House of Representatives

Explanatory Memorandum

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

Chapter 1 - Disposal of leases and leased plant

Outline of Chapter

1.1 This Chapter explains new Division 45, inserted into the ITAA 1997 by item 12 of Schedule 1 to this Bill. Division 45 will include an amount in the assessable income of a plant lessor when plant which has been used principally for leasing is disposed of on or after 22February1999 and the consideration and other benefits received from the disposal exceed the plants depreciated value. Division 45 will also apply when an interest in leased plant is disposed of, including by the disposal of an interest in a partnership or by a wholly-owned company group selling a majority beneficial interest in shares in a subsidiary company that holds leased plant. It will also apply where there is a disposal of rights under a lease of plant (e.g. the rights to receive a flow of rental income). Some part of the plant lease period must have occurred on or after 22February1999.

1.2 Division 45 will also treat each member of a wholly-owned group of companies as jointly and severally liable for any unpaid tax liability of a leasing subsidiary imposed as a result of the application of the Division to that subsidiary.

1.3 The operation of Division 45 is modified for the period 22February1999 to 11.45 am AEST on 21 September 1999.

Context of Reform

1.4 Under the current law tax can be avoided through arrangements known as lease assignments. While lease assignments may take various forms, their intended effect can be to avoid the tax that would be payable in the later period of a lease when it begins to generate positive taxable income. The assignment is made by disposing of leased plant (or interests in leased plant) after most of the benefits of tax depreciation allowances have been taken so that future deductions will be less than future taxable rentals.

1.5 The proposed measure will ensure that all forms of consideration received in connection with the lease assignment including the benefit of being relieved of debt will be taken into account in calculating the assignors assessable income.

Summary of new law

1.6 Division 45 will apply when plant, or an interest in plant, is disposed of on or after 22 February 1999 where:

•

the plant was a leased asset on or after 22 February 1999;

•

the plant has been used by the lessor primarily for leasing to others; and

•

the lessor has deducted amounts for depreciation.

(For these purposes, the reference to the lessor includes a reference to a related entity see the amendments to section 41-40 of ITAA 1997.)

Division 45 is to apply in the following way:

•

Where the disposal constitutes a balancing adjustment event, the lessors assessable income will include any excess of the money consideration and the value of other benefits obtained from disposing of the plant (or an interest in the plant) over the plants written down value (or relevant proportion thereof).

•

If the lessor disposes of rights under the lease of the plant without disposing of the plant itself, the lessors assessable income will include the money consideration for the disposal plus the value of other benefits obtained as a result of the disposal.

•

Similar consequences as in the 2 previous dot points will follow if a partner in a partnership disposes of an interest in the partnership so as to reduce the partners interest in plant which the partnership has used mainly to lease to other entities, or disposes of rights or an interest under the lease.

•

If an interest in leased plant is effectively disposed of by selling more than 50% of the shares in a wholly-owned leasing subsidiary which owns the plant, the leasing subsidiary will be treated as having disposed of the plant and reacquired it at market value. This means that the depreciation balancing adjustment rules would bring to tax any excess of the plants market value over its written down value at the deemed disposal time. There will be no such effect, however, if the main business of the new owners of the subsidiary is the same as the main business of the former group.

•

If more than 50% of the shares in a wholly-owned subsidiary which is a partner in a leasing partnership changes hands, the subsidiary will be treated as having disposed of its interest in plant that had been used by the partnership principally to lease to other entities. The consequence will be that the de-grouped subsidiary will become liable to tax on the difference between the market value of its interest in the leased plant and the proportion of its written down value attributable to that interest. This rule will not apply, however, if the main business of the new owners of the subsidiary is the same as the main business of the former group.

•

In either of the cases outlined in the 2 previous dot points, the companies that were in the same group as the de-grouped subsidiary will become liable for the tax upon which the subsidiary was assessed, attributable to the transactions described above, if the former subsidiary does not pay the tax within 6 months of it becoming payable. This tax is imposed by theNew Business Tax System (Former Subsidiary Tax Imposition) Bill 1999 (Imposition Bill).

Comparison of key features of new law and current law

1.7 The legislative rules contained in Division 45 are designed to prevent tax being avoided on profits from plant primarily used for leasing that can occur under the present law from lease assignments.

Current law

1.8 In the early years of a lease, lessors get tax advantages because deductions for depreciation and interest can exceed assessable lease income. Tax losses generated from leases are used to offset the tax liability from other income of the lessor. In later years, this situation is reversed so that rentals exceed deductions as deductions for depreciation of the plant decline. At this point, lessors may seek to get out of the lease by disposing of or assigning their interests in the plant or lease to a tax loss or other tax-preferred entity.

1.9 A tax effective assignment means that the revenue loss during the early tax loss phase of the lease is never redressed by tax collected on the lease income generated in the later tax positive phase.

