Senate

Explanatory Memorandum

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

Chapter 6 - Treatment of payments made under firearms surrender arrangements

Overview

6.1 Schedule 6 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to provide for the taxation treatment of payments made under the firearms surrender arrangements. The Bill will also make consequential amendments to the Income Tax Assessment Act 1997 .

Summary of the amendments

Purpose of the amendments

6.2 The amendments will provide that those taxpayers who are not gun dealers and who use firearms either in their business (for example, a farmer or professional shooter) or for private purposes will be exempt from any tax which may arise from the payments received.

6.3 In the case of gun dealers, the effect of the amendments will be that during the income years a firearm is held as trading stock, the taxable income in respect of that firearm will be zero. Compensation payments received by gun dealers for business lost as a result of the firearms surrender arrangements will be exempt from tax.

Date of effect

6.4 The amendments will apply to the income years during which compensation payments are made under the firearms surrender arrangements. [Items 9 and 13]

Background to the legislation

6.5 At a meeting on 10 May 1996, State and Territory Police Ministers resolved to specify common standards for the control of firearms in their respective jurisdictions. The resolutions were issued on 29 July 1996 by the Commonwealth Law Enforcement Board as the Compensation for the Surrender of Prohibited Firearms Guidelines (the guidelines). Meetings were also held on 17 July 1996 and 15 November 1996.

6.6 The central features of the guidelines are the prohibition of possession and use of all automatic and self-loading rifles and shotguns and pump-action shotguns except in special circumstances and the provision for compensation in respect of, and an amnesty period to enable the surrender of, certain prohibited firearms. Compensation payments may be made to firearms dealers, individual owners and collectors. As an alternative to receiving compensation from the State or Territory governments, individual owners and collectors have the option of consigning their prohibited firearm(s) with a nominated dealer for sale overseas.

6.7 The guidelines state that firearms dealers will be compensated for:

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prohibited firearms and unusable ammunition, spares, maintenance equipment and manuals held in stock which are specific to those firearms; and

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any loss in business caused by the prohibition of certain firearms.

The guidelines also state that surrender values for firearms will be the published selling price as at 1 March 1996.

6.8 The legislation to implement the firearms surrender arrangements in the States and Territories is listed below. In some jurisdictions, regulations have also been made in relation to the surrender scheme. Whether provision is made for compensation in legislation or regulations, or whether it is dealt with administratively, will depend on the particular State or Territory.

How does the current tax legislation apply to gun dealers?

6.9 The current provisions of the Act that may affect dealers who receive compensation payments for firearms surrendered are:

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section 25 - assessable income;

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sections 28 and 36 - trading stock;

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section 51 - deductions;

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sections 54 and 59 - depreciable items; and

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section 79E - prior year losses.

Assessable income

6.10 Under the existing legislation, a dealer is assessed on sales income under section 25 of the Act and on the disposal of trading stock under section 36 where the disposal is not in the ordinary course of business. Section 25 may also apply to include in assessable income the compensation received for loss of business caused by the prohibition of certain firearms.

Trading stock and allowable deductions

6.11 Subsection 51(1) of the Act allows a deduction for losses and outgoings necessarily incurred in carrying on a business except to the extent that they are losses of a capital, private or domestic nature or are incurred in producing exempt income. Subsection 51(2) provides a deduction for trading stock, for example a firearm, by deeming the expenditure not to be an outgoing of a capital nature.

6.12 The value of a dealer's trading stock on hand at the beginning and end of a year of income are taken into account to determine whether assessable income or an allowable deduction arises under section 28. Where the value of closing stock exceeds the value of opening stock, subsection 28(2) applies to include the excess in assessable income. Where the value of opening stock exceeds the value of closing stock, subsection 28(3) applies to treat the excess as an allowable deduction.

