Senate

Taxation Laws Amendment Bill (No. 4) 1997

Explanatory Memorandum

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

General outline and financial impact

Thin capitalisation

Amends the thin capitalisation rules of the income tax law to:

·
reduce the allowable foreign debt to foreign equity gearing ratio for taxpayers who are not financial institutions from 3:1 to 2:1;
·
broaden the definition of 'foreign debt' in relation to companies who are not financial institutions to generally treat certain guaranteed debt from unrelated overseas lenders as foreign debt for thin capitalisation purposes;
·
amend the definition of 'foreign equity' for partnerships and fixed trusts;
·
limit asset revaluations for partnerships and trusts to market value changes;
·
deny discretionary trusts a gearing ratio to the extent their foreign equity cannot be effectively measured because of the existence of the trustee's discretion;
·
amend the definition of 'foreign investor' so that foreign partners, beneficiaries and trustees of Australian partnerships and trusts will be subject to the thin capitalisation debt to equity ratio requirement; and
·
repeal the specific anti-avoidance provisions dealing with back to back avoidance arrangements and instead apply the general avoidance provisions to counter such arrangements.

Date of effect: 1997-98 year of income.

Proposal announced: 20 August 1996.

Financial impact: Nil in 1997-98 and increased revenue of $70 million in 1998-99, $75 million in 1999-2000 and $75 million in 2000-2001.

Compliance cost impact: The proposed amendments will result in a minor increase in compliance costs.

Finance shares

Amends various provisions relating to eligible finance shares (EFS) and widely distributed finance shares (WDFS) to ensure the EFS dividends and WDFS dividends are denied non-portfolio status and an underlying foreign tax credit paid by the foreign issuer.

Date of effect: The changes will apply to dividends paid on EFS or WDFS on or after 3 February 1997.

Proposal announced: The measures were announced by the Treasurer in Press Release (No. 4) dated 3 February 1997.

Financial impact: Estimated revenue savings of $130 million per annum.

Compliance cost impact: A slight increase in the cost of compliance for affected taxpayers. They may be required to calculate a foreign tax credit associated with dividends from EFS and WDFS.

Group certificates for employees ceasing employment

Removes the general requirement that employers must provide an employee with a group certificate within seven days of that employee's termination of employment.

Date of effect: 28th day after Royal Assent.

Proposal announced: The proposal was announced by the Prime Minister in his statement of 24 March 1997, 'More Time for Business'.

Financial impact: Nil.

Compliance cost impact: Employers' compliance costs in issuing group certificates will be reduced to the extent that employees leaving employment during a financial year wait for their group certificates, generally until 14 July after the end of the relevant year of income by which date group certificates for continuing employees must be issued.

Tax exempt entities that become taxable

Ensures that where a tax exempt entity has become taxable:

·
a deduction is allowed for the amount of any surplus in the entity's defined benefit superannuation scheme at transition time;
·
a deduction is allowed for contributions in arrears made after transition where the defined benefit superannuation scheme was in surplus at transition time; and
·
the amount of bad debt deductions to be disallowed is reduced where a debt in existence immediately before the transition time is sold after the transition time.

Date of effect: Applies to entities that become taxable on or after 3 July 1995.

Proposal announced: Not previously announced.

Financial impact: Difficult to quantify due to the generic nature of the legislation. Any revenue impact would need to be determined on a case by case basis.

Compliance cost impact: The amendments are not expected to impose any additional compliance costs on taxpayers as taxpayers will not be required to keep additional records.

Measures to address tax avoidance through tax exempt entities distributing funds offshore

Amends the exemption provisions of the income tax law to:

·
remove the exemption provided by subparagraph 23(j)(ii) for funds established by will or instrument of trust for public charitable purposes ('charitable trusts') that are located offshore;
·
restrict the exemption provided to charitable trusts established in Australia by will or instrument of trust for public charitable purposes;
·
remove various exemptions from income tax provided by section 23 for certain organisations which are located offshore;
·
remove various exemptions from income tax provided by section 23 for certain organisations who do not incur their expenditure and pursue their objectives principally in Australia; and
·
remove the exemption from non-resident interest, dividend and royalty withholding tax provided by paragraph 128B(3)(a) for certain organisations located offshore.

Date of effect: In the case of charitable trusts, the measures will take effect after the commencement of the charitable trusts' 1996-97 year of income (generally 1 July 1996). The other measures will apply from 7.30 pm, Eastern Standard Time, 20 August 1996.

Proposal announced: 1996-97 Budget, 20 August 1996.

Financial impact: The estimated impact of these measures is a gain to the revenue of $25 million in 1996-97 and then $30 million per annum from 1997-98.

Compliance cost impact: The measures are being enacted primarily to prevent tax avoidance. However, the requirements are consistent with existing accounting practices and standards and with those of other areas of taxation.

Quasi-ownership of fixtures

Amends the Income Tax Assessment Act 1997 (the 1997 Act) and the Income Tax Assessment Act 1936 (the 1936 Act) as a consequence of the Tax Law Improvement Project rewrite. Inserts new provisions into Division 42 of the 1997 Act concerning depreciation of a lessor's plant that has become a fixture on another person's land. Similar rules are being inserted into the 1936 Act by Taxation Laws Amendment Bill (No. 3) 1997.

The rules treat lessors of depreciable plant under a chattel lease as retaining ownership notwithstanding that the leased equipment may be a fixture on another person's land. To be treated as an owner - or quasi-owner for purposes of the 1997 Act - the lessor must retain an effective right to recover the leased property.

Date of effect: Applies generally to 1997-98 and later income years. Two minor corrections to the 1936 Act apply from 1 July 1996.

Proposal announced: Treasurer's Press Release No 25 of 1996, dated 11June 1996.

Financial impact: Nil.

Compliance cost impact: Nil.

Electronic lodgment and electronic funds transfer

Amends the Income Tax Assessment Act 1936 (the Act), the Fringe Benefits Tax Assessment Act 1986 (the FBTAA) and the Taxation Administration Act 1953 (the TAA) to:

·
provide a legal basis for the electronic lodgment of returns, applications for amendment and other notices; and
·
allow the Commissioner to pay, by electronic transfer, any refunds to an account (which may be a third-party account) nominated by the taxpayer.

Date of effect: The amendments to facilitate the electronic lodgment service (ELS) and electronic funds transfer (EFT) for income tax will commence on 1 July 1998. The amendments to facilitate ELS and EFT for fringe benefits tax will commence on 1 April 1998.

Proposal announced: Not previously announced

Financial impact: There is no revenue impact. It is expected that there will be administrative savings from the increased use of EFT.

Compliance cost impact: The compliance costs imposed on taxpayers will be minimal. Taxpayers will be required to keep a copy of the declaration made to a tax agent authorising the electronic transmission and/or consenting to an EFT of a refund to a third-party account.

A tax agent will no longer be required to keep income tax or fringe benefits tax returns as is currently the situation under the contract for participation in the interim paperless ELS. However, where a taxpayer uses the tax agent's address as the address for service of notices the tax agent will be required to give the taxpayer the notice of assessment, or a copy therof.

Rate of tax for friendly societies

Amends the Taxation (Deficit Reduction) Act (No 2) 1993 so that the rate of tax imposed on the eligible insurance business of friendly societies and other registered organisations will be retained at 33% for the 1997-98 and 1998-99 income years. Similarly, the rebate available to policyholders who receive assessable bonuses on life insurance policies issued by friendly societies and other registered organisations will be retained at 33% for the 1997-98, 1998-99 and 1999-2000 income years. The trustee rate will be increased to 39% from 1999-2000 and the rebate rate will be increased to 39% from 2000-01.

Date of effect: 1July1997.

Proposal announced: 1997-98 Budget, Treasurer's Press Release No 40 of 13May1997.

Financial impact: The estimated cost to the revenue is $6 million in 1997-98, $29 million in 1998-99 and $4 million in 1999-2000. A revenue gain of $2million is expected in 2000-01.

Compliance cost impact: Nil.

Leases of luxury cars

Amends the Income Tax Assessment Act 1997 and the Income Tax Assessment Act 1936 as a consequence of the Tax Law Improvement Project rewrite to ensure that the legislative rules for the taxation treatment of leases of luxury cars in Schedule 2E of the Income Tax Assessment Act 1936 continue to apply to the 1997-98 and later income years.

Date of effect: 1997-98 and later income years.

Proposal announced: 1996-97 Budget, 20 August 1996 and Treasurer's Press Release No 83 of 20 August 1996.

Financial impact: Nil

Compliance cost impact: Nil

Chapter 1 - Thin capitalisation

Overview

1.1 Schedule 1 of the Bill will amend the thin capitalisation rules contained in Division 16F of Part III of the Income Tax Assessment Act 1936 (the Act) to:

·
reduce the allowable foreign debt to foreign equity gearing ratio for taxpayers who are not financial institutions from 3:1 to 2:1;
·
broaden the definition of 'foreign debt' in relation to companies who are not financial institutions to generally treat certain guaranteed debt from unrelated overseas lenders as foreign debt for thin capitalisation purposes;
·
amend the definition of 'foreign equity' for partnerships and fixed trusts;
·
limit asset revaluations for partnerships and trusts to market value changes;
·
deny discretionary trusts a gearing ratio to the extent their foreign equity cannot be effectively measured because of the existence of the trustee's discretion;
·
amend the definition of 'foreign investor' so that foreign partners, beneficiaries and trustees of Australian partnerships and trusts will be subject to the thin capitalisation debt to equity ratio requirement; and
·
repeal the specific anti-avoidance provisions dealing with back to back avoidance arrangements and instead apply the general avoidance provisions to counter such arrangements.

Summary of the amendments

Purpose of the amendments

1.2 The purpose of the amendments is to improve the effectiveness of the thin capitalisation rules. The proposed reduction in the foreign debt to foreign equity ratio from 3:1 to 2:1 will require foreign investors to structure their investments in Australian enterprises on a more commercial basis.

1.3 The definition of foreign debt in relation to companies is being expanded to include borrowings from an overseas lender either guaranteed by a foreign controller or subject to a security provided by a foreign controller. This amendment is designed to complement the proposal to decrease the foreign debt to foreign equity ratio so that foreign controllers will be required to provide adequate equity capital to Australian companies. This amendment will not apply to financial institutions.

1.4 In the absence of such a measure, a foreign controller of an Australian company could avoid the impact of the thin capitalisation rules by allocating debt rather than equity capital to the company from arm's length overseas lenders, with a guarantee or security provided by the foreign controller. In this situation, the Australian enterprise would be able to use the foreign controller's (or their non-resident associates') equity overseas to obtain a loan from an arm's length lender. This measure will not apply if the Commissioner can be satisfied that the Australian company could have borrowed the amount of the loan from a prudent arm's length lender without having the foreign controller's (or their non-resident associates') guarantee or security provided to the lender.

1.5 The amendments will deny a foreign controlled discretionary trust a deduction for interest paid to foreign controllers of the trust because the foreign equity of a discretionary trust cannot be measured in a meaningful way.

1.6 The definition of foreign equity for fixed trusts will be amended so that it is calculated on the basis of the foreign controllers' fixed interests in the capital or income of the trust. For partnerships, the definition of foreign equity will be based on partners' fixed interests in the capital or income of the partnership.

1.7 The specific provisions dealing with back to back avoidance arrangements will be repealed as the general anti-avoidance provisions of the income tax law are considered to more effectively counter such schemes. Back to back arrangements are used to give a transaction between related parties the appearance of being a transaction between arm's length parties by interposing an unrelated person between the related parties.

1.8 The asset revaluation rules in relation to partnerships and trusts will be brought into line with the current rules for companies. This will ensure that partnerships and trusts can only revalue assets up to their arm's length value. In addition, the asset revaluations will only be taken into account in determining a partnership or trust's foreign equity in the income year following the year in which the assets were revalued.

1.9 Foreign partners, beneficiaries and trustees of Australian partnerships and trusts will be subject to the thin capitalisation debt to equity ratio requirement, as well as the underlying Australian partnership or trust. This will still provide foreign partners, beneficiaries and trustees of Australian partnerships and trusts with some scope for borrowing from related-parties to invest in the partnership or trust.

Date of effect

1.10 The measures will apply from the 1997-98 income year. Transitional arrangements are provided for taxpayers with substituted accounting periods.

Background to the legislation

What is thin capitalisation?

1.11 Thin capitalisation is used to describe the situation where the ratio of non-arm's length debt to equity funding of an entity is considered to be excessive. Thin capitalisation of investments in Australia is influenced by the preferential taxation treatment provided to debt funding relative to equity funding. In the case of debt funding of a foreign controlled Australian company, interest paid by the company is deductible against its income and the interest income paid to its foreign investor is normally only subject to interest withholding tax at the rate of 10 per cent. In the case of equity funding, dividends paid to the foreign shareholders are generally paid from profits that are subject to the 36 per cent company rate of tax and under the imputation system are not subject to dividend withholding tax. This difference between the treatment of debt funding and equity funding creates the incentive for foreign controllers to maximise the debt funding and minimise the equity funding of their investments in Australian enterprises.

Thin capitalisation rules

1.12 The thin capitalisation rules of the income tax law, contained in Division 16F of Part III of the Income Tax Assessment Act 1936, place a limit, by means of specified non-arm's length debt to equity funding ratios, on the amount of interest expense payable on related party debt that can be deducted for Australian tax purposes. The ratio assists in ensuring that an appropriate amount of profit is derived in Australia, and in protecting Australia's revenue base.

1.13 Under the current thin capitalisation rules the ratio of related party foreign debt to foreign equity cannot exceed 6:1 for financial institutions and 3:1 for other taxpayers. The ratio of 6:1 is allowed for investments in banks and non-bank financial institutions in recognition of their special funding needs. If a taxpayer exceeds the gearing ratio, deductions for interest paid on the related party debt are disallowed to the extent of the excess. The thin capitalisation rules apply to resident companies, trusts and partnerships. The rules also apply to foreign investors, which are defined as non-residents who derive Australian source assessable income other than in the capacity of a partner in a partnership or a trustee or beneficiary of a trust.

What is a foreign equity product?

1.14 The term 'foreign equity product' is defined in section 159GZA. It is a multiple of an Australian enterprise's foreign equity. In the case of financial institutions, the multiple is 6 and in all other cases it is 3. The foreign equity product is a term used in Subdivision C of the thin capitalisation rules, to determine the maximum foreign debt interest that an Australian enterprise may claim as a tax deduction. If an Australian enterprise exceeds its foreign equity product the enterprise's deduction for foreign debt interest will be disallowed to the extent that the foreign equity product has been exceeded.

What is interest withholding tax?

