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Senate

Taxation Laws Amendment Bill (No. 6) 2001

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
This Memorandum takes account of amndments made by the House of Representatives to the bill as introduced

Glossary

The following abbreviations and acronyms are used throughout this revised explanatory memorandum.

Abbreviation Definition
ATO Australian Taxation Office
CGT capital gains tax
Commissioner Commissioner of Taxation
GDP gross domestic product
GST goods and services tax
GST Act A New Tax System (Goods and Services Tax) Act 1999
GTL gas to liquids
GTP gas transfer price
HCS HIH Claims Support Limited
HIH Trust HIH Claims Support Trust
ITAA 1936 Income Tax Assessment Act 1936
ITAA 1997 Income Tax Assessment Act 1997
LIC listed investment company
MPC marketable petroleum commodity
PAYG pay as you go
PRRT petroleum resource rent tax
PRRTA Act Petroleum Resource Rent Tax Assessment Act 1987
PST pooled superannuation trust
SIS Act Superannuation Industry (Supervision) Act 1993
STB State and Territory body
TFN tax file number
TAA 1953 Taxation Administration Act 1953

General outline and financial impact

Petroleum resource rent tax - sales gas

Part 1 of Schedule 1 to this bill amends the PRRTA Act to reduce the uncertainty surrounding the determination of a price for gas produced in integrated GTL projects.

Broadly, the amendments will provide for a new methodology to determine the price of gas where there is no comparable uncontrolled price and:

there is not a sale at the PRRT taxing point; or
there is a sale at the PRRT taxing point but the sale is non-arms length.

The new methodology will be incorporated in regulations to the PRRTA Act.

Date of effect: A day to be fixed by proclamation.

Proposal announced: The proposal was announced jointly by the Minister for Industry, Science and Resources and the Treasurer in Media Release No. 058 of 23 December 1998.

Financial impact: The revenue impact is unquantifiable.

Compliance cost impact: Industry will incur additional compliance costs in applying the proposed methodology to determine the GTP. These costs will be detailed in an explanatory statement to the proposed regulations.

Summary of regulation impact statement

Regulation impact on business

Impact: The measurereduces uncertainty surrounding the application of the PRRTA Act to GTL projects by providing a methodology to determine a GTP for feedstock gas that is subject to PRRT.

Main points:

Industry have been concerned that the application of the existing law in relation to PRRT liability on integrated GTL projects is unclear and could impede future developments.
The preferred option is to provide a methodology which is to be included in regulations to the PRRTA Act.
Industry will benefit from greater certainty in relation to GTL projects which will assist them in assessing the viability of proposed projects. Other industries who use large volumes of natural gas will benefit from the development of liquid to natural gas projects.
The methodology clarifies the administration of the PRRTA Act for the ATO and significantly reduces the potential for protracted negotiation with industry.

Petroleum resource rent tax - 5 year rule

Part 2 of Schedule 1 to this bill amends the PRRTA Act to modify the operation of the 5 year rule. Broadly, the 5 year rule applies to classify expenditures for the purpose of calculating PRRT liability. The amendments change the date used for classifying these expenditures from the day the production licence is issued to the day the Government has received sufficient information to determine the successful production licence application.

Date of effect: The amendments takes effect in relation to production licence applications for which an application has been made after 23 December 1998.

Proposal announced: The proposal was announced jointly by the Minister for Industry, Science and Resources and the Treasurer in Media Release No. 058 of 23 December 1998.

Financial impact: The measure will result in a small but unquantifiable cost to revenue.

Compliance cost impact: Nil.

Summary of regulation impact statement

Regulation impact on business

Impact: The change to the 5 year rule ensures that the petroleum industry is not financially disadvantaged by delays in production licence approvals.

Main points:

The option of resolving this problem by removing the delays in granting a production licence was not considered viable.
The favoured option is to make the reference date for the 5 year rule the time at which a taxpayer has provided sufficient information to successfully determine the application for production licence.

Income tax exemption for local government businesses

Schedule 2 to this bill amends the ITAA 1936 to extend income tax exemption to businesses that are owned or controlled at the local government level.

Schedule 2 also makes a minor technical amendment to correct a legislative reference.

Date of effect: The amendments apply to income derived after 30 June 2000.

Proposal announced: This measure was announced in Treasurers Press Release No. 52 of 19 June 2000.

Financial impact: The exemption is unlikely to involve any loss of Commonwealth revenue because municipal corporations and local governing bodies are currently exempt under section 50-25 of the ITAA 1997. The amendment will simply allow these bodies to restructure their operations to improve business efficiency.

Compliance cost impact: As the amendment does not impose any additional requirements on local government bodies, it will not involve additional compliance costs. The amendment is designed to assist local government bodies who seek to restructure their activities in order to improve their business efficiency.

Superannuation fund residence requirements

Schedule 3 to this bill amends the ITAA 1936 by amending the definition of resident superannuation fund in subsection 6E(1) and also by replacing the definition of active member in subsection 6E(5) with new definitions of active member and non-active member in subsection 6E(4A) and subsection 6E(4B) respectively.

The amendments will allow a fund, in particular a self-managed superannuation fund, to retain its residency status while the trustees and/or members of the fund are temporarily overseas so long as certain conditions are met.

Date of effect: The amendments will apply from the date of Royal Assent.

Proposal announced: This measure was announced in Assistant Treasurers Press Release No. 49 of 4 October 2000.

Financial impact: Nil.

Compliance cost impact: Nil.

Tax relief for shareholders in listed investment companies

Schedule 4 to this bill amends the ITAA 1997 to provide shareholders in listed investment companies with the benefit of the CGT discount on the eligible gain component of a dividend paid to shareholders.

Date of effect: 1 July 2001.

Proposal announced: The measure was announced in the 2001-2002 Federal Budget. Broad details of the concession were provided in Treasurers Press Release No. 33 of 22 May 2001.

Financial impact: The measure will result in a cost to revenue as set out in the following table.

2001-2002 2002-2003 2003-2004 2004-2005
$5m $20m $20m $20m

Compliance cost impact: There will be additional costs for listed investment companies from implementing changes to their systems, accounting for eligible gains and advising shareholders of their entitlement to the concession.

Summary of regulation impact statement

Regulation impact on business

Impact: The measure contained in this bill provides taxpayers with greater access to the benefits of the CGT discount.

Main points:

The measure has the support of industry who have been consulted during ongoing development and finalisation of the measure.
Compliance costs for investors will be minimal. There will be some additional compliance costs for industry associated with the change.
The net benefit of this change is the diversification of investment available for Australians choosing to invest.

HIH rescue package

Schedule 5 to this bill amends the ITAA 1997 to:

ensure that the income tax consequences of payments under the HIH rescue package are the same as if those payments had been made directly by HIH; and
exempt the HIH Trust from income tax.

Schedule 5 also amends the GST Act to ensure that:

the GST consequences of payments made under the HIH rescue package are the same as if those payments had been made directly by HIH; and
where an insurance portfolio transfer has occurred, the GST consequences of transactions made by the transferee insurer are the same as if those transactions had been undertaken by the original insurer.

Date of effect: The amendments to the ITAA 1997 apply with effect from on or after 15 May 2001. The amendments to the GST Act relating to payments made under an HIH rescue package apply, and are taken to have applied:

in relation to GST returns and net amounts for tax periods starting, or that started, on or after 15 March 2001; and
in relation to payments and supplies, of a kind referred to in section 78-120 of the GST Act, that are, or have been, made on or after 15 March 2001 to an entity that is neither registered nor required to be registered.

The amendments relating to insurance portfolio transfers apply, and are taken to have applied to GST returns and net amounts for tax periods starting, or that started, on or after 1 January 2001.

Proposal announced: Minister for Financial Services and Regulations Press Release No. 50 of 26 June 2001.

Financial impact: Nil impact on forward estimates.

Compliance cost impact: Nil.

Personal services income

Schedule 6 to this bill amends Part 2-42 of the ITAA 1997 which deals with personal services income, as well as the ITAA 1936 and the TAA 1953. The amendments are intended to reduce compliance costs for taxpayers, and allow certain agents to be excluded from the personal services income rules.

The personal services income measure applies from the 2000-2001 income year and was introduced in order to improve the integrity of the tax system. The measure addresses the capacity of individuals, and interposed entities providing the personal services of an individual, to deduct greater amounts than employees providing the same or similar services. The measure also addresses the alienation of personal services income through interposed entities. The measure does not apply if the individual or entity is conducting a personal services business.

Broadly, the current amendments will:

allow certain agents (who satisfy specific criteria) to be treated as having received their personal services income directly from the customers of their principal as a result of providing services directly to those customers;
allow all taxpayers earning personal services income (even those earning 80% or more from one source) to self-assess against the results test for conducting a personal services business, (which is currently further grounds for the Commissioner to give a personal services business determination). This will ensure that genuine independent contractors are not affected by the measure;
allow all taxpayers earning personal services income (even those earning less than 80% from each source) to apply to the Commissioner for a personal services business determination (based on the available grounds for a determination); and
make technical amendments to ensure that the personal services income rules work as intended.

These amendments are designed to ease compliance costs for taxpayers under the measure.

Date of effect: The amendments will, like the original provisions, generally apply to the 2000-2001 income year and later years. As these measures are favourable to taxpayers it is appropriate that they start from the same date. The amendments do not place any compliance obligations on taxpayers.

Some technical amendments apply prospectively - items 4A to 4C (clarification of the 80% test) and 16M (preventing a double benefit for promptly paid salary or wages) apply to the 2002-2003 income year and later income years. Items 16C to 16K (consequential amendments to the penalties for directors of non-remitting companies) apply from the date of Royal Assent.

Proposal announced: The majority of the amendments were announced in Treasurers Press Release No. 47 of 29 June 2001 and No. 51 of 9 July 2001. The other amendments are technical in nature and were not announced before being introduced to the House of Representatives.

Financial impact: The amendment relating to certain agents is expected to result in a revenue loss of $35 million for the 2000-2001 financial year and for each following year.

Clarifying that a taxpayer will satisfy the results test if 75% of their personal services income satisfies all the conditions in the test is expected to result in a revenue loss of $1 million for the 2000-2001 financial year and for each following year.

The other amendments will have no effect on revenue.

Compliance cost impact: The amendments will significantly reduce compliance costs for many taxpayers earning personal services income, especially those able to satisfy the results test.

Summary of regulation impact statement

Regulation impact on business

Impact: Low.

Main points:

The amendments were announced by the Government following concerns expressed by industry associations and commentators about the impact of the legislation on independent contractors.
The amendments are intended to reduce compliance costs for taxpayers and provide access to personal services business determinations for all taxpayers.

Chapter 1 - Petroleum resource rent tax - sales gas

Outline of chapter

1.1 Part 1 of Schedule 1 to this bill explains the changes to be made to the PRRTA Act to reduce the uncertainty surrounding its application to integrated GTL projects. The amendments will provide for rules to be prescribed by regulation to determine PRRT liability for the upstream operations of a GTL project where:

there is a sale of gas at the PRRT taxing point but the sale is a non-arms length transaction; or
there has been no sale of the gas at the PRRT taxing point.

Context of amendments

1.2 To calculate the taxable profit of a petroleum project under the PRRTA Act, an amount is required to be included in assessable receipts at the point where an MPC becomes an excluded commodity. Under the PRRTA Act, an excluded commodity means:

an MPC that has been sold; or
after being produced, the MPC has been further processed or treated, or has been moved away from its place of production or a storage site adjacent to its place of production.

1.3 For natural gas that is to be further processed in an integrated GTL project, the PRRT taxing point will be where the sales gas is first produced and not where the gas is liquefied.

1.4 In a GTL project, it is expected that there will be some common ownership of the upstream production stage (which extracts the natural gas) and the downstream processing stage (which transforms the gas to a liquefied product). As the PRRT applies only to the rents in the upstream (i.e. extraction) phase of a project, a transfer price is needed for sales gas delivered to the downstream (i.e. processing) phase of an integrated project where the sales gas is sold under a non-arms length transaction or where there has been no sale and an amount is required to be included in assessable petroleum receipts.

1.5 The current legislation provides no guidance on how the sales gas is to be valued in the circumstances as described in paragraph 1.4. Where an MPC is not sold at the PRRT taxing point, the current requirement in the PRRTA Act is that, where there is insufficient evidence of that market value, an amount is to be included in a persons assessable receipts that, in the opinion of the Commissioner, is fair and reasonable. Also, where the MPC is sold at the PRRT taxing point under a non-arms length transaction, the existing provisions in the PRRTA Act do not provide a clear methodology for the valuation of an MPC.

1.6 In Media Release No. 058 of 23 December 1998, the Minister for Industry, Science and Resources announced with the Treasurer that the Government would provide a methodology for determining a GTP. The proposal was developed following extensive consultations with industry.

Summary of new law

1.7 This bill amends the PRRTA Act so that certain assessable petroleum receipts for an integrated GTL project can be determined for the purposes of section 24 of the PRRTA Act in accordance with regulations. The regulations will apply to value sales gas where a sale of the gas does not take place at the taxing point or a non-arms length transaction has taken place and there is no comparable arms length price.

1.8 This bill also includes a revised definition of sales gas in the PRRTA Act in order to determine the PRRT taxing point of sales gas (i.e. when the gas becomes an excluded commodity) in the extraction phase of an integrated GTL project.

1.9 Further, this bill amends the collection by instalment provisions in the PRRTA Act so that where there are amounts included in assessable receipts under section 24 for GTL projects, the instalments of tax will be determined in accordance with the regulations.

Comparison of key features of new law and current law
New law Current law
In a GTL project, regulations will prescribe how to determine amounts to be included as assessable petroleum receipts in the following circumstances:

where sales gas is sold at the PRRT taxing point under a non-arms length transaction; and
where sales gas is not sold at the PRRT taxing point.

There are no specific rules for determining amounts to be included in assessable receipts for GTL projects:

where sales gas is sold at the PRRT taxing point under a non-arms length transaction the existing provisions in the PRRTA Act do not provide a clear methodology for the valuation of an MPC; and
where an MPC is not sold at the PRRT taxing point and there is insufficient evidence of its market value, the amount that, in the opinion of the Commissioner, is fair and reasonable, is to be included as an assessable petroleum receipt.

Detailed explanation of new law

Definition of sales gas

1.10 The current definition of sales gas in section 2 of the PRRTA Act is repealed by this bill and is replaced by a new expanded definition. This expanded definition of sales gas means a substance:

which is in a gaseous state when at a temperature of 15 degrees Celsius and one atmosphere;
which consists of naturally occurring hydrocarbons, or a naturally occurring mixture of hydrocarbons and non-hydrocarbons; and
the principal constituent of which is methane:

-
which has been processed to be suitable for direct consumption as energy; or
-
where it is to be used as a feedstock for conversion to another product and has been processed to be suitable for that use.

[Schedule 1, Part 1, item 1]

1.11 The definition of sales gas together with section 24 of the PRRTA Act will determine the PRRT taxing point for the sales gas (i.e. when it becomes an excluded commodity).

Amendments to section 24

1.12 Section 24 describes what amounts are assessable petroleum receipts derived by a person in relation to a petroleum project:

paragraph 24(b) describes the amounts to be included as assessable petroleum receipts where the MPC becomes an excluded commodity by virtue of being sold; and
paragraph 24(c) describes the amounts to be included as assessable petroleum receipts where the MPC becomes an excluded commodity otherwise than by virtue of being sold or treated as specified in subparagraph 24(1)(c)(ii).