6.13 The effect of sections 28 and 51 is to match the cost of goods sold with the sales income for those goods. Therefore, a deduction is allowed for the cost of guns in the year of disposal. Where guns are purchased and sold in the same year of income, section 28 does not apply while section 51 provides a deduction for the purchase cost against the sale proceeds. Where the guns are sold in a different year to their purchase, sections 28 and 51 apply to have a nil effect on taxable income in the year of acquisition. For the year of disposal, the opening balance of the trading stock account exceeds the closing balance and subsection 28(3) operates to allow a deduction for the excess amount. The deduction is for the cost of the goods sold in that year (see example 1 at paragraph 6.35). Where there is a revaluation of trading stock, the examples at paragraphs 6.39 and 6.44 illustrate how the trading stock account is affected.

Prior year losses

6.14 Under the existing law, section 79E provides that a domestic tax loss incurred in one income year may be carried forward as an allowable deduction against assessable income in succeeding income years. Further, where the taxpayer has derived exempt income in a year, paragraph 79E(3)(b) provides that prior year losses are to be deducted from net exempt income before being allowed as a deduction against assessable income of that year.

How does the current tax legislation apply to non gun dealers?

6.15 Professional farmers and shooters may be affected by the depreciation provisions in sections 54 and 59 and the capital gains tax (CGT) provisions in Part IIIA of the Act. As explained below, the CGT provisions may also impact on other individual gun owners.

Depreciation

6.16 A taxpayer who owns and uses assets, such as firearms, to produce assessable income is entitled to a deduction under section 54 for the depreciation of those assets during the income year. Where the asset is disposed of, lost or destroyed, section 59 provides for a balancing adjustment. The appropriate adjustment is determined after having regard to the consideration received and the depreciated value of the asset at the time of disposal. Where the depreciated value exceeds the consideration received, a deduction for the excess is allowed under subsection 59(1). Where the consideration received exceeds the depreciated value of the firearm, subsection 59(2) operates to include the excess in assess able income.

Capital gains and losses

6.17 For CGT purposes, assets such as firearms may be classified as follows:

6.18 The CGT provisions can currently apply if there is a disposal of an asset that was acquired after 19 September 1985. The asset disposal may result in either a capital gain or a capital loss. A capital gain is included in assessable income and a capital loss may be used to offset a capital gain made in the same or a future year of income.

6.19 Personal-use assets (see table above) are assets that are used primarily for the personal-use of the taxpayer and receive special treatment. Personal-use assets are divided into 'listed personal-use assets' and 'non-listed personal-use assets'.

6.20 Listed personal-use assets are personal-use assets of the types specified in subsection 160B(2) (for example, an antique), where the acquisition cost exceeds $500. A loss arising on disposal of a listed personal-use asset can only be offset against a gain arising from another listed personal-use asset (section 160ZQ).

6.21 Non-listed personal-use assets are deemed to have a minimum cost base or indexed cost base of $10,000 (section 160ZG). Therefore, a capital gain can only arise on disposal of a non-listed personal-use asset if the consideration exceeds $10,000. A capital loss cannot arise in respect of a non-listed personal-use asset (section 160Z).

Explanation of the amendments

6.22 The amendments are in two Parts. Part 1 of Schedule 6 will amend the Income Tax Assessment Act 1936 . Part 2 of Schedule 6 will make consequential amendments to the Income Tax Assessment Act 1997 .

Interpretative issues

6.23 'Firearms surrender arrangements' is the term used in the proposed amendments to describe:

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any Commonwealth, State or Territory legislation; or

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any administrative arrangements of a State or a Territory;

which implement the agreement of Police Ministers to uniform gun laws in Australia, including the surrender of prohibited firearms. A meeting of police ministers was held on 10 May 1996. [Subsection 6(1) - item 1]

Which income will be exempt from tax under the firearms surrender arrangements?

