House of Representatives

Tax Laws Amendment (2010 Measures No. 4) Bill 2010

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 3 - Amendments to the taxation of financial arrangements provisions

Outline of chapter

3.1 Part 1 of Schedule 3 to this Bill amends:

·
Division 230 of the Income Tax Assessment Act 1997 (ITAA 1997); and
·
the consequential and transitional provisions inserted by the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 (TOFA Act 2009).

3.2 Part 2 of Schedule 3 to this Bill extends the transitional arrangements relating to the application of the debt/equity rules made by the New Business Tax System (Debt and Equity) Act 2001 (Debt and Equity Act 2001) for Upper Tier 2 instruments to 1 July 2010, for instruments issued before 1 July 2001.

3.3 All references to legislative provisions in this chapter are references to the ITAA 1997 unless otherwise stated.

Context of amendments

3.4 The TOFA Act 2009, which received Royal Assent on 26 March 2009, inserted Division 230 into the ITAA 1997. Division 230 modernises the financial taxation system by better reflecting the economic and commercial substance of financial arrangements.

3.5 Division 230 applies for income years commencing on or after 1 July 2010, unless a taxpayer elects to apply the Division for income years commencing on or after 1 July 2009.

3.6 Division 230 represents a major legislative reform that affects a wide range of financial arrangements, including those of a complex nature. The amendments to Division 230, announced by the then Assistant Treasurer in Media Release No. 043 on 4 September 2009, follow the Government's monitoring of the implementation of this reform.

3.7 The Debt and Equity Act 2001 contains a transitional measure that allowed taxpayers to apply the tax rules prior to the introduction of Division 974 to instruments issued before 1 July 2001 (unless taxpayers elect to bring those instruments within the scope of Division 974).

Summary of new law

Amendments to Division 230 and the consequential and transitional provisions inserted by the TOFA Act 2009

3.8 The amendments to Division 230 and the consequential and transitional provisions inserted by the TOFA Act 2009 include:

·
minor policy refinements;
·
technical amendments to clarify and give better effect to the policy intention of Division 230; and
·
minor technical corrections to address drafting oversights.

3.9 These amendments mandatorily take effect for income years starting on or after 1 July 2010. The amendments take effect for income years starting on or after 1 July 2009, if an election is made to have the TOFA Act 2009 apply from that earlier time, except for items 95, 131 and 135 which have different commencement dates as set out in this Bill.

Minor policy and technical amendments

Core rules

3.10 This Schedule amends the scope of the term 'cash settlable', in respect of a financial arrangement, so that if a financial benefit is readily convertible into money or money equivalent and there is a market for the financial benefit that has a high degree of liquidity, then a right to receive, or an obligation to provide the financial benefit is cash settlable if:

·
the amount of the money, or money equivalent, in the hands of the entity who has the right to receive the financial benefit(s), is not subject to a substantial risk of substantial decrease in value; or
·
the purpose of entering into the arrangement, under which the financial benefit is received or provided, is to receive or provide the financial benefit to raise or provide finance, or so that the financial benefit may be liquidated or converted into money or money equivalent (other than as part of a taxpayer's expected purchase, sale or usage requirements).

3.11 This Schedule clarifies that a dividend on certain shares that are 'debt interests', as defined in Division 974, may be deductible in certain circumstances, consistent with the corresponding deductibility provision in section 25-85.

Accruals/Realisation

3.12 This Schedule clarifies that:

·
for the purposes of the accruals tax timing methodology in Subdivision 230-B, it is only that part of a financial benefit which is, at the relevant time, fixed or determinable with reasonable accuracy that is to be treated as 'sufficiently certain';
·
a pro-rata basis for attribution of a gain or loss in relation to the effective interest method or portfolio treatment of fees is not necessarily unreasonable; and
·
for the purposes of determining if a financial benefit is sufficiently certain, where all the financial benefits provided and received under a financial arrangement are in a particular foreign currency, they are not to be translated into Australian currency or a taxpayer's applicable functional currency.

Hedging

3.13 This Schedule ensures that:

·
a financial arrangement can qualify as a hedging financial arrangement where it hedges a risk in relation to multiple hedged items;
·
a hedging financial arrangement can exist where an arrangement that hedges a risk in relation to foreign currency is recorded as a hedging instrument in an entity's own financial reports; and
·
consequences arise where an entity ceases to have one or more, but not all, hedged items and provides reasonable attribution rules to ensure that appropriate gains and losses are brought to account when this occurs.

Foreign currency retranslation

3.14 This Schedule amends the foreign currency retranslation provisions to ensure that the wording of the provisions is consistent with the relevant accounting standards.

Scope and exceptions

3.15 This Schedule clarifies that:

·
an interest in a partnership or trust is subject to Division 230 where a fair value or reliance on financial reports election has been made. This is despite the fact that an interest in a partnership or trust is carved out of Division 230 for all other purposes; and
·
certain guarantees and indemnities, although subject to an exception to Division 230, are subject to Division 230 where a fair value or reliance on financial reports election has been made.

3.16 This Schedule amends the assets threshold test so that it applies to regulated superannuation funds and unregulated superannuation funds on the same basis.

Amendments to consequential and transitional amendments in the TOFA Act 2009

3.17 This Schedule makes the following technical amendments to the consequential and transitional amendments in the TOFA Act 2009 to:

·
put it beyond doubt that the net income of a transferor trust disregards Division 230;
·
modify the references to 'accounting standards' in Division 230 so that they extend to accounting standards formulated or made by the Australian Accounting Standards Board (AASB); and
·
modify the references to 'auditing standards' in Division 230 so that they encompass auditing standards formulated or made by the Auditing and Assurance Standards Board.

3.18 This Schedule reinstates the anti-overlap rule that ensures that the tax exempt asset financing provisions have priority over the capital gains tax (CGT) provisions.

3.19 This Schedule extends the application of the transitional provisions in the TOFA Act 2009 to include paragraph 230-165(1)(b). An entity can then apply the portfolio treatment of premiums and discounts, notwithstanding the entity held the financial arrangement prior to the income year in which an election was made under section 230-150.