1.15 Division 11A of Part III of the Act imposes interest withholding tax (IWT) on interest paid to a person outside Australia by a resident of Australia. It also applies to interest paid to a person outside Australia by a non-resident, to the extent that the interest relates to a business carried on by the non-resident in Australia. IWT is a flat and final tax of 10 per cent imposed on interest paid to overseas lenders. The obligation for the collection of IWT is placed on the Australian entity paying interest overseas.

Explanation of the amendments

The new foreign debt to foreign equity gearing ratio of 2:1 for taxpayers who are non-financial institutions

1.16 The thin capitalisation foreign debt to foreign equity ratio for Australian enterprises who are not financial institutions (defined in section 159GZA of the Act) will be decreased from 3:1 to 2:1 [item 1; amendment to section 159GZA 'definition of foreign equity product']. A consequential amendment has been made in relation to the adjustment of the 'foreign equity product' in certain cases involving financial institutions (section 159GZM). This will ensure that the changed gearing ratio will be applied to cases where the equity of a foreign controller is ultimately invested in a financial institution as distinct from other investments. [Item 13]

Guarantees or securities provided by a foreign controller or a non-resident associate of a foreign controller

1.17 In relation to a resident company, overseas borrowings that are either guaranteed by a foreign controller or subject to a security provided by a foreign controller will generally be treated as foreign debt for thin capitalisation purposes. In addition, overseas borrowings by a resident company that are guaranteed by a non-resident associate of a foreign controller or subject to a security provided by a non-resident associate of a foreign controller will generally be treated as foreign debt [item 3; new subsection 159GZF(1A)]. New subsection 159GZF(1A) will not apply to financial institutions [paragraph 159GZF(1A)(a)] .

1.18 The elements of new subsection 159GZF(1A) are:

·
an Australian resident company owes an amount of money [new paragraph 159GZF(1A)(a)] ;
·
interest is either payable or may become payable, in respect of the borrowing, to an unrelated non-resident lender [new paragraph 159GZF(1A)(b)] . Note that if an amount is owing by a resident company to a foreign controller or their non-resident associates, the amount will be foreign debt under subsection 159GZF(1);
·
the interest is, or will be, an allowable deduction for the Australian company [new paragraph159GZF(1A)(c)] ;
·
the interest is not assessable income in Australia in the hands of the person providing the borrowing [new paragraph 159GZF(1A)(d)] . Thus if the person who provides the borrowing includes the interest income in its assessable income in Australia, the borrowing will not be treated as foreign debt. If a borrowing is provided by a company resident in Australia and it includes the interest in its Australian assessable income, the borrowing will not be treated as foreign debt. Similarly if the borrowing is provided by a non-resident company operating in Australia through a permanent establishment and the interest in respect of the borrowing is included in the permanent establishment's Australian assessable income, the borrowing will not be treated as foreign debt; and
·
the company has obtained from its foreign controllers or their non-resident associates a guarantee in respect of the borrowing or the borrowing is subject to a security provided by such persons [new paragraph 159GZF(1A)(e)] .

1.19 The elements in new subsection 159GZF(1A) are the same as those in existing subsection 159GZF(1) with the exception that:

·
the amount owing is raised from someone that is not a foreign controller or non-resident associate of a foreign controller; and
·
the amount owing is either guaranteed by its foreign controllers or non-resident associates or is subject to a security provided by its foreign controllers or their non-resident associates.

1.20 However, if a resident company can establish to the satisfaction of the Commissioner that an amount owing to a non-resident lender could have been borrowed, whether or not on the same terms and conditions, without a guarantee or security from a foreign controller or non-resident associate of a foreign controller, the amount will not be treated as foreign debt [new subsection 159GZF(1B)] . This provision provides an exemption if the Australian resident company can establish that, in effect, the guarantee or security did not increase the amount the taxpayer could have borrowed. In other words the company's net equity was sufficient for it to obtain the same amount from a prudent lender without such a guarantee or security. In determining the borrowing capacity of a foreign controlled company, amounts owing to foreign controllers and their non-resident associates should be treated in the same manner as any other loans of the company. Related party loans should not be treated as quasi-equity.

1.21 In order to be able to obtain the benefit of new subsection 159GZF(1B) an Australian company must be able to establish for each income year that the guarantee or security provided by foreign controllers or their non-resident associates did not affect the amount of finance that the lender was willing to provide. The exemption in new subsection 159GZF(1B) is targeted at loans where a foreign controller has provided a guarantee or security in order to decrease the borrower's cost of borrowing. If this is the only effect of the guarantee or security, then the loan will not be treated as foreign debt.

1.22 For example, if an Australian company obtained a guarantee from its foreign controller for a loan of $100 million provided by an unrelated overseas bank, the loan will prima facie be foreign debt under new subsection159GZF(1A). If, however, the Australian company has net equity of $500million, and the company is able to establish that the guarantee did not affect its borrowing capacity, it will be able to satisfy the Commissioner that the loan is eligible for exemption under subsection159GZF(1B). Such a company would be clearly able to establish that a prudent lender would have provided it with a $100 million loan without the guarantee. In this situation the guarantee may have been provided to improve the company's credit rating in order to decrease its cost of borrowing.

Foreign equity for partnerships

1.23 The foreign equity of a partnership will be determined by calculating the fixed interests of foreign controllers and their non-resident associates in the net income (or loss) and capital of the partnership [item 8; new subsection 159GZG(3)] . This is achieved through a formula in new subsection 159GZG(3) that adds the fixed interests of foreign controllers and their non-resident associates in the net income (or loss) and capital of a partnership. Under the formula the maximum total interests in a partnership may be up to 200 per cent because the fixed interests of the foreign controllers and their non-resident associates in the net income or loss of the partnership may be different to their fixed interests in the assets of the partnership. Accordingly, under the formula the maximum total interests of foreign controllers is halved.

1.24 Under the formula in new subsection 159GZG(3) a partnership must determine its total partnership equity. This amount is then multiplied by the fraction determined under the formula. The term in the formula dealing with partnership capital is:

A/(A+B)

This fraction determines the proportion of the capital of a partnership which is attributable to foreign controllers or their non-resident associates. This is done on the basis of determining the partners' equity to which foreign controllers or their non-resident associates are entitled. The partners' equity must be based on the fixed interests of the partners in the assets of the partnership as reduced by amounts owed to the partnership by foreign controllers or their non-resident associates, other than amounts owed in respect of short-term trade credit. The numerator is therefore the sum of the foreign controllers' and their non-resident associates' net equity in the partnership. The denominator is the sum of the numerator and the net equity of partners who are not foreign controllers or their non-resident associates. If the foreign controllers and their non-resident associates are entitled to the entire net equity in the partnership the fraction will be 1/1. If the foreign controllers are entitled to half of the net equity of a partnership the fraction will be 1/2.

1.25 The term in the formula dealing with partnership income is:

C/(C+D)

This fraction determines the proportion of net partnership income (or loss) which is attributable to interests held by foreign controllers or their non-resident associates in the income (or loss). This is done by determining the amount of net partnership income derived by foreign controllers and their non-resident associates as a result of their fixed interests in the income of the partnership. This amount is the numerator. The denominator is the sum of the numerator and the partnership income derived by persons other than foreign controllers or their non-resident associates in respect of fixed interests in the income of the partnership. If the foreign controllers and their non-resident associates are entitled to the entire net income of a partnership, the fraction will be 1/1. If the foreign controllers are entitled to half of the net income of a partnership the fraction will be 1/2.

Example

Assume a partnership has four partners and that two partners who are non-residents of Australia are foreign controllers of the partnership. Assume that the other two partners are residents of Australia and that each partner has a 25 per cent fixed interest in the capital and net income or loss of the partnership. Assume that the net income of the partnership is $40,000 and the net equity of the partnership is $200,000.

Foreign equity =$200,00 * (1/2)*((100,00/200,000)+(20,000/40,000))
Foreign equity = $100,000

In this example half of the equity of the partnership will be attributable to foreign controllers. The foreign equity product of this partnership will be $200,000 ($100,00*2). The foreign controllers and their non-resident associates will be entitled to lend up to $200,000 under the new thin capitalisation provisions.

Foreign equity for trusts

Calculation of foreign equity if a trust derives net income

1.26 The foreign equity of a trust will be determined by calculating the fixed interests of foreign controllers and their non-resident associates in either the net income for a year of income or capital of the trust [item 8; new subsection 159GZG(4)] . This is achieved through a formula in new subsection 159GZG(4) that aggregates the fixed interests of foreign controllers and their non-resident associates in the net income and capital of a trust. Under the formula the maximum total interests in a trust may be up to 200 per cent because one group of foreign controllers may have a fixed interest in all the trust net income and another group of foreign controllers may have a fixed interest in all the capital of the trust. Accordingly, under the formula the maximum total interests of foreign controllers is halved.

1.27 Under the formula in new subsection 159GZG(4) a trust must determine its total trust equity. This amount is then multiplied by the fraction determined under the formula. The term in the formula dealing with trust capital is:

A/(A+B)

This fraction determines the proportion of the capital of a trust which is attributable to foreign controllers or their non-resident associates. This is done on the basis of determining the beneficiaries' equity to which foreign controllers or their non-resident associates are entitled. The beneficiaries' equity must be based on the fixed interests of beneficiaries in the assets of the trust. The numerator is the sum of the foreign controllers' and their non-resident associates' net equity in the trust. The denominator is the sum of the numerator and the net equity of beneficiaries who are not foreign controllers or their non-resident associates. If the foreign controllers and their non-resident associates are entitled to the entire net equity in the trust the fraction will be 1/1. If the foreign controllers are entitled to half of the net equity of a trust the fraction will be 1/2.

1.28 The term in the formula dealing with trust income is:

C/(C+D)

This fraction determines the proportion of net trust income for a year of income which is attributable to foreign controllers or their non-resident associates. This is done by determining the amount of net trust income derived by foreign controllers and their non-resident associates as a result of their fixed interests in the income of the trust. This amount is the numerator. The denominator is the sum of the numerator and the trust income derived by beneficiaries other than foreign controllers or their non-resident associates in respect of fixed interests in the income of the trust. If the foreign controllers and their non-resident associates are entitled to the entire net income of a trust, the fraction will be 1/1. If the foreign controllers are entitled to half of the net income of a trust the fraction will be 1/2.

Example

Assume there are two foreign controllers of a trust and one foreign controller is entitled to the entire net income for a year of income from the trust which is $10,000. Assume that the other foreign controller has a fixed interest in the entire capital of the trust which is $100,000.

Foreign equity = $100,000 * (1/2) * ((100,000/100,000) + (10,000/10,000))
Foreign equity = $100,000

In this example the entire net equity of the trust will be attributable to foreign controllers. The foreign equity product of this trust will be $200,000 ($100,000*2). The foreign controllers and their non-resident associates will be entitled to lend up to $200,000 under the new thin capitalisation provisions.

Example

Assume there are two foreign controllers in relation to a trust. One foreign controller has a fixed interest in half of the net income for a year of income of the trust and a resident beneficiary has a fixed interest in the other half of the net income of a trust. One foreign controller has a fixed interest in half of the capital of the trust with a resident beneficiary having a fixed interest in the other half of the trust capital. Assume that the trust has income of $10,000 and net assets of $100,000. The foreign equity calculation will be:

Foreign equity = $100,000 * (1/2) * ((50,000/100,000) + (5,000/10,000))
Foreign equity = $50,000

In this example, the foreign controllers are entitled to half of the net equity of trust and therefore the trust will have foreign equity of $50,000. The foreign equity product of this trust will be $100,000 ($50,000*2). The foreign controllers and their non-resident associates will be entitled to lend up to $100,000 under the new thin capitalisation provisions.

Calculation of foreign equity if a trust incurs a loss or has no net income

1.29 If a trust does not derive net income or incurs a loss for an income year, the foreign equity of the trust will be determined on the basis of the foreign controllers' fixed interest in the assets of the trust [item 8, new subsection 159GZG(4A)] . This is achieved through a formula in new subsection 159GZG(4A) that determines the fixed interests of foreign controllers in the capital of a trust. As a beneficiary cannot have a fixed interest in a trust loss, the formula in new subsection 159GZG(4A) does not apply to trust income. 1.30 Under the formula in new subsection 159GZG(4A) a trust must determine its total trust equity. This amount is then multiplied by the fraction determined under the formula. The formula is:

A/(A+B)

This fraction determines the proportion of the capital of a trust which is attributable to foreign controllers and their non-resident associates. This is done on the basis of determining the beneficiaries' equity to which foreign controllers and their non-resident associates are entitled. The beneficiaries' equity must be based on the fixed interests of beneficiaries in the assets of the trust. The numerator is the foreign controllers' net equity in the trust. The denominator is the sum of numerator and the net equity of beneficiaries who are not foreign controllers or their non-resident associates. If the foreign controllers and their non-resident associates are entitled to all the net equity in a trust the fraction will be 1/1. If the foreign controllers and their non-resident associates are entitled to half of the net equity of a trust the fraction will be 1/2.

Example

Assume there are two foreign controllers of a trust and one foreign controller is entitled to the entire net income of the trust. Assume that the other foreign controller has a fixed interest in half of the capital of the trust and a resident beneficiary has a fixed interest in the other half of the capital of the trust. Assume further that the equity of the trust is $100,000 and the trust incurs a loss for the income year.

Foreign equity = $100,000 * (50,000/100,000)
Foreign equity = $50,000

In this example, half of the net equity of the trust will be attributable to foreign controllers. The foreign equity product of this trust will be ($50,000*2) $100,000. The foreign controllers and their non-resident associates will be entitled to lend up to $100,000 under the new thin capitalisation provisions.

Determination of a trust's balance sheet 1.31 In order to determine the foreign equity of a trust, a notional balance sheet for the trust must be prepared at the end of the income year. The foreign equity of a trust is the fixed interests of the foreign controllers in the equity of the trust at that time, having regard only to the use of trust property in producing assessable income of the foreign controllers or their non-resident associates. The foreign equity determined through the preparation of the notional balance sheet must then be reduced by any amounts owing to the trustee of the trust by foreign controllers or their non-resident associates other than amounts owing in respect of short-term trade credit.

