House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 5 Elective Subdivisions: common requirements

Outline of chapter

5.1 This chapter explains:

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the requirements that are common to the elective tax-timing elections and which need to be met for any of the elective Subdivisions to apply: these are referred to as 'common requirements';

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how the elective Subdivisions apply to relevant financial arrangements;

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the circumstances under which an election under an elective Subdivision will cease to apply and the consequences of cessation in respect of gains or losses made from the financial arrangements that were subject to an elective methodology; and

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the consequences of making a new election where an election has ceased.

5.2 The elections which are the subject of this chapter are those provided by Subdivisions 230-C (fair value election), 230-D (general foreign exchange retranslation election only), 230-E (hedging financial arrangement election) and 230-F (election to rely on financial reports). In this chapter, these Subdivisions are referred to as the 'elective Subdivisions'.

Overview of common elective requirements

5.3 There are four main elective tax timing methods under Division 230, namely:

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the fair value method (Subdivision 230-C);

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the foreign exchange retranslation method (Subdivision 230-D);

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the hedging financial arrangements method (Subdivision 230-E); and

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the reliance on financial reports method (Subdivision 230-F).

5.4 This chapter looks at the common features of each of the elective tax-timing methods including common requirements for making an election and outcomes. In particular, it discusses the requirements that taxpayers must prepare audited financial reports before being able to elect to apply the elective Subdivisions.

5.5 The chapter also discusses the practical implications of having to satisfy these requirements, such as who is to prepare the audited financial reports and the impact of not being required to prepare a financial report because of a Class Order.

Context of amendments

5.6 The framework of Division 230 incorporates a number of elective Subdivisions which provide for different tax treatments (fair value, retranslation, hedging, and the financial reports method). Taxpayers are able to select among these elective regimes in order to obtain the tax treatment that best suits their commercial circumstances and the functions of the financial arrangements they hold or issue.

Summary of new law

5.7 In order to rely on any of the elective Subdivisions, taxpayers must have prepared financial reports in accordance with relevant accounting standards and these reports must be audited in accordance with relevant auditing standards. Taxpayers must continue to satisfy these requirements for these elections to continue to apply.

5.8 Once an election has been made, the elective Subdivisions allow the gains and losses on relevant financial arrangements to be determined, in appropriate circumstances, in accordance with relevant accounting standards. That is, in these circumstances taxpayers can effectively rely on amounts in their financial reports to determine gains and losses for tax purposes for relevant financial arrangements.

5.9 Where the elective requirements cease to be satisfied, relevant financial arrangements will be deemed to have been disposed of and reacquired, and the election will cease to apply. Taxpayers may make new elections where the requirements are once more satisfied.

Comparison of key features of new law and current law

Detailed explanation of new law

The elective Subdivisions

5.10 There are four elective Subdivisions under which taxpayers may elect to apply a tax-timing method to relevant financial arrangements, subject to their meeting relevant requirements. These elective Subdivisions allow a taxpayer to bring gains and losses from their financial arrangements to account using the:

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fair value method (Subdivision 230-C);

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retranslation method (Subdivision 230-D) - (this chapter discusses the general foreign exchange retranslation election only);

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method that is consistent with the tax treatment of the hedged item (Subdivision 230-E); or

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method which relies on the relevant accounting standards more broadly (Subdivision 230-F).

5.11 The operation of the elective Subdivisions will assist in reducing taxpayers' compliance costs as the elective treatments will, in effect, allow taxpayers to rely on their financial reports to determine the amount of the gain or loss from relevant financial arrangements that is, for income tax purposes, attributable to a particular income year.

5.12 The common requirements and the outcomes under the elective Subdivisions are discussed within this chapter to avoid duplication in each relevant chapter. Further details that are specific to each election are then discussed in Chapters 6 to 9.

Common requirements for making an election

Accounting and auditing requirements

5.13 In order for a taxpayer to make an election under one of the elective Subdivisions, they must have financial reports that are:

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prepared in accordance with relevant accounting standards; and

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audited in accordance with relevant auditing standards.

[ Schedule 1, item 1, subsections 230-210(2), 230-255(2), 230-315(2) and 230-395(2 )]

5.14 In certain circumstances a taxpayer will be taken to have prepared an audited financial report even though it is in fact prepared by someone else. The relevant circumstances that must be satisfied before this can occur are:

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a connected entity of the taxpayer has prepared an audited financial report;

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the report of the connected entity is a consolidated financial report that deals with both the taxpayer's affairs and the affairs of the connected entity; and

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the report properly reflects the taxpayer's affairs (see discussion below on financial reports of a connected entity).

