House of Representatives

Explanatory Memorandum

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

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Special transitional provision for some oyster farmers

Schedule 1 to this bill amends the IT(TP) Act 1997 and the ITAA 1997 to provide special transitional arrangements for oyster farmers capturing oyster spat by the traditional stick farming method.

Oyster farmers using the traditional stick farming method will be able to value certain stock at the start of the 2001-2002 income year based on an amount per stick used to capture the spat. The amount per stick is set out in the bill and depends on the type of stick used.

Date of effect: The proposed change applies to the valuation of certain oyster trading stock on hand at the start of the 2001-2002 income year.

Proposal announced: The measure was announced in former Assistant Treasurers Press Release No. 40 of 24 August 2001.

Financial impact: The amendments are expected to have an overall revenue cost of less than $5 million over a 4 year period commencing with the 2002-2003 income year.

Compliance cost impact: The measure will not increase compliance costs, or record keeping costs, for eligible oyster farmers. They are already required to comply with the trading stock rules.

Summary of regulation impact statement

Regulation impact on business

Impact: The eligible oyster farmers can comply with the trading stock rules from the 2001-2002 income year without having a large one-off increase in taxable income. This could have caused serious financial hardship for some farmers.

Main points:

•

The amendments do not create any new obligations or requirements for the taxpayers impacted. Therefore, there will be no increase in compliance costs for eligible oyster farmers.

•

The valuation method for oyster trading stock covered by the measure is the easiest for the industry. Amounts per stick were chosen after sample costings were prepared by the industry representatives.

Work in progress

Schedule 2 to this bill amends the ITAA 1997 to prevent the possibility of double taxation where an amount is paid in respect of work in progress (partially completed work for which a recoverable debt has not yet arisen).

The amendments will provide a specific deduction where a payment is made for a work in progress amount. They will also confirm that receipt of a work in progress amount is assessable income.

Date of effect: The amendments will apply to amounts paid on or after 23 September 1998.

Proposal announced: The measure was announced in former Assistant Treasurers Press Release No. 8 of 8 March 2001.

Financial impact: The revenue impact is unquantifiable, but is expected to be minimal because the amendments prevent an unintended gain to the revenue. The amendments are beneficial to taxpayers as they prevent the potential for double taxation.

Compliance cost impact: The amendments are expected to reduce compliance costs for business.

Capital allowances

Schedule 3 to this bill makes a number of technical corrections and amendments to the ITAA 1936, the ITAA 1997, IT(TP) Act 1997 and the New Business Tax System (Capital Allowances - Transitional and Consequential) Act 2001. The amendments all relate, directly or indirectly, to the capital allowances system.

Date of effect: These amendments have various dates of effect, but will generally apply from 1 July 2001.

Proposal announced: These amendments have not previously been announced.

Financial impact: There is no revenue impact as a result of these amendments as the amendments ensure that the capital allowance system operates as intended and as originally costed. However, there would be a significant but unquantifiable revenue cost if these amendments were not made.

Compliance cost impact: These amendments will involve no additional compliance costs.

Recovery of PAYG withholding amounts

Schedule 4 to this bill amends the ITAA 1936 to enable the Commissioner to recover all outstanding PAYG withholding amounts by making an estimate of the debt. The amendment will also allow a taxpayer to have the estimate of any PAYG withholding amount reduced or revoked by giving the Commissioner a statutory declaration.

Date of effect: The amendments in Schedule 4 will apply to PAYG withholding amounts that are due and payable in the year ended 30 June 2002 and in subsequent years.

Proposal announced: The amendments have not been announced.

Financial impact: The amendments will allow $50 million to be collected in 2002-2003 and in subsequent years.

Compliance cost impact: The amendments do not have any compliance cost impacts.

Chapter 1 - Special transitional provision for some oyster farmers

Outline of chapter

1.1 This chapter explains the amendments in Schedule 1 to this bill which provide a transitional measure for oyster farmers using the traditional stick farming method, to assist them to apply the trading stock provisions in the income tax law.

Context of amendments

1.2 Oyster farmers use the traditional stick farming method to catch Sydney rock oysters. The method consists of placing sticks (or slats) in the water in areas of natural oyster spatfall, to which immature oyster spat attach themselves. Sydney rock oysters take 4 years to grow to maturity. During this time they may remain attached to the sticks (or slats), or the farmer may knock the spat off the sticks (or slats) at various stages of growth, and allow them to grow to maturity in baskets or trays in the water. This allows more even growth and produces better shaped oysters. Once the oysters have been knocked off the stick or slat, they will not reattach to any surface.

1.3 Generally, oyster farmers using the traditional stick farming method have not been bringing to account as trading stock the oysters they hold which are growing in the water. Those oysters are trading stock, and farmers carrying on a business are required to bring them to account where they are on hand at the end of an income year.

1.4 If oyster farmers using the traditional stick farming method for the first time brought their trading stock to account in the 2001-2002 income year, there would be a large one-off excess in the value of their closing stock over their opening stock (zero). This difference would be assessable income, and could cause severe financial hardship for some farmers in the industry.

Summary of new law

1.5 The amendments will allow eligible oyster farmers to bring to account an opening value for their oyster trading stock in the 2001-2002 transitional year, equivalent to a value per stick multiplied by the number of sticks used to capture the oysters as spat.

Detailed explanation of new law

1.6 These amendments apply to particular oysters that are trading stock on hand to give them a special value as at the start of the 2000-2001 income year. The amendments insert section 70-41 into the IT(TP) Act 1997. If this section applies, the value of the particular oyster trading stock on hand at the start of the 2001-2002 income year is calculated using the method statement in this section, rather than any other trading stock valuation rules.

To whom does the transitional provision apply?

1.7 The transitional provision, section 70-41, will only apply to taxpayers carrying on a business of oyster farming. It does not apply to oyster hatcheries. Hatcheries generally breed oysters in a controlled environment for the purpose of selling the immature spat to oyster farmers. [Schedule 1, item 1, paragraph 70-40(1)(a)]

1.8 It is also a requirement that the taxpayer held certain oysters (described in paragraph 1.15) as trading stock on hand at the start of the 2001-2002 income year. These are called the relevant stockin the section.

1.9 The final requirement is that the relevant stock should have been, but were not, taken into account as trading stock at the end of the 2000-2001 income year under Division 70 of the ITAA 1997 (the trading stock rules). [Schedule 1, item 1, paragraphs 70-41(1)(b), (c) and (d)]

1.10 Without a special transitional valuation rule for these oysters, the opening value for the purposes of the trading stock rules of this oyster trading stock would be nil, in accordance with subsection 70-40(2) of the ITAA 1997.

1.11 In summary, these amendments apply to oyster farmers who have stock on hand at the start of the 2001-2002 income year, that consists of certain oysters (described in paragraph 1.15) that should have been, but were not, brought to account as trading stock on hand at the end of the 2000-2001 income year. They will be able to bring a special value for those oysters to account at the start of the 2001-2002 income year, in accordance with the method provided in subsection 70-41(6).

1.12 The transitional provision will not apply if the 2001-2002 income year is the first income year in which the taxpayer is carrying on a business of oyster farming. If 2001-2002 is the first year the taxpayer is carrying on a business they will not have had oyster trading stock that should have been brought to account at the end of the previous income year.

1.13 The transitional provision will also not apply if the taxpayer had brought any of the particular oysters to account as trading stock at the end of the 2000-2001 income year. If this is the case, the taxpayers opening stock value for the 2001-2002 income year will be worked out in accordance with section 70-40 of the ITAA 1997, and because the opening value will not be nil, no special transitional rule is required.

Which oysters are subject to the transitional provision?

1.14 Subsection 70-41(2) describes the oysters to which this transitional provision applies. It only includes those oysters that:

•

were farmed by the taxpayer solely for food as human consumption;

•

had not been harvested at the start of the 2001-2002 income year; and

•

had been acquired by the taxpayer using the traditional stick farming method.

[Schedule 1, item 1, subsection 70-41(2)]

1.15 Oysters that the taxpayer held as trading stock on hand at the start of the 2001-2002 income year and that satisfy these conditions, are called the relevant stock in the section.

1.16 Oysters that have been farmed for purposes other than solely for human consumption (such as pearling oysters) are already being brought to account as trading stock, and therefore do not require a special transitional provision. [Schedule 1, item 1, paragraph 70-41(2)(a)]

1.17 The practice in the oyster farming industry has been to bring harvested oysters that are on hand at the end of an income year to account as trading stock. Therefore, harvested oysters are excluded from this provision. [Schedule 1, item 1, paragraph 70-41(2)(b)]

1.18 The traditional stick farming method is the placing of plastic slats or wooden sticks in the water for the purpose of capturing oyster spat, and the oyster spat attaching themselves to those slats or sticks. [Schedule 1, item 1, paragraph 70-41(2)(c)]

1.19 The oysters must have been acquired by the taxpayer, using the traditional stick farming method. Therefore, even if someone else captured the oysters using the traditional stick farming method, and the taxpayer purchased the oysters from them, this transitional provision will not apply to those oysters. [Schedule 1, item 1, paragraph 70-41(2)(c)]

1.20 Although the oysters must have been acquired by the taxpayer using the traditional stick farming method, some of those oysters may have been knocked off the slats or sticks since acquisition and placed in trays or baskets (or some other container) in the water to continue to grow. As long as these oysters have not yet been harvested, this transitional provision will still apply to these oysters. [Schedule 1, item 1, paragraph 70-41(2)(c)]

What happens if the transitional provision applies?

1.21 If the transitional provision applies then the value of the relevant stock, as at the start of the 2001-2002 income year, is worked out under this transitional provision, rather than under Division 70 (the general trading stock rules) or Subdivision 328-E (the trading stock provisions for STS taxpayers) of the ITAA 1997. [Schedule 1, item 1, subsections 70-41(3) to (5)]

1.22 The general rule is that the value of the relevant stock as items of trading stock on hand is worked out using the method statement in new subsection 70-41(6) of the IT(TP) Act1997. It is not to be worked out under section 70-40 of the ITAA 1997.

STS taxpayers

1.23 There is a special rule in this transitional provision for calculating the value of opening stock for taxpayers that were STS taxpayers for the 2001-2002 income year. This is because subsection 328-295(1) of the STS provisions provides a value for all of the trading stock on hand at the start of the income year. There may be a situation where an oyster farmer has trading stock other than relevant stock (e.g. oysters that have been harvested), and in this case if the transitional provision applied to the exclusion of section 328-295, only a value for the relevant stock would be able to be brought to account at the start of the 2001-2002 income year.

1.24 The special rule for STS taxpayers in subsection 70-41(5) provides that trading stock on hand at the start of the 2001-2002 income year is to be valued by using the method statement in subsection 70-41(6) of the IT(TP) Act 1997for the value of the relevant stock, and adding this to the value of any other trading stock that was brought to account under Division 70 of the ITAA 1997at the end of the 2000-2001 income year. The relevant stock is not to be counted twice.

1.25 If there was no other trading stock, or no other trading stock was brought to account at the end of the 2000-2001 income year, then the value of all of the trading stock on hand at the start of the 2001-2002 income year is the value of the relevant stock worked out using this transitional provision.