Asset revaluation reserves for partnerships and trusts

1.32 In preparing a notional balance sheet for the purpose of the foreign equity calculations, a partnership or trust is allowed to revalue assets of the partnership or trust. A partnership or trust may only revalue assets up to their arm's length values [item 8; new subsection 159GZG(4B)] . For this provision to apply the partnership or trust must provide for asset revaluation reserves in it accounting records [new paragraph 159GZG(4B)(a)] . If the arm's length value of the assets of a partnership or trust are less than the amount shown in the balance sheet as representing the asset revaluation reserve, the asset revaluation reserve will be adjusted in accordance with the arm's length value changes for the purposes of determining the foreign equity of the partnership or trust [new paragraph 159GZG(4B)(b)] . For example, if a trust's asset revaluation reserve is $10,000 at the end of a year of income and the value of the assets has declined since the previous income year by $5,000, the trust's asset revaluation reserves are to be reduced to $5,000.

1.33 Credits to an asset revaluation reserve may only be included at the beginning of an income year, based on revaluations undertaken in the previous income year [new paragraph 159GZG(4B)(c)] . For example, if a trust has its income year ending on 30 June, the arm's length value of its assets has increased by $10,000 and the revaluation is included in its accounting records for that year, the increase will only be taken into account in the calculation of the trust's foreign equity for the following income year.

Foreign equity: Discretionary trusts

1.34 The foreign equity of a trust will be based on the fixed and indefeasible interests of foreign controllers and their non-resident associates in either the net income or capital of the trust. If a trust is treated as a discretionary trust under the definition in new subsection 159GZG(13), the trust's foreign equity will be reduced by the trust's maximum discretionary percentage. [Item 12; new subsections 159GZG(12) and (13)]

1.35 If the entire income or capital of a trust is subject to a discretionary power, the trust will be treated as having foreign equity of nil. If a trust is treated as having foreign equity of nil, its foreign equity product will be nil and it will be unable to obtain a deduction for interest on loans from foreign controllers or non-resident associates of the trust. Such discretionary trusts will only be able to obtain a deduction for interest on borrowings from arm's length parties or resident associates.

1.36 New subsection 159GZG(12) provides for apportionment of the foreign equity of discretionary trusts. This apportionment will apply to trusts in which some beneficiaries hold fixed interests in either the income or capital of the trust.

1.37 The foreign equity of a discretionary trust is determined by a three step process. Firstly the 'current equity amount' of a trust must be determined. This is the foreign equity of the trust determined under new subsection 159GZG(4). The second step is to determine if at any time during a year of income a trust was a discretionary trust [new paragraph 159GZG(12)(b)] . The third step is to determine the foreign equity of the trust using the formula in new subsection 159GZG(12). The formula, based on the definition of discretionary trust in new subsection 159GZG(13), determines the maximum proportion of a trust's income or assets that is subject to a discretion in respect of either the income or capital of the trust. This proportion is expressed as a percentage, called a 'maximum discretionary percentage'. A trust's current equity amount is then reduced by the maximum discretionary percentage.

1.38 The maximum discretionary percentage is defined in new subsection 159GZG(12) as meaning the amount determined using a table in that subsection. The table is divided into four categories, called cases. Each case is based on the three paragraphs of the definition of discretionary trust in new subsection 159GZG(13).

1.39 A discretionary trust is defined in new subsection 159GZG(13) as essentially a trust in respect of which any proportion of the interests of beneficiaries are not fixed. A trust will be treated as a discretionary trust if any one of the tests in new paragraphs 159GZG(13)(a), (b) or (c) are satisfied.

1.40 A trust will be a discretionary trust if a person, including a trustee, is empowered by whatever means to exercise a power of appointment or other discretion [new paragraph 159GZG(13)(a)(i)] . Also, if the power or discretion either in its use, or failure to use, results in determining the beneficiaries who may benefit under a trust, and the trust makes distributions to those beneficiaries, the trust will be held to be a discretionary trust [new paragraph 159GZG(13)(a)(ii)] .

1.41 The second test relates to a beneficiary's right to income or capital of a trust [new paragraph 159GZG(13)(b)] . A trust will be treated as a discretionary trust where one or more of its beneficiaries have a contingent or defeasible interest in some or all of the trust's income or capital.

1.42 The third test applies where the trustee of another trust, in respect of which both the conditions in new paragraph 159GZG(13)(a) are satisfied, benefits or is capable of benefiting from the first trust whether by the exercise of a power of appointment or otherwise. [New paragraph 159GZG(13)(c)]

Case 1: Discretionary power in relation to either trust income or capital

1.43 Under Case 1, if paragraph (a) of the new definition of discretionary trust in new subsection 159GZG(13) only applies in relation to a trust, the maximum discretionary percentage is the greatest percentage of the trust's income or capital that is subject at any time during the relevant income year ('the current year of income') to a trustee's discretion. If both the income and capital are subject to a discretion, the greater percentage is the maximum discretionary percentage. If either all the income, or capital, of a discretionary trust is subject to a discretionary power, the maximum discretionary percentage will be 100 per cent. Such a trust will have foreign equity of nil. If a trust's greatest percentage is less than 100 per cent, the foreign equity of the trust will be apportioned under the formula in new subsection 159GZG(12).

Example 1

Assume that a trust has a capital beneficiary with a fixed interest in the assets of the trust and another beneficiary with a fixed interest in half of the trust's income. The trustee has a discretion on how the other half of the net income of the trust will be distributed. Assume further that the foreign equity of the trust, called current equity amount, is $100,000. The maximum discretionary percentage will be 50 per cent because under Case 1 half of the net income of the trust is subject to a discretion. Applying the formula in new subsection 159GZG(12) the foreign equity of the trust will be:

Foreign equity = $100,000 - ($100,000 * 50 per cent)
Foreign equity = $50,000

Example 2

Assume the same facts as in Example 1, except that the trustee has the power to allocate up to three quarters of the trust's assets to certain beneficiaries. The maximum discretionary percentage will be 75 per cent as the trustee's discretion in relation to capital applies to a greater proportion of the trust's assets than the trustee's discretion in the relation to the income of the trust. Applying the formula in new subsection 159GZG(12) the foreign equity of the trust will be:

Foreign equity = $100,000 - ($100,000 * 75 per cent)
Foreign equity = $25,000

Case 2: Contingent or defeasible interests in trust income or capital

1.44 Under Case 2, if paragraph (b) of the definition of discretionary trust in new subsection 159GZG(13) only applies in relation to a trust, the maximum discretionary percentage is the percentage of the trust's income or capital to which the trust's beneficiaries have a contingent or defeasible interest. If both the income and capital are subject to a contingent or defeasible interest, the greater percentage is the maximum discretionary percentage. If the discretionary interest is 100 per cent the trust will be treated as having foreign equity of nil. If a trust's maximum discretionary percentage is less than 100 per cent, the foreign equity of the trust will be apportioned under the formula in new subsection 159GZG(12).

Example

Assume that a trust has two beneficiaries, one of which has a fixed interest in 50 per cent of the income and capital of a trust, and the other will be entitled to 50 per cent of the trust income and capital on reaching 21 years of age. Assume further, that the trust has current equity of $100,000. Prior to the contingent beneficiary reaching legal majority, the trustee may capitalise half of the income of the trust. The maximum discretionary percentage will be 50 per cent as one beneficiary has a contingent interest in 50 per cent of the net income and assets of the trust:

Foreign equity = $100,000 - ($100,000 * 50 per cent)
Foreign equity = $50,000

Case 3: Discretionary powers and concurrent contingent or defeasible interests

1.45 Under Case 3, if both paragraphs (a) and (b), but not paragraph (c) of the definition of discretionary trust in new subsection 159GZG(13), apply in relation to a trust, the maximum discretionary percentage is the greater of the percentage of the trust's income or capital that either is subject to the power or discretion mentioned in paragraph (a) or to which one or more of the trust's beneficiaries have a contingent or defeasible interest. Case 3 applies to provide that in this situation it is the greatest discretionary interest that is treated as the maximum discretionary interest of the trust.

Example

Assume that a trust has two beneficiaries. One beneficiary has a fixed interest in half of the net trust income and the trustee has a discretion as to the distribution of the other half of the net trust income. The other beneficiary has a fixed interest in 25 per cent of the trust's capital and has a defeasible interest in 75 per cent of the trust's capital. In this situation both paragraphs 159GZG(13)(a) and (b) apply concurrently to the trust. The maximum discretionary percentage will be 75 per cent because the capital beneficiary has a defeasible interest in three quarters of the trust's assets.

Case 4: Maximum discretionary percentage of 100 per cent

1.46 Under Case 4, if paragraph (c) of the definition of discretionary trust in new subsection 159GZG(13) applies in relation to a trust, the maximum discretionary percentage is 100 per cent. This will be the result whether or not either of the paragraphs (a) or (b) of the definition apply. New paragraph 159GZG(13)(c) applies if a beneficiary of a trust is a beneficiary in the capacity of a trustee of another trust in which the two conditions in new paragraph 159GZG(13)(a) are satisfied. A trust will be treated as a discretionary trust if the trustee of the other trust is capable of benefiting from the first trust whether by the exercise of a power of appointment or otherwise.

Consequential amendment

1.47 Section 159GZG(9), which involves a measure of the foreign equity of a partnership, trust or foreign investor, will be amended to take into account new subsection 159GZG(12). [Item 11]

Foreign partners, beneficiaries and trustees of partnerships and trusts

1.48 Foreign partners, beneficiaries and trustees of Australian partnerships and trusts will be subject to the thin capitalisation debt to equity ratio requirement, as well as the underlying Australian partnership or trust. This will be achieved by amending the definition of 'foreign investor' so that it no longer excludes partners in partnerships, beneficiaries of trusts and trustees of trusts. [Item 2; amendment to section 159GZA 'definition of foreign investor']

1.49 The foreign equity of a 'foreign investor' will include the investor's fixed interest in either the net income or capital of the underlying partnership or trust. Where the foreign investor is a beneficiary of a discretionary trust, the foreign equity will be based on the fixed and indefeasible interests of the foreign investor in either the net income or capital of the trust. [Item 10; new subsections 159GZG(5A) and (5B)]

1.50 To the extent that the income or capital of the trust is subject to a discretionary power, as described in new paragraph 159GZG(13)(a), it will be disregarded in calculating the foreign investor's equity [new paragraph 159GZG(5A)(a)] . To the extent that a beneficiary's interest is a contingent or defeasible interest, as described in new paragraph 159GZG(13)(b), it will also be disregarded in the calculation of foreign equity [new paragraph 159GZG(5A)(b)] . These amendments are a consequence of foreign equity not being capable of being effectively measured in those circumstances and complement the measures contained in Schedule 1 for determining the foreign equity of a discretionary trust.

1.51 When calculating a foreign investor's equity, any interest in a discretionary trust, where the trustee of another discretionary trust benefits, or is capable of benefiting under the first mentioned trust, is also to be disregarded [new subsection 159GZG(5B)] . The amendments will ensure that the foreign equity that a beneficiary has in an Australian trust is limited to fixed interests in the trust.

1.52 Paragraph 159GZG(5)(a), which defines the 'foreign equity' of a 'foreign investor', has been amended to reflect the revised definition of a 'foreign investor'. [Item 9]

Repeal of sections 159GZO and 159GZP

1.53 Sections 159GZO and 159GZP deal with back to back arrangements using intermediaries to give related party transactions the appearance of being transactions between arm's length parties in order to avoid the application of the thin capitalisation rules. Section 159GZO applies to loans from a foreign controller to its Australian enterprise provided through unrelated intermediaries and it re-characterises such loans as foreign debt. Section 159GZP applies to an Australian enterprise providing funds to its foreign controller through unrelated intermediaries and re-characterises such loans as equity loan-backs, which are reductions in the foreign equity of the enterprise. These provisions are being repealed because the general anti-avoidance provisions of Part IVA of the Act are considered to more effectively deal with such arrangements. [Items 14 and15]

1.54 As a result of the proposed repeal of section 159GZO the references to section 159GZO in paragraphs 159GZF(1)(c), 159GZF(2)(c), 159GZF(3)(c) and 159GZF(4)(c) will be deleted. [Items 4, 5, 6 and 7]

Application

1.55 The amendments made by Schedule 1 apply in relation to the 1997-98 income year and all later income years. [Item 16]

Transitional provisions - taxpayers with substituted accounting periods

1.56 The transitional provisions propose modifications to the application of the thin capitalisation measures for those Australian taxpayers who have a substituted accounting period [item 17] . Taxpayers with substituted accounting periods will be either early balancing taxpayers or late balancing taxpayers. Such taxpayers will have their income year divided into two notional income years ending on 30 June 1997 and commencing 1 July 1997 respectively. The existing thin capitalisation rules will continue to apply to the notional income year ending on 30 June 1997. The amendments contained in this Schedule will apply to the second notional year commencing on 1 July 1997.

1.57 A taxpayer with a substituted accounting period will calculate its foreign equity as usual, at the end of its income year, and this amount will be treated as the foreign equity for both notional income years. As usual, the taxpayer may increase its foreign equity before the end of its income year to ensure it does not exceed its foreign equity product. A taxpayer with a substituted accounting period will not have to calculate its foreign equity at 30 June 1997.

Late balancing taxpayers

1.58 An Australian taxpayer with a substituted accounting period for the 1996-97 income year that ends after 30 June 1997 will divide the 1996-97 income year into two notional income years. The first notional year will cover the period from the commencement of the taxpayer's income year until 30 June 1997. The second notional year will cover the remainder of the taxpayer's 1996-97 income year.

1.59 For example, for a taxpayer with its 1996-97 income year ending 31August 1997, the first notional income year will be from 1 September 1996 to 30 June 1997 and the second notional year will be from 1 July 1997 to 31 August 1997.

1.60 For the purposes of calculating the amount of foreign debt interest that is not allowable as a deduction, the term "days in year of income" in subsections 159GZS(3), 159GZT(4), 159GZU(3), 159GZV(3) and 159GZW(3) is defined as 365 for both the first and second notional years. The taxpayer's foreign equity for the 1996-97 income year will be used in both notional income years without any adjustment [paragraph (b) of subitem17(1)] . A taxpayer's foreign equity is calculated under section 159GZG.

Early balancing taxpayers

1.61 An Australian taxpayer with a substituted accounting period for the 1997-98 income year that ends before 30 June 1998, will divide the 1997-98 income year into two notional years. The first notional income year will cover the period from the commencement of the taxpayer's 1997-98 income year until 30 June 1997. The second notional income year will cover the remainder of the taxpayer's income year.

1.62 For example, for a taxpayer with its 1997-98 income year ending on 31 December 1997, the first notional income year will be from 1January 1997 to 30 June 1997, and the second notional year will be from 1July 1997 to 31 December 1997.

1.63 For the purposes of calculating the amount of foreign debt interest that is not allowable as a deduction, the term "days in year of income" in subsections 159GZS(3), 159GZT(4), 159GZU(3), 159GZV(3) and 159GZW(3) is defined as 365 for both the first and second notional income years. The taxpayer's foreign equity for the 1997-98 income year will be used in both notional income years without any adjustment [paragraph (b) of subitem 17(2)] . A taxpayer's foreign equity is calculated under section 159GZG.

