Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)General outline and financial impact
Australia as a regional financial centre
Amends the Income Tax Assessment Act 1936 (ITAA 1936) to provide for the implementation of the Australia - A Regional Financial Centre component of the Investing for Growth Statement announced by the Government on 8 December 1997.
The legislation was first introduced into Parliament on 2 July 1998 as Schedule 3 to the Taxation Laws Amendment Bill (No. 5) 1998 and lapsed when Parliament was prorogued for the election. The Statement announced that the measures were to apply from the date of introduction of the amending legislation. It is proposed that the legislation continue to apply from 2July1998 to ensure taxpayers are not disadvantaged by the delay in implementation.
The amendments in Schedule 1 relate to the interest withholding tax (IWT) exemption available under section 128F, the offshore banking unit (OBU) regime, the foreign investment fund (FIF) measures, the controlled foreign company (CFC) measures and the thin capitalisation provisions of the ITAA 1936.
The IWT exemption provided under section 128F of the ITAA 1936 will be widened by removing, for debentures issued by companies, the present requirements that they be issued outside Australia and that the interest be paid outside Australia.
The present restriction in section 128F prohibiting the acquisition of debentures by Australian residents will be removed.
The definition of company for the purposes of section 128F will be extended to include a company acting in the capacity of a trustee for an Australian trust, provided the trust is not a charitable trust and that the beneficiaries of the trust are companies for the purposes of section 128F.
A consequential amendment to section 126 will broaden the scope of that section to include holdings of bearer debentures by residents with a permanent establishment (eg. a branch) offshore.
The OBU concessions will be expanded to:
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- extend the range of entities eligible to register as OBUs;
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- provide a tax exemption for income and capital gains of overseas charitable institutions managed by an OBU;
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- extend the range of eligible OBU activities to include:
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- custodial services;
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- trading in Australian dollars where the other party to the transaction is an offshore person;
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- trading in gold bullion with offshore persons in any currency;
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- trading in gold bullion with any person other than in Australian dollars;
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- trading in base metals and palladium bullion with offshore persons in any currency;
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- other trading activities (apart from currency trading) in Australian dollars with offshore persons;
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- eligible contract activities in Australian dollars with offshore persons; and
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- hedging in Australian dollars with related offshore persons;
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- remove the current anti-avoidance measure which prevents Australia being used as a conduit to channel loans to other countries;
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- reduce the capital gains tax liability where non-residents dispose of interests in OBU offshore investment trusts;
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- provide a foreign tax credit for foreign tax paid by Australian resident OBUs regardless of whether a Double Tax Agreement applies;
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- remove the requirement that OBUs maintain separate nostro and vostro accounts for OBU transactions; and
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- reduce the rate of OBU withholding penalty tax for breaches of the IWT concession from 300 per cent to 75 per cent.
This measure will relax the effect of the thin capitalisation loan back provisions so that an Australian subsidiary of a foreign bank may raise section 128F IWT exempt funds and on-lend those funds to a related Australian branch without affecting the subsidiaries thin capitalisation position.
Foreign investment funds (FIFs)
Amends Part XI of the Income Tax Assessment Act 1936 (ITAA 1936) to provide an exemption from the FIF measures for interests in certain US FIFs. The exemption is intended to encourage Australian investment funds to be more efficient by exposing them to competition from US funds.
Changes to the calculation method in the FIF measures and consequential amendments to the general provisions for taxing trusts will also be made.
Amends Part X of Income Tax Assessment Act 1936 (ITAA 1936) to provide an exemption from the CFC measures for interests in US real estate investment trusts (REITs) that derive income or hold assets principally in the US. The exemption is similar to the proposed exemption for FIF interests in REITs in Part 2 of Schedule 1 to Taxation Laws Amendment Bill (No. 2) 1999.
Date of effect: The proposed measures in the package will generally apply from 2 July 1998, the date of first introduction. In relation to the FIF measures the exemption will apply for notional accounting periods of FIFs ending on or after 2 July 1998. The amendments to the calculation method and the consequential amendments will apply in relation to assessments for years of income ending on or after 2 July 1998. The exemption from the CFC measures will apply for statutory accounting periods of CFCs ending on or after 2 July 1998.
Proposal announced: Foreshadowed in the Australia - A Regional Financial Centre component of the Investing for Growth Statement announced by the Government on 8December 1997 and the Treasurers Press Release No. 80 of 13 August 1998. The CFC amendments have not been previously announced.
