House of Representatives

Explanatory Memorandum

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

Chapter 8 - Calculation of current year net income and tax loss

Overview

8.1 The following discussion sets out the provisions that apply where a trust is required to work out its net income and tax loss in a special way (i.e. the current year loss rules). In very broad terms, these provisions work by:

•

dividing the trust's income year into periods on the basis of when a specified event (e.g. change in ownership or control) occurs;

•

allocating to each period that assessable income and those deductions which can be allocated to periods and working out a notional net income or notional loss for each period; and

•

calculating the net income (if any) and the tax loss taking into account the notional net income and notional loss for each period and any income or deductions that cannot be allocated to periods.

Subdivision 268-B - Dividing the income year into periods

8.2 A trust that is required to calculate its net income and tax loss under the current year loss provisions will have its income year divided into two or more periods. An explanation of how the income year is divided into periods for the different types of trusts is set out below.

How is the income year of a fixed trust divided into periods?

8.3 The way in which the income year of a fixed trust (including a widely held unit trust) is divided into periods depends on whether the trust is required to calculate its income and loss under Division 268 because it has failed the 50% stake test or, if it is an ordinary fixed trust, because it has failed that test and the alternative condition for ordinary fixed trusts held 50% or more by non-fixed trusts.

Fixed trust failing the 50% stake test

8.4 The first period for a fixed trust starts at the start of the income year. Each later period starts immediately after the previous period and the last period ends at the end of the income year. [Subsections 268-10(2) and (3); 268-20(2) and (3)]

8.5 If the trust is not a widely held unit trust (i.e. an ordinary fixed trust), each period (except the last) ends at the latest time that would result in the trust passing the 50% stake test for the whole of the period. [Subsection 268-10(3)]

8.6 If the trust is a widely held unit trust each period (except the last) ends at the earliest time at which there is an abnormal trading in the trust's units and the trust does not pass the 50% stake test in respect of the following times:

•

the beginning of the period; and

•

immediately after the abnormal trading. [Subsection 268-20(3)]

8.7 If a listed widely held trust's income year is split up into periods, successive periods will be treated as a single period if throughout these periods the trust passes the same business test in relation to the time immediately before the end of the first of them [subsection 268-20(4)] . The current year loss provisions do not apply if the trust carries on at all times during the income year, the same business as the business which it carried on just before an abnormal trading. As a consequence, this provision will only ever have application where the income year is split up into at least three periods (i.e. there have been two changes in ownership which have resulted in the trust failing the continuity of ownership test).

Example

8.8 This example illustrates how what would otherwise be two or more periods would be treated as one period where the same business is carried on throughout the two or more periods. As discussed above, this situation is unlikely to arise in practice but this example is provided in order to explain how the circumstance would be dealt with.

8.9 A listed widely held trust fails the continuity of ownership test two times in the income year (shown as events (1) and (2) in the time line below). However, the trust continued to carry on the same business throughout the period of the income year between (1) and (2) as it had throughout the period from the start of the income year to (1). The trust's income year is split into two periods as shown on the time line below. If the same business test did not apply, the trust's income year would have been split up into three periods, each beginning on a change in ownership (except the first which commences at the start of the income year). However, what would otherwise be periods 1 and 2 are treated as one period because the trust carried on at all times during those periods the same business before both (1) and (2).

Ordinary fixed trust failing the 50% stake test and the alternative condition

8.10 If an ordinary fixed trust fails the 50% stake test and the alternative condition in section 266-45, its income year is divided into periods as follows.

8.11 The first period for the fixed trust starts at the start of the income year. Each later period starts immediately after the previous period and the last period ends at the end of the income year. Each period (except the last) ends the first time one of the following events occurs after the start of the period:

•

when the persons holding the fixed entitlements in the fixed trust (or holding entity), or the percentages that the persons hold, changes;

•

the latest time at which all the non-fixed trusts holding a direct or indirect fixed entitlement in the fixed trust meet the 50% stake condition in relation to the start of the period;

•

the first time a group begins to control one of the non-fixed trusts that holds a direct or indirect fixed entitlement in the fixed trust. [Section 268-15]

How is the income year of a non-fixed trust divided into periods?

8.12 The beginning of the first period will be the start of the income year. Any subsequent period starts immediately after the end of the previous period. [Subsections 268-25(2)]

8.13 The last period will end at the end of the income year [subsection 268-25(3)] . The point in time that any other period will end will depend on whether there are individuals who have more than 50% fixed entitlements to the income or capital of the non-fixed trust at any time during the income year.

