House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

General outline and financial impact

Distributions to entities connected with a private company and related issues

Schedule 1 to this Bill amends the Income Tax Assessment Act 1997 to remove the automatic debiting of the private company's franking account when a deemed dividend arises under Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

These amendments also provide the Commissioner of Taxation (Commissioner) with a general discretion to disregard the operation of Division 7A where deemed dividends have been triggered by honest mistakes or inadvertent omissions by taxpayers. In addition, other amendments are made to Division 7A to reduce the extent that taxpayers can trigger a deemed dividend inadvertently. The Fringe Benefits Tax Assessment Act 1986 is also amended so that fringe benefits tax (FBT) does not apply to Division 7A compliant loans. Section 108 of the ITAA 1936 is also being repealed.

Date of effect: In the main, the changes take effect from 1 July 2006. However, the Commissioner's general discretion is retrospective and can be utilised in respect of 2001-02 and later income years. The FBT amendments apply from 1 April 2007.

Proposal announced: This measure was announced in the Minister for Revenue and Assistant Treasurer's Press Release No. 089 of 6 December 2006.

Financial impact: The overall cost to revenue of these amendments is unquantifiable but expected to be minimal against the forward estimates.

Compliance cost impact: These amendments will reduce ongoing compliance costs for private companies, though there will be a small transitional cost.

Summary of regulation impact statement

Regulation impact on business

Impact: Overall the amendments are beneficial to taxpayers and will be welcomed by taxpayers and tax practitioners. This measure will reduce ongoing compliance costs for private companies and reduce tax penalties, especially for the many small businesses that use a company structure.

Main points:

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Removing the automatic debiting of a company's franking account when a deemed dividend arises will reduce the punitive impact of Division 7A.

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The Commissioner's new general discretion in Division 7A will allow the Commissioner to provide relief for deemed dividends that have arisen because of honest mistakes or inadvertent omissions by taxpayers.

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A number of mainly technical amendments will reduce the scope for normal business transactions to trigger a deemed dividend inadvertently, provide more certainty and increase flexibility for taxpayers.

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The FBT amendment for Division 7A compliant loans will reduce compliance costs as companies will no longer need to consider the application of FBT to loans to employee shareholders.

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There may be a small increase in transitional costs for taxpayers and their tax practitioners as they become familiar with the changes to Division 7A.

Transitional non-concessional contributions cap

Schedule 2 to this Bill amends the Income Tax (Transitional Provisions) Act 1997 to ensure that certain superannuation contributions (such as those made by a friend) made prior to 1 July 2007 are appropriately subject to a contributions cap.

Date of effect: 7 December 2006.

Proposal announced: This measure was announced in the Minister for Revenue and Assistant Treasurer's Press Release No. 037 of 24 April 2007.

Financial impact: Nil; this is a revenue protection measure necessary for the proper implementation of the Simplified Superannuation reforms.

Compliance cost impact: Nil.

Capital gains of testamentary trusts

Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 to allow a trustee of a resident testamentary trust to choose to be assessed on capital gains of the trust. The capital gains would otherwise be assessed to an income beneficiary (or the trustee on behalf of such a beneficiary) who, under the terms of the trust, would not receive the benefit of the capital gains.

Date of effect: These amendments apply to the 2005-06 and later income years.

Proposal announced: These amendments were announced in the Minister for Revenue and Assistant Treasurer's Press Release No. 074 of 17 October 2006.

Financial impact: The financial impact of these amendments is unquantifiable, but is expected to be low.

Compliance cost impact: The implementation compliance costs are expected to be minimal while ongoing compliance costs are expected to be reduced by $335,000.

Taxation of superannuation death benefits to non-dependants of defence personnel and police killed in the line of duty

Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 to align the tax treatment of lump sum superannuation death benefits paid to non-dependants with that applying to dependants, where the deceased was killed in the line of duty as a member of the Australian Defence Force or any Australian police force, or as an Australian Protective Service Officer.

Date of effect: These amendments will apply to lump sum superannuation death benefit payments received in the 2007-08 income year and later income years.

Proposal announced: This measure was announced in the Minister for Revenue and Assistant Treasurer's Press Release No. 032 of 5 April 2007.

Financial impact: These amendments will have a cost to revenue of $0.2 million per year.

Compliance cost impact: Low.

Thin capitalisation

Schedule 5 to this Bill amends the Income Tax (Transitional Provisions) Act 1997 to extend by one year (from three to four years) a transitional period relating to the application of accounting standards under the thin capitalisation rules.

Under the transitional arrangements, taxpayers subject to the rules may elect to use either current or former accounting standards to determine and value their assets, liabilities and capital for thin capitalisation purposes.

Date of effect: This amendment applies from the date of Royal Assent, such that the transitional period will apply to four consecutive income years commencing on or after 1 January 2005.

Proposal announced: This measure has not previously been announced.

Financial impact: Nil.

Compliance cost impact: This measure is expected to result in a minimal increase in compliance costs.

Repeal of dividend tainting rules

Schedule 6 to this Bill amends the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1997 to repeal the dividend tainting rules and to make consequential amendments that will:

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ensure that distributions from a share capital account (including a tainted share capital account) continue to be unfrankable; and

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modify a general anti-avoidance rule that applies in relation to the imputation system so that, when considering whether to apply the rule, the Commissioner of Taxation can take into account whether a distribution is sourced from unrealised or untaxed profits.

