Explanatory Memorandum
(Circulated by the authority of the Treasurer the Hon Ralph Willis, M.P.)General Outline and Financial Impact
AMENDMENTS TO THE FRINGE BENEFITS TAX ASSESSMENT ACT 1986
Amends the definition of "benchmark interest rate" in subsection 136(1) so that the rate is determined not by reference to a rate offered by the Commonwealth Bank for a housing loan but by reference to the standard variable rate for owner-occupied housing loans of the major banks, as determined by the Reserve Bank of Australia.
Date of effect: 1 April 1994
Proposal announced: Not previously announced
Financial impact: The gain to revenue will be $60 million in 1994-95 and $45 million in 1995-96.
AMENDMENTS TO THE INCOME TAX ASSESSMENT ACT 1936
Accruals assessability of certain securities
Amends Division 16E of Part III to overcome tax deferral advantages associated with indexed securities when compared with other securities covered by the Division.
The amendment will provide a proper basis of taxation by requiring that all returns from indexed securities and other variable return securities be brought to account on a compounding accruals basis.
Effectively, the same accruals methodology will be used for variable return securities as presently applies for fixed return securities under Division 16E.
A further amendment will remove an unintended consequence of Division 16E in relation to certain securities issued in a series to ensure that later issues in a series of securities will not fall within the scope of the Division where securities in the first of that series are outside its scope.
Date of effect: Applies to qualifying securities issued after 27 January 1994.
Proposal announced: The Treasurer's Press Release No. 7 of 27 January 1994.
Financial impact: Revenue savings from this measure are expected to be $10m in 1993-94, $18m in 1994-95 and $26m in 1995-96.
Capital gains tax: Payment of rebatable dividends from certain share premium accounts and revaluation reserves
Amends the CGT provisions of the Act so that any capital gain computed having regard to the disposal consideration for shares in a company or the amount of capital paid back on shares will not be reduced by the amounts of the payments that are treated as rebatable dividends. These amendments relate to:
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- liquidator's distributions;
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- off-market share buy-backs;
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- other disposals of shares; and
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- amounts paid in connection with a reduction of capital.
Date of effect: The amendments apply after 12:00 midday Eastern Summer Time 12 January 1994.
Proposal announced: The Assistant Treasurer's Press Release No 3 of 12 January 1994.
Financial impact: There is insufficient data available on which a reliable estimate of the revenue impact of these amendments can be made. However, the measure has the potential to prevent a significant future loss to revenue.
Capital gains tax: Rebatable dividends out of pre-acquisition profits
Amends the CGT provisions so that a capital loss that would otherwise be incurred by a controller of a company or an associate of the controller on the disposal of any share in the company will be reduced by any distribution made by the company to the controller or the associate that is a rebatable dividend paid out of pre-acquisition profits.
Date of effect: The amendment will apply in relation to disposals of shares made on or after the date of introduction of the Bill.
Proposal announced: Not previously announced.
Financial impact: There is insufficient data available on which a reliable estimate of the revenue impact of these amendments can be made. However, the measure has the potential to prevent a significant future loss to revenue.
Capital gains tax: Share value shifting arrangements
Removes certain CGT advantages currently attracted by value shifting transactions involving shares in a company. The amendments will apply to material shifts in value from shares held by the controller of a company and associates into other shares in the company held by them. A value shift will be considered to be material if the value shifted exceeds the lesser of 5% of the value of the shares or $100,000.
Date of effect: The amendments will apply to material shifts in the value of shares effected after 12:00 midday Eastern Summer Time on 12 January 1994.
Proposal announced: The Assistant Treasurer's Press Release No 3 of 12 January 1994.
Financial impact: There is insufficient data available on which a reliable estimate of the revenue impact of these amendments can be made. However, the measure has the potential to prevent a significant future loss to revenue.
Capital gains tax: Change in ownership of assets
Amends the operation of the CGT provisions as they apply to declarations of trust over assets, transfers of assets to trusts, and certain conversions of trusts to unit trusts. The amendments are intended to ensure that certain transfers of assets to a trust are treated as changes in the ownership of the assets so that a capital gain may arise on the transfer.
Date of effect: The amendments will apply to declarations of trusts, transfers of property to trusts, and relevant conversions of trusts to unit trusts, made after 12:00 midday Eastern Summer Time 12 January 1994.
Proposal announced: The Assistant Treasurer's Press Release No 3 of 12 January 1994.
Financial impact: There is insufficient data available on which a reliable estimate of the revenue impact of these amendments can be made. However, the measure has the potential to prevent a significant future loss to revenue.
Capital gains tax: Prerequisite for roll-over relief for the transfer of assets within company groups
Changes the requirement for the granting of roll-over relief for assets transferred within a company group that the transferor and transferee companies be group companies for the whole of the income year in which the transfer occurred. The companies will need to be group companies only at the time of transfer.
Date of effect: The amendments to the roll-over relief provisions will apply to disposals of assets that occur during the 1993-94 income year, and in any subsequent income year, of the transferor.
Proposal announced: The Assistant Treasurer's Press Release No 3 of 12 January 1994.
Financial impact: This measure would have a small but unquantifiable cost to the revenue.
Capital gains tax: Transfer of assets within company subgroups
Amends section 160ZZOA so that the deemed disposal and reacquisition rules, as they relate to the transfer of assets within company subgroups, do not operate as an impediment to business restructures.
Date of effect: The amendments will apply to the break-up of company groups which occur after 16 December 1992, which is the date from which section 160ZZOA took effect.
Proposal announced: The Assistant Treasurer's Press Release No 3 of 12 January 1994.
Financial impact: This measure would have a small but unquantifiable cost to the revenue.
Capital gains tax: Group company capital loss transfers
Amends section 160ZP which deals with cost base adjustments in relation to transfer of losses between group companies. The amendments will:
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- provide that the reduction of the cost base of shares and debts held in the company that has transferred a loss will be determined having regard also to any payment (subvention payment) made by the transferee company in consideration for the transfer; and
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- allow an appropriate increase in the cost base of post-CGT shares in the transferee company.
Date of effect: The amendments will apply to net capital losses transferred for offset against the net capital gains of the transferee company for the 1993-94 income year or later years.
Proposal announced: The Assistant Treasurer's Press Release No 3 of 12 January 1994.
Financial impact: This measure would have a small but unquantifiable cost to the revenue.
Capital gains tax: Assets used by non-residents in Australian permanent establishments
Amends the CGT provisions so that a capital gain or capital loss arising to a non-resident on the disposal of a taxable Australian asset used by the non-resident in carrying on a trade or business wholly or partly at or through a permanent establishment in Australia is to be calculated by reference only to the total period during which it is used in that way.
Date of effect: The amendments will apply to disposals which take place after 12:00 midday Eastern Summer Time 12 January 1994.
Proposal announced: The Assistant Treasurer's Press Release No 3 of 12 January 1994.
Financial impact: A cost to the revenue of less than $1m per year.
Capital gains tax: Division 19A and liquidators' distributions
Amends Division 19A in Part IIIA to ensure that it does not apply to interim or final in specie distributions of capital from liquidators if a company is dissolved within a period of three years after liquidation proceedings commenced, or within a further period allowed by the Commissioner.
Date of effect: The amendments will apply in relation to disposals of assets after 6 December 1990, which is the date from which Division 19A applied to certain disposals of property.
Proposal announced: The Assistant Treasurer's Press Release No 3 of 12 January 1994.
Financial impact: This measure would result in an insignificant cost to the revenue.
Capital gains tax: Application to Government incentive schemes
Amends the law so that there will be no liability to capital gains tax on the payment or re-imbursement of an expense under certain Commonwealth, State and Territory incentive schemes that are prescribed in the Regulations.
Date of effect: The amendments will apply in relation to all disposals, other than assignments, of rights under a scheme which is prescribed in Regulations applying to the time of disposal, even if the Regulations are not made until after that time.
Proposal announced: The Assistant Treasurer's Press Release No 3 of 12 January 1994
Financial impact: The estimated cost of this measure is less than $1m per year.
Capital gains tax: Amendment of assessments
Amends sections 160U and 170 to ensure that the time limits imposed by section 170 on amending assessments do not apply if the amended assessment is to:
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- give effect to subsection 160U(3) (time of acquisition or disposal of an asset under a contract) or 160U(8) (time of disposal if asset is compulsorily acquired); or
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- treat the disposal or acquisition of an asset as never having happened if the contract is later found to have been a nullity from the beginning.
Date of effect: Generally, assessments made at any time. However, an amended assessment increasing a liability is not permitted if section 170 prevented the Commissioner of Taxation from amending the assessment as at 11 January 1994.
Proposal announced: The Assistant Treasurer's Press Release No.3 of 12 January 1994.
Financial impact: This measure will result in an insignificant gain to the revenue.
Foreign investment funds and foreign life insurance policies
Amends the foreign investment fund (FIF) measures to:
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- allow a holding company exemption from the FIF measures for certain indirect investments in company FIFs which carry on general insurance, life insurance, real property or multi-industry activities; and
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- exclude construction activities from the black-list of activities for the purposes of the FIF measures thereby making them eligible activities for the purposes of the active business exemption.
Date of effect: 1 January 1993
Proposal announced: The amendments were announced by the Treasurer on 22 December 1993.
Financial impact: The amendments will have minimal effect on revenue.
Development allowance and general investment allowance
Proposes two amendments to both of these allowances and a further amendment to the development allowance only. The first relates to the use of property within wholly-owned company groups. The next will extend the allowances to property for use in the transport of minerals and quarry materials. The third will simplify procedures when a leasing company transfers, to a lessee, its entitlement to the development allowance in respect of leased property.
Property used within wholly-owned company groups
Companies are to be allowed to grant rights to use property to companies within the same wholly-owned company group, without losing entitlement to the general investment and development allowances. This will allow company groups to use property in the most efficient manner.
Date of effect: applies from the time when the allowances commenced; that is, 27 February 1992 in the case of the development allowance, and 9 February 1993 in the case of the general investment allowance.
Proposal announced: Announced by the Assistant Treasurer on 29 November 1993.
Financial impact: The amendment will impose some cost to the revenue, which, by the nature of the amendment, cannot be reliably estimated. However, the cost is unlikely to be significant.
Property used in the transport of minerals and quarry materials
The general investment allowance and the development allowances are to be extended to expenditure on plant, such a railways and pipelines, that qualifies for write-off under the mineral and quarry materials transport provisions, Division 10AAA. Currently, such expenditure is excluded from the allowances.
Date of effect: applies from the time when the allowances commenced; that is, 27 February 1992 in the case of the development allowance, and 9 February 1993 in the case of the general investment allowance.
Proposal announced: Announced by the Assistant Treasurer on 29 November 1993.
Financial impact: The cost to the revenue of this measure is unlikely to exceed $20 million per annum over the term of the allowances.
Transfer of entitlements to the development allowance by leasing companies
The requirement that a leasing company provide a written notice to the Commissioner of Taxation on the transfer of an entitlement to the development allowance to a lessee is be replaced with a requirement that the notice be given to the lessee. This will make the development allowance consistent with the general investment allowance in this regard.
Date of effect: Applies to leasing arrangements entered into after date of Royal Assent.
Proposal announced: Not previously announced.
Financial impact: The is amendment is revenue neutral, but should reduce the compliance costs of leasing companies.
HECS - Inclusion in provisional tax calculation
Amends Division 3 of Part VI to include a Higher Education Contribution (HEC) assessment debt in provisional tax calculations.
Date of effect: The inclusion will be for the calculation of provisional tax (including instalments) payable for the 1994-95 and later years of income.
Proposal announced: 1993-94 Budget, 17 August 1993
Financial impact: This measure will bring revenue forward by one year; thus increasing revenue by approximately $12m in 1994-95, $3m in 1995-96 and $2m in 1996-97.
Constitutionally protected superannuation funds
Amends the superannuation provisions to exempt from tax all income derived by certain State public sector superannuation funds that are constitutionally protected from tax on any of their receipts.
Date of effect: 1 July 1993. However, the amendments will apply with effect from 1 July 1988 to funds that have not paid income tax on the assumption that all their income was exempt from tax.
Proposal announced: Not previously announced.
Financial impact: The overall financial impact will be minimal. There will be a cost to revenue by exempting constitutionally protected superannuation funds from tax but a gain to revenue because benefits paid from such funds will be treated as being from an untaxed source.
Depreciation of employee amenity property
Ensures that the concessional rate of depreciation for employee amenities is available for property even if its use is shared between employees, or children of employees, of companies within wholly-owned company groups.
The amendment will allow wholly-owned company groups to use employee amenities in the most efficient manner, without losing entitlement to the concession.
Date of effect: Applies from the beginning of the 1993/94 year of income in relation to existing and future property.
Proposal announced: Announced by the Assistant Treasurer on 29 November 1993.
Financial impact: The amendment will impose some cost to the revenue, which, by the nature of the amendment, cannot be reliably estimated. However, the cost is unlikely to be significant.
Amendment to widen the scope of the borrowing and lending activities in subsection 121D(2)
Extends the meaning of "borrowing or lending activity" to include gold borrowings and gold loans.
Date of effect: Royal Assent
Proposal announced: Not previously announced.
Financial impact: The amendment will have a positive but unquantifiable revenue effect.
Amendment to restrict certain guarantee-type activities in subsection 121D(3)
Amends the definition of "guarantee-type activity" so that a guarantee, letter of credit or performance bond must be in respect of the activities of offshore parties in their performance outside Australia.
Date of effect: Royal Assent
Proposal announced: Not previously announced.
Financial impact: The proposal will minimise the possibility of revenue leakage.
Makes a minor technical amendment to subsection 128AE(7) to remove a reference to a repealed subsection.
Date of effect: Royal Assent
Proposal announced: Not previously announced.
Financial impact: None.
Makes a minor technical amendment to subsection 128GB(4) to redefine a previously deleted term required in subsection 128GB(3).
Date of effect: 21 December 1992, the date of Royal Assent for Taxation Laws Amendment Act (No.4) 1992.
Proposal announced: Not previously announced.
Financial impact: None.
Allows for a limited period an income tax deductions for gifts made to The "Weary" Dunlop Statue Appeal and The Sandakan Memorials Trust Fund respectively.
Dates of effect: Gifts to -
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- The "Weary" Dunlop Statue Appeal made between 16 July 1993 and 15 July 1994 inclusive; and
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- The Sandakan Memorials Trust Fund made between 30 July 1993 and 29 July 1995 inclusive.
Proposals announced: The decision to make gifts to The "Weary" Dunlop Statue Appeal tax deductible was announced in the Treasurer's Press Release No. 88 of 16 July 1993.
The decision to make gifts to The Sandakan Memorials Trust Fund tax deductible was announced in the Treasurer's Press Release No. 96 of 30 July 1993.
Financial impact: The amendments are not expected to have any significant impact on the revenue.
Amends section 16 to permit the Commissioner of Taxation to provide information to the Health Insurance Commission as to whether a registered carer or an applicant for registration as a carer under the new childcare rebate scheme has a tax file number.
Date of effect: The amendment will apply to the communication of information after 30 June 1994.
Proposal announced: Not previously announced.
Financial impact: Nil. However it will result in improved compliance with the tax laws by carers, and is not expected to increase the cost of compliance by carers.
Amends section 23AA to ensure technical accuracy of references to relevant provisions of United States income tax law but will have no practical effect on the operation of the section.
Date of effect: 22 October 1986
Proposal announced: Not previously announced.
Financial impact: No impact on revenue.
Non-compulsory uniforms or wardrobes
Amends the operation of the non-compulsory uniform/wardrobe provisions to:
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- remove from the operation of section 51AL of the Income Tax Assessment Act 1936 expenditure on clothing that is occupation specific;
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- extend the transitional arrangements until 30 June 1995; and
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- amend the transitional arrangements to allow deductions in certain limited circumstances where the designs of a set of one or more items of clothing are not approved or Registered until after 1 September 1993.
Date of effect: 1 September 1993.
Proposal announced: The Assistant Treasurer's Press Release No. 148 of 23 November 1993.
Financial impact: The amendments are not expected to have any significant impact on the revenue.
Entertainment expense payments
Amends the Fringe Benefits Tax Assessment Act 1986 to include a provision which will reduce the taxable value of a benefit which now arises when an employer makes a payment or reimbursement to an employee to cover expenses incurred by the employee in entertaining clients or other persons on behalf of the employer. The taxable value will be reduced by the amount of expenditure incurred by the employee in entertaining these other persons. The result is that only the part of the payment or reimbursement that relates to the expenditure on the employee or an associate will be included in the taxable value of the benefit.
Amends the Income Tax Assessment Act 1936 (ITAA) so that no deduction will be allowed under that Act for the amount by which the taxable value has been so reduced.
Date of effect: 1 April 1994
Proposal announced: The Assistant Treasurer's Press Release No.11 of 1994
Financial impact: Negligible
Chapter 1 Fringe Benefits tax - Benchmark interest rate
Overview
1.1 The Bill will amend the definition of "benchmark interest rate" in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) so that the rate is determined not by reference to a rate offered by the Commonwealth Bank for a housing loan, but by reference to the standard variable rate for owner-occupied housing loans of the major banks, as determined by the Reserve Bank of Australia.
Summary of amendments
1.2 Paragraph (a) of the definition of "benchmark interest rate" contained in subsection 136(1) of the FBTAA will be amended so that the value of a loan fringe benefit will be a more accurate reflection of the value of the benefit to the employee. In particular, "capped" interest rates will no longer be able to be used to determine the "benchmark interest rate" [Clause 4].
1.3 The amendment applies from 1 April 1994 [Clause 6].
Background to the legislation
1.4 Subsection 16(1) of the FBTAA provides that a loan benefit arises when an employer makes a loan to an employee or an associate of an employee. Loans that are made by an employer to a third party at the request of the employee or by a third party to an employee at the request of the employer may also constitute a loan benefit. Fringe benefits tax does not apply to exempt loan fringe benefits, such as loans to employees to meet certain work-related expenses.
1.5 The taxable value of a loan fringe benefit in relation to a year of tax is the difference between a notional amount determined by reference to the benchmark interest rate and the actual interest paid or deemed to be paid on the loan.
1.6 The taxable value is calculated by multiplying the daily balances of the loan by the difference between the notional amount of interest and interest actually paid. The daily amounts are added to obtain the taxable value of the benefit.
1.7 The "notional amount of interest" is the interest determined by applying a statutory rate of interest. The "statutory interest rate" for a loan taken out after 2 April 1986 is determined using a "benchmark interest rate". The terms "notional amount of interest", "statutory interest rate" and "benchmark interest rate" are all defined in subsection 136(1) of the FBTAA. The "benchmark interest rate" for a fringe benefits tax (FBT) year is the rate of interest offered by the Commonwealth Bank on its housing loans immediately before the commencement of the FBT year.
1.8 Where more than one benchmark interest rate applies, the lowest rate is used. If there is no benchmark interest rate, the statutory rate of interest may be prescribed by regulation.
1.9 Consequently, the benchmark interest rate in any FBT year is based at present on the lowest rate of interest offered by the Commonwealth Bank on a housing loan on the 31 March immediately preceding the FBT year.
1.10 A different "notional amount of interest" applies to fixed interest loans taken out before 1 July 1986 and also to housing loans made before 3 April 1986.
Explanation of the amendments
1.11 The definition of "benchmark interest rate" in subsection 136(1) of the FBTAA will be amended to delete the reference to the rate of interest on Commonwealth Bank housing loans. The amendment will replace that rate with the standard variable rate offered by the major banks for owner-occupied housing loans. The definition of "statutory interest rate" in subsection 136(1) of the FBTAA will be amended consequentially. [Clause 5]
1.12 The standard variable rate offered by the major banks for owner-occupied housing loans is determined by the Reserve Bank of Australia. It is known as the large bank housing lenders variable interest rate on loans for housing for owner occupation. The rate to be used will be the rate last published by the Reserve Bank of Australia before the start of the relevant FBT year. Each FBT year begins on 1 April.
Chapter 2 - Accruals assessability of certain securities
Summary of proposed amendments
2.1 To provide a proper accruals basis of taxation for variable return securities to which Division 16E of Part III applies. The present rule which brings to account the fixed component of a variable return security evenly over its term will no longer apply. The amendments will require that the whole return - both fixed and variable - be brought to account on a six monthly compounding accruals basis, consistent with existing Division 16E rules applicable to fixed return securities. This object is expressed in Clause 8 . The amendment will eliminate the distortion inherent in a method which evenly spreads any fixed returns from a variable return instrument which has a declining balance.
2.2 To remove an unintended consequence of Division 16E in relation to certain securities issued in a series. Broadly, where the first security issued in a series is not a qualifying security (ie Division 16E does not apply) and a subsequent security issued in that series would otherwise be a qualifying security (e.g. because it is issued at a discount), the amendments will treat that subsequent security as not being a qualifying security within the scope of Division 16E. This object is expressed in Clause 22.
2.3 The amendments apply to qualifying securities issued after 27 January 1994 [Clause 21] . The further amendment to exclude accruals assessability of certain securites issued in a series applies to qualifying securities issued after 16 December 1984 [Clause 24]
Background to the legislation
2.4 Division 16E was enacted to remove tax deferral opportunities which were available from certain discounted and deferred interest securities. An example would be an investment by an individual taxpayer in a term deposit on which interest was calculated on a compounding basis but not paid until maturity. The financial institution which received the money on deposit would obtain deductions for the interest over the term of the investment but the investor would be taxed only when the interest was actually paid. Deferral of tax in this way meant that investors were willing to accept a lower nominal rate of return because, on an after tax basis, they were better off than if they had made a traditional investment.
2.5 Division 16E was designed to prevent this form of tax deferral by spreading the income and deductions from such investments over the term of the security. It spreads the income and deductions on a basis which reflects the economic gains which have accrued at any point in time.
2.6 Division 16E applies to a class of securities defined as 'qualifying securities'. 'Qualifying securities' are divided into two groups; 'fixed return securities' and 'variable return securities'. Broadly, fixed return securities are those under which the amount of all the cash flows are known at the outset (see definition of 'fixed return security' in subsection 159GP(1)). An example is a fixed interest term deposit. Qualifying securities other than fixed return securities are variable return securities (see current definition of 'variable return security' in subsection 159GP(1)).
2.7 Division 16E treats variable return securities differently from fixed return securities. The taxable return from fixed return securities is brought to account on a six monthly compounding accruals (yield to maturity) basis over the term of the security. This is an actuarial calculation which provides a measure of economic income.
2.8 In contrast, the eligible return from variable return securities is separated into its fixed (or non-varying) and variable (varying) elements. The fixed element, referred to as the 'issue discount', is brought to account on a 'straight line' basis (see current paragraph 159GQ(2)(a) and similar rules in paragraphs 159GQ(3)(a) and (b) for the assessment or deduction of the purchase discount or purchase premium of variable return securities acquired other than on original issue). That is, an equal amount of the fixed element of the return is brought to account in each year of income during the term of the security. Where the security is held for only part of a year of income, an apportioned amount is brought to account in that year.
2.9 The varying element of a variable return security is brought to account on an 'attribution' basis. That is, so much of the varying element as is attributable to the relevant year of income, or which the Commissioner considers may reasonably be attributed to the year, is included in the assessable income of the holder of the security (see paragraph 159GQ(2)(b), and similar rules in paragraph 159GQ(3)(c) for variable return securities acquired other than at original issue).
2.10 The present requirement in paragraphs 159GQ(2)(a) and 159GQ(3)(a) that the fixed element of the return on a variable return security be taxed in equal instalments over the term of the security leads to an accrual of income which is inconsistent with the underlying economic substance of the arrangement. Where the security has a declining balance and the fixed element is a substantial portion of the total return, this can result in significant tax deferral. In economic terms, investments which have a declining balance earn more income in earlier years and less income in later years. In fact, the income component of payments falls to almost zero in the final year.
2.11 Division 16E was intended to tax such securities in a manner consistent with the economic substance of the instrument. While Division 16E achieves this objective for fixed return securities with a declining balance, the spreading of the fixed element in equal instalments over the term of the security means that Division 16E does not achieve its objective for variable return securities with a declining balance, such as indexed annuities.
2.12 Paragraph (e) of the definition of 'qualifying security' imposes an additional qualifying test in relation to fixed return securities. In simple terms, fixed return securities only fall within Division 16E where they are issued at a discount greater than 1.5% per annum. Whether or not a security is a qualifying security is determined at the time of issue of the security.
2.13 It is not uncommon for securities to be issued with exactly the same terms and conditions at different, usually frequent and regular, points in time. This is referred to as issuing securities in a series, although primarily it is to increase the liquidity of the market for the security and to avoid the additional administration costs of establishing a new 'series'.
2.14 Should the required market interest rate rise in the future, it is possible that subsequent issues in a 'series' of securities would come within the scope of Division 16E even though previous issues in that series were outside it. The reason is that, under those conditions, it would be necessary to issue new securities in a series at a discount. Division 16E may then apply.
2.15 In these circumstances, for the purpose of ascertaining the right tax liability it would be necessary to be able to separately identify those securities in the series to which Division 16E applies and those to which it did not apply. However in a practical sense this is not possible because securities issued in a series are fungible and ordinarily not capable of separate identification. The only practical outcome would be to discontinue the series and create a separate series in order to identify securities according to different tax effects.
2.16 This outcome is undesirable as it is likely to have significant adverse implications for the efficient operation of Australia's capital markets. These amendments will prevent such a consequence.
Explanation of amendments - accruals basis of taxation for certain securities.
Section 159GQ repealed; associated definitions repealed
2.17 Under the current law, assessable income in relation to fixed return securities is brought to account on a compounding accruals basis by subsection 159GQ(1). The terms 'eligible notional accrual period', 'notional accrual amount', 'notional accrual period' and 'taxpayer's yield to redemption', as defined in subsection 159GP(1), are incorporated into the application of subsection 159GQ(1). These definitions, and subsection 159GQ(1) itself, are being repealed by the Bill [Clauses 9 and 10].
2.18 The treatment of variable return securities under Division 16E is governed by subsections 159GQ(2) and 159GQ(3). Subsection 159GQ(2) applies where a variable return security is acquired at issue. In that case, the 'issue discount' (as defined in subsection 159GP(4)) is included in assessable income on a straight line basis over the term of the security. These provisions are also being repealed [Clause 10].
2.19 The 'varying element' of the 'eligible return' is brought to account under paragraph 159GQ(2)(b). That paragraph provides that the income amount to be accrued in a period is the amount attributable to that period having regard to the method of calculation of amounts payable under the security and the length of the period, or the amount which in the Commissioner's opinion may reasonably be attributed to that period. Subsection 159GQ(3) applies similarly in relation to variable return securities transferred to the holder after issue. These provisions are being repealed [Clause 10].