Financial impact: The package is estimated to cost $22 million in a full year. There may also be an indirect cost to the revenue as a result of the proposed FIF exemption because of increased investment in US FIFs. The cost to the revenue is unquantifiable because the amount of capital transferred to US funds will be dependent on prevailing economic conditions and on the investment strategies of Australian funds managers. The cost to the revenue of the CFC exemption is expected to be minor.
Compliance cost impact: The compliance cost impact is incorporated into the Regulation Impact Statements. The Regulation Impact Statement for the withholding tax, OBU and thin capitalisation measures is at the end of Part 1 of Chapter1 of the Explanatory Memorandum. The Regulation Impact Statement for the FIF measure is at the end of Part 2 of Chapter1 of the Explanatory Memorandum. The exemption from the CFC measures may result in a small decrease in compliance costs for affected taxpayers.
Summary of Regulation Impact Statement - Part 1 of Schedule 1
Interest Withholding Tax Exemption, Offshore Banking Units and Thin Capitalisation
Impact: Low
The objective of the measures is to make Australia more attractive as a regional financial centre. The package endeavours to develop our corporate debt market and increase Australia's competitiveness as an offshore banking regime.
The global financial industry is growing rapidly. These measures provide the Australian financial sector with the opportunity to achieve higher levels of participation in international trade in financial services. The affected groups are financial intermediaries for whom non-residents are a significant client group, primarily banks and funds managers, and non-residents investing in or through Australia.
The proposed amendments represent a package which is aimed at providing greater certainty and reducing compliance costs and tax burdens in relation to financial sector activities.
The proposed legislation is estimated to negatively affect revenue to the amount of $22 million in a full year. However, the package is expected to promote new business in the financial industry. To the extent that new business is generated revenue will increase.
The Treasury and the Australian Taxation Office will monitor these measures as part of the whole taxation system on a continuing basis. Furthermore, a task force within the Financial Sector Advisory Council was established as a consultative forum which will provide ongoing advice on the effect of the measures on Australia's attractiveness as a regional financial centre.
Summary of Regulation Impact Statement - Part 2 of Schedule 1
Impact: Low
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- The exemption will benefit resident taxpayers who hold interests in US FIFs.
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- The major impact is expected to be on superannuation and investment funds, who between them hold the majority of Australian interests in US FIFs.
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- The exemption is likely to increase Australian investment in US FIFs, particularly US mutual funds, that qualify for the exemption.
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- This investment is expected to be largely at the expense of direct investment in US securities, but also to some extent at the expense of investments in Australia and in other countries.
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- The exemption is likely to result in a minor reduction in compliance costs because the FIF measures will not apply to investments that qualify for the exemption.
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- The cost to the revenue of providing the exemption is expected to be $2 million in the 1998-99 income year and $3 million annually for subsequent income years.
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- Some informal consultation on the exemption has been undertaken with industry and professional associations, in particular, with the Investment & Financial Services Association which represents Australian funds managers.
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- The measure is not controversial to the extent it benefits taxpayers, however, it may be opposed by funds managers who face greater competition.
Summary of Regulation Impact Statement - Part 3 of Schedule 1
Impact: Low
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- The exemption will allow Australian collective investment funds to compete on an equal footing with US real estate investment trusts in attracting Australian investment.
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- The exemption is likely to result in an initial and recurrent reduction in compliance costs because the CFC measures will not apply to investments that qualify for the exemption.
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- The cost to the revenue of providing the exemption is expected to be minor.
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- An Australian collective investment fund was consulted on the proposed exemption.
Commercial debt forgiveness
Amends the Income Tax Assessment Act 1936 to require that:
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- the forgiven amount of a debt be applied, where relevant, to reduce unrecouped net capital losses in respect of all years of income before the forgiveness year of income, rather than the immediately preceding year of income;
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- where a taxpayer incurs a net capital loss in a year of income earlier than the forgiveness year of income, and the loss is reduced by the operation of the debt forgiveness provisions, the loss will also be reduced for the purposes of the capital gains tax provisions.
Date of effect: The amendments will apply to debts forgiven after the date of introduction. [Item 3 of Schedule 2]
Proposal announced: Not previously announced.
Financial impact: There should be no significant impact on revenue as the amendments merely ensure the debt forgiveness rules operate as intended.
