Senate

Explanatory Memorandum

(Circulated by authority of the Treasurer,the Hon. Peter Costello, MP)

Chapter 4 - Leased Cars

This chapter explains the rewritten provisions about the income tax treatment of profits made on the sale of previously leased cars.

Those provisions are contained in new Subdivision 20-B in Schedule 1 to the Tax Law Improvement Bill 1997.

Transitional and consequential amendments for the rewritten provisions are contained in Schedule 7 to the Bill.

Overview of this chapter

This chapter covers:

•

the rewritten provisions in Subdivision 20-B in Schedule 1 to the Tax Law Improvement Bill 1997. These will constitute Subdivision 20-B of the 1997 Act; and

•

the related transitional provisions and consequential amendments in Schedule 7.

Subdivision 20-B deals with profits on the sale of previously leased cars. The corresponding provision of the 1936 Act is section 26AAB.

Part A of this chapter summarises new Subdivision 20-B of the 1997 Act.

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 in Part 1 of Schedule 7 which set out how, and from when, the rewritten provisions will apply.

Part E explains amendments that need to be made to the 1936 Act and the 1997 Act because of the rewriting of the 1936 Act provisions. These amendments are in Parts 2 and 3 of Schedule 7.

A. Summary of the new law

Guide to Subdivision 20-B

Subdivision 20-B explains how an amount can be included in assessable income if it is a recoupment of deductible lease payments for a car that has been sold.

Purpose of the Subdivision

Normally, a profit on a car sale is a non-assessable capital gain.

However, if the car has been leased, a portion of the profit may be a recoupment of deductible lease payments and therefore will be assessed as income.

Subdivision 20-B deals separately with common situations in which it can apply (the usual case ) and with less common situations of transactions where associated parties are involved.

The more common case

This is where

•

a car is leased to a taxpayer

•

the lease payments are paid or payable by that taxpayer and deductible to anyone; and

•

that taxpayer buys the car from the lessor and disposes of it for a profit.

In this case:

The profit is included in that taxpayers assessable income. [section 20-110]

What is a profit?

It is the consideration for the disposal, less:

•

the acquisition cost to you; and

•

any capital expenditure you incurred. [section 20-115]

There is a limit on how much profit is included

The limit is the smaller of:

•

the deductible lease payments for the lease; and

•

the notional depreciation for the lease period. [subsection 20-110(2)]

If there is more than one lease:

The limit is increased to take account of deductible lease payments and notional depreciation under all leases from the same lessor. [subsections 20-110(3) and20-125(3)]

Successive leases of the same car can produce separate limits on the profit to be included in assessable income. Only the largest of those amounts is included. [section 20-130]

What is notional depreciation?

It is the car's cost to the lessor, less the consideration the lessor obtained from disposing of it, multiplied by:

days in the lease period/days the lessor owned the car


[section 20-120]

Less common cases

These involve associates

•

the car was leased to an associate of the taxpayer; or

•

the associate (whether alone or not) acquired the car from the lessor; or

•

someone else acquired the car under an arrangement which enabled the taxpayer or an associate to acquire it. [section 20-125]

In these cases, there is another limit on how much profit is included in assessable income

This is the difference between:

•

the consideration for disposing of the car; and

•

the cost of the car to the entity to whom the lessor disposed of it plus any capital expenditure that entity incurred on the car. [paragraph 20-125(2)(c)]

Exceptions and reductions

In some cases, none of the profit is included in assessable income

These are where:

•

you inherited the care [section 20-145] or

•

the lease was:

(a)

a hire purchase agreement; or

(b)

a normal short term hire; [section 20-155] or

•

after the lessor disposed of it and before you did, there as an intervening disposal by someone else which:

(a)

was for market value or more; or

(b)

caused an amount, based on market value to be included in that persons assessable income. [section 20-135]

In some cases, the amount to be included in assessable income is reduced

These include where:

•

an intervening disposal by the taxpayer or anyone else has already resulted in an amount being assessed [section 20-140] ; or

•

another provision includes an amount in the taxpayers assessable income because of the current disposal [section 20-150] .