[ Schedule 1, item 1, section 230-525 ]

5.15 As listed under the elective Subdivisions the financial reports of a taxpayer may, in effect, be relied upon to determine the amount of the gains or losses made from a financial arrangement that are to be brought to account for income tax purposes. Accordingly, the integrity of those reports is important. The accounting and auditing requirements, which the taxpayer must meet to be able to make an election under any of the elective Subdivisions, provide a level of integrity and certainty in relation to processes and methodologies used to calculate the amount of the gains or losses from financial arrangements that are to be brought to account for tax purposes. That integrity will work to ensure that opportunities for tax avoidance or tax deferral are minimised.

Financial reports

5.16 The term financial report is used in a number of provisions throughout Division 230. This term is not defined and instead takes its meaning from ordinary commercial usage. It would be expected that the contents of financial reports will generally be governed by the accounting standards applied in the relevant jurisdiction together with any relevant statutory requirements. For example, the Australian Accounting Standard AASB 101 Presentation of Financial Statements (AASB 101) prescribes the documents which together constitute what will, from 1 July 2009, be called financial statements (before recent amendments to this standard the term used was financial reports ). The documents that constitute the financial statements for the taxpayer under AASB 101 will therefore satisfy the meaning of the term financial reports where it is used in Division 230. Paragraph 10 of AASB 101 sets out the documents that comprise a complete set of financial statements:

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a statement of financial position (currently referred to as a balance sheet);

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a statement of comprehensive income (currently referred to as a profit or loss statement);

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a statement of changes in equity;

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a cash flow statement; and

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notes, comprising a summary of significant accounting policies and other explanatory notes.

5.17 The Corporations Act 2001 also has a definition in section 295 of financial reports which essentially mirrors the requirements of the accounting standards, but which also has certain additional requirements including a declaration of directors. Compliance with that section would similarly meet the ordinary meaning of financial report , but it would not be necessary that the additional requirements over and above that required under the relevant accounting standards be satisfied.

Prepared in accordance with accounting standards

5.18 The requirement in the elective Subdivisions for the preparation of financial reports in accordance with accounting standards is a fundamental requirement which ensures that the timing and measurement of the gains and losses made from relevant financial arrangements are reliable and suitable for tax purposes.

5.19 In the case of financial reports not prepared in accordance with the accounting standards, there may not be sufficient integrity associated with the preparation of such reports to allow them to be relied upon for tax purposes.

5.20 In the context of the elective Subdivisions within Division 230, three of the most relevant accounting standards are:

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Australian Accounting Standard AASB 139 Financial Instruments: Recognition and Measurement - which covers recognition and measurement of financial assets and liabilities;

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Australian Accounting Standard AASB 121 The Effects of Changes in Foreign Exchange Rates - which covers certain gains and losses attributable to changes in foreign exchange rates; and

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Australian Accounting Standard AASB 127 Consolidated and Separate Financial Statements (AASB 127) - which covers the preparation and presentation of consolidated financial statements for a group of entities under the control of a parent.

5.21 While these are the most relevant accounting standards for the methodologies contained within the elective Subdivisions, other Australian accounting standards may also be relevant (such as those Australian accounting standards mentioned in Chapter 1).

5.22 Where an entity prepares a financial report using comparable accounting standards of a foreign jurisdiction, those financial reports will satisfy this accounting standards requirement. (What constitutes a comparable standard is explained in paragraphs 5.46 to 5.48.)

5.23 Whether or not a taxpayer's financial reports have been prepared in accordance with relevant accounting standards is a question of fact. However, where an entity purports to have prepared a financial report in accordance with relevant accounting standards and there is an unqualified auditor's report in respect of the financial report, the auditor's report will ordinarily be indicative of, but not necessarily conclusive of, the fact that the financial report has been prepared in accordance with the relevant accounting standards.

Financial reports of a connected entity

5.24 A financial report prepared by another entity is treated as though it is prepared by the taxpayer where the other entity is a connected entity of the taxpayer and the financial report is a consolidated financial report that properly reflects the affairs of both the taxpayer and the connected entity [ Schedule 1, item 1, section 230-525 ]. What is meant by the term 'properly reflects' is a question of fact and degree; the term seeks to underline the importance of the accounting and auditing requirements being substantively met in respect of the particular taxpayer.

5.25 It may be possible that a taxpayer's affairs are reflected in more than one set of audited financial reports, for example in the context of a multiple entry consolidated group (MEC group) there could be more than one relevant audited financial report prepared for different levels of relevant interposed holding entities.