1.13 New paragraphs 24(1)(d) and 24(1)(e) describe the amounts to be included in assessable petroleum receipts where the commodity produced from petroleum recovered from the production licence area or areas in relation to the project is sales gas. The amounts to be included are as follows:

where the sales gas becomes or became an excluded commodity by virtue of being sold:

-
if the sale is a non-arms length transaction - an amount worked out in accordance with regulations; and
-
in any other case - the consideration receivable, less any expenses payable, by the person in relation to the sale; or

where the sales gas becomes or became an excluded commodity otherwise than by virtue of being sold, or is treated as specified in subparagraph 24(1)(e)(ii) - an amount worked out in accordance with regulations.

[Schedule 1, Part 1, item 5, paragraphs 24(1)(d) and (e)]

Non-arms length transaction

1.14 In order for subparagraph 24(1)(d)(i) to apply, the Commissioner needs to be satisfied that a non-arms length transaction has taken place. The term non-arms length transaction means a transaction where the Commissioner, having regard to any connection between the parties to the transaction or to any other relevant circumstances, is satisfied that the parties are not dealing with each other at arms length in relation to the transaction. [Schedule 1, Part 1, item 5, subsection 24(2)]

1.15 The Commissioners existing income tax rulings, for example, Taxation Ruling TR 94/14, provides the ATO interpretation of the expression dealing at arms length with each other. The Taxation Rulings can be used as a further guide to the meaning of the expression non-arms length transaction.

Adjustment to instalments of tax

1.16 Division 2 of the PRRTA Act contains rules for the collection of PRRT by instalments.

1.17 Section 96 of the PRRTA Act specifies the amount that is payable by a person as an instalment of tax in relation to an instalment period. That amount is referred to as the notional tax amount and is ascertained under section 97 of the PRRTA Act. Under section 97, the previous period liability is subtracted from the current period liability to arrive at the notional tax amount for the instalment period. The current period liability is an amount equal to the tax that would be payable by the person for the instalment period worked out in accordance with the rules set out in subsection 97(1A). The previous period liability is the notional tax amount or the sum of the notional tax amounts for any prior instalment period or periods in the year of tax.

1.18 This bill provides that where the amount of assessable petroleum receipts, that would be taken into account in working out the current period liability, is determined in accordance with new subparagraph 24(1)(d)(i) and new paragraph 24(1)(e), then, for the purposes of calculating the current year liability, any assessable receipts determined under those provisions are to be excluded and the amount is to be worked out in accordance with the regulations. [Schedule 1, Part 1, item 8, subsection 97(1AA)]

Review of certain decisions

1.19 This bill also provides that a taxpayer who is dissatisfied with a decision made under the PRRTA Act or the regulations can object against it in the manner set out in Part IVC of the TAA 1953 [Schedule 1, Part 1, item 9, subsection 97(1AA)] . This provision is necessary so that taxpayers have rights to object in relation todecisions made by the Commissioner under the PRRTA Act and also the new arrangements to be included in regulations.

Application and transitional provisions

1.20 The amendments will apply from a day to be fixed by proclamation [subclause 2(2)] . If no day is fixed by proclamation before the end of 6 months after Royal Assent of this bill, the amendments will apply from the end of that 6 month period [subclause 2(3)] .

Consequential amendments

1.21 Consequential amendments are made to paragraphs 24(b) and (c) to ensure these provisions do not apply in relation to sales gas. [Schedule 1, Part 1, items 2 to 4]

1.22 A consequential amendment is made to section 26 to change the reference to paragraph 24(c) to paragraphs 24(1)(c) and 24(1)(e). [Schedule 1, Part 1, item 6]

1.23 Section 57 of the PRRTA Act provides that where a person has derived receipts in a non-arms length transaction then the person shall be taken to have received receipts that would have been received if the transaction had been an arms length transaction. This section is amended to ensure that it does not apply to receipts determined under new subparagraph 24(1)(d)(i). [Schedule 1, Part 1, item 7]

REGULATION IMPACT STATEMENT

Policy objective

1.24 The policy objective is to reduce fiscal uncertainty for investment in high cost, long lead time GTL projects by providing a methodology to determine a GTP for sales gas that is subject to PRRT. The methodology will apply for the calculation of PRRT for the upstream operations of a GTL project where there is insufficient evidence of a market value for the gas.

1.25 The proposal was announced in Media Release No. 058 of 23 December 1998, by the Minister for Industry, Science and Resources and the Treasurer.

Background

1.26 The current PRRT regime was enacted in 1987 through the PRRTA Act. PRRT is a resource charge applied to the taxable profit of a projects petroleum production. To calculate the taxable profit, an amount is required to be included in assessable receipts at the point where an MPC becomes an excluded commodity. For natural gas, this means the point where sales gas is produced and not where it is liquefied.

1.27 The PRRT is applied at a 40% rate on the taxable profit of a project. That is, assessable receipts less project related expenditures including eligible exploration expenditures. Where in a year, expenditures are not immediately deducted (due to expenditures being greater than receipts), they are carried forward and are augmented in the next year at a risk-adjusted rate (long term bond rate) plus 15 percentage points for exploration and long term bond rate plus 5 percentage points for general (development) expenditure[F1].

1.28 For natural gas that is to be further processed in an integrated GTL project, the PRRT taxing point will be where the commodity (sales gas) is first produced and not where the gas is liquefied. It is expected that GTL projects will have the same ownership of the upsteam production stage, which extracts the natural gas, and the downstream processing stage, which transforms the gas into a liquefied product. Under the existing regime, the downstream phase of a GTL project is not subject to PRRT.

1.29 There is uncertainty surrounding the application of the PRRTA Act to integrated GTL projects because there may not be a market transaction in the transfer of gas (i.e. other than by sale) between the upstream and downstream stages. In this case a transfer price is required to value the gas for the purpose of calculating a PRRT liability. Where there is insufficient evidence of market value, the amount to be included will be, in the opinion of the Commissioner, is fair and reasonable. The same uncertainty arises where the product is sold under a non-arms length transaction and there is no comparable uncontrolled price.

Implementation options

1.30 The implementation of the Governments policy objective involves 3 options.

1.31 The first option is to continue with the status quo. The PRRTA Act currently allows the Commissioner to determine a notional arms length price where one does not, in reality, exist. However, this option fails to address the issues of stability and predictability that have been the basis of industrys concerns.

1.32 The second option is to develop a mechanism for the calculation of a GTP. This includes a methodology to value the gas where a sale of the gas does not take place at the taxing point or a non-arms length transaction has taken place.

1.33 The third option is to use a shadow price approach. The shadow pricing methodology would involve using the price observed in an arms length transaction between unrelated parties as the feedstock GTP.

1.34 The preferred option for implementing the policy objective is to include a methodology to determine a GTP. The shadow pricing methodology can only be used where there is an observable comparable arms length price. It is not expected that the shadow pricing method could be reliably applied in the foreseeable future.

Assessment of impacts (costs and benefits)

Impact groups

1.35 The measure will have impacts on the industry, Government and potentially the community if the changes facilitate investment in GTL projects.

Business

1.36 The measure impacts on companies intending to participate in an integrated GTL project in Australia utilising gas fields in PRRT liable areas.

Benefits

1.37 The introduction of a clearly defined mechanism for the determination of a GTP will provide increased regulatory transparency for industry involved, or planning on being involved, in GTL operations in Australia. The implementation of a mechanism will provide industry with greater certainty with regard to GTL projects, assisting them in assessing the viability of proposed projects.

1.38 To the extent that providing greater certainty to the industry will lead to increased investment, other industries may also benefit, particularly those who have planned industrial projects requiring large volumes of natural gas. For example, petrochemical as well as iron and steel projects.

1.39 The monetary benefits that will accrue to business from creating a favourable investment environment, whilst seen to be significant, will ultimately depend on the economics of individual projects undertaken. The magnitude of benefits cannot be readily estimated at this point in time.

Costs

1.40 Industry will incur compliance costs in using the methodology to determine a GTP and reporting information to the ATO. These compliance costs will be explained in detail in the regulation impact statement to be included with the regulations.

1.41 There may in fact be a nil net cost to industry if the requirement to calculate a market value for the gas using an alternative methodology is taken into account or a GTP is required to be determined under the existing law.

Government

Benefits

1.42 A GTP mechanism clarifies the administration for the ATO with regard to GTL projects and significantly reduces the potential for protracted negotiation with industry. The mechanism will provide an efficient method of determining a transfer price for all integrated GTL projects for which an arms length price cannot be determined, as opposed to individual determinations for each new project.

1.43 By providing increased certainty for industry, the Government may benefit in the long term through increased tax revenues, to the extent it encourages new developments. The proposed methodology will ensure that revenue is protected on GTL projects.

Costs

1.44 The ATO will incur administrative costs in administering the methodology. These costs will be explained in detail in the regulation impact statement to be included with the regulations.

Impact on revenue

1.45 The current (pre-GTP) regime (through disputations and court actions), may produce a taxable value for the gas not dissimilar to a GTP calculated using a methodology. However, the proposed regime provides certainty on the manner in which a taxing value is to be determined.

1.46 However, as there are no new large scale GTL projects imminent, the revenue impact of the introduction of the GTP is unquantifiable.

Community

Benefits

1.47 To the extent that a mechanism provides greater certainty to industry, and this leads to increased development, there would be some benefits to the community. Increased development may lead to the creation of jobs.

1.48 GTL projects are primarily export orientated and encouraging the development of such an industry is in the whole countrys interest.

Costs

1.49 None.

Consultation

1.50 The changes are in response to industry concerns about certain elements of the PRRT and were developed following wide consultation with the industry and assessment by an independent consultant.

Conclusion

1.51 The PRRTA Act currently allows for the determination of a GTP which is fair and reasonable by the Commissioner via the arms length provisions. However, the PRRTA Act does not provide any guidance to the Commissioner as to what a fair and reasonable price may be where gas is used as a feedstock into an integrated GTL project.

1.52 The favoured option is the inclusion of a mechanism to determine the GTP. This would provide greater certainty to industry and clarify the application of PRRT to integrated GTL projects. Of the 2 options considered, the inclusion of a methodology is the favoured option because it avoids the need to rely on a market value which may not be readily ascertained where there is no sale of the commodity at the taxing point.

Chapter 2 - Petroleum resource rent tax - 5 year rule

Outline of chapter

2.1 Part 2 of Schedule 1 to this bill amends the PRRTA Act to ensure that the 5 year rule which applies to classify expenditures for the purpose of calculating a persons PRRT liability does not have an adverse impact due to delays in approvals for production licence applications.

Context of amendments

2.2 A persons PRRT liability is based on any taxable profit received by the person from a petroleum project after taking into account their assessable receipts and deductible expenditure. The classes of expenditure include exploration expenditure, general project expenditure and closing down expenditure.

2.3 Taxpayers can carry forward all their exploration and general project expenditure on a petroleum project in which they hold an interest until it is absorbed by their assessable receipts from the project. Where, in a year, expenditures are not immediately deducted (due to expenditures being greater than receipts) they are carried forward.

2.4 At the time expenditure is allowed as a deduction there is a process of classification which determines whether expenditure is increased by an augmented bond rate or at a lower GDP factor rate. The difference in classification is based on whether expenditures are incurred more than 5 years prior to the issue of a production licence (referred to as the 5 year rule). Such expenditure is then referred to as GDP factor expenditure. Where the expenditures are incurred more than 5 years prior to the issue of a production licence, the lower GDP factor rate will apply.

2.5 Production licence applications can be delayed by circumstances beyond the control of the applicant. Applicants can be penalised by the application of the 5 year rule because the longer it takes to approve a production licence application, the more likely some exploration expenditure may be increased by the lower GDP factor rate. Thus, delays caused by the licence granting process may result in some companies having lower PRRT deductions than they otherwise would have had.

2.6 In Media Release No. 058 of 23 December 1998, the Minister for Industry, Science and Resources announced with the Treasurer that the Government will amend the 5 year rule to alter the reference date for determining the classifying expenditures.

2.7 The change is in response to industry concerns.

Summary of new law

2.8 The reference date in the 5 year rule for classifying expenditures will be changed from the day the production licence is issued to the day the Government has received sufficient information to determine the successful production licence application.

Detailed explanation of the new law

2.9 This bill amends the following provisions that contain the 5 year rule in respect of Class 2 expenditure (i.e. post-1990 expenditure):

paragraph 34A(1)(a) (which deals with Class 2 augmented bond rate general expenditure); and
paragraphs (a) and (b) of the definition of relevant pre-commencement day in Part 1 of the Schedule to the PRRTA Act (which are used in the classification of exploration expenditure between Class 2 augmented bond rate exploration expenditure and Class 2 GDP factor expenditure),

to provide that the reference date for the 5 year rule will be the date specified in a notice to be issued under consequential amendments being made to the Petroleum (Submerged Lands) Act 1967 in this bill. [Schedule 1, Part 2, items 10 to 12]

2.10 As the amendments are to take effect only in relation to applications for production licences made after 23 December 1998, only expenditure incurred in the 1993-1994 and subsequent financial years is effected. As a result, the following provisions that relate to expenditure incurred prior to 1 July 1990 do not need to be amended:

paragraph 33(1)(a) - Class 1 augmented bond rate general expenditure;
paragraph 34(1)(a) - Class 1 augmented bond rate exploration expenditure; and
paragraph 35(1)(a) - Class 1 GDP factor expenditure.

Consequential amendment to the Petroleum (Submerged Lands) Act 1967

2.11 Under the Petroleum (Submerged Lands) Act 1967 a person cannot carry out an operation for the recovery of petroleum unless they have been granted a production licence. This requires that the person make an application for a production licence to the Designated Authority (which will be a State/Territory Minister who has the portfolio dealing with mines). Subsection 41(1) requires that an application for a production licence be made in an approved form.

2.12 For the purposes of the amendment to the 5 year rule in the PRRTA Act, the Designated Authority must, within 28 days of receiving the application for the production licence, determine whether sufficient information has been provided by the applicant to allow the Designated Authority to determine the application. If the Designated Authority considers sufficient information has been provided it must issue a notice which specifies the last day on which the information was provided. [Schedule 1, Part 2, item 13, subsection 41(3)]

2.13 If the Designated Authority later requires more information in relation to the production licence application it is not prevented by the issue of a notice under new subsection 41(3) from seeking this further information [Schedule 1, Part 2, item 13, subsection 41(4)] . This provision makes it clear that the provision of a notice under subsection 41(3) does not preclude the Designated Authority from seeking further information after the notice has issued. Regardless of a request for further advice following the provision of the notice, the date provided under the notice in subsection 41(3) would continue to be the relevant date.

2.14 Where a person withdraws their production licence application or where the Designated Authority decides not to grant a production licence, or where the application is otherwise finalised without a production licence being granted, the notice referred to in new subsection 41(3) is taken never to have been issued. [Schedule 1, Part 2, item 13, subsection 41(5)]

Application and transitional provisions

2.15 A Designated Authority may have issued a notice referred to in new subsection 41(3) in the period between 23 December 1998 and the commencement date of these amendments. As a transitional measure:

these notices will be taken to have been issued under new subsection 41(3); and
the date that the notice was issued will be taken to be the date specified in the notice for the purposes of new subsection 41(3).

[Schedule 1, Part 2, item 14]

2.16 The amendments are to take effect in relation to projects for which an application for a production licence was made after 23 December 1998. [Schedule 1, Part 2, item 15]

REGULATION IMPACT STATEMENT

Policy objective

2.17 The policy objective is to ensure the equitable operation of the 5 year rule which applies to classify expenditures for the purpose of calculating PRRT liability.