The new Division 16E accruals rules
2.20 The amendments contained in the Bill provide consistent accruals accounting rules for both fixed return securities and variable return securities. Where a taxpayer holds a security to which Division 16E applies (a 'qualifying security' as defined in subsection 159GP(1)), new subsection 159GQ(1) specifies that an 'accrual amount' must be calculated for each 'accrual period' in the year of income. If the 'accrual amount' is positive, it must be included in assessable income [Clause 10; new subsection 159GQ(2)]. If the 'accrual amount' is negative, a deduction of the amount is allowable [Clause 10; new subsection 159GQ(3)]. In applying those rules, it is necessary to ascertain the 'taxpayer's maximum term' in relation to the security and to divide that term into 'accrual periods'.
2.21 The maximum term of a taxpayer, in relation to a security, is the remaining term of the security at the time it is acquired by the taxpayer. That is, the maximum term is the period between the acquisition of the security and its maturity. For example, where a taxpayer acquires the security at issue date, the full term of the security will be the taxpayer's maximum term. In effect, the taxpayer's maximum term in relation to a security is the maximum time that the taxpayer could hold that security. While a taxpayer may hold a security for a lesser period (for example, the taxpayer may transfer the security prior to its maturity) this will not reduce the maximum term. See the definition of 'taxpayer's maximum term' in Clause 9; new subsection 159GP(1).
Determination of accrual periods
2.22 Under the present law, the term of a qualifying security is divided into 'notional accrual periods' each of six months set so that the last ends at the maturity of the security: see the definition of 'notional accrual period' in subsection 159GP(1). Where the term of the security is not an exact multiple of six months (eg, 15 months), the first accrual period is the residual part of the first six month period (eg, 3 months for a 15 month security): see the definition of 'eligible notional accrual period' in subsection 159GP(1).
2.23 The concept of 6 monthly eligible notional accrual periods working back from the maturity of the security is being replaced by the rule in, new section 159GQA which requires the taxpayer's maximum term of a security to be divided into accrual periods. Under new section 159GQA where the whole of a year of income falls within the term, that year contains two accrual periods each of six months. Where only a part of a year of income falls within the term, ie either at the commencement of the term or the end of the term, the year may contain an accrual period of less than six months. The following example shows how accrual periods are worked out.
Example 1 - Determination of accrual periods
2.24 Assume the following in relation to a qualifying security acquired by the taxpayer at issue date:
- Term 2 Years
- Issue date 1 April 1994
- Maturity date 31 March 1996
- Tax year-end 30 June
The taxpayer's maximum term is two years as the security was acquired at issue date.
Accrual periods are:
1994 year of income 1 April 1994 - 30 June 1994 (3 months) 1995 year of income 1 July 1994 - 31 December 1994 (6 months) 1 January 1995 - 30 June 1995 (6 months) 1996 year of income 1 July 1995 - 31 December 1995 (6 months) 1 January 1996 - 31 March 1996 (3 months)
As accrual periods are now wholly within years of income, there is no need to apportion income from accrual periods between years of income.
Determination of accrual amount - fixed return securities
2.25 The amount to be accrued in an accrual period under Division 16E for a fixed return security will be determined by a formula equivalent to that which has applied in ascertaining the 'notional accrual amount' defined in subsection 159GP(1). The formula, in new subsection 159GQB(1) , is as follows:
[Implicit interest rate * Opening balance] - Periodic interest etc.
Calculation of implicit interest rate - fixed return securities
2.26 The implicit interest rate in the formula is the rate per six monthly compounding interval at which the sum of the present values of all amounts payable under the security during the 'taxpayer's maximum term' equals the issue price or transfer price (whichever is relevant) [Clause 10; new section 159GQC].
2.27 Where a taxpayer acquires the security on issue, the implicit interest rate is calculated from the issue date, the issue price being the relevant price. Example 2 illustrates the calculation. Where the security is transferred to the taxpayer, the implicit interest rate is determined from the transfer date, the rate being that at which the present value of all remaining amounts payable under the security equals the transfer price of the security. Example 3 illustrates this.
Example 2: Calculation of implicit interest rate - fixed return security acquired on issue
2.28 Assume the following in relation to a fixed return security:
- Security: 2 year term deposit
- Principal invested: $1,000
- Interest: 5% p.a., payable at maturity (ie, $100 interest)
- Issue Date: 1 April 1994
- Maturity Date: 31 March 1996
- The taxpayer's maximum term is 2 years.
The implicit interest rate is determined by solving the equation:
Present value of all payments under the security = Issue price
i.e. Payment/ (1+ r)n = Issue Price
where:
r: implicit interest rate.
n: number of six month periods, or part thereof, between the issue date and the payment date.
i.e. $1,100 / (1+ r)4 = $1,000
This results in an implicit interest rate of 2.411% (per period of 6 months).
Example 3: Calculation of implicit interest rate - fixed return security acquired after issue date
2.29 Assume the following in relation to a fixed return security:
- Security: 2 year deferred interest security
- Face Value: $1,000
- Transfer Price: $1,040
- Interest: 5% p.a., payable at maturity (ie, $100 interest)
- Issue Date: 1 April 1994
- Transfer Date: 1 May 1995
- Maturity Date: 31 March 1996
- The taxpayer's maximum term is 11 months.
The implicit interest rate is determined by solving the equation:
Present value of all remaining payments under the security = Transfer price
i.e. Payment / (1+ r)n = Transfer Price
where:
r: implicit interest rate.
n: number of six month periods, or part thereof, between transfer date and the payment date.
$1,100 / (1+ r)(11/6) = $1,040
This results in an implicit interest rate of 3.107% (per period of 6 months).
Adjust implicit interest rate for periods less than 6 months
2.30 Where an accrual period is less than 6 months it is necessary to adjust the implicit interest rate to reflect this [Clause 10; new subsection 159GQB(2)] . For example, if the implicit interest rate of a security was 5% per 6 month compounding interval, the adjusted rate for a two month accrual period is calculated as follows:
r adjusted = (1 + r 6 months)(length of accrual period/6 months) - 1
where:
r adjusted: Implicit interest rate adjusted for an accrual period less than 6 months.
r 6 months: Implicit interest rate for accrual periods of 6 months.
(1 + 5%)(2 months/6 months) - 1
This results in an adjusted implicit interest rate of 1.640% for the two month accrual period.
Calculation of opening balance - fixed return securities
2.31 The 'opening balance' of an accrual period will be determined in accordance with a formula equivalent to that which has applied in determining element "B" of 'notional accrual amount' in subsection 159GP(1). The formula, in new subsection 159GQB(3), is as follows:
Issue/transfer price + Previous accruals - Payments
2.32 The amount ascertained under that formula is referred to as the 'opening balance' because it represents the 'principal' balance outstanding in the compounding accruals calculation at the beginning of the accrual period (ie, the closing balance of the calculation at the end of the previous accrual period).
2.33 The issue price (or transfer price if the security has been transferred to the taxpayer) is the starting point in determining the opening balance. For the first accrual period in relation to the security (ie, that in which the security is acquired by the taxpayer), the opening balance is the issue price (or, if applicable, the transfer price) of the security. "Issue/transfer price" is thus the issue price or the transfer price, as the situation requires.
2.34 If in previous accrual periods in the taxpayer's maximum term there were accrual amounts calculated in accordance with new subsection 159GQB(1) , the sum of any such previous accrual amounts ( "previous accruals ") is added to the issue or transfer price, as the case requires, in determining the opening balance.
2.35 The taxpayer may have received payments under the security, other than amounts that are periodic interest (see subsections 159GP(6) and 159GP(7)) for the purposes of Division 16E, in previous accrual periods. In effect, such payments represent a distribution of 'principal' as they reduce the 'principal' balance of the compounding accruals calculation. Accordingly, any such payments that are made or liable to be made under the security in previous accrual periods within the taxpayer's maximum term ( "payments" ) are subtracted in the calculation of the opening balance in relation to a security.
2.36 The third element of the formula for the calculation of accrual amounts is "periodic interest etc." . This will be determined in the same way as element "C" of the existing 'notional accrual amount' in subsection 159GP(1). New subsection 159GQB(4) specifies how "periodic interest etc." is calculated.
2.37 "Periodic interest etc." , consists of two separate elements that are to be deducted in working out the accrual amount for each accrual period. Firstly, any amount that consists of periodic interest (as defined in subsections 159GP(6) and 159GP(7)) is excluded. Periodic interest does not form part of the taxable return from a security that is accrued under Division 16E, but is separately assessable under the general provisions of the Act. It must be excluded in calculating the accrual amount because, as part of the total payments under the security, it is taken into account in calculating the implicit interest rate. Not to exclude periodic interest would therefore constitute a double counting. (See Clause 10; new paragraph 159GQB(4)(a).)
2.38 The second element to be deducted is an adjustment to reflect payments made under the security other than at the end of the relevant accrual period. That kind of adjustment is necessary because the implicit interest rate in the 'accrual amount' formula will reflect an entire accrual period. Payments - either of periodic interest or otherwise - which are made other than at the end of an accrual period effectively reduce the 'principal' balance of the security at the time of payment. Accrual amounts need to be adjusted to properly reflect the reduced balance from that time. New paragraph 159GQB(4)(a) requires such an adjustment to be made in relation to payments of periodic interest made other than at the end of an accrual period. New paragraph 159GQB(4)(b) makes a similar specification in relation to payments other than periodic interest. Example 4 illustrates how this adjustment is calculated.
Example 4: Adjustment where payments made other than at the end of an accrual period.
2.39 Assume the following in relation to an accrual period of a qualifying security:
- Length of accrual period: 6 months
- Implicit interest rate: 5% (per 6 monthly interval)
- Assume also that a payment of $500 is made 3 months into the accrual period.
The early payment means that for three months of the accrual period the 'principal' amount of the security has been less than the opening balance. The adjustment should reflect this. For example, in this case it would be adjusted as follows:
Payment * 5% * Time remaining in accrual period when payment made/Accrual period
$500 * 5% * (3 months/6 months) = $12.50
This results in an adjustment amount of $12.50.
Calculation of accrual amount - fixed return securities
2.40 Because the elements of the accrual amount formula are known in relation to a fixed return security, it is possible to determine the accrual amount for all the taxpayer's accrual periods under the security. Example 5 is an illustration.
Example 5: Calculation of accrual amounts - fixed return securities
2.41 Assume the security has the same terms and conditions of those in Example 1 and 2.
Accrual Period 1 1 April 1994 - 30 June 1994 (3 months)
Calculate the implicit interest rate for a period of less than 6 months
Implicit interest rate per period of 6 months is 2.411% (See example 2).
Implicit interest rate for accrual period 1
i.e. = (1 + 2.411%)(3 months/6 months) - 1
= 1.199%
Opening balance: = $1,000 (issue price)
Periodic interest etc. = Nil
Accrual amount = [Implicit interest rate * Opening balance] - Periodic interest etc.
= 1.199% * $1,000 - 0
= $11.99
Accrual Period 2 1 July 1995 - 31 December 1995 (6 months)
Implicit interest for accrual period 2 = 2.411% per period of 6 months
Opening balance = Issue price + Previous Accruals - Payments
= $1,000 + $11.99 - 0
= $1,011.99
Periodic interest etc. = Nil
Accrual amount = [Implicit interest rate * Opening balance] - Periodic interest etc.
= 2.411% * $1,011.09 - 0
= $24.40
2.42 The following table shows the accrual amount for each accrual period by the application of the formula in subsection 159GQB(1):
| Accrual Period | Implicit Interest Rate | Opening Balance | Periodic Interest etc. | Previous Accruals | Accrual Amount |
|---|---|---|---|---|---|
| 1 | 1.199% | $1,000.00 | 0 | 0 | $11.99 |
| 2 | 2.411% | $1,011.99 | 0 | $11.99 | $24.40 |
| 3 | 2.411% | $1,036.39 | 0 | $36.39 | $24.99 |
| 4 | 2.411% | $1,061.38 | 0 | $61.38 | $25.59 |
| 5 | 1.199% | $1,086.97 | 0 | $86.97 | $13.03 |
| Total | $100 |
Determination of accrual amount - variable return securities
2.43 For variable return securities, the accrual amount for each accrual period is determined under the same formula in new subsection 159GQB(1) that applies for fixed return securities, viz.
[Implicit interest rate * Opening balance] - Periodic interest etc.
2.44 The opening balance and periodic interest etc. are determined in the same manner as explained earlier at 2.31 - 2.39.
2.45 However, because the quantum of payments to be made under a variable return security is not known with certainty at the outset, new section 159GQD requires that a new implicit interest rate be ascertained for each income year in which a taxpayer is the holder of such a security. In a case where there are two accrual periods of six months in the year, the implicit interest rate is the same for both new subsection 159GQD(1).
Calculation of implicit interest rate - variable return securities
2.46 The implicit interest rate in relation to a variable return security is the compound rate per 6 monthly interval at which the sum of the present values of all remaining amounts payable under the security equals the opening balance at the beginning of the year of income. In the first year of income in which the security is held by the taxpayer the opening balance will equal the issue price [Clause 10; new subsection 159GQD(2)]. In calculating the implicit interest rate each year, some or all of the remaining amounts payable under the security may not be known. In some cases, it may not be possible to determine whether an amount will be payable. New subsections 159GQD(4) to (11) specify certain assumptions that are to be made in determining such future payments. These assumptions are discussed in detail at 2.49 - 2.62.
Example 6: Calculation of implicit interest rate - variable return securities
2.47 1994 year of income
Issue Date: 1 April 1994
Assume issue price: $7,500
Assume the payments under the security for the purposes of the accruals calculations (ie, including estimated future payments) for the 1994 year of income are:
Payment Date Cash Flow 30 June 1994 $1,004.57 30 September 1994 $1,007.09 31 December 1994 $1,009.63 31 March 1995 $1,012.17 30 June 1995 $1,014.71 30 September 1995 $1,017.27 31 December 1995 $1,019.83 31 March 1996 $1,022.39
The implicit interest rate is determined by solving the equation:
Present value of all payments under the security = Opening Balance
i.e. Payments/(1+ r)n = Opening balance
where:
r: implicit interest rate.
n: number of six month periods, or part thereof, between issue date and the payment date.
In the 1994 year of income the opening balance is equal to the issue price of $7,500.
1004.57/(1+ r)(1/2) + 1007.09/(1+ r)1 + 1009.63/(1+ r)(3/2) + 1012.17/(1+ r)2 +
+ 1014.71/(1+ r)(5/2) + 1017.27/(1+ r)3 + 1019.83/(1+ r)(7/2) + 1022.39/ (1+ r)4
= $7,500
This results in an implicit interest rate for the first year of 3.549% (per period of 6 months). The accrual amount for the 1994 year of income is worked out under the formula in new subsection 159GQB(1) , as explained in paragraph 2.25 above.
Possible for implicit interest rate to be negative
2.48 The implicit interest rate would ordinarily be positive for the holder of the qualifying security, but it is possible for it to be negative in relation to a variable return security. This could occur where previous assumptions made in determining unknown future payments under the security cause previous accrual amounts to exceed the total taxable return that is calculated on the basis of assumptions made under current conditions.
Assumptions relating to cash flows the value of which is unknown at the end of the year of income
2.49 In order to calculate both the accrual amount and implicit interest rate in relation to variable return securities, it is necessary to make assumptions to help determine the amount of payments which are unknown as at the end of the relevant year of income. There are two basic rules: the assumption of continuing rate of change (or constant growth) and the assumption of constant level. There is a residual rule to cover situations where neither of these assumptions can apply.
Assumption of continuing rate of change
2.50 An assumption of a continuing rate of change will apply where the amount of a payment unknown at the end of a year of income is calculated or determined by taking into account the amount of change in an index or other thing that occurs during a period [Clause 10; new subsection 159GQD(7)] . This will include, for example, arrangements where future payments under a security are determined by reference to the level of the Consumer Price Index (CPI) at one point in time relative to the level of that index at another (usually earlier) point in time. Examples would be inflation-linked capital indexed bonds and inflation indexed annuities.
2.51 The assumption of a continuing rate of change will also apply to situations where, while the amount of a payment is not explicitly referable to the amount of change in an index or other thing during a period, it may reasonably be regarded as representing that situation [Clause 10; new subsection 159GQD(9)] . For example, payments under an inflation indexed annuity are usually made by reference to a formula where the denominator (eg the level of CPI at the issue of the security), is known at issue date. New subsection 159GQD(9) will cover situations where it is reasonable to conclude in all the circumstances that the calculation incorporates the current level of the CPI index. This would be the case for example where the terms and conditions of a security do not explicitly refer to the level of the CPI index at issue date, but specify a number equal to that level.
2.52 The assumption of a continuing rate of change is not limited to indexed securities or payments involving the level of an index. The phrase 'or other thing' in new subsections 159GQD(7) and (9) is expressed widely, so as to cover all situations where a payment is made, to any extent, by reference to the change in a variable over time, rather than being simply by reference to the value or level of that variable at a particular point in time in the future.
Application of assumption of continuing rate of change
2.53 Where a payment is subject to the assumption of a continuing rate of change, it is to be assumed that the relevant variable will continue to change at the same rate after the end of the relevant year of income as it did during the past year of income [Clause 10; new subsection 159GQD(7)].
2.54 If the rate of change for the 12 months which ends at the end of the year of income is not known at that time (usually because the index or other variable has not been published), the rate of change is to be measured by reference to the latest 12 month period for which relevant information is available. In these circumstances, it is to be assumed that the relevant variable will continue to change at this rate after the time at which the relevant information was last available in the year of income. For example, the latest available CPI figure for a taxpayer whose year of income ends on 30 June is usually that for the March quarter. In this case the rate of change will be determined by reference to the March quarter CPI figure in the current (relevant) year of income compared to the March quarter CPI figure in the previous year. Example 7 illustrates this process.
Example 7: Application of assumption of continuing rate of change - inflation indexed annuity
2.55 Assume the following in relation to an inflation indexed annuity variable return security.
- Term: 2 years
- Issue Date: 1 April 1994
- Maturity Date: 31 March 1996
- Payment Frequency: Quarterly
- Payment Dates: 30 June 1994, 30 September 1994, 31 December 1994, 31 March 1995, 30 June 1995, 30 September 1995, 31 December 1995, 31 March 1996.
- Assume March 1993 figure: 108.9
- Assume December 1993 figure: 109.5
- Assume March 1994 figure: 110
- Taxpayer's tax year end: 30 June
- Payment formula:
Minimum Annuity Payment * CPIn/ CPIo
where:
- A Minimum Annuity Payment of $1,000 is provided under the annuity.
- CPIn: Last CPI figure known at payment date n.
- CPIo: Last CPI figure known at issue date, in this case the December 1993 quarter figure.
This is a security to which the assumption of continuing rate of change will apply, as the payments are calculated by reference to the change in the CPI index during a period.
The first payment under the terms of the security is made on 30 June 1994. All payments under the security subsequent to 30 June 1994 will be unknown as at that time, as the relevant CPI figures would not be available.
The rate of change in the CPI index for the purposes of applying the continuing rate assumption in the 1994 year of income is determined as follows:
(CPI March 94-CPI March93)/CPI March93 = (110-108.9)/108.9 = 1.01% per annum
Therefore, for the purposes of the accruals calculations for the 1994 year of income, the CPI is assumed to increase at the rate of 1.01% per annum. As the June 1994 CPI will not be known on 30 June 1994, it is worked out for accruals purposes as follows:
CPI June 94 CPI March 94 * (1+ 1.01%)(3 months/12 months)
110 * (1.0101)(1/4) = 110.2767
The first unknown payment, on 30 September 1994, is therefore estimated to be:
$1,000 * CPI June 94/CPI December 93
$1,000 * 110.2767/109.5
$1007.09
By the same methodology, payments under the security for the purposes of calculating the accrual amount for the 1994 year of income would be:
Payment Date Cash Flow 30 June 1994 $1,004.57 30 September 1994 $1,007.09 31 December 1994 $1,009.63 31 March 1995 $1,012.17 30 June 1995 $1,014.71 30 September 1995 $1,017.27 31 December 1995 $1,019.83 31 March 1996 1,022.39
2.56 Another basis of assumption, the constant level assumption [new subsection 159GQD(5)] , applies where a payment under a qualifying security is calculated (to any extent) by reference to the amount or level, at a particular time, of a rate, price, index or other measure. The expression 'rate, price, index or other thing' in new subsection 159GQD(5) would encompass all manner of variables intended to form part of the calculation of a payment under a qualifying security. Example 8 illustrates when that assumption would apply.
2.57 Where a payment is subject to the assumption of constant level, it is to be assumed that the relevant variable will remain the same after the end of the relevant year of income as it was when it was last available in the relevant year of income [Clause 10; new subsection 159GQD(5)].
Example 8: Payment to which the assumption of constant level will apply
2.58 Assume the following in relation to a variable return security:
- Security: 2 year floating rate note
- Face Value: $1,000
- Interest: Bank Bill Rate (BBR) per annum at maturity, payable at maturity. BBR is an indicator of the current bank bill rate, and is available daily.
- Issue Date: 1 April 1994
- Maturity Date: 31 March 1996
The interest payment at maturity under this security is calculated at that time as follows:
BBR (pa)maturity * Face Value * Term (in years)
The assumption of constant level will apply to this payment, as it is calculated by reference to the level of a rate (BBR) at a particular time.
As at the end of the 1994 year of income, the amount of the payment due at maturity is unknown, as it is dependant on the future level of BBR. In order to calculate the implicit interest rate and the accrual amount for the 1994 year of income, it is necessary to determine a value of this amount payable. As the constant level assumption applies to this security, for the purposes of the 1994 year of income the amount of the payment due at maturity will be assumed to be based on the level of BBR as at 30 June 1994. If BBR is 6% p.a. on 30 June 1994, the determination is as follows:
BBR (pa)maturity * Face Value * Term (in years)
i.e. 6% * $1000 * 2 years.
2.59 Where the amount of a future payment cannot be determined on the basis of the assumptions of a continuing rate of change or constant level or both, the amount is to be determined on the basis of what is most likely in the circumstances. This rule would apply where there is no relevant rate, price, index or other variable available in the year of income.
2.60 The determination of what is most likely does not require that there be certainty as to what the amount of the payment will be. Rather, the determination is to be reasonably made on the balance of the probabilities of likely outcomes.
2.61 In rare cases, it may not be possible at the end of year of income to determine a future payment of payments on the basis of what is most likely. The mere fact that there may be a range of possible future outcomes would not, however, preclude a determination being made on that basis.
More than one assumption can apply to a payment
2.62 In relation to some payments under a security, several factors or variables may need to be taken into account in determining what is actually paid. In those cases, different assumptions may apply in relation to the different variables. Accordingly new subsection 159GQD(4) provides that the determination of unknown payments is to be made by applying the assumptions specified in new subsections 159GQD(5) , (7) or (11), or a combination of those assumptions. New section 159GQD is not to be read as meaning that if any part of an unknown payment cannot be determined then the whole of that payment is estimated to be zero, but rather that the assumptions of continuing rate of change, or constant level, or the residual "most likely" rule, are to apply in estimating future payments, or parts of payments, to the extent possible.
Treatment of issuers; new subsections 159GT(1), (1A), (1B), and (1C).
2.63 Division 16E applies symmetrically to holders and issuers of qualifying securities through the operation of subsection 159GT(1). It authorises a deduction to an issuer in a year of income of an amount equal to that which the original holder of the security would have included in assessable income under subsection 159GQ (assuming the original holder held the security until the end of its term).
2.64 As discussed at paragraphs 2.17 to 2.19, section 159GQ is to be repealed. Under new subsection 159GQ(3) , it will be possible in certain circumstances for a deduction to be allowed to the holder of a qualifying security prior to the disposal of that security either by way of transfer or at maturity (see paragraph 2.20 above). To maintain consistency of treatment under Division 16E as between holders and issuers of qualifying securities, it is necessary to amend subsection 159GT(1) to provide for an amount to be included in the assessable income of an issuer where the original holder would have been allowed a deduction for an amount during the term of the security [Clause 13; new subsection 159GT(1B)] . Issuers are allowed deductions on a similar basis as currently available under subsection 159GT(1) by Clause 13; new subsection 159GT(1A).
2.65 Section 159GQ is to be repealed. Subsection 159GR(2) currently provides for an adjustment to be made where subsections 159GQ(2) or 159GQ(3) have resulted in an incorrect accrual of income in relation to a payment under a variable return security. On the repeal of section 159GQ, subsection 159GR(2) is to be omitted as redundant [Clause 11].
2.66 A number of provisions in the Assessment Act currently refer either to subsection 159GR(2), or amounts being included in the assessable income or allowed as deductions under section 159GR. These references are to omitted as redundant. The provisions amended in this way are:
- Subsection 159GR(1) [Clause 11]
- Subsection 159GS(3) [Clause 12]
- Subsection 159GW(1) [Clause 14]
- Section 159GX [Clause 15]
- Section 159GY [Clause 16]
- Subsection 63(1A) [Clause 17]
- Paragraph 159GZZZZE(2)(b) [Clause 18]
- Paragraph 221YSA(4)(a) [Clause 20]
2.67 Paragraph 221YHZA(2B)(b) includes a reference to income included under paragraph 159GR(2)(c). The paragraph 221YHZA(2B)(b) is being revised [Clause 19; new paragraph 221YHZA(2B)(b)] to remove the reference.
2.68 Subsection 159GT(4) is the equivalent provision for issuers of qualifying securities to subsection 159GR(2) in relation to holders. Like subsection 159GR(2) it is to be omitted as redundant on the enactment of Clause 13; new section 159GQ.
Explanation of amendments - securities issued in a series
Definition of qualifying security amended
2.69 Division 16E is amended by this Bill to ensure that later issues in a series of securities will not fall within the scope of the Division where securities in the first issue of that series are outside its scope.
2.70 The definition of 'qualifying security' in subsection 15GP(1) is amended by the insertion of a new paragraph, (ba). It specifies that a security is not a qualifying security if it is 'part of an exempt series' [Clause 23 (a)]
2.71 The circumstances in which a security is part of an exempt series are set out in new subsection 159 GP(9A).
2.72 In order for a security to be regarded as issued as part of an exempt series the first security issued in the series after the commencement date of Division 16E (ie 16 December 1984) must not be a 'qualifying security', as defined in subsection 159GP [Clause 23(b);new subsection 159GP(9a)].
