Senate

Explanatory Memorandum

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

CHANGE OF TITLE - TAX LAW IMPROVEMENT BILL (No. 1) 1998 - SENATE - Explanatory Memorandum.

General Outline and Financial Impact

A. General outline

This Bill, the Tax Law Improvement Bill (No. 2) 1997, is the third instalment of the rewrite of the income tax law produced by the Tax Law Improvement Project. The first instalment is contained in the Income Tax Assessment Act 1997 (1997 Act) and the second in the Tax Law Improvement Act 1997 which amended the 1997 Act. Both of these Acts apply with effect for the 1997-98 and later income years.

Tax Law Improvement Bill (No. 2) 1997

The first instalment of the rewritten law established the structure and framework for the 1997 Act, which is progressively replacing the Income Tax Assessment Act 1936 (the 1936 Act). The second instalment comprised areas of law which affected a broad cross-section of taxpayers eg. the general depreciation provisions; and specialist topics relevant to specific groups such as land-holders.

This third instalment builds on the platform provided by the first two instalments and covers areas of the law which are significant for a broad range of taxpayers or specialist groups. It continues to adopt features designed to help people to more readily read, use and apply the new law and, as a result, lower costs of compliance. It is intended to apply with effect for the 1998-99 and later income years.

Content of the Bill

The Bill includes rewrites of provisions of the 1936 Act that deal with:

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capital gains and losses;

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company bad debts;

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intellectual property;

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horticultural plants;

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averaging of primary producers tax liability;

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environment protection; and

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above-average special professional income.

These rewritten rules also include some enhancements to the operation of the 1936 Act which will make affected areas of the law simpler, clearer and less burdensome for taxpayers. They do this by:

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clearly stating the rules;

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standardising multiple rules that have essentially the same effect;

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removing unnecessary requirements;

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reducing some record-keeping obligations;

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clarifying uncertain or ambiguous law;

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bringing the law into closer alignment with administrative and commercial practice; and

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addressing anomalies and inconsistencies.

As well, the Bill contains some transitional and consequential amendments that:

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amend Commonwealth Acts including the 1936 Act and the 1997 Act that contain references to the existing law, to ensure that they reflect the rewritten provisions; and

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make amendments closing off the application of provisions in the 1936 Act rewritten in the Bill.

The rewritten law will first apply for the 1998-99 income year.

Structure of the Bill

The content of the Bill is arranged in ten schedules.

The amendments to the 1997 Act are in Schedule 1, in the order in which they will appear in that Act. They are in one schedule to keep all of the rewritten provisions together in the Bill.

The next eight schedules contain transitional and consequential amendments needed for subject areas of the rewritten provisions. For example, the transitional and consequential amendments for the intellectual property provisions are in Schedule 4 and those for horticultural plants are in Schedule 5.

Schedule 10 contains amendments to the Dictionary of defined terms.

Adoption of JCPAA recommendations

The following table lists the amendments to the Bill, and explanatory memorandum references, that give effect to recommendations made by the JCPAA in Report 356 for changes in relation to the Bill:

The following table is a quick reference guide to the structure of the Bill:

B. Summary of main changes

In addition to the general improvements in structure, presentation and readability of the areas being rewritten, the Bill makes a number of specific changes to the operation of the law. These mainly facilitate simpler and clearer expression and less arduous compliance requirements.

Capital gains and losses

1. Exemption of personal use assets acquired for $10,000 or less

Change: Base the exemption for personal use assets on acquisition cost instead of disposal proceeds, with the consequence that it will no longer be necessary to keep records about personal use assets that cost $10,000 or less.

Existing law: Disposals of personal use assets are exempt where the disposal proceeds are $10,000 or less. This means that records must be kept of the acquisition holding costs for all personal use assets of any substance as taxpayers do not know in advance how much will be received for them.

2. Capital proceeds repaid

Change: Reduce capital proceeds by any amount repaid, for which a deduction is not available. This is a new provision which more equitably reflects the outcome of the transaction and provides symmetry with the corresponding proposed treatment of the buyer.

Existing law: The 1936 Act does not allow a capital gain or loss to be adjusted if the seller subsequently repays any of the consideration.

3. When is a building or a capital improvement a separate asset from land?

Change: Exclude from separate asset treatment certain capital improvements to land and buildings, which entitle the owner to claim capital allowance deductions, but which are not subject to balancing adjustment provisions. This approach simplifies calculation and record-keeping requirements.

Existing law: Improvements on land, such as buildings or other capital improvements, that qualify for an income tax deduction are treated as separate assets. In contrast, property law treats land and improvements as a single asset. This means that the CGT provisions require taxpayers to apportion sale proceeds between land and individual improvements even though this is not required for other income tax purposes.

4. Disposal of asset within 12 months of roll-over

Change: For the transfer of a CGT asset from one entity to another that attracts roll-over relief, indexation is available if the combined period of ownership by both the transferor and the transferee is at least 12 months. Correspondingly, if roll-over relief applies to an entity that replaces a CGT asset with another asset, the 12-month period begins when the original asset (rather than the replacement asset) is acquired.

Existing law: The indexation clock is reset at transfer, meaning that the transferee must own the asset for at least 12 months to get indexation irrespective of how long the transferor owned it. For a replacement asset roll-over, the 12-month period begins at acquisition of the replacement asset (rather than the original asset).

5. Main residence exemption - changing main residences

Change: Extend the period during which an individual can have exemption for two dwellings to six months.

Existing law: If a person moves into a new dwelling before disposing of their old dwelling, the exemption can be claimed for two main residences for up to three months. The extended period allows more time for selling.

6. Main residence exemption - destruction of dwelling and sale of land

Change: Apply the main residence exemption rules to a disposal of vacant land where the dwelling on the land is accidentally destroyed, for example, by bushfire.

Existing law: Under the 1936 Act a person loses the main residence exemption if:

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the residence is destroyed; and

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the vacant land on which it stood is disposed of.

Deductions for company bad debts

All the changes made to the bad debt provisions ensure that they are as consistent as possible with the losses provisions.

1. Use of standard continuity of beneficial ownership test and same business test

Change: Adopt, for the bad debt provisions, the continuity of beneficial ownership and same business tests that apply to the losses provisions.

Existing law: Even though the rules are basically the same for deducting bad debts and losses, the structure, and to some extent the content, of the provisions has varied over time. This means the reader must be acquainted with three different sets of provisions that generally have the same application. The process of standardisation adopted in the rewrite makes this unnecessary because the structure of the bad debt provisions, to the extent possible, mirrors that of the losses provisions. This includes placing the bad debt anti-avoidance provisions in a separate Division.

2. Simplified tracing rules for listed public companies

Change: Adopt for bad debts, the simplified rules for tracing beneficial ownership in listed public companies that were developed for the losses provisions.

Existing law: As with the 1936 Act losses provisions, the existing bad debt provisions impose heavy evidentiary requirements on listed public companies when it is necessary to discover beneficial ownership of their shares.

Intellectual property

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The rewrite improves the structure of the intellectual property provisions by:

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moving all existing capital expenditure provisions for intellectual property into one Division;

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arranging the other provisions into Subdivisions each dealing with a component of the deduction calculation, or consequences of disposal.

1. Determination of effective life

Change 1: For the first time, provide for an effective life for petty patents that is commercially realistic and takes account of their shorter legal life compared with standard patents.

Existing law: Petty patents, which were introduced into Australia in 1979, are not specifically dealt with in the 1936 Act.

Change 2: Bring the effective life provisions for copyrights, and standard and petty patents issued after the commencement of the rewritten law, into line with the Copyright Act 1968 and the Patents Act 1990.

Existing law: The 1936 Act has not been updated to reflect the legislative changes to effective life provisions in the Copyright and Patents Acts.

2. Termination value on an arms length disposal for no consideration

Change: Specify, where intellectual property is disposed of at arms length for no consideration, that the termination value is the written-down value.

Existing law: The 1936 Act does not specify what the termination value is in an arms length disposal for no consideration.

3. Consideration for a non-arms length disposal for no consideration

Change: Specify, where there is a non-arms length disposal of intellectual property for no consideration, that the termination value is the greater of written down value and market value.

Existing law: In such a case, the 1936 Act provides only that the termination value be the value applied.

Horticultural plants

The rewrite improves the structure of the law by placing the main rules first followed by the less commonly used rules. This makes it easier to gain an overview of the circumstances to which the provisions apply.

1. Adoption of defined terms

Change: Clarify the type of expenditure which is deductible by defining the terms horticultural plant, commercial horticulture and horticultural business.

Existing law: The 1936 Act uses terms without defining them. These terms have been defined to provide certainty and clarity.

2. Determination of effective life

Change: Allow the first owner to use a horticultural plant for commercial horticulture to elect to adopt the Commissioners determination of effective life.

Existing law: Under the 1936 Act, it is the owner of the plant at the time when it could first be used for commercial horticulture who can elect to adopt the Commissioners determination of effective life. This is so irrespective of whether they in fact use the plant for commercial horticulture. It is more appropriate that the taxpayer who first uses a horticultural plant for income-producing purposes should make the decision.

Averaging of primary producers tax liability

The rewrite improves the structure of the law as it is designed to provide the answers to common questions, with each question answered in a separate subdivision. It uses meaningful terms for key concepts, defines each term only once, and provides a step-by-step calculation procedure. Guide material, signposting, and graphics also assist readers to understand the law and find their way through it.

1. Continuation of averaging where primary production activities have ceased.

Change: Allow a taxpayer who receives income from a primary production business that has ceased, to continue to even out their tax liability.

Existing law: Only individuals who carry on a primary production business in an income year qualify for averaging in that year. For many years, however, the Commissioner has applied averaging to taxpayers on the basis of continuity of income from year-to-year, even where the business has ceased. The rewritten law incorporates this administrative practice.

2. Permanent reduction in income

Change: Clarify that, when a permanent reduction of income occurs, the taxpayer has a choice whether averaging recommences.

Existing law: It is unclear whether this happens automatically or only at the election of the taxpayer. The Commissioners administrative practice, however, is to recommence averaging only where the taxpayer shows that a permanent reduction has occurred. The rewritten provision is consistent with this.

Environment deductions

No policy changes have been incorporated in the rewrite. However, the rewritten provisions help readers to understand and access the law as they:

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are in plain language;

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adopt a more streamlined structure;

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avoid unnecessary use of defined terms; and

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provide links to other parts of the 1936 and 1997 Acts.

Above-average special professional income

The rewrite improves the structure and accessibility of these provisions by:

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adopting a simpler process (using steps and tables) for calculating whether a special rate of tax applies to taxable income; and

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signposting the reader to any specific rules that may apply.

C. Finding tables

This Explanatory Memorandum contains finding tables which cross-reference the existing and rewritten provisions to make it easier to find your way from the existing law to the new law, and vice versa (see Chapter 10).

D. Revenue impact

Overall, the Bill is expected to have a small cost to revenue but this may be made up by more accurate compliance due to greater clarity of requirements. Most measures will have no direct impact on revenue outcomes. Some proposals will result in insignificant, but unquantifiable, revenue costs.

E. Compliance impact

The Bill should achieve a noticeable reduction in compliance costs for those using the parts of the law it deals with. That reduction may not occur because of any single change but from the accumulation and combined impact of many small improvements.

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The law will be clearer and simpler.

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The following specific changes will contribute to reduction in compliance costs:

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Excluding capital improvements from separate CGT asset treatment if the deductible improvement expenditure is not subject to balancing charge on disposal of the CGT asset to which the improvement is made. This simplifies record-keeping and capital gain or loss calculations.

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Reducing, to a single calculation per year, the adjustment to the cost base of trust investments, irrespective of the number of non-assessable distributions made during an income year. This removes the need for separate calculations when more than one such distribution is made during a year.

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Including explicit rules for the CGT roll-over on the incorporation of a business. The 1936 Act is expressed in terms of the transfer of a single asset to a company. On the incorporation of a business, the existing law would literally need to be applied separately to each asset that is transferred, rather than to the assets of the business as a whole.

In addition, numerical examples have been included in the rewrite to assist with calculations.

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Standardising the provisions for deductions for company bad debts with the losses provisions to the extent possible.

F. Date of effect

All measures in the Bill will apply from the beginning of the 1998-99 income year. For some measures, special transitional arrangements will apply. These are explained in the notes describing those measures.

Chapter 1 - About the Tax Law Improvement Project

Overview

This chapter outlines the genesis and role of the Tax Law Improvement Project and its progress to date.

About the Tax Law Improvement Project

In November 1993, the Joint Committee of Public Accounts published a report recommending the setting up of a broadly based Task Force to rewrite the income tax law. In the following month, the Australian Government announced the Tax Law Improvement Project.

Scope of the project

This is a project to restructure, renumber and rewrite in plain language Australia's income tax law. It aims to improve taxpayer compliance, and reduce compliance costs, by making the law easier to use and understand.

It is not intended as a policy review, but there is scope to make minor content changes to aid the rewriting. These can reduce or eliminate unnecessary complexity in the law, and bring the law closer into line with administrative and commercial practice.

Progress to date

The first two instalments of the rewrite of the income tax law, the Income Tax Assessment Act 1997 (1997 Act) as amended by the Tax Law Improvement Act 1997, have operated since the beginning of the 1997-98 income year to express the law in the clearer structure, plainer language and more helpful style developed by the Tax Law Improvement Project.

The ATO, tax profession, tertiary education sector and the community have now invested the time and resources in acquainting themselves with the changes in presentation, structure and style of the 1997 Act. The very real benefits flowing from the clarity and accessibility of the rewritten law are already apparent and are reflected in feedback on the new law from working tax professionals.

This Bill, the Tax Law Improvement Bill (No. 2) 1997, is the third instalment of rewritten law produced by the project and will operate from the beginning of the 1998-99 income year. With its enactment, the 1997 Act will comprise key areas of the law having broad application to taxpayers including the basic provisions relating to core concepts of the income tax law (assessability of income and deductions), the Capital Gains Tax provisions and capital allowances such as depreciation and those relating specifically to land-holders.

These three instalments of the rewrite already provide a sound platform for tax reform. Pruned of its linguistic excesses, and readable by its audiences for the first time in decades, this new income tax law is primed for detailed policy analysis.

Chapter 2.1 - Structure of the CGT provisions

Overview

This segment describes the structure of proposed Parts 3-1 and 3-3 (capital gains and losses) of the Income Tax Assessment Act 1997.

Part A discusses why it was necessary to take a fresh approach to the rewriting of the capital gains and losses provisions and explains the underlying rationale for it.

Part B provides a brief outline of each of the Divisions that comprise the new parts 3-1 and 3-3. Fuller explanations follow in later segments of this Chapter.

Part C identifies provisions of the 1936 Act that are to be rewritten later.

A. The new approach

The aim of capital gains tax can be simply stated: to tax, as income, gains made on the disposal of assets and on the receipt of certain capital amounts. Theimplementation of that simple aim has previously been compromised by an unnecessarily complex approach to the presentation and expression of the law.

CGT applies to many events that do not, in fact, involve the disposal of an asset. However, the present law insists on treating each of those events as a disposal. Thisdeeming of something to be what it is not obscures the true scope of the tax and leads to a complex and highly artificial set of consequential deemings that can frustrate and mislead even experienced users of the law.

The rewritten provisions more clearly explain the operation of the law by applying CGT to these other events on the basis of their true nature. This will assist taxpayers to determine whether or not there is a liability to tax in particular circumstances.

For each event the provisions:

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describe how a capital gain or loss can arise;

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identify when the gain or loss arises;

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specify how to calculate the amount of the gain or loss; and

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identify specific exceptions that might apply.

Currently, all of this information is scattered throughout the law. In contrast, the rewritten CGT provisions bring it together in a logical and coherent way. As a result, the legislative intention is more simply and directly expressed.

The CGT provisions have been structured to try to make them as useful as possible to readers in identifying the rules that are relevant to their particular circumstances.

Benefits of the new structure

The new CGT structure is more accessible. Readers will find it easier to:

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understand what the law requires;

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identify the general principles of the law; and

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follow a path to the provisions they need to know.

The new structure will be flexible enough to accommodate any future changes.

B. Outline of the Divisions in Parts 3-1 and 3-3

New structure

The rewritten CGT provisions are structured in two layers, ie. general topics that apply quite widely and special topics covering less frequently encountered situations. This streamlines the law and means that readers will not have to work their way through specialised provisions only to find that they do not apply to them. TheDivisions, and the provisions within them, are arranged so that readers are assisted to locate the rules that apply to their circumstances.

Part 3-1 - general topics

This layer has the general provisions which establish the scope of the CGT regime and cover a broad range of commonly found situations.

Part 3-1 begins with Division 100 - a Guide to capital gains and losses. Itgives an aerial view of the CGT provisions as an introduction.

Division 102

Tells taxpayers how to work out whether they have a net capital gain or a net capital loss for the income year and if they do, what the consequences for them are. A net capital gainis included in assessable income under section 6-10 (statutory income). Division 102 thereby links the CGT provisions to the core provisions of the 1997 Act. Capital losses differ from other deductible amounts in that they can only be offset against current year or later capital gains.

Division 103

Has those rules that apply generally across the CGT structure. These rules are concerned with such things as constructive receipts and payments, the translation of foreign currency and the making of choices permitted by the CGT provisions.

Division 104

Describes each kind of event that call for consideration whether a capital gain or loss has arisen.

The CGT events are presented as a straightforward and comprehensive expression of actual events which may result in a capital gain or loss. The CGT event provisions describe what each kind of relevant event is, identify when it occurs and explain how to work out whether a capital gain or loss has been made.

All CGT events are presented in a consistent pattern to help regular readers become familiar with them.

The discipline of analysing the relevant elements of CGT events has helped to reveal grey areas in the 1936 Act and where possible the rewrite has addressed these. The clarifications and changes are identified in Chapter 2.4.

Division 106

Sets out the cases where a capital gain or loss is made by someone other than the entity to which a CGT event happens. Entities affected by these rules include partnerships, bankruptcy trustees, company liquidators, trustees of certain categories of trusts, and holders of assets as security.

Division 108

Deals with the three broad groups of assets relevant to working out capital gains and capital losses ie.:

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CGT assets;

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collectables (previously known as listed personal-use assets); and

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personal use assets (previously known as non-listed personal-use assets).

It shows how capital losses from collectables and personal use assets are to be accounted for in working out whether there is a net capital gain or net capital loss.

This Division also sets out when land, buildings and property improvements are to be dealt with as separate CGT assets.

Division 109

Contains rules about how and when a CGT asset is acquired.

Division 110

Has the general rules for calculating the cost base and reduced cost base of a CGT asset. The cost base of a CGT asset is used to help determine whether a capital gain has been made when a CGT event has occurred. Thereduced cost base (reduced because it excludes all deductible expenditure or costs) is relevant when a capital loss is made.

Division 112

Tabulates modifications to the cost base and reduced cost base. The modifications depend on the type of asset or the circumstances of the CGT event. The table allows taxpayers to readily identify whether a modification applies to them and provides signposts to the detailed rules about each kind of modification.

Division 114

Has rules for working out what amounts of expenditure in the cost base of a CGT asset are indexed for inflation and when to index them. Generally, the cost base amounts are indexed only if the taxpayer had owned the asset for at least 12 months. Rules on how to index the cost base are set out in Subdivision 960-M.

Division 116

Has rules for determining the capital proceeds (previously known as disposal consideration) from a CGT event. You need to know this to work out whether there is a capital gain or loss, by comparing the capital proceeds with the cost base or reduced cost base.

Division 118

Sets out various exemptions and exceptions. Some allow taxpayers to disregard or reduce a capital gain. Others prevent a capital loss.

Division 121

Sets out what records must be kept for CGT purposes and for how long they must be retained.

Part 3-3 and 3-5 - special topics

The second layer of the structure has rules of narrower application, such as those to do with deceased estates and non residents. Provisions specific to companies, such as those relating to intra-group dealings and share value shifting are also in Part 3-3.

This layer also has the provisions that deal with roll-overs which can allow the taxing point to be postponed. It also has specific rules for transactions in particular types of assets such as leases, options and other investments.

Division 122

Provides the roll-over rules for the transfer of an asset to, or the creation of an asset (eg. by giving an option) in a company that is wholly-owned by the transferor or creator. The rewritten rules in this Division also deal explicitly with the transfer of all of the assets of a business to a company, as occurs when incorporating an existing business. A roll-over can be available to an individual or trustee, or to all the members of a partnership. There are same-asset roll-overs for assets transferred to a company and replacement-asset roll-overs for exchanges of assets for shares in a company.

Division 124

Defines the circumstances in which most replacement asset roll-overs apply (the others are in Division 122) and sets out the tax consequences. Replacement asset rollovers defer the making of a capital gain or loss when, in specified circumstances, ownership of a CGT asset ends and a replacement asset is acquired.

Division 126

Provides for a roll-over when ownership of a CGT asset changes or a CGT asset is created:

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in circumstances of marriage breakdown; and

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within a wholly owned group of companies.

It allows the capital gain or loss that would otherwise arise to be disregarded for the time being, and for certain CGT attributes of the asset to be transferred to the new owner.

The Division also allows a reduction in the capital gain or capital loss a company makes when shares in its wholly owned subsidiary are cancelled on liquidation.

Division 128

Sets out the CGT consequences for assets that pass on death.

Division 130

Has specific rules for investments such as bonus shares and units, rights and options, convertible notes and shares acquired under employee share schemes.

Division 132

Has specific rules to do with leases.

Division 134

Has specific rules about options that are not covered in Division 130.

Division 136

Applies the CGT provisions to non-residents and limits their application to assets which have a necessary connection with Australia (previously known as taxable Australian assets). This Division also contains rules for the treatments of assets of non-residents who become Australian residents.

Division 140

Has rules guarding against arrangements known as share value shifting that have the effect of reducing or deferring CGT on shares.

Division 149

Explains how majority changes in underlying ownership of companies or trusts can require a pre-CGT asset to be treated as a post-CGT asset.

Rules dealing with the losses of companies, presently included in Part IIIA of the 1936 Act, have been relocated to parts of the 1997 Act that already contain rules with common elements.

Provisions in Parts 3-1 and 3-3 also draw on the general concept of indexation in Subdivision 960-M and on defined terms listed in the Dictionary [Division 995] .

Subdivisions 165-CA, 165-CB, 170-B, 175-CA and 175-CB (Part 3-5)

Provide the rules for company net capital losses, including the rules for transferring net capital losses between companies that are members of the same wholly-owned group. These Subdivisions also contain the rules for working out a companys net capital gain for a year in which there is a change in majority ownership or control and the company does not satisfy the same business test; and anti-avoidance provisions relating to capital losses of a company.

C. Provisions of the old law that have not been rewritten

This Bill does not contain rewrites of provisions dealing with small business roll-overs and the small business retirement exemption. Provisions dealing with these areas of CGT were enacted by Taxation Laws Amendment Act (No. 1) 1997 and Taxation Laws Amendment Act (No. 3) 1997. Extension of the roll-over is proposed by Taxation Laws Amendment Bill (No. 5) 1997.

The Bill also does not contain a rewrite of provisions dealing with value shifts between companies under common ownership.

These areas of the law are to be further reviewed by the JCPAA and will be included in the 1997 Act at a later date.

Chapter 2.2 - Assessable income includes net capital gain

Overview

This segment covers the rewritten rules in Division 102 for working out if a taxpayer has a net capital gain or net capital loss for an income year.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

A. Summary of the new law

Division 102: Assessable income includes net capital gain

What the division does

Division 102 explains how to work out whether a net capital gain or a net capital loss has been made for an income year.

Net capital gains are assessable income. A net capital loss cannot be deducted from assessable income but is instead applied against capital gains made in later years.

Making a capital gain or capital loss

A capital gain or capital loss is determined when a CGT event happens. [section 102-20]

For each event, there is provision for calculating the amount of the capital gain or loss from the event. [section102-22]

Generally, only one event can apply to any particular transaction. There are rules that specify when more than one event can apply, and what order of precedence applies. [sections 102-23 and 102-25]

Working out your net capital gain

The steps in working out a net capital gain are:

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Add up capital gains for the income year.

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Subtract from this the total sum of any capital losses for the year.

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Subtract any unapplied capital losses from previous years.

The remainder is the net capital gain for the income year. [section 102-5]

Working out your net capital loss

The steps in working out a net capital loss are:

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Add up capital losses for the income year.

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Subtract from this total, any capital gains for the year.

The remainder is the net capital loss for the income year. [section 102-10]

Applying net capital losses in later years

If there are net capital losses from two or more earlier years, they are applied in the order in which they were made. [section 102-15]

Exceptions and modifications

There are rules that exclude certain losses and net capital losses from the calculation of net capital gains. These are contained in a table of exceptions and modifications to the general calculation rules. [section 102-30]

B. Discussion of changes

Division 102 Assessable income includes net capital gain

Sections 102-5 and 102-10 explain how to calculate for an income year the amount of:

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a net capital gain included in assessable income; and

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a net capital loss.

Section 102-15 has the rules for applying net capital losses in later income years. The calculation method applies to capital gains and losses from all CGT assets, including collectables.

Change

Standardise the method for calculating a net capital gain when net capital losses from collectables are brought forward from previous income years.

Explanation

The 1936 Act attaches net capital losses to the income years in which they occur and carries them forward to be applied against later gains on an 'earliest year first' basis. However, this method is not used for the disposal of collectables (known as listed personal-use assets in the 1936 Act). For these assets, a listed personal-use asset loss made in one income year is always taken into account in calculating the net listed personal-use asset gain or loss in the next year even if there are no listed personal-use asset gains in that year.

The rewritten provisions will, in this respect, bring the calculation of net capital gains and losses from collectables into line with that used for other assets.

Chapter 2.3 - General rules

Overview

This segment contains rules in Division 103 that apply generally to other CGT provisions.

Part A summarises these rules.

Part B explains changes from the 1936 Act. Part C explains why some provisions of the 1936 Act have not been rewritten.

A. Summary of the new law

Division 103: General rules

What the division does

Division 103 contains rules that apply generally to other CGT provisions thereby avoiding duplication.

These rules extend the meaning given to particular terms used in the other provisions. [section 103-1]

Giving property

Payments or expenditure are not always in money. Some provisions indicate that payment includes the giving of property. In such cases the amount of the payment or expenditure will include the market value of the property. [section 103-5]

Receipt of money or property

Amounts received include amounts applied for an entitys benefit. An entitlement to receive an amount includes an entitlement to have it applied for an entitys benefit. It also includes an amount, or instalments, actually received at a later time. [section 103-10]

Requirement to pay money or give property

A requirement to pay money or give property includes an amount that is to be paid or given at a later date, and includes instalment payments. [section 103-15]

Amounts expressed in foreign currency

Amounts expressed in foreign currency must be translated into the Australian currency equivalent at the relevant time. [section 103-20]

Choices

It also provides the rules that relate to choices that a taxpayer may make under Parts 3-1 and 3-3. [section 103-25]

B. Discussion of changes

Section 103-5 Giving property as part of a transaction

When property is given as or as part of a payment, the market value of the property is taken into account in working out the amount of the payment.

Change

Include a common rule to cover all those provisions that refer to payments or expenditure that contemplate the giving of property instead of, or in addition to, the payment of money.

Explanation

The inclusion of a common rule avoids duplication.

Section 103-25 Choices

This section states that the choices contemplated by the CGT provisions are evidenced by the way income tax returns are prepared. For example, a taxpayers choice of roll-over relief is evident if a capital gain that would otherwise arise is not taken into account in calculating the net capital gain or loss as returned for that income year.

Change

Provide a standard rule for the making of choices.

Explanation

The rewritten provision states the general rule that will apply in the 1997 Act CGT provisions, thereby avoiding unnecessary repetition. It also standardises the time by which, in the absence of the Commissioner exercising a discretion to allow more time, a choice needs to be made.

C. Provisions of the old law that have not been rewritten

Redundant provisions

Some redundant provisions have not be included in the new law. They are summarised in the following table:

Chapter 2.4 - CGT events

Overview

Division 104 catalogues all of the various categories of CGT events that can result in a capital gain or loss and establishes the basis on which the gain or loss is calculated in each case.

Part A summarises the rules.

Part B explains the changes to the 1936 Act.

Part C explains why some provisions of the 1936 Act have not been rewritten. Part D provides cross references to all CGT events.

A. Summary of the new law

Guide to Division 104: CGT events

What the division does

Division 104 lists all the events that may results in a capital gain or capital loss. It also specifies for each kind of event:

•

how to calculate the amount of any gain or loss;

•

the time of the event, which in turn determines when the gain or loss is made; and

•

cases in which gains or loss are disregarded for CGT purposes.

Summary of CGT events

The Division includes as a Guide a table which lists the CGT events, identifies when each event occurs and sets out how a capital gain or loss is calculated. [section104-5]

Calculating a capital gain or loss

You make a capital gain if the money or property you receive because of a CGT event exceeds the associated costs; and you make a capital loss if the money or property you receive because of a CGT event is less than the associated costs.

Exceptions

Certain capital gains and capital losses are disregarded. These fall into two broad categories:

•

exclusions that are known at the time a CGT event happens (eg. if it is about an asset acquired before 20 September 1985);

•

exclusions that arise at a later time (eg. title in an asset does not pass to an entity at the end of an agreement which allowed that entity to have use and enjoyment of the asset).