Compliance cost impact: There should be no impact on compliance costs as taxpayers have to keep records of prior year net capital losses under the existing law.
Depreciation of plant previously owned by an exempt entity
Inserts new Division 58 into the Income Tax Assessment Act 1997 to set a common base for the depreciation deductions for plant that can be claimed by exempt entities which become taxable and by taxable entities which purchase plant from an exempt entity in connection with the acquisition of a business. The depreciation deductions available to such entities will be taken from a base which is a choice between the notional written down value of the plant at the time it enters the tax net and its undeducted pre-existing audited book value at that time. The amendments include a safeguard measure designed to ensure that, where such plant is on-sold to a subsequent owner, a balancing amount is included in the assessable income or deductions of the first taxable owner to reflect the special depreciation base which applies to that owner and so as to compensate for the effect on the on-sale price of the special depreciation base not applying to the purchaser.
The measure was previously introduced into Parliament but lapsed when Parliament was prorogued. The reintroduced measure contains some technical amendments to correct several potential anomalies which have been identified with the wording of the provisions as previously introduced and their interaction with the capital gains tax provisions. The reintroduced provisions will now more clearly give effect to the measure as originally intended.
Date of effect: Applies to exempt entities which first become taxable on or after 4 August 1997 and to acquisitions of plant by taxable entities from an exempt entity on or after 4 August 1997.
Proposal announced: Treasurers Press Release No. 84 of 4 August 1997.
Financial impact: No additional revenue is expected compared to current Budget estimates. However, failure to implement this measure poses a potentially significant threat to the revenue.
Compliance cost impact: There may be a minimal increase in compliance costs for affected entities.
Franking credits, franking debits and the intercorporate dividend rebate
Amends the Income Tax Assessment Act 1936 to prevent franking credit trading and mis-use of the intercorporate dividend rebate by denying the franking benefit or intercorporate dividend rebate from a dividend where the taxpayer does not satisfy:
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- a holding period rule that, subject to certain exceptions, requires taxpayers to hold shares at-risk for more than 45 days (or 90 days for preference shares); and
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- a related payments rule that requires taxpayers who are under an obligation to make a related payment with respect to a dividend paid on shares to hold the relevant shares at-risk for more than 45 days (or 90 days for preference shares) during the relevant qualification period.
Date of effect: The holding period rule applies generally to shares and interests in shares acquired on or after 1 July 1997 unless the taxpayer became contractually obliged to acquire the shares before 7.30 pm AEST 13 May 1997; special rules affecting certain trusts take effect from 3 pm AEST 31 December 1997. The related payments rule applies to arrangements entered into after 7.30 pm AEST 13 May 1997.
Proposal announced: 1997-98 Budget (13 May 1997). Modifications to the original proposal were announced in Treasurers Press Release No. 89 released on 8 August 1997, and Assistant Treasurers Press Release No.AT/25 released on 31 December 1997.
Financial impact: The holding period and related payments rules will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of franking credit trading and mis-use of the intercorporate dividend rebate. The rules are part of a package of measures targeting franking credit trading and dividend streaming. In the absence of the measures, to the extent that the revenue base would not be protected, there would be a significant revenue loss. While it is not possible to provide an exact estimate of the revenue loss that already existed from franking credit trading and dividend streaming, $130 million a year has been factored into the forward estimates for 1998-99 and subsequent years to take account of the effect of the measures on existing activities.
Compliance cost impact: Taxpayers who are required to comply with the rules will incur additional compliance costs. The extent of the compliance costs incurred will vary depending on the facts and circumstances of particular cases. Accordingly, no reliable data on the amount of these costs is available.
Summary of Regulation Impact Statement
Impact: Medium
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- Taxpayers who are required to comply with the rules will have to incur additional compliance costs. The extent of the compliance costs which will be incurred by taxpayers will vary depending on the facts and circumstances of particular cases. Accordingly, no reliable data on the amount of these costs is available.
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- Natural person shareholders (ie. shareholders claiming franking rebates of $2000 or less) are exempt from the holding period rule and low-risk taxpayers (eg. superannuation funds) will be able to elect to have a franking credit or rebate ceiling as opposed to applying the holding period rule.
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- Only taxpayers who enter into related payment arrangements will incur costs in complying with the related payments rule.
To prevent franking credit trading by implementing some of the measures announced by the Government in the 1997-98 Budget.