2.73 To be treated as issued in the same series, securities must have exactly the same payment dates, payment amounts and be the same in respect of all other terms [Clause 23(b); new paragraphs 159GP(9A)(b),(c)] . In short, securities issued in a series must have precisely the same terms and conditions. They should, for example, have the same rate of interest, and the same payment and maturity date irrespective of issue date. However the fact that, in a given case, securities could be separately identified, e.g. by serial number, would not preclude their being treated as issued in a series.
2.74 Nor will the fact that a security has a different issue price from another security have a bearing on whether they were both issued in the same series [Clause 23(c); new subsection 159GP(9B)].
2.75 Specifically, the amendments provide that where:
- •
- the first security issued in a series after 16 December 1984 is not a qualifying security; and
- •
- at a later time, the same issuer issues another security in that series, ie with the same payment dates, payment amounts and other terms as the first in the series
the later security is part of an exempt series [Clause 23(b); new paragraphs 159PG(9A)(a),(c)]
2.76 That is, later securities will not be treated as qualifying securities under these rules if the very first securities issued in the series were not qualifying securities.
Chapter 3 Capital Gains Tax - Payment of rebatable dividends from certain share premium accounts and revaluation reserves. Subdivision J of Division 3 (Part 3) of the Bill
Overview
3.1 The Bill will amend the capital gains tax (CGT) provisions of the Act so that any capital gain computed having regard to the disposal consideration for shares in a company or the amount of capital paid back on shares will not be reduced by the amounts of the payments that are treated as rebatable dividends. These amendments relate to:
- •
- liquidator's distributions;
- •
- off-market share buy-backs;
- •
- other disposals of shares; and
- •
- amounts paid in connection with a reduction of capital.
Summary of amendments
3.2 Subsection 160ZA(4) of the Act ensures that an amount taxed as ordinary income is not taxed again as a capital gain. The subsection applies if the disposal of an asset gives rise both to a capital gain under the capital gains tax (CGT) provisions of the Act and also assessable income under another provision of the Act. In such cases, subsection 160ZA(4) reduces the capital gain by the assessable income included under the other provision of the Act.
3.3 Dividends paid from one resident company to another are fully or partially rebatable under section 46 or 46A of the Act. A rebatable dividend is included in assessable income but is effectively made tax free or partly tax free by the grant of a tax rebate. This tax rebate is referred to as the inter-corporate dividend rebate.
3.4 Some corporate shareholders who derive a capital gain from the disposal of shares held in a company are able to structure the disposal in such a way that it also gives rise to a rebatable dividend. In such a case, subsection 160ZA(4) has the effect of reducing the amount of the capital gain by the amount of the dividend. This would give the correct result of avoiding double taxation if income tax is payable on the dividend. However, income tax is effectively not paid on the dividend if the taxpayer is a resident company that qualifies for the inter-corporate dividend rebate and the dividend is paid out of untaxed amounts.
3.5 The anti-avoidance provisions of Part IVA of the Act could apply where a tax advantage is obtained by converting one form of assessable income into a rebatable dividend. However, Part IVA has to be applied on a case by case basis and would apply only where, on the facts, it would be concluded that there is a sole or dominant object of tax avoidance.
3.6 The capital gain that should arise on the disposal of shares in a company may be reduced because certain distributions made by a company in relation to the disposal are treated as rebatable dividends.
3.7 The amendments will prevent a capital gain, whether arising from the disposal of shares, share buy-backs, liquidators' distributions or the repayment of capital on shares, from being reduced:
- •
- because part of the payment relating to the disposal, share buy-back, or the liquidator's distribution is treated as a rebatable dividend and excluded from the capital gain; or
- •
- because part of the payment or distribution is treated as a rebatable dividend and excluded from the disposal consideration on which the capital gain is computed.
3.8 The amendments relate only to distributions made by a company to the shareholders where the distribution is treated as funded from share premium accounts created in a specified way (see paragraph 3.18) or reserves created on the revaluation of specified assets (see paragraph 3.19) [Clause 63].
3.9 The amendments apply to:
- •
- liquidator's distributions;
- •
- off-market share buy-backs;
- •
- other disposals of shares; and
- •
- payments in connection with a reduction of capital; made after 12:00 midday Eastern Summer Time 12 January 1994 [Clause 71].
Background to the legislation
3.10 The amendments provide that a capital gain that would arise on the disposal of shares cannot be reduced by making distributions that could be treated as funded out of certain share premium balances and revaluation reserves. The taxation provisions that are affected by the amendments relate to:
- •
- off-market share buy-backs - sections 159GZZZJ to 159GZZZT;
- •
- liquidator's distributions - section 47;
- •
- other disposals of shares - section 160M; and
- •
- amounts of capital paid back on shares - section 160ZL.
3.11 A company can purchase, for cancellation, shares issued by the company. An on-market purchase is broadly where the shares are traded on a stock exchange and the buy-back is made in the ordinary course of business of the stock exchange. An on-market purchase also does not include a transaction described as 'special' under the rules of that stock exchange. An off-market purchase is any buy-back that is not an on-market purchase. The relevant provisions are contained in Division 16K of Part III of the Act (section 159GZZZJ to 159GZZZT).
3.12 Section 159GZZZP provides that an amount paid by the company in an off-market purchase, reduced by the sum of the paid up value of the shares and any part of the purchase price that is drawn from the company's share premium account, is treated as a dividend paid out of profits to the shareholder. The part of the purchase price that is not treated as a dividend is treated as consideration for the sale of the shares (section 159GZZZQ).
3.13 Under the current law, a liquidator's interim distribution that is not a dividend represents repayment of capital on a share. Section 160ZL would apply to such a distribution.
3.14 A liquidator's final distribution constitutes a payment on the disposal of the shares. Section 47 of the Act deals with liquidator's distributions. A liquidator's distribution funded from a revaluation reserve, for example, could constitute a dividend.
3.15 The capital gain or loss on the sale of shares, for example, would be affected by a repayment of capital on those shares. This is because the cost base, indexed cost base or reduced cost base by reference to which the gain or loss is calculated will be affected by the repayment of capital. A dividend may also be paid as part of the consideration for the disposal of shares.
3.16 Currently, section 160ZL of the Act applies to a payment which represents a repayment of capital on shares in a company. It does not apply to a dividend or a payment made on the disposal of the shares.
3.17 Section 160ZL has the effect that a payment to which that section relates reduces the cost base, indexed cost base or reduced cost base of the shares in relation to which the payment was made. If the payment exceeds the indexed cost base of the shares, a capital gain is recognised.
Explanation of the amendments
3.18 The amendments dealing with distributions made out of share premium accounts relate to arrangements under which a company issues shares at a premium and the funds made available by the share issue are used to make a distribution to, or for the benefit of, persons who were shareholders of the company prior to that share issue [Clause 64 - new subsection 159GZZZMA(1); Clause 70 new subsection 160ZLA(1)].
3.19 A revaluation reserve, or part of a revaluation reserve, to which the proposals apply is a reserve representing profits on the revaluation of an asset where, if the company had disposed of the asset immediately after the revaluation:
- •
- any profit that would have arisen on the disposal of the asset would have been included in the company's assessable income or any loss would have been allowed as a deduction from assessable income;
- •
- the CGT provisions of Part IIIA would have applied or would have applied but for a roll-over relief available under Division 17 of that Part. [Clause 64- new subsection 160GZZZMA(4); Clause 70 - new subsection 160ZLA(4)].
3.20 The expression 'rebatable dividend adjustment' is used to refer to the amount of the rebatable dividend that is to be:
- •
- excluded from the amounts by which a capital gain is reduced under subsections 160ZA(4) or 160ZA(5) [Clause 67 - new subsections 160ZA(4A) and 160ZA(5A)];
- •
- included as an amount paid out of share premium or as purchase consideration under paragraph 159GZZZQ(b) for the purposes of determining whether a capital gain or loss arises on the off-market share purchase [Clause 65 - new subsection 159GZZZP(1A); Clause 66 - new subsection 159GZZZQ(2)]; or
- •
- included under section 160ZL as an amount distributed as repayment of capital on shares [Clause 69 - new subsection 160ZL(5)].
Ordering arrangements for distributions
3.21 A company may have a share premium balance of the type described in paragraph 3.18, a revaluation reserve of the type described in paragraph 3.19, and other funds at the time a distribution is made. The ordering arrangement has the effect that the distribution is to be taken to be attributable first to any share premium, then to any revaluation reserve and finally to other funds of the company. [Clause 70 - new subsections 160ZLA(2) and (6)].
3.22 The rebatable dividend adjustment could arise from amounts distributed by the company from a share premium account of the type referred to in paragraph 3.18 or a revaluation reserve referred to in paragraph 3.19.
3.23 The amount that is treated as distributed by the company to a particular shareholder out of share premium arising from an arrangement is calculated using the formula:
Amount of distribution made to the shareholder * (total share premium/total of amounts distributed to shareholders under the arrangement)
The resulting amount is reduced by the share premium, if any, paid by the shareholder for the shares issued under the arrangement and in relation to which the distribution is made [Clause 70 - new subsections 160ZLA(2) and (3)].
3.24 Similarly, the amount treated as distributed by the company to a shareholder out of its revaluation reserve is calculated using the formula:
Amount of distribution made to the shareholder * (total revaluation reserve/total of amounts distributed to shareholders under the arrangement)
[Clause 70 - new subsection 160ZLA(5)]
3.25 If the distributions made from the share premium and the revaluation reserves are fully rebatable, the rebatable dividend adjustment is the total amount of those distributions.
3.26 If the distributions made from the share premium account and the revaluation reserves qualify for a partial rebate, the rebatable dividend adjustment is calculated using the formula:
Distributions from share premium & revaluation reserves * (Amount of dividend rebate obtained/Amount of the full dividend rebate on the dividend amount of the distribution)
[Clause 70 - new subsections 160ZLA(3) and (7)]
3.27 Any part of a liquidator's interim distributions to a shareholder that is funded from a share premium account of the type referred to in paragraph 3.18 or from a revaluation reserve of the type referred to in paragraph 3.19, and which is a rebatable dividend, is to be included in the amounts to which section 160ZL would apply. [Clause 69 - new subsection 160ZL(5)].
3.28 Currently, section 160ZL of the Act applies to a payment not being a dividend, which represents a return of capital on shares. After the amendment, section 160ZL will apply to a dividend to the extent that it is a rebatable dividend funded from a share premium account or a revaluation reserve referred to in paragraphs 3.18 and 3.19 respectively.
3.29 A capital gain computed in relation to the liquidator's final distribution will not be reduced under subsection 160ZA(4) to the extent that the distribution is a rebatable dividend funded from a share premium account of the type referred to in paragraph 3.18 or a revaluation reserve of the type referred to in paragraph 3.19. [Clause 67 - new subsections 160ZA(4A) and (5A)].
3.30 The amendments provide that the amount of the purchase consideration for an off-market share buy-back that is taken into account in calculating the capital gain or loss on the buy-back will include the amount of a rebatable dividend paid in relation to revaluation reserves referred to in paragraph 3.19. Under the current law, the purchase consideration taken into account in calculating the capital gain already includes payments in relation to a share premium account.
3.31 The amendments have the effect that a share buy-back price will not be treated as a dividend not only to the extent that it is treated as funded from a share premium account but also the extent that it relates to a rebatable dividend from a revaluation reserve of the type referred to in paragraph 3.19. [Clause 64 - new section 159GZZZMA; Clause 65 - new subsection 159GZZZP(1A); Clause 66 - new subsection 159GZZZQ(2)].
3.32 The ordering arrangements for distributions will have the effect that any amount paid by the company for the share buy-back is treated as first paid from any share premium account of the type referred to in paragraph 3.18, then from any revaluation reserve of the type referred to in paragraph 3.19 [Clause 64 - new subsections 159GZZZMA(2), (5) and (6)].
3.33 The amount funded from the share premium or the revaluation reserve will not be treated as a dividend if the dividend is fully rebatable. Where the dividend qualifies for a partial rebate, a part of the distribution will not be treated as a dividend [Clause 64 - new subsections 159GZZZMA(3) and (7)].
Chapter 4 Capital Gains Tax- Rebatable dividends out of pre-acquisition profits. Subdivision J of Division 3 (Part 3) of the Bill.
Overview
4.1 The Bill will provide that a capital loss that would otherwise be derived by a controller of a company or an associate of the controller on the disposal of any share in the company will be reduced by any distribution made by the company to the controller or the associate that is a rebatable dividend paid out of pre-acquisition profits.
Summary of amendments
4.2 The amendment will prevent a controller of a company or an associate of a controller from being able to generate a capital loss on the disposal of shares in the company in circumstances where the controller or associate does not suffer an economic loss to the extent of that capital loss.
4.3 Under the current law, a capital loss could be generated in relation to the disposal of shares in a company where there is no equivalent economic loss. This could arise where the shares are sold after the pre-acquisition profits of the company have been distributed in the form of rebatable dividends. Pre-acquisition profits, in relation to a shareholding in a company, are profits retained in the company at the time the shareholding was acquired.
4.4 The following example illustrates a case where a capital loss is generated where there is no equivalent economic loss.
Example
Company X acquired all the shares of company Y for their market value of $10,000. At the time of acquisition of the shares, the balance sheet of company Y was as follows:
Share capital 2,000 Retained profits $ 8,000 $10,000 Assets $10,000
Company Y continued business operations over the next four years. During this period, it distributed all of its current earnings as well as the retained profits. Company X then disposed of the shares in company Y for $2,000.
4.5 The dividends paid by company Y to company X qualified for the dividend rebate under section 46 of the Act. Consequently, no company tax was paid on those dividends. Moreover, company X has recovered the full amount of its investment of $10,000 in company Y in the form of dividends ($8,000) and disposal consideration ($2,000). Nevertheless, under the current law, company X may claim a capital loss of $8,000. This is the difference between the cost of the shares ($10,000) and the disposal consideration ($2,000).
4.6 The anti-avoidance provisions of Part IVA of the Act could apply where there is a scheme by way of or in the nature of dividend stripping or a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping. However, it should be the general rule that a capital loss should not be able to be claimed where the result of the course of action is that there is no economic loss to the taxpayer.
4.7 The amendments to the law will have the effect that a capital loss cannot be claimed by company X in the circumstances shown in the example [Clause 63].
4.8 The amendment will apply in relation to disposals of shares made on or after the date of introduction of the Bill [Clause 71].
Background to the legislation
4.9 Section 160Z provides that a capital loss arises in relation to the disposal of an asset where the reduced cost base to the taxpayer of the asset exceeds the consideration in respect of the disposal. Section 160ZH sets out the meaning of the cost base of an asset acquired by the taxpayer while section 160ZK deals with the calculation of the reduced cost base of the asset. Section 160ZD deals with the determination of the consideration for the disposal of an asset.
4.10 Sections 46 and 46A provide that a resident company which receives a dividend from another resident company can, depending on the circumstances, qualify for a full or a partial rebate of tax payable in relation to that dividend. A full rebate has the effect of freeing the dividend from tax while a partial rebate reduces the tax payable on that dividend.
Explanation of the amendments
4.11 The amendments deal with the situation where a company shareholder disposes of shares held in another company after that other company has distributed some or all of its pre-acquisition profits. The amendments apply only where the shares were held by the controller of the company or by another company that is an associate of the controller. The amendments will also only apply where the pre-acquisition profits were distributed as dividends that were fully or partly rebatable.
Controlling shareholder and associate
4.12 The expressions 'controller' and 'associate' are explained in the notes in Chapter 5.
4.13 The amendments will reduce the reduced cost base of shares held by the shareholder in calculating the capital loss arising on the disposal of the shares. It will not affect the calculation of the gain, if any, on the disposal of the shares [Clause 68 - new subsections 160ZK(1A) and (3B).]
4.14 It will apply where:
- •
- there is an arrangement under which a distribution has been made by a company to the controlling shareholder or an associate;
- •
- the distribution was wholly or partly a rebatable dividend; and
- •
- it is reasonable to treat the distribution as having been made out of the pre-acquisition profits of the company.
[Clause 68 - new subsection 160ZK(5)]
4.15 The concept of an arrangement is only used to allow a link to be made between a distribution out of pre-acquisition profits and the period by reference to which the test of whether there is a controller of the company is applied. It does not limit in any other way the application of the amendments to a distribution made by the company out of pre-acquisition profits.
4.16 Where the dividend qualifies for a full dividend rebate, the reduced cost base of the shares is to be reduced by the full amount of the dividend. Where the dividend qualifies for a partial rebate only, the reduced cost base is to be reduced by a proportionate part of the dividend [Clause 68 - new subsection 160ZK(6)].
Chapter 5 - Capital Gains Tax - Share value shifting arrangements - Subdivision A of Division 3 (Part 3) of the Bill
Overview
5.1 This Bill will subject share value shifting arrangements to appropriate capital gains tax (CGT) treatment.
Summary of proposed amendments
5.2 To remove the CGT advantages of share value shifting arrangements [Clause 25].
5.3 The amendment is to apply to arrangements where the share value shift occurs after 12:00 midday Eastern Summer Time on 12 January 1994 [Clause 28].
Background to the legislation
5.4 Share value shifting is the shifting of value from one share or class of shares in a company into another share or class of shares. There are many ways in which value may be shifted from one share in a company to another. Examples are changes to dividend or voting rights in the company, and a general dilution of value of existing shares when the company issues new shares for less than market value.
5.5 In some cases of share value shifting the effect of a disposal of a share or shares to another person may be achieved without an actual disposal for CGT purposes. In addition share value shifting may be undertaken as an attempt to generate a capital loss or to diminish a capital gain which would otherwise have accrued on the disposal of shares. For instance, a person may arrange for value to be shifted from one class of shares to another class also owned by the person, and then dispose of the shares out of which value has been shifted.
What were the CGT consequences of share value shifting before these proposed amendments?
5.6 Broadly speaking, the CGT provisions of the Act apply where there is a disposal of an asset. Even though a share value shift may achieve the effect of a disposal of a share or part of a share, it would usually not have been a disposal for CGT purposes before these proposed amendments.
5.7 However, some share value shifting transactions would entail CGT consequences even without these proposed amendments. A share value shift will generally come about because an act or transaction has taken place in relation to a share, or because an event affecting the share has occurred. In such a case subsection 160M(7) of the Act would apply to any consideration received by reason of the act, transaction or event. Moreover the general anti-avoidance provisions of Part IVA of the Act may apply in relation to a tax benefit gained from a share value shift.
5.8 One type of transaction relating to shares which may involve a value shift is the issue of bonus shares. The value shifting aspect of such issues are addressed by specific provisions in Part IIIA of the Act, namely Divisions 8 and 8A.
What are the CGT consequences of share value shifting under the proposed amendments?
5.9 Both subsection 160M(7) and Part IVA of the Act may continue to apply to share value shifting. However, the proposed amendment introduces new Division 19B into Part IIIA which specifically applies to certain share value shifting arrangements. Where this new Division applies, subsection 160M(7) will not operate; however, the operation of Part IVA is not excluded. To the extent that a share value shift is addressed by the specific provisions of Part 111A relating to the issue of bonus shares, those provisions will continue to apply to the exclusion of new Division 19B.
5.10 New Division 19B does not extend to all situations of share value shifting. For the Division to apply, the following elements (which are explained in detail later in this chapter) are required:
- •
- a controller of a company; and
- •
- an arrangement under which something is done in relation to a share in the company which it is reasonable to conclude caused:
- -
- a material decrease in value of one or more post-CGT shares (i.e. acquired on or after 20 September 1985) held by the controller or an associate of the controller; and
- -
- an increase in value (or issue at less than market value) of another share or other shares held by that person, or an associate of that person.
5.11 Where these elements are present there is:
- •
- a capital gain to the extent that:
- -
- the shares which increase in value are pre-CGT shares (i.e. acquired by the shareholder before 20 September 1985) or are held by someone else; and
- -
- the amount of the decrease in value of the decreased value shares which relates to that increase exceeds the cost base or indexed cost base of the share attributable to that decrease; and
- •
- in all cases, appropriate cost base adjustments to the shares involved in the value shift having regard to the capital gain and to ensure that there are no CGT advantages to be gained from the shift.
Explanation of amendments
5.12 The object of the Bill and of new Division 19B is to remove the CGT advantages of share value shifting arrangements, [Clause 25 and new section 160ZZRI].
5.13 This is to be achieved by inserting new Division 19B into Part IIIA of the Act [Clause 26].
5.14 To assist understanding of the provisions contained in new Division 19B, a simplified outline and list of definitions is provided by the Bill [New section 160ZZRJ and new section 160ZZRK].
(a) Requirements for Division to apply
5.15 The share value shifting provisions will apply if:
- •
- a share value shift takes place under an arrangement involving a company and a taxpayer;
- •
- the taxpayer is a controller of the company at some time during the course of the arrangement; and
- •
- there is a material decrease in the market value of a share involved in the share value shift..
[New section 160ZZRL].
5.16 The elements of these three prerequisites are discussed below.
5.17 An arrangement is very broadly defined. It incorporates the elements contained in the definition of scheme in subsection 177A(1) of the Act, as well as the conception in subsections 177A (3) and (4) that the arrangement may be that of one person or more than one person [New subsection 160ZZRM(3)].
5.18 There does not need to be a tax avoidance purpose before the share value shifting provisions may apply.
5.19 The concept of an arrangement allows a link to be made in a series of particular events to bring them all within the one arrangement. This ensures that even if, for instance, a share value shift proceeds over a long period, each decrease in value of a share may be attributed to a single arrangement.
5.20 Under the arrangement something must be done in relation to (which also includes 'to' ) a share or shares in the company. This proviso is intended to require a direct connection between the thing done and the shares in the company. Therefore a purely incidental share value shift as a result of, for instance, particular investments undertaken by the company will not trigger the share value shifting provisions. [New paragraph 160ZZRM(1)(a)].
5.21 The examples provided in new paragraph 160ZZRM(1)(a) of changing voting rights, buying back shares and issuing new shares at a discount are examples of where something is done in relation to a share or shares of the company. However, the list of examples is not intended to limit the types of situations where something is done in relation to a share or shares in the company for the purposes of the share value shifting provisions.
5.22 The thing done under the arrangement may be done by the company itself (for instance, by a company resolution or by an agent of the company or a company liquidator), by the controller or by an associate of the controller. It may done by those persons acting alone or with one or more persons. [New paragraph 160ZZRM(1)(a)].
(ii) Share value shift: decreased value share
5.23 At the same time as, or after, the thing under the arrangement is done there needs to be:
- •
- a material decrease in market value
- •
- of a post-CGT share
- •
- which is held by the controller of the company or an associate of the controller.
This share(together with any other post-CGT share held by the controller or associate which decreases in value under the share value shift whether or not the decrease is material) is called the decreased value share. The decreased value shares do not have to be the shares in relation to which something is done under the arrangement. [New subparagraph 160ZZRM(1)(b)].
5.24 The meaning of a material decrease is explained below.
5.25 A share includes an interest in a share, and a right or option (contingent or otherwise) to acquire a share or an interest in a share [New subsection 160ZZRM(4)].
5.26 A post-CGT share is a share acquired by the shareholder on or after 20 September 1985 [New subsection 160ZZRM(6)].
5.27 The meanings of controller and associate are explained below.
5.28 The holder of a share will be a controller of the company for these purposes even if not the controller at the time of the value shift, provided that the holder was the controller at some time during the course of the arrangement (from the time it was entered into to the end of the share value shift). For instance, if a person who controls the company enters into an arrangement under which a share value shift is to take place in relation to shares held by that person after control is passed to another person, the value shifting provisions may apply in relation to a decreased value share held by the former controller. [New paragraph 160ZZRL(b)].
5.29 An example of where a decrease in value of a share occurs at the same time as the thing under the arrangement is done is in a share buy-back at less than market value. In such a case there is a relevant decrease in the value of the shares bought back even though the decrease occurs at or immediately before the time at which they are bought back.
5.30 Because of the requirement that there be a decrease in value of the share, a share which is acquired for more than market value will not be a decreased value share even though it results in the increase in value of other shares held in the company. This is because the market value of the newly acquired share immediately after the issue would be the same as its market value at the time of its issue (its market value is not directly affected by the amount paid for it). However, although new Division 19B would not operate to adjust the cost base of the newly issued shares, if the parties to the share issue are not dealing at arm's length subsection 160ZH(9) of the Act will reduce the consideration paid for the shares to their market value. As explained below, shares issued for less than market value are specifically included as increased value shares.
(iii) Share value shift: increased value share
5.31 In addition to the material decrease in value of the decreased value share, for a share value shift to occur there needs to be, at the same time as, or after, the thing under the arrangement is done:
- •
- an increase in market value of another share or other shares in the company held by the person who holds a decreased value share, or by an associate of that person; or
- •
- at least one new share in the company issued to the person who holds a decreased value share, or to an associate of that person where the market value of that new share exceeds any consideration (money or property) given for it.
Each of these shares is called the increased value share. The increased value shares do not have to be the share in relation to which something is done under the arrangement. [New paragraph 160ZZRM(1)(c)]
5.32 In the case of the issue of a new share, the increase in market value of the share for the purposes of the value shifting provisions is the amount by which the market value of the new share exceeds any consideration given for it [New subparagraph 160ZZRM(1)(c)(ii)].
5.33 The increase in value of the increased value shares does not have to be the same as the decrease in value of the decreased value shares. Nor does the increase have to be a material increase.
5.34 It is not necessary for the kind of share which comprises the decreased value shares to be the same as the kind which comprises the increased value shares. For example, the decreased value shares may constitute options to acquire shares while the increased value shares may be interests in shares.
5.35 There needs to be a nexus between the decrease and the increase in market value of the shares involved in the share value shift. Therefore purely coincidental decreases and increases will not trigger the share value shifting provisions. The required nexus is that it must be reasonable to conclude that doing of the thing in relation to the share or shares caused (in whole or part) the decrease in value of the decreased value shares and the increase in value (or creation) of the increased value shares. This is an objective test and may be satisfied whether or not the decrease and the increase or creation were intended. [New paragraph 160ZZRM(1)(d)]
5.36 If the decrease and/or increase in market value of the shares which occurs after something is done under the arrangement was caused partly by doing the thing and partly by some unconnected event, the share value shifting provisions apply only to that part of the increase or decrease that was caused by the thing done under the arrangement [New subsection 160ZZRM(2)].