B. Discussion of changes

New Dictionary terms

Change

Section 995-1 of the Income Tax Assessment Act 1997 will be amended to insert additional definitions in the Dictionary. Some of the changes in terminology affect the operation of the law. These changes are explained in the notes that follow the table below.

Explanation

The definitions, and their equivalents in the old law, are identified and commented on in the table.

General changes

CGT events

The CGT provisions of the 1936 Act apply where there is a disposal of an asset acquired after 19 September 1985. They also apply to a range of events that do not involve the disposal of an asset. The approach of the 1936 Act is to fit the law to these events as if they were about the disposal of an asset (by deeming them to be disposals). This has produced additional layers of complexity.

Rather than continue this approach, the rewritten provisions apply CGT to events on the basis of their true nature. This makes clear much that is obscured in the 1936 Act.

As well, all CGT events are now listed at the start of the CGT provisions so that taxpayers can readily establish how the rules apply to their situations.

Clarification of timing rules

The 1936 Act is not always clear about when a disposal or a deemed disposal actually happens and when a capital gain or a capital loss occurs. The rewritten provisions identify when each CGT event happens. The following table identifies events where the uncertainty about timing has been remedied.

Section 104-70 Capital payment for trust interest: CGT event E4

This section treats the payment by a trustee of a non-assessable amount to a beneficiary for a trust interest as a CGT event. This may result in a capital gain or a cost base adjustment to the beneficiary's trust interest, but does not result in a capital loss.

1. Change

CGT event E4 does not apply to payments subject to withholding tax.

Explanation

Technically, the 1936 Act could apply to payments subject to withholding tax even though these amounts have already been taxed.

2. Change

Provide for annual cost base adjustments.

Explanation

Taxpayers with interests in trusts are currently required to reduce the cost base of the interest each time they receive a non-assessable distribution. This can cause an excessive compliance burden.

3. Change

Treat payments in kind in the same way as money payments.

Explanation

Broadly, under the 1936 Act, if a trustee pays an amount to a beneficiary the cost base of their trust interest is reduced by the payment. It is ambiguous as to how payments in kind should be treated. The rewrite ensures consistent treatment.

4. Change

CGT event E4 does not apply to an amount that has been assessed to the trustee.

Explanation

Strictly speaking, the old law could have inappropriately applied Part IIIA to such a transaction.

Section 104-80 Disposal to beneficiary to satisfy income right: CGT event E6

This section treats as a CGT event the disposal of a trust asset by the trustee to a beneficiary in satisfaction of the beneficiary's right to receive trust income.

Change

Specify that the trustee makes the capital gain or loss at the time of disposal.

Explanation

The 1936 Act is silent on timing.

Section 104-85 Disposal to beneficiary to satisfy capital interest: CGT event E7

This CGT event covers the disposal of a trust asset by a trustee to a beneficiary in satisfaction of an interest of the beneficiary in the trust capital.

Change

The trustee makes the capital gain or loss at the time of disposal of the asset to the beneficiary.

Explanation

The present law is silent on timing.

Section 104-90 Disposal by beneficiary of capital interest: CGT event E8

This section treats as a CGT event the disposal by a beneficiary of a capital interest in a trust.

Change

Clarify that this does not apply to the disposal of a trust interest acquired before 20 September 1985.

Explanation

This clarification is consistent with administrative practice.

Section 104-120 Lessor pays lessee to have lease changed: CGT event F3

This CGT event, which gives rise to a capital loss only, is where a payment is made by a lessor to a lessee to have a lease changed.

1. Change

Specify that the lessor makes the capital loss when the lease is changed.

Explanation

The 1936 Act is silent on timing.

2. Change

Clarify that the event can apply even if the lessee entered into the lease before 20 September 1985.

Explanation

The present law is unclear in these circumstances.

Section 104-130 Lessor receives payment for changing lease: CGT event F5

The receipt of an amount by a lessor for agreeing to change a lease is a CGT event.

1. Change

Specify that the lessor makes the capital gain when the lease is changed.

Explanation

The 1936 Act is silent on timing.

2. Change

Clarify that the event only applies if the lease was granted, or an extension or variation of the lease began, after 19 September 1985.

Explanation

The 1936 Act is unclear about this timing link.

3. Change

Clarify that the capital gain or loss is the difference between the amount received for agreeing to the change and any expenditure incurred in relation to the variation.

Explanation

The present law does not say how to calculate the gain or loss.

Section 104-135 Capital payment for shares: CGT event G1

Under this section a payment of a non-dividend amount is a CGT event which can result in a capital gain or a cost base adjustment for the share, but not a capital loss.

1. Change

Treat payments in kind in the same way as money payments.

Explanation

Under the 1936 Act, where a company pays an amount to a shareholder the cost base of their share is reduced by the payment. It is appropriate that payments in kind should have the same effect as cash payments.

2. Change

Align the treatment of interim liquidation distributions with that of final distributions if the company is dissolved within 18 months from the interim payment.

Explanation

It is clear that a finalliquidation distribution is paid as a result of the cancellation of the share and is taken into account in calculating whether a capital gain or loss is made when the share is cancelled. It is unclear whether an interim distribution is accounted for immediately, under the cost base reduction rules, or when the shares are cancelled.

Under the rewritten law, all liquidation payments, whether interim or final, that culminate in the dissolution of the company within 18 months will be accounted for under CGT event C2 (cancellation etc. of a CGT asset).

If winding-up does not occur within 18 months, the interim payment will come within CGT event G1 and reduce the cost base of the shares as at the time of payment. This prevents any long-term deferral of tax.

Section 104-145 Declaration by liquidator that shares worthless: CGT event G3

This section makes it a CGT event when a companys liquidator declares that there are reasonable grounds to believe that shareholders are unlikely to receive any further distribution on a winding-up of the company. This allows shareholders to take the benefit of capital losses.

1. Change

Specify that the capital loss equals the shares reduced cost base and that the cost base is then written down to nil.

Explanation

The rewritten section directly equates the capital loss with the reduced cost base of the shares. It then resets the cost base to nil for the calculation of the capital gain or capital loss on a later disposal or cancellation of the share.

2. Change

Clarify that a liquidators declaration may be made after a distribution has been made during a winding-up.

Explanation

The making of a winding-up distribution does not preclude a later declaration by the liquidator. If it did it would unnecessarily limit the scope of this event.

Section 104-150 Forfeiture of deposit: CGT event H1

This section treats as a CGT event the forfeiture of a deposit relating to a prospective purchase or other transaction.

1. Change

Include an example to illustrate the meaning of the term prospective purchase.

Explanation

The example is consistent with the interpretation given by the Full Federal Court in Federal Commissioner of Taxation v Guy (1996)
137 ALR 193; 96ATC 4520; (1996)
32 ATR 590. The Court concluded that the term prospective purchase brought within its scope the forfeiture of a holding deposit, a deposit paid in connection with the grant of an option, or a negative pledge or right of pre-emption. The term does not extend to a deposit paid by a purchaser under an actual contract of purchase.

2. Change

Clarify that the CGT event happens on forfeiture of the deposit.

Explanation

This interpretation is consistent with the interpretation of the existing provisions in Guy's Case.

Section 104-180 Company in a sub-group leaves wholly-owned group after a roll-over

This section is an exception to CGT event J1 which applies where a company ceases to be a member of a wholly-owned group, while it still owns a CGT asset that was rolled-over when it was a member of that group. The exception is when a sub-group, including the company and the other parties to the roll-over, breaks off from the wholly-owned group.

Change

Clarify that the holding company of the sub-group cannot be the ultimate holding company of the wholly-owned group.

Explanation

On a literal reading of the provisions of the 1936 Act, it could be argued that the holding company of the sub-group can be the ultimate holding company of the wholly-owned group. It could allow a single company leaving a group to avoid the intended taxing point in relation to a previously rolled-over asset. That would negate the purpose of the provisions.

Section 104-205 Partial realisation of intellectual property: CGT event K1

This section identifies the partial realisation of an item of intellectual property as a CGT event.

1. Change

Clarify that CGT event K1 applies to:

damages received for infringement of intellectual property; and

an amount paid by the Commonwealth or a State or an authorised person for use of a patented invention.

Explanation

It is appropriate that the CGT treatment of intellectual property

should match the special income tax treatment of intellectual property (see Division 373 of Schedule 1 of this Bill). The rewritten section achieves this.

2. Change

Ensure that no capital gain or loss can arise, in the case of a grant of a licence of intellectual property, if the property was acquired before 20 September 1985.

Explanation

It is unclear whether the present CGT provisions relating to intellectual property apply to the grant of a licence of intellectual property acquired before 20 September 1985. Therewritten provision is consistent with administrative practice.

3. Change

Clarify that the subsequent grant of a right in respect of intellectual property acquired before 20 September 1985 does not result in that property being treated as having been acquired on or after that date.

Explanation

The deemed disposal and reacquisition mechanism in section 160ZZD of the 1936 Act changes the status of pre-CGT intellectual property to post-CGT property. The rewritten provision rectifies this unintended consequence.

Section 104-215 Asset passing to tax-advantaged entity: CGT event K3

This section deals with cases where an asset passes from a deceased person to a tax-advantaged entity.

Change

Specify that the time for determining the status of a tax-advantaged beneficiary is when the asset passes to the beneficiary.

Explanation

The 1936 Act is unclear whether the relevant time is:

•

when the former owner died; or

•

when the asset passed to the beneficiary.

The rewritten provision adopts the Commissioners interpretation of the law.

C. Provisions of the old law that have not been rewritten

Redundant provisions

The following provisions are redundant and have not been rewritten:

D. Cross references to all CGT events

This table identifies cross references to provisions that specifically refer to a CGT event.

Chapter 2.5 - Entity making the gain or loss

Overview

This segment covers the special rules in Division 106 for identifying the entity that makes a capital gain or loss in circumstances where more than one entity is involved in a CGT event.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

A. Summary of the new law

Division 106: Entity making the gain or loss

What the division does

In some cases, although an entity is involved in the CGT event, it is another entity which accounts for the capital gain or loss. Division 106 identifies which particular entity is accountable for the capital gain or loss.

It covers:

•

partnerships;

•

backruptcy trustees;

•

company liquidators;

•

trustees, shere there is an absolutely entitled beneficiary; and

•

security holders.

Partnerships

The provisions make it clear that it is the partners who make a capital gain or loss from a CGT event and not the partnership. In the case of each partner, their capital gain or loss is determined either by the partnership agreement or, where no agreement exists or is silent on the point, by partnership law. [section 106-5]

Retirement or admission of partner

Where a partner leaves the partnership, a continuing partner acquires separate CGT assets to the extent that they acquire a share of the departing partners interest in the partnership assets. [subsection 106-5 (3)]

Where a partner is admitted to a partnership, the original partners each dispose of a part of their interest in the partnership assets to the new partner to the extent that the new partner has acquired it . [subsection 106-5 (4)]

Bankruptcy

The vesting of a persons CGT assets in a trustee under a bankruptcy law does not trigger any immediate CGT consequences. The CGT provisions apply as if acts done in relation to the bankrupts assets by the trustee are acts of the bankrupt. [section 106-30]

Company liquidation

The CGT provisions apply as if an act of the liquidator of a company is an act of the company. [section 106-35]

Absolutely entitled beneficiaries

Acts by a trustee in relation to an asset that a beneficiary is absolutely entitled to are treated for CGT purposes as if the beneficiary had taken the action. [section 106-50]

Security holders

Where a security holder acts to give effect to its security over an asset, the CGT provisions apply as if the owner of the asset had taken the action. [section 106-60]

B. Discussion of changes

Section 106-5 Partnerships

This section applies so that a capital gain or loss from the happening of a CGT event is made by the individual partners and not the partnership.

Change

Specify the CGT consequences of a change in the membership of a partnership.

Explanation

The 1936 Act is silent on this matter. However, the definition of asset in section 160A of that Act implies that a partner has an interest in each partnership asset. The rewritten provision clarifies the law by making this explicit for partners entering or leaving a partnership. This is consistent with the longstanding administrative practice.

Section 106-10 Modification of cost base for partnerships

This section sets out the modifications to the cost base rules in Division 110 for partnerships.

Change

Reduce a partners cost base for an interest in a CGT asset of the partnership by any amount of expenditure that the partnership has deducted, or can deduct, in relation to that CGT asset.

Explanation

It is not clear in the 1936 Act whether partners are required to reduce the cost base of their interest in a partnership asset if the partnership has claimed deductions for expenditure. The rewritten provision clarifies that they are.

Section 106-30 Effect of bankruptcy

This section deals with where an individuals assets are vested in a trustee under a bankruptcy law.

Change

State expressly that the act of vesting assets in a trustee under a bankruptcy law is ignored for CGT purposes.

Explanation

It is implicit in the 1936 Act that the vesting of assets in a trustee in bankruptcy does not, of itself, have CGT consequences. In the rewritten law, it is expressly stated that any acts of the trustee in relation to vested CGT assets are taken to be the bankrupts acts.

Chapter 2.6 - CGT assets

Overview

This segment deals with Division 108 covering the three categories of assets that are relevant to capital gains and capital losses:

•

CGT assets;

•

collectables;

•

and personal use assets.

It explains the circumstances in which land, buildings and other capital improvements are treated as separate CGT assets.

It indicates how capital losses from collectables and personal use assets are relevant in working out a net capital gain or loss.

•

Part A summarises Division 108.

•

Part B explains the changes to the 1936 Act.

•

Part C explains why some provisions of the 1936 Acthave not been rewritten.

A. Summary of the new law

Division 108: CGT assets

What the Division does

Division 108 defines three categories of assets:

•

CGT assets;

•

collectibles; and

•

personal use assets.

These are key components in working out whether the taxpayer has a capital gain or loss. It has rules for taking capital losses from collectables into account in working out a net capital gain or loss.

It also contains the rules for determining when land, buildings and improvements are taken to be separate CGT assets. [section 108-11]

CGT assets

A CGT asset is defined as property, or a legal or equitable right that is not property. To avoid any doubt, CGT assets are stated to specifically include:

•

a part of a CGT asset or an interest in one;

•

goodwill, or an interest in goodwill;

•

an interest in a partnership asset; and

•

any other interest in a partnership.

[section 108-5]

Joint tenants

Individuals who own a CGT asset as joint tenants are treated as if they each owned a separate asset corresponding to their share in the asset. [section 108-7]

Collectables

Collectables are the following categories of CGT assets (or interests in them) that are used or kept mainly for personal use or enjoyment:

•

artwork, jewellery, antiques or a coin or medallion;

•

a rare folio, manuscript or book;

•

a postage stamp or first day cover.

[subsections 108-10(2) and (3)]

Losses from collectables

Capital losses from collectables can only reduce capital gains from collectables.

If a capital loss from a collectable exceeds capital gains from collectables in an income year, the excess is carried forward to be applied against future gains from collectables. Unapplied net capital losses from collectables are applied in the order in which they were made. [subsections108-10(1) and (4)]

Cost base of a collectable

The cost base of a collectable does not include non-capital costs of ownership. [section 108-17, subsection 110-25(4)]

Sets of collectables

Section 118-10 exempts collectables that are acquired for $500 or less. To prevent manipulation of this limit there are special rules for collectables that would ordinarily be disposed of as a set. [section 108-15]

Personal use assets

There are four categories of personal use asset:

•

a CGT asset (other than a collectable) used or kept mainly for personal use or enjoyment;

•

an option or right to acquire such an asset;

•

a debt arising from a CGT event affecting such an asset; and

•

a debt arising other than in the course of gaining or producing assessable income or from carrying on a business.

[subsection 108-20(2)]

They do not include land, or a building that is taken to be a separate asset under Subdivision 108-D.

[subsection108-20(3)]

Losses from personal use assets

Capital losses from personal use assets are disregarded in working out a net capital gain or loss. [subsection 108-20(1)]

Cost base of a personal use asset

The cost base of a personal use asset does not include non-capital costs of ownership. [section 108-30, subsection110-25(4)]

Sets of personal use assets

Subsection 118-10(3) exempts personal use assets that are acquired for $10,000 or less. To prevent manipulation of this limit there are special rules for personal use assets that would ordinarily be disposed of as a set. [section 108-25]

Separate CGT assets

Subdivision 108-D sets out cases in which an asset that would generally be regarded as a single asset is to be treated as more than one asset for CGT purposes. [section 108-50]

When a building is a separate asset from land

A building constructed on post-CGT land is treated as a separate CGT asset, only if it is subject to balancing adjustment provisions. [subsection 108-55(1)]

A post-CGT building constructed on pre-CGT land is always treated as a separate CGT asset. [subsection 108-55(2)]

A unit of plant that becomes part of a building is also treated as a separate asset. [section 108-60]

When a capital improvement is a separate asset

Any capital improvement to pre or post-CGT land is treated as a separate CGT asset if it is subject to balancing adjustment provisions. [subsection 108-70(1)]

A major capital improvement made to a pre-CGT asset is treated as a separate asset if:

•

the cost base of each unrelated improvement exceeds the threshold test; or

•

the total of the cost bases of all related improvements does so.

[subsections 108-70(2) & (3)] When a capital improvement is not a separate asset

Separate asset treatment does not apply to:

•

pre-CGT improvements; [subsection 108-70(4)]

•

repairs or restorations made to a pre-CGT asset that is subject to roll-over relief under Subdivision 124-B. [subsection 108-70(6)]

Improvement threshold

The amount of the improvement threshold for the 1997-98 income year is $89,992. This amount is indexed for inflation and published annually. [section 108-85]

When improvements are related

Factors to be taken into account in determining whether improvements are related include:

•

the nature of the CGT asset;

•

the extent to which improvements depend on each other; and

•

how close in time the improvements are made.

[section 108-80]

Special rules for:

•

Crown leases;

•

mining or prospecting rights;

•

statutory licences

Major capital improvements made to one of these three categories of pre-CGT asset, for which roll-over relief may be available, are treated as separate CGT assets. [section 108-75]

Land adjacent to pre CGT land

If the title to post-CGT land is amalgamated with pre-CGT land, the post-CGT land will be treated as a separate asset. [section 108-65]

B. Discussion of changes

New Dictionary terms

Change

Section 995-1 of the Income Tax Assessment Act 1997 will be amended to insert additional definitions in the Dictionary. Some of the changes in terminology affect the operation of the law. These changes are explained in the notes that follow the table below.

Explanation

The definitions, and their equivalents in the old law, are explained in the following table:

Section 108-5 CGT assets

This section defines the term CGT asset. The term is defined differently from the definition of 'asset' in the existing law. However, the outcome is not a substantive change to the law.

1. Change

The new definition will include within its scope certain motor vehicles, or interests in motor vehicles, that are not assets for the purposes of the existing law.

Explanation

Although the rewritten law will treat these motor vehicles as assets, the change is not one of substance. Paragraph118-5(a) specifically exempts any capital gain or loss from these vehicles.

2. Change

The rewritten provision will also put beyond doubt that a divided part of a CGT asset and an undivided interest in a CGT asset are also CGT assets.

Explanation

The 1936 Act states only that the disposal of a part of an asset is included within the meaning of a disposal of an asset. The rewrite states expressly that parts of CGT assets and interests in CGT assets are also CGT assets.

Section 108-10 Losses from collectables offset only against gains from collectables

Change

The definitions of collectable and personal use asset are mutually exclusive.

Explanation

Under existing law listed personal-use assets are a sub-set of the wider category of personal-use asset. This overlap gives rise to the possibility that a collectable that is not a listed personal-use asset because it was acquired for $500 or less, could be treated as a non-listed personal-use asset. The rewritten law prevents this.

Section 108-20 Losses from personal use assets disregarded

Change

Capital gains on personal use assets are exempt if the personal use asset is acquired for $10,000 or less.

Explanation

Under existing law, capital gains on non-listed personal-use assets are effectively exempt unless consideration on disposal exceeds $10,000. This is achieved by deeming both the disposal consideration and the cost base of a non-listed personal-use asset to be a minimum of $10,000. Strictly, this imposes onerous record-keeping obligations for virtually all non-listed personal-use assets.

Changing the exemption to one based on the amount paid for the personal use asset simplifies their treatment.

Section 108-55 When is a building a separate asset?

Section 108-70 When is a capital improvement a separate asset?

These sections specify the circumstances in which a building or other capital improvement is treated as a CGT asset separate from the land on which it is constructed.

Change

The sections specify that a building [section 108-55] or capital improvement [section 108-70] is only treated as a separate CGT asset if it is subject to a balancing adjustment provision.

Explanation

Under property law, land and improvements are treated as one. For CGT purposes, any improvements for which an income tax deduction is available are treated as separate CGT assets. When improved land is sold, the proceeds must be apportioned and capital gain or loss calculations made for each separate asset.

Under the 1936 Act, this separate asset treatment often imposes additional record-keeping requirements on the landowner. The rewritten provisions limit the separate asset treatment only to cases where balancing adjustment provisions apply. Improvements that entitle owners to a deduction for capital works expenditure are no longer treated as assets separate from the land. This approach reduces compliance costs by simplifying calculations and record-keeping.

Section 108-65 Land adjacent to land acquired before 20 September 1985

Change

Separate asset treatment applies where post-CGT land and adjacent pre-CGT land are consolidated into one title.

Explanation

Under property law, if a taxpayer acquires land adjacent to an existing holding, both properties are treated as separate, unless the titles are amalgamated or consolidated. Under the proposed section, even if the titles are amalgamated the pre-CGT land retains its separate status as does the post-CGT land. This approach follows administrative practice.

Section 108-70 When is a capital improvement a separate asset?

Section 108-75 Capital improvements to CGT assets for which roll-over relief may be available

These sections specify when capital improvements to pre-CGT assets are treated as separate CGT assets.

Change

For improvements made to pre-CGT assets [section 108-70] or pre-CGT assets for which roll-over relief may be available [section 108-75] , the rewrite distinguishes between related and unrelated improvements when applying threshold tests.

Explanation

There is uncertainty whether all improvements are taken into account in determining if the threshold tests for the application of the existing provisions have been met. The rewritten provisions make it clear that only related improvements are to be considered. This is consistent with administrative practice.

Section 108-80 Deciding if capital improvements are related

This section lists the factors that establish whether capital improvements are related for the purposes of sections 108-70 and 108-75.

Change

This is a new provision.

Explanation

This section gives legislative guidance for determining whether particular capital improvements are related. It adopts the factors currently applied administratively.

C. Provisions of the old law that have not been rewritten

Redundant provisions

Some provisions of the existing law are redundant and have not been included in the new law. They are summarised in the following table:

Chapter 2.7 - Acquisition of CGT assets

Overview

This segment explains provisions which identify the various ways in which CGT assets can be acquired and establish the time at which the acquisition occurs in each case.

These rules are in Division 109 of the Bill.

Part A is a summary of Division 109.

Part B identifies a provision of the 1936 Act that has not been rewritten.

A. Summary of the new law

Division 109: CGT acquisitions

What the Division does

Division 109 sets out the various ways in which you can acquire a CGT asset and establishes the time of acquisition for CGT purposes.

Acquisition of a CGT asset

A taxpayer may acquire a CGT asset as a result of:

•

a CGT event - as examples, by transfer of land under a contract of sale or the creation of a right such as by the grant of an option;

•

other events - such as the issue of shares by a company or the making of capital improvements to a CGT asset in circumstances where the improvements are treated as separate assets; or

•

the application of specific rules such as where an individual dies and a CGT asset passes to the beneficiary.

The time of acquisition

Generally, you acquire a CGT asset at the time of the CGT event or when the other relevant event happens. The time of acquisition of a newly created CGT asset is generally when the asset is created. For example, the time of acquisition of an option is when the option is granted.

The time of acquisition is relevant for a number of reasons, the main ones being:

•

CGT generally does not apply to assets acquired before 20 September 1985;

•

indexation is only available for assets held more than 12 months; and

•

market value calculations are frequently based on the market value of an asset when it is acquired.

B. Provisions that have not been rewritten

Redundant provision

Subsection 160M(6D) of the 1936 Act containing the definition of the term vest has not been redrafted. The new CGT event approach made the definition redundant.

Chapter 2.8 - Cost base and reduced cost base

Overview

This segment explains the rewritten rules in Division 110 for working out the cost base or reduced cost base of a CGT asset.

Part A summarises the rules.

Part B explains the changes to the 1936 Act.

A. Summary of the new law

Division 110: Cost base and reduced cost base

What the Division does

Division 110 sets out the general rules for working out the cost base or reduced cost base of a CGT asset. These are key components as to whether a taxpayer makes a capital gain or capital loss. There are also special rules about cost base and reduced cost base in Division 112. sections 110-1, 110-5]

Some CGT events not included

A table sets out those CGT events which have their own cost rules. [section 110-10]

General rules about cost base

The cost base of a CGT asset has five elements.

1.

The price paid, or the market value of property given, to acquire the asset.

2.

Incidental costs of acquiring the asset or of the CGT event.

3.

Non-capital costs of ownership.

4.

Capital expenditure on improvements.

5.

Capital expenditure in respect of title or right to the asset.

[section 110-25]

A taxpayer who has owned the asset for more than twelve months, can index for inflation all elements except the third.

Costs not included in cost base

Some costs are not included in the cost base. These are:

•

expenditure in elements 2 and 3 for which deductions are claimed.

•

any expenditure recouped that is not included in assessable income.

[section 110-25]

Components of incidental costs

Incidental costs of acquiring a CGT asset or relating to a CGT event are:

•

remuneration for specified professional services

•

transfer costs

•

stamp duty or similar duty

•

advertising costs

•

valuation costs.

[section 110-35]

General rules about reduced cost base

There are also five elements in the reduced cost base of a CGT asset. Four of them are the same as those in the cost base, the exception being non-capital holding costs which are not included in the reduced cost base. The additional element in the reduced cost base takes into account any assessable balancing adjustment . [section 110-55]

Costs not included in reduced cost base

Costs not included in the reduced cost base are:

•

amounts allowable as a deduction. (These include balancing adjustments and amounts that would have been deductible except that the assets concerned had not been used, or installed ready for use, to produce assessable income.)

•

costs that have been recouped; and

•

if the CGT asset is a share, certain amounts derived by the company before the share was acquired.

[section 110-55]

Cost base modifications - partnerships

A partner's cost base and reduced cost base are modified by excluding:

•

expenditure in elements 2 and 3 for which deductions are claimed.

•

any expenditure recouped that is not included in assessable income.

[section 110-30]

Also excluded from a partners reduced cost base are amounts of:

•

heritage conservation expenditure for which the partner can obtain a tax rebate;

•

expenditure on plant that the partnership has been unable to deduct because it did not use the plant entirely to produce assessable income; and any rebatable dividend adjustment.

Cost base modifications - partnerships(contd)

Another modification includes in a partners reduced cost base his or her share of any assessable balancing adjustment borne by the partnership. [section 110-60]

B. Discussion of changes

Section 110-25 General rules about cost base

This section contains the elements that comprise the cost base.

1. Change

Include in the cost base non-deductible interest on borrowings to refinance a loan used to acquire a CGT asset.

Explanation

The 1936 Act includes non-deductible interest on borrowings to finance the acquisition of a CGT asset. But it is not clear whether interest on refinancing loans is included in the cost base. This change removes the uncertainty and is consistent with administrative practice.

2. Change

Include in the cost base non-deductible interest on loans used to finance improvements to an asset.

Explanation

The 1936 Act includes non-deductible interest on improvement loans only if the improvement is treated as a separate asset for CGT purposes. This is inequitable as between owners who improve assets and those who acquire assets already improved.

3. Change

Stipulate that recoupment of expenditure only reduces the cost base if it is not included in assessable income.

Explanation

If expenditure included in the cost base of an asset is recouped by the owner any capital gain would be understated, and any capital loss overstated, if the cost base were not reduced by the recoupment.

The change adopts the Commissioners interpretation of the law and puts beyond doubt that a recoupment of expenditure cannot both reduce the cost base and be included in assessable income.

Chapter 2.9 - Modifications to cost base and reduced cost base

Overview

This segment covers the rules in Division 112 about modifications to the cost base and reduced cost base of CGT assets.

Part A summarises these rules.

Part B explains the changes to the 1936.

A. Summary of the new law

Subdivision 112-A: General modifications

What the Subdivision does

Subdivision 112-A sets out four situations that may modify the general rules for working out the cost base and reduced cost base of a CGT asset.

Market value substitution rule

In some cases the market value of the CGT asset is taken into account in calculating the cost base and reduced cost base. Broadly, these are where:

•

no money is paid or no property given to acquire the asset; or

•

part or all of the consideration cannot be valued; or

•

the asset is not acquired through an arms length dealing.

[section 112-20]

Merged, split or changed assets

If two or more CGT assets are merged the respective cost bases or reduced cost bases are combined.

A reasonable apportionment of the cost base and reduced cost base of a CGT asset is required if:

•

the asset is divided into two or more separate assets; or

•

the asset is changed, wholly or partly, into an asset of a different nature.

[section 112-25]

Apportionment rules on acquisition or part disposal

An apportionment is also required where:

•

a transaction covers the acquisition of two or more CGT assets; or

•

part of a transaction is for the acquisition of a CGT asset; or

•

part of a CGT asset comes under a specific CGT event.

[section 112-30]

Assumption of liability on acquisition

If a liability is assumed when a CGT asset is acquired, the cost base and reduced cost base of the asset take account of the liability. [section 112-35]

Subdivision 112-B: Finding tables for special rules

What the Subdivision does

Subdivision 112-B is a guide that sets out in tabular form:

•

situations that modify the general rules about cost base and reduced cost base;

•

elements of the cost base or reduced cost base affected by the modification; and

•

where the detailed rules can be found.