Minor technical corrections

3.20 The minor technical corrections include:

·
correcting referencing, including the use of asterisks;
·
correcting typographical errors; and
·
re-inserting provisions which were incorrectly repealed by the TOFA Act 2009.

Amendments to transitional provisions in the Debt and Equity Act 2001

3.21 Part 2 of this Schedule extends the debt/equity transitional period to 1 July 2010 for Upper Tier 2 instruments that were issued before 1 July 2001, to allow transition to the proposed regulations that will facilitate the debt tax treatment of certain Upper Tier 2 instruments.

Comparison of key features of new law and current law

New law Current law
The new elements of the definition of 'cash settlable' rights or obligations are satisfied where:

·
the amount of the money or money equivalent to the recipient of the relevant financial benefit is not subject to a substantial risk of substantial decrease in value; or
·
the taxpayer's purpose for entering into the arrangement (under which the financial benefit is to be provided or received) is to either receive or deliver the financial benefit:

-
to raise or provide finance; or
-
to convert or liquidate the financial benefit into money or money equivalent (other than as part of the taxpayer's expected purchase, sale or usage requirements).

The relevant current elements of the definition of 'cash settlable' rights or obligations are satisfied where:

·
the amount of the money or money equivalent in respect of the relevant financial benefit is not subject to a substantial risk of change in value; or
·
the taxpayer's purpose for entering into the arrangement (under which the financial benefit is to be provided or received) is to either receive or deliver the financial benefit so that it may be converted or liquidated into money or a money equivalent (other than in the ordinary course of business).

Where a taxpayer does not have an applicable functional currency, and all of the financial benefits under an arrangement are denominated in a particular foreign currency, the financial benefits are not to be translated into Australian currency for the purpose of determining whether the financial benefits are sufficiently certain. Only taxpayers with an applicable functional currency are not required to translate where all of the financial benefits under an arrangement are denominated in a particular foreign currency, for the purpose of determining sufficient certainty.
New 'events' are inserted into section 230-305 to ensure that the allocation of a gain or loss from a hedging financial arrangement occurs where an entity ceases to have some, but not all, of the hedged items. No tax 'event' occurred where a taxpayer ceased to have some, but not all, of the hedged items.
The threshold test that applies to regulated superannuation funds is extended so that it also applies to non-regulated superannuation entities. Regulated and unregulated superannuation funds have different threshold requirements for the mandatory application of Division 230.
References to 'accounting standards', 'auditing standards' and related references are replaced with references to 'accounting principles', 'auditing principles' and related references. The defined terms, 'accounting standards' and 'auditing standards' are used.
The debt/equity transitional period is extended to 1 July 2010 for Upper Tier 2 instruments that were issued before 1 July 2001 unless an election to apply the debt/equity rules from 1 July 2001 is made. The debt/equity transitional period was to 1 July 2004 unless an election to apply the debt/equity rules from 1 July 2001 is made.

Detailed explanation of new law

Amendments to Division 230 and the consequential and transitional provisions inserted by the TOFA Act 2009

Minor policy and technical amendments

Core rules

Amendments to the definition of 'cash settlable' rights or obligations

3.22 This Schedule amends paragraph 230-45(3)(c) and inserts new subsections 230-45(4) and (5) so that if:

·
a financial benefit is readily convertible into money or money equivalent; and
·
there is a market for the financial benefit that has a high degree of liquidity; and

-
the amount of the money or money equivalent that the financial benefit(s) can be converted into is not subject to a substantial risk of substantial decrease in value (for example, the investment amount is guaranteed) in the hands of the entity who has the right to receive the financial benefit(s) [Schedule 3, item 7, subsection 230-45(4)] ; or
-
the taxpayer's purpose for entering into the arrangement (under which the financial benefit is to be provided or received) is to receive or deliver the financial benefit either:

·
to raise or provide finance; or
·
in other situations, so that it may be liquidated or converted into money or money equivalent (other than as part of the taxpayer's expected purchase, sale or usage requirements) [Schedule 3, item 7, subsection 230-45(5)],

then a right to receive, or an obligation to provide the financial benefit, is cash settlable under paragraph 230-45(2)(f).

3.23 Section 230-45 defines 'financial arrangement' for the purposes of Division 230. Central to the meaning of 'financial arrangement' is the definition of 'cash settlable' rights or obligations in subsection 230-45(2). Subsection 230-45(3), together with either subsection 230-45(4) or (5), seeks to bring within the scope of 'cash settlable' rights or obligations, a right to receive, or an obligation to provide, a certain type of financial benefit that is not in a formal sense money or money equivalent but is money-like.

3.24 One way in which a financial benefit is considered to be money-like is where, in broad terms:

·
it is convertible to money or money equivalent;
·
it is liquid; and
·
its value in monetary terms is not subject to a substantial risk of substantial decrease in value.

3.25 As indicated above, a right to receive, or an obligation to provide, a financial benefit which is liquid and convertible into money is 'cash settlable' if the recipient of the financial benefit(s) is entitled to receive at least a predetermined money equivalent amount of the financial benefit(s). An example of this would be a right to receive $100 worth of Big Bank shares. In this case, while the Big Bank shares are not money or money equivalent and the right to receive and the obligation to provide Big Bank shares are not to be settled in money or money equivalent, the monetary value of the financial benefits is at least $100. Assuming that the Big Bank shares are readily convertible into money and there is a liquid market for Big Bank shares, the right to receive or the obligation to provide $100 of Big Bank shares is economically akin to a right to receive, or an obligation to provide, $100.

3.26 These amendments provide that a right or obligation is 'cash settlable' if the value to the recipient of relevant cash-convertible, liquid financial benefits is not subject to a substantial risk of substantial decrease in value. Consistent with ordinary tax principles, the assessment of this risk should be done in nominal terms. [Schedule 3, item 7, subsection 230-45(4)]

3.27 These amendments seek to address, among other things, uncertainty about whether the rights and/or obligations under certain deferred purchase agreements are 'cash settlable'. The intention of the amended definition is to ensure that substantially capital protected deferred purchase agreements are 'cash settlable' financial arrangements. It also clarifies that convertible and similar instruments will generally be financial arrangements. More broadly, it is consistent with the notion that in substance debt, even with upside potential (whether through convertibility or otherwise), should as a general principle be treated as a financial arrangement.