5.37 A taxpayer is a controller of a company if the taxpayer meets one of three control tests:
- •
- Strict control test. Under this test, the taxpayer, together with associates of the taxpayer, owns or is entitled to acquire a control interest of at least 50% in the company. The sum of the interests of an entity and its associates in the company is referred to as the associate inclusive control interest. The meaning of associate and associate inclusive control interest is explained below. [New paragraph 160ZZRN(1)(a)]
- •
- Assumed controller test. This test is satisfied if the taxpayer owns, or is entitled to acquire, an associate inclusive control interest of at least 40% in the company, unless the company is controlled by a party (referred to as an 'entity' ) or parties (referred to as a 'group of entities' ) unrelated to the taxpayer or to any associate of the taxpayer and including neither the taxpayer nor any associate of the taxpayer [New paragraph 160ZZRN(1)(b).]
- The expressions 'entity' and 'group' are to have the same meaning as in Part X of the Act, which deals with controlled foreign companies. In this regard, Part X provides that:
- -
- 'entity' means a company, a partnership, a person in the capacity of trustee or any other person; and
- -
- 'group' includes one entity alone or a number of entities the members of which are not in any way associated with each other nor acting together, and so is not restricted to a number of entities which are associated or are acting together [New subsection 160ZZRN(2)].
- •
- De facto control test. This test is satisfied if the taxpayer and the taxpayer's associates do effectively control the company. If the taxpayer can, for example, control the appointment of directors of a company, the taxpayer will generally be taken to have de facto control of the company. [New paragraph 160ZZRN(1)(c)]
5.38 It is possible for there to be more than one controller of a company (for instance, because associates together have strict control, assumed control or de facto control). A controller can be a company or a natural person.
5.39 The tests require ascertainment of interests held in a company. In most cases an interest in a company will be held in the form of shares. Interests in a company include those held directly or indirectly. At a particular time, a taxpayer's interests in a company include the interests the taxpayer holds in the company as well as the interests the taxpayer is entitled to acquire in the company.
5.40 To determine whether a taxpayer has an associate inclusive control interest in a company (see below), the interests of the taxpayer's associates in the company are also relevant.
5.41 The following paragraphs explain what interests in a company are taken into account in the tests for determining whether a company is controlled for value shifting purposes. These tests are based on those contained in Division 3 of Part X of the Act for determining whether a foreign company is a controlled foreign company. The modifications which have been made to the Part X tests are explained after the explanation of how the tests operate.
Direct control interests in a company
5.42 A direct control interest that a taxpayer has in a company is calculated as the greatest of the percentages that the taxpayer holds, or is entitled to acquire, of the following:
- •
- the total paid-up share capital in the company;
- •
- the total rights to vote, or to participate in any decision making, in relation to:
- -
- the distribution of capital or profits;
- -
- the changing of the constituent documents;
- -
- the varying of the share capital of the company;
- -
- total rights to distributions of capital or profits of the company on winding-up; or
- -
- total rights to distributions of capital or profits of the company other than on winding-up.
5.43 In calculating a taxpayer's direct control interests in a company, shares referred to as eligible finance shares in the company are not taken into account. These are, generally, shares issued under preference shares financing arrangements with Australian financial intermediaries (such as banks) and their subsidiaries. In effect, they stand in place of loans.
Indirect control interest in a company
5.44 A taxpayer may hold a direct control interest in an entity (entity A) which holds a direct control interest in another entity (entity B). In this case the taxpayer has an indirect control interest in entity B.
5.45 A taxpayer's indirect control interest in entity B is obtained by multiplying the direct control interest of the taxpayer in entity A by the entity's direct control interest in entity B. This process of multiplication is continued where there are further entities in the chain.
Deeming rules for tracing an indirect control interest
5.46 For the purpose of determining the indirect control interest in an entity a taxpayer or an interposed entity is deemed, in specified circumstances, to own a 100% interest in a lower tier entity. These circumstances are described in the following chart:
| Direct control interest of taxpayer together with associates | Interest deemed to be |
|---|---|
| A taxpayer has an interest of at least 50% in a company | 100% |
| A taxpayer satisfies the assumed controller test in relation to a company | 100% |
| A taxpayer actually controls the company | 100% |
| A taxpayer is a partner in a partnership | 100% |
| A taxpayer has interest of at least 50% in a trust | 100% |
Associate inclusive control interest
5.47 A taxpayer's associate inclusive control interest in a company is the sum of the taxpayer's:
- •
- direct control interests in the company;
- •
- indirect control interests in the company;
- •
- associates' direct control interests in the company; and
- •
- associates' indirect control interests in the company.
5.48 In calculating a taxpayer's associate inclusive control interest in a company, double counting of a direct control interest or an indirect control interest held by the taxpayer and the taxpayer's associates is rectified by special provisions.
Modifications of the Part X tests of control
5.49 The above tests for determining whether a taxpayer has an associate inclusive control interest of a certain amount are modified versions of the control tests contained in Division 3 of Part X. The modifications (which have been incorporated in the explanation provided above) are described below. [New subsection 160ZZRN(3)].
5.50 The expression 'company' in Part X does not include a company in the capacity of trustee. However, the tests of control provided in Part X of the Act are applied to determine whether a taxpayer is the controller of a company for value shifting purposes even if the company acts in the capacity of a trustee [New paragraph 160ZZRN(4)(a)].
5.51 Subsection 349(4) deals with the tracing of control through chains of entities and provides that, for tracing of interests, an entity is in certain circumstances deemed to hold a 100% control interest in another entity. The Bill applies this provision to the tracing of control interests in a company. [New paragraph 160ZZRN(4)(b)].
5.52 Subsections 350(6) and 350(7) deal with the case where a company is controlled by a group of 5 or fewer Australian entities. These rules will not apply in determining, in the value shifting provisions, whether a taxpayer controls a company. [New paragraph 160ZZRN(4)(c)]
5.53 Subsection 352(2) provides that an indirect control interest can only be traced through an interposed entity if the entity is a controlled foreign entity. This test is modified so that an interposed entity is not to be taken into account in calculating an indirect control interest unless the entity is:
- •
- a company of which the taxpayer or associate is a controller;
- •
- a partnership; or
- •
- a trust.
[New paragraph 160ZZRN(4)(d)]
5.54 Section 354 provides that each partner in a controlled foreign partnership is treated as having a 100% control interest in the partnership in tracing control of another entity through the partnership. This rule is to be applied in the share value shifting provisions in tracing control through any partnership and not only through controlled foreign partnerships. [New paragraph 160ZZRN(4)(e)].
5.55 Section 355 sets out rules that apply to the tracing of control interests through a controlled foreign trust. These rules are to be applied in the share value shifting provisions to tracing of interests through all trusts. However, the special rule in subsection 355(1), that an eligible transferor in relation to a controlled foreign trust holds a control tracing interest of 100% in the trust, will not apply to the value shifting provisions. [New paragraphs 160ZZRN(4) (c) and (f)].
5.56 For the purpose of the value shifting provisions, the expression associate is to have the same meaning as in Part X of the Act [New subsection 160ZZRN(2)].
5.57 The determination of who are the associates of an entity proceeds in four parts. The first part deals with associates of an individual. The second deals with associates of a company, the third with associates of a trustee and the fourth with associates of a partnership. When an entity acts in the capacity of a trustee, the part dealing with the associates of a trustee will determine the associates of that entity in that capacity.
Part 1 - Associates of an individual
5.58 The associates of an individual (other than an individual acting in the capacity of a trustee) are:
- •
- relatives of the individual, as follows:
- -
- the parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or of his or her spouse (including de facto); and
- -
- the spouse (including de facto) of the individual or any other person mentioned above;
- •
- a partner of the individual or a partnership of which the individual is a partner;
- •
- the spouse (including de facto) or child of a partner, where the partner is also an individual (other than an individual acting in the capacity of a trustee);
- •
- the trustee of a trust, where the individual or another entity that is an associate of the individual by virtue of this Part benefits under the trust; or
- •
- a company where that company is sufficiently influenced by:
- -
- the individual; or
- -
- another entity that is an associate of the individual because of the rules in this Part; or
- -
- another company which is sufficiently influenced by the individual; or
- -
- two or more of the above entities; or
- •
- a company where the capacity to cast or control greater than 50% of the maximum votes at a general meeting of the company is held by:
- -
- the individual; or
- -
- associates of the individual under the rules in Part 1; or
- -
- the individual and the associates.
Part 2 - Associates of a company
5.59 Part 2 deals with the associates of a company (company A). The associates of company A include:
- •
- a partner of company A;
- •
- a partnership of which company A is a partner;
- •
- where a partner of company A is a natural person otherwise than in the capacity of a trustee, the spouse or child of the partner;
- •
- the trustee of a trust where company A, or an entity that is an associate of company A under Part 2, benefits under the trust;
- •
- an entity (entity B) that exerts sufficient influence over company A or holds a majority voting interest in company A. The influence may be exerted by entity B alone or together with other entities. The majority interest may be held by entity B alone or together with entities that would be associates of entity B if it is treated as if it were company A and the first three Parts of the tests for associates applied to it;
- •
- a company (company C) that is sufficiently influenced by company A or in which company A holds a majority voting interest. The influence may be exerted by company A alone or together with other entities that are sufficiently influenced by company A or in which company A hold majority voting interests. The majority voting interests may be held by company A alone or together with entities that are associates of company A as determined under Part 2 of the tests for associates; and
- •
- any other entity (entity D) that would be an associate of a third entity (entity E) which would be an associate of company A if the associates of entity E are determined treating it as if it were company A and applying the first three parts of the tests for associates.
5.60 An entity holds a majority voting interest in a company where:
- •
- the entity's direct shareholding in the company, and
- •
- the entity's indirect shareholding in the company (for example through a subsidiary),
amount to 50% or more of the maximum number of votes that might be cast at a general meeting of the company. An example is where a company has a wholly owned subsidiary which has a 75% voting interest in another company. Both the parent and subsidiary would be associates of the third company. This is because the subsidiary has a majority voting interest in the third company and the parent has a majority voting interest in the subsidiary.
5.61 An entity is sufficiently influenced by a second entity or other entities if the entity is accustomed or under an obligation or might reasonably be expected to act in accordance with the directions, instructions or wishes of the second entity or other entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts).
Part 3 - Associates of a trustee
5.62 The associates of a trustee are:
- •
- any entity that benefits under the trust;
- •
- any entity that is an associate, under Part 1 or Part 3, of an individual who benefits under the trust; or
- •
- where a company is an associate of the trustee under either of the two above dot points, an entity that would be an associate of the company under Part 2 or Part 3.
Rules relating to public unit trusts
5.63 In applying the tests for associates, the trustee of a public unit trust is treated as if it were a company. Special rules apply in order to determine whether a public unit trust is sufficiently influenced by another entity or whether an entity has a majority voting interest in the public unit trust.
5.64 Generally, a public unit trust will be sufficiently influenced by another entity or entities where the trust is accustomed to act or is under an obligation to act or might reasonably be expected to act in accordance with the directions, instructions or wishes of the entity or entities.
5.65 The concept of a 'majority voting interest' in relation to public unit trusts will be determined by reference to the corpus or income of the trust. If an entity is entitled to, or is entitled to acquire, 50% or more of the income or corpus of the trust then the entity is considered to hold a majority voting interest in the public unit trust. Corresponding rules apply to test whether a group of entities have a majority voting interest in the trust.
Part 4 - Associates of a partnership
5.66 The associates of a partnership are:
- •
- a partner in the partnership;
- •
- where the partner is an individual, any entity which would be an associate under Part 1 or Part 3 of that individual; or
- •
- where the partner is a company, any entity which would be an associate of the company because of Part 2 and Part 3.
(vii) Material decrease in value
5.67 The share value shifting provisions will only apply if the decrease in market value of the decreased value share is material. A particular decrease (referred to in new subsection 160ZZRO(1) as the current decrease) in market value of a share under a share value shifting arrangement will be material if:
- •
- it is 5% or more of the total market value of the share immediately before the decrease, or if it is one of a number of decreases under the arrangement and the sum of all the decreases (whether before or after the particular decrease) is 5% or more; or
- •
- the total decrease in market value of all the decreased value shares held by the controller or associate is $100,000 or more.
[New subsection 160ZZRO(1)]
5.68 The share value shifting provisions apply to the whole of a material decrease, not just to that part of the decrease which exceeds the thresholds outlined above.
5.69 Under a particular value shifting arrangement there may be a series of decreases in value of a share, each decrease being part of the one arrangement. In such a case the sum of all the decreases is used to determine whether there is a material decrease in value. Therefore if, for instance, a share value shift takes place in two stages so that first there is a 6% decrease in the market value of a share and then, some time later, a 4% decrease in the same share, the whole of the decrease, whether taken individually or cumulatively, will be taken into account for the purposes of the value shifting provisions.
5.70 Although it is a requirement before the share value shifting provisions apply that the decrease in market value of the decreased value share be material, it is not necessary that the increase in market value of the increased value share be material. However, as explained below, certain consequences for the increased value share follow only if the increase is material.
(b) Operation of share value shifting provisions
5.71 Where the above prerequisites are met so that the value shifting provisions apply, the Bill provides what the consequences are for the shares whose market value decreases (the decreased value shares) where the decrease is material, and for the shares whose market value increases materially. The consequences depend on whether the increased value shares are pre-CGT or post-CGT shares.
5.72 A pre-CGT share is a share which was acquired by the shareholder before 20 September 1985 [New subsection 160ZZRM(5)]. A post-CGT share is a share which was acquired by the shareholder on or after 20 September 1985 [New subsection 160ZZRM(6)].
(i) Consequences of value shift to pre-CGT share or different shareholder share
5.73 The operative provisions described below ( subsections 160ZZRP(2) and (3) ) apply if any of the increased value shares is a pre CGT share [New subsection 160ZZRM(6)]
5.74 If those operative provisions apply, the consequences are as follows:
- •
- there may be a deemed capital gain; and
- •
- there is a reduction in the cost base, indexed cost base or reduced cost base of the decreased value shares
These are explained below. there is no adjustment to the cost base of the pre-CGT increased value shares because those shares do not have a cost base.
5.75 In relation to each decreased value share for which there was a material decrease, the holder will be deemed to receive a capital gain equal to the amount by which the consideration calculated under new subparagraph 160ZZRP(2)(a)(ii) exceeds (if at all) the proportion of the cost base or indexed cost base calculated under new subparagraph 160ZZRP(2)(a)(iii) . No capital loss will arise if the proportion of the cost base used against the decrease is more than the amount of the decrease. [New subsection 160ZZRP(2)].
5.76 The consideration referred to above is the amount of the (material) decrease in value of each decreased value share which is referable to the increase in value of the pre-CGT increased value shares. This is calculated by multiplying the total decrease in market value of each of the decreased value shares by the proportion of the total market value increase (as defined) which is attributable to the pre-CGT increased value shares. [New subparagraph 160ZZRP(2)(a)(ii)].
5.77 The total market value increase is the sum of:
- •
- all increases in market value of all increased value shares (i.e. shares held by the controller or associate, or associate of that person, which increase in value pursuant to a share value shift as defined in new section 160ZZRM); and
- •
- all increases in market value of all other shares where the requirements of a share value shift under new section 160ZZRM are satisfied but for the fact that the shares are not increased value shares because they are not held by the controller or associate, or associate of that person.
[New subsection 160ZZRO(3)]
5.78 For example, if there are:
- •
- 200 decreased value shares held by the controller, each of which decrease in market value by $40 from $100 to $60; and
- •
- 50 increased value shares which are pre-CGT shares of the controller which increase in value by $80 from $20 to $100;
- •
- 50 increased value shares which are post-CGT shares held by an associate of the controller which increase in value by $40 from $20 to $60; and
- •
- 50 increased value shares which are post-CGT shares held by a third party, unassociated with the controller, which also increase in value by $40 from #20 to $60.
then, since the decrease in value referable to the increase in the post-CGT shares held by the associate and third party are not taken into account for new section 160ZZRP purposes, the consideration in respect of each decreased value share will be:
($80 * 50(pre-CGT shares)/([$80 * 50(pre-CGT shares)] + [ $40 * 100 (other increasing shares)])) * $40 = $20
[New subparagraph 160ZZRP (2) (a) (ii)]
5.79 The cost base used against the decrease is calculated by multiplying:
- •
- the amount that would have been the cost base or indexed cost base of the share if it had been disposed of immediately after the decrease; by
- •
- the same proportion that the decrease in the market value of the share referable to the pre-CGT increased value shares bears to the market value of that share immediately before the decrease.
[New subparagraph 160 ZZRP(2)(a)(ii)]
5.80 In the example provided above, if the amount that would have been the indexed cost base of each of the decreased value shares is $60, then the cost base used against the consideration would be:
($20/$100) * $60 = $12
This would result in a capital gain of $8 in respect of each decreased value share in relation to the value shifted into the pre-CGT increased value shares.
5.81 In determining the amount that would have been the cost base or indexed cost base of a decreased value share if it had been disposed of immediately after the decrease, any previous application of new subsection 160ZZRP(3) (see below) should be taken into account. For instance, if:
- •
- there are a number of material decreases in value under one share value shifting arrangement, and
- •
- a reduction would be made to the cost base or indexed cost base under new subsection 160ZZRP(3) in relation to previous decreases,
then the cost base or indexed cost base to be used for the purposes of new subparagraph 160ZZRP(2)(a)(iii) in relation to a subsequent decrease in value is what would have been the cost base or indexed cost base of the share as reduced by new subsection 160ZZRP(3). This is because new subsection 160ZZRP(3) states that it applies for the purposes of any application of Part IIIA to a later disposal of the decreased value share, which must include for the purposes of application of new subparagraph 160ZZRP(2)(a)(iii).
5.82 New subsection 160ZZRP(2) operates on the assumption that a part of the decreased value share is disposed of. If the company disposes of an asset to another company in the same company group, roll-over relief may be available under section 160ZZO of the Act. However, roll-over relief is not available in relation to capital gains accruing on share value shifting transactions because, although there is a presumed disposal of part of the share, there is no deemed acquisition such that it can be said that part of the share has been disposed of to a particular taxpayer (for instance, a company within the same company group).
5.83 Any capital gain accruing under new subsection 160 ZZRP(2) (i.e. in relation to the shift in value to pre-CGT shares) will be additional to any capital gain accruing under new subsection 160ZZRQ(2) ( i.e in relation to the shift in value to post-CGT increased shares held by another person). Therefore, in relation to the example explained above, the controller will incur a further capital gain in relation to the value shifted to the shares held by the associate. This is explained below.
Adjustment to acquisition consideration etc. for decreased value share
5.84 Whether or not there is a deemed capital gain, a reduction is to be made to the cost base, indexed cost base or reduced cost base of the decreased value share for the purposes of a subsequent disposal (including a disposal for new subparagraph 160ZZRP(2)(a)(iii) purposes). This reduction prevents a capital loss being generated, or a capital gain being reduced, by the value shifting transactions. [New subsection 160ZZRP(3)].
5.85 The reduction is made in relation to each decreased value share for which there was a material decrease in value by reducing:
- •
- the consideration and other expenditures which, immediately before the decrease in value took place, would comprise the cost base, indexed cost base or reduced cost base of the share under section 160ZH of the Act; by
- •
- the same proportion that the decrease in the market value of the share referable to the increase in market value of the pre-CGT increased value shares bears to the market value of that share immediately before the decrease.
5.86 The result is, therefore, that there is a reduction to what would be the cost base, indexed cost base or reduced cost base by an amount equivalent to the cost base calculated under new subparagraph 160ZZRP(2)(a)(iii) which would be used against the consideration received for the deemed disposal if that subsection applied (i.e. the $12 calculated in the above example). The approach of reducing each of the expenditures comprising the cost base rather than directly reducing the cost base as a whole is adopted since, on a later disposal of the share, the cost base is calculated by reference to the consideration and other expenditures in section 160ZH.
5.87 New subsection 160ZZRP(3) can apply successively to a number of decreases in value under a share value shift arrangement or arrangements. Moreover, the cost base reduction calculated under the subsection is additional to any cost base reduction calculated under new subsection 160 ZZRQ(3). Therefore, in the example outlined above, the expenditure comprising the indexed cost base of the decreased value shares will be further reduced by reference to the value shifted into the post-CGT shares held by the associate. This is explained below.
(ii) Consequences of value shift to post-CGT shares
5.88 The operative provisions described below (new subsections 160ZZRQ(2) to (6) ) apply if at least one of the increased value shares is a post-CGT share. Any post-CGT increased value shares will be held by the controller, an associate of the controller, or, if that associate holds a decreased value share, an associate of the associate. [New subsection 160ZZRQ(1)]
5.89 If those operative provisions apply, the consequences are as follows:
- •
- there may be a deemed capital gain in relation to the decreased value shares held by someone other than the holder of the increased value shares new subsection 160ZZRQ(2)] ;
- •
- the cost base, indexed cost base or reduced cost base of the decreased value shares are reduced new subsection 160ZZRQ(3)] ; and
- •
- subject to certain conditions, there is an increase in the cost base, indexed cost base or reduced cost base of the increased value shares [New subsections 160ZRQ(4) to (6)]
5.90 As with shifts of value into pre-CGT shares, if value is shifted from shares held by a taxpayer to shares held by another person, the taxpayer will not be subject to CGT in relation to capital gains accrued on the value shifted when the increased value shares are disposed of. Therefore it is necessary to subject that gain to CGT at the time of the shift in value.
5.91 Therefore new subsection 160ZZRQ(2) determines any capital gain that may arise in relation to the decreased value shares which suffer a material decrease to the extent that value is shifted from those shares into post-CGT increased value shares held by another person. To achieve this, the subsection identifies the decreased value shares to which it applies as 'different person shares'. These are decreased value shares held by a person other than the person who held a particular post-CGT increased value share. Because a share value shift requires that increased value shares be held by the same person as the holder of decreased value s hares or an associate of that person, the holder of a different person share will always be an associate of the holder of an increased value share. Moreover, since new Division 19B only applies in relation to a material decrease in value, a different person share must be one whose decrease in value is material. [New paragraph 160ZZRQ(2)9a)].
5.92 The capital gain in relation to a different person share is calculated in the same way as a capital gain in relation to a shift in value to pre-CGT shares under new subsection 160ZZRP(2). The gain is equal to the amount by which the consideration calculated under new subparagraph 160ZZRQ(2)(a)(iv) exceeds (if at all) the proportion of the cost base or indexed cost base calculated under new subparagraph 160ZZRQ(2)9a)(v) . Once again, no capital loss can arise under the subsection. [New subsection 160ZZRQ(2)(a)(iv)] .
5.93 The consideration to above is the amount of the decrease in value of each different person share which is referable to the increase in value of the post-CGT increased value shares held by the different person. This is calculated by multiplying the decrease in market value of each of the different person shares by the proportion of the total market value increase (as defined above) which is attributable to those post-CGT increased value shares. [New subparagraph 160 RQ(2)(a)(iv)] .
5.94 In the example provided above in paragraph 5.78 the decreased value shares would be different person shares in relation to the increased value shares held by the associate. Therefore, since there are 50 increased value shares held by the associate which increase in value by $40, the consideration in respect of each of the decreased value shares (which decrease in value by $40) would be:
(($40 * 50 (increased values shares held by associate)/([$80 * 50 (pre-CGT shares)] + [440 * 100 (other increasing shares)])) * $40 = $10
[New subparagraph 160ZZRQ(2)(a)(iv)]
5.95 The cost base or indexed cost base used against the decrease is calculated by multiplying:
- •
- the amount that would have been the cost base or indexed cost base of the different person share if it had been disposed of immediately after the decrease; by
- •
- the same proportion that the decrease in its market value which is attributable to the post-CGT increased value shares held by the different person bears to its market value immediately before the decrease.
[New subparagraph 160ZZRQ(2)(a)(v)]
5.96 In the example in paragraph 5.78 above, assuming a $60 indexed cost base for the decreased value shares, the cost base to be used in determining the capital gain would be:
($10/$100) * $60 = $6
This would result in a capital gain of $4 in respect of each decreased value share in relation to the value shifted into the post-CGT increased value shares held by the associate. It would be added to the $8 capital gain in relation to the shift to the pre-CGT increased value shares, giving a total capital gain for the share value shift of $12. The cost base of the share involved in the share value shift will also be adjusted, as explained below.
5.97 There is no deemed capital gain in relation to the value shifted into post-CGT shares from decreased value shares which are held by the same person. These decreased value shares which are called 'same person shares', which, like different person shares, must suffer a material decrease in value. There is no immediate capital gain liability in relation to this shift in value because any capital gain that had accrued in relation to the value shifted is not shifted out of the person's shareholding (or into CGT-exempt, pre-CGT shares). By making the cost base adjustments described below to the shares involved in the value shift, CGT is deferred until the capital gain is realised by disposing of those shares.
Adjustment to acquisition consideration etc for decreased value share
5.98 The amount of the reduction to the components comprising the cost base, indexed cost base or reduced cost base of the decreased value shares (both different person and same person shares) in relation to the shift in value to post-CGT shares is calculated in the same way as where the increased value shares are pre-CGT (i.e. if new subsection 160ZZRP(3) had applied to the transaction). These components are reduced by the same proportion that the decrease in the market value of the shares referable to the post-CGT increased value shares bears to the market value of those shares immediately before the decrease. [New subsection 160ZZRQ(3)] .
5.99 In the example described above in paragraph 5.78, if the decreased value shares were disposed of immediately after the value shift the original $60 indexed cost base of each of the decreased value shares would be reduced by $6 under new subsection 160 ZZRQ(3). This is the cost base used against the consideration in calculating the capital gain for new subsection 160ZZRQ(2) purposes. Combined with the cost base reduction under new subsection 160ZZRP(3) (explained above), the total reduction to the indexed cost base of each decreased value share would be $18, giving a new indexed cost base (for the purposes of an immediate disposal) of $42.
5.100 An adjustment is also made to the cost bases of the increased value shares provided the increase is material. [New subsection 160 ZZRQ(4)]
5.101 The test of whether an increase is material is equivalent to the test of whether a decrease is material. Therefore a particular increase (referred to in new subsection 160ZZRO(2) as the current increase) in market value of a share under a share value shifting arrangement will be material if:
- •
- it is 5% or more of the total market value of the share immediately before the increase, or if it is one of a number of increases under the arrangement and the sum of all the increases (whether before or after the current increase) is 5% or more; or
- •
- the total increase in market value of all the increased value shares held by the controller or associate is $100,000 or more
If the increased value share is a new share issued at less than market value, the increase in market value for the purposes of new Division 19B (ie. the difference between market value and the consideration paid) will be material if it is 5% or more of the market value of the share as soon as it comes into existence. Therefore , if no consideration is paid for the share, the increase will be material. [New subsection 160ZZRO(2)]
5.102 The increase is made to prevent the same gain being taxed twice. However, because the value shift referable to different person shares is subject to an immediate CGT liability, while that referable to same person shares is not, the increase in the cost bases of the increased value shares which relates to different person shares will usually be greater than the increase in relation to different person shares will usually be greater than the increase in relation to the value shift from same person shares. Therefore, although the reduction in the cost bases of both different person and same person shares is the same, the increase to the cost base of the increased value shares is determined as the sum of two amounts, being the amount referable to different person shares and the amount referable to same person shares. [New subsection 160ZZRQ9(4)]
5.103 Broadly speaking, subject to the limits explained below, the cost base, indexed cost base or reduced cost base of each of the post-CGT increased value shares is increased by the sum of:
- •
- so much of the increase in value attributable to different person shares [New paragraph 160 ZZRQ(5) (a)] ; and
- •
- the amount that, if the shift in value from the same person shares had been subject to an immediate CGT liability, would have been the cost base used against the deemed consideration in respect of those shares [New paragraph 160ZZRQ(6)(c)].
