House of Representatives

Explanatory Memorandum

Circulated By the Authority of the Minister for Climate Change and Energy Efficiency, the Honourable Greg Combet Am MP

Taxation Amendments

Outline of chapter

2.1 Schedule 2 to the Clean Energy (Consequential Amendments) Bill 2011 amends the Income Tax Assessment Act 1997 ( ITAA 1997), the Income Tax Assessment Act 1936 ( ITAA 1936) and the Taxation Administration Act 1953 ( TAA 1953) to establish a rolling balance treatment of registered emissions units for income tax with the following main features:

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The cost of a registered emissions unit (a unit) is deductible, with the effect of the deduction being deferred through the rolling balance (in the standard case where banked units are valued at cost) until the sale or surrender of the unit.

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The proceeds of selling a unit are assessable income.

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Any difference in the value of units held at the beginning of an income year and at the end of that year is reflected in taxable income, with:

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any increase in value included in assessable income; and

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any decrease in value allowed as a deduction.

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Taxpayers can elect to value all units held at the end of the first income year they hold units at either cost or market value.

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The valuation method chosen continues to apply but can be changed once at any time before the end of the 2014-15 income year (the fixed charge period) after which a change will only be allowed after a method has been used for four years.

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Where an entity surrenders a unit for a purpose unrelated to producing assessable income, the deduction for the cost is effectively reversed by including in assessable income an amount equal to the amount deducted for its acquisition.

2.2 Schedule 2 also inserts a provision to make an amount of unit shortfall charge an amount that is not deductible under the income tax law.

2.3 Schedule 2 also amends the A New Tax System (Goods and Services Tax) Act 1999 ( GST Act) to make supplies of eligible emissions units under the carbon pricing mechanism GST-free.

2.4 Legislative references in this chapter are to the ITAA 1997, except where indicated.

Context of amendments

Summary of how existing law would have applied

2.5 When the carbon pricing mechanism commences, the proposed tax amendments apply immediately to set out the income tax treatment of units, and clarify the goods and services tax (GST) treatment of eligible units. The summary below outlines how the existing law would have applied to these units, if the proposed tax amendments were not enacted.

Income tax

2.6 For a taxpayer carrying on a business or undertaking other assessable income earning activities, the existing income tax law would recognise the cost of acquiring units. The particular treatment and provisions that would apply in any particular case would depend on the taxpayer's activities and its purpose, both when purchasing the unit and while holding the unit.

2.7 An entity could purchase a unit for the following purposes:

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to meet an obligation under the carbon pricing mechanism;

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to surrender voluntarily as part of a marketing campaign;

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as part of its trading portfolio; or

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otherwise for sale at a profit.

2.8 Under the existing law in the first two cases the cost may be deductible but the timing of the deduction would be unclear. In the third case, where units were bought for trading, the cost would generally be deductible on acquisition but any change over an income year in the value of units held would be brought to account as a deduction (where the value declined) or assessable income (where the value increased). In all three cases, any proceeds on the sale of the unit would be assessable income.

2.9 In the fourth case, where the cost would not be deductible or the proceeds assessable, both would be taken into account in working out any assessable gain or deductible loss on the sale of a unit. In all cases, it would be very unlikely that a capital gain or loss would be recognised under the capital gains tax (CGT) or losses provisions.

2.10 A unit acquired for private or domestic purposes (for example, to be surrendered voluntarily to offset the carbon footprint of the purchaser's private residence) would not be deductible under the current tax law.

Goods and services tax

2.11 The supply of an eligible emissions unit is a taxable supply if the requirements of section 9-5 of the GST Act are met.

2.12 GST applies to an eligible emissions unit acquired from an entity outside Australia if the supply is connected with Australia and the other requirements of a taxable supply are met. If the supply of an eligible emissions unit to a GST registered recipient carrying on an enterprise in Australia is not connected with Australia and the unit is acquired by the recipient solely for a creditable purpose, GST does not apply.

2.13 The supply of an eligible emissions unit to an entity outside Australia may be GST-free under an item in the table in subsection 38-190(1) of the GST Act if it is a supply other than of goods or real property. To satisfy certain items in the table, it is a requirement that the supply of the eligible emissions unit is not a supply directly connected with real property.

Objectives of the tax treatment of units

2.14 The tax treatment of units aims to:

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assist the carbon pricing mechanism's main aim of cost effectively meeting Australia's emissions reduction targets and contributing to the development of an effective global response to climate change; and

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incorporate the tax axioms of simplicity, efficiency and equity.

Income tax

2.15 To prevent complexities and uncertainties that would result from applying the existing income tax law to emissions units, discrete income tax provisions specify the income tax treatment for units registered on the Australian National Registry of Emissions Units. Those specific provisions establish a rolling balance treatment, similar to the trading stock provisions, under which:

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the cost of a unit would be deductible when the unit is acquired;

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the proceeds from selling a unit would be assessable income; and

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any difference in the value of units held at the beginning of an income year and at the end of that year would be reflected in taxable income, with any increase in value included as assessable income and any decrease in value allowed as a deduction.

2.16 The preference for specific provisions establishing a rolling balance treatment for units was the Government's position in the Carbon Pollution Reduction Scheme (CPRS) White Paper.

Goods and services tax

2.17 The Government's preferred position on the application of GST to eligible emissions units is to minimise compliance costs for taxpayers associated with the GST treatment of emissions unit transactions. Under the CPRS this was achieved by applying the normal GST rules to carbon pricing mechanism transactions. This was intended to ensure that carbon pricing mechanism transactions would receive the same treatment as similar transactions in the broader economy.

2.18 Under the carbon pricing mechanism, the policy objective remains to minimise compliance costs. However, the approach to achieving this is to make supplies of eligible emissions units GST-free and to apply the normal GST rules to financial derivatives of eligible emissions units and payments of grants of government assistance and other transactions under the carbon pricing mechanism.

Summary of new law

2.19 Schedule 2 of the Clean Energy (Consequential Amendments) Bill 2011 establishes the income tax treatment, and clarifies the GST treatment, of emissions units.

Income tax

2.20 The Bill introduces discrete provisions that establish a rolling balance method of accounting for registered emissions units, similar to that for trading stock. The main features are:

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the cost of a unit is deductible, with the effect of the deduction being deferred through the rolling balance (in the default case where banked units are valued at cost) until its sale or surrender;

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the proceeds of selling a unit are assessable income;

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any difference in the value of units held by a taxpayer at the beginning of an income year and at the end of that year are reflected in taxable income, with:

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any increase in value included in assessable income; and

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any decrease in value allowed as a deduction;

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a taxpayer can elect to value all units held at the end of an income year at cost, using the 'first-in, first-out' (FIFO) cost method or the actual cost method, or at market value;

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a taxpayer's chosen valuation method continues to apply; however, a taxpayer will be able to change valuation methods once at any time before the end of the 2014-15 income year (the fixed charge period) after which a change will only be allowed after a method has been used for at least the previous four years that units were held at the end of the income year;

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the value of an eligible emissions unit will be deemed to be its market value where:

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it is transferred under a non-arm's length transaction or a transaction with an associate;

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it is issued as a free carbon unit (except in certain circumstances relating to emissions intensive trade exposed entities); and

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it is a unit issued under the Carbon Credits (Carbon Farming Initiative) Act 2011;

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where an entity surrenders a unit for a purpose unrelated to producing assessable income, the deduction for the cost of the unit is effectively reversed by including in assessable income an amount equal to the amount deducted;

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an amount of unit shortfall charge is not deductible under the income tax law.

Goods and services tax

2.21 The measure adds 'Subdivision 38-S - Eligible Emissions Units' to the GST Act, making eligible emissions units under the carbon pricing mechanism GST-free.

Detailed explanation of new law

Income tax

2.22 The income tax treatment of units centres on the holding of units on the Australian National Registry of Emissions Units (Registry or Australian Registry). The treatment of emissions units can be divided into what happens to an entity's holding of units on the Registry when the entity:

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becomes the holder of a registered emissions unit during an income year;

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holds a registered emissions unit at the end of an income year;

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ceases to hold a registered emissions unit during an income year by:

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surrendering it, in which case the unit is removed from the Registry (section 122 of the Clean Energy Bill 2011 ( the main bill));

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transferring the unit to a registry account held by another entity on the Registry (for example, under sections 104 and 105 of the main bill) or to another entity's foreign account;

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transferring the unit to the entity's own foreign account, or the foreign account of its nominee upon which it ceases to be a registered emissions unit (section 35 and 52 of the Australian National Registry of Emissions Units Act 2011 ( the Registry Act));

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relinquishing it, in which case the unit is cancelled or transferred to the Commonwealth (section 210 of the main bill).