1.26 Subsection 70-41(5) only refers to other trading stock brought to account under Division 70 at the end of the 2000-2001 income year (rather than under Division 70 or Subdivision 328-E), because the STS provisions in Division 328 of the ITAA 1997 only apply to an income year starting after 30 June 2001. Therefore, no value for the other stock could have been brought to account under the STS provisions at the end of the 2000-2001 income year.

How does the transitional valuation method work?

1.27 The method statement in subsection 70-41(6) applies to give a value to the relevant stock on a per stick (or slat) basis.

1.28 The method statement effectively requires the number of wooden sticks or plastic slats that were used to capture the relevant stock to be calculated. This requires a calculation of not only the sticks (or slats) that were in use at the start of the 2001-2002 income year to capture spat, but also the number of sticks (or slats) that were used to capture the relevant stock that is no longer attached to sticks. The numbers of wooden sticks, 1 metre long plastic slats and 2 metre long plastic slats must be differentiated.

1.29 As well, if any sticks (or slats) were reused, they must be counted each time they were used.

1.30 The number of wooden and 2 metre long plastic slats used to capture the relevant stock are multiplied by $1, and the number of 1 metre long plastic slats used is multiplied by $0.50. The value of the relevant stock is the sum of those 2 calculations.

1.31 These values were arrived at based on an average of sample costings prepared by industry representatives.

1.32 The application of the method statement is demonstrated in Example 1.1.

Example 1.1

Robert is an oyster farmer to whom the transitional provision applies.

At 1 July 2001 Robert had wooden sticks and 1 metre long plastic slats in the water to capture oyster spat, as well as oysters at various stages of maturity in baskets in the water.

Steps 1 and 2: Robert calculates that he had 2,000 1 metre long plastic slats in the water at 1 July 2001, and the oysters in baskets were captured using 1,000 of the plastic slats that are currently in the water being reused, and another 1,000 plastic slats that were each used twice. Therefore the result of step 1 and step 2 is 5,000 1 metre long plastic slats.

Step 3: The 5,000 plastic slats from step 2 are multiplied by 50 cents to give $2,500.

Step 4: Robert does not use any plastic slats that are 2 metres long. He also does not reuse any of his wooden sticks. He had 3,000 wooden sticks in the water at 1 July 2001, and he estimates that the oysters in baskets were captured using 6,000 wooden sticks. Therefore the total number of wooden sticks used to acquire the relevant stock is 9,000.

Step 5: As none of the wooden sticks are reused the result of step 5 is also 9,000.

Step 6: The result of step 5 is multiplied by $1 to give $9,000.

Step 7: The results of steps 3 and 6 are added together:

$2,500 + $9,000 = $11,500.


This is the value of Roberts relevant stock.

1.33 The slats and sticks that are referred to in the method statement as being used to acquire the relevant stock are the slats and sticks that were placed in the water for the purposes of capturing the oyster spat using the traditional stick farming method (as described in paragraph 70-41(2)(c)). [Schedule 1, item 1, subsection 70-41(7)]

Certain provisions not affected

1.34 Section 70-41 does not affect the operation of any of the following provisions:

•

section 102AAY of the ITAA 1936 (modified application of trading stock provisions for certain non-resident trust estates);

•

section 397of the ITAA 1936 (modified application of trading stock provisions for eligible CFCs);

•

section 57-115 of Schedule 2D to the ITAA 1936 (modified application of trading stock provisions for tax exempt entities that become taxable); and

•

section 165-115W of the ITAA 1997 (trading stock decrease for a CGT asset).

[Schedule 1, item 2, subsection 70-41(5)]

Application and transitional provisions

1.35 The amendments will only apply to the opening stock value of eligible oyster farmers for the 2001-2002 income year. After this, the normal trading stock rules will apply.

Consequential amendments

1.36 Notes have been inserted into the ITAA 1997at the end of section 70-40 (the general trading stock rule about the value of trading stock at the start of an income year) and at the end of subsection 328-295(1) (the STS rules about the value of trading stock at the start of an income year). These notes provide signposts to the transitional provision for oyster trading stock acquired using the traditional stick farming method. [Schedule 1, items 2 to 5]

1.37 Also, a note has been inserted into the dictionary in subsection 995-1(1) of the ITAA 1997 after the definition of value of an item of trading stock. This note also acts as a signpost to the transitional provision for oyster trading stock acquired using the traditional stick farming method. [Schedule 1, items 6 and 7]

REGULATION IMPACT STATEMENT

Policy objective

1.38 The objective of these amendments is to assist oyster farmers using the traditional stick farming method (eligible oyster farmers) to apply the trading stock rules. The amendments will provide a transitional treatment to allow oyster farmers to apply an opening stock value to their trading stock in the transitional year. This will remove any transitional costs in complying with the trading stock rules.

Implementation options

1.39 Legislative amendments are necessary to implement the transitional measure to assist eligible oyster farmers to apply the trading stock rules.

1.40 Without legislative amendments eligible oyster farmers who have not been bringing trading stock to account would be required to have an opening value for trading stock of nil in the first year they began to comply with the trading stock rules.

1.41 There were 2 options considered for describing the value that could be used by eligible oyster farmers for their opening stock for the 2001-2002 income year. The first was to allow these oyster farmers to bring the costs of their trading stock to account on a per stick basis, but require each individual oyster farmer to calculate their costs, and average them over the number of sticks.

1.42 The second option was to provide a value per stick in the legislation that could be applied to the number of sticks used by an eligible oyster farmer in capturing their oyster stock.

Assessment of impacts

1.43 Under either of the 2 options, the amendments will only have an impact for the transitional income year of 2001-2002. These amendments are designed to ensure that there will be no transitional cost to stick farmers in applying the trading stock rules for the first time. Eligible oyster farmers will not be required to account for the difference between the nil value of the opening stock (which is what the law would otherwise provide) and the value of the closing stock in the year they commence compliance with the trading stock rules (2001-2002).

Impact group identification

1.44 The transitional measure applies to oyster farmers using the traditional stick farming method to capture oyster spat grown solely for human consumption (eligible oyster farmers). This method of capturing oyster spat is almost exclusively used to capture spat of the Sydney rock oyster (Saccostrea commercialis), which is grown in New South Wales and Queensland. There are approximately 500-600 oyster farmers using the traditional stick farming method.

Analysis of costs/benefits

1.45 Neither option would create any new obligations or requirements for the taxpayers impacted.

1.46 There will be no increase in administrative costs for the ATO.

1.47 The amendments will benefit eligible oyster farmers, who otherwise would have been required to bring the value of all of their trading stock to account in one income year, in the first year they began to apply the trading stock rules. This would have resulted in a large one-off increase in income that would have caused serious financial hardship to some eligible farmers. Instead, they will be allowed to apply an opening stock value for the transitional year, which means that only changes in the value of their trading stock over the year will be brought to account at the end of the income year.

1.48 The first option would require each farmer to calculate the actual costs incurred in capturing their oyster trading stock on hand at the start of the 2001-2002 income year. As Sydney rock oysters take 4 years to mature, many of these costs would have been incurred over the previous 3 to 4 years. The number of sticks (or plastic slats) used to capture the oyster trading stock would also need to be calculated and the costs incurred averaged over the number of sticks (or slats) used.

1.49 The second option would require each farmer to calculate the number of sticks (or plastic slats) that were used to capture their oyster trading stock on hand at the start of the 2001-2002 income year. They would then multiply this by the value provided for each stick in the legislation. There would be no need to calculate the actual costs incurred in capturing the stock on hand at the start of the 2001-2002 income year.

Consultation

1.50 Oyster industry representatives have been consulted extensively over several years on the trading stock obligations of oyster farmers, and on the current proposal to provide transitional measures.

1.51 Following consultation it has been accepted by the industry that oysters are trading stock, and must be brought to account each income year.

1.52 The difficulties for oyster farmers in retrospectively calculating the actual costs involved in capturing the oyster trading stock on hand at the start of the 2001-2002 income year were highlighted during consultation.

Conclusion and recommended option

1.53 The amendments will benefit eligible oyster farmers and prevent a large one-off increase in their taxable income that would otherwise occur when they started to comply with the trading stock rules.

1.54 After consultation with industry representatives the second option (as described in paragraph 1.50) was chosen, as the method that imposed the least compliance costs on the industry. Values were chosen based on sample costings prepared by the industry representatives. The values provided in the legislation are $1 for each wooden stick and 2 metre plastic slat, and $0.50 for each 1 metre plastic slat.

Chapter 2 - Work in progress

Outline of chapter

2.1 This chapter explains amendments in Schedule 2 to this bill which clarify the taxation treatment of payments and receipts in respect of work in progress. The amendments do not cover partly completed goods (e.g. of manufacturers) which are normally brought to account as trading stock. The amendments will ensure that amounts in respect of work in progress that are assessable to the recipient, are deductible to the payer, and therefore are not effectively taxed a second time in the hands of the payer when they complete the work and bill the clients.

Context of amendments

2.2 Work in progress is work (but not goods) that has been partially performed but not yet completed to the stage that a recoverable debt has arisen in respect of the work. Commonly, a recoverable debt will arise when the work is billed, so work in progress will be work that has not yet been performed to a billable stage.

2.3 As a result of various court decisions, the taxation treatment of amounts paid or received in respect of work in progress has given rise to the potential for the taxation of the same amount twice, albeit in the hands of different taxpayers.

Example 2.1

Michael, Robyn and Emma carry on a practice as solicitors in partnership but Emma decides to leave the partnership. On 30 June 2002 the partnership is dissolved and Emma is paid $100,000 for her interest in the partnership, $60,000 of which is in respect of work in progress. Under the current law, the $60,000 would be assessable as ordinary income to Emma. However, it is not deductible to Michael and Robyn, even though when they complete the work and bill the clients, those amounts will be fully assessable. This effectively taxes the $60,000 twice - once in Emmas hands on leaving the partnership, and again in Michael and Robyns hands when the amounts are actually billed to the clients.

2.4 In Crommelin v DC of T (1998)
39 ATR 377,
98 ATC 4790 the Federal Court followed the decisions in previous cases (Jamieson v IRC (NZ) (1974)
4 ATR 327,
74 ATC 6008; Stapleton v FCT (1989)
20 ATR 996,
89 ATC 4818) and held that a payment received by a partner retiring from a partnership for his share of the work in progress of the partnership was assessable income according to ordinary concepts. The Federal Court also held that there was no need for an express agreement that a specific amount be paid in respect of work in progress, as long as that amount is capable of being identified as being paid for that reason.

2.5 Also, in Coughlan v FC of T
91 ATC 4505 the Federal Court held that, where there was a change in the partners of an accounting firm, an amount paid by the new partnership in respect of the work in progress of the old partnership was a non-deductible capital amount.

2.6 The Commissioner previously dealt with this anomaly in the case of an exiting partner by an administrative practice set out in Taxation Ruling IT 2551 (Sale of interest in a professional partnership: Amounts paid to retiring partners on account of work in progress). The ruling clarified that the Commissioner did not seek to tax the same amount twice. It stated that where an amount in respect of work in progress is included in the assessable income of an outgoing partner, it should be shown in the accounts of the reconstituted partnership as an advance to the outgoing partner. The ruling stated that no deduction would be allowable. However, as work in progress is completed and billed, the amounts billed would not be treated as income of the partnership to the extent that they are attributable to the advance.

2.7 The Commissioner withdrew Taxation Ruling IT 2551 on 23 September 1998 following the decision in Crommelin v FCT , as the approach taken was no longer tenable at law.

