Explanatory Memorandum(Circulated by authority of the Treasurer,the Hon. Peter Costello, MP)
General Outline & Financial Impact
This Bill is the second instalment of the rewrite of the income tax law by the Tax Law Improvement Project. The first instalment is contained in the Income Tax Assessment Act 1997
The Tax Law Improvement Project (TLIP) was established in December 1993 to restructure, renumber and rewrite in plain language Australia's income tax law. This was in response to a recommendation of the Joint Committee of Public Accounts that a task force be set up to rewrite the income tax law. An aim of the project is to reduce compliance costs, and improve compliance, by making the law easier to use and understand.
The Income Tax Assessment Act 1997 (the 1997 Act) established a structure and framework for a new Income Tax Assessment Act, to progressively replace the Income Tax Assessment Act 1936 (the 1936 Act).
Building on that platform, this Bill contains rewrites of further areas of the 1936 Act and continues to adopt features designed to make it easier for readers to read, use and apply the new law and, as a result, lower costs of compliance.
The Bill includes rewrites of provisions of the 1936 Act that deal with:
- including various miscellaneous amounts in assessable income;
- exempt income;
- deductions for various miscellaneous amounts;
- trading stock;
- profits from the sale of previously leased cars;
- deductions for depreciation of plant;
- deductions for capital expenditure of primary producers and some land-holders using land for business purposes;
- entertainment expenses;
- deductions for gifts; and
- the treatment of amounts that recoup deductible expenses.
The rewritten rules also include approximately 30 enhancements in the operation of the rewritten provisions which will make the law simpler, clearer and less burdensome for taxpayers. They do this by:
- replacing impractical rules with ones which facilitate taxpayer compliance;
- simplifying rules which are too complex;
- deleting unnecessary rules;
- removing anomalies; and
- clarifying ambiguities.
About half of these changes pick up existing administrative practices which are largely to the benefit of taxpayers.
As well, the Bill will contain transitional and consequential amendments that support the rewritten rules. Among other things, these will:
- 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
- make amendments closing off the application of provisions in the existing law rewritten in the Bill.
As a general rule, the rewritten law will first apply for the 1997-98 income year.
The content of the Bill is arranged in schedules.
All of the rewritten provisions of the 1936 Act are in Schedule 1, in the order in which they will appear in the 1997 Act. These provisions are in one schedule to keep all of the rewritten provisions together in the Bill.
After Schedule 1, the Bill contains a number of other schedules. Each of those schedules contains all the transitional and consequential amendments needed for one subject in the rewritten provisions. For example, the transitional and consequential amendments for the assessable income rewrite are in Schedule 2, for exempt income in Schedule 3, and so on.
The following table is a quick reference guide to the structure of the Bill:
|TLIB Schedule 1- Division||EM Chapter No.||Consequential and Transitional Schedule No.|
|Division 15 - Assessable Income||2||2|
|Division 20 - Recoupment of||3||8|
|Divisions 25, 26 & 34 -||5||4|
|Deductions: particular items|
|Division 30 -||6||9|
|Division 32 -||7||10|
|Division 42 -||8||6|
|Depreciation of Plant|
|Divisions 50-53, 55 -||9||3|
|Divisions 70 & 385 -||10||5|
|Division 387 -||11||11|
|Capital Allowances for Primary Producers and some Land-holders|
In addition to the general improvements in structure, presentation and readability of the areas being rewritten, the Bill will make a number of specific changes to the operation of the law. These will mainly facilitate simpler and clearer expression and less arduous compliance requirements.
The rewritten provisions which include particular amounts in assessable income will also contain the following specific change.
Change: Omit a provision which includes in assessable income premiums received for the grant of a lease of property that is not for use for income producing purposes. The result will be to deal with these under the capital gains tax provisions.
Existing law: Assesses the premium a lessor receives for granting a lease where the lessee did not intend the property to be used in gaining or producing assessable income. The capital gains tax provisions also apply to the grant of a lease and although there is no double taxation, the overlap causes confusion and unnecessary cost.
As well as rewriting provisions that allow deductions for various amounts, the Bill will make the following specific changes.
Change: Align the law with administrative practice by confirming that deductions for rates and land tax are allowable on premises used to produce mutual income.
Existing Law: Under the principle of mutuality, an entity cannot derive income from itself. This technically precludes clubs, professional associations and similar organisations from deducting land tax and rates.
Change: Confirm the administrative practice of allowing a money lender to deduct bad debts on a purchased loan when the debt is written off.
Existing law: If a money lender purchases a debt, the law is not completely clear on when a bad debt can be deducted. Administrative practice allows a deduction when the debt is written-off.
- allow a deduction for any remaining undeducted borrowing expenses if the loan is repaid early; and
- clarify that a deduction is only allowed for borrowing expenses to the extent that the money is used to produce assessable income in the year in which the deduction is claimed.