Meaning of registered emissions unit

2.23 'Registered emissions unit' is a defined term that covers those units that are actually registered on the Registry. An emissions unit is a registered emissions unit if it is:

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a carbon unit; or

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a Kyoto unit; or

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a prescribed international unit; or

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an Australian Carbon Credit Unit (ACCU), as defined by the Carbon Credits (Carbon Farming Initiative) Act 2011 ( CFI Act);

for which there is an entry in a registry account for the unit . [Schedule 2, item 28, section 420-10 and item 67, definition registered emissions unit, subsection 995--1(1)]

2.24 The term 'carbon unit' has the same meaning as in the main bill. The terms 'Kyoto unit', 'prescribed international unit' and 'Registry account' all have the meanings as defined in the Registry Act (as amended by this bill). An eligible emissions unit is one that an entity can surrender to prevent a unit shortfall. Some types of Kyoto units (assigned amount units and certified emission reductions derived from afforestation or reforestation projects) and some ACCUs cannot be surrendered to prevent a unit shortfall but nevertheless they can be registered on the Registry, and are therefore by definition registered emissions units but are not eligible emissions units.

Holding a registered emissions unit

2.25 For income tax, an entity ordinarily holds a registered emissions unit if it is the registered holder of the unit within the meaning of the Registry Act. The holder of a registered emissions unit is defined in section 5 of the main bill as the person in whose Registry account there is an entry for the unit . [Schedule 2, item 28, section 420-12]

Registered emissions units held by a person as a nominee

2.26 There is a specific 'look-through' rule that clarifies the income tax treatment where the registered holder of a registered emissions unit is merely a nominee for another entity. The other entity is treated as holding the unit and the registered holder is treated as not holding the unit . [Schedule 2, item 28, subsection 420-12(2)]

2.27 Nominee has its ordinary meaning, which in this context is someone who holds bare legal title for the benefit of another (Black's Law Dictionary, 8th edition).

2.28 While the entity that is taken to hold the registered emissions unit under the 'look-through' rule can themselves be holding the unit as nominee, the provision only operates to 'look-through' the registered holder of the unit.

Example 2.1

Z is a stock broker who acquires and holds 50,000 carbon units in a Registry account. Z acquired and holds those units on behalf of its client, Company B.

The 'look-through' rule applies for income tax because Z holds the units as nominee for Company B. Company B is treated as holding the 50,000 carbon units, which are registered emissions units, and Z is treated as not holding those units.

Example 2.2

T is the trustee of a discretionary trust. Acting as trustee, T acquires and holds 10,000 carbon units in a Registry account.

The 'look-through' rule for nominees does not apply because T is not a mere nominee. The units are held by the trust for income tax purposes. Under the Registry Act, carbon units are held in a Registry account kept by a person. Person is defined to include a trust, which in turn is defined to mean a person in the capacity as trustee or, as the case requires, a trust estate. Both meanings of trust under the main bill are consistent with treating the unit as held by the trust for the purpose of working out income tax liabilities.

Becoming the holder of a registered emissions unit

2.29 An entity becomes the holder of a registered emissions unit during an income year by having that unit entered into their Registry account. This may occur as the result of:

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purchasing a registered emissions unit:

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at an original auction conducted by the Authority for the Commonwealth (section 111 of the main bill);

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on the secondary market, including at a secondary market auction (section 112 of the main bill);

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as part of the fixed charge arrangement (section 100 of the main bill);

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transmission of the registered emissions unit by operation of law (section 106 of the main bill);

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being issued a free carbon unit by reason of:

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the Jobs and Competitiveness Program (Part 7 of the main bill);

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being a coal-fired electricity generator (Part 8 of the main bill);

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being issued an ACCU by reason of certain activities undertaken by the entity under the CFI Act; and

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transferring an international emissions unit from a foreign account onto the Registry (section 36 or section 53 of the Registry Act).

Deductions for expenditure incurred in obtaining a unit

2.30 An entity can deduct expenditure to the extent that the entity incurs it in becoming the holder of a registered emissions unit. The expenditure is deductible in the year the entity starts to hold the unit, ensuring that the timing of the deduction is matched to the income year in which the unit enters the entity's rolling balance account . [Schedule 2, item 28, subsections 420-15(1) and (2)]

2.31 However, there are exceptions. Expenditure incurred in becoming the holder is not deductible under the proposed provisions in Division 420 if the registered emissions unit is issued in accordance with:

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the Jobs and Competitiveness program ; [Schedule 2, item 28, paragraph 420-15(3)(a)]

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coal-fired electricity generation assistance; or [Schedule 2, item 28, paragraph 420- 15(3)(b)]

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the CFI Act resulting in the issue of ACCUs . [Schedule 2, item 28, subsection 420-15(4)]

2.32 Expenditure that does not come within one of the deduction provisions in Division 420, and which is not made non-deductible by that Division, may nevertheless be deductible under other provisions of the income tax law.

2.33 Where an entity is undertaking activities under the Carbon Farming Initiative the normal deduction provisions apply to work out the deductibility of the expenses they incur in those activities. The activities are effectively regarded as directed towards establishing an eligible offsets project rather than towards producing ACCUs. If Division 420 were applied in these cases, various deductions would potentially be deferred until the ACCUs produced started to be held . [Schedule 2, item 28, subsection 420-15(4)]

2.34 Expenditure incurred in preparing or lodging an application for a certificate of entitlement or an offsets report in relation to the CFI can be deducted under Division 420 (where the relevant conditions are satisfied) . [Schedule 2, item 28, paragraphs 420- 15(4)(a) and (b)]

Example 2.3

An entity engages an expert to assist in submitting an offsets report and applying for a certificate of entitlement under the CFI Act. The amount paid to the expert so far as this is for preparation of the offsets report and of the application for a certificate of entitlement is deductible under subsection 420-15(4).

2.35 Expenditure incurred in becoming the holder of a registered emissions unit (including under a deemed acquisition) is also not deductible where, if the unit were sold immediately after the taxpayer began to hold it, the proceeds would not be assessable income. This is primarily designed to prevent foreign residents who are not assessable on the proceeds of sale of units from obtaining a deduction which could be offset against other Australian assessable income. For a more detailed discussion of the treatment of foreign residents see below under 'Foreign residents - whether they are taxable in relation to registered emissions units' . [Schedule 2, item 28, subsection 420-15(5)]

Non-arm's length transactions and transactions with associates

2.36 If the consideration provided in a non-arm's length transaction or in a transaction between associates by which an entity became the holder of a registered emissions unit is not equal to the market value of the unit, the consideration is instead taken to have that market value. That is, market value consideration is taken to have been incurred whether the actual consideration was less than, or greater than, the market value of the unit or if there was no consideration paid or given . [Schedule 2, item 28, subsection 420-20(1)]

2.37 There are a number of carve outs from this general principle. The principle does not apply to the issue of carbon units under the carbon pricing mechanism. Carbon units issued in Australia via auctions will by their nature be issued at the market value and so do not need to be covered by the principle. The tax treatment of recipients of free carbon units is specifically dealt with elsewhere in the Division. The recipients are not taken to have provided any consideration. The other broad category of units is ACCUs issued under the CFI Act . [Schedule 2, item 28, subsection 420-20(3)]

2.38 Another category of transaction that is carved out from the non-arm's length transactions and transactions with associates principle is the transmission of registered emissions units arising from the death of individuals who held them just before their death, whether to a legal personal representative or to a beneficiary in the individual's estate . [Schedule 2, item 28, subsection 420-20(2)]

Relationship with international transfer pricing provisions

2.39 Section 136AB of the ITAA 1936 is amended to clarify the relationship between the proposed non-arm's length transaction sections (sections 420-20 and 420-30) and the international transfer pricing provisions in Division 13 of Part III of the ITAA 1936. If both or either section 420-20 or section 420-30 and Division 13 could otherwise apply, the potential operation of section 420-20 and/or section 420-30 is to be disregarded. This leaves Division 13 to apply comprehensively in the international area, subject to the terms of any relevant double tax treaty . [Schedule 2, item 3, subsection 136AB(2) of the ITAA 1936]

2.40 The result is that the relationship of sections 420-20 and 420-30 with Division 13 is the same as that of section 70-20, the non-arm's length rule for trading stock.

