House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon. P.J. Keating, M.P.)

MAIN FEATURES

The main features of the Bills are as follows:

Taxation Laws Amendment Bill (No. 3) 1986

Cash Bidding (Clauses 22 to 24 and 29)

This Bill will give effect to the proposal announced on 15 January 1986 to allow income tax deductions for cash bids paid in respect of certain off-shore petroleum exploration permits. The system of cash bidding is governed by the Petroleum (Submerged Lands) Act 1967 and, broadly, requires the successful bidder to pay to the Commonwealth the amount specified by that bidder in an application for the award of the permit.

For income tax purposes, the amount of the cash bid will, in effect, be treated as development expenditure for the purposes of the petroleum mining provisions (Division 10AA) of the Income Tax Assessment Act 1936 - that is, the bid will be deductible on a straight-line basis over the lesser of 10 years and the life of the producing field. Entitlement to the deduction will not be available, however, until the income year in which a production licence is granted in respect of the relevant permit area.

In the event that, prior to the granting of a production licence, the original cash bidder sells all or part of the interest acquired under the bid, the parties to the sale will be entitled to lodge a written notice with the Commissioner of Taxation stating the amount of the original cash bid that they have agreed is to be transferred to the purchaser of the interest. The effect of the election will be to treat the nominated amount as a cash bid incurred by the purchaser, thereby entitling the purchaser to deductions of that amount over the lesser of 10 years or the life of the producing field, commencing in the income year in which a production licence is granted. The vendor's entitlement to a deduction in respect of the cash bid will be correspondingly reduced.

The amendments will apply in respect of cash bids paid on or after 15 January 1986.

Death or compulsory destruction of live stock (Clauses 18 and 19)

This Bill will implement the proposal, announced in the Economic and Rural Policy Statement of 15 April 1986, to amend section 36AAA of the Income Tax Assessment Act 1936 to permit profit from the death or destruction of live stock, after 30 June 1986 by reason of bovine brucellosis or tuberculosis, to be offset against the cost of replacement live stock on a herd basis over a period of up to 10 years.

The existing law provides for 2 different elections in relation to profit arising as a result of the death or destruction of live stock - being assets of a primary production business carried on in Australia - where the death or destruction results from a disease (including, but not limited to, brucellosis and tuberculosis) in respect of which a Commonwealth, State or Territory law makes provision for the compulsory destruction of live stock. The effect of an election under section 36AA of the Assessment Act is to include one-fifth of the profit on death or destruction in assessable income of the year of death or destruction and of each of the 4 succeeding years of income.

An alternative election is provided by sub-section 36AAA(1A) of the Act. This has the general effect of deferring the assessment for income tax purposes of the profit on death or destruction of the live stock until the year of disposal of replacement stock. This is achieved by excluding the profit from the taxpayer's assessable income of the year of death or destruction and applying the average profit applicable to each animal that died or was destroyed to reduce the cost of each replacement animal purchased during the year of death or destruction or any of the 5 succeeding years. Any profit not so applied or otherwise brought to account as at the end of that five year period is included in the assessable income of the fifth succeeding year.

The amendments being made by the Bill will modify the effect of the alternative election where the death resulted from bovine brucellosis or tuberculosis or the destruction was required by a Commonwealth, State or Territory law relating to the compulsory destruction of live stock to control or eradicate bovine brucellosis or tuberculosis (e.g., the Brucellosis and Tuberculosis Eradication Campaign). In such cases, the profit on death or destruction will continue to be excluded from the assessable income of the year of death or destruction, but will be applied to reduce the total cost of replacement live stock purchased during that year or any of the 10 succeeding years of income, instead of reducing (on an average basis) the cost of each replacement animal over the 5 succeeding years. The amendments will not affect the section 36AA election and the alternative election will be retained with its present effect in respect of live stock that die or are destroyed as a result of a relevant disease other than bovine brucellosis or tuberculosis.

Interest withholding tax (IWT) changes (Clauses 25 to 28 and 33)

The Bill will implement the proposal, announced on 1 July 1986, to withdraw the section 128GA IWT exemption relating to interest payments on external borrowings by the States and by Commonwealth and State authorities. This measure is to have effect in relation to interest paid in respect of borrowings or loans contracted for after 1 July 1986 but, subject to safeguards against abuse, will not affect payments made on or before the date on which the amendment becomes law.

