 84, subsection 320-255(4)]

5.207 Finally, if an asset that is a unit of plant is transferred from the segregated exempt assets, the company must assume, for the purposes of the depreciation provisions (Division 42), that:

the unit had at all times been used by the company wholly for the purpose of producing assessable income; and
deductions for depreciation in respect of the asset had been allowed to the company during the period using the diminishing value method (subsection 42-160(3)) or the prime cost method (subsection 42-165(2A)).

[Schedule 2, item 84, subsection 320-255(5)]

5.208 If an asset that is a unit of plant is transferred to the segregated exempt assets of a life insurance company, then, in determining for depreciation purposes whether an amount is included in, or can be deducted from, the company's assessable income as a result of the transfer, the company is taken:

to have, at the time immediately before the transfer, sold the asset for a consideration equal to its market value at that time; and
to have, at the time of the transfer, purchased the asset again for a consideration equal to its market value at that time.

[Schedule 2, item 84, subsection 320-255(6)]

5.209 If an asset that is a unit of plant that has been included in the segregated exempt assets of a life insurance company since the asset was acquired by the company or since the initial segregation of those assets is transferred from those assets, then, the company must assume for depreciation purposes that:

if the asset's market value at the time of the transfer is greater than its notional undeducted cost[F4] at that time, the company is taken:

-
to have, at the time immediately before the transfer, sold the asset for a consideration equal to its notional undeducted cost at that time; and
-
to have, at the time of the transfer, purchased the asset again for a consideration equal to its notional undeducted cost at that time; or

if the asset's market value at the time of the transfer is equal to or less than its notional undeducted cost at that time, the company is taken:

-
to have, at the time immediately before the transfer, sold the asset for a consideration equal to its market value at that time; and
-
to have, at the time of the transfer, purchased the asset again for a consideration equal to its market value at that time.

[Schedule 2, item 84, subsection 320-255(7)]

5.210 If an asset that is a unit of plant that was previously transferred to the segregated exempt assets of a life insurance company is transferred from those assets, then, the company must assume for depreciation purposes that:

if the asset's market value at the time of its transfer from those assets is greater than its market value at the time when it was transferred to those assets, the company is taken:

-
to have, at the time immediately before the transfer from those assets, sold the asset for a consideration equal to its market value at the time when it was transferred to those assets; and
-
to have, at the time of the transfer from those assets, purchased the asset again for a consideration equal to its market value at the time when it was transferred to those assets; or

if the asset's market value at the time of its transfer from those assets is equal to or less than its market value at the time when it was transferred to those assets, the company is taken:

-
to have, at the time immediately before the transfer from those assets, sold the asset for a consideration equal to its market value at that time; and
-
to have, at the time of the transfer from those assets, purchased the asset again for a consideration equal to its market value at that time.

[Schedule 2, item 84, subsection 320-255(8)]

Example 5.1 An asset that is a unit of plant that was purchased by a life insurance company for $1,000 is transferred to the company's segregated exempt assets. At the time of transfer:

the market value of the asset is $650; and
the undeducted cost of the asset is $400.

The company is deemed to have sold the asset immediately before the transfer and repurchased the asset at the time of transfer for consideration equal to its market value at the time (subsection 320-255(6)) - that is, $650. Therefore, $250 is included in the company's assessable income at that time as a balancing adjustment amount under section 42-190.The asset is transferred from the segregated exempt assets 2 years later. At that time:

the market value of the asset is $500; and
the notional undeducted cost of the asset is $450.

The company is deemed to have sold immediately before the transfer from the segregated exempt assets and repurchased the asset at that time of transfer for consideration equal to its market value at that time (paragraph 320-255(8)(b)) - that is $500. No amount is included in the company's assessable income because the asset has been held in the segregated exempt assets (paragraph 320-35(1)(b)).The company uses the asset for the purposes of producing assessable income and claims deductions for depreciation based on a cost of $500. It subsequently disposes of the asset for $200. The undeducted cost of the asset at that time is $350. Therefore, the company is allowed a balancing adjustment deduction of $150 under section 42-195.

Examples illustrating the application of Division 320 to life insurance companies

5.211 These examples set out the cash flow transactions for the policies in the year of income, and the tax treatment of those transactions.

Example 5.2:

Example 5.2 Non-Participating , unbundle life insurance policies, where the liabilities are to be discharge from virtual PST assets

Note in this example, there is no transfer to or from the virtual PST at the annual valuation date due to a mismatch in asset and liability values.

As a variation on this example, consider the same policy but where investment management fees are not explicitly deducted - a net return is allocated. In this case the transfer value of assets at the end of the year would increase by $196 (the $230 investment management fees adjusted for the tax effect) resulting in a mismatch between the asset and liability values at the annual valuation. A $230 transfer from the virtual PST would be required to rebalance assets and liabilities in the virtual PST. This transfer would be deductible to the virtual PST, giving exactly the same tax outcome.

Example 5.3: Participating life insurance policies, where the liabilities are to be discharged from virtual PST assets

Example 5.3 Participating , unbundle life insurance policies, where the liabilities are to be discharge from virtual PST assets

In this example, the deduction for life insurance premiums is defined to be equal to the premium transferred to the virtual PST. Note also that the transactions for expenses and total claims (including risk component) occur within the virtual PST. This is in accordance with the nature of participating business and the practical difficulty in unbundling the components of premiums and claims.

The gross profit transfer to the shareholder emerges as the transfer from the virtual PST (to rebalance assets and liabilities at the annual valuation).

Example 5.4: Non-participating, unbundled life insurance policies

Example 5.4 Non-Participating, unbundle life insurance policies

In this example, the deduction for life insurance premiums is defined to be equal to the premium less all fees and charges - this is the mechanism for bringing all fees and charges into assessable income for the company.

Life insurance bonuses paid to superannuation entities

Bonuses paid to complying superannuation entities

5.212 Life insurance companies and registered organisations are currently taxed on investment income relating to complying superannuation business at a rate of 15%. Life insurance bonuses are exempt from tax if they are paid to:

complying superannuation funds;
complying ADFs;
PSTs; and
another life insurance company in respect of policies held in relation to complying superannuation business.

5.213 As the complying superannuation business of life insurance companies will continue to be taxed at a rate of 15% if it is held in a virtual PST, bonuses paid to complying superannuation entities will continue to be exempt from tax. [Schedule 2, item 5, paragraph 26AH(7)(b)]

Bonuses paid to non-complying superannuation funds

5.214 Life insurance companies and registered organisations are currently taxed on investment income relating to non-complying superannuation fund business at a rate of 47%. Life insurance bonuses paid to non-complying superannuation funds are currently exempt from tax (see paragraph 26AH(7)(b) of the ITAA 1936).

5.215 From 1 July 2000 life insurance companies will be taxed on non-complying superannuation fund business at the company tax rate. Therefore, life insurance bonuses paid to non-complying superannuation funds will be included in the fund's assessable income. [Schedule 2, item 4, subsection 26AH(6A)]

5.216 If a policy is taken out before 1 July 2001, the fund will be entitled to a rebate under section 160AAB of the ITAA 1936 to compensate for the tax paid by the life insurance company.

5.217 If a policy is taken out after 30 June 2001, the imputation system will apply to amounts paid out to non-complying superannuation funds.

Losses on the disposal or redemption of traditional securities

5.218 Section 70B of the ITAA 1936 allows a deduction for losses on the disposal or redemption of traditional securities. However, it is not appropriate to allow a deduction for such a loss where the security is held in the exempt assets of a life insurance company, complying superannuation fund or PST as any gains on such securities are exempt from tax.

5.219 Therefore, new subsection 70B(2A) prevents a deduction from being allowable for losses on the disposal or redemption of traditional securities that are:

segregated exempt assets of a life insurance company;
segregated current pension assets of a complying superannuation fund; or
segregated exempt superannuation assets of a PST.

[Schedule 2, item 6, subsection 70B(2A)]

Partnership losses

5.220 Section 92 of the ITAA 1936 includes the net income of a partnership in the assessable income of a partner and allows a deduction for a share of partnership losses. However, it is not appropriate to allow a deduction for such a loss where the partnership interest is held in the exempt assets of a life insurance company, complying superannuation fund or PST as any net income of the partnership interest is exempt from tax.

5.221 Therefore, new subsection 92(2A) prevents a deduction from being allowable for partnership losses where the partnership interest in the partnership is:

a segregated exempt asset of a life insurance company;
a segregated current pension asset of a complying superannuation fund; or
a segregated exempt superannuation asset of a PST.

[Schedule 2, item 7, subsection 92(2A)]

CGT treatment of existing CS/RA business of life insurance companies and friendly societies

Life insurance companies

5.222 Under the current law income relating to the complying superannuation business of life insurance companies is allocated to the CS/RA class of assessable income and taxed broadly consistently with complying superannuation funds. These arrangements will change with effect from 1 July 2000 when assets relating to this business will need to be transferred into a virtual PST.

5.223 Therefore, the amendments ensure that the CGT provisions apply appropriately to the CS/RA business of life insurance companies for the period before 1 July 2000.

5.224 That is, the amendments ensure that Division 114 and Division 115 of the ITAA 1997 apply to notional capital gains of life insurance companies. To the extent that the notional capital gain is allocated to CS/RA class of assessable income, the life insurance company will have the same one-third reduction in relation to discount capital gains as applies to complying superannuation funds.

5.225 Section 116CB requires life insurance companies to calculate the amount included in assessable income for notional CGT events on a number of different bases and allocates the appropriate amount of capital gains to the 4 different classes of income.

5.226 This Bill identifies a new class of capital gain - the non-exempt modified discount capital gain - and allocates that gain to the CS/RA class (i.e. the complying superannuation/roll-over annuity class) of assessable income. [Schedule 2, items 13 and 14, section 116CB]

5.227 The non-exempt modified discount capital gain for a notional CGT event is the discount capital gain (including any discount capital gain taken to arise under Subdivision 115-C in respect of an interest in a trust) that would arise from the event if Division 10 of Part IX applied in respect of the event. [Schedule 2, item 9, subsection 110(1)]

5.228 Division 10 of Part IX of the ITAA 1936 provides that CGT rules are the primary code for the treatment of gains and losses unless the asset is a security or the amount is a gain or loss attributable to foreign exchange rate fluctuations.

5.229 Consequential amendments are made to the definitions of:

non-exempt modified capital gain;
non-exempt ordinary capital gain; and
total non-exempt modified capital gain.

[Schedule 2, items 8, 10 and 11, subsection 110(1)]

5.230 This Bill amends sections 110-25 and 114-5 of the ITAA 1997 to ensure that, for a CGT event happening after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999 and before 1 July 2000, the life insurance company can elect to have capital gains worked out using an indexed cost base. [Schedule 2, items 85 and 86, sections 110-25 and 114-5 of the Transitional Provisions Act]

5.231 Section 115-10 of the ITAA 1997 allows the company to make a discount capital gain in relation to a non-exempt modified discount capital gain for a notional CGT event happening after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999 and before 1 July 2000. [Schedule 2, item 86, section 115-10 of the Transitional Provisions Act]

5.232 Section 116CD of the ITAA 1936 contains rules for allocating capital losses against capital gains for each of the classes of assessable income. The company chooses the extent to which the losses applicable to the CS/RA class are offset against non-exempt modified capital gains and non-exempt modified discount capital gains respectively. To the extent that the remaining part of the overall non-exempt capital gain for the CS/RA class is attributable to:

non-exempt modified capital gains - the whole amount is included in assessable income of the CS/RA class; or
non-exempt modified discount capital gains - two-thirds is included in assessable income of the CS/RA class.

[Schedule 2, item 15, section 116CD]

Example 5.5 On 1 January 2000 a life insurance company sold an asset for $1,000. The asset had been purchased on 1 January 1998 at a cost of $600. The indexed cost base of the asset was $700. The asset was included in an insurance fund of the company:

60% of the average calculated liabilities of the insurance fund were referable to CS/RA policies;
30% of the average calculated liabilities of the insurance fund were referable to AD/RLA policies; and
10% of the average calculated liabilities of the insurance fund were referable to eligible policies.

The core amounts for the disposal are an unmodified ordinary income amount - $360 (i.e. the gross gain ($400) reduced by the amount referable to eligible policies as calculated under section 112A ($40)) and, depending on whether the company chooses to use an indexed cost base, either:

a non-exempt modified capital gain - $270 (i.e. the gain net of indexation ($300) reduced by the amount referable to eligible policies as calculated under section 112A ($30)); or
a non-exempt modified discount capital gain - $360 (i.e. the gross gain without indexation ($400) reduced by the amount referable to eligible policies as calculated under section 112A ($40)).

The company will include $120 in AD/RLA class of assessable income - that is, one-third (30% divided by 90%) of the unmodified ordinary income amount.Depending on whether the company has a non-exempt modified capital gain or a non-exempt modified discount capital gain (and assuming that there are no reductions in respect of losses) the company will include in CS/RA class of assessable income either:

$180 - that is, the amount calculated applying subsection 116CB(2) to the non-exempt modified capital gain (60%/90% $270); or
$160 - that is:

-
the amount calculated applying subsection 116CB(2) to the non-exempt modified discount capital gain (

(60% / 90%) * $360 = $240

)

less

-

a one-third CGT discount ($80) - the result of applying new paragraph 116CD(7)(b)

.

Friendly societies and other registered organisations

5.233 Under the current law income relating to the complying superannuation business of friendly societies and other registered organisations is allocated to the CS/RA class of assessable income and taxed broadly consistently with complying superannuation funds. These arrangements will change with effect from 1 July 2000 when assets relating to this business will need to be transferred into a virtual PST.

5.234 Therefore, the amendments ensure that the CGT provisions apply appropriately to the CS/RA business of friendly societies and other registered organisations for the period before 1 July 2000.

5.235 That is, the amendments ensure that Divisions 114 and 115 of the ITAA 1997 apply to notional capital gains of friendly societies and other registered organisations. To the extent that the notional capital gain is allocated to the CS/RA class of assessable income, it will have the same one-third reduction in relation to discount capital gains as applies to complying superannuation funds.

5.236 Section 116GA requires the amount included in assessable income of friendly societies and other registered organisations for notional CGT events to be calculated on a number of different bases and allocates the appropriate amount of capital gains to the 4 different classes of income.

5.237 This Bill identifies a new class of capital gain - the modified discount capital gain - and allocates that gain to the CS/RA class of assessable income. [Schedule 2, items 20 and 21, section 116GA]

5.238 The modified discount capital gain for a notional CGT event is the discount capital gain (including any discount capital gain taken to arise under Subdivision 115-C) that would arise from the event if Division 10 of Part IX applied in respect of the event. [Schedule 2, item 17, subsection 116E(1)]

5.239 Consequential amendments are made to the definitions of:

modified capital gain;
ordinary capital gain; and
total modified capital gain.

[Schedule 2, items 16, 18 and 19, subsection 116E(1)]

5.240 This Bill amends sections 110-25 and 114-5 of the ITAA 1997 to ensure that, for a CGT event happening after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999 and before 1 July 2000, the friendly societies can elect to have capital gains worked out using an indexed cost base. [Schedule 2, items 85 and 86, sections 110-25 and 114-5 of the Transitional Provisions Act]

5.241 Section 115-10 of the ITAA 1997 allows the friendly society to make a discount capital gain in relation to a modified discount capital gain for a notional CGT event happening after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999 and before 1 July 2000. [Schedule 2, item 86, section 115-10 of the Transitional Provisions Act]

5.242 Section 116GB of the ITAA 1936 contains rules for allocating capital losses against capital gains for each of the classes of assessable income. The friendly society chooses the extent to which the losses applicable to the CS/RA class are offset against modified capital gains and modified discount capital gains respectively. To the extent that the remaining part of the overall capital gain for the CS/RA class is attributable to:

modified capital gains - the whole amount is included in assessable income of the CS/RA class; or
modified discount capital gains - two-thirds is included in assessable income of the CS/RA class.

[Schedule 2, item 22, section 116GB]

Repeal of current provisions for taxing life insurance companies

5.243 Division 8 of the ITAA 1936 contains special provisions for the taxation of life insurance companies. Division 8 will be repealed with effect from 1 July 2000. Therefore, as a transitional rule, the period in a life insurance company's year of income ending at the end of 30 June 2000 will be treated as a year of income for the purposes of applying Division 8. [Schedule 2, items 12 and 23, section 110A]

5.244 Division 8A of the ITAA 1936 applies similar provisions to tax the life insurance business of friendly societies and other registered organisations. Division 8A will be repealed with effect from 1 July 2000. [Schedule 2, item 23]

Mutual insurance associations

5.245 Section 121 of the ITAA 1936 applies to determine the taxable income of mutual insurance associations that are not life insurance companies. This Bill amends section 121 so that premiums received by mutual insurance associations are included in assessable income. This will ensure that mutual insurance associations are taxed consistently with other insurance companies. [Schedule 2, item 24, section 121]

Rebate on assessable life insurance bonuses

5.246 Section 160AAB of the ITAA 1936 allows a rebate for taxpayers who are assessable on life insurance bonuses under section 26AH. The purpose of the rebate is to compensate taxpayers for tax paid by the life insurance company. The rate of the rebate is set at the same rate that applies to the insurance business of life insurance companies. If that rate changes, the rebate rate also changes but with a one year delay.

5.247 The current rates of rebate are:

39% if the bonuses are paid from a life insurance company; or
33% if the bonuses are paid from a friendly society or other registered organisation.

5.248 The rebate rate will be amended to reflect the change to the rates of tax of life insurance companies and friendly societies in respect of ordinary life insurance business.

5.249 Therefore, the rebate rate for life insurance bonuses paid from life insurance companies (other than friendly societies) that are included in assessable income under section 26AH will be:

39% in the 2000-2001 income year;
34% in the 2001-2002 income year; and
the company tax rate of 30% in the 2002-2003 and subsequent income years.

5.250 The rebate rate for life insurance bonuses paid from friendly societies that are included in assessable income under section 26AH will be:

33% in the 2000-2001 and 2001-2002 income years; and
the company tax rate of 30% in the 2002-2003 and subsequent income years.

[Schedule 2, items 25 and 26, section 160AAB]

Current pension business of complying superannuation fund and exempt superannuation business of PSTs

5.251 Income derived on the segregated current pension assets of a complying superannuation fund or the segregated exempt superannuation assets of a PST will be exempt from tax.

Segregation of assets of a complying superannuation fund or PST

5.252 A complying superannuation fund will be able to segregate assets to be used for the sole purpose of discharging its current pension liabilities on or after 1 July 2000. Except as provided for under the transitional arrangements in new section 273J, an asset can be included in the segregated assets only if the whole of the asset is segregated. [Schedule 2, item 43, subsections 273A(1) and 1A)] . The segregated assets will be known as segregated current pension assets [Schedule 2, item 38, subsection 267(1)] .

5.253 Income generated on the segregated exempt superannuation assets will be exempt from tax under section 282B. Capital gains derived from segregated assets are exempt from tax under new section 118-320 [Schedule 2, item 81, section 118-320] .

5.254 Similarly, a PST will be able to segregate assets to be used for the sole purpose of discharging its liabilities under exempt superannuation liabilities on or after 1 July 2000. Except as provided for under the transitional arrangements in new section 273J, an asset can be included in the segregated assets only if the whole of the asset is segregated. [Schedule 2, item 43, subsections 273A(1) and (1A)] . The segregated assets will be known as segregated exempt superannuation assets [Schedule 2, item 39, subsection 267(1)] .

5.255 Income generated on the segregated exempt superannuation assets will be exempt from tax under new section 297B [Schedule 2, item 52, section 297B] . Capital gains derived from segregated assets are exempt from tax under new section 118-355 [Schedule 2, item 82, section 118-355] .

5.256 The segregated assets at the time of initial segregation must be a representative sample of all the assets supporting the current pension liabilities of the fund or the exempt superannuation liabilities of the PST immediately before the segregation of assets. [Schedule 2, item 43, subsection 273A(2)]

5.257 The total transfer value of the segregated assets must not exceed the sum of:

the current pension liabilities of the fund or the exempt superannuation liabilities of the PST; and
any reasonable provision for liability for tax on unrealised gains that relates to those segregated assets.

[Schedule 2, item 43, subsection 273A(3)]

5.258 As a transitional rule, if a complying superannuation fund or PST segregates assets in accordance with new section 273A between 1 July 2000 and 30 September 2000, the fund or PST will be taken to have segregated those assets on 1 July 2000 [Schedule 2, item 43, subsection 273A(4)] . The purpose of this transitional rule is to allow sufficient time to segregate assets relating to current pension liabilities or exempt superannuation liabilities.

5.259 The Commissioner has a discretion to extend the period of time allowed for complying superannuation funds and PSTs to segregate their assets. The purpose of the discretion is to permit the Commissioner to allow additional time for funds (particularly self managed funds) to segregate assets.

5.260 If a complying superannuation fund currently has segregated current pension assets, those segregated assets will continue to be segregated current pension assets as at 1 July 2000. [Schedule 2, item 43, subsection 273A(5)]

5.261 The segregated assets must be maintained for the sole purpose of discharging the current pension liabilities of the fund or exempt superannuation liabilities of the PST [Schedule 2, item 43, subsection 273A(6)] . This does not prevent the segregated assets from being used to pay fees and expenses relating to the carrying on of the current pension business.

An asset includes money

5.262 A transfer of an asset to or from the segregated current pension assets or the segregated exempt superannuation assets includes the transfer of money to or from the segregated assets. If an asset transferred to or from the segregated assets is money, the transfer value of the asset transferred is the amount of the money. [Schedule 2, item 43, subsection 273A(7)]

Transitional rule for certain assets held as at 1 July 2000

5.263 A segregated asset is an asset that relates solely to segregated current pension liabilities of a complying superannuation fund or the segregated exempt superannuation liabilities of a PST. That is, an asset can be included in the segregated assets only if the whole of the asset is segregated. However, as a transitional rule, the segregated assets will include the share of certain existing assets that the trustee of the fund or of the PST certifies before 1 October 2000 to be included in the segregated current pension assets or segregated exempt superannuation assets. The part of the asset certified will be treated as a separate asset for taxation purposes.

5.264 If the fund is not a self managed fund (as defined in the Superannuation Industry (Supervision) Act 1993), this transitional rule will apply to an asset if:

the asset was acquired by the fund or PST before 1 July 2000; and
the market value of the asset as at 1 July 2000 exceeds the lesser of:

-
$50 million; or
-
the greater of 2% of the value of the fund or PST or $5 million.

5.265 If the fund is a self managed fund, this transitional rule will apply to an asset if:

the asset was acquired by the fund before 1 July 2000; and
the market value of the asset as at 1 July 2000 exceeds 50% of the value of the fund.

[Schedule 2, item 43, section 273J]

Transitional rule for liabilities held as at 1 July 2000

5.266 The taxation consequences of a transfer of assets to the segregated current pension assets of a complying superannuation fund are disregarded if the fund had a liability before 1 July 2000 to a member of the fund in respect of a current pension where the income of the fund attributable to that liability was exempt from tax before that date and the liability in respect of that pension is transferred to the segregated assets.

5.267 Similarly, the taxation consequences of a transfer of assets to the segregated exempt superannuation assets of a PST are disregarded if the PST had a liability before 1 July 2000 to the holder of a unit in the PST where the income attributable to that liability was exempt from tax before that date and the liability is transferred to the PSTs segregated assets. [Schedule 2, item 43, section 273K]

5.268 For example, when an asset that is included in the segregated current pension assets or segregated exempt superannuation with effect from 1 July 2000 is disposed of by the fund or PST, the cost base of the asset will not be adjusted to reflect the transfer value at the time of segregation.

Annual valuation of segregated current pension assets

5.269 The trustee of a complying superannuation fund or PST that segregates current pension assets or exempt superannuation assets must determine the transfer value of the assets annually as at the end of the income year of the fund or PST. The valuation must be made within 90 days of the end of the income year of the fund or PST or such further time as the Commissioner allows. The purpose of the discretion is to permit the Commissioner to allow additional time for funds (particularly self managed funds that do not have to comply with the reporting obligations imposed on larger superannuation funds) to value assets held in the segregated pool. [Schedule 2, item 43, section 273B]

Consequences of annual valuation

5.270 If the total transfer value of the segregated current pension assets of a complying superannuation fund exceeds the sum of:

the fund's current pension liabilities; plus
any reasonable provision made in the fund's accounts for liability for tax on unrealised gains that relates to those segregated assets,

then assets with a transfer value equal to the excess must be transferred out of the segregated current pension assets within 30 days of the annual valuation. [Schedule 2, item 43, subsection 273C(1)]

5.271 Similarly, if the total transfer value of the segregated exempt superannuation assets of a PST exceeds the sum of:

the PSTs exempt superannuation liabilities, plus
any reasonable provision made in the PST's accounts for liability for tax on unrealised gains that relates to those segregated assets,

then assets with a transfer value equal to the excess must be transferred out of the segregated exempt superannuation assets within 30 days of the annual valuation. [Schedule 2, item 43, subsection 273C(1)]

5.272 A transfer of assets under new subsection 273C(1 ) will be deemed to have been made in the income year at the end of which the valuation time occurred. [Schedule 2, item 43, subsection 273C(3)]

5.273 If the total transfer value of the segregated current pension assets of a complying superannuation fund is less than the sum of:

the fund's current pension liabilities; plus
any reasonable provision made in the fund's accounts for liability for tax on unrealised gains that relates to those segregated assets,

then assets with a transfer value not exceeding the difference may be transferred to the segregated current pension assets. [Schedule 2, item 43, subsection 273C(2)]

5.274 Similarly, if the total transfer value of the segregated exempt superannuation assets of a PST is less than the sum of:

the PSTs exempt superannuation liabilities, plus
any reasonable provision made in the PST's accounts for liability for tax on unrealised gains that relates to those segregated assets,

then assets with a transfer value not exceeding the difference may be transferred to the segregated exempt superannuation assets. [Schedule 2, item 43, subsection 273C(2)]

5.275 A transfer of assets under new subsection 273C(2 ) made within 30 days of the annual valuationwill be deemed to have been made in the income year at the end of which the valuation time occurred. [Schedule 2, item 43, subsection 273C(4)]

Transfer of assets to the segregated current pension assets or segregated exempt superannuation assets other than as a result of an annual valuation

5.276 There are 4 circumstances in which a complying superannuation fund or PST can transfer assets to the segregated current pension assets or segregated exempt superannuation assets other than as a result of an annual valuation.

5.277 First, if a complying superannuation fund determines at a time, other than the annual valuation time, that the total transfer value of the segregated current pension assets is less than its current pension liabilities plus any reasonable provision made in its accounts for liability for tax on unrealised gains that relates to those segregated assets, then assets with a transfer value not exceeding the difference can be transferred to the segregated current pension assets. [Schedule 2, item 43, subsection 273D(1)]

5.278 Similarly, if a PST determines at a time, other than the annual valuation time, that the total transfer value of the segregated exempt superannuation assets is less than its exempt superannuation liabilities plus any reasonable provision made in its accounts for liability for tax on unrealised gains that relates to those segregated assets, then assets with a transfer value not exceeding the difference can be transferred to the segregated exempt superannuation assets. [Schedule 2, item 43, subsection 273D(1)]

5.279 Second, if a current pension begins to be paid to the member of a complying superannuation fund other than because of the roll-over of an eligible termination payment, and the trustee elects to have the liability for that pension discharged out of the fund's segregated assets, then:

the trustee must, at the time of the election, transfer assets to the segregated pool; and
the assets transferred to the segregated pool must have a total transfer value equal to the current pension liabilities of the fund attributable to the pension at that time.

[Schedule 2, item 43, subsection 273D(2)]

5.280 Similarly, if:

a unit in a PST that is held by a complying superannuation fund becomes an exempt unit because of subsection 273D(2); or
a unit in a PST that is held by a life assurance company becomes an exempt unit because of subsection 320-195(1) of the ITAA 1997;

and the trustee elects to have the liability for that unit discharged out of the PST's segregated assets, then at the time of the election the trustee must transfer assets to the segregated pool. The assets transferred to the segregated exempt superannuation assets of the PST must have a total transfer value equal to the value of the unit at that time. [Schedule 2, item 43, subsection 273D(3)]

5.281 Third, a complying superannuation fund or PST can at any time transfer assets of any kind to the segregated current pension assets or segregated exempt superannuation assets in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. This might occur if, for example, the fund or PST holds a parcel of shares outside the segregated assets which is no longer consistent with the investment strategy for that part of its business. The fund or PST may wish to transfer the shares to the segregated assets. To save transaction costs, the shares could be transferred to the segregated assets for consideration equal to the transfer value. [Schedule 2, item 43, subsection 273D(4)]

5.282 Fourth, a complying superannuation fund must transfer to its segregated assets, assets having a total transfer value equal to any eligible termination payments made to the fund for the purchase of current pensions. [Schedule 2, item 43, subsection 273D(5)]

5.283 Similarly, a PST must transfer to its segregated exempt superannuation assets, assets having a total transfer value equal to the amounts paid to the PST in respect of exempt units. [Schedule 2, item 43, subsection 273D(6)]

Current pension liabilities

5.284 The current pension liabilities of a complying superannuation fund are worked out for current pensions[F5] only to the extent that the liability for those pensions are to be discharged from the fund's segregated current pension assets. Current pension liabilities of a complying superannuation fund are the sum of:

the withdrawal benefits (as defined in the Superannuation Industry (Supervision) Regulations) held by the fund in respect of members who are being paid allocated pensions; and
the present values (calculated by an actuary using best estimate assumptions as to future experience in the payment of current pensions other than allocated pensions) of the future payments to be made by the fund of current pensions (other than allocated pensions).

[Schedule 2, item 43, section 273E]

Exempt superannuation liabilities

5.285 The exempt superannuation liabilities of a PST are worked out for exempt units only to the extent that the liabilities under those units are to be discharged from the PST's segregated exempt superannuation assets. Exempt superannuation liabilities of a PST are the sum of:

the values of exempt units that are held for the sole purpose of providing allocated pensions or allocated annuities[F6];
the present values (calculated by an actuary using best estimate assumptions as to future experience in the payment of current pensions and immediate annuities other than allocated pensions or allocated annuities) of exempt units that are held for the sole purpose of providing for future payments of current pensions or immediate annuities (other than allocated pensions or allocated annuities); and
the present values (calculated by an actuary using best estimate assumptions as to future experience) of any other exempt units.

[Schedule 2, item 43, section 273F]

5.286 Exempt units of a PST are:

units held by the trustee of a complying superannuation fund that are segregated current pension assets of the fund;
units held by the trustee of a constitutionally protected superannuation fund;
units held by a life insurance company that are segregated exempt assets of the company; and
units held by another PST that are exempt units of that PST.

[Schedule 2, item 33, subsection 267(1)]

Transfers of assets and payments of amounts from segregated current pension assets or segregated exempt superannuation assets otherwise than as a result of annual valuation

5.287 There are 2 circumstances in which an asset can be transferred from segregated current pension assets or segregated exempt superannuation assets.

5.288 First, the fund or PST can at any time transfer assets of any kind from the segregated assets in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. [Schedule 2, item 43, subsection 273G(1)]

5.289 Second, if the fund or PST:

imposes fees or charges in respect of segregated current pension assets or segregated exempt superannuation assets;
imposes fees or charges in respect of amounts paid to the segregated assets; or
determines, at a time other than the annual valuation time, that there are excess assets in the segregated assets,

then the fund or PST must transfer from the segregated assets (at the time fees or charges are imposed or the excess is identified) having a total transfer value equal to the fees, charges or excess.

[Schedule 2, item 43, subsection 273G(2)]

5.290 Amounts will be considered to have been transferred from the segregated assets when fees and charges are imposed or the excess is identified provided they are transferred within a reasonable time having regard to normal business practice.

5.291 In addition, the trustee of a complying superannuation fund or of a PST must pay directly from the segregated current pension assets or segregated exempt superannuation assets:

any pension payments or other benefits relating to exempt current pension liabilities of the fund or exempt superannuation liabilities of the PST; and
any expenses incurred directly in respect of the segregated assets. Examples of expenses incurred directly in respect of the segregated assets include stamp duty, brokerage costs and expenses relating to a rental property that is a segregated asset.

[Schedule 2, item 43, subsection 273G(3)]

5.292 The trustee of a complying superannuation fund or of a PST can also pay directly from the segregated current pension assets or segregated exempt superannuation assets any tax liability that relates to realised gains on assets that are transferred to those segregated assets under subsections 273D(2) or (3). [Schedule 2, item 43, subsection 273G(4)]

Consequence of transfer of assets to or from segregated current pension assets or segregated exempt superannuation assets[F7]

5.293 New section 273H applies if:

an asset (other than money) is transferred from the segregated current pension assets of a complying superannuation fund or segregated exempt superannuation assets of a PST under new subsections 273C(1) or 273G(1) or (2); or
an asset (other than money) is transferred to the segregated assets under new subsections 273C(2) or 273D(1), (4), (5) or (6).

[Schedule 2, item 43, subsection 273H(1)]

5.294 If these provisions apply, then for the purposes of determining whether:

an amount is included in assessable income or is an allowable deduction (other than under the depreciation provisions) in respect of the transfer of the asset; or
the fund or PST made a capital gain or capital loss in respect of the transfer;

the fund or PST is taken to have:

sold the asset immediately before the transfer for consideration equal to its market value; and
purchased the asset again at the time of transfer for consideration equal to its market value.