Disposals of interests in cars

There are special rules for the disposal of an interest in a car

Subdivision 20-B applies as it would to a disposal of the car but with these modifications:

•

there are no fixed limits on how much profit is included - a reasonable proportion is included;

•

the cost is also a reasonable amount; and

•

disregard any previous disposal of the car. [section 20-160]

B. Discussion of changes

Removing discretions

The administrative discretions in section 26AAB use the term an amount determined by the Commissioner. These are being replaced by objective tests based on reasonableness, eg. the inclusion of a reasonable amount. This material does not comment further on those changes.

Structure

Subdivision 20-B will deal first with the usual case, which should cover most disposals of leased cars. Consequently, most readers will not need to consider the more complex parts of the Subdivision.

There are some special rules dealing with multiple disposals and multiple leases of the same car and with disposals of interests in a car.

Terminology

Cars- The Subdivision will apply to a disposal of a car instead of a motor car or station wagon, which is the expression used in section 26AAB. Car is a defined term in the new law and its meaning may be a little different from motor car or station wagon. Therefore, the Subdivision is limited so that it only applies to cars designed mainly for carrying passengers [paragraphs 20-110(1)(aa) and 20-125(1)(ba)] . This is the interpretation the Administrative Appeals Tribunal has given to the words in the existing law, so the scope of the rewrite will be the same as section 26AAB.

Associates- The term associate is used frequently in this Subdivision and throughout the 1936 Act. Instead of using many different definitions of the word, the new law will use a standard definition.

The differences between the new definition and that in section 26AAB are:

•

in the new definition, a company is an associate of another entity if it might reasonably be expected to act in accordance with the wishes of the other entity, even if the company is not accustomed, or obliged, to so act (including where those wishes are communicated through interposed companies, partnerships or trusts);

•

a spouse living separately and apart from the taxpayer on a permanent basis is not an associate under the new definition; and

•

the rules for identifying who public unit trusts are associated with under the new definition are more like those used for companies than for trustees.

These differences are minor and have no significant effect on the treatment of leased cars.

Section 20-115 Working out the profit on the disposal

This section states how to work out the profit on a disposal of a car. It is the consideration receivable on disposal, less the cost of the car and any capital expenditure on the car after it was acquired.

Change

Subsection 20-115(2) will add, to the list of things that are consideration receivable, an amount receivable under an insurance policy if the car is lost or destroyed.

Explanation

This change will ensure consistency in the treatment of insurance proceeds and sales proceeds. This accords with the way the law is administered.

Section 20-120 Notional depreciation

This section sets out how to work out the notional depreciation for a car. Notional depreciation is one of the elements in establishing how much of the profit is assessable on disposal of the car.

Commentary

Section 26AAB works out the notional depreciation by first taking how much the lessee could have deducted for depreciation if the lessee had owned the car instead of leasing it. That amount is the difference between its original cost to the lessor and what its written down value would have been when the lessor disposed of it.

Then, an adjustment is made to reflect the difference between the written down value and the lessor's disposal price. If the disposal price is above the written down value, the balancing adjustment reduces the depreciation. If the disposal price is less than the written down value, the balancing adjustment increases the depreciation.

In either case, to obtain the notional depreciation, pro-rate the depreciation amount to reflect the period the lessee leased the car.

The rewrite will simply subtract the disposal price from the lessor's original cost before pro-rating the result. This produces the same mathematical outcome as section 26AAB, but more simply.

This relies on the premise that notional depreciation under section 26AAB is calculated as if the lessee had used the car only for income producing purposes. That is the generally held view of how section 26AAB works and is how the Commissioner administers it.

C. Provisions of the old law that have not been rewritten

Redundant provisions

The Bill will not rewrite sub-section 26AAB(18), which defines market value to mean what the Commissioner thinks is reasonable if there is insufficient evidence of market value.