2.18 The proposed amendment was announced jointly by the Minister for Industry, Science and Resources and the Treasurer in Media Release No. 058 of 23 December 1998.

Background

2.19 PRRT is a resource charge applied to the taxable profit of a projects petroleum production[F2].

2.20 The PRRT is applied at a 40% rate on the taxable profit of a project. That is, assessable receipts less project related expenditures including eligible exploration expenditures. Where in a year, expenditures are not immediately deducted (due to expenditures being greater than receipts), they are carried forward and augmented in the next year at a risk-adjusted rate (long term bond rate) plus 15 percentage points for exploration and long term bond rate plus 5 percentage points for general (development) expenditure[F3].

2.21 The 5 year rule is a revenue protection measure included in the PRRTA Act and applies to expenditures incurred more than 5 years prior to the issue of a production licence. Such expenditure is then referred to as GDP factor expenditure. Under the PRRTA Act, the GDP factor expenditure is carried forward at the GDP factor rate. Hence, while the real value of the expenditure is maintained, the expenditure does not benefit from the application of a risk-adjusted carry forward rate. Delays caused by the licence granting process may result in some businesses having lower PRRT deductions than they otherwise would have had.

Implementation options

2.22 There are 2 implementation options to meet the policy objective.

The first option is to amend the expenditure provisions contained in the PRRTA Act to reference the 5 year rule to the time at which the Government acknowledges that the company has provided sufficient information to determine a production licence application. This is instead of the current situation where the 5 year rule is bound to the time when the licence is actually granted.
The second option is to remove the delays involved with the process of granting a project licence.

2.23 The first option is the preferred option because of the complexities involved with the granting of a project licence and the number of reasons that can give rise to a delay.

Assessment of impacts (costs and benefits)

Business

2.24 The measures will impact on companies involved in exploration and petroleum operations in PRRT liable waters.

Benefits

2.25 Changing the reference point of the 5 year rule will ensure that the petroleum industry is not financially disadvantaged by the processing of an application for a production licence.

Costs

2.26 None.

Government

Benefits and costs

2.27 Changing the 5 year rule as proposed simply removes an anomaly in the working of the PRRTA Act.

Impact on revenue

2.28 The measure will produce a small but unquantifiable cost to revenue.

Community

2.29 No impact.

Consultation

2.30 The changes are in response to industry concerns about certain elements of the PRRT. They were developed following consultation with the industry.

Conclusion

2.31 The current operation of the 5 year rule contains a technical anomaly which can potentially disadvantage industry through the process of granting of production licences.

2.32 While the process of granting production licences is currently being streamlined, some delays are inherent in the process and hence unavoidable. These amendments will overcome any such disadvantages a taxpayer may have incurred.

Chapter 3 - Income tax exemption for local government businesses

Outline of chapter

3.1 Schedule 2 to this bill amends the ITAA 1936 to extend to local government businesses the income tax exempt status currently available to bodies at the State and Territory level. This amendment supports the National Competition Policy, which encourages local government bodies to operate separate businesses, so as to improve their efficiency and service delivery.

3.2 Schedule 2 also makes a minor technical amendment to correct a legislative reference in section 24AT of the ITAA 1936.

Context of amendments

Income tax exemption for local government businesses

3.3 Division 1AB of the ITAA 1936 exempts wholly-owned STBs from income tax. This Division was designed to meet the needs of STBs which operate as separate business entities.

3.4 A government entity is defined in section 24AT of the ITAA 1936 as a State, a Territory or another STB that is not an excluded STB. The current definition does not extend to a municipal corporation or a local governing body. This means that sections 24AO to 24AS, which specify the 5 ways in which an entity can be an STB, do not apply to businesses that are owned or controlled at the local government level.

3.5 Section 50-25 of the ITAA 1997 provides an exemption for the income of a municipal corporation or a local governing body. However, a business that is owned or controlled by a local governing body does not qualify for exemption under this section.

3.6 The practical effect of the current law is that a local government business which is owned or controlled at the local government level does not qualify for exemption under the provisions mentioned in paragraphs 3.4 and 3.5. This is because the exemption currently available under Division 1AB is limited to entities at the State and Territory level and the exemption available under section 50-25 is limited to municipal corporations and local governing bodies and does not include businesses owned or controlled by those bodies.

Explanation of amendments

Income tax exemption for local government businesses

3.7 This amendment ensures that where a municipal corporation or local governing body (which itself is exempt by virtue of section 50-25 of the ITAA 1997) owns or controls a business, that business is also exempt under Division 1AB of the ITAA 1936 if it meets one of the 5 ways of becoming an STB. Without this amendment a business owned or controlled, at the local government level, would not be exempt under either Division 1AB of the ITAA 1936 or section 50-25 of the ITAA 1997.

3.8 A new paragraph has been inserted in section 24AT of the ITAA 1936, which extends the definition of government entity to include a municipal corporation or other local governing body. This amendment ensures that the five ways of becoming an STB (sections 24AO to 24AS) will also apply to businesses owned or controlled at the local government level. [Schedule 2, item 2, paragraph 24AT(ba)]

3.9 This amendment supports the National Competition Policy which is designed to improve the efficiency and service delivery of businesses at the local government level.

Technical correction

3.10 This technical correction makes a minor change to the definition of excluded STB in section 24AT of the ITAA 1936. It replaces the existing reference to paragraph 23(d) of the ITAA 1936 with a reference to section 50-25 of the ITAA 1997. The amendment correctly aligns Division 1AB with section 50-25 which is the appropriate exemption provision for municipal corporations and local governing bodies. Paragraph 23(d) of the ITAA 1936 was rewritten as section 50-25 of the ITAA 1997 as part of the Tax Law Improvement Project and this amendment simply updates the reference. [Schedule 2, item 1]

Application and transitional provisions

3.11 The amendments apply to income derived after 30 June 2000. [Schedule 2, item 3]

Chapter 4 - Superannuation fund residence requirements

Outline of chapter

4.1 The amendments made by items 1 to 4 of Schedule 3 will allow a superannuation fund, in particular a self-managed superannuation fund, to retain its residency status while the trustees and/or members of the fund are temporarily overseas if certain conditions are met.

Context of amendments

4.2 In order to be a complying superannuation fund under the SIS Act,and to therefore be taxed concessionally as well as be able to accept superannuation guarantee contributions, a fund must satisfy, amongst other things, the definition of a resident superannuation fund in the ITAA 191936 at all times during the year.

4.3 The definition of resident superannuation fund determines the residency status of a fund at a point in time. However, if at any point in time during the year a fund is not a resident superannuation fund, then it is not a complying superannuation fund for the entire year under the SIS Act.

4.4 One of the requirements of the definition of resident superannuation fund is that the central management and control of the fund must be in Australia. Consequently, if the majority of trustees are temporarily overseas the fund may fail the central management and control test. This would mean that the fund is not a resident superannuation fund and consequently the fund is not a complying superannuation fund for the entire year.

4.5 Another of the requirements of the definition of a resident superannuation fund is that the entitlements of resident active members be at least equal to 50% of the entitlements of all active members. If a non-resident member receives a contribution at any stage during the year, they become a non-resident active member even if the contribution relates to a period when they were a resident. Becoming a non-resident active member may mean that the fund fails the 50% test and therefore fails the residency test at that point in time. Consequently, the fund would not be a complying fund for the entire year.

Summary of new law

4.6 The amended provisions will enable a fund to retain its residency status while the trustees of the fund are temporarily overseas for a period of up to 2 years and will also enable a non-resident member to receive superannuation contributions in respect of a period in which they were a resident member without them subsequently becoming a non-resident active member.

Comparison of key features of new law and current law
New law Current law
A superannuation fund can retain its residency status while the funds trustees are temporarily overseas for a period of up to 2 years. Where trustees are overseas, the superannuation fund may fail the central management and control test and thus not be a resident superannuation fund.
If a non-resident member of a superannuation fund receives superannuation contributions in respect of a period in a year in which they were a resident this alone will not make them a non-resident active member for that entire year. If a non-resident member of a superannuation fund receives superannuation contributions in respect of a period in a year in which they were a resident this alone will make them a non-resident active member for that entire year.

Detailed explanation of new law

4.7 Paragraph 6E(1)(c) is repealed and replaced by new paragraph 6E(1)(c) which requires that the central management and control of the fund is in Australia or that the fund satisfies subsection 6E(1A) or 6E(1B). [Schedule 3, item 1]

4.8 Subsection 6E(1A) deals with funds that have individuals as trustees and where one or more of those trustees is temporarily overseas for a period that does not exceed 2 years or a longer period, if one is specified in circumstances outlined in the regulations. Such a fund satisfies the subsection if it is the case that if the trustee or trustees were in Australia then the central management and control of the fund would be in Australia. [Schedule 3, item 2]

Example 4.1 Jack and Jill are trustees of the Hill Superannuation Fund. During the year Jack and Jill work overseas for 4 months. As they are temporarily overseas for a continuous period of less than 2 years, and had they been in Australia during that time the central management and control of the fund would have been in Australia, they satisfy subsection 6E(1A) which in turn satisfies paragraph 6E(1)(c) of the residency test.

4.9 Subsection 6E(1B) deals with funds that have a corporate trustee and where one or more of the directors of the trustee is temporarily overseas for a period that does not exceed 2 years or a longer period, if one is specified in circumstances outlined in the regulations. Such a fund satisfies the subsection if it is the case that if the director or directors were in Australia then the central management and control of the fund would be in Australia. [Schedule 3, item 2]

4.10 In determining whether a trustee or director of a trustee company has been outside of Australia for a continuous period not exceeding 2 years subsection 6E(1C) states that a person that returns to Australia for a continuous period of 28 days or less is treated as being outside Australia for that period. While the time overseas must always meet the temporary requirement of paragraphs 6E(1A)(a) and 6E(1B)(a), subsection 6E(1C) is designed to provide clarity that short trips back to Australia cannot be used to re-trigger the 2 year period. This is achieved by providing that during such trips the individual is considered to still be overseas. [Schedule 3, item 2]

4.11 Subsection 6E(4A) defines a member of a fund as an active member of the fund at the relevant time if the member of the fund is a contributor to the fund at that time, or another person has made a contribution to the fund on the members behalf at any time in respect of the year of income in which the relevant time occurs. This is the same as the existing definition in subsection 6E(5) but is now affected by new subsection 6E(4B). [Schedule 3, item 3]

4.12 Subsection 6E(4B) excludes a member of a fund from being an active member at the relevant time if at the time they are not a resident of Australia, they are not a contributor and the only contributions that have been made on their behalf since they ceased being a resident were made in respect of a time when they were a resident. [Schedule 3, item 3]

Example 4.2 Mark, John and Harry are members of the MJH Superannuation Fund and are all Australian residents. Harrys employer makes a superannuation contribution for Harry in July. Harry ceases to be a resident of Australia in August. From that time on Harry is not a contributor to the fund and does not have any contributions made to the fund on his behalf. He is therefore not an active member at any stage during that time. In October a further contribution is made for Harry by the employer in relation to work carried out by him in July. As Harry is not a resident and both the July and October contributions relate to a period when Harry was a resident, he does not become a non-resident active member because of the contributions.

4.13 The definition of active member in subsection 6E(5) is repealed and replaced by the definition of active member in subsection 6E(4A) and the definition of when a member is not an active member in 6E(4B) (see paragraphs 4.11 and 4.12 respectively). [Schedule 3, item 4]

Application and transitional provisions

4.14 This measure was announced in Assistant Treasurers Press Release No. 49 of 4 October 2000.

4.15 The amendments will apply from the date of Royal Assent.

Chapter 5 - Tax relief for shareholders in listed investment companies

Outline of chapter

5.1 A capital gain made by a company is not reduced by the CGT discount, a concession that is available to other entities making a capital gain. Similarly, a shareholder receiving a distribution of a capital gain as a dividend does not benefit from the CGT discount that may have been available if the shareholder had made the capital gain directly. The amendments in Schedule 4 to this bill amend Division 115 of the ITAA 1997 by introducing Subdivision 115-D. These amendments enable certain shareholders in LICs to effectively reduce the eligible capital gain component of a dividend by the CGT discount.

Context of amendments

5.2 In the 2001-2002 Federal Budget and Treasurers Press Release No. 33 of 22 May 2001 the Government announced that a shareholder in a LIC will benefit from the CGT discount on assets realised on or after 1 July 2001 by the LIC, providing those assets have been held for at least 12 months.

5.3 Schedule 4 to this bill gives effect to the Governments announcements.

5.4 Under the current law a shareholder in a LIC receiving a dividend attributable to an eligible capital gain made by that company receives a different tax outcome to an investor in a managed fund receiving a similar amount from the managed fund.

Summary of new law

5.5 The addition of Subdivision 115-D will:

enable certain capital gains made by a LIC to be classified as a notional discount capital gain (LIC capital gain); and
allow certain shareholders in a LIC, on receiving a dividend that includes a LIC capital gain amount, a deduction that reflects the CGT discount the shareholder could have claimed if they had made the LIC capital gain directly.

5.6 The amendments to Division 115 will ensure that a LIC capital gain amount, reflected in a dividend paid to a shareholder in a LIC, receives a similar tax outcome to a payment of a similar amount to a member of a managed fund. This outcome is achieved without disturbing the operations of the company tax or imputation systems.

5.7 The amendments will apply to a payment of a dividend including a LIC capital gain amount from capital gains made by a LIC on or after 1 July 2001.

Comparison of key features of new law and current law
New law Current law
A LIC will be able to make a LIC capital gain. A company cannot make a discount capital gain.
A shareholder of a LIC will effectively benefit from the CGT discount if they are paid a dividend that includes a LIC capital gain amount. A resident shareholder in a LIC who receives a dividend that includes a capital gain is not entitled to the benefit of the CGT discount.
A resident shareholder in a LIC may be allowed a deduction if they receive a dividend that includes a LIC capital gain amount. Generally a deduction will be allowed if the shareholder is an entity of a kind that can make a discount capital gain. To work out the deduction allowed the shareholder will apply the appropriate CGT discount percentage to the LIC capital gain amount.  

Detailed explanation of new law

Overview of CGT discount rules

5.8 Section 115-25 of the ITAA 1997 allows a capital gain made from a CGT event happening to a CGT asset to be a discount capital gain if the asset has been held for at least 12 months.

5.9 A discount capital gain can only be made by:

an individual;
a complying superannuation entity;
a trust; or
a life insurance company in respect of a virtual PST asset.

5.10 The amendments modify the rules in Division 115 to enable a LIC to make a LIC capital gain.

Meaning of listed investment company

5.11 A company is a LIC if:

it is an Australian resident;
it is listed on the Australian Stock Exchange or any other approved Australian stock exchange; and
90% or more of the market value of its CGT assets consist of permitted investments.

[Schedule 4, item 10, subsection 115-290(1)]

5.12 A wholly-owned subsidiary of a LIC can itself be treated as a LIC if it satisfies the requirements in paragraph 5.11 (apart from the listing requirement). [Schedule 4, item 10, subsection 115-290(2)]

Permitted investments

5.13 Permitted investments made by a LIC are:

equity investments which include shares, units, options, rights or similar interests;
financial instruments which includes loans, debts, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts and a right or option in respect of a share, security, loan or contract;
an asset whose main use in the companys business is to derive interest, an annuity, rent, royalties or foreign exchange gains (unless it is an intangible asset and its market value has been substantially altered or the derivation of rent was only temporary); and
goodwill.

