Explanatory Memorandum
(Circulated by authority of the Treasurer,the Hon. Peter Costello, MP)
Chapter 3 - Recoupment of deductible expenses
This chapter explains the rewritten provisions that deal with recoupment of deductible expenses.
These are contained in new Subdivision 20-A in Schedule 1 to the Tax Law Improvement Bill 1997.
Transitional and consequential amendments for the rewritten provisions are contained in Schedule 8 to the Bill.
This chapter covers:
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- the rewritten provisions in Subdivision 20-A (Insurance, indemnity or other recoupment for deductible expenses) in Schedule 1 to the Tax Law Improvement Bill 1997; and
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- the transitional provisions and consequential amendments for those provisions in Schedule 8 to the Bill.
Subdivision 20-A contains the rewritten provisions of the 1936 Act that deal with recoupment of (or compensation for) deductible amounts. The rewritten provisions will treat certain recoupment amounts as assessable income on a consistent basis. The corresponding provisions of the 1936 Act are dispersed throughout that Act. Those rules either treat recoupment as assessable income, or claw back deductions allowable as a result of incurring deductible expenses.
The rewritten provisions complement the general provision that includes ordinary income in assessable income. Part A of this chapter summarises new Subdivision 20-A. Part B explains changes proposed to the content of the current provisions. Part C explains why some provisions of the 1936 Act have not been rewritten. Part D explains the transitional provisions which set out how and when the rewritten provisions will apply. Part E explains the amendments being made to the 1997 Act, the 1936 Act and other Commonwealth legislation, because of the rewrite of the provisions of the 1936 Act.
A. Summary of the new law
Guide to Subdivision 20-A: Insurance, indemnity or other recoupment for deductible expenses
Subdivision 20-A will include in assessable income an amount received by way of insurance, indemnity or other recoupment if:
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- it is for deductible expense; and
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- it is not otherwise assessable income.
The Subdivision has two groups of provisions. When using the Subdivision, these groups should be considered separately. [section 20-15]
The first group determines what recoupment amounts are assessed under Subdivision 20-A. [sections 20-20 to 20-30] These recoupments will be known as assessable recoupments . The second group of provisions does not have to be read if an assessable recoupment has not been received.
The second group determines how much of an assessable recoupment is assessable under Subdivision 20-A. [sections 20-35 to 20-55]
Assessable recoupments - the amounts Subdivision 20-A will assess
Only assessable recoupments will be assessable under Subdivision 20-A. There is a three-step process involved in determining whether an amount is an assessable recoupment. [Section 20-20]
Step 1: Ignore amounts that are otherwise assessable
Amounts that are ordinary income, or are statutory income, because of a provision outside Subdivision 20-A are not assessable recoupments. [subsection 20-20(1)]
Step 2: Insurance and indemnity amounts
Insurance and indemnity amounts received for any deductible loss or outgoing are assessable recoupments. [subsection 20-20(2)]
Step 3: Other recoupment amounts
Recoupment amounts (except an insurance or indemnity) received for a deductible loss or outgoing are also assessable recoupments, but only if the loss or outgoing is deductible under a provision listed in section 20-30. [subsection 20-20(3)]
The ordinary meaning of recoupment encompasses any type of compensation for a loss or outgoing. Nevertheless, to make it clear that the term includes certain common types of compensation, it will be defined to include any kind of recoupment, reimbursement, recovery, refund, insurance or indemnity. [paragraph 20-25(1)(a)]
The following amounts will also be within the definition:
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- a grant in respect of a loss or outgoing [paragraph 20-25(1)(b)] ;
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- amounts paid on the taxpayers behalf for a loss or outgoing [subsection 20-25(2)] ; and
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- an amount received for disposing of a right to recoupment [subsection 20-25(3)] .
Balancing charge amounts are not recoupment.
Recoupment does not extend to an amount received on disposal, loss or destruction of property to which the loss or outgoing relates. A balancing charge on disposal, loss or destruction of such property is expressly excluded. [subsection 20-25(5)]
What if the amount you receive is recoupment of a loss or outgoing to an unspecified extent?
