Senate

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)

Chapter 9 - Payment of instalments by companies

Overview

9.1 Legislation governing the payment of company tax instalments, which was inserted in the law by the Taxation Laws Amendment Act (No. 2) 1993, provides for quarterly payments of company tax commencing from the 1994-95 year of income for small and medium taxpayers and the 1995-96 year of income for large taxpayers.

9.2 Amendments made by Part 10 of Schedule 1 of the Bill will repeal the existing general anti-avoidance provision of that legislation, which is contained in Division 1C of Part VI of the Income Tax Assessment Act 1936 (the Act), and replace it with measures that target specific types of instalment deferral or avoidance arrangements . The Bill will also make a technical amendment to that Division which will provide that where a taxpayer's instalments are based on an earlier year's tax liability, the amount of that liability can be varied by regulation if tax rates have changed from the earlier year to the current year.

9.3 The Bill will also make consequential amendments to the provisions which impose penalty for late payment and interest on underpayments so that the penalty and interest calculations commence on the final instalment due date.

Summary of the amendments

Purpose of the amendments

9.4 The amendments will:

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replace the existing anti-avoidance provision with one that applies specifically to schemes to defer or reduce instalments by shifting income or deductions between associated taxpayers;

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ensure that where a taxpayer lodges an estimate of liability after paying any instalment, including the third instalment, the taxpayer is required to pay the shortfall in the instalment at the time of lodging the estimate;

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ensure that where a taxpayer lodges a downwards estimate of tax liability for the purpose of delaying instalments through being classified as a smaller taxpayer the estimate will not have that effect;

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where a taxpayer's current year's instalments are based on an earlier year's tax liability, allow the amount of that liability to be varied by regulation for instalment purposes if tax rates have changed from the earlier year to the current year.

9.5 The Bill will make consequential amendments to the provisions which impose penalty for late payment and interest on underpayments so that the penalty and interest calculations commence on the final instalment due date.

Date of effect

9.6 The amendments generally apply from the 1994-95 year of income for small and medium instalment taxpayers and from the 1995-96 year of income for large instalment taxpayers. [Subitems 85(2), (3) and (4)]

Background to the legislation

9.7 The Act was amended in 1993 to reintroduce quarterly payments of company tax . Under the new company tax instalment regime, the timing, and amount, of payments differ depending upon the amount of the instalment taxpayer's likely tax for the year of income.

9.8 Broadly, the new regime will bring forward instalments, with concessions available depending on the amount of tax likely to be payable. For example, small instalment taxpayers will be required to make only one payment of tax five months after the end of the year of income. Medium and large instalment taxpayers will be required to make four payments with some payments due during the relevant year of income.

9.9 Instalment taxpayers to which the new regime applies are companies and the trustees of certain trusts and funds.

Explanation of the amendments

Anti-avoidance provision

9.10 This Bill will repeal section 221AZU, which is the existing general anti-avoidance provision for Division 1C. It will be replaced with several specific anti-avoidance measures. The first deals with arrangements entered into by associated taxpayers seeking to defer or reduce instalments by shifting income or deductions between them. [Item 84, new section 221AZU]

9.11 By lodging a downwards estimate the company losing the income or receiving a deduction can reduce instalments payable. The other company receiving the income or losing the deduction does not have to pay compensating increased instalments as its instalments are based on a previous year's tax assessed and it is not required to lodge an upwards estimate of its tax liability.

9.12 For the purposes of the new anti-avoidance provision the term 'arrangement' is defined in a manner similar to 'arrangement' for the purposes of section 221AX of Division 1B of Part VI of the ITAA [new subsection 221AZU(9)] . The definition recognises that an arrangement may involve more than one taxpayer. It not only refers to the carrying out of an arrangement by a person but also refers to the carrying out of an arrangement by a person together with other persons [new subsection 221AZU(10)] .

9.13 New section 221AZU can only be applied where the following four objective tests are satisfied:

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the taxpayer has entered into or carried out an arrangement;

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(a) an amount has been included in the assessable income of the instalment taxpayer (where the instalment taxpayer is a company) or in the assessable income of a fund or unit trust (where the instalment taxpayer is a trustee of the fund or unit trust) being an amount which but for the arrangement, would, or might reasonably be expected not to have been included in the assessable income; or

(b) a deduction is not allowable to the instalment taxpayer (where the instalment taxpayer is a company) or a fund or unit trust (where the instalment taxpayer is the trustee of a fund or unit trust) and the whole or part of that deduction would have been so allowable, or might reasonably be expected to have been allowable, if the arrangement had not been entered into or carried out;

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the arrangement has the effect of reducing the sum of the instalments (but not including the final instalment) payable by the taxpayer and another taxpayer or taxpayers for the current year;

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income tax has become due and payable by the taxpayer in the current year. [New subsections 221AZU(1), (2), (3)]

9.14 As long as the objective tests outlined above are satisfied, section 221AZU will apply, i.e., it is not relevant that the instalment taxpayer or taxpayers entered into the arrangement for the purpose of reducing or deferring instalments.