Existing Law: Expenses of borrowing money for use in producing assessable income are normally deducted over the period of the loan or over five years. The first change provides a new benefit for taxpayers. The second change clarifies an area of uncertainty.
Change: Omit the provision which specifically allows a deduction for $50 in capital legal expenses.
Existing law: Allows a deduction of up to $50 of legal expenses incurred in carrying on a business to produce assessable income, even if the expenses are of a capital nature. The deduction must be reduced by any legal expenses that can be deducted under the general deduction provision.
The Bill will enhance the structure of the law on trading stock by moving the provisions for deferring profit on forced disposal of live stock from the general trading stock rules to the primary production provisions in the new law. By concentrating specialist rules together they do not complicate the general parts of the law, and are more easily found by specialists.
The Bill will also make the following specific changes.
Change: Bring the formula for reducing the tax cost of replacement stock on the disposal of tubercular cattle into line with the formula used for disposals due to other diseases.
Existing Law: If diseased cattle are disposed of, a primary producer can elect to spread the assessment of any profits over five years or to reduce the tax cost of replacement stock acquired in those five years. The formula for reducing the tax cost of purchased replacement stock is different if the disease is bovine tuberculosis than it is for other diseases.
Change: Clarify the law by replacing rules that apply to disposals of part interests in trading stock with rules that apply to a change in the taxpayer who accounts for the trading stock.
Existing Law: A partial disposal of trading stock outside the ordinary course of business is treated as a sale of the trading stock at market value from the old owners to the new owners, even if they are the same entities and only their proportionate interests have changed.
Change : Remove an anomaly by extending the deduction allowed for the cost of plantation trees on their disposal outside the ordinary course of business to cases where the trees are disposed of because of the owner's death.
Existing Law: Allows a deduction for the cost of plantation trees acquired with land when they are disposed of outside the normal course of business but not for disposals caused by the death of the owner. In the latter cases, the full value of the trees is assessed without deduction.
Change: Simplify the valuation of the natural increase of live stock, by standardising the choices of valuation to actual cost or a prescribed minimum value.
Existing Law: Choices for working out the cost of natural increase of live stock are excessively complicated and have inconsistent conditional requirements.
Change: Allow partnerships and trusts to make a single election to defer assessing income from:
- certain abnormal disposals of live stock;
- insurance recoveries for losses of live stock or trees;
- the sale of double wool clips; and
- the devolution of trading stock on death by allowing each partnership and trust estate to make a single election.
Existing law: There are a number of different systems requiring either elections by individual beneficiaries and partners, at the partnership or trust level or a combination of these.
Change: Standardise the valuation of live stock and other kinds of trading stock by allowing:
- the choice of replacement price as a valuation method;
- different items of live stock to be valued on different bases; and
- valuation methods to be changed yearly without approaching the Commissioner.
Existing Law: In valuing closing stock a general trader can choose between different values for each item of stock (cost, replacement price, or market selling value). In contrast, for live stock the choice of replacement price is unavailable; the same method is required for all live stock and the Commissioner's permission is required in order to use another basis in a later year.
Change: Standardise the forms of elections to defer the assessment of profits from abnormal disposals of live stock.
Existing Law: Taxpayers may elect to defer the taxing point for profits on disposal of live stock outside the ordinary course of their business rather than return the market value of that stock as assessable income. The forms of the elections are complex, confusing and inconsistent.
Change: Ensure that the value of stock on hand at the start of a year is always the same as the value used for it at the end of the previous year.
Existing Law: The value of trading stock at the start of a year may be able to be amended if it is wrong. Time limits may mean that the previous years closing figure (which should be the same) can not also be amended.
The Bill will improve the structure of the depreciation provisions by:
- placing the main operative provisions up front; and
- arranging the other provisions into Subdivisions each dealing with a component of the deduction calculation.
Areas of uncertainty have been clarified and unnecessary rules removed. The following notes discuss the most important of those changes. There are also a number of miscellaneous changes. All changes are discussed in detail in Part B of Chapter 8.
Change: Allow taxpayers who acquire previously depreciated plant to depreciate it on the basis of its cost to them without having to approach the Commissioner for approval. However the Commissioner will have a discretion to reduce its cost in certain circumstances.
Existing Law: The amount a taxpayer can deduct for previously depreciated plant is automatically limited to the vendor's written down value and any assessable balancing charge, unless the Commissioner exercises a discretion to allow depreciation on the basis of its cost.
Change: Provide a cost for plant acquired with other assets without a specific price being allocated to it.
Existing Law: There is no guidance on what the cost should be for plant acquired in these circumstances (although the law contains the basis for calculating a termination value for plant sold in such cases.)
Change: Clarify that plant is to be notionally written down for any period when it is used for a purpose other than producing assessable income.
Existing Law: While the law is applied in this manner, it is not expressly stated.