The rules deal with:

•

main residence;

•

the effect of an individual dying;

•

bonus shares and units;

•

exercise of rights;

•

convertible notes;

•

employee share schemes

•

leases;

•

options;

•

units that stop being a pre-CGT unit;

•

transfer of a net capital loss;

•

modifications outside Parts 3-1 & 3-3;

•

residency.

Subdivision 112-C: Replacement-asset roll-over

What the Subdivision does

Subdivision 112-C is a guide containing:

•

a list of the replacement-asset roll-overs; and

•

where details of these can be found.

Meaning of replacement-asset roll-over

A replacement-asset roll-over is one where the CGT consequences are deferred until a later event affects the replacement-asset.

Some of the more common examples of such roll-overs are:

•

a strata title conversion;

•

the receipt of a new asset for the compulsory acquisition, loss, destruction or damage of a CGT asset; and

•

the receipt of shares or units in exchange for the transfer of a CGT asset to a wholly-owned company or trust. [section 112-105]

Cost base and reduced cost base of a replacement asset

The first elements of the cost base and reduced cost base of a replacement asset adopt the cost base and reduced cost base of the original asset at the time of replacement. [section 112-110]

Subdivision 112-D: Same-asset roll-over

What the Subdivision does

Subdivision 112-D is a tabular guide to all of the same-asset roll-overs.

Meaning of same-asset roll-over event

A same-asset roll-over is where a CGT asset changes hands and any capital gain or loss is deferred until another CGT event under the new ownership.

The same-asset roll-overs are:

•

transfer of an asset from a company or trust to a spouse because of a marriage breakdown;

•

transfer of an asset between spouses because of a marriage breakdown;

•

transfer to a wholly-owned company;

•

transfer from a partnership to a wholly-owned company;

•

transfer between related companies; and

•

disposal of a CGT asset because a trust deed is changed.

[section 112-150]

How the cost base and reduced cost base are modified

The new owner calculates the cost base and reduced cost base of the rolled-over asset as if the first element of the cost base or reduced cost base were the cost base and reduced cost base of the original asset, at the time the new owner acquired it. [section 112-145]

B. Discussion of the change

Structure

The Division brings together all the cost base and reduced cost base modification rules.

The 1936 Act contains the same rules but they are not collocated. This makes it difficult to determine when a cost base or reduced cost base is subject to modification.

Section 112-30: Apportionment rules on acquisition or part disposal

An apportionment is made to calculate a CGT assets cost base and reduced cost base when:

•

a transaction relates to the acquisition of more than one CGT asset; or

•

an asset is acquired as part of a broader transaction; or

•

only part of an asset is the subject of a CGT event.

Change

Require allocation, on a reasonable basis, of money paid or property given if a CGT asset is acquired as part of a broader transaction. The first element of the cost base and reduced cost base of the asset is based on that allocation.

Explanation

The 1936 Act states that the first element of the cost base or reduced cost base is the consideration in respect of the acquisition of the asset. It is implicit that this requires the reasonable allocation of any undissected amount paid or given in relation to a broader transaction. The rewritten provision makes this explicit.

Chapter 2.10 - Indexation of cost base

Overview

This segment covers the rules in Division 114 for indexing the cost base of a CGT asset for inflation. Part A summarises these rules. Part B explains the changes to the 1936 Act.

A. Summary of the new law

Division 114: Indexation of cost base

What expenditure is indexed

The cost base of a CGT asset consists of five elements, each of which is an amount of expenditure. You are entitled to index each element, other than element 3 - non-capital costs of ownership of the asset. [section 114-1]

When the cost base is indexed

Indexation of the cost base occurs when the cost base of the asset is taken into account on the happening of a CGT event. [section 114-5]

The 12 month rule

Expenditure in the cost base of an asset is only indexed for inflation if the taxpayer had owned the unit for at least 12 months. [section 114-10]

Exceptions to the 12 month rule

There are five exceptions. The first exception is when CGT event E8 (disposal by beneficiary of a capital interest) occurs within 12 months of the trustee acquiring an asset. The beneficiary can index the cost base of the asset if he or she acquired an interest in the trust capital at least 12 months before the event. [subsection 114-10(3)]

The second is when a replacement asset roll-over or a same asset roll-over occurs.

For a same asset roll-over, indexation is available for both the entity that owned the asset before the roll-over and the successor entity, if the combined ownership periods are at least 12 months. [subsection 114-10(4)]

For a replacement asset roll-over, indexation is available if your ownership periods for both the original asset and the replacement asset together reach 12 months. [subsection 114-10(5)]

The exception equally applies to an unbroken chain of roll-overs. [subsections 114-10(4), (5)]

The third and fourth exceptions apply where an individual dies. Where an asset devolves to a legal personal representative or passes to a beneficiary, the period that the deceased owned the asset is included in measuring the 12 month requirement. Similarly, a surviving joint tenant can take into account the period that the deceased held his or her interest. [subsections 114-10(6), (7)]

The fifth exception is when CGT event J1 [section 104-175] happens. For the purpose of indexation, the recipient company is not taken to have acquired the unit at break-up time. [subsection 114-10(8)]

Indexation and cost base modifications

There are a number of cases where modifications are required in indexing the cost base of CGT assets. The effects of these modifications are in sections 112-20 and 112-35, and Subdivisions 112-B, 112-C and 112-D. [section 114-15]

Indexation where cost base element is substituted

If a modification replaces (or includes an amount in) an element of the cost base, the substituted amount is indexed as if it had been incurred at the time of the modification. [subsection 114-15(2)]

Indexation where modification reduces the cost base

If a modification reduces the cost base, the new element is indexed as if it had been incurred at the time of the modification. [subsection 114-15(3)]

Indexation where cost base of original asset or roll-over asset is adopted for the new asset

Where the whole cost base of an original asset or roll-over asset becomes the first element of the cost base of a new CGT asset, it is indexed as if it had been incurred when the roll-over happened. [section 114-20]

B. Discussion of changes

Section 114-10 Requirement for 12 months ownership

1. Change

Clarify that indexation is available (with certain exceptions) only if the CGT asset was acquired at least 12 months before a CGT event happens in relation to the asset.

Explanation

Sections 160ZX and 160ZZT of the 1936 Act only refer to indexed cost base in working out whether a capital gain or loss is made. No reference is made (unlike other sections) to cost base or reduced cost base. This has led to uncertainty as to the period over which assets affected by these sections can be indexed. The rewritten provision clarifies that indexation is available where the asset was acquired at least 12 months before the relevant CGT event.

2. Change

Allow indexation of the cost base of a replacement asset (for a replacement-asset roll-over) where a CGT event happens to that asset within 12 months of the roll-over, but at least 12 months after the original asset was acquired.

Explanation

The 1936 Act does not permit indexation if a CGT event happens to a replacement asset within 12 months of its acquisition (the roll-over). To be consistent with the general design of the roll-over provisions which transfer the CGT attributes of the original asset to the replacement asset, indexation should be allowed for this period.

3. Change

Similarly, allow indexation of the cost base of a roll-over asset to which a CGT event happens within 12 months of the roll-over, but at least 12 months after the transferor acquired the roll-over asset.

Explanation

Again this extension brings greater consistency to the indexation rules.

Chapter 2.11 - Capital proceeds

Overview

This segment covers the rules in Division 116 for working out what are the capital proceeds from a CGT event.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

A. Summary of the new law

Division 116: Capital proceeds

What the Division does

Division 116 specifies the capital proceeds to be taken into account in working out whether a capital gain or loss has been made. A table describes modifications and whether any special rules apply. [sections 116-5, 116-10, 116-20 and 116-25]

General rules about capital proceeds

Capital proceeds from a CGT event are ordinarily:

•

money a taxpayer receives, or is entitled to receive, for the event happening;

•

the market value of any property a taxpayer receives, or is entitled to receive, for the event happening; or

•

a combination of these.

[section 116-20]

Modifications to the general rules

•

1. The market value of the CGT asset is substituted if:

•

there are no capital proceeds; or

•

any part or all of the capital proceeds cannot be valued; or

•

the asset was disposed of in a non-arms length dealing. [section 116-30]

2.

An amount is apportioned if only part of it relates to the CGT event [section 116-40] ;

3.

Capital proceeds are reduced by any amount owed that is unlikely to be received (as long as the taxpayer tries to recover it). [section 116-45] ;

4.

Capital proceeds are reduced by any non-deductible amount a taxpayer has to repay [section 116-50] ; and

Modifications to the general rules continued

5. Capital proceeds are increased by the amount of any liability assumed in connection with the asset. [section 116-55]

Special rules

CGT event A1

If CGT event A1 (disposal of a CGT asset) happens because an option has been exercised over the asset,the capital proceeds include those from the grant of the option. [section 116-65]

CGT event C2: Cancellation, surrender etc. of a CGT asset

Where CGT event C2 (cancellation, surrender and similar endings) happens to an asset there are three special rules:

1.

The first modification to the general rules does not apply if the CGT asset expires or it is a statutory licence that is cancelled. [subsection 116-30(3)]

2.

In all other cases where a CGT asset ends, the market value is determined as if the asset still existed. [subsection 116-30(4)]

3.

On expiry, surrender or forfeiture of a lease, the capital proceeds include any amount that the lessor pays to the taxpayer as lessee for improvements to the lease property. [section 116-75]

Where a company or trust owns a collectable or personal use asset

Where a taxpayer disposes of shares or an interest in a trust, and the capital proceeds reflect a fall in the market value of collectables or personal use assets (other than a car, motor cycle or similar vehicle) of the company or trust, the market value of the shares or interest is determined as if that fall had not occurred. [section 116-80]

Section 47A of the 1936 Act applies to certain rolled-over assets

Where a CGT event happens to a CGT asset you own, the capital proceeds from the event are reduced if you acquired the asset in the following circumstances:

•

you acquired the asset from a company;

•

the company obtained roll-over relief for that disposal;

•

in relation to that disposal, you or another entity received an assessable deemed dividend under section 47A of the 1936 Act.

[section 116-85]

CFC changes residency from an unlisted country to a listed country

The capital proceeds are adjusted if a CGT event happens to an asset that the taxpayer acquired from a CFC which held it since changing residency from an unlisted country to a listed country. [section 116-95]

B. Discussion of changes

Section 116-25 Table of modifications to the general rules

Change

The section clarifies that the market value substitution rule does not apply to CGT events F1, F2, F4 and F5 which deal with the grant or variation of a lease.

Explanation

The 1936 Act is unclear whether the market value substitution rule applies when a lease is granted or varied without the payment of a premium or other amount. The section clarifies that it does not apply. This is consistent with administrative practice.

Section 116-50 Repaid rule: modification 4

Change

Reduce capital proceeds by any amount repaid, to the extent that a deduction is not allowable for the repayment.

Explanation

The 1936 Act does not allow for a capital gain or loss to be adjusted for consideration that the seller later repays.

The rewritten provision gives a more equitable result, corresponding with the treatment of the purchaser.

Chapter 2.12 - Main residence exemption

Overview

This segment covers the rules in Subdivision 118-B which allow an exemption if a CGT event happens concerning a main residence.

Part A summarises these rules.

Part B explains the changes proposed to the 1936 Act.

Part C explains why some provisions of the 1936 Act have not been rewritten.

A. Summary of the new law

Subdivision 118-B: Main residence exemption

What the Subdivision does

Subdivision 118-B determines the extent to which any capital gain or loss is ignored when a CGT event happens to your dwelling.

Basic case

Any such capital gain or capital loss will be fully exempt if:

•

the dwelling was your main residence throughout your ownership; and

•

it was not used for any income producing purpose.

[section 118-110]

Meaning of dwelling

A dwelling is any building, or part of a building, that consists mainly of residential accommodation and the land it is built on. It includes a caravan, houseboat or other mobile home. [section 118-115]

Extension to adjacent land

The main residence exemption extends to adjacent land that has been used primarily for private or domestic purposes with the dwelling. The maximum area of land that qualifies for exemption is two hectares.

[section 118-120]

Ownership period

The ownership period is the period after 19 September 1985 during which the person concerned had an ownership interest in the dwelling or land on which the dwelling is later built. [section 118-125]

Ownership interest

You own a dwelling if you have:

a legal or equitable interest in the land on which the dwelling is built; or

a licence or right to occupy it.

There are special rules covering a flat or home unit, and when ownership of a dwelling is acquired under a contract. [section 118-130]

Rules that may extend the exemption

Changing main residences

For individuals who acquire a new dwelling while retaining their old dwelling, their main residence is the one that they live in. However, they can treat both dwellings as their main residence for up to six months provided:

the old dwelling was their main residence for a continuous period of at least three months in the previous twelve months; and

during that twelve month period it was not used for the purpose of producing assessable income while it was not their main residence. [section 118-140]

Absences from an individuals main residence

If a dwelling ceases to be your main residence, you may continue to treat it as your main residence in some circumstances.

If part of the dwelling that was your main residence is used for the purpose of producing assessable income, the maximum period that it can continue to be treated as the main residence is six years.

If the dwelling later becomes your main residence again, the six year rule restarts. [section 118-145]

Building, repairing or renovating a dwelling

Persons who build, repair or renovate a dwelling on land that they already own may be able to treat the land as their main residence for up to four years before taking up residence. No other dwelling can be treated as their main residence during this time. [section 118-150]

Special rules apply where the person dies after entering into contracts for the construction work. [section 118-155]

Accidental destruction of dwelling

The main residence exemption applies if a dwelling is accidentally destroyed (eg. by a bushfire) and the land is disposed of without another dwelling being built on it. [section 118-160]

Rules that may limit the exemption

Separate CGT event happens to adjacent land or other structures

The exemption is affected if a separate CGT event happens to land adjacent to a dwelling or to other structures such as a garage or storeroom. [section 118-165]

Spouse or dependent child having different main residences

Generally, if an individual lives in one dwelling and their spouse or dependent child lives in another, only one of the dwellings can be nominated as the main residence. Special rules apply if spouses nominate different main residences for the same period. [sections 118-170 and 118-175]

Acquisition of dwelling from company or trust on marriage breakdown

When a dwelling is transferred to an individual from a company or trustee under a court order resulting from a marriage breakdown, the individual is treated as having owned the dwelling while it was owned by the company or trustee. However, the dwelling is not treated as the individuals main residence during that period. [section 118-180]

Partial exemption rules

Dwelling used for the purpose of producing assessable income

The exemption may be reduced if the dwelling is used for the purpose of producing assessable income. [section 118-190]

Market value for first income producing use

Special rules substitute a market value cost base the first time a main residence is used for income producing purposes. [section 118-192]

Dwellings acquired from deceased estates

Dwelling acquired from a deceased estate

Any capital gain or loss on a dwelling acquired by an individual as a beneficiary of a deceased estate or by a trustee of a deceased estate is fully exempt if:

(a)

the dwelling was the deceased's main residence just before the deceased's death or it was pre-CGT property of the deceased; and

(b)

the dwelling was disposed of within two years of the deceaseds death or it was, from the time of the deceaseds death until the disposal, the main residence of:

the deceased's spouse;

an individual who had a right to occupy the dwelling under the will; or

a beneficiary.

[section 118-195]

Partial exemption for deceased estate dwellings

If the gain or loss is not fully exempt, any partial exemption is calculated using a formula. [section 118-200]

Special rules apply if the deceased acquired the dwelling as a beneficiary in or as trustee of a deceased estate. [section 118-205]

Trustee acquiring dwelling under will

If a trustee of a deceased estate acting under a will acquires a dwelling for occupation by an individual, roll-over or a full or partial exemption may be available if a CGT event happens affecting that dwelling. [section 118-210]

B. Discussion of changes

Section 118-100 What this Subdivision is about

Section 118-105 Map of this Subdivision

Commentary

These proposed sections are guide material and will give a logically organised overview of the main residence exemption. They assist taxpayers to identify, and find their way to, provisions which apply to their situation.

Section 118-110 Basic case

Change

Adopt the term main residence.

Explanation

The 1936 Act uses the term sole or principal residence. The new term is shorter and more apt. The change does not affect the operation of the provisions.

Section 118-115 Meaning of dwelling

Change

Clarify the meaning of dwelling.

Explanation

The rewritten provisions make clear that references to a dwelling do not include land adjacent to the building but do include land beneath the building.

Section 118-120 Extension to adjacent land

Change

Specify that adjacent land qualifies for exemption if it is used primarily for private or domestic purposes in association with the dwelling throughout the ownership, not merely at the time of disposal.

Explanation

Under the 1936 Act, the exemption is expressed in the context of land used for private purposes in association with the dwelling at the time of disposal. The administrative practice has been to look at how the land has been used over the whole ownership period. This is consistent with the rules for exemption of the building itself.

Section 118-130 Meaning of ownership interest in land or a dwelling

Change

The term ownership interest is defined.

Explanation

This term is used to denote the expanded meaning of ownership under subsections 160ZZQ(1AA), (1AB) and (2) of the 1936 Act.

Section 118-135 Moving into a dwelling

Change

Extend the main residence exemption to take account of the time needed to move into a dwelling, ie. from acquisition until it is first practicable for the individual to move into the dwelling that becomes your main residence.

Explanation

The rewritten provision takes account of situations where, for example, there is a delay in moving in because of illness or other reasonable cause.

The exemption does not extend to cases where an individual is unable to move into the dwelling because it is being rented out. However, it would cover a period after the end of the tenancy if the owner could not take up residence immediately because of the nature of repairs required to the dwelling.

Section 118-140 Changing main residences

Change

Extend the period during which a taxpayer can have concurrent exemptions for two dwellings from three months to six months.

Explanation

Under the 1936 Act, if a person moves into a new dwelling before disposing of their old dwelling, the exemption can be claimed for both as main residences for up to three months. The extension allows more time for a sale.

Section 118-145 Absences

The 1936 Act in some cases allows an individual to continue to treat their dwelling as their main residence after they have moved out. If the dwelling is used for the purpose of producing assessable income, this is limited to six years.

Change

Provide that, if a dwelling is used to produce assessable income, the maximumperiod for it to be treated as a main residence while so used is six years. The rule does not specify when this period commences or ends.

Explanation

Under the 1936 Act, if a dwelling ceases to be a main residence, it can continue to be treated as one by election. If it is not used to produce assessable income, this can continue indefinitely. If it is used to produce assessable income, a six year limit applies commencing when the dwelling begins to be so used. This can give an anomalous result when, during an absence, there is also a period when the dwelling is vacant or otherwise not used to produce assessable income.

The following examples illustrate this:

Example 1

Clare ceases to use her post-CGT dwelling as her main residence and leaves it vacant for four years, rents it out for a further six years, then sells it.

Clare is entitled to an exemption for the full ten years. This is because under the six year absence rule the period commences from the time the dwelling starts to be used to produce assessable income.

Example 2

Elizabeth ceases to use her post-CGT dwelling as her main residence, rents it out for six years and leaves it vacant for a further four years, then sells it.

Elizabeth is entitled to an exemption for the first six years only. Again, this is because the six year period commences from the time the dwelling starts to be used to produce assessable income.

Under the rewritten section, both Clare and Elizabeth will be entitled to an exemption for ten years. This is because the rewritten rule does not specify when the six year period commences or ends. The rule will simply provide that, if the dwelling is used to produce assessable income, the maximum period that it can continue to be treated as a main residence while it is so used is six years.

Commentary

1. Relationship with section 118-140 (Changing main residences)

Where a dwelling is used to produce assessable income during an absence, and the individual chooses to treat the dwelling as their main residence during the absence, no other dwelling can be treated as the individuals main residence for the period, with one exception.

An individual will have a choice under this section and proposed section 118-140, to claim exemption for up to six months for two residences while moving from one main residence to another. The relationship between these choices is clearly stated in subsection 118-145(4).

2. Six year limitation - more than one absence

If a dwelling ceases to be an individuals main residence more than once during the ownership period, the maximum six year period of income producing use can apply to each period of absence.

A person need not choose whether to treat the dwelling as their main residence at the time of the absence. The choice only needs to be made on disposal of the dwelling.

3. Aggregation of non-continuous income producing use where there is one period of absence

The six year period need not be continuous. If there are intermittent periods of income producing use during a period of absence, those periods are aggregated to see whether the six year limitation has been exceeded.

Example

Lindy ceases to use her post-CGT dwelling as her main residence and rents it out for five years. She then leaves it vacant for one year, rents it out for a further three years, then sells it.

As there has only been one period of absence, Lindy chooses to continue to treat the dwelling as her main residence until the property has been used to produce income for six years. The exemption covers the first five years of rental use, the period when the dwelling was vacant, and a further one year of rental use. For the remaining two years until sale, the exemption is not available.

Section 118-150 If you build, repair or renovate a dwelling

1. Change

Provide that the exemption covers the construction period when a dwelling is constructed on land that had an existing dwelling on it regardless of whether the existing dwelling is demolished.

Explanation

The 1936 Act does not allow the exemption to include the time taken to build a dwelling if there was another dwelling on the land when it was acquired, unless the initial dwelling is demolished. Individuals will now be able to claim the construction period exemption whether or not the initial building is demolished.

2. Change

Provide that the exemption covers up to four years before the dwelling becomes an individuals main residence, including the period from completion to occupancy.

Explanation

Under the 1936 Act the four year limit does not always cover from when the building is completed until it is occupied.

Section 118-160 Destruction of dwelling and sale of land

Change

Provide that a person can continue to apply the main residence exemption to a disposal of vacant land where the dwelling that was on it is accidentally destroyed.

Explanation

Under the 1936 Act, an individual loses the exemption if:

•

their main residence is destroyed; and

•

the vacant land on which it stood is disposed of.

Under the rewritten law, the individual is able to apply the main residence exemption rules as if the residence was not destroyed until the time of disposal of the land.

This applies, for example, to a dwelling that is lost in a bushfire.

Section 118-190 Use of dwelling for the purpose of producing assessable income

1. Change

Confine the income producing limitation to situations where interest on a mortgage in relation to the dwelling could have been deducted.

Explanation

Under the 1936 Act, the main residence exemption is reduced if the dwelling is used to produce assessable income. It is administrative practice to apply this rule only where the taxpayer would be able to deduct rates, rent or interest on a mortgage (if any), for all or such part of a dwelling as is used exclusively as a place of business. An example is when part of a dwelling is used as a doctors surgery.

Current administrative practice is to accept that the exemption is not affected where part of a dwelling is used as a home office. (Generally, rates, rent or interest are not deductible in these circumstances.) The rewritten provision adopts this administrative concession.

2. Change

Replace the Commissioners discretion to reduce the exemption if a main residence is also used for the purpose of producing assessable income with a test of reasonableness.

Explanation

Under the 1936 Act, the exemption may be reduced to an amount determined by the Commissioner if there is concurrent income producing use. This discretion will be replaced with an objective test more appropriate to self assessment.

Section 118-195 Dwelling acquired from a deceased estate

This section establishes when a trustee or beneficiary of a deceased estate is entitled to exemption on the disposal of a dwelling.

Change

Provide that any occupation of the dwelling by a beneficiary, the spouse of the deceased, or an individual who had a right to occupy the dwelling under the will, during the time between death and disposal, is taken into account in determining the extent of the exemption.

Explanation

Under the 1936 Act, occupation of the dwelling as a main residence by individuals within these three categories is taken into account in determining the extent of the exemption but only for specific times. For a beneficiary, this covers a time when the beneficiary owned the dwelling or had a right to occupy the dwelling under the will. For the spouse of the deceased, or an individual with a right to occupy under the will, it covers the time when the dwelling was owned by the legal personal representative of the deceased.

The rewritten section allows any occupation between the death and disposal by these three categories of persons to be taken into account.

Section 118-205 Adjustment if dwelling inherited from deceased individual

This section operates on disposal of a dwelling inherited from the estate of a deceased person who acquired the dwelling after 19 September 1985 as beneficiary or trustee of another deceased estate.

Change

Replace with an objective test, the Commissioners discretion to increase or decrease, in certain cases, a capital gain or loss on disposal of a dwelling inherited from a deceased person.

Explanation

An individual may inherit a dwelling from someone who had themselves inherited it. Under the 1936 Act, any capital gains or losses in the hands of individuals earlier in an inheritance chain are included in the capital gain or loss on the disposal of the dwelling, apart from the main residence exemption.

However, the Commissioner has a discretion to increase or decrease any capital gain or loss to take account of any time, after 19 September 1985 and before the dwelling was acquired by the deceased, that it was a main residence of:

•

a person who owned the dwelling at their death;

•

their spouse;

•

a person with a right to occupy under a will; or

•

a beneficiary.

The rewritten provision replaces this discretion with an objective formula that takes account of times when the dwelling was the main residence of any such persons.

C. Provisions of the old law not rewritten

Redundant provisions

Some provisions of the 1936 Act have not been rewritten for reasons summarised in the following table:

Chapter 2.13 - Exemptions

Overview

This segment covers the exemptions from capital gains tax dealt with in Division 118, but not the main residence exemption.

Part A summarises the exemptions.

Part B explains the changes to the 1936 Act.

Part C identifies provisions that have not been rewritten.

A. Summary of the new law

Subdivision 118-A: General exemptions

What the Subdivision does

This Subdivision contains exemptions for gains and losses relating to specific types of assets and capital receipts. It also sets aside gains and losses dealt with by other provisions.

Exempt assets

Capital gains and losses from the following assets are disregarded:

•

cars, motorcycles or similar vehicles [section 118-5] ;

•

valour and brave conduct decorations [section 118-5] ;

•

collectables acquired for $500 or less [section 118-10] ;

•

personal use assets acquired for $10,000 or less [section 118-10] ;

•

assets used to produce exempt income [section 118-12] ; and

•

shares in a PDF [section 118-13].

Exempt capital receipts

The following capital receipts are disregarded in working out net capital gains or losses:

•

compensation or damages for wrong or injury suffered in a person's occupation;

•

compensation or damages for wrong, injury or illness suffered by a person or their relative;

•

gambling wins or prizes; and

•

amounts paid under listed government schemes.

[section 118-15]

Anti-overlap provisions: reduction of capital gain if amount is otherwise assessable

A capital gain made from a CGT event is reduced to take account of any other provision that includes an amount in assessable or exempt income. [section 118-20]

If the amount included in assessable income is greater than, or equal to, the capital gain, the gain is reduced to zero. [subsection 118-20(4)]

The capital gain is reduced by the assessable amount if the gain exceeds it. [subsection 118-20(5)]

When capital gain is not reduced

A capital gain is not reduced if an amount:

•

is included in assessable income because of a share buy-back under section 159GZZZP of the 1936 Act [subsection 118-20(3)] ;

•

is included in assessable income in relation to franked dividends under section 160AQT of the 1936 Act [subsection 118-20(3)] ;

•

was taken into account in working out a superannuation funds net previous income for earlier income years under sections 228A and 228B of the 1936 Act [subsections 118-20(7) & (8)] ;

•

is included in assessable income because of a balancing adjustment [subsection 118-20(9)] ; or

•

is included in a shareholders exempt income under section 23AJ of the 1936 Act because a company pays certain types of dividend [subsection 118-20(10)] .

Anti-overlap provisions: full exemption for capital gains and losses

To prevent double taxation, capital gains and losses from CGT events are disregarded if, as a result of the event, an amount is included in assessable income under a provision relating to:

trading stock [section 118-25] ;

Australian films [section 118-30] ; or

research and development [section 118-35] .

If an entity commences to hold as trading stock an asset it already owns, the capital gain or loss accruing at the time the basis upon which it is held changes is disregarded if the entity elects to treat the sale as having been for cost.

Modification for partners and an absolutely entitled beneficiary

The anti-overlap provisions are modified to prevent double taxation of partners and absolutely entitled beneficiaries. [sections 118-20, 25, 30 and 35]

Exempt and loss denying transactions

•

Capital gains and losses can be disregarded in certain cases concerning:

•

transfers of stratum units [section 118-42] ;

•

mining rights [section 118-45] ;

•

foreign currency hedging [section 118-55] ; or

•

testamentary gifts under the Cultural Bequests Program [section 118-60] .

A capital loss made by a lessee on the expiry, transfer, forfeiture or assignment of a lease is disregarded if the lease was not used mainly to produce assessable income. [section 118-40]

Subdivision 118-C: Goodwill

What the Subdivision does

Half of a capital gain attributable to the goodwill of a business is disregarded if the net value of the business (and related businesses) is less than the business exemption threshold. [section 118-250]

Net value of a business

The net value of a business is the sum of the market values of the assets (including goodwill) less the liabilities. [section 995-1]

Business exemption threshold

The business exemption threshold for the 1997-98 income year is $2,248,000. The threshold is indexed annually. [section 118-260]

Related businesses

The subdivision sets out the situations regarded as the carrying on of related businesses, eg. by groups of companies or chains of trusts. [subsections 118-250(3) and (4)]

Subdivision 118-D: Insurance and superannuation

What the Subdivision does

Subdivision 118-D deals with the treatment of interests in an insurance policy, a superannuation fund or a retirement savings account.

