The Senate

Taxation Laws Amendment Bill (No. 4) 1995

Income Tax (Franking Deficit) Amendment Bill 1995

Income Tax (Deficit Deferral) Amendment Bill 1995

Second Reading

Senator BOLKUS (South Australia--Minister for Immigration and Ethnic Affairs and Minister Assisting the Prime Minister for Multicultural Affairs) (5.50 p.m.)--I table a revised Explanatory Memorandum and move:

That these bills be now read a second time.

I seek leave to have the Second Reading Speeches incorporated in Hansard

Leave granted.

The speeches read as follows--

The Taxation Laws Amendment Bill (No. 4) 1995 (the bill) will amend the taxation laws in a number of respects. It includes ten measures which give effect to announcements in the 1995-96 Budget.

The bill is mostly drafted in the new style emerging from the tax law improvement project. This will help taxpayers and their advisers in understanding the proposed changes.

Capital gains tax measures

The 1995-96 Budget included a number of measures relating to capital gains tax.

Amendments relating to value shifting

The bill proposes amendments to Division 19A of Part IIIA which operates to prevent the creation of capital losses, or reduction of capital gains realised on the disposal of shares or loans in a company. Losses can be created (or gains reduced) by shifting value out of the shares or loans through the transfer of assets to commonly owned companies for low or nil consideration. Where a value shift is taken to have occurred, the cost bases of shares and loans in the transferor company are reduced to reflect the transferred value. The proposed amendments will generally operate to reduce the costs for taxpayers in complying with Division 19A, and to rectify certain anomalies in its current operation.

Compliance costs will be reduced by enabling companies to transfer depreciable assets generally at their written down value without the need to make cost base adjustments provided that the market value of the assets is not substantially greater. Companies will also be able to group some assets that are transferred rather than deal with them on an asset by asset basis.

A simplified test will also be applied for assets acquired prior to the time at which the transferor and transferee companies came under common ownership. This measure will simplify the operation of the law, reduce uncertainty and thereby reduce compliance costs.

An anti avoidance measure is included in the bill so that Division 19A will apply to the creation and transfer of rights relating to an asset where the asset has not itself been transferred. Where the consideration for the transfer of the new asset is less than its market value, a value shift will be taken to have occurred.

This bill will also make a number of other technical amendments to Division 19A.

These amendments, which will have no significant impact on revenue, will apply to transfers of assets after 7.30pm AEST on 9 May 1995.

Increase in personal-use asset thresholds

The bill increases the thresholds applicable to both listed and non-listed personal-use assets to $500 and $10,000 respectively.

The amendment to increase the thresholds for listed and non-listed personal-use assets will apply to disposals of assets occurring on or after 1 July 1995. The amendments will result in a cost to revenue of up to $2 million per year.

Taxable Australian assets

The bill will clarify the provisions relating to the disposal of certain taxable Australian assets. Some taxpayers have argued that gains on the disposal of taxable Australian assets used solely to produce franked dividends or income subject to withholding tax in Australia (such as certain shares in Australian companies and assets used in a permanent establishment in Australia) are not subject to capital gains tax.

This interpretation of the law is contrary to the clear intention of parliament. The amendments will ensure that capital gains tax will apply appropriately to disposals by non-residents of all taxable Australian assets and, thereby, will give effect to the intention underlying the existing law. They will apply or disposals of taxable Australian assets on or after 20 September 1985, which is the date from which capital gains tax applies.

The financial impact of this measure is unquantifiable.

Exempt receipts

The bill contains measures that will extend the existing capital gains tax relief which applies to a gain realised on the disposal of shares in a foreign company where the disposal also gives rise to a tax exempt non-portfolio dividend. The capital gain is reduced by the amount of the exempt dividend as though the dividend was taxable. Currently, capital gains tax relief applies in relation to the disposal of shares in foreign companies which were created after 25 June 1992.

The bill proposes that capital gains tax relief will also be available in relation to disposals of shares in foreign companies where the shares were created before 26 June 1992. This measure will apply to disposals occurring from the 1990-91 year of income, which is the year from which the exemption provided for non- portfolio dividends also applies.

A related measure will ensure that disposals of shares which take place after 7.30pm AEST on 9 May 1995 and which give rise to non- portfolio dividends from foreign companies which are exempt from income tax, will only qualify for capital gains tax relief to the extent that the dividends are not paid out of a share capital account, share premium account or revaluation reserve of the foreign company. The bill also modifies the existing general capital gains tax relief which applies in relation to gains realised on the disposal of assets where a capital amount is expressly included (in whole or in part) in the assessable income of a taxpayer. The existing general capital gains tax relief will be modified to apply specifically to disposals of rights to receive eligible termination payments. The amendments will apply to disposals taking place after 7.30pm AEST on 9 May 1995.

The financial impact of these measures is unquantifiable.

Compulsory rollover of assets

The bill will provide that, where a company disposes of an asset to a related company and the disposal would give rise to a capital loss, a compulsory capital gains tax rollover will generally apply in relation to the transfer of the asset.

An exception is provided, subject to safeguards, where the company into which the loss asset is transferred is to be sold or floated within a specified time period.