1.10 Lease assignments generally occur when depreciation allowances relating to the leased asset have been substantially exhausted and the market value of the asset exceeds its tax written down value.

1.11 The appropriate tax outcome when an asset is disposed of for more than its written down value is that the excess of the disposal price over written down value is brought to tax as a balancing charge essentially a recoupment of excess depreciation deductions. Tax effective lease assignments generally ensure the balancing charge is not taxed by utilising a balancing charge roll-over option that is available when there is only a partial change in the ownership of depreciable assets, for example when there is a change in the composition of a partnership.

1.12 Where the roll-over option is taken, the balancing charge is not applied and the new owners continue to depreciate the asset as if it had not changed hands. In lease assignment cases, the usual pattern is for about 99% of the ownership of the asset to change, leaving only a nominal percentage with the original lessor. The new majority owner is usually a tax exempt body, or a taxpayer with substantial tax losses or some other tax preferred entity such as a superannuation fund.

1.13 Another element of a tax effective lease assignment is that the assignor obtains a benefit from being relieved of the obligation to pay outstanding debts relating to the leased asset. The debts are met by the future rentals that have been assigned to the new owner. Invariably, this benefit is not returned as assessable income of the assignor.

New law

1.14 In summary, lease assignments have been designed so that little or no tax is ever paid on the lease rentals. The lessor obtains the benefit of tax losses generated in the early years of the lease, but escapes tax on balancing charges and debt relief when the lease is assigned. Subsequent lease rentals are sheltered from tax because of the assignees tax-advantaged status as a tax-exempt body, tax loss entity or superannuation fund.

1.15 Division 45 will counteract this method of avoiding tax by ensuring that all forms of consideration received in connection with a lease assignment including the benefit of being relieved of debt will be taken into account in calculating the assignors assessable income. It will apply to lease assignments that are effected directly by the disposal of the leased plant or an interest in the leased plant or rights under the lease, or indirectly by the disposal of an interest in a partnership, or the shares in a wholly-owned group leasing subsidiary. To ensure that the Division operates appropriately it will also apply in circumstances where the plant is not subject to a lease at the time of disposal.

Detailed explanation of new law

Disposal of leased plant

1.16 The provisions contain rules for working out an amount to be included in the assessable income of a taxpayer who disposes of leased plant or an interest in leased plant or who, without disposing of the plant, disposes of rights derived from the lease (e.g. some or all of the lease receivables) [section 45-5]. The terms dispose of and acquire in relation to Division 45 have their ordinary meaning. The term plant is defined in section 42-18 of Division 42 of the ITAA 1997.

1.17 The rules apply only if the taxpayers primary use of the plant was to lease it to another entity and some of the lease period occurred on or after 22 February 1999 [subsection 45-5(1)]. They may apply, therefore, to plant that is not being leased at the time of the disposal.

1.18 An amount will be included in a taxpayers assessable income if the taxpayer disposes of plant or an interest in plant on or after 22February1999 and the following tests are satisfied:

•

the taxpayer is entitled to deductions for depreciation of the plant;

•

the taxpayer leased the plant to another entity for most of the time it was the owner or quasi-owner of the plant;

•

some part of the lease period occurred on or after 22February1999;

•

the disposal constitutes a balancing adjustment event as defined in section 42-30, i.e. broadly a disposal or deemed disposal which can trigger a balancing adjustment either assessable or deductible if the disposal price is more or less than the plants written down value; and

•

the total amount of all the benefits obtained by the taxpayer (in relation to the disposal) exceeds the written down value of the plant at the time it is disposed of or, if only an interest in the plant is disposed of, the proportion of the written down value represented by that interest.

[Subsection 45-5(1)]

1. 19 The benefits, (referred to as disposal benefits ), that may be obtained from disposing of plant or an interest in plant are:

•

money received or receivable;

•

the amount of any reduction in a liability of the taxpayer; or

•

the market value of any other benefit obtained.

[Paragraph 45-5(1)(e)]

1.20 A liability reduction benefit would apply, for example, if leased plant was sold and liability for a loan that had been taken to finance the plant was transferred to the purchaser. Market value would apply in a case where, although there was no formal agreement to reduce a legal liability of the taxpayer, informal arrangements created such an effect in practice. For example, if the new owner of the leased asset applied the future lease rentals against an ongoing debt obligation of the taxpayer.

1.21 Where the conditions are satisfied, the taxpayer must include in assessable income the difference between the disposal benefits and the written down value (or relevant proportion thereof) of the plant. [Subsection 45-5(2)]

1.22 In summary, the provisions operate to assess the benefits derived from disposing of leased plant, or an interest in leased plant, to the extent that they exceed its written down value. Where the transitional measures apply, the amount assessed is capped at the amount of depreciation deductions obtained for the plant, or the part that was disposed of.