[Schedule 2, item 43, subsection 273H(2)]

5.295 In addition, if a complying superannuation fund or PST could deduct an amount, except an amount that the fund or PST can deduct under subsection 281B(1) or 296B(1), or make a capital loss as a result of the transfer of an asset to the fund or PST to the segregated assets, the deduction or capital loss is disregarded until:

the asset ceases to exist; or
the asset, or a greater than 50% interest in it, is acquired by an entity other than an entity that is an associate of the company immediately after the transfer.

[Schedule 2, item 43, subsection 273H(3)]

5.296 A complying superannuation fund or a PST cannot deduct an amount or apply a capital loss as a result of the transfer of an asset from its segregated current pension assets or segregated exempt superannuation assets. [Schedule 2, item 43, subsection 273H(4)]

5.297 Finally, if an asset that is a unit of plant is transferred from the segregated assets, the fund or PST must assume, for the purposes of the depreciation provisions (Division 42 of the ITAA 1997), that:

the unit had at all times been used by the fund or PST wholly for the purpose of producing assessable income; and
deductions for depreciation in respect of the asset had been allowed to the fund or PST during the period using the diminishing value method (subsection 42-160(3)) or the prime cost method (subsection 42-165(2A)).

[Schedule 2, item 43, subsection 273H(5)]

5.298 If an asset that is a unit of plant is transferred to the segregated current pension assets of a complying superannuation fund or to the segregated exempt superannuation assets of a PST, then, in determining for depreciation purposes whether an amount is included in, or can be deducted from, the assessable income of the fund or PST as a result of the transfer, the fund or PST is taken to have:

at the time immediately before the transfer, sold the asset for a consideration equal to its market value at that time; and
at the time of the transfer, purchased the assets again for a consideration equal to its market value at that time.

[Schedule 2, item 43, subsection 273H(6)]

5.299 If an asset that is a unit of plant that has been included in the segregated current pension assets of a complying superannuation fund or the segregated exempt superannuation assets of a PST since the asset was acquired by the fund or PST or since the initial segregation of those assets is transferred from those assets, then, the fund or PST must assume, for depreciation purposes, that:

if the asset's market value at the time of the transfer is greater that its notional undeducted cost at that time, the fund or PST is taken to have:

-
at the time immediately before the transfer, sold the asset for a consideration equal to its notional undeducted cost[F8] at that time; and
-
at the time of the transfer, purchased the asset again for a consideration equal to its notional undeducted cost at that time; or

if the asset's market value at the time of the transfer is equal to or less than its notional undeducted cost at that time, the fund or PST is taken to have:

-
at the time immediately before the transfer, sold the asset for a consideration equal to its market value at that time; and
-
at the time of the transfer, purchased the asset again for a consideration equal to its market value at that time.

[Schedule 2, item 43, subsection 273H(7)]

5.300 If an asset that is a unit of plant that was previously transferred to the segregated current pension assets of a complying superannuation fund or the segregated exempt superannuation assets of a PST, is transferred from those assets, then, the fund or PST must assume, for depreciation purposes, that:

if the asset's market value at the time of its transfer from those assets is greater than its market value at the time when it was transferred to those assets, the fund or PST is taken to have:

-
at the time immediately before the transfer from those assets, sold the asset for a consideration equal to its market value at the time when it was transferred to those assets; and
-
at the time of the transfer from those assets, purchased the asset again for a consideration equal to its market value at the time when it was transferred to those assets; or

if the asset's market value at the time of its transfer from those assets is equal to or less than its market value at the time when it was transferred to those assets, the fund or PST is taken to have:

-
at the time immediately before the transfer from those assets, sold the asset for a consideration equal to its market value at that time; and
-
at the time of the transfer from those assets, purchased the asset again for a consideration equal to its market value at that time.

[Schedule 2, item 43, subsection 273H(8)]

Taxable income of a complying superannuation fund

Assessable income

5.301 The assessable income of a complying superannuation fund will include:

the transfer value[F9] of assets transferred from segregated current pension assets under new subsection 273C(1) or subsection 273G(2); and
the amount included in assessable income under section 273H where an asset other than money is transferred to the segregated current pension assets under new subsection 273C(2) or subsection 273D(1), (4) or (5).

[Schedule 2, item 49, subsection 281A(1)]

5.302 In addition, if an asset other than money that was transferred to the fund's segregated current pension assets under new subsection 273D(2) is disposed of by the fund and the transitional rule in new subsections 281A(4) and (5) does not apply, the assessable income of the fund includes the lesser of:

the amount (if any) that would have been included in assessable income if section 273H applied at the time of transfer; and
the amount (if any) that would have been included in assessable income if the asset was not a segregated current pension asset at the time of disposal.

[Schedule 2, item 49, subsection 281A(2)]

5.303 Similarly, if an asset other than money that was transferred to the fund's segregated current pension assets under new subsection 273D(2) is transferred from those segregated current pension assets under subsections 273C(1) or 273G(1) or (2) and the transitional rule in new subsections 281A(4) and (5) does not apply, the assessable income of the fund includes the lesser of:

the amount (if any) that would have been included in assessable income if section 273H applied at the time of transfer to the segregated current pension assets; and
the amount (if any) that would have been included in assessable income because of section 273H if the asset were not a segregated current pension asset at the time of its transfer from those assets.

[Schedule 2, item 49, subsection 281A(3)]

Allowable deductions

5.304 If an asset other than money that was transferred to the fund's segregated current pension assets under new subsection 273D(2) is disposed of by the fund and the transitional rule in new subsections 281AA(3) and (4) does not apply, the fund can deduct the lesser of:

the amount (if any) that could have been deducted if section 273H applied at the time of transfer; and
the amount (if any) that could have been deducted if the asset was not a segregated current pension asset at the time of disposal.

[Schedule 2, item 49, subsection 281AA(1)]

5.305 Similarly, if an asset other than money that was transferred to the fund's segregated current pension assets under new subsection 273D(2) is transferred from those segregated current pension assets under subsections 273C(1) or 273G(1) or (2) and the transitional rule in new subsections 281AA(3) and (4) does not apply, the fund can deduct the lesser of:

the amount (if any) that could have been deducted if section 273H applied at the time of the transfer to the segregated current pension assets; and
the amount (if any) that could have been deducted because of section 273H if the asset were not a segregated current pension asset at the time of its transfer from those assets.

[Schedule 2, item 49, subsection 281AA(2)]

5.306 In addition, a complying superannuation fund can deduct the transfer values of assets transferred to the fund's segregated current pension assets under subsections 273C(2) or 273D(1). [Schedule 2, item 49, subsection 281B(1)]

5.307 Finally, if an asset (other than money) is transferred to the fund's segregated current pension assets under subsection 273C(2) or 273D(1), (4) or (5), the fund can deduct the amount (if any) that it can deduct because of section 273H. [Schedule 2, item 49, subsection 281B(2)]

5.308 However, a complying superannuation fund is not entitled to a deduction (other than under section 279) for fees and charges incurred in respect of:

virtual PST life insurance policies;
exempt life insurance policies; or
exempt units in a PST.

[Schedule 2, item 48, subsection 279E(3)]

5.309 The reason for the denial of a deduction for these expenses is that the life insurance company or PST effectively gets a deduction for these fees and charges.

Transitional arrangements for self managed funds and small APRA funds

5.310 As a transitional rule, subsections 281A(2) and (3) and subsections 281AA(1) and (2) (that apply to the transfer of an asset under subsection 273D(2)) do not apply to complying superannuation funds that:

have fewer than 5 members as at 1 July 2000 - that is, that are self managed funds or small APRA funds; and
transfer assets that were acquired by the fund before 1 July 2000 to their segregated current pension assets between 1 July 2000 and 30 June 2005 under subsection 273D(2) - that is, because a pension commences to paid to a member of the fund other than because of the roll-over of an ETP where the trustee elects to have that liability discharged out of the fund's segregated current pension assets.

5.311 Instead, the assessable income of the fund will include the amount calculated as follows:

the amount that would be included in assessable income if section 273H applied to the asset at the time of transfer to the segregated current pension assets

less

the amount that would be included in assessable income if the asset had been transferred to the segregated current pension assets on 1 July 2000 and section 273H applied to that asset.

5.312 If the amount calculated is positive, the fund will include the amount in its assessable income of the fund at the time the asset is disposed of by the fund or is subsequently transferred out of the segregated assets. [Schedule 2, item 49 subsections 281A(4) and (5) of the ITAA 1936]

5.313 Similarly, if the amount calculated above is negative, the fund will be entitled to a deduction for that amount at the time the asset is disposed of by the fund or is subsequently transferred out of the segregated assets. [Schedule 2, item 49 subsections 281AA(3) and (4) of the ITAA 1936]

5.314 The purpose of the transitional relief is to alleviate the immediate impact of the measures on members of self managed superannuation funds and small APRA funds who are close to retirement. It will also give other members of these funds a reasonable time to adjust their retirement plans having regard to the new taxation arrangements.

Example 5.6 A member of a self managed superannuation fund commences a pension on 1 July 2004. The trustee of the fund transfers assets on that date to the segregated current pension assets to support the pension. One of the assets transferred has:

a cost base of $41,000 at both 1 July 2000 and 1 July 2004;
a market value of $50,000 as at 1 July 2000; and
a market value of $56,000 as at 1 July 2004.

The amount that would be included in assessable income if section 273H applied to the asset at the time of transfer to the segregated current pension assets (assuming that the fund would have made a discount capital gain and has no capital losses) is $10,000 (i.e. 2/3 of $15,000 ($56,000 less $41,000)).The amount that would be included in assessable income if the asset had been transferred to the segregated current pension assets on 1 July 2000 and section 273H applied to that asset (assuming that the fund would have made a discount capital gain and has no capital losses) is $6,000 (i.e. 2/3 of $9,000 ($50,000 less $41,000)).Therefore, the fund will include $4,000 in its assessable income at the time the asset is disposed of by the fund or is subsequently transferred out of the segregated assets.

Exempt income

5.315 The income derived by a complying superannuation fund on segregated current pension assets is exempt from tax under section 282B.

5.316 As a transitional measure, certain defined benefit superannuation schemes will be exempt from tax on income relating to their current pensions under either section 282B or new section 282C. The transitional measure will only apply to a defined benefit scheme (as defined in the Superannuation Guarantee (Administration) Act 1992) that:

is a complying superannuation fund for the purposes of the Superannuation Industry (Supervision) Act 1993;
at the end of the income year, has current pension liabilities that are less than 1% of it's total liabilities;
is closed to new members as at 1 July 2000; and
does not, before or during the income year, choose to use the segregated current pension assets approach.

5.317 The exempt income relating to current pensions of defined benefit superannuation schemes that qualify for this transitional measure will be worked out applying the formula:

Normal assessable income * (average value of current pension liabilities during the income year / average value of total liabilities during the income year)

[Schedule 2, item 49A, section 282C of the ITAA 1936]

5.318 A transitional rule will also apply to exempt a complying superannuation fund from tax on one-third of a proportion of certain amounts transferred for the segregated current pension assets that relate to its current pension liabilities as at 1 July 2000. The exemption will cease to apply from 30 June 2005.

5.319 The transitional relief will apply to exempt from tax one-third of a proportion of amounts transferred under the following provisions (reduced by the amounts transferred under subsections 273C(2) or 273D(1)):

subsection 273C(1);
paragraph 273G(2)(a);
paragraph 273G(2)(b); and
paragraph 273G(2)(c).

5.320 Any income that is exempt under this transitional arrangement is treated as assessable income for the purpose of claiming deductions under section 8-1 of the ITAA 1997. [Schedule 2, item 50, section 283]

Taxable income of a PST

Assessable income

5.321 The assessable income of a PST will include:

the transfer value of assets transferred from segregated exempt superannuation assets under new subsection 273C(1) or subsection 273G(2); and
the amount included in assessable income under section 273H where an asset other than money is transferred to the segregated exempt superannuation assets under new subsection 273C(2) or subsection 273D(1), (4) or (6).

[Schedule 2, item 51, subsection 296A(1)]

5.322 In addition, if an asset other than money that was transferred to the PSTs segregated exempt superannuation assets under new subsection 273D(3) is disposed of by the PST, the assessable income of the PST includes the lesser of:

the amount (if any) that would have been included in assessable income if section 273H applied at the time of transfer; and
the amount (if any) that would have been included in assessable income if the asset was not a segregated exempt superannuation asset at the time of disposal.

[Schedule 2, item 51, subsection 296A(2)]

5.323 Similarly, if an asset other than money that was transferred to the PSTs segregated exempt superannuation assets under new subsection 273D(3) is transferred from those segregated exempt superannuation assets under subsections 273C(1) or 273G(1) or (2), the assessable income of the PST includes the lesser of:

the amount (if any) that would have been included in assessable income if section 273H applied at the time of transfer to the segregated exempt superannuation assets; and
the amount (if any) that would have been included in assessable income because of section 273H if the asset were not a segregated exempt superannuation asset at the time of its transfer from those assets.

[Schedule 2, item 51, subsection 296A(3)]

Allowable deductions

5.324 If an asset other than money that was transferred to the PSTs segregated exempt superannuation assets under new subsection 273D(3) is disposed of by the PST, the PST can deduct the lesser of:

the amount (if any) that could have been deducted if section 273H applied at the time of transfer; and
the amount (if any) that could have been deducted if the asset was not a segregated current exempt superannuation asset at the time of disposal.

[Schedule 2, item 51, subsection 296AA(1)]

5.325 Similarly, if an asset other than money that was transferred to the PSTs segregated exempt superannuation assets under new subsection 273D(3) is transferred from those segregated exempt superannuation assets under subsections 273C(1) or 273G(1) or (2), the PST can deduct the lesser of:

the amount (if any) that could have been deducted if section 273H applied at the time of the transfer to the segregated exempt assets; and
the amount (if any) that could have been deducted because of section 273H if the asset was not a segregated exempt superannuation asset at the time of its transfer from those assets.

[Schedule 2, item 51, subsection 296AA(2)]

5.326 In addition, a PST can deduct the transfer values of assets transferred to the PSTs segregated exempt superannuation assets under subsections 273C(2) or 273D(1). [Schedule 2, item 51, subsection 296B(1)]

5.327 Finally, if an asset (other than money) is transferred to the PSTs segregated exempt superannuation assets under subsection 273C(2) or 273D(1), (4) or (6), the PST can deduct the amount (if any) that it can deduct because of section 273H. [Schedule 2, item 51, subsection 296B(2)]

Exempt income

5.328 The income derived by a PST on segregated exempt superannuation assets is exempt from tax under new section 297B. [Schedule 2, item 52, section 297B]

5.329 In addition, as a transitional rule, a PST will be exempt from tax on one-third of a proportion of certain amounts transferred for the segregated exempt superannuation assets that relate to exempt superannuation liabilities as at 1 July 2000. The exemption will cease to apply from 30 June 2005.

5.330 The transitional relief will apply to exempt from tax one-third of a proportion of amounts transferred under the following provisions (reduced by the amounts transferred under subsections 273C(2) or 273D(1)):

subsection 273C(1);
paragraph 273G(2)(a);
paragraph 273G(2)(b); and
paragraph 273G(2)(c).

5.331 Any income that is exempt under this transitional arrangement is treated as assessable income for the purpose of claiming deductions under section 8-1 of the ITAA 1997.

[Schedule 2, item 52, section 297BA]

Section 275 transfers

5.332 Complying superannuation funds and complying ADFs are specifically required to include taxable contributions in assessable income under sections 281 and 290 of the ITAA 1936. Taxable contributions are defined in section 274 to mean, broadly, superannuation contributions made by an employer and tax deductible superannuation contributions made by an individual.

5.333 Section 275 allows the trustee of a complying superannuation fund or a complying ADF (the transferor) to enter into an agreement with a life insurance company or PST (the transferee) to transfer taxable contributions to that company or PST. The effect of the agreement is that taxable contributions covered by the agreement are included in the assessable income of the transferee rather than in the assessable income of the transferor. The transferor can enter into only one agreement with a particular life insurance company or PST. The agreement must be in writing and, under the current law, is irrevocable.

5.334 This Bill amends section 275 so that:

the amount specified in the agreement is excluded from the assessable income of the transferor and included in the assessable income of the transferee only if the transferor has given the transferee a certificate, signed by an auditor who is independent of the transferee, stating that the amount specified in the agreement meets the requirements of section 275 [Schedule 2, items 44 and 45, subsection 275(2A)] ; and
section 275 transfer notices can be varied by giving a written notice to the Commissioner signed by both the transferor and the transferee. The effect of the variation is that the Commissioner will amend the taxation returns of both the transferor and the transferee for the year to which the section 275 notice relates provided that the variation is made within the time limits for requesting amendments to assessments (i.e. generally within 4 years from the due date for payment of tax under an assessment). [Schedule 2, items 46 and 47, subsections 275(7), (8) and (9)]

Controlled foreign corporation provisions

5.335 This Bill makes amendments to the controlled foreign corporation provisions as a consequence of the repeal of the current provisions for taxing life insurance companies in Division 8. [Schedule 2, items 55 to 60, sections 317 and 446]

Taxation of friendly societies

5.336 This Bill makes consequential amendments to ensure that the income of friendly societies, including income derived on that part of their life insurance business that relates to income bonds, funeral polices and scholarship plans, is exempt from tax under section 50-1 of the ITAA 1997. Income derived by friendly societies on other life insurance business will not be exempt from tax under section 50-1. [Schedule 2, items 66 and 69, sections 50-20 and 50-72]

5.337 The section 50-1 exemption will be removed with effect from 1 July 2001. [Schedule 2, items 66, 67 and 70]

Consequential amendments to the CGT provisions

5.338 To avoid any unintended consequences, the references to a life insurance policy in section 118-300 and section 152-20 are restricted to those policies that qualify as life insurance policies under the current law - that is, to policies of insurance that are taken out on the life of an individual. [Schedule 2, items 79A, 79B and 83A, subsection 118-300(1) and subparagraph 152-20(2)(b)(v) of the ITAA 1997]

Amendments to the Income Tax Rates Act

What rate of tax will apply to life insurance companies?

5.339 Subsection 23(4A) of the Income Tax Rates Act 1986 specifies the rates of tax that apply to life insurance companies. Subsection 23(4) specifies the rates of tax that apply to registered organisations (including friendly societies).

5.340 The change to the rates of tax on the insurance business of life insurance companies and the change to the basis for calculating taxable income will apply from 1 July 2000. However, the changes to the rate of tax on the non-insurance business of life insurance companies (which is taxed at the company tax rate) apply to the 2000-2001 income year - see the Income Tax Rates Act No. 1.

5.341 Therefore, if the life insurance company has an ordinary accounting period, the rates of tax in respect of its taxable income for the 2000-2001 income year will be:

in respect of the complying superannuation class - 15%; and
in respect of the ordinary class:

-
if the company is a friendly society - 33%; or
-
in any other case - 34%.

5.342 The rate of tax in respect of the ordinary class of taxable income of life insurance companies (including friendly societies) will be reduced to 30% (consistent with changes to the company tax rate), from the 2001-2002 income year.

[Schedule 2, item 111, section 23A of the Income Tax Rates Act 1986]

5.343 Transitional rules will apply to life insurance companies and friendly societies that have substituted accounting periods.

Early balancing life insurance companies

5.344 If the life insurance company is an early balancing company, the rates of tax in respect of its taxable income for the 2000-2001 income year will be as follows:

Rates of tax for early balancing life insurance companies in the 2000-2001 income year

Rates of tax for early balancing life insurance companies in the 2000-2001 income year
Class of taxable income Period from start of 2000-2001 income year until 30 June 2000 Period from 1 July 2000 until end of 2000-2001 income year
CS/RA component 15%
General fund component:

RSA component
Standard component:

-
Non-mutual company
-
Mutual company

15%
34%
39%

AD/RLA component 39%
NCS component 47%
Complying superannuation class 15%
Ordinary class 34%

5.345 The rates of tax in respect of its taxable income for the 2001-2002 income year will be:

in respect of the complying superannuation class - 15%; and
in respect of the ordinary class - 30%.

[Schedule 2, item 111, subsections 23B(2) and (3) of the Income Tax Rates Act 1986]

Late balancing life insurance companies

5.346 If a life insurance company is a late balancing company, the rates of tax in respect of its taxable income for the 1999-2000 income year will be as follows:

Rates of tax for late balancing life insurance companies in the 1999-2001 income year
Class of taxable income Period from start of 1999-2000 income year until 30 June 2000 Period from 1 July 2000 until end of 1999-2000 income year
CS/RA component 15%
General fund component:

RSA component
Standard component:

-
Non-mutual company
-
Mutual company

15%
36%
39%

AD/RLA component 39%
NCS component 47%
Complying superannuation class 15%
Ordinary class 36%

5.347 The rates of tax in respect of its taxable income for the 2000-2001 income year will be:

in respect of the complying superannuation class - 15%; and
in respect of the ordinary class - 34%.

5.348 The rates of tax in respect of its taxable income for the 2001-2002 income year will be:

in respect of the complying superannuation class - 15%; and
in respect of the ordinary class - 30%.

[Schedule 2, item 111, subsections 23B(4) and (5) of the Income Tax Rates Act 1986]

Early balancing friendly societies

5.349 If a friendly society is an early balancing company, the rates of tax in respect of its taxable income for the 2000-2001 income year will be as follows:

Rates of tax for early balancing friendly societies in the 2000-2001 income year
Class of taxable income Period from start of 2000-2001 income year until 30 June 2000 Period from 1 July 2000 until end of 2000-2001 income year
CS/RA component 15%
RSA component:

RSA category A component
RSA category B component

15%
34%

EIB component 33%
NCS component 47%
Complying superannuation class 15%
Ordinary class 33%

5.350 The rates of tax in respect of its taxable income for the 2001-2002 income year will be:

in respect of the complying superannuation class - 15%; and
in respect of the ordinary class - 30%.

[Schedule 2, item 111, subsections 23C(2) and (3) of the Income Tax Rates Act 1986]

Late balancing friendly societies

5.351 If a friendly society is a late balancing company, the rates of tax in respect of its taxable income for the 1999-2000 income year will be as follows:

Rates of tax for late balancing friendly societies in the 1999-2000 income year
Class of taxable income Period from start of 1999-2000 income year until 30 June 2000 Period from 1 July 2000 until end of 1999-2000 income year
CS/RA component 15%
RSA component:

RSA category A component
RSA category B component

15%
36%

EIB component 33%
NCS component 47%
Complying superannuation class 15%
Ordinary class 33%

5.352 The rates of tax in respect of its taxable income for the 2000-2001 income year will be:

in respect of the complying superannuation class - 15%; and
in respect of the ordinary class - 33%.

5.353 The rates of tax in respect of its taxable income for the 2001-2002 income year will be:

in respect of the complying superannuation class - 15%; and
in respect of the ordinary class - 30%.

[Schedule 2, item 111, subsections 23C(4) and (5) of the Income Tax Rates Act 1986]

Amendments to the Income Tax Act 1986

5.354 Items 112 and 113 make a consequential amendment to the Income Tax Act 1986 to reflect the removal of the definition of registered organisation in the Income Tax Rates Act. [Schedule 2, items 112 and 113, subsections 23C(4) and (5) of the Income Tax Rates Act 1986]

Amendments to the Taxation Administration Act 1953

PAYG

5.355 This Bill makes consequential amendments to provisions in the TAA 1953 relating to the collection of tax instalments from life insurance companies to reflect the new classes of business of life insurance companies.

5.356 The instalment income of a life insurance company will include:

any part of its statutory income that is reasonably attributable to a period that is included in the complying superannuation class of taxable income of the company; and
any part of its statutory income (other than net capital gains) that is included in the ordinary class of taxable income of the company.

[Schedule 2, item 114, subsection 45-120(2A) of the TAA 1953]

5.357 Consequential amendments are made to the formulae to work out the adjusted taxable income of a life insurance company to reflect the new classes of assessable income. [Schedule 2, item 116, subsection 45-330(3) of the TAA 1953]

5.358 In addition, as a transitional rule, the Commissioner will be able to take into account the amendments to the law affecting base assessment instalment income for the purposes of working out the instalment rate for life insurance companies for the 2000-2001 income year. [Schedule 2, item 115, subsection 45-330(3)]

5.359 Finally, section 45-370 is amended to insert a special rule to work out the adjusted assessed taxable income of life insurance companies. [Schedule 2, item 117, subsection 45-370(3)]

Section 1: Summary of the implications of transfers to and from a virtual PST
Transferring assets (including money) to a virtual PST Effect of transfer (other than because of the deemed sale/disposal) Consequences of the deemed sale and disposal of the asset
If the company determines insufficient assets are segregated at a valuation time, assets that have a total transfer value not exceeding the difference can be transferred to its virtual PST. The transfer is taken to have been made in the year of income at the end of which the valuation time occurred if it is made within 30 days after the day on which the valuations are made. [ss320-180(2) and (4)]

If the company determines at a time other than a valuation time insufficient assets are segregated, the company can transfer to its virtual PST, assets having a total transfer value not exceeding the difference. [ss320-185(1)]

Include in the virtual PST component the transfer values of any assets transferred during the income year. This reduces the ordinary component of taxable income. [p320-205(3)(b)] If an asset (other than money) is transferred the company is taken to have sold the asset immediately before the transfer and to have purchased the asset again at the time of the transfer for a consideration equal to its market value. [ss320-200(2)].

The company's assessable income includes the amount (if any) that arises because of s320-200 as a consequence of the sale and disposal of the asset [s320-15(e)]. Conversely, the company can deduct the amount (if any) that arises because of s320-200 as a consequence of the sale and disposal of the asset when the asset ceases to exist or the asset, or a greater than 50% interest in it, is acquired by an entity other than an entity that is an associate of the company immediately after the transfer. [s320-87 and ss320-200(3)]

For other consequences - see s320-200.

The company can at any time transfer an asset to a virtual PST in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. [ss320-185(2)]   As above.
The company can transfer to a virtual PST, assets having a total transfer value not exceeding the total amount of the life insurance premiums paid to the company for the purchase of virtual PST life insurance policies. [ss320-185(3)] Include in assessable income the total amount of life insurance premiums received in the income year. [p320-15(a)]

Allocate to the virtual PST component the transfer value of the premiums transferred. [p320-205(3)(b)]

Allow a deduction for the amount transferred to the virtual PST (other than the risk component). [s320-55]

Allocate the deduction to the virtual PST. [p320-205(4)(a)]

As above.
Transferring assets (including money) to a virtual PST Effect of transfer (other than because of the deemed sale/disposal) Consequences of the deemed sale and disposal of the asset
If the company determines excess assets are segregated at a valuation time, it must, within 30 days after the day on which the valuations are made, transfer from the virtual PST, assets having a total transfer value equal to the excess. The transfer is taken to have been made in the year of income at the end of which the valuation time occurred. [ss320-180(1) and (3)]

If the company imposes any fees or charges in relation to its virtual PST assets, or in respect of virtual PST life insurance policies (other than policies that provide participating death or disability benefits where the liabilities for those benefits are to be discharged out of its virtual PST) or the company determines at a time other than a valuation time excess assets are segregated, assets having a total transfer value equal to the fees, charges or excess must be transferred from the virtual PST at the time the fees or charges are imposed or the excess is determined. [ss320-195(3)]

Reduce the virtual PST component by the transfer values of the assets transferred. [p320-205(4)(c)]

This increases the ordinary component of taxable income.

If an asset (other than money) is transferred the company is taken to have sold the asset immediately before the transfer and to have purchased the asset again at the time of the transfer for a consideration equal to its market value. [ss320-200(2)].

The company's assessable income includes the amount (if any) that arises because of s320-200 as a consequence of the sale and disposal of the asset [s320-15(e)]. This amount is allocated to the virtual PST. [p320-205(3)(c)]

Conversely, the company can deduct the amount (if any) that arises because of s320-200 as a consequence of the sale and disposal of the asset when the asset ceases to exist or the asset, or a greater than 50% interest in it, is acquired by an entity other than an entity that is an associate of the company immediately after the transfer. [s320-87 and ss320-200(3)]. This amount is allocated to the virtual PST. [p320-205(4)(ca)]

For other consequences - see s320-200.

The company can at any time transfer an asset from its virtual PST in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. [ss320-195(2)]   As above.
If an amount held in a virtual PST relates to a pension or annuity that commences to be paid, assets with a total transfer value not exceeding the sum of:

the company's liabilities in respect of the pension or annuity; plus
any reasonable provision made at that time in the company's accounts for liability for tax on unrealised gains that relates to the assets transferred,

can be transferred from its virtual PST to its segregated exempt assets. [ss320-195(1)]

  If the asset (other than money) is disposed of, or transferred from the segregated exempt assets, the company must include in its assessable income, at the time of the disposal or transfer of those assets from the segregated exempt assets, the lesser of:

the amount (if any) that would have been included if s320-255 applied at the time of the transfer to the segregated exempt assets; or
the amount (if any) that would have been included because of s320-255 if the asset was, or had been, an asset of the virtual PST at the time of the disposal or the transfer from the segregated exempt assets.

[s320-20, 320-25]

The amount is allocated to the virtual PST component . [p320-205(3)(f) and 320-205(4)(g)]

For other consequences, including deductions that may be available, see s320-90, 320-95 and 320-255

Section 2: Summary of the implications of transfers to and from segregated exempt assets
Transferring assets (including money) to a life insurance company's segregated exempt assets Effect of transfer (other than because of the deemed sale/disposal) Consequences of the deemed sale and disposal of the asset
If the company determines insufficient assets are segregated at a valuation time, assets having a total transfer value not exceeding the difference can be transferred to its segregated exempt assets. The transfer is taken to have been made in the year of income at the end of which the valuation time occurred if it is made within 30 days after the day on which the valuations are made. [ss320-235(2) and (4)]

If the company determines at a time other than a valuation time insufficient assets are segregated, the company can transfer to its segregated exempt assets, assets of any kind having a total transfer value not exceeding the difference. [ss320-240(1)]

The company can claim a deduction for the transfer values of assets transferred in the income year. [ss320-105(1)] If an asset (other than money) is transferred, the company is taken to have sold the asset immediately before the transfer and to have purchased the asset again at the time of the transfer for a consideration equal to its market value. [s320-255].

The company's assessable income includes the amount (if any) that arises because of s320-255 as a consequence of the sale and disposal. [p320-15(g)]

For other consequences - see s320-255.

The company can at any time transfer an asset to its segregated exempt assets in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. [ss320-240(2)]   As above.
The company can at any time transfer to its segregated exempt assets, assets having a total transfer value not exceeding the total amount of the life insurance premiums paid to it for the purchase of exempt life insurance policies. [ss320-240(3)] The company's assessable income includes the total amount of life insurance premiums paid to it in the income year. [p320-15(a)]

The company can deduct the amounts of life insurance premiums transferred in the income year. [s320-60]

As above.
If an amount held in a virtual PST relates to a pension or annuity that commences to be paid, assets with a total transfer value not exceeding the company's liabilities in respect of the pension or annuity can be transferred from its virtual PST to its segregated exempt assets. [ss320-240(4)]   See 'Transferring assets (including money) from a virtual PST'.
Transferring assets (including money) from a life insurance company's segregated exempt assets Effect of transfer (other than because of the deemed sale/disposal) Consequences of the deemed sale and disposal of the asset
If the company determines excess assets are segregated at a valuation time, it must, within 30 days after the day on which the valuations are made, transfer from the segregated exempt assets, assets having a total transfer value equal to the excess. The transfer is taken to have been made in the year of income at the end of which the valuation time occurred. [ss320-235(1) and (3)]

If the company:

imposes any fees or charges in respect of its segregated exempt assets; or
imposes any fees or charges in respect of policies where the liabilities are to be discharged out of those assets; or
determines at a time other than a valuation time excess assets are segregated,

assets having a total transfer value equal to the fees, charges or excess must be transferred from the segregated exempt assets when the fees or charges are imposed or the excess is determined. [ss320-250(2)]

Include in the company's assessable income the transfer values of the assets transferred. [p320-15(f)] If an asset, other than money, is transferred, the company is taken to have sold the asset immediately before the transfer and to have purchased the asset again at the time of the transfer.

The consideration the asset is sold for and purchased at depends on the asset transferred. [p320-255(1)(a), ss320-255(2), (5), (7) and (8)]

The company cannot deduct an amount or make a capital loss as a result of the transfer. [ss320-255(4)]

For other consequences - see s320-255.

The company can at any time transfer an asset from its segregated exempt assets in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. [ss320-250(1)]   As above.
Section 3: Summary of the implications of transfers to and from segregated current pension assets or segregated exempt superannuation assets
Transferring assets (including money) to a life insurance company's segregated exempt assets Effect of transfer (other than because of the deemed sale/disposal) Consequences of the deemed sale and disposal of the asset
If the trustee determines insufficient assets are segregated at a valuation time, assets having a total transfer value not exceeding the difference can be transferred to its segregated assets. The transfer is taken to have been made in the year of income at the end of which the valuation time occurred if it is made within 30 days after the day on which the valuations are made. [ss273C(2) and (4)]

If the trustee determines at a time other than a valuation time insufficient assets are segregated, the trustee can transfer to its segregated assets, assets having a total transfer value not exceeding the difference. [ss273D(1)]

The fund or PST can claim a deduction for the transfer values of assets transferred in the income year. [s281B(1) and 296B(1) respectively] If an asset (other than money) is transferred to the segregated assets the fund or PST is taken to have sold the asset immediately before the transfer and to have purchased the asset again at the time of the transfer for a consideration equal to its market value. [p273H(1)(b), ss273H(2) and (6)]

The assessable income of the fund or PST includes the amount (if any) that arises because of s273H as a consequence of the sale and disposal. [p281A(1)(b) and 296A(1)(b)]

For other consequences - see s273H, 281B(2) and 296B(2).