Date of effect: These amendments will apply in relation to distributions made on or after 1 July 2004.

Proposal announced: This measure was announced in the Minister for Revenue and Assistant Treasurer's Press Release No. 080 of 9 November 2006.

Financial impact: Negligible.

Compliance cost impact: Nil.

Clarification of exemption from interest withholding tax

Schedule 7 to this Bill amends the Income Tax Assessment Act 1936 to more closely specify which debt interests are eligible for exemption from interest withholding tax (IWT) in sections 128F and 128FA.

These amendments ensure that the IWT exemption remains consistent with the Government's original policy intent that Australian business does not face a higher cost of capital, or constrained access to capital, consequent to the IWT burden being shifted onto the Australian borrower.

These amendments correct an unintended broadening of the exemption. Closer specification of the range of debt interests eligible for the exemption will realign the exemption to the Government's policy intent and enhance the integrity of the tax system.

Date of effect: 7 December 2006.

Proposal announced: This measure has previously been announced in the Minister for Revenue and Assistant Treasurer's Press Release No. 091 of 7 December 2006.

Financial impact: Nil.

Compliance cost impact: Nil.

Investments in forestry managed investment schemes

Schedule 8 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide that initial investors in forestry managed investment schemes (forestry schemes) will receive a tax deduction equal to 100 per cent of their contributions and subsequent investors will receive a tax deduction for their ongoing contributions to forestry schemes, provided that at least 70 per cent of the scheme manager's expenditure under the scheme is expenditure attributable to establishing, tending, felling and harvesting trees (direct forestry expenditure or DFE). The new provision retains the existing principle that the managers of forestry schemes must include the investors' contributions in their assessable income in the year in which the deduction is first available to the investor for those contributions.

This Schedule also amends the ITAA 1997 and the Income Tax Assessment Act 1936 (ITAA 1936) to clarify the tax treatment for sale and harvest proceeds that are received by secondary investors in forestry schemes, and payments made by secondary investors in relation to forestry schemes.

Date of effect: This measure applies to amounts paid by a participant under a forestry scheme on or after 1 July 2007, provided that no other amounts were paid by the participant or any other participant under the scheme before 1 July 2007.

Proposal announced: This measure was announced in the Minister for Revenue and Assistant Treasurer's Press Release No. 097 of 21 December 2006.

Financial impact: This measure will have these revenue implications:

Compliance cost impact: These amendments are expected to have a small impact on compliance costs.

Non-resident trustee beneficiaries

Schedule 9 to this Bill amends the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1997 to ensure that a trustee can be taxed on net income of the trust in relation to a non-resident trustee beneficiary similar to the treatment of non-resident company and individual beneficiaries. This treatment is, in effect, similar to a withholding system because the beneficiary is still assessed on these amounts but can reduce their tax liability by the tax paid by the trustee.

Date of effect: These amendments generally apply to income years starting on or after 1 July 2006. Changes to the conduit foreign income provisions apply from 1 July 2005, which is when those provisions first applied. The conduit foreign income changes favour the taxpayer.

Proposal announced: This measure was announced in the Treasurer's Press Release No. 039 of 9 May 2006 as part of the 2006-07 Budget.

Financial impact: This measure will have these revenue implications:

Compliance cost impact: This measure will result in a small increase in compliance costs for trustees with foreign trustee beneficiaries.

New withholding arrangements for managed fund distributions to foreign residents

Schedule 10 to this Bill amends the income tax law to expand the existing pay-as-you-go withholding system to cover distributions made to foreign residents, of net income by managed investment trusts attributable to Australian sources (either directly or through certain Australian intermediaries). Income consisting of dividends, interest or royalty income is generally excluded from this measure, as are capital gains on assets other than taxable Australian property.

Date of effect: This measure will apply to income years beginning on or after 1 July following Royal Assent.

Proposal announced: This measure was announced in the Treasurer's Press Release No. 039 of 9 May 2006.

Financial impact: This measure is expected to increase revenue by $10 million in the first year of its application. Thereafter, the measure is expected to increase revenue by $15 million per annum.

Compliance cost impact: The new regime for managed fund distributions to foreign residents is estimated to involve medium costs in relation to once-off implementation of systems changes, and a small ongoing compliance cost to manage ongoing record keeping and information collection obligations. However, the new regime will reduce compliance costs by removing the need for withholders to ascertain whether the foreign resident is an individual, company, trustee or foreign superannuation fund.

Summary of regulation impact statement

Regulation impact on business

Impact: The new withholding arrangements for managed fund distributions to foreign residents will provide the Australian property trust industry (the main distributors of the type of income this measure applies to) with compliance savings by having a single rate applied to distributions to different types of entities. This reduces compliance costs associated with ascertaining what type of entity the foreign resident is.

Main points:

The new withholding regime will simplify and clarify withholding obligations for Australian managed funds (particularly Australian property trusts) and Australian custodians.

As a result of this new regime:

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Australian managed funds and Australian custodians will no longer need to know whether the foreign investor is a company, individual, trustee or foreign superannuation fund information about which they are unlikely to know; and

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withholding obligations will be clarified for payments made via an Australian custodian. Payments made via Australian custodians are the common method via which distributions from Australian managed funds are made to foreign residents.