The Bill will also ensure that particular financing techniques, namely, loan roll-overs and loan extensions, cannot be used to preserve IWT exemptions under sections 128EA and 128G which, by 1983 amendments of the income tax law, were intended to be removed in relation to borrowings on or after 20 May 1983. The Bill will thus close off avenues, revealed by a recent court decision, by which IWT exemptions under those sections could otherwise be effectively preserved indefinitely in relation to loans raised under contractual obligations entered into before 20 May 1983. The amendments being proposed by the Bill to withdraw the section 128GA IWT exemption contain similar safeguarding provisions. Those measures were also foreshadowed in relation to sections 128G and 128GA by the 1 July 1986 announcement and will have effect in relation to relevant interest payments made, after the measures become law, under loan draw downs to which the borrower was not contractually committed on or before 1 July 1986 and loan roll-overs or extensions effected after that date. For section 128EA, the interest payments affected will be those made, after the amendment becomes law, under relevant loan draw downs, roll-overs or extensions effected after the date of introduction of the Bill.

Whether the whole or a part of a loan had been rolled-over, and so falls within the scope of this amending legislation, would ordinarily be clear from the facts of the particular case.

The exercise, after the introduction date, of an option to renew the whole, or a part, of a loan would give rise to a new loan, the interest payments on which would not be exempt from IWT after the amending Bill receives the Royal Assent. On the other hand, the mere regular adjustment, during the term of a loan, of the loan interest rate would not necessarily result in the loss of an IWT exemption. For example, in the case of section 128G, the use of an interest rate re-setting facility such as revolving note issues, some of which occur after 1 July 1986, to set a market interest rate would not, of itself, preclude from IWT exemption interest payments made after the date on which the Bill receives the Royal Assent, provided that the relevant borrowing was contracted for before 20 May 1983, it was for a specified amount and a fixed term and the borrower was, before 2 July 1986, committed to that facility by reason of the underlying loan contract or a directly connected interest and/or currency swap contract.

Although the Bill withdraws the section 128GA IWT exemption referred to earlier, it will provide for access by the States and by Commonwealth and State authorities to the IWT exemption contained in section 128F. That exemption presently applies to interest paid on certain loans raised overseas by public or widely spread debenture issues by Australian resident companies for use in Australian businesses.

Amendments proposed by the Bill will treat the States and authorities as if they were Australian resident companies thereby enabling them (subject to their satisfying the other requirements of the section) to qualify for the section 128F IWT exemption. Also, that section as it is proposed to be amended, will not require that overseas borrowings by the States and authorities be for use in an Australian business. If this latter restriction were to be maintained, the States and many State and Commonwealth bodies would be deprived of the benefit of the section 128F exemption because their activities would not ordinarily be described as businesses.

These changes will apply in relation to a loan raised by a State or a Commonwealth or State authority pursuant to a contractual obligation entered into after 1 July 1986. It will be possible, therefore, for a State or authority to obtain IWT exemption under section 128GA in respect of interest paid under certain loans raised after 1 July 1986, which exemption will be effective in relation to interest payments made before the withdrawal of the section 128GA exemption has effect (upon enactment of that amendment), and then to obtain continuation of IWT exemption for later interest payments under the loan under section 128F.

The Bill also proposes an easing of the conditions on which the section 128F IWT exemption may be obtained, by removing the requirement that relevant overseas borrowings and interest payments be in non-Australian currencies. That amendment will apply in relation to interest payments made after the date of enactment of the Bill.

Service fees incurred in acquiring horses by natural increase (Clause 17)

The Bill will give effect to the proposal, announced in the 1986-87 Budget, that service fees incurred after 19 August 1986 in the acquisition of horses by natural increase be taken into account in the valuation of such horses for trading stock purposes.

In the case of live stock generally, the income tax law provides that live stock on hand at the end of a year of income may be valued at cost price, market selling value or some other value that circumstances may justify. Where the cost price of natural increase of a particular class of live stock has not previously been taken into account by the taxpayer, the taxpayer may select a cost price per head in respect of natural increase of that class and the amount selected must continue to be used by the taxpayer in subsequent years unless the Commissioner of Taxation agrees to the adoption of another cost price. The selected cost price may not be less than the amount prescribed in respect of the particular class of live stock - in the case of horses $5 - and, if the taxpayer does not select a cost price, the prescribed amount is adopted. Thus, the cost price of a horse acquired by natural increase may be taken to be as little as $5.

The amendments being made by the Bill will have the effect that a horse acquired by natural increase shall be taken to have a cost price not less than any Service fee (whether for physical service or service by artificial insemination) incurred after 19 August 1986 in acquiring the horse. Fees paid for the agistment of a mare while at stud, veterinary fees and other costs not forming part of the actual service fee will not be included in the cost price of natural increase. Safeguarding provisions will, however, operate to counter arrangements aimed at circumventing the measure - for example, where costs that are in reality service fees are misdescribed in the relevant contract.