The amount is taken to be recoupment to the extent that is reasonable. [subsection 20-25(4)]
Deductions for which recoupments (except insurance and indemnity amounts) are assessed under Subdivision 20-A
Recoupment amounts (except insurance or indemnity amounts) are only assessed by Subdivision 20-A if the amount is received for certain deductible losses or outgoings, [subsection 20-20(3)]
These deductions [listed in section 20-30] currently have specific recoupment rules.
On the other hand, Subdivision 20-A will assess insurance and indemnity amounts received for any deductible loss or outgoing, including those listed in section 20-30. [subsection 20-20(2)]
Recoupment amounts will generally be assessable income
Any assessable recoupment received for a loss or outgoing will be included in assessable income. [subsection 20-20(2)
How much of the recoupment is assessable?
There is a limit on the total of assessable recoupments to be included in assessable income at any given time. the limit is the total amount of the loss or outgoing that can be or has been deducted at that time. [subsections 20-35(1) and 20-40(1)]
What if the loss or outgoing is deductible over 2 or more income years?
These cases are dealt with separately [section 20-40] to distinguish them from the more common single year deduction case. [section 20-35]
The limit on how much is assessable is particularly important for losses or outgoings deductible over 2 or more income years. Any part of an assessable recoupment that is not included in assessable income in the year of receipt because of this limit will be assessed when further amounts are deducted for the expense.
The limit takes into account amounts included in your assessable income under a previous recoupment law . This defined term refers to provisions in the existing law that assess recoupment amounts. [section 20-55]
What if a recoupment is received before the income year in which the loss or outgoing can be deducted?
If the amount is deductible in a single income year, the assessable recoupment is included in assessable income in the year the loss or outgoing is deducted. [subsection 20-35(3)]
If the amount is deductible over more than one year, an amount will be assessed in the first year a deduction is allowed for the loss or outgoing. The most that will be included in assessable income in that year is the amount you claimed as a deduction for the year. [section 20-40]
What is the effect of a balancing charge?
If an amount is assessable under a balancing adjustment provision, the limit on how much can be assessed is reduced by that balancing charge. [section 20-45]
This prevents the double recovery of deductions.
What if the recoupment is for a loss or outgoing of which only a proportion is deductible?
You are treated as only receiving that proportion as recoupment in working out how much of the recoupment is assessable under the recoupment clauses. [section 20-50]
Discussion of changes
Subdivision 20-A Insurance, indemnity or other recoupment for deductible expenses
This Subdivision will consolidate 23 recoupment provisions in the existing law in one place.
The provisions in the 1936 Act which specifically deal with recoupment of deductible expenses are spread throughout that Act. These provisions take one of two main approaches:
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- assessing the compensation in the year in which it is received (the assessing approach); or
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- reducing or denying the deductions allowed for the recouped expense (the reduction of deductions approach).
The disadvantages of this are:
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- the scattering of the compensation provisions throughout the Act makes them hard to find;
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- the repetition of the two basic approaches takes up unnecessary text; and
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- the approach taken is not consistent.
These provisions have been consolidated in Subdivision 20-A, where a uniform assessing approach will treat recoupment amounts.
This will produce a significant reduction in compliance and administration costs because:
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- there will no longer be a need to amend assessments of previous years, as is the case with the reduction of deductions approach; and
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- the new law is simpler, easier to find, and much shorter than the existing provisions.
The consolidation of differing rules has necessitated some changes. The rest of this Part explains the consolidated rules and how they differ from the existing law.
The Subdivision is structured in two parts. The first tells the reader whether they have an assessable recoupment. [sections 20-20 to 20-30] The second determines how much of an assessable recoupment is assessed. [section 20-35 to 20-55]
Section 20-20 Assessable recoupment
This section explains what amounts will be assessed by Subdivision 20-A.
The section will clarify the law by establishing a three step process for determining whether a recoupment of a deductible expense is assessable.
In the existing law:
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- a recoupment is assessable income under the general income provision if it is ordinary income (subsection 25(1));
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- an insurance recovery or indemnity for any deductible loss or outgoing is assessable income (paragraph 26(j)); and
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- there are specific recoupment provisions applying to particular deductions.