8.14 If a non-fixed trust is one in which persons have more than 50% fixed entitlements to income or capital at any time in the income year the 50% stake (continuity of ownership) condition will apply to the trust. If this is the case, a period (except the last) will end the first time after the start of the period that:

•

the individuals who had more than a 50% stake in the trust at the start of the period no longer have more than a 50% stake; or

•

a group begins to control the trust (i.e. a change of control occurs). [Subsection 268-25(4)]

8.15 If the 50% stake condition does not apply to the non-fixed trust, a period (except the last) will end when, after the start of the period, there is a change of control of the trust. [Subsection 268-25(5)]

Subdivision 268-C - other steps in working out the net income or tax loss

How do you work out the trust's notional net income or notional tax loss for a period?

8.16 A notional loss or net income of a trust has to be calculated for each period of the income year [subsection 268-30(1)] . These calculations have to be made in respect of each period in the income year as if it were itself a year of income. Where a trust is a partner the notional loss or notional net income for each period is worked out under section 268-70.

8.17 If there is no notional loss in any of the periods these provisions do not apply and the net income of the trust is calculated in the usual way [subsection 268-30(4)] . There is no mischief in these cases because there are no current year deductions that can be utilised by new owners or controllers of a trust in the current income year.

8.18 A notional loss will arise where certain deductions attributable to the period exceed the assessable income attributable to the same period [subsections 268-30(2)] . A notional loss incurred in the last period in an income year may be able to be carried forward to a later year of income. If the relevant deductions do not exceed the relevant assessable income, the trust will have a notional net income for the period [subsection 268-30(3)] .

How are deductions attributed to a period?

8.19 For the purpose of allocating deductions to respective periods there are three types:

•

deductions that are attributed to each period in proportion to the length of the period (i.e. pro-rated);

•

deductions that are attributable to periods as if each period were an income year;

•

full year deductions.

Pro-rated deductions

8.20 The first type of deduction is one that can be pro-rated over the income year according to the length of the period being considered. These kinds of deductions are listed in subsection 268-35(2) and include, for example, depreciation which is deductible under section 54, or section 42-15 of the ITAA 1997, and some deductions for expenditure which are spread over 2 or more years. [Subsection 268-35(2)]

Example

8.21 A fixed trust has depreciation expenses of $3,000 for an item of capital equipment in the current year of income. As a result of section 268-10, the current income year of the trust is divided into 3 periods of 4 months. Depreciation expenses of $1,000 are allocated to each of the 4 month periods.

Example 2

8.22 A fixed trust has taken out a three year loan. The borrowing expenses that are deductible under section 67 or section 25-25 of the ITAA 1997 are $600. Pro-rated on a daily basis, $200 of this expense is applicable to the year of income. As a result of section 268-10, the income year of the fixed trust is divided into 2 periods of 6 months. The amount of the deduction that is attributed to each of the periods is $100 (i.e. half of $200).

8.23 The second type of deduction is a deduction that is attributed to a period as if the period were an income year. [Subsection 268-35(3)]

Example 1

8.24 A non-fixed trust disposes of an item of depreciable property during a year of income. As a result of the disposal an amount of $2,000 is available for deduction under subsection 59(1), or subsection 42-195(1) of the ITAA 1997. Under section 268-25, the income year of the non-fixed trust is to be divided into 2 periods. The $2,000 deduction is to be allocated to the period in which the disposal took place.

Example 2

8.25 As a result of section 268-25, a non-fixed trust is required to divide its income year into 2 periods. A stock take of trading stock is carried out at the end of the first period. The value of the opening stock exceeds the value of the closing stock by $2,000. A deduction for the excess is allowable under subsection 28(3), or subsection 70-35(3) of the ITAA 1997. This deduction is allocated to the first period.

Example 3

8.26 A fixed trust prepares its accounts on an accruals basis. As a result of section 268-10, the income year of the fixed trust is to be divided into 2 periods. The trust incurs a deductible expense in the first period but it is not paid for until the second period. The expense is allocated to the first period.

Full year deductions

8.27 The third type of deduction is a full year deduction. These deductions are not allocated to a particular period or dissected between the relevant periods but are brought to account in the final calculation of the trust's net income for the year. [Subsection 268-35(4)]

8.28 Full year deductions are listed fully in the legislation and include, forexample, deductions allowable for bad debts or for losses on debt/equity swaps under section 63E, gifts, and tax losses for earlier years. [Subsection 268-35(5)]

8.29 However, a deduction for the balance of capital expenditure is not a full year deduction if the deduction results from the disposal, loss etc. of property [subsection 268-35(6)] . This deduction would be of a kind that falls within subsection 268-35(3).