5.26 There may also be circumstances where an entity that prepares a financial report (or for whom the report is prepared) may not make an election under any of the elective Subdivisions (because, for example, it is not an Australian resident taxpayer) while an entity it controls (in the corporations law sense) may make an election to apply one of the elective Subdivisions. There is also the possibility that a controlled entity (in the corporations law sense) may seek to make the election in respect of itself because it is a separate taxpayer from the taxpayer that has prepared the financial report.

5.27 In this regard, any entity that is a controlled entity (in the corporations law sense) is eligible to make an election under the elective Subdivisions where a financial report properly reflects the affairs of the taxpayer making the election, that is, the controlled entity. The availability of this election is on the proviso that the audited financial report is a consolidated financial report for the reporting group of which the controller and the controlled entity are members.

5.28 This provision allows an entity to make an election under the elective Subdivisions where the entity's financial arrangements are dealt with in a set of audited financial reports of an accounting consolidated group of which it is not the parent entity. For example, the entity could be the head company of a tax consolidated/MEC group or a subsidiary of an accounting consolidated group.

More than one financial report

5.29 It is expected that taxpayers who are able to rely on one set of financial reports for the purpose of calculating their Division 230 gains and losses will have significantly reduced compliance costs. This will be the ordinary case where the taxpayer's accounting year and income year align.

5.30 However, in cases where accounting and income years do not align, taxpayers will still be able to rely on financial reports to calculate their Division 230 gains and losses. In those circumstances it will be possible for taxpayers to rely on more than one set of financial reports. Where this arises, taxpayers will need to reasonably and properly allocate gains and losses from their financial reports to the income year in which those gains and losses are properly referable.

5.31 It must be noted, however, that the operation of Division 230, and the application of this exception where accounting and income years do not align, does not, of itself, provide a rationale for changing income years to align with accounting years.

5.32 If the taxpayer's accounting and income tax years do not align, it will be necessary to determine whether more than one set of audited financial reports will satisfy the requirements for making an election under the respective elective Subdivisions.

5.33 In order to satisfy those requirements, the taxpayer must be able to identify and use two or more sets of financial reports, each of which:

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covers at least part of the income year for which the election is being made;

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is prepared in accordance with relevant accounting standards;

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is audited in accordance with relevant auditing standards; and

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is unqualified by the auditor.

[ Schedule 1, item 1, subsections 230-215(1), 230-260(1), 230-320(1) and 230-400(1 )]

5.34 Where a taxpayer can demonstrate that they have multiple audited financial reports that cover the relevant income year, they are able to treat themselves as eligible to make an election under the elective Subdivisions. [ Schedule 1, item 1, subsections 230-215(2), 230-260(2), 230-320(2) and 230-400(2 )]

5.35 The reports that are relied upon must also cover at least the entire income year. As with financial reports for accounting and income years that align, the financial reports of a connected entity can, in certain circumstances, be relied on (see above).

5.36 Examples of where non-alignment of accounting and income years may occur, and the relevant financial reports that may be used include:

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the accounting year is to 31 December and the income year is to 30 June - the taxpayer may use an audited interim financial report prepared in accordance with Australian Accounting Standard AASB 134 Interim Financial Reporting and an audited full year financial report prepared in accordance with AASB 101; and

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the accounting year is for 52 weeks - the taxpayer may use the audited full year financial reports prepared in accordance with AASB 101 for two years.

Reasonably attributing the gain or loss

5.37 Where more than one financial report satisfies the requirements for making a valid election under the elective Subdivisions for an income year (and in fact the election is then made), it will be necessary to determine how much of each gain or loss worked out under the relevant accounting standards in each of the reporting periods for relevant financial arrangements is attributable to the income year. Where multiple financial reports are used, it may be the entire gain or loss for a period worked out under the standard that is attributable to the relevant income year (eg, where the reporting period is for six months), and for other periods (eg, where the reporting period is for 12 months) only part of the gain or loss will be attributable to the relevant income year.

5.38 When undertaking this attribution process it is important to note that it will not always be acceptable to simply attribute gains or losses for a reporting period on a pro-rated time basis. This is especially so in respect of gains and losses that arise on an unsystematic basis. In addition, it is expected that taxpayers will use the same basis for attributing gains and losses in relation to one period as they do for other periods that relate to an income year. Further, that basis should be consistent with that used under the relevant accounting standards. For example, it will be inappropriate to apply an accruals type calculation to a financial arrangement that is being fair valued for accounting purposes.

Example 5.1 : Attribution process

ABC Co has an income tax year that ends on 30 September and an accounting year that ends on 30 June. ABC Co has made a valid election under Subdivision 230-C (using more than one financial report) and wishes to determine the amount of its assessable income and deductions under Division 230 for relevant financial arrangements. The following example illustrates how ABC Co should attribute gains and losses on a financial arrangement that is subject to an election under Subdivision 230-C:

Financial arrangement - variable rate bond.

