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

Medicare levy and Medicare levy surcharge low income thresholds

Schedule 1 to this bill amends:

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the MLA 1986 to:

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increase the Medicare levy low income thresholds for individuals, married couples and sole parents. The dependent child/student component of the family threshold will also be increased. The increases are in line with movements in the CPI; and

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increase the Medicare levy low income threshold for pensioners below age pension age so that they do not have a Medicare levy liability where they do not have an income tax liability;

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the A New Tax System (Medicare Levy Surcharge-Fringe Benefits) Act 1999 to:

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increase the Medicare levy surcharge low income threshold in line with movements in the CPI.

Date of effect: The increased Medicare levy and Medicare levy surcharge low income thresholds apply from the 2002-2003 year of income and later years of income.

Proposal announced: This measure was announced in the 2003-2004 Federal Budget.

Financial impact: This measure will cost the revenue $34 million in 2003-2004, $17 million in 2004-2005, $17 million in 2005-2006 and $17 million in 2006-2007.

Compliance cost impact: Compliance costs will be negligible.

Value shifting: transitional exclusion for certain indirect value shifts relating mainly to services

Schedule 2 to this bill will amend the IT(TP) Act 1997 to modify the general value shifting regime so that, as a transitional measure, the consequences arising under that regime do not apply to most indirect value shifts involving services.

Date of effect: The transitional measure will apply to relevant indirect value shifts that occur before:

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the beginning of a losing entity's 2003-2004 income year; or

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if a losing entity's 2002-2003 income year ends before 30 June 2003, the beginning of the entity's 2004-2005 income year.

Proposal announced: This measure was announced in Minister for Revenue and Assistant Treasurer's Press Release No. C014/03 of 6 March 2003.

Financial impact: The amendments will have a cost to revenue of $5 million in 2003-2004 and a negligible cost to revenue in 2004-2005.

Compliance cost impact: This measure will reduce compliance costs for affected taxpayers.

Consolidation: refinements

With the introduction of the consolidation regime, a number of refinements (included in Schedules 3 to 8 to this bill) are being made to further clarify the following:

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cost setting rules for linked assets;

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cost setting rules for partners and partnerships;

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membership rules for subsidiaries of MEC groups held through an interposed non-resident entity; and

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minor technical amendments.

Date of effect: The consolidation measure took effect on 1 July 2002. The refinements made by this bill will also take effect from 1 July 2002.

Proposal announced: These measures were foreshadowed in Minister for Revenue and Assistant Treasurer's Press Release No. C014/03 of 6 March 2003.

Financial impact: None.

Compliance cost impact: These refinements are aimed at reducing the compliance costs stemming from the cost setting rules and the membership rules. The measures either align new rules with existing rules or clarify the existing rules' application.

Release from particular liabilities in cases of serious hardship

Schedule 9 to this bill amends the ITAA 1936, FBTAA 1986, TAA 1953, ITAA 1997 and the Administrative Appeals Tribunal Act 1975 to streamline the procedures under which an individual taxpayer can be released from a tax liability where payment would entail serious hardship. Consistent with contemporary review practices, the amendments will also introduce a new right to have tax relief decisions reviewed internally under the ATO objections process, and externally by the AAT sitting as the Small Taxation Claims Tribunal.

Date of effect: The new arrangements will commence on the later of 1 September 2003 or Royal Assent.

Proposal announced: Not previously announced.

Financial impact: No effect on revenue is expected, as the amendments do not alter the existing eligibility and decision making criteria.

Compliance cost impact: The amendments impose additional administrative costs on the ATO. Taxpayers should only incur increased compliance costs where they make use of the new review rights that the amendments afford.

Trans-Tasman (triangular) imputation

Schedule 10 to this bill inserts new Division 220 into Part 3-6 of the ITAA 1997 so that NZ companies may choose to enter the Australian imputation system. The Australian imputation rules will generally apply to a NZ company in the same way as they apply to an Australian company. This means that a NZ company will be able to maintain an Australian franking account and attach Australian franking credits to dividends.