The insurer

For the insurer, a capital gain or loss on any general insurance policy, life insurance policy or annuity instrument is disregarded. [section 118-300, item 1]

The insured - general insurance policies

For the insured, the treatment of a capital gain or loss on a general insurance policy is consistent with that applicable to the insured property itself. [section 118-300, item 2]

Life insurance policies or annuity instruments - entities other than the insurer

A capital gain or loss is disregarded in the case of:

•

the original beneficial owner;

•

a successor to the policy for no consideration;

•

the trustee of a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust. [section 118-300, items 3, 4 and 5]

Superannuation

There are particular exemptions for assets of a superannuation fund or approved deposit fund and for allowances, annuities or capital amounts paid out of a superannuation fund or approved deposit fund. [section 118-305]

Retirement savings accounts

Any capital gain or loss from a CGT event happening in relation to a retirement savings account is disregarded. [section 118-310]

Subdivision 118-E: Units in pooled superannuation trusts

B. Discussion of changes

Division 118 Exemptions

1. Change

Standardise the way exemptions are conferred.

Explanation

The rewritten provisions standardise the way in which exemptions from CGT are conferred in order to avoid confusion that arises under the 1936 Act.

2. Change

Clearly define new terms.

Explanation

The new defined term and its equivalent from the 1936 Act is contained in the following table:

Section 118-5 Cars, motorcycles and valour decorations

Change

Make clear that a capital gain or loss on a car is to be disregarded.

Explanation

Under the 1936 Act, cars are excluded from the definition of 'asset'. This has the effect of exempting capital gains or losses on cars. As cars are included in the concept of CGT asset in the rewritten law it is necessary to exclude them explicitly to achieve the same outcome in the 1997 Act.

Section 118-10 Collectables and personal use assets

Change

Provide an exemption for a capital gain on a personal-use asset if it is acquired for $10,000 or less.

Explanation

Under the 1936 Act, the capital gain on the disposal of a 'non-listed personal-use asset' is exempt if it is disposed of for $10,000 or less. This makes it necessary to keep records for all 'non-listed personal-use assets' as it is impossible to know in advance how much they will bring on disposal.

Basing the exemption on the amount paid for the asset will reduce the need to keep records.

Section 118-15 Exempt capital receipts

This section exempts certain capital receipts from capital gains tax.

1. Change

Exempt amounts received as compensation for illness.

Explanation

The 1936 Act specifies that compensation for personal injury is exempt from capital gains tax. Strictly, illness is not an injury. However, the circumstances in which compensation for personal injury and compensation for illness occur are broadly similar. The change ensures equitable treatment.

2. Change

Exempt amounts received by the spouse or a relative of an injured person.

Explanation

The 1936 Act exempts compensation for injury suffered by the recipient of the payment. The rewritten law adopts administrative practice by extending exemption to amounts received by a spouse or relative.

3. Change

List payments under government schemes which are exempt from capital gains tax in the 1997 Act and not in the Income Tax Regulations as is the case under the 1936 Act.

Explanation

The rewritten law is consistent with the practice of incorporating information required by readers within the main legislation, where possible.

Section 118-20 Reducing capital gains if amount otherwise assessable

Change

Clarify that a capital gain is not reduced by an amount included in assessable income under section 160AQT of the 1936 Act.

Explanation

Under the 1936 Act, a capital gain is reduced by an amount included in assessable income under a non-CGT provision that results from the disposal of an asset. Where shares are disposed of it is unclear whether a capital gain is reduced by the extra amount section 160 AQT includes in the assessable income of shareholders who are paid a franked dividend. The rewritten law adopts the Commissioner's interpretation that the capital gain is not reduced by this amount.

Section 118-250 Exempting part of a capital gain attributable to goodwill

1. Change

Clarify that, in determining the net value of a business, assets are valued at market value.

Explanation

Under the 1936 Act, the goodwill exemption is available where the net value of the business disposed of is below the exemption threshold. It is unclear how the net value of the business is calculated. The rewrite aligns the law with administrative, and commercially accepted, practice.

2. Change

Clarify that, in determining the net value of a business, the assets of the business include motor vehicles.

Explanation

Under the 1936 Act it is unclear whether 'asset', in the context of the goodwill exemption threshold, includes motor vehicles. The rewritten provision clarifies this and adopts administrative and commercially sensible practice.

C. Provisions of the old law that have not been rewritten

Redundant provisions

Redundant provisions not rewritten are summarised in the following table:

Chapter 2.14 - Record keeping

Overview

This segment covers the rules for keeping records dealt with in Division 121.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C explains why some provisions of the 1936 Act have not been rewritten.

A. Summary of the new law

Division 121: Record keeping

What the Division does

Division 121 sets out the requirements for making and retaining records that are relevant to determining CGT liability.

The general rule

Records must be kept of acts, transactions, events or circumstances that can reasonably be expected to be relevant to working out whether there is a capital gain or loss from a CGT event. [section121-20]

What records must be kept

The records must contain the detail relevant to working out the capital gain or loss. Records are to be in English or, if they are in electronic form, they must be readily accessible and convertible into English. [section121-20]

Retention period

Generally, records must be retained for fiveyears after the last CGT event to which they relate. [section121-25]

Exception

Records do not need to be kept if an exclusion applies. [section121-30]

B. Discussion of changes

Section 121-20 What records you must keep

Change

State the record-keeping requirements in terms relevant to CGT events.

Explanation

Under the 1936 Act the focus of the record-keeping provisions is on the asset disposed of. In the rewritten law, the record-keeping focus is on matters that are relevant to working out whether a capital gain or loss is made, in relation to a CGT event.

C. Provisions of the old law that have not been rewritten

The existing record-keeping provisions in section 160ZZU of the 1936 Act that are specific to the transferee of an asset have been incorporated in the general CGT record-keeping provision (section 121-20).

The record keeping provisions in sections 160ZZPI and 160ZZPIA of the 1936 Act have not been rewritten as these sections have limited prospective application.

Chapter 2.15 - Roll-over for disposal of assets to, or the creation of assets in, a wholly-owned company

Overview

This segment covers the rules, dealt with in Division 122, that allow a roll-over when an entity transfers an asset, or the net assets of a business, to a company that it wholly owns. Division 122 also allows a roll-over where an entity creates certain assets in a wholly-owned company.

Part A summarises these rules.

Part B explains changes to the 1936 Act.

Part C explains why some provisions have not been rewritten.

A. Summary of the new law

Subdivision 122-A: Disposal or creation of assets by an individual to a wholly-owned company

What the Subdivision does

Subdivision 122-A allows an optional roll-over where an individual or a trustee disposes of an asset or all the assets of a business to a company that is wholly owned by the person. The roll-over is also available where an individual or trustee creates certain rights in a wholly-owned company. [section 122-15 and subsection 122-25(1)]

Consideration for the disposal or creation

The consideration for the disposal or creation of rights must be:

•

non-redeemable shares in the company; or

•

non-redeemable shares together with the company undertaking to discharge liabilities in respect of the assets, where existing assets are transferred.

[subsections 122-20(1) & (2)]

Value of the shares

The market value of the shares received must equal the market value of the assets transferred, less any liabilities undertaken by the company, or the market value of any assets created in the company. [subsection 122-20(3)]

Disposal of a single asset

If a single CGT asset is disposed of, roll-over is not available if it:

•

is a collectable or personal use asset;

•

is a decoration awarded for valour or brave conduct (except if the decoration was purchased);

•

is a precluded asset;

•

becomes trading stock of the company upon its disposal.

[subsection 122-25(2)]

If the asset to be rolled-over is a right, option or convertible note, the asset acquired by the company upon its exercise or conversion must not become trading stock upon its acquisition. [subsection 122-25(4)]

Meaning of precluded asset

A precluded asset is:

•

a car, motorcycle or similar vehicle;

•

trading stock;

•

an interest in the copyright in a film referred to in section 118-30; or

•

a right to mine referred to in section 118-45.

[subsection 122-25(3)]

Disposal of all the assets of a business

The assets disposed of can include precluded assets but special rules apply to these assets. [subsection 122-25(2) and sections 122-50 and 122-60]

Status of company acquiring the asset or assets of a business

The company that acquires the assets cannot be one whose income is exempted under Division 50. [subsection 122-25(5)]

Where the transferor or the company are not Australian residents

If either the transferor or the company is not an Australian resident, the roll-over is confined to assets that have the necessary connection with Australia. [subsections 122-25(6) and (7)]

Liabilities in respect of transferred assets

There are special rules if the company undertakes to discharge liabilities in respect of transferred assets. [sections 122-35 and 122-37]

Effect of roll-over on the transferor where a single asset is transferred

Any capital gain or loss the transferor makes from the disposal is disregarded. [subsection 122-40(1)]

If the transferred asset was acquired by the transferor on or after 20 September 1985 (post-CGT), the cost base and reduced cost base of the shares acquired on the roll-over are essentially the cost base and reduced cost base of that asset, less any related liabilities that the company undertakes to discharge. [subsection 122-40(2)]

If the transferred asset was acquired by the transferor before 20 September 1985 (pre-CGT), the shares acquired on the roll-over are also taken to have been acquired before then. [subsection 122-40(3)]

Effect of roll-over on the transferor where all the assets of a business are transferred

The capital gain or loss from the disposal is disregarded. [section 122-45]

If all the transferred assets were acquired by the transferor post-CGT, the cost base and reduced cost base of the shares acquired on the roll-over are essentially the sum of:

•

the market values of any precluded assets; and

•

the cost bases and reduced cost bases respectively, of the other assets, less any liabilities the company undertakes to discharge in respect of them.

[section 122-50]

If any transferred assets, except precluded assets, were acquired by the transferor pre-CGT, some of the shares received for the transfer may be taken to have been acquired before then. [sections 122-55 and 122-60]

Effect of roll-over on the creator where an asset is created in a company

Any capital gain or loss the creator makes from the creation is disregarded. [subsection 122-65(1)]

The cost base and reduced cost base of the shares acquired as consideration are essentially the costs incurred in creating the asset in the company. [subsection 122-40(2)]

Effect of roll-over on the company where one or more assets is transferred

In the hands of the company, the cost base and reduced cost base of transferred assets that were acquired by the transferor post-CGT (except for precluded assets) are essentially their cost base and reduced cost base in the hands of the transferor at the time of the roll-over.

If the transferor acquired the assets pre-CGT (except for precluded assets), the company is also taken to have acquired them pre-CGT. [section 122-70]

Effect of roll-over on the company if an asset is created in the company

The company's cost base and reduced cost base for the created asset are essentially the costs the creator incurred in creating the asset in the company. [section 122-75]

Subdivision 122-B: Disposal or creation of assets by partners to a wholly-owned company

B. Discussion of changes

Division 122

Change

Provide explicit rules for the transfer of the net assets of a business to a wholly-owned company.

Explanation

The 1936 Act is expressed solely in terms of the transfer of a single asset to a company. On the incorporation of a business, the existing law would literally need to be applied separately to each asset of the business that is transferred to the company, rather than to the assets of the business as a whole. The additional rules in the rewritten law recognise normal commercial activity and will reduce compliance costs.

Section 122-20 What you receive for the trigger event

Section 122-130 What the partners receive for the trigger event

1. Change

Make it explicit that shares must always form part of the consideration for the asset or assets disposed of to the company.

Explanation

In the existing law it is not clear whether, as a limiting case, the whole of the consideration could consist of the company undertaking to discharge one or more liabilities.

2. Change

Provide that a contingent tax liability is to be disregarded when deciding whether the shares received in consideration for the asset have a market value that is substantially the same as the market value of the transferred asset.

Explanation

There is a separate requirement that the shares received for the transfer must have a market value that is substantially the same as the market value of the asset, less any liabilities the company assumes in connection with the transfer. It can be impossible to satisfy this requirement if there is a significant contingent tax liability, such as an unrealised capital gain or balancing adjustment, inherent in a transferred asset which affects its market value. To overcome this, the rewritten provision states that a contingent liability (for example, a contingent tax liability or accrued leave entitlements of employees) is to be ignored in comparing the market values of the asset and of the shares received in consideration for the asset.

Sections 122-25, 122-35, 122-37, 122-45, 122-50, 122-55 and 122-60

The existing roll-over provisions apply on an asset by asset basis. As explained above, the rewritten provisions will specifically provide for the roll-over of the net assets of a business to a wholly-owned company. There are changes that have been required as a result of this new approach. These changes are listed below.

1. Change

Define the term precluded assets. [section 122-25]

Explanation

The term precluded assets is used for assets which may form part of the assets of a business but for which non-roll-over treatment applies.

2. Change

Provide a rule that any liabilities transferred to the company that are in respect of precluded assets must not exceed the market value of the precluded assets. [section 122-35]

Explanation

The new rule parallels the existing law that applies to transfers of single assets to a wholly-owned company.

3. Change

Provide that:

•

a liability incurred for the purposes of a business that does not relate to a specific asset or assets of the business will be taken to be a liability in respect of all assets of the business; and

•

a liability covering two or more assets will be allocated to the respective assets in proportion to their market values. [section 122-37]

Explanation

The existing law does not address liabilities of a business being undertaken by a company, unless they are in respect of particular assets. In allowing the roll-over of the net assets of a business, it is appropriate that all liabilities incurred for the purposes of the business be taken into account.

4. Change

State how roll-over applies in all circumstances in which an individual or a trustee transfers the net assets of a business to a company. [sections 122-45 to 122-60]

Explanation

These sections each deal respectively with the three possible cases when the net assets of a business are disposed of to a wholly owned company. These are where:

•

all the assets of the business were acquired post-CGT; [section 124-50]

•

all the assets of the business were acquired pre-CGT; [section 122-55] and

•

some of the assets of the business were acquired post-CGT. [section 122-60]

Sections 122-35 & 122-130 What if the company undertakes to discharge a liability (disposal case)

These sections will specify the limits on the amount of liabilities the company can undertake to discharge as consideration for assets transferred to it.

Change

For a post-CGT asset - allow the company to undertake to discharge liabilities up to an amount equal to the cost base of the asset.

Explanation

Where a later disposal of the asset results in a capital loss, the existing law permits the company to undertake to discharge liabilities up to an amount equal to the reduced cost base of the asset only. The amount of liabilities the company undertakes to discharge affects the cost base of the shares received in consideration for the transfer of the asset to the company. It is not practicable to have the amount of the cost base of those shares conditional upon the outcome of an event which may not occur before a CGT event happens to those shares.

Section 122-40 Disposal of a CGT asset

This section will set out the roll-over consequences for the transferor of a single asset.

Change

Allow indexation of the cost base of the shares received in consideration of the transfer of the asset where a CGT event happens in relation to them within 12 months of the roll-over event, but at least 12 months after the transferred asset was acquired by the transferor.

Explanation

The existing law denies indexation if the shares are disposed of within 12 months of the transferor acquiring them. This is inconsistent with the general design of the roll-over provisions, which transfer the CGT attributes of the asset rolled-over to the shares acquired on the roll-over.

Sections 122-65 & 122-195 Creation of asset

These sections will set out the roll-over consequences for the creation of an asset.

Change

Broadly, the cost base and indexed cost base of the shares received as consideration are set equal to the costs incurred in creating the asset.

Explanation

The existing law does not deal explicitly with the case where an asset is created in a company.

Sections 122-70 & 122-200 Consequences for the company (disposal case)

Change

The company will be able to index the cost base of the transferred asset provided a CGT event does not affect the asset within 12 months of its acquisition by the transferor or, in the case of partners, acquisition of their interests in it.

Explanation

The existing law allows indexation only if the transferred asset is retained for 12 months by the company acquiring it.

Sections 122-75 & 122-205 Consequences for the company (creation case)

Change

Broadly, the company's cost base and indexed cost base for the created asset are set equal to the costs incurred in creating the asset.

Explanation

The existing law does not deal explicitly with the case where an asset is created in a company.

Section 122-130 What the partners receive for the asset

Change

Provide that each partner must only receive shares that have a market value equal to the partners interest in the asset transferred to, or created in, the company less any liabilities in respect of that interest that the company undertakes to discharge.

Explanation

The 1936 Act also requires that each partner own shares in the company in the same proportion as that partners interest in the transferred asset. The two conditions are incompatible unless the liabilities of partners undertaken by the company are in proportion to the market value of each partners interest.

Section 122-135 Other requirements to be satisfied

Change

Provide that relief is not available where an asset or assets are transferred to a company whose income is exempt from income tax.

Explanation

The 1936 Act has a gap in that this requirement, which is specifically stated in the provisions for individuals or trustees transferring an asset to a company, is not contained in the equivalent partnership roll-over provision.

Section 122-140 What if the company undertakes to discharge a liability (disposal case)

This section will limit the amount of liabilities a company can undertake to discharge as consideration for the transfer of an asset or the assets of a business.

Change

Provide a new rule that any liabilities undertaken by the company that are in respect of precluded assets must not exceed the market value of the precluded assets.

Explanation

As in the case of section 122-35, this new rule parallels the existing law that applies to transfers of single assets to a wholly owned company.

Section 122-145 Rules for working out a liability in respect of an asset

This section provides new rules for determining the amount that can be taken to be a liability in respect of an asset.

Change

Provide that:

•

a liability incurred for the purposes of a business, that does not relate to a specific asset or assets of the business, will be taken to be a liability in respect of all of the assets of the business; and

•

a liability covering two or more assets, will be allocated to the respective assets proportionately to their market values.

Explanation

As in the case of corresponding section 122-37, it is appropriate that all liabilities incurred for the purposes of the business be taken into account in allowing the roll-over of its net assets.

Section 122-155 Disposal of post-CGT or pre-CGT interests

This section states the roll-over consequences where a partners interests in a transferred asset were all acquired pre-CGT or were all acquired post-CGT.

1. Change

Allow indexation of the cost base of the shares acquired for the transfer where a CGT event concerning them happens within 12 months of the roll-over, but at least 12 months after the partner acquired an interest in the transferred asset.

Explanation

The existing law does not allow indexation if the replacement shares are disposed of within 12 months of the partner acquiring them. This is inconsistent with the general design of the roll-over provisions, which transfers the CGT attributes of the original asset to the replacement asset.

2. Change

Where all of a partners interest in an asset was acquired post-CGT, the cost base of the partners shares received for the transfer of the asset will be equal to the cost base of the partners interest when the asset was transferred, less any related liabilities undertaken by the company.

Explanation

The 1936 Act allots to the partners any liabilities the company undertakes in relation to a partnership asset, in proportion to their respective interests in the asset. The rewritten law allows for the possibility that partners shares in the liabilities may not be proportionate to their respective interests in the asset.

Section 122-160 Disposal of both post-CGT and pre-CGT interests

This section will state the roll-over consequences where an asset is transferred in which a partner has some interests that were acquired post-CGT and some acquired pre-CGT.

1. Change

Allow indexation of the cost base of the shares received in consideration of the transfer of the asset to the company where a CGT event happens to them within 12 months of the roll-over, but at least 12 months after the partner acquired an interest in the transferred asset.

Explanation

This change corresponds to the first change under section 122-155. It applies to shares that are in respect of the partners interests that were acquired post-CGT.

2. Change

Provide that, where some of a partners interests were acquired post-CGT, the cost base of the partners shares received for the transfer will be equal to the cost base when the asset was transferred, of the partners interests that were acquired post-CGT less any liabilities in respect of those interests that are undertaken by the company.

Explanation

This change corresponds to the second change under section 122-155. It applies to liabilities relating to interests acquired post-CGT.

3. Change

Provide that the maximum number of shares in a company that a partner could elect to have treated as shares acquired pre-CGT under the 1936 Act, will be taken to have been acquired before then without the requirement to make an election.

Explanation

The 1936 Act is framed in a way that sets a maximum number of shares based on the partners proportionate interests and allows the election up to that limit. However, it is always in the partners interest to elect that the number of shares received for the transfer of the asset that are taken to be acquired pre-CGT is the maximum that is permitted.

Section 122-170 Capital gain or loss disregarded

Section 122-175 Other consequences

Section 122-180 All interests acquired on or after 20 September 1985

Section 122-185 All interests acquired before 20 September 1985

Section 122-190 Interests acquired before and after 20 September 1985

The existing roll-over provisions apply on an asset by asset basis. The rewritten provisions will specifically provide rules for when partners transfer the net assets of a business to a wholly-owned company. The changes referred to below are required to take account of these proposed rules and to ensure that they operate on the same basis as the roll-over rules for transfers of single assets to a company wholly-owned by the partners.

Change

State how the roll-over applies in all circumstances in which partners transfer the net assets of a business to a company.

Explanation

The new rules in these sections correspond to the changes made by sections 122-45 to 122-60.

C. Provisions of the old law that have not been rewritten

Redundant provisions

Some provisions of the existing law are redundant and have not been rewritten.

They are summarised in the following table:

Chapter 2.16 - Replacement asset roll-overs

Overview

This segment covers the rules that are dealt with in Division 124 that allow a roll-over of CGT liability where ownership of one or more CGT assets ends and replacement CGT assets are acquired.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C identifies provisions that have not been rewritten.

A. Summary of the new law

Subdivision 124-A: General rules

What the Subdivision does

Subdivision 124-A sets out the roll-over relief available when ownership of certain CGT assets ends under a CGT event and another asset or assets are acquired. Roll-over allows deferral of a capital gain or loss until a later CGT event happens to the new assets. [sections 124-10 and 124-15]

New assets' cost bases

If the original asset or assets were acquired after 19 September 1985 (post-CGT), their cost bases are apportioned across the new assets. This becomes, broadly speaking, the cost base of the new asset or assets. [subsections 124-10(3) and 124-15(3)]

Original asset or assets acquired pre-CGT

If the original asset or assets were acquired before 20September1985 (pre-CGT), the new assets are taken to have been acquired pre-CGT. [subsections 124-10(4) and 124-15(4)]

Some of the original assets acquired pre-CGT

If some, but not all, of the original assets were acquired pre-CGT, a formula applies to determine which of the new assets are to be taken as acquired pre-CGT. [subsection 124-15(5)]

Cost base of new assets taken to have been acquired post-CGT

The cost bases of original assets acquired post-CGT are apportioned among the new assets taken to have been acquired post-CGT. [subsection 124-15(6)]

Indexation of new assets cost base

Indexation is available from the time of acquisition of the original assets provided the combined ownership period for both the original and new assets is at least 12 months. [sections 114-10 and 114-20 and Subdivision 960-M]

Subdivision 124-B: Asset compulsorily acquired, lost or destroyed

What the Subdivision does

Subdivision 124-B provides an optional roll-over if your asset is:

•

compulsorily acquired;

•

disposed of under threat of compulsory acquisition;

•

lost or destroyed; or

•

an expired lease that is not renewed

and in return you receive money, another CGT asset or both.[section 124-70]

Receipt of money

If you receive money, it must be used to acquire a new asset or for repairs or restoration of the original asset. [section 124-75]

Consequences if original asset is a post-CGT asset

If the original asset is a post-CGT asset, any gain on its disposal is reduced or eliminated, depending on the kind and amount of compensation. [sections 124-85 and 124-90]

Capital loss situation

If a capital loss is made a roll-over is not available. [subsection 124-70(1)]

Consequences if original asset is a pre-CGT asset

If the original asset is a pre-CGT asset, the new asset is taken to have been acquired pre-CGT only if:

•

the expenditure on it is less than 120% of the market value of the original asset when the event happened ; or

•

the original asset was lost or destroyed as a result of a natural disaster and it is reasonable to treat the new asset as being substantially the same as the original asset.

[subsection 124-85(3)]

Connection with Australia

Both the original asset and the new asset must have a necessary connection with Australia or the taxpayer must be an Australian resident. [subsection 124-70(4)]

Subdivision 124-C: Statutory licences

What the Subdivision does

Subdivision 124-C provides automatic roll-over where a taxpayer's statutory licence (original licence) expires or is surrendered and the taxpayer gets a new licence by renewing or extending it. [section 124-140]

Statutory licence

A statutory licence is an authority, licence, permit or quota granted by an Australian government agency or a foreign government agency.

It does not include a lease or a mining right or a prospecting right. [subsection 124-140(3)]

Cost base of new licence

The cost base or reduced cost base of the new licence includes any amount paid for it. [subsection 124-140(2)]

Subdivision 124-D: Strata title conversion

What the Subdivision does

Subdivision 124-D provides an optional roll-over where a building is converted to strata title. [section 124-190]

Right to occupy

Roll-over is only available if the stratum unit that is transferred to the taxpayer is the unit that they had the right to occupy just before the strata title conversion. [paragraph 124-190(1)(c)]

Cost base of stratum unit

The cost base or reduced cost base of the stratum unit includes any amount paid for it. [subsection 124-190(2)]

Subdivision 124-E: Exchange of shares or units

What the Subdivision does

Subdivision 124-E provides an optional roll-over to a shareholder where a company or trustee of a unit trust redeems or cancels all the shares or units of a certain class and issues new shares or units in substitution. [sections 124- 240 and 124-245]

Market value of new shares or units

The market value of the new shares or units must not be less than the market value of the original shares or units.

Subdivision 124-F: Exchange of rights or options

What the Subdivision does

Subdivision 124-F provides an optional roll-over to the holder of an option to acquire shares or units where, as part of a consolidation or division of shares or units, a company or trustee of a unit trust cancels the options and issues new ones. [sections 124-295 and 124-300]

Market value of new option

The market value of the new options must not be less than the market value of the original ones. [subsections 124-295(6) and 124-300(6)]

Subdivision 124-G: Exchange of shares in one company for share in another company

What the Subdivision does

Subdivision 124-G gives the option of roll-over relief to shareholders where, in the reorganisation of the affairs of a company, their shares are exchanged for non-redeemable shares in another company that is interposed directly between the original company and the shareholders. [sections 124-360 and 124-370 and subsection 124-380(1)]

Methods of reorganisation

A shareholder can choose a roll-over if:

•

all shareholders in the original company dispose of their shares to the interposed company in exchange for shares in the interposed company [section 124-360] ; or

•

the interposed company acquires not more than 5 shares in the original company, and all other shares in the original company are redeemed or cancelled and shares in the interposed company are issued in exchange.

[section 124-370]

Ownership of shares in interposed company

There are rules concerning the ownership of shares in the interposed company after the re-organisation. [sections 124-365, 124-375 and 124-380]

Connection with Australia

Either the shareholder must be an Australian resident or his or her shares in the original company must have the necessary connection with Australia. [subsections 124-365(4) and 124-375(4)]

Both the original company and the interposed company must be Australian residents at the completion of the reorganisation. [subsection 124-380(4)]

Choice by interposed company

The right of shareholders to choose a roll-over depends upon the interposed company agreeing, within two months after the completion of the reorganisation, that the roll-over consequences are to apply to it. [subsection 124-380(5)]

Consequences for the interposed company

Some shares in the original company owned by the interposed company are taken to be acquired pre-CGT, if sufficient of the original companys assets were acquired pre-CGT. There are rules for working out the cost base and reduced cost base of the post-CGT shares. [section 124-385]

Subdivision 124-H: Exchange of units in a unit trust for shares in a company

What the Subdivision does

Subdivision 124-H gives a unit holder an optional roll-over where, in the reorganisation of the affairs of a unit trust, the unit holder's units are replaced by non-redeemable shares in a company that is interposed between it and the unit holders. [sections 124-445 and 124-455]

The provisions of this subdivision parallel those of Subdivision 124-G. [sections 124-440 to 124-470]

Subdivision 124-I: Conversion of a body to an incorporated body

What the Subdivision does

Subdivision 124-I contains an optional roll-over for a member of a body that is incorporated under a law (other than company law) where, as a result of the body being converted to a company, the members receive shares in the company in exchange for their interests in the body. [section 124-520]

Ownership

The roll-over is not available if there is a significant change in the ownership of the body on its conversion. [paragraph 124-520(1)(d)]

Subdivision 124-J: Crown leases

What the Subdivision does

Subdivision 124-J gives an automatic roll-over to a holder of rights under a Crown lease over land when the lease is renewed, extended or converted to a fee simple title. [section 124-575]

Same land or acceptable variation

The new right must relate to the same land or, if different, specified criteria must be satisfied. [section 124-585]

Partial roll-over if land excised

A partial roll-over is available if some of the land that is the subject of the original right is not covered by the new right. [section 124-590] The cost base of the original right is adjusted to take account of any excised land. [section 124-600]

Change of lessor

Roll-over may apply if there is a change of lessor. [section 124-605]

Subdivision 124-K: Depreciable plant

What the Subdivision does

Subdivision 124-K provides automatic roll-over if plant is attached to land that you hold under a quasi-ownership right granted by an exempt Australian or foreign government agency, and you are granted a new right or an estate in fee simple in the land. [section 124-655]

Right granted to associate

If the new quasi-ownership right or estate in fee simple is instead given to your associate, roll-over is not available, but the reduced cost base of the plant is adjusted. [section 124-660]

Subdivision 124-L: Prospecting and mining entitlements

What the Subdivision does

Subdivision 124-L provides an automatic roll-over where a prospecting or mining right expires or is surrendered and is replaced by a new prospecting or mining right. [section 124-700]

B. Discussion of changes

Subdivision 124-A General rules

Change

Adopt a standard statement of the consequences of a roll-over.

Explanation

In the 1936 Act, the consequences of choosing a roll-over are separately stated for each provision that allows a roll-over. The rewritten provisions identify all of these instances and state the roll-over consequences in standard terms. This avoids repetition and simplifies the law.

Section 124-10 & Section 124-15 Your ownership of one or more CGT assets ends

Change

Allow indexation of the cost base of a new asset where a CGT event happens to that asset within 12 months of the event to which the roll-over applies, but at least 12 months after the original asset was acquired.