Example 1.1: Consideration for assignment

Avalon Co. owns a leased asset. It assigns a 50% interest in the asset to another entity. The debt obligation owing at the time of assignment is $60,000. The total deductions are $150,000. The deductions attributable to the 50% interest in the asset are $75,000. The tax written down value of the asset is $20,000:

•

The cash consideration for the assignment is $40,000.

•

Under the assignment, the assignee takes over 50% of Avalon Co.s obligation to make debt service payments.

•

Therefore the debt obligation effectively transferred in connection with the assignment is $30,000.

•

The total consideration is $70,000.

•

The amount included in assessable income under Division 45 is $60,000 (the total consideration ($70,000) minus 50% of the assets written down value ($10,000)).

Disposal of lease rights

1.23 An amount will also be included in assessable income where a taxpayers main use of plant was to lease it to other entities and the taxpayer disposed of rights or interests derived from the lease or plant even if there was not a disposal of an ownership interest in the plant. For instance, this would occur where a taxpayer disposes of rights to payments under a lease but not the leased asset itself. Again, some part of the lease period must have occurred on or after 22February 1999 and the taxpayer must be entitled to depreciation deductions for the plant. [Subsection 45-5(3)]

1.24 The amount to be included in assessable income in that case is the total of the disposal benefits (whether in cash, liability reduction or any other form). The amount is included in the income year in which the disposal takes place. [Subsection 45-5(4)]

1.25 Subsection 45-5(3) would not include an amount that was already included under subsection 45-5(1). For example, if the taxpayer disposed of both the leased asset and the lease under the same transaction only subsection 45-5(1) would apply.

What happens if an amount is already included in assessable income?

1.26 Amounts will not be included in assessable income under Division 45 to the extent that they are already directly included in assessable income by another provision (e.g. as a balancing charge), or would be included except for specific relieving provisions (e.g. where it is subject to roll-over relief to a related entity). [Subsection 45-5(5)]

1.27 The rule excluding an amount from assessment in Division 45 if that amount is included by another provision avoids the double counting of an amount and establishes that the other provision takes precedence over provisions contained in Division 45.

1.28 A transitional rule applies for disposals before 11.45 am AEST on 21September 1999. Such disposals can be subject to CGT. The transitional provisions contain a modified double counting rule to ensure that for disposals before 21 September 1999, Division 45 will take precedence over the CGT provisions. [Item 18, Schedule1, subsection 45-3(3) of the IT (TP) Act 1997]

1.29 Another transitional rule caps the amount that Division 45 will include in assessable income on a disposal of plant, or an interest in plant, that constitutes a balancing adjustment event. The cap is equal to the total deductions available for depreciation of the plant. If the disposal was only of an interest in the plant, the cap is the part of those deductions attributable to the interest. [Item 18, Schedule 1, subsection 45-3(2) of the IT (TP) Act1997]

1.30 The transitional measure arises because during the transitional period any excess of the disposal proceeds over the cost of the asset may be subject to the CGT provisions. From 21 September 1999 depreciable assets will be excluded from the CGT regime so the cap is no longer necessary.

Example 1.2: The interaction between section 45-5 and the balancing adjustment provisions in the ITAA 1997

Merlin Pty Ltd assigns a 50% interest in leased plant it owns to another entity. The debt obligation owing at the time of assignment is $60,000. Total depreciation deductions taken amount to $140,000 and the market value of the leased asset at the time of assignment is $160,000. The tax written down value is $20,000:

•

The cash consideration for the assignment is $50,000.

•

Under the assignment, the assignee takes over 50% of Merlin Co.s obligation to make debt service payments.

•

Therefore the debt obligation effectively transferred in connection with the assignment is $30,000.

•

The total consideration is $80,000.

•

The amount assessable under Division 45 is $70,000 (the total consideration ($80,000) minus 50% of the assets written down value ($10,000)).

Amount otherwise taxed (section 45-5(5)):

•

The assignment is a balancing adjustment event (section 42-30 and Subdivision 42-J).

•

The balancing charge, and the amount included in assessable income, under section 42-190 is $140,000.

•

Therefore, the additional assessable amount under Division 45 is nil (if the balancing charge amount is not included in assessable income then the assessable amount under Division 45 is $70,000).

Disposal of an interest in partnership

1.31 There are similar rules where a partner disposes of an interest, or part of an interest, in a partnership and, in so doing, either disposes of or reduces its interest in plant (that the partnership has used mainly to lease to other entities) or disposes of rights or an interest in the lease. [Section 45-10]

1.32 Thus, an amount must be included in a partners assessable income if the partner disposes of its interest in partnership plant on or after 22 February 1999 and the following tests are satisfied:

•

the partnership is entitled to deductions for depreciation of the plant which would be reflected in the partners share of the partnership net income or partnership loss;

•

the partnership leased the plant to another entity for most of the time it held the plant;

•

some part of the lease period occurred on or after 22February1999;

•

the disposal constitutes a balancing adjustment event as defined in section 42-30, for example where there is a partial change in the ownership of, or in the interests of entities in, the plant; and

•

the total amount of all the benefits obtained by the taxpayer (in relation to the disposal) exceeds the proportion of the plants written down value that represents the interest in the plant that the partner has disposed of.