9.15 For the purposes of paragraph 221AZU(1)(b) the reference made to a 'deduction (that) is not allowable' also includes a reference to a deduction that is allowable to another taxpayer under section 80G of the ITAA because of the arrangement. Although the transfer of losses between wholly-owned companies is allowable under section 80G, one of the purposes of section 221AZU is to ensure that this provision cannot be used in a manner which would allow wholly owned group companies to defer or reduce instalments of tax. [New subsection 221AZU(8)]

9.16 Where the tests outlined in para 9.13 are satisfied additional tax is payable at the rate of 12% on the amount by which the sum of instalments, other than the final instalment, payable by the taxpayer and the other taxpayer or taxpayers is exceeded by the sum of instalments that would have been payable or might reasonably be expected to have been payable had the arrangement not been entered into or carried out. [New subsection 221AZU(4)]

9.17 Where an instalment taxpayer has secured a refund of instalments paid during the year of income the amount on which additional tax is payable is increased by the amount of the refund. [New subsection 221AZU(5)]

9.18 The Bill will also permit the Commissioner of Taxation to remit penalties under this anti-avoidance provision in special circumstances. [New subsection 221AZU(6)]

9.19 For the purposes of this provision the term 'income tax payable' refers to income tax that is payable after deducting certain credits to which an instalment taxpayer may be entitled under the ITAA. [New subsection 221AZU(7)]

Example

Companies A, B & C are members of a wholly owned group. Companies A & C both have a taxable income of $1m (before deducting any loss transferred from another member of the group) in both the previous and current years. Company B incurs a loss of $1m in each of these years. Under an arrangement Company B transferred its loss to Company A in the previous year and transfers it to Company C in the current year.

Although the group as a whole has a combined 'taxable income' in the current year of $1m, there is no amount payable until the final instalment date. This is because both Companies A & C have a 'likely tax' of nil:

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Company A's 'likely tax' is the previous year's tax amount, which is nil;

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Company C is able to lodge an estimate of the current year's tax liability reducing its 'likely tax' to nil by claiming an expected deduction for the loss to be transferred to it from Company B.

By moving Company B's losses alternately between Company A & Company C the group ensures that it will not have to pay any instalments.

Under the new anti-avoidance provisions in this Bill, Company A will be liable to a 12% penalty on the difference between the sum of the first three instalments that would have been payable if the avoidance arrangement had not been entered into and the sum of the first three instalments actually paid. The penalty would be $90,000, i.e. $750,000 x 12%.

The penalty could be avoided if Company C did not lodge a downwards estimate or if Company A lodged an upwards estimate.

Amounts to be payable to the Commissioner as a result of lodging an upwards estimate after the third instalment

9.20 Subsection 221AZO(1) provides that an instalment taxpayer can lodge up to two estimates for any year. Where an estimate is made, the amount of an instalment due, for a medium or large instalment taxpayer, is based on the latest estimate. If a company has not lodged an estimate, the amount upon which instalments are levied will be the previous year's tax amount or the tax amount of the most recent earlier year.

9.21 Where a company lodges an estimate after paying an instalment and that instalment was more or less than it would have been if that instalment had been calculated on the basis of the estimate then:

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in the case of an excessive instalment, the Commissioner is required to refund the amount of the overpayment (subsection 221AZQ(1));

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in the case of an underpayment of an instalment, the taxpayer must pay the difference to the Commissioner (subsection 221AZR(1)).

9.22 Subsections 221AZQ(3) and 221AZR(3) currently provide, however, that where an estimate is lodged after the third instalment no refunds are payable by the Commissioner nor are any amounts payable by an instalment taxpayer to the Commissioner as a result of the estimate having been lodged.

9.23 These provisions can operate in such a way that a taxpayer can obtain a refund for all or part of instalments already paid without fear of penalty by lodging an artificially low first estimate immediately before the due date of the third instalment and then lodging a realistic estimate immediately after the date.

9.24 Any penalty that results from the lodgement of the artificially low estimate will only be for the period between the lodgement of the first and second estimates.

9.25 This Bill will repeal subsection 221AZR(3) so that an instalment taxpayer will be required to pay any outstanding amounts where an estimate is lodged after the third instalment date. [Item 83]

Temporary estimates designed to put a taxpayer in a smaller class

9.26 Under subsection 221AZK(3) of the new instalment provisions, an instalment taxpayer is classified as 'small', 'medium' or 'large' according to the taxpayer's likely tax for the current year, calculated on the first day of month 9 (the test date). Months are reckoned from the start of the current year so if the current year starts on 1 July 1995 then month 9 will be March 1996.

9.27 An instalment taxpayer can receive the more concessional instalment due date schedules for small or medium companies by lodging an artificially low estimate before the test date. Penalties which are applied under section 221AZP for the under-estimation of tax can be minimised if the taxpayer lodges an upwards estimate shortly after the test date.