Explanation

The 1936 Act denies indexation if a new asset is disposed of within 12 months of its acquisition (the roll-over). The rewritten provision is consistent with the general design of the roll-over provisions, which transfer the CGT attributes of the original asset to the new asset or assets.

Section 124-15 Your ownership of more than one CGT asset ends

Change

Provide that the maximum number of the new assets that can be treated as acquired pre-CGT are so treated automatically.

Explanation

The 1936 Act allows you to elect that a number of the new assets be taken to have been acquired pre-CGT where a proportion of the original assets were acquired before that date. It is always in your interest to choose that the maximum number be taken as acquired pre-CGT. Making this automatic reduces compliance costs and streamlines the law.

Section 124-75 Other requirements if you receive money

This section lists additional requirements that need to be met before roll-over relief is available for the compulsory acquisition, loss or destruction of an asset.

Change

State that only some of the expenditure incurred on acquiring a new asset, or on repairs or restoration of the original asset must be incurred within the specified time.

Explanation

The 1936 Act requires expenditure on acquiring a new asset, or on the repair or restoration of the original asset to be incurred within a specified time of the disposal of the original asset. It is unclear whether it is the total expenditure, or only a part of it, that must be incurred within this period. The rewritten provision adopts current administrative practice that only some of the expenditure must be incurred within the specified time.

Section 124-95 You receive both money and an asset

This section helps determine the roll-over relief consequences of receiving both money and another CGT asset as a result of an involuntary disposal.

Change

This is a new provision.

Explanation

This section gives legislative guidance as to how to determine the roll-over consequences when, as a result of the involuntary disposal of the original asset, the taxpayer receives both cash and a new asset. It adopts current administrative practice.

Section 124-190 Strata title conversion

Change

Provide a standard definition of stratum unit.

Explanation

The 1936 Act contains two conflicting definitions of stratum unit. The rewritten provisions, to simplify and standardise the law, adopt the broader definition which extends to units registered in another country and commercial buildings. The only practical effect of the adoption of this wider definition is that it enables the main residence exemption to be claimed for an overseas stratum unit that is the main residence of an Australian resident.

Section 124-240 Exchange of shares in the same company

Section 124-245 Exchange of units in the same unit trust

Section 124-295 Exchange of options to acquire shares in a company

Section 124-300 Exchange of options to acquire units in a unit trust

Change

State specifically that the time at which the security holder must be an Australian resident is when the original securities are redeemed or cancelled.

Explanation

The 1936 Act states that the security holder must be a resident of Australia without specifying when this condition must be satisfied. It is implicit that it must be satisfied at the time of redemption or cancellation.

Sections 124-365, 124-375, 124-450 & 124-460 Other requirements to be satisfied

These sections set out the requirements for a roll-over where a shareholder in a company, or a unit holder in a unit trust, exchange shares or units for shares in an interposed company.

1. Change

Require that each exchanging shareholder or unit holder be issued a whole number of shares in the interposed company.

Explanation

The 1936 Act requires that each exchanging shareholder or unit holder be issued a number of shares in the interposed company that is equal to, or is a multiple of, the number of shares or units that the shareholder or unit holder previously held in the original company or unit trust respectively. This prevents an exchange of shares or units that results in joint ownership of some shares in the interposed company. The rewritten provision achieves the same result more directly and states clearly the purpose of the requirement.

2. Change

Remove the requirement that each exchanging shareholder or unit holder dispose of all their shares or units in the original company or unit trust at the same time.

Explanation

The 1936 Act requires that each exchanging shareholder or unit holder dispose of all their shares or units in the original company or unit trust at the same time. This is to ensure that the holdings in the original company or unit trust can be compared to shareholdings in the interposed company immediately after completion of the reorganisation. This is unnecessary as the existing separate requirement that each exchanging shareholder or unit holder retain their shares in the interposed company until the reorganisation has been completed enables this comparison to be made.

3. Change

Change the time for measuring the ratio of the market value of the taxpayers shares or units in the original company or unit trust to the market value of all the shares or units in that company or unit trust respectively.

Explanation

The purpose of measuring this ratio is to ensure that the exchanging shareholder or unit holders holding in the interposed company is the same as in the original company or unit trust. The present law gives an inappropriate result if all the shares in the company, or units in the unit trust, are not redeemed or cancelled at the same time. In this case, the market value of shares or units being redeemed or cancelled is compared to the market value of a progressively declining number of shares or units. The rewritten provision ensures that this ratio is measured appropriately in all circumstances to give the test its intended effect.

Section 124-370 Redemption or cancellation of shares in one company for shares in another

Section 124-455 Redemption or cancellation of units in a unit trust for shares in a company

Change

Remove unnecessarily prescriptive requirements for the issuing of shares in the original company or units in the unit trust to the interposed company.

Explanation

The 1936 Act requires that:

•

the interposed company acquire not more than five shares, called formal shares in the original company; and

•

the original company issue to the interposed company shares in itself, called scheme shares, and that the number of scheme shares be equal to, or a multiple of, the shares that were redeemed or cancelled.

Corresponding rules apply as between an interposed company and a unit trust.

The critical outcome of these requirements is that, immediately after the reorganisation, the interposed company owns all of the shares in the original company or all the units in the unit trust. This requirement is directly stated in the rewritten provision.

Section 124-380 Requirements to be satisfied in both cases

1. Change

Adopt the 1997 Act definition of redeemable shares.

Explanation

This standardises terminology.

2. Change

Require that both the original and interposed company be Australian residents at the completion of the reorganisation.

Explanation

The 1936 Act imposes this requirement from the time of the first disposal of shares in the original company until the completion of the reorganisation to ensure that, where the companies are either private companies or public companies in which a shareholder (alone or with associates) owns 10% or more of the capital, all shares in both companies have the necessary connection with Australia at the time of the reorganisation. The same outcome is achieved by the rewritten provision in a less restrictive way.

Sections 124-385 & 124-470 Consequences for the interposed company

1. Change

Provide that the maximum number of the interposed entitys shares or units in the original company or unit trust that can be treated as though they were acquired pre-CGT are so treated automatically.

Explanation

This parallels the change to section 124-15.

2. Change

Apply the standard rule which permits indexation of cost bases where assets are held for at least 12 months.

Explanation

Under the 1936 Act, if the interposed company disposes of any of its shares or units in the original company or unit trust, within 12 months of acquiring them, the cost base of those shares or units is based on the unindexed cost base of the assets of the original company or unit trust. This could disadvantage taxpayers where the original company or trust has held assets through a period of significant price increase.

Section 124-465 Requirements to be satisfied in both cases

1. Change

Adopt the 1997 Act definition of redeemable shares.

Explanation

This standardises terminology.

2. Change

Require that the company be an Australian resident at the completion of the reorganisation.

Explanation

This parallels the second change to section 124-380.

Section 124-520 Conversion of a body corporate to an incorporated company

1. Change

Remove from the income tax law the requirement that the body have at least two members.

Explanation

Specification of the minimum number of members for an association is properly a matter for the law under which the body is incorporated, not the income tax law.

2. Change

Replace two administrative discretions with objective tests.

Explanation

To bring the law in line with the self-assessment system, the following discretions have been replaced by objective tests:

C. Provisions of the old law that have not been rewritten

Redundant provisions

The following provisions of the 1936 Act have not been rewritten:

Chapter 2.17 - Same asset roll-overs

Overview

This segment covers the rules rewritten in Division 126 that allow a roll-over when a CGT asset is disposed of to, or created in, another entity.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C identifies provisions of the 1936 Act that have not been rewritten.

A. Summary of the new law

Subdivision 126-A: Marriage breakdown

What the Subdivision does

Subdivision 126-A gives automatic roll-over relief where a CGT asset is transferred to a spouse or former spouse because of marriage breakdown.

Court orders and maintenance agreements

It covers assets transferred because of:

•

a court order under the Family Law Act 1975 or a maintenance agreement approved under that Act or under a corresponding foreign law; or

•

a court order under a State, Territory or foreign law relating to ending of a defacto marriage.

[subsection 126-5(1)]

B. Discussion of changes

Division 126 Same-asset roll-over events

Change

Allow the 12 month qualifying period for indexation to be satisfied by taking into account the period of ownership of both parties.

Explanation

The extension of indexation in these cases is consistent with the general design of the roll-over provisions.

Section 126-15 Company or trustee transfers CGT asset to a persons spouse

Change

Provide a general principles approach to replace the detailed and complex formulae that apply under the 1936 Act where an asset held by a company or trust is transferred to a spouse or former spouse as a result of a marriage breakdown.

In such cases, the cost base or reduced cost base of the shares, units and other interests in the company or trust will be reduced by an amount that reasonably reflects the fall in their market value as a result of the transfer of the asset.

Explanation

The 1936 Act provisions are excessively complicated and apply rarely. The result under the simplified approach is the same.

In determining what is a reasonable reduction in the cost base or reduced cost base, regard is to be had to:

•

the resultant reduction in the assets and liabilities of the company or trust;

•

the market value of the shares, units or other interests immediately before the transfer;

•

whether the roll-over asset was acquired by the transferor before or after 20 September 1985; and

•

whether the shares, units or other interests in the company or trust were acquired before or after 20 September 1985.

Section 126-85 Subsidiary company liquidation

Change

Align the treatment of interim liquidation distributions with that of final distributions if the company is dissolved within 18 months of the interim distribution.

Explanation

The 1936 Act provided a reduction only to in specie distributions that were part of the final distribution to the holding company by the liquidator in the course of winding up the subsidiary.

The rewrite of CGT event G1 [section 104-135] aligned the treatment of interim distributions within 18 months of the dissolution of the company with that of final distributions. The CGT consequences of those distributions are now to be determined under CGT event C2 [section 104-25] . This change similarly aligns the roll-over available for interim distributions within 18 months of the dissolution of the company to that available for final distributions.

C. Provisions of the old law not rewritten

Redundant provisions

Redundant provisions of the 1936 Act not rewritten are summarised in the following table:

Chapter 2.18 - Effect of death

Overview

This part covers the rewritten CGT provisions in Division 128 that apply when an individual dies.

Part A summarises these provisions.

Part B explains the changes to the 1936 Act.

Part C identifies provisions that have not been rewritten.

A. Summary of the new law

Division 128: Effect of death

What the Division does

It contains rules that modify the application of the CGT provisions when an individual dies. [section 128-1]

Exemptions

A capital gain or capital loss made from a CGT asset owned on death is generally disregarded if it arises because of:

•

the death [section 128-10] ; or

•

the passing of the asset from the deceased's legal personal representative to a beneficiary.

[subsection 128-15(3)]

Meaning of passing

A CGT asset passes to a beneficiary of an estate if the beneficiary acquires it:

•

under the deceased's will;

•

by operation of an intestacy law; or

•

under a deed of arrangement that was made to settle a claim by the beneficiary to participate in the estate.

[section 128-20]

Cost base if asset was a post-CGT asset of the deceased

If the asset was acquired by the deceased on or after 20 September 1985, the assets cost base or reduced cost base in the hands of the legal personal representative or beneficiary is essentially based on its cost base or reduced cost base on the date of death. [subsection 128-15(4)]

Cost base modification if asset was deceased's main residence just before death

If the asset was a dwelling that was the deceased's main residence just before death and was not then being used to produce assessable income, the cost base or reduced cost base is based on its market value on the date of death. [subsection 128-15(4)]

Cost base if asset was a pre-CGT asset of the deceased

If the asset was acquired by the deceased before 20 September 1985, the assets cost base or reduced cost base in the hands of the legal personal representative or the beneficiary is based on its market value on the date of death. [subsection 128-15(4)]

Cost base modification if asset was trading stock of deceased

If the asset was trading stock of the deceased, the cost base or reduced cost is based on the amount worked out under section 70-105. Generally, this is its market value at the time of death. [subsection 128-15(4)]

Cost base modification if K3 happens

If the beneficiary is a:

•

complying superannuation fund;

•

complying approved deposit fund; or

•

pooled superannuation trust

the cost base or reduced cost base of the asset is its market value on the date of death. [section 128-25]

Special rules apply if the beneficiary is:

•

an exempt entity (Division 57 of Schedule 2D of the 1936 Act) ;or

•

a non-resident. [Subdivision 136B]

Rules for joint tenants

A sole surviving joint tenant is taken to have acquired the interest of the deceased joint tenant on the date of death. If there are 2 or more surviving joint tenants, they are taken to acquire the deceased's interest in equal shares. [section 128-50]

The cost base and reduced cost base rules for the interest acquired by the survivors are calculated in the same way as for a legal personal representative or beneficiary. That is, they depend on whether the deceased acquired the relevant asset before or after 20 September 1995. [section 128-50]

B. Discussion of changes

Section 128-15 Effect on the legal personal representative or beneficiary

This section exempts a capital gain or loss that arises when an asset passes from a legal personal representative to a beneficiary of a deceased person. It also contains rules that establish the cost base and reduced cost base of the asset in the hands of the legal personal representative or beneficiary.

1. Change

State expressly that the exemption only applies to assets owned at the date of death.

Explanation

This clarifies that the exemption does not apply to assets which were acquired by the legal personal representative during administration of the estate and is consistent with the Commissioner's interpretation of the law.

2. Change

Base the cost base or reduced cost base of an asset that was trading stock of the deceased, in the hands of the legal personal representative or beneficiary on its market value on the date of death.

Explanation

Under the 1936 Act , the market value of trading stock held by a deceased person is included in assessable income for the period up to the date of death. However, for CGT purposes, the estate acquires the asset with a cost base equal to the deceaseds cost base or indexed cost base. This rule does not operate appropriately in relation to trading stock because any increase in the value of the stock can be assessable as income of the deceased and again as a capital gain when ultimately disposed of by the estate or beneficiary.

The new provision removes this anomaly. However, in unusual cases, the market value of the asset at death may be less than the deceased's cost base but increase in value after death. In such a case, tax may be payable on the resulting gain.

Section 128-20 Meaning of asset passing

This section explains when an asset passes to a beneficiary.

1. Change

Specify that an asset passes to a beneficiary if the legal personal representative appropriates the asset to satisfy the beneficiary's entitlement under a will or an intestacy law.

Explanation

The rewritten law makes it clear that an asset can 'pass' to a beneficiary where, for example, it is not specifically bequeathed to them. This concessional change is consistent with administrative practice.

2. Change

Specify that an asset does not pass to a beneficiary if the beneficiary becomes the owner of the asset by exercise of a power of sale by the legal personal representative.

Explanation

The rewritten law makes it clear that an asset does not pass via the estate to a person who purchases it from the estate, just because that person is also a beneficiary of the estate. This is consistent with the Commissioner's interpretation of the law.

Section 128-25 The beneficiary is a trustee of a superannuation fund etc.

This section contains the modified cost base and reduced cost base rules that apply if CGT event K3 (asset passing to tax-advantaged entity) happens.

Change

Clarify that the CGT cost base modifications for deceased estates do not apply where an asset passes to an exempt entity or a non-resident entity.

Explanation

There are rules in other provisions that specify that:

•

a non-resident entity that has acquired an Australian asset and later becomes a resident is to account for the asset as if it acquired the asset at its then market value [Subdivision 136-B] ; and

•

an exempt entity that ceases to be exempt similarly carries assets forward at market value (Division 57 of Schedule 2D of the 1936 Act).

The rewrite removes any potential conflict between the deceased estate rules and those other rules.

C. Provisions of the old law that have not been rewritten

Redundant provisions

Some redundant provisions not included in the rewritten law are summarised in the following table:

Chapter 2.19 - Investments

Overview

This segment explains the special rules, in Division 130, for cost base modifications and timing of acquisition of bonus shares and units, rights, employee share schemes and the conversion of convertible notes.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C identifies provisions of the 1936 Act not rewritten.

A. Summary of the new law

Subdivision 130-A: Bonus shares and units

What the Subdivision does

Subdivision 130-A sets out the rules for modifying the cost base or reduced cost base in working out a gain or loss on the issue of a bonus share or unit (bonus equity) in satisfaction of an amount payable to an equity holder. It also determines when the equity holder is taken to acquire the bonus equity. [section 130-20]

Working out the cost base of the bonus share or unit

Where the bonus equity is assessable, the cost base or reduced cost base of the bonus equity includes the assessable amount at the time of issue. [subsection 130-20(2)]

If the bonus equity is not assessable, the cost base or reduced cost base will depend on when the original equity was acquired. The following table sets out the time at which the bonus equities are taken to be acquired and the effect on the cost base and reduced cost base.

[subsection 130-20(3)]

Subdivision 130-B: Rights

What the Subdivision does

Subdivision 130-B has rules for modifying the cost base or reduced cost base when an equity holder exercises rights to acquire additional shares, units or options that they did not pay or give anything for and establishes the time when the equity holder is taken to acquire the share, unit or option. [section 130-40]

It also contains cost base modification rules for an entity acquiring rights from an existing equity holder.

Working out the cost base

Three situations can have an impact on the cost base or reduced cost base of equities acquired as a result of exercising a right. These are set out in a table which explains the modification to be made. [subsections 130-40(2)-(6)]

The shares, units or options are taken to be acquired at the time the rights are exercised. [subsection 130-45(2)]

Consequences if rights are disposed of

If the right is not exercised and is disposed of at a gain, CGT event A1 determines the amount of the capital gain.

Rights are taken to have been acquired at the same time as the original shares or units. [subsection 130-45(1)]

Subdivision 130-C: Convertible notes

When the convertible note is a traditional security

If the convertible note is a traditional security, the cost base or reduced cost base of the resulting share or unit is its market value at the time of conversion. [subsection 130-60(1), item 1]

When the convertible note is not a traditional security

If the convertible note is not a traditional security the cost base or reduced cost base of the share or unit is the sum of:

•

the amount paid for the convertible note; and

•

any further amount paid for the conversion. [subsection 130-60(1), item 3]

Subdivision 130-D: Employee share schemes

What the Subdivision does

Subdivision 130-D contains rules for modifying the cost base or reduced cost base of a share or right acquired at a discount under an employee share scheme. It also deals with how a trustee of an employee share trust is treated on the disposal of shares or rights held in the trust.

Working out the cost base or reduced cost base

Generally, the first element of the cost base or reduced cost base is the market value of the share or right at acquisition. [subsection 130-80(2)]

Exception

There is an exception if the share or right is a qualifying share or right, and the taxpayer did not elect to be assessed immediately. [section 130-83]

In these circumstances, the assessment is normally made in the year in which the schemes restriction on disposing of the share or right ceases.

Trustee of the employee share trust

A capital gain or loss that a trustee makes when a beneficiary becomes absolutely entitled to a share or right held on behalf of an employee is disregarded, unless the disposal proceeds exceed the cost base of the share or right. [section 130-90]

B. Discussion of changes

Division 130 Investments

Structure

The provisions dealing with investments have been restructured to reduce complexity and repetition, mainly by the merger of 10 separate Divisions of the 1936 Act into four Subdivisions. There are no substantive changes in the way the provisions operate.

Subdivision 130-B Rights

Change

Adopt a new label, right, for the terms right and option.

Explanation

The terms right and option are commonly used interchangeably in the 1936 Act and have a comparable interpretation. The use of a common label, right, simplifies expression of the law and is consistent with the approach taken in the 1997 Act of adopting common labels whenever appropriate. Subdivision 130-B applies to options in the same way as to rights.

Subdivision 130-C: Convertible notes

Change

Clarify the rules dealing with how indexation applies to a share or unit acquired on conversion of a convertible note.

Explanation

It is unclear under the existing provisions whether indexation would be available for the cost of the convertible note on disposal of the share or unit. The new provisions clarify that indexation for the cost of the convertible note will be allowed on a share or unit acquired from conversion from the time when the liability first arose to pay the convertible note. [subsection 130-60(2)] This clarification reflects the current administrative practice of the Australian Taxation Office.

Subdivision 130-D: Employee share schemes

Change

Where an employee becomes absolutely entitled to a share as against a trustee, and the share passes at market value, it will be made clear that the trustee is not liable to tax.

Explanation

The present law operates in this way where the share is at discount but not where market value applies.

C. Provisions of the old law not rewritten

Redundant provisions

Some provisions of the 1936 Act are redundant or have rare application with the passage of time and are not included in the rewritten law. They are summarised in the following table:

Chapter 2.20 - Leases

Overview

This segment covers the special rules for cost base modifications and timing of acquisition for lessors and lessees in Division 132.

Part A summarises these rules.

Part B explains changes proposed to the 1936 Act.

Part C explains why some provisions of the 1936 Act have not been rewritten.

A. Summary of the new law

Division 132: Leases

What the Division does

Division 132 makes modifications to the cost base of a lease where the lessee or lessor incurs expenditure relating to the lease in three situations:

•

the lessee pays to have a term of the lease varied or waived;

•

the lessor pays the lessee for lease improvements;

•

the lessor pays to vary or waive a term of a long term lease.

It also has rules to determine the time of acquisition of, and the expenditure of a lessee to acquire, the lessor's reversionary interest in land.

Expenditure to vary or waive a lease term

If a lessee incurs expenditure for the variation or waiver of a term of the lease, the amount is included in the cost base of the lease. [section 132-1]

Expenditure for lease improvements

If, at the end of the lease, the lessor pays for expenditure of a capital nature incurred by the lessee in making improvements to the leased property, the amount paid is included in the cost base of the property. [section 132-5]

Expenditure to vary or waive a term of a long term lease

If a lessor pays the lessee for a variation or waiver of a term of a long-term lease (ie. a lease for at least 50 years), the amount is included in the cost base of the property. [subsection 132-10(3)]

Lessee of land acquires reversionary interest

If the lessee acquires the lessors reversionary interest in land, this is treated as an acquisition of the land by the lessee. Specific rules determine the time of acquisition of the land and the amount for which it is acquired.

[section 132-15]

B. Discussion of changes

General

Division 132 contains special rules for some lease transactions.

In contrast with Division 5 of Part IIIA of the 1936 Act, which contains most of the rules for lease transactions, the structure of the rewritten provisions is such that most of these rules will be in more general Divisions, for example, Division 104 - CGT events and Division 116 - Capital proceeds. Rules that are not dealt with in those Divisions will be contained in Division 132.

Section 132-1 Lessee incurs expenditure to get term of lease varied or waived

Change

Ensure that expenditure for the variation or waiver of a term of the lease forms part of the cost base of the lease.

Explanation

The expenditure to vary or waive a term of a lease arguably does not meet the description of allowable expenditure in the existing cost base rules.

Section 132-1 states that such amounts are an element of the cost base and reduced cost base of the lease. This reflects current administrative practice.

C. Provisions of the old law that have not been rewritten

Redundant provisions

Some provisions of the 1936 Act have not been rewritten for reasons summarised in the following table:

Chapter 2.21 - Options

Overview

This segment covers the rules in Division 134 for the treatment of options.

Part A summarises these rules.

Part B identifies provisions of the 1936 Act not rewritten.

A. Summary of the new law

Division 134: Options

What the Division does

Division 134 has rules for modifying the cost base or reduced cost base of an asset where an option that relates to it is exercised. These apply if an option is granted to acquire or dispose of a CGT asset.

The Division applies if consideration is paid or given for the option and the conditions outlined in Subdivision 130-B are satisfied. Broadly, these deal with the situation where

an equity holder is issued rights to acquire a share, unit or option at no cost.

Option to acquire an asset

Effect on grantee

The second element of the cost base or reduced cost base for the CGT asset includes the amount paid for the grant of the option. [section 134-1, item 2]

Effect on grantor

The cost base or reduced cost base for the asset is the amount paid for the exercise of the option, reduced by the amount received for the grant of the option. [section 134-1, item 2]

Option to dispose of an asset

Effect on grantee

The first element of the cost base of the CGT asset is the amount paid for the exercise of the option plus the amount paid for the grant of the option. [section 134-1, item 1]

Effect on grantor

This Subdivision does not apply to the grantor of an option to dispose of a CGT asset. This situation is covered by section 116-70 which sets out how capital proceeds are treated.

B. Provisions of the old law not rewritten

Redundant provisions

The following provisions of the existing law have not been rewritten:

Chapter 2.22 - Non-residents

Overview

This segment deals with rules about non-resident entities contained in Division 136.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C explains why some provisions have not been rewritten.

A. Summary of the new law

Subdivision 136-A: Making a capital gain or loss

What the Subdivision does

Subdivision 136-A applies in relation to a non-resident entity who makes a capital gain or loss only if:

•

there is a CGT event concerning an asset that has a necessary connection with Australia; or

•

CGT events D1 or E9 apply (which are, respectively, about creating contractual or other rights and creating a trust over future property).

CGT assets that have a necessary connection with Australia

The CGT rules treat the following categories of assets owned by non-residents as having a sufficient connection with Australia:

•

land, buildings or structures in Australia, including stratum units and shares in companies that confer occupancy rights;

•

assets used in carrying on business through a permanent establishment in Australia;

•

shares in a private company that is an Australian resident;

•

an interest in a resident trust;

•

units in a resident trust 10% or more of whose units were held by non-residents;

•

shares in a public company that is an Australian resident 10% or more of whose shares were held by non-residents; options to acquire assets in any of the above categories;

•

shares or securities in a company received in connection with the roll-over of a CGT asset to a wholly-owned company.

[section 136-25]

Table of CGT assets having the necessary connection

A table identifies the categories of CGT assets having the necessary connection with Australia for each CGT event. [section 136-10]

CGT events D1 and E9

There are also tables of circumstances in which CGT events D1 and E9 (which involve the creating of CGT assets) apply to non-residents. [section 136-15]

CGT events not applicable to non-residents

Finally, there is a table of CGT events that do not apply to non-residents. [section 136-20]

Subdivision 136-B: Becoming a resident

B. Discussion of changes

New Dictionary term

Change

Section 995-1 of the Income Tax Assessment Act 1997 will be amended to insert an additional definition necessary connection with Australia in the Dictionary. This replaces the concept taxable Australian asset used in the existing law but has no practical effect other than to improve clarity.

Section 136-10 Clarifying which CGT events apply to non-residents

Change

Express more clearly the circumstances in which CGT applies to non-residents, ie. involves an asset with a necessary connection with Australia.

Explanation

In the case of non-residents, the 1936 Act focuses on the disposal of taxable Australian assets but is less than clear in its application where there are deemed disposals of assets. The rewritten law clearly sets out how and when CGT events apply to non-residents. The following table identifies cases where the 1936 Act is less than clear and how the corresponding CGT event applies to non-residents.

Chapter 2.23 - Share value shifting

Overview

This segment covers the rules in Division 140 that deal with attempts to obtain a capital gains tax advantage through schemes that shift value between different shares.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

A. Summary of the new law

Subdivision 140-A: When there is share value shifting

What the Subdivision does

Subdivision 140-A identifies what are share value shifts. The purpose of Division 140 is to prevent entities from obtaining a capital gains tax advantage from share value shifting which transfers value from one lot of shares to another lot.

CGT event G2 - a shift in share values

A shift in share values occurs if there is a material decrease in the market value of a share, or a right or option to acquire a share as a result of a scheme involving the company and its controller. [sections 104-140, 140-10 and 140-30]

How a share value shift occurs

A share value shift occurs if:

•

the company, a controller of the company or an associate does something under a scheme involving one or more shares in the company;

•

there results a decrease in the market value of one or more of the shares held by a complicit entity;

•

the shares were acquired after 19September1985 (post-CGT);

•

new shares in the company are issued at a discount to the entity or an associate, or shares held by the entity or associate increase in value; and

•

the changes in value are reasonably attributable to the events of the scheme.

[section 140-15]

When an entity is a controller of a company

An entity is a controller if:

•

it has an associate-inclusive control interest of at least 50%; or

•

it has an associate-inclusive control interest of at least 40% and no other entities control the company; or

•

alone or with an associate, it controls the company.

[section 140-20]

An associate-inclusive control interest

An entity has an associate-inclusive control interest in a company if the requirements in Subdivision A of Division 3 of PartX of the 1936 Act are met.

Material decrease in the market value of a share

There are rules for determining whether a shares market value has materially decreased as a result of a share value shift. [section 140-25]

Exceptions - off-market buy-backs

A share value shift is disregarded if it is attributable to certain off-market buy-backs of shares. [subsection 140-15(8)]

Subdivision 140-B: Consequences of share value shifting

What the Subdivision does

Subdivision 140-B determines the capital gain and the required adjustments to the cost bases and reduced cost bases of shares following a share value shift. [sections 140-55, 140-60 and 140-65]

The rules vary when value is shifted into shares that were acquired before 20 September 1985 (pre-CGT). [sections 140-90 and 140-95]

There are exceptions if the decreases and increases in value cancel for every shareholder. [sections 140-50]

When a controller of a company or an associate of a controller makes a capital gain

The controller, or their associate, will make a capital gain if:

•

their shares materially decrease in market value; and

•

the shift proceeds are greater than a specific part of the cost base of those shares.

•

The capital gain is the excess. [subsection 140-55(2)]

Cost base adjustment - shares decreasing in value

There is a statutory formula for adjusting the cost base and reduced cost base of shares that decrease in value as a result of the value shift. [section 140-60]

Cost base adjustment - post-CGT shares increasing in value

There are formulas for increasing the cost base and reduced cost base of post-CGT shares that materially gain value as a result of the value shift, if they are held by:

•

a controller;

•

an associate of a controller; or

•

in some cases, an associate of such an associate.