The trustee can at any time transfer an asset to its segregated assets in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. [ss273D(4)]

When an ETP is rolled over to purchase a current pension, then at the time of the roll-over the trustee must transfer to its segregated assets assets having a total transfer value equal to the amount of the ETP. [ss273D(5)]

When an amount is paid to a PST in respect of exempt units, the trustee must transfer, at that time, assets having a total transfer value equal to the amount paid to its segregated assets. [ss273D(6)]

  As above.
If a current pension begins to be paid to a member of a complying superannuation fund other than because of the roll-over of an ETP, or a unit in a PST becomes an exempt unit because of ss273D(2) or ss320-195(1) and the trustee of the fund or of the PST elects to have that liability discharged out of the segregated assets, then the trustee must, at the time of the election, transfer assets to the segregated pool. The assets transferred to the segregated pool must have a total transfer value equal to the value of the current pension liabilities of the fund attributable to the current pension or the value of the unit, as the case may be. [ss273D(2) and (3)]   If the asset (other than money) is disposed of, or transferred from the segregated assets, the fund or PST must include in its assessable income, at the time of the disposal or transfer of those assets from the segregated assets, the lesser of:

the amount (if any) that would have been included if s273H applied at the time of the transfer to the segregated assets; or
the amount (if any) that would have been included if the asset was not, or had not been, a segregated asset at the time of the disposal or the transfer from the segregated assets.

[ss281A(2) and (3), 296A(2) and (3)]

For other consequences, including deductions that may be available, see s273H, 281AA and 296AA.

If the trustee determines excess assets are segregated at a valuation time, the trustee must, within 30 days after the day on which the valuations are made, transfer from the segregated assets, assets having a total transfer value equal to the excess. The transfer is taken to have been made in the year of income at the end of which the valuation time occurred. [ss273C(1) and (3)]

If the trustee:

imposes any fees or charges in respect of its segregated assets; or
imposes any fees or charges in respect of amounts paid for the purchase of current pensions or exempt units where the liabilities for those pensions and units are to be discharged out of those assets; or
determines at a time other than a valuation time excess assets are segregated;

assets having a total transfer value equal to the fees, charges or excess must be transferred from the segregated assets when the fees or charges are imposed or the excess is determined. [ss273G(2)]

Include in the assessable income of the fund or PST the transfer values of the assets transferred. [p281A(1)(a) and 296A(1)(a) respectively] If an asset, other than money, is transferred, the fund or PST is taken to have sold the asset immediately before the transfer and to have purchased the asset again at the time of the transfer.

The consideration the asset is sold for and purchased at depends on the asset transferred. [p273H(1)(a), ss273H(2), (5), (7) and (8)]

The fund or PST cannot deduct an amount or make a capital loss as a result of the transfer. [ss273H(4)]

For other consequences - see s273H.

The trustee can at any time transfer an asset from its segregated assets in exchange for an amount of money equal to the transfer value of the asset at the time of the transfer. [ss273G(1)]   As above.

Chapter 6 - Imputation PAYG instalments

Outline of Chapter

6.1 This Chapter explains the consequential amendments made to the dividend imputation provisions resulting from the introduction of the PAYG system.

6.2 The amendments, which are contained in Part 1 of Schedule 3 to this Bill, provide for the generation of franking credits and debits from the payment and refund of tax and PAYG rate variation credits under the PAYG system.

Context of Reform

6.3 Under the current dividend imputation system companies receive franking credits and debits for the payment and refund respectively of tax under Division 1C of Part VI of the ITAA 1936 (the company tax instalment system).

6.4 With the introduction of the PAYG system from the 2000-2001 income year, consequential amendments are needed to the dividend imputation provisions so that franking credits and debits also arise from the payment and refund of tax and PAYG rate variation credits under PAYG.

Summary of new law

6.5 The new law will provide for the generation of franking credits and debits from the payment and refund of tax and PAYG rate variation credits under the PAYG system.

Comparison of key features of new law and current law

Comparison of key features of new law and current law
New law Current law
Franking credits and debits arise for the payment and refund of tax made under the PAYG system. Franking credits and debits arise for the payment and refund of tax made under the company tax instalment provisions.
Franking credits arise for the application of a PAYG rate variation credit to discharge a PAYG instalment liability. There is no comparable credit under the current law.
Franking debits arise when a PAYG rate variation credit is claimed. There is no comparable credit under the current law.

Detailed explanation of new law

When do franking credits arise from paying an income tax liability under the new PAYG system?

6.6 Under the new PAYG system, which applies from the 2000-2001 income year, companies will generate class C[F10] franking credits from paying an income tax liability in 2 different circumstances.

6.7 First, a company, other than a life insurance company[F11], will generate class C franking credits when it pays a PAYG instalment. The franking credit arises on the day the instalment is paid and is equal to the adjusted amount[F12] of the amount paid. [Schedule 3, Part 1, item 17, section 160APME]

6.8 Second, a company will generate class C franking credits when it makes a payment in respect of an income tax assessment liability (referred to in the provisions as 'company tax'). The franking credit arises on the day the payment is made and is equal to the adjusted amount of the amount paid. [Schedule 3, Part 1, item 17, section 160APMG]

6.9 For the purposes of these provisions, a person 'pays' a PAYG instalment or company tax only if:

the person has a current liability to pay the instalment or company tax; and
either:
-
the person makes a payment to satisfy the liability (in whole or in part);

-
a credit (other than the particular credits explained below) is applied to discharge or reduce the liability; or
-
an RBA surplus is applied to discharge or reduce the liability.

The total amount of payments that may be made under these provisions in respect of a liability is limited to the full amount of that liability. [Schedule 3, Part 1, item 12, subsection 160APBB(1)]

6.10 Consistent with the current tax laws, certain credits do not generate franking credits where they are applied to discharge or reduce an income tax liability. These are foreign tax credits arising under:

Division 18, 18A, or 18B of Part III of the ITAA 1936; or
the International Tax Agreements Act 1953.

[Schedule 3, Part 1, item 12, paragraphs 160APBB(2)(a) and (b)]

6.11 In addition, credits which arise under sections 45-30 and 45-215 in Schedule 1 to the TAA 1953 are not payments for the purposes of generating franking credits where they are applied to discharge or reduce an income tax liability. [Schedule 3, Part 1, item 12, paragraph 160APBB(2)(c)]

6.12 Each instalment payable under the PAYG instalment system represents a liability of the taxpayer in relation to a particular income year. When the Commissioner makes an assessment of the company tax payable (or determines there is no company tax payable) for that income year, the taxpayer is entitled to a credit under section 45-30 in Schedule 1 to the TAA 1953 for 'PAYG instalments payable' against the assessment. The credit is to ensure that the taxpayer's aggregate income tax liability for the income year is not overstated. The amount of the credit is equal to the amount of any instalment liabilities for the income year reduced by any PAYG rate variation credits for that income year. The credit arises whether or not the PAYG instalments have been paid.

6.13 As this credit for PAYG instalments payable effectively operates to adjust the net income tax liability of the taxpayer for the income year rather than to discharge any income tax liability, no franking credits arise (or should arise) from its application to an income tax liability. [Schedule 3, Part 1, item 12, paragraph 160APBB(2)(c)]

6.14 Section 45-215 in Schedule 1 to the TAA 1953 allows a taxpayer to claim a PAYG rate variation credit in certain circumstances. For the purposes of these measures the application of a PAYG rate variation credit to discharge a PAYG instalment or company tax liability is not a payment of that liability. Again this is a credit which adjusts rather than discharges a liability and therefore no franking credits should arise. [Schedule 3, Part 1, item 12, paragraph 160APBB(2)(c)]

What is the amount of a payment of a PAYG liability or company tax?

6.15 Generally speaking, the amount of a payment of a PAYG instalment liability or company tax liability will be the amount by which the liability has been reduced. If the liability has been discharged in full, the amount of the payment will be the amount of the liability. However, for the purpose of calculating franking credits, the amount of the payment taken to have arisen from the application of an RBA surplus will be reduced when the surplus being applied has the character of a section 45-30 credit for PAYG instalments payable. [Schedule 3, Part 1, item 12, subsections 160APBB(3) and (4)]

6.16 As discussed at paragraph 6.12 and 6.13, section 45-30 credits are designed to ensure that the taxpayer's aggregate income tax liability for the income year is not overstated. The credit achieves this effect by reducing the amount of a company tax assessment for an income year by the amount of PAYG instalment liabilities for that income year.

6.17 In circumstances where the amount of PAYG liabilities arising for the income year exceed the company tax, the application of the section 45-30 credit produces an excess. As the company tax is currently recorded in a separate RBA to the PAYG liabilities, the excess of the section 45-30 credit over the assessment may create a RBA surplus even though the PAYG liabilities may not have been satisfied and remain outstanding. This surplus may be refunded to the taxpayer (if there are no outstanding liabilities) or it may be applied to a liability of the taxpayer to pay, for example, PAYG instalments outstanding for that income year.

6.18 If the taxpayer has made full payment of PAYG instalment liabilities for the income year, the amount of the RBA surplus described above represents an amount previously paid. The application of this surplus to discharge a subsequent PAYG instalment liability or company tax represents a payment of the full amount discharged. Franking credits will arise for the full amount of the payment[F13].

6.19 However, if the taxpayer has not paid the PAYG instalment liabilities for the income year, the RBA surplus merely represents a section 45-30 credit and is not the product of the overpayment of tax. In this case, the surplus would be applied against the outstanding liability to pay the unpaid PAYG instalments, and because the surplus does not represent an amount paid, no franking credits should arise from its application.

6.20 It is in this circumstance, where an RBA surplus is generated by a section 45-30 credit for an income year and applied to reduce a PAYG instalment for the same income year, that the amount of the payment taken to have arisen for the purposes of calculating franking credits will be reduced.

6.21 Therefore, if:

an RBA surplus is applied to a PAYG instalment for a particular year of income;
a section 45-30 variation credit has arisen in relation to the same year of income as the PAYG instalment and is credited to the account which generated the RBA surplus;
PAYG instalment liabilities are not recorded in the RBA in which the surplus arises; and
the amount of the section 45-30 credit is greater than the amount of the company tax for that year of income;

the amount of the payment taken to have arisen from the application of the RBA surplus will be reduced. [Schedule 3, Part 1, item 12, subsection 160APBB(4)]

6.22 The payment is reduced by the amount by which the section 45-30 credit exceeds company tax for the income year. If the amount by which the payment is to be reduced is greater than the amount of the payment, the payment is taken to be zero. [Schedule 3, Part 1, item 12, subsection 160APBB(4)]

6.23 Reducing the payment by the identified amount ensures that the payment is only reduced to the extent to which the RBA surplus has the character merely of a section 45-30 credit.

When do franking debits arise from the refund of tax under the new PAYG system?

6.24 Under the new PAYG system, a company, other than a life insurance company[F14], will generate a class C franking debit when:

a class C franking credit arises from:

-
the payment of a PAYG instalment or company tax; or
-
the application of a PAYG rate variation credit to discharge a PAYG liability or company tax (see paragraph 6.30);

the company receives a refund (as defined below) of that payment or credit applied; and
the refund is not referable to a reduction in company tax which produced a franking debit under section 160APZ of the ITAA 1936.

[Schedule 3, Part 1, item 18, section 160APYBAA]

6.25 The franking debit arises on the day the refund is received and is equal to the adjusted amount of the amount of the refund. [Schedule 3, Part 1, item 18, section 160APYBAA]

6.26 For the purposes of these provisions, a company receives a 'refund' of a company tax instalment (including a PAYG instalment) or company tax if:

either:

-
the company receives an amount as a refund; or
-
the Commissioner applies a credit, or an RBA surplus, against a liability or liabilities of the company; and

the amount refunded or applied represents in whole or in part a return to the company of an amount paid or applied to satisfy the company's liability to pay the company tax instalment or company tax.

[Schedule 3, Part 1, item 12, section 160APBD]

6.27 The 'refund' or application of an amount to a liability of the taxpayer will not be a refund for the propose of these provisions to the extent to which it is referable to a PAYG rate variation credit. [Schedule 3, Part 1, item 12, section 160APBD(3)]

Example 6.1: Payments and refunds Instalment 1 Marko Co's PAYG instalment liability for the first quarter of its 2000-2001 income year is $1,000. Marko Co pays the full amount of the instalment generating $1,941 franking credits (i.e. $1,000 66/34 - based on a 34% company tax rate). The balance in its franking account is $1,941. Instalment 2 Marko Co's PAYG instalment liability for the second quarter of its 2000-2001 income year is $5,000. Marko Co pays the full amount of the instalment generating $9,706 franking credits (i.e. $5,000 66/34). The balance in their franking account is $11,647. Instalment 3 Marko Co's PAYG instalment liability for the third quarter of its 2000-2001 income is $2,000. Marko Co pays the full amount of the instalment generating $3,882 franking credits (i.e. $2,000 66/34). The balance in their franking account is $15,529. Instalment 4 Marko Co's PAYG instalment liability for the final quarter of its 2000-2001 income year is $2,000. Marko Co only pays $1,000 of the instalment generating $1,941 franking credits (i.e. $1,000 66/34). The balance in their franking account is $17,470. Assessment The company tax assessment for Marko Co's 2000-2001 income year is $8,000. Upon assessment, a section 45-30 credit for PAYG instalments payable arises of $10,000 (i.e. $1,000 + $5,000 + $2,000 $2,000).The application of the section 45-30 credit against the company tax assessment in Marko Co's RBA produces a surplus of $2,000.Marko Co has $1,000 outstanding PAYG liability in relation to the fourth instalment. $1,000 of the RBA surplus is applied to discharge that liability. To determine whether a franking credit arises in relation to this application it is necessary to first identify the amount of the instalment paid.At first instance, the amount of the PAYG instalment paid is $1,000. However, this amount is reduced as the requirements in section 160APBB are satisfied. That is:

the surplus of an RBA account is applied to satisfy a PAYG instalment for the 2000-2001 income year;
a section 45-30 RBA credit has arisen for the 2000-2001 income year;
the RBA surplus arose in a different account of the taxpayer from the account in which the PAYG instalment discharged is recorded; and
the amount of the section 45-30 credit is greater than the company tax assessment for the year of income.

The amount taken to be paid of $1,000 is reduced by the amount by which the section 45-30 credit is greater than the company tax for the 2000-2001 income year. That is $2,000. The resulting amount of the payment for the purposes of these provisions is $0. Consequently, no franking credits arise.The application of $1,000 of the RBA surplus to discharge the outstanding PAYG instalment liability is not a refund. This is because the surplus applied does not represent a return to Marko Co of an amount previously paid or applied to satisfy a liability to a PAYG instalment or company tax. Consequently, no franking debit is created.The remaining $1,000 of the RBA surplus is returned to Marko Co. This amount is a refund as it represents the return of an amount paid to satisfy a PAYG instalment liability. The refund produces a franking debit equal to $1,941 (i.e. $1,000 66/34). The remaining balance in Marko Co's franking account is $15,529.

When do franking credits and debits arise from a PAYG rate variation credit?

6.28 A PAYG rate variation credit is a credit that a taxpayer may claim under the PAYG system if the taxpayer has varied down their instalment rate to a lower rate than that used to calculate the amount of a PAYG instalment for a previous quarter.

6.29 A company claims a PAYG rate variation credit under section 45-215 in Schedule 1 to the TAA 1953 only when the company is entitled to the credit in accordance with that section and claims the credit on the approved form - a BAS. Broadly speaking, the credit is provided to effectively reduce the amount of the previous instalment or instalments to the amount they would have been if calculated in accordance with the lower instalment rate. The effect is achieved by offsetting the credit against the PAYG instalment liability rather than directly amending it.

6.30 If a PAYG instalment liability is outstanding at the time the PAYG rate variation credit arises, the credit may be applied to reduce the liability to the amount it would have been if originally calculated in accordance with the varied instalment rate.

6.31 If all PAYG liabilities have been paid in full at the time the PAYG rate variation credit arises, the credit may be applied to other outstanding liabilities or returned to the taxpayer. This application or return is not a refund for the purposes of these provisions as it is referable to a PAYG rate variation credit and will not produce a franking debit. As discussed at paragraph 6.33, claiming a PAYG rate variation credit produces a franking debit. Any further franking debit resulting from a return or application of the credit would be inappropriate.

6.32 A company will generate class C franking credits when a PAYG rate variation credit is applied to reduce the company's liability for a PAYG instalment. In this case the amount of the franking credit is equal to the adjusted amount of the amount by which the company's liability for a PAYG instalment is reduced. The franking credit arises on the day the PAYG rate variation credit is applied to reduce company's liability for a PAYG instalment. [Schedule 3, Part 1, item 17, section 160APMF]

6.33 To ensure the correct net amount of franking credits arise from claiming a PAYG rate variation credit and its application to discharge PAYG instalment liabilities, a company will generate class C franking debits when it claims a PAYG rate variation credit to which it is entitled. The franking debit arises on the day that the company claims the variation credit and is equal to the adjusted amount in relation to the amount of the PAYG rate variation credit. [Schedule 3, Part 1, item 18, section 160APYBAB]

6.34 For the purpose of these provisions only, if a company is liable to pay a PAYG instalment and has a PAYG rate variation credit the PAYG rate variation credit must be fully applied to reduce the liability for the PAYG instalment before any other credit or payment can be applied to reduce that liability. This is to ensure that franking credits arise at the earliest opportunity in order to offset the franking debit that arises at the time the PAYG rate variation credit is claimed. [Schedule 3, Part 1, item 12, section 160APBC]

Example 6.2: PAYG variation credits and payments of PAYG instalments and company tax Instalment 1 The Commissioner has notified Company A that its instalment rate is 15%. Company A uses that rate to calculate its first quarterly instalment for the income year. Its instalment income for that quarter is $80,000 and therefore the company is liable to pay $12,000 (i.e. 15% $80,000) as its first quarterly instalment. Company A pays $10,000 of the instalment.At the time of making the payment, the company receives a class C franking credit equal to the adjusted amount of the payment. That is $19,411 (i.e. $10,000 66/34 - assuming a 34% company tax rate). The balance in Company A's class C franking account is $19,411. Instalment 2 Company A's instalment income for its second instalment quarter is $10,000. It is concerned that the instalment rate notified by the Commissioner is too high. Company A varies its instalment rate to 10%. In accordance with the operation of section 45-215 in Schedule 1 to the TAA 1953, the amount of the variation credit is calculated as follows.

Step 1:
Company A's earlier instalment liabilities for the year add up to $12,000.
Step 2:
Company A has no previous credits by which to reduce the $12,000.
Step 3:
Company A's $80,000 instalment income from the first instalment quarter is multiplied by its varied instalment rate of 10%. The result is $8,000.
Step 4:
The difference between the instalment liabilities for the year and the amount they would have been if calculated by reference to the current instalment rate is $4,000 (i.e. $12,000 $8,000).
Step 5:
The amount of the variation credit that the company may claim is $4,000.

For the second quarter, the company will have an instalment liability of $1,000 (i.e. 10% $10,000) and claims a variation credit of $4,000.At the time of claiming the PAYG rate variation credit Company A receives a class C franking debit equal to the adjusted amount of that credit. That is $7,764 (i.e. $4,000 66/34). The balance in Company A's class C franking account is now $11,647.Company A has a $3,000 outstanding PAYG instalment liability ($2,000 for instalment 1 and $1,000 for instalment 2). The PAYG rate variation credit is applied on the day the credit is claimed to those liabilities to the extent of $3,000. Company A receives a class C franking credit equal to the adjusted amount of the extent to which the PAYG rate variation credit was applied to reduce the Company's liability. That is $5,823 (i.e. $3,000 66/34). The balance in Company A's class C franking account is now $17,470.The remaining balance of the PAYG rate variation credit of $1,000 is returned to Company A. No franking debit arises in relation to the remaining $1,000 as it is not a refund for the purposes of these measures. Assessment Company A's company tax assessment for the income year is $13,000. Upon assessment credits for PAYG instalments payable arise under section 45-30 in Schedule 1 of the TAA 1953. The amount of that credit is $9,000 (i.e. $12,000 + $1,000 - $4,000). No franking credit arises for the application of this credit to the assessment as the application of the credit is not a payment of the company tax.Company A has an outstanding company tax liability of $4,000. The company pays this amount in full. Company A receives a class C franking credit on the day the payment is made equal to the adjusted amount of the payment. That is $7,764 (i.e. 4,000 66/34). The balance in Company A's class C franking account is now $25,234.

Application and transitional provisions

6.35 The amendments apply to the 2000-2001 and later income years. [Schedule 3, Part 1, item 28]

Consequential amendments

6.36 In order to implement the amendments described above a number of further consequential amendments have also been made. In broad terms, these amendments make appropriate definitional changes and ensure that the provisions relating to deficit deferral tax, estimated debit determinations and franking additional tax continue to operate appropriately. [Schedule 3, Part 1, items 1 to 11, 13 to 16, and 19 to 27]

Chapter 7 - Imputation - Life assurance companies

Outline of Chapter

7.1 This Chapter explains the measures contained in Part 2 of Schedule 3 to this Bill which amend the dividend imputation regime and the intercorporate dividend rebate provisions applying to life assurance companies.

7.2 In broad terms, the amendments set out for life assurance companies the circumstances for when franking credits and debits arise from:

the payment and refund of tax under the new PAYG system;
PAYG rate variation credits; and
the receipt of franked dividends.

7.3 The amendments also set out the circumstances when a life assurance company will be entitled to an intercorporate dividend rebate.

Context of Reform

7.4 Treasurer's Press Release No. 58 of 21 September 1999, released details of the New Business Tax System package including the broadening of the tax base applying to life insurers so that all profit from funds management, underwriting and other life assurance and immediate annuity business is taxed (see Chapter 5 for details of these changes).

7.5 The Treasurer also announced in the same press release that the imputation system relating to life insurers will be modified to reflect these changed taxation arrangements. In addition, consequential amendments are needed to the imputation system relating to life insurers so that the payment and refund of tax and PAYG rate variation credits under the new PAYG system give rise to franking credits and debits.

Summary of new law

7.6 In summary the amendments will:

provide franking credits for the payment of tax on income derived after 1 July 2000 if the income is attributable to:

-
insurance business income allocated to shareholders; or
-
non-insurance business income;

consistent with the current tax laws:

-
reduce by 80% the amount of franking credits and debits arising from the payment and refund of tax on income derived before 1 July 2000 if the income is attributable to the insurance funds of the company; and
-
provide franking credits and debits for the payment and refund of tax on income derived before 1 July 2000 if the income is attributable to the non-insurance funds of the company;

in respect of dividends paid on, or after, 1 July 2000:

-
allow an entitlement to the intercorporate dividend rebate where the assets of the company from which the dividend was derived is allocated to shareholders;
-
allow franking credits to arise in respect of the receipt of franked dividends where the assets of the company from which the dividend was derived is allocated to shareholders; and
-
allow an entitlement to the franking rebate where the assets of the company from which the dividend was derived is allocated to anything other than shareholders; and

make consequential amendments so that franking credits and debits arise in respect of the payment and refund of tax and PAYG rate variation credits under the new PAYG regime.

Comparison of key features of new law and current law
New law Old Current law
For income derived after 1 July 2000, franking credits and debits only arise to the extent that the payment or refund of tax is attributable to the company's shareholders. Franking credits and debits arising from the payment and refund of tax are reduced by 80% to the extent that they are attributable to the insurance funds of the company.
For dividends paid after 30 June 2000, the intercorporate dividend rebate only applies if the dividendsare attributable to shareholders' funds income. The intercorporate dividend rebate applies if the dividends form part of the 'standard component' of the company's taxable income.
For dividends paid after 30 June 2000, no franking credits arise in respect of the receipt of franked dividends if the assets of the company from which the dividend was derived were included in the insurance funds of the company unless they are held on behalf of the company's shareholders. Franking credits arising in respect of the receipt of franked dividends are reduced by 80% if the assets of the company from which the dividend was derived, are included in the insurance funds of the company.
For dividends paid after 30 June 2000, the franking rebate applies to the extent that the assets of the shareholder from which the dividend was derived, are included in the insurance funds of the company but not held on behalf of shareholders. The franking rebate applies to the extent that the assets of the shareholder from which the dividend was derived, are included in the insurance funds of the company.
Franking credits and debits arise for the payment and refund of tax made under the PAYG system and PAYG rate variation credits. Franking credits and debits arise for the payment and refund of tax made under the company tax instalment system.

Detailed explanation of new law

Franking credits and debits for the payment and refund of tax

Background

7.7 Under the current tax laws life assurance companies other than mutual life assurance companies[F15], receive franking credits and debits for the payment and refund of income tax on the same basis as other companies. Franking credits and debits that are attributable to statutory fund income of a life assurance company (i.e. insurance business income) are reduced by 80% to reflect prudential requirements that limit the portion of statutory fund income that can be distributed to shareholders. To the extent that the franking credits are not attributable to statutory fund income (i.e. non-insurance business income), no reduction takes place.

7.8 Until an assessment of tax payable for an income year is made, the life assurance company will not know the actual tax payable on its statutory fund and other components of taxable income. Therefore, the reducing franking credits and debits that arise before this time are interim ones that are based on the previous year's income tax assessment. Upon assessment, the interim franking credits are reversed out of the life companies franking account and reinstated in accordance with the current years income tax assessment.

7.9 The current imputation measures for life companies are amended to provide different treatment for tax paid on income derived on or after 1 July 2000. The explanation of these amendments is divided into the following sections:

standard balancing life assurance companies;
early balancing life assurance companies - 2000-2001 income year; and
late balancing life assurance companies - 1999-2000 income year.

Standard balancing life assurance companies

7.10 The new PAYG system for company instalments commences for taxpayers from their 2000-2001 income year. The 2000-2001 income year of a standard balancing life assurance company commences 1 July 2000 and ends on 30 June 2001. Therefore, all PAYG instalments paid by a standard balancing company for the 2000-2001 and subsequent income years will be referable to income derived on or after 1 July 2000.

7.11 Franking credits and debits arise for these life assurance companies for the payment or refund of tax or PAYG rate variation credits under the PAYG system to the extent that the payment, refund or credit is attributable to 'shareholders' funds income'.

7.12 Shareholders' funds income of a year of income is defined in these provisions as:

insurance business income allocated to shareholders; and
non-insurance business income;

derived in the relevant year of income and included in shareholders' funds before assessment for the income year. [Schedule 3, Part 2, item 54, section 160APA]

When do franking credits and debits arise for the payment of a PAYG instalment or company tax?

7.13 Standard balancing life assurance companies receive franking credits for the payment[F16] of income tax, which includes PAYG instalments and company tax, equal to the adjusted amount[F17] to which the payment of tax is attributable to income included in shareholders' funds income.

Before assessment

7.14 When a life assurance company pays a PAYG instalment for an income year, before assessment for that year, it may not be aware of the amount of the payment that will be finally attributable to tax on income that will be included in shareholders' funds income.

7.15 To enable franking credits to arise at the time of making the payment the life assurance company must undertake a 2 step process. Firstly, the company must estimate the amount of income derived upon which the PAYG instalment is calculated that will be included in shareholders' funds income. The company must then attribute none, some, or all of the tax paid to that income. The amount of the tax paid that is attributable to income that the company estimates will be included in shareholders' funds for that year of income is called the 'provisional franking component'. [Schedule 3, Part 2, item 67, section 160APVJ]

7.16 Franking credits of the life assurance company arise upon the payment of the PAYG instalment equal to the adjusted amount of the provisional franking component. The resulting franking credits are 'provisional franking credits'.

Assessment

7.17 Assessment occurs for a life assurance company in respect of a year of income on the day on which a notice of original company tax assessment for that income year is served, or taken to have been served, on the company. On or after this day the life assurance company's 'company tax is assessed' for the purposes of these measures. [Schedule 3, Part 2, item 56, section 160APBE]

7.18 Upon assessment, any provisional franking credits that have arisen for the payment, or application of a PAYG variation credit (see paragraphs 7.37 to 7.45) to discharge a PAYG instalment for that income year are reversed out of the life assurance company's franking account. A franking debit equal to the provisional franking credits obtained under section 160AQVJ reverses the credits. [Schedule 3, Part 2, item 75, section 160AQCNCB]

7.19 The provisional franking credits are replaced with final franking credits based on the reassessment of both the extent to which the original payment was attributable to shareholders' funds income and the amount of shareholders' funds income. [Schedule 3, Part 2, item 67, section 160APVK] As assessment has occurred, this amount is known with certainty and is referred to in these measures as the final franking component of the payment. The resulting franking credits are final franking credits . These credits are relevant to the application of the over estimation penalty explained at paragraphs 7.24 to 7.29.

After assessment

7.20 If a life assurance company makes a payment of a PAYG instalment for a particular year on or after assessment for that year, franking credits arise equal to the adjusted amount of the 'franking component' of the payment.

7.21 The franking component of the payment is that part of the payment that is attributable to income that has been allocated to shareholders' funds income for that year [Schedule 3, Part 2, item 67, section 160APVL] . As the payment has occurred after assessment, the franking component of the payment is known with certainty, and therefore no provisional franking credits are required.

7.22 Equivalent provisions also apply when a life assurance company makes a payment of company tax[F18] (i.e. franking credits arise to the extent to which the payment is attributable to income included in shareholders' funds). [Schedule 3, Part 2, item 67, section 160APVM]

Payment of excess foreign tax credits

7.23 Under section 160APQB, a life assurance company receives class C franking credits for the payment of excess foreign tax credits. However, franking credits should only arise for the payment of excess foreign tax credits for the 2000-2001 or subsequent income years to the extent to which the payment is attributable to income included in shareholders' funds income. Therefore, if a life assurance company receives a franking credit under section 160APQB, the full amount of the franking credit is reversed out of the life assurance company's franking account by a corresponding franking debit. The amount of the credit is then replaced by a franking credit equal to the adjusted amount of payment that is attributable to shareholders' funds income for the income year. [Schedule 3, Part 2, item 67, section 160APVO]

Over estimation penalty

7.24 Life assurance companies will be subject to an over estimation penalty if they over estimate the provisional franking component in respect of payments of PAYG instalments for the income year. If a life assurance company over estimates the amount of the provisional franking component in respect of payments by more than 10%, they will incur an additional franking debit. [Schedule 3, Part 2, item 75, section 160AQCNCC]

7.25 The franking debit is designed to discourage life assurance companies from over estimating the provisional franking component in respect of payments to artificially increase the balance in its franking account.

7.26 The over estimation penalty compares the amount of provisional franking credits that arise from the payment of a PAYG instalment based on the provisional franking component with the amount of final franking credits that arise for those payments on assessment.

7.27 If the sum of the provisional franking credits that arose from payments of PAYG instalments for the income year exceed, by more than 10%, the final franking credits that arise upon assessment for the income year in relation to those payments, the life assurance company will incur the additional franking debit.

7.28 The franking debit that arises is the difference between the provisional franking credits generated by payments and 110% of the final franking credits. [Schedule 3, Part 2, item 75, subsections 160AQCNCC(1) and (2)]

7.29 The Commissioner has discretion to determine that the franking debit does not arise or reduce the amount of the penalty. [Schedule 3, Part 2, item 75, subsections 160AQCNCC(4) and (5)]

When do franking debits and credits arise from the refund of tax under the new PAYG system and amended assessments?

Refunds of tax

7.30 For the purposes of these provisions, a life assurance company receives a 'refund' of company tax if:

either:

-
the company receives an amount as a refund; or
-
the Commissioner applies a credit, or a RBA surplus, against a liability or liabilities of the company; and

the amount refunded or applied represents in whole or in part a return to the company of an amount paid or applied to satisfy the company's liability to pay the company tax instalment or company tax.

[Schedule 3, Part 1, item 12, section 160APBD]

7.31 An amount refunded or applied will not be a refund for the purposes of these provisions to the extent to which it is attributable to a PAYG rate variation credit (see paragraph 7.42). [Schedule 3, Part 1, item 12, subsection 160APBD(3)]

7.32 Under the new PAYG system, a life assurance company, will generate a class C franking debit when:

a class C franking credit arises from:

-
the payment of a PAYG instalment or company tax; or
-
the application of a PAYG rate variation credit to discharge a PAYG liability or company tax; and

the company receives a refund of the amount paid or applied; and
the refund is not referable to a reduction of company tax which produced a franking debit under section 160APZ.

[Schedule 3, Part 2, item 75, subsection 160AQCNCD(1)]

7.33 The franking debit arises on the day the refund is received and is equal to the adjusted amount of the refund that is attributable to shareholders' funds income. [Schedule 3, Part 2, item 75, subsection 160AQCNCD(2)]

Amended assessments

7.34 Companies, including life assurance companies, receive a class C franking debit under section 160APZ when they receive an amended assessment that reduces their income tax liability. The amount of the debit under this section is the same for both ordinary companies and life assurance companies.

7.35 The amount of the debit for life assurance companies in relation to their 2000-2001 and subsequent income years should be reduced to reflect only that portion of the reduction in the income tax liability of the company that is referable to shareholders' funds income.

7.36 This is achieved by ensuring that when the 160APZ franking debit arises a corresponding franking credit is created to reverse out the full amount of the 160APZ franking debit [Schedule 3, Part 2, item 75, paragraph 160AQCNCD(3)(a)] . A replacement class C franking debit then arises equal to the amount by which the reduction in income tax liability produced by the amended assessment represents a return to the company of an amount previously paid to satisfy a company tax instalment or company tax in respect of shareholders' funds income [Schedule 3, Part 2, item 75, paragraph 160AQCNCD(3)(b)] .