The relationship between these rules is unclear. The Bill will establish a three-step process to clarify the linkages.
The three-step process is:
- 1.
- Is the amount assessable income outside Subdivision 20-A? If so, the amount is assessed under the provision which includes the amount in assessable income and will not be an assessable recoupment under Subdivision 20-A. For example, if the amount is ordinary income, it will be assessed under section 6-5 of the 1997 Act.
- 2.
- Is the amount an insurance recovery or indemnity for any deductible loss or outgoing? If so, it is an assessable recoupment under Subdivision 20-A.
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- Is the amount a recoupment (except an insurance or indemnity) of a loss or outgoing that is deductible under a provision listed in section 20-30? If so, it will also be an assessable recoupment.
Section 20-25 What is recoupment?
The section establishes that the following amounts are recoupment :
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- any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described;
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- a grant in respect of a loss or outgoing;
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- amounts paid on the taxpayers behalf for a loss or outgoing; and
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- an amount received for disposing of a right to recoupment.
Amounts received on the disposal, loss, destruction or termination of use of property to which a loss or outgoing relates are not recoupment of that loss or outgoing.
This section makes clear the main types of compensation that are within the defined term.
In the existing law, the recoupment provisions vary widely in describing the types of compensation covered.
The new definition of recoupment gives a consistent approach by expressly covering recoupments, reimbursements, refunds, insurance recoveries, indemnities, amounts recovered and grants in respect of a loss or outgoing.
There will be a standard rule that amounts received for disposing of a right to recoupment will be treated as recoupment .
Disposal of a right to recoupment is covered in only one recoupment rule in the existing law (subsection 70A(6) dealing with mains electricity connection expenditure) but is subject to the capital gains and losses provisions (Part IIIA).
This change will ensure that all amounts which take the place of recoupment are treated in the same way. This is important to ensure equitable treatment and to prevent avoidance.
The disposal of a right to be recouped need not be to another entity. Therefore, the new section includes any method of giving up such a right, eg. surrender, forfeiture, release, abandonment or expiry.
So far as the amount received for disposing of the right is assessable, subsection 160ZA(4) of the existing law will prevent double taxation by reducing the amount of any capital gain. If the amount received is assessable in full, there will be no capital gain.
There will be a standard apportionment rule for amounts that are recoupments to an unspecified extent. They will be taken to be recoupments of a loss or outgoing to the extent reasonable.
In the existing law, most specific recoupment provisions (e.g. subsections 70A(8) and 75AA(9)) contain an apportionment rule. In many of these, an amount received is taken to be a recoupment to the extent the Commissioner decides.
The standard rule will apply to all assessable recoupments under Subdivision 20-A and will use a reasonableness test.
The section will clarify that, if a balancing adjustment is required for property on which a loss or outgoing was incurred, no part of any balancing charge is a recoupment .
Any amount received due to the disposal, loss, destruction or termination of use of property effectively recovers losses or outgoings incurred on the property. However, generally they are not truly compensation for the loss or outgoing on the property, but relate to the current value of the property.
These amounts are not to be treated as recoupment under Subdivision 20-A. In certain cases balancing adjustment provisions specifically deal with the disposal, loss, destruction or termination of use of the property.
Section 20-35 Recoupment of expenses fully deductible in a single income year
Section 20-40 Recoupment of expenses fully deductible over more than one income year
These sections uniformly assess amounts that are assessable recoupments, ie. insurance and indemnity amounts for any deductible expense; and other recoupment amounts for expenses deductible under a provision listed in section 20-30.
There are separate sections dealing with expenses deductible in a single income year and for expenses deductible over more than one income year.
The rules in the single year case are more simply expressed than in the multiple year case. Therefore, for most who recoup an expense deductible in a single year, the more complex rules for multiple year deductions can be ignored.
The new provisions adopt a uniform approach of assessing recoupment, generally in the year the amount is received.
The effect of this change is discussed at the start of this Part of this chapter.
Adopting a uniform assessing approach can have some effect on taxpayers liabilities.
Where a recoupment provision currently uses the reduction of deductions approach, the net effect will depend on marginal tax rates from year to year.