9.28 To remove any undue advantage that can be obtained from lodging estimates in this manner this Bill will insert a provision into Division 1C to ensure that for the purposes of determining an instalment taxpayer's classification, where:

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a second estimate is lodged not more than 2 months after the test date; and

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had the tax liability estimated in the second estimate been the taxpayer's likely tax at the test date, the taxpayer would have been classified larger than it was classified on the basis of the first estimate,

a taxpayer's classification will be based on the second estimate. In addition, all instalment amounts will be based on the second estimate. [Item 80, new subsections 221AZKA(1),(2),(3) and (4)]

Example

This example illustrates row 4 of the table in section 221AZKA(2). An instalment taxpayer lodges a downwards estimate before or on the test date. If the taxpayer had not lodged the estimate, its classification would be based on a previous year's tax amount which would have resulted in it being classified as 'large'. [Column 2] As a result of lodging the estimate, the instalment taxpayer is classified as 'small'. [Column 1] Within 2 months of the classification date the instalment taxpayer lodges a second estimate, which, if it had been the likely tax at the test date, would have caused the taxpayer to have been classified as 'large'. [Column 3] As a result of section 221AZKA, the instalment taxpayer will be reclassified as 'large' [Column 4].

9.29 Where new section 221AZKA operates to reclassify a taxpayer and recalculate the amount of instalments payable, a late payment penalty as well as a penalty for the underestimation of tax under section 221AZP may be applied. In the example set out in paragraph 9.27, the instalment taxpayer will be liable for a late payment penalty on any instalments, recalculated as a result of subsection 221AZKA(4), which have not been paid in accordance with the 'large' instalment taxpayer schedule. In addition, a penalty under section 221AZP will be applied for the underestimation of tax, for the period between the 2 estimates, assuming that the taxpayer's tax assessed is not substantially smaller than the previous year's tax amount.

9.30 The operation of this provision is subject to section 221AZMA which broadly operates to treat a medium instalment taxpayer which is a member of a large group as a large instalment taxpayer. Therefore, if section 221AZKA operates to change the classification of an instalment taxpayer from small to medium then section 221AZMA can operate to change its classification to large. [New subsection 221AZKA(5)]

Previous year's tax amount to be changed by regulation

9.31 As explained in paragraph 9.18 a company's instalments are ordinarily based on the tax payable for a year before the current year.

9.32 There is no provision which allows these amounts to be varied by regulation to take into account tax rate increases or decreases from the earlier year to the current year. The current company tax collection provisions - Division 1B of Part VI - contain such a provision.

9.33 This Bill will insert subsection 221AZN(3A) which will allow the 'previous year's tax amount' or the 'earlier year's tax amount' to be so varied by regulation. [Item 82, new subsection 221AZN(3A)]

Classification time on test date

9.34 Under subsection 221AZK(3) of the new instalment provisions an instalment taxpayer is classified according to the taxpayer's 'likely tax' for the current year, calculated on the first day of month 9. The 'likely tax' will generally be the previous year's tax amount.

9.35 It is possible for a taxpayer to have more than one amount of 'likely tax' on the first day of month 9. This may happen where an estimate is lodged during that day. Accordingly, to make it clear which 'likely tax' is used when classifying an instalment taxpayer, subsection 221AZK(3) will be amended so that an instalment taxpayer will only be classified at the end of the first day of month 9. [Item 79]

9.36 Section 221AZMA which broadly operates to treat a medium instalment taxpayer which is a member of a large company group as a large instalment taxpayer will be amended in order to bring the timing of the classification into line with the amendment to subsection 221AZK(3). Paragraph 221AZMA(b) which refers to an instalment taxpayer being classified as medium at the beginning of the first day of month 9 will be amended so that it refers to the classification time as being the end of the first day of month 9. [Item 81]

Consequential amendments

Additional tax and interest on late payments; payment of interest where assessment amended

9.37 Sections 207 and 207A of the ITAA provide that where tax remains unpaid after the time when it becomes due and payable, the taxpayer becomes liable to pay as penalty additional tax and interest on the unpaid tax. For the purpose of calculating these penalties under the current company tax collection regime (Division 1B), the date when the final payment of tax assessed is due and payable is specified as the statutory date by which a taxpayer's final tax payment is required to be made and not a later date on which the company might lodge its return. Certain credits and offsets can be taken into account when determining the amount of tax subject to penalties.

9.38 Section 170AA of the ITAA provides that, where a taxpayer's liability to tax is increased as a result of an amended assessment, interest is payable on the increase in the tax payable. Again, under Division 1B, the interest is calculated from the statutory date when final payments of tax are required to be made, whether or not the particular taxpayer is required to make a final payment.

9.39 When the new company tax instalment regime - Division 1C - was introduced, equivalent modifications were not made to sections 170AA, 207 and 207A.

9.40 This Bill will make the equivalent amendments to sections 170AA, 207 and 207A to modify their operation for instalment taxpayers to which Division 1C applies. [Items 74, 75, 76 and 77]