When do franking credits and debits arise from a PAYG rate variation credit?

7.37 A PAYG rate variation credit is a credit that a taxpayer may claim under section 45-215 in Schedule 1 to the TAA 1953if the taxpayer has varied down their instalment rate to a lower rate than that used to calculate the amount of a PAYG instalment for a previous quarter.

7.38 A taxpayer claims a PAYG rate variation credit to which it is entitled by lodging the claim in the approved form - a BAS. The BAS also records the taxpayer's PAYG instalment liability for the period.

7.39 Broadly speaking, the credit is provided to effectively reduce the amount of the previous instalment or instalments to the amount that they would have been if calculated in accordance with the lower instalment rate. This is achieved by offsetting the credit against the PAYG instalment liability rather than directly amending the liability.

7.40 If a PAYG instalment liability is outstanding at the time the PAYG rate variation credit arises, the credit may be applied to reduce the liability to the amount it would have been if originally calculated in accordance with the varied instalment rate. This application may produce provisional franking credits (see paragraph 7.43).

7.41 If all PAYG liabilities have been paid in full at the time the PAYG rate variation credit arises, the credit may be applied to other outstanding liabilities or returned to the taxpayer. This application or return is not a refund for the purposes of this provision and will not produce a franking debit. [Schedule 3, Part 1, item 12, subsection 160APBD(3)]

Before assessment

7.42 A franking debit arises when a PAYG rate variation is claimed prior to assessment only if the credit is:

referable to an amount previously paid or applied; and
the amount paid or applied gave rise to franking credits.

[Schedule 3, Part 2, item 75, section 160AQCNCE]

7.43 A return or application of an amount referable to a PAYG rate variation credit is not a refund for the purposes of these provisions, the franking debit for a PAYG rate variation credit serves this purpose.

7.44 The application of a PAYG rate variation credit to discharge a PAYG instalment liability gives rise to provisional franking credits. The amount of the provisional franking credits is equal to the extent to which the credit is attributable to tax paid on income the company estimates will be included in shareholders' funds income. [Schedule 3, Part 2, item 67, section 160APVJ]

7.45 The franking credit arises on the day the PAYG rate variation credit is applied to reduce the company's liability for a PAYG instalment. [Schedule 3, Part 2, item 67, section 160APVJ]

Assessment

7.46 At the time of assessment, the amount of the class C franking credits that arose from the application of the PAYG rate variation credit to discharge a PAYG instalment liability are reversed out of the life assurance company's franking account by an equivalent reversing franking debit. [Schedule 3, Part 2, item 75, section 160AQCNCB]

7.47 Similarly, the amount of the franking debit that arose from claiming the PAYG rate variation credit before assessment is also cancelled. A class C franking credit equal to the amount of the franking debit arises under section 160APVN to achieve this result. [Schedule 3, Part 2, item 67, section 160APVN]

7.48 It is not necessary to reinstate a franking credit or debit upon assessment for either claiming or applying a PAYG rate variation credit. Upon assessment, franking credits and debits only arise to the extent to which they are referable to tax paid on income included in shareholders' funds income. Upon assessment, when the component of payments and credits are reassessed, the PAYG rate variation credit applies as intended to reduce the overall PAYG instalment tax liabilities. Therefore, at that time, the credit is not referable to discharging tax attributable to income included in shareholders' funds income. The temporary impact of the PAYG rate variation credit on the life assurance company's franking account before assessment is removed and it is not necessary to make any further adjustments.

After assessment

7.49 For the reasons discussed at paragraph 7.48, no franking credits or debits will arise for either claiming a PAYG rate variation credit after assessment or applying the credit to discharge a PAYG liability.

Summary of franking credits and debits

7.50 Table 7.1 provides a summary of the franking debits and credits that arise for standard balancing life assurance companies.

Table 7.1: Franking credits and debits of a standard balancing life assurance company
Event Franking credits Franking debits Amount
Paying a company tax instalment or PAYG rate variation credit before assessment. 160APVJ PAYG rate variation credit

160AQCNCE

Franking credits - adjusted amount of the amount paid attributable to income estimated to be included in shareholders' funds income.

Franking debits - adjusted amount of the amount of the PAYG credit referable to an amount paid or applied that gave rise to franking credits.

Reversing provisions. 160APVO 160AQCNCB Franking debits - amount of 160APVJ franking credits.

Franking credits - amount of 160AQCNCE franking debits.

Reinstating provisions and payments of company tax instalments and company tax after assessment. 160APVK

160APVL

160APVM

  Adjusted amount of the amount paid attributable to income included in shareholders' funds income.
Refunds and 160APZ franking debit from reduction in company tax. 160AQCNCD(3)(a) 160AQCNCD Franking credits - the amount of the class C franking debit that arose under section 160APZ.

Franking debits - adjusted amount of the amount of the refund or reduction that represents a return to the taxpayer of an amount previously paid or applied to satisfy an income tax liability in respect of shareholders' funds income.

Over estimate the amount of provisional franking credits from payments.   Additional franking debit 160AQCNCC Provisional franking credits (from payments) - 110% of final franking credits.

Example 7.1: Payments and refunds of company tax instalments and company tax Instalment 1 Better Life is a standard balancing non-mutual life assurance company. Better Life's PAYG instalment liability for the first quarter of its 2000-2001 income year is $1,000. Better Life pays the full amount of the instalment. Better Life estimates that half of the $10,000 of income upon which the PAYG instalment liability was calculated will be included in shareholders' funds income.The company attributes $400 of the payment of income tax to the $5,000 estimated to be included in shareholders' funds income. The provisional franking component of the payment is $400.The payment of $1,000 generates $776 franking credits(i.e. $400 * 66/34 - based on a 34% company tax rate). The balance in its franking account is $776. Instalment 2 Better Life's PAYG instalment liability for the second quarter of its 2000-2001 income year is $5,000. Better Life pays the full amount of the instalment. Better Life estimates that one quarter of the $50,000 income upon which the PAYG instalment was calculated will be included in shareholders' funds income.The company attributes $2,500 of the payment of income tax to the $12,500 estimated to be included in shareholders' funds income. The provisional franking component of the payment is $2,500.The payment of $5,000 generates $4,853 franking credits(i.e. $2,500 * 66/34). The balance in its franking account is $5,629. Instalment 3 Better Life's PAYG instalment liability for the third quarter of its 2000-2001 income is $2,000. Better Life pays the full amount of the instalment. Better Life estimates that one fifth of the $20,000 income upon which the PAYG instalment was calculated will be included in shareholders' funds income.The company attributes $100 of the payment of income tax to the $4,000 estimated to be included in shareholders' funds income. The provisional franking component of the payment is $2,500.The payment of $2,000 generates $194 franking credits(i.e. $100 * 66/34). The balance in its franking account is $5,823. Instalment 4 Better Life's PAYG instalment liability for the final quarter of its 2000-2001 income is $2,000. Better Life only pays $1,000 of the instalment. Better Life estimates that one half of the $20,000 income upon which the PAYG instalment was calculated will be included in shareholders' funds income.The company attributes $100 of the $1,000 payment of income tax to the $10,000 estimated to be included in shareholders' funds income. The provisional franking component of the payment is $2,500.The payment of $1,000 generates $194 franking credits(i.e. $100 * 66/34). The balance in its franking account is $6,017. Assessment Upon assessment, a class C franking debit arises. The amount of the debit is equal to the amount of the provisional franking credits that arose for the income year. Better Life accumulated $6,017 provisional franking credits for the income year. Therefore, the class C franking debit that arises upon assessment is $6,017. The balance in Better Life's franking account is nil.At the time of assessment, both the final company tax liability and the amount of income included in shareholders' funds income is known.At this time, Better Life uses generally accepted accounting principles to identify that the actual amount of the payments made during the income year that is referable to tax paid on shareholders' funds income (i.e. final franking component) is:

Instalment 1 - $500
Instalment 2 - $2,500
Instalment 3 - $150
Instalment 4 - $50

Franking credits arise under section 160APVK on the assessment day equal to:

Instalment 1 - $970 ($500 * 66/34)
Instalment 2 - $4,853 ($2,500 * 66/34)
Instalment 3 - $291 ($150 * 66/34)
Instalment 4 - $97 ($50 * 66/34)

The payments of PAYG instalment liabilities before assessment generate $6,211 franking credits at the time of assessment. The balance in Better Life's franking account is $6,211. Payment after assessment Better Life's company tax assessment for the 2000-2001 income year is $12,000. Better Life makes a payment of $3,000 on the assessment day.Of the $3,000 payment, $1,000 is attributable to the fourth instalment. Franking credits arise for the payment of a PAYG instalment after assessment equal to the franking component of the payment. Better Life uses generally accepted accounting principles to identify that $80 of the payment is attributable to tax paid on income included in shareholders' funds income. The payment of $1,000 generates $155 franking credits ($80 66/34). The balance in its franking account is $6,366.The remaining $2,000 of the payment is a payment of company tax. Franking credits arise for this payment under section 160APVL equal to the adjusted amount of the payment that is attributable to tax paid on income included in shareholders' funds. Better Life uses generally accepted accounting principles to identify that $180 of the payment is attributable to tax paid on income included in shareholders' funds income. The payment of $2,000 generates $349 franking credits($180 66/34). The balance in its franking account is $6,715. Refund - amended assessment The taxpayer obtains an amended assessment for the income year reducing its tax liability from $12,000 to $11,000 producing a $1,000 refund. On the day of the amended assessment a $1,941 class C franking debit arises under 160APZ. The balance in Better Life's franking account is $4,774.This 160APZ debit is reversed out of Better Life's franking account by a $1,941 franking credit, returning the franking account balance to $6,715.The amount of the $1,000 return to Better Life that represented a reassessment of tax attributable to shareholders' funds income is $200. The refund from the amended assessment generates a $388 franking debit. The balance in Better Life's franking account is $6,327.

Example 7.2: Over estimation penalty Adopting the facts in Example 7.1, Better Life accumulated $6,017 provisional franking credits for payments of PAYG instalment liabilities under section 160APVJ.Upon assessment, $6,211 final franking credits arise under section 160APVK to replace the provisional franking credits.The section 160APVJ franking credits do not exceed 110% of the 160APVK franking credits. Therefore, Better Life is not subject to a penalty franking debit.Now assume that upon assessment that final franking component of the relevant payments are as follows:

Instalment 1 - $200
Instalment 2 - $1,500
Instalment 3 - $100
Instalment 4 - $20

Franking credits arise under section 160APVK on the assessment day equal to:

Instalment 1 - $388 ($200 66/34)
Instalment 2 - $2,912 ($1,500 66/34)
Instalment 3 - $194 ($100 66/34)
Instalment 4 - $39 ($20 66/34)

Upon assessment, $3,533 final franking credits arise to replace the provisional franking credits under 160APVK.The section 160APVJ franking credits do not exceed 110% of the 160APVK franking credits. Therefore, Better Life is not subject to a penalty franking debit.The amount of the debit is:

$6,017 - (110% * $3,533)

= $6,017 - $3,886

= $2,131

Early balancing life assurance companies - 2000-2001 income year

7.51 The 2000-2001 income year of an early balancing life assurance company commences before 1 July 2000. Therefore payments of company tax made under the new PAYG system in relation to the company's2000-2001income year may be referable to income derived both before and after 1 July 2000.

7.52 Under the proposed amendments, tax paid and refunded on income derived:

before 1 July 2000 will ultimately produce:

-
class C franking credits and debits equal to the adjusted amount of the tax paid or refunded that is attributable to non-insurance business income; and
-
class A franking credits and debits equal to the adjusted amount of 20% of tax paid or refunded that is attributable to insurance business income.

on or after 1 July 2000 will ultimately produce class C franking credits equal to the adjusted amount of the tax paid that is attributable to income included in shareholders' funds income.

7.53 Special transitional amendments are required for the 2000-2001 income year for early balancing life assurance companies to ensure that franking credits and debits arise appropriately to reflect that their income tax liability is referable to income derived both before and after 1 July 2000.

7.54 Payments of company tax in relation to the company's 2001-2002 and subsequent income years is always referable to income derived after 1 July 2000. Therefore, franking credits and debits arise for early balancers for the 2001-2002 and subsequent income years as for standard balancing life assurance companies.

When do franking credits or debits arise for the payment of a PAYG instalment or company tax?

Before assessment

7.55 If an early balancing life assurance company pays a PAYG instalment before assessment it may be unaware of the amount of the payment that will be finally attributable to tax on income derived before and after 1 July 2000. To overcome this limitation franking credits will arise for the payment of a PAYG instalment for the 2000-2001 income year by an early balancing life assurance company in the same way as for standard balancing life assurance companies.

7.56 That is, franking credits arise equal to the adjusted amount of the extent to which the payment is attributable to tax on income that the company estimates will be included in shareholders' funds income (see 7.13 to 7.15). [Schedule 3, Part 2, item 67, section 160APVJ]

Assessment

7.57 Upon assessment, any provisional franking credits that have arisen for the payment, or application of a PAYG variation credit to discharge a PAYG instalment for that income year prior to assessment, are reversed out of the life assurance company's franking account. The credits are reversed by franking debits, equal to the sum of provisional franking credits that arose under section 160AQVJ. [Schedule 3, Part 2, item 75, section 160AQCNCB]

7.58 If any part of the early balancing life assurance company's company tax for the 2000-2001 income year is referable to income that was derived before 1 July 2000, franking credits are reinstated as follows:

class C franking credits equal to the adjusted amount of the payment that is attributable to non-insurance business income derived before 1 July 2000;
class A franking credits[F19] equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and
class C franking credits equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 that is included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCG]

After assessment

7.59 If, on or after assessment, a life assurance company makes a payment of a PAYG instalment or company tax or receives a section 160APQB franking credit from the payment of excess foreign tax credits, franking credits arise as follows:

class C franking credits equal to the adjusted amount of the payment that is attributable to non-insurance business income derived before 1 July 2000;
class A franking credits equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and
class C franking credits equal to the adjusted amount of the payment that is attributable to income included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCG]

Over estimation penalty

7.60 The over estimation penalty does not apply to the 2000-2001 income year of early balancing life assurance companies as the basis upon which franking credits initially arise and are reinstated is significantly different. However, the penalty does apply to subsequent income years for early balancers (see paragraphs 7.24 to 7.29). [Schedule 3, Part 2, item 75, subsection 160AQCNCC(3)]

When do franking debits and credits arise from the refund of tax under the new PAYG system and amended assessments?

Refunds of tax

7.61 When an early balancing life assurance company receives a refund (as discussed at paragraphs 7.30 and 7.33) in relation to its 2000 income year, the following franking debits arise:

class C franking debits equal to the adjusted amount of the refund that is attributable to non-insurance business income derived before 1 July 2000;
class A franking debits equal to the adjusted amount of 20% of the amount of the refund that is attributable to insurance business income derived before 1 July 2000; and
class C franking debits equal to the adjusted amount of the refund that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCI]

Amended assessments

7.62 When a franking debit that is attributable to a reduction in company tax for the company's 2000-2001 income year of an early balancing life assurance company arises under section 160APZ, the following franking credit and debits arise:

class C franking credit equal to the class C franking debit that arose under section 160APZ to reverse out the original debit [Schedule 3, Part 2, item 75, paragraph 160AQCNCD(3)(a)] ;
class C franking debit equal to the adjusted amount of the reduction that is attributable to non-insurance business income derived before 1 July 2000;
class A franking debit equal to the adjusted amount of 20% of the amount of the reduction that is attributable to insurance business income derived before 1 July 2000; and
class C franking debit equal to the adjusted amount of the reduction that is attributable to income included in shareholders' funds income derived on or after 1 July 2000.

[Schedule 3, Part 2, item 75, section 160AQCNCI]

When do franking credits and debits arise for a PAYG rate variation credit?

7.63 Franking credits and debit arise for claiming and applying a PAYG rate variation credits to discharge PAYG instalment liabilities for early balancing life assurance companies in the same way as they do for standard balancing life assurance companies. (See paragraphs 7.48 to 7.54)

When do franking credits and debits arise for the purposes of calculating franking deficit tax, deficit deferral tax and franking additional tax?

7.64 Payments of PAYG instalments and PAYG rate variation credits produce franking debits and credits for a life assurance company.

7.65 Where the payment or credit arises before assessment, the resulting provisional franking credits and debits are generated without reference to the extent to which the payment or credit is attributable to tax on income derived before 1 July 2000. It is only upon assessment after the provisional franking credits and debits are reversed out of the life assurance company's franking account that they are reinstated in accordance with when the underlying income was derived.

7.66 Where the provisional franking credits arise in a different franking year (the 'first franking year') than assessment (the 'second franking year'), the balance of company's franking account at the end of the first franking year may be distorted. This distortion only arises to the potential disadvantage of the taxpayer for the 2000-2001 income year of early balancing life companies.

7.67 To ensure that the taxpayer is not disadvantaged by the distortion, franking credits and debits that arise upon assessment for:

the payment of a PAYG instalment before assessment;
the application of a PAYG rate variation credit to discharge a PAYG instalment liability before assessment; or
the claiming of a PAYG rate variation credit before assessment;

during the first franking year (the 2000-2001 income year) are deemed, for the purposes of franking deficit tax, deficit deferral tax, and franking additional tax, to have arisen on the last day of that franking year.

[Schedule 3, Part 2, item 75, section 160AQCNCJ]

Example 7.3: Franking deficit tax, deficit deferral tax and franking additional tax Simple Life is an early balancing life assurance company.Simple Life accrues the following franking credits and debits for payments of PAYG instalments and company tax for its 2000-2001 income year.

Table 7.2: Franking credits and debits for the payment of tax for the 2000-2001 income year
Date Tax paid Provisional franking component Provisional franking credits (based on 34% co tax rate) Franking debits on assessment Final franking credits
pre 01-07-00 post 1-07-00
Class A[F20] Class C Class C
21-04-2000 $10,000 $1,000 $1,941 $1,941 $1,200[F21] $0 $970
21-07-2000 $20,000 $1,000 $1,941 $1,941 $1,500 $0 $700
21-10-2000 $15,000 $500 $971 $971 $800 $0 $400
21-01-2001 $20,000 $2,000 $3,882 $3,882 $3,500 $0 $900
Assume the taxpayer makes a distribution on 1 April creating a $5,000 deficit in its franking account. On the last day of the franking year - 31 December 2000 - Simple Life's franking account has a $147 deficit.The franking credits and debits that arise for the payment of tax during the 2000-2001 income year are deemed to have arisen on the last day of the franking year (i.e. 31 December 2000). Simple Life's franking account will have a $570 franking account surplus on this day for the purposes of franking deficit tax, deficit deferral tax and franking additional. Consequently, Better Life will not be subject to franking deficit tax for the 2000-2001 income year.

2000-2001 income year

Summary of franking credits and debits

7.68 Table 7.3 provides a summary of the franking debits and credits that arise for the 2000-2001 income year for early balancing life assurance companies.

Table 7.3: Franking credits and debits of an early balancing life assurance company
Event Franking credits Franking debits Amount
Paying a company tax instalment or PAYG rate variation credit before assessment. 160APVJ PAYG rate variation credit.

160AQCNCE

Franking credits - amount paid attributable to income estimated to be included in shareholders' funds income.

Franking debits - amount of PAYG credit referable to an amount paid or applied that gave rise to franking credits.

Reversing provisions. 160APVO 160AQCNCB Franking debits - amount of 160APVJ franking credits.

Franking credits - amount of 160AQCNCE franking debits.

Reinstating provisions and payments of company tax instalments and company tax after assessment. 160AQCNCG Class C franking credits equal to the adjusted amount of the payment that is attributable to non-insurance business income derived before 1 July 2000;

Class A franking credits equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and

Class C franking credits equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

Refunds and 160APZ franking debit from reduction in company tax. 160AQCNCD(3)(a) 160AQCNCI Franking credits the amount of the class C franking debits that arose under section 160APZ.

Franking debits class C franking debits equal to the adjusted amount of the refund or reduction that is attributable to non-insurance business income derived before 1 July 2000;

Class A franking debits equal to the adjusted amount of 20% of the amount of the refund or reduction that is attributable to insurance business income derived before 1 July 2000; and

Class C franking debits equal to the adjusted amount of the refund or reduction that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

7.69 The COIN system under Division 1C of Part IV of the ITAA 1936 is to be replaced by the PAYG system from the 2000-2001 income year.

7.70 The current law provides for franking credits and debits to arise for the payment and refund of tax under the COIN system to produce the following net result:

class A franking credits and debits equal to the adjusted amount of 20% of the extent to which the payment or refund is attributable to insurance business income of the company; and
class C franking credits or debits equal to adjusted amount of the extent to which the payment or refund is attributable to non-insurance business income of the company.

7.71 However as payments and refunds under the COIN system for the 1999-2000 income year of a late balancing life assurance company may be referable to income derived both before and after 1 July 2000 transitional amendments are necessary.

7.72 The effect of these amendments is to provide that franking debits and credits ultimately arise in respect of the 1999-2000 income year of late balancing life assurance companies as follows:

class C franking credits and debits equal to the adjusted amount of the tax paid or refunded that is attributable to non-insurance business income derived before 1 July 2000;
class A franking credits and debits equal to the adjusted amount of 20% of the amount of tax paid or refunded that is attributable to insurance business income derived before 1 July 2000; and
class C franking credits and debits equal to the adjusted amount of the tax paid or refunded that is attributable to income derived on or after 1 July 2000 that is included in shareholders' funds income.

7.73 Payments of company tax in relation to the company's 2000-2001 and subsequent income years will always be referable to income derived after 1 July 2000. Therefore, franking credits and debits arise for late balancing life assurance companies for the 2000-2001 and subsequent income years as for standard balancing life assurance companies.

When do franking credits and debits arise for the payment of a COIN instalment or company tax?

Before assessment

7.74 Late balancing life assurance companies receive franking credits for the payment of income tax (COIN instalments) for the 1999-2000 income year before assessment, in accordance with the current imputation system.

7.75 Broadly speaking, under the current law a life assurance company receives class C franking credits equal to the adjusted amount of a payment of a company instalment made before assessment under sections 160APM and 160APMAA.

7.76 The class C franking credit is then reduced by a class C franking debit equal to the adjusted amount of the extent to which the payment is referable tax paid in relation to insurance business income. The extent to which the payment is referable to tax paid in relation to insurance business income is based on the proportions of income tax on insurance business income to non-insurance business income for the previous income year. These debits arise under section 160AQCCA.

7.77 When the reducing class C franking debits arise, they trigger a class A franking credit. The amount of the class A franking credit is equal to the adjusted amount of 20% of the extent to which the payment is attributable to tax paid in relation to insurance business income. The credit arises under section 160APVH. Again the amount of the class A franking credit arising from the payment is determined by reference to the previous year's proportions of tax paid on insurance and non-insurance income.

Assessment

7.78 Upon assessment, the reducing class C franking debits are reversed out of the life assurance company's franking account by corresponding class C franking credits arising under section 160APVB. The class A franking credits are similarly reversed by class A franking debits under section 160AQCN.

7.79 By reversing out the reducing class C franking credits, the life assurance company is left with class C franking credits equal to the adjusted amount of the original payment.

7.80 Under the current law, the class C reducing franking debits and class A franking credits would ordinarily be reinstated upon assessment in accordance with the current years proportion of tax paid on insurance business income and non-insurance business income. However, the proposed amendments prevent reducing class C franking debits, and consequently class A franking credits, from being reinstated after assessment for the 1999-2000 income year for late balancing life assurance companies. [Schedule 3, Part 2, item 71, paragraph 160AQCCA(3A)(b)]

7.81 Instead the proposed amendments reinstate franking credits and debits to take account of income derived before and after 1 July 2000 as follows:

class C franking debits arise equal to the adjusted amount of the payment that is attributable to:

-
income derived before 1 July 2000 other than non-insurance business; or
-
income derived on or after 1 July 2000;

class A franking credits arise equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and
class C franking credits arise equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCF]

After assessment

7.82 If, on or after assessment, the life assurance company makes a payment of a COIN instalment or company tax or receives a section 160APQB franking credit for the payment of excess foreign franking credits, franking credits and debits arise as follows:

class C franking credits equal to the adjusted amount of the payment (see sections 160APM, 160APMA, 160APMD of the ITAA 1936);
class C franking debits equal to the adjusted amount of the payment that is attributable to:

-
income derived before 1 July 2000 other thannon-insurance business; or
-
income derived on or after 1 July 2000;

class A franking credits equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and
class C franking credits equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCF]

7.83 Consequential amendments to the current law ensure that no other franking credits and debits arise for late balancing life assurance companies from these payments. [Schedule 3, Part 2, items 71 to 74.]

Over estimation penalty

7.84 The over estimation penalty does not apply to the 1999-2000 income year for any life assurance companies. However, the penalty can apply to subsequent income years for late balancers under the provisions described for standard balancing life assurance companies at paragraphs 7.27 to 7.29. [Schedule 3, Part 2, item 75, section 160AQCNCC]

When do franking debits and credits arise from the refund of tax under Division 1C of Part VI and amended assessments?

Before assessment

7.85 Late balancing life assurance companies receive franking debits for refunds of income tax for the 1999-2000 income year before assessment in accordance with the current imputation system.

7.86 Broadly speaking, under the current law, a life assurance company receives a class C franking debit equal to the adjusted amount of the refund received before assessment under sections 160APY and 160APYA.

7.87 The class C franking debit is then reduced by a class C franking credit equal to the adjusted amount of the extent to which the refund is referable to tax paid on insurance business income based on the proportions of income tax on insurance business income to non-insurance business income for the previous income year. These credits arise under section 160APVA.

7.88 When the reducing class C franking credits arise, they trigger a class A franking debit. The amount of the class A franking debit is equal to the adjusted amount of 20% of the extent to which the refund is attributable to tax paid in relation to insurance business income (see section 160AQCN).

Assessment

7.89 Upon assessment, the reducing class C franking credits are reversed out of the life assurance company's franking account by a corresponding class C franking debit arising under section 160AQCCB. The class A franking debits are similarly reversed by class A franking credits under section 160APVH.

7.90 By reversing out the reducing class C franking credits, the life assurance company is left with class C franking debits equal to the adjusted amount of the original refund.

7.91 Under the current law, the class C reducing franking credits and class A franking debits would ordinarily be reinstated upon assessment in accordance with the current year's proportion of tax paid on insurance business income and non-insurance business income. Amendments have been made to ensure that these credits and debits do not arise for the 1999-2000 income year for late balancing life assurance companies. [Schedule 3, Part 2, items 64 and 74]

7.92 Rather, the following franking debits and credits arise reflecting the extent to which the refund was referable to tax paid on income derived before and after 1 July 2000:

class C franking credits equal to the adjusted amount of the refund that is attributable to:

-
income derived before 1 July 2000 other than non-insurance business; or
-
income derived on or after 1 July 2000;

class A franking debits equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and
class C franking debits equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCH]

After assessment

7.93 If the life assurance company receives a refund after assessment or a reduction in company tax that produces a section 160APZ franking debit in relation to its 1999-2000 income year, franking credits and debits arise as follows:

class C franking debits equal to the adjusted amount of the refund (see sections 160APY, 160APYA and 160APYBA of the ITAA 1936);
class C franking credits equal to the adjusted amount of the refund or reduction that is attributable to:

-
income derived before 1 July 2000 other thannon-insurance business; or
-
income derived on or after 1 July 2000;

class A franking debits equal to the adjusted amount of 20% of the amount of the refund or reduction that is attributable to insurance business income derived before 1 July 2000; and
class C franking credits equal to the adjusted amount of the refund or reduction that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCH]

7.94 The current law is also amended to ensure franking credits and debits do not arise in relation to these payments for late balancing life assurance companies. [Schedule 3, Part 2, items 64 to 66 and 74]

Summary of franking credits and debits

7.95 Table 7.4 provides a summary of the franking debits and credits that arise for the 1999-2000 income year for late balancing life assurance companies.

Table 7.4: Franking credits and debits of the 1999-2000 income year of a late balancing life assurance company
Event Franking credits Franking debits Amount
Paying a company tax instalment before assessment. Class C 160APM, 160APMAA.[F22] Class C 160AQCCA. Franking credits - adjusted amount of the payment.

Franking debits - adjusted amount of the extent to which the payment was referable to insurance business income.

Class A 160APVH. Adjusted amount of 20% of the payment attributable to insurance business income.
Reversing provisions. Class C 160APVB. Class A 160AQCN. Franking credits - amount of 160AQCCA debit.

Franking debits - amount of 160APVH credit.

Reinstating provisions and payments of company tax instalments and company tax after assessment.[F23] Class C 160AQCNCF. Class C 160AQCNCF.

Franking debits - adjusted amount of the payment attributable to:

insurance business derived before 1 July 2000 other than non-insurance business; or
income derived on or after 1 July 2000;

Franking credits - class A franking credits equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000.

Class C franking credits equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

Refunds of tax before assessment. Class C 160APVA. Class C 160APY, 160APYA[F24]. Franking debits class C franking debits equal to the adjusted amount of the refund.

Franking credits adjusted amount of the extent to which the refund is referable to insurance business income.

Class A franking debit 160AQCN. Adjusted amount of 20% of the refund attributable to insurance business income.
Reversing provisions. Class A 160APVH. Class C 160AQCCB. Franking credits - amount of 160AQCN class A franking debits.

Franking debits - amount of 160APVA class C franking credits.

Reinstating provisions and refunds and 160APZ franking debits from reduction in company tax after assessment.[F25] Class C 160AQCNCH Class C 160AQCNCH Franking credits adjusted amount of the refund. attributable to:

insurance business derived before 1 July 2000 other than non-insurance business; or
income derived on or after 1 July 2000.

Franking debits class A franking debits equal to the adjusted amount of 20% of the amount of the refund that is attributable to insurance business income derived before 1 July 2000.

Class C franking credits equal to the adjusted amount of the refund that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds. income.

7.96 As a result of the proposal to broaden the tax base of life assurance companies, modifications have also been made to the provisions in the ITAA 1936 that provide for the intercorporate dividend rebate (under sections 46 and 46A), franking credits arising from the receipt of franked dividends (under sections 160APP and 160APQ) and the franking rebate (under sections 160AQU and 160AQZA).

7.97 In summary, these amendments, which apply in respect of franked dividends paid on or after 1 July 2000, will entitle a life assurance company to:

an intercorporate dividend rebate in respect of franked dividends received provided the assets of the company from which the dividend was derived is, at all relevant times, allocated to shareholders;
a franking credit in respect of franked dividends received provided the assets of the company from which the dividend was derived is, at all relevant times, allocated to shareholders; and
a franking rebate in respect of franked dividends received where the assets of the company from which the dividend was derived is not at any relevant time allocated to shareholders.

When is a life assurance company entitled to an intercorporate dividend rebate?

7.98 Subsections 46(2) and 46A(5) of the ITAA 1936 set out the general provisions for determining a company's entitlement to the intercorporate dividend rebate. In broad terms, a resident company is entitled to a rebate in its assessment for an income year by applying the average rate of tax payable by the company to the part of any dividends that are included in its taxable income for that year.

7.99 However, the entitlement to the rebate for life assurance companies is limited to those dividends forming part of the standard component of the life assurance company's taxable income (see subsections 46(1A) and 46(10)).

7.100 As a result of the wider proposal to broaden the tax base of life assurance companies, amendments have been made so that a life assurance company will only be entitled to the intercorporate dividend rebate in respect of dividends included in its taxable income that are included in the shareholders' funds of the life assurance company.[F26] This is achieved by deeming the taxable income of a life assurance company to be that part of the company's taxable income that is attributable to shareholders' funds income of the company for that income year for the purposes of the rebate. [Schedule 3, Part 2, items 37 and 43, subsections 46(1A) and 46A(6A)]

7.101 However, no entitlement to the rebate arises in respect of a particular dividend if:

the assets of the life assurance company from which the dividend was derived were included in the insurance funds of the life assurance company at any time during the period that:

-
starts at the beginning of the income year of the life assurance company in which the dividend was paid; and
-
ends at the time when the dividend was paid,

PARA> unless at all times when those assets were included in the insurance funds during that period they were held on behalf of the life assurance company's shareholders. [Schedule 3, Part 2, items 39 and 45, subsections 46(10) and 46A(17)]

7.102 For the purpose of these provisions the term:

'shareholders' funds' has the same meaning as in the Life Insurance Act; and
'insurance funds' has the same meaning of that term provided in Division 8 of Part III immediately before 1 July 2000.

[Schedule 3, Part 2, items 30 and 33, subsection 6(1)]

7.103 As a result of the proposed tax rate changes applying to the various components of a life assurance company's taxable income, a consequential amendment is also necessary to the term 'average rate of tax payable' in subsections 46(6AA) and 46A(8AA) of the ITAA 1936. The 'average rate of tax payable' for a year of tax will now be the rate of tax applicable under sections 23A and 23B of the ITRA 1986. [Schedule 3, Part 2, items 38 and 44, subsections 46(6AA) and 46A(8AA)]

7.104 To ensure that these amendments operate as intended a number of definitional amendments have also been made to subsections 6(1) and 46(1). [Schedule 3, Part 2, items 30 to 36, subsections 6(1) and 46(1)]

When does a life assurance company receive franking credits from the receipt of franked dividends?