Where one service fee is incurred in acquiring more than one horse - for example, where a single fee is paid for the service of a number of mares or a service results in a multiple birth - the service fee will be apportioned between the resultant foals on a basis that, in the opinion of the Commissioner of Taxation, is reasonable in the circumstances. Although fees paid in respect of an unsuccessful service will not be taken into account in the trading stock valuation of any horse, no apportionment of a service fee will be made in those cases where, for the one fee, a mare is serviced more than once and a live foal results.

Limitation of special live stock valuation option for horse breeders (Clause 16)

The Bill proposes amendments of the trading stock provisions of the Income Tax Assessment Act 1936 to provide that the special live stock valuation option for horse breeders is not available in respect of a horse acquired after 19 August 1986 until the year in which the horse reaches the age of 3 years. These amendments will give effect to a proposal announced in the 1986-87 Budget.

As with live stock generally, horses may be valued on the basis of cost price, market selling value or some other value that circumstances may justify. A special option, introduced by the Taxation Laws Amendment Act (No. 3) 1985, provides horse breeders with an additional basis of valuing breeding stock. Under that option, breeding horses purchased after 20 August 1985 may be valued as follows -

Stallions

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cost price reduced by up to 50% per annum on a diminishing value basis;

Mares

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cost price reduced by 33 1/3% per annum on a diminishing value basis; or

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cost price reduced by a minimum of 3 annual amounts that will reduce the value of the horse to $1 by the time the horse is aged 12 years or more.

By specifying that the option is available only in respect of horses that have attained 3 years of age, the amendments being made by this Bill will broadly ensure that, as intended, the special option is limited to horses that are capable of breeding. The full benefit of the valuation option will, however, be available in the year of income in which an otherwise eligible horse attains the age of 3 years.

Exemption of pay and allowances for part time service by members of the Defence Force Reserves and Emergency Reserves (Clause 15)

The amendment proposed by clause 15 will modify the existing law which exempts half of the pay and allowances of members of the Defence Force Reserves and Emergency Reserves for part time service as members of those Reserves. The amendment will give effect to the 1986-87 Budget announcement to reinstate full tax exemption for payments made in respect of service on or after 1 January 1987. The proposed amendment will also apply to reinstate full tax exemption of any gratuity paid to members of the Emergency Reserves by reason of a calling out for continuous service on or after 1 January 1987. In each case the exemption had been limited since 1 December 1983 to one-half of the relevant payments.

Provisional tax for 1986-87 year (Clause 32)

Provisional tax for the 1986-87 year of income is to be calculated, basically, by applying 1986-87 rates of tax and Medicare levy to 1985-86 taxable incomes as increased by 11 per cent. Rebates and credits allowed in 1985-86 income tax assessments will be taken into account as appropriate in calculating the 1986-87 provisional tax.

In the case of the rebate of tax available to Christmas Island residents as part of the personal income tax phasing arrangements the amount be taken into account in the provisional tax calculation will be two-thirds of the amount allowed in 1985-86 assessments. Arrangements for pro-rating the tax free threshold which may apply where a person leaves full-time education in the 1986-87 year of income or is a resident of Australia for only part of that year will not be taken into account.

Gifts (Clause 21)

The Bill will give effect to a 1986-87 Budget proposal by extending those provisions of the Income Tax Assessment Act 1936 that authorise deductions for gifts of the value of $2 or more made to specified organisations to include the Australian Academy of Technological Sciences and the Australian College of Occupational Medicine. Gifts made to those organisations after 19 August 1986 will qualify for deduction.

Approved research institutes (Clause 20)

The Bill will add the Secretary to the Department of Science to the list of authorities who may approve a university, college, institute, association or organisation as an approved research institute for income tax purposes. Certain payments made to an approved research institute may qualify as allowable income tax deductions. They are -

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payments in respect of scientific research related to the payer's business;

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payments in consideration for the approved research institute performing research and development activities on behalf of the payer company; and

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gifts for the purposes of scientific research.

