Interaction rules

Due to the introduction of TOFA, certain consequential amendments were made to provisions in the ITAA 1936 and the ITAA 1997 that deal with matters within the scope of, or affected by, TOFA.

For example, specific amendments have been made to the consolidation, capital gains tax (CGT) and foreign currency gains and losses provisions. Anti-overlap rules have also been introduced to address specific interaction issues.

These consequential and interaction amendments generally fall into 6 categories:

1. Ordering rules: These rules provide guidance on which tax law provisions will prevail when a financial arrangement falls within the scope of other tax laws outside TOFA (see ordering rules).
2. Value-setting rules: These rules set the values of financial benefits for the purposes of the tax law, including for TOFA (see value-setting rules).
3. Recognition of gains and losses: This category of amendments provides rules on whether an amount is assessable or deductible where a financial arrangement within TOFA is involved.
4. Definitional: Certain definitions in existing tax law have changed due to TOFA.
5. Referencing: Under these amendments, references to Division 230 have been added in other tax law provisions, and relevant referencing tables in the ITAA 1997 have been updated.
6. Record keeping: These amendments outline how record-keeping requirements have been modified due to the introduction of TOFA.

Ordering rules

There are a number of provisions that may apply to an arrangement that is also a TOFA financial arrangement.

As a consequence, there are rules to work out which provision should take precedence. Some of these rules are:

• 12-month prepayment rule: Subdivision H of Division 3 of the ITAA 1936 sets out the timing of the deduction that may be allowable when such expenditure is prepaid. When the prepayment period is more than 12 months, TOFA will take precedence over Subdivision H of Division 3 of the ITAA 1936.
• Qualifying securities: TOFA will bring to account most of the gains and losses made on discounted and deferred interest securities acquired or issued on or after 1 July 2010, or 1 July 2009 if a relevant entity makes an early-start election.
• Deductions for returns on debt interests: Where a debt interest (as per Division 974) is also a TOFA financial arrangement, the gains or losses on those debt interests may be brought to account or allowable as a deduction under TOFA.
• Trading stock: An item of trading stock that is a financial arrangement will be dealt with under TOFA and not Division 70.
• Superannuation funds: Section 295-85 provides that, where a CGT event happens to a CGT asset that is also a financial arrangement, the relevant gain or loss is generally brought to account under the CGT provisions and not TOFA.

For more information, see:

• Subdivision H of Division 3 of the ITAA 1936
• Division 974 – Debt and equity interests
• Division 70 – Trading stock
• Section 295-85 – Taxation of superannuation entities.

Value-setting rules

Financial arrangements may be dealt with in circumstances involving dealings with other things. The objective of section 230-505 is to provide appropriate proceeds and cost base interaction rules between the provisions of Division 230 and the rest of the ITAA 1997 and the ITAA 1936. This is to ensure symmetry between TOFA and other provisions of the act, such as the capital gains tax (CGT) regime.

Specifically, section 230-505 applies if an entity starts or ceases to have a TOFA financial arrangement as consideration for:

• the provision of a thing
• the acquisition of a thing
• the starting to have a thing
• the ceasing to have a thing
• providing or receiving services
• incurring an obligation
• extinguishing a right or obligation
• varying a right or obligation.

Examples of each of these types of circumstances are:

• Provision of a thing – the entity sells an asset subject to capital gains tax, and instead of receiving capital proceeds upfront, the entity is issued a debt interest under which the proceeds will be paid 2 years after the asset is sold.
• Acquisition of a thing – the entity acquires an item of plant that is subject to Division 70, and under the acquisition contract, the entity issues a promissory note as consideration for the acquisition of the plant.
• Starting to have a thing – the entity enters into a contract is entered into with the purchaser of the business not to operate a similar business in the same town. The contract states that $20,000 was paid for this 4 years after the contract date.
• Ceasing to have a thing – a right the entity has come to an end, and the entity will receive consideration for the ending of the asset in instalments over a 10 year period.
• Incurring an obligation – an entity creates an obligation in itself, and in consideration for this starts to hold a bond.

The effect of section 230-505 is to reset the tax cost of the thing, service, obligation or right. The amount provided or received in order to acquire or assume the thing, service, right or obligation is deemed to not equal the amount actually provided or received to acquire or assume the thing, but instead to equal the market value of that thing, service, right or obligation at the time when it was actually acquired or assumed.

The effect of section 230-505, in the context of these examples, may be to reset the following:

• the capital proceeds from a CGT event that occurs when the asset is sold to equal the market value of the asset when it was sold
• the cost base of the depreciating asset to equal the market value of the asset when it was acquired
• the proceeds from entering into the contract to equal the market value of the contract when it was entered into
• the proceeds from the ending of the right to equal the market value of the asset when it ended
• the amount provided to acquire the asset to equal the market value of that asset when it was created
• the amount received as consideration for agreeing to vary the lease to equal the market value of the varied right under the lease when it was varied.

Section 230-505 will also apply where the starting or ceasing to have the TOFA financial arrangement is not consideration for one of the circumstances outlined above, but rather where the starting or ceasing is, in substance or effect, done for one of those circumstances. For example, an entity that is a tenant under a lease, satisfies the obligation to pay rentals as consideration for its tenancy by issuing promissory notes.

Additionally, the market value of the thing, service right or obligation will also be used in calculating the gains and losses the entity makes from the financial arrangement it started or ceased to have in consideration for the acquisition or assumption of the thing, service right or obligation.