Transfer of an emissions unit from a foreign registry to the Australian Registry

2.41 An entity may transfer an international emissions unit from a foreign registry to its account on the Australian Registry. The process for this is set out in Part 4 of the main bill and it is commonly called importing an emissions unit. The importing rules also cover the following cases where both before and after importation the same entity holds the unit, either in an account in its own name or because another entity holds the unit as its nominee:

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an entity transferring an international emissions unit from its account on a foreign registry to its or its nominee's account on the Australian Registry; and

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an entity's nominee transferring an international emissions unit from its account on a foreign registry to the entity's account or its nominee's account, on the Australian Registry . [Schedule 2, item 28, section 420-21]

2.42 An international emissions unit is defined in the Dictionary to the ITAA 1997 to mean a Kyoto unit or prescribed international unit, both of which have the same meaning as they have in the Registry Act . [Schedule 2, item 63, definition international emissions unit, subsection 995-1(1)]

2.43 In addition to international emissions units, an entity may also transfer a carbon unit or ACCU that has previously been transferred from the Australian Registry to a foreign registry back onto the Australian Registry. These units are treated in the same way as international emission units when transferred onto the Australian Registry. There are thus three categories of units that may be imported - international emissions units, carbon units previously exported and ACCUs previously exported.

2.44 Division 420 provides specific rules for registered emissions units once they become registered on the Australian Registry. The general income tax provisions apply to international emissions units and to carbon units and ACCUs that have been transferred to a foreign account until the time the units are registered on the Australian Registry and become subject to Division 420 treatment (that is, when they are transferred from your foreign account). The treatment of the importation of these emission units depends on how the unit is treated under the income tax law before importation - in particular, on whether it was held on revenue or capital account.

2.45 Before they become registered emissions units in Australia, the international emissions units would generally be dealt with on revenue account (the cost and proceeds would be directly deductible and assessable or taken into account in working out assessable profits or deductible losses). In this context it is necessary to determine whether, just before the transfer, the unit was trading stock or a revenue asset of the entity. Trading stock and revenue assets are both defined terms in the existing law . [Schedule 2, item 28, section 420-21]

2.46 For each of the three categories of emissions units that may be imported new provisions describe the transfer of each type from either the entity's or the entity's nominee's foreign account to the entity's or the entity's nominee's registry account respectively. This is consistent with the way units may be held discussed above . [Schedule 2, item 28, paragraph 420-21(1)(a)]

2.47 Where the importing entity (the entity or the entity's nominee) held the emissions unit on revenue account before importation, the entity is treated as having sold the unit to someone else just before it became a registered emissions unit for its cost. The entity is also treated as having immediately bought it back as a registered emissions unit for the same amount (the former cost). This process effectively rolls the unit onto the Australian Registry without a taxing point . [Schedule 2, item 28, subsection 420-21(1)]

Example 2.4

An Australian resident company carries on a large manufacturing business in Australia and in the ordinary course of that business acquires, sells and surrenders emissions units. The company holds 100,000 emission reduction units (a type of international emissions unit) that are registered in New Zealand. The company then transfers all those emission reduction units from the New Zealand Register to its Australian Registry account and immediately after that surrenders them to acquit an Australian emissions liability.

Before the transfer the units were trading stock or revenue assets of the company. The company is treated as having sold each unit to someone else just before it became a registered emissions unit in Australia at its cost.

The company is also treated as having bought 100,000 registered emissions units for the same amount. The company is entitled to a deduction for that amount (section 420-15).

2.48 It is expected to be unusual for an importing entity to hold units that may be imports on capital account before importation. If this happens, the emissions unit is brought into Division 420 at its market value. A 'roll-over' treatment would be inappropriate because it would result in capital gains or losses being rolled over onto revenue account. Capital gains and losses are treated differently from revenue gains and losses under the income tax law . [Schedule 2, item 28, subsection 420-21(2)]

2.49 Treating the incoming unit at market value causes a realisation event before the unit is transferred onto revenue account. It is important to note that taxpayers have discretion as to when they move units onto the Australian Registry and therefore they choose when to realise an amount on capital account, before commencing treatment under Division 420.

2.50 As for units held on revenue account, rules are inserted to recognise that transfers of units held on capital account may occur from either the entity's or their nominee's foreign account to the entity's or their nominee's Registry account. Here, the importing entity is treated as if it sold the imported emissions unit for market value to someone else, and repurchased it for the same amount, just before it was entered on the Australian Registry. This ensures that any gain or loss that accrued before the unit was registered is brought to account under the provisions that applied before registration and any gain or loss while the unit is registered is treated under Division 420 . [Schedule 2, item 28, subsection 420-21(2)]

2.51 The capital gains and capital losses provisions are also amended because the capital gains tax (CGT) events generally do not rely on deemed sales or disposals. When a taxpayer starts to hold as a registered emissions unit, an international emissions unit they already held as neither trading stock nor a revenue asset, a CGT event happens. This is done by inserting a new CGT event K1, which expressly provides that the entity can make a capital gain or capital loss when they start to hold an international emissions unit as a registered emissions unit. The unit must, just before importation, be neither trading stock nor a revenue asset of the entity . [Schedule 2, items 14 to 16, sections 104-5, table item relating to CGT event K1, and 104-205]

2.52 Where an emissions unit transferred to the Australian Registry was held as trading stock just before the transfer, the Division 420 rules apply rather than the trading stock rules that deal with a taxpayer ceasing to hold an item as trading stock but still owning it . [Schedule 2, items 12 and 13, subsection 70-110(2)]

Ceasing to hold a registered emissions unit

2.53 An entity ceases to hold a registered emissions unit during an income year by:

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transferring it to either another account holder on the Australian Registry (for example, under paragraph 104(1)(a) of the main bill) or to another account holder on the Registry of another country (for example, under paragraph 104(1)(c) of the main bill);

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surrendering it to the Authority, upon which the registration is cancelled or the unit is removed from the entity's Registry account (under section 122 of the main bill);

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transferring it from their account on the Australian Registry to their account on the registry of another country (for example, under paragraph 104(1)(d) of the main bill); or

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relinquishing it, in which case the unit is cancelled or transferred to the Commonwealth relinquished units account (under section 210 of the main bill).

2.54 An entity's assessable income includes an amount the entity is entitled to receive because they cease to hold a registered emissions unit. The amount is assessable income in the income year they cease to hold the unit, ensuring that the timing of assessability is matched to the income year in which the unit leaves the entity's rolling balance account. That amount is also taken to have a source in Australia . [Schedule 2, item 28, section 420-25]

Non-arm's length transactions and transactions with associates

2.55 If the consideration an entity is entitled to receive in a non-arm's length transaction or in a transaction between associates by which an entity ceases to be the holder of a registered emissions unit, is not equal to the market value of the unit, the consideration is instead taken to have that market value. That is, market value consideration is taken to have been receivable by the entity that ceases to hold the unit whether the actual consideration was less than, or greater than, the market value of the unit or if there was no consideration paid or given . [Schedule 2, item 28, section 420-30]

Transfer of a registered emissions unit from the Australian Registry to a foreign registry

2.56 An entity, or its nominee, may transfer a registered emissions unit from the Australian Registry to the entity's own account or its nominee's account on a foreign registry. The process for this is set out in Part 4 of the main bill and is commonly called exporting an emissions unit.

2.57 The income tax treatment under Division 420 ceases when the emissions unit ceases to be registered in Australia on the Australian Registry. The unit thus ceases to be held as a registered emissions unit. After that, the emissions unit is treated under the general income tax law. Similarly to the importation of a unit, the termination of the Division 420 treatment and the commencement of the new treatment are both based on market value at de-registration. Any gain or loss while the unit is registered on the Australian Registry is treated under Division 420. Any gain or loss after registration on the Australian Registry ceases is brought to account under the general provisions of the income tax law.