[Schedule 4, item 10, subsection 115-290(4)]

5.14 A LIC will have permitted investments if it owns:

a 100% subsidiary, providing the subsidiary is a LIC in its own right;
any percent (directly or indirectly) of another LIC; or
10% (directly or indirectly) of any other company or trust.

[Schedule 4, item 10, subsections 115-290(5) to (7)]

If the LIC exceeds the 10% threshold, those shares or interests will not be permitted investments.

5.15 In testing levels of equity all forms of equity interest must be considered (including voting, non-voting and participating interests). In applying these ownership tests, any indirect ownership is disregarded if this ownership is through a listed public company or a publicly traded unit trust. Tracing of indirect interests through another LIC (that is not a wholly-owned subsidiary) is only required if the first LIC owns more than 50% of the second LIC. [Schedule 4, item 10, subsection 115-290(8)]

Example 5.1 Banjo Investments has a large portfolio of investments in listed and unlisted securities, cash and short term deposit accounts, and qualifies as a LIC. Half of its portfolio is held via a wholly-owned subsidiary, Snowy River Co. Snowy River Co also satisfies the requirements of paragraphs 115-290(1)(a) and (c) and subsection 115-290(2) and qualifies as a LIC. Both Banjo and Snowy River Co satisfy the 90% permitted investment test in paragraph 115-290(1)(c). Any capital gain made by Banjo or Snowy River Company on assets that are permitted investments may be able to be treated as LIC capital gains.

Breach of LIC requirements

5.16 A company will continue to be regarded as a LIC (discussed in paragraph 5.11) if it fails the 90% permitted investments test because of circumstances beyond its control and the non-compliance is only of a temporary nature [Schedule 4, item 10, subsection 115-290(3)] . This may enable a company to satisfy the definition of a LIC at 1 July 2001, when the measure commenced, and at any later time.

Example 5.2 The Vimera Investment Company Limited, a LIC, owned 9.5% of the shares in Millner Sports Limited. As a consequence of a share buy-back undertaken by Millner, Vimeras shareholding in Millner then represented 10.3% of the LIC equity in that company. Vimera fails the 10% ownership in subsection 115-290(5), and this may also trigger the failure of the 90% test in paragraph 115-290(1)(c).Vimera sold part of its equity in Millner reducing its ownership of LIC equity to 9.8%. Subsection 115-290(3) would apply to enable Vimera to continue to be treated as a LIC as if the breach had not occurred.

Example 5.3 Latham Limited, a LIC, believed that the price of shares in Booming Technology Limited was likely to rise rapidly. Latham acquired 16% of the shares in Booming Technology and sold them 3 months later when Latham determined the share price had peaked.In purchasing these shares, Latham failed the 10% ownership test in subsection 115-290(5). These shares are therefore not permitted investments, and this causes Latham to fail the 90% test in paragraph 115-290(1)(c). Latham ceases to be a LIC at the time it purchased the shares. Section 115-290(3) would not apply to ignore the breach as while the breach may have been temporary, it was not beyond Lathams control.

5.17 Administrative guidelines in relation to certain aspects of the LIC measures will be settled between the ATO and industry members. These are likely to include the record keeping requirements and the tests discussed in paragraph 5.16.

Meaning of LIC capital gain

5.18 A LIC capital gain is a capital gain made by a LIC from a CGT event that happened on or after 1 July 2001 to a permitted asset. The gain must also satisfy certain discount capital gain eligibility tests in Subdivision 115-A.

5.19 It is also a requirement that the LIC capital gain be included in both the companys net capital gain and taxable income for the income year in which the capital gain is made. [Schedule 4, item 10, subsection 115-285(1)]

Example 5.4 Sound Investments Limited, a LIC, made a $50,000 capital gain on 23 October 2001 that was a LIC capital gain. The company also made a capital loss of $4,000 on 11 January 2002.The companys net capital gain for the 2001-2002 income year is $46,000 which is included in its taxable income of $360,000.The LIC capital gain available to be paid to the companys shareholders is $46,000.If Sound Investments had carried forward tax losses of $400,000 it would have no taxable income for the income year and no LIC capital gain.If Sound Investments had carried forward tax losses of $300,000, it could apply those losses against its other income so that a LIC net capital gain of $46,000 was included in its taxable income of $60,000.

5.20 A company that became a LIC after 1 July 2001 can only make a LIC capital gain from a CGT event happening to a CGT asset acquired on or after the day it became a LIC. [Schedule 4, item 10, subsection 15-285(2)]

5.21 An integrity rule ensures that in certain situations where an asset is taken to have been acquired after a company became a LIC, because of the operation of another provision of ITAA 1997, the asset will be treated as having been acquired before that time [Schedule 4, item 10, subsection 115-285(3)] . This rule ignores the freshening up of the date of acquisition of the asset that would otherwise occur (e.g. because of certain rollover provisions).

Example 5.5 In December 2001, Beejay Investments restructured its portfolio of investments to meet the LIC requirements in section 115-290. As part of this process it determines that certain assets in its trading portfolio will no longer be held as trading stock. Instead those shares in listed companies will be held for dividend flows and longer term growth.Section 70-110 applies at that time and Beejay Investments is treated as having acquired those shares at cost at that time.Subsection 115-285(3) means that any capital gain arising on the happening of any future CGT event to those shares cannot be a LIC capital gain.

Deduction for certain dividends - impacts for LICs

5.22 Under the current law a payment of a capital gain amount made by a LIC to a shareholder may be a franked or unfranked dividend. These amendments do not disturb the operation of the dividend or imputation systems when a LIC capital gain amount is paid to a shareholder as part of a dividend.

5.23 These amendments enable certain shareholders in LICs to claim a deduction if they receive a dividend that includes a LIC capital gain amount (the attributable part).

5.24 A formula is provided to enable a LIC to work out the attributable part [Schedule 4, item 10, subsection 115-280(3)] . This formula requires the LIC to determine the part of the original LIC capital gain included in its taxable income for the income year.

5.25 A LIC must maintain appropriate records so it can advise its shareholders of their share of the attributable part included in each dividend it pays to its shareholders. [Schedule 4, item 10, section 115-295]

5.26 The attributable part can include amounts from 2 sources:

a LIC capital gain made by the LIC that pays a dividend to its shareholders; and
an attributable part included in a dividend received by a LIC from:
-
another LIC; or
-
a 100% subsidiary that would be a LIC other than it not being listed on an approved stock exchange,

that it passes on to its own shareholders as a dividend.

[Schedule 4, item 10, paragraphs 115-280(1)(c) and (d)]

5.27 These amounts can only be determined after the income year in which the LIC capital gain was made or the dividend was paid because of the requirement that they must be included in the taxable income of the LIC for that income year (see paragraph 5.19).

5.28 There is no mechanism to allow for incorrect or over-allocation of LIC capital gains to shareholders. If the company miscalculates or requires an amendment, the attributable part for each shareholder may alter. If so, the LIC must advise the shareholders of the corrected details as soon as possible.

Deduction for certain dividends - impacts for LIC shareholders

5.29 A resident shareholder receiving a dividend with an attributable part is eligible to claim a deduction if they are:

an individual;
a trust;
a partnership;
a complying superannuation entity; or
a life insurance company (where the attributable part is part of a dividend paid in respect of shares that are virtual PST assets).

[Schedule 4, item 10, paragraphs 115-280(1)(a) and (b)]

5.30 The amount of the deduction allowed to the shareholder is:

50% of the attributable part if the shareholder is an individual, a trust or a partnership; or
331/3% of the attributable part if the shareholder is a complying superannuation entity or a life insurance company.

[Schedule 4, item 10, subsection 115-280(2)]

5.31 The deduction is allowed in the income year in which the dividend is paid.

Example 5.6 On 25 August 2002, Gomez received a fully franked dividend of $210 from a LIC. The dividend notice stated that Gomezs share of the attributable part paid to shareholders was $110.In completing his income tax return for the 2002-2003 income year, Gomez included in his assessable income a franked dividend of $210 and imputation credit of $90. Gomez also claimed a deduction of $55, being 50% of the $110 attributable part.

Inclusion of assessable income in certain cases

5.32 These amendments provide tax relief to shareholders in a LIC. If a shareholder is a trust or a partnership, a beneficiary or partner that is an individual will receive the full benefit of the deduction allowed to the trust or partnership because it is reflected in the calculation in the net income of the trust or partnership. A beneficiary or partner that is a complying superannuation entity or a life assurance company, will receive a lesser benefit. A beneficiary or partner that is a company, trust or partnership will receive no benefit. In all cases the benefit for the beneficiary or partner is the equivalent to the benefit that would have been obtained if the beneficiary or partner has owned the asset directly. The concession is connected with the payment of a dividend and does not pass through a series of trusts or partnerships. [Schedule 4, item 10, subsection 115-280(4)]

5.33 The mechanism to reduce or deny the benefit of the deduction allowed requires certain beneficiaries or partners to include an amount in their assessable income. The amount included is:

that part of the deduction allowed to the trust or partnership that is reflected in the share of the net income of a beneficiary or partner that is a company, trust or partnership; or
one-third of that part of the deduction allowed to the trust or partnership that is reflected in the share of the net income of a beneficiary or partner that is a complying superannuation entity or life insurance company.

[Schedule 4, item 10, subsection 115-280(5)]

5.34 The amount is included in the beneficiary or partners assessable income for the income year in which the dividend is paid to the trust or partnership shareholder.

Example 5.7 The Robbie Partnership received a $210 fully franked dividend from a LIC that also contained an attributable part of $180.The partnership has 3 equal partners, Joe Robbie, Robbie Limited and the Robbie Superannuation Fund, a complying superannuation entity.The partnership claimed a deduction of $90 in respect of the attributable part in working out its net income of $12,000, including the $210 dividend. Each partners share of the net income is $4,000 and their reduction amount is $30 (one-third of $90)Each partner includes $4,000 in their assessable income. The partners must also include the following additional amounts in their assessable income:

Joe Robbie - nil. Joe is an individual partner in the partnership;
Robbie Limited - $30 (the reduction amount); and
Robbie Superannuation Fund - $10 (one-third of the reduction amount).

Application and transitional provisions

5.35 The amendments made by Schedule 4 apply to LIC capital gains made by a LIC on or after 1 July 2001. [Schedule 4, item 15]

Consequential amendments

5.36 A reference to the amount included in the assessable income of certain beneficiaries or partners because the trust or partnership is a shareholder in a LIC is added to the table of particular kinds of assessable income in section 10-5 of the ITAA 1997. [Schedule 4, item 1]

5.37 A reference to the deduction allowed to a shareholder in a LIC is added to the table of specific types of deductions in section 12-5 of the ITAA 1997. [Schedule 4, item 2]

5.38 A note is added to subsection 102-3(2) that a shareholder in a LIC can effectively receive the benefit of the CGT discount on capital gains made by a LIC. [Schedule 4, item 3]

5.39 A new exception to CGT event E4 is provided for a payment attributable to a LIC capital gain. This ensures that the benefit of the LIC concession claimed by the trustee is not inappropriately clawed back on distribution to certain beneficiaries. [Schedule 4, items 4 and 5]

5.40 A new item is added to the table in subsections 110-25(8) and 114-5(2) as the choice of working out a capital gain using indexation is now relevant for a LIC. [Schedule 4, items 6 and 7]

5.41 A new paragraph has been added to the Guide material in section 115-1 about the new CGT concession for a shareholder in a LIC. [Schedule 4, item 8]

5.42 A note is added to subsection 115-20(1) that a LIC capital gain must be calculated without reference to indexation. [Schedule 4, item 9]

5.43 A new paragraph is added to subsections 320-205(3) and (4) to support the application of this measure to a life insurance company in respect of its virtual PST assets. [Schedule 4, items 11 and 12]

5.44 Definitions of listed investment company and LIC capital gain are added to the dictionary in subsection 995-1(1) of the ITAA 1997. [Schedule 4, items 13 and 14]

5.45 Certain other consequential amendments are necessary to ensure that shareholders in LICs receive a comparable tax outcome compared with investors in managed funds. These amendments will be contained in a later bill.

REGULATION IMPACT STATEMENT

Policy objective

5.46 The policy objective is to provide shareholders in LICs with comparable tax treatment to investors in managed funds. This will assist investors to access the benefits of portfolio diversification without adverse tax consequences.

5.47 Currently, investors in a managed fund are able to benefit from the CGT discount on eligible capital gains received from the fund. This benefit is not available to investors in a LIC.

Implementation options

5.48 A number of options were considered for the implementation of this concession.

Option 1 - Allow a deduction to the shareholder on receipt of a dividend comprising of an eligible capital gain

5.49 This option would allow the shareholder a deduction that reflects the value of the CGT discount that applies to an eligible capital gain contained within a dividend received from the LIC. An eligible capital gain is a capital gain that would, in the hands of the shareholder if received directly, qualify for the CGT discount.

Option 2 - Allow the LIC to reduce its eligible capital gains

5.50 This option would allow a LIC to reduce an eligible capital gain by the CGT discount.

Option 3 - Provide the shareholder with a franking rebate

5.51 This option would allow the shareholder a franking rebate when a LIC pays an eligible capital gain amount to its shareholders.

Option 4 - Use a similar approach as that applicable to managed funds

5.52 The mechanism that applies when a managed fund distributes a discount capital gain to its members requires the members to gross up the discount capital gain received from the managed fund and after offsetting any capital losses apply the appropriate CGT discount.

Assessment of impacts

Impact group identification

Investors

5.53 The proposed amendments will affect persons investing in LICs. Industry estimates there are at least 100,000 shareholders in LICs. By providing appropriate access to the CGT discount on capital gains made by LICs, more taxpayers may choose to invest in these entities.

Listed investment companies

5.54 Currently, there are approximately 20 known LICs in Australia. The proposed amendments will also affect compliance costs incurred by LICs. The level of investments in these companies is likely to increase.

ATO

5.55 The proposed amendments will also impact on the ATO who will administer the new concession.

Analysis of costs/benefits

Table 5.1: Cost effectiveness comparison
  Option 1 Option 2 Option 3 Option 4
Compliance costs        
Investors[F4] Initial costs

Minimal familiarisation costs as industry members will advise their shareholders. Additional costs if shareholders seek advice from the ATO and tax practitioners.

Initial costs

As for option 1.

Initial costs

As for option 1.

Initial costs

As for option 1.

Investors (cont) Ongoing costs

Minimal additional costs in completing tax returns as industry members will advise their shareholders. Additional costs if shareholders seek advice from the ATO.

Ongoing costs

As for option 1.

Ongoing costs

As for option 1.

Ongoing costs

As for option 1.

LICs[F5] Initial costs

Seeking advice on the concession.

Making changes to systems to identify the different types of capital gains and the eligible capital gain components of dividends paid to shareholders.

Initial costs

As for option 1. Costs would be higher as this option is more complex.

As for option 1 plus additional costs in making changes to systems to correctly advise shareholders of imputation regime consequences.

Initial costs

As for option 2.

As for option 2.

Initial costs

As for option 2.

As for option 1.

LICs (cont) Ongoing costs

Ensuring record keeping systems are updated to record eligible payments to shareholders.

Ongoing costs

As for option 1.

Ongoing costs

As for option 1.

Ongoing costs

As for option 1.

Administration costs Initial costs

Making changes to material prepared for taxpayers, tax practitioners and industry for education about the new concession. Costs will be minimal as the ATOs CGT booklets, return forms, schedules and guides are updated annually.

Training staff on the new rules. This training will be done internally as part of ongoing ATO training, and therefore additional costs will be minimal.