Example 3.1 : Deferred purchase agreement - capital protected AEHR Co pays $10,000 to enter into an investment product, commonly referred to as a deferred purchase agreement, issued by Big Bank, on 1 July 2011. The terms of the deferred purchase agreement entitles AEHR Co to an unspecified number of shares in Edward Finance Co. They are deliverable on 30 June 2015. Assume that Edward Finance Co shares are listed on the Australian Securities Exchange (ASX) and the market for them has a high degree of liquidity.Under the terms of the deferred purchase agreement, AEHR Co is entitled to receive, on 30 June 2015, 95 per cent of the initial investment (the $10,000) in the form of Edward Finance Co shares. This is the basis of the capital protection. AEHR Co is entitled to a further amount, the value of which is contingent on changes in the level of a nominated market index over the term of the deferred purchase agreement. Thus AEHR Co receives shares in Edward Finance Co at least equal in value to $9,500.The requirements in subsections 230-45(3) and (4) are satisfied for both Big Bank and AEHR Co as Edward Finance Co shares are readily convertible into money, the market for Edward Finance Co shares is highly liquid and the financial benefits AEHR Co is entitled to receive under the arrangement are not subject to a substantial risk of substantial decrease in value. As such, AEHR Co's right to receive, and Big Bank's obligation to provide, the Edward Finance Co shares are 'cash settlable' rights and obligations.

Example 3.2 : Convertible note On 1 January 2011 Nourt Co issued a converting note to Nanfam Co, with a face value of $1,000 maturing on 31 December 2019. The convertible note entitles Nanfam Co to annual payments of 10 per cent of the face value. At maturity the note will convert into shares in Nourt Co. Assume that shares in Nourt Co are listed on the ASX and the market for them is highly liquid.Nanfam Co's right to receive shares in Nourt Co is a cash settlable right. The requirements in subsections 230-45(3) and (4) are satisfied as Nourt Co shares are readily convertible into money, the market for them is highly liquid and the value of the financial benefits Nanfam Co will receive under the arrangement (that is, $1,000 of Nourt Co shares) is not subject to a substantial risk of substantial decrease in value.

3.28 A right to receive, or an obligation to provide a cash convertible and liquid financial benefit is also 'cash settlable' if the taxpayer's purpose for entering into the arrangement (under which the financial benefits are to be provided or received) is to either:

·
raise or provide finance; or
·
receive or deliver the financial benefit, so they it may be converted into money or money equivalent (other than as part of the taxpayer's expected purchase, sale or usage requirements).

3.29 These amendments are intended to cover cash convertible and liquid financial benefits that are not money-like as described above, but are intended to be used by taxpayers in a money-like manner.

3.30 That is, a financial benefit such as a commodity can be considered to be money-like in certain situations. One such situation would be where the financial benefit meets the convertibility and liquidity criteria in paragraphs 230-45(3)(a) and (b), and the purpose of obtaining the financial benefit is to convert it into money, other than as part of the taxpayer's purchase, sale or usage requirements. That is, while the financial benefit in this case is not in the form of money, the dealing in it is money-like.

3.31 Similarly, the receipt of a cash-convertible and liquid commodity could be used to raise finance and thereby be used in a money-like way. So a right to receive, or an obligation to provide financial benefits which are convertible into money, is cash settlable if the purpose of the financial arrangement under which the financial benefits are to be provided or received is financing. In such a situation, the financial benefits are intended to be liquidated or converted into money or money equivalent in a liquid market or otherwise to be used as money or money equivalent. [Schedule 3, item 7, paragraph 230-45(5)(a)]

Example 3.3 : Gold loan GI & L Co, a mining company, seeks to expand its operations. To finance this, the company enters into an arrangement under which it borrows 100 ounces of gold from Avlis Co with an agreement to repay 120 ounces in two years time. For GI & L Co, this arrangement consists of a right to receive 100 ounces of gold and an obligation to provide 120 ounces of gold.The right to receive, and the obligation to provide, the gold are cash settlable. The requirements in subsection 230-45(3) are satisfied as the gold is readily convertible into money, there is a market for the gold which has a high degree of liquidity and paragraph 230-45(5)(a) is satisfied as the arrangement is for the purpose of obtaining finance.

3.32 A right to receive, or an obligation to provide, financial benefits which are convertible into money, is cash settlable if the purpose of the financial arrangement under which the financial benefits are to be provided or received is to receive or deliver the financial benefits so that they may be converted into money or money equivalent (other than as part of the taxpayer's ordinary business requirements). [Schedule 3, item 7, paragraph 230-45(5)(b)]

3.33 Depending on the purpose of the parties to a transaction, a right to receive, or an obligation to provide financial benefits, which may be converted into money, may be cash settlable for one party but not the other. From the recipient's perspective, for the right to receive the financial benefit (assuming it meets the convertibility criterion) to be cash settlable, the recipient's purpose for receiving the financial benefit has to be to convert the financial benefit obtained into money or money equivalent and the conversion is not to satisfy the recipient's ordinary business requirements. From the provider's perspective, for the obligation to provide the financial benefit to be cash settlable, the provider's purpose of delivering the financial benefit has to be that the financial benefit may be converted into money or money equivalent and the conversion is not part of the provider's ordinary business requirements.

Example 3.4 : Derivatives RI & CE Co, a wheat company, enters into a deliverable forward contract to acquire 50 ounces of gold in one year for $50,000. The contract provides that it must be settled by way of delivery of the gold.The right to receive the gold in one year's time is a cash settlable right for RI & CE Co. The requirements in subsection 230-45(3) are satisfied as the gold is readily convertible into money, the market for gold is highly liquid and paragraph 230-45(5)(b) will be satisfied if the purpose of the arrangement for RI & CE Co is to receive the gold in order to convert it into money and not as part of its expected purchase, sale or usage requirements.