2.58 To achieve this result for income tax, the entity that transfers the unit is treated as having sold the unit to someone else for its market value just before it ceased to be a registered emissions unit with the market value of the transferred unit being included in the entity's assessable income under section 420-25. The entity is also treated as having immediately bought it back as an emissions unit that is not a registered emissions unit in Australia for the same amount . [Schedule 2, item 28, section 420-35]

2.59 Where the entity that transfers a registered emissions unit from the Australian Registry to its account on a foreign registry holds the unit as trading stock just after the transfer, the Division 420 rules apply rather than the trading stock rules that deal with a taxpayer starting to hold as trading stock an item they already own . [Schedule 2, item 11, subsection 70-30(6)]

Example 2.5

An Australian resident company carries on a business of trading in emissions units. The company owns 10,000 emission reduction units (a type of an international emissions unit) that are registered in Australia. 5,000 of those units are transferred from the Australian Registry to its foreign account on the New Zealand Register.

The company is treated as having sold each unit to someone else at its market value just before it stopped holding the unit as a registered emissions unit. As the unit was a registered emissions unit, the market value is included in the company's assessable income (section 420-25).

The company is also treated as having bought 5,000 emission reduction units for the same amount. The company may be able to deduct that amount under section 8-1 and, assuming the units became trading stock of the company, normally would be able to do so (subject to other special provisions that might deny a deduction).

2.60 The proposed treatment applies across the income tax law - it is not just for the purposes of Division 420. After an emissions unit ceases to be a registered emissions unit in Australia, it would normally be dealt with on revenue account (the cost and proceeds would be directly deductible and assessable or taken into account in working out assessable profits or deductible losses). However, if it were not a revenue asset in a particular case, a capital gain or capital loss on its eventual disposal would be brought to account.

2.61 The deemed acquisition of the emissions unit is an acquisition of a CGT asset for the capital gains and capital losses provisions. The capital gains and capital losses provisions are amended to clarify how to work out the cost base of a unit that is deemed to be acquired. The first element of the cost base (what the taxpayer paid for the unit) is the market value just before the unit stopped being a registered emissions unit . [Schedule 2, item 16, section 112-97]

Disposal for a purpose other than gaining assessable income

2.62 Where an entity ceases to hold a registered emissions unit and that cessation is unrelated to gaining assessable income, there is a claw back of any amount that the entity has deducted or can deduct for expenditure incurred in acquiring or disposing of the unit . [Schedule 2, item 28, subsection 420-40(1)]

2.63 This claw-back provision tests for whether or not there is a sufficient connection between the disposal of the unit and the taxpayer's assessable income producing activities (for example, was the disposal for a private or domestic purpose) at the time of disposal of the unit . [Schedule 2, item 28, subsection 420-40(1)]

2.64 The test is based on the general deduction provision, section 8-1. It is whether the cessation is neither:

•

in gaining or producing an entity's assessable income; nor

•

in carrying on a business for the purpose of gaining or producing assessable income . [Schedule 2, item 28, paragraph 420-40(1)(d)]

2.65 The wording of this test is not identical to the corresponding words in section 8-1. In particular, the second limb of the test differs from the second positive limb of section 8-1 in that it does not contain the word 'necessarily'. This minor difference flows from the context of the words and is not intended to result in any material difference in meaning. The courts have interpreted 'necessarily' in section 8-1 to mean 'clearly appropriate or adapted for'.

2.66 A business entity that surrenders units (beyond any potential emissions liability) for promotional or marketing purposes would not satisfy this test and the claw-back provision would not apply. In contrast, an individual who surrenders units to offset the carbon footprint of their private residence would satisfy the test and the clawback would apply (assuming other conditions were met) . [Schedule 2, item 28, subsection 420-40(1)]

2.67 The claw-back operates by including in assessable income, for the income year in which the cessation occurred, an amount equal to the amount that the entity can deduct or has deducted. This claw-back method is used rather than denying the original deduction because it avoids the compliance and administration costs of re-opening assessments for previous income years. The amount included under the claw-back method is taken to have a source in Australia . [Schedule 2, item 28, subsections 420-40(1) and (6)]

2.68 If the entity ceases to hold the unit as a result of a non-arm's length transaction to which section 420-30 applies, section 420-30 applies instead of the claw-back provision . [Schedule 2, item 28, paragraph 420-40(1)(e)]

2.69 Where the cessation is because of the death of an individual and the unit passes to the deceased's legal personal representative or (directly or indirectly) to a beneficiary of the deceased's estate, there is essentially a "roll-over" treatment. The acquirer is treated as acquiring the unit for the amount included in the transferor's assessable income under the claw-back provision, which is equal to any amounts deducted or deductible for expenditure incurred in acquiring it (basically its cost). A legal personal representative who passes the unit to a beneficiary is also treated as disposing of the unit for the same amount . [Schedule 2, item 28, subsections 420-40(2) and (3)]

2.70 Where the cessation is for a purpose unrelated to producing assessable income and is not because of death, the acquirer is also treated as acquiring the unit for the amount included in the transferor's assessable income under the claw-back provision. In this case, the transferor must notify the transferee that, because this rule applies, the acquirer is treated as purchasing the unit for consideration and the amount of that consideration. Failure to notify the acquirer at, or as soon as practicable after, the time of transfer is an offence under section 8C of the TAA 1953 . [Schedule 2, item 28, subsections 420-40(4) and (5)]

Expenditure incurred in ceasing to hold a registered emissions unit

2.71 An entity can deduct expenditure to the extent that the entity incurs it in ceasing to hold a registered emissions unit. The expenditure is deductible in the year the entity ceases to hold the unit, ensuring that the timing of the deduction is matched to the income year in which the unit leaves the entity's rolling balance account . [Schedule 2, item 28, section 420-42]

2.72 This expenditure (for example, transaction costs incurred in disposing of units) would otherwise have been deductible under the general deduction provision, section 8-1. A specific rule has been included because Division 420 is intended to cover most (but not all) issues about acquiring, holding and disposing of registered emissions units.

Deductibility of the top-up charge

2.73 Under the carbon pricing mechanism, entities will be charged a top-up amount by virtue of the Clean Energy (International Unit Surrender Charge) Act 2011 where they dispose of an eligible international emissions unit and the cost of that unit is below the carbon pricing mechanism floor price - see section 124 of the main bill.

2.74 To avoid doubt, this top-up charge is made specifically deductible in the income year in which an entity pays the amount . [Schedule 2, item 28, section 420-43]

Accounting for registered emissions units held at the start or end of the income year

2.75 A key feature of the rolling balance treatment is that a taxpayer must bring to account any difference between the value of the registered emissions units they held at the start and the value of the registered emissions units they held at the end of the income year . [Schedule 2, item 28, subsection 420-45(1)]

2.76 Any excess of the value at the end of the income year over the value at the start of the income year is included in the taxpayer's assessable income . [Schedule 2, item 28, subsection 420-45(2)]

2.77 Any excess of the value at the start of the income year over the value at the end of the income year is deductible . [Schedule 2, item 28, subsection 420-45(3)]

Value of registered emission units at the start of the income year

2.78 The value of a registered emissions unit held by a taxpayer at the start of an income year is defined to be the same amount at which it was taken into account under the registered emissions provisions at the end of the last income year. In this context if the unit was not taken into account under this Subdivision at the end of the last income year (for example, due to an error by the taxpayer in completing their income tax return that can no longer be corrected) the value of the unit is a nil amount . [Schedule 2, item 28, section 420-50]

Value of registered emissions units at the end of the income year

2.79 A taxpayer has a choice between three methods:

•

the FIFO cost method,

•

the actual cost method

•

the market value method

in valuing the registered emissions units it holds at the end of an income year. The taxpayer makes the choice for the first income year where it holds registered emissions units at the end of the income year. This choice allows taxpayers to select the method that best suits their business practices . [Schedule 2, item 28, section 420-51, subsections 420-55(1) and (2) and 420-57(1) and (2)]

2.80 A choice must be made before a taxpayer lodges their income tax return for the income year for which they can make a choice. The choice is made by applying the chosen method in the income tax return that is lodged. A choice is irrevocable for the income year for which it is made . [Schedule 2, item 28, subsections 420-55(4) and (5) and 420-57(7) and (8)]

2.81 If the taxpayer fails to make a choice the default valuation method is the FIFO cost method. Default choice rules like this are commonly included in the income tax law to prevent a possible problem in assessing a taxpayer that fails to make a choice. Under either the FIFO cost or actual cost methods, unrealised gains on units are not assessed and unrealised losses are not deducted . [Schedule 2, item 28, subsection 420-55(3)]

2.82 A taxpayer's chosen method continues to apply for later income years. However, a taxpayer will be able to change their choice of valuation method once at any time during the fixed charge period ending with the 2014-15 income year. If a taxpayer changes methods it must value any units it holds at the end of a later income year according to the same method . [Schedule 2, item 28, subsections 420-57(3), (4) and (5)]

Example 2.6

Company A first holds registered emissions units at the end of the 2012-13 income year. It values those units using the FIFO cost method under Subdivision 420-D. For the 2013-14 income year, it values the units it holds at the end of the income year at FIFO cost. For the 2014-15 income year it chooses to value the units it holds at the end of the income year at market value.