Providing advice on the new concession. The cost will depend on the effectiveness of the ATOs and industrys education programme.

Initial costs

As for option 1. Costs would be higher as changes are required to ATO systems for administering the imputation regime.

As for option 1. Costs would be higher as the rules are more complex.

As for option 1. Costs would be higher as the rules are more complex.

Initial costs

As for option 2.

As for option 2.

As for option 2.

Initial costs

As for option 1.

As for option 2.

As for option 2.

  Ongoing costs

Costs will continue to be incurred on providing advice on the concession but these costs should reduce over time.

Ongoing costs

As for option 1. Costs would be higher as the rules are more complex.

Ongoing costs

As for option 2.

Ongoing costs

As for option 2.

Revenue costs $5 million in 2001-2002.

$20 million per annum thereafter.

Similar to option 1. As for option 1. As for option 1.

Economic benefits

5.56 There may be some expansion in the level of investment in LICs. There also may be some increase in the number of LICs as other companies seek LIC status so as to provide the benefit of CGT discount to their shareholders. Overall there will be an increase in the level of competitiveness within the investment industry.

5.57 Taxation will not be an impediment to how an investor chooses to make indirect passive investments because one of the major differences in the taxation treatment of capital gains made by LICs and managed funds is now removed.

Other issues - consultation

5.58 The ATO and Department of Treasury held consultation meetings with peak bodies representing the LICs and managed funds industries and representatives of companies and funds in those industries. Draft legislation was provided to those representatives for their comment.

5.59 Concerns were raised as to the eligibility rules for LICs and their investments. These concerns have been addressed and the legislation reflects an appropriate balance between industry practices and the policy supporting the concession.

5.60 The amendments have industry support.

Conclusion and recommended option

5.61 The proposed amendments will provide a comparative tax outcome for persons investing in LICs and managed funds on discount capital gains made by these investment vehicles. The compliance costs associated with this change in the law will be minimal for the investor. There will be some increase in compliance costs for LICs associated with this concession. The increase in costs will be minimised by adopting the most cost-effective mechanism to provide the concession.

5.62 The measures to provide shareholders in LICs with the benefit of the CGT discount should be adopted because:

the increased incentive for investment in LICs will outweigh the costs to industry; and
the proposal provides for diversification of investment for Australians who wish to invest.

5.63 The analysis of the merits of each option concluded that option 1 is the most appropriate mechanism for providing the concession. Option 1 does not require significant changes to the imputation system and other provisions of taxation law. It is the simplest method of providing the concession, which makes it easier to understand and implement. The other options were not supported for the following reasons.

Option 2 would have reduced the tax paid by the LIC and enabled the company to accumulate this after-tax income. Generally managed funds are unable to accumulate income. Complex rules would have been required to give the appropriate tax outcome to shareholders when the company paid an eligible capital gain amount to its shareholders.
Option 3 would have required significant changes to the imputation provision with complicated amendments introducing unnecessary complexity to the law.
Option 4 would have added an unnecessary level of complexity to providing the concession and changed the nature of the payment by the LIC from a dividend to a capital gain.

Chapter 6 - HIH rescue package

Outline of chapter

6.1 Schedule 5 to this bill amends the ITAA 1997 to:

ensure that the income tax consequences of payments under the HIH rescue package are the same as if those payments had been made directly by HIH; and
exempt the HIH Trust from income tax.

6.2 Schedule 5 also amends the GST Act to ensure that:

the GST consequences of payments made under the HIH rescue package are the same as if those payments had been made directly by HIH; and
where an insurance portfolio transfer has occurred, the GST consequences of transactions made by the transferee insurer are the same as if those transactions had been undertaken by the original insurer.

Context of amendments

6.3 As a consequence of the financial collapse of the HIH group of companies, the Commonwealth has established a scheme to assist certain qualifying individuals and small businesses who experience financial hardship as a direct result of the collapse.

6.4 The Commonwealth HIH rescue package involves the establishment of the HIH Trust with HCS as its trustee. HCS will make payments from the HIH Trust to qualifying policyholders who have claims under general insurance policies issued by the various HIH insurance companies.

6.5 On 26 June 2001 the Government announced that it would legislate to ensure that Commonwealth payments from the HIH rescue entity to eligible policyholders do not attract additional income tax or GST.

PART 1 - Income tax consequences

Summary of new law

6.6 This bill will amend the ITAA 1997 to ensure that:

payments received from the HIH Trust in settlement of a claim under a general insurance policy held with an HIH company will be taxed as if those payments were made:

-
by the HIH company; and
-
under the terms and conditions of the original policy;

no CGT consequences arise as a result of the assignment of a policy to HCS; and
the HIH Trust is exempt from income tax.

Comparison of key features of new law and current law
New law Current law
Payments received from the HIH Trust for the assignment of rights under or in relation to a claim under a general insurance policy held with an HIH company will be taxed as if those payments were made:

by the HIH company; and
under the terms and conditions of the original policy.

The taxation treatment of payments received for the assignment of rights under or in relation to a claim under a general insurance policy depends on the circumstances and character of the payment. In particular, special CGT rules apply to payments under a general insurance policy from a general insurance company.

Payments received for the assignment of rights under or in relation to a claim under a general insurance policy from the HIH Trust may have a different outcome for taxation purposes.

No CGT consequences will arise as a consequence of the assignment of rights under or in relation to a general insurance policy to HCS. An assignment of rights under or in relation to a general insurance policy to HCS, as required under the terms of the HIH rescue package, may trigger a CGT event.
The HIH Trust will be exempt from income tax. The HIH Trust would be subject to income tax on any income derived.

Detailed explanation of new law

6.7 This bill inserts new Division 322 into the ITAA 1997. The new Division sets out special measures to assist in the rescue package provided in response to the collapse of the HIH Group. [Schedule 5, item 6, section 322-1]

6.8 Division 322 ensures that:

HIH rescue payments are treated as insurance payments by an HIH company;
no CGT consequences arise as a consequence of the assignment rights under or in relation to a general insurance policy to HCS; and
the HIH Trust is exempt from income tax.

HIH rescue payments treated as insurance payments by an HIH company

6.9 The amendments will ensure that a payment from the Commonwealth of Australia, the HIH Trust or a prescribed entity for the assignment of rights under or in relation to a claim under a general insurance policy held with an HIH company will be treated for income tax purposes as though:

the payment had been made by the HIH company; and
the payment had been made under the terms and conditions of the policy held with the HIH company.

[Schedule 5, item 6, subsection 322-5(1)]

6.10 The HIH Trust is the HIH Claims Support Trust which was established by deed of trust entered into between the Commonwealth and HCS on 6 July 2001. [Schedule 5, items 6 and 8, subsections 322-5(2) and 995-1(1)]

6.11 The State and Territory Governments may establish separate arrangements to assist HIH policyholders. If so, payments under those arrangements will receive identical income tax treatment to payments under the Commonwealth HIH rescue package arrangements by listing the relevant payer as a prescribed entity. A prescribed entity is an entity that is prescribed in the Income Tax Assessment Regulations 1997 (see section 17 of the Acts Interpretation Act 1901).

6.12 A general insurance policy is defined in subsection 995-1(1) to mean a policy of insurance that is not a life insurance policy or an annuity instrument.

6.13 An HIH company is defined to mean:

CIC Insurance Limited;
FAI General Insurance Company Limited;
FAI Reinsurances Pty Limited;
FAI Traders Insurance Company Pty Limited;
HIH Casualty and General Insurance Limited;
HIH Underwriting and Insurance (Australia) Pty Limited;
World Marine and General Insurances Pty Limited; or
any other related company specified in writing by the Commissioner.

[Schedule 5, items 6 and 7, subsections 322-5(3) and 995-1(1)]

6.14 As the amendments apply to payments received for the assignment of rights in relation to a claim under a general insurance policy, payments received from the HIH Trust as a result of rights of the policyholder that are pursued against third parties, for example, will be treated for income tax purposes as if those payments had been made directly by the HIH company under the terms of the policy.

Example 6.1 Levi receives a lump sum payment from the HIH Trust for the assignment of his rights under a general insurance policy with an HIH company to compensate him for the loss of a limb. No part of the payment represents compensation for loss of earnings or interest. Therefore, if the payment had been made directly by the HIH company:

no part of the payment would be included in Levis assessable income under ordinary principles; and
the payment would have no CGT consequences because of the operation of section 118-37.

Section 322-5 operates to ensure that the same outcome arises for the payment Levi receives from the HIH Trust.

Example 6.2 Babette, who operates a small business, receives a payment from the HIH Trust for the assignment of her rights under a general insurance policy with an HIH company to compensate her for the destruction of a building from which she runs her business and that was owned by Babette. The amount of compensation paid to Babette for the replacement cost of the building exceeds the cost base of the building. No part of the payment represents compensation for loss of earnings or interest. Therefore, if the payment had been made directly by the HIH company:

no part of the payment would be included in Babettes assessable income under ordinary principles;
the payment would represent capital proceeds and, to the extent that those capital proceeds exceed the buildings cost base, would be included in Babettes assessable income as the disposal of a CGT asset (CGT event C1); and
the discharge of Babettes rights under the policy (CGT event C2) would have no CGT consequences because of the operation of section 118-300.

Section 322-5 operates to ensure that the same outcome arises for the payment Babette receives from the HIH Trust.

Example 6.3 Maggie, who operates a small business, receives a payment from the HIH Trust for the assignment of her rights under a general insurance policy with an HIH company to compensate her for a loss of trading stock as the result of a fire. Therefore, if the payment had been made directly by the HIH company, the payment would be included in assessable income under section 70-115. Section 322-5 operates to ensure that the same outcome arises for the payment Maggie receives from the HIH Trust.

Certain capital gains and capital losses disregarded

6.15 A feature of the Commonwealths HIH rescue package is that the policyholder will assign their rights under or in relation to the general insurance policy with an HIH company to HCS (as trustee of the HIH Trust). Any capital gain or capital loss that a taxpayer makes as the result of such an assignment to the Commonwealth, HCS (as trustee of the HIH Trust) or a prescribed entity will be disregarded. This will ensure that the assignment is not the disposal of a CGT asset (CGT event A1). [Schedule 5, items 2, 3 and 6, subsection 104-10(5) and section 322-15]

6.16 The State and Territory Governments may establish separate arrangements to assist HIH policyholders. If so, assignments of policies under those arrangements will receive identical income tax treatment to assignments of policies under the Commonwealth HIH rescue package arrangements provided that the relevant assignee is listed as a prescribed entity in the Income Tax Assessment Regulations 1997.

HIH Trust exempt from tax

6.17 As the HIH Trust is funded from Commonwealth revenue, the Trust will be exempt from income tax. Similarly, any similar bodies established by the State or Territory Governments to assist HIH policyholders will be exempt from income tax provided they are prescribed in the Income Tax Assessment Regulations 1997. [Schedule 5, items 1 and 6, sections 11-5 and 322-10]

Application and transitional provisions

6.18 The measures will apply with effect from on or after 15 May 2001 (which is the date that the details of the Commonwealths HIH rescue package arrangements were announced). [Schedule 5, item 9]

Consequential amendments

6.19 The amendments to the ITAA 1997 are to be inserted in Part 3-35. Consequently, the heading for Part 3-35 will be changed from Life Insurance Business to Insurance Business and the link note at the end of section 320-255 will be repealed. [Schedule 5, items 4 and 5]

PART 2 - Goods and services tax

Summary of new law

6.20 This bill will amend the GST Act to ensure that a payment or supply made by an HIH rescue entity for:

the transfer or surrender of the HIH policyholders rights under an insurance policy held with an HIH company;
the transfer or surrender of an entitys rights against another entity that is insured under an insurance policy held with an HIH company; or
the transfer or surrender of an entitys rights against another entity in relation to a matter to which the entity also has or had rights under an insurance policy held with an HIH company,

is treated as relating to the settlement of an insurance claim under an insurance policy by an insurer.

6.21 This bill also amends the GST Act to ensure that the insurance provisions within the GST Act apply as if the transferee insurer were the insurer in relation to the insurance policy. In particular, the amendments ensure that, regardless of which insurer issued the policy:

decreasing adjustments may be available to an insurer that is settling a claim under an insurance policy that was a taxable policy; and
an insurer is not entitled to input tax credits on acquisitions made by the insurer to provide in settlement of a claim under an insurance policy that was a GST-free policy.

Comparison of key features of new law and current law
New law Current law
Division 78 of the GST Act applies where payments or supplies are made by an HIH rescue entity as consideration for:

the transfer or surrender of the HIH policyholders rights under an insurance policy held with an HIH company;
the transfer or surrender of an entitys rights against another entity that is insured under an insurance policy held with an HIH company; or
the transfer or surrender of an entitys rights against another entity in relation to a matter in relation to which the entity also has or had rights under an insurance policy held with an HIH company.

The transfer or surrender of the entitys rights may be a taxable supply under the GST Act.
Payments or supplies by an HIH rescue entity are excluded from the calculation of the recipients annual turnover. The consideration received for this supply would form part of the entitys annual turnover. This may cause the entity to exceed thresholds such as the GST registration threshold.
Division 78 of the GST Act applies to insurers who, because of an arrangement in the nature of a portfolio transfer, have undertaken to settle claims under insurance policies issued by another insurer.

In particular, the transferee insurer:

may be entitled to a decreasing adjustment when it makes a payment or supply in settlement of a claim under an insurance policy issued by another insurer; and
is not entitled to an input tax credit on the acquisition of things which are to be provided in settlement of a claim under a GST-free insurance policy issued by another insurer.

Many of the provisions in Division 78 of the GST Act would not apply to the transferee insurer. In particular, the transferee insurer would:

be denied a decreasing adjustment because it is not the insurer that issued the insurance policy; and
inappropriately be entitled to an input tax credit for the acquisition of something to provide in settlement of a claim under a GST-free insurance policy.

Detailed explanation of new law

Payments made under an HIH rescue scheme

6.22 Division 78 of the GST Act sets out the GST treatment for payments or supplies that relate to the settlement of a claim under an insurance policy. Except in limited circumstances, the supply of anything in settlement of a claim under an insurance policy is not treated as a taxable supply. In addition, a payment of money or a supply, made by an entity in settlement of a claim under an insurance policy is treated as not being consideration for a supply made by the recipient of the payment or supply.

6.23 When an HIH rescue entity makes a payment or supply to an entity pursuant to an HIH rescue scheme, it does not make a settlement of a claim under an insurance policy, but rather, it acquires that entitys rights under an HIH insurance policy. In addition, an HIH rescue entity is not an insurer. Therefore, Division 78 of the GST Act will not apply to any payment or supply made by an HIH rescue entity. Payments or supplies made by an HIH rescue entity to an entity in relation to a claim under an HIH insurance policy may be consideration for a taxable supply made by that entity.

Division 78 applies to certain non-insurance transactions

6.24 New section 78-120 is inserted into the GST Act so that Division 78 applies to a payment or a supply made by an HIH rescue entity. This section provides that a payment or supply made by an HIH rescue entity for:

the transfer or surrender of the HIH policyholders rights under an insurance policy held with an HIH company;
the transfer or surrender of an entitys rights against another entity that is insured under an insurance policy held with an HIH company; or
the transfer or surrender of an entitys rights against another entity in relation to a matter in relation to which the entity also has or had rights under an insurance policy held with an HIH company,

is treated as relating to the settlement of an insurance claim under an insurance policy by an insurer. [Schedule 5, item 10, section 78-120]

6.25 The section applies Division 78 to transactions made by an HIH rescue entity as though the HIH rescue entity is an insurer making settlements of claims under insurance policies. This will mean that HIH policyholders have the same GST treatment on transactions as would have occurred if the payment or supply was from HIH in settlement of a claim under an insurance policy.