The formula to be used depends on whether the gain in value is as a result of the decrease in value of shares owned by the owner of the shares that decreased in value or by another entity. [sections 140-65, 140-70 and 140-75]

Material increase in the market value of a share

There are rules for determining whether a shares market value has materially increased as a result of a share value shift. [subsections 140-65(3) to (5)]

Value shifted into shares acquired pre-CGT

When a controller makes a capital gain

When the value is shifted to shares acquired by the controller or their associate pre-CGT, a capital gain will be made if:

•

their post-CGT shares materially decrease in market value; and

•

the shift proceeds exceed a specific part of the cost base of those shares.

•

The capital gain is the excess. [section 140-90]

Cost base adjustment - post-CGT shares decreasing in value

There is a statutory formula for adjusting the cost base and reduced cost base of post-CGT shares that decrease in value as a result of the value shift. [section 140-95]

B. Discussion of changes

Subdivision 140-B Consequences of share value shifting

Change

Examples have been used extensively to illustrate the operation of the formulas.

Explanation

The rewritten provisions make extensive use of numerical examples to illustrate the application of formulas. This is because the formulas, which reflect existing policy, are complex and difficult to understand.

Section 140-50 What if the share value shift is neutral for each shareholder

This section applies if, for each shareholder whose shares are affected by a share value shift, the sum of the gains in market value of shares that increased in value is equal to the sum of the losses in market value of shares that decreased in value. The effect of the section is to apply the Division to each shareholder as though the share value shift consisted only of a shift in value among that shareholders shares.

Change

This is a new provision.

Explanation

In circumstances such as an issue of new shares at other than market value to existing shareholders, in proportion to their respective existing shareholdings, provided value is not shifted into shares acquired pre-CGT, no shareholder will be taken to have made a capital gain. There will be adjustments to the cost base (and reduced cost base) of the shares only.

The provision will simplify the application of the law.

Sections 140-55 and 140-90 Making a capital gain

These sections explain how to calculate a capital gain that results from CGT event G2.

Change

Clarify that the capital gain is calculated by reference to all relevant increased value shares.

Explanation

Under the existing law, it is unclear whether the capital gain that results from a share value shift is calculated on a share by share basis. The rewritten provisions clarify that the capital gain is calculated by reference to all relevant shares that increase in value. This is a practical outcome that is consistent with the underlying policy and administrative practice.

Section 140-60 Cost base adjustment for shares decreasing in value

Section 140-95 Adjustments to cost base and reduced cost base

These sections will adjust cost bases and reduced cost bases of shares that have been reduced in value by a share value shift.

1. Change

Specify that cost base reduction of any share cannot exceed the reduction in its market value.

Explanation

Without this restriction, the formulas would operate to eliminate some or all losses in value that had accrued but were unrealised at the time of the share value shift.

2. Change

Specify that cost base adjustments become effective at the time of the share value shift.

Explanation

Under the existing law, if there are successive share value shifts without intervening disposals of affected shares, the cost base adjustments made as a result of earlier share value shifts are not effective for the purpose of later share value shifts. Consequently, capital gains and cost base adjustments in later share value shifts may be determined by reference to cost bases of shares without regard for the earlier value shifts. The rewritten provision corrects this unintended result.

Section 140-65 Cost base adjustment for shares increasing in value

This section will adjust cost bases and reduced cost bases of shares that have increased in value because of a share value shift.

1. Change

Specify that cost base adjustments become effective at the time of the share value shift.

Explanation

The explanation for this change is the same as that for the second change under sections 140-60 and 140-95.

2. Change

Standardise the formulas for increasing the cost bases of shares that materially increase in value in a share value shift.

Explanation

In all of the formulas, the rewritten law makes the increase in the cost bases dependent upon the increase in market value being reflected in the state or nature of the shares on their subsequent disposal.

Chapter 2.24 - When an asset stops being a pre-CGT asset

Overview

This segment covers the rules that govern when an asset acquired before 20 September 1985 is to be treated as acquired after that date.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C identifies provisions that have not been rewritten.

A. Summary of the new law

Subdivision 149-A: Key concepts

What the Subdivision does

Subdivision 149-A defines the key concepts used in Division 149.

Pre-CGT asset

An asset is a pre-CGT asset if it was last acquired before 20 September 1985 and no provision has operated to treat it as having been acquired after that date. [section 149-10]

Majority underlying interests in a CGT asset

The majority underlying interests in an asset consist of more than one half of the beneficial interests that ultimate owners have (directly or indirectly) in an asset or in ordinary income that may be derived from the asset. [section 149-15]

Special rules apply to work out majority underlying interests in an asset if an ultimate owner acquired an underlying interest in it because of:

•

the death of the former owner; or

•

roll-over under Subdivision 126-A.

•

[sections 149-30 and 149-60]

Ultimate owner

An ultimate owner is:

•

an individual;

•

a company that is prevented by its constituent documents from making any distribution to its members;

•

the Commonwealth, a State or Territory

•

a local governing body; or

•

a foreign country government.

[section 149-15]

When ultimate owner has indirect beneficial interest in capital or ordinary income of an entity.

An ultimate owner has an indirect beneficial interest if it would receive for its own benefit any capital or ordinary income distributed by the entity through interposed entities. [section 149-15]

Subdivision 149-B: When asset of non-public entity stops being a pre-CGT asset

What the Subdivision does

Subdivision 149-B sets out when an asset of a non-public entity stops being a pre-CGT asset. It also contains rules that modify the cost base of the asset. [section 149-25]

When asset stops being a pre-CGT asset

An asset stops being a pre-CGT asset if the majority underlying interests in it are not held by ultimate owners who held those interests just before 20 September 1985. [section 149-30]

Effect if asset stops being a pre-CGT asset

The entity is taken to have acquired the asset at the earliest time when majority underlying interests in the asset were no longer held by ultimate owners who had held majority underlying interests immediately before 20 September 1985. The first element of the asset's cost base is its market value at that earliest time. [sections 149-30 and 149-35]

Subdivision 149-C: When asset of public entity stops being a pre-CGT asset

What the Subdivision does

Subdivision 149-C sets out when an asset of a public entity stops being a pre-CGT asset. It also contains rules that modify the cost base of the asset.

Which entities are affected

The subdivision applies to:

•

a company, if its shares are listed on an approved stock exchange;

•

a publicly traded unit trust;

•

a mutual insurance or mutual affiliate company; and

•

certain related entities.

[section 149-50]

When entity is to test whether asset is still a pre-CGT asset

Generally, an entity must determine the majority underlying interests in the asset within 6 months after each test day. [section 149-55]

Test day

Test days recur each five years, after 20 January 1997. If the day is a non-business day the test day is the next business day.

It is also a test day if there is abnormal trading of relevant shares or units. [subsection 149-55(2)]

What the determination must show

The determination is whether majority underlying interests in the asset on the test day were held by ultimate owners who also held majority underlying interests on the starting day. [section 149-60]

Starting day

The starting day is 19 September 1985 or any day the entity chooses in the period 1 July 1985-30 June 1986 that gives a reasonable approximation of the ultimate owners who had underlying interests in the assets of the entity on 19 September 1985. [section 149-60]

Effects of not making determination

If the entity does not make a determination, the asset stops being a pre-CGT asset. The entity is then treated as if it acquired the asset at the end of the preceding test day. The first element of the asset's cost base is its market value at that time. Special rules apply if the entity became a public entity since the last test day. [section 149-65]

Effects if asset no longer has the same majority underlying ownership

If the determination shows that majority underlying interests have not been maintained, the asset stops being a pre-CGT asset. The entity is treated as if it acquired the asset at the end of the test day. The first element of the asset's cost base is its market value at that time. [sections 149-70 and 149-75]

Subdivision 149-D: How to treat holdings of less than 1% in certain entities

What the Subdivision does

This subdivision has rules that assist companies and trusts determine who has underlying interests in an asset.

Holdings of less than 1%

All holdings of shares or units of less than 1% in the entity are treated as if they were held by a single notional individual. Similarly, holdings of less than 1% in an interposed entity are treated as if they were held by a different single notional individual. [sections 149-110 - 149-125]

When the Subdivision does not apply

The notional holder rules do not apply if the Commissioner considers it reasonable to assume that at the end of the test day majority underlying interests in the asset were not held by ultimate owners who had majority underlying interests in the asset at the end of the starting day. [section 149-140]

Subdivision 149-E: How to treat certain interposed funds, companies and government bodies

What the Subdivision does

This subdivision has rules that assist companies and trusts determine who has underlying interests in an asset where certain superannuation or approved deposit funds, companies or government bodies are interposed between the entity and the ultimate owners.

The particular rules that apply depend on whether the interposed entity is a government body or has more than 50 members. [sections 149-150 and 149-155]

Subdivision 149-F: How to treat a 'demutualised' public entity

What the Subdivision does

Subdivision 149-F contains rules for determining the underlying interests in assets of certain entities that were mutual companies at the starting day but have demutualised since that time. It also contains rules that apply when an interposed entity is demutualised.

Members underlying interests in assets

An ultimate owner who was a member of the entity (or interposed entity) immediately before the demutualisation is regarded as having had an underlying interest at all times from the starting day until just after the demutualisation. [sections 149-165 and 149-170]

B. Discussion of changes

Sections 149-35 & 149-70 Cost base elements of asset that stops being a pre-CGT asset

These sections contain cost base modifications that apply when an asset stops being a pre-CGT asset.

Change

Specify that any expenditure incurred before the time when an asset stops being a pre-CGT asset is not included in any element of its cost base (market value applies).

Explanation

This ensures that expenditure such as incidental expenditure incurred before the asset stops being a pre-CGT asset cannot be included in its cost base. The result is consistent with the 1936 Act.

Section 149-30 Effects if asset no longer has same majority underlying ownership

Section 149-60 What the determination must show

Change

Specify that where a pre-CGT share is acquired as the result of a Subdivision 126-A same-asset roll-over, the person acquiring the share is treated as having held an underlying interest in it before 20 September 1985.

Explanation

The 1936 Act is silent as to the effect of these roll-overs in determining the majority underlying interest in a CGT asset. The change is consistent with administrative practice.

C. Provisions of the old law that have not been rewritten

Redundant provisions

The following provision of the 1936 Act is redundant and has not been included in the new law:

Chapter 2.25 - Company net capital losses

Overview

This segment covers the rules for company net capital losses in Divisions 165, 170 and 175 of the 1997 Act.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C explains why some provisions of the 1936 Act have not been rewritten.

A. Summary of the new law

Subdivision 165-CA: Applying net capital losses of earlier income years

What the Subdivision does

Subdivision 165-CA makes the ability of a company to set off a net capital loss of an earlier income year against capital gains in a later year subject to the same conditions that it must satisfy to deduct a tax loss of an earlier income year.

The general rule is

A company cannot apply a net capital loss of an earlier year unless:

•

it has the same majority ownership and control throughout the loss year and the income year; or

•

it carried on the same business and did not enter into new kinds of business or transactions.

[subsection 165-96(1)]

Subdivision 165-CB: Working out the net capital gain and net capital loss for the income year of change

What the Subdivision does

Subdivision 165-CB requires a company to work out its net capital gain and net capital loss differently for a year in which it has not had the same majority ownership and control and does not satisfy the same business test.

A company must work out its net capital gain and net capital loss under this Subdivision

•

if it is required to calculate its taxable income and tax loss under the special rules for the income year of change (Subdivision 165-B); or

•

if it would have been required to do so except for its not having made a notional loss in any of the periods into which the year was divided.

[section 165-102]

Did the company have a notional net capital loss in a period?

The year is divided into periods according to the same rules as those that apply for working out the companys taxable income and tax loss for the year of change.

A company has a notional net capital gain for a period if the capital gains it makes during the period exceed its capital losses. If the capital losses exceed the capital gains, it has a notional net capital loss. [sections 165-105 and 165-108]

A company makes a net capital gain

equal to the excess of its notional net capital gains for the year over any available net capital losses of earlier years. [section 165-111]

A company makes a net capital loss

equal to the sum of its notional net capital losses for the year. [section 165-114]

Subdivision 170-B: Transfer of net capital losses within wholly-owned groups of companies

What the Subdivision does

Subdivision 170-B has rules that apply where a company transfers an amount of net capital loss to another company.

The general rule is

A resident company with a net capital loss (the loss company) can transfer all or part of it to another resident company (the gain company) if the companies are members of the same wholly-owned group during:

•

the income year in which the net capital loss was made; and

•

the income year for which the net capital loss is transferred; and

•

any intervening year.

[sections 170-110 and 170-130 and subsections 170-135(1) and 175-140(1)]

Effects of the transfer

The gain company is taken to have made the net capital loss in the year in which it was made by the loss company. [section 170-120]

The gain company must apply the net capital loss immediately. [subsection 170-115(1)]

Companies that have share or debt interests in the loss company or the gain company, including interests acquired indirectly through other companies, will have the cost bases of those interests adjusted in specified circumstances. [sections 170-175 and 170-180]

Limits on the amount transferred

The amount to be transferred cannot exceed:

•

the amount the loss company would otherwise carry forward to the next year;

•

the amount that the gain company can apply in the year of the transfer; or

•

the sum of the cost bases of the share and debt interests of members of the wholly-owned group in the loss company.

[section 170-145]

The order in which net capital losses may be transferred

Capital losses are transferable in the order in which they were made. [section 170-155]

Subvention payments

Any payment made for the transfer:

•

is not assessable income, exempt income or a source of a capital gain to the loss company; and

•

is neither a deduction nor a source of a capital loss to the gain company. [section 170-125]

A transfer agreement

A transfer can only take place under a duly made written agreement. [section 170-150]

Subdivision 175-CA: Tax benefits from unused net capital losses or earlier income years

What the Subdivision does

Subdivision 175-CA specifies circumstances in which the Commissioner may disallow the application of a net capital loss of an earlier year.

The general rule is

The Commissioner can do this if:

•

a capital gain was injected into the company because the net capital loss was available (but not if the continuing shareholders benefit); or

•

someone would obtain a tax benefit in connection with a scheme entered into because the net capital loss was available (unless the benefit is fair and reasonable in view of the persons shareholding).

[sections 175-45 and 175-50] his sanction is not applied if the company fails to maintain the same majority ownership but satisfies the same business test. [subsection 175-40 (2)]

Subdivision 175-CB: Tax benefits from unused capital losses of the current year

What the Subdivision does

Subdivision 175-CB deals with situations where the Commissioner may disallow the application of some or all of a capital loss made during the year.

The general rule is

The Commissioner can disallow the application of some or all of a capital loss made during the year if:

•

a capital gain was injected into the company because the capital loss was available (except to benefit continuing shareholders);

•

the capital loss was injected because a capital gain was available to absorb the loss (except where continuing shareholders benefit);

•

someone would obtain a tax benefit from a scheme entered into because the company had made a capital loss (unless the benefit is fair and reasonable in view of the persons shareholding); or

•

someone would obtain a tax benefit from a scheme entered into because the company had made a capital gain before it made the capital loss (again unless the benefit is fair and reasonable based on the persons shareholding).

[sections 175-60, 175-65 and 175-70]

B. Discussion of changes

Section 170-125 Tax treatment of consideration for transferred loss

Change

A subvention payment made by the gain company will be neither assessable income nor exempt income of the loss company. Nor will it cause a capital gain to be made by the loss company.

Explanation

Under the existing law, such a receipt is specifically prevented from being income or the source of a capital gain only where the loss company is a shareholder in the gain company.

The change aligns the treatment of subvention payments for net capital losses with that of subvention payments for tax losses.

Section 170-135 The loss company

Section 170-140 The gain company

These sections state conditions that must be satisfied by the companies between which the loss is transferred.

Change

Clarify that the loss company must be an Australian resident throughout the loss year and that the gain company must be an Australian resident throughout the year for which the loss is to be applied.

Explanation

The existing law requires these companies to be Australian residents but is not explicit as to when they must be Australian residents.

Section 170-150 Transfer by written agreement

This section will set out the requirements for an agreement transferring a net capital loss.

1. Change

The time for making an agreement has been extended to include the day on which the gain company lodges its income tax return for the year in which the transferred net capital loss is applied.

Explanation

The existing law requires the agreement to be made before that date. It is usual for such deadlines to conclude on or before the specified date.

2. Change

It has been made explicit that the agreement must specify the amount being transferred.

Explanation

It is implicit in the existing law that an amount will be specified in the transfer agreement. The change aligns with the specified requirements for agreements to transfer revenue losses.

Section 170-170 The gain company cannot transfer a previously transferred net capital loss

Change

It has been made explicit that the gain company cannot transfer to another company any part of a net capital loss that is transferred to it.

Explanation

This condition is implicit in the existing law.

C. Provisions of the old law that have not been rewritten

Redundant provisions

The following provision of the existing law have not been rewritten:

Chapter 2.26 - Indexation

Overview

This segment covers the rules for indexing amounts for inflation contained in Subdivision 960-M.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C explains the transitional arrangements. Part D explains amendments that need to be made to the 1997 Act and the 1936 Act as a consequence of the rewriting of the 1936 Act.

A. Summary of the new law

Subdivision 960-M: Indexation

What the Subdivision does

There are some provisions in the taxation law that require amounts to be indexed. Subdivision 960-M explains how to do the indexation calculations.

B. Discussion of changes

Subdivision 960-M Indexation

This Subdivision contains the indexation rules.

Section 960-270 Indexing amounts

Change

Make it clear that cost base amounts are not required to be reduced in periods of deflation.

Explanation

Some of the indexation requirements in the 1936 Act could be read as involving downward adjustments in periods of deflation. This was not intended and the rewrite makes this specific.

C. Amendment of the Income Tax (Transitional Provisions) Act 1997

Part 1 of Schedule 9 amends the Income Tax (Transitional Provisions) Act 1997. It inserts a provision needed for the transition from the 1936 Act to the rewritten law relating to indexation. [Schedule 9, item 1]

Section 42-70 (Adjustment: acquiring a car at a discount) is inserted in that Transitional Act to ensure that the adjustment provision has effect if the car was first used in a year to which the corresponding 1936 Act provision applied.

D. Consequential amendments

Part 2 of Schedule 9 amends the 1997 Act to update references to the rewritten indexation provisions and related concepts.

Part 3 of Schedule 9 amends the 1936 Act to give effect to a Government decision to amend the law so that the indexation factor used to calculate the car depreciation limit cannot be negative. This change was announced by the Treasurer in Press Release No. 71 on 27June 1997. It ensures that taxpayers are not disadvantaged by a decline over time in the index number for the motor vehicle purchase sub-group of the Consumer Price Index.

The consequential changes are summarised in following table:

Chapter 2.27 - Amendment of the Income Tax (Transitional Provisions) Act 1997

Overview

This Chapter outlines the transitional amendment of the Income Tax (Transitional Provisions) Act 1997 resulting from the rewritten CGT rules.

Background

Transitional provisions for the CGT rewritten rules are contained in Part 1 of Schedule 2 of the Bill.

What Part 1 will do

Part 1 of Schedule 2 contains measures needed for the transition from the old CGT law to the rewritten law. Items 1 to 3 will amend the Income Tax (Transitional Provisions) Act 1997.

Under that Act, the 1997 Act applies to assessments for the 1997-98 income year and later years.

The approach of the CGT transitional provisions is to apply the rewritten law to CGT events that occur in the 1998-99 or later income years. [section 102-1, item 2]

In some situations, it is necessary to modify the rewritten provisions or to specify that they apply when working out whether a capital gain or loss is made in the 1998-99 or later income years, even though certain things that affect that calculation may have happened before 1998-99.

One important such modification is for roll-overs. The transitional provision will ensure that where a CGT asset has been acquired as part of a roll-over transaction before the 1998-99 income year, the rewritten law applies to the asset from when the roll-over happened. However, the first element of the cost base and reduced cost base is the assets acquisition consideration under the 1936 Act.

The rule about the first element of cost base or reduced cost base applies to, but is not limited to, the asset as acquired by the transferee (in the case of a same-asset roll-over) or to the replacement asset (in the case of a replacement-asset roll-over). It also extends to any other asset for which an amount is taken to have been paid as acquisition consideration under the roll-over provision in the 1936 Act.

For example, if a roll-over provision in the 1936 Act applied to the transfer of an asset to a company and specified that the shares in the transferee company had a particular acquisition consideration (say, their market value), the first element of the cost base or reduced cost base of the shares would be their specified acquisition consideration under the roll-over rule in the 1936 Act. [subsection 102-5(2), item 2]

The remainder of the transitional provisions in items 2 to 3 are explained in the following table:

Chapter 2.28 - Consequential amendments of the Income Tax Assessment Act 1997

Overview

This Chapter explains the consequential amendments of the 1997 Act that are required as a result of the rewrite of the CGT provisions.

Background

The amending items 4 to 48 are in Part 2 of Schedule 2.

What Part 2 of Schedule 2 does

Part 2 of Schedule 2 to the Bill amends the 1997 Act as a consequence of the rewrite of the CGT provisions.

Listed below are summaries of the various categories of amendment made by the items of Part 2, Schedule 2:

•

Replace references to 1936 Act provisions with 1997 Act references

Item numbers: 4, 5, 6, 11, 13, 16

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Replace references to old Part IIIA with reference to new Parts 3-1 and 3-3

Itemnumber: 15

•

Replace references to Part IIIA concepts with references to Parts 3-1 and 3-3 concepts

Item numbers: 7, 10, 12, 14, 17

•

Insert references to rewritten provisions

Item numbers: 9, 26, 27, 29, 31, 32, 34, 35

•

Substitute or insert references to newly defined terms

Item numbers: 20, 21, 22, 23, 24, 25, 43, 44, 47, 48

•

Replace defined terms with words having an ordinary meaning not requiring definition

Item numbers: 36, 37, 38, 39, 40, 41

•

Substitute updated references to rewritten roll-over provisions

Item number: 8

•

Improve the wording of provisions

Item numbers: 19, 30, 42, 45

•

Insert signposts

Item numbers: 28, 33

•

Repeal link notes

Item numbers: 18, 46

Chapter 2.29 - Consequential amendments of the Income Tax Assessment Act 1936

Overview

This Chapter explains the consequential amendments of the Income Tax Assessment Act 1936 required as a result of the rewriting of the CGT provisions.

Background

The amending items 49 to 522 are in Part 3 of Schedule 2.

What Part 3 of Schedule 2 does

Part 3 of Schedule 2 to the Bill amends the 1936 Act as a consequence of the rewrite of the CGT provisions.

The amendments made by the items in Part 3 of Schedule 2 are identified and classified as follows:

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Insert 3 new sections into the 1936 Act that will ensure the continued operation of Divisions 17A, 17B and 19A of Part IIIA

Item numbers: 397, 398, 399

•

Replace references to 1936 Act provisions with 1997 Act references

Item numbers: 63, 91, 101, 108, 114, 135, 145, 150, 206, 217, 272, 281, 298, 299, 300, 301, 302, 308, 309, 310, 311, 312, 314, 318, 325, 326, 327, 328, 329, 330, 331, 354, 361, 373, 374, 381, 400, 404, 405, 407, 408, 421, 422, 447, 448, 455, 456, 457, 458, 475, 510, 519

•

Replace references to Part IIIA with references to new Parts 3-1 and 3-3

Item numbers: 87, 89, 95, 96, 104, 105, 106, 107, 110, 111, 112, 113, 115, 116, 118, 220, 283, 323, 341, 342, 343, 345, 362, 363, 367, 377, 378, 380, 382, 384, 385, 386, 418, 423, 431, 450, 451, 521

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Replace references Part IIIA with either a reference to Part 3-1 or to Part 3-3 as appropriate

Item numbers: 72, 76, 77, 78, 82, 83, 84, 85, 97, 98, 99, 332, 403, 414

•

Replace certain references to Part IIIA with references to the Income Tax Assessment Act 1997

Item numbers: 128, 129

•

Replace a reference to 'the Act' with 'this Act'

Item number: 430

•

Replace references to Part IIIA concepts with references to Parts 3-1 and 3-3 concepts

Item numbers: 64, 65, 66, 67, 68, 69, 70, 71, 73, 74, 75, 79, 80, 81, 88, 90, 92, 94, 102, 109, 117, 119, 122, 123, 124, 125, 134, 136, 140, 146, 147, 151, 152, 153, 158, 159, 160, 161, 162, 163, 167, 168, 169, 174, 177, 178, 181, 184, 185, 186, 189, 190, 191, 192, 193, 194, 195, 196, 197, 198, 199, 200, 201, 202, 203, 204, 205, 207, 208, 209, 210, 211, 212, 213, 214, 215, 218, 219, 221, 222, 223, 228, 229, 230, 231, 234, 235, 240, 241, 244, 245, 248, 253, 254, 255, 256, 257, 258, 259, 260, 261, 262, 263, 264, 265, 266, 267, 268, 269, 270, 271, 273, 274, 275, 276, 277, 278, 279, 282, 284, 285, 287, 288, 290, 291, 293, 294, 296, 303, 304, 306, 313, 317, 321, 324, 333, 334, 335, 344, 346, 347, 348, 349, 351, 352, 353, 355, 356, 357, 358, 359, 368, 369, 370, 371, 372, 375, 376, 379, 383, 387, 410, 411, 415, 417, 420, 424, 426, 427, 428, 437, 438, 444, 445, 446, 449, 452, 459, 462, 471, 498, 499, 500, 502, 503, 504, 507, 508, 509, 511, 513, 514, 515, 516, 517, 518, 520, 522

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Insert references to rewritten provisions

Item numbers: 93, 148, 389, 390, 391, 401, 425, 429, 433, 434, 435, 436, 439, 440, 441, 442, 443, 460, 464, 466, 467, 468, 469, 473, 474, 476, 477, 478, 479, 480, 481, 482, 483, 484, 485, 486, 487, 488, 489, 490, 491, 492, 493, 494, 495, 496, 497

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Substitute references to defined terms

Item numbers: 49, 50, 51, 52, 53, 54, 55, 56, 57, 58, 59, 60, 61, 62, 137, 144

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Update references to roll-over provisions

Item numbers: 126, 130, 132, 139, 142, 143, 286, 338, 465, 472

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Improve the wording of provisions

Item numbers: 121, 133, 289, 292, 295, 297, 305, 307, 315, 316, 319, 320, 402, 406, 416, 432, 470, 501, 505, 512

•

Insert application provisions

Item numbers: 392, 393, 394, 395, 396

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Repeal redundant provisions or expressions

Item numbers: 86, 103, 120, 127, 138, 141, 149, 154, 155, 156, 157, 164, 165, 166, 170, 171, 172, 173, 175, 176, 179, 180, 182, 183, 187, 188, 216, 224, 225, 226, 227, 232, 233, 236, 237, 238, 239, 242, 243, 246, 247, 249, 250, 251, 252, 280, 336, 337, 340, 350, 360, 364, 365, 366, 388, 409, 412, 413, 419, 453, 454, 461, 463, 506

•

Add or replace link notes

Item numbers: 100, 322, 339

Definitions used in Division 8 - Life Assurance Companies

Subsection 110(1) of the 1936 Act contains the definitions of terms used in the provisions relating to life assurance companies. Items 151 to 191 of Schedule 2 contain amendments to these defined terms.

The following table matches the existing terms which are being repealed with the corresponding new terms.

Definitions used in Division 8A - Annuity and insurance business of certain organisations

Subsection 116E(1) of the 1936 Act contains the definitions of terms used in the provisions relating to the annuity and insurance business of certain organisations. Items 222 to 258 of Schedule 2 contain amendments to these definitions.

The following table matches the existing terms which are being repealed with the corresponding new terms.

Chapter 2.30 - Consequential amendments of other Acts

Overview

This Chapter outlines the consequential amendments of other Commonwealth Acts required because of the rewriting of the CGT provisions.

Background

The amending items 523 to 550 are in Part 4 of Schedule 2.

What Part 4 of Schedule 2 will do

Part 4 of Schedule 2 to the Bill amends Commonwealth Acts (other than the 1936 Act and the 1997 Act) to make changes that are necessary as a consequence of the rewriting and relocation of 1936 Act CGT provisions dealt with by the Bill.

The amendments replace references to 1936 Act provisions and concepts relating to CGT with references to the rewritten provisions and concepts.

The Bill will amend the following Acts (item numbers in the right-hand column refer to those in Schedule 2 to the Bill).

Chapter 3 - Company bad debts

Overview

This chapter covers:

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the rewritten provisions in Subdivisions 165-C (income tax consequences of changing ownership or control of a company - deducting bad debts) and 175-C (tax benefits from bad debt deductions); and

•

the new provisions in Subdivision 166-C (income tax consequences of changing ownership or control of a listed public company - deducting bad debts).

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C explains the transitional provisions which set out how, and when, the new provisions apply.

Part D explains amendments that need to be made to the 1997 Act, the 1936 Act and other Commonwealth Acts as a consequence of the rewriting of the 1936 Act.

A. Summary of the new law

The 1936 Act had similar rules for companies deducting prior year and current year losses and bad debts. The 1997 Act brings these rules together in Divisions 165 (Income tax consequences of changing ownership or control of a company) and Division 175 (Use of a companys tax losses or deductions to avoid income tax). In addition to bringing the similar rules for losses and bad debts together, the rewritten law also standardises them.

Division 166 of the 1997 Act contains simplified rules for tracing beneficial ownership of shares in listed public companies. These rules require continuity of ownership requirements to be met when deducting losses and bad debts. This Bill will apply these provisions when proving ownership for the purpose of deducting bad debts.