Summary of new law

2.8 The proposed amendments will provide a specific deduction where apayment is made in respect of work in progress. They will also confirm that receipt of a workin progress amount is assessable income. This will remove any potential for double taxation.

2.9 Although the issue of work in progress commonly arises in the context of professional partnerships, the amendments apply generally to situations where payments are made in respect of work in progress. They are not restricted to partnership situations.

Detailed explanation of new law

Definition of work in progress amount

2.10 A work in progress amount has been defined in subsections 25-95(3) and (4) of the ITAA 1997.

2.11 Under this definition an amount will be a work in progress amount to the extent that it satisfies the criteria in paragraphs 25-95(3)(a) and (b). The use of the expression to the extent that means that, although a larger lump sum amount may be paid in some situations, it must be apportioned between that part of the amount that is a work in progress amount and that part that is not. To the extent that an amount is a work in progress amount, the rules about assessability and deductibility contained in these amendments will apply. [Schedule 2, item 5, subsection 25-95(3)]

2.12 The conditions in paragraphs 25-95(3)(a) and (b) are that an entity agrees to pay the amount to another entity, and that the amount can be identified as being in respect of work (but not goods) that has been partially performed by the recipient for a third entity, but not yet completed to the stage where a recoverable debt has arisen in respect of the work. [Schedule 2, item 5, paragraphs 25-95(3)(a) and (b)]

2.13 It is a requirement that the work has been partially performed by the recipient of the amount for a third entity. This eliminates the possibility that a payment made by the entity for whom the work is being performed would satisfy the definition of a work in progress amount, and therefore potentially be deductible under these provisions. It is generally envisaged that the entity who pays an amount for work in progress will attempt to complete the work and bill the entity for whom the work is being performed. It is recognised however, that the work may not be completed, or billed for, in all cases.

2.14 As defined for the purposes of the ITAA 1997, work in progress does not cover work in progress that is goods, for example, the work in progress of a manufacturer. Partially completed goods are generally brought to account as trading stock of the manufacturer of the goods. A work in progress amount also does not include an amount paid for a partially completed structure such as a building.

2.15 A payment for shares in a company or units in a unit trust will not be a work in progress amount even if the value of work in progress was taken into account in valuing the shares or units.

2.16 The work in progress amount is defined in terms of work that has been performed but which has not yet been completed to a stage where a recoverable debt has arisen. Once a legal entitlement to payment for the work arises and a debt is created, the amount can then be brought to account as a receivable of the entity to whom the payment is owed.

2.17 The amount must be able to be identified as an amount in respect of work that has been performed but not yet completed to the stage where a recoverable debt has arisen. A work in progress amount need not be specified in a contract between the parties. A work in progress amount may be able to be identified by looking to all the surrounding circumstances, including working documents or accounts demonstrating how the amount was calculated.

Future payments

2.18 In some situations payments may be made in respect of work in progress at one or more future points in time. This may occur when an amount is specified in an agreement, but paid in instalments over time. One or more of those instalments may be paid after the work has been completed. The amendments provide that an amount does not stop being a work in progress amount because it is paid after a recoverable debt has arisen in respect of the completion of the work. [Schedule 2, item 5, subsection 25-95(4)]

2.19 If the amount specified in the agreement can be identified as being in respect of work in progress, then each time a payment of part of this amount is paid, it will also be in respect of work in progress. In this case, each time part of the amount is paid, it will be deductible in the income year in which it is paid (subject to the rules about timing of a deduction for a work in progress amount in subsections 25-95(1) and (2)). This is the case even if the work has been completed before the amount is paid.

2.20 Parties may also agree to make payments in respect of work in progress at future points in time based on a formula. In this case, no amount is specified, rather, a method of calculating the quantum of each payment is provided. When each amount is quantified it will still be an amount in respect of work in progress if the original formula is intended to provide for an amount or amounts in respect of work in progress. This is so, even if the work has been completed and billed by the time the amount(s) is calculated and paid. The amount(s) is not deductible until the income year in which it is paid (and is subject to the rules about timing of a deduction for a work in progress amount in subsections 25-95(1) and (2)).

Cash and accruals taxpayers

2.21 The amendments apply to taxpayers whether they return their income on a cash basis or an accruals basis. The potential for double taxation arises even if both the payer and the payee account for their income on a cash basis.

Method of calculating the value of work in progress

2.22 The provisions do not provide a method for valuing a work in progress amount. This is a commercial decision between the parties.

Deductibility of work in progress amounts

2.23 Section 25-95 provides a deduction for a work in progress amount that a taxpayer pays. [Schedule 2, item 5, section 25-95]

2.24 The payment of a work in progress amount will be deductible in the income year in which it was paid, to the extent that, as at the end of that income year:

•

a recoverable debt has arisen in respect of the completion or partial completion of the work to which the amount related; or

•

you reasonably expect a recoverable debt to arise in respect of the completion or partial completion of that work within 12 months after the amount was paid.

[Schedule 2, item 5, subsection 25-95(1)]

2.25 At the end of the income year in which a party pays a work in progress amount, the party should evaluate when a recoverable debt for the completion or partial completion of the work in progress to which the payment relates, is likely to arise.

2.26 To the extent to which a recoverable debt for the completion or partial completion of the work in progress to which the payment relates, cannot reasonably be expected to arise within 12 months of the date of the payment, that amount will be deductible in the following income year. [Schedule 2, item 5, subsection 25-95(2)]

2.27 If none of the work in progress amount is deductible in the income year in which the payment is made, the entire amount is deductible in the following income year. This is the case even if no recoverable debt is expected to arise in the future.

2.28 This deferral of a deduction is required to make the tax treatment of the payment more accurately reflect the economic outcome of the payment. Where part of the payment relates to gaining assessable income of a future income year, part of the deduction should also be deferred to that later year. However a simplified approach has been taken to defer the deduction for only one income year, in recognition of the compliance costs that would be involved in matching the deduction to the income year in which each individual item of work was billed. This full matching approach was previously required by the Commissioners administrative practice, set out in Taxation Ruling IT 2551.

Example 2.2

David runs an accounting practice as a sole trader. On 25 August 2002, David accepts an offer from Tom and Tina to buy the practice. As part of the agreement Tom and Tina will pay David $10,500 for the work in progress of the practice. This amount is set out in the agreement, along with various other amounts for the assets of the practice. Tom and Tina then carry on the accounting practice as a partnership.

On 30 June 2003, $3,000 of the work in progress as at 25 August 2002 has already been billed to clients, and of the remaining work related to the payment made to David, $5,000 of it could reasonably be expected to be completed and billed by 25 August 2003. Therefore, $8,000 of the payment will be deductible in the 2002-2003 income year. The remaining $2,500 will be deductible in the following income year (2003-2004).

2.29 The term you reasonably expect requires the payer to have the expectation (that a recoverable debt will arise within 12 months) and that the expectation is objectively assessed. For an expectation to be reasonable it must be more than a mere possibility, and could be based on a number of factors including deadlines imposed by the client, external factors such as court hearing dates, stage of completion of the work and progress payments built into the contract for the work.

Assessability of work in progress payments

2.30 A work in progress amount that is received will be included in the assessable income of the recipient under section 15-50 of the ITAA 1997. It will be assessable income in the income year in which it is received. [Schedule 2, item 3, section 15-50]

Recoupment

2.31 If a work in progress amount is paid and that payment gives rise to a deduction under section 25-95, any later recoupment of any of that work in progress amount will be included in the taxpayers assessable income under the rules contained in Subdivision 20-A of the ITAA 1997. [Schedule 2, item 4, subsection 20-30(1)]

Application and transitional provisions

2.32 The proposed amendments will apply to amounts paid on or after 23 September 1998. This is the date on which Taxation Ruling IT 2551 was withdrawn. The amendments will be beneficial to taxpayers as they will prevent any potential for double taxation. [Schedule 2, item 7]

Consequential amendments

2.33 Sections 10-5 and 12-5 of the ITAA 1997 will be amended to include sections 15-10 and 25-95 in the respective summary tables. [Schedule 2, item 1, section 10-5 and item 2, section 12-5]

Chapter 3 - Capital allowances

Outline of chapter

3.1 This chapter explains technical corrections and amendments made to:

•

various provisions of the ITAA 1997 to ensure that the capital allowances system operates as intended and that the other capital allowances, GST, STS and CGT provisions interact appropriately with the capital allowances system;

•

various provisions in the ITAA 1936 and the IT(TP) Act 1997 that relate to the capital allowances system or to depreciating assets, to ensure that they apply as intended;

•

overcome the fact that certain consequential amendments to particular provisions were not taken into account when later amendments repealed and replaced those provisions; and

•

an application clause in the New Business Tax System (Capital Allowances - Transitional and Consequential) Act 2001 to ensure that amendments made by that Act, apply as intended.

Context of amendments

3.2 The capital allowances system was enacted with effect from 1 July 2001 to allow deductions for the cost of a depreciating asset over a period that reflects the effective life of the asset. The capital allowances system is also intended to provide deductions over 5 years for 7 categories of capital expenditure that are not recognised elsewhere in the income tax law (i.e. certain blackhole expenditure). The provision intended to achieve that objective is section 40-880 of the ITAA 1997.

3.3 The technical corrections and amendments explained in this chapter ensure that the capital allowances system operates as intended and interacts appropriately with other related provisions.

Detailed explanation of the amendments

Capital allowances - Division 40 of the ITAA 1997

Subdivision 40-B - core provisions

Prime cost method

3.4 Subsection 40-75(1) contains the formula for using the prime cost method of working out the decline in value of a depreciating asset. The formula applies for both the year in which an assets start time occurs, called the start year, and later income years. However, subsection 40-75(2) adjusts the formula should any of the circumstances in paragraphs 40-75(2)(a) to (f) arise in later income years.

3.5 Paragraph 40-75(2)(c) applies to adjust the prime cost formula where section 40-90 (about debt forgiveness) applies. Item 17amends this paragraph by deleting the reference to cost and replacing the reference to adjustable value with opening adjustable value. The concept of cost is only relevant for calculating the decline in value in the start year and, as explained in paragraph 3.4, subsection 40-75(2) only applies in later income years. Further, replacing adjustable value with opening adjustable value will make the paragraph consistent with subsection 40-90(3) which adjusts an assets opening adjustable value, not its adjustable value.

3.6 Paragraph 40-75(2)(d) adjusts the prime cost formula where section 40-340 (about roll-over relief) applies. Item 18repeals this paragraph. As explained in paragraph 3.4, adjustments to the prime cost formula are only necessary in later income years and not in the start year. As the section 40-340 roll-over only applies for the start year it is unnecessary to have a provision requiring the prime cost formula to be adjusted.

3.7 Paragraph 40-75(2)(e) applies to adjust the prime cost formula where paragraph 40-365(5)(b) (about involuntary disposals) applies. Item 19replaces adjustable value with opening adjustable value. This amendment makes paragraph 40-75(2)(e) consistent with paragraph 40-365(5)(b), which adjusts an assets opening adjustable value, not its adjustable value.

3.8 Paragraph 40-75(2)(f) applies to adjust the prime cost formula where certain provisions regarding the interaction of GST and Division 40 apply. Item 21 adds subsection 27-80(3A) to paragraph 40-75(2)(f) to ensure that the prime cost formula is adjusted where an assets opening adjustable value is reduced by an input tax credit in the circumstances set out in subsection 27-80(3A). Further, item 20 deletes an asterisk from the term opening adjustable value which is now unnecessary due to the earlier use of the defined term in paragraph 40-75(2)(c).