Change: Allow a taxpayer, when choosing a method of calculation, to elect to use the prime cost method for any unit of depreciable plant.
Existing Law: The election to use prime cost is irrevocable and must be made at the commencement of depreciation for all units of depreciable property that have been acquired during the income year.
Change: There will be no restriction against adopting a lower depreciation rate.
Existing law: Plant cannot be written off over a period that is longer than its effective life.
The Bill will create new Subdivision 20-B which improves on the structure of the provision it replaces by separating the usual treatment of profits on the sale of leased cars from the special rules for disposals by associates. Consequently, most affected taxpayers will not have to deal with the more specialised parts of the Subdivision.
The Bill will also make the following specific change.
Change: Standardise the treatment of the profit from the disposal of previously leased cars to include insurance payments in assessable income where property passes to an insurance company.
Existing Law: The existing law includes in assessable income any profit on the disposal of a car by a taxpayer who had previously leased it for income producing purposes but is unclear on the treatment when property passes to an insurance company.
The Bill will make structural improvements to the capital allowance provisions for primary production and some land-holders by:
- collocating seven of the capital allowances in one division because of their common theme of the use of land for business; and
- merging the timber access road and timber mill building subdivisions into one subdivision thereby reducing duplication.
The Bill will also make the following specific changes.
Change: Align the law with administrative practice by allowing taxpayers acting in good faith to deduct capital expenditure on a forestry road or timber mill building on the basis of its cost to them, if they acquire it from someone who has previously claimed deductions for it.
Existing Law: The current law limits the amount a taxpayer can deduct to the sum of the vendor's written down value and any assessable balancing charge. The Commissioner has a discretion which is usually exercised to allow deductions to be based on actual expenditure.
Change: Remove an anomaly by allowing a deduction for capital expenditure incurred on a telephone line where a deduction for it has also been allowed to the entity which installed it for the taxpayer.
Existing Law: A deduction is denied for any part of the line for which another taxpayer has been allowed a deduction.
The Bill will incorporate structural improvements in rewriting the entertainment provisions by:
- bringing together at the beginning of the Division the two operative provisions in the entertainment area that do not allow a deduction for expenditure incurred in providing entertainment and not allow a deduction in relation to property;
- including to the extent possible the relationship between the entertainment provisions and the FBT provisions in the first exception; and
- incorporating the rest of the exceptions into tables that group related exceptions and are easy to read, bringing together the assessing provision previously contained in section 26AAC with related deduction provisions about in-house dining facilities.
The Bill will also make the following specific change.
Change: Remove the exception for 'self entertainment' to the general rule that entertainment expenses are non deductible, as it has little or no application.
Existing Law: Provides a taxpayer with an exception to the general rule that entertainment expenses are not deductible under the general deduction provision, where the expenditure is on the entertainment of a recipient who could have deducted the expenditure if they had incurred it themselves. The type of expenditure envisaged by the exception is now not considered to be entertainment.
The Bill improves on the structure of the existing 23 provisions dealing with recoupment of deductible expenses by consolidating these provisions in one place. This will make the law simpler, shorter and easier to find.
Change: Standardise the treatment of recoupment of certain deductible expenses so that these recoupment amounts will be assessable when received, but only to the extent that they do not exceed the amount of deductions already allowed.
Existing Law: There are 23 provisions in the existing law dealing with recoupment received for amounts that are allowable as deductions. These provisions either disallow deductions or treat the recoupment as assessable income when received.
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 14).
The Bill will have a broadly neutral impact on revenue. All but two of its measures will have no measurable effect.
A proposal to allow a deduction for rates and land tax on premises used to produce mutual receipts will have an annual cost of less than $10 million.
A change to bring the valuation methods for live stock closer into line with those for other kinds of trading stock will cost up to $10 million in most years. In an occasional year where there is a large fall in stock prices the cost could exceed $25 million.
The Bill should achieve a noticeable reduction in compliance costs for those using the parts of the income law it deals with. That reduction will not occur because of any single change but from the accumulation and combined impact of many small improvements.
The law will be shorter, clearer and simpler. Together, through provision after provision, these will produce a significant effect. There are particular measures aimed at reducing compliance costs by which:
- unnecessary requirements of the existing law will be removed;
- the number of complex calculations will be cut back;
- rules that have essentially the same effect will be standardised;
- record keeping obligations will be reduced; and
- the law will be brought into line with practical administrative positions.
A more significant reduction in compliance costs will arise as a result of the following changes:
- allowing partnerships and trust estates to make a single election to defer assessable income from various sources. This change will reduce the number of elections required, simplify calculations and save text; and
- including compensation amounts for certain deductible expenses in assessable income rather than disallowing the deduction. This eliminates the need to seek amended assessments for an earlier year when an amount of compensation is received.
All measures in the Bill will apply from the beginning of the 1997-98 income year. For some measures, special transitional arrangements will apply. These are explained in the notes describing those measures.