House of Representatives

Explanatory Memorandum

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

Chapter 20 Amendments to carry forward Loss Provisions

[Clause: 88, 114, 115, 116]

Overview

Ensures that taxpayers are not disadvantaged by the rules that provide for conversion of the foreign income losses from the pre 1990-91 income year. This will enable a taxpayer to treat a pre 1990-91 loss that is able to be carried forward to subsequent years as relating to the same class of income to which it would have belonged had it been a loss incurred in the 1990-91 income year.

Summary of the proposed amendments

20.1. The proposed amendment will provide relief from the effect of certain anomalies which may arise when carry forward foreign losses of pre 1990-91 years of income, relating to a particular class of income from a foreign source, are converted into losses relating to the new classes of income that apply for the 1990-91 and subsequent years of income.

20.2. Broadly, subject to certain conditions, the amendment will allow a taxpayer to elect to reclassify foreign losses for pre 1990-91 years of income as belonging to the class of income which they would have belonged to if they had been incurred during the 1990-91 year of income.

20.3. Amendments of a technical nature are also being made to correct certain references in the provisions relating to the carry forward of losses.

Background to the legislation

Treatment of foreign losses - pre 1990-91

20.4. Former section 160AFD of the Income Tax Assessment Act 1936 (ITAA) had the effect that a foreign loss incurred by a taxpayer in a year of income, in respect of a class of income from a foreign source, could only be used to reduce future income from the same class of income from the same source.

20.5. Before 1990-91, a taxpayer could have had two foreign sources in relation to each foreign country (subsection 160AFD(7) of former section 160AFD). These were:

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all the permanent establishments in that country through which the taxpayer carried on business in that country;

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all other business, commercial and investment activity carried on by the taxpayer in that country.

20.6. From each of these foreign sources, a taxpayer could derive a maximum of three classes of income, i.e., interest income, offshore banking income and all other income.

Treatment of losses - 1990-91 and subsequent years

20.7. With effect from the 1990-91 income year, foreign losses are no longer quarantined on a per-country basis. The foreign losses are quarantined only on a class of income basis. The new classes of income used for this purpose are:

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interest income;

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offshore banking income;

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modified passive income; and

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all other income.

Conversion of pre 1990-91 losses into losses relating to the new classes

20.8. As the pre 1990-91 classes of losses were different from the new classes of losses, it was necessary to provide rules for the conversion of the pre 1990-91 losses of the old classes into the new classes of losses.

20.9. The following table shows how this conversion is effected (Section 53 of the Taxation Laws Amendment (Foreign Income) Act 1991 ).

20.10. The conversion of pre 1990-91 losses into losses of the new classes, gives rise to certain anomalies. For instance, a loss for a pre 1990-91 year of income relating to a particular source of income may be converted into a particular class of loss for the 1990-91 year of income even though that loss would have been classified as belonging to a different class of foreign income if it had arisen during the 1990-91 year of income. The loss for the pre 1990-91 year of income may, therefore, not be able to be offset against income derived during the 1990-91 year of income from the same source.

Example

20.11. A professional sportsperson may have incurred a loss in the United States in the 1989-90 year of income. That loss would have fallen into the "other income" class of losses in that year. For the 1990-91 year of income, that loss would be converted into the "modified passive income" class of loss as it relates to a business activity carried on in the US other than through a permanent establishment.

20.12. However, if the taxpayer derives assessable income as a professional sportsperson in the US during the 1990-91 year of income, that income will not belong to the modified passive class of income (as defined in section 160AEA of the ITAA for the purposes of section 160AFD) but will belong to the "other income" class of income. Consequently, the pre 1990-91 foreign loss cannot reduce the 1990-91 foreign income of the taxpayer relating to his or her profession.

Explanation of the proposed amendment

20.13. Where a taxpayer elects that proposed section 88 will apply, a loss for pre 1990-91 years of income relating to a particular class of foreign income, which satisfies certain conditions, will be reclassified as belonging to the class of income to which it would have belonged if it had been incurred during the 1990-91 year of income.

20.14. It should be noted that these conditions are only to be tested after the application of the transitional provision for new section 160AFD (section 53 of the Taxation Laws Amendment (Foreign Income) Act 1991) . This means that deductions relating to amounts that would have been exempt if sections 23AH and 23AJ had always applied are to be ignored when calculating the pre 1990-91 loss attributable to assessable foreign income derived from a particular foreign source. [Paragraph 88(1)(d)]

20.15. A loss for a pre 1990-91 year of income which satisfies the following conditions will be reclassified as belonging to the class of income that it would have belonged to if it had been incurred during the 1990-91 year of income.

20.16. The taxpayer must elect that proposed section 88 is to apply [paragraph 88(1)(e)] . This election is to be made within 6 months of the commencement of the section (i.e., the day the Act receives Royal Assent) or within such further period as the Commissioner allows. [Subclause 88(2)]

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The taxpayer must have incurred an overall foreign loss (as defined in subsection 160AFD(7)) in respect of a particular class of assessable foreign income in a pre 1990-91 year of income (paragraph 88(1)(a)).

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The whole or a part of the loss must be attributable to assessable foreign income derived from a particular foreign source (paragraph 88(1)(b)). "Foreign source" is defined in subclause 88(3) to mean any business, commercial or investment activity carried on by the taxpayer in a foreign country.

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The loss would have been classified as belonging to a different class of income if it had been incurred in relation to the same source of foreign income during the 1990-91 year of income (paragraph 88(1)(c)).

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The loss would have been capable of offseting foreign income of the same class. This ensures that a taxpayer cannot carry forward a loss that could not otherwise have been carried forward to the 1990-91 income year under section 160AFD.

Commencement date

20.17. The amendment will apply with effect from the 1990-91 income year. Its application from 1990-91 will benefit taxpayers.

Clauses involved in the proposed amendments

Clause 88 : will provide transitional rules for section 160AFD which, subject to certain conditions, will enable a taxpayer to elect to reclassify certain foreign losses for pre 1990-91 years of income as belonging to the class of income which they would have belonged to if they had been incurred during the 1990-91 year of income.

Technical Amendments

The Bill will also make certain technical corrections to the provisions of the Taxation Laws Amendment (Foreign Income) Act 1990 that deal with the carry forward of pre 1990-91 losses. These amendments are contained in Part 3A of the Bill.

Clauses involved in the proposed amendments

Clause 114 : facilitates reference to the Taxation Laws Amendment (Foreign Income) Act 1990.

Clause 115 : will effect the technical correction by replacing the erroneous references in subparagraphs 53(2)(b)(ii) and (iii) of the Taxation Laws Amendment (Foreign Income) Act 1990 with references to "modified passive" income.

Clause 116 : provides that this amendment will apply to assessments in respect of income of the 1990-91 and subsequent years of income.