Remaining effective life and roll-over relief

3.9 Where roll-over relief applies to a depreciating asset under section 40-340 (e.g. disposal of a depreciating asset to a wholly-owned company), section 40-345 ensures that an amount is not included in assessable income. Section 40-345 also ensures that the transferee deducts the decline in value of the asset using the same method that the transferor was using. This means the transferee will need to apply the formula in subsection 40-75(1), if the transferor was using the prime cost method, and will need to work out the remaining effective life of the transferred asset.

3.10 Currently, the definition of remaining effective life in subsection 40-75(4) refers to the period of an assets effective life that is yet to elapse as at the start of the change year. However, as paragraph 40-75(2)(d) is to be repealed (refer to paragraph 3.6), there will be no change year in relation to roll-over relief and therefore the remaining effective life definition would not apply.

3.11 Item 22amends subsection 40-75(4) to ensure that the definition of remaining effective life can apply to roll-over relief under section 40-340. The amendment will define remaining effective life for roll-over relief purposes as the period of an assets effective life that is yet to elapse at the time the balancing adjustment event occurs for the transferor.

Opening adjustable value

3.12 Broadly, the opening adjustable value for a depreciating asset for an income year, as defined in subsection 40-85(2), is its adjustable value to the taxpayer at the end of the previous income year. The adjustable value of an asset, as defined in subsection 40-85(1), generally reflects its cost less its decline in value at a certain point in time. Item 23 repeals the 2 existing notes to subsection 40-85(2) and replaces them with a note that comprehensively lists all the provisions that potentially modify the opening adjustable value of a depreciating asset. This signposts the reader to these other provisions to ensure that they take them into account when working out the opening adjustable value of an asset for an income year.

Subdivision 40-C - cost

3.13 Subdivision 40-C, comprising sections 40-170 to 40-230, deals with how the cost of a depreciating asset is worked out. Section 40-175 provides that the cost of a depreciating asset consists of first and second elements of cost. Item 24 adds a note to section 40-175 to list all the provisions that potentially modify cost. This signposts the reader to these other provisions to ensure that they take them into account when working out the cost of a depreciating asset, for example, in the case where CGT event K7 applies.

3.14 Section 40-180 states that the first element of cost is either the amount worked out by reference to the table contained in subsection 40-180(2), or the amount the taxpayer is taken to have paid to hold the asset under section 40-185.

3.15 Item 25reverses the order of existing items 5 and 6 in the table in subsection 40-180(2). Existing item 5 in the table sets out the cost of a depreciating asset in the case where roll-over relief applies under section 40-340 for a balancing adjustment event happening to that asset. Existing item 6 in the table sets out cost of a depreciating asset in the case where an asset becomes a partnership asset and was previously held by a person who is a partner or, where there is a variation in the constitution of the partnership or in the interests of the partners in the partnership.

3.16 Where there is a variation in the constitution of a partnership, or in the interests of the partners in the partnership, as envisaged by existing item 6 in the table, there is optional balancing adjustment roll-over relief available under section 40-340. If roll-over relief is chosen, taxpayers should have a cost as determined by item 5. However, because the structure of the table states that you apply the last applicable item, item 6 will always prevail over item 5 in the case of a variation in the partnership. This is irrespective of the fact that roll-over relief under section 40-340 may apply to the balancing adjustment event. Reversing the items in the table will ensure that where roll-over applies, the cost of a depreciating asset is correctly determined by reference to the roll-over relief item.

3.17 Item 26 amends item 12 of the table in subsection 40-180(2) to ensure that the cost for a depreciating asset is able to be worked out where a balancing adjustment event happens to a depreciating asset because a person dies and the asset, which is allocated to a low-value pool, devolves to the persons legal personal representative. The item in the table currently states that the assets cost is its adjustable value at the time of death.

3.18 Where assets are allocated to a low-value pool they do not retain an identifiable adjustable value as the adjustable value is subsumed into the pool balance. Item 26 will ensure that cost is able to be worked out when an asset is allocated to a low-value pool. In that case, the assets cost will be so much of the closing pool balance for the income year in which the person dies as is reasonably attributable to that asset. The amendment will also ensure that the terminology used in relation to the persons death is consistent with terminology used in the CGT provisions.

3.19 Item 38amends subsection 40-365(5) (about involuntary disposals) to ensure that cost is always adjusted where there has been an involuntary disposal of an asset and the taxpayer has chosen, under section 40-365, to reduce the cost or opening adjustable value of a replacement asset rather than include a balancing adjustment amount in assessable income. Currently, only the opening adjustable value is adjusted in a later income year. This amendment ensures section 40-365 interacts appropriately with the definition of cost by providing that cost is always reduced whether the relevant year is the start year or a later income year.

Car limit

3.20 Special provisions apply under the capital allowances system to luxury cars. Broadly, the first element of cost of a luxury car is reduced to the car limit (an amount that is indexed annually), thereby limiting the amount able to be written off.

3.21 Item 28amends subsection 40-230(1) and ensuresthat both section 40-225 and Subdivision 27-B (which deals with the effect of GST on the capital allowances system) apply to reduce the cost of a luxury car before it is reduced by the car limit applicable to the financial year in which the taxpayer starts to hold the car. This ensures that the GST component does not apply after the car limit and does not further reduce the cost of the car below the car limit.

3.22 Item 29 amends section 40-230 to ensure that where a luxury car is held by one or more entities, the car limit is applied to the cost of the car and not to the cost of each entitys interest in the car. This is despite section 40-35, which generally treats each individual interest in a jointly held depreciating asset as a separate asset. However, once the car limit is applied to the cost of the car, section 40-35 then applies to apportion the cost of the car, as reduced to the car limit, between the holders. This amendment ensures that where the car is jointly held, each entitys interest in the cost of the car is not compared with the car limit.

Subdivision 40-D - balancing adjustments

3.23 Broadly, section 40-285 explains when an amount is included in assessable income (subsection 40-285(1)) or a deduction is allowed (subsection 40-285(2)) as a result of a balancing adjustment event. Item 31 adds a new note 2 to subsection 40-285(2). The new note highlights to readers that the timing of a deduction under subsection 40-285(2) is determined under Subdivision 170-D (which deals with transactions by a company that is a member of a linked group) where that Subdivision applies to the balancing adjustment event. Item 30 consequentially makes the existing note, note 1.

Partners and partnerships

3.24 There are special rules that apply to partners and partnerships for the purposes of Subdivisions 40-D (balancing adjustments) and 40-G (which deals with capital expenditure incurred on landcare operations, electricity connections and telephone lines).

3.25 Items 32 and 37 amend paragraphs 40-295(2)(b) (which sets out the meaning of balancing adjustment event) and 40-340(3)(b) (about roll-over relief) of Subdivision 40-D. The amendments replace the word held with the words had an interest in. These amendments arise because item 7 of the table in section 40-40 (which sets out the meaning of hold) treats the partnership as the holder of partnership assets. As a consequence, when read literally, paragraphs 40-295(2)(b) and 40-340(3)(b) may not apply. For example, where there is a variation in a partnership that holds a partnership asset, the partnership that held the asset prior to the variation will not be the same partnership that holds the asset after the variation. However, one or more of the partners that have an interest in the asset prior to the variation may be the same partners that have an interest in the partnership asset after the variation. Where this is the case, these amendments will ensure that subsections 40-295(2) and 40-340(3) apply as intended.

Termination value

3.26 Section 40-300 provides the meaning of termination value which is used to calculate a balancing amount. Item 33 amends item 9 in the table in subsection 40-300(2) to ensure that the termination value for a depreciating asset is able to be worked out where a balancing adjustment event happens to a depreciating asset because a person dies and the asset, which is allocated to a low-value pool, starts being held by the persons legal personal representative. It currently states that termination value is the adjustable value of the asset. Assets allocated to a low-value pool do not retain an identifiable adjustable value as the adjustable value is subsumed into the pool balance.

3.27 Item 33 will ensure that the termination value can be worked out when an asset is allocated to a low-value pool. In that case, the assets termination value will be so much of the closing pool balance for the income year in which the person died as is reasonably attributable to that asset. This amendment, and the amendment in item 34 of this bill, will also ensure that the terminology used, in relation to a persons death, in items 9 and 10 in the table in subsection 40-300(2) is consistent with terminology used in the CGT provisions.

3.28 Item 35amends section 40-300 to ensure that the termination value of an asset does not include an amount that is included in assessable income as ordinary income under section 6-5 of the ITAA 1997, or in statutory income under section 6-10 of that Act, except where the amount is statutory income because of Division 40. It is arguable under the existing law that some amounts may be included in termination value as worked out under the table in paragraph 40-305(1)(b) and may also be regarded as ordinary or statutory income because of some other provision outside of Division 40. This item ensures that double taxation does not occur. It also inserts a note immediately after the provision to highlight to the reader that the termination value may be modified by Subdivision 27-B (about GST).

Car limit

3.29 As explained in paragraph 3.20, certain provisions apply to adjust the first element of cost of a luxury car. Similarly, section 40-325 applies a formula to reduce the termination value of the car so that it reflects an amount proportional to the amount that the taxpayer used to work out the decline in value.

3.30 Item 36 adjusts the equation in section 40-325 so that, in working out the fraction to be applied to adjust the termination value, the total cost of the car (ignoring the car limit) is subject to the application of Subdivision 27-B (about GST). As the GST component is excised from cost before the car limit applies, it should also be excised from the total cost of the car for the purposes of the equation in this provision.

Interaction of Subdivisions 40-B and 40-D with Subdivisions 40-E, 40-F and 40-G

3.31 Subdivision 40-E sets out rules governing the use of low-value pools for certain low-cost assets. Broadly, in relation to low-value pools, a taxpayer may choose to work out the decline in value of a depreciating asset through a low-value pool where that asset is a low-cost asset (i.e. cost is less than $1,000) or where the decline in value has been worked out using the diminishing value method and the assets opening adjustable value in the relevant income year is less than $1,000.

3.32 In relation to low-value pool assets,item 14amends subsection 40-25(5) of Subdivision 40-B. The amendmentensures that, despite subsection 40-25(1), a taxpayer is able to continue to deduct an amount for a depreciating asset that was allocated to a low-value pool, even though the taxpayer no longer holds that asset. Upon disposal of a pooled asset the termination value of that asset is reflected as a reduction of the pool balance. However, where the termination value is less than the amount still to be written off, this amendment will allow the taxpayer to continue to write-off the remaining pool balance attributable to that asset even though they no longer hold it.

3.33 Item 14 creates an exception to the general rule in subsection 40-25(1) that a deduction equal to the decline in value of an asset for an income year is only available if an entity holds the asset during the income year.

3.34 Subdivision 40-F sets out the deduction rules for capital expenditure on depreciating assets that are water facilities, horticultural plants or grapevines. Subdivision 40-G sets out the rules for capital expenditure incurred on landcare operations, electricity connections and telephone lines.