How is assessable income attributed to a period?

8.30 For the purpose of spreading assessable income over periods of the income year there are six classes of income that are attributed to periods as set out below.

Income from other trusts

8.31 The first class is income that is included in the assessable income of the trust under section 97 (i.e. the trust's share in the net income of another trust as a presently entitled beneficiary) or section 98A (i.e. the trust is a non-resident beneficiary). This income is reasonably attributed to periods in the income year where possible. [Subsection 268-40(2)]

Pro-rated assessable income

8.32 The second class is those items of assessable income that can be pro-rated over the income year according to the length of the period being considered. These kinds of income are listed in subsection 268-40(3) and include, for example, insurance pay outs for loss of livestock or trees which, under section 26B, or section 385-130 of the ITAA1997, can be spread in equal instalments over 5 years. [Subsection 268-40(3)]

Wool clips

8.33 The third class is amounts included in the trust's assessable income under section 26BA or under section 385-135 (Election to defer including profit on second wool clip) of the ITAA 1997. These are attributed to the period when the wool would ordinarily have been shorn. [Subsection 268-40(4)]

Deemed dividends

8.34 The fourth class is amounts included in the trust's assessable income that are deemed to be dividends under either sections 65, 108 or 109. This income is attributed to the period when the amount was paid or credited, whichever occurred first. [Subsection 268-40(5)]

Assessable income attributed to periods as if each period were an income year

8.35 The fifth class is income that is attributable to periods as if each period were an income year. This income is attributed accordingly. [Subsection 268-40(6)]

Example

8.36 As a result of section 268-25, a non-fixed trust is required to divide its income year into 2 periods. A stock take of trading stock is carried out at the end of the first period. The value of the closing stock exceeds the value of the opening stock by $2,000. This amount is to be included in assessable income under subsection 28(2), or subsection 70-35(2) of the ITAA 1997. This income is allocated to the first period as this is the period the income would have been attributed to if the period were an income year.

Full year amounts

8.37 The sixth class is full year amounts. This is income that is included in the assessable income of the trust in the year of income under section 97 (i.e. the trust's share in the net income of another trust as a presently entitled beneficiary) or section 98A (ie. the trust is a non-resident beneficiary) but where the income cannot be reasonably attributed to a particular period. As with full year deductions, these amounts are not attributed to a period but are brought to account in the final calculation of the trust's net income for the year. [Subsection 268-40(7)]

Example

8.38 A non-fixed trust receives income as a beneficiary of a trust estate which is assessable under section 97. As a result of section 268-25, the trust is required to divide its income year into 2 periods. It is not possible to reasonably attribute any of this trust income to a particular period of the income year. The amount is treated as a full year amount which at a later stage is added on to the trust's total net income.

How do you work out the trust's net income for the income year?

8.39 If the income year of a trust has been divided into periods under Subdivision 268-B, the net income of the trust is calculated as follows:

•

the sum of the notional net incomes for the relevant periods;

plus

•

any 'full-year amounts' that are to be included in the assessable income of the trust (i.e. the income of a trust that cannot be reasonably attributed to any period);

less

•

certain full year deductions (those listed in paragraphs 268-45(4)(a), (b) and (c)) unless these deductions exceed the total of the notional net incomes and the full year amounts (if they equal or exceed that total, the trust does not have a net income for the income year);

•

if any amount remains, other full year deductions in the order specified in subsection 268-45(5) unless these deductions exceed the amount remaining (if they equal or exceed that amount, the trust does not have a net income for the income year). [Section 268-45]

8.40 An example of how the net income of the trust is calculated is shown at paragraph 8.47.

How do you work out the trust's section 79E loss for the income year?

8.41 Section 79E is the general provision in the ITAA 1936 that allows the carry forward of losses for post-1989 income years. If the income year of a trust has been divided into periods under Subdivision 268-B, the section 79E loss of the trust is:

•

the sum of the notional losses of any of the periods;

plus

•

the amount by which any full year deductions listed at paragraphs 268-50(3)(a), (b) and (c) exceed:

-

the total of the notional net incomes (if any); and

-

the full-year amounts referred to in section 268-40 (i.e. trust income that is not reasonably attributable to any period in the income year).

less

•

if the trust has derived any exempt income, the net exempt income. [Section 268-50]

How do you work out the trust's film loss for the income year?