1 February 2013 - acquire bond for $1,000,000 (its fair value).

Its fair value over time is as follows:

30 June 2013 ^[3] $987,500

30 September 2013 $876,900

30 December 2013 $870, 000

31 March 2014 $913,500

30 June 2014 $978,400

For the accounting period ending 30 June 2013 the change in fair value on the bond worked out in accordance with the accounting standards is a loss of $12,500 and is wholly attributable to the income year ended 30 September 2013.

For the accounting period ending 30 June 2014 the change in fair value on the bond worked out in accordance with the accounting standards is a loss of $9,100. If ABC Co were to allocate this loss to the 2013 income year on a pro-rated time basis it would allocate the loss as follows:

$9,100 x 273/365 = $9,100 x 0.7479 = $6,806.30

However, this is an inappropriate attribution because the actual change in fair value that occurred during the relevant part of the income year, (ie, from 1 July 2013 to 30 September 2013), is:

Value at 1 July 2013 $987,500

Value at 30 September 2013 $876,900

Change in fair value ($110,600)

[ Schedule 1, item 1, subsections 230-215(3) to (5), 230-260(3) to (5) and 230-400(3) to (5 )]

Class Orders

5.39 Some entities within an accounting consolidated group may not be required to prepare financial reports because of, for example, an Australian Securities and Investment Commission Class Order. However, if a particular financial asset or liability is held by such an entity and that financial asset or liability is reflected in a set of audited financial reports of another entity within the accounting consolidated group - typically the consolidated financial reports - then the elective Subdivisions may still be able to apply to that financial asset or liability - provided it is a financial arrangement which is subject to Division 230. [ Schedule 1, item 1, paragraphs 230-220(1)(b), 230-265(1)(b), 230-335(1)(c) and 230-410(1)(c )]

Audited in accordance with auditing standards

5.40 It is a requirement of the elective Subdivisions that the financial reports of the taxpayer be audited in accordance with the Australian auditing standards or comparable foreign standards. This audit requirement provides additional integrity in respect of the amounts which are in effect relied upon for income tax purposes.

5.41 Under section 336 of the Corporations Act 2001 , an auditing standard is defined as a standard that is made by the Auditing Standards Board for the purposes of the Corporations Act 2001 . An auditor will be required to follow those auditing standards in the audit of a financial report.

5.42 For the purposes of the Australian Auditing Standards, Auditing Standard ASA 700 - The Auditor's Report on a General Purpose Financial Report states, in paragraph 39, that:

'The auditor's report shall state that the audit was conducted in accordance with Australian Auditing Standards.'

Auditing Standard ASA 700 is operative for financial reporting periods commencing on or after 1 July 2006.

5.43 Where the preparation or audit of the relevant financial report is carried out in a foreign jurisdiction, then comparable auditing standards will be seen to provide integrity in the same manner as the Australian auditing standards. For further discussion on what would be required for an accounting or auditing standard to be considered comparable, see paragraphs 5.46 to 5.48.

5.44 Not all entities are required by Australian law to have their financial reports audited in accordance with the auditing standards (or by comparable foreign law and auditing standards made under a foreign law). An entity that falls into this category is not precluded from making an election under any of the elective Subdivisions provided the financial reports of that entity are in fact audited in accordance with the relevant auditing standards.

5.45 The auditing requirement in the elective Subdivisions is such that either of the following election eligibility conditions must be satisfied prior to making an election:

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the financial reports are audited in accordance with the relevant Australian auditing standards; or

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the financial reports are audited in accordance with relevant comparable foreign auditing standards.

[ Schedule 1, item 1, paragraphs 230-210(2)(b), 230-255(2)(b), 230-315(2)(b) and 230-395(2)(b )]

Comparable accounting and auditing standards

5.46 In having regard to what is a comparable accounting or auditing standard, consideration is to be given to whether the foreign accounting or auditing standard, when compared to the Australian accounting or auditing standard, results in a particular financial asset or liability being:

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recognised, classified and treated in the same way in the financial reports of the entity;

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measured in the same way in the financial reports of the entity. That is, the methods by which the changes in value, or gains and losses are calculated, is the same or is substantially the same; and

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subject to the same level of scrutiny as required under the Australian auditing standards.