6.26 In addition, section 78-100 of the GST Act applies as if references in that section to a claim for compensation under a statutory compensation scheme, were references to a claim made to the HIH rescue entity corresponding to a claim for compensation under the scheme. However, this will only be the case if section 78-100 would have normally applied to the settlement of a claim by HIH.

6.27 Sections 78-10, 78-15 and 78-40 of the GST Act, which relate to decreasing adjustments that an insurer is generally entitled to in relation to the settlement of a claim under an insurance policy, do not apply to any payments or supplies made by an HIH rescue entity. HIH, as the entity that issued the insurance policy, will be entitled to a decreasing adjustment when, and if, it makes a payment or supply to an HIH rescue entity in settlement of the rights the HIH rescue entity has acquired in respect of the original HIH insurance policy.

6.28 Pursuant to section 78-50 of the GST Act, a payment or supply made by an insurer in settlement of a claim under an insurance policy, will be treated as consideration for a supply by the entity insured, or any entity that was entitled to an input tax credit on the premium paid on the insurance policy, unless the entity informs the insurer of its entitlement to input tax credits on the insurance premium. The information is used by the insurer to determine its entitlement to a decreasing adjustment under section 78-10 of the GST Act. Therefore, for the purposes of subsection 78-50(1), the original HIH policyholder will still need to inform HIH of the policyholders entitlement to input tax credits on the insurance premium.

6.29 If the original HIH policyholder does not inform HIH of its entitlement to input tax credits on the insurance premium, section 78-50 will operate to treat any payment or supply received from an HIH rescue entity as being consideration for a supply made by the HIH policyholder. The resulting GST liability will be based upon the amount of the payment, or value of the supply, that the HIH policyholder has received from an HIH rescue entity.

Annual turnover

6.30 Under section 188-22 of the GST Act, when an entity works out its current annual turnover or projected annual turnover, it disregards any supply that the entity has made to the extent that the consideration for the supply is a payment or a supply by an insurer in settlement of a claim under an insurance policy. This is to avoid entities triggering thresholds, such as the registration threshold, because of the receipt of a payment or supply made in settlement of a claim under an insurance policy. This provision is amended so that payments or supplies by an HIH rescue entity will also be excluded from the calculation of the entitys turnover. [Schedule 5, item 11, section 188-22]

Definitions

6.31 The Dictionary within section 195-1 of the GST Act has been amended to include definitions of an HIH company and an HIH rescue entity. The definition of an HIH company has the meaning as given by section 322-5 of the ITAA 1997 (see paragraph 6.13). An HIH rescue entity means the Commonwealth, the HIH Trust or a prescribed entity for the purposes of subsection 322-5(1) of the ITAA 1997. [Schedule 5, items 12 and 13, section 195-1]

Application and transitional provisions

6.32 The amendments to the GST Act apply, and are taken to have applied:

in relation to GST returns and net amounts for tax periods starting, or that started, on or after 15 March 2001; and
in relation to payments and supplies, of a kind referred to in section 78-120 of the GST Act, that are, or have been, made on or after 15 March 2001 to an entity that is neither registered nor required to be registered.

[Schedule 5, item 14]

Insurance portfolio transfers

6.33 Division 78 of the GST Act sets out the GST treatment for payments or supplies made between insurers, insureds and certain third parties. Generally, the supply of anything in settlement of a claim under an insurance policy is not a taxable supply and a payment or supply made by an entity in settlement of a claim under an insurance policy is not consideration for a supply made by the recipient of the payment or supply. The GST legislation also provides insurers with various increasing and decreasing adjustments.

6.34 The insurance industry has advised that it is not unusual for one insurer to transfer a book of insurance to another insurer. These transfers are known within the industry as a portfolio transfer. Where a portfolio transfer has occurred, the provisions within Division 78 of the GST Act may not apply to give the appropriate GST outcome. For example, the decreasing adjustment available under section 78-10 of the GST Act and the denied input tax credit under section 78-30 of the GST Act, only apply to the insurer that issued the policy.

6.35 The inability of insurers to claim decreasing adjustments has been highlighted by the financial collapse of the HIH group of companies. As a result of various contractual arrangements with HIH companies, portfolio transfers have occurred so that some insurers have undertaken to make payments under insurance policies issued by an HIH company. There are a variety of other situations where such a portfolio transfer can arise.

6.36 New section 78-118 of the GST Act ensures that where a portfolio transfer has occurred, the insurance provisions within the GST Act apply as if the transferee insurer were the insurer in relation to the insurance policy. [Schedule 5, item 9A, section 78-118]

6.37 The new section only applies where a portfolio transfer has occurred. Generally, a portfolio transfer occurs where an arrangement is entered into by 2 insurers and under the arrangement the second insurer undertakes to meet the liabilities, such as the liability to pay claims, under insurance policies issued by the first insurer. A portfolio transfer is contractual in nature and does not include situations where statutory provisions may provide that an entity will assume liability for a claim without any contractual agreement between the 2 insurers. For example, legislation providing for compulsory third party schemes may also provide that where an insurer is declared to be insolvent, the Nominal Defendant is liable to meet claims under a compulsory third party insurance policy issued by the insolvent insurer. This assumption of liability by the Nominal Defendant would not be an arrangement in the nature of a portfolio transfer.

6.38 In particular, the amendments ensure that:

anything done by the transferee insurer is done under the insurance policy if it would have been done under the policy by the first insurer;
regardless of which insurer issued the policy:

-
decreasing adjustments may be available, under section 78-10 of the GST Act, to an insurer that is settling a claim under an insurance policy that was a taxable policy; and
-
an insurer is not entitled to input tax credits, under section 78-30 of the GST Act, on acquisitions made by the insurer to provide in settlement of a claim under an insurance policy that was a GST-free policy; and

where there is a payment of an excess to either the transferor or transferee insurer, the insurer that settles the claim under the insurance policy is the insurer that has an increasing adjustment under section 78-18 of the GST Act.

[Schedule 5, item 9A, section 78-118]

6.39 The decreasing adjustment available to the transferee insurer is calculated under section 78-15 of the GST Act and is limited to the amount to which the insurer that issued the policy would have been entitled, if it had made the settlement of the claim under the insurance policy. The first insurer will not be entitled to a decreasing adjustment under section 78-10 of the GST Act because it no longer settles a claim under the insurance policy.

Example 6.4 Ostrich Insurance Company (Ostrich) and Whyte Nite Insurance Company (Whyte Nite) enter into an arrangement where Ostrich transfers its home and contents insurance portfolio to Whyte Nite. The arrangement is in the nature of a portfolio transfer and Whyte Nite has undertaken to settle claims that may arise from those policies that had been issued by Ostrich. Section 78-118 provides that Division 78 of the GST Act applies to Whyte Nite as if Whyte Nite were an insurer in relation to the policies.If Ostrich had settled a claim under one of the insurance policies (and the insurance policy had not been transferred):

the supply of something by Ostrich in settlement of the claim would not be a taxable supply;
any payment or supply made by an entity in settlement of a claim under an insurance policy is not consideration for a supply made by the recipient of the payment or supply; and
a decreasing adjustment would be available to Ostrich (where section 78-10 of the GST Act is satisfied).

Section 78-118 of the GST Act operates to ensure that the same outcome arises for payments or supplies made by Whyte Nite in settlement of a claim under the transferred insurance policy.In particular, when Whyte Nite settles claims under an insurance policy issued by Ostrich, Whyte Nite would be entitled to a decreasing adjustment under section 78-10 of the GST Act to the same extent that Ostrich would have if the insurance policy had not been transferred.

Application and transitional provisions

6.40 These amendments apply, and are taken to have applied to GST returns and net amounts for tax periods starting, or that started, on or after 1 January 2001. As a result, insurers who have been transferred HIH insurance policies may be entitled to a decreasing adjustment when they settle a claim under an HIH insurance policy. [Schedule 5, item 14]

Chapter 7 - Personal services income

Outline of chapter

7.1 Schedule 6 to this bill explains amendments to Part 2-42 of the ITAA 1997 which is about the tax treatment of personal services income. Part 2-42 broadly limits the entitlement of individuals and entities to deductions that can be claimed against personal services income. It also attributes personal services income paid to an entity, to the individual who is performing the services. Part 2-42 applies from the 2000-2001 income year. Part 2-42 does not apply if the individual or entity is conducting a personal services business.

7.2 The amendments provide special rules for certain agent-principal relationships. They also provide that all taxpayers earning personal services income will be able to self-assess whether they are independent contractors against the results test. Independent contractors (as opposed to contractors who work in essentially the same way as employees) are treated as personal services businesses and will therefore not be affected by the measure. In addition all taxpayers will be able to apply to the Commissioner for a personal services business determination.

7.3 The amendments also include consequential amendments to the additional PAYG withholding provisions for personal services income, which are in the TAA 1953. In addition, there are technical amendments to the personal services income rules and certain provisions in the TAA 1953 and the ITAA 1936 affected by the rules, to ensure the provisions work as intended.

Context of amendments

7.4 The measures contained in Part 2-42 were recommended by the Review of Business Taxation. The amendments explained in this chapter are designed to ease the compliance burden of certain taxpayers affected by those measures, and to allow certain agents to be excluded from the measures.

Summary of new law

7.5 The amendments will have the effect of treating certain agents as having received their results based income directly from the customers of the principal, as a result of providing services to those customers. This may allow certain agents to be treated as obtaining less than 80% of their personal services income from each source and to satisfy the unrelated clients test. Consequently they are treated as conducting a personal services business, without having to apply to the Commissioner for a personal services business determination.

7.6 As well, the amendments will allow all individuals or entities whose ordinary or statutory income would include an individuals personal services income to self-assess whether they are personal services businesses against the results test (previously the further grounds in subsections 87-60(5) and (6) and 87-65(5) and (6)). This includes those individuals who earn 80% or more of their personal services income from one source. Previously, the measure would have applied to these individuals unless they obtained a personal services business determination from the Commissioner. If an individual or personal services entity can meet the results test which is based on the traditional tests for determining independent contractors they will be outside the measure.

7.7 If those individuals who earn 80% or more of their personal services income from one source do not satisfy the results test, they will still have to obtain a determination from the Commissioner to be outside the personal services income measure. They cannot self-assess against the other personal services business tests.

7.8 Those individuals who earn less than 80% of their personal services income from each source can continue to self-assess against the existing 3 personal services business tests as well as the results test.

7.9 The amendments also provide that all taxpayers are able to apply to the Commissioner for a personal services business determination, regardless of whether 80% or more of their personal services income comes from one source. Previously, individuals who earned less than 80% of their personal services income from each source could not obtain a determination from the Commissioner.

7.10 Neither Part 2-42 nor these amendments to it preclude the operation of Part IVA of the ITAA 1936 (the general anti-avoidance provisions). Part IVA may still apply to income splitting arrangements or to the retention of personal services income in a company beyond the end of the income year, even when an individual or personal services entity is conducting a personal services business for the purposes of Part 2-42.

Comparison of key features of new law and current law
New law Current law
For the purposes of the 80% test, an agent who satisfies certain conditions will be able to treat the income they receive from the principal on a look through basis - that is, as though it were earned directly from the customers of the principal. If the agent represents the principal to multiple customers, the agent will generally obtain less than 80% of their personal services income from each source. Consequently, the agent will be able to self-assess against all the personal services business tests, including the unrelated clients test. An agent representing a principal receives income from that principal (and has rights and obligations in respect of that principal under general agency law). If an agent represents only one principal they will necessarily obtain 80% or more of their personal services income from one source. Consequently, the agent will be subject to the personal services income regime unless they obtain a personal services business determination from the Commissioner.
For the purposes of the unrelated clients test, an agent who satisfies certain conditions will be treated as providing services directly to the customers of the principal they represent. If the agent provides these services to the customers of the principal as a result of making offers or invitations to the public at large (or a section of the public) the agent will satisfy the unrelated clients test. The agent provides services to their principal. The agent can only provide services to the principals customers on the principals behalf, not on their own behalf.

Moreover, the unrelated clients test is generally unavailable for an agent who works for one principal because 80% or more of the agents personal services income is from one source.

All taxpayers will be able to self-assess against the results test, to determine if they are an independent contractor. Meeting the results test means the taxpayer is conducting a personal services business. This is regardless of whether 80% or more of their personal services income comes from one source. Taxpayers who earn 80% or more of their personal services income from one source will only be a personal services business if they obtain a determination from the Commissioner. Those taxpayers who earn less than 80% of their personal services income from each source do not currently have access to the results test.
All taxpayers can seek a personal services business determination from the Commissioner, regardless of whether 80% or more of their personal services income comes from one source. Currently, only those taxpayers earning 80% or more of their personal services income from one source can obtain a personal services business determination from the Commissioner.
The general anti-avoidance rules in Part IVA can still apply to income splitting arrangements, or the retention of personal services income in a company beyond the end of the income year, even when an individual or personal services entity is conducting a personal services business. The general anti-avoidance rules in Part IVA can still apply to income splitting arrangements, or the retention of personal services income in a company beyond the end of the income year, even when an individual or personal services entity is conducting a personal services business.

Detailed explanation of new law

PART 1 - Agents

7.11 The amendments, in particular section 87-40, will modify the way in which the personal services business rules in Division 87 apply to certain agents.

Conditions

7.12 Section 87-40 modifies the application of Division 87 for those agents who satisfy the following conditions (set out in subsection 87-40(2)):

receive income from the principal that is for services the agent provides to customers on the principals behalf [Schedule 6, item 2, paragraph 87-40(2)(b)] ;
at least 75% of that income is commissions, or fees, based on the agents performance in providing services to the customers on the principals behalf [Schedule 6, item 2, paragraph 87-40(2)(c)] ;
the agent actively seeks other entities to whom the agent could provide services on the principals behalf [Schedule 6, item 2, paragraph 87-40(2)(d)] ; and
the agent does not provide any services to the customers, on the principals behalf, using premises that the principal, or an associate of the principal, owns or has a leasehold interest in, unless the agent uses the premises under an arrangement entered into at arms length [Schedule 6, item 2, paragraph 87-40(2)(e)] .

7.13 These conditions take into account that agents acting in this manner assume a degree of entrepreneurial risk.

7.14 This is intended to apply to both individuals and personal services entities who act as agents. However, it does not apply to employees [Schedule 6, item 2, paragraph 87-40(2)(a)] . Agent has its ordinary meaning of acting for or representing another.

7.15 At least 75% of the agents personal services income from the principal must be income based on the agents performance in providing services to the customers on the principals behalf, such as a percentage of income generated or fees for service. The agent may have up to 25% fixed remuneration, such as retainer or salary like payment, and may still satisfy these conditions. The object of this condition is that most of the agents income must be at risk, for example if the agent does not perform well enough, or bring in enough customers, they will not receive that income. [Schedule 6, item 2, paragraph 87-40(2)(c)]

7.16 The agent must also actively seek other entities to which they could provide services on behalf of the principal. There is no requirement that the customers to whom the agent does provide services on behalf of the principal be obtained by these methods, or that the methods that the agent uses actually result in services being provided to any customer. However, the agent must be able to demonstrate that they themselves are making an active effort (e.g. by advertising) to obtain customers, and that they are not merely receiving referrals from their principal, or allowing the principal to take all the responsibility for obtaining customers. [Schedule 6, item 2, paragraph 87-40(2)(d)]

7.17 If an agent satisfies this condition it will not necessarily mean that they will satisfy the unrelated clients test in section 87-20. That test requires a further condition to be met, namely that the services are provided as a direct result of the agent making offers or invitations.