[Subsection 45-10(1)]

1.33 All of the following are included in the benefits, (the disposal benefits ) that may be obtained from disposing of an interest in partnership plant:

•

money received or receivable;

•

the amount of any reduction in a liability of the taxpayer; or

•

the market value of any other benefit obtained.

[Paragraph 45-10(1)(f)]

1.34 Liability reduction would apply if, for example, when the interest in the partnership plant was disposed of, the acquirer of that interest perhaps a new partner undertook the outgoing partners legal obligations in relation to a loan by which the partnership had financed the plant. Market value would apply in a case where, although there was no formal agreement to reduce a legal liability of the partner, the arrangements by which the disposal or part disposal of that plant took place caused such an effect in practice, for example, if future rentals were applied against debts for which the partner had a legal obligation.

1.35 Whilst in that circumstance, there may be no change in any of the legal obligations of the taxpayer as a partner, the effect of the assignment would be to dilute in a practical sense both the benefits and liabilities of being a partner. In that case, any monetary consideration received for the assignment plus the amount of the benefit of any de facto reduction of a partners share of partnership liabilities would be treated as the relevant benefit from the disposal. [Paragraph 45-10(1)(f)]

1.36 The amount that is included in the partners assessable income in the disposal year is the excess of the disposal benefits over the partners proportion of the plants written down value. [Subsection 45-10(2)]

1.37 However, if the transitional provisions apply, the amount included in the partners assessable income is capped at the share of the plant depreciation deductions reflected in the partners share of partnership net income or loss. [Item 18, Schedule 1, subsection 45-3(4) of the IT (TP) Act 1997]

Disposal of lease rights by a partner

1.38 An amount is also included in a partners assessable income if the partnership has leased the plant for most of the period it has held it and, on or after 22 February 1999, the partner disposes of rights or interests derived from the lease, or interest in the plant, without causing a depreciation balancing adjustment event as defined in section 42-30 of the ITAA 1997. [Subsections 45-10(3) and (4)]

1.39 In this regard, it has been argued that a partner who disposes of part of its interest in a partnership by assigning that part is not thereby disposing of a proprietary interest in partnership assets. On that view, no balancing adjustment event is required.

1.40 The amount included in assessable income is the total of any monetary consideration for the disposal, the amount of any reduction in a liability of the taxpayer that occurs in connection with the disposal, and the market value of any other benefit obtained by the taxpayer in connection with the disposal. [Subsection 45-10(4)]

1.41 Notwithstanding that there may be no change in any of the legal obligations of the taxpayer as a partner, the effect of an assignment of a partnership interest as described would be to dilute in a practical sense both the benefits and liabilities of being a partner. In that case, any monetary consideration received for the assignment plus the amount of any de facto reduction of a partners share of partnership liabilities would be the relevant benefits from the disposal.

Avoiding double counting

1.42 A partner will not be required to include an amount in assessable income to the extent that the amount:

•

is otherwise included in its assessable income under another provision of the ITAA 1936 or ITAA 1997; or

•

would be included as a taxable balancing charge on the disposal of plant, but instead is offset against the written down value of other plant.

[Subsection 45-10(5)]

1. 43 Again, if the disposal occurs before 11.45 am on 21 September 1999, an amount would be included under these provisions before it would be included as a capital gain. [Item 18, Schedule 1, subsection 45-3(5) of the IT (TP) Act 1997]

Example 1.3: Proportionate balancing charge where an interest in a leased asset is relinquished

Jason is a partner who holds a 50% interest in a partnership that is formed to lease plant costing $150,000. The plant is not currently being leased, but has been leased for most of the time the partnership has owned it. He assigns his interest in the partnership to a tax-advantaged entity. Jason and the other partners elect to take the roll-over relief provided under section 42-335. The partnership has deducted $140,000 for depreciation of the plant. The cash consideration is $60,000, the partnership debt is $80,000 and Jasons share of the debt service repayments is $40,000, (which the other partner has agreed to take over).

•

The total consideration for the assignment is - ($60,000 + $40,000) $100,000.

•

Written down value of the formerly leased plant $10,000.

•

Jasons share of the written down value $5,000.

•

Taxable consideration $100,000.

•

The amount assessable under section 45-10 is theexcessreferredto in paragraph 45-10(1)(f) whichis($100,000 $5,000) $95,000.

Therefore $95,000 is assessable.

•

However, if the transitional provisions apply, (because the assignment occurred between 21 February 1999 and 11.45 am AEST on 21 September 1999) the amount included in assessable income is the lesser of $95,000; and

•

Jasons share of amounts deducted for depreciation of the plant, which is $70,000.