5.47 Comparable accounting standards include United States of America Financial Accounting Standards and those standards that are compliant with International Financial Reporting Standards in the broad sense of the term (ie, compliance with the entire body of International Accounting Standards Board pronouncements). [ Schedule 1, item 1, subparagraphs 230-210(2)(a)(ii) and (b)(ii), 230-255(2)(a)(ii) and (b)(ii), 230-315(2)(a)(ii) and (b)(ii) and 230-395(2)(a)(ii) and (b)(ii )]

5.48 Regulations may be made to specify whether a particular foreign accounting or auditing standard is to be treated as comparable with the Australian accounting and auditing standards for the purposes of Division 230. [ Schedule 1, item 1, section 230-500 ]

5.49 As previously mentioned, in addition to the generic requirements mentioned in this chapter, there are additional requirements that are specific to particular elective Subdivisions which also need to be met for the elective Subdivisions to apply. For discussion on these specific requirements for elections, see each of the relevant chapters - Chapter 6 (fair value election), Chapter 7 (the foreign exchange retranslation election), Chapter 8 (hedging financial arrangements election) and Chapter 9 (financial reports election).

Effect of change of accounting standards

5.50 Generally, the elective methods apply by relying on figures that are included in the profit or loss statement in the financial report. However, there are circumstances where, as a result of a change in the application of an accounting standard, an amount that would otherwise be recorded in profit or loss may be taken directly to equity. From a Division 230 perspective this amount may be a gain or a loss made from a financial arrangement but for the change in accounting standard. Given this, there is a requirement that amounts that go directly to equity, as a result of the change in application of an accounting standard, are to be included as Division 230 gains or losses in the year of the restatement.

5.51 These provisions ensure that taxpayers are not required to amend prior year tax returns when such an accounting change is made. That is, these amendments are designed to reduce compliance and administration costs by providing that the restated amount is a gain or loss that is made in the year in which the restatement occurs.

Australian Accounting Standard AASB 108

5.52 Where there is a change in either the relevant accounting standard or its application, accounting standard Australian Accounting Standard AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors (AASB 108) requires that certain restated amounts (gain or loss amounts) go directly and permanently to equity instead of going through the profit or loss statement. The adjustment amount, reflecting amounts not brought to account in previous years (which, based on the changes to the accounting standard, would have been brought to account in profit or loss had the new approach applied since the inception of the financial arrangement), will go directly to equity. As a result, the amount cumulatively returned from an accounting perspective through profit or loss will no longer align with the amount returned for tax purposes (if the accounting change had not been made).

5.53 Paragraph 22 of AASB 108 states that:

'Subject to paragraph 23, when a change in accounting policy is applied retrospectively in accordance with paragraph 19(a) or (b), the entity shall adjust the opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied.'

5.54 Paragraph 42 states that, subject to paragraph 43, an entity shall correct material prior period errors retrospectively in the first financial report authorised for issue after their discovery by:

'restating the comparative amounts for the prior period(s) presented in which the error occurred; or...'

5.55 Finally, paragraph 46 states that the correction of a prior period error is excluded from profit or loss for the period in which the error is discovered.

5.56 As can be seen from the AASB 108 extracts, the accounting standards do not include the restated amount in profit or loss. In a Division 230 context, the restated amount is to be considered as a relevant gain or loss notwithstanding that the amount is not included in profit or loss. [ Schedule 1, item 1, section 230-495 ]

Making an election under the elective Subdivisions

Who may make an election

5.57 Generally, entities that are subject to Division 230 may make an election under one or more of the elective Subdivisions (see Chapter 1 for discussion of the hierarchy of elective treatments).

5.58 However, individuals and entities that fall below the relevant threshold tests specified in subsections 230-455(2) to (4), are generally excluded from the operation of Division 230 (except in relation to certain qualifying securities they hold). For such taxpayers an election under one of the elective Subdivisions will only have effect if the taxpayer has also made the election under subsection 230-455(7) to have Division 230 apply to all of their financial arrangements (apart from those excluded in Subdivision 230-H).

Example 5.2 : Individual excluded

Nik is an individual who is in the business of trading securities. As Nik has not made an election under subsection 230-455(7) for Division 230 to apply to all of his financial arrangements any election(s) Nik may make under any of the elective Subdivisions will be invalid (see subsections 230-225(2), 230-270(2), 230-330(3) and 230-415(2)).

Elections where a consolidated or MEC group contains a life insurance company

5.59 In the case of a consolidated group or a MEC group, elections are made by the head company of the group. Generally, an election under Division 230 will apply to all the relevant transactions of all members of the consolidated group or MEC group. This is discussed in detail in Chapter 12.

5.60 However, there is an exception to this where a consolidated group or MEC group includes a member that carries on a 'life insurance business' (as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997). The member running the life insurance business will be a life insurance company that is registered under the Life Insurance Act 1995 .