See Section 230-505 – Financial arrangement as consideration for provision or acquisition of a thing.

Consolidation interactions – assets

When a consolidated group acquires a company, the shares in the acquired company cease to be recognised for taxation purposes and the acquired company’s assets effectively become assets of the head company. Broadly, the tax costs of those assets are set at their tax cost-setting amounts.

In essence, section 701-55 sets the tax cost of an asset (being its tax cost-setting amount) to be used when applying other provisions of the income tax law to that asset.

Subsections 701-55(5A) and (5B) apply to an asset that is a financial arrangement and specifies the use of the tax cost-setting amount for the purposes of applying TOFA and section 701-61.

For more information, see:

• Section 701-55 Setting the cost of an asset
• Section 701-61 Assets in relation to Division 230 financial arrangement – head company's assessable income or deduction.

Subsection 701-55(5A)

If subsection 701-55(5A) applies then the asset will be deemed to be acquired:

• if the accruals/realisation or hedging method in TOFA is to apply in relation to the asset – at the asset’s tax cost-setting amount
• if the fair value, retranslation or reliance on financial reports method in TOFA is to apply in relation to the asset – at the asset’s accounting value at the joining time.

The effect of subsection 701-55(5A), in conjunction with section 715-378, is that the deemed acquisition amount (be it the tax cost-setting amount or accounting value at the joining time) can be taken into account when working out the gains or losses the head company makes from the financial arrangement asset.

Note that generally speaking, there are no special rules that apply for working out the amount of the tax cost-setting amount for assets in relation to which TOFA applies. Subsection 701-55(5A) only specifies how the tax cost-setting amount is to be taken account of under TOFA or section 701-61. It does not specify the amount of the tax cost-setting amount.

There is, however, one exception to this. As per subsection 705-25(5) of the prospective-rules period (as defined in Schedule 3 to Tax Laws Amendment (2012 Measures No. 2) Act 2012), a retained cost-base asset includes a right to future income. A right to future income can include many types of assets, some of which may be financial arrangements: subsection 701-63(5) of the prospective-rules period. There is a carve-out in the definition of rights to future income for rights that are either a TOFA financial arrangement, or a part of a TOFA financial arrangement.

This leads to the following consequences:

• If the TOFA carve-out applies, then the asset may be a retained cost-base asset (provided the other elements of the definition are satisfied).
• If the TOFA carve-out does not apply, then the asset may be a reset cost-base asset (unless it is a retained cost-base asset under one of the other definitions of retained cost-base asset).

See Section 701-55 – Setting the cost of an asset.

Section 701-61

Where the fair value, retranslation or reliance on financial reports method applies, there is a special adjustment rule provided for under section 701-61. The difference between the asset’s tax cost-setting amount at the joining time and the accounting value of the asset at the joining time is to be:

• where the accounting value exceeds the tax cost-setting amount – included in the head company’s assessable income, equally spread over the income year in which the joining time occurs, and the following 3 income years
• where the accounting value is less than the tax cost-setting amount – allowed as a deduction from the head company’s assessable income, equally spread over the income year in which the joining time occurs, and the following 3 income years.

This adjustment should not be confused with the transitional balancing adjustment – this is a completely different process calculated under a different set of provisions.

See Section 701-61 – Assets in relation to Division 230 financial arrangement – head company's assessable income or deduction.

Consolidation interactions – liabilities

Under section 715-375, where a joining entity brings a liability into a consolidated group in relation to which TOFA applies, the liability will be deemed by subsection 715-375(2) to have been assumed at the joining time for (broadly) receiving the liability’s accounting value at the joining time.

This is similar to the tax cost-resetting process for assets in that it deems an assumption of the liability for an amount. The difference between the cost-setting rule for liabilities is that the quantification of the cost of the liability is simply its accounting value. The cost-setting process for liabilities does not involve a push-down process.

 

See Section 715-375 – Cost setting – amount of liability that is Division 230 financial arrangement.

Consolidation interactions – transitional aspects

Special rules apply to financial arrangement assets and liabilities brought into consolidated groups as a result of an entity joining the head company's consolidated group where the joining time occurred before TOFA started to apply to the head company, and that were still on hand when TOFA started for the head company, where the head company made a transitional election.

Broadly, the effect of these changes are to require, for the purposes of TOFA and the TOFA transitional balancing adjustment, that the cost-setting rules for both assets and liabilities in subsection 701-55(5A) and 715-375(2) respectively be applied for the purposes of calculating the amount of the transitional balancing adjustment and gains and losses the head company makes under TOFA.

In relation to assets, an additional adjustment also applies where the fair value, retranslation or financial reports method is to apply in relation to the asset (see sub-item 104B(2) of Schedule 1 to the TOFA Act). This adjustment mirrors section 701-61, except it applies transitionally.

The effect of the special transitional rules is essentially to replicate what subsection 701-55(5A) working with section 701-61 and subsection 715-375(2) would have done, had the rules applied at the joining time. They achieve this effect by deeming application of the rules for the purposes of the transitional balancing adjustment and TOFA.

This has 2 important implications:

• When calculating the transitional balancing adjustment, an entity should have regard only to things that occurred after the joining time, but before the start of TOFA. Things that occurred before the joining time must be disregarded.
• An entity needs to apply the transitional balancing adjustment and TOFA on the assumption that the deemed acquisition/assumption value as provided for in subsection 701-55(5A) or subsection 715-375(2) actually did occur at the joining time (despite the fact that at the joining time these provisions were not in existence).