Example

A foreign controller company has a wholly owned Australian subsidiary (Ausco) which it has funded with $1 million of equity and a $3 million loan with interest payable at 5% per annum ($150,000 per annum).

Ausco has a substituted accounting period ending 31 December 1997 for its 1997-98 income year and is therefore an early balancing taxpayer. Ausco's first notional income year will be from 1 January 1997 to 30 June 1997 whilst Ausco's second notional income year will be from 1 July 1997 to 31 December 1997. The existing thin capitalisation provisions of Division 16F will apply unchanged to the first notional year whilst the new measures will apply to the second notional income year. The taxpayer's foreign equity product for the first notional income year will be $3 million which is equal to its maximum foreign equity product of $3 million (based on a foreign debt to foreign equity gearing ratio of 3:1). As the taxpayer has not exceeded the set thin capitalisation threshold, the interest in respect of the first notional income year will not be disallowed.

In relation to the second notional income year, the taxpayer's foreign equity product is $3 million, which breaches the new prescribed foreign equity product of $2 million (based on a foreign debt to foreign equity gearing ratio of 2:1). Consequently interest in respect of the excess foreign debt will be disallowed. The amount of the taxpayer's foreign debt interest to be disallowed is calculated under subsection 159GZS(3) as follows:

= $150,000 * (($3,000,000 - ($1,000,000 * 2))/3,000,000) * (184/365)
= $25,205

In this example the taxpayer will be allowed a deduction of $124,795 for the 1997-98 income year in respect of foreign debt interest.

Chapter 2 - Finance shares

Overview

2.1 The proposed amendments in Schedule 2 of the Bill will amend the Income Tax Amendment Act 1936 (the Act) to:

·
address tax avoidance arrangements involving Eligible Finance Shares (EFS) and Widely Distributed Finance Shares (WDFS);
·
ensure that EFS dividends and WDFS dividends do not qualify as non-portfolio dividends; and
·
deny an underlying foreign tax credit for dividends paid on EFS and WDFS.

Summary of the amendments

Purpose of the amendments

2.2 The amendments will exclude dividends paid on EFS and WDFS from qualifying as non-portfolio dividends and from being eligible for an underlying foreign tax credit.

Date of effect

2.3 The changes will apply to dividends paid on EFS or WDFS on or after 3 February 1997 which is the date the measures were announced. [Item 6]

Background to the legislation

2.4 The Controlled Foreign Company (CFC) provisions contained in Part X of the Act provide special treatment for EFS and WDFS in recognition that these shares are in effect the equivalent of a debt rather than an equity investment.

2.5 Where shares qualify as EFS under section 327 they are eligible for special treatment under sections 350, 356 and 394. EFS held by Australian Financial Institutions (AFIs) are excluded from both the calculation of the direct control interest (subsection 350(5)) and the direct attribution interest (subsection 356(4)) in the company in which the AFI holds the EFS. This has the general effect that an AFI will not be subject to attribution on the CFC's income solely because it has financed the foreign entity by taking up an issue of EFS.

2.6 Further section 394 ensures that the attributable income of other shareholders (eg ordinary shareholders) does not include any amount that relates to the AFI's EFS dividend. This is achieved by allowing a CFC to claim a deduction when it pays a dividend on an EFS. The profits remaining, for attribution purposes, then equate to the profits available to the ordinary shareholders.

2.7 Where shares qualify as WDFS under section 327A they are also eligible for special treatment but only under sections 356 and 394. Subsection 356(4) provides for their exclusion from the calculation of the direct attribution interest in the company in which the WDFS are held and that company (if a CFC) is able to claim a section 394 deduction on any WDFS dividend it pays.

2.8 The Act affords certain tax treatments to shares that qualify as non-portfolio dividend shares in recognition of the fact that the investment represents a direct and active participation in the business of the foreign company (ie., in recognition that it is an equity investment). A non-portfolio dividend is defined as the dividend paid on a share which entitles the holder to control 10% or more of the voting interest in the offshore company (sections 160AFB and 317). Taxpayers who hold shares with the requisite voting interest can in certain circumstances derive dividend income in an exempt form or where the dividend income is assessable be entitled to an underlying foreign tax credit.

2.9 In contrast portfolio dividends are generally assessable in the recipient's hand and a credit is allowed for withholding tax (ie., no credit is given for the foreign underlying tax).

2.10 Tax avoidance schemes have been detected whereby AFIs exploited the tax treatment afforded to non-portfolio share dividends described in paragraph 2.8. It was never intended that this tax treatment would extend to dividends paid on EFS and WDFS which are afforded special tax treatment equating them to debt instruments.

2.11 To ensure that EFS and WDFS are treated in an equivalent manner to a debt instrument, dividends from these classes of shares will be treated as portfolio dividends by denying them non-portfolio dividend status.

2.12 Further the proposed amendments will deny holders of EFS or WDFS access to the underlying foreign tax credit, such credits not being available to portfolio share holdings.

Explanation of the amendments

2.13 The Bill amends paragraph 160AFB(4)(a) by inserting the words 'other than EFS and WDFS within the meaning of Part X' after 'beneficial owner of shares'. This ensures that EFS and WDFS dividends will not be able to access non-portfolio dividend status. Dividends from these classes of shares will no longer qualify as non-portfolio dividends, wherever the term appears in the Act. This will ensure, amongst other things, that they do not qualify as an exempting receipt for the purposes of section 23AJ and in certain circumstances will not qualify as notional exempt income under sections 402 and 403. Further this amendment will prevent an underlying foreign tax credit being claimed in respect of dividends paid on these classes of shares. Such treatment was intended for ordinary shareholders who beneficially own shares in an entity with a voting interest of 10% or greater. [Item 1]

2.14 The section 317 definition of non-portfolio dividend is also amended to exclude EFS and WDFS dividends. This is to ensure the dividends paid on these categories of shares do not qualify as non-portfolio dividends through the holding of other classes of shares. [Item3]

2.15 The Bill will also amend section 160AO to ensure the maximum foreign tax credit allowable for dividends paid on EFS and WDFS is limited to the foreign tax paid on the dividend, generally referred to as withholding tax. This will ensure that dividends paid on EFS and WDFS do not qualify for an underlying foreign tax credit through the holding of other classes of shares for any purposes of the Act. New subsection 160AO(4) makes it clear that in determining the tax paid on the dividend amounts of foreign underlying tax that are deemed to have been paid are ignored. [Item 2 - new subsections 160AO(3) and (4)]

2.16 The reference to 'Widely Distributed Finance Share Dividends' in paragraphs 402(2)(c) and (d) is superfluous with the amendment to section 317 and will be removed. [Items 4 and 5]

Chapter 3 - Group certificates for employees ceasing employment

Overview

3.1 Schedule 3 of the Bill will amend the Income Tax Assessment Act 1936 (ITAA) to remove the general requirement that employers must provide an employee with a group certificate within seven days of that employee's termination of employment.

Summary of the amendments

Purpose of the amendments

3.2 The legislation relating to group certificates is to be amended to generally allow employers to issue group certificates by 14 July after the end of the relevant year of income unless an employee who leaves employment during the year makes a written request for their group certificate at an earlier date. Employers making an eligible termination payment will be required to issue a group certificate within 14 days of making a payment rather than seven days as is presently required.

Date of effect

3.3 The amendments will apply from the 28th day after the day on which the Bill receives Royal Assent.

Background to the legislation

3.4 Subsection 221F(5C) of the ITAA currently requires employers to provide an employee with a group certificate within seven days of the employee ceasing to be employed by the employer. The Prime Minister's statement of 24 March 1997, 'More Time for Business', identified an advantage for small business if they could avoid the costs of having to issue group certificates during the year to employees who terminate employment.

3.5 There will be occasions, however, when employees will require a group certificate at the time they leave an employer. These include, for example, the situation where an employee doesn't know where he or she will be living at the end of the year. For these reasons employers will be required to provide group certificates to employees in those cases where an employee leaving employment requests a group certificate.

Explanation of the amendments

3.6 The amendments are contained in Schedule 3 of the Bill.

3.7 Existing subsection 221F(5C) of the ITAA is to be repealed and replaced with new subsections 221F(5C), (5CA) and (5CB) [Item 1 of Schedule 3] .

3.8 New subsection 221F(5C) contains a requirement that, subject to subsections (5E) and (5H) (see paragraphs 3.13 and 3.14 below), employers must issue a group certificate in respect of any employee who ceases to be employed in a 12 month period ending on 30 June. The issue of the certificate must take place no later than the day determined in accordance with new subsections 221F(5CA) and 221F(5CB), whichever is applicable.

3.9 New subsection 221F(5CA) provides that where an employer receives a written request for a group certificate, the employer is required to provide the certificate no later than 14 days after the employee ceases employment or 14 days after receiving the request, whichever is the later.

3.10 The request can be made by the employee after he or she ceases to be employed (new paragraph (5CA)(a)), or while still employed. Where employment has not ceased, the request can be made either if the employer has notified the employee that employment will cease (new paragraph (5CA)(b)) or where the employee has notified the employer that he or she will be ceasing employment (new paragraph (5CA)(c)).

3.11 The day by which the employer must comply with the request depends on whether the employee makes the request before or after ceasing employment. Where the request is made before ceasing employment, new paragraph (5CA)(d) applies and the employer has until the 14th day after employment ceases to provide the certificate. Where the request is made after ceasing employment, new paragraph (5CA)(e) applies and the employer must comply by the 14th day after receiving the request.

3.12 New subsection 221F(5CB) applies in cases where an employee does not make a request for a group certificate. These are cases to which new subsection 221F(5CA) does not apply. Where the employee has not made a request for a group certificate the employer is required to issue a group certificate to a former employee no later than 14 July after the end of the relevant year. This accords with the requirement in subsection 221F(5A) that annual group certificates for continuing employees must be issued by 14 July after the relevant year.

3.13 Subsection 221F(5E) remains unchanged. It removes the requirement to issue a group certificate where the payment is made;

(i)
to a resident employee;
(ii)
in relation to casual domestic employment (e.g., child minding); and
(iii)
is not of an amount in respect of which the employer is obliged to make deductions.

3.14 Subsection 221F(5H) currently requires an employer to issue a group certificate within seven days after making an eligible termination payment. The seven day period is to be extended to 14 days to be consistent with the time frame in new subsection 221F(5CA) [Item 2 of Schedule 3] .

Chapter 4 - Tax exempt entities that become taxable

Overview

4.1 Part 1 of Schedule 4 of the Bill will amend Schedule 2D, Division 57 of the Income Tax Assessment Act 1936 (the Act) to:

·
ensure that a deduction is allowed to the transition taxpayer for a surplus in a defined benefit superannuation scheme that exists at the time of transition from exempt to taxable [item 3] ;
·
insert a transitional provision to enable tax exempt entities, that have become taxable before this amendment comes into effect, to make an election in order to obtain a deduction for the surplus [item 9] ;
·
ensure that the provision which establishes the amount of superannuation deductions to be disallowed, operates as intended [items 4 & 5] ;
·
allow a deduction for all superannuation contributions made by the transition taxpayer after transition time to a defined benefit superannuation fund which is in surplus at the transition time [item 6] ;
·
make minor technical corrections by inserting the word 'superannuation' before 'scheme(s)' at paragraphs 57-40(1)(b), 57-40(5)(c) and the heading to section 57-45 [items 1 & 2] ; and
·
ensure that the amount of bad debt deductions to be disallowed is reduced where a debt is sold after the transition time [item 7] .

Summary of the amendments

Purpose of the amendments

4.2 The purpose of the amendments is to ensure that:

·
a deduction is allowed to a transition taxpayer for a surplus in a defined benefit superannuation scheme in the transition year;
·
deductions are not allowed for superannuation contributions made by a taxpayer that relate to the period in which the taxpayer was exempt from tax;
·
a deduction is not denied to the transition taxpayer where the taxpayer has a surplus in its superannuation fund and makes a contribution after transition that relates to the period before transition; and
·
in the event of the sale at or after the transition time of a debt in existence immediately before the transition time, the amount of bad debt deductions to be disallowed is reduced accordingly.

Date of effect

4.3 The amendments will apply to entities that cease to be wholly exempt from tax on or after 3 July 1995.

Background to the legislation

Superannuation

4.4 Where a transition taxpayer has accumulated unfunded liabilities before the transition time, deductions are not allowable for contributions made after the transition time in respect of the unfunded liabilities (section 57-40 of the Act). Also, superannuation contributions generally, to the extent that they relate to employment of an employee during the exempt period, are not allowable (section 57-50 of the Act).

4.5 At transition time a defined benefit superannuation scheme may have funds in excess of the employer's actual obligations to contribute and thus have a surplus. The surplus may be available to the transition taxpayer to, among other things, meet future contributions. Where the surplus is used by the taxpayer to solely reduce future contributions, a deduction should be allowed. Section 57-50 purported to do this but there is some ambiguity about the effect of the relevant provisions.

4.6 Where a taxpayer makes contributions periodically in arrears, any contributions made after transition in respect of pre-transition time employment of an employee would be denied a deduction by section 57-50. However, where a taxpayer has a surplus in the fund, arrears contributions made after transition should not be denied a deduction because the taxpayer in such a situation has no unfunded liabilities. In fact, the taxpayer in such a situation has over funded its liabilities.

Bad debts

4.7 Section 57-65 denies deductions otherwise allowable for bad debts written off after transition time by an entity, to the extent of provision for doubtful debts at the transition time. This is defined in the section as the "pre-transition doubtful debt limit" (PTDDL). A debt recovered after transition would reduce the PTDDL by the amount of the appropriate transition time provision against the debt. Where a debt is recovered in excess of the net amount (ie. amount of the debt less provision for doubtful debt), paragraph 57-65(6) requires the reduction of the PTDDL by the amount of that excess.

4.8 Similarly, where a debt ceases to exist because of its sale, the PTDDL should be reduced by the amount of the appropriate transition time provision. Otherwise, a taxpayer is penalised by having a deduction disallowed, notwithstanding that the debt has been sold.

Explanation of the amendments

Superannuation

Defined benefit superannuation schemes

4.9 Item 1 omits reference to "defined benefit scheme" in paragraph 57-40(1)(b) and substitutes "defined benefit superannuation scheme".

4.10 Item 2 omits reference to 'defined benefit schemes' in paragraph 57-40(5)(c) and substitutes 'defined benefit superannuation schemes' and alters the heading to section 57-45 by inserting 'superannuation' after 'defined benefit'.