Prescribed minimum values of natural increase (Clauses 17 and 41)

Under the trading stock provisions of the Income Tax Assessment Act 1936, a taxpayer who adopts the cost price basis of valuing live stock may select a cost price per head in respect of natural increase of that live stock. The Income Tax Regulations prescribe minimum cost prices per head for sheep, cattle, horses and pigs, with higher minima applying to natural increase born after 30 June 1984. Technically, however, it may be argued that those higher minima apply only where a cost price per head has not previously been taken into account by the taxpayer for natural increase of the particular class of live stock. If that argument was sustainable, it would mean, for example, that a taxpayer who, prior to 1 July 1984, had selected 40 cents per head for natural increase of sheep could continue to value such natural increase occurring after 30 June 1984 at that price, instead of at $1 per head - the minimum intended to apply to post June 1984 natural increase of sheep. This Bill will amend the trading stock provisions of the Assessment Act and the Income Tax Regulations to ensure that, as intended, the higher prescribed minimum cost prices apply to all natural increase of the specified classes of live stock born after 30 June 1984.

Second protocol to the agreement with the Netherlands (Clauses 36, 37 and 39)

The second protocol will amend the existing agreement and protocol with the Netherlands (which were both signed on 17 March 1976) so that interest from debt claims secured by mortgage of real property or of any other direct interest in or over land is treated in the same way as other interest income under the agreement.

By the terms of the existing agreement, such income is treated as income from real property and each country is free to tax it with the country of residence of the recipient allowing credit against its tax for the other country's tax. In practice, however, Netherlands tax does not generally apply to interest from Australia that is treated under the agreement as income from real property and such interest is subject only to Australian withholding tax of 10 per cent. The amendments made by the second Netherlands protocol will allow the Netherlands to tax such interest from Australia in full, subject to the allowance of a credit for the Australian withholding tax paid in accordance with the agreement on the interest.

The second protocol will not affect the treatment in Australia of interest of this type flowing from Australia to the Netherlands. Such interest will continue to be subject to Australian withholding tax at the rate of 10 per cent. Outgoing mortgage interest is subjected to full income tax or corporation tax in the Netherlands and, where derived by an Australian resident, would generally be exempt from tax in Australia at present pursuant to paragraph 23(q) of the Income Tax Assessment Act. The protocol will have the effect of treating mortgage interest derived by a resident of Australia from the Netherlands in the same way as other interest income derived by Australian residents from the Netherlands - that is, it will be subject to Australian tax, subject to the allowance of a credit against that tax for the Netherlands tax which, in accordance with the agreement, will be limited to a maximum of 10 per cent of the gross amount.

The protocol will enter into force on the first day of the second month after the date on which both countries exchange notes through the diplomatic channel notifying each other that the last of such things has been done as is necessary to give the protocol the force of law in Australia and in the Netherlands. Upon entering into force, the protocol will generally have effect in Australia for years of income commencing on or after 1 July 1986 and, in the Netherlands, for taxable years or periods beginning on or after 1 January 1986.

However, transitional arrangements will ensure that the protocol will not affect interest paid under contractual obligations in existence prior to the date of signature on 30 June 1986 until Australian years of income commencing on or after 1 July 1988 and Netherlands taxable years and periods beginning on or after 1 January 1988.

Those transitional arrangements are subject to two safeguarding anti-avoidance measures. The first will apply to interest derived in pursuance of a contract in existence prior to 30 June 1986 if the term of the contract was extended after that date. The other measure will apply to any prepayment of interest to the extent it is attributable to a period after the end of the transitional period. Interest to which these safeguarding measures apply will fall outside the transitional arrangements and, as a consequence, the protocol will apply to such interest from the earlier dates of effect.

Comprehensive taxation agreement with Austria (Clauses 36, 38 and 39)

The comprehensive taxation agreement with Austria is designed to avoid double taxation of all forms of income flowing between Australia and Austria and to prevent fiscal evasion of taxes covered by it. Double taxation is avoided by allocating taxing rights between the two countries in relation to certain categories of income and by setting out how relief from double taxation is to be provided where income may be taxed by both countries. The basis provided by the agreement for allocating taxing rights and providing double taxation relief is substantially similar to that adopted in Australia's other modern comprehensive taxation agreements.

The agreement provides that certain categories of income are to be taxed as follows:

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Income from real property (which includes natural resources royalties) may be taxed in full by the country in which the property is situated.

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Business profits are to be taxed only in the country of residence of the recipient unless they are derived by a resident of one country through a branch or other "permanent establishment" in the other country, in which case that other country may tax the profits.

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Profits from international operations of ships and aircraft will be taxed only in the country of residence of the operator.

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Dividends, interest and royalties may be taxed in the country of source, but there are general limits on the tax that that country may charge on such income flowing to residents of the other country. These limits are 15 percent for dividends and 10 per cent for interest and royalties.

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Income from professional services or other similar independent activities will generally be taxed only in the country of residence of the recipient unless the income is attributable to activities performed from a fixed base of the recipient in the other country, in which case the income may be taxed in the other country.