7.105 Sections 160APP and 160APQ of the ITAA 1936 set out the circumstances for determining when a company records a franking credit from the receipt of franked dividends (section 160APP for dividends received directly from other companies and section 160APQ for dividends received indirectly through trusts or partnerships). These provisions provide that a franking credit arises to the recipient company equal to the franked amount of the dividend at the time the dividend is paid, in the case of direct dividends, or at the end of the relevant income year, in the case of indirect dividends.

7.106 However, for life assurance companies the provisions are modified in circumstances where the assets from which the dividend was derived were included in the insurance funds of the company at any time commencing at the start of the relevant income year and ending at the time the dividend is paid. In these circumstances the franking credit is reduced by 80% to take into account that there is a 20% limit on the amount of profits that can be distributed to shareholders because of various prudential rules contained in the Life Insurance Act.[F27]

7.107 There are further rules contained in section 160AQCA to claw back franking credits arising under either section 160APP or 160APQ where the assets from which the dividend was derived are included in the insurance funds of the company after the dividend has been received and before the end of the relevant income year.

7.108 In keeping with the proposal to broaden the tax base of life assurance companies, amendments have been made to sections 160APP and 160APQ by preventing franking credits arising from the receipt of a franked dividend if the assets from which the dividend was derived were included in the insurance funds of the company at any time from the beginning of the relevant income year to the time the dividend was paid unless those assets were held on behalf of the company's shareholders during that time. [Schedule 3, Part 2, item 60, subsection 160APP(5)]

7.109 An equivalent amendment has also been made in respect of indirect distributions provided under section 160APQ and exempting distributions provided under section 160APPA. [Schedule 3, Part 2, items 61 and 62, subsections 160APPA(9) and 160APQ(3)]

7.110 The rules in section 160AQCA have also been amended so that where the assets from which a dividend was derived cease to be held on behalf of shareholders after the dividend has been received and before the end of the relevant income year, the franking credits that arose in respect of the receipt of the original dividend under section 160APP or 160APQ are cancelled (with an offsetting franking debit). [Schedule 3, Part 2, item 69, subsection 160AQCA(3)]

When is a life assurance company entitled to a franking rebate or venture capital franking rebate?

7.111 Under the current dividend imputation provisions, where a franked dividend is paid to a shareholder who is a resident individual, or a partnership or trustee of a trust estate, the shareholder is required to include the imputed company tax attached to the dividend as assessable income, and is entitled to a rebate, or to pass on the rebate in the case of a partnership or trust, of the amount so included under sections 160AQT and 160AQU of the ITAA 1936.

7.112 These provisions also apply to life assurance companies to the extent that the assets of the shareholder from which the dividend was derived are included in the insurance funds of the company at any time during the period starting at the beginning of the relevant income year and ending at the time the dividend was paid (see example in subsection 160AQT(1C)).[F28]

7.113 As a result of the proposals to broaden the tax base of life assurance companies, a life assurance company will be required to include the imputed company tax attached to the dividend as assessable income if:

at any time during the period that:

-
starts at the beginning of the income year of the life assurance company in which the dividend was paid; and
-
ends at the time when the dividend was paid; and

the assets of the life assurance company from which the dividend was derived were both:

-
included in the insurance funds of the life assurance company; and
-
not held on behalf of the life assurance company's shareholders.

[Schedule 3, Part 2, item 77, subsection 160AQT(1C)]

7.114 Where the amount is so included in the life assurance company's assessable income, the company is entitled to franking rebate equal to the amount provided under section 160AQU.

7.115 An equivalent rebate is available to life assurance companies under section 160AQZA in respect of distributions received indirectly through a trust or partnership provided subsection 160APQ(3) applies in respect of the distribution. Subsection 160APQ(3) applies where the assets from which the distribution is attributable are included in the insurance funds of the life assurance company in the relevant income year.

7.116 Certain life assurance companies who engage in superannuation business may be eligible for the venture capital franking rebate. The operation of this rebate has also been amended to ensure it will only be available if the relevant assets of the life assurance company from which the eligible dividend was derived were both:

included in the insurance funds of the life assurance company; and
not held on behalf of the life assurance company's shareholders.

[Schedule 3, Part 2, item 83, paragraph 160ASEP(1)(i)]

Application and transitional provisions

7.117 The amendments governing franking credits and debits for the payment and refund of tax under the new PAYG system and PAYG rate variation credits apply to the 2000-2001 income year.

7.118 The amendments governing franking credits and debits for the 1999-2000 income year for late balancing life assurance companies apply from the 1999-2000 income year.

7.119 The amendments to the intercorporate dividend rebate, franking credits arising from the receipt of franked dividends, and the franking rebate apply to dividends paid on or after 1 July 2000.

7.120 Consequential amendments are required to reflect the changes to life assurance company taxation base made under items 78 to 82 apply to income derived on or after 1 July 2000.

Consequential amendments

7.121 To facilitate the amendments described at paragraphs 7.117 to 7.120 a number of further consequential amendments have also been made. In broad terms, these amendments make appropriate definitional and interpretation changes and ensure that the provisions relating to calculating the 'adjusted amount' and applying rebates continue to operate appropriately. [Schedule 3, Part 2, items 30 to 36, 40 to 42, 46 to 55, 57 to 59, 63, 68 and 70]

7.122 Further consequential amendments have been made to take account of amendments to the ITAA 1936 from the broadening of the tax base applying to life insurance companies[F29] [Schedule 3, Part 2, items 78 to 82]

Chapter 8 - Imputation - conversion of franking account balances

Outline of Chapter

8.1 This Chapter explains amendments that, broadly speaking, ensure the dividend imputation system in the ITAA 1936 properly takes account of the new 34% company tax rate. The amendments are contained in items 85 to 97 of Schedule 3 to this Bill.

8.2 Some of the provisions being amended in this Bill were recently introduced to convert, on 1 July 2000, those parts of the imputation system reflecting a 36% rate to instead reflect the 34% rate.

8.3 The amendments arise from:

the life insurance company measures to be introduced in this Bill, the broad effect of which will be that the 39% tax rate, currently applying to some parts of taxable income, will be reduced to the company tax rate;
the possibility of franking credits and debits arising before the conversion date of 1 July 2000 that reflect a 34% rate, particularly in relation to the payment of PAYG instalments by early balancing companies; and
changes to the way estimated debit determinations are treated for the purposes of converting the imputation system to reflect the 34% rate.

Context of Reform

8.4 The reductions in the company tax rate, provided for in the Income Tax Rates Act No. 1, are a key component of the New Business Tax System announced in Treasurer's Press Release No. 58 of 21 September 1999 (refer to Attachment A).

8.5 The reduced company tax rate will provide Australia with an internationally competitive company tax rate. The eventual reduction of the company tax rate to 30% will bring the Australian rate into line with rates in other countries in the Asia Pacific region and will boost investment in Australia.

8.6 As a result of the reduction in the company tax rate for the 2000-2001 income year, amendments to the dividend imputation system were introduced in the NBTS Miscellaneous Bill 1999. That Bill amends the imputation system to:

convert class C franking account balances from 1 July 2000, from being based on a tax rate of 36%, to instead reflect the new company tax rate of 34%;
convert most franking credits and franking debits arising on or after 1 July 2000 that reflect a tax rate other than 34% to instead reflect the new company tax rate of 34%; and
provide that most franked dividends paid on or after 1 July 2000 carry imputation credits reflecting a 34% rate.

8.7 The 2 key tax reform measures giving rise to most of the amendments explained in this Chapter are:

the measures broadening the tax base for life insurance companies from 1 July 2000; and
the application of the PAYG system from the 2000-2001 income year for tax instalments payable by companies.

Summary of new law

Life insurance company measures

8.8 The new law will convert class A franking surpluses and deficits of life insurance companies to corresponding class C franking credits and debits on 1 July 2000. This will effectively close-off class A franking accounts for life insurance companies.

8.9 The balance of class A franking accounts represent tax paid at a 39% rate. Closing-off these accounts for life insurance companies recognises that these companies will, from 1 July 2000, no longer pay tax at a 39% rate.

8.10 Class A franking credits and debits of life insurance companies arising on or after 1 July 2000 will generally be converted to equivalent class C franking credits and debits reflecting a 34% rate.

34% credits and debits arising before 1 July 2000

8.11 The new law will also convert class C franking credits or franking debits arising before 1 July 2000 that reflect a company tax rate of 34% into equivalent class C franking credits or debits reflecting a 36% rate. This change is necessary because class C franking account balances will reflect a company tax rate of 36% before 1 July 2000, and will only reflect a 34% rate after that date.

Amendments related to estimated debit determinations

8.12 Finally, the new law will amend the conversion of franking account provisions to simplify, and correct potential anomalies in the treatment of franking credits and debits arising from estimated debit determinations.

Comparison of key features of new law and current law

Chapter 8 - Imputation - conversion of franking account balances

Outline of Chapter

8.1 This Chapter explains amendments that, broadly speaking, ensure the dividend imputation system in the ITAA 1936 properly takes account the new 34% company tax rate. The amendments are contained in items 85 to 97 of Schedule 3 to this Bill.

8.2 Some of the provisions being amended in this Bill were recently introduced to convert, on 1 July 2000, those parts of the imputation system reflecting a 36% rate to instead reflect the 34% rate.

8.3 The amendments arise from:

the life insurance company measures to be introduced in this Bill, the broad effect of which will be that the 39% tax rate, currently applying to some parts of taxable income, will be reduced to the company tax rate;
the possibility of franking credits and debits arising before the conversion date of 1 July 2000 that reflect a 34% rate, particularly in relation to the payment of PAYG instalments by early balancing companies; and
changes to the way estimated debit determinations are treated for the purposes of converting the imputation system to reflect the 34% rate.

Context of Reform

8.4 The reductions in the company tax rate, provided for in the Income Tax Rates Act No. 1, are a key component of the New Business Tax System announced in Treasurer's Press Release No. 58 of 21 September 1999 (refer to Attachment A).

8.5 The reduced company tax rate will provide Australia with an internationally competitive company tax rate. The eventual reduction of the company tax rate to 30% will bring the Australian rate into line with rates in other countries in the Asia Pacific region and will boost investment in Australia.

8.6 As a result of the reduction in the company tax rate for the 2000-2001 income year, amendments to the dividend imputation system were introduced in the NBTS Miscellaneous Bill 1999. That Bill amends the imputation system to:

convert class C franking account balances from 1 July 2000, from being based on a tax rate of 36%, to instead reflect the new company tax rate of 34%;
convert most franking credits and franking debits arising on or after 1 July 2000 that reflect a tax rate other than 34% to instead reflect the new company tax rate of 34%; and
provide that most franked dividends paid on or after 1 July 2000 carry imputation credits reflecting a 34% rate.

8.7 The 2 key tax reform measures giving rise to most of the amendments explained in this Chapter are:

the measures broadening the tax base, and changing the tax rates, for life insurance companies from 1 July 2000; and
the application of the PAYG system from the 2000-2001 income year for tax instalments payable by companies.

Summary of new law

Life insurance company measures

8.8 The new law will convert class A franking surpluses and deficits of life insurance companies to corresponding class C franking credits and debits on 1 July 2000. This will effectively close-off class A franking accounts for life insurance companies.

8.9 The balance of class A franking accounts represent tax paid at a 39% rate. Closing-off these accounts for life insurance companies recognises that these companies will, from 1 July 2000, no longer pay tax at a 39% rate.

8.10 Class A franking credits and debits of life insurance companies arising on or after 1 July 2000 will generally be converted to equivalent class C franking credits and debits reflecting a 34% rate.

34% credits and debits arising before 1 July 2000

8.11 The new law will also convert class C franking credits or franking debits arising before 1 July 2000 that reflect a company tax rate of 34% into equivalent class C franking credits or debits reflecting a 36% rate. This change is necessary because class C franking account balances will reflect a company tax rate of 36% before 1 July 2000, and will only reflect a 34% rate after that date.

Amendments related to estimated debit determinations

8.12 Finally, the new law will amend the conversion of franking account provisions to simplify, and correct potential anomalies in the treatment of franking credits and debits arising from estimated debit determinations.

Comparison of key features of new law and current law
New law Current law[F30]
Class A franking accounts of life insurance companies will be closed off on 1 July 2000, with class A franking surpluses and deficits being converted to equivalent class C franking credits and debits. Class A franking credits and debits arising on or after 1 July 2000 will generally be converted to equivalent class C franking credits and debits.

As a result, life insurance companies will, for practical purposes, only keep a class C franking account, reflecting a 34% rate, from 1 July 2000.

Life insurance companies keep both a class C franking account (for tax paid at the general company tax rate) and a class A franking account (for tax paid at 39% on some components of their taxable income).
Franking credits and debits based on a 34% tax rate arising before the conversion date of 1 July 2000 will be converted to reflect a 36% tax rate. Franking credits and debits based on a 34% tax rate arising before the conversion date of 1 July 2000 would not have been converted at the time they arise. The conversion of class C franking accounts on 1 July 2000 would then inappropriately inflate these credits and debits.
Only one test will apply to work out whether franking credits or debits arising from estimated debit determinations reflect a 34% rate under the conversion of franking account provisions.

Under this test, all applications for estimated debits made on or after 9 June 2000 will be taken to reflect a 34% rate.

Two tests would have applied to work out whether franking credits or debits arising from estimated debit determinations reflect a 36% or a 34% rate under the conversion of franking account provisions.

Under one of these tests, companies applying for estimated debit determinations between 9 June 2000 and 30 June 2000 (inclusive) could have chosen either a 36% or a 34% rate as a basis for the debit they apply for.

Detailed explanation of new law

Closing-off class A franking accounts

8.13 Life insurance companies will effectively close-off their class A franking accounts on 1 July 2000.

Converting class A account balances into class C franking credits and debits on 1 July 2000

8.14 On 1 July 2000, the class A franking account of a life insurance company will be closed-off by:

cancelling any class A franking surplus or deficit with:

-
in the case of a surplus, an offsetting class A franking debit equal to the surplus; or
-
in the case of a deficit, an offsetting class A franking credit equal to the deficit; and

having a class C franking credit or debit arise equal to the offsetting debit or credit adjusted by this conversion factor:

(39 / 61) * (66 / 34)

[Schedule 3, item 86, section 160ATC]

8.15 The class C franking credits or debits arising from the closure of the class A franking account will reflect a 34% tax rate. This is consistent with changes made in the NBTS Miscellaneous Bill 1999, under which class C franking accounts of all companies are to be converted to reflect the new 34% company tax rate, also on 1 July 2000.

8.16 The class A franking account of a life insurance company will be closed-off after the company converts its class C franking account to reflect the new 34% company tax rate. [Schedule 3, item 85, paragraph 160ATA(1)(aa)]

Example 8.1 Meningov Ltd is a life insurance company. It maintains a class A franking account and has a franking year of 1 June to 31 May. On 1 July 2000 it has a class A franking deficit of $500. Meningov Ltd closes-off its class A franking account as follows:

* class A franking account balance ($500.00)
* offsetting class A franking credit $500.00
* class C franking debit $620.54
($500.00 * 39/61 * 66/34)

8.17 Subsection 160ATA(2) of the ITAA 1936 (inserted by the NBTS Miscellaneous Bill 1999) deals with a life insurance company's 2000-2001 franking year commencing on 1 July 2000. In this case, a class A franking credit under section 160APL, carrying forward a class A franking surplus from the end of the 1999-2000 franking year, will arise before the franking account is converted.

Converting class A franking credits and debits of a life insurance company arising on or after 1 July 2000

8.18 Once class A franking accounts for life insurance companies are closed-off, it is necessary to ensure that most class A franking credits and debits of life insurance companies arising on or after 1 July 2000 are converted. Those credits and debits are converted to equivalent class C franking credits and debits that reflect the 34% company tax rate.

8.19 This is done by multiplying the class A credit or debit by the conversion factor applied to close-off the class A franking account:

(39 / 61) * (66 / 34)

8.20 There is already a provision in section 160ATD of the ITAA 1936 which applies this factor to convert class A franking credits and debits arising on or after 1 July 2000 for a company other than a life insurance company. Amendments in this Bill ensure that these rules also apply to life insurance companies. [Schedule 3, items 88 and 89]

8.21 Not all class A franking credits or debits of a life insurance company arising on or after 1 July 2000 will be converted. Subsection 160ATD(1) of the ITAA 1936 ensures that the following class A credits and debits are not converted:

a class A franking credit or a class A franking debit arising under Division 14 of the ITAA 1936 (inserted by the NBTS Miscellaneous Bill 1999):

-
These credits and debits arise as part of the conversion process. To convert them again would frustrate the conversion;

a class A franking credit arising under subsection 160APL(1), which carries forward a class A franking surplus from the end of one franking year into a new franking year:

-
This credit is not converted because, if it arises on 1 July 2000, it is already taken into account before the class A franking account is closed-off (see paragraph 8.17). Such a credit will not arise after 1 July 2000 because the class A franking account is closed-off on 1 July 2000;

franking debits arising under sections 160AQB (payment of franked dividends), 160AQCB, 160AQCBA, 160AQCNA or 160AQCNB (dividend streaming or franking credit trading arrangements):

-
These debits are not converted because all of them are based on actual franked amounts. There should not be any class A franked amounts arising on or after 1 July 2000 as the class A franking account of life insurance companies will be closed-off; and

franking debits arising under sections 160APX (under-franking), 160AQCC (on-market share buy back arrangements) or 160AQCNC (private company distributions treated as dividends):

-
These debits are not converted because all of them are based on required franking amounts. There needs to be a class A franking surplus to have a class A required franking amount. This will not be possible on or after 1 July 2000 as class A franking accounts of life insurance companies will be closed-off.

8.22 Parts of subsection 160ATD(1) have been replaced under an amendment in this Bill. The new version of this subsection contains information about what particular provisions referred to in the subsection do. This improves the subsection from a user's perspective. [Schedule 3, item 87, subparagraphs 160ATD(1)(b)(ii) and (iii)]

Repealing the provision dealing with companies ceasing to be life insurance companies

8.23 Section 160ATE of the ITAA 1936 (inserted by the NBTS Miscellaneous Bill 1999) deals with the case where a company ceases to be a life insurance company on or after 1 July 2000. In these circumstances, section 160ATE would have converted the class A franking surplus or deficit into a class C franking credit or debit.

8.24 The amendments in this Bill mean that life insurance companies will not have operating class A franking accounts on or after 1 July 2000 (see paragraphs 8.14 to 8.17). Because of these changes, section 160ATE is no longer necessary. Therefore, the section is repealed. [Schedule 3, item 92]

Changes to the required franking amount and dividend declaration rules

8.25 The NBTS Miscellaneous Bill 1999 introduced provisions into the ITAA 1936 to address potential anomalies in working out required franking amounts and the effect of franking declarations. These anomalies may arise because of the conversion of franking accounts on 1 July 2000. These provisions:

provide for the splitting of resolutions under which dividends are paid both before and after 1 July 2000 (section 160ATF);
allow variations to certain dividend declarations (sections 160ATF and 160ATG); and
provide for changes to the required franking amount rules relating to over-franked earlier dividends (section 160ATH).

Resolution splitting

8.26 Subsection 160ATF(1) and paragraph 160ATF(2)(a) deal with the case where a company (including a life insurance company):

pays a number of class C franked dividends under a resolution made before 1 July 2000; and
some of the dividends ('first series dividends') are paid before that date, while other dividends ('second series dividends') are paid after that date.

8.27 The effect of these provisions is that the first series dividends and the second series dividends will be taken to have been made under separate resolutions.

8.28 Amendments in this Bill extend the operation of this rule to cases where a life insurance company pays:

only class A franked dividends before 1 July 2000; or
both class A and class C franked dividends before 1 July 2000;

under a resolution made before that date, under which dividends are paid both before and after 1 July 2000. [Schedule 3, item 93, paragraphs 160ATF(1)(a) and (aa)]

8.29 Because of this amendment, the second series dividends of life insurance companies (i.e. those dividends paid on or after 1 July 2000) will be taken to be paid under a separate resolution. These dividends will have a 'reckoning day' occurring on or after 1 July 2000 as a result. There will be no class A required franking amount for the second series dividends because life insurance companies will not have a class A franking surplus from 1 July 2000 (see paragraphs 8.14 to 8.17). Instead, there will only be class C required franking amounts in relation to these dividends.

Declaration variations

8.30 The effect of paragraph 160ATF(2)(b) is to allow a company to make a new declaration in relation to the second series dividends. The amendment that was just explained ensures that a life insurance company will also be able to make a new declaration where it pays a class A franked dividend in the first series.

8.31 Paragraph 160ATF(2)(c) only applies if the company does not take the opportunity provided by paragraph 160ATF(2)(b) and makes no declaration in respect of the second series dividends. It provides that the second series dividends will be taken to be franked to the same percentage as specified under the original declaration for the first series dividends.

8.32 Amendments in this Bill will ensure that paragraph 160ATF(2)(c) also extends to cases where life insurance companies have paid a class A franked dividend in the first series dividends.

8.33 Two additional rules have been added to paragraph 160ATF(2)(c):

A life insurance company paying only class A franked dividends under the original declaration will be taken to have made a declaration that any second series dividends are class C franked dividends.

-
That dividend or those dividends will be franked to the extent of the class A percentage in the original declaration; and

A life insurance company paying both class A and class C franked dividends under the original declaration will be taken to have made a declaration that any second series dividends are class C franked dividends.

-
That dividend or those dividends will be franked to the extent of the sum of the class C percentage and the class A percentage in the original declaration.

[Schedule 3, item 94, paragraph 160ATF(2)(c), items 2 and 3 in the table]

8.34 Section 160ATG also allows companies to vary declarations or make new declarations in relation to franked dividends paid on or after 1 July 2000. However, unlike paragraph 160ATF(2)(b), section 160ATG will apply only where dividends are paid on or after 1 July 2000 under the original resolution.

8.35 Amendments in this Bill ensure that declarations of class A franked dividends made by life insurance companies before 1 July 2000 can be varied or revoked but only where those dividends are paid on or after 1 July 2000 under the original resolution. [Schedule 3, item 95, subsection 160ATG(1)]

Modifications to rules for over-franked earlier dividends

8.36 Subsection 160AQE(3) of the ITAA 1936 provides that any committed future dividend must be franked to at least the same extent as an earlier over-franked dividend.

8.37 This rule is modified by section 160ATH. This section prevents the required franking amount of a committed future dividend with a reckoning day on or after 1 July 2000 being distorted by the franked amount of the earlier franked dividend paid before 1 July 2000. This distortion would arise because the earlier dividend would have been paid out of a franking account not reflecting a 34% rate, whereas the committed future dividend will be paid out of a franking account reflecting a 34% rate.

8.38 Amendments in this Bill convert class A franked amounts paid by a life insurance company before 1 July 2000 into amounts reflecting a 34% rate for the purposes of working out the required franking amount of committed future dividends with a reckoning day on or after 1 July 2000. [Schedule 3, item 96, subsection 160ATH(3)]

Converting franking credits and debits that reflect 34% company rate that arise before 1 July 2000

8.39 Although the company tax rate of 34% will not take effect until the 2000-2001 income year, it is still possible that franking credits and debits will arise prior to 1 July 2000 reflecting a 34% rate.

8.40 This possibility arises because of substituted accounting periods. Early balancing companies will commence their 2000-2001 income year before 1 July 2000. Therefore, the 34% tax rate will apply to these companies for a period of time before 1 July 2000.

8.41 The introduction of PAYG instalments from the 2000-2001 income year will lead to the payment of those instalments before 1 July 2000 for some early balancing companies. Those instalments will be based on the 34% tax rate.

8.42 Other amendments to the imputation system in this Bill will ensure that a payment of a PAYG instalment, or a refund related to such an instalment, gives rise to a class C franking credit or debit respectively (see Chapter 6). These will be the major cases of class C franking credits and debits arising before 1 July 2000 based on a 34% rate.

8.43 These credits and debits will arise at a time when the class C franking account reflects a 36% rate. That account will only reflect the 34% rate when the conversion of franking account provisions, introduced in the NBTS Miscellaneous Bill 1999, convert on 1 July 2000.

8.44 Left untreated, the true value of these credits and debits will be distorted by the proposed conversion of class C franking account balances on 1 July 2000. Therefore, it is necessary to convert any franking credits or debits arising before 1 July 2000 that reflect a 34% rate into an equivalent credit or debit reflecting a 36% rate.

The conversion process

8.45 The conversion process for these franking credits and debits mirrors the conversion process for franking credits and debits arising at a 36% rate after the class C franking account has been converted on 1 July 2000 (see section 160ATD of the ITAA 1936).

8.46 A company converts a 34% class C franking credit or debit arising before 1 July 2000 by:

cancelling any 34% class C franking credit or debit arising at that time with:

-
in the case of a credit, an offsetting class C franking debit; or
-
in the case of a debit, an offsetting class C franking credit; and

reinstating a class C franking credit or debit equal to the offsetting debit or credit adjusted by this conversion factor:

(34 / 66) * (64 / 36)

[Schedule 3, item 91, section 160ATDA]

Example 8.2 Wires Ltd maintains a class C franking account and has a franking year of 1 January to 31 December. It makes its first PAYG instalment payment for the 2000-2001 income year on 21 April 2000. The amount of the instalment is $500. A franking credit arises in relation to this instalment based on the general applicable company tax rate of 34% for the 2000-2001 income year. The company converts this credit to reflect the 36% company tax rate as follows:

* class C franking credit $970.59
* offsetting class C franking debit $970.59
* reinstating class C franking credit $888.89
($970.59 * 34/66 * 64/36)

8.47 A number of credits and debits are excluded from the conversion. Those that are not converted include:

a franking credit arising under section 160APL, which carries forward a class C franking surplus from the end of one franking year into a new franking year:

-
This credit is not converted because it will reflect a tax rate of 36% if it arises before 1 July 2000; and

franking debits arising under sections 160APX (under-franking), 160AQB (payment of franked dividends), 160AQCB, 160AQCBA, 160AQCNA, 160AQCNB (all of which deal with dividend streaming or franking credit trading arrangements), 160AQCC (on-market share buy back arrangements), or 160AQCNC (private company distributions treated as dividends):

-
These debits are not converted because they are based on class C franked amounts or class C required franking amounts. Any class C franked amount or class C required franking amount arising before 1 July 2000 will reflect a 36% rate.

[Schedule 3, item 91, paragraph 160ATDA(1)(b)]

What 'reflects an applicable general company tax rate of 34%'?

8.48 The proposed conversion is limited to those class C franking credits and debits arising before 1 July 2000 that reflect an applicable general company tax rate of 34% . [Schedule 3, item 91, subsection 160ATDA(2)]

8.49 The most common case of where a credit or debit reflects an applicable general company tax rate of 34% is where that rate is used in working out the amount of the credit or debit. This includes where that rate is used in working out an 'adjusted amount' when calculating the amount of a credit or debit (e.g. a franking credit arising from a PAYG instalment made in the 2000-2001 income year).

Treating estimated debit determinations under the conversion of franking account provisions

8.50 A company can request an estimated debit determination if it can foresee a reduction in company tax in certain circumstances.

8.51 Under section 160ATI of the ITAA 1936 (introduced in the NBTS Miscellaneous Bill 1999) applications for class C estimated debit determinations made between 9 June 2000 and 30 June 2000 (inclusive) could be made on the basis of either a 36% or a 34% rate. This period is critical because the amount of the estimated debit specified in the application automatically takes effect if the Commissioner does not make a determination within 21 days of the application being lodged. Any estimated debit from an application lodged in this period could therefore arise either before or after the conversion of class C franking accounts on 1 July 2000, depending on whether the Commissioner makes a determination.

8.52 There are 2 tests in paragraphs 160ATD(2)(b) and (c) (introduced in the NBTS Miscellaneous Bill 1999) for working out whether a credit or debit arising from an estimated debit determination reflects a 36% tax rate. These tests are for the purposes of converting such a credit or debit if it arises on or after 1 July 2000. The first test, in paragraph 160ATD(2)(b), relies on the company tax rate for the income year in which the company tax payment, potentially subject to reduction, is made. The second test, in paragraph 160ATD(2)(c), relies on any choice made under section 160ATI.

8.53 There is a possibility that these 2 tests could conflict, leading to uncertainty and potential anomalies. The 2 tests in paragraphs 160ATD(2)(b) and (c), and section 160ATI, have all therefore been removed from the law. [Schedule 3, items 90 and 97]

8.54 Instead, the law will proceed on the assumption that any applications for estimated debits made on or after 9 June 2000 (the start of the critical period identified in paragraph 8.51 above) will be class C estimated debit applications. The law will also assume that the debit applied for will be based on the 34% rate. This will be the case even if the application would have otherwise led to a class A or a class B debit. A company will be able to factor in the conversion of franking accounts to reflect a 34% rate when working out the debit specified in its application.

8.55 Section 160ATDA (explained in paragraphs 8.45 to 8.49 above) will apply if the Commissioner makes a determination in relation to such an application before 1 July 2000. Franking debits arising in these cases will be based on a 34% rate, and will therefore need to be converted to reflect a 36% rate at the time they arise. [Schedule 3, item 91, paragraph 160ATDA(2)(b)]

Application and transitional provisions

8.56 The amendments made in Part 3 of Schedule 3 to this Bill commence immediately after item 13 of Schedule 3 of the NBTS Miscellaneous Bill 1999. That item inserts the original conversion of franking account provisions, which commence on 1 July 2000. Therefore, these amendments will also take effect on 1 July 2000. [Subclause 2(9) of this Bill]

Consequential amendments

8.57 There are no other consequential amendments.

Chapter 9 - Imputation - thresholds for franking credit trading rules

Outline of Chapter

9.1 This Chapter explains the amendments made by Part 4 of Schedule 3 to this Bill to the franking credit trading rules. These amendments will increase the threshold for the small shareholder exemption under the holding period rule (the '45-day rule') from $2,000 to $5,000, and simplify the exemption by applying the threshold without a taper, for the 1999-2000 year of income and later years.

Context of Reform

9.2 This measure will ensure that more small investors are relieved of the effect of the holding period rule. It is part of the Government's response to the Recommendations of the Review concerning the dividend streaming and franking credit trading rules.

9.3 The holding period rule requires taxpayers to hold shares at risk for at least a certain number of days (45) to be eligible for the franking rebate. Individual taxpayers with small shareholdings can bypass the requirements of the holding period rule by electing for a cap to apply to their franking rebate entitlement. The current threshold for this exemption is $2,000. Taxpayers with a total franking rebate entitlement of $2,000 or less receive a full rebate. Increasing the threshold to $5,000 will allow more small shareholders to receive their franking rebates without having to comply with the holding period rule.

Summary of new law

9.4 The threshold for the small shareholder exemption under the holding period rule will be increased from $2,000 to $5,000. The exemption will also be simplified by removing the taper that applies to the existing threshold of $2,000. Taxpayers who do not satisfy the holding period rule are currently entitled to a partial rebate if their franking rebate entitlement is between $2,001 and $2,499.

9.5 Under the new rules, the exemption will apply to all individual taxpayers with a total franking rebate entitlement of $5,000 or less. The exemption will be easier for taxpayers to understand and apply. In particular, they will no longer need to elect for the exemption to apply as it will always be no less favourable than complying with the holding period rules. These changes will apply to assessments for the 1999-2000 year of income and later years.

Comparison of key features of new law and current law

Comparison of key features of new law and current law
New Law Current Law
The threshold for the small shareholder exemption under the 45-day rule will be $5,000. The threshold is $2,000.
The exemption will not be tapered. The exemption is tapered.
The exemption will apply to all individual taxpayers with a total franking rebate entitlement of $5,000 or less. Taxpayers have to elect for the exemption to apply, because if the taper applies it may be more or less favourable than the 45-day rule.

Detailed explanation of new law

9.6 The threshold for the small shareholder exemption will be increased to $5,000. [Schedule 3, item 98, new section 160APHT]

9.7 The exemption is currently tapered. If a taxpayer's total franking rebates are greater than $2,000, the taxpayer's franking rebate entitlement is reduced under section 160AQZJ by $4 for every $1 that the taxpayer's total franking rebates exceed $2,000. The franking rebate cuts out at $2,500. A taxpayer is entitled to a deduction under section 160AQZK equal to any reduction of his or her franking rebate entitlement under the taper to offset the gross-up of the taxpayer's assessable income on receipt of the franked dividends.

9.8 Under the existing rules, taxpayers have to elect for the exemption to apply under section 160AQZI because of the taper. If the exemption was not elective, a taxpayer with a total franking rebate entitlement between $2,001 and $2,499 who satisfied the 45-day rule would be denied part of his or her rebate.

9.9 The exemption will be simplified by removing the taper. A taxpayer will not need to make an election for the exemption to apply. Also, the rules for the proportionate reduction of the rebate and the complementary deduction will no longer be necessary. Accordingly, Subdivision BB of Division 7 of Part IIIAA, which contains sections 160AQZI, 160AQZJ and 160AQZK, will be repealed. The conditions for this exemption otherwise remain unchanged. [Schedule 3, item 99]

Application and transitional provisions

9.10 The increased threshold of $5,000 for the small shareholder exemption will apply to assessments for the 1999-2000 year of income and later years. [Schedule 3, item 100]

Consequential amendments

9.11 There are no consequential amendments for this measure.

Chapter 10 - CGT: capital payments for trust interests (CGT event E4)

Outline of Chapter

10.1 A payment by the trustee to a beneficiary of a trust that is not assessable income of the beneficiary may reduce the cost base of the beneficiary's interest in the trust. The amendment in Schedule 4 to this Bill amends section 104-70 (CGT event E4) of the ITAA 1997 and inserts sections 104-71 and 104-72. These amendments take into account the effect of payments out of the CGT discount and small business CGT concessions.

