Revised Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 14 - Regulation impact statement - General value shifting regime
Policy objective
14.1 The GVSR is an important integrity measure in the Government's broad ranging reforms to give Australia a New Business Tax System. The GVSR is based on the recommendations of the Review of Business Taxation, which was instituted by the Government to consider reform of Australia's business tax system.
14.2 Recommendations 6.12 to 6.16 of A Tax System Redesigned recommended the introduction of a GVSR to replace the current value shifting rules in Divisions 138, 139 and 140 of the ITAA 1997. The Government indicated its acceptance of these recommendations in Treasurer's Press Release No. 58 of 21 September 1999. Treasurer's Press Release No. 16 of March 2001 deferred commencement date of those recommendations to 1 July 2002. The GVSR was further foreshadowed in the Minister for Revenue and Assistant Treasurer's Press Release No. C57/02 of 14 May 2002.
14.3 Broadly, 'value shifting' describes transactions and other arrangements that reduce the value of some assets and (usually) increase the value of other assets. Assets for these purposes include shares in companies and interests in trusts. The assets involved may be owned by the same taxpayer or by different taxpayers. The assets may be held on capital account or may be trading stock or revenue assets.
14.4 Where assets are held on capital account, most capital gains (capital losses) are calculated as the difference between an asset's cost base (reduced cost base) and its market value when the asset is realised.
14.5 Value shifting arrangements can distort the relationship between an asset's market value and its relevant cost base without generating either a taxing point (e.g. a disposal), or without generating other tax adjustments under the normal rules. When assets are realised, inappropriate losses and gains may result.
14.6 Where assets are held on revenue account, or as trading stock, value shifting arrangements can have a similar effect on the relationship between the market value of the asset and the values that are used to work out what amounts are included in assessable income or as deductions when the asset is realised.
14.7 For assets where gains are brought to tax, and losses allowed, on a realisation basis, value shifting presents a particular problem to the integrity of the tax system. It is possible to create losses by shifting value out of assets, yet defer gains on assets to which the value is shifted by choosing not to realise them.
Situations where value shifting can occur
14.8 Types of situations where value shifting transactions can commonly occur include:
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- modifications to rights attaching to equity or loan interests in companies or trusts, and new issues of interests in these entities at a discount to market value;
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- internal restructures of group of entities, involving the transfer of assets and the cancellation and issue of interests;
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- restructures of group financing arrangements;
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- transfers or creations of assets or debt forgiveness for less or more than market value; and
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- new and continuing service arrangements involving commonly controlled or commonly owned entities that are conducted on a non-arm's length, non-market value basis.
Problems with the current value shifting rules
14.9 The current value shifting rules are flawed in several key respects, including:
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- they focus on particular types of value shift involving particular types of entities - the current tax law has arisen in an ad hoc fashion and therefore lacks a sound base;
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- appropriate exclusions are non-transparent and, in some cases, non-existent;
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- safe-harbours are limited;
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- de minimis rules are either very limited or non-existent; and
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- complex rules apply to entities of all sizes and types although the risk of value shifting involving smaller entities is less in some cases.
As a consequence the associated compliance costs are high and the integrity benefits achieved uncertain and debatable.
14.10 The aim of the GVSR is to add integrity, equity and efficiency to the business tax system by:
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- achieving comparable integrity in respect of value shifting outside consolidated groups to that attained within consolidated groups by its cost setting rules;
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- enhancing the integrity of the CGT rules by implementing a generalised regime to replace the current value shifting rules which are deficient in many respects; and
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- providing consistent and comprehensive tax treatment for the impact of value shifting.
14.11 The proposed changes to the taxation law are intended to have the effects as listed in paragraphs 14.12 to 14.20.
14.12 Usually, the GVSR will adjust realised losses or gains, or realign values for tax purposes (e.g. cost bases) of assets affected by value shifting, in order to ensure that inappropriate gains or losses do not arise when they are realised. Sometimes, a value shift out of an asset may be effectively treated as a part disposal of the asset with possible taxable gain (but not loss) consequences.
14.13 The GVSR will apply mainly to equity and loan interests in certain companies and trusts that are affected directly, or indirectly, by value shifting arrangements. (One part of the GVSR deals with the creation of rights at less than market value in associates over non-depreciating assets and the impact of such value shifting at that, or a later time).