Where a NZ company receives a franked dividend from an Australian company or pays Australian income tax or withholding tax, the NZ company will receive a franking credit and be able to frank dividends to its shareholders. Accordingly, Australian shareholders of NZ companies with Australian operations may receive franking credits reflecting Australian tax paid on Australian-sourced income and therefore be eligible for a tax offset.

NZ will make reciprocal changes to its imputation system to allow Australian companies to maintain a NZ imputation account.

Australian shareholders of NZ companies that earn Australian income are currently unable to receive Australian franking credits arising from company tax paid on that income. The same problem exists with NZ shareholders of Australian companies that earn NZ income. In effect, both groups of shareholders are taxed twice on such income. This is known as 'triangular taxation'. This measure will generally remove triangular taxation.

Date of effect: A NZ company may choose to maintain an Australian franking account from 1 April 2003. However, a NZ company will not be able to attach Australian franking credits to dividends until 1 October 2003.

Proposal announced: This measure was announced jointly by the Australian Commonwealth Treasurer and the NZ Minister for Finance and Revenue on 19 February 2003 (Treasurer's Press Release No. 7 of 19 February 2003).

Financial impact: This measure will have a cost to revenue of $5 million in 2003-2004, $20 million in 2004-2005, $20 million in 2005-2006 and $25 million in 2006-2007.

Compliance cost impact: NZ companies that choose to enter the Australian imputation system will incur a minor increase in compliance costs in maintaining an Australian franking account.

Summary of regulation impact statement

Regulation impact on business

Impact: This measure will have implications for a NZ company that chooses to enter the Australian imputation system.

Main points:

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NZ companies that choose to enter the Australian imputation system will incur a minor increase in compliance costs. They will have to maintain an Australian franking account and amend their distribution statements to give Australian shareholders information about the franking credit attached to dividends.

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This measure will increase administrative costs for the ATO. Forms and systems changes will be required to enable NZ companies to enter the Australian imputation system. Information and promotional material will be prepared to advise NZ companies and Australian shareholders about the changes. The ATO will also need to undertake specific compliance activities in relation to NZ companies.

GST amendments relating to compulsory third party schemes

Schedule 11 to this bill amends the GST Act to:

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modify the GST insurance provisions to apply to an insurer that makes payments or supplies in relation to CTP insurance policies and to apply similar provisions to payments and supplies that are made in relation to CTP compensation and other CTP non-insurance related matters; and

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ensure that the GST insurance provisions apply to payments and supplies made by CTP insurers and others pursuant to CTP settlement sharing arrangements.

Schedule 11 also amends the GST Transition Act to ensure that no adjustment or taxable supply arises in relation to the settlement of a claim under a CTP scheme, to the extent that the event giving rise to the claim happened before 1 July 2000.

Date of effect: 1 July 2000.

Proposal announced: These measurers were announced in the 2002-2003 MYEFO.

Financial impact: For the measures relating to settlement sharing arrangements, the expected cost to revenue is as follows:

For the remaining CTP measures the cost to revenue has not been quantified but is expected to be minimal.

Compliance cost impact: These measures are expected to reduce compliance costs.

Register of harm prevention charities

Schedule 12 to this bill amends the ITAA 1997 to establish a new category of DGR, namely, a register of harm prevention charities. Harm prevention charities are charitable institutions whose principal activity is to promote the prevention or the control of behaviour that is harmful or abusive to human beings.

Date of effect: The amendment applies to gifts made on or after 1 July 2003.

Proposal announced: This measure was announced in Treasurer's Press Release No. 49 of 29 August 2002.

Financial impact: Cost to revenue of $5 million per annum for 2004-2005, 2005-2006 and 2006-2007.

Compliance cost impact: Nil.

Chapter 1 Medicare levy and Medicare levy surcharge low income thresholds

Outline of chapter

1.1 Schedule 1 to this bill amends the MLA 1986 and the A New Tax System (Medicare Levy Surcharge-Fringe Benefits) Act 1999 to increase the Medicare levy low income threshold amounts (threshold amounts) for individuals, married couples, sole parents and pensioners below age pension age. It also increases the phase-in limits as a result of the increased threshold amounts.