This ensures that, on disposal of the post-CGT increased value shares:
- •
- there will be no capital gain in relation to the shift in value from the different person shares (because any such gain is liable to CGT at the time of the value shift); and
- •
- any capital gain that would have been realised at the time of the value shift if the shift had been to shares held by another person will be realised at the time of the disposal of the increased value shares.
5.104 The increase in the cost base of the increased value shares is attributable to the value shifted out of the decreased value shares. In this regard it is akin to expenditure of a capital nature incurred by a taxpayer for the purpose of enhancing the share's value. Therefore the increase is deemed to be expenditure of that kind. [New subsection 160 ZZRQ94)]
5.105 The amount of the increase in market value of a particular post-CGT increased value share which is referable to the value shifted from different person shares is obtained by multiplying the total increase in value by the same proportion that the decrease in value of all different person shares bears to the total decrease in value of all decreased value shares. Although the decrease in value of each different person share is, by definition , a material decrease, the total decrease in value of all decreased value shares is not restricted to material decreases of those shares. [New paragraph 160 ZZRQ (5)(a)]
5.106 The increase in market value must be reflected in the market value of the increased value share at the time of its disposal. To the extent that it is not, the relevant cost base will not be increased. For instance, if the material increase in value of the increased value shares was attributable to extra dividend or voting rights and, at the time of their disposal, the shares no longer had those increased rights, there would be no increase of the cost base, indexed cost base or reduced cost base. [ New paragraph 160 ZZRQ (5) (a)].
5.107 Moreover, the increase to the relevant cost base cannot exceed the sum of the amounts of the decrease in market value of all the different person shares which is referable to the increase in value of the particular increased value share. This is because any excess would not represent a shift of value from the decreased value shares into the increased value shares. [New paragraph 160 ZZRQ (5) (b)].
5.108 In the example provided in paragraph 5.78 above, it is only the increased value shares held by the associate that would have an increased cost base. This is because the shares held by the third party are not 'increased value shares'. The increase in cost base of the increased value shares held by the associate would be determined under new subsection 160 ZZRQ(5) since the decreased value shares are different person shares. The increase to the indexed cost base would be the amount of the actual increase in value because the whole of the increase in market value is attributable to different person shares.
Deemed expenditure referable to decreased value shares of same person
5.109 Since there is no immediate capital gain in relation to the value shift referable to same person shares, the cost base increase to the increased value shares as a result of the value shift from those shares will usually be less than if the shifted value had been subject to CGT at the time of the shift. Essentially, subject to the limits described below, the cost base increase will be the amount that would have been the cost base used against the consideration deemed to have been received in relation to the value shift if the shifted value had been subject to CGT at the time of the shift (i.e. if the value shift had been to shares held by another person or to pre-CGT shares). This ensures that, when any increased value share is sold, the capital gain that would have been realised at the time of the value shift from the same person shares ( i.e the difference between the amount of the value shifted into the share and the cost base attributable to that shifted value) will be subject to CGT at the time of the disposal [New paragraph 160 ZZRQ(6) (c)]
5.110 To determine the cost base increase to the increased value shares as a result of the value shift from same person shares, it is necessary to apply the calculation provided in new subsection 160ZZRQ(3) to same person shares. Under this calculation, in relation to each same person share, the components comprising their cost base, indexed cost base or reduced cost base of that share is reduced by the fraction in new paragraph 160ZZRQ(3)(b). For the purposes of the application of new paragraph 160 ZZRQ (6) (c) , this fraction is the proportion of the total market value increase which is attributable to the particular increased value share multiplied by the percentage reduction in value of the same person share. The sum of the reductions of each same person share is the amount by which the cost base, indexed cost base or reduced cost base of the increased value share is to be increased under new subsection 160ZZRQ(6). [New paragraph 160 ZZRQ(6)(c)]
5.111 As with the shift in value from different person shares, the increase in the cost base, indexed cost base or reduced cost base of the increased value shares referable to the value shift from same person shares cannot exceed:
- •
- the extent to which the increase in value referable to the same person shares is reflected in the increased value shares at the time of their disposal [New paragraph 160 ZZRQ (6) (a)] ; or
- •
- the total decrease in value of the same person shares which is referable to the increase in value of the post-CGT increased value shares [New paragraph 160 ZZRQ(6)(b)]
5.112 The Bill proposes to amend section 160ZZU of the Act to ensure that a person subject to the share value shifting provisions is required to retain sufficient records to enable calculation of any capital gain and cost base adjustments which arise by virtue of the share value shift. This includes:
- •
- details of essential features of the value shifting arrangement (including dates of the decreases);
- •
- the amounts of the decreases in market value of the decreased value shares;
- •
- the amounts of the increases in market value of the increased value shares, and other shares which would be increased value shares if held by the controller or associate, or associate of the holder of the decreased value shares; and
- •
- the amount that would have been the cost base of the decreased value shares if disposed of at the time of the share value shift.
[Clause 27 - substituted paragraph 160ZZU(1)(b)].
Chapter 6 - Capital Gains Tax - Change in ownership of assets - Subdivision B of Division 3 (Part 3) of the Bill
Overview
6.1 The amendments deal with the operation of the CGT provisions as they apply to declarations of trust over assets, transfers of assets to trusts and certain conversions of trusts to unit trusts. The amendments are intended to ensure that certain transfers of assets to a trust are treated as changes in the ownership of the assets so that a capital gain may arise on the transfer.
Summary of amendments
6.2 The amendments make clear the circumstances in which subsection 160M(1A) of the Act will have the effect that a change in the legal ownership of an asset is not to be treated as a change of ownership of an asset for CGT purposes. They will also provide that a declaration of trust over an asset owned by a person or the transfer of an asset to a trust will be a change of ownership of the asset unless the previous owner is absolutely entitled to the asset as against the trustee and the trust is not a unit trust. There will be no change of ownership if there is a mere change of trustee without any change at all in the trust arrangements including the interest of each beneficiary in the trust income and assets [Clause 29].
6.3 The amendments will apply to declarations of trusts, or transfers of property to trusts, made after 12:00 midday Eastern Summer Time on 12 January 1994 [Clause 32].
6.4 The capital gains tax (CGT) provisions of the Act apply where there is a disposal of an asset. Subsection 160M(1) of the Act deems a disposal whenever a change has occurred in the ownership of an asset.
Changes in beneficial ownership
6.5 Subsection 160M(1A) of the Act provides that a change in legal ownership of an asset, without a corresponding change in beneficial ownership, does not constitute a change in ownership and hence a disposal within the meaning of the CGT provisions. The explanatory memorandum to the Taxation Laws Amendment Bill 1990 which inserted subsection 160M(1A) identifies two situations where there will be a change in legal ownership but no change in beneficial ownership:
- •
- first, where there is a change of trustee of a trust under which the beneficiary is absolutely entitled to the trust property (or would be but for a legal disability); and
- •
- secondly, where a trust is established over property previously owned by a person and that person, as beneficiary of the trust, remains absolutely entitled to it (or would remain so but for a legal disability).
6.6 The existence of subsection 160M(1A) has given rise to possible opportunities for avoidance of CGT in cases where it is arguable that no change in beneficial ownership of an asset has occurred. An example is where a person transfers an asset to a unit trust in which he or she holds all the units, and then disposes of those units for an amount equal to their cost base (the market value of the asset).
6.7 Paragraph 160M(3)(a) of the Act provides that a declaration of trust over an asset constitutes a change in ownership (and therefore a disposal) of the asset to the beneficiary if the beneficiary is absolutely entitled to the asset as against the trustee.
6.8 If there is no beneficiary absolutely entitled to the asset there is no disposal to the beneficiary. However, if a person (the settlor) appoints another person (the trustee) to hold an asset for beneficiaries who are not absolutely entitled to the asset, there is a disposal by the settlor to the trustee since there has been a change in legal and beneficial ownership of the asset.
6.9 It has been argued that the current law is unclear as to whether there is a disposal from the settlor to the trustee if they are the same person (ie. if the settlor declares himself or herself to be trustee of the asset). In the case of a fixed trust there would be a disposal by reason of a change in beneficial ownership of the asset.
6.10 It has been argued that, in the case of a discretionary trust, the law is uncertain in its application where the settlor is also the trustee. This is because it is not completely clear what has happened to (and therefore whether there has been a change in) the beneficial ownership of the asset previously held by the settlor. Some have argued that paragraph 160M(3)(a) leads to a conclusion that there is no disposal of an asset when the beneficiary of the trust is not absolutely entitled to the asset as against the trustee.
6.11 In policy terms, there should be no difference between, on the one hand, the situation where a person appoints another to be trustee, and, on the other hand, where the person declares himself or herself to be trustee. This is because it is the position of trustee rather than the identity of the trustee which is important. Therefore, since a transfer to another person as trustee is a disposal for CGT purposes, the same should apply when the transferor is also the trustee.
Explanation of the amendments
6.12 The Bill will amend the Act to ensure that subsection 160M(1A) does not apply to transfers to a unit trust. The effect of the amendment is that any transfer of an asset to a unit trust will be a change in ownership of the asset. [Clause 30 - new paragraphs 160M(3)(a)].
6.13 The amendments will also have the effect that, subject to certain exceptions, the creation of a trust by declaration or settlement over an asset, or the transfer of an asset to a trust, will constitute a change in ownership. [Clause 30 - new paragraph 160M(3)(a), new subsection 160M(3A)] One exception applies where:
- •
- there is a creation of a trust over an asset by declaration or settlement, or a transfer of an asset to a trust; and
- •
- all of the following conditions are satisfied in relation to the creation or transfer:
- -
- first, the person who owned the asset before the creation of the trust, or the transfer of the asset, is the sole beneficiary of the trust;
- -
- secondly, the person is absolutely entitled to the asset as against the trustee or would, but for a legal disability, be so entitled; and
- -
- thirdly, the trust is not a unit trust.
[Clause 30 - new subparagraph 160M(3)(a)(i)]
6.14 A further exception applies where there is a settlement of an asset to a trustee to hold on terms of an existing trust where the only change that occurs is a change of trustee. The effect of this exception is that where property is transferred from one trustee to another to be held under the same trust arrangements without any change at all in the trust arrangements including the interest of each beneficiary in the trust income and assets, there will be no change of ownership for CGT purposes [Clause 30 - new subparagraph 160M(3)(a)(ii)].
6.15 The amendments will also provide that the conversion of a trust to a unit trust will be a change in ownership of the assets of the trust if a person was absolutely entitled to the asset as against the trustee of the first trust or would, but for a legal disability, have been so entitled [Clause 30 - new paragraph 160M(3)(aa)].
6.16 The amendments provide a cost base to the trustee of the asset equal to the market value of the asset at the time of the change of ownership where:
- •
- there is a creation of a trust over an asset by declaration or settlement, or a transfer of an asset to a trust and any of the following conditions are satisfied in relation to the creation or transfer:
- -
- the person who owned the asset before the creation of the trust, or the transfer of the asset, is not the sole beneficiary of the trust;
- -
- the person is not absolutely entitled to the asset as against the trustee or would, but for a legal disability, be so entitled; or
- -
- the trust is a unit trust.
- •
- the person who owned the asset before the creation of the trust is also the trustee of the trust; and
- •
- on creation of the trust, no beneficiary is absolutely entitled to the asset as against the trustee. [Clause 30 - new subsections 160M(4A) and (4B)]
This market value will be the same amount as the disposal consideration that was taken into account in computing the capital gain or loss on the change of ownership.
6.17 The amendments will also provide that nothing in section 160V(1) will displace the change of ownership that occurs under paragraphs 160M(3)(a) and 160M(3)(aa) [Clause 31 - new subsection 160V(1B)].
6.18 The table that follows explains the effect of the amendments on declarations of trusts or transfers of property to trusts.
| Type of transaction | Will there be a change in ownership (ie. a disposal) under the proposed amendment? |
|---|---|
| Declaration of a trust over an asset which was previously owned absolutely by the person who is now the trustee | Yes:
|
| Transfer of an asset to a trust where the transferor (and previous absolute owner) is not absolutely entitled to it | Yes:
|
| Transfer of an asset to a trust where the transferor (and previous absolute owner) remains absolutely entitled to it as against the trustee (who is not the transferor); for example, on the creation of a bare trust | No, unless the trust is a unit trust, in which case there would be a transfer to the trustee. |
| Change in trustee of a trust, eg. a change in trustee of a superannuation fund | No (no change in beneficial ownership), provided that the other interests under the trust remain the same. |
| Transfer of an asset held in a trust to the beneficiary who is absolutely entitled to it as against the trustee | No |
| Transfer of an asset held in a trust to a beneficiary who is not absolutely entitled to it as against the trustee | Yes |
6.19 The Bill provides that the amendments are to be disregarded in determining the meaning that the CGT provisions had before the amendments [Clause 33].
Chapter 7 - Capital Gains Tax - Pre-requisite for roll-over relief for the transfer of assets within company groups. - Subdivision C of Division 3 (Part3) of the Bill.
Overview
7.1 The Bill will change the requirement for the granting of roll-over relief for assets transferred within a company group that the transferor and transferee companies be group companies for the whole of the income year in which the transfer occurred. The companies will need to be group companies only at the time of the transfer.
Summary of proposed amendments
7.2 To ensure that efficiency-motivated corporate restructures are not unnecessarily impeded, by:
- •
- removing the requirement for the granting of roll-over relief for assets transferred within a company group that the transferor and transferee companies be group companies for the whole of the income year in which the transfer occurred; and
- •
- requiring that the transferor and transferee be group companies only at the time of the transfer.
[Clause 34]
7.3 The amendments to the roll-over relief provisions (section 160ZZO) will apply to disposals of assets that occur during the 1993-94 income year, and in any subsequent income year, of the transferor. Consequential amendments to sections 160ZZT, 160ZZRA and 160ZZRB will apply in the same way.
7.4 Consequential amendments to sections 160ZYK and 160ZYR will apply in relation to issues of rights or issues of options that occur during the 1993-94 income year, and in any subsequent income year, of the shareholder. The amendments to sections 26BC and 160ZZU will have effect from the same income year [Clause 43].
Background to the legislation
7.5 The CGT provisions of the Act (section 160ZZO) allow roll-over relief for assets transferred between group companies (ie. companies within a company group sharing 100% common ownership) because the underlying ownership of the assets does not change. The effect of roll-over relief is to maintain the pre-CGT status of assets acquired by the transferor before 20 September 1985, and to delay the realisation of an accrued gain on assets acquired on or after that date.
7.6 A pre-requisite for obtaining roll-over relief is that the transferor and transferee companies must, except in certain specified circumstances, be group companies for the whole of the year of income in which the transfer takes place. Therefore, roll-over relief would not be available for the transfer of assets between two group companies in a particular year of income if one of those companies was acquired by the group, or disposed of by the group, at some time in that year.
7.7 There is now a general anti-avoidance provision (section 160ZZOA) which recaptures roll-over relief in certain circumstances to prevent inappropriate use of the group company roll-over provisions. This anti-avoidance provision deems a disposal and re-acquisition for market value of an asset for which roll-over relief has been claimed if the asset held by the transferee company subsequently leaves the control of the company which, at the time of the transfer, was the ultimate holding company of the group. This is because the group will have effectively disposed of the asset. Certain exceptions to the recapture are provided in the other amendments in this Bill (see Chapter 8).
7.8 In light of the deemed disposal and re-acquisition rule explained above, it is not necessary to require that the group company relationship exist for the whole of the income year in which the transfer takes place. Instead of requiring that the group relationship exist for the whole of the income year, it would be sufficient for the Act to provide that the group relationship should exist at the date of the transfer. In such cases it is appropriate to provide roll-over relief (there being no change in underlying ownership of the asset), and the deemed disposal and re-acquisition rule will ensure that inappropriate use is not made of the roll-over relief.
7.9 The Bill will also make consequential amendments to various other sections of the Act which make reference to the group company concept that currently exists in section 160ZZO, to take account of the changes made to section 160ZZO.
Explanation of amendments
Prerequisite for roll-over relief
7.10 The legislation is being amended to change one of the requirements of eligibility for roll-over relief for the transfer of assets between companies in the same group. The amendment will mean that the companies now need not be group companies for the whole of the income year. They need to be members of a wholly owned group only at the particular time at which the transfer of the asset takes place [Clause 38 - amended paragraph 160ZZO(1)(b)].
7.11 The amendment to paragraph 160ZZO(1)(b) will provide that the transferee company should be related to the transferor company only at the time the disposal referred to in subparagraph 160ZZO(1)(a)(i) took place. Section 160G sets out what will constitute a 'related company' for the purposes of Part IIIA. The amendment adopts this concept to deal with the relationship that exists between companies at the time of transfer of the asset [Clause 38(a)].
7.12 The use of section 160G to determine the relationship between companies will mean that the section 160ZZO definition of group company, and accompanying definitions, are no longer required. Subsections 160ZZO(3) to (8B) are therefore omitted by these amendments [Clause 38(b)].
7.13 As a result of the changes to section 160ZZO, it is necessary to amend other sections which have reference to the concept of group companies in section 160ZZO.
7.14 Sections 160ZYK, 160ZYR and 160ZZT are amended to reflect the requirement that the companies concerned should be related companies at the particular point in time when a certain event occurs, rather than group companies for the year of income in which the event occurs [Clauses 36, 37 and 41 respectively].
7.15 Section 160ZZRB currently refers to the group company relationship existing at a particular time. The amendment will only reflect the change in the terminology used, from 'group company' (within the meaning of section 160ZZO) to 'related' [Clause 40].
7.16 As there will no longer be a definition of 'subsidiary' in section 160ZZO, sections 160ZZOA, 160ZZU, 160ZZRA and 26BC, which refer to the section 160ZZO definition, are amended to refer instead to the definition of 'subsidiary' contained in section 160G [Clauses 45, 42, 39 and 35 respectively].
7.17 The sections to which consequential amendments are made deal with:
- Section 26BC Securities lending arrangements
- Section 160ZYK Application - Rights to acquire shares
- Section 160ZYR Application - Company issued options to shareholders to acquire unissued shares
- Section 160ZZOA Break-up of company group after section 160ZZO application
- Section 160ZZRA Interpretation - Transfers of assets between companies under common ownership
- Section 160ZZRB When companies under common ownership
- Section 160ZZT Disposal of shares or interest in trust
- Section 160ZZU Keeping of records
Chapter 8 - Capital Gains Tax - Transfer of assets within company subgroups - Subdivision D of Division 3 (Part 3) of the Bill.
Overview
8.1 The Bill will ensure that there will be no realisation of a capital gain on an asset previously rolled over from one member of a subgroup of a company group to another merely because that subgroup leaves the ultimate holding company group, if that asset was not rolled over at any time from a company outside the subgroup into the subgroup.
Summary of proposed amendments
8.2 The amendments will ensure that the deemed disposal and reacquisition rules under section 160ZZOA of the Act, as they relate to the transfer of assets within company subgroups, do not operate as an impediment to business restructures. They will not apply if the transferred asset has always remained within a discrete company subgroup, and that subgroup is subsequently disposed of by the ultimate holding company group [Clause 44].
8.3 The amendments to section 160ZZOA will apply to the break-up of company groups which occur after 16 December 1992, which is the date from which that section took effect [Clause 46].
Background to the legislation
Roll-over relief 8.4 The capital gains tax provisions (CGT) of the Act allow roll-over relief for assets transferred between companies which share 100% common ownership (ie. companies within a wholly owned company group). The effect of the roll-over relief is to maintain the pre-CGT status of assets acquired by the transferor before 20 September 1985, or to delay the realisation of an accrued gain on assets acquired on or after that date.
8.5 To ensure that CGT cannot be avoided by abusing the company group roll-over provisions, the Act provides in certain circumstances for a deemed disposal and reacquisition for market value of an asset for which roll-over relief has been claimed. The deemed disposal and reacquisition rules currently apply if the asset held by the transferee company subsequently leaves the control of the company which, at the time of the transfer, was the ultimate holding company of the group. This is because the group will have effectively disposed of the asset.
8.6 This deemed disposal and reacquisition rule may apply inappropriately in relation to subgroups of a company group. As an example, if an asset has been transferred between companies within a subgroup and the ultimate holding company of the group disposes of its shares in the holding company of the subgroup, there will be a deemed disposal and reacquisition of the asset even though it may have always been held within that subgroup. This would not have occurred if the asset had been retained at all times by only one company within the subgroup.
Explanation of amendments
8.7 The amendments will ensure that efficiency motivated reorganisations of company groups are not discouraged by the operation of the deemed disposal and reacquisition rules, while retaining their effectiveness as an anti-avoidance provision. The Act is being amended to ensure that if:
- •
- an asset has been rolled over only between members of a subgroup (including its holding company); and
- •
- one of the following paragraphs apply:
- -
- the asset is held by the holding company of the subgroup and the holding company leaves the group such that none of the shares of the company are held by companies in the group [Clause 45 - new subparagraph 160ZZOA(2)(f)(iii)]; or
- -
- the asset is held by a member of the subgroup and that member and the holding company of the subgroup leave the group at the same time such that none of the shares of those companies are held by companies in the group [Clause 45 - new subparagraph 160ZZOA(2)(f)(iv)] ;
then there will be no deemed disposal and reacquisition of the asset by reason of the subgroup companies leaving the ultimate holding company group [Clause 45 - new paragraph 160ZZOA(1)(ca)].
8.8 The amendments to section 160ZZOA will apply to the break-up of company groups which occur after 16 December 1992, the date from which section 160ZZOA took effect [Clause 46].
Chapter 9 Capital Gains Tax - Group company capital loss transfers - Subdivision H of Division 3 (Part 3) of the Bill
Overview
9.1 The Bill will amend section 160ZP of the Act, which deals with cost base adjustments in relation to transfers of losses between group companies, to:
- •
- provide that the reduction of the cost base of shares and debts held in the company that has transferred a loss will be determined having regard also to any payment (subvention payment) made by the transferee company in consideration for the transfer; and
- •
- allow an appropriate increase in the cost base of post-CGT shares in the transferee company.
Summary of proposed amendments
9.2 The amendments will refine the adjustments made to the cost bases of the shares in group companies where one member of the group transfers a capital loss to another. They also provide appropriate cost base adjustments when a subvention payment is made [Clause 57].
9.3 The amendments will apply to net capital losses transferred for offset against the net capital gains of the transferee company for the 1993-94 income year or later years [Clause 59].
9.4 Section 160ZP of the Act provides for the transfer of a net capital loss within a company group. This allows a group company which incurs a net capital loss (the transferor) to agree with another company within the group (the transferee) to transfer the loss to that other company.
9.5 Subsection 160ZP(13) has the effect that the cost base of shares or debts acquired or commenced to be owed after 19 September 1985 which are held by other group companies in the transferor company will be reduced by reference to the amount of the capital loss transferred. The extent of the reduction will be proportional to the extent to which a particular share or debt forms part of the total interests held in the loss company. This prevents a capital loss being incurred on those shares or debts which is attributable to the loss which has been transferred.
9.6 The operation of subsection 160ZP(13) may disadvantage certain corporate structures. For instance, if a group company transfers to another company a capital loss incurred on the disposal of an asset, the value of the post-CGT shares held by its holding company and higher tier holding companies will be reduced under subsection 160ZP(13). This prevents a disposal of the shares in the transferor company giving rise to a capital loss which is attributable to the capital loss incurred on the asset. However, a capital gain may be realised on a disposal of the shares in the transferee company which is attributable to the tax benefit derived from the off-setting of a net capital gain by the transferred loss. This result could be overcome if an appropriate increase in the cost base of shares in the transferee company was made when the loss was transferred.
9.7 Another problem arises in relation to subvention payments, which are sums paid by the transferee company to the transferor as consideration for the transferred loss. These payments relate to the tax saving made by the transferee company because of the loss transfer. Subvention payments do not constitute income of the transferor (subsection 160ZP(11)), nor is a deduction allowable to the transferee for the payment (subsection 160ZP(12)). However, because the subvention payment increases the value of the transferor company, a capital gain may be generated upon a disposal of shares held in that company if an appropriate adjustment is not made to the cost base or indexed cost base of the shares.
Explanation of amendments
Compensating cost base increases
9.8 Subsection 160ZP(13) provides for an adjustment to the cost base, indexed cost base or reduced cost base, as the case may be, of shares held or debt provided by other group companies to the loss company. The adjustment is by such amount as is appropriate having regard to the direct or indirect interests of the group company in the loss company.
9.9 New subsection 160ZP(14) provides for an appropriate increase in the cost base of the shares or debts held by other group companies in the company to which the loss was transferred (the gain company). This subsection is modelled on subsection 160ZP(13). In making the appropriate adjustments to the cost base, regard is to be had to:
- (a)
- the amount of the loss transferred under subsection 160ZP(7);
- (b)
- the direct or indirect interests of the group company in the gain company; and
- (c)
- the amount, if any, of the payment made by the gain company, being a payment referred to in subsection 160ZP(12),(i.e. a subvention payment).
[Clause 58 - new subsection 160ZP(14)]
9.10 Subvention payments made both by a subsidiary to a parent and between sister companies can be taken into account for cost base adjustment purposes. The amount of the subsection 160ZP(12) subvention payment taken into account shall not exceed the amount of reduction in tax that would accrue to the gain company because of the loss transfer.
9.11 In any event, an increase in the cost base will be made only to the extent that the increase is reflected in the market value of the asset [Clause 58 - new subsection 160ZP(15)].
9.12 Subsection 160ZP(12) describes how a loss company may receive a payment from the gain company as consideration for the whole or part of a net capital loss incurred by the loss company being treated under subsection 160ZP(7) as a capital loss incurred by the gain company.