If the marginal tax rate is lower in the year an amount is assessed compared to the year the deduction is allowed, a benefit will accrue under the new law. If the marginal tax rate is higher in the year an amount is assessed compared to the year the deduction is allowed, there will be a cost.
The change to an assessing approach from the reduction of deductions approach may also see some amounts brought to account earlier where a loss or outgoing deductible over two or more years is partially recouped.
However, in most cases there will be no effect, as the amount of the recoupment is usually received in the same year the deduction is allowed. Even if the recoupment is received in a year after the deduction year, the marginal rate will often be the same.
Recoupment amounts will be assessed up to the amount that can be or has been deducted for the loss or outgoing up to the current year.
This will mean that at the end of any income year, the sum of recoupments assessed for a particular loss or outgoing will not exceed the total amount that can be or has been deducted for that loss or outgoing. The total sum of recoupments assessed includes amounts assessed under provisions of the existing law that used the assessing approach. These provisions are covered by the new defined term previous recoupment law .
This approach has been adopted because the object of the Division is to recover only the benefit of the deductions for which no net detriment has been suffered.
See example at subsection 20-40(2).
Recoupment amounts will be assessed for amounts that can be deducted in an earlier income year.
Provided the amendment period has not expired, a taxpayer can deduct an amount in an earlier income year even if the taxpayer has not yet claimed the deduction. Where an assessable recoupment is received in these circumstances, it will still be assessable - the taxpayer can amend their prior assessment to claim the deduction.
On expiration of the amendment period, the taxpayer can no longer deduct the amount. In these circumstances, an amount that would otherwise be an assessable recoupment will not be assessable, as the taxpayer cannot deduct an amount in the earlier income year.
The words you can deduct for the loss or outgoing for the current year, or you have deducted or can deduct for the loss or outgoing for an earlier income year used in Subdivision 20-A will have the above result. They are comparable to the words [a deduction] has been allowed or is allowable that are used in the majority of provisions that use the assessing approach in the existing law.
Recoupment amounts received before the income year of deduction will be assessable in the income year the deduction arises.
Under the existing law, this result is achieved in provisions that use the reduction of deductions approach. Where the recoupment is received before the income year of deduction, the deduction is reduced to the extent of the recoupment in the year the deduction arises. The treatment under the assessing approach is unclear.
This change adopts a standard approach where recoupment is received before the income year of deduction. The approach will be that the amount is assessable in the income year the deduction arises.
Section 20-45 Effect of a balancing charge
Under the recoupment provisions (sections 20-35 and 20-40), the total amount of deductions allowed for an outgoing is reduced by any amount assessed under a balancing adjustment.
This section provides a standard treatment for amounts assessed as a balancing charge, preventing double recovery of deductions.
This change was required as a result of the change to a uniform assessing approach for recoupment amounts.
The assessment of an amount under a balancing adjustment provision recoups the deductions allowed for that amount. In each case in the existing law where a balancing charge may interact with a recoupment, the reduction of deductions approach applies to the recoupment. No treatment of balancing charges is required under this approach.
This is taken into account under section 20-45 by reducing the total deductions that are eligible to be recouped under the recoupment provisions by the amount assessable under the balancing adjustment provision.
Section 20-45 applies if there is a balancing charge for the income year a recoupment is assessable, or for an earlier income year.
See example at section 20-45.
Section 20-50 Recoupment of partially deductible losses or outgoings
The section applies where the total amount that can be deducted for a loss or outgoing cannot exceed a proportion of the loss or outgoing. In this case, only that proportion of a recoupment is treated as being received for the purposes of determining how much of the recoupment is assessable.
This rule will apply in all cases where the total amount that can be deducted for a loss or outgoing is a proportion of that loss or outgoing.
Where the reduction of deductions approach applies to the recoupment of proportionate deductions in the existing law (eg. development allowance and drought investment allowance), the same result is achieved.
Section 20-50 will ensure that all proportional deductions are recouped in a proportional way. The section will apply in all cases where the deduction that can be claimed cannot exceed the amount of the expense that gives rise to the deduction. Without this rule, taxpayers could be treated as recouping the deductible part of the expenditure first.