Franking of dividends by exempting companies and former exempting companies
Amends the Income Tax Assessment Act 1936 by introducing a rule that limits the source of franking credits available for trading by:
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- prescribing that franked dividends paid by companies which are effectively wholly owned by non-residents or tax-exempts will only provide franking benefits in limited circumstances; and
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- quarantining the franking surpluses of companies which were formerly wholly owned by non-residents or tax-exempts.
The measure will also ensure that non-resident shareholders in receipt of franked dividends from affected companies will continue to be exempt from dividend withholding tax.
Date of effect: Subject to the transitional measures explained in Chapter5, the rule to limit the source of franking credits available for trading will apply to:
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- companies that are effectively wholly owned by non residents or tax-exempts at 7.30 pm AEST, 13 May 1997;
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- companies that are effectively wholly owned by non residents or tax-exempts at 7.30 pm AEST, 13 May 1997 and cease to be so owned; and
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- companies which become effectively wholly owned by non residents or tax-exempts at 7.30 pm AEST, 13 May 1997.
Proposal announced: 1997-98 budget.
Financial impact: The amendments are part of a package of measures targeting franking credit trading and dividend streaming that will protect the revenue base. In the absence of the measures, to the extent that the revenue base would not be protected, there would be a significant revenue loss. The measures will result in unquantifiable revenue gains to the extent of existing tax minimisation.
Compliance cost impact: There is unlikely to be any significant compliance costs associated with the proposed measures. The rule will not apply to taxpayers unless they are wholly owned by non-residents to tax-exempts or have ceased to be so wholly owned.
Summary of Regulation Impact Statement
Impact: Low
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- The measure will impact on companies and their tax advisers (eg. Members of the legal and accounting professions) who are effectively wholly owned, or have, since 13 May 1997, been effectively wholly owned by non-residents or tax-exempts.
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- The measure will also impact on the ATO (in administering the rule, for example, information campaigns), the Government (in that the revenue base will be protected) and non-residents and tax-exempt shareholders (who are no longer able to transfer franking credits).
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- The implementation option adopted avoids the need, for most companies, to create a separate account: this minimises compliance costs for those companies, as well as significantly limiting the number of amendments required to the tax laws.
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- The amendments to the income tax law to implement this option are based on exiting provision of the tax law which are familiar to companies.
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- The alternative option would involve greater compliance costs and complexity without any commensurate additional benefits.
Policy objective: The policy objective is to prevent franking credit trading by limiting the source of franking credits available for trading.
Di stributions to beneficiaries and partners that are equivalent to interest
Amends the Income Tax Assessment Act 1936 to prevent franking credit trading and mis-use of the intercorporate dividend rebate by denying the franking benefit or intercorporate dividend rebate from a trust or partnership distribution attributable to a dividend where the distribution is equivalent to interest.
Date of effect: The amendments apply to trust and partnership interests created or acquired, and finance arrangements entered into, after 7.30 pm AEST 13 May 1997, and to existing arrangements extended after that time.
Proposal announced: The 1997-98 Budget, 13 May 1997.
Financial impact: The amendments will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of franking credit trading and mis-use of the intercorporate dividend rebate. The amendments are part of a package of measures targeting franking credit trading and dividend streaming. In the absence of the measures, to the extent that the revenue base would not be protected, there would be a significant revenue loss. While it is not possible to provide an exact estimate of the revenue loss that already existed from franking credit trading and dividend streaming, $130 million a year has been factored into the forward estimates for 1998-99 and subsequent years to take account of the effect of the measures on existing activities.
Compliance cost impact: Taxpayers who enter into relevant arrangements will incur additional compliance costs in determining whether their distributions are equivalent to the payment of interest on a loan. However, the extent of the compliance costs which will be incurred by taxpayers will vary depending on the facts and circumstances of particular cases. Accordingly, no reliable data on the amount of these costs is available.
Summary of Regulation Impact Statement
Impact: Low
Policy objective: To prevent franking credit trading by implementing one of the measures announced by the Government in the 1997-98 Budget.
Menzies Research Centre Public Fund
This measure amends the Income Tax Assessment Act 1997 to allow deductions for gifts of $2 or more made to the Menzies Research Centre Public Fund.
Date of effect: Gifts made after 2 April 1998 will be tax deductible.
Proposal announced: The proposal was announced in the Treasurers Press Release No.102 of 10 October 1996.
Financial impact: The proposed amendment is not expected to have a significant revenue impact.
Compliance cost impact: None.