9.13 The amendment to subsection 160ZP(13) will mean that where such a payment is received by the loss company, then the cost base, indexed cost base or reduced cost base, as the case may be, of shares held in or debts owed by the loss company is reduced having regard to:
- (a)
- the amount of the loss transferred under subsection 160ZP(7);
- (b)
- the direct or indirect interests of the group company in the loss company; and
- (c)
- the amount, if any, of the payment made by the gain company, being a payment referred to in subsection 160ZP(12).
[Clause 58 - amendment to subsection 160ZP(13)]
Chapter 10 - Capital Gains Tax - Assets used by non-residents in Australian permanent establishments - Subdivision G of Division 3 (Part 3) of the Bill.
Overview
10.1 The Bill will amend the Income Tax Assessment Act 1936 (the Act) so that a capital gain or capital loss arising to a non-resident on the disposal of a taxable Australian asset used by the non-resident in carrying on a trade or business wholly or partly at or through a permanent establishment in Australia is to be calculated by reference only to the total period during which it is used in that way.
Summary of proposed amendments
10.2 The amendment will provide a more equitable CGT treatment in cases where, under the current law, CGT is payable upon gains which have accrued over the whole period of ownership of the asset, despite the fact that the asset may only have been used at a permanent establishment in Australia for a portion of the total period of ownership [Clause 54].
10.3 The amendments will apply to disposals which take place after 12:00 midday Eastern Summer time 12 January 1994 [Clause 56].
Background to the legislation
10.4 Subsections 160L (1) and (2) provide that the capital gains tax (CGT) provisions may apply upon the disposal of any asset by a resident, or upon the disposal of a taxable Australian asset by a non-resident. There is no actual definition of 'taxable Australian asset' within the Act. However, subsection 160T(1) deems that certain disposals are disposals of taxable Australian assets in particular circumstances. The disposal itself is still by way of a change of ownership as provided for in section 160M.
10.5 Paragraph 160T(1)(b) deems that a disposal of an asset is a disposal of a taxable Australian asset if the asset has at any time been used by the taxpayer in carrying on a trade or business wholly or partly at or through a permanent establishment in Australia. When such an asset is disposed of, the capital gains tax provisions apply based on the cost base of the asset at the time of acquisition and the consideration upon disposal (even though the asset may not have been used at a permanent establishment throughout the whole period from its acquisition to its disposal).
10.6 The use of the term 'at any time' means that CGT will be payable upon gains which have accrued over the whole period of ownership of the asset, despite the fact that the asset may only have been used at a permanent establishment in Australia for a portion of the total period of ownership. Similarly, any capital loss made over the entire period of ownership may be fully utilised when calculating a net capital gain, even though much of the loss may be attributable to a period when the asset was not being used at a permanent establishment.
Explanation of amendments
10.7 Paragraph 160T(1)(b) currently deems a disposal to be a disposal of a taxable Australian asset if the asset has at any time been used in carrying on a trade or business at or through a permanent establishment in Australia.
10.8 The Bill will subject to CGT a capital gain (or allow a capital loss) on the disposal of an asset, that has been used by a non-resident in carrying on a business or trade at or through a permanent establishment in Australia, by reference to the period of such use [Clause 55 - new section 160ZAA].
10.9 This treatment will apply only to an asset that is covered by paragraph 160T(1)(b) and, at the same time, not covered by any of the other paragraphs of subsection 160T(1). The current rules would continue to apply to the asset if it falls also within a paragraph of subsection 160T(1) other than paragraph (b) [Clause 55 - new paragraph 160ZAA(a)].
10.10 The capital gain or capital loss on the disposal of an asset referred to in paragraph 160T(1)(b), not being an asset referred to in any of the other paragraphs of subsection 160T(1), is to be reduced in proportion to the total period during which it is used by the taxpayer in carrying on a trade or business wholly or partly at or through a permanent establishment in Australia, as a proportion of the period between the taxpayer acquiring the asset and disposing of it.
10.11 The capital gain or capital loss on the disposal of that asset calculated under the current provisions of Part IIIA is to be reduced to the proportion of the gain or loss that the number of days during which it is used by the taxpayer in carrying on a trade or business at or through a permanent establishment in Australia bears to the number of days during the period by reference to which the capital gain or loss has been calculated.
10.12 A non-resident taxpayer acquires a machine on 1 February 1994, for $21,000. On 1 June 1994, the machine is first used by the taxpayer in carrying on a business at his permanent establishment in Australia. The taxpayer sells the asset on 10 November 1994 for $30,000.
10.13 A capital gain of $9,000 has accrued in respect of the disposal, as calculated under Part IIIA. There will be no indexation of the cost base as the asset was owned for less than 12 months.
10.14 The number of days in the ownership period is 283 days. The number of days the asset was used in the way described in paragraph 160T(1)(b) is 163 days.
10.15 The $9,000 capital gain is reduced to reflect the period in which the asset was actually used in the way described in paragraph 160T(1)(b). Therefore, the amount of the taxpayer's capital gain is taken to be $5184
[$9,000 * 163/283 = $5184].
Chapter 11 - Capital Gains Tax - Division 19A and liquidators' distributions
Overview
11.1 The Bill will ensure that the provisions of Division 19A will not apply to interim or final distributions from liquidators where the liquidation is completed and the company dissolved within a period of three years after liquidation proceedings commenced, or within a further period allowed by the Commissioner.
Summary of proposed amendments
11.2 The Bill will remove anomalies in relation to the interaction between the capital gains tax (CGT) provisions contained in Division 19A of Part IIIA of the Act, which was designed to apply to the disposal of shares in companies that have been subject to an asset strip, and those CGT provisions relating to the taxation treatment of liquidators' in specie distributions to shareholders [Clause 60].
11.3 Currently, it is arguable that each could simultaneously apply, to the detriment of taxpayers, to increase any capital gain, or reduce any capital loss, on interim or final in specie distributions of capital from a liquidator.
11.4 The amendments will apply in relation to disposals of assets after 6 December 1990, which is the date from which Division 19A applied to certain disposals of property [Clause 62].
Background to the legislation
11.5 Division 19A of the Act was designed to apply to the sale of shares in companies that had been subject to an asset strip. One way in which an asset strip could occur is where the market value of shares in a company is reduced by the transfer of assets out of the company to another company in the same company group for no consideration or for inadequate consideration. Roll-over relief can be claimed on the transfer of the asset to the other company in the group.
11.6 The shares in the company out of which the assets have been transferred are then disposed of at the reduced market value. As a result of this, the holding company, being the shareholder, could reduce a capital gain or create a capital loss.
11.7 In such cases, Division 19A generally operates to reduce the cost base of the shares in the company out of which the assets have been transferred by an amount equal to the lower of the indexed cost base or market value of the asset transferred. This would eliminate the capital loss or reduction in any capital gain that would have otherwise arisen as a result of the asset strip.
11.8 Correspondingly, Division 19A generally operates to increase the cost base of the shares held in the transferee company by the lower of the indexed cost base or market value of the asset transferred. This eliminates any excessive capital gain, or reduced capital loss, on any subsequent disposal of the shares of the company into which the assets have been transferred
Provisions relating to liquidators' in specie distributions of capital
11.9 A liquidator may distribute property of the company to its shareholders rather than realising the property and making cash distributions. These distributions of property are referred to as in specie distributions. Before final liquidation, which results in the cancellation and disposal of shares held in the liquidated company, a liquidator can make interim distributions to shareholders.
11.10 Under the provisions of section 160ZL, an interim in specie distribution of capital by a liquidator that is not rendered assessable as a dividend by any other provision of the Act will reduce the cost base or the indexed cost base (broadly, the cost base indexed for inflation) to the shareholder of the shares in the company that is being liquidated. Any excess of the amount of the distribution over the indexed cost base of the shares will be a capital gain.
11.11 The final distribution of capital, which results in the cancellation of the shares, is treated as consideration for the disposal of the shares. In computing the capital gain on the disposal, a deduction is allowed for the indexed cost base of the shares, as reduced having regard to the interim distributions of capital.
Interaction of Division 19A with the provisions relating to liquidators' distributions.
11.12 The interaction of Division 19A with the provisions relating to liquidators' distributions may give rise to unintended consequences.
11.13 Firstly, upon an interim in specie distribution of capital it is possible that the indexed cost or reduced cost base of the shares in the company being liquidated will be reduced both under both Division 19A and section 160ZL (to the extent that the distribution is not a dividend).
11.14 Secondly, upon the final in specie distribution of capital on liquidation:
- •
- Division 19A will reduce the cost base, indexed cost base or reduced cost base of the shares held in the company under liquidation generally by an amount equal to the lower of the indexed cost base or market value of the property being distributed.
- •
- at the same time the shares are cancelled and the distribution is also treated as consideration for the disposal of the shares that were held in the company .
11.15 As a result, upon the final in specie distribution of capital from a liquidator, there could be an unduly large capital gain or unduly reduced capital loss.
Explanation of amendments
11.16 This Bill will amend Division 19A so that it does not apply to a distribution made by a liquidator in the course of winding up a company that is a member of a wholly owned company group [Clause 61; new subsection 160ZZRD(3)].
11.17 This exclusion will apply only if the company is dissolved within 3 years after the winding up commenced, or within such further time as the Commissioner allows [Clause 61; new paragraph 160ZZRD(3)(b)].
Chapter 12 - Capital Gains Tax - Application to Government incentive schemes - Subdivision E of Division 3 (Part 3) of the Bill.
Overview
12.1 This Bill will amend the law to prevent an inappropriate liability which can arise under the Capital Gains Tax (CGT) provisions to amounts paid under certain Commonwealth, State and Territory incentive schemes. A specific exemption from CGT will apply to reimbursements or payments of expenses under such schemes that are prescribed in the Income Tax Regulations on a case by case basis.
Summary of proposed amendments
12.2 To ensure that the liability to CGT does not provide a financial impediment to taxpayers who participate in government incentive schemes [Clause 47].
12.3 The amendments will apply in relation to all disposals, other than assignments, of rights under a scheme which is prescribed in Regulations applying to the time of disposal, even if the Regulations are not made until after that time [Clause 49].
Background to the legislation
12.4 As a result of the definition of asset in section 160A of the Income Tax Assessment Act, a CGT liability can arise in relation to the disposal of rights created under Government incentive schemes.
Explanation of amendments
12.5 To ensure that the liability to CGT does not provide a financial impediment to participants in such incentive schemes, the Act will be amended to provide an exemption from CGT in relation to the reimbursement or payment of certain expenses under government schemes prescribed on a case by case basis. [Clause 48; new subsection 160L(6A)].
12.6 Payments made under a prescribed scheme will lose their CGT-exempt status if the scheme is subsequently omitted from the Regulations. If a scheme is omitted from the Regulations and is no longer eligible for the exemption, CGT would apply in relation to disposals of the rights under the scheme made after its omission, but not to earlier disposals.
12.7 The exemption will not apply in any situation where a taxpayer disposes of rights under an approved scheme by way of an assignment of those rights.
12.8 In the event that a disposal under a scheme is subject to CGT, and the scheme is subsequently prescribed in Regulations applicable to the time of the disposal, then the relevant assessment can be amended to give retrospective effect to the CGT exemption provided by the prescription. Any time limits imposed by section 170 will not prevent the amendment of an assessment to give effect to a scheme becoming a prescribed scheme [Clause 48; new section 160L(6B)].
Chapter 13 - Capital Gains Tax - Amendment of assessments - Subdivision F of Division 3 (Part 3) of the Bill
Overview
13.1 The Bill will amend the Income Tax Assessment Act 1936 (the Act) to ensure that nothing in section 170 of the Act prevents the amendment of an assessment for capital gains tax purposes to:
- (a)
- give effect to subsection 160U(3) or 160U(8) of the Act; or
- (b)
- treat the disposal or acquisition of an asset as never having happened if the contract is later found to have been a nullity from the beginning.
Summary of proposed amendments
13.2 The purpose of the amendments to the law is to ensure that the time limits imposed by section 170 of the Act for the making of amended assessments do not prevent necessary amendments for capital gains tax purposes [Clause 50].
13.3 Generally, the amendments to the law will apply to assessments made at any time. This date of effect is subject to the exception that the amendments to the law do not permit the amendment of an assessment if the amendment would increase a taxpayer's liability and the Commissioner of Taxation was prevented by section 170 from amending the assessment as at the end of 11 January 1994 (the day before the date of the Assistant Treasurer's announcement foreshadowing the amendments) [Clause 53].
13.4 Section 170 of the Act imposes time limits on the amendment of assessments. Section 160U of the Act provides for the time of acquisition or disposal for capital gains tax purposes.
13.5 Subsection 160U(3) of the Act provides that if an asset was acquired or disposed of under a contract, the time of acquisition or disposal is to be taken to have been the time of the making of the contract. In some cases, there is no change in ownership under a contract until the time at which the contract is completed.
13.6 For example, for capital gains tax purposes, a change in the ownership of land occurs at the completion of the contract under which the land is sold. Completion of an ordinary contract for the sale of land normally takes place at the time of settlement. However, in accordance with subsection 160U(3), the time of disposal by the seller and of acquisition by the buyer are taken to be the time of the making of the contract. In other words, when an actual change in ownership occurs on completion of the contract, the disposal and acquisition then relate back to the time of the making of the contract.
13.7 At present, the time limits imposed by section 170 can prevent necessary amended assessments to give effect to subsection 160U(3). The proposed amendments to the law will correct this situation.
13.8 Subsection 160U(8) of the Act provides that if an asset was disposed of as a result of the exercise of a power of compulsory acquisition conferred by a law, the time of disposal is to be taken to be the time at which the earliest of certain specified events occurred (for example, when the person acquiring the asset became its owner). In some cases, an asset that has been compulsorily acquired is treated as having been disposed of some time before the consideration for the disposal of the asset (for example, any compensation payable) can be determined.
13.9 At present, the time limits imposed by section 170 can prevent necessary amended assessments to give effect to subsection 160U(8). The proposed amendments to the law will correct this situation.
Contract void from the beginning
13.10 In some exceptional cases, a contract can fall through after completion for reasons that render the contract void ab initio (from the beginning); that is, the contract is treated in law as having never existed. An example is where a contract is set aside because fraud of one of the parties is discovered after completion of the contract. The capital gains tax position is that a change in the ownership of the asset is taken never to have occurred since the purported contract for sale was at law a nullity from the beginning.
13.11 At present, the time limits imposed by section 170 can prevent necessary amended assessments to reflect the fact that there has actually been no change in the ownership of an asset because a purported contract has been found to have been a nullity from the beginning. The proposed amendments to the law will correct this situation.
Explanation of amendments
13.12 The Bill will ensure that section 170 does not prevent the amendment of an assessment if, after the assessment was made, an acquisition or a disposal is taken, under subsection 160U(3) or 160U(8), to have happened before the assessment [Clause 51 - new subsection 160U(10)].
13.13 The Bill will ensure that section 170 does not prevent the amendment of an assessment if the amendment is made, in relation to a contract that is found to be void ab initio (that is, void from the beginning), to ensure that the capital gains tax provisions of Part IIIA are taken always to have applied as if the contract had never been made [Clause 52; new subsection 170(9D)].
Application of amendments
13.14 Generally, the amendments to the law apply to assessments made at any time. However, a transitional provision ensures that the amendments to the law do not permit the amendment of an assessment if the amended assessment would increase a taxpayer's liability and the Commissioner of Taxation was prevented by section 170 from amending the assessment as at the end of 11 January 1994 (that is, the day before the date of the Assistant Treasurer's announcement foreshadowing the statutory amendments) [Clause 53].
13.15 The reason for including the transitional provision is to ensure that if the door had already closed before 12 January 1994 on the making of an amended assessment that increased a taxpayer's liability, the proposed statutory amendments did not reopen that door. However, if the door was still open on 12 January 1994, the statutory amendments are intended to apply to keep the door open.
Chapter 14 - Foreign investments funds and foreign life insurance policies.
Introduction
14.1 The foreign investment fund (FIF) measures came into effect on 1 January 1993. The measures provide for the taxation, on an accruals basis, of investments held by Australian residents in non-controlled foreign companies, interests held by Australian beneficiaries in non-controlled foreign trusts, and investments in foreign life policies (FLPs) by Australian policy holders. Also, as part of those measures, new rules governing the taxation of Australian beneficiaries of foreign trust estates were introduced with effect from the 1992-93 income year.
14.2 The FIF measures aim to remove the tax advantage of deferring Australian tax by accumulating income in offshore companies and trusts that are not controlled by Australian residents. They complement the controlled foreign company (CFC) and transferor trust measures which have been in operation since the 1990-91 income year.
14.3 Amendments to the law are required to give effect to certain changes to the FIF measures which were announced by the Treasurer on 22 December 1993.
14.4 The proposed amendments will:
- •
- allow a holding company exemption from the FIF measures for certain indirect investments in company FIFs which carry on general insurance, life insurance, real property or multi-industry activities; and
- •
- exclude construction activities from the non-exempt list thereby making them eligible activities for the purposes of the active business exemption.
Each of these amendments is explained in its own section of this Chapter, following a short overview of the FIF measures.
Overview of the FIF measures
14.5 The FIF measures apply to Australian resident taxpayers who, at the end of an income year, have an interest in a foreign company or trust. The measures also apply to taxpayers who hold a FLP at any time during a year of income.
14.6 Broadly, the FIF measures operate to approximate a resident taxpayer's share of the undistributed profits of a FIF (called FIF income) and to assess the taxpayer on those profits. This treatment is designed to remove the deferral of Australian tax on the profits of a FIF which may otherwise arise where those profits are accumulated offshore rather than remitted to Australian investors.
14.7 The FIF measures provide a number of exemptions from FIF taxation. These exemptions are designed to exclude from the FIF measures interests in FIFs which are not the target of the measures. Where an exemption does not apply, the amount of FIF income to be included in a taxpayer's assessable income is determined using one of the following three taxing methods:
- (a)
- the market value method;
- (b)
- the deemed rate of return method; or
- (c)
- the calculation method.
In the case of FLPs, the amount of FIF income will be determined under the cash surrender value method or the deemed rate of return method.
14.8 Under these methods of taxation, a taxpayer's interest in a FIF is measured in relation to notional accounting periods of a FIF commencing on 1 January 1993 and for subsequent periods. The notional accounting period of a FIF is generally the same as a taxpayer's year of income. However, a taxpayer may elect to use the period for which the annual accounts of the FIF are made.
14.9 The assessable income arising under the FIF measures is included in the taxpayer's assessable income for the income year in which the notional accounting period of the FIF ends.
HOLDING COMPANY EXEMPTIONS
Summary of proposed amendments
14.10 The amendments will allow a holding company exemption from the FIF measures for certain indirect investments in companies which carry on life insurance, general insurance, real property or multi-industry activities [Clause 72].
14.11 The amendments will apply from the commencement of the FIF measures, 1 January 1993 [Subclause 2(4)].
Background to the legislation
14.12 There are currently exemptions from the FIF measures which may apply to an Australian taxpayer's interest in a company FIF where the FIF itself carries on life insurance, general insurance, real property or a combination of several specified activities. [Sections 506, 509, 511 and 523 respectively]
14.13 However, these exemptions do not apply to an interest held by an Australian taxpayer in a holding company FIF whose wholly owned subsidiaries are principally engaged in these activities. In contrast, there is a holding company exemption with regard to the exemption for company FIFs whose wholly owned subsidiaries are principally engaged in carrying on banking business. [Section 504]
Explanation of proposed amendments
14.14 It is proposed that the law be amended to provide an exemption from the FIF measures for a holding company FIF whose wholly owned subsidiaries are principally engaged in life insurance, general insurance, real property or several specified activities. These exemptions are modelled on the existing holding company exemption for banking [Clause 72].
Holding company exemption for life insurance business
14.15 New section 507A will be inserted into the Income Tax Assessment Act to provide for the holding company exemption for life insurance business [Clause 73].
14.16 To qualify for the holding company exemption for life insurance business:
- (i)
- the taxpayer's shares in the holding company are to be widely held and actively traded on an approved stock exchange [Paragraphs 507A(1)(a) and (2)(b)];
- (ii)
- the holding company must be classified on an approved stock exchange or an approved international sectoral classification system as being engaged in the carrying on of life insurance [Paragraph 507A(2)(a)];
- (iii)
- the holding company must have one or more wholly owned subsidiaries. That only subsidiary, or those subsidiaries considered together, must be principally engaged in the active carrying on of a life insurance business, and a subsidiary must also be authorised under the law of its place of residence to carry on life insurance business. [Subsection 507A(3)]
14.17 The principal activities of one or more subsidiaries are to be determined by calculating the sum of the gross value of the assets of each wholly owned subsidiary which are used in carrying on life insurance business and comparing that sum with the sum of the gross value of the assets of each wholly owned subsidiary. The comparison to be used is set out in the next paragraph.
14.18 The subsidiaries will be taken to be principally engaged in the carrying on a life insurance business if the total gross value of the assets of the subsidiaries which are used in carrying on life insurance business is at least half of the total gross value of assets of the subsidiaries.
14.19 The provisions are structured such that if there is only a single subsidiary, new subsection 507A(5) applies to determine if that subsidiary is principally engaged in the active carrying on of life insurance business. Where two or more subsidiaries are involved, new subsection 507A(6) contains the appropriate test. Both tests are carried out by applying sections 507(3) to (11), which apply the existing direct FIF exemption for life insurance business.
Holding company exemption for general insurance activities
14.20 New section 509A will be inserted into the Income Tax Assessment Act to provide for the holding company exemption for general insurance business [Clause 74].
14.21 To qualify for the holding company exemption for general insurance activities:
- (i)
- the taxpayer's shares in the holding company must be of a class of shares in that company that are widely held and actively traded on an approved stock exchange [Paragraphs 509A(1)(a) and 509A(2)(b)];
- (ii)
- the holding company must be classified on an approved stock exchange or an approved international sectoral classification system as being engaged in carrying on a business of general insurance [Paragraph 509A(2)(a)];
- (iii)
- the holding company must have one or more wholly owned subsidiaries. That only subsidiary, or those subsidiaries considered together, must be principally engaged in the active carrying on of a general insurance business and at least one subsidiary must also be authorised under the law of its place of residence to carry on general insurance business. [Subsection 509A(3)]
Holding company exemption for real property activities
14.22 New section 511A will be inserted into the Income Tax Assessment Act to provide for the holding company exemption for real property activities [Clause 75].
14.23 To qualify for the holding company exemption for real property activities:
- (i)
- the taxpayer's shares in the holding company must be of a class of shares in that company that are widely held and actively traded on an approved stock exchange [Paragraphs 511A(1)(a) and 511A(2)(b);]
- (ii)
- the holding company must be classified on an approved stock exchange or an approved international sectoral classification system as being engaged in activities of construction, capital improvement of real property, earning rent from letting commercial real property managed, maintained and serviced by the company or its subsidiaries, provision of management services for real property, agency on sales or purchase of commercial real property, or any combination of these [Paragraph 511A(2)(a)]
- (iii)
- the holding company must have one or more wholly owned subsidiaries. That only subsidiary, or those subsidiaries considered together, must be principally engaged in the active carrying on of any one or more of the activities listed in subparagraph 511(b)(ii) [Subsection 511A(3)].
Holding company exemption for multi-industry activities
14.24 New section 523A will be inserted into the Income Tax Assessment Act to provide for the holding company exemption for multi-industry activities [Clause 76].
14.25 To qualify for the holding company exemption for multi-industry activities:
- (i)
- the taxpayer's shares in the holding company must be of a class of shares in that company that are widely held and actively traded on an approved stock exchange [Paragraph 523A(1)(a) and subsection 523A(2)]
- (ii)
- the holding company must have one or more wholly owned subsidiaries. That only subsidiary, or those subsidiaries considered together, must be principally engaged in the active carrying on of any two or more of the activities listed in subparagraph 523(b)(ii). [Subsection 523A(3)]
14.26 Subparagraph 523(b)(ii) forms part of the test for the existing direct FIF exemption for multi-industry activities. The listed activities include life insurance, general insurance, the various real property activities relevant to section 511 and 511A, and eligible activities within the meaning of Division 3.
CONSTRUCTION ACTIVITIES
Summary of proposed amendments
14.27 The amendments will exclude activities in connection with construction from the general non-exempt list of activities for the purposes of the FIF measures thereby making them eligible activities for the purposes of the active business exemption [Clause 77].
14.28 The amendments will apply from the commencement of the FIF measures, 1 January 1993 [Subclause2(4)].
Background to the legislation
14.29 The active business exemption from the FIF measures applies to interests in company FIFs principally engaged in certain active business, known as eligible activities. [Section 497]
14.30 These eligible activities include all activities other than those non-exempt listed activities described in Schedule 4 of the Act. [Subsection 496(1)]
14.31 Accordingly, the reference to "activities in connection with real property" in paragraph (g) of Schedule 4 means that construction activities will not normally be eligible activities for the purposes of the active business exemption. ( Note, however, there is currently a specific exemption from the FIF measures for interests in certain company FIFs which are principally engaged in the active carrying on of construction. [Section 511])
Explanation of proposed amendments
14.32 It is proposed to amend the law to exclude construction activities from the general non-exempt list of activities for the purposes of the FIF measures thereby making them eligible activities for the purposes of the active business exemption. In other words, in addition to the specific exemption contained in section 511 of the Act, a general exemption will now apply under the active business exemption to interests in companies principally engaged in the carrying on of construction activities.
14.33 This amendment will be achieved by amending paragraph (g) of Schedule 4 of the Act to exclude activities in connection with construction [Clause 79 - amendment to Schedule 4]. A consequential change to section 496 is also required [Clause 78 - amendment to subsection 496(2)].
GLOSSARY
An alternative method, available at the taxpayer's election, to determine the amount to be included in a taxpayer's assessable income under the FIF measures. The amount is calculated by determining a taxpayer's share of a FIF's profits. A FIF's profits are calculated using rules similar (but simpler than) those that apply for a resident taxpayer.
Method of taxation applying to taxpayers who have an interest in a FLP. In general, the amount included in assessable income is calculated by measuring the increase, if any, in the cash surrender value of an interest in a FLP between the last day of the previous notional accounting period and the last day of the current notional accounting period, with an adjustment for acquisitions, disposals and distributions.
The backup method to determine the amount to be included in the taxpayer's assessable income under the FIF measures which is used where it is not possible to use the market value method and a taxpayer does not choose (elect) to use the calculation method. The amount is calculated by applying a deemed rate of return to the value of the FIF or FLP interest.
A foreign investment fund.