5.61 A financial arrangement relates to life insurance business carried on by a life insurance company that is a member of a consolidated group or MEC group if the financial arrangement is held directly or indirectly by the life insurance company. Therefore, a financial arrangement that is held by a wholly-owned subsidiary of the life insurance company relates to the life insurance business carried on by the life insurance company member and therefore is covered by the exception.

5.62 Consolidated groups and MEC groups may wish to elect to apply one of the elective Subdivisions. However, for consolidated or MEC groups which contain, for example, both a financial institution member and a life insurance company member, bringing to account gains or losses which arise on an unsystematic, unrealised basis may provide a competitive disadvantage to the life insurance company of the consolidated group or MEC group. For this reason the head company of a consolidated group or MEC group which contains a member that carries on a life insurance business may elect to:

•

have an election under one of the elective Subdivisions apply to all of their relevant financial arrangements; or

•

specify that an election under one of the elective Subdivisions is to only apply to all of their relevant financial arrangements excluding those related to the life insurance business carried on by a member of the group.

[ Schedule 1, item 1, subsections 230-225(3), 230-270(3), 230-330(4) and 230-415(3 )]

Remaking an election - life insurance company as a joining entity

5.63 The amendments to subsection 715-660(1) of the ITAA 1997 (discussed in Chapter 12) ensure that the elections under Division 230 are subject to the operation of Subdivision 715-J of the ITAA 1997. Broadly, Subdivision 715-J operates to override the entry history rule in relation to certain choices by an entity that joins a consolidated group or MEC group (including the absence of a choice) and to extend the time for the head company of the group to make a new choice.

5.64 Therefore, the head company of an existing consolidated or MEC group is able to remake its Division 230 election in respect of the group if:

•

a life insurance company joins the group;

•

the life insurance company has made an election under Division 230 prior to its entry into the group; and

•

the life insurance company's election is inconsistent with the existing Division 230 election of the head company.

5.65 In these circumstances, the head company has until the later of the following times to make a new election under Division 230:

•

the last time the head company may make an election under Division 230 (ie, by the end of the relevant income year); and

•

the end of 90 days after the Commissioner of Taxation (Commissioner) is given notice under Division 703 of the ITAA 1997 that the life insurance company has become a member of the group or such later time as the Commissioner allows.

5.66 Consequently, if a life insurance company joins an existing consolidated group or MEC group, the head company will be able to make an election under Division 230 in relation to its life insurance business that is different to the election that applies to its other business.

5.67 However, if a life insurance company that joins an existing consolidated group or MEC group has made an election under Division 230 prior to joining the group that is consistent with the existing election of the head company, then the head company is precluded from making a new election under Division 230. This includes a situation where the group already carries on life insurance business and has made an election under Division 230 in respect of that business which is consistent with the Division 230 election of the joining life insurance company. [ Schedule 1, item 1, subsections 230-225(3), 230-270(3), 230-330(4) and 230-415(3 )]

The manner in which elections are to be made

5.68 The form by which the taxpayer makes an election available under the elective Subdivisions is not prescribed in Division 230. However, the election will need to be made in a manner that clearly reflects that the election has been made and also the time when the election is made. That election will need to form part of the tax records of the entity.

Elections are irrevocable

5.69 An election made under one of the elective Subdivisions is irrevocable. [ Schedule 1, item 1, subsections 230-210(3), 230-255(5), 230-315(3) and 230-395(4 )]

Financial arrangements that are subject to the election, and the effect of the election

Financial arrangements to which the elective Subdivisions apply

5.70 Elections made under the elective Subdivisions apply to relevant Division 230 financial arrangements to the extent that:

•

the relevant financial arrangement starts to be held in the income year in which the election is made, or the relevant financial arrangement starts to be held in income years following the income year in which the election is made; and

•

the gain or loss on the relevant financial arrangement is recognised or recorded in the taxpayer's audited financial reports.

[ Schedule 1, item 1, subsections 230-220(1), 230-265(1) and 230-410(1), section 230-325 ]

5.71 An election under the elective Subdivisions does not apply to financial arrangements that are held by a taxpayer prior to the income year in which the election is made. An exception applies where the taxpayer makes a transitional year election for existing financial arrangements (discussed in Chapter 13).

Financial arrangements to which the elective Subdivisions do not apply

5.72 If the taxpayer makes an election under Subdivisions 230-C or 230-F, the election does not apply in respect of:

•

a financial arrangement that is an equity interest that:

-

is not classified or designated as at fair value through profit or loss; or

-

is issued by the taxpayer [ Schedule 1, item 1, subsections 230-225(1) and 230-415(1 )]; and

•

franked distributions. The assessability of these distributions, to the degree that they are franked, will remain outside Division 230. For example, dividends, to the degree that they are franked, will remain assessable in accordance with section 44 of the Income Tax Assessment Act 1936 [ Schedule 1, item 1, subsections 230-225(1) and 230-480 ].