Deductibility of dividends on debt interests

3.34 Subsection 230-15(4) is intended to broadly reflect the effect of section 25-85 in respect of financial benefits provided or received under financial arrangements that are debt interests. However, there have been doubts as to whether legal form dividends from debt interests can be deductible under Division 230, given the absence of a rule that replicates subsection 25-85(3). Subsection 25-85(3) allows for deductibility of such dividends in certain circumstances.

3.35 Accordingly, this Schedule inserts a new subsection 230-15(4A) to allow, under certain conditions, for the deductibility of a dividend to the extent that it would have been a deductible loss under subsection 230-15(2). The timing of the deductibility is to be determined in accordance with Division 230 [Schedule 3, item 6, subsection 230-15(4A)] . The conditions are that:

·
the payment of the amount of the dividend were the incurring of a liability to pay the same amount as interest [Schedule 3, item 6, paragraph 230-15(4A)(a)] ;
·
the interest was incurred in respect of the finance raised by the taxpayer and in respect of which the dividend was paid or provided [Schedule 3, item 6, paragraph 230-15(4A)(b)] ; and
·
the debt interest retains its character as a debt interest for the purposes of subsection 230-15(4). In other words, the interest continues to satisfy the debt interest test in section 974-20 [Schedule 3, item 6, paragraph 230-15(4A)(c)] .

Accruals/Realisation

Allowing financial benefits to be sufficiently certain to an extent

3.36 This Schedule amends subsection 230-115(1) so that, in deciding whether it is sufficiently certain at a particular time that a taxpayer will make a gain or loss from a financial arrangement, regard should be had only to financial benefits that the taxpayer is sufficiently certain to receive or provide, to the extent that the amount or value of the benefit is, at that time, fixed or determinable with reasonable accuracy. [Schedule 3, item 11, subsection 230-115(1)]

3.37 These amendments clarify that, for the purposes of Subdivision 230-B, a financial benefit can be sufficiently certain even if not all of the financial benefit is, at the relevant time, fixed or determinable with reasonable accuracy. To the extent that only part of the financial benefit is, at the relevant time, fixed or determinable with reasonably accuracy, only that part is treated as sufficiently certain.

Example 3.5 : Financial benefits sufficiently certain to an extent Investor Co has an investment that is a Division 230 financial arrangement under which it has a right to a financial benefit, the amount of which is fixed at $100, with a further amount of between $0 and $30 that is wholly dependent on the profits of a company.For the purpose of subsection 230-115(2), assume that:

·
it is reasonably expected that Investor Co will receive the financial benefit (assuming that it continues to have the financial arrangement for the rest of its life); and
·
at least some of the amount or value of the benefit, namely the $100 (and only the $100), is fixed or determinable with reasonable accuracy.

Accordingly, the financial benefit is one that Investor Co is sufficiently certain to receive.Subsection 230-115(1) provides that, for the purpose of deciding whether it is sufficiently certain that Investor Co will make a gain from the financial arrangement, only $100 is to be taken into account.

Pro-rata attribution of gain or loss not necessarily unreasonable for accruals

3.38 When the effective interest method is used in applying the compounding accruals tax timing methodology but the taxpayer's income year and financial reporting year are different, section 230-145 allows the results from more than one audited financial report that covers the income year to be attributed - using a reasonable methodology - to the income year.

3.39 While pro-rata attribution is not appropriate for the fair value, retranslation and reliance on financial reports elections (because of the unsystematic nature of the gains and losses that they cover), a pro-rata basis for attribution of an accruals methodology may be reasonable, particularly if the methodology uses straight-line accruals appropriately. This Schedule repeals subsection 230-145(5) so that for the purposes of paragraph 230-145(4)(a), a methodology that attributes the gain or loss on a pro-rata basis is not necessarily unreasonable. [Schedule 3, item 14, subsection 230-145(5)]

Pro-rata attribution of portfolio treatment of fees not necessarily unreasonable

3.40 In a similar vein to the repeal of subsection 230-145(5), subsection 230-155(5) is repealed so that, for the purposes of paragraph 230-155(4)(a), a methodology that attributes the portfolio treatment of fees on a pro-rata basis is not necessarily unreasonable. [Schedule 3, item 21, subsection 230-155(5)]

Foreign currency arrangements

3.41 This Schedule amends subsection 230-115(8) so that where all the financial benefits under a financial arrangement are denominated in a particular foreign currency they are not to be translated into Australian currency for the purpose of determining whether the financial benefits are sufficiently certain, even if the taxpayer does not have an applicable functional currency. This ensures that the law gives effect to the original policy intention of the subsection. [Schedule 3, item 12, subsection 230-115(8)]

Hedging

Enabling one hedging financial arrangement to hedge more than one hedged item

3.42 This Schedule inserts 'or items' after 'hedged item' in paragraph 230-335(1)(a). This amendment is made to remove doubt about whether the tax hedge rules in Subdivision 230-E can apply when multiple hedged items are hedged by a single hedging financial arrangement. The intention is that they can (subject to the various requirements of Subdivision 230-E being satisfied) apply in this situation. This amendment is intended to provide clarity for this paragraph only and is not intended to affect the interpretation of the rest of Division 230. [Schedule 3, item 65, paragraph 230-335(1)(a)]

Hedged item recorded in own financial reports

3.43 This Schedule inserts 'your financial report or' before 'the financial report of a consolidated entity' in subparagraph 230-335(1)(c)(ii). [Schedule 3, item 68, subparagraph 230-335(1)(c)(ii)]

3.44 This amendment ensures that the hedging item is, as intended, able to be recorded in an entity's own financial reports.

Circumstances where an entity ceases to have one or more but not all hedged items

3.45 This Schedule inserts 'events' into the table in section 230-305 where the entity ceases to have some, but not all, of the hedged items. These events are:

·
the entity ceases to have one or more, but not all, of the hedged items;
·
the entity ceases to expect that one or more, but not all, of the hedged items will come into existence; or
·
the entity ceases to expect that the entity will have one or more, but not all, of the hedged items.

