Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 5 Equity investments in small-medium enterprises
Overview
5.1 The amendments contained in Part 5 of Schedule 1 of the Bill will introduce new Division 11B into the Income Tax Assessment Act 1936 (the Act) to change the tax treatment of certain equity investments in small and medium enterprises (SMEs) where the investment is held by a lending institution. Any profit or loss from the eligible equity investments will now be taxed under Part IIIA, the capital gains tax provisions, rather than on revenue account.
Summary of the amendments
5.2 The purpose of the amendments is to facilitate investment in SMEs by lending institutions.
5.3 Applies to eligible equity investments made after 30 June 1996.
Background to the legislation
5.4 Some SMEs have reported difficulties in obtaining finance.
5.5 At present, equity investments by banks and other financial intermediaries who provide equity finance as part of their business are usually taxed on revenue account. At the time an equity investment is made by such taxpayers there is no deduction for the expenditure. When the investment is realised its initial cost is taken into account in determining any profit or loss.
5.6 The new measure, the subjecting of eligible equity investments to capital gains tax, will facilitate equity investment in SMEs as investors will be now able to index the cost of their investments.
Explanation of the amendments
5.7 The proposed amendments will extend the capital gains tax treatment to gains and losses on realisation of eligible equity investments in SMEs that have been undertaken by banks and by other financial institutions conducting a business of lending money and for whom these eligible equity investments do not constitute trading stock.
5.8 An SME, for the purposes of this measure, is a company which has assets the total value of which is no more than $50million. This valuation is obtained from the last audited accounts prepared for the purposes of the relevant Corporations law. [New subsections 128TK(1) and (2)]
5.9 If no audited accounts were prepared in the previous 12 months from the date of the share issue, or if the last set of audited accounts were prepared 18 months or more before the share issue, the company the subject of the equity investment is not an SME unless the investor obtains an audited statement. This statement must show that before the shares were issued the value of the SME's assets did not exceed $50 million. [New subsection 128TK(3)]
5.10 For the purposes of these provisions, an audited statement is a statement prepared by a person who is a company auditor under the relevant corporations law or who is eligible to consent to such an appointment. [New subsection 128TK(4)]
5.11 An eligible equity investment for the purposes of this new Division in the Act is a share holding that represents at least 10% of the paid-up capital of the company (including the newly issued ordinary shares).
5.12 Where the 10% share holding is acquired, the taxpayer has only to pay the amount necessary to effect the purchase. The proposed provisions assume that all the amounts that are payable for the issue of the shares have been paid for the purposes of determining whether the 10% threshold has been met. [New section 128TJ]
5.13 Where a lending institution acquires shares before 1 July 1996, those shares can never be counted towards the 10% threshold. However, where the lending institution has acquired a parcel of shares in an SME on or after 1 July 1996, which is less than the threshold and at a later date it acquires additional shares so that the total parcel equals or is more than the threshold, there will be a deemed disposal and reacquisition. The shares will be disposed of and reacquired at their market value. Any profit or loss that occurs on the deemed disposal will be brought to account under section 25 or section 51 of the Act in the year of income in which the shares are actually disposed of. The shares acquired by the deemed reacquisition will then be subject to capital gains tax and their cost base will be their market value on the date of the reacquisition. [New section 128TI]
5.14 Whether a business is engaged in lending money is a matter determined by an evaluation of facts surrounding the conduct of the business. It is a concept already used in paragraph 63(1)(b) of the Act.
Consequences of new provisions
5.15 As a consequence of the proposed amendments, and subject to the various conditions in those amendments, profits or losses made by lending institutions from the sale of shares held in SMEs will be dealt with under the capital gains tax provisions of the Act instead of being dealt with under sections 25 or 51 of the Act.