See example at section 20-50.
C. Provisions of the old law that have not been rewritten
Provisions not to be rewritten
Subsections 75AA(10), 82BE(3), 82BP(3), 124BD(3) and 124ZZN(3) will not be rewritten. These all provide for an unlimited amendment period for recoupment provisions that use the reduction of deductions approach.
Section 170 of the 1936 Act generally prescribes a four year limit on amending previous assessments. However, recoupment amounts could be received many years after the initial expenditure. This meant that this limit had to be specifically overridden in each case where a recoupment provision used the reduction of deductions approach. In some cases this was done in subsection 170(10). In the cases listed above, a subsection was added to the particular recoupment provision.
There is no need to amend previous assessments under the assessing approach adopted in Subdivision 20-A. This makes all the specific subsections listed above redundant.
D. Transitional arrangements
Part 1 of Schedule 8 of the Tax Law Improvement Bill 1997 will amend the Income Tax (Transitional Provisions) Act 1997 to insert the transitional provisions for the rewritten sections discussed earlier in this chapter.
Part 1 will insert in the Income Tax (Transitional Provisions) Act 1997 new Subdivision 20-A. New Subdivision 20-A will set out how and when the rewritten sections will apply.
The rewritten provisions will apply to recoupment amounts received in the 1997-98 or later income years [Schedule 8, Part 1: subsection 20-1(1), Transitional Provisions Act] . They will also apply to amounts that are deemed by the existing law to be recouped in the 1997-98 income year [Schedule 8, Part 1: subsection 20-1(2), Transitional Provisions Act] .
In some cases, however, it is necessary that some recoupment provisions of the 1936 Act apply to assessments for the 1997-98 and later income years when those provisions deal with recoupments that were received before the 1997-98 income year [Schedule 8, Part 1: section 20-5, Transitional Provisions Act] . These provisions are reduction of deductions recoupment provisions that apply to expenditure deductible over more than one year. Under these provisions, a recoupment may still affect a deduction in the 1997-98 income year or a later income year, even if the initial expenditure was incurred, and the recoupment was received, before the 1997-98 income year.
E. Consequential amendments
Amendments of the Income Tax Assessment Act 1997
Part 2 of Schedule 8 to the Bill will amend the 1997 Act to:
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- update references to provisions of the 1936 Act that have been rewritten in Subdivision 20-A;
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- repeal sections of the 1997 Act that deal with recoupment;
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- take amounts assessed under Subdivision 20-A into account in calculating amounts assessable under a balancing adjustment; and
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- insert additional definitions in the Dictionary in section 995-1 of terms used in the rewritten provisions.
There are currently a number of references in the 1997 Act to existing recoupment provisions. Most of these are in section 10-5, which contains a list of all the provisions of both the existing and rewritten law that deal with particular kinds of assessable income.
Part 2 of Schedule 8 will bring the list in section 10-5 up to date by taking into account the new approach to recoupment in Subdivision 20-A. [Schedule 8, Part 2: items 2 to 23]
Part 2 of Schedule 8 will also update other references in the 1997 Act to existing recoupment provisions that have been rewritten in Subdivision 20-A, so that the reference is to the rewritten provisions. [Schedule 8, Part 2, item 25]
Repeal sections dealing with recoupment
Sections 41-45 and 330-585 of the 1997 Act deal with recoupment. These provisions have been consolidated in, or have been made redundant by, Subdivision 20-A. Therefore Part 2 of Schedule 8 will repeal these provisions. [Schedule 8, Part 2, items 24 and 27]
Take account of Subdivision 20-A in a balancing adjustment provision
Under subsection 330-485(2) of the 1997 Act, an amount to be included in assessable income under a balancing adjustment provision for mining and quarrying expenditure is limited to amounts covered by paragraph 330-480(1)(a) of the 1997 Act. That paragraph broadly covers amounts deductible under Subdivision 330-A, 330-C, 330-H or a corresponding previous law.