[Schedule 3, item 54, section 230-305 (after item 2 in the table)]

3.46 These amendments ensure that the allocation of gain or loss from a hedging financial arrangement as worked out under subsection 230-300(5) occurs where these events occur. [Schedule 3, items 50 and 52, subsections 230-300(5) and (11)]

3.47 Amendments are also made to section 230-305 to require that the gain or loss from a hedging financial arrangement is attributed, on a reasonable basis, to a particular hedged item that the hedging financial arrangement hedges. [Schedule 3, items 53 and 55, section 230-305]

3.48 The extent to which the gain or loss from a hedging financial arrangement, as worked out under subsection 230-300(5), is reasonably attributable to a particular hedged item that the hedging financial arrangement hedges, must be determined on a reasonable and objective basis, having regard to the following:

·
the fair value of the particular hedged item;
·
the length of time the entity has held the hedged item;
·
commercially accepted valuation principles; and
·
any other relevant factors.

Example 3.6 An entity that has a 30 June income year acquires a floating rate loan portfolio on 1 July 2015. The entity enters into a 10 year interest rate swap in order to hedge the interest rate risk in relation to the loans in the portfolio. At that time, the swap has a nil value.The portfolio has two loans, one worth $900,000 and the other one worth $100,000.On 1 July 2020, the entity disposes of the loan that is worth $100,000. At that time, the interest rate swap has a fair value of $10,000.On 1 July 2022, the entity disposes of the swap for its fair value of $30,000.On 1 July 2020, the gain from the swap as worked out under subsection 230-300(5) is its fair value at the time, that is, $10,000. In the absence of other factors relevant to subsection 230-300(5), it would be reasonable to attribute 10 per cent of the gain ($1,000) to the loan being disposed of, given the relative values of the loans in the portfolio.

3.49 The gain or loss that is reasonably attributable to the one or more hedged items being disposed of is allocated to the income year in which the event occurs, and the gain or loss that is reasonably attributable to the remaining hedged item or items is allocated over income years according to the basis determined under subsection 230-360(1).

3.50 The above amendments make subsection 230-300(6) redundant as the situation in which a taxpayer ceases to have one or more, but not all, of the hedged items, is dealt with by the above amendments. As such, the regulation-making power is no longer needed. [Schedule 3, item 51, subsection 230-300(6)]

Foreign currency retranslation

Ensuring consistency with accounting standards

3.51 This Schedule amends the wording of some provisions to ensure consistency with the Australian Accounting Standards (AAS) and the equivalent International Accounting Standards. The following changes are made:

·
the words 'an amount in profit' in subsection 775-305(2) are replaced by the words 'an amount of gain in profit or loss' [Schedule 3, item 127, subsection 775-305(2)] ; and
·
the words 'an amount in loss' in subsection 775-305(3) are replaced by the words 'an amount of loss in profit or loss' [Schedule 3, item 128, subsection 775-305(3)] .

Exceptions

Asset test applies to both regulated and unregulated superannuation funds

3.52 This Schedule amends subparagraph 230-445(1)(a)(ii) to ensure that the asset threshold test in subsection 230-455(2) applies to both regulated and non-regulated superannuation funds on the same basis. [Schedule 3, items 5 and 106, subparagraphs 230-5(2)(a)(ii) and 230-455(1)(a)(ii)]

3.53 Section 230-455 provides that Division 230 does not apply to the financial arrangement gains or losses of certain taxpayers.

3.54 One such exclusion is contained in subparagraph 230-455(1)(a)(ii) and relates to superannuation entities.  The exclusion applies where the value of a superannuation entity's assets for an income year is less than $100 million.

3.55 Section 10 of the Superannuation Industry (Supervision) Act 1993 defines a superannuation entity as a regulated superannuation fund or an approved deposit fund or a pooled superannuation trust. A regulated superannuation fund has the meaning given by section 19 of the Superannuation Industry (Supervision) Act 1993 . A non-regulated superannuation fund is not covered by this definition. Therefore, the non-regulated fund's financial arrangement gains or losses are excluded from Division 230 essentially if:

·
the value of the entity's aggregated turnover is less than $100 million;
·
the value of its financial assets is less than $100 million; and
·
the value of its assets is less than $300 million.

3.56 Without these amendments, a non-regulated superannuation fund is therefore excluded from Division 230 if the value of the entity's assets is less than $300 million. This is anomalous where the comparable threshold for regulated superannuation funds is $100 million.

3.57 Accordingly, the threshold test that applies to regulated superannuation funds is extended so that it also applies to non-regulated superannuation entities.

Interests in partnerships and trusts subject to fair value or financial reports elections are Division 230 financial arrangements

3.58 This Schedule amends subsection 230-460(4) to correct an anomaly that prevents the subsection from operating as intended.

3.59 By subsection 230-460(3), Division 230 does not apply to gains and losses from specified interests in a partnership or trust. This means that such interests are not Division 230 financial arrangements.

3.60 Subsection 230-460(4) is intended to be a carve-out to the subsection 230-460(3) exception. Subsection 230-460(4) is intended to allow the fair value election or the election to rely on financial reports to apply to an otherwise excluded interest in a partnership or trust. However, for either election to apply, the financial arrangement has to be a Division 230 financial arrangement . The carve-out to the exception cannot operate as such interests are not Division 230 financial arrangements.

3.61 To correct this anomaly and to enable the original intention of subsection 230-460(4) to be restored, this Schedule amends subsection 230-460(4) to allow a taxpayer to assume that the financial arrangement is a Division 230 financial arrangement for the purposes of subsection 230-460(4). If the fair value election or the election to rely on financial reports applies to the entity, subsection 230-460(3) does not apply to the financial arrangement. [Schedule 3, item 108, subsection 230-460(4)]

Guarantees and indemnities subject to fair value or financial reports elections are Division 230 financial arrangements

3.62 Similar to the above situation in relation to subsection 230-460(4), subsection 230-460(8) operates so that Division 230 does not apply to the gains and losses from a financial arrangement in relation to a right or obligation under a guarantee or indemnity. As such, the financial arrangement is not a Division 230 financial arrangement.