3.35 Item 16 amends subsections 40-50(1) and (2) of Subdivision 40-B (core provisions). These subsections currently ensure that a deduction does not arise under Subdivision 40-B for depreciating assets covered by Subdivision 40-E (in respect of software development pools) or Subdivisions 40-F or 40-G. This amendment ensures that the decline in value of the asset is not worked out under Subdivision 40-B where these other Subdivisions apply. This in turn ensures that the general balancing adjustment rules in Subdivision 40-D do not apply to assets covered by Subdivisions 40-E (in respect of software development pools), 40-F or 40-G. This is the correct result as these assets should either not be subject to balancing adjustment rules or should be subject to specific balancing adjustment rules that are contained in their respective Subdivisions.

3.36 Item 39amends subsection 40-665(3) (about how Subdivision 40-G applies to partners and partnerships). The amendment ensures that the operation of Subdivision 40-G, and not just section 40-665, is disregarded in calculating the net income or loss of a partnership under section 90 of the ITAA 1936. This will ensure that the deduction, which arises under Subdivision 40-G, is only available to the partners, not both the partners and the partnership.

Subdivision 40-I (capital expenditure that is deductible over time) - section 40-880

3.37 The intention of section 40-880 is to provide deductibility over five years for seven categories of business related capital expenditure that, prior to 1 July 2001, were not recognised in the income tax law (i.e. blackholeexpenditure). A number of amendments will be made to subsection 40-880(1) to ensure that it operates as intended and to clarify its operation by the insertion of examples.

3.38 In applying the various tests set out in the relevant paragraphs in subsection 40-880(1) it is necessary that the expenditure be for the appropriate purpose. Item 48 ensures that expenditure can be deductible under subsection 40-880(1) if the business will be carried on for a taxable purpose. Under the current law, the business must be, or have been, carried on for a taxable purpose.

Paragraph 40-880(1)(a) - expenditure to establish your business structure

3.39 Item 40 amends paragraph 40-880(1)(a) to ensure that it operates as intended. The paragraph will cover only capital expenditure incurred by a taxpayer in establishing the business structure through which they will carry on their business. In addition, item 41 inserts an example immediately after the paragraph to provide further clarification of its operation.

3.40 Consistently, with its existing use in paragraph 40-880(1)(b), the term business structure will ensure that paragraph 40-880(1)(a) covers the legal entity (such as a company) or the legal relationship (such as a partnership or trust) that is established as the entity that will carry on the business for a taxable purpose and that will hold the business assets. Examples of expenditure that will fall within paragraph 40-880(1)(a) are the expenditure incurred in incorporating a company, forming a partnership or in creating a trust. The example to be included in the law makes this clear.

3.41 It has been suggested that expenditure incurred in relation to leases or other legal or equitable rights, franchise fees or the acquisition of goodwill could be covered by paragraph 40-880(1)(a). It was never intended that the paragraph encompass such expenditure and the amendments to the paragraph and the amendments to subsection 40-880(3) discussed in paragraphs 3.63 to 3.71 ensure that the intended outcome is achieved.

Paragraph 40-880(1)(b) - expenditure to convert your business structure to a different structure

3.42 Paragraph 40-880(1)(b) allows a deduction for capital expenditure incurred by a taxpayer to convert their business structure to a different structure. Item 42 inserts an example immediately after the paragraph to clarify its operation.

3.43 The example deals with a situation in which the partners in a partnership decide to carry on their business through a company structure. Capital expenditure incurred in establishing the company and in transferring the business assets of the partnership to the company falls within this paragraph.

3.44 The same kinds of expenditure are deductible under this paragraph where an individual decides to carry on his or her business through a company structure.

3.45 Another example of expenditure which falls within the paragraph, is expenditure incurred in varying contracts, such as supply contracts, to reflect that the transferee (as opposed to the transferor) is a party to them as a result of the conversion of the business structure.

3.46 However, the costs associated with an internal reorganisation, such as where a holding company incurs expenses in selling off some part of a wholly owned subsidiary, do not come within paragraph 40-880(1)(b). This is because the type of structural change intended by this paragraph is about how something was held and not what was held. If something held is disposed of, the associated expenses are more likely to be costs of disposal rather than costs of structural change and would be recognised through other parts of the income tax law, such as the capital gains and losses provisions of the ITAA 1997.

Paragraph 40-880(1)(c) - expenditure to raise equity for your business

3.47 Paragraph 40-880(1)(c) allows deductions for capital expenditure incurred in both an initial and additional equity raising. Item 43 inserts an example immediately after the paragraph to clarify its operation.

3.48 The example deals with a situation in which a company raises equity through the issue of new shares in order to fund an expansion of its business. The capital expenditure it incurs in raising the equity, such as the preparation and issuing of a prospectus, is covered by this paragraph.

3.49 The intention of paragraph 40-880(1)(c) is to provide similar tax treatment to that afforded to borrowing costs. Borrowing costs are deductible over five years under section 25-25 of the ITAA 1997. Expenditure to raise equity that is not a form of borrowing,as defined in subsection 995-1(1) of the ITAA 1997 is not deductible under section 25-25 of the ITAA 1997 and is considered to be blackhole expenditure. As such, it is appropriate that it be deductible over 5 years under existing paragraph 40-880(1)(c).

3.50 Paragraph 40-880(1)(c) generally only applies where there is a raising of equity capital by a company or a fixed unit trust through either a private placement or public issue of shares or a rights issue. Examples of expenditure associated with these types of equity raisings that could come within paragraph 40-880(1)(c) to the extent to which they are capital expenditure include:

•

the preparation of disclosure documents such as a prospectus, a short form prospectus, a profile statement or an offer information statement for small fundraisings of $5 million or less;

•

underwriting costs;

•

legal fees;

•

printing costs;

•

postal costs; or

•

advertising costs.

3.51 An employee share acquisition scheme is not an equity raising if a company acquires shares in itself and settles them on trust for the benefit of employees. However, if the employee share acquisition scheme involved raising capital from employees through the allotment of new shares to the employees, expenditure incurred in raising that capital may be an equity raising and therefore deductible under paragraph 40-880(1)(c).

3.52 The expenditure associated with the issue of a convertible debt instrument is not deductible under paragraph 40-880(1)(c) but may be deductible under section 25-25 of the ITAA 1997. Where that instrument is converted to shares, the costs of converting that instrument will come within paragraph 40-880(1)(c).

3.53 Likewise, the expenditure associated with the conversion of options and rights to shares comes within paragraph 40-880(1)(c).

Paragraph 40-880(1)(d) - expenditure to defend against a takeover

3.54 Paragraph 40-880(1)(d) allows deductions for capital expenditure incurred by a taxpayer to defend their business against a takeover. The use of the words defend and against in paragraph 40-880(1)(d) means that there must be resistance of the attempted takeover for paragraph 40-880(1)(d) to apply. Generally, paragraph 40-880(1)(d) applies only where there is a takeover under the Corporations Act 2001.

3.55 Item 44 inserts an example immediately after the paragraph to clarify its operation. The example deals with a situation in which a public limited company launches a hostile takeover bid for another public limited company. The target company must take certain steps prescribed by the Corporations Act 2001. The capital expenditure it incurs in following those steps is covered by this paragraph.

3.56 The following types of expenditure incurred in defending a takeover under the Corporations Act 2001 could come within paragraph 40-880(1)(d) to the extent to which they are capital expenditure:

•

legal and accounting costs;

•

stockbrokers fees;

•

compliance fees under the Corporations (Fees) Regulations 2001;

•

consultancy fees paid for public relations, merchant bankers and the media;

•

printing, advertising and mailing of documents produced for shareholders;

•

costs of independent evaluations of the takeover offer;

•

the salary or wages of individuals employed specifically to undertake takeover defence activities; and

•

the preparation of and issuing of Part B statements or Part D statements.

3.57 Due to the amendments discussed in paragraphs 3.63 to 3.71, expenditure such as the costs of acquiring shares as a defensive manoeuvre engaged in by a company under threat of a takeover will not be deductible under paragraph 40-880(1)(d). Such costs are recognised in the cost base of the shares under the capital gains and losses provisions.

Paragraph 40-880(1)(e) - costs of unsuccessfully attempting a takeover

3.58 Paragraph 40-880(1)(e) allows deductions for capital expenditure incurred in unsuccessfully attempting a takeover. Item 45 inserts an example immediately after the paragraph to clarify its operation. The example will deal with a situation in which a public company tries unsuccessfully to take over another public company. The company attempting the takeover must take certain steps prescribed by the Corporations Act 2001 in the course of attempting the takeover. The capital expenditure it incurs in following those steps is covered by this paragraph.

3.59 Paragraph 40-880(1)(e) generally only applies where there is a takeover under the Corporations Act 2001. Examples of capital expenditure associated with a takeover under the Corporations Act 2001 that could come within paragraph 40-880(1)(e) to the extent to which they are capital expenditure are similar to those outlined in paragraph 3.56.

Paragraph 40-880(1)(g) - costs to stop carrying on your business

3.60 Item 46 amends paragraph 40-880(1)(g) to clarify that costs incurred by a taxpayer to stop carrying on their business, as opposed to any business, come under the provision.

3.61 In addition, item 47 inserts an example immediately after the paragraph to clarify its operation. The example deals with a situation in which a taxpayer incurs capital expenditure in the form of legal costs for terminating the services of employees when it stops carrying on its business. That expenditure is covered by this paragraph.

3.62 Examples of other categories of expenditure that may come within the paragraph are site rectification costs and the costs associated with the removal of tenants fixtures if those costs are not already recognised in the income tax law. For example, if such costs did not form part of the cost of a depreciating asset or did not reduce the termination value of a depreciating asset where a balancing adjustment event occurs for the asset they may be deductible under this paragraph.

Amendments to subsection 40-880(3)

3.63 Section 40-880 is intended to be a provision of last resort. It does not, and is not intended to, encompass all blackhole expenditure. Item 49 amends subsection 40-880(3) to add further exclusions from deductibility to ensure that the section operates as intended.

3.64 As a provision of last resort, expenditure should only be deductible under section 40-880 if it is not already recognised elsewhere in the income tax law. In seeking to give effect to this intention, section 40-880, as currently enacted, states that expenditure is only deductible under section 40-880 to the extent that it is not:

•

included in the cost of a depreciating asset held by the taxpayer;

•

included in the cost of land; or

•

deductible under another provision of the income tax law apart from section 40-880.

3.65 However, these exclusions were not sufficient to give effect to the policy intention of section 40-880. This is because they do not exclude expenditure that is already recognised in some other manner, for example, through the cost base of an asset under the capital gains and losses provisions, or that, for other policy reasons, is intended to be excluded from deduction.

3.66 Item 49 amends subsection 40-880(3) to provide that expenditure will only be deductible under section 40-880 to the extent that it is also not:

•

incurred in relation to leases or other legal or equitable rights [Schedule 3, item 49, paragraph 40-880(3)(d)]

•

taken into account in working out an assessable profit or a deductible loss [Schedule 3, item 49, paragraph 40-880(3)(e)]

•

taken into account in working out a capital gain or capital loss under the capital gains and losses provisions [Schedule 3, item 49, paragraph 40-880(3)(f)]

•

specifically made non-deductible under a provision of the income tax law [Schedule 3, item 49, paragraph 40-880(3)(g)]

3.67 The Government is reviewing the treatment of expenditure incurred in relation to leases or other legal or equitable rights as part of the consideration of the recommendations of the Review of Business Taxation. The appropriate income tax treatment of capital expenditure incurred in relation to these leases and rights will be determined as part of that review. Consequently, capital expenditure on leases or other legal or equitable rights will be excluded from deduction under section 40-880. For example, expenditure representing lease surrender payments incurred in closing down your business will not be deductible under section 40-880.