Context of amendments

Medicare levy low income thresholds

1.2 The MLA 1986 provides that no Medicare levy is payable for low income individuals and families where taxable income or combined family taxable income does not exceed stated threshold amounts. For couples and single parents, the family income threshold increases by a set amount per child. The Medicare levy shades in at a rate of 20 cents in the dollar where the taxable income or combined family taxable income exceeds the threshold amounts.

Medicare levy surcharge low income threshold

1.3 A Medicare levy surcharge (the surcharge) of 1% applies on taxable income in certain cases where taxpayers do not have private patient hospital cover (sections 8B to 8G of the MLA 1986). The surcharge of 1% also applies to reportable fringe benefits in certain cases where taxpayers do not have private patient hospital cover (sections 12 to 16 of the A New Tax System (Medicare Levy Surcharge-Fringe Benefits) Act 1999). However, a married person who would otherwise be liable for the surcharge is not required to pay the surcharge where the total of the person's taxable income and reportable fringe benefits do not exceed the individual low income threshold amount. Unlike the Medicare levy, there is no shading-in of the surcharge above the threshold amount.

Summary of new law

1.4 The measure amends:

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subsections 3(1) and 8(5) to (7) of the MLA 1986 to raise the threshold amounts and phase-in limits for individuals, married couples, sole parents and pensioners who are under age pension age;

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paragraphs 8D(3)(c) and 8G(2)(c) and subparagraphs 8D(4)(a)(ii) and 8G(3)(a)(ii) of the MLA 1986 to raise the threshold below which a family member is not required to pay the surcharge on taxable income; and

•

paragraphs 15(1)(c) and 16(2)(c) of the A New Tax System (Medicare Levy Surcharge-Fringe Benefits) Act 1999 to raise the threshold below which a family member is not required to pay the surcharge on reportable fringe benefits.

Detailed explanation of new law

Medicare levy low income thresholds

1.5 Schedule 1 proposes to increase the low income thresholds for individuals, married couples and sole parents for the 2002-2003 year of income and subsequent years of income. The increases are in line with movements in the CPI.

1.6 Section 7 of the MLA 1986 states that no levy is payable where a taxpayer has a taxable income at or below the applicable threshold amount as specified in subsection 3(1).

1.7 The individual threshold amount specified in paragraph (c) of the definition of the 'threshold amount' in subsection 3(1) of the MLA 1986 is to be increased from $14,539 to $15,062. [Schedule 1, item 4]

1.8 The level of the 'family income threshold' referred to in subsections 8(5) to (7) of the MLA 1986 is to be increased from $24,534 to $25,417 [Schedule 1, items 5, 7 and 8] . The family income threshold is to be increased by a further $2,334 instead of the previous figure of $2,253 for each dependent child or student [Schedule 1, item 6] .

1.9 Schedule 1 also proposes to increase the threshold amount for pensioners below age pension age for the 2002-2003 year of income and subsequent years of income. The increase ensures that such pensioners do not have a Medicare levy liability where they face no income tax liability.

1.10 The threshold amount for pensioners who are under age pension age specified in paragraph (b) of the definition of the 'threshold amount' in subsection 3(1) of the MLA 1986 is to be increased from $16,570 to $17,164. [Schedule 1, item 3]

Phase-in limit

1.11 Section 7 of the MLA 1986 also provides that the Medicare levy applies at a reduced rate to taxpayers with taxable incomes above the threshold amount but not more than the phase-in limit specified in subsection 3(1). The rate of the Medicare levy payable in these circumstances is limited to 20% of the excess over the threshold amount that is relevant to the particular person.

1.12 The phase-in limit for individuals contained in paragraph (c) of the definition of phase-in limit in subsection 3(1) of the MLA 1986 is increased from $15,717 to $16,283. [Schedule 1, item 2]

1.13 The phase-in limit for pensioners who are under age pension age specified in paragraph (b) of the definition of phase-in limit in subsection 3(1) of the MLA 1986 is increased from $17,913 to $18,555. [Schedule 1, item 1]

1.14 There is no phase-in limit stated in the MLA 1986 for families as the figure changes with the number of dependants. Instead, subsection 8(2) of the MLA 1986 contains a formula that limits the levy payable by persons with families to 20% of the amount of family income that exceeds their family income threshold. This range is increased for dependants as indicated in Table 1.1.