2.83 After the 2014-15 income year, a taxpayer will be able to change its valuation method at any time after it has used a particular method for the four most recent income years they held an emissions unit at the end of the year (the income years may not be consecutive). Allowing for this ongoing periodic change of valuation method, while preventing a direct change from the FIFO cost method to the actual cost method, provides for changing business circumstances while limiting the opportunities for tax arbitrage. Tax arbitrage opportunities may arise from the exploitation of differences between what units the FIFO cost method treats as on hand at the end of the income year and what units the actual cost method treats as on hand at the end of the income year and also any differences between the cost and market value of units . [Schedule 2, item 28, subsections 420-57(5) and (6)]

Example 2.7

The 2016-17 income year is the first income year for which Company B holds registered emissions units at the end of the income year. It values those units using the actual cost method under Subdivision 420-D. For that year and for each of the following 3 income years the company values all the units it holds at the end of the income year using the actual cost method. Company B can choose to adopt the market value or FIFO method from the 2020-21 income year.

Cost of a registered emissions unit

2.84 The cost of a registered emissions unit is a defined term. The cost of a registered emissions unit that is not issued to you free of charge and is not an ACCU is the total of expenditure you incurred in becoming the holder of the unit that you can deduct under section 420-15 . [Schedule 2, item 58, definition cost of a registered emission unit, subsection 995-1(1), item 28, section 420-60]

2.85 This cost would typically not be limited to the price paid for a unit but would also cover transaction costs (for example, a brokerage fee) incurred in becoming the holder of a registered emissions unit.

2.86 Consequently, while there is a degree of 'absorption costing' required, the range of costs that should be included in the opening value of the unit would ultimately depend on the degree of nexus between the cost and the act of holding the emissions unit. For example, in most circumstances the general overhead costs of a business would not have a sufficient nexus to the holding an emissions unit. The deductibility of those overhead costs would fall for consideration under the ordinary deduction provisions.

2.87 The cost of a free carbon unit or a unit issued under the Carbon Farming Initiative is its market value just after you started to hold it. This is explained in more detail below under 'Valuation of free carbon units and units issued under the Carbon Farming Initiative'.

2.88 In working out the cost of emissions units on hand at the end of an income year for income tax purposes taxpayers who want to use historic cost have a choice of applying the FIFO cost method or the actual cost method.

First-in, first-out

2.89 FIFO is an accounting method commonly used in accounting for fungible items on an historic cost basis. Certain categories of registered emissions units are essentially fungible in that one unit can replace another. For example carbon units of the current or a past vintage and can be used interchangeably to prevent or reduce a shortfall. Similarly carbon units with different future vintages would form separate categories of fungible items.

2.90 The FIFO cost method is used to determine the value of the units still on hand at the end of an income year. Rather than requiring that a taxpayer trace each unit actually sold, transferred, relinquished or surrendered the FIFO method treats units within the same category as having been disposed of in the order in which they were acquired. That is units in the same category, for example the same future vintage, are treated as being disposed of in the same order as they are acquired . [Schedule 2, item 28, section 420-52]

2.91 The FIFO rule does not apply beyond income tax. For example, the rule does not affect the operation of the Registry accounts in the National Registry of Emissions Units . [Schedule 2, item 28, section 420-52]

Actual cost

2.92 The actual cost method is a version of historic cost that requires the tracking of individual emissions units, when they were acquired and for what cost, and the specific emissions units that are on hand at the end of the income year. This method depends on the Registry and takes into account the cost of the actual units that a taxpayer holds at the end of the income year in the rolling balance. This method is possible because each emissions unit on the Registry will have a unique identification number. This method is called the actual cost method in the legislation but is also often referred to as the specific identification method . [Schedule 2, item 28, section 420-53]

Market value method

2.93 The market value method entails valuing the emissions units on hand at the end of the income year at their market value at that time. Market value is a defined term in the ITAA 1997. Market value generally has its ordinary meaning but that ordinary meaning is affected by Subdivision 960-S . [Schedule 2, item 28, section 420-54]

Valuation of free carbon units and units issued under the Carbon Farming Initiative

Cost of free carbon units issued as part of an assistance measure

2.94 If the Authority issues a unit free of charge to a taxpayer under the main bill and that taxpayer still holds that unit at the end of an income year, the general rule is that the cost of the unit is its market value just after the taxpayer began to hold it . [Schedule 2, item 28, subsection 420-60(1)]

2.95 This reflects what it would have cost the taxpayer to buy a unit at that time and, therefore, provides a neutral treatment between free units and purchased units which does not distort a taxpayer's choice to surrender or sell the free unit. It is also consistent with the ordinary treatment of Government assistance (like a cash grant) received by a taxpayer in relation to carrying on its business, which is that the amount is assessable income in the year it is derived (for ordinary income) or received (for statutory income).

2.96 There is an exception in limited circumstances where a taxpayer holds carbon units at the end of an income year that were allocated free of charge to the taxpayer under the Jobs and Competitiveness Program in respect of EITE industries.

Free carbon units issued under the Jobs and Competitiveness Program

2.97 A free carbon unit issued to an entity in accordance with the Jobs and Competitiveness Program is valued at zero at the end of an income year in specified circumstances. This valuation rule was referred to in the CPRS White Paper as a 'no-disadvantage rule'. For the rule to apply, all of the following conditions must be satisfied:

•

the entity holds the unit at the end of the relevant income year;

•

the entity held the unit at all times from when the Authority issued it to the entity until the end of that income year; and

•

the relevant income year ends on or before the last day for surrendering units for the financial year of that particular vintage - ending 1 February after the end of the vintage year.

[Schedule 2, item 28, section 420-58]

2.98 This no-disadvantage rule is designed to minimise any timing disadvantage that an entity in an EITE industry might arguably suffer by bringing to account the value of the free carbon unit as income during the no-disadvantage period where it receives a free carbon unit and still holds it in the circumstances described.

2.99 Under this 'no-disadvantage rule' applies the units have a nil value at the end of the income year regardless of whether the taxpayer has chosen to value all the units it holds under the FIFO cost method, the actual cost method or the market value method . [Schedule 2, item 28, section 420-58]

2.100 However, where an entity holds a free carbon unit at the end of an income year that ends after last day for surrendering units for the financial year of that particular vintage, the free carbon unit is valued at cost or market value depending on the choice of valuation method that the taxpayer makes. The cost of a free unit in those circumstances under both the FIFO cost and actual cost methods is its market value immediately after it began to be held, in accordance with the general rule for valuing at cost units issued free of charge . [Schedule 2, item 28, subsections 420-60(1) and (2)]

2.101 EITE industries are different from coal-fired electricity generators as EITEs entities compete on the world market. The aim of the annual assistance is to minimise the impact of the carbon pricing mechanism on decisions of EITE entities on whether to continue to produce in Australia. Coal-fired electricity generators are being provided with transitional assistance which is not expected to influence their production decisions. Free carbon units issued to coal-fired electricity generators, if held at the end of the income year, are included in assessable income for that year, consistent with the approach to taxing industry assistance generally.