4.11 The purpose of items 1 and 2 is to make it clear that the section deals only with defined benefit superannuation schemes.

Defined benefit superannuation scheme surplus

4.12 Item 3 repeals paragraphs 57-45(a) and (b), substitutes new paragraphs (a) and (b) and inserts paragraph (c).

4.13 The new paragraphs require three criteria to be satisfied in order for a surplus to be an allowable deduction. Firstly, at transition time the accounts of the scheme must show that there is an amount available to meet liabilities to provide superannuation benefits. [New paragraph 57-45(a)]

4.14 Secondly, that amount must exceed the actuarially calculated value of the liabilities accrued up to transition time. [New paragraph 57-45(b)]

4.15 Thirdly, the transition taxpayer must make a written election before the transition time that the excess will be used solely to meet liabilities accruing after the transition time [new paragraph 57-45(c)]. New paragraph 57-45(c) ensures that there is no scope for the surplus to be used in any other way since it requires that the excess is actually used to reduce future liabilities.

Transitional provision

4.16 There would be some tax exempt entities that have become taxable after 2 July 1995 but before the amendments in this Bill come into effect. Such entities would not be denied a deduction for a surplus in a defined benefit superannuation scheme fund where a written election is made within 28 days of the amending Act coming into effect. [Item 9 of Part 2]

Contributions generally

4.17 Section 57-50 purports to be a mechanism for disallowing deductions for superannuation contributions made by a transition taxpayer which relate to the pre-transition period by calculating the transition taxpayer's undischarged superannuation liability amount (USLA) at the transition time and disallowing deductions for contributions until the total deductions disallowed equals the USLA. The USLA amount refers to the deficit in the transition taxpayer's obligations to make contributions in respect of its employees. The USLA is determined by way of a four step method in subsection 57-50(5). A net figure is reached for each employee after subtracting actual contributions in Step 2 from required contributions in Step 1. These individual figures are added together in order to arrive at the transtion taxpayer's total amount.

4.18 The wording in step 2 is ambiguous and may be interpreted to require the deduction of contributions in relation to a period of employment before the beginning of the transition year. This would clearly give a wrong result because it would both reduce the USLA and allow a deduction for a contribution in respect of pre-transition employment. The amendments to step 2 in subsection 57-50(5) ensure that contributions made in the period between the beginning of the transition year and the transition time are excluded from the calculation of the undischarged superannuation liability amount because such contributions are also deductible under section 82AAC. [Items 4 and 5]

4.19 Where a taxpayer has a surplus in a defined benefit superannuation scheme there are several options open to the taxpayer. By way of example, a taxpayer may opt to utilise the surplus to satisfy the required superannuation guarantee contribution amount(s) for a period of time. Alternatively, a taxpayer may opt to utilise the surplus to satisfy a reduced percentage of the required superannuation guarantee contribution amount(s), thus effectively spreading the benefit over several years.

4.20 If the latter option is taken, a payment made in arrears after transition time would technically be in respect of a period of employment before the transition. Consequently, section 57-50 would disallow a deduction because there would be a 'required superannuation contribution amount' which would be reducible by the payment. In these circumstances, a deduction should be allowed. New section 57-52 ensures that taxpayers who take the approach of spreading the benefit over several years are not penalised by providing that section 57-50 does not apply where there is a surplus in a defined benefit superannuation scheme fund at transition time.

Bad debts

4.21 Where a pre-transition time debt is recovered after transition, the pre-transition doubtful debt limit (PTDDL) is reduced by virtue of section 57-65 by the amount of the appropriate transition time provision against the debt. Where a debt is recovered in excess of the net amount (that is, the amount of the debt less provision for doubtful debt), paragraph 57-65(6) requires the reduction of the PTDDL by the amount of that excess.

4.22 There should be a similar reduction where a debt is sold after the transition time. If the debt no longer exists, there should be no provision in respect of that debt reflected in the PTDDL. New paragraph 57-65(7) ensures that, where a pre-transition debt, against which there is a specific provision, is sold after the transition time, the PTDDL is reduced by the amount of the appropriate transition time provision in relation to that debt.

4.23 Where the pre-transition time debt is sold after a partial write-off(s), then the PTDDL is reduced by the excess (if any) of the appropriate transition time provision against that debt, over the sum of the write-off(s) of that debt between the transition time and the time of the sale [new paragraph 57-65(7)(d)] . Where the debt is sold without any write-off having occurred after the transition time, the PTDDL is reduced by the amount of the appropriate transition time provision against that debt [new paragraph 57-65(7)(e)] .

Chapter 5 - Measures to address tax avoidance through tax exempt entities distributing funds offshore

Overview

5.1 The proposed amendments contained in the legislation will amend the Income Tax Assessment Act 1936 (the Act) to:

·
remove the exemption provided by subparagraph 23(j)(ii) for funds established by will or instrument of trust for public charitable purposes ('charitable trusts') that are located offshore;
·
restrict the exemption provided to charitable trusts established in Australia by will or instrument of trust for public charitable purposes;
·
remove exemptions from income tax provided by paragraphs 23(e), (ea), (f), and (g) and subparagraph (j)(iii) for certain organisations which are located offshore;
·
remove the above exemptions from income tax provided by section 23 for those organisations who do not incur their expenditure and pursue their objectives principally in Australia; and
·
remove the exemption from non-resident interest, dividend and royalty withholding tax provided by paragraph 128B(3)(a) for certain organisations located offshore.

Summary of the amendments

Purpose of the amendments

5.2 The measures will address avoidance arrangements which take advantage of the tax exempt status of charitable trusts and close off the possibility of certain organisations which also currently enjoy an income tax exemption from being used for tax avoidance purposes. Additionally, they will prevent, in particular circumstances, the transfer of revenue from Australia to a foreign country where Australia foregoes its taxing right by providing an income tax exemption for the Australian source income of an offshore organisation but the organisation is not exempt from tax on this income in its home country. The proposed amendments will:

·
amend subparagraph 23(j)(ii) so that charitable trusts will be required to meet additional eligibility criteria. A charitable trust falling within this category will be required to be established in Australia and incur its expenditure and pursue its charitable purposes solely in Australia if it is to retain its tax exempt status. Alternatively, it may distribute solely to an Australian charitable trust which, to the best of the trustee's knowledge, meets these conditions. In addition, if a charitable trust has tax deductibility status under the gift provisions of the income tax law (section 78), or distributes its funds solely to a charitable fund, foundation or institution with section 78 status it will automatically retain its exempt status; and
·
remove the income tax exemption under paragraphs 23(e), 23(ea), and 23(g) for certain organisations which are located offshore or where they have a physical presence in Australia and do not incur their expenditure and pursue their objectives principally in Australia;
·
remove the income tax exemption provided for employer and trade union associations under paragraph 23(f) and scientific research funds under subparagraph 23(j)(iii) unless they are located in Australia and, respectively, pursue their objectives and, conduct their research principally in Australia; and
·
remove the exemption from non-resident interest, dividend and royalty withholding tax provided by paragraph 128B(3)(a) for certain offshore organisations which currently fall within paragraphs 23(e), 23(ea), 23(f), 23(g) and 23(j) - (see paragraph 5.26 for details of organisations which fall within these paragraphs of section 23).

Date of effect

Charitable trusts

5.3 The charitable trust measures will apply from the commencement of a charitable trust's 1996-97 year of income (generally 1July 1996). Accordingly, distributions made by charitable trusts after the commencement of their 1996-97 year of income will need to meet the new requirements.

Affected organisations

5.4 Income derived by the organisations affected by the measures after the 1996-97 Budget announcement will no longer be exempt from Australian income tax. A liability to withholding tax will also arise in relation to payments of interest, dividends or royalties made to affected offshore organisations after the 1996-97 Budget announcement.

5.5 Organisations which lose their income tax exemption, will therefore, be subject to tax on all of their income including capital gains from the date that they lose their exemption. Specific provisions (Division 57 of Schedule 2D), which were inserted into the Act in 1996 to provide for transitional tax issues of previously exempt bodies becoming taxable will apply.

Background to the legislation

Charitable trusts

5.6 Subparagraph 23(j)(ii) exempts from income tax, funds established by will or instrument of trust for public charitable purposes ('charitable trusts') provided that the fund is being applied for the purpose for which it was established. The proposed legislation is designed to counter arrangements which exploit this provision and which circumvent the gift provisions in the Act (section 78).

5.7 The arrangements provide opportunities to shift tax exempt income offshore through the use of a charitable trust and purported charitable organisations located offshore. A number of the distributions made to these organisations are either retained overseas or returned to Australia for the benefit of the controllers of the charitable trust.

5.8 Section 78 provides a tax deduction for donations of money or property of $2 or more where the recipient is either specifically listed or falls within existing general categories under the section.

5.9 The section is generally directed towards donations made to institutions whose activities are confined to Australia. However, the concession is extended, under the 'Overseas Aid Gift Deduction Scheme' (OAGDS), to certain public funds which operate offshore. Although these public funds are established exclusively for the relief of persons in certified developing countries they must be established and administered in Australia. To qualify under OAGDS a fund must be approved by the Treasurer and the Minister for Foreign Affairs under subsection 78(21) to be an eligible fund.

5.10 At present, however, by using a charitable trust, taxpayers can make distributions to any offshore charitable organisation, whether or not it has been approved by the Australian Government, and thereby circumvent the gift provisions. The proposed legislation will ensure that only those overseas organisations which have been approved by the Australian Government can receive income tax concessions.

5.11 The arrangement mentioned in paragraph 5.7 is structured so that distributions are received by an Australian charitable trust as beneficiary of a family trading trust. Under trust law the beneficiary would normally be taxable on the trading profits instead of the trust itself. However, because the beneficiary is a charitable trust, no tax is paid on the trading profits at all. As the overseas 'charities' are not required to be approved by the Government or scrutinised by the Australian Taxation Office it is possible for the trading profits to escape Australian income tax completely even though the funds are not used for charitable purposes.

Charitable trusts established other than by will and charitable trusts established by will after 7:30 pm eastern standard time on 20 August 1996 (the 1996-97 Budget announcement)

5.12 The proposed legislation is designed to address the tax avoidance arrangements by prohibiting charitable trusts from making distributions to offshore organisations and from undertaking direct charitable activities offshore if the trust is to retain its tax exempt status. Flow chart 2 provides an explanation of this measure.

5.13 In performing its work a charitable trust often undertakes direct charitable activities, for example, purchasing and distributing food to persons in necessitous circumstances or providing scholarships to underprivileged but gifted children. Alternatively, a charitable trust may act as a conduit through which funds are distributed to other charitable organisations which undertake the direct charitable activities. To remain eligible for the exemption currently provided by subparagraph 23(j)(ii) charitable trusts will be required to meet additional eligibility criteria. A charitable trust falling within this category will be required to be established in Australia and:

·
undertake any direct charitable activities in Australia;
·
make any distributions to other charities located in Australia which undertake their activities solely in Australia; or
·
make distributions to charitable funds, foundations or institutions with section 78 status.

5.14 If a charitable trust fails to comply with the new eligibility criteria at any time it will lose its exemption from income tax entirely and permanently. Consequently, any income derived by the trust will be assessed in accordance with the general trust provisions of the Act.

Charitable trusts established by will prior to the 1996-97 Budget announcement

5.15 The Government has decided to exclude charitable trusts established by will ('testamentary charitable trusts') prior to the 1996-97 Budget announcement from certain requirements imposed by the proposed legislation. The income and capital held by the trustees of these existing testamentary charitable trusts as at 20 February 1997 will not be subject to the new requirements and trustees will be permitted to continue to distribute these funds offshore without affecting a charitable trust's tax exempt status. Flowchart 3 provides an explanation of this measure.

The 'new trust'

5.16 In order to prevent testamentary trusts from being used as conduits in tax avoidance arrangements, settlements (for example trust distributions, funds or shares) received on or after 20 February1997 (the date of the release of this legislation in draft form) will be subject to the proposed new measures.

5.17 Where assets are received by way of settlements etc. on or after 20February1997 the proposed amendments will have the effect of separating the existing charitable trust into two notional trusts. Assets received on or after that date together with any income derived from those assets will be deemed to form part of the new notional trust, (referred to as the 'new' trust') for which separate accounting records will need to be kept.

5.18 The 'newtrust' will be governed by the existing trust deed and will generally be required to meet the same restrictions as non-testamentary charitable trusts and testamentary trusts established by will after the 1996-97 Budget announcement. To remain eligible for the income tax exemption the assets which constitute the 'new trust' must be used to:

·
undertake any direct charitable activities in Australia;
·
make any distributions to other charities located in Australia which undertake their activities solely in Australia; or
·
make distributions to charitable funds, foundations or institutions with section 78 status.

5.19 Because the 'new trust' will be subject to the existing trust deed it will not have to be established in Australia.

5.20 Where the 'new trust' fails, at any time, to comply with the new eligibility criteria it will lose its exemption from income tax entirely and permanently. Consequently, any income derived by the 'new trust' will be assessed in accordance with the general trust provisions of the Act.

The 'old trust'

5.21 Assets held by the charitable trust as at 20 February 1997 together with any income derived from those assets will be deemed to form part of a second and separate notional trust, (referred to as the 'old trust'). The 'old trust' will be governed by the existing trust deed and will be totally excluded from the new measures. Trustees will be permitted to distribute these funds offshore without affecting a charitable trust's tax exempt status.

5.22 It will also be necessary for trustees to maintain separate accounts in respect of the 'old trust'.

Affected offshore organisations

Removal of the income tax exemption

5.23 Section 23 provides an exemption from income tax for income derived from sources in Australia by a range of entities irrespective of whether these entities are located in Australia or offshore or whether their activities are undertaken in Australia or offshore. A similar exemption from non-resident interest, dividend and royalty withholding tax is provided by paragraph 128B(3)(a) where the non-resident entity is also exempt from income tax in the country in which it resides.

5.24 The Government has decided to remove these exemptions for these organisations if they are located or pursue their objects offshore in order to prevent:

·
certain tax avoidance arrangements which could use these organisations to shift untaxed funds overseas; and
·
a transfer of revenue from Australia to a foreign country where income is exempted in Australia but not in the organisation's country of residence.

5.25 The following provisions which currently provide the exemption will be amended:

·
23(e) - income of a religious, scientific, charitable or public educational institution;
·
23(ea) - the income of a public hospital, or of a non-profit hospital;
·
23(f) - the income of a trade union or of an association of employers or employees relating to the settlement of industrial disputes;
·
23(g) - the income of non-profit friendly societies, associations or clubs which are established for:

-
musical purposes, or for the encouragement of music, art, science or literature;
-
the encouragement or promotion of a game or sport;
-
the encouragement or promotion of animal races; or
-
community service purposes; and

·
23(j) - the income of funds established by will or instrument of trust for public charitable purposes and of funds established for the purpose of enabling scientific research to be conducted by or in conjunction with a public university or public hospital.