7.18 The agent will not satisfy these conditions if they provide services from the premises of the principal, or an associate of the principal, unless the agent has an arms length agreement for the use of the agencies.

7.19 An arms length agreement will be one entered into on terms, and for a consideration, that could be expected if the agent entered the agreement with a completely independent third party on a commercial basis.

7.20 This condition does not require that the agent has commercial premises. The agent could satisfy this condition by working from home, or from their car for instance. This condition also does not preclude agents from entering the premises of the principal for the purposes of negotiating, organising or administering arrangements solely between the agent and the principal, such as negotiating the agency agreement, rates of commission, or collecting commissions, receiving training or attending sales strategy meetings.

7.21 If any part of the services provided to the customer are performed on the premises of the principal, or an associate of the principal, other than premises that the agent uses under an arms length arrangement they will not satisfy this condition. This will depend on what services are actually provided.

7.22 Section 87-40 will apply only where there is a relationship of agent-principal which will be determined by reference to all relevant circumstances.

Special rules for agents

7.23 If an agent satisfies the conditions in subsection 87-40(2), then there will be 2 special rules to use when applying Division 87 to the activities of that agent as an agent. These are contained in subsections 87-40(2) to (4).

7.24 The first special rule in subsections 87-40(3) and (4) relates to whether 80% of an individuals personal services income comes from one source. If an agent satisfies the conditions set out in subsection 87-40(2), then the income that the agent receives from the principal during the income year for services provided to customers on behalf of the principal is treated as though the income were from the customers. [Schedule 6, item 2, subsections 87-40(3) and (4)]

7.25 Although the income is received from the principal, and the agent would normally have no contractual right to recover the income from anyone other than the principal, this special rule allows the agent to look through the principal to the customers to whom they provide services on behalf of the principal. They are treated as though the customers were customers of the agent and as though the personal services income received from the principal for providing services to those customers was personal services income from the customers.

7.26 In many cases an agent may work for only one principal, and would therefore not have satisfied the 80% test if not for this special rule.

7.27 The second special rule is in subsection 87-40(5) and relates to the application of the unrelated clients test. The unrelated clients test in section 87-20 has 2 requirements. The first requires that the individual or personal services entity gains or produces income from providing services to 2 or more entities that are not associates of each other, or associates of the individual or personal services entity. The second requires that the services be provided as a direct result of making offers or invitations to the public at large or to a section of the public. If this test is satisfied, the individual or personal services entity will be considered to be conducting a personal services business.

7.28 Agents provide services on behalf of the principal, and therefore would generally not satisfy the unrelated clients test themselves. However, the special rule in subsection 87-40(5) provides that where an agent satisfies the conditions in subsection 87-40(2), the services the agent provides on behalf of the principal will be treated as though the agent, and not the principal, provided the services to the customer. [Schedule 6, item 2, subsection 87-40(5)]

7.29 This is a look through for these agents, as it allows them to treat the customers of the principal, to whom they provide services, as their customers.

7.30 This special rule will assist these agents to satisfy the first limb of the unrelated clients test, however they must still be able to demonstrate that the services were provided as a direct result of the agent making offers or invitations to the public at large or to a section of the public, to provide the services. This is the second limb of the unrelated clients test in paragraph 87-20(1)(b). An agent may fail to satisfy that limb if all of its commissions come directly from referrals by the principal, for example, even though the agent may have actively sought customers for the principal.

Example 7.1 Gordon is a financial planner who holds a proper authority under the Corporations Law to act as agent for Champagne Financial Services, a licensed securities dealer. Gordon receives 85% of his income from Champagne as commissions, dependent on the level of services Gordon provides to customers of Champagne. Gordon advertises his services once a month in financial papers, and in journals of professional associations.Champagne operate from 5 floors of an office block which they lease, and one of those floors is dedicated to offices for Champagnes proper authority holders. Gordon uses an office on this floor under an agreement on commercial terms. Gordon does not have access to any other facilities of Champagne.Gordon would satisfy all of the conditions set out in subsection 87-40(1), and therefore he would have access to the special rules for agents. Gordon would be treated as having less than 80% of his personal services income from one source as he has provided services to 50 of Champagnes customers, and he can treat the income he receives from Champagne that can be attributed to services he has provided those customers, as income directly from those customers. Gordon would also satisfy the unrelated clients test, as he can treat the services he provided to the customers on Champagnes behalf as though they are services provided directly by Gordon to the customers. Gordon would also satisfy the second limb of the unrelated clients test, as he provides the services to the customers as a direct result of his advertising. He does not receive referrals from Champagne.Therefore Gordon would be considered to be conducting a personal services business, and would not be affected by the personal services income measure. He does not need to obtain a determination from the Commissioner to be outside the measure.

7.31 Of course, these agents can also consider the other personal services business tests, however, the operation of these tests is not amended in any way for these agents.

PART 2 - Personal services business tests

7.32 It is necessary to consider the personal services business tests only if an individual (working as a sole trader or through an entity) has personal services income. Personal services income is income that is mainly a reward for a particular individuals personal efforts or skills. An entitys income from the rendering of personal services by an arms length employee of the entity is not normally personal services income of such an employee, if the employee has no entitlement to that income of the entity other than as salary, wages, commissions, bonuses or allowances.

7.33 The primary rules about what is a personal services business are contained in section 87-15. The section will be amended to reflect the proposed changes to allow self-assessment of the results test for a personal services business and to allow the Commissioner to grant personal services business determinations regardless of whether 80% or more of an individuals personal services income is from one source.

7.34 The amendments to subsection 87-15(1) reflect the fact that all individuals and personal services entities will be able to apply for a personal services business determination. Therefore anyone who has a personal services business determination will be carrying on a personal services business. [Schedule 6, item 4, subsection 87-15(1)]

7.35 Taxpayers may self-assess whether they are conducting a personal services business against the results test, which is included in the list of personal services business tests in subsection 87-15(2). This will ensure that independent contractors are treated as conducting personal services businesses and therefore, are outside the measure. Subsection 87-15(3) is amended to reflect the fact that, regardless of whether 80% or more of an individuals personal services income is from one source, the individual or personal services entity can self-assess against the results test. In contrast, a taxpayer cannot self-assess against any of the other tests if 80% or more of an individuals personal services income is from one source. [Schedule 6, item 4, subsection 87-15(3)]

7.36 If 2 or more individuals gain personal services income through one entity, section 87-15 looks at the personal services income of each individual. This prevents people escaping from the provisions simply by teaming up.

7.37 These amendments to section 87-15 reflect the new structure of the legislation.

The results test

7.38 Proposed section 87-18 contains the results test. The conditions that make up the results test were previously contained in subsections 87-60(5) to (7) and subsections 87-65(5) to (7) as the further grounds on which the Commissioner could make a determination. These amendments will make those same conditions into a new personal services business test. [Schedule 6, item 4, section 87-18]

7.39 As a personal services business test, if an individual or personal services entity meets the results test, they will be conducting a personal services business. There is no need to obtain a personal services business determination although an individual or entity could apply for a determination if they were unsure. In addition, taxpayers could apply to the Commissioner for a private binding ruling about the potential application of Part IVA to their activities.

7.40 The results test is also the only personal services business test that is available for self-assessment where 80% or more of an individuals personal services income is from one source. If 80% or more of an individuals personal services income is from one source and the individual or personal services entity does not meet the results test, they will be a personal services business only if they obtain a personal services business determination. Without these amendments, if 80% or more of an individuals personal services income is from one source, the individual or personal services entity is conducting a personal services business only if they obtain a personal services business determination.

7.41 The existing conditions for the results test (which are traditional tests for determining whether a taxpayer is an independent contractor), are in subsections 87-60(5) and 87-65(5) . The 3 conditions are:

the individuals personal services income is for producing a result (whether or not it is received by a personal services entity);
the individual or personal services entity is required to supply the plant and equipment, or tools of trade, needed to perform the work from which the individual or personal services entity produces the result; and
the individual or personal services entity is, or would be, liable for the cost of rectifying any defect in the work performed.

7.42 Previously the conditions in the results test were only relevant to a personal services business determination. As a result of these amendments, taxpayers will now be able to self-assess against them. The discussion of these conditions can be found in the explanatory memorandum to the bill that introduced these provisions, the New Business Tax System (Alienation of Personal Services) Bill 2000.

7.43 The results test applies over the whole income year, as do the other 3 personal services business tests. However, the existing results test does not expressly state how to apply the test where some personal services income satisfies the conditions and some do not.

7.44 Section 87-18 will ensure that the results test can be met even where the taxpayer does not work exclusively in a way that would otherwise meet the results test. Accordingly, to clarify the application of the results test in a particular income year, where not all of a taxpayers personal services income satisfies the results test, a percentage basis for the amount of income that must meet the test will be inserted. The amendment requires that, in determining whether the taxpayer meets the results test, they must receive at least 75% of their personal services income, not including income received as an employee or office holder, for producing a result. This means that the individual may have some personal services income that is for producing a result and some that is not, and still pass the test and therefore conduct a personal services business. [Schedule 6, item 4, subsections 87-18(1) and (3)]

7.45 If more than 25% of an individuals personal services income is not for producing a result (or one of the other conditions is not satisfied for some of the income year), they may also be able to obtain a determination from the Commissioner based on unusual circumstances that prevented them from meeting the results test.

Effect of personal services business determination

7.46 Item 6 repeals section 87-55 as it is no longer necessary. Section 87-55 explained the effect of obtaining a personal services business determination, however this is being incorporated into subsection 87-15(1). This new subsection will provide that a taxpayer conducts a personal services business if they have a personal services business determination in force in relation to the individuals personal services income, or if they meet one of the 4 personal services business tests. This supersedes section 87-55. [Schedule 6, item 6]

Technical amendments

80% of personal services income

7.47 The 80% test in subsection 87-15(3) refers to the individual or entity receiving 80% or more of an individuals personal services income from the same entity (or one entity and its associates). Where an individual or entity meets the 80% test, but does not pass the results test in section 87-18, the individuals personal services income is not taken to be from conducting a personal services business unless a personal services business determination is in force. Therefore, it is important to establish what income is to be included in the 80% test to accurately determine whether the 80% test is met.

7.48 The personal services income rules (in Part 2-42 of the ITAA 1997) have no operation for employees (leaving aside those who are employees of interposed entities). Consequently, the provisions are directed at personal services income derived under non-employment arrangements. However, personal services income is broadly defined to mean income that is mainly a reward for your personal efforts or skills and, consequently, may include income as an employee.

7.49 As subsection 87-15(3) currently stands, the 80% test takes into account salary or wages and income from holding an office. This could distort who must seek a personal services business determination from the Commissioner in order to be outside the measure, and therefore cause some workers to be covered by the measure who would otherwise have been outside it (and vice versa).

7.50 Subsection 87-15(4) will be inserted and subsection 87-15(3) amended, to ensure that income that an individual gains as an employee or an office holder is not included in calculating whether the individual obtains 80% or more of their personal services income from the same entity (or one entity and its associates). Subsection 87-15(4) also ensures that the 80% test ignores personal services income received by an individual to the extent that they are payments subject to the proposed new withholding arrangements for religious practitioners. The proposed new withholding arrangements for religious practitioners are contained in Taxation Laws Amendment Bill (No. 5) 2001. [Schedule 6, item 4A, subsection 87-15(3) and items 4B and 4C, subsection 87-15(4)]

The employment test

7.51 Section 87-25 contains the employment test for a personal services business. Under subsection 87-25(2), an entity will meet the employment test if it engages one or more other entities to perform work and that entity, or those entities together, perform at least 20%, by market value, of the individuals principal work.

7.52 It is possible that a partner in a partnership will be performing principal work that is helping to generate the personal services income of another partner. However, in this case, the partnership has not engaged another entity because the first mentioned partner is not a separate entity from the partnership. This can result in partnerships not passing the employment test where it was intended that they would - thus treating partnerships more harshly than companies or trusts.

7.53 Item 5A, which will insert subsection 87-25(2A) into the employment test, will ensure that the test takes into account the principal work performed by a partner that helps to generate the personal services income of another partner, thereby treating partnerships in the same way as companies or trusts. [Schedule 6, item 5A, subsection 87-25(2A)]

PART 3 - Personal services business determinations

7.54 Currently an individual or personal services entity can obtain a personal services business determination only if they obtain 80% or more of an individuals personal services income from one source.

7.55 The proposed amendments will remove this restriction, and allow all taxpayers earning personal services income to apply to the Commissioner for a determination.

7.56 Items 7 to 9 amend subsection 87-60(3) which deals with personal services business determinations for individuals. The amendments ensure that the Commissioner can make a determination based on the fact that the taxpayer is an independent contractor who met (or could reasonably be expected to meet) the results test, or that unusual circumstances prevented them from meeting the results test. [Schedule 6, items 7 to 9]

7.57 As well, items 12 to 14 amend subsection 87-65(3) in a similar manner in relation to personal services entities applying for a personal services business determination. [Schedule 6, items 12 to 14]

7.58 To allow all taxpayers earning personal services income to apply for a personal services business determination, items 10 and 15 repeal paragraphs 87-60(3)(c) and 87-65(3)(c) which currently limit the availability of determinations to situations where 80% or more of an individuals personal services income is from one source. [Schedule 6, items 10 and 15]

7.59 The amendments will allow all individuals or personal services entities earning an individuals personal services income to apply for a personal services business determination from the Commissioner. The determinations are still subject to the conditions in section 87-60 (for individuals) and section 87-65 (for personal services entities).

7.60 The amendments also repeal subsections 87-60(5) to (7) and subsections 87-65(5) to (7). These contain the further grounds for the Commissioner to make a determination. These provisions are no longer necessary as they have been incorporated into the new results test in section 87-18. [Schedule 6, items 11 and 16]

PART 4 - Other amendments

Guide material and diagram

7.61 The guide material for Division 87 (section 87-1) and the diagram showing the operation of Division 87 (section 87-5) will be amended to reflect the amendments affecting the personal services business tests and the personal services business determinations explained in paragraphs 7.32 to 7.60. [Schedule 6, item 17]

PAYG arrangements

7.62 PAYG withholding arrangements (Division 13 of Schedule 1 to the TAA 1953) details withholding arrangements for personal services entities. That Division contains rules that require the personal services entity to remit amounts to the Commissioner if it is a personal services payment remitter and certain other conditions are satisfied. An entity that starts providing personal services during the income year is a personal services payment remitter if there is a reasonable expectation that its personal services income is not from conducting a personal services business.

7.63 Subsection 13-15(3) provides that that expectation will not be met if it is reasonable to expect that the entity will receive at least 80% of that income from one entity and that entitys associates. The subsection is being amended to add a further requirement that it is reasonable to expect that the entity will not meet the results test. [Schedule 6, item 18]

Technical amendments

TFN provisions

7.64 The current definition of payer (section 202A of the ITAA 1936) applying to the TFN provisions in the ITAA 1936, does not take account of the personal services income measure. Under the TFN provisions, a TFN declaration may be made to a payer where a person is a recipient of the payer. The payer is a person who makes an eligible PAYG payment which, by definition, includes an alienated personal services payment. These payments are made to the entity by the service acquirer. Consequently, where a worker quotes their TFN under the PAYG alienation rules (to avoid withholding at the top marginal rate), the rules incorrectly contemplate quotation to the service acquirer, instead of the personal services entity.