14.14 Affected equity and loan interests are those in companies and trusts that satisfy a control test, or, if the entities are closely-held, a common ownership test (set at a minimum 80% level).
14.15 Affected interest holders are usually controllers and their associates, or common owners and their associates. Active participants in value shifting arrangements involving closely-held entities may also be subject to the GVSR.
14.16 The GVSR will apply to equity and loan interests held on capital account and on revenue account (i.e. as trading stock or revenue assets).
14.17 The GVSR does not implement a domestic transfer pricing regime which restates the tax values of economic benefits provided and received. It does, however, provide certain consequences if interests are realised in affected entities that have exchanged unequal value benefits in non-arm's length transactions.
14.18 The GVSR will replace the current share value shifting and asset stripping rules in the tax law.
14.19 Importantly, for compliance cost reasons, taxpayers able to satisfy the CGT small business $5 million net asset threshold and taxpayers eligible for the STS are excluded from the IVS rules of the GVSR.
14.20 Generally, and subject to some transitional arrangements, the GVSR will apply to value shifting that happens on or after 1 July 2002.
Minor change to the loss integrity measures and insertion of a special value shifting rule
14.21 In addition, some minor changes are proposed to the loss integrity measures, introduced in 1999 and 2000, that deal with the duplication of companies' realised and unrealised losses (Subdivisions 165-CC and 165-CD of the ITAA 1997).
14.22 Compliance costs can be significantly reduced in these measures by allowing the choice to value an entity's assets globally to determine its unrealised loss position. The current rules require that assets be valued individually. A special value shifting rule will be inserted in Subdivision 165-CD to ensure that the inclusion of gain asset value in a global valuation will not result in any significant loss of integrity in that Subdivision. There will be a small compliance cost increase in complying with this value shifting rule, however this increase is expected to be significantly outweighed by the compliance cost reductions associated with allowing global asset valuations.
14.23 The global asset valuation option will also assist cost setting under the consolidation rules where entities have been subject to the integrity measures.
14.24 These minor amendments, being optional and favourable to taxpayers in comparison with the current law, will apply from 11 November 1999 being the date that Subdivisions 165-CC and 165-CD commenced.
Implementation options
14.25 The GVSR is based on Chapter 29 of A Platform for Consultation and Recommendations 6.12 to 6.16 of A Tax System Redesigned .
14.26 The implementation of the recommendations in A Tax System Redesigned without any modification was the first option considered for the GVSR (option 1). Option 1 would involve the implementation of a GVSR having the following features:
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- it would apply to assets having tax values determined on a realisation basis under the tax value method;
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- it would apply to interests in, and assets of, entities (and their associates) that are controlled by other entities (and their associates);
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- it would apply to non-controlling interests in entities, but only where the holders of those minority interests actively participate in, or otherwise facilitate, value shifting arrangements;
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- it would include de minimis exceptions that would balance integrity considerations and the containment of compliance costs;
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- it would apply to direct value shifts (involving the shift of value directly from an asset or interests) not covered by other reform measures, including value shifts from pre-CGT assets to post-CGT acquired assets;
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- that gains or losses not be crystallised for indirect value shifts (where an arrangement affects the value of an entity and, as a result, the values of interests in an entity are indirectly affected). A tax value adjustment method, using a loss-focused approach to working out adjustments was to be used instead; and
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- it would replace the current share value shifting and asset stripping rules from 1 July 2000.
14.27 A modified option (option 2) is based on the recommendations in A Tax System Redesigned modified in certain ways. These modifications:
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- apply the recommendations in A Tax System Redesigned in the context of the current tax regime, modified for the deferred commencement of the consolidation regime until 1 July 2002 - recognising that it would not be appropriate to continue with the existing value shifting rules until such time as a new way of calculating income and deductions was implemented;
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- extend the application of the GVSR to cases of value shifting not explicitly referred to in A Tax System Redesigned but consistent with its policy thrust (e.g. value shifting by individual controllers of companies), or to cases of value shifting that were expected to be dealt with under another measure that has not yet been implemented (e.g. a comprehensive rights regime); and
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- apply the policy of the measure in a practical way by not extending some of the rules to certain classes of taxpayers (i.e. small business taxpayers) where the integrity benefits that would be achieved would be far outweighed by the compliance costs imposed. The modifications also address matters raised and discussed in consultation with representatives of industry and the profession.