In this case, $70,000 is assessable.

In addition, some further amount may be assessable as a capital gain.

Reduction in the amount to be included in assessable income in relation to plant acquired before 21 September 1999

1.44 An amount required to be included in a taxpayers assessable income due to the disposal of an interest in leased plant or a lease of plant (subsection 45-5(2)) or of an interest in a leasing partnership (subsection 45-10(2)) will be reduced in certain circumstances. This is necessary to give effect to the indexation of assets subject to CGT. However, the Government announced on 21 September 1999 that for depreciable assets subject to CGT that are acquired before, but disposed of after, 21September 1999 indexation will be frozen as of 30September 1999.

1.45 Such a reduction in the amount to be included in assessable income will occur if the plant, or an interest in the plant, is acquired before, but disposed of after, 21 September 1999 and the sum of the disposal benefits (whether in cash, liability reduction or any other form) exceeds the cost of the plant or the part of the cost attributable to the disposed interest. [Subsection 45-30(1)]

1.46 If these conditions are met, the amount to be included in those provisions is reduced by the lesser of:

•

any excess of the cost base of the plant, or the part attributable to the disposed interest in the plant, over the cost of the plant or the interest in it. The excess is calculated as at the day of disposal. Refer to sale price 1 in Diagram 1.1; and

•

the difference between all disposal benefits (whether in cash, liability reduction or any other form) and the cost of the plant, or the interest in it. Refer to sale price 2 in Diagram 1.1.

[Subsection 45-30(2)]

1.47 However, the amount included in assessable income will not be reduced as described above, if:

•

the plant was a pre-CGT asset (as defined in section 149-10 of the ITAA 1997) at the time of the disposal [paragraph 45-30(3)(a)] ; or

•

if a capital gain or loss from certain plant, or interests in certain plant, is disregarded by virtue of sections 118-5, 118-10 or 118-12 of the ITAA 1997 and that gain or loss arises from CGT event A1 (as defined in section 104-10 of the ITAA 1997) that occurs at the time of the balancing adjustment event. Specifically, sections 118-5, 118-10 and 118-12 concern cars, motor cycles, valour decorations, collectables, personal use assets and plant used to produce exempt income [paragraph 45-30(3)(b)] .

1.48 In these cases, the amount included in assessable income under Division 45 is limited [subsection 45-35(1)] . The purpose of the limit is to preserve the effect of the CGT exemption for these assets despite the general removal of depreciable assets from the CGT regime.

1.49 In relation to the disposal of an interest in leased plant or a lease of plant (subsection 45-5(2)) the limit is the lesser of:

•

the amount by which the disposal benefits exceed the written down value of the plant or that part of it attributable to the interest disposed of [paragraph 45-5(1)(e)] ; and

•

the depreciation amounts deducted (or able to be deducted) for the plant, or the part of those deductions attributable to the interest disposed of.

[Subsection 45-35(2)]

1.50 In relation to the disposal of an interest in a leasing partnership (subsection 45-10(2)) the limit is the lesser of:

•

the amount by which the disposal benefits exceed the written down value of the plant attributable to the interest in it being disposed of [paragraph 45-10(1)(f)] ; and

•

the amount of the depreciation deductions claimed by the partnership for the plant that are, or would be, reflected in the partners share of the partnership net income or loss (the partnership amount ), or where the partner disposes of an interest in the plant so much of that partnership amount attributable to the interest disposed of.

[Subsection 45-35(3)]

Sale of a group company that owns leased plant

1.51 By selling shares in an entity that owns a leased asset, rather than selling the asset, an ultimate owner can avoid the application of a balancing charge that would otherwise have applied. This is particularly relevant where the entity that holds the asset is a 100% subsidiary in a wholly-owned group because any losses from accelerated depreciation can be transferred to other entities in the group before the subsidiary is disposed of.

Disposal of shares in a 100% leasing subsidiary

1.52 Rules covering these cases apply to any disposal of a majority beneficial ownership of shares in a 100% owned subsidiary, or in a 100% owned subsidiary in a leasing partnership, whose main business was to lease assets, and prior to the disposal any plant owned was primarily used for leasing to other entities. [Sections 45-15 and 45-20]

1.53 In the case of a 100% owned leasing subsidiary of a wholly-owned group, (referred to as the former subsidiary ), more than 50% of the former subsidiarys beneficial ownership must be acquired by one or more entities not in the same wholly-owned group [section 45-15] . The term wholly-owned group is defined in section 975-500 of the ITAA 1997.

1.54 Diagram 1.2 provides an example of this case. Subsidiary A has leased plant out for most of the time it has owned it. Section 45-15 will apply if Company Z sells more than a 50% direct beneficial interest, or Company X sells more than a 50% indirect beneficial interest, in Subsidiary A after 21 February 1999. It does not matter if the 50% beneficial interest in Subsidiary A is transferred via a single transaction or a number of transactions. If Subsidiary A had simply sold the leased plant, section 45-15 would not apply, but section 45-5 would have applied instead.