3.63 Paragraph 230-460(8)(a) is intended to be a carve out to the exception in subsection 230-460(8). Paragraph 230-460(8)(a) allows the fair value election or the election to rely on financial reports to apply to an otherwise excluded guarantee or indemnity. However, for either election to apply, the financial arrangement has to be a Division 230 financial arrangement . Paragraph 230-460(8)(a) is amended so that the guarantee or indemnity is assumed to be a Division 230 financial arrangement for the purposes of paragraph 230-460(8)(a). [Schedule 3, item 109, paragraph 230-460(8)(a)]

Amendments to consequential and transitional amendments in the TOFA Act 2009

Anti-overlap rule for tax exempt asset financing

3.64 This Schedule reinstates the effect of the previous section 118-27 so as to give priority to Subdivision 250-E (relating to tax exempt asset financing) over the CGT provisions. At the same time, the effect of the new section 118-27 is retained. [Schedule 3, items 3 and 4, section 118-27(heading) and subsection 118-27(4)]

3.65 The original section 118-27 was an anti-overlap provision which ensured that there was no double counting between financial arrangements to which both Subdivision 250-E and the CGT provisions apply.

3.66 Item 76 of the TOFA Act 2009 repealed section 118-27 and replaced it with a new one that deals with Division 230 financial arrangements only. As a consequence there is now the potential for overlap between Subdivision 250-E and the CGT provisions. The amendments remove this overlap.

Amendments to 'accounting standards' references

3.67 This Schedule changes all references to 'accounting standards' and related references in Division 230 to 'accounting principles' and related references.

3.68 The term 'accounting standards' is defined in subsection 995-1(1), to have the same meaning as under the Corporations Act 2001 (Corporations Act). Section 9 of the Corporations Act limits accounting standards to those the AASB makes for the purposes of the Corporations Act. However, the Australian Securities and Investments Commissions Act 2001 (ASIC Act) provides for the AASB to formulate accounting standards for 'other purposes'. As these standards do not fall within the definition of 'accounting standards' in the Corporations Act, they do not satisfy the definition of 'accounting standards' for the purposes of Division 230.

3.69 AAS 25 is such a standard, and is therefore not an accounting standard within the meaning of Division 230 without these amendments. AAS 25 is, however, the standard used by superannuation funds that are reporting entities, to prepare their financial reports. Consequently, the superannuation funds that use AAS 25 are unable to make elections under Division 230 that depend on the entity preparing a financial report in accordance with the accounting standards.

3.70 The definition of 'accounting principles' was introduced in the Tax Laws Amendment (2010 Measures No. 1) Act 2010 and is defined in subsection 995-1(1) to include accounting standards and other authoritative pronouncements of the AASB. This Schedule amends the Tax Laws Amendment (Measures No. 1 2010) Act 2010 to ensure that the definition of 'accounting principles' applies from the commencement of the TOFA Act 2009. [Schedule 3, item 132, subsection 2(1) (item 11 in the table) of the Tax Laws Amendment (2010 Measures No. 1) Act 2010]

3.71 Amendments are made to Division 230 to replace various references to 'accounting standards' with references to 'accounting principles'. These amendments are:

·
'accounting standards' are replaced with 'accounting principles' [Schedule 3, items 15, 22, 26, 27, 34, 41, 56, 57, 58, 73, 74, 75, 77, 80, 83, 92, 107, 113, 119 and 122, subparagraphs 230-150(1)(a)(i) and 230-185(2)(e)(i), subsection 230-190(8), subparagraphs 230-210(2)(a)(i), 230-220(1)(c)(i) and 230-255(2)(a)(i), subsection 230-310(4), paragraph 230-310(5)(a), subparagraph 230-315(2)(a)(i), paragraphs 230-335(10)(c) to (e), and 230-355(1)(b), subparagraph 230-365(c)(i), 230-395(2)(a)(i) and 230-410(1)(d)(i), paragraphs 230-455(5)(b) and 230-500(a), subparagraphs 230-530(3)(d)(i) and 230-530(4)(e)(i)] ;
·
'those standards' are substituted by 'the accounting principles' [Schedule 3, items 16, 23, 28, 35, 42, 59, 84, 93, 120 and 123, subparagraphs 230-150(1)(a)(ii), 230-185(2)(e)(ii), 230-210(2)(a)(ii), 230-220(1)(c)(ii), 230-255(2)(a)(ii), 230-315(2)(a)(ii ), 230-395(2)(a)(ii), 230-410(1)(d)(ii), 230-530(3)(d)(ii) and 230-530(4)(e)(ii)] ; and
·
'comparable accounting standards' are substituted by 'comparable standards for accounting' [Schedule 3, items 17, 24, 29, 36, 43, 60, 85, 94, 121 and 124, subparagraphs 230-150(1)(a)(ii), 230-185(2)(e)(ii), 230-210(2)(a)(ii), 230-220(1)(c)(ii), 230-255(2)(a)(ii), 230-315(2)(a)(ii), 230-395(2)(a)(ii), 230-410(1)(d)(ii), 230-530(3)(d)(ii) and 230-530(4)(e)(ii)] .

3.72 The amendments broaden the definition so that superannuation funds can make Division 230 elections.

Amendments to 'auditing standards' references

3.73 Similar to the above paragraphs, the term 'auditing standards', as defined in subsection 995-1(1), is confined only to auditing standards that are made under the Corporations Act. However, the ASIC Act also confers power to the Auditing and Assurance Standards Board to formulate auditing and assurance standards for 'other purposes' not included in the Corporations Act.

3.74 Auditing Standard ASA 300 is an auditing standard prepared under the power given to the Auditing and Assurance Standards Board in section 227B of the ASIC Act, to formulate auditing and assurance standards for 'other purposes'. Therefore, it is not an auditing standard to which the definition in subsection 995-1(1) applies.