6.24 Under the amendments proposed, those taxpayers (other than taxpayers such as gun dealers) who use firearms in their business or for their private use will be exempt from both income tax and capital gains tax in respect of payments received under the firearms surrender arrangements. The exemption applies whether the payment is a compensation payment made by a State or Territory government or the proceeds of an overseas sale by consignment. [Items 4, 5 and 8]

6.25 An amendment to the general exemption provisions in section 23 of the Act is also proposed to ensure that the compensation payments received by gun dealers for loss of business aretreated as exempt income [new paragraph 23(jd)) - item 2] . In the case of gun dealers who hold firearms as trading stock, the amendments will ensure that during the income years a firearm is held as trading stock, the taxable income in respect of that firearm will be zero [item 3].

How will the taxable income in respect of a firearm be zero?

6.26 Under the current law, over the period for which a firearm is held as trading stock, a dealer's taxable income in relation to the firearm will be the difference between the proceeds of sale and the acquisition cost of the firearm. The income years in which the taxable income arises in relation to a firearm depends on whether the firearm is revalued whilst it is held as trading stock. As demonstrated in the examples below, where the firearm is not revalued, taxable income in relation to the firearm only arises in the year of disposal. On the other hand, where the firearm is revalued as trading stock and is held for more than one year of income, taxable income may arise prior to the year in which the firearm is disposed of.

6.27 The amendments proposed will ensure that during the income years a firearm is held as trading stock, the taxable income in respect of that firearm will be zero. This will be achieved by allowing an additional deduction against assessable income in the year of income that the compensation is derived. The additional deduction will be the difference between the amount included in assessable income as a result of the surrender of the firearm and the acquisition cost of that firearm. [New subsection 51(2B) - item 3]

6.28 In the case where revaluation has not occurred the additional deduction will reduce to nil any tax liability that would have arisen in the income year that assessable income was derived as a result of surrendering the firearm. Where revaluation has occurred giving rise to taxable income in an earlier year, the effect of the proposed amendment is to ensure that during the income years the firearm is held as trading stock, the taxable income in respect of that firearm will be zero.

How will the depreciation provisions be amended?

6.29 A taxpayer who owns and uses a firearm to produce assessable income is currently entitled to a deduction for depreciation during an income year. Where the firearm is disposed of, lost or destroyed, the existing legislation provides for a balancing adjustment having regard to the compensation received and the depreciated value of the asset. The adjustments may result in either an additional amount being included in assessable income or being allowed as a deduction and are explained in paragraph 6.16 above.

6.30 An amendment to section 59 of the Act is proposed so that the amount, if any, by w hich the compensation payment exceeds the depreciated value is not included in assessable income. Allowable deductions which are currently available when the compensation payment is less than the depreciated value will not be affected by these amendments [new subsection 59(2AAA) - item 5] . A further amendment is proposed to ensure that new subsection 59(2AAA) will continue to apply under the Act rather than the Income Tax Assessment Act 1997 for the income years during which payments are received under the firearms surrender arrangements [item 4].

Will existing deductions for prior year losses be affected?

6.31 As explained in paragraph 6.14 above, the existing legislation currently operates to deny a deduction for prior year losses equal to the amount of exempt income. Under the amendments proposed, the compensation payments received by gun dealers for loss of business are to be treated as exempt income.

6.32 In order to protect the amount deductible for prior year losses, amendments are proposed to section 79Eof the Act. The proposed amendments will ensure that the following amounts are excluded from the definition of 'exempt income' in subsection 79E(12) for the purposes of section 79E:

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compensation payments received for loss of business [item 6] ; and

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in the case of taxpayers who use firearms to produce assessable income, the amount, if any, by which the consideration received under the firearms surrender arrangements exceeds the depreciated value of those firearms (see paragraphs 6.29 and 6.30) [item 7] .

How will the amendments affect the capital gains tax provisions?

6.33 The capital gains tax (CGT) provisions currently operate to include a capital gain in assessable income upon disposal of an asset which was acquired after 19 September 1985. Depending on the value of the firearm surrendered, firearm owners may be subject to the CGT prov isions unless they are amended.