5.26 To remain eligible for the exemption from income tax provided by the abovementioned provisions of section 23 it will be necessary for an organisation to meet an extended set of eligibility criteria. These criteria will differ depending on the type of organisation involved. Flowchart 4 provides an explanation of this measure.

Meaning of "in Australia"

5.27 The Bill provides that for an organisation to remain exempt it must generally have a 'physical presence' in Australia or in some cases be 'located' in Australia. These terms are not defined in the legislation and therefore take their ordinary or everyday meaning.

5.28 In the case of 'physical presence' a broad interpretation is to be adopted - all that is required is for an organisation to operate through a division, sub-division or the like in Australia. The structure of the organisation is immaterial as is whether it has its central management and control or principal place of residence in Australia. On the other hand, the term would not apply where an organisation merely operates through an agent based in Australia.

5.29 A much narrower meaning is intended in relation to the term 'located'. A mere physical prescence will not be sufficient to satisfy this requirement although it will not be necessary for an organisation to be a resident for income tax purposes. A separate centre of operations such as a branch would fall within the meaning of this term.

Trade unions, employer associations and scientific research funds

5.30 To remain eligible for the exemption from income tax provided by paragraph 23(f) it will be necessary for the organisation to be located in Australia and to incur its expenditure and pursue its objectives principally in Australia.

5.31 Similarly, in the case of scientific research funds falling within subparagraph 23(j)(iii) it will be necessary for the fund to be located in Australia and for the expenditure to be incurred and the research conducted principally in Australia. Alternatively, it may be a scientific research fund with section 78 status.

Offshore testamentary charitable trusts established by will before the 1996-97 Budget announcement

5.32 Testamentary charitable trusts established before the 1996-97 Budget announcement will not lose their income tax exemption in relation to income generated from investments held at the 1996-97 Budget announcement whether or not the trust has been established offshore.

5.33 As explained in paragraphs 5.16 to 5.20, however, assets received by these trusts on or after 20February1997 will be deemed to form part of the 'new trust 'and will be subject to the proposed measures outlined in those paragraphs. Accordingly, the exemption will only apply to the 'new trust' if the trustee complies with the new requirements.

5.34 The effect of the proposed amendments is that testamentary charitable trusts which operate offshore will lose their income tax exemption in relation to any income derived by the 'new trust' as they will be unable to comply with the new eligibility criteria.

Religious, scientific, charitable or public educational institutions, public and non-profit hospitals and non-profit cultural, sporting and friendly societies

5.35 An organisation which falls within paragraphs 23(e), 23(ea) or 23(g) which has a physical presence in Australia but which does not incur its expenditure and pursue its objectives principally in Australia will only remain eligible for the exemption from income tax if the organisation falls within section 78 (see paragraph 5.8).

5.36 An organisation which falls within the above paragraphs but which is located offshore can only be exempt from Australian tax on its Australian source income if it is exempt from income tax in the country in which it is located and is specifically prescribed by the Income Tax Regulations to be exempt.

5.37 In the case of a charitable or religious institution which falls within paragraph 23(e), and which has a physical presence in Australia it will also be possible to gain an exemption by being specifically prescribed in the Regulations.

5.38 These conditions recognise that there may be some organisations that fall within section 78 although they undertake activities offshore. It will also allow the Government to grant income tax exemptions, on a case by case basis, to paragraph 23(e), 23(ea) or 23(g) organisations located offshore or paragraph 23(e) charitable or religious institutions with a physical presence in Australia but which pursue their objectives offshore.

5.39 This regulation making process will allow Parliament the opportunity to fully scrutinise the organisation to determine whether it should receive the benefit of the exemption.

The 'Activity test' - gifts

5.40 Voluntary payments of money such as donations, tithes, plate money and the like or transfers of property from one person to another are generally not income in the hands of the recipient. Broadly speaking, these payments or transfers constitute a 'gift' where they are made without legal obligation, by way of benefaction and without any advantage of a material character being received in return. However, a payment or transfer of property may constitute income in the hands of the recipient notwithstanding that it is a gift.

5.41 The test as to whether a gift is income in the ordinary sense of the word is whether it is made in relation to some activity or occupation of the donee of an income producing character. Therefore, the character of the receipt in the hands of the recipient becomes the determinative issue in each particular case in deciding whether the 'gift' constitutes income.

5.42 Accordingly, gifts received by either Australian or offshore organisations which are not made in relation to some activity of the organisation of an income producing character will not constitute income in the hands of the organisation and will not be assessable.

5.43 These gifts will be disregarded when determining whether an organisation incurs its expenditure and pursues its objectives principally in Australia and, therefore, can be applied overseas without affecting an organisation's income tax exempt status. Government grants may also be applied offshore without affecting the tax exempt status of organisations. Flow chart 1 provides an explanation of this measure.

Removal of the non-resident withholding tax exemption

5.44 As with the exemptions from income tax, eligibility for the exemption from non-resident interest, dividend and royalty withholding tax will depend on the type of organisation involved.

Trade unions, employer associations and scientific research funds

5.45 Paragraph 128B(3)(a) will be amended to remove the exemption from non-resident interest, dividend and royalty withholding tax for organisations falling within paragraph 23(f) and subparagraph 23(j)(iii).

Offshore Testamentary charitable trusts established before the 1996-97 Budget announcement

5.46 Offshore testamentary charitable trusts established prior to the 1996-97 Budget which fall within subparagraph 23(j)(ii) will remain exempt from non-resident interest, dividend and royalty withholding tax in respect of any interest, dividend or royalty income derived from investments held at the 1996-97 Budget announcement.

5.47 As explained in paragraphs 5.16 to 5.20, however, assets received by these trusts on or after 20February1997 will be deemed to form part of the 'new trust 'and will be subject to the proposed measures outlined in those paragraphs.

5.48 The effect of the proposed amendments is that testamentary charitable trusts which operate offshore will also lose their non-resident interest, dividend and royalty withholding tax exemption in relation to any interest, dividend or royalty income derived by the 'new trust'.

Religious, scientific and public educational institutions, public and non-profit hospitals and non-profit cultural, sporting and friendly societies

5.49 In the case of paragraphs 23(e), 23(ea), and 23(g) the exemption will only be available for offshore organisations which can satisfy the new requirements. This is a complementary measure which will allow the Government to grant, in addition to an exemption from income tax, a non-resident withholding tax exemption.

Explanation of the amendments

Charitable trusts

Charitable trusts established other than by will and charitable trusts established by will after the 1996-97 Budget announcement

5.50 In order to restrict the exemption currently provided by subparagraph 23(j)(ii) in relation to these trusts the proposed amendments will insert new subparagraph 23(j)(iia). This new provision will limit the exemption to charitable trusts which meet the following additional requirements:

·
the trust is established in Australia;
·
the trust incurs, and has at all times since 20 August 1996 incurred, its expenditure principally in Australia and pursues, and has at all times since 20 August 1996, pursued its charitable purpose solely in Australia; or
·
is a fund to which a gift by a taxpayer is an allowable deduction because it is referred to in a table in subsection 78(4) or is an ancillary fund as defined in subsection 78(5); or
·
distributes solely, and has at all times since 20 August 1996 distributed solely, to a charitable fund, foundation or institution which, to the best of the trustee's knowledge:

(i)
is located in Australia and incurs its expenditure principally in Australia and pursues its objects solely in Australia; or
(ii)
is a charitable fund, foundation or institution to which a gift by a taxpayer is an allowable deduction because it is referred to in a table in subsection 78(4) or is an ancillary fund as defined in subsection 78(5). [Item 6]
5.
51 Failure to meet these requirements will result in the charitable trust losing its income tax exemption entirely and permanently. [Item 6]

Charitable trusts established by will prior to the 1996-97 Budget announcement

5.52 The income and capital held as at 20 February 1997 by trustees of testamentary charitable trusts, whether or not it is established in Australia, and any income derived from the investment of that income or capital will not be subject to the new requirements. Distributions of this income or capital overseas for charitable purposes will not affect the income tax exemption.

5.53 However, if assets (for example trust distributions, funds or shares) are received, other than in return for valuable consideration, by these testamentary trusts on or after 20February1997 new subsection 23AAAB(1) creates, for the purposes of new subparagraph 23(j)(iia), two separate notional trusts from the existing testamentary trust. These are referred to in the proposed legislation as the 'new trust' and the old trust'. [Items 5 and 8]

The 'new trust'

5.54 If a testamentary charitable trust established before the 1996-97 Budget announcement receives assets after 20 February 1997 (the date of the release of this legislation in draft form) those assets and any income derived from those assets will be deemed to form part of a separate notional trust called the 'new trust'. [Item 8 - new subsection 23AAAB(1)]

5.55 This 'new trust' must comply with new subparagraph 23(j)(iia) and its assets and any income derived from those assets must, subject to one exception, be used in accordance with the requirements of this provision. [Item 6]

5.56 The exception is contained in new subsection 23AAAB(2) which provides that new subparagraph 23(j)(iia) applies to the 'new trust' as if the words 'in Australia' were omitted from that provision This will allow testamentary charitable trusts established offshore prior to the 1996-97 Budget announcement to remain eligible for the income tax exemption in relation to the 'new trust' as long as they meet the other new requirements. [Item 8]

The 'old trust'

5.57 The 'old trust' will consist of assets which existed at 20 February 1997 including any income derived from those assets. [Item 8 - new subsection 23AAAB(1)]

5.58 As the 'old trust' is taken to have been created before the 1996-97 Budget announcement it will be subject to an amended subparagraph 23(j)(ii) and will, therefore, not be subject to the new eligibility criteria. Distributions of these assets overseas which are made in accordance with the trust deed will not affect the existing exemption. [Item 5]

5.59 Income derived after the 1996-97 Budget announcement from assets which existed at 20 February 1997 will also be subject to subparagraph 23(j)(ii) and excluded from the new requirements. [Item 8 -new subsection 23AAAB(1)]

5.60 Paragraph 23(j)(ii) will not require the 'old trust' to be established in Australia. [Item 5]

Affected offshore organisations

Removal of the income tax exemption

Trade unions, employer associations and scientific research funds

5.61 Item 3 will amend paragraph 23(f) to provide that the trade union or employer association must be located in Australia and incur its expenditure and pursue its objectives principally in Australia in order to be eligible for this exemption.

5.62 Similarly, subparagraph 23(j)(iii) will be amended to provide that the scientific research fund must be established for the purpose of enabling scientific research to be conducted principally in Australia by or in conjunction with a public university or public hospital located in Australia and where its expenditure is also incurred principally in Australia. Alternatively, it may be a scientific research fund with section 78 status. [Item 7]

Offshore testamentary charitable trusts established before the 1996-97 Budget announcement

5.63 Testamentary charitable trusts established offshore prior to the Budget announcement will retain their income tax exemption in relation to any income generated from investments held at 7:30 pm EST on 20 August 1996. [Item 5 - subparagraph 23(j)(ii)]

5.64 As explained in paragraphs 5.54 to 5.56, however, new subsection 23AAAB(1) will deem assets received by these trusts on or after 20February1997 to form part of the 'new trust ' which will be subject to new paragraph 23(j)(iia). Accordingly, the exemption will only apply to the 'new trust' if the trustee complies with the new requirements. [Items 6 and 8]

Religious, scientific, charitable or public educational institutions, public and non-profit hospitals and non-profit cultural, sporting and friendly societies

5.65 Paragraphs 23(e), 23(ea) and 23(g) are amended by Items 1, 2 and 4 to provide an extended set of eligibility criteria in relation to organisations falling within these provisions. These organisations will be eligible for the income tax exemption if they meet any of the following criteria:

·
the organisation has a physical presence in Australia and that particular body in Australia incurs its expenditure and pursues its objects principally onshore; or
·
the organisation falls within subsection 78(4); or
·
if the organisation is located offshore;

-
it is exempt from income tax in its country of residence; and
-
has been prescribed by the Income Tax Regulations to be an exempt organisation.

5.66 In the case of charitable and religious institutions covered by paragraph 23(e) an exemption may also be granted by regulation, on a case by case basis, even if the organisation has a physical presence in Australia but does not incur its expenditure and pursues its objects onshore.

The "Activity test" - gifts

5.67 New section 23AAAA will be inserted in order to allow gifts and government grants to be applied overseas without affecting the income tax exempt status of organisations and funds falling within paragraphs 23(e), 23(ea), 23(f) and 23(g) and subparagraphs 23(j)(iia) and 23(j)(iii). This provision will allow gifts and government grants received by an organisation, fund or other body to be disregarded for the purpose of determining whether it incurs its expenditure and pursues its objects in Australia. [Item 8]

5.68 Where an organisation is not referred to in subsection 78(4) itself but operates a fund which is referred to in that subsection, distributions may also be made offshore from the fund itself without affecting the "activity test". The moneys of these funds are, therefore to be treated in exactly the same way as gifts and government grants distributed offshore. [Item 8 - new subsection 23AAAA(2)]

5.69 The legislation is silent about whether an institution has to monitor the source of the funds that it applies overseas - ie. whether they are obtained from income or from gifts. While it would be expected that an institution would have strict procedures in place to account separately for government grants and/or approved fund moneys under section 78, money is fungible and it loses its particular identity when combined with other money.

5.70 In these circumstances it would be reasonable to assume, that with the exception of government grants and section 78 fund moneys, money applied overseas would be applied firstly from "gifts" and that the "activity test" would only need to be applied if the total funds applied overseas exceeded the sum of the gifts and donations received.

Removal of the non-resident withholding tax exemption

5.71 Item 9 will omit the references to paragraphs 23(e), 23(ea), 23(f) 23(g), 23(h), 23(j) and 23(jb) from paragraph 128B(3)(a) and substitute paragraphs 23(e), 23(ea), 23(g), 23(h), 23(jb) and subparagraph 23(j)(ii). This drafting technique has the following effects.