Context of Reform

10.2 Under the current law a payment by a trustee of a small business 50% reduction amount is not correctly treated in calculating the non-assessable part to which CGT event E4 applies.

10.3 Schedule 4 to this Bill addresses this deficiency. This amendment was foreshadowed in the explanatory memorandum to the Capital Gains Tax Act that enacted the small business 50% reduction.

Summary of new law

10.4 Amendments were made to section 104-70 by the Integrity and Other Measures Act to take account of a payment by a trustee to a beneficiary of a CGT discount amount.

10.5 With the introduction of the new small business CGT concessions by the Capital Gains Tax Act, section 104-70 requires further amendments to deal with a payment by a trustee of the small business 50% reduction amount.

10.6 The CGT provisions contain rules to support the operation of section 104-70. These rules will apply when determining the non-assessable part of a payment to a beneficiary if the payment includes an amount out of:

the 50% CGT discount or frozen indexation amount;
the small business 50% reduction amount; or
both of the above.

10.7 The rules also apply where the beneficiary has applied a capital loss against their capital gain (notional gain)[F31]. Special rules apply where the beneficiary is a trustee of a fixed trust and receives a payment from another trust in a chain of trusts.

Comparison of key features of new law and current law

Comparison of key features of new law and current law
New Law Current Law
The exclusion from the non-assessable part now recognises that both the CGT discount and/or the small business 50% reduction may be claimed for a capital gain made by a trust. The exclusion from the non-assessable part did not take account of the small business 50% reduction being claimed for a capital gain made by a trust.
The full amount of capital losses offset by a beneficiary against a notional gain may be excluded from the non-assessable part. The exclusion from the non-assessable part only allowed one half of the capital losses applied to reduce the notional capital gain.
Payments of the CGT concession amounts to a beneficiary that is the trustee of a fixed trust in a chain of trusts are now treated appropriately. Payments of the CGT concession amounts to a beneficiary in a chain of trusts may have resulted in an element of double taxation.

Detailed explanation of new law

Overview of the cost base adjustment rules

10.8 Section 104-70 of ITAA 1997 reduces the cost base of a unit or fixed interest in a trust where the trustee pays a non-assessable amount to the beneficiary. If the payment is more than the beneficiary's cost base, a capital gain is made. If the beneficiary has owned the unit or interest in the trust for at least 12 months, the beneficiary may claim the CGT discount.

10.9 Section 104-70 applies to non-assessable amounts which consist of 2 elements:

the CGT concession amount; or
the return of the trust's cost base for the asset disposed of.

10.10 The following payments are CGT concession amounts:

the CGT discount;
frozen indexation; or
the small business 50% reduction.

10.11 The new provisions reduce the effect of section 104-70 in some cases where a CGT concession amount is paid to a beneficiary. Payments of other non-assessable amounts continue to be dealt with under section 104-70 and are not affected by the new provisions.

Treatment of a payment to a beneficiary of a CGT concession amount

10.12 These amendments recognise that section 104-70 may incorrectly calculate the non-assessable part of a payment to a beneficiary when the trustee has claimed any of the CGT concessions. Section 104-71 determines the maximum reduction (the maximum excluded amount ) necessary to reflect the difference between those CGT concessions claimed by the trustee and the CGT concessions able to be claimed by the beneficiary (the concession amount ). The concession amount also reflects capital losses claimed by the beneficiary. [Schedule 4, item 4, subsections 104-71(1) to (3)]

10.13 In effect, these rules may exclude the following amounts from the non-assessable part:

the amount of the capital gain deemed to be made by the beneficiary after allowing the beneficiary the CGT concessions;
the full amount of capital losses applied by the beneficiary in claiming the CGT concessions; and
any previous payments caught within CGT event E4.

10.14 If the payment is not more than the capital gain component of the income of the trust, these provisions can have no effect, as there is no non-assessable part. If the trustee has only claimed indexation of the cost base in calculating the capital gain in the trust, these provisions can have no effect, because there is no difference between the CGT concessions claimed by the trustee and those able to be claimed by the beneficiary.

Calculation of the reduction

10.15 The amount of the reduction depends on a comparison of the payment and the maximum excluded amount. If the payment is less than the maximum excluded amount, the non-assessable part is reduced. If the payment is more than the maximum excluded amount, these provisions have no effect, and there is no reduction of the non-assessable part. [Schedule 4, item 4, subsection 104-71(4) to (6)]

10.16 The effect of these provisions is to modify the calculation of the non-assessable part for the purposes of section 104-70 where the payment by the trustee is in the range between the concession amount for the trustee and the maximum excluded amount. It is only within this range that the provisions do not appropriately reflect the difference between the CGT concessions claimed by the trustee and those able to be claimed by the beneficiary.

10.17 Previous payments to the beneficiary from the proceeds of the trust gain to which section 104-70 applied, reduces the concession amount and the maximum excluded amount. [Schedule 4, item 4, subsection 104-71(7) to (9)]

Chains of trusts

10.18 If payments out of the concession amount pass through one or more trusts before being paid to the beneficiary at the end of the chain of trusts, there is a potential for double taxation from applying CGT event E4 to each trustee in the chain.

10.19 This inappropriate outcome is removed by disregarding the capital gain from a CGT event E4 happening to a beneficiary that is the trustee of a fixed trust, if the gain results from the payment out of the concession amount flowing through the trusts. Cost base adjustments under CGT event E4 will continue to be made. A payment out of the concession amount can only result in a capital gain under CGT event E4 if the beneficiary is not the trustee of a fixed trust. [Schedule 4, item 4, subsection 104-72]

Examples

10.20 Examples 10.1 and 10.2 illustrate how sections 104-70 and 104-71 operate where a beneficiary receives a payment out of the proceeds of a trust gain. They cover the payment of the trust gain amount attributable to the beneficiary and the payment of the capital gain component of the income of the trust attributable to the beneficiary.

Example 10.1 The Marlin Unit Trust made a capital gain of $1,800 in Year 1 that was eligible for the 50% CGT discount and the small business 50% reduction. Its net capital gain was calculated as:

Trust gain $1,800
less 50% CGT discount $900
$900
less Small business 50% reduction $450
Net capital gain $450
Peter Marlin owns one of the 3 units in the trust. The cost base of the unit, which he has owned for 5 years, is $250. Peter is presently entitled to the income of the trust in Year 1. Peter also has a capital loss of $100 in Year 1.Peter's share of the net capital gain is $150 (1/3 of $450). His notional gain is $600(4 * $150) (paragraph 115-215(3)(c)). Peter calculates his capital gain in Year 1 as:
Notional gain $600
less Capital loss $100
$500
less 50% CGT discount $250
$250
less Small business 50% reduction $125
Net capital gain $125
The trustee pays Peter $600 in Year 2 and advises him that this amount is from the proceeds of the trust gain made in Year 1.Peter calculates his capital gain from CGT event E4 in Year 2 as follows:
Payment received $600
less Capital gain component of the trust distribution $150
Original non-assessable part

(Section 104-71 applies to this amount)

$450
less Excess of CGT concessions (CGT concessions allowed in trust ($450) less CGT concessions allowed to Peter ($375)) $75
Non-assessable part $375
less Cost base $250
$125
less 50% CGT discount $63
Capital gain $62

Example 10.2 Assume the same facts as in Example 10.1 except that the trustee pays Peter $150 in Year 2.Peter calculates the effect of CGT event E4 in Year 2 as follows:

Payment received $150
less Capital gain component of the trust distribution $150
Original non-assessable part nil
As Peter has no original non-assessable part there is no adjustment to the cost base of his unit.

10.21 Example 10.3 illustrates how sections 104-70 to 104-72 operate where a beneficiary who is the trustee of a fixed trust in a chain of trusts, receives a payment out of the proceeds of a trust gain.

Example 10.3 Assume the same facts as in Example 10.1 except that the beneficiary of the Marlin Unit Trust is the Snapper Fixed Trust and that Peter is a beneficiary of the Snapper Fixed Trust and the cost base of his unit is $200.Snapper Fixed Trust's share of the net capital gain is $150 (1/3 of $450). Its notional gain is $600(4 * $150) (paragraph 115-215(3)(c)). The Snapper Fixed Trust calculates its capital gain in Year 1 as:

Notional gain $600
less 50% CGT discount $300
$300
less Small business 50% reduction $150
Net capital gain $150
The trustee pays the Snapper Fixed Trust $600 in Year 2 and advises it that this amount is from the proceeds of the trust gain made in Year 1.The Snapper Fixed Trust calculates its capital gain from CGT event E4 in Year 2 as follows:
Payment received $600
less Capital gain component of the trust distribution $150
Original non-assessable part

(Section 104-71 applies to this amount)

$450
less Excess of CGT concessions (CGT concessions allowed in Marlin Unit Trust ($450) less CGT concessions allowed to Snapper Fixed Trust ($450)) nil
Non-assessable part $450
less Cost base $250
Capital gain $200
The capital gain is disregarded as the beneficiary is the trustee of a fixed trust and the capital gain resulted from the payment of CGT concessions relating to a trust gain made by the Marlin Unit Trust. However, the cost base of the unit is reduced to nil.Peter's share of the net capital gain of the Snapper Fixed Trust is $150 (1/3 of $450). His notional gain is $600(4 * $150) (paragraph 115-215(3)(c)). Peter calculates his capital gain in Year 1 as:
Notional gain $600
less Capital loss $100
$500
less 50% CGT discount $250
$250
less Small business 50% reduction $125
Net capital gain $125
The trustee of the Snapper Fixed Trust pays Peter $600 in Year 2 and advises him that this amount is from the proceeds of the trust gain made in Year 1.Peter calculates his capital gain from CGT event E4 in Year 2 as follows:
Payment received $600
less Capital gain component of the trust distribution $150
Original non-assessable part

(Section 104-71 applies to this amount)

$450
less Excess of CGT concessions (CGT concessions allowed in trust ($450) less CGT concessions allowed to Peter ($375)) $75
Non-assessable part $375
less Cost base $200
$175
less 50% CGT discount $88
Capital gain $87

Application and transitional provisions

10.21 The amendments made by this Schedule apply to assessments for the income year including 21 September 1999 and all later income years, for a CGT event happening after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999. [Schedule 4, item 5]

Consequential amendments

10.22 Notes are added to subsections 104-70(1) and 104-70(4) referring to the provisions that affect the calculation of the non-assessable part [Schedule 4, item 1 and 2] . Subsection 104-70(7A) is repealed as sections 104-71 and 104-72 now deal with the rules contained in this subsection [Schedule 4, item 3] .

Chapter 11 - Scrip for scrip roll-over

Outline of Chapter

11.1 This Chapter explains the amendments, to be made by Schedule 5 to this Bill, relating to the CGT scrip for scrip roll-over provisions in Subdivision 124-M of the ITAA 1997. Subdivision 124-M was inserted in the ITAA 1997 by the Capital Gains Tax Act, which received Royal Assent on 10 December 1999.

11.2 Subdivision 124-M allows a CGT roll-over when original equity interests (original interests) in one entity are exchanged for replacement equity interests (replacement interests), typically because of a takeover. This roll-over defers recognition of any capital gain (but not a capital loss) until a CGT event happens to the replacement interests.

Context of Reform

11.3 The Government introduced the scrip for scrip roll-over to remove an impediment to corporate acquisition activity in Australia.

11.4 In Treasurer's Press Release No. 87 of 10 December 1999, the Treasurer indicated that the Government was assessing options to deal with the cost base of original interests to the acquiring entity. It also indicated that the Government was considering submissions on other aspects associated with the implementation of the roll-over.

Summary of new law

Extending the roll-over

11.5 The amendments will extend the circumstances in which scrip for scrip roll-over is available.

11.6 The amendments will ensure that roll-over may be available for takeovers undertaken by way of a scheme of arrangement where that scheme may not have been covered under the current law.

11.7 If the acquiring entity is a member of a wholly-owned group, roll-over will also be extended to situations ('downstream' acquisitions) where the original interest holder receives replacement interests in the ultimate holding company of the wholly-owned group.

11.8 A limited form of roll-over will be introduced for pre-CGT original interests, if the disposal of the interest results in a capital gain under CGT event K6. That event applies on the disposal of interests in certain private companies and trusts if at least 75% of the net value of the company or trust is represented by post-CGT acquired property.

Cost base rules for acquiring entity

11.9 The amendments will provide cost base rules for interests acquired by an acquiring entity.

11.10 The normal cost base rules will generally apply to determine the acquisition cost of interests acquired by an acquiring entity in the original entity. There will be an exception where an interest holder, together with associates, has either:

a 30% or more stake in the original entity and in the entity in which the replacement interest is issued; or
at least part of an 80% or more holding common to both entities (but only if both entities are not widely-held).

11.11 In these cases, if the original interest holder and the replacement entity jointly elect for the roll-over, the cost base is to be transferred from the original interest holders to the acquiring entity.

11.12 The rules are modified if an acquiring entity is an original interest holder at the start of the arrangement.

Roll-overs involving non-resident companies

11.13 The amendments will limit the availability of roll-over in an arrangement where both the acquiring and original companies are non-residents.

11.14 Scrip for scrip roll-over for arrangements involving a non-resident original company and a non-resident acquiring company will only be available if:

the original company has at least 300 members; or
the acquiring company has at least 300 members or is a wholly-owned subsidiary of a non-resident ultimate holding company that has at least 300 members.

Other changes

11.15 The amendments will also make several technical changes and clarifications.

Comparison of key features of new law and current law
New Law Current Law
The roll-over will clearly apply to schemes of arrangement and cases where there is a cancellation of original interests and a new issue of interests. The current law may not allow the roll-over in these cases.
The roll-over will be available in certain downstream acquisitions. At present, an original interest must be exchanged for an interest in the acquiring entity itself.
There will be a limited form of roll-over arising from the exchange of a pre-CGT interest if a gain arises under CGT event K6. There is currently no roll-over in these circumstances.
Special cost base rules for interests acquired by the acquiring entity will be introduced. Under the current law, these interests have an acquisition cost equal to the market value of interests issued by the acquiring entity in return for the original interests (this is often equal to the market value of the original interests).
Scrip for scrip roll-over will be allowed for arrangements involving a non-resident original company and a non-resident acquiring company but only if:

the original company has at least 300 members; or
the acquiring company has at least 300 members or is a wholly owned subsidiary of a non-resident ultimate holding company that has at least 300 members.

Scrip for scrip roll-over is allowed for all arrangements involving a non-resident original company and a non-resident acquiring company.

Detailed explanation of new law

11.16 Currently, section 124-780 deals with company and trust interests. The amendments will split the provision into section 124-780 dealing with company interests and new section 124-781 dealing with trust interests.

Extending and clarifying the scope of the roll-over

Extension of roll-over

11.17 Under the current law, an acquiring entity must make 'an offer' to acquire specified interests in the original entity (existing paragraph 124-780(1)(b)). It has been argued that this requirement is inappropriate because it means that roll-over will not apply, for example, where:

a takeover is achieved by way of a scheme of arrangement, as there is generally no 'offer' by the acquiring entity; or
a transaction involves the cancellation/redemption of interests held by the original interest holders, as there is no acquisition by the acquiring entity.

11.18 The amendments will ensure that the roll-over does clearly apply in these cases.

11.19 An acquiring entity will no longer be required to make an offer. It will now be sufficient that the exchange be in consequence of an arrangement that results in an entity (an acquiring entity) becoming the owner of 80% or more of the specified interests in the original entity. In the context of a wholly-owned group of companies, the arrangement must result in a company in the group (an acquiring entity) increasing the percentage of voting shares that it owns in the original entity and the members of the group becoming the owners of 80% or more of those interests. [Schedule 5, item 4, paragraphs 124-780(2)(a) and 124-781(2)(a)]

11.20 An increase in the ownership of interests in an entity can result from an acquisition of additional interests or the cancellation of interests held by others. If an entity (or group) held 80% or more of the relevant interests prior to the start of the arrangement, roll-over will be available if that holding is increased.

11.21 For company cases, the arrangement must be one in which at least all owners of voting shares in the original entity can participate [Schedule 5, item 4, paragraph 124-780(2)(b)] . For trust cases, it must be one in which at least all owners of trust voting interests (or, where there are no voting interests, of units or other fixed interests) in the original entity can participate. [Schedule 5, item 4, paragraph 124-781(2)(b)]

11.22 Participation in the arrangement must have been on substantially the same terms for all of the owners of interests of a particular type in the original entity. [Schedule 5, item 4, paragraphs 124-780(2)(c) and 124-781(2)(c)]

11.23 What constitutes a single arrangement is a question of fact. Relevant factors in determining whether what takes place is part of a single arrangement would include, but not be limited to, whether there is more than one offer or transaction, whether aspects of an overall transaction occur contemporaneously, and the intention of the parties in all the circumstances as evidenced by objective facts. The following examples illustrate this point.

Example 11.1 Green Bottles Ltd proposes a scrip for scrip takeover for Tincans Ltd. Tincans has 2 classes of voting shares and options on issue. In respect of each type of interest Green Bottles makes an identical takeover offer to each holder. Green Bottles acquires 62% of the shares in Tincans through acceptances of the offer. Roll-over is not available to the shareholders in Tincans as Green Bottles did not acquire 80% of the shares under this arrangement.Six months later Green Bottles makes a second scrip for scrip offer to Tincans shareholders (a new arrangement) and as a consequence increases its shareholding to 85%. Co-incidentally the terms of the offer are substantially the same as the original arrangement. The shareholders in Tincans who accepted the offer under the second arrangement are eligible for scrip for scrip roll-over. Roll-over is still not available for the shareholders that participated in the first arrangement as the 80% threshold was not reached as a result of that arrangement even though both arrangements were on substantially the same terms.

Example 11.2 Jumbo Ltd makes a takeover offer for shares in Hippo Ltd (both are resident companies listed on the Australian Stock Exchange). Jumbo offers 2 of its shares for every 10 Class A Hippo shares and 1 share for every 20 Class B Hippo shares. As the offer in respect of both classes of shares are made concurrently they are considered to form part of one arrangement for the purposes of the roll-over.Jumbo obtains ASIC approval to establish a nominee sale arrangement for odd-lot shareholders. Shares in Jumbo that would otherwise be allocated to former Hippo shareholders are allocated to a nominee for sale if the shares do not constitute a marketable parcel. This does not prevent the arrangement being on substantially the same terms for all shareholders of a particular type.

Roll-over extended to 'downstream' acquisitions in company cases

11.24 At present, the law requires that taxpayers exchange their shares in the original entity for shares in the acquiring entity.

11.25 It is said to be common commercial practice, however, for a subsidiary of a group of companies to acquire the shares in the original entity, with shares in its ultimate holding company being issued as consideration. These arrangements are known as 'downstream' acquisitions.

11.26 It has been decided that scrip for scrip roll-over should be available for certain 'downstream' acquisitions. The amendments will ensure that the roll-over is available if an acquiring entity is a 100% subsidiary of another member of its wholly-owned company group and the replacement interest is a share or other relevant interest in the ultimate holding company. [Schedule 5, item 4, paragraph 124-780(3)(c)]

11.27 A consequential amendment is to be made to ensure that roll-over is not available for a non-resident who acquires replacement interests in a non-resident ultimate holding company entity. [Schedule 5, item 7, subsection 124-795(1)]

11.28 This measure is limited to companies. Its extension to trusts will be reviewed in association with the introduction of the consistent entity regime.

Limited form of roll-over for pre-CGT original interests

11.29 Roll-over was introduced to alleviate cash flow problems that arose in relation to meeting a tax liability resulting from a scrip for scrip transaction. Roll-over was not extended to the disposal of an original interest that was acquired prior to 20 September 1985 because there is generally no liability in these cases.

11.30 However, a liability can arise if the disposal of a pre-CGT original interest results in a capital gain under CGT event K6. That event applies on the disposal of interests in certain private companies and trusts if at least 75% of the net value of the company or trust is represented by post-CGT acquired property.

11.31 A modified form of roll-over is to be provided in this case. The roll-over will:

disregard a capital gain under CGT event K6 to the extent that roll-over would have been available had the original interest been acquired on or after 20 September 1985 [Schedule 5, item 2, subsection 104-230(10)] ;and
effect a cost base reduction of the replacement interests by the amount of the CGT event K6 gain that is disregarded [Schedule 5, item 10, subsection 124-800(2)] .

Cost base of interests acquired by acquiring entity

Why are cost base rules required?

11.32 At present Subdivision 124-M does not specify the first element of the cost base (i.e. acquisition cost) of an original interest in the hands of the acquiring entity. The effect of the general CGT cost base rules is that usually these interests will have an acquisition cost equal to their market value.

11.33 A 'step-up' to market value for an acquisition cost where no capital gain has been recognised creates a structural CGT issue involving potential tax deferral. For example, there is a deferral opportunity because the acquiring entity (in which original interest holders have an interest) can choose to sell the interests in the original trust or company (that have a market value cost base) rather than their underlying assets (on which a greater gain may be realised). This would allow the original interest holders to benefit from the reinvested untaxed gains attributable to gains on the assets of the original entity. Other jurisdictions (USA and Canada) do not allow a market value cost base.

11.34 The Treasurer's Press Release No. 87 of 10 December 1999 recognises that a market value cost base for the acquiring entity is generally not appropriate where a capital gain is not recognised for the transfer. However, it also recognises that requiring a cost base transfer from original interest holders may impose significant compliance costs, especially where the original entity is widely held.

11.35 The proposed amendments will require a cost base transfer only from original interest holders that are likely to have some influence over the acquiring entity.

How will the cost base rules operate?

11.36 Generally, the first element of the cost base of interests acquired by an acquiring entity will be determined under the general rules about cost base in Divisions 110 and 112 of the ITAA 1997. However, a cost base transfer will apply to interests in respect of which a roll-over was obtained in 2 cases only.

11.37 The first case is where, on an associate-inclusive basis, an entity has a 30% or more stake (significant stake) in the original entity before the arrangement and in the entity in which its replacement interests are held just after the arrangement. [Schedule 5, item 4, subsection 124-782(1) and subsections 124-783(1), (6) and (7)]

11.38 For a widely-held entity (generally one with 300 or more shareholder/beneficiaries), it will be assumed that no interest holder has a 'significant stake' in it if that assumption is reasonable. It would not be reasonable to make that assumption if, for example, evidence is available from which a reasonable person would conclude that there may be an interest holder with a 'significant stake'. [Schedule 5, item 4, subsection 124-783(8)]

Example 11.3 Yellow Co has 3 million ordinary shares on issue of which Brown Co holds 1 million. Mr Brown owns all the shares in Brown Co.A 1:3 takeover offer is made by Green Co for all the ordinary shares in Yellow Co. Before the takeover, Green Co has 1 million ordinary shares on issue. Mr Brown owns 600,000 ordinary shares in Green Co. Brown Co receives 333,333 shares in Green Co as part of the takeover arrangement.Immediately before the takeover arrangement, Brown Co owned 33% of the original entity Yellow Co. This is a significant stake.Immediately after the takeover arrangement, Brown Co and Mr Brown (an associate of Brown Co) together own 933,333 shares out of the 2 million shares on issue in Green Co. Again this is a significant stake.In order for roll-over to be obtained on the transfer of the shares by Brown Co to Green Co, there must be a joint roll-over choice by these companies. If this occurs, the cost base of the shares for Brown Co will become the first element of their cost base for Green Co.

Example 11.4 If Mr Brown had only 10,000 shares in Green Co just before the takeover arrangement, then the significant stake test would not be satisfied. Although Brown Co owned a 33% stake in Yellow Co before the arrangement, Brown Co and Mr Brown would own only 343,333 shares out of the 2 million shares in the acquiring company (Green Co) immediately thereafter. This is less than 30%. There would be no cost base transfer in this case.

11.39 An additional significant stake test applies if an acquiring entity for an arrangement is an original interest holder. In this case any other original interest holder may also be a significant stakeholder if:

it had a significant stake in the original entity before the arrangement; and
just after the arrangement it is an associate of the entity in which it holds replacement interests.

[Schedule 5, item 4, subsection 124-783(2)]

11.40 This test operates on an equivalent basis to the primary test taking into account associate interests that may not be appropriately counted where the acquiring entity is an original interest holder.

Example 11.5 Shares in Adventure Co are held as follows:

Atlantis Co - 45%;
Euphoria Co - 25%; and
widely-held by 500 unrelated entities - 30%.

Ivory Tower Co owns 90% of the shares in Atlantis Co and 75% of the shares in Euphoria Co. Atlantis Co makes an offer to acquire shares it does not hold in Adventure Co in exchange for shares in Atlantis Co.Atlantis Co is an associate of Euphoria Co just before the arrangement (see section 318 of the ITAA 1936). On an associate-inclusive basis Euphoria Co had a 70% stake (45% 25%) in Adventure Co prior to the arrangement. This is a significant stake.If Euphoria Co and Atlantis Co jointly elect for roll-over on Euphoria's shares in Adventure Co, their cost base will be transferred to Atlantis Co regardless of whether or not it has a significant stake in Atlantis Co immediately after the arrangement. This is because Euphoria Co and Atlantis Co are associates just after the arrangement.As Adventure Co is widely-held just before the arrangement the common stake test (see paragraph 11.41) will not apply.

11.41 The second case where a cost base transfer may be required is where an interest is part of an 80% or more common holding (a common stake) of interests (determined on an associate-inclusive basis) in a non-widely-held original entity just before the arrangement and in a non-widely-held replacement entity just after the arrangement. [Schedule 5, item 4, subsection 124-782(1) and subsections 124-783(3), (5), (9) and (10)]

Example 11.6 Charles, Ian, Peter and David, who are unrelated businessmen, each holds 25% of the 100 units in a small unit trust (Print Trust) which runs a printing business. Each unit has a market value of $250.They wish to reorganise the business by setting up a 'holding' trust (Hold Trust) that they, and their spouses, will control and in which they will all have an investment.Hold Trust is capitalised with $10 million and 50 units are issued to each of the 4 businessmen and their spouses. The trustee of Hold Trust makes an offer to each of Charles, Ian, Peter and David to acquire their units in Print Trust in exchange for units in Hold Trust. The market value of the replacement units is substantially the same as the original units.None of the stakes held by Charles, Ian, Peter and David qualifies as a significant stake.However, they each have a common stake in Print Trust and Hold Trust, because together they, with their associated spouses, have 100% of the rights to income and capital of both trusts.Provided Charles, Ian, Peter and David elect with Hold Trust for roll-over, the first element of cost base of their replacement interests in Hold Trust will be the cost base of their original interests in Print Trust. The first element of Hold Trust's interests in Print Trust will be the cost base of those same original interests in Print Trust.

11.42 An additional test applies if an acquiring entity for an arrangement is an original interest holder. Reflecting the fact that in this case direct and indirect interests in the original entity are maintained, another original interest holder (i.e. apart from the acquiring entity) may also have a common stake if the:

original entity is not widely-held just before the arrangement; and
replacement entity is not widely-held just after the arrangement.

[Schedule 5, item 4, subsection 124-783 (4) and (5)]

Example 11.7 Adventure Co has 3 non-associated shareholders:

Atlantis Co with 70% of its ordinary shares;
Euphoria Co with 15% of its ordinary shares; and
Capable Co with 15% of its ordinary shares.

All the shares in Atlantis Co are held by Ivory Tower A Co and B Co.Atlantis Co makes an offer to Euphoria Co and Capable Co to buy out their minority interests in Adventure Co in exchange for shares in Atlantis Co. Atlantis Co obtains a 15% holding from Euphoria Co and 5% from Capable Co, taking it to an 90% interest in Adventure Co.Neither Euphoria Co nor Capable Co had a significant stake in Adventure Co prior to the arrangement so the significant stakeholder test will not apply.However, Adventure Co was not widely-held before the arrangement and Atlantis Co was not widely-held after the arrangement. Because Atlantis Co was an original interest holder, there will be a cost base transfer in respect of the shares acquired from Euphoria Co and Capable Co.

11.43 In determining whether the above percentage tests for cost base transfer are met, all pre and post-CGT interests will be taken into account. However, as noted at paragraph 11.36 there is a cost base transfer only for those interests for which roll-over is obtained.

11.44 An original interest holder with a 'significant stake' or 'common stake', can obtain the scrip for scrip roll-over only where a joint election is made with the replacement entity in respect of the interest. While cost base transfer is not an issue that will directly affect the replacement entity in a downstream arrangement, it is considered appropriate to require it (as the ultimate holding company of the wholly-owned group) to make the election. The ultimate holding company will be part of the overall arrangement and would be expected to consult closely with the acquiring entity, or entities if more than one. In some cases involving cancellation of interests there may be more than one acquiring entity and the original interest holder would be unable to determine with which entity it was required to make a joint election. [Schedule 5, item 4, paragraphs 124-780(3)(d) and 124-781(3)(c)]

11.45 If a joint roll-over election is made, there will be a transfer of cost base from the original interest holder to the acquiring entity. The joint election will not need to be lodged with the Commissioner but must be in writing and include the interest holder's cost base details so that the acquiring entity can properly determine its acquisition cost. [Schedule 5, item 4, paragraphs 124-780(3)(e) and 124-781(3)(d)]

11.46 If a joint election is not made in respect of an interest forming part of a significant or common stake, scrip for scrip roll-over will not apply to it and the acquiring entity will determine its first element of cost base for it under the normal cost base rules. The acquiring entity may indicate to interest holders that have a significant stake or common stake its unwillingness to make a joint election at the start of the scrip for scrip arrangement. This may occur, for example, because the acquiring entity does not want to take on a potential tax liability that belonged to the holder of a significant stake or common stake.

11.47 For a downstream acquisition where the acquiring subsidiary issues debt or equity to the ultimate holding company, the acquisition cost to the ultimate holding company for that debt or equity will be based on the acquisition cost (as set out in paragraphs 11.36 to 11.46) for the shares in the original company that the subsidiary acquires. [Schedule 5, item 4, section 124-784]

Example 11.8 Target Co has 3 associated shareholders Able Co, Better Co and Competent Co that each holds 300 shares. Each share has a cost base of $200 and a market value of $333.Sub Co (a 100% subsidiary of Parent Co which holds 200 shares) makes a 1:3 offer to acquire all the shares in Target Co in exchange for shares in Parent Co. Before the takeover, Parent Co is worth $300,000 and is owned by 2 shareholders, Dependable Co and Efficient Co, each with 150 shares. Sub Co is worth $300,000. As part of the arrangement, Sub Co issues 200 shares to Parent Co making the total number of shares on issue to Parent Co 400.Able Co, Better Co and Capable Co each has (on an associate inclusive basis) a significant stake in Target Co before the arrangement and in Parent Co after the arrangement. They choose, with Parent Co, for roll-over.Each of the 900 shares acquired by Sub Co obtains a first element of cost base of $200. The total of these cost bases ($180,000) is reasonably apportioned to the 200 shares issued by Sub Co to Parent Co as follows: $180,000/200 = $900 per share.

11.48 In a downstream arrangement, a loan may be recorded by the ultimate holding company to the acquiring entity representing the value of the replacement interests issued by it. Under the cost base transfer rules, the cost base allocated to the debt (an asset of the ultimate holding company) may be less than its market value. If that debt is assigned to an independent third party for cash, so that the group indirectly realises the value of the original entity, it is not inappropriate that a capital gain arises on that transaction. However, if the loan is merely repaid by the acquiring entity, any capital gain made on the debt from that repayment is disregarded. This is appropriate because, within the group, there has been no realisation of any value of the original entity. [ Schedule 5, item 4, subsection 124-784(3)]

Limitation of scrip for scrip roll-over for arrangements involving non-resident companies

11.49 Currently, scrip for scrip roll-over is available for arrangements involving a non-resident original company and a non-resident acquiring company. Allowing roll-over for these arrangements could, however, facilitate the tax free repatriation of low taxed profits under the exemption for foreign dividends (section 23AJ of the ITAA 1936).

11.50 The exemption for foreign dividends is intended to reduce compliance costs under the foreign tax credit system by exempting from tax dividends received by an Australian company where little or no Australian tax would be payable after allowing a credit for foreign taxes. As such, it follows that the exemption for foreign dividends is intended to apply only to dividends paid from profits that have been taxed without concession in a listed comparable tax country.

11.51 The integrity of the exemption for foreign dividends could be compromised if scrip for scrip roll-over is allowed for arrangements involving closely-held foreign companies. Scrip for scrip roll-over could, for instance, be used to channel low taxed profits through a listed comparable tax country to obtain the exemption for foreign dividends.

Availability of the roll-over to be limited

11.52 To protect the exemption for foreign dividends, scrip for scrip roll-over for arrangements involving a non-resident original company and a non-resident acquiring company will only be available if:

the original company has at least 300 members; or
the acquiring company has at least 300 members or is a wholly-owned subsidiary of a non-resident ultimate holding company that has at least 300 members.

[Schedule 5, item 9, subsections 124-795(4) and (5)]

11.53 The roll-over will not be limited, however, where there is a cancellation of interests in the original company without new interests being issued to the acquiring company. Only where the acquiring company acquires an interest in the original company as a result of the arrangement will the roll-over be limited.

11.54 Roll-over will continue to be available for entities with over 300 members because the risk of abuse of the exemption for foreign dividends is lower where entities are not closely-held.

Foreign source income review

11.55 In Treasurer's Press Release No. 74 of 11 November 1999, it was announced that a comprehensive review will be undertaken of the foreign source income rules. It is proposed that the application of the scrip for scrip roll-over to arrangements involving non-resident companies be further considered as part of that review.