Subdivision 165-C: Income tax consequences of changing ownership or control of a company - deducting bad debts

The general rule

A company cannot deduct a bad debt unless the company retains the same majority ownership and control:

•

if the debt was incurred in an earlier year - from the time the debt was incurred until the end of that year and throughout the year in which it is deducted; or

•

if the debt was incurred in the year in which it is deducted - throughout that year;

or the company continues to carry on the same business.

Does a company have the same majority ownership?

Ownership is measured by:

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voting power;

•

rights to dividends; and

•

rights to capital distributions.

To determine majority ownership:

•

apply the primary test; or

•

if at least one company is a beneficial owner of shares in the company, apply the alternative test.

The primary test

There are persons who, between them at all times during the relevant periods, beneficially owned shares that carry rights to more than 50% of ownership rights in the company.

After tracing through interposed entities, it is reasonable to assume, there are individuals who between them at all times during the relevant periods:

•

are able to control the voting power in the company;

•

would receive more than 50% of any dividend paid by the company; and

•

would receive more than 50% of any distribution of capital by the company.

Has the company continued to carry on the same business?

If majority ownership has changed or there is a change of control, the company must:

if the debt was incurred in an earlier year - carry on throughout the year in which it is deducted the same business as it did immediately before the change in majority ownership or control; or

if the debt was incurred in the year in which it is deducted - carry on throughout the remainder of that year the same kind of business as it did immediately before the change in majority ownership or control.

Has the company continued to carry on the same business?

If majority ownership has changed or there is a change of control, the company must:

•

if the debt was incurred in an earlier year - carry on throughout the year in which it is deducted the same business as it did immediately before the change in majority ownership or control; or

•

if the debt was incurred in the year in which it is deducted - carry on throughout the remainder of that year the same kind of business as it did immediately before the change in majority ownership or control.

Tax losses resulting from bad debts

If a company can deduct a bad debt written off after a change in majority ownership only because:

•

it carried on the same business; and

•

the company carried on the same business in order to secure the deduction;

the company cannot, in a subsequent year, deduct a tax loss or part of a tax loss caused by the bad debt unless it also satisfies the same business test in that subsequent year.

Exceptions

Company need not have the same majority ownership nor carry on the same business

Subject to a Commissioner's discretion, a company can deduct a bad debt without having the same majority ownership and without carrying on the same business. The Commissioner will exercise the discretion in favour of the company if he considers it would be unreasonable to deny a deduction, having regard to the persons who were beneficial owners of shares in the company when the debt became bad.

A debt incurred on the last day of the year

A company cannot deduct as bad in a year a debt that was incurred on the last day of that year.

Subdivision 166-C: Income tax consequences of changing ownership or control of a listed public company - deducting bad debts

The general rule

A listed public company, or a wholly-owned subsidiary of a listed public company, is taken to have had the same majority ownership if it satisfies the test for substantial continuity of ownership in section 166-145 of the 1997 Act.

When does the company have to have substantial continuity of ownership?

In relation to a debt incurred in an earlier year, the company must have substantial continuity of ownership as between the day on which the debt was incurred or, if the company chooses, the commencement of the year in which the debt was incurred and:

•

each subsequent time of abnormal trading in shares in the company; and

•

the end of each subsequent year,

up to and including the year in which the debt is written off as bad.

In relation to a debt incurred and written off in the same year, the company must have substantial continuity of ownership as between the commencement of that year and:

•

each time of abnormal trading in shares in the company during the year; and

•

the end of the year.

What if the company does not have substantial continuity of ownership?

A company that fails the substantial continuity of ownership test will still be able to deduct a bad debt if it satisfies the same business test applied from immediately before it failed to satisfy substantial continuity of ownership.

Substantial continuity of ownership rules need not apply

If a company chooses that the substantial continuity of ownership rules not apply for a particular income year, the majority ownership rules will apply to that company for that year without modification.

Subdivision 175-C: Use of a company's tax losses or deductions to avoid income tax - tax benefits from unused bad debt deductions

The general rule

The Commissioner can disallow some or all of a deduction for a bad debt if:

•

income or a capital gain is injected into the company because the bad debt is available (except where the continuing shareholders benefit to an extent that is fair and reasonable); or

•

someone other than the company would obtain a benefit in connection with a scheme entered into because a deduction was available for a bad debt (except a person who beneficially owns shares in the company and for whom the benefit is fair and reasonable).

Who are the continuing shareholders?

These are the majority beneficial owners of shares in the company throughout the two continuity periods.

The general rule does not apply if

The company fails to maintain majority ownership but satisfies the same business test.

B. Discussion of changes

Ways in which particular provisions relating to company bad debts have been altered are detailed in the discussion of changes following. In addition to other explanations specific to particular changes, the changes are part of the standardisation of the provisions for company bad debts and losses in the 1997 Act.

Subdivision 165-C Income tax consequences of changing ownership or control of a company - deducting bad debts

This Subdivision will set out the conditions a company must satisfy before it can deduct a bad debt.

Change

Adopt the standardised tests that are already in the 1997 Act for determining whether a company has maintained the same majority ownership or continued to carry on the same business.

Explanation

The tests have been standardised for current and prior year losses and now bad debts. This structural change does not affect the application of the tests and the outcomes for bad debts will be the same as under the 1936 Act.

Section 165-123 Company must maintain the same owners

This section sets out the conditions that must be satisfied for a company to be treated as having maintained the same majority ownership.

1. Change

Require the company to maintain continuity of majority beneficial ownership throughout the period from the day on which the debt was incurred until the end of that year, as part of the requirements for deductibility of a debt incurred in an earlier income year.

Explanation

The 1936 Act initially states a requirement that the company maintain continuity of majority beneficial ownership throughout the year in which the debt was incurred but then relaxes it to allow a deduction if, amongst other things, the company satisfies the Commissioner that it has maintained continuity of majority beneficial ownership from the day on which the debt was incurred until the end of that year.

2. Change

Provide that when testing for beneficial ownership of a company the second, and alternative, test automatically applies where one or more companies beneficially own shares in the company claiming a deduction for a bad debt.

Explanation

Under the 1936 Act, the alternative test only applies if:

•

the company requests the Commissioner to apply it; or

•

the Commissioner considers it reasonable to do so.

This is inconsistent with self-assessment.

Section 165-126 Alternatively, company must carry on same business

This section sets out when a company must satisfy the same business test.

1. Change

Clarify precisely when a change of beneficial ownership has occurred that results in a company not maintaining majority ownership.

Explanation

Broadly, the section requires a company to carry on the same business at all times during the period to when the bad debt is deducted as it did immediately before a change in beneficial ownership of its shares that results in it not maintaining the same majority ownership.

The 1936 Act does this but not as clearly.

2. Change

Make clear that the new business or new transactions elements of the standardised same business test are triggered if a company derives assessable income from the business or transaction.

Explanation

Under the 1936 Act, the new business test and the new transactions test refer to 'income'. This creates an uncertainty because that term could be taken to mean income according to ordinary concepts, both exempt and assessable. However, in the context of the same business test, having regard to its purpose, the only sensible meaning that can be given to the term is assessable income. This is the meaning given to the term as set out in the Taxation Ruling TR95/31.

Section 165-129 Same people must control the voting power, company must carry on same business

This section provides that a bad debt cannot be deducted if:

•

there is a change in control of the voting power in the company between the relevant periods; and

•

the reason for the change is to provide someone with a tax benefit.

The relevant periods are:

•

if the debt was incurred in an earlier year - from the day on which the debt was incurred until the end of that year and throughout the year in which it is deducted; or

•

if the debt was incurred in the year in which it is deducted - the whole of that year.

Change

Provide that, even if there is a change in the voting power, the company can deduct the bad debt if it satisfies the same business test.

Explanation

Under the 1936 Act, if there is a change in control of the voting power in the company, the same business test does not automatically apply.

However, such a change generally precedes, or is part of, a change of majority ownership. As the same business test already applies to this outcome, it should also apply where there is a change in control. This simplifies the law by having both cases subject to the same business test.

Subdivision 166-C Income tax consequences of changing ownership or control of a listed public company - deducting bad debts

Division 166 of the 1997 Act contains a set of rules that make it easier for listed public companies (and wholly-owned subsidiaries of listed public companies) to test for continuity of majority beneficial ownership. It already contains specific provisions to apply these rules for companies to establish their entitlement to deduct losses. Subdivision 166-C contains the specific provisions necessary to apply these rules for companies to establish their entitlement to deduct bad debts. Under the 1936 Act, these simplified rules do not apply in relation to the deduction of bad debts.

1. Change

Provide that, if a listed public company satisfies the test for substantial continuity of majority ownership at the end of each year and at times of abnormal trading in its shares, it is taken to have satisfied the majority ownership requirements during the intervening periods.

Explanation

To deduct a bad debt under the 1936 Act, a listed public company is required to satisfy the conditions for continuity of majority ownership right throughout prescribed periods.

2. Change

Provide that the test for substantial continuity of majority ownership counts all registered shareholdings of less than 1% as being held by a single shareholder.

Explanation

The existing test for continuity of majority ownership requires all shareholdings to be separately taken into account.

3. Change

Provide that the test for substantial continuity of majority ownership does not require ownership of shares to be traced through a superannuation fund, an

approved deposit fund, a mutual affiliate company, a mutual insurance company, a trade union, a sporting club or a company that is prescribed in regulations.

Explanation

The existing test for continuity of majority ownership requires that ownership be traced through all companies.

Subdivision 175-C Use of a companys tax losses or deductions to avoid income tax - tax benefits from unused bad debt deductions

This Subdivision contains anti-avoidance measures that allow the Commissioner to reverse the effect of schemes that bring together in the same company:

•

assessable income; and

•

a deduction for a bad debt that would not otherwise be used or would be used at a later time.

1. Change

Collocate the anti-avoidance provisions for bad debts with the anti-avoidance provisions for losses.

Explanation

This is a structural change to clearly identify anti-avoidance provisions which, in the 1936 Act, are not identified as such and are merged with the other loss and bad debt provisions.

2. Change

Omit an anti-avoidance rule that denies a deduction for a bad debt if the operations of a company are managed or conducted without paying regard to the rights of the continuing shareholders.

Explanation

The rule is very difficult to apply and little understood. The circumstances it is meant to cover are clearly indicative of either a change of ownership or control, which are dealt with by other provisions.

Section 175-85 First case: income injected into the company because of an available bad debt

This section authorises the Commissioner to disallow the deduction if assessable income is injected into the company because of the availability of a bad debt.

Change

Clarify that it is assessable income that must be injected into the company for the deduction to be disallowed.

Explanation

Under the 1936 Act, the income injection test refers to income being derived because of the availability of the bad debt. This creates uncertainty because the term could be taken to mean income according to ordinary concepts, including exempt income. However, in the context of these tests,

especially having regard to their purpose, the only sensible meaning that can be given to the term is assessable income.

The change makes the law certain in its application.

Section 175-90 Second case: someone else obtains a tax benefit because of bad debt deduction available to a company

This section authorises the Commissioner to disallow the deduction if a person other than the company would obtain a tax benefit in connection with a scheme about bad debts.

Change

Give the term tax benefit, when used in this section, the same meaning as in Part IVA of the 1936 Act.

Explanation

Under the 1936 Act, the company bad debt provisions have a specific meaning for the term benefit. This meaning is slightly different from that in Part IVA of that Actie. the general anti-avoidance provision.

Broadly, the 1936 Act bad debt provisions state that a person receives a benefit in relation to the application of the income tax law to the extent that the persons income tax liability is reduced because of the scheme.

Under Part IVA the main circumstances where a person obtains a tax benefit are:

•

an amount is not included in the persons assessable income and that amount would have been included, or might reasonably be expected to be included, but for the scheme; or

•

a deduction is allowable to the person and the whole or part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, but for the scheme.

The effect of adopting the Part IVA definition is to narrow the focus of the benefit to income not being assessed or deductions being allowed. Also, the concept of reasonable expectation is introduced.

The adoption of the Part IVA definition increases consistency in the income tax law. Taxpayers will no longer need to take account of slight variations to what is essentially a single concept.

New Dictionary terms

The rewrite includes in the Dictionary (section 995-1 of the 1997 Act) definitions of first continuity period, minimum continuity period and second continuity period. [Schedule 9, items 58, 83 and 124] . These are concepts for defining the periods to be taken into account when testing for continuity of majority ownership and continuity of business.

C. Transitional arrangements

The rewritten bad debt rules for companies have effect for the 1998-99 and subsequent income years.

D. Consequential amendments

Amendment of the Income Tax Assessment Act 1997

The rewrite amends the 1997 Act to:

•

update references to provisions in the 1936 Act that have been rewritten in Subdivisions 165-C, 166-C and 175-C; and

•

insert definitions in the Dictionary in section 995-1.

Updated references

Section 12-5 of the 1997 Act lists all the provisions of the current law (in both the 1936 and 1997 Acts) that contain rules about specific types of deduction. The rewrite updates these lists so that they refer to the newly rewritten provisions about company bad debts and losses being inserted in the 1997 Act, instead of the provisions in the 1936 Act that they replace. [Schedule 3 Part 2 items 3 and 4]

Subsection 25-35(5) of the 1997 Act identifies provisions of the current law that contain rules about entitlement to deductions for bad debts. References in items 1 and 2 of subsection 25-35(5) to sections in the 1936 Act are updated so that they refer to provisions in the 1997 Act that replace them. [Schedule 3 Part 2 items 5 and 6]

Section 165-1 is amended to indicate that the coverage of Division 165 has been extended to include company deductions for bad debts. [Schedule 3 Part 2 item 7]

Section 165-195, which excludes redeemable shares from tests for continuity of majority beneficial ownership of a company, is amended so that it does not apply to shares allotted before the first date from which continuity of ownership is required in order to deduct any particular bad debt. [Schedule 3 Part 2 item 8]

Amendment of the Income Tax Assessment Act 1936

The rewrite amends the 1936 Act to:

•

close off the application of provisions of the 1936 Act that have been rewritten in Subdivisions 165-C and 175-C, so that the existing provisions generally apply only up to 30 June 1998; and

•

deal with references to provisions that have been rewritten by those Subdivisions.

Closing off the application of existing provisions

The rewrite inserts new provisions into the 1936 Act that close off the application of provisions that have been rewritten.

Sections 63A, 63B, 63C and 63CA need to be closed off so that they dont apply to bad debts deducted in 1998-99 or later income years because Subdivisions 165-C and 175-C now apply to those transactions. [Schedule 3 Part 2 items 13, 14, 15 and 16]

Dealing with existing references

Subsections 63A(14), 63B(11) and 63C(4) of the 1936 Act extend the application of the continuity of beneficial ownership, anti-avoidance and same business rules that apply to deductions for bad debts to deductions for debts that are extinguished in a debt/equity swap. The rewrite replaces these subsections with a new subsection in the 1936 Act (subsection 63E(5A)) that makes deductions for debts that are extinguished in a debt/equity swap subject to the rewritten bad debt provisions in the 1997 Act. [Schedule 3 Part 2 item 17]

The Commissioner can amend assessments within six years to give effect to provisions in the 1997 and 1936 Acts that are identified in subsection 170(13) of the 1936 Act. The reference to section 63B of the 1936 Act is removed as this section has been rewritten in Division 175 of the 1997 Act, which is already identified in subsection 170(13). [Schedule 3 Part 2 item 18]

Section 427 of the 1936 Act identifies provisions that are to be disregarded in calculating the attributable income of a Controlled Foreign Corporation. The reference in this section to section 63CA of the 1936 Act is replaced by a reference to the corresponding rewritten provision, ie. section 165-120 of the 1997 Act. [Schedule 3 Part 2 items 19 and 20]

Amendment of Commonwealth Acts

Commonwealth Acts (other than the 1936 Act and the 1997 Act) are amended as a result of the rewrite of the 1936 Act bad debts provisions.

The amendments consisting of items 21 to 24 in Schedule 3 update the Commonwealth Bank Sale Act 1995 and the Financial Corporations (Transfer of Assets and Liabilities) Act 1993. These items replace existing 1936 Act references with reference to the 1997 Act equivalents.

Chapter 4 - Intellectual Property

Overview

This chapter covers the rules that are dealt with in Division 373 of Part 2-10 of the 1997 Act that allow deductions for intellectual property.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C explains why some provisions of the 1936 Act have not been rewritten.

Part D explains the transitional provisions which set out how, and when, the new provisions apply.

Part E explains amendment that need to be made to the 1997 Act and the 1936 Act as a consequence of the rewritten 1936 Act.

A. Summary of the new law

Subdivision 373-A: Deduction for expenditure on registering items of intellectual property

What the Subdivision does

It allows a deduction for capital expenditure incurred in obtaining or seeking to obtain the registration of an item of intellectual property. [section 373-1]

The general rule

An amount can be deducted to the extent that the intellectual property is used to produce assessable income. [section 373-5]

Meaning of intellectual property

Intellectual property broadly means the rights held by an owner or licencee of a patent, copyright or registered design. [section 373-15]

Subdivision 373-B: Deduction for capital expenditure on intellectual property

What the Subdivision does

It allows a deduction for capital expenditure to acquire an item of intellectual property.

The general rule

The expenditure can be deducted in an income year if the item:

•

is owned by the taxpayer at the end of that year; and

•

has ever been used by the taxpayer to produce assessable income.

[section 373-10]

Amount that can be deducted

The deduction for a year is worked out by dividing the taxpayers unrecouped expenditure by the number of years remaining in the effective life of the intellectual property. [section 373-20]

Meaning of unrecouped expenditure

Unrecouped expenditure for an item of intellectual property is the taxpayers expenditure on the item reduced by the sum of:

•

any amounts the taxpayer has been allowed to deduct for it;

•

any consideration received by the taxpayer from its partial realisation; and

•

any amount the taxpayer could not deduct because the taxpayer obtained a benefit from outside Australia that related to it.

Unrecouped expenditure may also be increased if the taxpayer who granted the licence pays an amount to have the licence surrendered to him or her. [section 373-25]

Meaning of expenditure

A taxpayers deductible expenditure on an item of intellectual property may be calculated differently depending on how they came to own it. [section 373-30]

A table is provided which sets this out for each type of owner.

Effective life of intellectual property

Effective life varies for different types of intellectual property. It is generally linked to the period for which the intellectual property rights subsist under the relevant Commonwealth law. [section 373-35]

Subdivision 373-C: Partial realisation of intellectual property

What the Subdivision does

It specifies the consequences if an item of intellectual property is realised partially. [section 373-40]

Meaning of partial realisation of an item of intellectual property

A partial realisation happens if:

•

a part interest in the intellectual property is disposed of;

•

an interest in the patent, copyright or registered design is granted by licence;

•

an amount is received for the exploitation of the patent by the Commonwealth or a State or an authorised entity;

•

an amount is received for infringement of the patent, copyright or registered design.

[section 373-45]

Effect of a partial realisation of an item of intellectual property

A partial realisation of intellectual property can have three effects.

First, the unrecouped expenditure for the intellectual property is reduced by the amount obtained because of the partial realisation. [section 373-50]

Second, if the amount obtained from the partial realisation exceeds the unrecouped expenditure, the excess (subject to a limiting provision) is included in the taxpayers assessable income. [section 373-50]

Third, the part of the intellectual property remaining after the partial realisation is taken to be the same intellectual property as existed before the partial realisation.

[section 373-55]

Subdivision 373-D: Balancing adjustments

What the Subdivision does

It determines how to calculate a balancing adjustment. [section 373-60]

Purpose of a balancing adjustment

It is a final accounting to ensure that total deductions correspond to actual loss.

When to calculate a balancing adjustment

A balancing adjustment is calculated when a balancing adjustment event occurs in an income year. [section 373-60]

Meaning of balancing adjustment event

A balancing adjustment event happens if an item of intellectual property:

•

is disposed of;

•

ceases to exist;

•

is subject to a partial change of ownership;

or, where the item of intellectual property is a licence, it is surrendered. [section 373-60]

Inclusion of an amount in assessable income

An amount is included in the taxpayers assessable income if the termination value of the item of intellectual property exceeds its written down value. The amount to be included is the lesser of:

•

the excess; and

•

the total deductions for the item less any amount previously included in assessable income due to its partial realisation.

[section 373-65]

Deduction of an additional amount

An additional amount is deducted if the termination value of the item of intellectual property is less than its written down value. The amount that can be deducted is the difference. [section 373-65]

Termination value

Generally, the termination value of an item of intellectual property is its sale price (less expenses of sale). Other termination values apply if the intellectual property is disposed of other than by sale. [section 373-70]

Written down value

The written down value of an item of intellectual property is the unrecouped expenditure on the item immediately before the balancing adjustment event. [section 373-75]

Subdivision 373-E: Application of the common rules

What the Subdivision does

It explains that Common rules 1 and 2 (dealing respectively with roll-over relief for related entities and non-arm's length transactions) apply to this capital allowance. The common rules for capital allowances are contained in Division 41 of the 1997 Act. [section 373-80]

Modification of Common rule 1

Common rule 1 is modified in certain respects for this capital allowance. The most important of these modifications make it clear that, as transmissions by operation of law or partial realisations are not balancing adjustment events, roll-over relief is not available. [section 373-85]

Subdivision 373-F: Adjustments affecting deductions under this Division

What the Subdivision does

It states when a deduction is to be adjusted under this Division. It also sets out the circumstances in which unrecouped expenditure or expenditure on an item of intellectual property is adjusted.

Adjusting a deduction

A deduction is reduced if a benefit relating to the intellectual property is obtained from outside Australia.

[section 373-90]

Increasing unrecouped expenditure

Unrecouped expenditure for a licence may generally be increased by any amount incurred to obtain its surrender. A special rule applies if the taxpayer and the licencee are not dealing at arms length. [section 373-95]

Adjusting expenditure

Expenditure on an item of intellectual property is also adjusted in certain non-arm's length dealings.

[section 373-100]

If only a part of intellectual property is acquired from another entity, the expenditure may be adjusted.

[section 373-105]

B. Discussion of changes

Division 373-General

Removing discretions

The administrative discretions in Division 10B use the term an amount determined by the Commissioner. These are being replaced by objective tests based on reasonableness, eg. the inclusion of a reasonable amount.

New Labels

The term unit of industrial property has been replaced by the more meaningful intellectual property. Other new terms and their equivalents under the 1936 Act are as follows:

Section 373-30 Meaning of expenditure

This section contains a table which sets out what expenditure on intellectual property qualifies for deduction purposes.

1. Change

Provide that expenditure that gives rise to more than one item of intellectual property can only be written off once.

Explanation

An invention may give rise to a patent in many countries if multiple registration is sought. Thus an inventor may acquire several items of intellectual property from one invention.

The 1936 Act does not prevent the expenditure in devising the invention from being deducted in relation to each of the items of intellectual property.

The change is consistent with the general policy that an amount can only be deducted once for income tax purposes.

2. Change

Specify that market value applies in the non-arms length provisions.

Explanation

The 1936 Act uses the term value. In line with the approach adopted generally in the 1997 Act as exemplified by Common rule 2, this rewrite uses market value as the appropriate term.

Section 373-35 Effective life of intellectual property

This section explains how to determine the effective life of items of intellectual property.

1. Change

Extend the effective life of intellectual property in a standard patent to the end of the income year in which the 20th anniversary of the patent occurs.

Explanation

The original Explanatory Memorandum for Division 10B states that the effective life of a patent is linked to the period for which it is granted under the relevant Commonwealth law. In1995 the Patents Act 1990 was amended to extend the term of a standard patent granted after 1 July 1995, from 16 to 20 years. This change aligns the 1997 Act with the general law.

2. Change

Provide an effective life for petty patents that reflects their shorter duration.

Explanation

Petty patents, introduced to Australia in 1979, are designed for gadgets and appliances with a relatively short commercial life. A petty patent is granted initially for a term of one year, but may be extended for a further five years.

The 1936 Act does not provide for petty patents and they are treated as having the same effective life as standard patents.

This change makes specific provision for them and establishes their effective life consistently with the Patents Act 1990.

3. Change

Removal of a provision requiring the Commissioner of Taxation to determine the effective life of a work of joint authorship.

Explanation

Calculating the effective life of a work of joint authorship under the 1936 Act reflects copyright law as it stood in 1956. Under the Copyright Act 1968, the previous uncertainty in calculating effective life was removed.

The rewrite reflects the current copyright law. This enables the removal of a Commissioners discretion.

Section 373-45 Partial realisation of intellectual property

This section contains a table that explains how to determine the amount arising from the partial realisation of intellectual property.

1. Change

Specify that market value applies in the non-arms length provisions.

Explanation

The 1936 Act uses the term value. The rewrite specifies market value consistently with the use of that term in section 373-30.

2. Change

Ensure that only one taxpayer obtains a deduction for the same expenditure in a non-arms length partial realisation of intellectual property for no consideration.

Explanation

Broadly, the deduction allowable in realisations of this type is based on a calculation of what would have been payable as consideration in an arms length transaction. The rewrite guards against the unintended consequence of allowing both parties a deduction for the same expenditure by basing the amount of the deduction on the greater of market value and unrecouped expenditure.

3. Change

Prevent double deductions in an arms length partial realisation of intellectual property for no consideration.

Explanation

Generally, deductions for intellectual property on disposal and acquisition are based on what is paid for it. However, while the 1936 Act allows the acquirer to base a deduction on the items unrecouped expenditure, it also allows the disposer to calculate a deduction as if nothing had been received. The rewrite prevents an unintended consequence of allowing both parties a deduction for the same amount, by having both parties base their deduction on the unrecouped expenditure.

Section 373-70 Meaning of termination value

This section contains a table for calculating the termination value of intellectual property.

1. Change

Clarify the existing non-arms length provision by specifying that market value applies.

Explanation

The 1936 Act uses the term value. This rewrite specifies market value consistent with the use of that term in section 373-30.

2. Change

Provide that in a non-arms length disposal of intellectual property for no consideration, the termination value is the greater of market and written down values.

Explanation

Taking the termination value to be the market value can produce an inappropriate result - see example below. This result is avoided by taking the termination value to be the greater of market and written down values.

Example

X disposes of intellectual property to Y for no consideration in a non-arms length dealing. At that time the written down value of the intellectual property is $100 but the market value is $20. If value is taken as market value X would be entitled to a balancing deduction of $80 (ie. $100 written down value - $20 termination value).

Y's expenditure is equal to the written down value ($100). As Y is entitled to base a deduction on this amount, a double deduction would result.

3. Change

Provide that in an arms length disposal of intellectual property for no consideration, the termination value is the written down value.

Explanation

The 1936 Act does not provide a termination value in this case. This could result in double deductions for the same expenditure ie. with the same amount being deducted by a donor on disposal as is taken to be the donees expenditure. This is overcome by providing the termination value to be the written down value.

C. Provisions of the 1936 Act that have not been rewritten

Redundant provisions

Some provisions of the 1936 Act are redundant and have not been included in the 1997 Act. They are summarised in the following table:

Australian films

A review has recently been undertaken into Commonwealth assistance to the film industry.

The Government is presently considering the report on this review. Until a decision on it has been made by Government, these provisions will not be rewritten.

D. Transitional arrangements

The rewritten intellectual property provisions inserted by this Bill apply to assessments for the 1998-99 income year and later income years. [section 373-1]

When explaining how a specific provision of the rewritten law is to apply, the transitional provisions use the same section number as that provision.

The transitional provisions are explained in the following table:

E. Consequential amendments

Amendment of the Income Tax Assessment Act 1997

Part 2 of Schedule 4 contains amendments to the 1997 Act. It inserts references to Division 373 into the checklist of core provisions.

Updated references

Amendment of the Income Tax Assessment Act 1936

Items 12 to 27 in Part 3 of Schedule 4 contains amendments to the 1936 Act. These amendments:

•

close off application of that part of Division 10B that has been rewritten; and

•

substitute references to Division 373 in corresponding provisions of the 1936 Act.

Closing off the application of the existing provisions

Item 22 of Part 3, Schedule 4 closes off that part of Division 10B that has been rewritten, so that it only applies to the 1997-98 and earlier income years. Part of Division 10B of the 1936 Act remains operative for units of industrial property that relate to copyright in an Australian film. [Schedule 4, item 22] This complements the transitional provisions which ensure that the rewritten provisions apply to the 1998-99 and later income years.

Inserting references to rewritten provisions

References in the 1936 Act to former provisions are updated with references to the new provisions or expressions. [Schedule 4, items 12 to 21 and 23 to 27]

Chapter 5 - Horticultural plants

Overview

This chapter covers the rules that allow deductions for capital expenditure on establishing horticultural plants. These rules are in Subdivision 387-C of Part 3-45 of the 1997 Act.

Part A summarises these rules.

Part B identifies the changes to the 1936 Act.

Part C explains the transitional provisions which set out how and when the rewritten provisions apply.

Part D explains the amendments that need to be made to the 1997 Act and the 1936 Act as a consequence of the rewriting of the 1936 Act.

A. Summary of the new law

Subdivision 387-C: Establishing horticultural plants

What the subdivision does

Subdivision 387-C allows a deduction for capital expenditure on the establishment of horticultural plants used in horticulture businesses. [sections 387-160, 387-162]

The general rule

Capital expenditure on establishing a horticultural plant used for commercial horticulture is deductible.