8.42 As a result of subsection 79E(4) of the ITAA 1936, film losses incurred in a post-1989 year of income (i.e. a year of income commencing on 1 July 1989 or subsequent year of income) are effectively quarantined and can only be deducted in a later year of income against film income.

8.43 A trust's section 79F film loss is essentially worked out in the same way as a general section 79E loss except only the assessable film income, net exempt film income and film deductions are taken into account. The trust's film loss is the amount worked out in this way to the extent that it does not exceed the amount of the overall section 79E loss (including film losses) incurred in the year of income. The terms 'film deductions', 'assessable film income' and 'net exempt film income' are terms defined in subsection 79F(12). [Section 268-55]

Example

8.44 A trust's section 79E losses (including film losses) from the whole of its activities, calculated under section 268-50 are $8m. A trust's losses from its film activities calculated under subsections 268-55(1),(2) and (3) are $10m. Since the section 79E losses are less than the losses from its film activities the amount of the film loss for the year is $8m.

How do you work out the trust's section 36-10 tax loss for the income year?

8.45 Section 36-10 is the provision in the ITAA 1997 that sets out how to calculate a tax loss. If the income year of a trust has been divided into periods under Subdivision 268-B, the steps for calculating the section 36-10 tax loss are essentially the same as those for calculating a section 79E loss as described in paragraph 8.41. [Section 268-60]

How do you work out the film component of the trust's tax loss for the income year for the purposes of section 375-805 of the ITAA 1997?

8.46 The steps for calculating the film component of a trust's tax loss for the purposes of section 375-805 of the ITAA 1997 are essentially the same as the steps for calculating a trust's section 79F film loss as described in paragraphs 8.42 to 8.44. The terms 'assessable film income', 'net exempt film income' and 'film deductions' are defined in section 375-805 of the ITAA 1997. [Section 268-65]

An example of how to calculate a trust's net income or tax loss for an income year

8.47 The trust's income year is divided into two periods with notional net income and notional losses as follows:

The amount remaining, $28,500, is the trust's net income for the income year. The amount is assessable under Division 6 of the ITAA 1936.

The amount remaining, $21,800, is the trust's tax loss for the income year. The loss may be able to be carried forward for deduction in a later year of income.

8.48 A trust may have derived a class of foreign income during the year of income for which there is a foreign income deduction of the same class that is reduced under section 79D. For the purposes of Division 268, the deduction will need to be calculated for the income year and then (assuming the deduction is not a full year deduction) apportioned to each of the periods according to the amount of foreign income deductions attributed to each of the periods under either subsections 268-35(2) or (3).

Subdivision 268-D - Supplementary rules for partnerships

How does the trust calculate its notional loss or net income for a period when the trust is a partner in a partnership?

8.49 Subdivision 268-D applies where a trust is a partner in a partnership from which it derives a share of the net income of the partnership or is entitled to a deduction for its share of the partnership loss.

8.50 The broad aim of the Subdivision is to attribute a share of the partnership's net income or tax loss to the trust. To do this, a notional net income of the partnership or a notional partnership loss is calculated on the same basis as if that partnership were a trust for which a notional net income or notional loss were being ascertained in relation to a period into which the trust's income year has been divided.

8.51 The trust's share of the partnership's notional loss or notional net income is added in to the trust's notional loss and notional net income for each of the periods. [Section 268-70]

8.52 If a trust has the same accounting period as the partnership the notional income and the notional loss of the partnership is to be allocated to the relevant periods of the trust on a percentage basis, i.e. according to the percentage interest of the trust in the partnership. If the trust has no net income or tax loss under Division 6 of the ITAA 1936, ie. breaks even in the income year, the trust's share is a percentage that is fair and reasonable, having regard to the trust's interest in the partnership. [Section 268-75]

8.53If the trust has a different accounting period from the partnership, the partnership's notional net income or notional loss will be that which can be reasonably attributed to the income year of the trust. The trust's share is then calculated on a percentage basis as set out in paragraph 8.50. [Section 268-80]

8.54 If the trust and the partnership have the same accounting period, the full year deductions of the partnership are allocated to the trust on a percentage basis, depending on the trust's share in the partnership. If the trust and the partnership have a different accounting period the trust's share of full year deductions is to be what ever is fair and reasonable, having regard to any relevant circumstances. If the partnership had neither a net income nor partnership loss, the percentage is to be what is fair and reasonable having regard to the percentage interest of the trust in the partnership. [Section268-85]