Example 2.8

In August 2016 the Authority issues 1 million free carbon units with a 2016-17 vintage to an EITE entity. The market value of a unit at issue (as per the secondary market) is $21.

In October 2016 the entity sells 400,000 of the free carbon units for $22 each. The entity has an emissions liability for the 2016-17 emissions year and surrenders 400,000 units in June 2017 and a further 100,000 in December 2017 to avoid a unit shortfall penalty (for not surrendering sufficient units by the due date, 1 February 2018).

The entity sells the remaining 100,000 units in July 2018 for $25 each.

For income tax, the entity has a standard income year ended 30 June and has chosen to value all units held at the end of an income year at actual cost.

For simplicity this example concentrates on the group of free carbon units with a 2016-17 vintage and ignores any other units acquired, held or surrendered by the entity.

Income tax treatment

Income year ended 30 June 2017: the proceeds of selling units (400,000 @ $22 = $8.8 million) are assessable income. The surrender of units has no effect on taxable income because none of the units were held at the start of the income year and no amount is included in assessable income. The remaining 200,000 units held at year end are valued at zero in the rolling balance under the no disadvantage rule. The net effect on taxable income is an increase of $8.8 million.

Income year ended 30 June 2018: The surrender of units has no effect on taxable income because the opening balance is zero and no amount is included in assessable income. At year end last surrender date for the 2016-17 emissions year (1 February 2018) has passed. Consequently, the remaining 100,000 units held at year end are valued in the rolling balance at their deemed cost, the market value at the date of issue (100,000 @ $21 = $2.1 million). The net effect on taxable income is an increase of $2.1 million.

Income year ended 30 June 2019: the proceeds of selling units (100,000 @ $25 = $2.5 million) are assessable income. The entity deducts the decline in the value of units held in the rolling balance (100,000 @ $21 = $2.1 million). Therefore, the net effect on taxable income is an increase of $400,000.

Valuation of units issued under the Carbon Farming Initiative

2.102 ACCUs issued under the CFI will receive the same treatment as free eligible emission units provided under the carbon pricing mechanism. The cost of an ACCU issued under the CFI is the market value of the unit immediately after the taxpayer began to hold the unit. The value of the ACCUs for the purposes of applying the rolling balance account treatment is then determined according to the valuation method chosen by the taxpayer . [Schedule 2, item 28, subsection 420-60(3)]

Interactions of emissions units provisions with the rest of the income tax law

No deduction for unit shortfall charge

2.103 Unit shortfall charge imposed under the carbon pricing mechanism is not a penalty. As such, unit shortfall charge is an amount that taxpayers may seek to deduct under the general deductibility provisions of the income tax law. A new provision is inserted to make an amount of unit shortfall charge an amount that is specifically not deductible under the income tax law. This ensures that the entity liable to the unit shortfall charge bears the full cost of the charge . [Schedule 2, item 8, section 26-18]

Anti-overlap rules

2.104 Division 420 covers most, but not all, issues about the acquisition, holding and disposing of registered emissions units. One matter it does not cover is the deductibility of any expenses incurred in holding emissions units. Those expenses are covered by the ordinary deduction provisions, especially the general deduction provision, section 8-1. Similarly, interest expenses incurred in financing the acquisition of registered emissions units are considered under the general deduction provision.

2.105 Where Division 420 covers an issue, it generally has priority over the rest of the income tax law in working out the income tax treatment of the acquisition, holding and disposing of units. Subdivision 420-E contains detailed rules to give effect to this object and sets out exceptions to the general primacy of Division 420. Those detailed rules specifically cover:

•

expenditure an entity incurs in becoming the holder of registered emissions unit [Schedule 2, item 28, section 420-65]

•

an amount an entity is entitled to receive because it ceases to hold a registered emissions unit . [Schedule 2, item 28, section 420-70]

2.106 Expenditure incurred in becoming the holder of, or ceasing to hold, a registered emissions unit is generally deducted under Division 420 and not under the other provisions of the income tax law. Nor is that expenditure taken into account in working out the amount of a net profit or loss that is assessable or deductible respectively outside Division 420. However, for expenditure relating to acquiring free carbon units and ACCUs there are special rules that are discussed above under the heading 'Deductions for expenditure incurred in obtaining a unit' . [Schedule 2, item 28, subsections 420-65(1), (2), (3), (4) and (6)]

2.107 The assessability of an amount that an entity is entitled to receive because it ceases to hold a registered emissions unit is considered primarily under Division 420 and not under other provisions of the income tax law. Nor is the amount receivable taken into account in working out the amount of a net profit or loss that is assessable or deductible respectively outside Division 420. This does not affect the operation of the residence and source rules in sections 6-5 and 6-10, which are central assessable income provisions that all amounts of ordinary and statutory income must satisfy to be assessable income . [Schedule 2, item 28, subsections 420-70(1) and (2)]

2.108 Division 420 also has priority in the treatment of free carbon units or ACCUs. Contrary to the normal treatment, the value of free carbon units or ACCUs received is not assessed as ordinary income or as a bounty or subsidy received in relation to carrying on a business (under section 15-10). Rather, the value of any of these units held at the end of an income year is taken into account (under Subdivision 420-D) in working out any change in the value of units held over the income year . [Schedule 2, item 28, subsections 420-70(3) and (4)]

Carbon Farming Initiative

2.109 As discussed above under 'Deductions for expenditure incurred in obtaining a unit', expenditure incurred in establishing an offsets project under the CFI is not deducted under Division 420. Those expenditures will continue to be considered for deduction under the provisions that ordinarily apply to those activities, for example, the general deduction provision (section 8-1) and capital allowance provisions (Division 40) . [Schedule 2, item 28, subsections 420-15(4)]

Free carbon units issued under the Jobs and Competitiveness Program and to coal-fired electricity generators

2.110 Free carbon units issued under the Jobs and Competitiveness Program and to coal-fired electricity generators are essentially Government assistance and not the result of expenditure by the entity receiving free units. Any expenditure that might be considered to be incurred in becoming the holder of these units is considered under the ordinary deduction provisions and not under Division 420 . [Schedule 2, item 28, subsection 420-15(3)]

Gifts

2.111 Whether a taxpayer is entitled to a deduction for a gift of a registered emissions unit to a deductible gift recipient is determined under the rules about deductions for gifts in Division 30 . [Schedule 2, item 28, subsection 420-65(5)]

Capital gains and losses

2.112 Consistent with the priority given to Division 420, any capital gain or capital loss that a taxpayer makes from a registered emissions unit or from the right to a free carbon unit is disregarded. Amendments are also made to clarify that certain CGT roll-overs do not apply to registered emissions units because the tax treatment is provided exclusively by Division 420, similar to the exclusion of trading stock from the relevant roll-overs . [Schedule 2, item 17, section 118-15 and items 18 to 25]

Trading stock

2.113 To make it completely clear that the trading stock provisions do not apply to registered emissions units (even where they might otherwise be trading stock), registered emissions units are expressly excluded from the definition of trading stock . [Schedule 2, items 10 and 68, section 70-12 and definition trading stock subsection 995-1(1)]

Taxation of financial arrangements

2.114 Division 230 defines 'financial arrangement' and sets out the methods under which gains and losses from financial arrangements will be brought to account for income tax purposes.

2.115 Registered emissions units are exempt from Division 230 and as such, Division 230 will not apply to the acquisition, holding and disposal of registered emissions units. To avoid any doubt as to whether a registered emissions unit is a financial arrangement, Division 230 is amended so that registered emissions units are exempt from the Division . [Schedule 2, item 26, section 230-481]

2.116 Division 230 may apply to derivatives of registered emissions units (for example, an option in relation to a unit) where the derivatives satisfy the relevant conditions (including relevant thresholds for the entity that has the derivative). As derivatives of units are one of many types of derivatives, the normal rules that apply to derivatives also apply to them.

Foreign residents - whether they are taxable in relation to registered emissions units

2.117 Proposed Division 420 applies to registered emissions units held by both Australian and foreign residents. For foreign residents the application of Division 420 is subject to the terms of any relevant double tax treaty between Australia and the taxpayer's country of residence.

2.118 Under the core income tax rules, foreign residents are subject to Australian income tax on the ordinary and statutory income that they derive from Australian sources or that is included in a taxpayer's assessable income on some basis other than having an Australian source.