3.68 Under the current income tax law, expenditure may be taken into account in working out an assessable profit or a deductible loss. For example, it may be taken into account in working out a profit arising from the carrying on or carrying out of a profit-making undertaking or plan that is included in assessable income under section 15-15 of the ITAA 1997. Such expenditure is recognised in the income tax law through a lesser amount being included in the taxpayers assessable income. It is inappropriate for such expenditure to be deductible and hence it will be excluded from section 40-880.

3.69 The amendments to subsection 40-880(3), together with the amendment to paragraph 48-880(1)(a) discussed in paragraphs 3.39 to 3.41, will make it clear that certain expenditure (e.g. for franchise fees and goodwill incurred in establishing a taxpayers business) is not deductible under section 40-880. This expenditure was never intended to come within paragraph 48-880(1)(a). Further, as it is already recognised in the income tax law as part of the cost base of an asset under the capital gains and losses provisions, as it was intended to be excluded by subsection 40-880(3).

3.70 As item 49 excludes expenditure that is taken into account in working out a capital gain or capital loss under the capital gains tax provisions from deductibility under section 40-880, the words apart from this section that appear in paragraph 40-880(3)(f) ensure that this exclusion interacts in the correct manner with the cost base rules in the capital gains and losses provisions.

3.71 Finally, the current income tax law specifically makes certain items of expenditure non-deductible. Fines, entertainment expenses and certain taxes are examples of such expenditure. However, taxpayers may incur expenses of these description in, for example, closing down their business. In keeping with the current treatment of these items of expenditure under the income tax law, section 40-880 will be amended to make it clear that these items of expenditure remain non-deductible.

Interaction of Subdivision 27-B (about GST) and Division 40 of the ITAA 1997

3.72 Division 27 sets out the effect of the GST in working out deductions for income tax purposes. Generally speaking, input tax credits, GST, and adjustments under the GST Act, are disregarded. In particular, Subdivision 27-B contains the rules dealing with the interaction of GST and the capital allowances system.

3.73 The amendments made to subsections 27-80(3A), 27-80(4), 27-85(3) and 27-90(3) by items 4, 6, 9 and 11, respectivelyensure that the cost of an asset is adjusted whenever the taxpayer is entitled to an input tax credit or, an increasing adjustment or decreasing adjustment is required to be made in relation to that asset.

3.74 Each of these subsections currently adjusts an assets opening adjustable value to ensure deductions for decline in value are correctly worked out where a taxpayer is entitled to an input tax credit, or an increasing adjustment or a decreasing adjustment is required to be made in relation to that asset. These amendments similarly ensure that an assets cost is also adjusted. This in turn ensures for example, where CGT event K7 happens to a depreciating asset, the capital gain or loss is correctly worked out. CGT event K7 takes into account an assets cost to work out a capital gain or loss in respect of the non-taxable use of a depreciating asset. Therefore, the cost of the asset needs to reflect any input tax credits, increasing adjustments or decreasing adjustments as these affect the amount that should be recognised as the gain or loss.

3.75 Item 5amends subsection 27-80(3A) tomake it clear to taxpayers that the reduction in opening adjustable value and cost required by that subsection is the amount of the input tax credit. The subsection does not currently specify the amount of the reduction.

3.76 Items 7 and 8 amend subsection 27-80(5) and paragraph 27-80(5)(b) to ensure that, to the extent an input tax credit for a depreciating asset exceeds the assets opening adjustable value, the excess will be included in the assessable income of the taxpayer. These amendments are consequential amendments which were omitted in error at the time the New Business Tax System (Capital Allowances - Transitional and Consequential) Bill 2001 was amended to include subsection 27-80(3A).

3.77 Item 10amends subsection 27-87(1) to ensure that section 27-87 does not apply where section 27-95 applies to increase the termination value of that asset. Without this amendment, both sections 27-87 and 27-95 may apply simultaneously, with the effect of including the decreasing adjustment amount in assessable income twice. This amendment will ensure that section 27-95 prevails over section 27-87 and that the decreasing adjustment is only included in assessable income once.

3.78 Item 12 amends subsection 27-105(5) to clarify the operation of section 27-105 in relation to the partners in a partnership that is entitled to an input tax credit, or is required to make an increasing adjustment or a decreasing adjustment. It makes it clear that an amount equal to the input tax credit, the increasing adjustment or the decreasing adjustment, is apportioned between the partners and not the partnership. This is because the deduction is attributed to the partners, rather than taken at the partnership level under sections 40-570 and 40-665.

Capital works - Divisions 40 and 43 of the ITAA 1997

3.79 Division 43 sets out the rules for working out deductions for capital works such as assessable income producing buildings. Subsection 40-45(2) ensures that Divisions 40 and 43 interact correctly. It achieves this in 2 ways. First, it excludes from Division 40 those capital works for which an entity can deduct an amount under Division 43 because it satisfies the conditions for deductibility and the expenditure on the capital works is not excluded from Division 43. This ensures that such capital works are not deductible under both Division 40 and 43. Further, it ensures that expenditure on capital works that are plant, and therefore excluded from Division 43, will fall within Division 40.

3.80 Second, subsection 40-45(2) excludes those capital works for which an entity would be able to deduct an amount under Division 43 but for the expenditure being incurred, or the capital works being started, before a particular day. This ensures that those capital works that are not deductible under Division 43, for example, because of the time they were constructed, cannot inappropriately be deductible under Division 40.

3.81 Item 15 effectively amends subsection 40-45(2) to further clarify the interaction between Divisions 40 and 43. This is achieved by excluding from Division 40 those capital works for which an entity would be able to deduct an amount under Division 43 had the capital works been used for the relevant purpose under section 43-140. For example, an individual cannot deduct an amount under Division 43 for their principal place of residence because it is not used for the purposes of producing assessable income. This ensures that such a residence will not come within Division 40.

3.82 Item 50adds subsection 43-140(2) to section 43-140 to provide that an entity is taken to use property for the purposes of producing assessable income if it is used for environmental protection activities or for carrying out an activity for an environmental impact assessment of a project. The new subsection applies unless another provision of the income tax law expressly provides that the particular use is not to be taken for the purposes of producing assessable income.

3.83 Prior to 1 July 2001 (the start date of the capital allowances system), property used for carrying out environmental protection activities or environmental impact assessments was taken to be used for the purposes of producing assessable income under section 400-100 of the ITAA 1997. This meant that taxpayers may have been able to write-off the cost of capital works used in these activities under Division 43. However, Division 400 was repealed consequential upon the enactment of the capital allowances system and as a result of an oversight former section 400-100 was not replicated elsewhere within the income tax law. The proposed amendment will correct this error and thereby ensure that the relevant capital works may be deductible under Division 43.

3.84 Item 76 amends the definition of capital allowance in subsection 995-1(1) to include a reference to Division 43. The amendment ensures that any reference to capital allowance within the income tax legislation will include deductions allowed under Division 43 for expenditure on capital works. This item gives effect to an omitted consequential amendment.

Disposal of leases and leased plant - Division 45 of the ITAA 1997

3.85 Division 45 deals with the disposal of leases and leased plant and is designed to prevent tax being avoided in certain circumstances where amounts have been deducted for the decline in value of plant. Items 51 to 58 update the terminology used in various provisions in Division 45 to make it consistent with the terminology used by the capital allowances system. These items give effect to omitted consequential amendments.

CGT provisions - Parts 3-1 and 3-3 of the ITAA 1997

CGT event K7

3.86 Broadly, subsection 104-235(1) provides that CGT event K7 happens where a balancing adjustment event occurs for a depreciating asset held by a taxpayer who used it, or had it installed ready for use, for a purpose other than a taxable purpose (e.g. an asset used for private purposes). Subsection 104-235(1A) sets out the circumstances when CGT event K7 will not apply. At present the exclusion only relates to certain assets used for the purposes of research and development activities.

3.87 Item 59amends subsection 104-235(1A) to ensure that CGT event K7 will also not apply where:

•

there is roll-over relief for the balancing adjustment event under section 40-340. This will ensure that the CGT consequences align with Division 40 consequences; or

•

the depreciating asset is covered by Subdivision 40-F (water facilities, horticultural plants or grapevines) or 40-G (landcare operations, electricity connections or telephone lines). As explained in paragraphs 3.95 to 3.97, assets to which Subdivision 40-F or 40-G apply are intended to be subject to the normal operation of the CGT provisions.

3.88 Subsection 115-20(1) only allows a capital gain to be a discount capital gain where it was worked out using a cost base that has not been indexed. However, CGT event K7 does not use the concept of cost base, instead it uses the concept of cost. Item 65amends subsection 115-20(1) to ensure that a capital gain that arose under CGT event K7 may also be a discount capital gain if it was worked out using cost. This item gives effect to an omitted consequential amendment.

3.89 Item 66 amends the table in section 116-25 by deleting an incorrect reference to CGT event K7 from the table. The reference is incorrect as the table sets out modifications to the concept of capital proceeds and CGT event K7 does not use this concept.

Section 118-24 - general CGT exemption for depreciating assets

3.90 Broadly, subsection 118-24(1) operates to ensure that all capital gains and losses made from a CGT event (that is also a balancing adjustment event) that happens to a depreciating asset, are disregarded where the decline in value of the asset was worked out under Division 40 or 328 or, would have been, had the asset been used. Subsection 118-24(2) excepts from this general rule capital gains or losses arising as a result of CGT event K7 happening.

3.91 Item 67will repeal and replace section 118-24. New subsection 118-24(1) only differs from the existing subsection in that it ensures that:

•

ambiguity in the existing provision is removed by inserting brackets before and after the words that is also a balancing adjustment event. This ensures that the word happens refers to the CGT event and not the balancing adjustment event; and

•

instead of the words where the decline in value of the asset was worked out being relevant to both Divisions 40 and 328, they will refer only to Division 40. With regard to Division 328 (which contains particular rules for STS taxpayers), wording more appropriate to that Division has been added. Division 328 does not refer to a decline in value for depreciating assets. Broadly, they deduct amounts based on a pool that is treated as a single depreciating asset.

3.92 New subsection 118-24(2) ensures that, in addition to CGT event K7 being excepted from the operation of subsection 118-24(1), subsection 118-24(1) does not apply to disregard capital gains or losses where:

•

CGT event J2 happens; or

•

a taxpayer or another entity has deducted, or can deduct, amounts under Subdivision 40-F (water facilities, horticultural plants or grapevines) or 40-G (landcare operations, electricity connections or telephone lines).

CGT event J2

3.93 CGT event J2 happens if an asset, chosen as a replacement asset following a small business roll-over (carried out before 1 July 2001): stops being the taxpayers active asset; becomes trading stock; is given as a testamentary gift under the Cultural Bequests Program; or starts being used solely for producing exempt income. CGT event J2 happens when the change in the status of the replacement asset happens. The taxpayer makes a gain from CGT event J2 equal to the notional capital gain (i.e. the tagged capital gain) for the roll-over asset that was ignored because of the small business roll-over.