1.55 Further conditions that must be satisfied if the rules are to apply to the disposal of a leasing subsidiary are that:

•

the subsidiarys main business was to lease assets to another entity;

•

it owned plant that was primarily used for leasing; and

•

some of the lease period of that plant occurred on or after 22February 1999.

[Subsection 45-15(1)]

1.56 It does not matter that the plant was not being leased at the time of the disposal of the shares.

1.57 The disposal will create a balancing adjustment event for the purposes of section 42-30 of the ITAA 1997. The 100% subsidiary will be treated as disposing of the plant at market value (and reacquiring it at the same price) where there is a change in the controlling interest of the subsidiary on or after 22 February 1999. [Paragraph 45-15(1)(f)]

1.58 Treating the former subsidiary as disposing of and reacquiring the plant will have no effect for tax purposes on any lease to which the plant may be subject at that time. [Subsection 45-15(3)]

1.59 The balancing adjustment offset elections under sections 42-285 and 42-290 are not available for the balancing adjustment events created by section 45-15. [Subsection 45-15(4)]

1.60 In summary, for the disposal of a 100% subsidiary to come within the provisions, the following requirements must be met:

•

the subsidiary must be entitled to deductions for depreciation of plant;

•

it must have leased the plant to another entity for most of the time it was the owner or quasi-owner of the plant;

•

its main business must have been to lease assets;

•

at least some of the lease period must have occurred on or after 22February 1999;

•

the beneficial ownership of more than 50% of the shares in the subsidiary must have been acquired by one or more entities outside the subsidiarys wholly-owned group on or after 22February 1999; and

•

at the time of the disposal, the written down value of the plant must have been less than its market value.

1. 61 The provisions do not apply to a change in beneficial ownership in a wholly-owned leasing subsidiary if the main business of all the entities that acquire the controlling interest is the same as the main business of the former group [subsection 45-15(2)] . For example, if a commercial banking group transfers beneficial ownership in a 100% leasing subsidiary to a superannuation fund, the transfer would be caught by the rules because the superannuation fund is not in the same business as the banking group.

Example 1.4: Balancing charge arising from the sale of an interest in a 100% subsidiary

A company group ceases to hold a majority beneficial interest in a subsidiary. The following details relate to the depreciable plant and equipment held by the subsidiary company:

•

Market value $100,000.

•

Depreciated value $10,000.

•

Balancing charge if the company sold the asset $90,000.

•

Total assessable amount under section 42-190- ($100,000 $10,000) is $90,000.

1.62 Example 1.4 demonstrates that the company is treated as having disposed of and reacquired the asset at market value. This reflects the fact that the former owners of the company have effectively disposed of the assets held by the company. The re-acquisition rule allows the company to commence depreciating the asset from its market value, but requires tax to be paid on the same basis as if the company had sold the asset.

1.63 Another rule applies if there is a disposal of shares in a 100% subsidiary that leases plant in partnership. Where the requirements are satisfied the disposal of the subsidiary will also be treated as a disposal by the subsidiary of its interest in the plant for the purposes of Division 42 and section 45-10. The effect of this kind of disposal of plant at market value is discussed under the partnership rule in section 45-10 subject to the modifications outlined below. [Section 45-20]

1.64 There are some requirements additional to those in section 45-10. The former subsidiary must have been a 100% subsidiary in a wholly-owned group at the time it was a member of the leasing partnership and the main business of the partnership must have been to lease assets. In addition, more than 50% of the beneficial ownership of the former subsidiary must have been acquired by an entity outside the subsidiarys wholly-owned group on or after 22February1999. Further, at the time of this acquisition the written down value of the plant must be less than its market value.

1.65 Again, the former subsidiary is not treated as having disposed of and reacquired its interest in the plant at market value if the main business of each of the entities that acquired beneficial ownership of the subsidiary is the same as the main business of the wholly-owned group of which the former subsidiary was a member. [Subsections 45-20(2)]

1.66 The balancing adjustment offset rules under sections 42-285, 42-290 and 42-293 are not available for the balancing adjustment events created by the deemed disposal. Section 42-293 is to be inserted into the ITAA 1997 by the New Business Tax System (Capital Allowances) Bill1999. In the event of section 42-293 not being enacted, the reference to it in Division 45 will become redundant. [Subsection 45-20(4)]

Former group member(s) liable to pay outstanding tax

1.67 In some circumstances a 100% leasing subsidiary that has been degrouped may not have the funds to pay the tax liability arising from the operation of sections 45-15 or 45-20. This may occur for a number of reasons. For example, the former group may have previously taken most of the resources from the subsidiary.