2.119 Registration of an emissions unit on the Australian register is to be treated as founding an Australian source because registration on the Australian register is a clear and verifiable link to Australia. Further, in most cases the ultimate use of a carbon unit is to acquit an Australian emissions liability. However, in the absence of a specific source rule, it is uncertain whether, in all cases, income arising from dealing in registered emissions units would have a source in Australia under the common law.

2.120 To ensure that amounts Division 420 includes in assessable income have an Australian source, the proceeds from selling units, increases in the rolling balance over an income year and amounts assessable upon disposals unrelated to gaining assessable income will be treated as having an Australian source and, therefore, as assessable income of a foreign resident . [Schedule 2, item 28, subsections 420-25(3), 420-40(6) and 420-45(4)]

Some foreign residents are not taxable in relation to registered emissions units

2.121 However, for a resident of a country with which Australia has a tax treaty, the deemed source rules are subject to the treaty terms. Australia's taxing rights may be limited by the relevant tax treaty to circumstances where a foreign resident's units are connected to a permanent establishment in Australia. Where Australia has no taxing right, a foreign resident would not maintain a rolling balance account for their units or be able to claim a deduction for the cost of acquiring units. To ensure that the law achieves this result, specific rules provide that if the proceeds of selling a registered emissions unit would not have been assessable income in Australia when a taxpayer started to hold a unit, a taxpayer cannot deduct expenditure incurred in buying the unit or a decrease in the value of any units they hold. These rules extend to where a taxpayer is deemed to acquire a registered emissions unit, for example on importation of an international emissions unit. These rules may also apply to the case where a Government owned entity is privatised . [Schedule 2, item 28, subsections 420-15(5) and 420-45(5)]

Changes in whether an entity is taxable in Australia in relation to registered emissions units

2.122 An entity may be taxable in Australia in relation to registered emissions units when it acquires a unit but becomes non-taxable before it stops holding the unit. This could result, for example, where an entity changes its residence from Australia to a country with which Australia has a double tax treaty. The entity is treated as having sold the unit to someone else for its market value just before the time when the entity ceased to be taxable in Australia in relation to registered emissions units (called the taxable status cessation time) and to have repurchased it for the same amount at the taxation status cessation time. Consequently, the market value will be assessable income under section 420-25 and the unit is subsequently ignored in accounting for registered emissions units held at the start and end of an income year (unless the entity becomes taxable again) . [Schedule 2, item 28, section 420-41]

2.123 Similarly, an entity that is not taxable in Australia in relation to registered emissions units when it acquires a unit might become taxable before it stops holding the unit. This could result, for example, where an entity changes its residence from a country with which Australia has a double tax treaty to Australia or in the case where a Government owned entity is privatised. The entity is treated as having bought the unit from someone else for its market value and as starting to hold the registered emissions unit at the time immediately after the entity started to be taxable in Australia (called the taxable status commencement time). If the entity still holds the unit at the end of an income year after the entity becomes taxable, the unit is taken into account as a registered emissions unit held at the end of that income year and also at the start of the next income year. The cost of the registered emissions unit is its deemed acquisition cost, being its market value at the date the entity became taxable . [Schedule 2, item 28, section 420-22]

2.124 Changes in taxability in relation to registered emissions units are not expected to be common. However, these rules have been included to make the treatment clear. They ensure that only a gain or loss that accrues while the entity is taxable in Australia, and only that gain or loss, is brought to account for tax purposes under Division 420, which is consistent with the scheme of the Division. The rules are designed to also produce that result where there is more than one change in taxability, for example a taxable entity becomes non-taxable but later becomes taxable again.

Consolidated groups of entities

Consequences when an entity joins a consolidated group - Interaction with the 'hold' rules

2.125 The consolidation rules apply to treat a group of eligible wholly owned entities as a single entity for income tax purposes. Under the single entity rule (section 701-1 of the ITAA 1997), subsidiary members lose their individual income tax identity on entry to a consolidated group and are treated as parts of the head company.

2.126 As a result of the single entity rule, the head company of a consolidated group will be treated as holding the registered emissions units that a subsidiary member brings into the group. The head company will cease to hold the subsidiary member's registered emissions units from the time the subsidiary member leaves the group.

2.127 Similarly, the subsidiary member is taken not to hold its registered emissions units from the joining time. It begins to hold its registered emissions units from the leaving time.

2.128 Broadly, the consolidation rules would have the effect that a registered emissions unit is an asset of the head company under the single entity rule. The tax cost setting rules will apply to the emissions unit as though the head company held the emissions unit from the start of the income year in which the subsidiary member joins the consolidated group.

2.129 If an entity that holds registered emissions units joins a consolidated group or multiple entry consolidated group (MEC group) part way through an income year, it treats the period in its income year before the joining time as if it were an income year that ends at the joining time (section 701-30 of the ITAA 1997). To ensure a tax neutral outcome for an entity that ceases to hold a registered emissions unit because it joins a consolidated group or MEC group, the value of the registered emissions unit at that time will be taken to be equal to:

•

if the unit was held by the joining entity at the start of the income year - the value of the unit at the start of the income year; or

•

otherwise - the expenditure incurred by the joining entity in becoming the holder of the unit.

[Schedule 2, items 35-38, section 701-35]

2.130 However, if the entity becomes an eligible tier 1 company of a MEC group, section 701-35 will not apply to set the value of registered emissions units held by the joining entity at a tax neutral amount . [Schedule 2, items 52 and 53, subsection 719-165]

2.131 As a consequence of fixing the value of the registered emissions unit at the end of the income year in which the joining time occurs under subsection 701-35(5), no election would be available under Subdivision 420-D to value the registered emissions unit at that time.

2.132 Under the consolidation tax cost setting rules, registered emissions units held by a joining entity will be reset cost base assets. However, the tax cost setting amount will not exceed the greater of the market value of the registered emissions units and the joining entity's terminating value for the units . [Schedule 2, items 41-44, section 705-40]

2.133 The terminating value for a registered emissions unit held at the joining time will be:

•

if the unit was held by the joining entity at the start of the income year - the value of the unit at the start of the income year; or

•

otherwise - the expenditure incurred by the joining entity in becoming the holder of the unit.

[Schedule 2, item 40, subsection 705-30(1A)]

2.134 For the purpose of applying Division 420, if the head company of a consolidated group or MEC group acquires a joining entity that holds a registered emissions unit:

•

the head company will be taken to have held the unit at the start of the income year in which the joining time occurs; and

•

the value of the unit at the start of the income year will be the tax cost setting amount for the unit . [Schedule 2, item 39, subsection 701-55(3A)]

2.135 However, where the same registered emissions unit has its tax cost set more than once in an income year, the head company will include the last tax cost setting amount as the value of the unit at the start of the income year in which the joining time occurs . [Schedule 2, items 29 and 30, subsection 701-10(5) and paragraph 701-10(5)(a)]

2.136 The head company will value the registered emissions units at the end of the income year based on the choice that it has made for valuing registered emissions units. This choice will override any choice made by the joining entity . [Schedule 2, item 51, item 2 of the table in subsection 715-660(1)]

2.137 The head company's four-year election period is not reset simply because an entity holding registered emissions units joins the consolidated group. This situation is analogous with an entity buying more units in a particular income year -the act of buying additional units does not impact on an entity's four-year election period.

2.138 If there is more than one joining entity the head company's choice will override any choice previously made by the joining entities. However, where the head company has not yet made a choice, the head company will not be bound by the joining entities choices and is able to make a new choice in relation to the method used to value the registered emissions units. If a choice is made, the four-year election period will apply from the time the head company makes the 'new' valuation choice . [Schedule 2, item 51, item 2 of the table in subsection 715-660(1)]

Transactions within a consolidate group

2.139 In the case of a consolidated group, the single entity rule would disregard any transaction within the consolidated group for income tax purposes. Therefore, any movement of registered units within a consolidated group will not trigger a taxing point in Division 420.

Example 2.9

The 2016-17 income year is the first income year for which Company B (head company of a consolidated group) holds registered emissions units at the end of the income year. It values those units using the actual cost method under Subdivision 420-D.