These amendments will apply to transfers of assets between related companies taking place after 7.30pm AEST on 9 May 1995. They will prevent a potentially significant risk to revenue.

Amendment or replacement of trust deeds

The bill provides that a capital gains tax rollover will be available in relation to the disposal of the assets of a complying approved deposit fund (ADF) that would otherwise occur as a consequence of the conversion of the ADF to a complying superannuation fund. A rollover will also be available in relation to a disposal of the assets of an existing complying ADF or complying superannuation fund where the trust deed of the ADF or superannuation fund is amended or replaced in order to comply with the Superannuation Industry (Supervision) Act 1993.

The rollover will only be available where there is no change in the assets of the fund or interest of members in the fund as a consequence of the conversion of the ADF to a superannuation fund, or the amendment or replacement of the trust deed of the ADF or superannuation fund. This measure will apply to disposals of assets taking place on or after 12 January 1994, the date from which certain amendments to the CGT relating to settlements of trusts and transfers of property to trusts took effect.

The revenue impact of this proposal is insignificant.

Dividend imputation

The bill will amend the dividend imputation provisions as a result of the increase in the company tax rate from 33% to 36% with effect from the 1995-96 income year. The amendments, which will apply from 1 July 1995, will allow companies to record franking credits and debits and distribute imputation credits to shareholders by reference to tax paid at 36%. The value of existing 33% and 39% franking credits will be preserved for shareholders.

The amendments will reduce compliance costs for most companies because they will convert from the present dual franking account system to a single franking account.

The bill will also correct certain defects in the current dividend imputation provisions relating to life insurance companies. The amendments will apply from the time the defects in the current provisions first arose. One amendment will prevent an unintended gain to the revenue and the other amendment will prevent a significant potential loss to the revenue.

As part of the dividend imputation amendments, the bill also provides for the calculation of class C franking deficit tax and deficit deferral tax. These taxes are imposed by the Income Tax (Franking Deficit) Amendment Bill 1995 and the Income Tax (Deficit Deferral) Amendment Bill 1995 respectively. These separate bills are required for constitutional reasons.

Franking credits--international profit misallocation

In the 1995-96 Budget the government announced a measure to deny franking credits for profit shifting adjustments.

Under the current imputation system for company taxation, transfer pricing or non-arm's length dealing adjustments resulting in additional tax payable by an Australian resident company will give rise to a franking credit. This provision of a franking credit largely negates the additional tax payable by the resident company because the profits, which have been taxed under the transfer pricing and non-arm's length dealing adjustment provisions, have already been shifted or misallocated offshore and are not actually in Australia. Accordingly, the franking credits arising from the payment of the additional company tax assessed as a result of the transfer pricing adjustments can be used to frank proftu distributions that would not otherwise be franked dividends and subject to the relevant tax relief measures.

The proposed amendment will ensure that the Australian revenue is not disadvantaged by international transfer pricing practices or non-arm's length dealings which misallocate or shift profits offshore.

Demutualisation of insurance companies

The Treasurer announced in the 1995-96 Budget that specific taxation measures would be introduced for the demutualisation of mutual life and general insurance companies. These measures are proposed in this bill. The bill provides that a demutualisation may occur under a specified method and then describes the taxation consequences of certain transactions which may occur in the course of the demutualisation. All of the methods of demutualisation require that the interests of members in the mutual company will be extinguished in exchange for ordinary shares in the demutualised company.

The bill provides that capital gains tax will not apply to the surrender by a member of his or her membership interests in a mutual insurance company or a mutual affiliate company.

The bill establishes, for capital gains tax purposes, the date and cost of acquisition of shares acquired by former members as part of the demutualisation process. In relation to a life insurance company, the deemed acquisition cost of shares will be determined by reference to the embedded value of the company. For general insurance companies the deemed acquisition cost of shares will be determined by reference to the net tangible assets of the company.

No capital loss will be available in relation to the disposal of demutualisation shares and interests prior to the listing of ordinary shares in the demutualised entity. After listing, the deemed cost of acquisition of the shares will be the lesser of the amount calculated by reference to the embedded value or net tangible assets of the company and the last published price at which the demutualisation shares were traded on their first day fn trading. The new provisions substantially relate to the application of the capital gains and losses provisions. However, parallel provisions have been included for transactions which would otherwise lead to amounts being included in the assessable income of a taxpayer.

The amendments will only apply to demutualisations of mutual companies that were in existence at 7.30pm AEST on 9 May 1995. The nature of the measure is such that the cost to revenue cannot be reliably estimated.

Establishment costs of horticultural plants

On 29 November 1994, the Treasurer and the Minister for Primary Industries and Energy announced that a form of taxation write-off would be extended to expenditure on new horticultural plantations. The details of the form of write-off were announced on 9 May 1995 as part of the 1995-96 budget.

The purpose of the amendments is to give capital expenditure on horticultural plantations such as orchards and perennial crops comparable tax treatment to capital expenditure in other industries.