Refer to Chapters 2, 3, 6 and 9 for more information on these exceptions.

5.73 Where the head company of a consolidated or MEC group chooses not to make elections in respect of its life insurance business, Subdivision 230-C, 230-D, 230-E or 230-F will not apply to financial arrangements of that member of the consolidated group to the extent that the financial arrangement relates to the life insurance business. [ Schedule 1, item 1, subsections 230-225(3), 230-270(3), 230-330(4) and 230-415(3 )]

5.74 Regulations may also exclude other financial arrangements associated with a business of a specified kind. [ Schedule 1, item 1, subsections 230-225(4), 230-270(4), 230-330(5) and 230-415(4 )]

5.75 Note that although individuals and other entities not subject to Division 230 under the threshold tests contained in section 230-455 can elect to apply the elective Subdivisions, the election will be invalid unless the taxpayer has also made an election under subsection 230-455(7) - refer to paragraph 5.58. [ Schedule 1, item 1, subsections 230-220(1), 230-265(1), 230-325(3) and 230-410(1 )]

Effect of relying on elective Subdivisions

5.76 Where an election made under the elective Subdivisions applies to a financial arrangement, the gain or loss that is made from that financial arrangement is equal to the amount that is required by the relevant accounting standards to be recognised for that financial arrangement in the entity's profit and loss statement of its financial reports.

5.77 Generally, the effect of making an election under the elective Subdivisions is that the taxpayer relies on their financial reports to determine the amount of any gain or loss that is taken to have been made from a relevant financial arrangement. [ Schedule 1, item 1, subsections 230-230(1), 230-280(1) and 230-420(1 )]

5.78 With respect to specific elective Subdivisions:

•

financial arrangements or assets or liabilities that fall within the definition of 'financial arrangement', including those arrangements that fall within the additional operation of the Division as set out in Subdivision 230-J, which are fair valued for the purpose of the profit or loss account, can be fair valued for tax purposes [ Schedule 1, item 1, subsection 230-230(1 )];

•

amounts that are recognised in taxpayers' profit or loss statements of their financial reports that are attributable to the change in currency exchange rates are recognised as gains and losses for tax purposes [ Schedule 1, item 1, subsection 230-280(1 )]; and

•

amounts that are recognised in the profit or loss statement of the financial reports, in effect, determine whether, and the amount of, a gain or loss from a relevant financial arrangement is regarded as arising. Financial reports also determine when the gain or loss is regarded as arising [ Schedule 1, item 1, subsection 230-420(1 )].

Intra-group transaction for the purposes of AASB 127

5.79 Where an election is made by a member of an accounting consolidated group or of a MEC group, and a financial arrangement is not recognised in an audited financial report only because the arrangement is an intra-group transaction under AASB 127, the requirement that the financial arrangement be recognised in the financial reports is deemed to have been satisfied in relation to that financial arrangement. Financial arrangements between members of a consolidated group or MEC group are not covered by this subsection because the single entity rule in subsection 701-1(1) of the ITAA 1997 operates to treat them as not being financial arrangements for all income tax purposes.

5.80 This provision is intended to allow taxpayers to rely on entity accounts for the purposes of satisfying this requirement. To the extent that the arrangement is recognised for tax purposes, the taxpayer is able to rely on the relevant entity accounts for the purpose of determining the amount of relevant gains and losses. That is, this provision only extends to transactions that occur between two tax entities but within the one accounting consolidated group. [ Schedule 1, item 1, subsections 230-220(2), 230-265(2) and 230-410(3), paragraphs 230-230(1)(b) and 230-420(1)(b), subparagraph 230-280(1)(b)(ii )]

5.81 For a discussion of the application of elective Subdivisions to intra-group transactions of foreign bank branches and offshore banking units, see Chapter 11.

Financial arrangement leaving a consolidated group

5.82 The elective Subdivisions may apply in a modified manner where an entity joins or leaves a consolidated group. For details about the application of elective Subdivisions in relation to the consolidation regime, see Chapter 12.

The order in which the elections under the elective Subdivisions apply

5.83 It is important to note that, where more than one election has been made under the elective Subdivisions, only one elective method may apply to an eligible financial arrangement. For further discussion of the hierarchy of tax treatments refer to Chapter 1. [ Schedule 1, item 1, section 230-40 ]

Where requirements for an election are no longer satisfied

5.84 Although an election under the elective Subdivisions is irrevocable, the election may cease to apply, depending on the circumstances applying to either:

•

all of a taxpayer's financial arrangements; or

•

one or more particular financial arrangements of the taxpayer.