1.68 Therefore, where the leasing subsidiary (the former subsidiary ) does not pay the tax arising from this balancing adjustment within 6months of the due date of the assessment, members of the former group will also become liable for the outstanding amount of the tax associated with the balancing adjustment. The former subsidiary will continue to be liable to pay the outstanding amount associated with the adjustment. The outstanding amount is the income tax debt of the former subsidiary reduced by any payments of tax imposed under the Imposition Bill. [Section 45-25]

1.69 In that case, both the former subsidiary and the companies that were members of the former group at the time the interest in the former subsidiary was acquired will also become jointly and severally liable for any interest accruing on the primary tax liability, including the interest that accrued in the first 6 months after the due date. This joint liability to tax is imposed on the other company members of the wholly-owned group by the Imposition Bill. [Subsection 45-25(2)]

Application of the New Business Tax System (Former Subsidiary Tax Imposition) Bill 1999

1.70 The Imposition Bill requires the tax payable under section 45-25 of the ITAA 1997 to be paid by any company that was a member of the former subsidiarys wholly-owned group at the time the direct or indirect beneficial ownership of more than 50% of the shares in the former subsidiary was acquired by an entity or entities outside that wholly-owned group. [Section 3, Imposition Bill]

1.71 The Imposition Bill makes companies in the former group liable as if the tax payable were an amount of income tax payable by that company [subsection 4(1), Imposition Bill] . The amount is the lesser of either:

•

the outstanding amount of tax in section 45-25 of the ITAA 1997 arising for the former subsidiary for that income year, including any interest for late payment that is attributable to that amount; and

•

the amount of income tax, including any interest for late payment, that would be payable by the former subsidiary under section 45-25 of the ITAA 1997 for that income year in which an amount is included in the assessable income of the company under section 45-15 or 45-20 of the ITAA 1997. For this purpose it is assumed that the tax arising from the balancing adjustment was the only amount that was assessed to the former subsidiary in that year, and it was not able to deduct any amount or claim any tax offset in that income year. [Subsection 4(2), Imposition Bill]

1.72 When the tax on an amount that is included in the subsidiarys assessable income under section 45-15 or 45-20 is paid in accordance with the Imposition Bill, by any of the jointly and severally liable companies (except the former subsidiary, refer to paragraph 1.53), the other jointly liable companies cease to be liable to the extent of the amount paid [subsection 4(3)] . When an amount of tax arising from the operation of sections 45-15 or 45-20 of the ITAA 1997 is paid by the former subsidiary itself, this payment reduces the outstanding amount in section 45-25 of the ITAA 1997.

1.73 Section 259 of the ITAA 1936 provides for contribution between taxpayers that are jointly and severally liable and applies to the joint and severally liable companies in Division 45.

Common rule 1 roll-over relief for related entities

1.74 Common rule 1 of Division 41 allows roll-over relief to be used to delay balancing adjustments on the transfer of property between related entities. Section 41-40 changes the balancing adjustments on final disposal where no roll-over relief is taken. It also attributes to the final transferor certain characteristics of previous transferors.

1.75 The amendments insert a new subsection into section 41-40 which adds to the characteristics the transferee is assumed to have. [Item 8, Schedule 1, subsection 41-40(4)]

1.76 These characteristics are:

•

if the transferor leased out the plant on or after 22February1999, the transferee is also taken to have done so;

•

if the transferor primarily used the plant for leasing to others, then the transferee is taken to have done so too; and

•

if the transferors main business was to lease assets to others then the transferees main business is taken also to have been leasing assets.

1.77 For the purposes of Division 45, the above characteristics do not apply to roll-over relief under Common rule 1 if the sum of all the disposal benefits is equal to, or greater than, the market value of the plant, or interest in it, disposed of.

1.78 A further characteristic is added for disposals between 22February 1999 and 21 September 1999. It attributes deductions of the transferors partnership to the transferee so that the limit on the amount assessed for disposals during that period can be calculated for the transferee. [Item 16, Schedule 1, paragraph 41-40(4)(d) of the IT (TP) Act 1997]

Application and transitional provisions

1.79 The proposed measures relating to the assignment of leased property will apply to arrangements entered into on or after 22February1999. [Item 19, Schedule 1]

Consequential amendments

1. 80 Schedule 1 also amends various provisions in the ITAA 1997 as a consequence of the enactment of Division 45.

Income Tax Assessment Act 1997

Entities that must pay income tax

1.81 The lists in sections 9-1, 9-5, 10-5 and 12-5 of the ITAA 1997 are amended. The first amendment adds to the list of entities that pay income tax those companies that are members of a wholly-owned group when a former subsidiary of that group is treated as having disposed of plant and does not pay all the income tax resulting from that treatment. [Item 1 of Schedule 1]

1.82 These companies are also added to the list in section 9-5 of entities who work out their income tax by reference to something other than taxable income (in this case, by reference to the former subsidiarys unpaid tax debt). [Item 2 of Schedule 1]

1.83 The list of assessing rules in section 10-5 is updated to include references to Division 45 [items 3 and 4 of Schedule 1] . The section 12-5 list of provisions about deductions is also updated [items 5 and 6 of Schedule 1] .