3.94 Because of the way existing section 118-24 is worded, capital gains and losses arising under CGT event J2 are currently disregarded where they arise in relation to a depreciating asset. This is incorrect. The capital gains arising under CGT event J2 should be taken into account in working out net capital gains. The amendment to section 118-24 ensures that this outcome is achieved.

Subdivision 40-F or 40-G

3.95 Prior to 1 July 2001 (the start date of the capital allowances system), assets that are currently covered by Subdivisions 40-F (water facilities, horticultural plants or grapevines) and 40-G (landcare operations, electricity connections or telephone lines) were not subject to the recoupment of deductions through a balancing adjustment event on disposal. Where the asset did not also qualify as plant, the CGT provisions captured any gain over and above the original cost, or recognised any loss to the extent that the assets reduced cost base (reduced by capital allowances deductions) was less than the proceeds received for the asset. However, where the asset also qualified as plant, any gain over and above the original cost was brought to account as further income under former Division 42. Similarly, a further deduction was allowed under former Division 42 where the sale proceeds were less than the adjustable value of the asset.

3.96 Under the current capital allowances system, no gain or loss over and above original cost is brought to account as either a revenue or a capital gain and, similarly, there is no recognition of any loss or further deduction. This is not the intended outcome and to correct the position, amendment discussed in paragraph 3.92 will ensure that any gain or loss is recognised under the CGT provisions for all assets covered by Subdivisions 40-F and 40-G.

3.97 As a result, for non-plant assets now covered by Subdivision 40-F or 40-G, this amendment will reinstate the outcome that applied prior to the enactment of the capital allowances system. However, for assets that were plant under former Division 42, this amendment achieves a more favourable outcome. This is because under former Division 42 any gain on plant over and above the original cost would have been brought to account as a revenue gain and not as a capital gain. Therefore, the CGT discount provisions, for example, would not have applied to reduce that gain.

Section 106-5 - partners and partnerships

3.98 Item 61repeals subsection 106-5(5) as it is considered unnecessary. Subsection 106-5(1) of the ITAA 1997 provides that any capital gain or loss from a CGT event happening to a partnership asset is made by the partners individually and not the partnership. Subsection 106-5(5) was inserted, as subsection (1) was not intended to apply where a CGT event happens in relation to a partnership asset whose decline in value is worked out under Division 40, or whose deduction is calculated under Division 328. This is because Division 40 assesses the gain in the hands of the partnership and not in the hands of the individual partners. Subsection 106-5(5) is considered unnecessary as, for CGT purposes, paragraph 118-24(1)(b) operates to disregard capital gains or losses in the hands of the partners where the decline in value of the asset was worked out under Division 40 or the deduction was calculated under Division 328.

Division 124 - CGT roll-over relief

3.99 Broadly, Division 124 provides for a replacement asset roll-over to defer the making of a capital gain or loss from one CGT event until a later CGT event happens. In particular, Subdivision 124-B applies where an asset has been compulsorily acquired, lost or destroyed.

3.100 Items 68 to 70 qualify the references to depreciating asset in paragraph 124-75(2)(a) and subsections 124-75(5) and 124-80(2) of Subdivision 124-B to ensure that they only refer to those depreciating assets whose decline in value is worked out and deducted under Division 40 or, for which a deduction is claimed under Division 328. These amendments ensure that roll-over relief under Subdivision 124-B continues to apply for depreciating assets that are not the subject of Division 40 or 328.

Division 152 - small business relief

3.101 Broadly, Division 152 sets out certain CGT concessions that are available to small business where certain conditions are satisfied. Subdivision 152-B sets out the small business 15-year exemption. This concession allows a small business to disregard any capital gain arising from a CGT asset that it has owned for at least 15 years if certain conditions are met. Also any amount of income a company or trust derives from a CGT event covered by this Subdivision is neither assessable income nor exempt income.

3.102 Item 71amends section 152-110 of Subdivision 152-B, to ensure that the exemption regarding income derived by a company or a trust does not apply to any income derived as a result of a balancing adjustment event occurring to a depreciating asset that is subject to Division 40 or 328. This amendment will limit the operation of subsection 152-110(2) to ensure that it does not apply inappropriately to disregard a balancing adjustment amount.

Miscellaneous

3.103 The amendments in items 62 to 64are necessary as the result ofconsequential amendments to those provisions not being taken into account when later amendments repealed and replaced those provisions.

STS taxpayers - Divisions 40 and 328 and Part 3-1 of the ITAA 1997

3.104 Broadly, Division 328 applies to give certain businesses with straightforward, uncomplicated financial affairs the choice of an alternative method of determining their taxable income. If a business chooses to enter the STS, new accounting arrangements, a simplified trading stock regime, and a simplified capital allowances regime will apply.

3.105 Subsection 40-25(1) provides a deduction equal to the decline in value of an asset that is held by a taxpayer during an income year. Item 13 amends note 2 of subsection 40-25(1) to reflect the fact that an STS taxpayer both deducts, and works out the amount they can deduct, under Division 328.

3.106 Item 27 will ensure that the cost of a depreciating asset is not reduced by any deduction allowable under Division 328. Section 40-215 already ensures that the cost of any depreciating assets for which a deduction is allowable under Division 40 is not reduced.

3.107 Item 60 amends paragraph 104-235(4)(b) with the effect of removing the reference to decline in value in relation to Division 328. As there is no reference to decline in value under Division 328, this amendment will ensure the terminology used is consistent.

3.108 Item 72 will allow a deduction to be claimed under the capital allowance provisions in Division 328 unless it is reasonably expected that the depreciating asset will be predominantly leased in the future. Because taxpayers will not always be in a position to know how a depreciating asset is intended to be used, they may have had difficulty in interpreting this provision.

3.109 Items 73 and 74 will allow a deduction for a cost addition of less than $1,000 for a low cost asset in the year of purchase. Where the cost addition is $1,000 or more, as well as any subsequent cost additions of any value, both the cost addition and the underlying low cost asset are added to the pool.

3.110 Item 74 will also allow a cost addition of $1,000 or more for a low cost asset, and any subsequent cost additions, regardless of their cost, to be added to a pool, even after the STS taxpayer has left the STS.

3.111 Item 75 will ensure that, in determining the adjustment to the opening pool balance where there has been a change in the business use of an asset, only those cost additions made to the asset until the beginning of the income year in which the adjustment applies are included in the asset value.

3.112 Item 77 will update the definition of capital allowance to include a reference to Division 328. The amendment ensures that any reference to capital allowance within the income tax legislation will include deductions allowed under Division 328 for expenditure on capital items.

3.113 Item 78 will update the definition of in-house software to include a reference to Division 328. The amendment ensures that any reference to in-house software within the income tax legislation will include deductions allowed under Division 328 for expenditure on in-house software.

Division 57, Schedule 2D to the ITAA 1936

3.114 Broadly, Division 57, Schedule 2D to the ITAA 1936 is about the income tax treatment of a taxpayer whose income ceases to be wholly exempt from income tax. Broadly, income, outgoings, gains and losses are attributed to the periods before and after the loss of full exemption.

3.115 Division 58 of the ITAA 1997 also sets out special rules that apply in calculating deductions for the decline in value of depreciating assets and balancing adjustments for assets previously owned by an exempt entity in certain circumstances. Prior to the streamlining of Division 58, it was limited to the depreciation of plant under former Division 42 of the ITAA 1997 and Division 57 applied to all other capital allowances. To avoid any overlap, section 57-130, Schedule 2D was inserted to ensure that Subdivisions 57-I (about depreciation deductions) and 57-K (about balancing adjustments) did not apply to balancing adjustments for plant or depreciating assets where Subdivision 58-B of the ITAA 1997 applied.

3.116 As a result of the streamlining of Division 58 of the ITAA 1997, as part of the introduction of the capital allowances system, Division 58 was extended to apply to all depreciating assets.

3.117 Therefore, where there is an entity sale situation, and there is an amount of expenditure that does not relate to a depreciating asset (e.g. site preparation costs) it is intended that Division 57, Schedule 2D apply to that expenditure instead of Division 58. This intended outcome is achieved by the existing provisions where the expenditure is incurred on or after 1 July 2001. However, where the expenditure was incurred prior to 1 July 2001, it is currently treated as a notional depreciating asset and is made deductible under Subdivision 40-B through section 40-35 of the IT(TP) Act 1997. However, for section 40-35 to work, section 57-90, Schedule 2D must apply. The amendments made by item 1 to items 10 and 11 in the table insubsection 57-85(3), Schedule 2D ensure that Division 57 can apply to expenditure incurred prior to 1 July 2001 that did not constitute a depreciating asset but was transitioned into Division 40 as a notional depreciating asset under section 40-35 of the IT(TP) Act 1997.

3.118 As explained in paragraph 3.116, Division 58 is intended to apply to all depreciating assets. However, there is a potential application of both Division 58 of the ITAA 1997 and Division 57, Schedule 2D to the ITAA 1936 to non-plant depreciating assets, for example, intellectual property. As Division 58 is intended to apply to all depreciating assets item 2 prevents the potential dual application by amending section 57-130 to ensure that Subdivision 57-J (capital allowances and certain other deductions) does not apply where Subdivision 58-B of the ITAA 1997 applies.

3.119 Notwithstanding section 57-130 and the amendment made by item 2, Subdivision 57-J still needs to apply when the non-plant depreciating asset is a notional depreciating asset, hence the amendment made by item 1, and explained in paragraph 3.117. Therefore, to overcome the potential conflict between the amendments at items 1 and 2, item 3 inserts a new subsection into section 57-130 to ensure that Subdivision 57-J is still able to apply, for the purposes of section 40-35 of the IT(TP) Act 1997, to capital expenditure incurred by a transition taxpayer before 1 July 2001 that relates to property that is not a depreciating asset.

Division 40 of the IT(TP) Act 1997

3.120 Division 40 of the IT(TP) Act 1997 facilitates the transition of depreciating assets into the capital allowances system from the various separate capital allowances regimes that operated before it. Broadly, the transitional provisions allow taxpayers to apply the new capital allowances system to existing depreciating assets and certain capital expenditures. Effectively, Division 40 of the ITAA 1997 applies to depreciating assets created, acquired etc. after 30 June 2001 and depreciating assets subject to the transitional provisions that are created, acquired etc. on or before that date.

3.121 Items 79 and 80ensure that the terms, former Act and new Act in paragraph 40-10(1)(a) and subsection 40-10(2) reflect that the ITAA 1997 is also amended by the New Business Tax System (Capital Allowances - Transitional and Consequential) Act 2001.

3.122 Items 85, 88, 90 and 91amend subsections 40-25(2), 40-30(2), 40-45(2) and 40-50(2) to ensure that the cost for depreciating assets covered by those provisions, for example, software, spectrum licences etc., is transitioned into the ITAA 1997 for the purposes of Division 40 and not just Subdivision 40-B of the ITAA 1997. This has flow on consequences for other provisions such as the CGT provisions.

3.123 Items 81 to 84, 86, 87 and 89ensure that the following provisions - paragraphs 40-10(2)(b), 40-20(1)(a) and (2)(a), 40-25(2)(d) and 40-45(1)(b) and subsections 40-25(2) and 40-30(1) - apply where the taxpayer could have deducted an amount under the relevant provision if they had used the asset for the purpose of producing assessable income before 1 July 2001. These provisions, which apply to transition in various existing assets (e.g. plant, software, etc.) do not presently transition into Division 40, assets that were acquired on or before 30 June 2001 but were yet to be used for an income producing purpose before that date. These amendment will correct this.