The courts have been able to find a market value, even for items in which there are no current dealings, by assuming that there are willing buyers and sellers.

D. Transitional arrangements

Part 1 of Schedule 7 to the Tax Law Improvement Bill 1997 will amend the Income Tax (Transitional Provisions) Act 1997 to insert Sub-division 20-B, containing the transitional provisions for the rewritten provisions discussed earlier in this chapter. That Subdivision will set out how, and when, the rewritten provisions will apply.

The rewritten provisions in Subdivision 20-B of the 1997 Act will apply to assessments for the 1997-98 and later income years [Schedule 7, Part 1: section 20-100, Transitional Provisions Act] .

In some cases, it is necessary to specify in the transitional provisions how the rewritten provisions apply in the 1997-98, or a later, income year if certain events happen before that time. Those events are set out in this table:

E. Consequential amendments

Amendment of the Income Tax Assessment Act 1997

Part 2 of Schedule 7 to the Bill will amend the 1997 Act to:

•

update a reference to section 26AAB that has been rewritten in Subdivision 20-B; and

•

insert additional definitions in the Dictionary in section 995-1 of terms that are used in the rewritten provisions.

Updated reference

Section 10-5 of the 1997 Act lists all the provisions of both the 1936 and 1997 Acts that deal with particular kinds of assessable income. Part 2 of Schedule 7 to the Bill will replace the reference to section 26AAB in that list with a reference to Sub-division 20-B. [Schedule 7, Part 2: item 2]

New Dictionary terms

Part 2 of Schedule 7 will also insert new definitions of terms used in the rewritten provisions in Subdivision 20-B.

New Definition: Notional depreciation for a lease period [Schedule 7, Part 2: item 3]

Commentary: A new label for the existing term the amount of depreciation that is deemed in accordance with subsection (6) to have been allowable to the lessee in respect of the unit of property. How the definition has been simplified is discussed under section 20-120, notional depreciation in Part B of this chapter.

New Definition: Profit on the disposal of a leased car [Schedule 7, Part 2: item 4]

Commentary: A label for an idea already in the 1936 Act.

Part 2 of Schedule 5 will insert a new definition of consideration receivable, a term also used in the rewritten provisions in Subdivision 20-B. A change to that term is discussed under section 20-115, working out the profit on the disposal in Part B of this chapter.

Application of amendments

The consequential amendments made by Part 2 of Schedule 7 generally apply to assessments for the 1997-98 and later income years [clause 4, Tax Law Improvement Bill 1997] . This ensures that these consequential amendments take effect at the same time as the rest of the amendments relating to disposals of leased cars.

Amendment of the Income Tax Assessment Act 1936

Part 3 of Schedule 7 to the Bill will amend the 1936 Act to:

•

insert a reference to Subdivision 20-B where the 1936 Act currently refers to section 26AAB; and

•

close off the application of section 26AAB of the 1936 Act, now rewritten in Subdivision 20-B, so that section 26AAB applies only to the 1996-97 and earlier income years.

Inserting references to rewritten provisions

Part 3 of Schedule 7 will add a reference to Subdivision 20-B of the 1997 Act in section 170 of the 1936 Act. Section 170 currently refers to section 26AAB. [Schedule 7, Part 3: item 7]

This dual reference to the existing and the rewritten provision is required because section 170:

•

has not yet been rewritten and closed off; and

•

can apply to assessments for income years both before and after the 1997-98 income year.

Closing off the application of existing provisions

Part 3 of Schedule 7 will amend the 1936 Act to close off the application of section 26AAB so that it only applies to disposals in the 1996-97 and earlier income years. [Schedule 7, Part 3: items 5, 6]

Application of amendments

The consequential amendments made by Part 3 of Schedule 7 generally apply to assessments for the 1997-98 and later income years [clause 4, Tax Law Improvement Bill 1997] . This ensures that they take effect at the same time as the substantive amendments relating to disposals of leased cars.