Technical amendments

11.56 This Bill makes a number of minor technical amendments to clarify the scope of and correct unintended outcomes arising from the current scrip for scrip roll-over provisions

Chess Units of Foreign Securities

11.57 Chess Units of Foreign Securities (CUFS) are a type of depositary interest developed by the Australian Stock Exchange to facilitate the transferring and holding of foreign securities.

11.58 CUFS are units of beneficial ownership in foreign securities. Legal title in the securities is held by an Australian depositary entity on behalf of and for the benefit of the CUFS holders.

11.59 For the purposes of scrip for scrip roll-over, the holder of a CUFS is to be treated as the owner of the security that the CUFS represents. For example, the exchange of a share in a company for a CUFS that relates to a share in another company may qualify for roll-over. [Schedule 5, item 4, subsections 124-780(6) and 124-781(5)]

Non arm's-length dealings

11.60 The roll-over conditions that apply in certain non arm's-length dealing are to be amended to provide:

that the market value of the capital proceeds for the exchange be at least substantially the same as the market value of the original interest; and
the replacement interests have the same kind of rights and obligations as the original interests.

[Schedule 5, item 4, subsections 124-780(5) and 124-781(4)]

11.61 These amendments will make the conditions easier to satisfy in practice without detracting from the integrity they give to the scrip for scrip measures.

Interaction with other roll-overs

11.62 The explanatory memorandum to the Capital Gains Tax Act that introduced Subdivision 124-M indicated at paragraph 2.47 that scrip for scrip roll-over does not apply in respect of a CGT event that qualifies for roll-over under Subdivision 124G.

11.63 The law will now make it clear that roll-over is not available in this case or in respect of a transaction that qualifies for roll-over under Division 122. [Schedule 5, item 8, subsections 124-795(3)]

11.64 Where the circumstances are such that roll-over would ordinarily be sought under those provisions, those provisions and not Subdivision 124-M should apply. Attempts to 'disqualify' arrangements from relief under those provisions (to secure a better, or different, relief under Subdivision 124-M) may attract the general anti-avoidance provisions in Part IVA of the ITAA 1936.

Partial roll-over where ineligible proceeds received

11.65 Only a partial roll-over is available if an original interest holder receives something (referred to in the legislation as 'ineligible proceeds') other than a replacement interest. The legislation will be amended to make it clearer that the 'ineligible proceeds' are not limited to cash. [Schedule 5, item 5, subsections 124-790(1)]

11.66 As there is no partial roll-over for an original interest that would have given rise to a capital loss there is no need to provide rules for determining the reduced cost base of the ineligible part. Therefore, subsection 124-790(3) is to be repealed. [Schedule 5, item 6, repealed subsection 124-790(3)]

Cost base of interest received for pre-CGT interest

11.67 The cost base rules for interests acquired in exchange for pre-CGT interests arguably only applies if the interest holder qualifies for roll-over in respect of a post-CGT interest. Section 124-800 is to be amended to make it clear that it applies to an original interest holder who exchanges pre-CGT original interests whether or not the interest holder otherwise qualifies for roll-over. [Schedule 5, item 10, subsection 124-800(1)]

Assets having the necessary connection with Australia

11.68 The note in subsection 124-795(1) of the ITAA 1997 indicates that if a non-resident's replacement interest is an interest in an Australian resident company or trust, it is treated as having the 'necessary connection with Australia'. This ensures that the replacement asset is a taxable asset when the non-resident later disposes of it.

11.69 Whilst item 9 in the table in section 136-25 of the ITAA 1997 indicates that certain replacement interests are treated as having the necessary connection with Australia, the operative provision in section 136-10 does not refer to this category of asset. Section 136-10 is to be amended so that a capital gain or loss can arise when a CGT event happens to an asset listed in item 9 of section 136-25. [Schedule 5, items 13 to 29, section 136-10]

11.70 Section 136-25 (item 9) will also be amended to include relevant replacement interests comprising options, rights and similar interests. [Schedule 5, item 30, section 136-25]

Application and transitional provisions

11.71 With the exception of the measure dealing with non-resident companies, the amendments will apply to CGT events that happen on or after 10 December 1999 - the commencement date of the scrip for scrip roll-over. The amendments were foreshadowed by Treasurer's Press Release No. 87 of the 10 December 1999 and generally will extend the scope of the roll-over. [Schedule 5, subitem 34(1)]

11.72 The amendment to limit the availability of roll-over where non-resident companies are involved will apply to CGT events that occur on or after 13 April 2000. [Schedule 5, subitem 34(2)]

11.73 Original interest holders who have obtained a roll-over under Subdivision 124-M before the date on which this Bill receives Royal Assent and who, as a result of amendments contained in this Bill are required to inform the acquiring entity of their cost base, must do so within 28 days from the day on which this Bill receives Royal Assent. [Schedule 5, item 31]

Consequential amendments

11.74 Amendments are made to the ITAA 1997 to reflect the changes that are being made to the scrip for scrip roll-over.

11.75 A note has been added to subsection 104-25(5) as a signpost to subsection 124-784(3) which disregards a capital gain in certain circumstances. [Schedule 5, item 1, subsection 104-25(5)]

11.76 Section 112-53 is inserted as a signpost to cost base rules in Subdivision 124-M. [Schedule 5, item 3, section 112-53]

11.77 Section 124-805 is deleted as the definition of 'trust voting interest' is now contained in subsection 124-781(6) [Schedule 5, item 11, repealed section 124-805] . The definition of trust voting interest in subsection 995-1(1) is also amended to reflect this change [Schedule 9, item 61, subsection 995-1(1)] .

11.78 Section 124-810 is amended as the rules it contains now operate for the whole of Subdivision 124-M. [Schedule 5, item 12, subsections 124-810(1) and (2)]

11.79 Subsection 995-1(1) is amended to include a definition of 'ultimate holding company'. [Schedule 9, item 62, subsection 995-1(1)]

11.80 Amendments are also made to subsections 396(3) and 406(3) of the ITAA 1936 to ensure a controlled foreign company is treated as a non-resident for the purpose of determining whether any interests it holds in a company or trust, as a result of choosing scrip for scrip roll-over, have the necessary connection with Australia. [Schedule 5, items 32 and 33, subsections 396(3) and 406(3)]

Chapter 12 - PAYG instalments anti-avoidance rules

Outline of Chapter

12.1 This Chapter explains the amendments to the PAYG instalments regime which are contained in Schedule 7 to this Bill.

12.2 The PAYG instalments regime replaces the existing COIN and provisional tax systems with effect for the 2000-2001 income year and later income years. Broadly, the regime ensures that entities pay:

quarterly or annual instalments of their tax liabilities that reflect their current trading and investment conditions;
annual instalments based on last year's tax liabilities; or
quarterly instalments based on last year's tax liabilities and a GDP adjustment.

12.3 This Bill will amend Part 2-10 of Schedule 1 to the TAA 1953 to provide PAYG instalments anti-avoidance rules and to clarify the object of the Part.

12.4 Unless otherwise stated, legislative references are to provisions in Schedule 1 to the TAA 1953.

Context of reform

12.5 Business and investors currently pay instalments of their expected tax liabilities through the COIN or provisional tax systems. For example, companies, superannuation funds and some corporate unit trusts, public trading trusts and corporate limited partnerships pay tax instalments under the COIN system. Some trustees and individuals who carry on business or who have investment income are required to pay tax instalments under the provisional tax system.

12.6 Those in the COIN system mostly pay their tax instalments after the income year in which their income is earned. Taxpayers in the provisional tax system pay instalments of tax based on last year's tax and a provisional tax uplift factor within the income year.

12.7 The PAYG instalments regime is designed to achieve several aims including:

to get business entities, both individuals and companies, paying their tax liabilities at the same time;
to allow all entities with fluctuating incomes to make payments more closely aligned with their income receipts and trading conditions; and
subject to 2 limited exceptions, to collect instalments after the end of each quarter of the income year, based on the income earned in the quarter.

Summary of new law

12.8 The proposed anti-avoidance rules will support the integrity of the PAYG instalments regime. Further, the statement of the object of the PAYG instalments regime will be stated more clearly.

12.9 The PAYG instalments anti-avoidance rules are designed to apply where it would be concluded, on an objective view of a particular scheme and the surrounding circumstances, that an entity's sole or dominant purpose in entering into or carrying out the scheme is to obtain one or more tax benefits.

12.10 The provisions will penalise entities who obtain a tax benefit or tax benefits from schemes that avoid, reduce or defer PAYG instalments in ways that are inconsistent with the objects and purposes of the PAYG instalments regime. The anti-avoidance rules will not apply to a tax benefit that an entity gets from a straight-forward use of a structural feature of the PAYG instalments regime, for example, a choice to pay annually, if that use is in accordance with the purposes and objects of the regime.

12.11 The provisions will impose a penalty in the form of the GIC on twice the amount of the tax benefit or tax benefits. However, an entity will be allowed a credit which will effectively reduce the penalty if it gets one or more tax detriments arising from the scheme.

12.12 The Commissioner can remit the GIC where special circumstances exist that make it fair and reasonable to do so.

12.13 The provisions will apply to the 2000-2001 income year and later income years as does the PAYG instalments regime as a whole.

Comparison of key features of new law and current law

Comparison of key features of new law and current law
New law Current law
The integrity of the PAYG instalments regime will be supported by its own anti-avoidance rules. Part IVA of the ITAA 1936 does not apply to the PAYG instalments regime. Both the COIN and provisionaltaxsystems are supported by their own anti-avoidance rules. Part IVA of the ITAA 1936 does not apply to either system.
The PAYG anti-avoidance rules will address schemes to avoid, reduce or defer PAYG instalments from one instalment period to another. For example, they will cover deferring instalment income from one instalment quarter to another, whether within an income year or to a later income year. The COIN and provisional tax anti-avoidance rules address schemes to avoid and reduce instalments in respect of a particular year. However, they do not address deferral of instalments within a particular income year.
A penalty by way of GIC will be payable on twice the amount of each tax benefit for the period from the due date of the instalment to the due date for payment of assessed tax. However, a credit will be allowed where an entity that is penalised in respect of a tax benefit also has one or more tax detriments from the scheme.

The Commissioner cannot prevent the entity from varying its instalment rate or, where applicable, estimating its benchmark tax.

COIN system: Additional tax is imposed on the amount avoided at the rate of 12% per annum for the period from the due date for the relevant instalment to the due date for payment of assessed tax.

Provisional tax system: No penalty is imposed, but the Commissioner may refuse to accept an entity's request for variation of the amount of provisional tax.

There will be no review, under Part IVC of the TAA 1953, of the imposition of the penalty by way of GIC or of the decision not to remit the GIC. COIN system: There is no review, under Part IVC of TAA 1953, of the imposition of additional tax or of the decision not to remit the additional tax.

Provisional tax system: A right of review of the Commissioner's refusal to allow a provisional tax variation is available under Part IVC of TAA 1953.

The Commissioner will have a power to remit all or part of the penalty imposed by way of GIC if satisfied that there are special circumstances that make it fair and reasonable to remit. COIN system: The Commissioner has a power to remit all or part of the additional tax if satisfied that there are special circumstances that make it fair and reasonable to remit.

Provisional tax system: Not applicable.

Detailed explanation of new law

Amendment of the object of the PAYG instalments regime

Object of Part 2-10

12.14 Section 45-5, which sets out the object of the PAYG instalments regime, will be amended to ensure that it sets out, in clearer terms, the object of Part 2-10. The object of the Part is to ensure that:

income tax, Medicare levy, higher education contribution scheme and student financial supplement scheme liabilities are collected efficiently through the application of the principles set out in the object [Schedule 7, item 2, subsection 45-5(1)] ;
with 2 limited exceptions, an entity pays PAYG instalments after the end of each instalment quarter on the instalment income that the entity earns in that instalment quarter [Schedule 7, item 2, subsection 45-5(2)] ;
an entity's instalments for an income year are as close as possible to the entity's tax liabilities for that year. Consequently, the amount payable on assessment will be small or nil [Schedule 7, item 2, subsections 45-5(3) and (4)] ;
the amount of each instalment for an income year is, as nearly as possible, the same proportion of the total of those instalments as the instalment income for that instalment quarter is of the total instalment income for the year [Schedule 7, item 2, subsection 45-5(5)] ; and
with some exceptions, when an instalment is payable and how it is worked out are determined on the same basis irrespective of the type of entity involved [Schedule 7, item 2, subsection 45-5(6)] .

12.15 The amendment to the object of the PAYG instalments regime will help readers of PAYG instalments legislation to understand the objects and purposes of the regime. The amended object will also facilitate the interpretation and application of the new PAYG instalments anti-avoidance rules which will be inserted by this Bill.

Amendment to insert PAYG instalments anti-avoidance rules

12.16 A new Subdivision will be inserted into Division 45. It will contain anti-avoidance rules to support the integrity of the PAYG instalments regime. [Schedule 7, item 3, Subdivision 45-P]

Object of PAYG instalments anti-avoidance rules

12.17 The new Subdivision will contain a statement of its object, to help clarify in what circumstances the PAYG instalments anti-avoidance rules will apply.

12.18 The object of the PAYG instalments anti-avoidance rules is to penalise an entity whose tax position in relation to PAYG instalments is altered by a scheme that is inconsistent with the purposes and objects of the PAYG instalments regime, or any relevant provisions of the regime. It does not matter that the purposes and objects are not stated expressly in the provisions. [Schedule 7, item 3, subsection 45-595(1)]

12.19 The PAYG instalments anti-avoidance rules are not intended to apply to a straightforward use of the structural features of the PAYG instalments regime if that use is consistent with its purposes and objects. For example, no tax benefit that would attract the operation of the anti-avoidance rules would arise merely because of a choice to use a varied instalment rate, or to pay instalments on the basis of notional tax or GDP-adjusted notional tax. [Schedule 7, item 3, subsection 45-595(2)]

12.20 The PAYG instalments anti-avoidance rules are to be interpreted and applied according to the objects and purposes of those rules. [Schedule 7, item 3, subsection 45-595(3)]

Liability for GIC

12.21 An entity will be liable to pay a penalty by way of the GIC if:

that entity gets a tax benefit from a scheme;
the tax benefit relates to a component of that entity's tax position for an income year; and
having regard to specified matters, it would be concluded that the sole or dominant purpose of an entity that enters into or carries out the scheme (or a part of it) is for any entity (whether alone or together with others) to get one or more tax benefits from the scheme.

[Schedule 7, item 3, subsection 45-600(1)]

12.22 An entity will be separately liable to the GIC for each tax benefit arising from the scheme. [Schedule 7, item 3, subsection 45-600(4)]

12.23 An entity that obtains a tax benefit (which for ease of comprehension is sometimes referred to as entity A in this Chapter) is liable to pay the GIC even if:

entity A does not enter into, or carry out, the scheme (or a part of it) from which it gets the tax benefit or tax benefits;
the entity that enters into or carries out the scheme, or a part of it, did so alone or together with one or more other entities;
the scheme, or a part of the scheme, is entered into or carried out outside Australia; or
the tax benefit that entity A gets from the scheme is of a different kind from the tax benefit sought to be obtained from the scheme.

[Schedule 7, item 3, subsection 45-600(2)]

12.24 There are a number of elements to be established before liability to GIC arises, namely, that:

there is a scheme; and
the scheme is entered into, or carried out, for the relevant purpose; and
a tax benefit, relating to a component of the entity's tax position, arises from the scheme.

Each of these separate elements is discussed immediately below.

Scheme

12.25 Scheme is effectively defined in subsection 995-1(1) of the ITAA 1997 to mean:

any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings; or
any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

Purpose of the scheme

12.26 The purpose of the scheme must be determined on an objective basis. An entity's purpose in entering into or carrying out the scheme to obtain one or more tax benefits must be the sole or dominant purpose for entering into or carrying out the scheme before the PAYG anti-avoidance rules will apply. [Schedule 7, item 3, paragraph 45-600(1)(c)]

12.27 The words 'dominant purpose' will have their ordinary meaning. 'Dominant' refers to a purpose that is 'ruling, prevailing or most influential'.

12.28 Regard is to be had to a number of matters in determining, objectively, an entity's purpose in entering into or carrying out a scheme, namely:

the manner in which the scheme, or a part of the scheme, is entered into or carried out. This will include consideration of the method or procedure by which the particular scheme, or part of the scheme, is implemented [Schedule 7, item 3, paragraph 45-600(3)(a)] ;
the form and substance of the scheme. This will specifically include a consideration of the legal rights and obligations that have been created as a result of the scheme, and the economic and commercial substance of the scheme [Schedule 7, item 3, paragraph 45-600(3)(b)] ;
the purposes and objects of the PAYG instalments regime, and any relevant provisions of that regime. Tax benefits to which the PAYG instalments anti-avoidance rules will apply are those that are inconsistent with the purposes or objects of the PAYG instalments regime, whether or not the purposes and objects are stated expressly in that regime [Schedule 7, item 3, paragraph 45-600(3)(c)] ;
the timing of the scheme, and the period over which the scheme is entered into or carried out [Schedule 7, item 3, paragraphs 45-600(3)(d) and (e)] ;
the effect of the ITAA 1936, the ITAA 1997 and Schedule 1 to the TAA 1953 on the scheme without regard to the operation of the PAYG instalments anti-avoidance rules [Schedule 7, item 3, paragraph 45-600(3)(f)] ;
any change in entity A's financial position that results from, or may reasonably be expected to result from, the scheme [Schedule 7, item 3, paragraph 45-600(3)(g)] ;
any change that results from, or may reasonably be expected to result from, the scheme in the financial position of any entity that has, or had, a connection or dealing with entity A. The connection may be of a family, business or other nature [Schedule 7, item 3, paragraphs 45-600(3)(h)] ;
any other consequence for entity A or another entity with which entity A has, or had, a connection or dealing [Schedule 7, item 3, paragraph 45-600(3)(i)] ; and
the nature of the connection between entity A and another entity. This will specifically include a consideration of whether or not the parties are or were dealing at arm's length [Schedule 7, item 3, paragraph 45-600(3)(j)] .

12.29 It is not necessary to establish the existence of the sole or dominant purpose separately for each tax benefit where more than one tax benefit is obtained from a scheme.

Tax benefit

12.30 In simple terms, a tax benefit is a tax advantage that is obtained from a scheme.

12.31 A provision of the PAYG instalments anti-avoidance rules will prescribe how to work out whether an entity gets a tax benefit from a scheme and, if so, the amount of the tax benefit. [Schedule 7, item 3, subsection 45-605(1)]

12.32 First, an entity's actual tax position for an income year is worked out [Schedule 7, item 3, subsection 45-605(2)] . The actual tax position is the entity's tax position as a result of the scheme.

12.33 Next, an entity's hypothetical tax position is worked out. It is what would have been, or what could reasonably be expected to have been, the entity's tax position for the same income year if the scheme had not been entered into or carried out. [Schedule 7, item 3, subsection 45-605(3) and section 45-615]

12.34 Then, each component of the entity's actual tax position is compared with the corresponding component of the hypothetical tax position. If the amount of a component of the actual tax position is less than the amount of that component of the hypothetical tax position, the difference between the two amounts is a tax benefit from the scheme. If there is also a difference in relation to another component, that is a separate tax benefit. [Schedule 7, item 3, subsection 45-605(4)]

Component of a taxpayer's tax position

12.35 There are 4 different types of components of an entity's tax position:

the quarterly instalment component ,which is the instalment for each instalment quarter in the income year. There will be a quarterly instalment component regardless of whether an entity pays its instalments quarterly or annually;
the annual instalment component , which is the annual instalment for an income year. There will be an annual instalment component regardless of whether an entity pays its instalments quarterly or annually;
the variation credit component , which is the credit claimed by an entity under section 45-215 for an instalment quarter because it has chosen a lower instalment rate; and
the variation GIC component , which is the GIC payable under subsection 45-230(2) or 45-232(2) or 45-235(2) or 45-235(3) in respect of a varied instalment rate or an entity's estimated benchmark tax.

[Schedule 7, item 3, section 45-610]

12.36 The nature of a particular scheme will determine which of the components of an entity's tax position will need to be taken into account and how the amount of each component is worked out. For example, whether there is a variation GIC component of an entity's tax position will need to be determined having regard to whether a variation is part of the particular scheme under consideration.

12.37 The amount of each component is worked out separately [Schedule 7, item 3, section 45-610] . Examples 12.1 and 12.2 help illustrate how the components of an entity's actual tax position and hypothetical tax position are determined and how the amounts of those components are worked out.

Example 12.1 An entity varies its instalment rate at the end of the third instalment quarter of an income year because its expenditure has significantly increased during the year as compared with the previous year. It varies from the Commissioner's instalment rate of 10% to 5% but does not claim a variation credit. Further, during the final instalment quarter, the entity enters into a scheme to defer a one-off income receipt of $1 million that would otherwise be derived in that quarter to the next income year. This will enable the entity to take advantage of the company tax rate reduction from 34% to 30% and reduce its PAYG instalments for the income year. However, the entity still earns $1 million instalment income in that quarter.For the fourth instalment quarter, the entity's quarterly instalment component of its:

actual tax position will be $50,000 (5% of $1 million); and
hypothetical tax position will be $100,000 (5% of $2 million).

There is a $50,000 tax benefit in relation to the quarterly instalment component for the fourth instalment.The 5% instalment rate is used to work out the quarterly instalment component for the hypothetical tax position in this case because the variation of the instalment rate is not part of the scheme to obtain a tax benefit. However, because the entity has varied its instalment rate the variation GIC component has to be worked out for the entity's actual and hypothetical tax position.For the fourth instalment quarter, the entity's variation GIC component of its:

actual tax position will be nil because, on assessment, the varied instalment rate of 5% is assumed, for the purposes of this example, to be more than 85% of the benchmark instalment rate; and
hypothetical tax position is assumed to be $10,000 because a variation penalty would have been imposed because the higher hypothetical instalment income would have resulted in a different benchmark instalment rate.

There is a $10,000 tax benefit in relation to the variation GIC component for the fourth instalment quarter.

Example 12.2 As per Example 12.1, but the entity only varies its instalment rate in the fourth instalment quarter as part of the scheme to defer $1 million to the subsequent income year. The entity claims a variation credit of $50,000.In this case, the respective amounts of relevant components would be:

$50,000 (5% of $1 million) for the quarterly instalment component of the actual tax position;
$200,000 (10% of $2 million) for the quarterly instalment component of the hypothetical tax position which would not have included a variation of the instalment rate;
$50,000 for the variation credit component of the actual tax position;
nil for the variation credit component of the hypothetical tax position;
nil for the variation GIC component of the actual tax position because, on assessment, the varied instalment rate of 5% is assumed, for the purposes of this example, to be more than 85% of the benchmark instalment rate; and
nil, for the variation GIC component of the hypothetical tax position because in the hypothetical tax position in this example there would have been no variation.

Therefore, in this alternative situation, the entity would obtain the following tax benefits:

$150,000 in relation to the quarterly instalment component for the fourth instalment;
$50,000 in relation to the variation credit component for the fourth instalment; and
nil in relation to the variation GIC component for the fourth instalment.

Calculation of the GIC

12.38 Where an entity is liable to pay a penalty, that penalty is by way of the GIC on twice the amount of the tax benefit for each day in the period that:

starts on the day by which the instalment to which the component relates was due, or would have been due, to be paid; and
finishes on the due date for payment of the assessed tax.

[Schedule 7, item 3, subsections 45-620(1) and (2)]

12.39 The Commissioner must give an entity written notice of the GIC to which it is liable. The GIC must be paid within 14 days after the notice is given. [Schedule 7, item 3, subsection 45-620(3)]

12.40 If the amount of penalty in the Commissioner's notice is not paid at the end of the 14 day period, the amount unpaid will be subject to the late payment GIC for each day that it remains unpaid. This means that the late payment GIC applies both to the unpaid amount of penalty and to any late payment GIC. [Schedule 7, item 3, subsection 45-620(4)]

Credit entitlement if an entity gets a detriment from the scheme

12.41 A scheme that gives rise to one or more tax benefits may also give rise to one or more tax detriments.

12.42 An entity will be entitled to a credit if it is liable to the GIC because it gets one or more tax benefits from a scheme and the Commissioner is satisfied that:

the entity gets a tax detriment from that scheme; and
the tax detriment relates to a component of that entity's tax position for an income year.

It is irrelevant whether or not the income year in which the tax detriment or tax detriments arise is the same as the income year in which the entity got the tax benefit or tax benefits. [Schedule 7, item 3, subsection 45-625(1)]

12.43 The methods used to determine whether an entity gets a tax detriment from a scheme and the amount of the tax detriment are similar to the methods used in relation to tax benefits. It is necessary to work out the entity's actual tax position for an income year, the hypothetical tax position for the same income year, and then the amount of the components for both the actual tax position and the hypothetical tax position. If the amount of a component of the actual tax position is higher than the amount of the corresponding component of the hypothetical tax position, the difference between the 2 amounts is a tax detriment from the scheme. [Schedule 7, item 3, section 45-630]

12.44 The amount of the credit will be equal to the GIC on twice the amount of the tax detriment for each day in the period that:

starts on the day by which the instalment to which the component relates was due, or would have been due, to be paid; and
finishes on the due date for payment of the assessed tax.

[Schedule 7, item 3, subsection 45-625(2)]

12.45 However, the credit allowed to an entity cannot exceed the total GIC the entity is liable to pay because it gets one or more tax benefits from a scheme. [Schedule 7, item 3, subsection 45-625(3)]

12.46 The credit is determined separately where there are 2 or more tax detriments. The total amount of all the credits must not exceed the total GIC payable in relation to the tax benefits obtained from the scheme. [Schedule 7, item 3, subsection 45-625(4)]

No tax benefit or tax detriment results from certain choices

12.47 Section 45-635 qualifies the concepts of tax benefit and tax detriment by ensuring that the difference between the amount of a component of the actual tax position and the amount of the corresponding component of the hypothetical tax position is not a tax benefit or tax detriment in certain circumstances. The difference is not a tax benefit or tax detriment to the extent that the difference results merely from an entity:

making an agreement, choice, declaration, election, or selection; or
giving a notice or exercising an option,

for which the income tax law expressly provides. [Schedule 7, item 3, subsections 45-635(1), (2) and (3)]

12.48 However, this is not the case if an entity enters into or carries out the scheme for the sole or dominant purpose of creating the circumstances or state of affairs necessary to enable that relevant choice or other action to be taken. [Schedule 7, item 3, subsection 45-635(4)]

12.49 Similarly, no tax benefit or tax detriment results from specific choices made under the capital gains and losses provisions of the ITAA 1997. [Schedule 7, item 3, subsections 45-635(5), (6) and (7)]

Remission of GIC

12.50 The Commissioner may remit the whole or a part of the GIC payable under section 45-620 if he or she is satisfied that there are special circumstances that would make it fair and reasonable to do so. [Schedule 7, item 3, subsection 45-640(1)]

12.51 If the Commissioner remits the GIC, the amount of the credit that is allowed under section 45-625 (because the entity got a tax detriment) is worked out as if the remitted amount had never been payable. This is necessary to ensure that the total amount of the credit does not exceed the amount of the GIC imposed on the tax benefit or tax benefits. [Schedule 7, item 3, subsection 45-640(2)]

Rights of review

12.52 There will be no right of review under Part IVC of the TAA 1953 in relation to the GIC imposed under the PAYG instalments anti-avoidance rules. This is because:

an entity that is liable to GIC will be entitled to a credit which effectively reduces the penalty imposed if the entity has a tax detriment arising from the scheme;
the Commissioner has a power to remit the penalty if satisfied that there are special circumstances that make it fair and reasonable to do so; and
such rights of review are not provided elsewhere in the income tax law in relation to the penalties imposed by way of GIC.

An entity that is dissatisfied with the imposition of the penalty or with a decision not to remit the penalty may seek a review of the decision under the Administrative Decisions (Judicial Review) Act 1977.

Application and transitional provisions

12.53 The commencement of Schedule 7 to this Bill is linked to the commencement of earlier Acts which establish the PAYG instalments regime. Schedule 7 will commence immediately after the commencement of A New Tax System (Tax Administration) Act (No. 1) 2000 [Subclause 2(10) of this Bill] . That Act commenced immediately after the commencement of A New Tax System (Tax Administration) Act 1999, which, in turn commenced immediately after Royal Assent was given to A New Tax System (Pay As You Go) Act 1999. That occurred on 22 December 1999. This ensures that the amendments made by Schedule 7 to this Bill to Part 2-10 of Schedule 1 to the TAA 1953 apply for the 2000-2001 income year, and later income years, in the same way as Part 2-10 applies to those years.

Consequential amendments

12.54 Only one consequential amendment is necessary. Subsection 8AAB(5) of the TAA 1953 will be amended to insert a reference to the GIC imposed under section 45-600 and 45-620 of Schedule 1 to the TAA 1953. Subsection 8AAB(5) contains a list of provisions of Acts (other than the ITAA 1936) that deal with liability to the GIC. [Schedule 7, item 1, Table item 17H]

Chapter 13 - Regulation Impact Statement

Policy objective

The objectives of the New Business Tax System

13.1 The measures in this Bill are part of the Government's broad ranging reforms which will give Australia a New Business Tax System. The reforms are based on the Recommendations of the Review, instituted by the Government to consider reform of Australia's business tax system.[F32]

13.2 The Government instituted the Review to consult on its plan to comprehensively reform the business income tax system (as outlined in ANTS). The Review made 280 recommendations to the Government, designed to achieve a more simple, stable and durable business tax system.

13.3 The New Business Tax System is designed to provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings, as well as providing a sustainable revenue base so the Government can continue to deliver services to the community.

13.4 The New Business Tax System also seeks to provide a basis for more robust investment decisions. This is achieved by:

improving simplicity and transparency;
reducing the cost of compliance; and
providing fairer, more equitable outcomes.

13.5 This Bill is part of the legislative program implementing the New Business Tax System. Other Bills have been introduced and passed already.

Table 13.1: Earlier business tax legislation
Legislation Status
New Business Tax System (Integrity and Other Measures) Act 1999

New Business Tax System (Capital Allowances) Act 1999

New Business Tax System (Income Tax Rates) Act (No.1) 1999

New Business Tax System (Former Subsidiary Tax Imposition) Act 1999

Introduced into the Parliament on 21 October 1999.

Received Royal Assent on 10 December 1999.

New Business Tax System (Capital Gains Tax) Act 1999

New Business Tax System (Income Tax Rates) Act (No.2) 1999

Introduced into the Parliament on 25 November 1999.

Received Royal Assent on 10 December 1999.

New Business Tax System (Miscellaneous) Bill 1999

New Business Tax System (Venture Capital Deficit Tax) Bill 1999

Introduced into the Parliament on 9 December 1999.

Introduced into the Senate on 6 March 2000.

The objectives of measures in this Bill

13.6 Broadly, the New Business Tax System will enhance Australia's competitiveness through lower company and capital gains tax rates, and reduced compliance costs.

13.7 More specifically, the measures contained in this Bill have these objectives:

Table 13.2: Objectives of the measures in this Bill
Measure Objective
Losses measures
The 'inter-entity loss measures', which affect the tax treatment of realised and unrealised losses of a company where:

there has been a change of ownership or control in the company; or
a liquidator has declared the company's shares to be worthless.

Preventing the multiple recognition of losses for tax purposes by reducing capital losses and deductions of an entity in respect of interests ('inter-entity interests') it holds in a loss company in which it has a controlling stake.
To take account of the inter-entity loss measures:

amend the continuity of ownership test applying to company losses; and
align the application date of the unrealised loss measures (contained in the Integrity and Other Measures Act) with that of the inter-entity loss measures.

Ensuring that the inter-entity loss measures and other measures dealing with losses interact appropriately.
Technical amendments to loss and pre-payment measures contained in the Integrity and Other Measures Act. This covers a number of amendments with varying objectives. These include:

ensuring that the measures operate in the way that they were intended; and
reducing compliance costs.

Life insurers measures
Broaden the tax base for life insurers, as well as changing the basis of taxing the current pension business of superannuation funds. Ensuring greater competitive neutrality and consistency with other entities by broadly:

taxing the various businesses of life insurers on a comparable basis to those types of businesses generally; and
taxing the current pension business of superannuation funds consistently with life insurers.

Imputation measures
Amend the imputation system as it applies to life insurers so that:

franking credits and debits arise for tax paid on income actually allocated to shareholders applying generally accepted accounting standards; and
the imputation system applies to virtual PSTs of life insurance companies.

The objectives of these respective measures are:

ensuring that franking credits and debits arise based on tax paid on income actually allocated to shareholders rather than on income available to shareholders in accordance with prudential requirements; and
ensuring that the treatment of virtual PSTs of life insurance companies under the imputation system is equivalent to complying superannuation funds.

Amend the imputation system as it applies to life insurers so that:

life insurers allocate franking credits and debits to shareholders applying generally accepted accounting standards; and
the imputation system applies to virtual PSTs of life insurance companies.

The objectives of these respective measures are:

ensuring that franking credits will be allocated to shareholders on an equitable basis; and
ensuring that the treatment of virtual PSTs of life insurance companies under the imputation system is equivalent to complying superannuation funds.