Part 2 of Schedule 8 will amend subsection 330-485(2) to reduce the limit by any recoupment amount included in assessable income by Subdivision 20-A [Schedule 8, Part 2, item 26] . This will apply if a recoupment amount is assessed in an income year before the balancing adjustment is required.
Subdivision 20-A will assess amounts of recoupment for a deductible loss or outgoing. As this will nullify deductions allowed to that extent, it is necessary to reduce the limit in subsection 330-485(2).
Part 2 of Schedule 8 will insert new definitions of terms used in the rewritten provisions.
New Definition: Assessable recoupment [Schedule 8, Part 2, item 28]
Commentary: An explanation of this term is provided in this chapter, at Part A ( Assessable recoupments - the amounts Subdivision 20-A will assess), and at Part B, section 20-20 ( Assessable recoupment ).
New Definition: Current year [Schedule 8, Part 2: item 29]
Commentary: This term is used in sections 159S, 159ZR and 221AZH of the existing law. In these provisions, it means either the year of income for which rebates are being calculated or the year of income for which instalments are being calculated.
In the new law, the term will refer to the income year for which assessable income and deductions are being worked out. This term makes clear the distinction between that year, earlier income years and future income years.
New Definition: Previous recoupment law [Schedule 8, Part 2: item 30]
Commentary: This is a new term which performs a transitional function. It refers to provisions in the existing law that assess recoupment amounts. The definition is necessary because of Subdivision 20-As approach of limiting the total recoupments assessed for a particular expense to the deductions allowed so far for that expense. This defined term takes account of amounts assessed under recoupment provisions in the 1936 Act.
New Definition: Recoupment [Schedule 8, Part 2: item 31]
Commentary: An explanation of this term is provided in this chapter, at Part A (What is recoupment ?), and at Part B, section 20-25 (What is recoupment ?).
The amendments made by Part 2 of Schedule 8 apply to assessments for the 1997-98 and later income years [clause 4, Tax Law Improvement Bill] . This ensures that these consequential amendments take effect at the same time as other amendments relating to the recoupment provisions.
Amendments of the Income Tax Assessment Act 1936
Part 3 of Schedule 8 to the Bill will amend the. 1936 Act to:
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- add references to Subdivision 20-A where the 1936 Act currently refers to the existing provisions; and
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- close off the application of provisions of the 1936 Act that have been rewritten in Subdivision 20-A, so that the existing provisions apply only to recoupments received in the 1996-97 and earlier income years.
Adding references to rewritten provisions
Part 3 of Schedule 8 will add in the 1936 Act references to Subdivision 20-A where the 1936 Act currently refers to the existing provisions [Schedule 8, Part 3: items 33 and 37 to 39] . References to Subdivision 20-A are being added because the provisions being consequentially amended can apply to amounts relating to more than one income year (including an income year before the 1997-98 income year).
Closing off the application of existing provisions
Part 3 of Schedule 8 will insert new provisions into the 1936 Act to close off the application of existing provisions rewritten or made redundant [Schedule 8, Part 3: items 32, 34 to 36 and 40 to 51] . Part 3 of Schedule 2 will also close off the application of paragraphs 26(j) and 26(k), to the extent they deal with recoupment [Schedule 2, Part 3: item 20] .
In these cases, the existing provisions are being closed off so that they only apply to recoupments received in the 1996-97 and earlier income years. This complements the transitional provisions in Part 1 of Schedule 8 which ensure that the corresponding rewritten provisions apply to recoupments received in the 1997-98 and later income years.
The amendments made by Part 3 of Schedule 8 apply to assessments for the 1997-98 and later income years [clause 4, Tax Law Improvement Bill] . This ensures that these consequential amendments take effect at the same time as other amendments relating to the recoupment provisions.
Amendments of other Commonwealth legislation
Part 4 of Schedule 8 to the Bill will amend the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 to add a reference to Subdivision 20-A, where the Act currently refers to the existing provisions. [Schedule 8, Part 4: item 52]
The amendments made by Part 4 of Schedule 8 apply to assessments for the 1997-98 and later income years [clause 4, Tax Law Improvement Bill] . This ensures that these consequential amendments take effect at the same time as other amendments relating to the recoupment provisions.