The bill allows taxpayers to write off the original capital expenditure incurred in establishing horticultural plants which are used, or are held ready for use, by taxpayers to produce assessable income in businesses of horticulture. The period over which the expenditure is written off will be based on the effective life of the plants, and gives the same rate of deduction as prime cost (or `straight line') depreciation of plant and equipment with the same effective life. Where effective life is less than three years there is an immediate write-off for establishment expenditure to the first taxpayer to use the plant, or hold it ready for use, to produce assessable income from a business of horticulture.

There is expected to be a cost to revenue of $1 million in 1997- 98, $2 million in 1998-99 and $4 million in 1999-2000.

Forestry plantations

The bill will give effect to the measures announced in the 1995-6 Budget relating to immature forests and plantations.

This measure is designed to overcome an anomaly that exists in some circumstances where an established but immature plantation or forest is purchased by a taxpayer engaged in forestry operations, and subsequently sold with the timber still standing. This taxpayer may be taxed on the gross value of the standing timber rather than the net profit.

The measure provides that where a taxpayer, who is engaged in timber operations and has purchased an established but immature plantation or forest, sells that plantation or forest after 9 May 1995 outside the normal course of business the taxpayer is assessed on the net profit from the sale.

The bill also contains certain anti-avoidance provisions relating to non arm's length transactions.

There is expected to be a cost to revenue of $1 million in 1995-96 and $4 million in subsequent years.

Research and development

In the 1995-96 Budget the government announced a measure to deny a deduction for expenditure on research and development activities incurred to a private tax exempt body where that expenditure is not fully at risk.

Where a company incurs expenditure in relation to research and development activities carried out on its behalf, the arrangements are often structured in such a way that the company receives a guaranteed return for its expenditure.

When expenditure is incurred to a tax exempt body, that body faces no tax liability on its income. Therefore the arrangement may support higher guaranteed returns than an arrangement in which expenditure is incurred to a taxpayer. In effect, the Commonwealth is funding the higher guaranteed return. The company owning the research will derive a tax benefit because of the tax exempt status of the researcher.

The proposed amendment will ensure that companies receive the same taxation treatment for research and development expenditure incurred to private tax exempt entities as is presently providd for expenditure incurred to public tax exempt entities. If there is any guaranteed return for the expenditure, the expenditure will not be deductible.

Transitional provisions will protect companies relying on a finance scheme approved by the Industry Research and Development Board before the budget and implemented by 3 August 1995.

There is expected to be a gain to revenue of $20 million in 1995- 96, $85 million in 1996-97, $120 million in 1997-98 and 145 million in 1998-99.

Wholesale sales tax--exemption for rice milk

The bill proposes to amend the sales tax law to exempt rice milk from sales tax as recently announced by the Treasurer.

The amendments will ensure that rice milk is treated for sales tax purposes the same as other similar milk and soy milk beverages.

The cost to revenue of exempting rice milk from sales tax is estimated to be less than $300,000 per annum.

Trust losses

This bill gives effect to the government's 1995-96 Budget announcement that new rules will be introduced to limit the circumstances in which trusts can deduct current year and prior year losses.

The government is making these changes to stop the significant erosion of revenue that has been occurring through trafficking in trust losses.

The tax law already contains tests which limit the deductibility of losses incurred by companies. The proposed rules that are to apply to trusts will differ in some respects from those that apply to companies, reflecting the different characteristics of trusts. The government has been concerned to ensure that the law operates fairly and has therefore decided that the tests to be satisfied before losses are deductible will vary depending on the type of trust.

For example, family trusts will generally be able to deduct losses, provided that members of the same family are the only persons who could benefit from the trust.

Special rules will also apply to widely held listed unit trusts. These rules will help to minimise compliance costs for this tyex of trust.

While fixed trusts will be subject to a continuity of ownership test, non family discretionary trusts will be subject to continuity of ownership, continuity of control and pattern of distribution tests. This reflects the fact that it is not possible to apply the same beneficial ownership test to discretionary trusts.

Trusts (including family trusts) will be subject to an income injection test to ensure generally that trust losses are not used by outsiders to shelter their income from tax.

Exceptions from these measures are provided for complying superannuation funds, complying approved deposit funds and pooled superannuation trusts. The measures will also not apply to deceased estates for a reasonable period of administration.

The proposed rules designed to prevent trafficking in trust losses necessarily reflect the complex nature of the different types of trusts. The amendments are therefore lengthy but, as already indicated, they are designed to ensure fairness in the system.

The drafting approach for these amendments follows the new tax law improvement style and the structure follows that of the redrafted company loss provisions which are due to be introduced into Parliament later this year.

The estimated gain to revenue from the proposed changes is $90 million in 1995-96, $185 million in 1996-97, $155 million in 1997- 98 and $65 million in 1998-99.

Non-compulsory uniforms or wardrobes

Also included in this bill is a measure to give effect to the 1995- 96 Budget announcement to transfer responsibility for the maintenance of the Register of Approved Occupational Clothing from the Textiles, Clothing and Footwear Development Authority to AusIndustry in the Department of Industry, Science and Technology.

This amendment has no effect on revenue.

Full details of the measures in the bills are contained in the Explanatory Memorandum circulated to honourable senators.

I commend the bill to the Senate.

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