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Income from dependent personal services, that is, employees' remuneration, will generally be taxable in the country where the services are performed.

However, it shall be taxable only by the country of residence of the employee where the services are performed during a short visit to the other country, and the remuneration is not an expense borne by a resident of, or a permanent establishment in, the country visited and provided it will be subject to tax in the country of residence of the recipient.

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Directors' fees may be taxed in the country of residence of the paying company.

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Income derived by public entertainers from their activities as such may be taxed by the country in which the activities are performed.

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Pensions and annuities will generally be taxed only in the country of residence of the recipient except for certain Government service pensions, which are taxable only in the other country.

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Government officials will generally be taxed only in their home country.

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Students resident in one country who are temporarily present in the other country solely for the purpose of their education will be exempt from tax in the country visited in respect of payments made from abroad for the purposes of their maintenance or education.

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Double taxation relief to be allowed by the country of residence where it taxes income which, under the agreement, may also be taxed in the other country will be:

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in Australia, by the allowance of a credit against its tax on the income derived by a resident of Australia from sources in Austria for the Austrian tax paid in respect of the income. This reflects the position that will generally apply in Australia following the commencement of the general foreign tax credit system from the beginning of the 1987-1988 income year. In the case of a dividend, the Agreement does not require Australia to give a credit for Austrian tax paid in respect of the profits out of which the dividend is paid. However, under the foreign tax credit system an Australian resident company which receives dividends from an Austrian company or other foreign company will in fact be allowed credit for foreign withholding taxes on dividends received and, where the recipient Australian company and the Austrian company or other foreign company are related, for the "underlying" Austrian or other foreign tax, as the case may be, on that portion of the profits from which the dividends are paid.

Under the Australian domestic law, certain salary and wages earned by an Australian resident while performing duties overseas, in Austria or elsewhere, will be exempt from Australian income tax if the income is not exempt from tax in the country in which that income is derived.

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in Austria, by the exemption from Austrian tax of income taxed by Australia in accordance with the agreement, except as follows:

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a credit will generally be given against Austrian tax in respect of the limited Australian tax paid, (in accordance with the agreement) on dividends, interest, royalties and for Australian tax on certain income from the alienation of real property or on income not otherwise expressly mentioned in the agreement to the extent to which that tax is attributable to items of income derived from sources in Australia.

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income which is exempt from tax in Austria by the operation of the agreement may nevertheless be used to calculate the Austrian tax on the remaining income of a resident of Austria.

The agreement also provides for such things as the exchange of information and for consultation between the taxation authorities of the two countries.

The agreement will not enter into force until the first day of the third month after the month in which Australia and Austria exchange notes notifying each other that the last of the constitutional processes necessary to give the agreement the force of law in the respective countries has been completed.

Upon entering into force, the agreement will have effect in Australia for withholding tax purposes in respect of income derived by non-residents on or after 1 January in the calendar year following that in which it enters into force. For all other Australian taxes covered by the Agreement, it will first have effect in respect of the income year beginning on or after 1 July in the calendar year after that in which it enters into force. It will have effect in Austria for tax withheld at source on amounts paid on or after 1 January in the calendar year next following the year in which the agreement enters into force and for other Austrian tax for taxable years and periods beginning on or after 1 January in the calendar year next following the year in which the agreement enters into force.

Burden of proof (Clauses 6, 8, 11, 13, 30 and 43)

The longstanding rule that, in a taxation reference to a Taxation Board of Review (now replaced by the Taxation Appeals Division of the Administrative Appeals Tribunal) or appeal to a Supreme Court, the Federal Court or the High Court, the burden of proving that an assessment is excessive or a decision is incorrect rests with the taxpayer, was unintentionally altered by the enactment of the Taxation Boards of Review (Transfer of Jurisdiction) Act 1986. This Bill amends the various taxation laws affected to ensure that in taxation appeals to the Federal Court and the High Court the burden of proving that an assessment is excessive or that a decision is incorrect rests with the person who took objection to the assessment or decision. This is currently the position with taxation references to the Administrative Appeals Tribunal and the Supreme Court.

Bank Account Debits Tax Amendment Bill 1986

This Bill will give effect to the 1986-87 Budget proposal to increase the highest rate of bank account debits tax from $1.50 to $2 and the lower rates by up to one-half, for cheque accounts other than those kept with banks in the Australian Capital Territory (including Jervis Bay). Debits to ACT cheque accounts will continue to be subject to tax at double the existing general rates. The proposed increased rates are to apply to debits made on or after 1 December 1986.

A more detailed explanation of the provisions of the Bills is contained in the following notes.