14.28 In summary, the modified GVSR would broadly operate in a similar way to option 1, with the key modifications being an extension to deal with certain value shifting where rights are created over assets, and an exclusion for small business and taxpayers eligible for the STS from most of the GVSR. Most other changes implement the original policy in a more practical and cost-minimising way.
14.29 Option 2 is the result of extensive consultation on option 1 and also adjusts option 1 so that its intent applies in the context of the current tax regime, rather than the one envisaged when option 1 was being developed. Table 14.1 summarises the modifications to the A Tax System Redesigned recommendations and the reasons for them.
| Option 2 | Option 2 compared with option 1 |
|---|---|
| Apply the value shifting rules to closely held companies and trusts where there is a very high degree of 'common ownership' as well as in control cases - recommendations referred only to 'controlled' entities. | Option 1, in being restricted to controlled entities, could have allowed significant value shifting to occur where there was a high degree of common ownership in entities. This risk is most evident in closely-held entities, and the common ownership tests are limited to them. Option 2 recognises, and addresses the potential for significant value shifting in these cases. |
| Apply the value shifting rules if value is shifted out of a company or trust to any other entity, including an individual - recommendations did not apply to transfers to an individual. | Option 1 would have allowed, for example, an individual controlling a company to shift value to himself or herself and sell the shares in the company for an artificial loss. Option 2 recognises, and addresses the potential for significant value shifting in these cases. |
| Apply the value shifting rules to assets being taxed on a 'realisation basis' under the current law - recommendations referred to assets having tax values determined on a realisation basis under the new law. | Option 2 aligns the GVSR recommendations with language and concepts under the current law, whereas option 1 referred to concepts that do not currently exist. |
| Allow taxpayers choice of method for effecting IVS adjustments - adjustable value adjustment at the time of the shift or reduction of gains or losses on realisation -recommendations provided only for adjustable value adjustments at the time of the value shift. | Option 2 provides taxpayers with maximum flexibility in complying with the policy outcomes intended for the GVSR and avoids unnecessary adjustments in some cases. This can be achieved without any discernible loss of integrity in the measure. Consultation revealed a strong preference for option 2 in this regard. Option 1 would have provided less flexibility and may have resulted in unnecessary adjustments in some cases. |
| To provide that in particular cases, taxable gains may arise if value is shifted between assets of a different nature, for example, the shift occurs from shares that are held as trading stock to shares that are not held as trading stock -recommendations did not address the fact that value shifts involving the same person's interests could involve a shift between interests of a different tax character. | Option 2 ensures that inappropriate tax advantages are not obtained by applying the mere realignment of adjustable values in cases where value is shifted between assets of a different nature held by the same taxpayer. Option 1 could have allowed value of one tax character (e.g. income on trading stock or a revenue asset) to be shifted to become value of another tax character (e.g. capital gain) to facilitate the offset of capital losses or to obtain the CGT discount (neither of which is available for non-CGT income). |
| Apply the value shifting rules to certain arrangements in which a right is created over an underlying asset held by an associate and the devalued underlying asset is sold - recommendations suggested this would be addressed under a comprehensive rights regime. |
Option 2 addresses some value shifting potential where rights are created over assets in the absence of a comprehensive regime for the taxation of rights. Option 1, if implemented, would have left unaddressed potentially significant value shifting opportunities. |
| Exclude, for compliance cost reasons, small business taxpayers and taxpayers eligible for the STS from the IVS rules of the GVSR -recommendations did not expressly exclude such taxpayers. | Option 2 recognises that in the process of balancing integrity benefits with compliance costs, small business and STS eligible taxpayers can be excluded from the IVS rules of the GVSR. The general anti-avoidance provisions in the tax law are still capable of applying to value shifting arrangements and schemes. Option 1 could have imposed compliance costs on certain entities that would far outweigh any integrity benefits achieved. |
Assessment of impacts
14.30 As option 2 has been developed and refined from option 1 against the backdrop of the current tax regime (rather than the one envisaged when option 1 was formulated) and as it responds to the detailed consultations undertaken (see Table 14.1), this latter option will not be assessed further. The assessment below concentrates on the impacts of option 2.