7.65 Amendments to section 202A are designed to allow an individual providing personal services income through an interposed entity to make a TFN declaration to the interposed entity rather than the service acquirer. This is more appropriate because it is the entity that must calculate the amount of a possible PAYG withholding obligation under Division 13 of Schedule 1 to the TAA 1953. To achieve this, 2 changes will be made.

7.66 First, item 16A adjusts the definition of payer in section 202A of the ITAA 1936 to include a person who receives an alienated personal services payment, or is likely to receive such a payment. This person is the personal services entity (company, partnership or trust) through which the individual service provider operates. [Schedule 6, item 16A]

7.67 Item 16B also amends the definition of recipient in section 202A to include a person in relation to whose personal services income a payer receives an alienated personal services payment, or is likely to receive such a payment. The effect of this is to make the individual service provider the party that can quote their TFN. [Schedule 6, item 16B]

Division 9 - penalties for directors of non-remitting companies

7.68 Division 9 of Part VI of the ITAA 1936 deals with penalties for directors of companies who fail to remit amounts withheld under the PAYG withholding provisions. The Division ensures that companies meet their obligations under, among other provisions, Subdivision 16-B of the TAA 1953, to pay withheld amounts to the Commissioner, or to go promptly into voluntary administration or liquidation. The Division imposes a duty on directors to cause the company to do so and this duty is enforced by penalties.

7.69 When the personal services income provisions were enacted, there were consequential amendments to Division 9 (e.g. to the application provision, section 222AOA). These were intended to support the collection of the additional PAYG withholding obligations where the payer was a company. However, some of the necessary amendments were overlooked.

7.70 As Division 9 currently stands, there is no obligation on directors of companies to cause the company to remit or go into voluntary administration or liquidation if the requirements of Division 13 (alienated personal services payments) are not met. Item 16C inserts section 222AOBAA whichwill ensure that obligations are placed on directors to cause the company to comply with the PAYG rules. Item 16D inserts subsection 222AOC(1) which will impose a penalty on directors for failing to comply with the obligations in section 222AOBAA. There are also flow-on changes, in items 16E to 16K, to section 222AOD (penalty for new directors), section 222AOE (Commissioner must give 14 days notice before recovering penalty), section 222AOG (remission of penalty if sections complied with), section 222AOH (effect of director paying penalty or company discharging underlying liability) and section 222AOJ (defences). [Schedule 6, items 16C to 16K]

Section 85-20 - non-deductible payments to associates

7.71 An individual deriving personal services income cannot deduct payments (including payments in kind, e.g. most fringe benefits) to an associate for non-principal work. The personal services income law does not exclude the non-deductible amount from the assessable income of the associate, which effectively results in the same amount being taxed twice, once in the hands of the service provider and then in the hands of the associate.

7.72 Item 16L, which inserts subsection 85-20(3), ensures that there is not double taxation of the non-deductible amount. The amount is to be treated as neither assessable nor exempt income of the associate. [Schedule 6, item 16L]

7.73 This amendment reflects the general policy of the income tax law of not taxing the same amount twice. In particular, the provisions are not intended to tax an individual service provider and an associate on the same amount or benefit. Nor are they intended to tax a personal services entity and a service provider (or a related party, such as their spouse) on the same amount (see section 86-35).

Deductions for salary or wages

7.74 The personal services income regime includes personal services income generated by an individual who works through an entity in the individuals assessable income. However, this does not apply to amounts of personal services income that the entity promptly pays to the individual service provider as salary or wages (section 86-15 of the ITAA 1997).

7.75 In addition, amounts received by a personal services entity for the personal services of an individual, and promptly paid to the individual as salary or wages, is deductible to the personal services entity (sections 86-80 and 8-1). Under section 86-20 this deduction will reduce the amount of personal services income included in the individuals assessable income.

7.76 Some tax practitioners have argued that, under section 86-20 in its current form, the worker could effectively get a double benefit for the same amount where only part of the personal services income is paid as salary or wages. This interpretation is contrary to the intended scheme of Division 86, that the prompt payment of the whole of personal services income (less permitted other deductions) to the service provider as salary or wages would result in no attribution of personal services income to that service provider.

7.77 Item 16M, which amends section 86-20, ensures that the reduction of the amount included in the individual workers assessable income excludes an amount obtained by the entity that is promptly paid to the individual as salary or wages.

Entitlements to shares of net income

7.78 The alienation rules currently contain provisions designed to prevent double taxation where personal services income received by an entity is assessed to the individual service provider. The rules ensure that the amounts actually distributed to the service provider (or associates) are not assessed to the extent that they are already assessable to the service provider.

7.79 Subsection 86-35(2) applies where the entity is a partnership or trust and the service provider is entitled to a share of the net income (including personal services income) of the entity. This rule is intended to apply whether or not the individual receives the share, because the rules for assessing partnerships and beneficiaries of trusts depend on entitlement, but this is not clear from the provision.

7.80 Item 16N, which amends subsection 86-35(2), will clarify that the relief from double taxation applies whether or not the individual service provider (or associate) receives their share of the net income.

Removing an unnecessary asterisk

7.81 Schedule 1 to the TAA 1953 contains the PAYG provisions. In subsection 45-120(3), an asterisk has been used to denote that amounts is a defined term. However, as in the ITAA 1997, amount is a basic term that is not identified with an asterisk (see section 2-15 of the ITAA 1997 and section 3AA of the TAA 1953). Furthermore, the asterisk does not denote a longer defined term such as amounts required to be paid under Division 13. [Schedule 6, item 18A]

Application and transitional provisions

7.82 The amendments will generally apply to the 2000-2001 income year and later income years [Schedule 6, subitem 19(1)] . However, the amendment to the special PAYG withholding rules for alienated personal services income (Division 13 of Schedule 1 to the TAA 1953) will apply to amounts received on or after 1 July 2000 [Schedule 6, subitem 19(3)] .

7.83 Some of the technical amendments apply prospectively. Items 4A to 4C (which amend the 80% test in section 87-15) and item 16M (section 86-20, deductions for salary or wages) apply to assessments for the 2002-2003 income year and later income years [Schedule 6, subitem 19(2A)]. The amendments to Division 9 of Part VI of the ITAA 1936 contained in items 16C to 16K will apply from the date of Royal Assent [Schedule 6, subitem 19(2B)]. Item 18A (which removes an unnecessary asterisk) applies, and is taken to have applied, to an amount received, or a non-cash benefit provided, on or after 1 July 2000.

7.84 The remaining technical amendments can only benefit taxpayers and therefore the application rules ensure that taxpayers get the benefit of the proposed amendments from when the provisions commenced, the 2000-2001 income year.

7.85 The declaration made by the Commissioner which has the effect that prescribed payments system entities are excluded from the measure until the end of the 2001-2002 income year, applies to the provisions in Part 2-42 of the ITAA 1997 as amended by this bill. [Schedule 6, subitem 19(2)]

REGULATION IMPACT STATEMENT

Policy objective

7.86 The amendments to the alienation of personal services income legislation are intended to reduce compliance costs for taxpayers and provide access to personal services business determinations for all taxpayers.

7.87 The amendments were announced by the Treasurer following concerns expressed by industry associations and commentators about the potential compliance burden imposed by the legislation on independent contractors.

Implementation options

Principal/agent amendments

7.88 These amendments allow certain commission agents to satisfy the requirement that less than 80% of their personal services income comes from services to each customer of their principal, even though the income is received from the principal. Agents will satisfy the requirement if at least 75% of that income is achievement or results based, they actively seek customers for their principal and do not provide services to the customers from the premises of their principal (or principals associate) except under an arms length agreement with the principal or associate.

Results test amendments

7.89 These amendments allow all taxpayers to self-assess their status as a personal services business against the results test, regardless of the proportion of income they receive from each income source, rather than seek a determination from the Commissioner.

7.90 They also ensure that a taxpayer will meet the results test where at least 75% of their personal services income satisfies the conditions in the results test.

Amendments giving access to determinations to all taxpayers earning personal services income

7.91 These amendments allow all taxpayers that earn personal services income to apply for a determination from the Commissioner. Previously only taxpayers that earned more than 80% of personal services income from one source were required to apply for a determination.

Assessment of impacts

7.92 The amendments have been proposed following discussions about the impact of the original legislation on various groups. The amendments are intended to reduce compliance costs.

Impact group identification

Principal/agent amendments

7.93 It is estimated that there are more than 15,000 taxpayers in the principal/agent category.

Results test amendments

7.94 It is difficult to estimate the number of taxpayers affected by these amendments.

Amendments giving access to determinations to all taxpayers earning personal services income

7.95 All taxpayers that derive personal services income are affected by these amendments. The estimate of taxpayers in this category is 166,000. This is made up of 46,000 companies, 47,000 partnerships and trusts and 73,000 sole traders.

Analysis of costs/benefits

Compliance costs

7.96 The amendments in this bill are intended to reduce compliance costs for affected taxpayers.

Principal/agent amendments

7.97 Taxpayers in this category will be able to look through their principal in determining the source of their income for the purpose of the measure. For the purposes of satisfying the 80% test income will be treated as having come from the customers rather than from the principal. Where this look through results in an agent having less than 80% of their personal services income from each customer, that agent will be able to self-assess against the personal services business tests. They will no longer need to seek a personal services business determination from the Commissioner and will no longer have to fill out the application form. The benefit of self-assessment is reduction in time taken to fill out the determination.

7.98 These taxpayers will continue to have the option of applying for a determination from the Commissioner. It is difficult to estimate how many will do so.

Results test amendments

7.99 All taxpayers may self-assess against the results test, regardless of the proportion of income they receive from each income source. They will continue to have the option of applying to the Commissioner for a personal services business determination on the basis of the results tests or the other tests if they so desire. Taxpayers who self-assess will not have to fill out the determination request form. The benefit of self-assessment is reduction in time taken to fill out the determination.

Amendments giving access to determinations to all taxpayers earning personal services income

7.100 All taxpayers who are affected by the alienation of personal services income measure and who previously were able to self-assess their status against the personal services business tests will now also be able to apply to the Commissioner for a determination. The benefit of a personal services business determination is certainty for the taxpayer.

Administration costs

7.101 The amendments will be administered by the ATO with the resources currently allocated to administering the alienation of personal services income legislation.

Government revenue

7.102 The amendment relating to individuals operating under principal/agent relationships is estimated to cost $35 million per year.

7.103 The amendment to clarify that a taxpayer will meet the results test if at least 75% of their personal services income satisfies the conditions in the results test, is estimated to cost $1 million per year.

7.104 The other amendments will have no impact on revenue.

Other issues - consultation

7.105 These amendments have been developed following extensive consultation with various industry associations and have their support.

Conclusion and recommended option

7.106 This option is expected to significantly reduce compliance costs for taxpayers affected by the alienation of personal services income legislation.

Index

Schedule 1: Petroleum resource rent tax

Part 1 - Sales gas

Bill reference Paragraph number
Item 1 1.10
Items 2 to 4 1.21
Item 5, paragraphs 24(1)(d) and (e) 1.13
Item 5, subsection 24(2) 1.14
Item 6 1.22
Item 7 1.23
Item 8, subsection 97(1AA) 1.18
Item 9, section 97(1AA) 1.19

Part 2 - 5 year rule

Bill reference Paragraph number
Items 10 to 12 2.9
Item 13, subsection 41(3) 2.12
Item 13, subsection 41(4) 2.13
Item 13, subsection 41(5) 2.14
Item 14 2.15
Item 15 2.16

Schedule 2: Income tax exemption for local government businesses

Bill reference Paragraph number
Item 1 3.10
Item 2, paragraph 24AT(ba) 3.8
Item 3 3.11

Schedule 3: Superannuation fund residence requirements

Bill reference Paragraph number
Item 1 4.7
Item 2 4.8, 4.9, 4.10
Item 3 4.11, 4.12
Item 4 4.13

Schedule 4: Tax relief for shareholders in listed investment companies

Bill reference Paragraph number
Item 1 5.36
Item 2 5.37
Item 3 5.38
Items 4 and 5 5.39
Items 6 and 7 5.40
Item 8 5.41
Item 9 5.42
Item 10, paragraphs 115-280(1)(a) and (b) 5.29
Item 10, paragraphs 115-280(1)(c) and (d) 5.26
Item 10, subsection 115-280(2) 5.30
Item 10, subsection 115-280(3) 5.24
Item 10, subsection 115-280(4) 5.32
Item 10, subsection 115-280(5) 5.33
Item 10, subsection 115-285(1) 5.19
Item 10, subsection 15-285(2) 5.20
Item 10, subsection 115-285(3) 5.21
Item 10, subsection 115-290(1) 5.11
Item 10, subsection 115-290(2) 5.12
Item 10, subsection 115-290(3) 5.16
Item 10, subsection 115-290(4) 5.13
Item 10, subsections 115-290(5) to (7) 5.14
Item 10, subsection 115-290(8) 5.15
Item 10, section 115-295 5.25
Items 11 and 12 5.43
Items 13 and 14 5.44
Item 15 5.35

Schedule 5: HIH rescue package

Bill reference Paragraph number
Items 1 and 6, sections 11-5 and 322-10 6.17
Items 2, 3 and 6, subsection 104-10(5) and section 322-15 6.15
Items 4 and 5 6.19
Item 6, section 322-1 6.7
Item 6, subsection 322-5(1) 6.9
Items 6 and 7, subsections 322-5(3) and 995-1(1) 6.13
Items 6 and 8, subsections 322-5(2) and 995-1(1) 6.10
Item 9 6.18
Item 9A, section 78-118 6.35, 6.37
Item 10, section 78-120 6.23
Item 11, section 188-22 6.29
Items 12 and 13, section 195-1 6.30
Item 14 6.31, 6.39

Schedule 6: Personal services income

Bill reference Paragraph number
Item 2, paragraph 87-40(2)(a) 7.14
Item 2, paragraph 87-40(2)(b) 7.12
Item 2, paragraph 87-40(2)(c) 7.12, 7.15
Item 2, paragraph 87-40(2)(d) 7.12, 7.16
Item 2, paragraph 87-40(2)(e) 7.12
Item 2, subsections 87-40(3) and (4) 7.24
Item 2, subsection 87-40(5) 7.28
Item 4, subsection 87-15(1) 7.34
Item 4, subsection 87-15(3) 7.35
Item 4, section 87-18 7.38
Item 4, subsections 87-18(1) and (3) 7.44
Item 4A, subsection 87-15(3) 7.50
Items 4B and 4C, subsection 87-15(4) 7.50
Item 6 7.46
Item 5A, subsection 87-25(2A) 7.53
Items 7 to 9 7.56
Items 10 and 15 7.58
Items 11 and 16 7.60
Items 12 to 14 7.57
Item 16A 7.66
Item 16B 7.67
Items 16C to 16K 7.70
Item 16L 7.72
Item 17 7.61
Item 18 7.63
Item 18A 7.81
Subitems 19(1) and (3) 7.82
Subitem 19(2) 7.85
Subitems 19(2A) and 2(B) 7.83

Different rules apply depending on whether expenditure is incurred pre- or post-1990.

PRRT applies to all production in Commonwealth waters except for the North West Shelf project and its associated exploration and production areas.

Different rules apply depending on whether expenditure is incurred pre- or post-1990.

The exact compliance costs for investors cannot be reliably quantified as investors will use a variety of means to familiarise themselves with the concession and to complete their income tax returns.

As each LIC may have different systems in place for accounting and record keeping purposes, a reliable quantification of the compliance costs cannot be obtained.


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