In 2017-18 income year, Company C (subsidiary member) joins the consolidated group with 100 carbon units. In the 2015-16 income year, Company C elected to value its units at market value.

Because of the interaction of Division 420 and the consolidation rules, in 2017-18 income year, Company B will be taken to hold the 100 carbon units actually acquired by Company C and they will be valued using actual cost method (Company B's valuation method automatically overrides Company C's valuation method).

Company B's election to use actual cost method is not 'reset' by the act of Company C joining the consolidated group. If Company B did not have a valuation choice in force, Company B would not be bound by Company C's previous choice to use market value.

Consequences when an entity leaves a consolidated group

2.140 When an entity that holds registered emissions units leaves a consolidated group or MEC group, the units will be taken to be an asset of the head company at the end of the income year in which the leaving time occurs, but not at the start of the next income year. The value of the registered emissions unit at that time will be taken to be equal to:

•

if the unit was held by the head company at the start of the income year - the value of the unit at the start of the income year; or

•

otherwise - the expenditure incurred by the head company in becoming the holder of the unit.

[Schedule 2, items 31-34, section 701-25]

2.141 As a consequence of fixing the value of the registered emissions unit at the end of the income year in which the leaving time occurs under subsection 701-25(5), no election would be available under Subdivision 420-D to value the registered emissions unit at that time.

2.142 The leaving entity will be able to choose the valuation method for registered emissions units that it holds at the end of the income year in which the leaving time occurs. In this regard, as a consequence of the amendments to subsection 715-660(1), the leaving entity can ignore the exit history rule and can therefore make a fresh choice in relation to the valuation method for registered emissions units (section 715-700).

Consequential amendments

2.143 Consequential amendments will ensure that the following provisions apply to registered emissions units in the same way that they apply to trading stock:

•

section 701-58, which adjusts the tax cost setting amount for an asset the head company does not hold under the single entity rule ; [Schedule 2, item 39A, section 701-58]

•

sections 705-57, 705-163 and 705-240, which adjust the tax cost setting amount where there has been a loss of pre CGT status of membership interests in a joining entity;

•

section 713-225, which adjusts the way in which the tax cost setting amounts are worked out for partnership cost setting interests [Schedule 2, items 45-50, sections 705-57, 705-163, 705-240 and 713-225];

•

sections 715-910 and 715-920 which ensure the tax-neutral treatment for registered emissions units is switched off for certain consolidated group restructures . [Schedule 2, items 51B to 51E, sections 715-910 and 715-920];

•

section 701A-7 of the Income Tax (Transitional Provisions) Act 1997 which is an integrity measure to prevent registered emissions units held by certain subsidiary members from receiving an uplift in tax value as a result of the tax cost setting mechanism . [Schedule 2, items 72A, sections 701A-7 of the Income Tax (Transitional Provisions) Act 1997]

Pay As You Go instalments

2.144 Currently, instalment income primarily includes ordinary income that is assessable. Proceeds from ceasing to hold units (or from being taken to have ceased to hold them) would mainly be ordinary income. One possible exception is for units acquired for the purpose of resale at a profit. In such cases the proposed rules include gross proceeds in the taxpayer's assessable income, whereas the net gain or loss would be brought to account under the tax law's ordinary income principles.

2.145 The PAYG instalment provisions are amended so that instalment income includes all amounts included in assessable income from ceasing to hold (or from being taken to cease to hold) units. This will remove uncertainty about whether the proceeds of sales or otherwise from ceasing to hold units are instalment income, while furthering the aim of the PAYG instalment provisions of efficiently collecting liabilities to the Commonwealth. Income from an increase in the value of units on hand, and deductions from a decrease in the value of units on hand, will not be taken into account in determining instalment income. The PAYG instalment provisions will thus operate similarly for units under Division 420 and for trading stock . [Schedule 2, item 73, subsection 45-120(5) of the TAA 1953]

Goods and Services tax

2.146 Schedule 2 creates Subdivision 38-S of the GST Act that provides that supplies of eligible emissions units will be GST-free. However, the normal GST rules will apply to transactions involving financial derivatives of eligible emissions units and the payment of grants of government assistance and other transactions under the carbon pricing mechanism . [Schedule 2, item 1, Subdivision 38-S of the GST Act 1999]

2.147 The term 'eligible emissions unit' has the same meaning as in the Clean Energy Bill 2011 . [Schedule 2, item 2, section 195-1 of the GST Act 1999]

2.148 Registered emissions units that are not eligible emissions units will be subject to the normal GST rules.

Consequential amendments

2.149 Amendments that govern how the provisions in Division 420 about registered emissions units interact with the rest of the income tax law are discussed above under the heading 'Interactions of emissions units provisions with the rest of the income tax law'. Other consequential amendments are explained below.

Inclusion of definitions

2.150 The amendments to the taxation law discussed in this chapter have necessitated the inclusion of various new definitions in the taxation law and the amendment of some others. The substantive effects of these changes are discussed in the course of this chapter. The definitions included (or amended) are in the:

•

ITAA 1997 [Schedule 2, items 54-71, subsection 995-1(1)]

•

GST Act 1999 [Schedule 2, item 2, subsection 195-1 of the GST Act 1999]

Amendment of checklists

2.151 The amendments to the taxation law discussed in this chapter have necessitated the amendment of various checklists in the ITAA 1997 . [Schedule 2, items 4, 5, 6 and 7, sections 10-5, 12-5 and subsection 20-30(1) of the ITAA 1997]

Application and transitional

2.152 The amendments to the GST Act in Part 1 of Schedule 2 will commence on the later of the following:

•

the day after the Treasurer announces by notice in the Gazette that the States, the Australian Capital Territory and the Northern Territory have agreed to the amendments to make eligible emissions units GST-free; and

•

the day section 3 of the main bill commences.

[Section 2]

2.153 The notice announcing the agreement of the States and Territories is not a legislative instrument . [Section 2]

2.154 While the agreement of the States and Territories has been sought, not all jurisdictions have responded.

2.155 The amendments to the tax law in Part 2 of Schedule 2 are to commence from the same time as section 3 of the main bill. This ensures that as soon as the carbon pricing mechanism starts, the tax amendments can apply. The application of the tax amendments is not tied to any particular income year of the taxpayer . [Section 2]

2.156 Sections 3 to 312 of the main bill commence on a single day to be set by proclamation. However, a proclamation must not specify a day that occurs before all of the Acts listed in Item 2 of the table in section 2 of the main bill receive the Royal Assent. This qualification is designed to ensure that the bills comprising the legislative package for the carbon pricing mechanism commence together . [Clause 2 of the main bill]

Application of income tax provisions

2.157 Taxpayers are able to hold accounts on the Registry prior to the carbon pricing mechanism commencing and these accounts continue to exist when the carbon pricing mechanism commences. Division 420 of the ITAA 1997 only applies to registered emissions units that a taxpayer start to hold (or is taken to start to hold) after Division 420 commences, ensuring that there is no retrospective application . [Schedule 2, item 72, section 420-1 of the Income Tax (Transitional Provisions) Act 1997]

Kyoto units held on the National Registry when the carbon pricing mechanism commences

2.158 Taxpayers have been able to hold and trade Kyoto units on the Registry from 30 September 2009 and are able to hold ACCUs issued under the CFI Act from the commencement. The Registry was initially established under the executive power of the Commonwealth and has subsequently been continued in existence by the Registry Act. Before the carbon pricing mechanism commences, the existing income tax provisions apply to these taxpayers.

2.159 Division 420 provides a common income tax treatment of emissions units regardless of the purpose of the emissions unit holder in acquiring or holding them. A taxpayer that holds a Kyoto unit or an ACCU on the Registry immediately before Division 420 commences automatically has the units transferred to the new tax regime under Division 420 . [Schedule 2, item 72, section 420-5 of the Income Tax (Transitional Provisions) Act 1997]

2.160 The deemed sale and re-purchase will occur at cost, regardless of whether the asset was held on capital or revenue account when the carbon pricing mechanism legislation commences. This deemed sale and re-purchase at cost ensures that there is neither taxation of unrealised gains nor deductions for unrealised losses when the legislation commences . [Schedule 2, item 72, section 420-5 of the Income Tax (Transitional Provisions) Act 1997]