3.75 This Schedule inserts a new definition of 'auditing principles' in subsection 995-1(1) which includes 'auditing standards' and other authoritative pronouncements of the Auditing and Assurance Standards Board. [Schedule 3, item 129, subsection 995-1(1)]

3.76 Amendments are made to Division 230 to replace various references to 'auditing standards' with references to 'auditing principles'. These amendments are:

·
'auditing standards' are replaced with 'auditing principles' [Schedule 3, items 18, 19, 30, 31, 44, 45, 61, 62, 86, 87 and 114, subparagraphs 230-150(1)(b)(i) and (ii), 230-210(2)(b)(i) and (ii), 230-255(2)(b)(i) and (ii), 230-315(2)(b)(i) and (ii), 230-395(2)(b)(i) and (ii) and paragraph 230-500(b)] ; and
·
'comparable auditing standards' are replaced by 'comparable standards for auditing' [Schedule 3, items 20, 32, 46, 63 and 88, subparagraphs 230-150(1)(b)(ii), 230-210(2)(b)(ii), 230-255(2)(b)(ii), 230-315(2)(b)(ii) and 230-395(2)(b)(ii)] .

3.77 The amendments are intended to broaden the definition so that superannuation funds can make Division 230 elections.

3.78 Consequential to the above amendments, the following amendments are also made:

·
'Australian accounting and auditing standards' are substituted by 'Australian accounting and auditing principles' to reflect the intentions outlined above [Schedule 3, items 33, 47, 64 and 89, subsections 230-210(2) (note), 230-255(2)(note), 230-315(2)(note) and 230-395(2)(note 1)] ;
·
'those standards' are replaced with 'those principles or standards'; 'the standards' are replaced with 'the principles or standards'; and 'standards' are replaced with 'principles or standards' [Schedule 3, items 25, 37 to 40, 66, 69 to 72, 78, 79, 81, 90, 91, 96, 99 to 104 and 112, paragraphs 230-185(2)(e), 230-230(1)(a) to (c), subsection 230-230(3), paragraph 230-335(1)(b), subparagraph 230-335(3)(c)(i), paragraph 230-335(5)(b), subsections 230-335(8) and (9), subparagraph 230-355(5)(a)(ii), paragraphs 230-365(a) and (c) and 230-405(2)(a) and (b), subsection 230-410(2), paragraphs 230-420(1)(a) to (c), subsection 230-420(3), paragraphs 230-430(4)(a) and (c) and 230-495(1)(d)] ; and
·
the heading to section 230-495 is amended and 'the relevant standards' in paragraph 230-495(1)(b) is replaced by 'the relevant principles or standards' [Schedule 3, items 110 and 111, section 230-495 (heading), paragraph 230-495(1)(b)] .

Net income of a transferor trust disregards Division 230

3.79 To put the matter beyond doubt, this Schedule amends subsection 102AAW(2) of the Income Tax Assessment Act 1936 (ITAA 1936) to ensure that Division 230 is disregarded for the purposes of the transferor trust provisions in Division 6AAA of Part III of the ITAA 1936. [Schedule 3, items 1 and 2, paragraphs 102AAW(2)(a) and (b) of the ITAA 1936]

Transitional election for portfolio discounts and premiums

3.80 This Schedule amends the transitional provisions in the TOFA Act 2009 to allow a taxpayer to make an election for portfolio treatment of fees, discounts and premiums in relation to pre-existing financial arrangements provided certain conditions are satisfied.

3.81 Under section 230-150, an entity can make an election under that section if it satisfies the requirements of that section. The effect of making such an election is that the entity satisfies both paragraphs 230-160(1)(a) and 230-165(1)(a) so that it can use the portfolio treatment of fees as per section 230-160 and premiums and discounts as per section 230-165.

3.82 An additional requirement in paragraphs 230-160(1)(b) and 230-165(1)(b) is that the entity must have started to have the financial arrangement that is the subject of the portfolio treatment in the income year in which the election is made, or a subsequent income year. In other words, the portfolio treatment of fees, discounts and premiums can only apply in relation to financial arrangements that entities start to have in the income year in which they make the election or subsequent income years.

3.83 Subitem 104(7) of the TOFA Act 2009 provides an exception to the above requirement. Subitem 104(7) is intended to have the effect of allowing entities that have made an election under section 230-150 to apply the portfolio treatment of fees, premiums and discounts in relation to financial arrangements they started to have prior to the income year in which the election is made, notwithstanding the limitation in paragraphs 230-160(1)(b) and 230-165(1)(b). A technical amendment to insert paragraph 230-165(1)(b) is needed to achieve the intended outcome. [Schedule 3, item 133, subitem 104(7) of Schedule 1 to the TOFA Act 2009]

3.84 This Schedule also inserts a new provision in item 104 of the TOFA Act 2009 to provide that an election made under section 230-150 extends to a financial arrangement that the entity started to have in the income years preceding the making of the election only if:

·
the election is made on or before the entity's first lodgement date that occurs after the start of the first Division 230 applicable income year;
·
the requirements in subsection 230-160(3) or 230-165(3) are satisfied, at the time of making the election; and
·
the requirements in subsection 230-160(4) or 230-165(4) are satisfied at, or soon after the time, the election is made.

[Schedule 3, item 134, subitem 104(7A) of Schedule 1 to the TOFA Act 2009]

3.85 These amendments ensure that the transitional arrangements for the application of portfolio treatment of fees, premiums and discounts are consistent with the rest of the transitional arrangements and are consistent with the integrity measures in sections 230-160 and 230-165.

Minor technical corrections

Amendments to correct asterisks in various provisions

3.86 This Schedule removes asterisks in front of terms that are not defined in section 995-1 and inserts asterisks where the term is defined but no asterisk was inserted by the TOFA Act 2009.

3.87 The word 'cease' is not defined in section 995-1. This Schedule removes the asterisks in front of 'cease', 'ceases' and 'ceasing' in:

·
paragraph 230-70(1)(b);
·
paragraph 230-75(1)(b);
·
paragraph 230-110(1)(c);
·
subparagraph 230-130(5)(b)(ii); and
·
subsection 230-435(5).