14.31 The GVSR will impact on different taxpayers in different ways.
14.32 There are a number of taxpayers that are subject to the current value shifting rules that will be subject to the GVSR. They are:
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- controllers and associates that hold equity interests in companies that are subject to share value shifting adjustments; and
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- taxpayers holding equity or loan interests in companies that are 100% commonly owned, and that are subject to value shifting adjustments when the companies shift value by asset stripping or debt forgiveness.
14.33 These taxpayers will be required to make the same type of adjustments under the GVSR. The application of different methods for calculating adjustments may reduce the compliance costs associated with the measure for these taxpayers.
14.34 There are a number of taxpayers that are not subject to the current value shifting rules that will be subject to the GVSR. They are:
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- controllers and associates that hold equity or loan interests in controlled trusts subject to DVS arrangements (e.g. variation of rights) - however, the 'interests' of mere objects in discretionary trusts are not subject to value shifting adjustments;
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- controllers, associates and common owners that hold interests in trusts that satisfy common control or common ownership tests with other trusts or companies - in circumstances where there is an indirect effect on the value of the interests from value shifting - however, the 'interests' of mere objects in discretionary trusts are not subject to value shifting adjustments;
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- controllers, associates or common owners with loan interests in controlled or commonly owned companies that are not covered by the value stripping rules in the current law;
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- controllers, associates or common owners with equity interests in controlled companies, or closely-held companies with less than 100% but more than 80% common ownership;
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- in some cases involving closely-held entities, persons, with interests in entities, who do not form part of a control or common ownership framework that actively participate in a value shifting scheme; and
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- taxpayers creating rights over assets at less than market value in favour of their associates where the underlying assets (or replacement assets) are realised by the taxpayers or certain other parties at reduced values for losses.
14.35 Taxpayers affected by the GVSR will need to make appropriate adjustments to account for the effect of value shifting transactions on the values of their assets to ensure that inappropriate gains and losses do not arise on the realisation of those assets.
14.36 There are a number of entities subject to the current value shifting rules that will not be affected by the GVSR. The GVSR will not impact on:
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- entities with interests in consolidated group members and MEC group members whose values for tax purposes are reconstructed under consolidation rules; and
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- interest holders affected by an indirect value shift that can satisfy the CGT small business taxpayer $5 million net asset test or are eligible for the STS.
14.37 Also, transactions that involve small value shifts will not be subject to the GVSR.
14.38 Many of the GVSR rules are 'loss-focused' which means that they may only have a practical application if an interest is realised at a loss.
14.39 Additionally, transactions and dealings that can be shown to have been done at arm's length, or for market value, will largely avoid the GVSR except for cases involving variations in rights of equity and loan interests in trusts.
Analysis of costs and benefits associated with implementation
14.40 Taxpayers to whom the current value shifting rules apply would expect a small increase in compliance costs as they familiarise themselves with the GVSR. Overall taxpayers should benefit from the GVSR by moving from an ad hoc set of rules to an integrated and clearer set of rules.
14.41 For taxpayers not currently subject to the current value shifting rules and that are not excluded from the GSVR there will be a small to moderate increase in compliance costs. Such costs may arise, for example, from the familiarisation process, and establishing methods of measuring, and in many cases minimising, their exposure to the GVSR. For example, taxpayer's that control entities that provide services to other related parties may need to set up systems to determine the market value of the services provided, or the costs of providing those services.
14.42 Compliance costs will be reduced for the following cases:
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- low value transactions will be excluded from the GVSR;
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- taxpayers able to satisfy the small business CGT $5 million threshold and taxpayers eligible for the STS will be excluded from the IVS rules of the GVSR; and
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- interests in entities that enter the proposed consolidation regime and whose values for tax purposes are reconstructed by those rules will not be subject to the GVSR.
14.43 For all entities subject to the GVSR, the introduction of guidance material by the ATO will reduce compliance costs, as it will assist with an understanding of the measures.