Trade unions, employer associations and scientific research funds

5.72 The references to paragraphs 23(f) and 23(j) will be omitted from paragraph 128B(3)(a) thereby removing the exemption from non-resident interest, dividend and royalty withholding tax for trade unions, employer associations and scientific research funds. [Item 9]

Offshore testamentary charitable trusts established before the 1996-97 Budget announcement

5.73 A reference to subparagraph 23(j)(ii) will be inserted into paragraph 128B(3)(a). This will provide an exemption from non-resident interest, dividend and royalty withholding tax in respect of any interest, dividend or royalty income derived from investments held at the 1996-97 Budget announcement for these testamentary charitable trusts. [Item 9]

Religious, scientific and public educational institutions, public and non-profit hospitals and non-profit cultural, sporting and friendly societies

5.74 The exemption from non-resident interest, dividend and royalty withholding tax will be retained for organisations falling within 23(e), 23(ea), and 23(g). However, these organisations will need to satisfy the new and more stringent requirements of those provisions. This will reduce the number of organisations which will be eligible for this exemption. [Item 9; paragraphs 23(h) and 23(jb)]

5.75 There will be no effect on non-profit aviation, tourism, agricultural and manufacturing associations which promote the development of resources of Australia or foreign superannuation funds etc.

Record keeping

5.76 Where new subsection 23AAAB(1) creates a 'new trust' and an 'old trust', new subsection 262A(1C) will provide that the trustee must maintain separate accounting records in respect of each trust. [Item 10]

Application

5.77 The amendments to the charitable trust provisions made by item 6 apply in relation to income derived during the 1996-97 (generally 1 July 1996) and subsequent years of income. [Item 11]

5.78 The amendments made by items 1 to 4 and 7 to 10 apply in relation to income derived after 7:30 pm EST on 20 August 1996. [Item 11]

5.79 The amendments made by item 5 to subparagraph 23(j)(ii) will apply from Royal Assent.

Flow Chart 1 - Application

Flow Chart 2 - Application

Flow Chart 3 - Application

Flow Chart 4 - Application

Flow Chart 4 (Continued) - Application

Chapter 6 - Quasi-ownership of fixtures

Overview

6.1 This chapter covers:

·
rewritten provisions of the Income Tax Assessment Act 1936 (the 1936 Act) relating to leased plant fixtures which are being inserted into the Income Tax Assessment Act 1997 (the 1997 Act); and
·
consequential amendments to the 1936 Act.

Amendments to the Income Tax Assessment Act 1997

6.2 Part 1 of Schedule 6 will amend the 1997 Act to include rewritten provisions of the 1936 Act which give lessors entitlement to taxation depreciation allowances in respect of leased chattels that become a fixture on another person's land in circumstances where they would otherwise be so entitled had the leased item continued to be a chattel and not a fixture. The corresponding provisions are being inserted in Subdivision A of Division 3 of the 1936 Act by Taxation Laws Amendment Bill (No. 3) 1997.

6.3 The amendments will mean that a lessor of plant (as defined in section 42-18 of the 1997 Act) under a chattel lease will qualify as the quasi-owner of the plant. Under section 42-15 of the 1997 Act, the owner or quasi-owner of plant may deduct an amount for depreciation of the plant.

6.4 The amendments will apply in the following circumstances:

·
the lessor grants the plant lessee the right to use the plant for monetary or other consideration;
·
the right is granted under a lease but not a lease of plant or hire purchase agreement;
·
the lessor is not the owner of the plant because it is a fixture on another person's land; and
·
but for being a fixture, the plant would be owned by the lessor.

Where these circumstances apply, the lessor will be quasi-owner of the plant entitled to depreciation deductions under the 1997 Act, instead of any other person. However, the lessor will not be the quasi-owner unless there is an effective right to recover the plant or if the lessor acquired it under a sale and leaseback transaction. (There is an exception to the sale and leaseback prohibition, however, if the sale and leaseback to the plant lessee takes place within 6 months of the lessee - or an associate - first owning and using the plant and at that time there was an arrangement in place to sell and leaseback the plant.)

Date of effect

6.5 The rewritten provisions being inserted in the 1997 Act apply to the 1997-98 income year and later income years.

Amendments to the Income Tax Assessment Act 1936

6.6 Part 2 of Schedule 6 will amend existing provisions of the 1936 Act to ensure that a lessor who is a quasi-owner of plant under the amendments to the 1997 Act explained above, or who is treated as the owner under equivalent amending provisions to the 1936 Act contained in Taxation Laws Amendment Bill (No. 3) 1997, is appropriately treated as the owner of the plant for the purposes of those existing provisions. They are:

·
Section 51AD - Property used in certain leveraged arrangements
·
Section 82AQ - Development allowance
·
Section 159GE - Non-leveraged arrangements relating to the use of property
·
Section 673 - Drought investment allowance

Chapter 7 - Electronic lodgment and electronic funds transfers

Overview

7.1 Schedule 7 of the Bill will amend the Income Tax Assessment Act 1936 (the Act), the Fringe Benefits Tax Assessment Act 1986 (the FBTAA) and the Taxation Administration Act 1953 (the TAA) to:

·
provide a legal basis for the electronic lodgment of returns, applications for amendment and other notices; and
·
allow the Commissioner to pay, by electronic transfer, any refunds to an account (which may be a third-party account) nominated by the taxpayer.

Summary of the amendments

Purpose of the amendments

7.2 The amendments will provide a legislative basis for taxpayers to give documents to the Commissioner by electronic transmission. The amendments will allow the Commissioner to pay a taxpayer's refund by means of electronic funds transfer (EFT) into an account of a person nominated by the taxpayer.

Date of effect

7.3 The amendments in schedule 7 will commence from the date of Royal Assent and will apply from the following dates:

·
to returns, applications for amendment or other documents relating to income tax that are given to the Commissioner on or after 1 July 1998; [Item 32(1)(a)]
·
to statements relating to income tax made on or after 1 July 1998; [Item 32(1)(b)]
·
to refunds of income tax payable by the Commissioner on or after 1July 1998; [Item 32(1)(c)]
·
to returns, applications for amendment or other documents relating to fringe benefits tax that are given to the Commissioner on or after 1 April 1998; [Item 32(2)(a)]
·
to statements relating to fringe benefits tax made on or after 1 April 1998; and [Item 32(2)(b)]
·
to refunds of fringe benefits tax payable by the Commissioner on or after 1 April 1998. [Item 32(2)(c)]

Background to the legislation

Electronic lodgment service

7.4 In 1990 the ATO introduced the electronic lodgment service (ELS) to enable tax agents to furnish returns of individual taxpayers by electronic transmission. Tax agents who wanted to use ELS had to enter into a contract with the Commissioner that set out the terms of participation in the ELS. The basic requirements placed on tax agents were as follows:

·
the taxpayer must be given the choice to lodge a return electronically or by the paper method;
·
the taxpayer must sign the return prior to transmission;
·
the return can only be furnished using an ELS software package authorised by the ATO;
·
the tax agent must retain a copy of the original signed and dated paper return on behalf of the ATO; and
·
upon request, the original return must be provided to the ATO within 14 days.

7.5 ELS proved to be a very efficient system for receiving return form information upon which an assessment could be made. ELS also provided faster processing of returns. In 1992, ELS was extended to cover partnerships, trusts, companies, superannuation funds, approved deposit funds, public trading trusts and corporate unit trusts. ELS was further extended in April 1997 to allow for the lodgment of fringe benefits tax returns by employers.

7.6 The amendments provide a legislative basis for the ELS and remove the need for individual contracts with tax agents. The amendments incorporate the requirements at paragraph 7.4 above, however they will remove the requirement for tax agents to store original tax returns on behalf of the Commissioner.

Electronic funds transfer

7.7 The cost to the tax office of issuing refunds to taxpayers by EFT is considerably less than that of sending cheques. EFT is currently available to taxpayers but, to date, its use has been limited. Almost 80% of individual tax returns are lodged through tax agents. In most cases, the address for service of notices is the tax agent's address and this is where the refund cheque is sent. Many agents have their clients sign an authority to deposit the client's refund cheque into the agent's account and pay the client the amount of the refund less the tax agent fee.

7.8 The amendments will allow the Commissioner to pay a taxpayer's refund by EFT to an account nominated by the taxpayer. The account may be an account of another person. This will enable tax agents to receive refunds electronically in a similar way to the current practice with cheques.

Explanation of the amendments

Lodging an electronic return

7.9 Under subsection 161(1) of the current law the Commissioner can require a person to lodge a return for a year of income on a form provided by the Commissioner. The return must be signed by the person, furnished in the prescribed manner and contain information relating to the person's income and deductions. A person's signature must be given on the return because it attributes the information in the return to the person. A person's signature is a form of identification that cannot easily be repudiated. The current provision does not allow the Commissioner to provide electronic return forms or for taxpayers to verify, by way of signature, information that is transmitted electronically.

7.10 The Bill will omit the current subsection 161(1) and introduce new provisions that will clarify lodgment requirements in an electronic environment. The current law requires a person to lodge a return for a year of income, if required by the Commissioner by a notice published in the Gazette. The amendments will reiterate this requirement, however, the form and content of the returns will be clarified [new subsection 161(1) of the ITAA - item 5] .

7.11 The amendments allow the Commissioner to approve the form of return that each taxpayer must use (for example, individual, company or trust returns). The form of the return can be either paper or electronic. The amendments will allow the Government to introduce regulations that prescribe the information that different taxpayers must provide in the return. The prescribed information will include all details necessary to make an assessment, that is, all assessable income and allowable deductions and rebates. It may also include credits and interest entitlements necessary for the Commissioner to determine the net tax payable or refundable following assessment. [New subsection 161A(1) of the ITAA - item 6] .

7.12 Similarly, for fringe benefits tax, the lodgment provision in section 70 will be amended to cater for electronic lodgment. The law will require the Commissioner to approve in writing the form of a fringe benefits tax return. [Paragraph 70(c) of the FBTAA - item 19]

7.13 The amendments will also allow the Commissioner to permit a return to be given in an electronic form. The Commissioner will be able to determine the software requirements for electronic forms where a return is to be given by electronic transmission (such as electronic mail) or on a kind of data processing device (such as diskette). This will apply to any return that is lodged in an electronic form whether by:

·
a registered tax agent using his or her facilities to transmit a return on behalf of a taxpayer;
·
a registered tax agent using the facilities of another person to transmit a return on behalf of a taxpayer; or
·
a person who transmits a return without the services of a tax agent.

This will give the Commissioner the discretion to approve new technologies for electronic transmissions as they emerge. [New subsection 161A(2) of the ITAA, item 6 and new subsection 70(2) of the FBTAA - item 21]

7.14 Registered tax agents are referred to throughout the amendments. A registered tax agent is a person who meets standards of qualifications, experience and character that are set out in Part VIIA of the Act and registered by a Tax Agents' Board. The definition of registered tax agent in Part VIIA of the Act is picked up by these amendments. [Subsection 6(1) of the ITAA - item 2 and subsection 136(1) of the FBTAA - item 31]

7.15 The amendments restate an existing requirement in section 161 of the ITAA that the regulations will prescribe the manner in which the return must be given. The regulations refer to the office or location where a taxpayer must lodge a return. [New section 161B - item 6]

Signing a return or other notice

7.16 When a return or other document is lodged electronically it is not possible for it to contain the written signature of the taxpayer in the declaration or the written signature of the tax agent in the agent's certificate. Accordingly, the law will be amended to give a person the means of verifying the information in the electronic return, or other electronic document, by means of an electronic signature.

7.17 The amendments will allow the Commissioner to approve an electronic signature that is a unique identifier of a person. The type of electronic signature to be used by a taxpayer may differ from the type of signature to be used by a tax agent. Signatures may vary depending on the specifications of the software used to transmit and receive electronic documents. The requirements for electronic signatures will probably change with developments in electronic technology. Examples of electronic signatures are personal identification numbers and public and private key systems. [Subsection 6(1) of the ITAA - item 1 and subsection 136(1) of the FBTAA - item 30]

7.18 In the case of returns and other documents that are lodged in an electronic form by taxpayers who do not use a tax agent, the information in the return will be attributed to the taxpayer by the taxpayer using an approved electronic signature. However, in cases where an electronic return is transmitted to the Commissioner by a tax agent on behalf of a taxpayer, it is not practical for a taxpayer to use an electronic signature. The taxpayer could provide the agent with the electronic signature but this would compromise the security of the signature. In these cases, an amendment will be made that will require the taxpayer to provide the tax agent with a signed written authority to transmit the return on behalf of the taxpayer (refer to paragraph 7.20.).

7.19 The amendments will require that a return, an application for amendment or a notice must be signed in the following ways:

·
where a return or other document is provided in written form (on paper) the return or other notice must be signed by the taxpayer.
·
where the return or other document is lodged by the taxpayer electronically it must contain the electronic signature of the taxpayer (refer to paragraph 7.17).
·
where the return or other document is lodged electronically by a tax agent on behalf of a taxpayer it must contain the electronic signature of the tax agent (refer to paragraph 7.17).

This requirement for a tax agent to provide an electronic signature is necessary because the document must be identified as a valid transmission from the tax agent. [ITAA: new section 161C - item 6, new subsection 170(6A) - item 10 and new section 264B - item 16; FBTAA: paragraph 70(c) - item 20, new subsection 74(6A) - item 24 and new section 124B - item 28]

Taxpayer declaration to authorise electronic document

7.20 As mentioned in paragraph 7.18 above, when a taxpayer lodges an electronic document through a tax agent, the amendments will require the taxpayer to complete a declaration. The purpose of the declaration is to ensure that the taxpayer authorises the electronic transmission of his or her return or request for an amendment and agrees with the information to be transmitted. The Commissioner will approve the form of the declaration and ensure that it contains all the information necessary to authorise the transmission. [New section 161D of the ITAA - item 6 and new section 70A of the FBTAA - item 22]

Taxpayer and tax agent duties in relation to the declaration

7.21 The amendments will require the taxpayer to keep the original of the declaration for 5 years after the declaration is made. This requirement is a protection for both the taxpayer and the tax system. The declaration is evidence of the information the taxpayer intended the tax agent to transmit to the Commissioner and may be needed in case of a problem with the return or other document. For example, if there is a dispute about content of the transmission the declaration will show the information that was intended for transmission. The taxpayer must produce the declaration if requested to by the Commissioner within the 5 year retention period. This period is the standard period in the law for the retention of taxation records. Failure to comply with these requirements could result in the taxpayer being liable for a penalty on prosecution of 30 penalty units (currently a penalty unit is $100). [New subsections 161E(1) and (2) of the ITAA - item 6 and new subsection 70B(1) and (2) of the FBTAA - item 22]

7.22 The tax agent must not transmit the taxpayer's document before receiving a copy of the declaration. This requirement is necessary because the declaration gives the agent the taxpayer's permission to transmit the document electronically and authorises the information to be sent on the taxpayer's behalf. Transmitting information without the taxpayer's consent on the declaration could result in a tax agent being liable for a penalty on prosecution of 30 penalty units. [New subsection 161E(3) of the ITAA - item 6 and new subsection 70B(3) of the FBTAA - item 22]

Tax agent certificate

7.23 Under the current law, tax agents are required to sign a certificate setting out the sources of information used for preparing a return. This is called the 'agent's certificate'. The amendments will rewrite this requirement to cater for electronic lodgment. There will be three different methods for making the agent's certificate.