[Schedule 3, items 8 to 10, 13 and 105, paragraph 230-70(1)(b), 230-75(1)(b) and 230-110(1)(c), subparagraph 230-130(5)(b)(ii), and subsection 230-435(5)]

3.88 The term 'foreign currency' is defined in section 995-1. This Schedule inserts an asterisk in front of 'foreign currency' in subsection 230-115(8), subparagraph 230-335(1)(c)(ii) and subsection 230-530(1). [Schedule 3, items 12, 67 and 118, subsection 230-115(8), subparagraph 230-335(1)(c)(ii) and subsection 230-530(1)]

3.89 The term 'direct value shift' is defined in section 995-1. This Schedule amends the asterisked reference in paragraph 230-520(1)(b) from value shift to 'direct value shift'. [Schedule 3, item 115, paragraph 230-520(1)(b)]

Amend provisions which were incorrectly amended or repealed.

3.90 The TOFA Act 2009 incorrectly amended or repealed some provisions within the ITAA 1997. To correct these errors, the following provisions are amended:

·
the original text of subsections 230-275(1) and 230-275(2) is to be restored because the subsequent changes made to those provisions should have been made to subsection 230-380(1) [Schedule 3, items 48, 49 and 82, subsections 230-275(1) to (3) and 230-380(1)] ;
·
the original paragraph (aa) of the definition of 'special accrual amount' in section 995-1 is to be reinstated as it was incorrectly repealed by item 28 of the TOFA Act 2009. Paragraph (aa) was repealed on the basis that Subdivision 250-E would be repealed. However, Subdivision 250-E has not been repealed [Schedule 3, item 130, subsection 995-1(1)] ; and
·
current paragraph (aa) of the definition of 'special accrual amount' referring to Subdivision 230-A is to be renumbered as paragraph (ab) [Schedule 3, item 130, subsection 995-1(1)].

3.91 The Tax Laws Amendment (Transfer of Provisions) Bill 2010 proposes to undo the amendments mentioned in paragraph 1.90. The original paragraph (aa) which refers to Subdivision 250-E needs to be reinstated if the Tax Laws Amendment (Transfer of Provisions) Bill 2010 is enacted. [Schedule 3, item 131, subsection 995-1(1)]

Correcting typographical errors in the TOFA Act 2009

3.92 Some typographical errors were made in the TOFA Act 2009. This Schedule corrects these errors by:

·
reversing the sequence of the words 'financial' and 'hedging' in the heading of section 230-340. The heading of section 230-340 will read: 'Generally whole arrangement must be hedging financial arrangement' [Schedule 3, item 76, section 230-340(heading)] ;
·
making the reference in paragraph 775-295(1)(c) a reference to paragraph 230-255(2)(a), not paragraph 230-255(1)(a) [Schedule 3, item 125, paragraph 775-295(1)(c)] ;
·
making the reference in paragraph 775-305(1)(b) a reference to paragraph 230-255(2)(a), not paragraph 230-255(1)(a) [Schedule 3, item 126, paragraph 775-305(1)(b)] ;
·
making the reference in subparagraph 230-410(1)(e)(ii) to subsection (1) a reference to 'this subsection' [Schedule 3, item 95, subparagraph 230-410(1)(e)(ii)] ;
·
making the reference in subsection 230-410(5) to paragraph (3)(b) a reference to subsection (3) [Schedule 3, item 97, subsection 230-410(5)] ; and
·
making the reference in subsection 230-410(6) to paragraph 3(b) a reference to subsection (3) [Schedule 3, item 98, subsection 230-410(6)] .

Addressing incorrect references to provisions in Division 230

3.93 This Schedule corrects the following incorrect references in Division 230:

·
the reference in subsection 230-520(2) to paragraph 230-520(1)(d) is incorrect and is removed. The 'realisation event' definition did not apply to the repealed value shifting provisions [Schedule 3, item 117, subsection 230-520(2)] ; and
·
the reference to Division 723 contained in paragraph 230-520(1)(d) is removed. That Division is about a type of value shifting that was not dealt with under the repealed provisions [Schedule 3, item 116, paragraph 230-520(1)(d)] .

Amendments to transitional provisions in the Debt and Equity Act 2001

3.94 Part 2 of this Schedule extends the debt/equity transitional period to 1 July 2010 for Upper Tier 2 instruments that were issued before 1 July 2001, provided the issuer does not make an election under paragraph 118(6)(b) of the Debt and Equity Act 2001 to have the debt/equity rules in Division 974 apply from 1 July 2001. [Schedule 3, Part 2, item 135]

3.95 Upper Tier 2 instruments are instruments known as Upper Tier 2 capital instruments for prudential regulation purposes.

3.96 For the purposes of determining whether an Upper Tier 2 instrument was issued before 1 July 2001, minor alterations that do not affect rights and obligations in relation to the interest are disregarded. So are alterations that permit or require any deferred payments under the instrument to accumulate.

3.97 Issuers of Upper Tier 2 instruments have an opportunity to amend their instruments so as to come within the terms of the proposed Upper Tier 2 regulations prior to the first transaction in relation to the interest on or after 1 July 2010.

Application and transitional provisions

3.98 The amendments to Division 230 and the consequential and transitional provisions inserted by the TOFA Act 2009 (except for items 95, 131 and 132) apply for income years commencing on or after 1 July 2010, unless a taxpayer elects to apply Division 230 for income years commencing on or after 1 July 2009. [Clause 2, items 2, 4 and 7 in the table]

3.99 Item 95 commences on Royal Assent. [Clause 2, item 3 in the table]

3.100 Item 131 commences immediately after the commencement of Part 2 of Schedule 3 to the Tax Laws Amendment (Transfer of Provisions) Bill 2010. However, the item does not commence at all if Part 2 of Schedule 3 to the Tax Laws Amendment (Transfer of Provisions) Bill 2010 does not commence. [Clause 2, item 5 in the table]

3.101 Item 132 commences immediately after the commencement of section 2 of the Tax Laws Amendment (2010 Measures No. 1) Act 2010 . [Clause 2, item 6 in the table]

3.102 The amendments to the debt/equity transitional provisions commence on Royal Assent and apply to Upper Tier 2 instruments issued before 1 July 2001. [Clause 2, items 1 and 8 in the table]


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