When an election ceases to apply to all existing financial arrangements

5.85 The elections, other than (in certain circumstances) an election under Subdivision 230-E, will cease to apply to all of the relevant financial arrangements in the following circumstances:

•

the accounting requirement is no longer satisfied;

•

the auditing requirement is no longer satisfied; or

•

a requirement particular to an elective Subdivision is no longer satisfied.

5.86 If the taxpayer relies on more than once financial report for an income year (because the financial and income years do not align), then ceasing to satisfy the accounting or auditing requirements in relation to any one of the financial reports relied on will result in the election ceasing to apply. [ Schedule 1, item 1, subsections 230-240(1), 230-285(1), 230-370(1) and 230-425(1 )]

Where an election ceases to apply to particular financial arrangements

5.87 The elections will cease to apply to one or more particular financial arrangements in the following circumstances:

•

it is no longer recognised in audited financial reports;

•

it is recognised in financial reports which are not audited; or

•

the taxpayer ceases to meet a particular requirement of an elective Subdivision.

5.88 As with an election ceasing to apply to all financial arrangements, it will similarly cease to apply to a particular financial arrangement if the taxpayer relies on more than one financial report for an income year (because the financial and income years do not align), and the particular financial arrangement is no longer recognised in any one of the audited financial reports relied on. [ Schedule 1, item 1, subsections 230-240(3), 230-285(3) and 230-425(3 )]

When does the election cease to apply?

5.89 Where an election made under the elective Subdivisions ceases to apply to a financial arrangement, that election ceases to apply from the start of the income year in which the circumstances described above occur. [ Schedule 1, item 1, subsections 230-240(1) and (3), 230-285(1) and (3), 230-370(1) and 230-425(1) and (3 )]

5.90 If an election under any of the elective Subdivisions ceases to a financial arrangement, that election cannot subsequently apply to it again. Further, even if a subsequent election under the relevant elective Subdivision is made, that election cannot apply to any financial arrangement to which the prior election applied. [ Schedule 1, item 1, subsections 230-240(2) and (4), 230-285(2) and (4), 230-370(2) and 230-425(1) and (4 )]

A balancing adjustment if an election ceases to apply

5.91 Where an election made under an elective Subdivision ceases to have effect, a balancing adjustment must be made in respect of all the financial arrangements to which the election ceases to apply. [ Schedule 1, item 1, subsections 230-245(1), 230-290(1) and 230-430(1 )]

5.92 Where an election made under an elective Subdivision ceases to apply to a particular financial arrangement, a balancing adjustment must be made in respect of that arrangement. [ Schedule 1, item 1, subsections 230-245(3), 230-290(3) and 230-430(3 )]

5.93 The balancing adjustment rules deem the taxpayer to have disposed of the relevant financial arrangement(s) at the time the election ceases to apply (ie, at the start of the relevant income year). The disposal is deemed to be for the financial arrangement's fair value at that time, and any balancing adjustment gain or loss is brought to account accordingly. The balancing adjustment gain or loss is calculated as if it were a balancing adjustment made under Subdivision 230-G. Further, the taxpayer is taken to have immediately reacquired the financial arrangement for its fair value. [ Schedule 1, item 1, subsections 230-245(2), 4) and (5), 230-290(2), 4) and (5) and 230-430(2), 5) and (6 )]

5.94 Note that, for those financial arrangements subject to Subdivision 230-D (the general foreign exchange retranslation election) the balancing adjustment will only apply in respect of those gains or losses attributable to foreign currency exchange rate fluctuations. Further, this balancing adjustment does not apply to Subdivision 230-E (hedging financial arrangements method). Subdivision 230-E has specific provisions dealing with the consequences if an election ceases to have effect (see Chapter 8).

5.95 Chapter 10 provides a comprehensive outline of the operation of the balancing adjustment rules contained in Subdivision 230-G.

The making of a new election

5.96 Where an election made by a taxpayer ceases to have effect because one or more of the requirements for making the election is no longer being met, they may subsequently make a new election where the requirements for making the election are once more satisfied [ Schedule 1, item 1, subsections 230-240(2), 230-285(2), 230-370(2) and 230-425(2 )]. For each of the elective methods, other than Subdivision 230-E, only financial arrangements that are entered into after the new election is made can be subject to that election. This means that those financial arrangements that were held at the time the election ceases to have effect cannot then be subject to a subsequent election that is made [ Schedule 1, item 1, subsections 230-240(4), 230-285(4), 230-325(1), 230-425(4) and the note to subsection 230-370(2 )].