·
Where a return or application for an amendment is lodged electronically by the tax agent using the facilities of another person, the tax agent cannot provide an electronic signature because the agent is not the transmitter of the return. In these cases the agent must complete a certificate which will be endorsed on or annexed to the taxpayers declaration (refer to paragraph 7.20). [Subsection 165(1) and paragraph 165(1AA)(a) of the ITAA - item 7 and subsection 71(1) and paragraph 71(1AA)(a) of the FBTAA - item 23]
·
In the case of a return or application for an amendment lodged with the Commissioner on paper, the agent's certificate must be on the return or application for an amendment. [Subsection 165(1) and paragraph 165(1AA)(b) of the ITAA - item 7 and subsection 71(1) and paragraph 71(1AA)(b) of the FBTAA - item 23]
·
Where a return or application for an amendment is transmitted electronically by the tax agent using his or her own facilities, the agent's certificate must be provided electronically. That is, the agents certificate will need to be certified with the electronic signature of the agent. (refer to paragraphs 7.17 and 7.19). [Subsections 165(1) and (1AB) of the ITAA - item 7 and subsections 71(1) and (1AB) of the FBTAA - item 23]

7.24 Under the current law, where a person is carrying on a business and does not use a tax agent to lodge his or her income tax return the person must provide particulars, in prescribed form, of the sources of information used to complete the return. This requirement will be amended to incorporate returns that are lodged electronically by a taxpayer. [subsection 165(2) of the ITAA - item 8]

Amendments

7.25 Under the current laws there are no requirements relating to the form and manner of submitting an application for an amendment. In a self assessment environment, an application for an amendment is a significant adjunct to the assessment process and has a similar effect to the lodgment of a return. A number of changes are being made to formalise this process.

7.26 As is the case with a return, a taxpayer will be able to lodge an amendment request in writing or electronically which must be signed in accordance with the requirements explained in paragraph 7.19 [new subsection 170(6A) of the ITAA - item 10 and new subsection 74(6A) of the FBTAA - item 24] . An application for an amendment will be required to be given to the Commissioner in a prescribed manner and contain prescribed information. That is, the application must be lodged at a certain office or location and must contain the information necessary for processing the amendment. [New subsection 170(6B) of the ITAA and new subsection 74(6B) of the FBTAA]

Taxation statements

7.27 The current penalty for a tax shortfall under Part VII of the ITAA is imposed where there is a difference between the tax properly payable at law (proper tax) and the tax payable calculated on the basis of statements made by the taxpayer in a return or other document (statement tax). A statement made by a taxpayer can either be a statement made to a taxation officer or another person in the return, or other document. To ensure that statements made in electronically transmitted documents are subject to the tax shortfall provisions, the definitions of 'taxation officer statement' and 'taxation purpose statement' in subsection 222A(1) will be amended to include statements made in electronic documents. [Subsection 222A(1) of the ITAA - items 13 and 14]

7.28 A franking deficits tax shortfall is also calculated on the basis of a statement made by a taxpayer in a return or other document. Amendments will be made to include statements made in electronic documents. This will be done by amending the definition of taxation statement in the franking deficits tax shortfall provisions. [Subsection 160ARXA(1) of the ITAA - item 3]

7.29 In the case of fringe benefits tax, penalties are based on whether a taxpayer has made a false or misleading statement in the return or request for amendment. The definitions of 'statement made to a taxation officer' and 'statement made to other persons' are amended to include statements made by way of electronic transmission. [Subsections 115(3) and (4) of the FBTAA - items 25 and 26]

7.30 The amendments propose that all documents furnished electronically to the Commissioner by a tax agent on behalf of a taxpayer will prima facie be statements made by the taxpayer. It is necessary, however, to protect a taxpayer from a penalty in respect of statements made in a return, an application for amendment or other document that is lodged by a tax agent on behalf of the taxpayer, that are not authorised by the taxpayer. Accordingly the Bill provides that statements made in an electronic return lodged through a tax agent will be deemed to be those of the taxpayer unless the taxpayer can show that he or she did not authorise the statement. All of the available evidence would need to be considered in determining whether a taxpayer authorised a statement made in a return. A taxpayer may, for example, be able to prove that he or she did not authorise a statement by providing a declaration (refer to paragraph 7.20) that differed from the information sent electronically, depending on any other evidence to the contrary. [ITAA: new subsection 160ARXA(3) - item 4 and new subsection 222A(3) - item 15; and new subsection 115(6) of the FBTAA - item 27]

7.31 There are several offence provisions in the Taxation Administration Act 1953 (TAA) that relate to a person making a false or misleading statement to a taxation officer. The current definition of statement made to a taxation officer refers to statements made in a data processing device but does not refer to statements made in an electronic transmission. The Bill will amend the definition of statement made to a taxation officer to incorporate statements made by electronic transmission new subsection 8J(2) of the TAA - item 17. An amendment will also be made to the TAA to allow a person to refute a statement where the person can show that a statement contained in a document lodged electronically by the tax agent on behalf of the person was not authorised. [New subsection 8J(2A) of the TAA - item 18]

Evidence

7.32 The current law allows the Commissioner to produce copies or extracts from a return or notice of assessment and these are taken to be evidence in the same way that the original would be (refer subsection 177(4) of the Act). The amendments being made by the Bill will provide for copies or extracts (eg. print-outs or paper versions) of electronic documents to be treated in the same way for evidentiary purposes. However, a copy of an electronic document is not evidence of the return or notice if the taxpayer can show that he or she did not authorise the document. This will apply to copies or extracts of electronic returns and notices of assessment. [New subsection 177(5) of the ITAA - item 11 and new subsection 126(3A) of the FBTAA - item 29]

Electronic funds transfer (EFT)

7.33 Under the current law the Commissioner is obliged to pay a refund to the person entitled to receive that refund. This can be by way of cheque or by electronic funds transfer. These amendments will allow the Commissioner to pay the refund by way of EFT to any one account specified by the taxpayer. The account will not have to be the taxpayer's account. For instance, it may be an account of the tax agent or another third party. If a taxpayer wants to receive the refund by EFT the taxpayer will be required to request the Commissioner, by written notice, to pay the refund to a specified account with a financial institution. The notice must be signed in accordance with new section 264B of the ITAA or new section 124B of the FBTAA (see paragraph 7.17 above). If the taxpayer's request for an EFT refund is lodged electronically by a tax agent, the taxpayer must complete a declaration (see paragraph 7.17) which includes a statement making the request for the EFT and specifying the account. [New section 264C of the ITAA - item 16 and new section 124C of the FBTAA - item 28]

7.34 The amendments will allow a taxpayer to change the account details for EFT payments. However this will only be valid where the taxpayer gives the Commissioner a subsequent notice in accordance with new subsection 264C(1) of the ITAA and new subsection 124C(1) of the FBTAA. The notification will apply to all payments made by the Commissioner after the later notice is received by the Commissioner. [New subsection 264C(5) of the ITAA and new subsection 124C(5) of the FBTAA]

7.35 Under the amendments, any payment made by way of EFT into the account specified in the notice under new subsection 264C(1) will extinguish the Commissioner's obligation to pay the refund to the taxpayer. The exception to this is where the Commissioner is satisfied that the taxpayer did not authorise the EFT payment into the account. [New subsection 264C(3) of the ITAA and new subsection 124C(3) of the FBTAA]

7.36 There will be a new requirement for tax agents to provide the notice of assessment, or a copy of the notice, to a taxpayer. The requirement will apply in those cases where a taxpayer's address for service of notices is the tax agent's address. Having a notice of assessment will enable a taxpayer to check that the details match the information authorised by the taxpayer's declaration (refer to paragraph 7.20). This will give a taxpayer the opportunity to check the accuracy of the transmission for errors or unauthorised statements by the tax agent. It will also allow a taxpayer to know the amount of the tax refund to which he or she is entitled. This is a fraud prevention measure where there is an EFT to an account of a third person. [New section 161G of the ITAA - item 6 and new section 70D of the FBTAA - item 22]

Self assessment

7.37 There are problems with the current self assessment requirements in subsection 166A(2) of the ITAA. This provision deems the Commissioner to make an assessment where an instalment taxpayer lodges a return that specifies the amount of taxable income, or net income, and the tax payable thereon. An instalment taxpayer is a company, a superannuation fund, an approved deposit fund and certain trusts. The way the provision is currently worded allows a taxpayer to lodge more than one return. The consequences of this are that an assessment is deemed to be made every time a further return is lodged by the instalment taxpayer. This is not the proper procedure for making an amendment.

7.38 The new provisions will give certainty to the original assessment by allowing a self assessment to occur only in respect of the lodgment of the first return. Any changes to the assessment will then be made by the taxpayer following the amendment processes outlined in paragraphs 7.25 and 7.26 above. It may be noted that these changes will bring subsection 166A(2) into line with the approach adopted under the FBTAA. [Subsection 166A(2) of the ITAA - item 9]

Tax vouchers and group certificates

7.39 Tax vouchers and group certificates are currently required to be sent to the Commissioner with a tax return. However, it is not possible to furnish these paper documents with an electronic transmissions of a return. The amendments will remove the requirement for tax vouchers and group certificates to be sent in with both paper and electronic returns. Instead, a person will be required to retain tax vouchers or group certificates for a period of 5 years after the person's assessment. The person will be required to provide the tax vouchers and group certificates to the Commissioner if requested within the period. [Subsections 221H(1) and (1A) of the ITAA - item 12]

Chapter 8 - Rate of tax for friendly societies

Overview

8.1 Schedule 8 of the Bill will amend the Taxation (Deficit Reduction) Act (No 2) 1993 so that the rate of tax imposed on the eligible insurance business of friendly societies and other registered organisations will be retained at 33% for the 1997-98 and 1998-99 income years. Similarly, the rebate available to policyholders who receive assessable bonuses on life insurance policies issued by friendly societies and other registered organisations will be retained at 33% for the 1997-98, 1998-99 and 1999-2000 income years. The trustee rate will be increased to 39% from 1999-2000 and the rebate rate will be increased to 39% from 2000-01.

Summary of the amendments

Purpose of the amendments

8.2 The amendments will implement the 1997-98 Budget announcement to freeze the rate of tax applying to friendly societies and other registered organisations and the rebate that applies to policyholders.

Date of effect

8.3 The amendments will commence with effect from 1 July 1997.

Background to the legislation

8.4 Paragraph 23(4)(b) of the Income Tax Rates Act 1986 declares that the rate of tax on the eligible insurance business component of the taxable income of a company that is a registered organisation (that is, a friendly society, a trade union or certain employee associations) is 33%. Section19 of Taxation (Deficit Reduction) Act (No2) 1993 increases that rate to 39% for the 1997-98 and later years of income.

8.5 Section 26AH of the Income Tax Assessment Act 1936 (ITAA) includes in the assessable income of a policyholder bonuses on life insurance policies that are surrendered within 10 years. If such an amount is included in a policyholder's assessable income, a rebate is available under section160AAB to compensate the policyholder for the tax paid by the insurance company or registered organisation.

8.6 The rebate on bonuses paid from life insurance policies issued by friendly societies and other registered organisations is currently 33% of the amount included in assessable income under section26AH (see paragraph (a) of the definition of statutory percentage in subsection160AAB(1)). Section 15 of Taxation (Deficit Reduction) Act (No.2) 1993 increases the rebate to 39% for the 1997-98 and later years of income.

8.7 In the 1997-98 Budget the Government announced that, in keeping with the competition objectives of the Financial System Inquiry that reported in March 1997, it would recommence the review of the taxation treatment of life insurance that was initiated in the 1995-96 Budget, but not completed by the former Government prior to the election. The main objectives of the review are to improve the efficiency of the taxation treatment of life insurance companies and friendly societies, and the equity of their investors, to ensure a more neutral taxation outcome for competing investment products.

8.8 The review will be undertaken by the Treasury and the Australian Taxation Office through ongoing consultation with the life insurance and friendly society industries. The taxation review should be completed in time for a decision to be announced prior to, or in, the 1998-99 Budget.

8.9 The proposed increase in the trustee rate of tax for the eligible insurance business of friendly societies and other registered organisations and the rebate rate for taxable policyholders will be deferred for the duration of the review.

Explanation of the amendments

Rate of tax imposed on the eligible insurance business of friendly societies and other registered organisations

8.10 The rate of tax imposed on the eligible insurance business of friendly societies and other registered organisations will be retained at 33% for the 1997-98 and 1998-99 years of income. [Items5and6]

8.11 The rate will increase to 39% for the 1999-2000 and later years of income. [Items7and8]

8.12 The provisions to increase the rate of tax imposed on the eligible insurance business of friendly societies and other registered organisations to 39% in the 1997-98 and later years of income will commence on 1July1999. [Item 1; new subsection 2(4) of Taxation (Deficit Reduction) Act (No.2) 1993]

Rebate on bonuses paid on the surrender of a life assurance policy issued by a friendly society or other registered organisation

8.13 The rebate available to policyholder's of friendly societies and other registered organisations under section 160AAB of the ITAA will be retained at 33% for the 1997-98, 1998-99 and 1999-2000 years of income. [Item2]

8.14 The rebate will be increased to 39% in the 2000-2001 and later years of income. [Items 3 and 4]

8.15 The provisions to increase the rebate to 39% will commence on 1 July 2000. [Item 1; new subsection 2(3) of Taxation (Deficit Reduction) Act (No.2) 1993]

Chapter 9 - Leases of luxury cars

Overview

9.1 This chapter explains consequential amendments being made to the Income Tax Assessment Act 1997 (the 1997 Act) and the Income Tax Assessment Act 1936 (the 1936 Act) because of changes to the 1936 Act proposed by Taxation Laws Amendment Bill (No. 2) of 1997.

Amendments to Income Tax Assessment Act 1997

9.2 Part 1 of Schedule 9 will amend the 1997 Act to ensure that the taxation treatment of leases of luxury cars contained in Schedule 2E of the 1936 Act will continue to have application in relation to the 1997-98 and later income years.

Amendments to Income Tax Assessment Act 1936

9.3 Part 2 of Schedule 9 will also amend Schedule 2E of the 1936 Act to reflect the amendments to the 1997 Act being made by Part 1.


View full documentView full documentBack to top