An attribution account establishes a link between:
- •
- income that has been attributed under the FIF measures to the taxpayer from an entity; and
- •
- income actually distributed to that taxpayer by that entity.
This makes it possible to identify when, and to what extent, it is necessary to provide relief from double taxation on the distribution of profits which have been taxed under the FIF measures.
A FLP is a life assurance policy (as defined in subsection 482(2)) issued by a non-resident.
The total of all instruments in a company held by the taxpayer (such as a share, option, convertible note etc.) or in a trust (such as a unit, option to acquire a unit, a note convertible into a unit).
The primary method to determine the amount to be included in the taxpayer's assessable income under the FIF measures. In general, the amount is calculated by measuring the increase, if any, in the market value of a FIF interest between the last day of the previous notional accounting period and the last day of the current notional accounting period with adjustment for acquisitions, disposals and distributions.
The period by reference to which the FIF measures will apply. In general, this will be the same as the taxpayer's year of income. The taxpayer may elect that the notional accounting period coincide with the accounting period that the FIF uses for reporting to shareholders or beneficiaries. In relation to FLPs, the taxpayer may elect that the notional accounting period of the FLP coincide with the period for which cash surrender values are available.
Chapter 15 - Development allowance and general investment allowance.
Overview
15.1 Two amendments are to be made to general investment and development allowances and one to the development allowance only.
15.2 The amendments relating to both allowances will:
- •
- allow a wholly-owned company group to share the use of property without losing entitlement to either of the allowances; and
- •
- extend both of the allowances to property used in the transport of minerals or quarry materials.
15.3 The third amendment will require leasing companies to give notices of transfer of entitlement to the development allowance in respect of leased property to lessees instead of to the Commissioner of Taxation.
Summary of proposed amendments
1. Property used within wholly-owned company groups
15.4 Presently, a taxpayer is not entitled to the general investment allowance or the development allowance in respect of property if the taxpayer grants another person the right to use that property. This restriction can inhibit the efficient use of property within wholly-owned company groups. Accordingly, the restriction is to be removed where the use of property is granted to another company within the same wholly-owned company group [Clause 84].
15.5 Applies from the time when the allowances commenced; that is, 27 February 1992 in the case of the development allowance, and 9 February 1993 in the case of the general investment allowance [Subclause 2(5)].
2. Property used in the transport of minerals and quarry materials.
15.6 Currently, expenditure on the acquisition or construction of otherwise eligible property cannot qualify for either of the allowances if it qualifies for write-off under the provisions relating to the transport of minerals or quarry materials. Such expenditure will now be able to qualify for the allowances [Clause 91].
15.7 Applies from the time when the allowances commenced; that is, 27 February 1992 in the case of the development allowance, and 9 February 1993 in the case of the general investment allowance [Subclause 2(5)].
3. Transfer of entitlements to development allowance by leasing companies.
15.8 Currently, a leasing company that wishes to transfer to a lessee, some or all of its entitlement to the development allowance in respect of leased property, must give a written notice of the transfer to the Commissioner of Taxation. This requirement is to be replaced with a requirement that the leasing company give the notice to the lessee [Clause 80].
15.9 The amendment will apply to leasing arrangements entered into after the date of Royal Assent [Clause 83].
Introduction
15.10 The general investment allowance and the development allowance are incentives for taxpayers to invest in new items of plant for use solely in Australia for the production of assessable income. Both allowances constitute a deduction equal to 10% of the capital cost of eligible property. The deduction is allowable in the year the property is first used for the purposes of producing assessable income, or held in reserve for that purpose. The allowances are in addition to other deductions that may be available in respect of the cost of the property, such as plant depreciation. Taxpayers can access both allowances in respect of the same property if they meet the respective conditions of each allowance.
15.11 The general investment allowance applies to items of plant costing $3000 or more. To qualify, the item must be acquired under a contract entered into after 8 February 1993 and before 1 July 1994. If constructed by the taxpayer, construction must commence during that period. As well, the property must be first used, or held in reserve, before 1 July 1995 for the purpose of producing assessable income.
15.12 The development allowance applies to expenditure on plant that has pre-qualified under the Development Allowance Authority Act 1992. Broadly, that Act relates to projects costing $50m or more that were registered with the Authority on or before 31 December 1992 and which meet certain other specified criteria (relating to improved labour relations and pricing of manufacturing etc. inputs). To qualify, the expenditure must be in respect of an item plant acquired under a contract entered into after 26 February 1992, or if constructed by the taxpayer, that was commenced to be constructed after that date. As well, the item must be first used for the purpose of producing assessable income before 1 July 2002, or be installed ready for such use before that date.
1. Property used within wholly-owned company groups
Background to the legislation
15.13 A taxpayer, other than a leasing company, is not entitled to the allowances in respect of property that they acquire for the purpose of leasing or of granting of rights to use to another person. As well, an entitlement can be withdrawn if a taxpayer acquires or leases property without such a purpose but subsequently leases the property or grant rights to another person to use the property, within 12 months of the property being first used or installed ready for use.
15.14 These restrictions can operate harshly in relation to wholly-owned company groups. The use of property of a company by another company within the same group would be a disqualifying use of the property and would cause entitlement to the allowances to be withdrawn. This can inhibit the efficient use of property within wholly-owned company groups. Accordingly, the restrictions are to be eased in relation to wholly-owned company groups.
Explanation of the amendment
15.15 Entitlement to the general investment allowance is mainly worked out using the development allowance provisions. Accordingly, the necessary amendments only need to be made to the development allowance provisions.
15.16 The term "related company" is relevant for working out whether two companies are within the same wholly-owned company group. The term has the same meaning as in section 51AE, which deals with entertainment expenses. [Clause 90 inserts definition of "related company"]
15.17 A company is a related to another company if one of the companies is a subsidiary of the other or both are subsidiaries of the same company. Broadly, a company is a subsidiary of another company if all of the shares in the company are beneficially owned by the other company. [Existing subsections 51AE(16) to (19)]
Leasing etc property to related company
15.18 A taxpayer, other than a leasing company, is not entitled to either of the allowances if the taxpayer acquires the property for the purpose of leasing the property or of granting rights to use the property to other person [existing sub-subparagraphs 82AA(1)(a)(ii)(A) & (C)].
15.19 This rule will not apply where property is acquired for either of these purposes if the property is to be leased to, or the rights are to be granted to, a related company. [Clause 85 inserts new subsection 82AA(3)]
15.20 There are a number of conditions:
- 1.
- the related company must intend using the property wholly and exclusively both in Australia and for the purpose of producing assessable income other than by leasing the property or granting rights to another person to use the property; and
- 2.
- it is intended that the related company, or related companies, will remain as such during the term of the lease or the use.
Lease etc of property within 12 months
15.21 Entitlement to the allowances is withdrawn in respect of property owned by a taxpayer, other than a leasing company, if the taxpayer leases the property, or grants rights to use the property to another person, within 12 months of the property being first used, or installed ready for use [existing subsection 82AG(1)].
15.22 Similarly, a lessee of property that has qualified for the allowances must not enter into a contract or arrangement for the use of the property by another person, within the 12 month period [existing subsection 83AG(3)]. A corresponding rule applies to property leased from a partnership [existing subsection 82AJ(7)].
15.23 These rules will not apply where the lease, or the grant of rights to use, is to a related company. [Clauses 86(a) & (b) insert new subsections 82AG(1B) & (3B); clause 88(a) inserts new subsection 82AJ(7AB)]
15.24 A number of conditions apply:
- 1.
- the related company must remain a related company for whole of the period ending at the earlier of the end of the term of the lease, grant, contract, or arrangement and the end of the 12 month period; and
- 2.
- the related company must use the property wholly and exclusively both in Australia and for the purpose of producing assessable income other than by leasing the property or granting rights to use the property to another person.
Agreement for use made before lease entered into
15.25 Neither allowance is available for property leased by a taxpayer from a leasing company if, before entering into the lease, the taxpayer entered into a contract or arrangement with another person for the use of the property by that other person [existing subsection 82AG(4)]. A similar rule applies in relation to property leased from a partnership [existing subsection 82AJ(7A)].
15.26 This provision will not apply where the contract or arrangement is with a related company. [Clause 86(c) inserts new subsection 82AG(6); clause 88(b) inserts new subsection 82AJ(7C) ] The following are the conditions that apply:
- 1.
- the related company must intend to, and actually, use the property wholly and exclusively both in Australia and for the purpose of producing assessable income other than by leasing the property or granting rights to another to use the property; and
- 2.
- the related company must remain a related company during the whole of the period ending at the earlier of end of the term of the contract or arrangement or 12 months after the property was first used.
Lease etc of property after 12 months
15.27 Entitlement to the allowances can be withdrawn if a taxpayer leases property, or grants rights to use property, after 12 months, if the Commissioner of Taxation is satisfied that the taxpayer acquired or leased the property with the intention of granting the lease or the right to use [existing subsections 82AH(1), (3) & (4)]. A corresponding rule applies to property leased from a partnership [existing subsection 82AJ(8)].
15.28 These provisions will not apply if it was intended that the lease or the grant was to be made to a related company. [Clause 87 inserts new subsections 82AH(1B), (3B) & (6); Clause 88(c) inserts new paragraph 82AJ(10)]
15.29 These conditions apply:
- 1.
- the related company must have intended to use the property wholly and exclusively both in Australia and for the purpose of producing assessable income other than by leasing the property or granting rights to another to use the property; and
- 2.
- it was intended that the related company would remain a related company during the subsistence of the lease, grant, contract or arrangement.
Disposals within wholly-owned public company groups
15.30 The disposal of property within 12 months of it being first used, or installed ready for use, would ordinarily result in a loss of entitlement to the allowances. This does not occur if the disposal is between companies within a wholly-owned public company group [existing section 82AJA]. There are a number of conditions for this rollover. The principal condition is that the property remain in the group during the whole of the 12 month period [paragraph 82AJA(1)(b)].
15.31 Another condition is that the owner of the property neither leases the property nor grants rights to another person to use the property [subparagraphs 82AJA(1)(d)(i) & (ib)]. This other condition will not apply where the lease or rights are granted to a public company that is related to the owner. [Clause 89 inserts new subsections 82AJA(1B) & (1C)]
15.32 The following are the conditions that apply:
- 1.
- the company must remain a public company that is related to the owner for whole of the period ending at the earlier of the end of the term of the lease or grant and the end of the 12 month period; and
- 2.
- the company must use the property wholly and exclusively both in Australia and for the purpose of producing assessable income other than by leasing the property or granting rights to another to use the property.
15.33 The amendments are to apply from the commencement of the allowances; that is, from 26 February 1992 under the development allowance and from 8 February 1993 under the general investment allowance. Because of the way the two allowances interact, specifying that the amendments are to apply to the development allowance from the commencement of that allowance means that the amendments automatically apply to the general investment allowance from its commencement time [Subclause 2(5)].
2. Property used in the transport of minerals and quarry materials.
Background to the legislation
15.34 The development allowance and the general investment allowance do not apply to expenditure on plant that attracts special treatment under other provisions such as: 100% depreciation; 3 year write-off for 150% of cost under the R & D provisions; immediate deduction under the mining/quarrying exploration and prospecting provisions [section 82AM].
15.35 Also excluded from both allowances is expenditure eligible for write-off under the mineral and quarry materials transport provisions [Division 10AAA]. They allow expenditure on facilities principally for use in the transport of minerals and quarry materials from the mine-site or quarry to be deducted over 10 years in the case of mineral transport and over 20 years in the case of quarry materials. The sort of property covered includes railways, roads, pipelines and port facilities. It also covers contributions to capital expenditure of others (usually public authorities and the like) on such facilities.
15.36 This exclusion applied under the former investment allowance. At that time, depreciation rates for the sort of property covered by these transport provisions were less concessional (providing a 15 to 40 year write-off depending on effective life). However, the current depreciation rates system is more generous. This sort of property now qualifies for a minimum 13 year write-off when used in other circumstances.
15.37 If expenditure on the plant component of mineral and quarry materials transport facilities was deductible under the plant depreciation provisions, the investment allowance would then be available even though depreciation might also allow higher deductions. However, taxpayers who incur expenditure covered by both the transport provisions and the depreciation provisions must use the former and so cannot qualify for the allowances under the existing rules.
Explanation of the amendment
15.38 The current exclusion of expenditure on plant for use in transporting mineral and quarry materials is to be removed for plant that would qualify for the allowances but for the current exclusion. This is to be achieved by removing the reference to sections 123B & 123BE from subsection 82AM(2) [Clause 92].
15.39 As mentioned earlier, the minerals and quarry materials transport provisions also cover contributions to expenditure of others. This amendment does not extend the allowances to such expenditure. It only applies to plant that is either owned by the taxpayer or is deemed by subsection 82AQ(3A) to be owned by the taxpayer because it is installed on a Crown lease.
15.40 The amendment is to apply from the commencement of the allowances; that is, from 26 February 1992 under the development allowance and from 8 February 1993 under the general investment allowance. Because of the way the two allowances interact, specifying that the amendments apply to the development allowance from the commencement of that allowance means that the amendments automatically apply to the general investment allowance from its commencement time [subclause 2(4)].
3. Transfer of entitlements to development allowance by leasing companies.
Background to the legislation
15.41 As mentioned earlier, the allowances are generally not available where the owner of otherwise eligible plant grants rights to use the plant to another person. An exception to this relates to the leasing business of leasing companies. Leasing companies are entitled to the allowances if the lessee contracts to lease plant for not less than four years.
15.42 There is an option for a leasing company to transfer some or all of its entitlement to the allowances from a leasing transaction to the lessee [section 82AD]. To do this under general investment allowance, the company must give a declaration and statement to the lessee [section 82AW]. However, the development allowance requires that the declaration and statement must be given to the Commissioner of Taxation [subsection 82AD(1)].
Explanation of the amendment
15.43 This requirement under the development allowance for leasing companies to lodge such declarations and statements with the Commissioner is not consistent with recent "self-assessment" changes to income tax law. The general trend under self-assessment is to minimise the amount of information that taxpayers must give to the Commissioner. Rather, taxpayers need to retain sufficient information to verify their income tax affairs upon enquiry from the Commissioner, generally for not less than five years.
15.44 Accordingly, this requirement is to be changed to a requirement that the leasing company give the declaration and statement to the lessee [Clause 81 amends subsection 82AD(1)]. Lessees will need to retain these documents for five years, to justify their claims for the allowance [existing section 262A].
15.45 Because the general investment allowance provisions adopt the development allowance provisions subject to any necessary changes, a special provision provides for the documents to be given to lessees rather than the Commissioner. In consequence of the change to the development allowance, that special provision is no longer needed and is repealed [Clause 82 repeals section 82AW].
15.46 The amendment applies to leasing agreements entered into after the date on which this Bill receives Royal Assent [Clause 83].
HECS - Inclusion in provisional tax calculation.
Overview
16.1 This Bill will amend Division 3 of Part VI of the Income Tax Assessment Act 1936 to include a Higher Education Contribution (HEC) assessment debt in provisional tax calculations.
Summary of proposed amendments
16.2 To provide for the inclusion of a HEC assessment debt in provisional tax calculations [Clause 93].
16.3 Calculation of provisional tax (including instalments) payable for the 1994-95 and later years of income [Clause 96].
Background to the legislation
16.4 The Government announced in the 1993-94 Budget on 17 August 1993 that HEC assessment debts will be recovered through the provisional tax and pay-as-you-earn (PAYE) arrangements for the 1994-95 and later years of income. These amendments only relate to the provisional tax arrangements. The income tax regulations will be amended to reflect the increased PAYE deductions to recover HEC assessment debts.
16.5 At present, the calculation for provisional tax does not have regard to accumulated HEC debts and the resultant HEC assessment debts. For the 1994-95 and later years of income, HEC debts will be recovered through the provisional tax arrangements. Provisional taxpayers with HEC assessment debts will continue to pay those debts after PAYE taxpayers.
16.6 The Higher Education Funding Legislation Amendment Act 1993 amended the Higher Education Funding Act 1988 and inserted new subsection 106U(4). Subsection 106U(4) enables the calculation of provisional tax in Division 3 of Part VI of the Income Tax Assessment Act 1936 to include a HEC assessment debt. This approach is consistent with the existing legislation which requires a HEC assessment debt to be treated as income tax assessed.
Explanation of the amendments
16.7 Division 3 in Part VI of the Assessment Act provides for the calculation of provisional tax. Section 221YCAA details the calculations and assumptions made in determining the amount of provisional tax for a particular year. The following explanation will assume the particular year is 1994-95. At present, provisional tax for 1994-95 will be determined by:
- •
- applying the 1994-95 income tax rates and medicare levy to the preceding year's (1993-94) taxable income as uplifted by the provisional tax uplift factor; and then
- •
- reducing the resultant tax payable by rebate and other credit entitlements in 1993-94, adjusted as appropriate.
16.8 These amendments [Clause 94] will insert new paragraph 221YCAA(2)(ca) into Division 3 to enable HEC assessment debts, as calculated under the Higher Education Funding Act 1988, to be included in the calculation of provisional tax (including instalments) payable for the 1994-95 and later years of income.
16.9 The Bill also proposes to insert new subsection 221YDA(9) into the Act so that a HEC assessment debt is taken into account in situations where a taxpayer elects to vary their provisional tax under section 221YDA [Clause 95].
16.10 The four examples below demonstrate how the calculation of provisional tax for the 1994-95 year will have regard to HEC assessment debts. The following notes may assist:
- •
- Where a provisional taxpayer's 1993-94 assessment includes a HEC assessment debt, the accumulated HEC debt which is subject to the 1994-95 provisional tax calculation will be the accumulated debt on 1 June 1994 reduced by the HEC debt included in the 1993-94 assessment.
- •
- The following table shows the HEC repayment rates (as a percentage of taxable income) assumed for the 1994-95 financial year:
| Taxable income | HEC contribution |
|---|---|
| $26 852 or less | Nil |
| $26 853 - $30 516 | 3% |
| $30 517 - $42 722 | 4% |
| $42 723 or more | 5% |
16.11 In the 1993-94 financial year, Carolyn earned salary or wage income only, and had an accumulated HEC liability on 1 June 1994 of $6,000. Carolyn's 1993-94 PAYE deductions were $2000. Carolyn will be required to pay provisional tax for the 1994-95 financial year (under sections 221YAB and 221YA) because:
- •
- the shortfall in PAYE tax instalments deducted in the 1993-94 year of income; and
- •
- the tax payable for 1993-94 ($12,304) less credited amounts ($2,000);
were both $3,000 or more.
16.12 Carolyn's 1994-95 provisional tax, based on provisional income of $44 000, will be calculated as follows:
- (i)
- tax payable on provisional income of $44,000 $11 522
- (ii)
- medicare levy ($44,000 x 1.4%) $616
- (iii)
- provisional HEC assessment debt ($44,000 x 5%) $2 200
less adjusted credit for tax attributed to salary* ($2 331)
1994-95 provisional tax $12 007
16.13 In the 1993-94 financial year, Helen earned salary or wage income and interest income. Unlike Carolyn in Example 1, Helen's PAYE tax instalments were in accordance with the prescribed rates and there was no shortfall. Helen also had an accumulated HEC liability on 1 June 1994 of $6 000. Her provisional income for the 1994-95 financial year was $38 500 which consisted of $33 000 in salary or wages and $5 500 in interest income.
16.14 Helen's 1994-95 provisional tax, based on provisional income of $38 500, will be calculated as follows:
- tax payable on provisional income of $38 500 $9 157
- medicare levy (1.4% of $38 500) $539
- provisional HEC assessment debt (4% of $38 500) $1 540
- less PAYE credit (on $33 000 salary or wages) ($9 024)
- 1994-95 provisional tax $2 212
16.15 In the 1993-94 financial year, Lucy earned only business income under the prescribed payments system (PPS). Following Lucy's 1993-94 assessment, her accumulated HEC liability was $400 and her provisional income for the 1994-95 financial year was $44 000. Lucy ceased her studies in 1992.
16.16 Lucy's 1994-95 provisional tax, based on provisional income of $44 000, will be calculated as follows:
- tax payable on provisional income of $44 000 $11 522
- medicare levy (1.4% of $44 000) $616
- provisional HEC assessment debt* $400
- less provisional PPS credits (8 800)
- 1994-95 provisional tax $3 738
16.17 In the 1993-94 financial year, Michael's income was made up of 50% salary or wage income and 50% untaxed business income. He had an accumulated HEC liability on 1 June 1994 of $6 000 and provisional income for the 1994-95 financial year of $44 000.
16.18 Michael's 1994-95 provisional tax, based on provisional income of $44 000, will be calculated as follows:
- tax payable on provisional income of $44 000 $11 522
- medicare levy (1.4% of $44 000) 616
- provisional HEC assessment debt (5% of $44 000)* $2 200
- less PAYE credits (on $22 000 salary or wages) ($3810)
- 1994-95 provisional tax $10 528
Chapter 17 - Constitutionally protected superannuation funds.
Overview
17.1 The amendment will exempt from tax all income derived by certain State public sector superannuation funds that are constitutionally protected from tax on any of their receipts [Clause 97].
17.2 The constitutional power of the Commonwealth to tax the South Australian Superannuation Fund Investment Trust (SASFIT) was considered by the High Court of Australia in The State of South Australia & Anor v The Commonwealth of Australia & Anor (1992) 105 ALR 171, 92 ATC 4066. The High Court found that:
- •
- SASFIT is exempt from tax on capital gains under section 114 of the Constitution because tax on capital gains is a tax on property; and
- •
- by majority, SASFIT is not exempt from tax on interest income.
17.3 As a result of the High Court's decision State superannuation funds that are constitutionally protected are exempt from tax on part of their income. However, any payment from such a fund is from an untaxed source. Consequently members of the fund will be subject to tax at the higher rates applying to eligible termination payments and superannuation pensions from an untaxed source, even though part of the income of the fund is taxed.
17.4 An additional complication arises because State superannuation funds which are constitutionally protected on part of their income have behaved differently. Some funds have always considered that they are exempt from tax on all of their income. Benefits paid from these funds have been treated as being from an untaxed source. Other funds have assumed that they are liable to tax on all their income and have paid benefits out on the presumption that they are from a taxed source.
Explanation of the amendment
17.5 A fund is a constitutionally protected superannuation fund if the assets of the fund belong to a State Government. That is, a State public sector superannuation fund is a constitutionally protected fund unless the assets of the fund are held in trust in the ordinary legal sense (see Superannuation Fund Investment Trust v Commissioner of Stamps (SA) (1979) 145 CLR 330; 79 ATC 4429). The current definition of constitutionally protected fund will be replaced. To remove any doubt about the matter, funds which qualify as a constitutionally protected fund will be listed in the Income Tax Regulations [Clause 100 and 101; New definition of constitutionally protected fund in subsection 267(1)].
17.6 Income derived by a constitutionally protected fund will be exempt from tax. [Clause 102; New section 271A]
17.7 If a constitutionally protected fund invests in a pooled superannuation trust (PST), the income derived by the PST that is attributable to that investment will be exempt from tax [Clause 103; New section 297C].
17.8 Similarly, if a constitutionally protected fund purchases a life assurance policy from a life assurance company or registered organisation, the assessable income of the life assurance company or registered organisation that is attributable to that policy will be exempt from tax. [Clauses 98 and 99; New section 110CA and section 116FC]
17.9 Benefits paid from a constitutionally protected fund are from an untaxed source and therefore taxed at a higher rate. Subsection 27AB(1) determines the taxed and untaxed elements of the post-June 1983 component of an eligible termination payment. A benefit is from a taxed source if it is paid from a taxed superannuation fund. A taxed superannuation fund is defined in subsection 27A(1) and specifically excludes a constitutionally protected fund. Similarly, any pension paid from a constitutionally protected fund will not qualify for a rebate because it is not paid from a taxed superannuation fund (subsection 159SM(2)).
17.10 Subsection 271(1) will be retained so that if a fund that is not listed as a constitutionally protected fund in the Regulations is, in fact, exempt from tax on property under section 114 of the Constitution, Part IX will not apply to tax the fund on its constitutionally protected receipts. Benefits paid from such a fund will, of course, be from an untaxed source.
Application of amendments
17.11 The date of effect of the proposed amendments depends on the behaviour of the particular fund since 1 July 1988. The reason for having different application dates is to minimise the disruption to affected funds and the impact on members of constitutionally protected funds who received benefits between 1 July 1988 and 30 June 1993.
17.12 Generally the proposed amendments will apply to assessments made in respect of the 1993-94 and subsequent years of income. However, if a constitutionally protected fund has not paid income tax because it assumed that all of the income of the fund was exempt from tax, the proposed amendments will apply to assessments made in respect of the 1988-89 and subsequent years of income [Clause 104].
17.13 A constitutionally protected fund will be considered to have assumed that it was exempt from tax, and therefore be regarded as not having paid tax, if it paid benefits out as though they were wholly from an untaxed source.
Transitional arrangements
17.14 The proposed amendments will apply to constitutionally protected funds that have paid income tax since 1 July 1988 with effect to assessments made in respect of the 1993-94 and subsequent years of income. Such funds are entitled to the benefit of constitutional protection on that part of their income which represents a tax on property in respect of assessments made in earlier years. Benefits paid to members by those funds were regarded as being from a taxed source whereas, in fact, they should have been treated as though they were from an untaxed source.
17.15 Therefore, to alleviate the need for such funds to revise benefits paid to members since 1 July 1988 and to ease the impact on members who have made investment decisions on the basis that the benefits they received were from a taxed source, the transitional provisions will ensure that benefits paid in a year of income between the 1988-89 to 1992-93 years of income by a constitutionally protected fund that paid income tax in respect of the relevant year of income will be treated as though they were from a taxed source [Clause 105].
17.16 A constitutionally protected fund will be considered to have paid income tax for these purposes even though it may not have actually paid income tax in respect of a particular year because of the impact of concessions such as pre-July 1988 funding credits, the exemption of income attributable to current pension liabilities and dividend imputation credits. The crucial test is that the fund behaved as a taxed superannuation fund in the relevant year and lodged income tax returns accordingly.
17.17 As a consequence of these transitional measures the post-June 1983 component of eligible termination payments made between 1 July 1988 and 30 June 1993 from constitutionally protected funds that paid income tax in the relevant year will be regarded as being from a taxed source.
17.18 Similarly, pensions paid between 1 July 1988 and 30 June 1993 from constitutionally protected funds that paid income tax in the relevant year will be regarded as being from a taxed source and therefore be rebatable superannuation pensions in the 1988-89 to 1992-93 years of income. Those pensions will no longer be rebatable from 1 July 1993.