Amend the imputation system to take account of PAYG instalments. Ensuring that the imputation system applies appropriately to the new collection mechanisms introduced under ANTS.
Technical amendments to the provisions converting franking accounts to reflect the 34% company tax rate. Taking into account changes to the taxation of life insurers (also in this Bill), as well as ensuring that the provisions operate in the way intended.
Increase in the threshold for the exemption of small shareholders from the franking credit trading rules. Reducing compliance costs for small individual shareholders by ensuring that more of these taxpayers are not adversely affected by the rules.
CGT measures
Amend the CGT cost base adjustment provisions applying to capital payments made to a beneficiary for an interest in the trust, to give effect to CGT small business concessions introduced in the Capital Gains Tax Act. Broadening the scope of the provisions to ensure that general and small business CGT concessions introduced as part of a New Business Tax System operate effectively in the case of capital payments for trust interests.
Technical amendments to the scrip for scrip roll-over provisions. Clarifying the scope, and correcting some technical aspects, of the provisions.
Integrity measures
Amend the object of the PAYG instalments regime and introduce integrity rules designed to penalise taxpayers who obtain a tax benefit from a scheme the effect of which is to avoid, defer or reduce PAYG instalments. Clarifying the object and purposes of the PAYG instalments regime and protecting the integrity of that system.

Implementation options

13.8 The major measures in this Bill arise directly from recommendations of the Review. Those Recommendations were the subject of extensive consultation. The implementation options for these measures can be found in A Platform for Consultation (APFC) and A Tax System Redesigned (ATSR). Table 13.3 shows where the measures (or the principles underlying them) are discussed in those publications.

Table 13.3: Options for implementing measures in this Bill arising directly from the Recommendations
Measure APFC ATSR
The 'inter-entity loss measures'. Chapter 28, pp. 591-609. Recommendation 6.9(b), pp. 256-258.
Changes to take account of the inter-entity loss measures. Chapter 28, pp. 591-609. Recommendations 6.9(a) and (b), pp. 256-258.
Broaden the tax base for life insurers, as well as changing the basis of taxing the current pension business of superannuation funds. Chapters 34 and 35, pp. 713-733; 735-756. Recommendations 14.1 to 14.10, pp. 489-507.
Amend the imputation system as it applies to life insurers. Chapter 34, pp. 728-733. Recommendation 14.5, pp. 495-497.
Increase in the threshold for the exemption of small shareholders from the franking credit trading rules. Not discussed. Recommendation 6.7, pp. 247-250.

13.9 The remaining measures are of a more technical nature, and were not directly discussed in A Platform for Consultation and A Tax System Redesigned. Where appropriate, implementation options for these measures are outlined in Table 13.4.

Table 13.4: Implementation options for measures not explicitly addressed in the Review
Measure Implementation options
Technical amendments to loss and pre-payment measures contained in the Integrity and Other Measures Act. These amendments operate within the framework of the original measure that was legislated.

Implementation options for the original measure were discussed in the regulation impact statement for the Integrity and Other Measures Act.

Amend the imputation system to take account of PAYG instalments. This measure introduces specific provisions providing for franking credits and debits for:

the payment and refund of income tax under the PAYG instalments regime; and
PAYG rate variation credits.

This specific treatment is consistent with the treatment of previous company tax instalment regimes under the imputation system. It is also necessary to explicitly take into account features of the new collection mechanisms put in place under ANTS.

Technical amendments to the provisions converting franking accounts to reflect the 34% company tax rate. These amendments operate within the framework of the original measure that has been introduced.

Implementation options for the original measure were discussed in the regulation impact statement for the NBTS Miscellaneous Bill 1999.

Amend the CGT cost base adjustment provisions applying to capital payments made to a beneficiary for an interest in the trust to give effect to CGT small business concessions introduced under the New Business Tax System. These amendments operate within the framework of the CGT concessions that have been legislated.

Implementation options for the CGT concessions were discussed in the regulation impact statement for the Integrity and Other Measures Act and the Capital Gains Tax Act.

Technical amendments to the scrip for scrip roll-over provisions. These amendments clarify the coverage of the scrip for scrip roll-over provisions but otherwise operate within the framework of the original measure that was legislated.

Implementation options for the original measure were discussed in the regulation impact statement for the Capital Gains Tax Act.

Amend the object of the PAYG instalments regime and introduce integrity rules to penalise entities who obtain a tax benefit from a scheme the effect of which is to avoid, defer or reduce PAYG instalments. This measure adopts a general approach in dealing with schemes to avoid, defer or reduce PAYG instalments. Part IVA of the ITAA 1936 does not apply to the PAYG instalments regime, the company and superannuation fund instalment system or the provisional tax system. Without these rules, the instalment base would be undermined and there would be the potential for significant deferral of instalments. Similar integrity rules are a feature of the existing company and superannuation fund instalment system and the provisional tax system. The integrity rules in this Bill are consistent with the framework of a GAAR.

Assessment of impacts

13.10 The potential compliance, administrative and economic impacts of the measures in this Bill have been carefully considered, both by the Review and by the business sector. The Review focussed on the economy as a whole in assessing the impacts of its recommendations and concluded that there would be net gains to business, government and the community generally from business tax reform.

Impact group identification

13.11 The measures in this Bill specifically impact on those taxpayers identified in Table 13.5.

Table 13.5: Taxpayers affected by the measures in these Bills
Measure Affected taxpayers
Losses measures
The 'inter-entity loss measures'. Entities with interests in a company that experiences a substantial change in ownership or control.
Changes to take account of the inter-entity loss measures. As above.
Technical amendments to loss and pre-payment measures contained in the Integrity and Other Measures Act. Companies that either:

experience a substantial change in ownership or control; or
transfer losses or loss assets within a majority-owned company.

Life insurers measures
Broadening the tax base for life insurers, as well as changing the basis of taxing the current pension business of superannuation funds. Life insurance companies and friendly societies, of which there are approximately 80, are affected by the broadening of the tax base for life insurers.

Superannuation funds with pension business are affected by the changing basis of taxing the current pension business of superannuation funds. The precise number of funds affected is not known because many of them either do not lodge a tax return or are investing through a PST or a life insurance company.

Imputation measures
Amend the imputation system as it applies to life insurers. Life insurance companies, of which there are approximately 45.
Increase in the threshold for the exemption of small shareholders from the franking credit trading rules. Individual taxpayers entitled to franking rebates of between $2,000 and $5,000 who would not otherwise satisfy the 45-day rule in the franking credit trading rules.

Up to 115,000 individuals will benefit from this measure, although only a small proportion of this group would currently be denied franking rebates under the 45-day rule.

Amend the imputation system to take account of PAYG instalments. Approximately 240,000 entities, that make PAYG instalments and have franking credits and debits arise under the imputation regime.
Technical amendments to the provisions converting franking accounts to reflect the 34% company tax rate. The following taxpayers are affected by various aspects of this measure:

approximately 7,000 early balancing companies;
approximately 45 life insurance companies; and
a small number of companies applying for estimated debit determinations.

CGT measures
Technical amendments to the CGT cost base adjustment provisions applying to capital payments made to a beneficiary for an interest in the trust. Trustees and beneficiaries.
Technical amendments to the scrip for scrip roll-over provisions. The following taxpayers are affected by this measure:

companies involved in takeovers undertaken by way of a scheme of arrangement;
entities that acquire equity in the original entity; and
original and acquiring non-resident companies.

Integrity measures
Amend the object of the PAYG instalments regime and introduce integrity rules to penalise entities who obtain a tax benefit from a scheme the effect of which is to avoid, defer or reduce PAYG instalments. Entities involved in tax avoidance activities to avoid, defer or reduce PAYG instalments.

Analysis of costs / benefits

Compliance costs

13.12 As is standard with new measures, groups affected by them will need to incur a small up-front cost in either familiarising themselves with the new law or having advisers familiarise themselves with the new law.

13.13 However, overall, the measures in this Bill are expected to reduce compliance costs as part of providing a more consistent and easily understood business tax system.

13.14 The General Outline to this Explanatory Memorandum discusses the impact each measure in this Bill has on compliance costs. Below are some specific examples of how the measures in this Bill will impact on compliance costs. The examples have been listed according to how significant an impact the particular group of measures has on compliance costs.

Life insurers measures

13.15 Broadening the tax base for life insurers should reduce compliance costs by increasing the certainty and integrity of the tax base. For example, the taxable income of life insurance companies will only be split into 2 components rather than 4, reducing the need to undertake apportionment calculations. However, there are implementation and transitional costs that are expected to arise:

For example, segregating assets for the purposes of taxing the superannuation business of life insurers at a 15% rate rather than the company tax rate will require the creation of additional records.
The measures also apply from 1 July 2000 rather than on an income year basis. This will cause approximately 35 life insurers with substituted accounting periods to effectively work out their taxable income twice for the income year containing 1 July 2000. However, during consultation the life insurance industry strongly supported having these measures commence from a set date, as a means of ensuring competitive neutrality. Those life insurers that are early balancers will also have additional time to prepare for all of the changes.

13.16 Compliance costs should decrease for superannuation funds that only carry on pension business as a result of the measure affecting superannuation funds with a pension business. Currently, these funds require an actuarial certificate every 3 years to qualify for an exemption from tax. This will no longer be required.

Other changes affecting the pension business of superannuation funds may increase compliance costs in the implementation phase, for example where self-managed funds have members in both the accrual and pension phase. These funds will now have to separately identify assets to be entitled to an exemption from tax. Currently the exemption is worked out using figures provided by an actuary. Identifying these assets will require the creation of additional records.

Imputation measures

13.17 Requiring life insurers to accrue franking credits and debits for the payment of tax on income actually allocated to shareholders will require more calculations. However, using accepted and already used accounting practices to identify income allocated to shareholders will limit any additional complexity.

The current method for accruing franking credits and debits involves applying a set proportion to tax paid, reflecting prudential requirements. While this is simple, it is an arbitrary rule that does not reflect the true underlying circumstances.

13.18 Increasing the threshold for the exemption from the franking credit trading rules reduces compliance costs for individual taxpayers entitled to a franking rebate between $2,000 and $5,000. These taxpayers no longer have to consider the application of the 45-day rule.

The increase in the threshold will also eliminate the complexity involved with the current tapering of the exemption between $2,000 and $2,500. This tapering involves difficult calculations.

13.19 The amendments to the conversion of franking account provisions will cause a small, one-off cost for companies affected by the measure arising from implementing changes to their systems.

However, the method adopted in the conversion of franking account provisions minimises ongoing compliance costs (particularly record-keeping costs associated with companies maintaining multiple franking accounts).

Losses measures

13.20 Making adjustments to capital losses and deductions to prevent multiple recognition of losses under the inter-entity measure may increase compliance costs, for example, through requirements for companies to provide information to entity shareholders.

However, special relief has been incorporated with this measure to ensure any increase in compliance costs is minimised.

13.21 Linking the continuity of ownership test to the new inter-entity measure will streamline the rules that apply to entities and provide greater integrity. The measures are expected to increase the requirement to maintain records regarding the direct and indirect ownership in a loss company.

13.22 Changes to the unrealised loss measures (originally introduced in the Integrity and Other Measures Act) will reduce compliance costs associated with valuation by:

excluding small business taxpayers (i.e. taxpayers with net asset values of $5 million or less) and low cost assets (i.e. assets that are acquired for less than $10,000);
allowing tax written-down value to be used as a proxy for market value, for depreciable plant; and
enabling the Commissioner to provide guidance about valuation methods.

13.23 Measures not discussed in paragraphs 13.15 to 13.22 will have no impact, or only a negligible impact, on compliance costs.

13.24 Further details on how the measures in this Bill impact on affected taxpayers can be found in the specific Chapters in this Explanatory Memorandum explaining each measure.

Administration costs

13.25 The implementation of the measures in this Bill are not expected to give rise to any significant increase in administration costs.

Government revenue

13.26 The revenue impact of each measure is noted in the General Outline for this Explanatory Memorandum.

Economic benefits

13.27 The New Business Tax System will provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings. The economic benefits of these measures are explained in more detail in the publications of the Review, particularly A Platform for Consultation and A Tax System Redesigned.

Other issues - consultation

13.28 The consultation process began with the release of ANTS in August 1998. The Government established the Review in that month. Since then, the Review has published 4 documents about business tax reform; in particular A Platform for Consultation and A Tax System Redesigned in which it canvassed options, discussed issues and sought public input.

13.29 Throughout that period, the Review held numerous public seminars and focus group meetings with key stakeholders in the tax system. It received and analysed 376 submissions from the public about reform options. Further details are contained in paragraphs 11 to 16 of the Overview of A Tax System Redesigned.

13.30 In analysing options, the Review was guided by, and frequently referred to views expressed during the consultation process.

13.31 The measures in this Bill dealing with PAYG instalments were not directly considered by the Review. The PAYG system was subject to extensive consultation prior to its implementation.

13.32 Many of the measures in this Bill have also been subject to extensive consultation between when the Review reported to Government and when this Bill was introduced.

Conclusion and recommended option

13.33 The measures contained in this Bill should be adopted to support a more efficient, innovative and internationally competitive Australian business sector, to reduce compliance costs and to establish a simpler and more structurally sound business tax system.

Index

Schedule 1: Company losses and bad debts

Bill reference Paragraph No.
Item 1, section 112-97, new item 12A 1.174
Item 2, subsection 165-12(2) (note); item 19, subsection 165-123(2) (note) 2.54
Item 3, subsection 165-12(7); item 5, subsection 165-37(4); item 15, subsection 165-115C(4); item 20, subsection 165-123(7) 2.26
Item 3, subsection 165-12(8); item 5, subsection 165-37(5); item 15, subsection 165-115C(5); item 20, subsection 165-123(8) 2.32
Item 4, subsection 165-37(3); sub-item 68(2) 2.54
Item 6, section 165-115 2.60
Item 7, paragraph 165-115A(1)(c); item 8, subsection 165-115A(1D) 2.66
Item 7, paragraph 165-115A(1)(d) 2.62
Item 8, paragraph 165-115A(1A)(b) 2.74
Item 8, section 165-115A(1B) 2.63
Item 8, section 165-115A(1C) 2.63
Item 9, paragraph 165-115A(2)(a) 2.50
Item 9, subsection 165-115A(2A) 2.31
Item 11, subsection 165-115B(1); item 12, subsection 165-115B (2); item 13, subsection 165-115B(5) and (6); item 14, subsection 165-115B(8); item 15, subsection 165-115BB(2) 2.69
Item 12, subsection 165-115B(2) 2.81
Item 14, subsection 165-115B(7); item 15, subsection 165-115BB(1) 2.70
Item 15, sections 165-115C and 165-115D 2.80
Item 15, subsection 165-115BA(1) to (3) 2.67
Item 15, subsections 165-115BA(4) and (5) 2.68
Item 16, section 165-115E 2.73
Item 17, subsection 165-115F(7) 2.61
Item 17, subsections 165-115F(5) and (6) 2.65
Item 18, Section 165-115E of Subdivision 165-CC 1.111
Item 18, paragraph 165-115K(1)(c) 1.62
Item 18, paragraph 165-115R(4)(a) 1.88
Item 18, paragraph 165-115R(4)(b) 1.89
Item 18, paragraph 165-115S(4) 1.92
Item 18, paragraph 165-115X(1)(c) 1.128
Item 18, paragraph 165-115ZB(3)(b) 1.153
Item 18, paragraph 165-115ZB(6)(f) 1.160, Example 1.15
Item 18, paragraphs 165-115P(1)(a) or 165-115Q(1)(a) 1.75
Item 18, paragraphs 165-115P(1)(b) and 165-115Q(1)(b) 1.76
Item 18, paragraphs 165-115X(1)(a) and (b) 1.127
Item 18, section 165-115F of Subdivision 165-CC 1.104
Item 18, section 165-115J 1.37
Item 18, section 165-115L 1.67
Item 18, section 165-115M 1.71
Item 18, section 165-115N 1.72
Item 18, section 165-115Q 1.64
Item 18, section 165-115R 1.84
Item 18, section 165-115T 1.99
Item 18, section 165-115U 1.111
Item 18, section 165-115X(3) and (4) 1.132
Item 18, section 165-115ZA 1.140
Item 18, section 165-115ZB 1.140
Item 18, section 165-115ZC(5) 1.165
Item 18, sections 165-115R and 165-115S 1.82
Item 18, sections 165-115V(2) and 165-115W(2) 1.108
Item 18, sections 165-115X and 165-115Y 1.118
Item 18, subsection 115-165S(2) 1.90
Item 18, subsection 165-115 ZA(9) 1A.14
Item 18, subsection 165-115 ZB(2) 1.151
Item 18, subsection 165-115K(1) 1.61
Item 18, subsection 165-115K(4) 1.42, 1.70
Item 18, subsection 165-115K(5) 1.59, 1.60
Item 18, subsection 165-115R(2) 1.85
Item 18, subsection 165-115R(3) 1.86
Item 18, subsection 165-115S(3) 1.91
Item 18, subsection 165-115U(1), step 1 1.113
Item 18, subsection 165-115U(1), step 2 1.114
Item 18, subsection 165-115U(1), steps 3 and 4 1.115
Item 18, subsection 165-115U(1) 1.110
Item 18, subsection 165-115U(2) 1.116
Item 18, subsection 165-115V(8) 1.102, 1.104
Item 18, subsection 165-115W(1) 1.107
Item 18, subsection 165-115X(2) 1.130
Item 18, subsection 165-115X(3) 1.131
Item 18, subsection 165-115Y(3) 1.137
Item 18, subsection 165-115Y(4) and (5) 1.138
Item 18, subsection 165-115Z(1) 1.123
Item 18, subsection 165-115Z(2) 1.126
Item 18, subsection 165-115ZA(10) 1A.18
Item 18, subsection 165-115ZA(2) 1.144
Item 18, subsection 165-115ZA(3) 1.141
Item 18, subsection 165-115ZA(5) 1.143, 1A.1
Item 18, subsection 165-115ZA(6) 1A.2
Item 18, subsection 165-115ZA(7) 1A.3
Item 18, subsection 165-115ZA(9) 1A.12
Item 18, subsection 165-115ZB (3) 1.152
Item 18, subsection 165-115ZB(2) 1.149
Item 18, subsection 165-115ZB(4) 1.141, 1.153
Item 18, subsection 165-115ZB(5) 1.155
Item 18, subsection 165-115ZB(6) 1.156, 1.158
Item 18, subsection 165-115ZB(7) 1.159
Item 18, subsection 165-115ZC(2) and subsection 165-115ZC(3) 1.163
Item 18, subsection 165-115ZC(5) 1.166
Item 18, subsection 165-115ZC(6) 1.167
Item 18, subsection 165-115ZC(7) 1.168
Item 18, subsection 165-115ZC(8) 1.169
Item 18, subsections 165-115P(1) and 165-115Q(1) 1.74
Item 18, subsections 165-115P(3) and 115Q(3) 1.75
Item 18, subsections 165-115P(3) and 165-115Q(3) 1.77
Item 18, subsections 165-115P(4) and 165-115Q(4) 1.77, 1.78
Item 18, subsections 165-115P(5) and 165-115Q(5) 1.78
Item 18, subsections 165-115P(6) and 165-115Q(6) 1.79
Item 18, subsections 165-115R(5) and 165-115S(5) 1.93
Item 18, subsections 165-115R(6) and 165-115S(6) 1.96
Item 18, subsections 165-115V(6) and (7) 1.109
Item 18, subsections 165-115X(3) and (4) and 165-115Y(4) and (5) 1.50
Item 18, subsections 165-115X(5) and 165-115Y(6) 1.45
Item 18, subsections 165-115X(6) and 165-115Y(7) 1.46
Item 18, subsections 165-115X(7) and 165-115Y(8) 1.45
Item 18, subsections 165-115Y(1) and 165-115Y(2) 1.136
Item 18, subsections 165-115ZA(5) and (6) 1.66
Item 18, subsections 165-115ZB(3) and 165-115ZB(6) 1.147
Item 18, subsections 165-115ZC(2) and 165-115ZC(4) 1.161
Item 21, subsection 165-150(2) 2.52
Item 21, subsections 165-150(2), 165-155(2) and 165-160(2) 2.52
Item 21, subsections 165-155(1) and 165-160(1) 2.52
Item 22, subsection 165-165(1) 2.10
Item 22, subsections 165-165(2) to (6) 2.16
Item 22, subsections 165-165(3) and (5) 2.13
Item 23, Heading to section 165-200; Item 25, section 165-200 2.37
Item 25, subsection 165-200(2) 2.38
Item 26, subsection 165-215(2) and (3); item 27, subsection 165-215(5); item 28, subsection 165-230(2) and (3) 2.57
Item 30, paragraph 166-80(3)(a) 2.45
Item 30, paragraph 166-85(2)(a) and subsection 166-85(5) 2.76
Item 30, section 166-80 2.45, 2.76
Item 30, section 166-90 and subsection 166-85(5), paragraph 166-85(2)(a) 2.48
Item 30, section 166-90 2.41, 2.76
Item 30, subsection 165-85(2) 2.47
Item 30, subsection 166-170(9) 2.35
Item 30, subsection 166-80(2) and (3) 2.44
Item 30, subsections 166-80(1) and 166-85(1) to (3) 2.76
Item 30, subsections 166-85(1) to (3) 2.46
Item 31, subsections 166-145(2) to (4); item 32, section 166-150; item 35, paragraph 166-265(1)(a); item 36, subsections 166-265(2) and (3) 2.53
Item 33, section 166-165 2.55
Item 34, subsection 166-170(1) and (2) 2.19
Item 34, subsection 166-170(3) to (6) 2.22
Items 37, 43, 48 and 54, paragraphs 170-210(3)(aa), 170-215(3)(aa), 170-220(3)(aa) and 170-225(3)(aa) 3.11
Items 38 and 49, paragraphs 170-210(3)(ba) and 170-220(3)(ba) 1.173
Items 38 and 49, paragraphs 170-210-(3)(ba) and 170-220(3)(aa) 3.12
Items 39 and 50, subsections 170-210(3A) and 170-220(3A) 3.17, 3.19
Item 39 and 50, subsections 170-210(3B) and 170-220(3B) 3.26
Item 40, section 170-210 notes 3.40
Items 41, 42, 52, 53, paragraphs 170-215(1)(h), 170-225(1)(g), 170-215(2)(h) and 170-225(2)(h) 3.32
Items 43 and 54, paragraph 170-215(3)(ab) and paragraph 170-225(3)(ab) 3.33
Items 44 and 55, subsections 170-215(4A) and 170-225(4A) 3.37
Items 45 and 52, sections 170-215 note and 170-220 note 3 3.41
Items 46 and 47, subsections 170-220(1), 170-220(2) and 170-220(3) 3.8
Items 56 and 57, paragraphs 170-260(4)(a) and 170-265(3)(a) 4.10
Items 56, 59, 62, 64, 65 and 65A, subparagraphs 170-255(1)(b)(ii) and (iii), paragraphs 170-275(1)(c), subsection 170-280(1) and 170-280(3) 4.12
Items 57, 58, subparagraph 170-255(1)(d)(v) 4.7
Items 60 and 61, existing subsection 170-260(4) and paragraph 170-265(3)(a) 4.09
Item 64, paragraph 170-280(1)(b) 4.16
Item 64, paragraph 170-280(1)(c) 4.16
Item 64, paragraph 170-280(1)(d) 4.16
Item 64, subsection 170-280(1) 4.14
Item 64, subsection 170-280(1A) 4.20
Item 64 4.15
Item 66, subsection 170(10AA) of the ITAA 1936 1.145
Item 67, paragraph 427(ba) 2.77
Item 67, proposed paragraph 427(ba) of the ITAA 1936 1.54
Subitem 68(1) 2.85
Subitem 68(2) 2.83
Subitem 68(2) 2.89
Subitem 68(4) 3.42
Subitem 68(4A) and 68(5) 3.43
Subitem 68(3) 2.84, 2.85
Subitem 68(6) 4.21

Schedule 2: Life insurance companies

Bill reference Paragraph No.
Item 5, paragraph 26AH(7)(b) 5.213
Item 6, subsection 70B(2A) 5.219
Item 6A, subsection 26AH(6) 5.215
Item 7, subsection 92(2A) 5.221
Items 8, 10 and 11, subsection 110(1) 5.229
Item 9, subsection 110(1) 5.227
Items 12 and 23, section 110A 5.243
Items 13 and 14, section 116CB 5.226
Item 15, section 116CD 5.232
Items 16, 18 and 19, subsection 116E(1) 5.239
Item 17, subsection 116E(1) 5.239
Items 20 and 21, section 116GA 5.237
Item 22, section 116GB 5.242
Item 23 5.244
Item 24, section 121 5.245
Items 25 and 26, section 160AAB 5.250
Item 33, subsection 267(1) 5.286
Item 38, subsection 267(1) 5.252
Item 39, subsection 267(1) 5.254
Item 43, subsection 273A(1) and (1A) 5.252, 5.254
Item 43, subsection 273A(2) 5.256
Item 43, subsection 273A(3) 5.257
Item 43, subsection 273A(4) 5.258
Item 43, subsection 273A(5) 5.260
Item 43, subsection 273A(6) 5.261
Item 43, subsection 273A(7) 5.262
Item 43, section 273B 5.269
Item 43, subsection 273C(1) 5.270, 5.271
Item 43, subsection 273C(2) 5.273, 5.274
Item 43, subsection 273C(3) 5.272
Item 43, subsection 273C(4) 5.275
Item 43, subsection 273D(1) 5.277, 5.278
Item 43, subsection 273D(2) 5.279
Item 43, subsection 273D(3) 5.280
Item 43, subsection 273D(4) 5.281
Item 43, subsection 273D(5) 5.282
Item 43, subsection 273D(6) 5.283
Item 43, section 273E 5.284
Item 43, section 273F 5.285
Item 43, subsection 273G(1) 5.288
Item 43, subsection 273G(2) 5.289
Item 43, subsection 273G(3) 5.291
Item 43, subsection 273G(4) 5.292
Item 43, subsection 273H(1) 5.293
Item 43, subsection 273H(2) 5.294
Item 43, subsection 273H(3) 5.295
Item 43, subsection 273H(4) 5.296
Item 43, subsection 273H(5) 5.297
Item 43, subsection 273H(6) 5.298
Item 43, subsection 273H(7) 5.299
Item 43, subsection 273H(8) 5.300
Item 43, section 273J 5.265
Item 43, section 273K 5.267
Items 44 and 45, subsection 275(2A) 5.334
Items 46 and 47, subsections 275(7), (8) and (9) 5.334
Item 48, subsection 279E(3) 5.308
Item 49, subsection 281A(1) 5.301
Item 49, subsection 281A(2) 5.302
Item 49, subsection 281A(3) 5.303
Item 49 subsections 281A(4) and (5) of the ITAA 1936 5.312
Item 49, subsection 281AA(1) 5.304
Item 49, subsection 281AA(2) 5.305
Item 49 subsections 281AA(3) and (4) of the ITAA 1936 5.313
Item 49, subsection 281B(1) 5.306
Item 49, subsection 281B(2) 5.307
Item 49A, section 282C of the ITAA 1936 5.317
Item 50, section 283 5.320
Item 51, subsection 296A(1) 5.321
Item 51, subsection 296A(2) 5.322
Item 51, subsection 296A(3) 5.323
Item 51, subsection 296AA(1) 5.324
Item 51, subsection 296AA(2) 5.325
Item 51, subsection 296B(1) 5.326
Item 51, subsection 296B(2) 5.327
Item 52, section 297B 5.255, 5.328
Item 52, section 297BA 5.331
Items 55 to 60, sections 317 and 446 5.335
Items 66 and 69, sections 50-20 and 50-72 5.336
Items 66, 67 and 70 5.337
Item 71, section 102-3 5.167
Item 74 and 75, section 110-25 5.168
Items 77 to 79, section 114-5, section 115-10 and section 115-100 5.166
Item 78, section 115-10 5.169
Item 79, section 115-100 5.170
Items 79A, 79B and 83A, subsection 118-300(1) and subparagraph 152-20(2)(b)(v) of the ITAA 1997 5.338
Item 81, section 118-315 5.45
Item 81, section 118-320 5.253
Item 82, section 118-355 5.255
Item 84, Division 320 5.26
Item 84, section 320-1 5.29
Item 84, section 320-5 5.30
Item 84, section 320-15 5.31, 5.32
Item 84, section 320-20 5.39
Item 84, section 320-25 5.40
Item 84, section 320-30 5.43
Item 84, section 320-35 5.45
Item 84, section 320-40 5.52
Item 84, section 320-45 5.164
Item 84, section 320-55 5.56
Item 84, section 320-60 5.57
Item 84, section 320-65 5.58
Item 84, section 320-70 5.64
Item 84, section 320-75 5.67
Item 84, section 320-80 5.73
Item 84, subsection 320-80(2) 5.74
Item 84, subsection 320-80(3) 5.76
Item 84, section 320-85 5.77
Item 84, subsection 320-85(2) 5.80
Item 84, subsection 320-85(3) 5.83
Item 84, subsection 320-85(4) 5.81
Item 84 section 320-87 5.93
Item 84, section 320-90 5.95
Item 84, section 320-95 5.96
Item 84, section 320-100 5.97
Item 84, subsection 320-105(1) 5.101
Item 84, subsection 320-105(2) 5.103
Item 84, section 320-110 5.106
Item 84, section 320-115 5.107
Item 84, section 320-120 5.110
Item 84, section 320-125 5.163
Item 84, section 320-135 5.108
Item 84, section 320-140 5.109
Item 84, section 320-145 5.107, 5.111
Item 84, section 320-155 5.116
Item 84, section 320-160 5.117, 5.120
Item 84, subsections 320-170(1), (1A) and (6) 5.121
Item 84, subsection 320-170(2) 5.123
Item 84, subsection 320-170(3) 5.124
Item 84, subsection 320-170(4) 5.126
Item 84, subsection 320-170(5) 5.127
Item 84, subsection 320-170(7) 5.128
Item 84, paragraph 320-170(7)(b) 5.32
Item 84, section 320-175 5.135
Item 84, subsection 320-180(1) 5.137
Item 84, subsection 320-180(2) 5.139
Item 84, subsection 320-180(3) 5.138
Item 84, subsection 320-180(4) 5.140
Item 84, subsection 320-185(1) 5.142
Item 84, subsection 320-185(2) 5.143
Item 84, subsection 320-185(3) 5.144
Item 84, section 320-190 5.149
Item 84, subsection 320-195(1) 5.152, 5.190
Item 84, subsection 320-195(2) 5.154
Item 84, subsection 320-195(3) 5.155
Item 84, subsection 320-195(4) 5.157
Item 84, subsection 320-200(1) 5.158
Item 84, subsection 320-200(2) 5.159
Item 84, subsection 320-200(3) 5.94, 5.160
Item 84, subsections 320-205(1), (3) and (4) 5.161
Item 84, subsection 320-205(2) 5.162
Item 84, section 320-215 5.171
Item 84, section 320-225 5.172
Item 84, subsection 320-225(2) 5.175
Item 84, subsection 320-225(3) 5.176
Item 84, section 320-230 5.184
Item 84, subsection 320-225(4) 5.177
Item 84, subsection 320-225(5) 5.179
Item 84, subsection 320-225(6) 5.180
Item 84, subsection 320-235(1) 5.186
Item 84, subsection 320-235(2) 5.188
Item 84, subsection 320-235(3) 5.187
Item 84, subsection 320-235(4) 5.189
Item 84, subsection 320-240(1) 5.191
Item 84, subsection 320-240(2) 5.192
Item 84, subsection 320-240(3) 5.193
Item 84, subsection 320-245(2) 5.195
Item 84, subsection 320-245(3) 5.196
Item 84, subsection 320-250(1) 5.198
Item 84, subsection 320-250(2) 5.199
Item 84, subsection 320-250(3) 5.201
Item 84, subsection 320-250(4) 5.202
Item 84, subsection 320-255(1) 5.203
Item 84, subsection 320-255(2) 5.204
Item 84, subsection 320-255(3) 5.205
Item 84, subsection 320-255(4) 5.206
Item 84, subsection 320-255(5) 5.207
Item 84, subsection 320-255(6) 5.208
Item 84, subsection 320-255(7) 5.209
Item 84, subsection 320-255(8) 5.210
Items 85 and 86, sections 110-25 and 114-5 of the Transitional Provisions Act 5.230, 5.240
Item 86, section 115-10 of the Transitional Provisions Act 5.231, 5.241
Item 87, section 320-5 of the Transitional Provisions Act 5.134
Item 87, section 320-85 of the Transitional Provisions Act 5.84
Item 87, section 320-170 of the Transitional Provisions Act 5.129
Item 87, section 320-225 of the Transitional Provisions Act 5.181
Item 87, subsection 320-175(1) of the Transitional Provisions Act 5.131
Item 87, subsection 320-175(2) of the Transitional Provisions Act 5.136
Item 87, subsection 320-230(1) of the Transitional Provisions Act 5.182
Item 87, subsection 320-230(2) of the Transitional Provisions Act 5.185
Item 111, section 23A of the Income Tax Rates Act 1986 5.342
Item 111, subsections 23B(2) and (3) of the Income Tax Rates Act 1986 5.345
Item 111, subsections 23B(4) and (5) of the Income Tax Rates Act 1986 5.348
Item 111, subsections 23C(2) and (3) of the Income Tax Rates Act 1986 5.350
Item 111, subsections 23C(4) and (5) of the Income Tax Rates Act 1986 5.353
Items 112 and 113, subsections 23C(4) and (5) of the Income Tax Rates Act 1986 5.354
Item 114, subsection 45-120(2A) of the TAA 1953 5.356
Item 115, subsection 45-330(3) 5.358
Item 116, subsection 45-330(3) of the TAA 1953 5.357
Item 117, subsection 45-370(3) 5.359

Schedule 3, Part 1: Imputation - PAYG instalments

Bill reference Paragraph No.
Items 1 to 11 6.36
Item 12 section 160APBC 6.34