Meaning of termination value

1.84 The number of ways the balancing adjustment is affected is increased from 2 to 3 because of the amendment discussed in paragraph 1.76. [Item 7 of Schedule 1]

1.85 The table in section 42-205 is amended to explain that the termination value for plant you are taken to have disposed of under section 45-15 is the market value of the plant. [Item 9 of Schedule 1]

Offsetting balancing adjustments

1.86 Notes are added to subsections 42-285(1) and 42-290(1) of the ITAA 1997 to alert the reader that the offsetting mechanisms they provide are not available when a company or corporate partner is treated as disposing of and reacquiring plant by sections 45-10, 45-15 or 45-20. [Items 10 and 11 of Schedule 1]

Depreciation of plant previously owned by an exempt entity

1.87 Division 58 of the ITAA 1997 introduces the concept of a notional written down value for plant in certain circumstances where the plant was previously owned by an exempt entity. Paragraph 58-85(6) of that Division modifies the meaning of cost in section 42-200 which describes how the written down value of plant is worked out. Division 45 will require an amendment to that paragraph to signpost that the cost of the plant under section 42-200 and sections 45-5 and 45-10 will be the notional written down value of the plant at the transition time (as defined in Division 58) plus any amounts of capital expenditure that have been incurred in improving the plant. [Item 13 of Schedule 1]

1.88 The definition of written down value in the dictionary in subsection 995-1 is amended to include a reference to section 58-85. This amendment to the dictionary corrects a previous omission in relation to Division 58. [Item 6 of Schedule 10]

Income Tax (Transitional Provisions) Act 1997

1.89 As part of introducing the New Business Tax System, the Treasurer announced, on 21 September 1999, that plant and equipment would be removed from the CGT regime. This measure has effect from 11.45 am AEST on 21 September 1999.

1.90 Because the main provisions on lease assignments commence on 22 February 1999, there is a need to have transitional provisions to cover the period from 22 February 1999 until 11.45 am AEST on 21 September 1999 when plant and equipment were within the CGT regime. The transitional provisions will be included in the IT (TP) Act 1997. How the transitional measures affect the lease assignments provisions are discussed in paragraphs dealing with these provisions. Their effect on Common rule 1 is discussed at paragraph 1.75.

1.91 The link note before Division 42 is amended [item 15 of Schedule 1] . The link note at section 43-110 is repealed [item 17 of Schedule 1] . This is necessary because of the insertion of Divisions 41 and 45, respectively.

Application of consideration rules in sections 45-5 and 45-10 to plant formerly owned by tax exempt entities

1.92 The amendments made by section 45-40 ensure that the amounts calculated by subsections 45-5(2) and 45-10(2) are the same as if Division 58 had applied to the disposal of the leased plant or an interest in leased plant [section 45-40] . The amendments are necessary because the amounts included by those sections would not otherwise include the full amount that would be incorporated by Division 58.

1.93 Division 58 of the ITAA 1997 sets out special rules that apply in calculating depreciation deductions and balancing adjustments for plant that was previously owned or quasi-owned by an exempt entity. It places a cap on the depreciation deductions that are available for that plant when it enters the tax net.

1.94 Division 58 provides for a special balancing adjustment calculation if the plant is on-sold (for more than that cap) after it enters the tax net. The special balancing adjustment recovers both:

•

the depreciation deducted since the asset entered the tax net; and

•

the difference between the depreciation cap and the market value at the time it entered the tax net (or up to the sale price if the sale price is less than that market value). Note: where the plant is sold for an amount in excess of that market value, capital gains would normally apply. However, capital gains will no longer apply from 11.45 am AEST on 21 September 1999, apart from a frozen indexation amount.

1. 95 Diagram 1.3 demonstrates the operation of the special balancing adjustment.

1. 96 Section 45-40 will only apply in the case of disposals to tax exempt and other tax advantaged entities [subsection 45-40(3)] . Where the plant or interest is disposed of to a taxable entity and roll-over relief is available, the depreciation cap will still operate to limit future deductions. In that case it is appropriate that sections 45-5 and 45-10 operate without modification. Where there is no roll-over, Division 58 will apply.

Modification of written down value

1. 97 The written down value of plant is generally its cost less amounts deducted for depreciation. When an entity enters the tax net (the transition time) it can choose to calculate its tax depreciation based on the notional written down value of the plant at that time. Division 58 modifies the definition of written down value (contained in section 42-200) so that the cost of the plant to that entity is taken to be its notional written down value at the transition time. The amendments will therefore modify the definition of written down value in subsection 995-1(1) of the ITAA 1997. [Item 6 of Schedule 10]