6.34 An amendment to the CGT provisions is, therefore, proposed to ensure that taxpayers are not assessed on capital gains realised as a result of compensation being received under the firearms surrender arrangements. [New subsection 160Z(6A) - item 8]

Examples illustrating how the new provisions will work

Example 1

6.35 A Gun Shop (Harry's Pty Ltd) sells and repairs firearms and related merchandise. On 1 August 1995, the company purchases a Browning .22 rimfire self-loading rifle as stock-in-trade for $700 with a retail price of $1000. Following the introduction of the firearms surrender arrangements, the company surrenders the weapon on 30 November 1996 and receives $1000 compensation from the New South Wales Government.

6.36 The company's trading stock account, valued at cost price, would reflect the following values for the gun surrendered:

6.37 The tax treatment under the existing law (sections referred to are sections in the Act) would be:

6.38 The tax treatment that would result from the proposed amendments in the 1996-97 year of income is shown in the table below. Under the amendments proposed, the taxable income of $300 that would have arisen in the 1996-97 year of income will be zero, as shown below:

Example 2

6.39 On 1 August 1995, a Gun Shop (Arnie's Pty Ltd) purchases a Browning .22 rimfire self-loading rifle for $700 as trading stock but instead of valuing it at cost price, the company values the gun at the market selling value at the end of 1995-96. On 30 November 1996, the company surrenders the weapon and receives $1000 compensation from the Victorian Government.

6.40 The company's trading stock account, assuming a market selling value of $1000 for the gun, would reflect the following values:

6.41 The tax treatment under the existing law (sections referred to are sections in the Act) would be:

6.42 The tax treatment that would result from the proposed amendments in the 1996-97 year of income is shown in the table below:

6.43 The amendments proposed will result in an additional tax deduction of $300 (compensation received of $1000 less acquisition cost of $700) for 1996-97. The outcome will be that during the income years the gun is held the taxable income in respect of that gun will be zero. This is because the additional deduction of $300 in 1996-97 will offset the taxable income of $300 which arose in the 1995-96 year when the gun was valued above its acquisition cost.

Example 3

6.44 On 1 August 1995, a Gun Shop (Capone and Son Pty Ltd) purchases a Browning .22 rimfire self-loading rifle for $700 as trading stock. The company values the weapon at $650 in the trading stock account at the end of 1995-96. On 30 November 1996, the company surrenders the gun and receives $1000 compensation from the Tasmanian Government.

6.45 The company's trading stock account, assuming a market selling value of $650 for the gun, would reflect the following values:

6.46 The tax treatment under the existing law (sections referred to are sections in the Act) would be:

6.47 The tax treatment that would result from the proposed amendments in the 1996-97 year of income is shown in the table below:

6.48 The amendments proposed will result in an additional tax deduction of $300 (compensation received of $1000 less acquisition cost of $700) for 1996-97. The outcome will be that during the income years the gun is held the taxable income in respect of that gun will be zero. This is because the additional deduction of $300 in 1996-97 will offset the net effect of the taxable income of $350 which would have arisen in 1996-97 and the taxable loss of $50 which arose in the 1995-96 year when the gun was valued below its acquisition cost.

What amendments are being made to the Income Tax Assessment Act 1997 (the 1997 Act)?

6.49 Part 2 of Schedule 6 of the Bill makes consequential amendments to the 1997 Act to ensure that the legislative changes will remain effective from 1 July 1997.

6.50 These amendments are necessary because some provisions in the Act are being replaced, with effect from 1 July 1997, with new provisions in the 1997 Act.

Deductions

6.51 Item 10 will update the index to section 12-5 in the 1997 Act to confirm that a deduction can be claimed for the amount described in new subsection 51(2B) . See paragraphs 6.26 to 6.28.

Prior year losses

6.52 Items 11 and 12 amend the prior year loss provisions in the 1997 Act (section 36-20) to ensure that exempt income received under the arrangements will not reduce the amount of loss that can be carried forward [new paragraphs 36-20(3)(aa) and (ea)] . Paragraphs 6.31 to 6.32 explain how prior year losses will be protected under the 1936 Act.

6.53 The amendments in Part 2 will have effect for as long as compensation payments are received under the firearms surrender arrangements. [Item 13]