[section 387-165]

Exceptions

The deduction is not available for capital expenditure that is:

•

on draining or clearing land;

•

otherwise deductible;

•

taken into account in working out a depreciation deduction; or

•

part of a pool of construction expenditure.

[section 387-195]

Limit on deductions

The deduction is not available for any period when the horticultural plant is not owned and used by the taxpayer for commercial horticulture. [section 387-165]

When the deduction commences

Deductions commence in the first year the horticultural plant is used or held ready for use for commercial horticulture. [section 387-165]

What period is the deduction available over?

The effective life of the horticultural plant determines the period over which the deduction is available.

[section 387-165]

Determination of effective life

The owner can either self assess the effective life or adopt the effective life determined by the Commissioner. This choice is made when the plant is first used (or held for use) in commercial horticulture. It can only be changed if a taxpayer chooses to adopt a later Commissioners determination. [section 387-175, 387-177]

Effective life of under three years

If the effective life of the horticultural plant is under three years the whole of its establishment expenditure is deductible in the year in which it is first used, or held ready for use, for commercial horticulture. [section 387-180]

Effective life of three years or more

If the effective life of the horticultural plant is 3 years or more, the deduction is worked out by applying specified write-off rates. [section 387-185]

Destruction of horticultural plant

If a horticultural plant with an effective life of three years or more is destroyed the balance of the capital expenditure less any amounts, such as insurance recoveries, received as a result of the destruction can be deducted in the year of destruction. [section 387-190]

Extended meaning of owner

The taxpayer owns a horticultural plant if:

•

it is on land held under lease or a quasi-ownership right granted by a government agency; and

•

it was planted by the holder of such a lease or right.

[section 387-210]

Notice requiring information upon transfer of ownership

If ownership of a horticultural plant is transferred, the transferee can give the transferor a written notice requesting relevant information. [section 387-205]

B. Discussion of changes

Section 387- 170 Meaning of horticultural plant, horticulture business, horticulture and commercial horticulture

1. Change

The term horticultural plant is defined in this section.

Explanation

The 1936 Act does not define this term. It relies on the definition of horticulture. The new definition provides greater clarity.

2. Change

The term commercial horticulture is defined.

Explanation

The term commercial horticulture has been adopted to provide a shorthand reference for the requirement that the horticultural plant be used for income producing purposes.

3. Change

The term horticulture business is defined.

Explanation

The business use requirement contained in the existing definition of horticulture has been removed and this term defined to make it clear that a deduction is only available when the horticultural plant is used in a business.

Section 387-175 Meaning of effective life

Change

The owner of a horticultural plant must choose its effective life at the time when it is first used, or held ready for use, for commercial horticulture.

Explanation

Under the 1936 Act, the owner of a plant works out its effective life at the time when it could first be used for commercial horticulture. This is so irrespective of whether the plant is in fact used for commercial horticulture at that time. It is more appropriate that the taxpayer who first uses a horticultural plant for income producing purposes should decide the effective life when it is first so used, on the basis of circumstances at that time.

Section 387-177 Choosing to adopt a retrospective determination

Change

Specify a time when the choice to adopt a retrospective determination must be made.

Explanation

The 1936 Act does not nominate the period within which taxpayers can adopt a Commissioners subsequent determination. The rewritten law sets out that such a choice can be made at any time prior to lodgement of the first return after the determination is issued. The Commissioner can extend this time.

Section 387-195 Expenditure you cannot deduct

Change

Modify the operation of the provision that ensures double deductions are not available for the same expenditure.

Explanation

Under the 1936 Act, the horticultural plants write-off comes behind other deductions. This is achieved by excluding from the write-off expenditure deductible under another provision of that Act. By oversight, the 1936 Act also excludes expenditure that is specifically made deductible under another provision of the horticultural plants write-off. The rewrite corrects this error.

Section 387-205 Requirement to comply with notice

Change

Delete the element of recklessness from an offence provision.

Explanation

Under the 1936 Act, the transferee of a horticultural plant is entitled to serve a notice requiring the transferor to provide certain information about the plant. It is an offence to intentionally or recklessly refuse or fail to comply with such a notice. The rewrite omits the element of recklessness to bring the law into line with the current approach to penalty provisions taken by the Commonwealth.

C. Transitional arrangements

The purpose of the transitional provisions is to explain how taxpayers who write off capital expenditure on establishing horticultural plants under the 1936 Act can continue to write it off under the 1997 Act. The transitional provisions also preserve determinations made by the Commissioner under the 1936 Act.

The rewritten provisions apply to assessments for the 1998-99 or later income years.

D. Consequential amendments

Application of amendments

The consequential amendments apply to assessments for the 1998-99 and later income years. This ensures that the consequential amendments take effect at the same time as the rewritten provisions relating to capital expenditure on establishing horticultural plants.

Chapter 6 - Averaging of primary producers' tax liability

Overview

This chapter covers the rules that help to even out primary producers tax liabilities from year-to-year. These rules are in Division 392 of Part 3-45 of the 1997 Act. Part A summarises these rules. Part B explains the changes to the 1936 Act. Part C explains why some provisions of the 1936 Act have not been rewritten. Part D explains the transitional provisions which set out how and when the rewritten provisions apply. Part E explains the amendments that need to be made to the 1997 Act and the 1936 Act as a consequence of rewriting the 1936 Act.

Part A summarises these rules.

Part B explains the changes to the 1936 Act.

Part C explains why some provisions of the 1936 Act have not been rewritten.

Part D explains the transitional provisions which set out how and when the rewritten provisions apply.

Part E explains the amendments that need to be made to the 1997 Act and the 1936 Act as a consequence of rewriting the 1936 Act.

A. Summary of the new law

Division 392: Long term averaging of primary producers tax liability

Is your income tax affected by averaging? [Subdivisions 392-A, 392-D]

Subdivisions A and D tell you whose income tax is subject to averaging

Averaging applies to individuals who carry on a primary production business. [section 392-10]

Most beneficiaries of trust estates that carry on a primary production business will also have their income tax liability smoothed. [section 392-20]

When does averaging first apply?

Averaging commences in the first assessment after the primary production business commences, in which basic taxable income is greater than or equal to what it was in the previous year.

In loss years, income is taken to be nil, so that two consecutive years as a primary producer with net losses will commence averaging. [section 392-10]

Basic taxable income

Some items of taxable income, such as net capital gains, are ignored in averaging calculations. Basic taxable income refers to taxable income less those items.

[section 392-15]

When does averaging cease to apply?

Averaging ceases to apply in the first year in which

•

the taxpayer no longer carries on the primary production business; and

•

their assessable income does not include income from that business.

[section 392-10]

What if the taxpayer doesn't want averaging to apply?

You can choose not to have your income tax averaged, but that choice is final. [section 392-25]

What if taxable income is permanently reduced?

Subdivision 392-D allows averaging to recommence if basic taxable income is permanently reduced to less than two thirds of average income.

If such a permanent reduction has occurred, the taxpayer may choose that

•

averaging does not apply for that year; and

•

the Division applies in later years as if the taxpayer had not carried on a business of primary production previously.

[section 392-95]

What kind of averaging adjustment must be made? [Subdivision 392-B]

What the Subdivision does

Subdivision 392-B explains how to work out the kind of averaging adjustment which can be made. [section 392-30]

Tax will be adjusted if some of the taxpayer's income is subject to averaging.

In high income years, when average income is less than basic taxable income, there will be an entitlement to a tax offset. In low income years, when average income is greater than basic taxable income, there will be a liability for extra income tax. [subsections 392-35(2), (3)]

The adjustment is the amount of tax offset or the amount of extra income tax payable to even out long term tax liability. [section 392-5]

What adjustment must be made?

The adjustment is worked out by comparing the income tax at basic rates on basic taxable income with a notional amount of tax. The notional amount is worked out by applying a special rate, the comparison rate, to basic taxable income. [subsection 392-35(1)]

Average income

Average income is usually the average of basic taxable incomes over the last five years. However, if averaging has applied in yourassessments for less than four years, basic taxable incomes beginning with the year before the year in which averaging first applied are averaged.

[section 392-40 and subsection 392-45(1)]

Basic rates of tax

The basic rates of tax are those set out in Schedule 7 of the Income Tax Rates Act 1986, excluding special rates such as those applied to uncontrolled partnership income. [subsections 392-35(4), (5)]

Comparison rate

The comparison rate is the overall rate of tax that would be payable if taxable income was the same as average income. [sections 392-50, 392-55]

Working out the averaging adjustment [Subdivision 392-C]

What this Subdivision does

This Subdivision determines the amount of the averaging adjustment (ie. the amount of the tax offset or the amount of extra income tax payable by the taxpayer as a result of the application of the averaging provisions.) [section 392-60]

Working out the adjustment

To work out the averaging adjustment it is necessary to work out the averaging component. Basically, this is the amount of taxable income that is subject to adjustment under averaging provisions. [sections 392-75 & 392-80]

Factors affecting the averaging component

The averaging component depends on the net income derived from theprimary production business (taxable primary production income) and net income derived from other sources (taxable non-primary production income). [section 392-65]

In working out these amounts, some components of assessable income are omitted, and there are special rules for apportioning deductions. A loss amount is taken to be nil. [sections 392-80, 392-85]

Taxable primary production income is always part of the averaging component. [section 392-90]

How much non-primary production income is included?

Some or all of your taxable non-primary production income may also be included in the averaging component:

It is included in full where taxable non-primary production income is less than $5000 (the non-primary production shade out amount is included where taxable non-primary production income is between $5000 and $10,000.)

If the taxable non-primary production income is $10,000 or more, the averaging component equals the taxable primary production income.

[subsection 392-90(1)]

B. Discussion of changes

Structure and Terminology

1. Change

Restructure the existing law to provide answers to practical questions in a logical order.

Explanation

In the 1936 Act, the answers to common problems such as how to calculate adjustments are obscured by a less than helpful arrangement of provisions, and a web of interlocking definitions. The rewritten law adopts three key building blocks:

•

the assessments it applies to;

•

the nature of the tax adjustment; and

•

the amount of that adjustment.

The rewritten law works through calculations in a logical sequence.

2. Change

Clarify existing definitions and clearly define new terms.

Explanation

The 1936 Act defines some key terms more than once. The rewritten law defines eachtermonce,and labels each term so as to indicate its meaning. The definitions, and their equivalents in the 1936 Act, are as follows:

Section 392-10 Continuation of averaging where primary production business has ceased

Change

Allow a taxpayer who receives income from a primary production business which ceased in an earlier year to even out their tax liability.

Explanation

Under the 1936 Act, only individuals who carry on a primary production business in an income year qualify for averaging in that year. For many years, the Commissioner has applied averaging to taxpayers on the basis of continuity of income from year-to-year, even where the business has ceased. The rewritten law incorporates this administrative practice.

Section 392-95 Permanent reduction of income

1. Change

Clarify that it is optional to recommence averaging when a permanent reduction of income occurs.

Explanation

In the 1936 Act, averaging recommences if a taxpayer establishes that taxable income has been permanently reduced. The rewritten provision makes it clear that averaging recommences only if a taxpayer, having established that taxable income has been permanently reduced, chooses to recommence averaging. This is consistent with current administrative practice.

2. Change

Specify when the choice to recommence averaging must be made.

Explanation

The 1936 Act is silent about the period within which taxpayers may choose to recommence averaging. The rewritten law spells out that the choice to recommence averaging can be notified at any time prior to lodgement of the return for the year in which income was permanently reduced. The Commissioner can extend the time limit.

C. Provisions of the old law that have not been rewritten

Two redundant 1936 Act provisions are not included in the rewritten law. They are summarised in the following table:

D. Transitional arrangements

The purpose of the transitional provisions is to explain how taxpayers who are currently subject to primary producer averaging under the 1936 Act can continue to have their tax liabilities averaged under the 1997 Act.

When explaining how a specific provision of the 1997 Act is to apply, the transitional provision uses the same section number as the corresponding 1997 Act provision.

Application

The transitional provisions, described in the following table, apply the rewritten provisions to assessments for the 1998-99 and later income years.

E. Consequential amendments

Amendments of the Income Tax Assessment Act 1997

The 1997 Act is amended to:

•

insert a signpost provision in the core provisions. This provision, section 4-25, alerts readers to the existence of a small number of provisions in the 1936 Act that apply special tax treatment to a component of taxable income. [Schedule 6 Part 2 items 2 and 3]

•

update references to provisions rewritten in Division 392. These are set out in the following table:

These amendments apply to assessments of income tax for the 1998-99 and later years. This ensures that these consequential amendments take effect at the same time as Division 392.

Amendments of the Income Tax Assessment Act 1936

The provisions allowing averaging adjustments for individuals under the 1936 Act areclosed off and references to the rewritten provisions replace references to the 1936 Act.

Closing off the existing provisions

New subsection 156(1A) is inserted into the 1936 Act to close off the application of the provisions providing for averaging adjustments for individuals under the 1936 Act. This change applies to income tax assessments for the 1998-99 and later years.

Inserting references to the rewritten provisions

The provisions in the following tables are amended to replace references to the averaging provisions of the 1936 Act with references to the averaging provisions of the 1997 Act.

These amendments apply to assessments of income tax for the 1998-99 and later years:

The following amendments apply in working out provisional tax in respect of income of the 1999-2000 and later income years:

Amendments of the Income Tax Rates Act 1986

Imposition of extra tax where averaging increases tax liability

Where the averaging provisions in the 1936 Act result in an increase in tax payable, subsection 12(3) of the Income Tax Rates Act 1986 sets a rate of complementary tax which effectively imposes the adjustment. Section 20G of the Income Tax Rates Act 1986 reduces this rate in some circumstances to ensure that primary producers receive the full benefit of Family Tax Assistance.

Amendments to the Income Tax Rates Act 1986 replace these provisions, to the extent that they apply to individuals, with a single provision setting the rate for extra income tax calculated by proposed subsection 392-35(3). A number of other amendments result from the above change.

References to the 1936 Act are replaced with references to the 1997 Act.

Inserting references to the rewritten provisions

Application of amendments

The amendments to the Income Tax Rates Act 1986 apply to assessments of income tax for the 1998-99 and later years.

Chapter 7 - Environment protection

Overview

This chapter covers the rules for deducting expenditure incurred on environmental impact assessment and environmental protection. These rules are in Division 400 of Part 3-45 of the 1997 Act.

Part A of this chapter summarises these rules.

Part B explains the changes to the 1936 Act.

Part C explains the transitional provisions which set out how and when the rewritten provisions apply.

Part D explains the amendments that need to be made to the 1997 Act and the 1936 Act as a consequence of rewriting the 1936 Act.

A. Summary of the new law

Division 400: Environmental impact assessment and environmental protection

Deducting expenditure on environmental impact assessment [Subdivision 400-A]

What the Division does

Division 400 contains two capital allowances for most expenditure (whether capital or otherwise) incurred on:

•

determining the impact of an income earning project on the environment [Subdivision 400-A]; or

•

preventing or treating waste or pollution of the environment as a result of an income earning project [Subdivision 400-B].

The deduction under Subdivision 400-A is generally allowable over 10 years, but it may be less depending on the estimated life of the project. The Subdivision 400-B deduction is immediate.

Division 400 also provides that property used for environmental impact assessment or environmental protection activities is taken to be used to produce assessable income for the purposes of either the 1936 Act or the 1997 Act. This may result in expenditure on that property being deductible under other provisions of those Acts rather than Division 400. [section 400-1]

Test for deduction

Expenditure can be deducted in an income year to the extent to which it is incurred for the sole or dominant purpose of evaluating the impact, or likely impact, on the environment of a project that is carried out for the purpose of producing assessable income. Expenditure on activities to investigate the impact of the project and activities to record or report on the project's impact is deductible.

[subsection 400-15(1)]

Amount and timing of deduction

Where:

•

the project is estimated to last 10 years or more; or

•

it cannot reasonably be estimated when the project will end,

the amount deducted is one-tenth of the expenditure in the year in which it is incurred and one-tenth in each of the following nine income years. [items 1 and 2 of the table in subsection 400-15(3)]

The deduction period may be less than 10 years. [items 3, 4 and 5 of the table in subsection 400-15(3)]

The project's life is estimated at the end of the income year in which the expenditure is incurred. That estimate has regard to the period over which the project is expected to earn assessable income for any person. [table in subsection 400-15(3)]

Limits on deduction

Last deduction

Deductions are not taken under this provision if the expenditure attracts a deduction elsewhere under either the 1936 or 1997 Act. [paragraph 400-20(1)(a)]

Plant

The cost of plant is excluded from the deduction. [paragraph 400-20(1)(b)]

Non-arm's length transactions

Common rule 2 (Non-arm's length transactions) of Division 41 (Common rules for capital allowances) applies with modifications. [subsections 400-20(2) and (3)]

Limits on section 8-1

If a provision of either the 1997 Act or the 1936 Act limits the operation of the main deduction provision, it also limits the deduction allowable under this Subdivision. [subsection 400-20(4)]

Deducting expenditure on environmental protection activities

[Subdivision 400-B]

The general rule is

Expenditure is immediately deductible to the extent to which it is incurred for the sole or dominant purpose of carrying on environmental protection activities. [section 400-55]

What are environmental protection activities?

Environmental protection activities are activities to:

•

prevent, fight or remedy pollution of the environment; or

•

treat, clean up, remove or store waste.

The pollution or waste must:

•

result, or be likely to result, from your earning activity; or

•

be on or from the site of your earning activity; or

•

be on or from a site where an entity carried on a business that you acquired and carry on substantially unchanged as your earning activity.

[subsection 400-60(1)]

What is your earning activity?

Your earning activity is one that will, or is proposed to, produce assessable income. It includes an investment activity; but not an activity to produce a capital gain. [subsection 400-60(2)]

Limits on deduction

Certain expenditure not deductible

Expenditure is not deductible under this Subdivision if it is on:

•

acquiring land; or

•

constructing, extending, altering or improving a building, structure or structural improvement which is of a capital nature; or

•

a bond or security for the performance of environmental protection activities.

[paragraphs 400-65(1)(a), (c), (d) and (e)]

Other limits

The Subdivision otherwise contains the same kinds of limits as Subdivision 400-A. [balance of section 400-65]

Property taken to be used for producing assessable income

[Subdivision 400-C]

B. Discussion of changes

Division 400 Environmental impact assessment and environmental protection

Division 400 sets out the conditions under which a deduction is allowable for expenditure on environmental impact assessment and environmental protection.

Change

The word environment is not defined in Division 400.

Explanation

The definitions of environment in sections 82BA and 82BJ of the 1936 Act do not clarify or extend the ordinary meaning of the word. Consequently, in restating the old law, the word has not been defined.

Section 400-15 Deducting expenditure on environmental impact assessment of your project

This section explains when expenditure on environmental impact assessment can be deducted.

Change

This section replaces the 1936 Act definitions of allowable environmental impact expenditure, eligible environmental impact activities and income-producing project by combining their effect.

Explanation

This section replaces sections 82BC and 82BD and the definition of income-producing project in section 82BA of the 1936 Act by merging them. The new section does not restate paragraphs (a), (b) and (c) of the definition of eligible environmental impact activity in section 82BD, because it is arguable that they could apply the deduction more narrowly than is intended.

To be deductible, expenditure must still be incurred on activities which are for the sole or dominant purpose of evaluating the impact or likely impact on the environment of an income earning project. Expenditure on activities to measure the economic feasibility of a project is not deductible.

For example, suppose the Hardwood Milling Company carries out an environmental impact study of proposed native forest logging as required by a local authority. It details the impact of its operations on the forest and sets out the economic benefits of its project, including an estimate of the jobs to be created. Expenditure on these activities would be deductible. But if the expenditure also related to activities Hardwood carried out to determine the economic feasibility of the project, say measuring the likely profit and the period for which profitable operations can be sustained, the expenditure would have to be apportioned.

Section 400-60 Meaning of environmental protection activities

This section defines the key concept environmental protection activities.

Change

Subdivision 400-B does not restate the definition of site in the 1936 Act.

Explanation

Section 82BJ of the 1936 Act defined site to include part of a site. The definition of site is unnecessary in Subdivision 400-B because the key concept environmental protection activities refers to pollution of or from a site of an income earning activity.

C. Transitional arrangements

Part 1 of Schedule 7 of this Bill contains the amendments to the Income Tax (Transitional Provisions) Act 1997 (the Transitional Provisions Act) to provide the transitional provisions required to give effect to the rewritten sections.

These transitional measures will be located in Division 400 in Part3-45 of the Transitional Provisions Act. New Division 400 sets out how and when the rewritten sections apply.

E. Consequential amendments

Amendments of the Income Tax Assessment Act 1997

Part 2 of Schedule 7 of this Bill contains amendments to the 1997 Act to insert references to Division 400 in provisions that refer to the equivalent provisions of the 1936 Act. Updated references

Updated references

Application of amendments

The consequential amendments to the 1997 Act apply to assessments for the 1998-99 and later income years. [clause 4 of the Bill] This ensures they take effect at the same time as Division 400.

Amendments of the Income Tax Assessment Act 1936

Amendments to the 1936 Act:

•

close off provisions rewritten in Division 400, so that they apply only to the 1997-98 and earlier income years; and

•

substitute references to Division 400 for references to corresponding provisions of the 1936 Act.

Closing off the application of the existing provisions

Provisions inserted into the 1936 Act close off its application of provisions rewritten in Division 400 so that they only apply to the 1997-98 and earlier income years. [Schedule 7, Part 3: items 12-17] This complements the transitional provisions which ensure that the rewritten provisions apply to the 1998-99 and later income years.

Inserting references to rewritten provisions

References in the 1936 Act to provisions rewritten in Division 400 are replaced by references to the new provisions. [Schedule 7, Part 3: items 18 and 19]

Application of amendments

The consequential amendments to the 1936 Act apply to assessments for the 1998-99 and later income years. [clause 4 of the Bill] This ensures they take effect at the same time as Division 400.

Chapter 8 - Above-average special professional income

Overview

This chapter covers the rules that allow the income of some professionals to be averaged. These rules are in Subdivision 405 of Part 3-45 of the 1997 Act.

Part A summarises these rules.

Part B identifies the changes to the 1936 Act.

Part C explains the transitional provisions which set out how and when the rewritten provisions will apply.

Part D explains the amendments that need to be made to the 1997 Act and the 1936 Act and other Commonwealth legislation, as a consequence of the rewriting of the 1936 Act.

A. Summary of the new law

Division 405: Above-average special professional income

What the Division does

Division 405 reduces the effect that fluctuations in special professional income would otherwise have on the income tax liability of authors, inventors entertainers and sportspersons.

It does this by applying special rates of tax to taxable income that includes above-average special professional income which, when added to other income, moves the taxpayer into a higher tax bracket.

Above-average special professional income is worked out by comparing taxable professional income for the year with the average of taxable professional incomes over a maximum of the last four years. [sections 405-1 & 405- 5]

Who does this Division apply to?

Application

This Division applies to:

•

authors of literary, dramatic, musical or artistic works;

•

inventors;

•

performing artists;

•

production associates;

•

sportspersons; [section 405-25]

who are Australian residents for at least part of the income year. [subsection 405-15(1)]

Joint works

Joint authors and inventors are treated in the same way as sole authors or inventors. [section 405-40]

Calculating above-average special professional income

Working out taxable professional income

Taxable professional income is assessable income from the following sources:

•

services rendered;

•

prizes;

•

promotions and commentary work;

•

assigning or licensing intellectual property in a work or invention; and

•

any other assessable income from works or inventions;

(called assessable professional income) reduced by any deductions relating to the derivation of that income. [sections 405-20, 405-35 & 405-45]

Authors and inventors who provide services to others

Income derived from rendering services to another person is assessable professional income if the service is for a specific work or invention, and is not part of a substantial continuity in services. [subsection 405-30(1)]

Exclusions

Assessable professional income does not include assessable income from:

•

coaching, umpiring or administering sporting activities;

•

being a member of the pit crew in motor sport;

•

being a theatrical or sports entrepreneur;

•

owning or training animals;

•

termination payments, including those in lieu of leave; or

•

capital gains.

[subsection 405-30(2)]

If an amount of assessable income consists of both assessable professional income and other income, then the amount to be attributed to assessable professional income is determined on a reasonable basis. [section 405-35]

Working out average taxable professional income

If:

•

taxable professional income for the year exceeds $2500 (or did in a prior year in which the taxpayer was an Australian resident); [paragraph 405-15(1)(d)] and

•

the first professional year was four or more years ago

the sum of all taxable professional income received over the last four income years is divided by four to arrive at average taxable professional income. [section 405-50]

Phasing-in arrangements apply if the first professional year was within four years. [section 405-50]

Above-average special professional income.

If taxable professional income exceeds average taxable professional income, the excess is the above-average special professional income. [subsection 405-10(3)]

B. Discussion of changes

Removal of discretions

Change

Objective tests replace administrative discretions.

Explanation

The following discretions have been removed and replaced with objective criteria, to be consistent with self-assessment.

New terms

1. Change

Some of the key concepts concerning the income of special professionals are given new labels.

Explanation

The new terms and their 1936 Act equivalents are:

2. Change

The term associate is given a standardised meaning.

Explanation

Under the 1936 Act, associate takes on the meaning in subsection 26AAB(14) of that Act. The rewrite uses a standardised definition. The differences are minor and have no significant effect on the treatment of income averaging for special professionals.

C. Transitional arrangements

The rewritten provisions apply to assessments for the 1998-99 and later income years.

The averaging process requires taxable professional incomes for the four income years prior to the current year to be used. For income years earlier than the 1998-99 income year, taxable professional income is what was known as eligible taxable income under the 1936 Act.

[section 405-1 of the Income Tax (Transitional Provisions ) Act 1997]

D. Consequential amendments

Amendments of the Income Tax Assessment Act 1936

Other amendments to the 1936 Act:

•

close off the application of provisions of the 1936 Act that have been rewritten in Division 405; and

•

insert references in the 1936 Act to those rewritten provisions where the 1936 Act currently refers to the existing provisions.

Closing off the eligible person averaging provisions

New section 158BA is inserted into the 1936 Act to close off the application of existing provisions that have been rewritten. This applies to assessments for the 1998-99 and later income years. [Schedule 8, Part 3: item 1]

Inserting references to the rewritten provisions

The provisions in the following tables replace references to the existing provisions with references to the rewritten provisions.

The following amendment applies to assessments for 1998-99 and later years:

The remaining amendments apply in working out provisional tax on income of the 1999-2000 and later income years:

Amendments of the Income Tax Rates Act 1986

Amendments to the Income Tax Rates Act 1986 replace references to abnormal income amount with references to above-average special professional income. [Schedule 8, Part 3: item 10]

Chapter 9 - Dictionary

Overview of this chapter

The Tax Law Improvement Bill (No. 2) 1997 will add a number of new definitions to the Dictionary of defined terms contained in the 1997 Act.

Part A of this chapter summarises how you can locate the definitions in the new law.

Part B explains how the Bill will incorporate the new definitions.

Part C lists the new definitions and explains any departures from definitions in the existing law.

A. How the definitions can be located

The Dictionary, found at the end of the 1997 Act (in Chapter 6), is the central reference point for locating the meanings of defined terms used in the new law.

All defined terms are listed in section 995-1. Each entry in that section either:

•

sets out the defined term and its meaning; or

•

directs the reader to where the term is defined in the general body of the Act.

The location point for the detail of definitions is signposted in many cases. The signposting complements the design feature of locating definitions at the place where readers will find the information most convenient and helpful to their understanding of the law.

All defined terms (except a small number of common terms) will be identified by an asterisk *, which will precede the term the first time it is used in each subsection.

Chapter 12 of the Explanatory Memorandum to the 1997 Act has a more detailed explanation of how the new law deals with definitions.

B. New definitions incorporated by the Bill

The rewritten provisions that this Bill will insert into the 1997 Act include many terms not previously defined.

Schedule 10 of this Bill will add Dictionary references to all new defined terms that are being inserted into the 1997 Act.

C. Discussion of the definitions

This Part of the chapter lists all the definitions that the Bill adds to the 1997 Act. It also lists definitions already in the 1997 Act that this Bill modifies.

If there is a change in the use of a term, or a new term has been used, the list generally directs readers to the subject chapter that explains the change or new term. The explanations are included in Part B (Discussion of changes) of each subject chapter. In some cases (particularly if the meaning of a term is actually explained in the Dictionary), the list itself explains a change to a term, instead of referring the reader to a subject chapter.

Part B of each subject chapter also discusses changes to the law caused by adopting a definition already in the 1997 Act (eg. using a standard definition instead of a slightly modified one).

In the following explanations:

No Change means that the term and its meaning from the 1936 Act are unchanged, although the words may have been changed to use a clearer or simpler style.

New label, previously [word or expression] means that a concept called '[word or expression]' in the 1936 Act has been given a new label in the 1997 Act.

New term means that the term is not defined in the 1936 Act.

Revised definition means that there has been change in the meaning of the term appearing in the 1997 Act compared with the 1936 Act.

Chapter 10 - Finding tables

Overview

This part contains finding tables to enable you to locate quickly the provision in this Bill that corresponds to a particular provision in the Income Tax Assessment Act 1936, and vice versa.

In the finding tables:

•

No equivalent means that this is a new provision that has no equivalent in the law being rewritten. Typically, these would be guide material.

•

Omitted means that the provision of the old law has not been rewritten in the new law.

•

# indicates that the provision is already present in the Income Tax Assessment Act 1997.

Finding Table 1 - New Law to Old Law