Chapter 18 - Depreciation of employee amenity property
Overview
18.1 This amendment will allow the concessional rate of depreciation for employee amenities to be available on a wholly-owned company group basis.
Summary of proposed amendments
18.2 The amendment will allow wholly-owned company groups to use employee amenities owned by any group member as a resource of the whole group, without losing entitlement to the concessional depreciation rates [Clause 106].
18.3 Applies from the commencement of the 1993/94 year of income in relation to existing and future property [Clause 109].
Background to the legislation
18.4 The plant depreciation provisions allow taxpayers to write-off the otherwise non-deductible capital cost of plant used in income-producing activities. Depreciation rates are generally set according to the effective life of the relevant asset. So, the shorter the effective life, the higher the applicable rate of depreciation and vice versa.
18.5 Special depreciation rates are available for certain categories of plant. One of those categories is "employee amenities": property used by a taxpayer principally for the purpose of providing clothing cupboards, first aid, rest-room or recreation facilities, or meals or facilities for meals for persons employed by the taxpayer or for the care of children of those persons. The minimum depreciation rate for such property is 33% prime cost or 50% diminishing value, irrespective of actual effective life [subsection 55(4)].
18.6 Further, plumbing fixtures and fittings ordinarily do not qualify as plant and therefore are not eligible for plant depreciation deductions; instead they qualify for deduction under the less concessional capital allowance for buildings [Division 10D]. However, they are treated as plant where provided principally for employees or for the care of children of employees [paragraph 54(2)(c)].
18.7 A requirement of these employee amenities concessions is that the property must be used principally in providing the relevant facilities for employees of the taxpayer or for the care of children of those employees. This requirement can make it difficult for some wholly-owned company groups to qualify for the concessions.
18.8 In some circumstances, employees of various companies within a wholly-owned group may share the use of facilities owned by one of the companies; for instance, a staff canteen or child day-care centre. If the majority of employees using the facilities are not employed by the company that owns the facilities, it would not be possible to say that the facilities are principally used by its employees and the concessions would therefore not be available.
18.9 Such an outcome is not appropriate and is inconsistent with the general trend in income tax law to treat wholly-owned company groups as if they were a single taxpayer. For instance, companies within wholly-owned groups are permitted to transfer losses between each other. Similarly, capital gains tax and capital allowance rollover relief is available for disposals of assets within wholly-owned company groups. The effect of these provisions is to treat wholly-owned company groups as if a single taxpayer.
18.10 Accordingly, the depreciation employee amenities concession is to be available on a wholly-owned group company basis; that is, the concession will also apply where relevant property of a company within a wholly-owned company group is provided principally for use by employees of any companies within the same company group, or for the care of children of any of those employees.
Explanation of the amendments
Plumbing fixtures and fittings
18.11 The existing law treats as plant, plumbing fixtures and fittings in premises if they are provided principally as "amenities" for the benefit of employees of the person who owns the fixtures and fittings. The present requirement that the amenities be provided principally for use by employees of the owner is to be amended in the case of companies so that it applies on a wholly-owned company group basis. This is achieved, in effect, by extending the reference to employees of the owner to include a reference to employees of a company that is related to the owner. [Clause 107, which modifies existing paragraph 54(2)(c)]
18.12 The meaning of "related company" is the same as for the purposes of existing section 51AE, which deals with entertainment expenses. A company is related to another company if one of the companies is a subsidiary of the other or both are subsidiaries of the same company [existing subsections 51AE(16) to (19)]. Broadly, a company is a subsidiary of another company if all of the shares in the company are beneficially owned by the other company.
18.13 Subsection 54(4) provides the special minimum depreciation rate for items of plant used by a taxpayer principally for the purpose of providing certain amenities for the benefit of employees of the taxpayer.
18.14 The current requirement that the amenities be used by a taxpayer principally for use by employees of the taxpayer is to be amended in the case of companies so that it applies on a wholly-owned company group basis. This is achieved, in effect, by extending the reference to employees of the taxpayer to include a reference to employees of a company that is related to the taxpayer, within the meaning of existing section 51AE (discussed above). [Clause 108, which substitutes a new subparagraph 55(4)(b)(i) for the existing subparagraph]
Application of the amendments
18.15 Both amendments commence from the start of the 1993-94 year of income. [Clause 109]
Chapter 19 - Offshore banking units.
Overview
19.1 The income from the activities of an offshore banking unit (OBU) is taxed at a concessional rate of 10%. This Bill will amend the concessional regime by extending its scope. It will also make some minor technical corrections.
Summary of proposed amendments
19.2 The Bill proposes to:
- •
- extend the scope of borrowing or lending activities to include gold borrowings and loans;
- •
- make it clear that a guarantee, letter of credit or performance bond must be in respect of the activities of offshore parties in their performance outside Australia in order to attract concessional tax treatment; and
- •
- make two minor technical amendments to correct deficiencies in the law [Clause 110].
19.3 The amendments will apply from the day the Bill receives Royal Assent except for a minor technical amendment to subsection 128GB(4). That amendment will apply from 21 December 1992, which is the date Taxation Laws Amendment Act (No.4) 1992 (which first provided the concessional tax regime) received Royal Assent [Subclause 2(6), Clause 114].
Background to the legislation
19.4 The term offshore banking broadly refers to the intermediation by institutions operating in Australia of financial transactions between non-resident borrowers and non-resident lenders. It also includes the provision of financial services to non-residents in respect of transactions/business occurring outside Australia.
Borrowing or lending activities
19.5 The meaning of an "OB activity", the income from which will qualify for concessional tax treatment, is set out in sections 121D, 121E and 121EA One such activity is borrowing or lending money. Given that there is now an established market for gold loans and gold borrowings as an alternative means of finance and trading, the Government has decided to extend OB borrowing and lending activities to include gold loans and borrowings.
19.6 A simple example of a gold loan might involve a New Zealand (NZ) gold producer that desires to borrow funds to expand its operations. The lender, say an Australian OBU, borrows gold from an institution which holds gold reserves (perhaps a central bank) and lends the gold to the NZ producer.
19.7 The NZ producer sells the gold and uses the proceeds for the intended purpose. The NZ producer pays a gold fee, to the lender, from gold produced by its operation or by purchasing gold in the spot market. This represents a payment in the nature of interest. The loan is also repaid using either gold produced by its operation or by purchasing gold in the spot market.
19.8 Subsection 121D(3) defines the type of guarantee-type activities which make up OB activities for the purposes of paragraph 121D(1)(b). Broadly speaking these are activities which involve fee income for providing a guarantee or letter of credit, syndicating a loan, providing a performance bond or underwriting a risk.
19.9 Subsection 121D(3) is to be amended to make it clear that a guarantee, letter of credit or a performance bond must be in respect of the activities of offshore parties in their performance outside Australia to attract concessional tax treatment. It would not be possible, for example, for an Australian importer to pay a fee to an OBU for providing a guarantee to an offshore exporter of goods into Australia.
19.10 When the OBU concessional tax regime was introduced it was necessary to align, as far as was practical, the exemptions from interest withholding tax which were then provided to OBUs with the transactions in relation to which income tax concessions were to be provided. This Bill will correct two minor technical deficiencies in the withholding tax provisions resulting from those amendments.
Explanation of amendments
Borrowing or lending activities
19.11 The definition of "borrowing or lending activity" in subsection 121D(2) will be expanded by inserting two new paragraphs to include gold borrowings [paragraph 121D(2)(c)] and gold loans [paragraph 121D(2)(d)] in order to provide concessional tax treatment for these activities [Clause 111].
19.12 The definition of "guarantee-type activity" in subsection 121D(3) will be amended to make it clear that a guarantee or letter of credit [paragraph 121D(3)(a)] , or performance bond [paragraph 121D(3)(d)] must be in relation to activities which are or will be conducted wholly outside Australia in order to attract concessional tax treatment [Clause 111].
19.13 The reference to the now repealed subsection 128AE(6) in 128AE(7) will be omitted [Clause 112].
19.14 The previously deleted term "offshore loan" used in 128GB(3) will be redefined by inserting a new definition in subsection 128GB(4). The new definition is consistent with the offshore banking unit legislation contained within Division 9A of Part III [Clause 113].
Chapter 20 - Gifts
Summary of proposed amendments
20.1 To allow, for a limited period, income tax deductions for gifts of $2 or more made to:
- •
- The "Weary" Dunlop Statue Appeal; and
- •
- The Sandakan Memorials Trust Fund [Clause 115].
20.2 Gifts made to The "Weary" Dunlop Statue Appeal after 15 July 1993 and before 16 July 1994.
20.3 Gifts made to The Sandakan Memorials Trust Fund after 29 July 1993 and before 30 July 1995 [Clause 116].
Background to the legislation
20.4 Broadly, section 78 of the Principal Act provides deductions for gifts of $2 or more to various funds and organisations. A deduction is allowable in the year of income in which the gift is made.
20.5 A fund or organisation can be granted tax deductible gift status in two ways. Firstly, a fund or organisation may qualify under one of the general categories listed in section 78 such as a public benevolent institution or a public hospital. Secondly, a fund or organisation may be specifically listed in section 78 or in a register kept for the purposes of that section as having tax deductible gift status.
20.6 In some circumstances, deductibility for a gift to a fund or organisation may only be available if the gift is made during a period specified in the law.
Explanation of proposed amendments
20.7 Gifts of $2 or more made to The "Weary" Dunlop Statue Appeal will be eligible for tax deductions under item 5.2.3 of table 5 in subsection 78(4). However, under the same item, the tax deductibility of gifts made to the Appeal under item 5.2.3 will be limited to those gifts that are made after 15 July 1993 and before 16 July 1994 [Clause 116 - new item 5.2.3 of table 5 in subsection 78(4)].
20.8 Gifts of $2 or more made to The Sandakan Memorials Trust Fund will be eligible for tax deductions under item 5.2.2 of table 5 in subsection 78(4). However, under the same item, the tax deductibility of gifts made to the Fund under item 5.2.2 will be limited to those gifts that are made after 29 July 1993 and before 30 July 1995 [Clause 116 - new item 5.2.2 of table 5 in subsection 78(4)].
Chapter 21 - Secrecy
Overview
21.1 This Bill will amend section 16 of the Income Tax Assessment Act 1936 (the Act) to permit the Commissioner of Taxation to provide information to the Health Insurance Commission (HIC) as to whether a registered carer or an applicant for registration as a carer under the new childcare rebate scheme has a tax file number (TFN). The Commissioner will not be providing the carer's TFN.
Summary of proposed amendments
21.2 To enable the Commissioner of Taxation to provide TFN information to the HIC for the purpose of administering the childcare rebate scheme [Clause 117].
21.3 The amendment will apply to the communication of information after 30 June 1994 [Clause 119].
Background to the legislation
21.4 The Childcare Rebate Act 1993, which received Royal Assent on 24 December 1993, introduced the childcare rebate scheme.
21.5 The childcare rebate scheme will allow families to claim a rebate on part of their work-related childcare expenses. The rebate will be payable through the HIC from 1 July 1994.
21.6 For a childcare user to obtain the childcare rebate, the carer will be required to have registered with the HIC. The registration form will require a declaration that the carer has a TFN.
Explanation of the amendments
21.7 The Bill proposes to insert new paragraph 4(fa) into section 16 of the Act. The amendment will enable the Commissioner of Taxation to provide information to the HIC as to whether a registered carer or an applicant for registration as a carer under the childcare rebate scheme has a TFN [Clause 118].
21.8 Under the proposed arrangements, the HIC will provide information to the Commissioner about the carer from the registration form. That information will then enable the Commissioner to confirm whether or not the carer has a TFN. The Commissioner will not provide the HIC with the carer's TFN.
21.9 The matching of information is expected to discourage artificial receipts by carers and encourage carers to comply with the tax laws.
Chapter 22 - Outdated references
Overview
22.1 The Bill will amend section 23AA of the Income Tax Assessment Act 1936 to correct outdated references to certain provisions of United States income tax law for technical accuracy purposes.
Summary of proposed amendments
22.2 To update the now redundant references to United States income tax law in section 23AA [Clause 120].
22.3 The amendments will be deemed to have had effect on or after 22 October 1986 [Subclause 2(2)].
Background to the legislation
22.4 Section 23AA was first introduced as part of the Income Tax Assessment Act 1936 in 1963. It applies to certain United States personnel in Australia deriving income connected with an approved project. The provision operates to give the personnel exemption from Australian income tax in certain circumstances.
22.5 The exemption is conditional on the income not being exempt from United States tax under certain provisions of the United States Internal Revenue Code of 1954. That Code has been succeeded by the Internal Revenue Code of 1986, which was enacted into United States law on 22 October 1986.
Explanation of proposed amendments
22.6 The proposed amendments will update the references to United States income tax legislation contained in section 23AA. This is to be achieved by replacing references to the Internal Revenue Code of 1954 in paragraphs 23AA(5)(b) and (6)(b) with references to the Internal Revenue Code of 1986 [Clause 121].
22.7 The amendments are necessary to ensure the technical accuracy of the Australian income tax law and will have no practical effect on the application of the section.
Chapter 23 - Non-compulsory uniforms or wardrobes
Overview
23.1 Section 51AL will be amended so that it does not apply to occupation specific clothing. Also, the transitional arrangements operating in respect of section 51AL of the Income Tax Assessment Act 1936 (the Act), which contains new rules applying to expenditure on non-compulsory uniform/wardrobe, will be revised and extended.
23.2 By removing occupation specific clothing from the operation of the new rules expenditure on such clothing can be considered for deduction under subsection 51(1) of the Act.
23.3 The amendments will extend, by one year, the operation of the phasing-in arrangements for the new rules applying to expenditure on non-compulsory uniforms/wardrobes and will modify their application [Clause 123].
23.4 1 September 1993 [Subclause 2(7)].
Background to the legislation
23.5 Section 51AL operates to restrict the circumstances in which a deduction is allowed for expenditure incurred by an employee in relation to the wearing of a corporate uniform or wardrobe. Broadly, the provision denies a deduction unless:
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- the wearing of the uniform or wardrobe is a compulsory condition of employment, and the clothing is not conventional in nature; or
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- the wearing of the uniform or wardrobe is not a compulsory condition of employment, and the design of the occupational clothing is registered with the Textile, Clothing and Footwear Development Authority (TCFDA) and entered on the Register of Approved Occupational Clothing.
These new rules apply from 1 September 1993.
23.6 A series of transitional arrangements was also enacted to phase in the new requirements. As part of those arrangements deductions are allowed until 1 July 1994 for expenditure incurred in relation to any non-compulsory uniform or wardrobe that has been approved, in writing, by the Commissioner of Taxation in accordance with the guidelines set down in Taxation Ruling IT2641. The transitional provisions are contained in section 5 of Taxation Laws Amendment Act (No. 6) 1992.
23.7 Section 51AL is intended to operate only in respect of uniforms or wardrobes which have a link with an employer and not to clothing which distinctively identifies a specific occupation (provided that the clothing is not conventional in nature). The latter type of clothing is referred to as occupation specific clothing.
23.8 Expenditure on occupation specific clothing is generally deductible under subsection 51(1), and should have continued to be deductible regardless of whether or not the clothing also identified the wearer's employer. Examples of occupation specific clothing are nurses' traditional uniforms, chef's checked pants and a religious cleric's ceremonial robes.
23.9 However, some items of occupational clothing can identify both the wearer's employer and also their occupation. It is this type of clothing which has been unintentionally caught by the new rules. This is because section 51AL operates to deny deductions for occupation specific clothing where:
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- it identifies the wearer's employer; and
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- the identifiers (e.g. logos), or the clothing itself fails to comply with the Occupational Clothing Guidelines (for example, the clothing has too many colours).
23.10 In other words, expenditure on non-compulsory occupation specific clothing, without any employer identification, will be deductible under subsection 51(1) but, once an employer identification is added, expenditure on the clothing will not be deductible unless the clothing conforms with the Occupational Clothing Guidelines. Non-compulsory occupation specific clothing that does not conform with the Guidelines can be made deductible simply by removing the employer identifier. Compulsory occupation specific clothing is deductible irrespective of whether it has employer identification attached. It was not intended that non-compulsory, occupation-specific clothing be covered by the new rules.
23.11 The existing transitional arrangements allow tax deductions to be claimed until 1 July 1994 for expenditure on non-compulsory uniforms or wardrobes that have been approved in writing by the Commissioner of Taxation. However, no deduction is allowable unless the Commissioner has given to an employer a written statement, at or before the time when the expense was incurred by the employee, that the clothing satisfies the guidelines set down in Taxation Ruling IT2641.
23.12 As they currently stand, the transitional arrangements operate to deny a deduction for expenditure incurred in respect of non-compulsory uniforms or wardrobes where:
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- the employer was not aware of the law's requirements and so had not lodged an application for approval of their employees' uniform or wardrobe before 1 September 1993;
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- the uniform's or wardrobe's design was submitted for approval before 1 September 1993 but the Commissioner had not issued his approval by that date (assuming the clothing satisfies the criteria in Taxation Ruling IT 2641). A deduction would be able to be claimed in respect of expenditure incurred after the date of issue of the approval letter.
Explanation of amendments
23.13 While the general requirements set down in subsection 51(1) would still need to be satisfied before a taxpayer can obtain a deduction, the insertion of the new term "occupation specific clothing" in subsection 51AL(4) will have the effect that this type of clothing, together with protective clothing, is removed from the rules outlined in section 51AL.
What is occupation specific clothing?
23.14 Occupation specific clothing is clothing that distinctively identifies an employee as a member of a particular profession, trade, vocation, occupation or calling [Clause 127, subsection 51AL(26)].
23.15 The clothing's design would have to be distinctive, or peculiar and unique, in the sense that by its nature or physical condition it is readily identified as belonging to a particular profession, trade, vocation, occupation or calling. The clothing would also have to be unconventional in nature if expenditure on it is to be deductible under subsection 51(1). Examples are nurses' traditional uniforms, chef's checked pants and a religious cleric's ceremonial robes.
23.16 Clothing which could belong to a number of occupations would not fall within the definition. An example of this is a white jacket or coat worn with white trousers. While a white jacket or coat worn with white trousers may indicate that the wearer belongs to the health profession, it is not sufficiently distinctive in design or appearance to readily identify the specific or particular occupation of the wearer. That is, the wearer could be a pharmacist, dentist, laboratory technician, or a number of other occupations.
Why remove occupation specific clothing from 51AL?
23.17 The effect of removing occupation specific clothing from section 51AL is best demonstrated by an example.
23.18 Expenditure on a nurse's traditional uniform (for example a set of clothing consisting of a cap, cape, white uniform, cardigan and special non-slip shoes) is generally deductible under subsection 51(1). This is because the clothing is considered to be peculiar to, and incidental and relevant to, the gaining of assessable income from the specific occupation of nursing. Deductions were available irrespective of whether the set of clothing was compulsory or non-compulsory.
23.19 After the introduction of the new rules for non-compulsory uniforms/wardrobes embodied in section 51AL, from 1 September 1993 if a set of clothing, in this example a nurse's uniform, had some form of employer identification attached (for example a hospital logo) and the wearing of the clothing was not compulsory, the clothing would need to be registered with the TCFDA for expenditure to remain deductible.
23.20 The requirement to register with the TCFDA could be circumvented by simply removing the employer identification. Expenditure on the clothing would then be deductible again.
23.21 It was not intended that this type of clothing be caught by section 51AL. The proposed amendments will ensure that non-compulsory clothing which:
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- is occupation specific,
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- is non-conventional in nature, and
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- if not for the operation of section 51AL, would have been deductible under subsection 51(1),
is no longer caught by the new clothing registration rules laid down in section 51AL.
Extension of the transitional arrangements
23.22 The transitional arrangements are set out in section 5 of Taxation Laws Amendment Act (No.6) 1992 and currently apply to expenditure incurred before 1 July 1994.
23.23 The proposed amendments will extend the period for which expenditure in relation to previously approved non-compulsory uniforms/wardrobes will be eligible for deduction to 1 July 1995 [Clause 125, new section 5 - Taxation Laws Amendment Act (No. 6) 1992 ].
Application of the transitional arrangements
23.24 Subsection 5(b) of Taxation Laws Amendment Act (No.6) 1992 sets out the circumstances that must be satisfied if a deduction is to be available for non-compulsory uniform/wardrobe expenses incurred when the design of the clothing is not registered with the TCFDA.
23.25 The requirement that the Commissioner's approval of the design must be issued before the expenditure is incurred by the employee will be removed. The amended transitional provision will allow deductions for expenditure on clothing incurred before 1 July 1995 where, in relation to clothing:
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- an application for approval of new clothing designs, or changes to existing designs was lodged before 1 September 1993 and the design satisfies the requirements of Taxation Ruling IT 2641 (this covers applications for approval of designs before their adoption); or
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- an application for approval was lodged after 31 August 1993, but the clothing the subject of the design has been available for purchase by employees before 1 September 1993, and the design satisfies the requirements of Taxation Ruling IT 2641 (this covers applications for approval of designs already adopted).
[Clause 125, subsections 5(b) and 5(c) Taxation Laws Amendment Act (No. 6) 1992 ].
Chapter 24 - Entertainment expense payments
Overview
24.1 This Bill will amend the Fringe Benefits Tax Assessment Act 1986 (FBTAA) to include a provision which will reduce the taxable value of a benefit which currently arises where an employer makes a payment or reimbursement to an employee to cover expenses incurred by the employee in entertaining clients or other persons on behalf of the employer. The taxable value will be reduced by the amount of expenditure incurred on these other persons who are not associates of the employee. Only the part of the payment or reimbursement that relates to the expenditure on the employee or an associate will be included in the taxable value of the fringe benefit.
24.2 The Bill will also insert a provision into the Income Tax Assessment Act 1936 (ITAA) which will ensure that the amount by which the benefit is reduced will be non-deductible for income tax purposes.
24.3 As part of the 1993 Budget measures, amendments were made to the FBTAA and the Income Tax Assessment Act (ITAA) so that certain benefits provided by an employer to an employee or an associate of the employee would become liable to fringe benefits tax (FBT). The amendments apply from 1 April 1994.
24.4 An effect of these amendments is that where an employee entertains persons on behalf of his or her employer and is subsequently reimbursed by the employer for the cost of providing the entertainment, the full amount of the reimbursement (i.e. for the cost of entertaining the employee (or associates) as well as other persons) is taxable to the employer as an expense payment fringe benefit.
24.5 This Bill will insert a provision into the FBTAA which will ensure that taxable value of the benefit which arises in these circumstances can be reduced by the amount of expenditure incurred by the employee on entertaining, on behalf of the employer, other persons who are not associates of the employee.
24.6 An amendment will also be made to the Income Tax Assessment Act 1936 (ITAA) to ensure that the amount by which the benefit is reduced will be non-deductible for income tax purposes [Clause 128].
24.7 The amendments will apply from 1 April 1994 [Clause 131, Clause 134].
Background to the legislation
24.8 In Taxation (Deficit Reduction) Act (No. 1) 1993, amendments were made to the FBTAA and the ITAA so that certain benefits provided by an employer to an employee or associate of the employee would become liable to FBT.
24.9 The benefits affected include the provision of entertainment.
24.10 Prior to the amendments, all of these benefits were fringe benefits under the FBTAA. The benefits could be expense payment fringe benefits, property fringe benefits, or residual fringe benefits depending on the type of benefits and how the benefits were provided (including how they were paid for). However, because the expense of providing these benefits was non-deductible under the ITAA, the taxable values of these fringe benefits were reduced by the non-deductible amount. Accordingly, no FBT was payable on these benefits.
24.11 As a result of the amendments, employers will be able to claim a deduction under the ITAA for the cost of providing these benefits to employees or associates of employees. Because the cost of providing these benefits will be deductible to the employer, their values will not be reduced for FBT purposes and a full FBT liability will arise.
24.12 Where these benefits are provided in the form of an expense payment fringe benefit (i.e. the employer pays the liability of the employee either directly to the employee or by reimbursement) the total amount of the payment becomes a fringe benefit. This is the result irrespective of whether the payment or reimbursement relates to a benefit provided to a person other than the employee or an associate of the employee.
24.13 Therefore, where an employee entertains persons on behalf of his or her employer and is subsequently reimbursed by the employer for the cost of providing the entertainment, the full amount of the reimbursement (i.e. the cost of entertaining the employee (or associates) as well as other persons) is taxable to the employer as an expense payment fringe benefit.
24.14 However, more favourable treatment is available under the FBTAA if the employer (rather than the employee) pays for the cost of providing the entertainment. In this case, the only fringe benefit that arises is the cost of the entertainment provided to the employee (or associate). The benefit provided is a residual fringe benefit.
24.15 This Bill will amend the FBTAA to ensure uniform treatment for the provision of entertainment either as a residual fringe benefit or an expense payment fringe benefit [Clause 128].
Explanation of amendments
24.16 The amendment will insert section 63A into Division 14 of Part III of the FBTAA. This section will operate to reduce the taxable value of an expense payment fringe benefit which arises where an employer makes a payment or reimburses an employee for expenditure incurred on entertaining persons other than the employee or associate [Clause 130].
24.17 For the purposes of this section, the provision of entertainment takes the same meaning as that set out in subsection 51AE(3) of the ITAA.
24.18 Subsection 63A(2) will provide that where the taxable value of the expense payment fringe benefit has been reduced under Division 5 of Part III of the FBTAA [Expense Payments Fringe Benefits] no further reduction in the taxable value will be allowed under subsection 63A(1) in respect of the same amount. An example as to how this provision may operate is as follows:
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- An employee pays for the lunch of a client of the employer at an "eligible seminar" as defined in subsection 51AE(1) of the ITAA. The employer reimburses the employee for the expenditure incurred by the employee on his lunch as well as the client's lunch. Subsection 63A(2) would operate to deny the employer a reduction in the taxable value of the benefit under subsection 63(A)(1) as the taxable value would have already been reduced to nil because of the 'otherwise deductible' provisions of section 24 of the FBTAA. This is because such expenditure incurred by an employee is not denied deductibility under subsection 51(1) because of the provisions of subsection 51AE(5).
24.19 The Bill will also amend subsection 51AE(5AA) of the Income Tax Assessment Act 1936(ITAA) and insert subsection 51AE(5AB) to ensure that where the taxable value of a benefit is reduced under section 63A of the FBTAA, the amount by which the taxable value is reduced will not be deductible for income tax purposes [Clause 133] . Subsection 51AE(5AA) provides that where entertainment provided by an employer is a fringe benefit then subsection 51AE(4) does not preclude the employer from claiming under subsection 51(1) of the ITAA a deduction for the cost of providing that benefit.