3.124 Item 92adds new section 40-100 which deems determinations of effective life made under former section 42-110 of the ITAA 1997 to be determinations made under new Division 40 of the ITAA 1997. This will ensure that taxpayers can rely upon those previous determinations.

3.125 Items 93 to 95add a reference to subsection 40-12(3) (which maintains accelerated depreciation in certain circumstances) to paragraphs 40-340(1)(b) and 40-340(2)(d) and subsection 40-340(3), which relate to roll-over relief. These amendments ensure that the transferee maintains accelerated depreciation concessions to which the transferor would have been entitled once the asset had been installed ready for use.

3.126 Section 40-425 allows a taxpayer to allocate an item of plant (held prior to the commencement of the capital allowances system) to a low-value pool under the capital allowances system if they were eligible to allocate that item of plant to the low-value pool under former Division 42 of the ITAA 1997. However, assets that have been depreciated to less than $1,000 under the diminishing value method under former Division 42, may in any case be allocated to a low-value pool. This is achieved through the interaction of section 40-70 and paragraph 40-10(2)(a). Item 96 repeals section 40-425 as it is redundant.

Item 488 of Schedule 2 to the New Business Tax System (Capital Allowances - Transitional and Consequential) Act 2001

3.127 The application clause for the consequential amendments made by Schedule 2 to the New Business Tax System (Capital Allowances - Transitional and Consequential) Act 2001 currently applies the amendments to assets held by a taxpayer on or after 1 July 2001. However, that application clause is not appropriate to all of the consequential amendments that were made by that Act. Items 97 and 98therefore amend the application clause contained in item 488 of that Schedule to ensure that certain consequential amendments made by that Schedule are able to apply as intended.

3.128 Former Division 388 of the ITAA 1997 which allowed a tax offset for landcare and water facility expenditure over 3 years was repealed with the introduction of the capital allowances system. However, where such expenditure was incurred in the 2000-2001 income year, the tax offset should be available to the taxpayer not only in that income year but also in the 2002 and the 2003 income years. Consequently, item 99amends subitem 488(3) of that Schedule to ensure that former Division 388 of the ITAA 1997 continues to apply until the end of the 2002-2003 income year.

Application and transitional provisions

3.129 The amendments that relate to provisions that were inserted as part of the capital allowances system will apply in accordance with the application provision to the capital allowances system (i.e. from 1 July 2001). [Schedule 3, subitem 100(1)]

3.130 The amendments to section 40-880 will apply to expenditure incurred on or after 1 July 2001 where that expenditure does not form part of the cost of a depreciating asset. Again, this is in line with the application provision for the original section 40-880. [Schedule 3, subitem 100(2)]

3.131 Due to the changes to the application of some consequential amendments discussed in paragraph 3.127, the amendments to section 104-235 will apply to balancing adjustment events occurring on or after 1 July 2001 [Schedule 3, subitem 100(3)] . All other amendments to the CGT provisions are to apply to CGT events happening on or after 1 July 2001 [Schedule 3, subitem 100(4)]

3.132 The amendments in items 62 to 64 are as a result ofconsequential amendments to provisions not being taken into account when later amendments repealed and replaced those provisions. They will apply as originally intended. [Schedule 3, subitems 100(5) to (7)]

3.133 The amendments to the STS provisions will apply in line with the application clause to those provisions (i.e. for assessments for the first income year starting after 30 June 2001) and for later income years. [Schedule 3, subitem 100(8)]

Chapter 4 - Recovery of PAYG withholding amounts

Outline of chapter

4.1 This chapter describes amendments to the ITAA 1936. Part 1 of Schedule 4 contains amendmentsthat will enable:

•

the Commissioner to recover all PAYG withholding debts that are due and payable by making an estimate of the amount; and

•

taxpayers to reduce the Commissioners estimate of any PAYG withholding amount by making a statutory declaration.

4.2 Part 2 of Schedule 4 contains a number of technical amendments to Divisions 8 and 9 of Part VI of the ITAA 1936.

Context of amendments

4.3 Divisions 8 and 9 of Part VI of the ITAA 1936facilitate recovery of amounts that have been deducted but not remitted to the Commissioner by empowering the Commissioner to make an estimate of the amount and to recover the estimated amount. The rules facilitate recovery of amounts withheld from payments made under the former PAYE, reportable payments and prescribed payments systems, and from natural resource, dividend, interest and royalty payments. These collection systems were replaced by the PAYG withholding system from 1 July 2000.

4.4 When the PAYG withholding system was introduced it was intended that Divisions 8 and 9 would also allow recovery of amounts payable under that system. Amendments to achieve this were made to section 222AFA, which states the object of the Division, and to the definition of remittance provision in section 222AFB. However, a number of other consequential amendments were inadvertently overlooked. These included amendments to provisions enabling a person who received an estimate of a liability under the PAYG withholding system to make a statutory declaration in order to have the estimate reduced or revoked.

Summary of new law

4.5 The Commissioner is able to take recovery action by estimating a debt for a PAYG withholding amount that has been withheld but not paid to the Commissioner. The amendments will expand this recovery power to all remittances required to be made under the PAYG withholding regime. The amendment will allow a taxpayer to have the estimate of any PAYG withholding debt reduced or revoked by giving the Commissioner a statutory declaration. The Commissioner may then recover the amount under the collection and recovery rules in Part 4-15 of Schedule 1 to the TAA 1953.

Comparison of key features of new law and current law

Detailed explanation of the amendments

4.6 Subsection 222AFB(1) currently defines due date for recovery by estimates of amounts deducted but not paid to the Commissioner. The definition is amended to ensure that it covers all amounts that must be paid to the Commissioner under the PAYG withholding provisions. This is done by amending the definition to provide that the due date means the day on, by or before which a person liable to remit an amount must pay that amount to the Commissioner. [Schedule 4, item 1, subsection 222AFB(1)]

4.7 A definition of non-cash benefit is included for the purposes of the estimate provisions referring to amounts which must be paid under Division 14 in Part 2-5 of Schedule 1 to the TAA 1953. [Schedule 4, item 2, subsection 222AFB(1)]

4.8 The definition of person in subsection 222AFB(1) includes the various entities that have obligations under the different withholding regimes. It is amended to make specific reference to an entity that has an obligation to pay under the PAYG withholding regime under Part 2-5 of Schedule 1 to the TAA 1953. [Schedule 4, item 3, subsection 222AFB(1)]

4.9 Section 222AGA specifies the circumstances when the Commissioner may make an estimate for the recovery of amounts not paid to the Commissioner and the things that the Commissioner may have regard to in making the estimate. It refers to deduction obligations which would exclude the provision of non-cash benefits and alienated personal services payments from the scope of the estimate provisions. Paragraphs 222AGA(1)(a) and (b) are amended to remove the reference to deductions. Subsection 222AGA(2) which determines the scope of the Commissioners considerations in making an estimate is amended so that it specifically refers to the different obligations to pay under the former deduction regime and the PAYG withholding provisions in Divisions 12 to 14 and 16 of Schedule 1 to the TAA 1953. [Schedule 4, item 4, paragraphs 222AGA(1)(a) and (b) and item 5, subsection 222AGA(2)]

4.10 Section 222AGB specifies that the Commissioner must send a written notice of the estimate made under section 222AGA, to the person liable to pay the estimate. It provides that the notice must state that the estimate will be reduced or revoked if the person, or the persons trustee, gives the Commissioner a statutory declaration stating that the person deducted a lesser amount or made no deductions. The section is amended to require the Commissioner to include in the notice, advice that the person, or the persons trustee, may make a statutory declaration about obligations under the PAYG withholding provisions in order to have the estimate reduced or revoked. [Schedule 4, item 6, paragraphs 222AGB(2)(e), (ea) and (eb)]

4.11 Section 222AGD provides that an estimate under section 222AGA is revoked if the person, or the persons trustee, liable to pay the estimate gives a statutory declaration that no deductions were made during the period concerned under the former PAYE, reportable payments and prescribed payments systems, and from natural resource, dividend, interest and royalty payments. Paragraph 222AGD(1)(b) is repealed and replaced to ensure that the estimate can also be revoked if the person, or the persons trustee, makes a statutory declaration about amounts withheld, or which must be paid to the Commissioner, under the PAYG withholding provisions. [Schedule 4, item 7, paragraph 222AGD(1)(b)]

4.12 Section 222AGF specifies the requirements for a statutory declaration. Subsection (4) is repealed and replaced with a requirement that the statutory declaration must specify the total of amounts deducted, withheld or paid as appropriate, or that no amounts were deducted, withheld or paid. Subsection (5) is amended so that it makes reference to the generic remittance obligations. These amendments ensure that the declaration covers amounts which must be paid to the Commissioner under the PAYG withholding provisions as well as those under the former withholding system. [Schedule 4, item 8, subsection 222AGF(4) and item 9, subsection 222AGF(5)]

4.13 Subsection 222ANB provides that an amount purported to have been deducted for the purposes of a particular provision of the former collection regimes is taken to have been made for the purposes of that provision. The subsection is amended to also provide that amounts purported to have been withheld for the purpose of a particular PAYG withholding event are taken to have been withheld for the purposes of that withholding event. This will ensure that recovery of an amount by the Commissioner will not be prevented only on the grounds that the amount has been withheld under the wrong withholding provision. [Schedule 4, item 10, subsection 222ANB(3)]

Technical amendments

4.14 Section 222AOF provides notification rules for recovering amounts from directors of companies that received an estimate. It contains references to identifying directors from documents lodged under the Corporations Act 2001. This Act was renumbered by Company Law Review Act 1998 and Corporate Law Economic Reform Program Act 1999. Section 222AOF is amended so that it refers to the renumbered provision and to the renamed Australian Securities and Investment Commission. Section 222AIB is also being amended so that it refers to renumbered provisions of the Corporations Act 2001. [Schedule 4, item 11, paragraph 222AIB(1)(a) and items 16 to 18, section 222AOF]

4.15 A correction is being made to section 222AIC to insert the word of into the phrase for the purposes of that section. [Schedule 4, item 12, section 222AIC]

4.16 Section 222AJB refers to "penalty" payable under certain withholding Divisions where the underlying liability remains undischarged. From 1 July 1999 the penalty under those Divisions for late payment of tax is imposed by way of a general interest charge. The references to a penalty in paragraph 222AJB(1)(b) and subsection 222AJB(3) are replaced by references to the general interest charge. The heading of the section is also amended to reflect this change. [Schedule 4, items 13 and 14, paragraph 222AJB(1)(b) and item 15, subsection 222AJB(3)]

4.17 Subsection 222AJB(3) refers to provisions of Divisions 1AAA, 3B or 4 of the ITAA 1936 and Subdivision 16B in Schedule 1 to the TAA 1953 which reduce the amount of general interest charge payable where a judgment debt carried interest. These references are no longer applicable as the relevant judgment provisions in those Divisions have been repealed and replaced by a generic judgment provision in section 8AAH of the TAA 1953. The amendment to subsection 222AJB(3) refers to that generic judgment provision. [Schedule 4, item 15, subsection 222AJB(3)]

Application provisions

4.18 The amendments made by Part 1 of Schedule 4 will apply to PAYG withholding amounts that are due and payable in the year ended 30 June 2002 and in subsequent years. [Schedule 4, item 19]