14.44 In addition, the minor amendments to the loss duplication rules in Subdivisions 165-CC and 165-CD of the ITAA 1997 will provide significant relief from compliance costs by allowing taxpayers to value assets globally rather than individually.
14.45 The proposed amendments do not require any systems changes for the ATO.
14.46 The ATO will release a detailed guide to the GVSR on its website taking into account the views of a representative sample of likely users of this material.
14.47 The ATO information booklets will need to be modified to include a reference to the new GVSR. Also, it is the ATO practice to produce information sheets and, where required, update the website to reflect the amendments ahead of printing the new booklets. The ATO is constantly updating information on its website and its booklets, return forms, schedules and guides are updated annually. The impact on administration from these amendments will be folded into this process. Therefore, there should be minimal additional cost to administration in this respect.
14.48 ATO staff will need to be trained on the GVSR in order to deal with requests for advice. This training will be part of on-going internal training, therefore additional administration costs in this respect will be minimal.
14.49 There is expected to be a gain to revenue over the next 4 years in respect of introducing the GVSR as follows:
| 2002-2003 | 2003-2004 | 2004-2005 | 2005-2006 |
| nil | $150 million | $160 million | $170 million |
14.50 The reason for the nil amount in the first year is that the GVSR will impact mostly at the time of assessment.
14.51 There is expected to be no significant change to revenue in respect of the minor amendments to the loss duplication rules in Subdivisions 165-CC and 165-CD of the ITAA 1997.
14.52 The core economic benefit of the GVSR will be that the true value of gains or losses made on assets, in particular interests in trusts and companies, will be less distorted.
14.53 There may be some changes to the behaviour of entities to the GVSR who may choose to deal at arm's length, at market value, or within the safe-harbours provided by the GVSR, to avoid adjustments, or later adjustments when assets are realised.
14.54 There will be efficiency benefits in that there will be no systemic tax advantage to value shifting outside consolidation.
14.55 Overall, and in the longer term, there should not be a significant increase in compliance costs.
14.56 In the development of this measure, there was significant consultation with tax practitioners and industry professionals. Special attention was given to the development of appropriate safe-harbours, de minimis exclusions, and a loss-focused realisation approach to many adjustments, so that entities would not be required to undertake elaborate transfer pricing analysis or benchmarking to market value to avoid the operation of the GVSR. Special attention was given to the treatment of services in this respect.
14.57 A cross-section of representatives of potentially affected parties participated in the consultation. These included representatives of large business and smaller business.
14.58 The GVSR recommendations and modifications were discussed and considered in detail. There was, in general, support for option 2 in preference to option 1 because of the exclusions for small business and taxpayers eligible for the STS, and for the greater flexibility in making IVS adjustments. The extensions to the GVSR as recommended to address the creation of rights in particular circumstances, and cases where individuals obtained value shifting advantages, were not considered to be unreasonable extensions of to the regime as originally recommended.
14.59 The preferred implementation option, option 2, builds on the recommendations in A Tax System Redesigned to ensure that the GVSR is implemented in such a way as to maximise the integrity benefits of the measure but at the same time keeping compliance and administration costs as small as possible. The modifications made by the GVSR strengthen those recommendations as they:
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- implement the GVSR in a consistent manner with the current tax system;
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- enhance the integrity of the measure by ensuring that the measure applies in circumstances not expressly mentioned in A Tax System Redesigned but consistent with the overall policy thrust of the recommended measure; and
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- introduce realistic limits on the compliance costs associated with the measure while preserving its integrity.
14.60 The GVSR will strengthen the integrity of the tax law by establishing a set of value shifting rules that will:
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- enhance the equity and efficiency of the tax law; and
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- provide a more consistent and comprehensive tax treatment for the transfers of value.
14.61 The economic benefits of the GVSR are that:
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- there will be less distortions on the gains and losses realised on assets affected by a value shift; and
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- there will be no disincentive to members of a wholly-owned group entering into the consolidation regime, as there will be no systemic tax advantage for value shifting outside consolidation.
14.62 Overall, this proposal will strengthen community confidence in the integrity of the tax system in that it will apply equitably in the community.