1.15 The increased Medicare levy low income threshold amounts and phase-in ranges for the 2002-2003 year of income and subsequent years of income is as shown in Table 1.1:

Medicare levy surcharge low income threshold

1.16 References to the individual low income threshold amount of $14,539 in the Medicare levy surcharge provisions (in sections 8D and 8G of the MLA 1986) in respect of surcharge on taxable income are also being increased to $15,062. [Schedule 1, items 9 to 12]

1.17 References to the individual low income threshold amount of $14,539 in the Medicare levy surcharge provisions (in sections 15 and 16 of the A New Tax System (Medicare Levy Surcharge-Fringe Benefits) Act 1999) in respect of surcharge on reportable fringe benefits are also being increased to $15,062. [Schedule 1, items 13 and 14]

Application provisions

1.18 The amendments to sections 8D and 8G and subsections 3(1) and 8(5) to (7) of the MLA 1986 and the amendments to sections 15 and 16 of the A New Tax System (Medicare Levy Surcharge-Fringe Benefits) Act 1999 are to apply for the 2002-2003 year of income and later years of income. [Schedule 1, item 15]

Chapter 2 Value shifting: transitional exclusion for certain indirect value shifts relating mainly to services

Outline of chapter

2.1 Schedule 2 to this bill will amend the IT(TP) Act 1997 to modify the general value shifting regime so that, as a transitional measure, the consequences arising under that regime do not apply to most indirect value shifts involving services where those value shifts occur before:

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the beginning of a losing entity's 2003-2004 income year; or

•

if a losing entity's 2002-2003 income year ends before 30 June 2003, the beginning of the losing entity's 2004-2005 income year.

Context of amendments

2.2 The general value shifting regime applies mainly to equity and loan interests in certain companies and trusts that are affected, directly or indirectly, by value shifting arrangements. The regime contains separate rules for direct value shifts and indirect value shifts.

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A direct value shift arises mainly where there is a value shift involving equity and loan interests in a single entity.

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An indirect value shift arises mainly where there is a value shift between entities that have not dealt with each other at arm's length.

2.3 The general value shifting regime generally applies to value shifts that happen on or after 1 July 2002. However, the regime does not affect interests in consolidated group members that are reconstructed under the consolidation rules.

2.4 Therefore, to facilitate the transition to consolidation, most indirect value shifts involving services will be excluded from the general value shifting regime where those value shifts occur before:

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the beginning of a losing entity's 2003-2004 income year; or

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if a losing entity's 2002-2003 income year ends before 30 June 2003, the beginning of the losing entity's 2004-2005 income year.

2.5 The amendments will:

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ensure that groups that consolidate during the exclusion period do not incur compliance costs associated with setting up systems to identify significant service related indirect value shifts when those systems will not be needed after consolidation; and

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allow groups that do not consolidate extra time to establish systems to track service related indirect value shifts that may require adjustments under the general value shifting regime.

Summary of new law

2.6 Most indirect value shifts where at least 95% of the market value of the benefits provided by the losing entity are services will be excluded from the consequences of the general value shifting regime if those value shifts occur before:

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the beginning of a losing entity's 2003-2004 income year; or

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if a losing entity's 2002-2003 income year ends before 30 June 2003, the beginning of the losing entity's 2004-2005 income year.

Comparison of key features of new law and current law

Detailed explanation of new law

2.7 Division 727 of the ITAA 1997 contains rules to regulate the impact of indirect value shifts. Broadly, a scheme results in an indirect value shift from one entity (the losing entity) to another entity (the gaining entity) if the total market value of the economic benefits that the losing entity has provided to the gaining entity in connection with the scheme (the greater benefits) exceed the total market value of the economic benefits that the gaining entity has provided to the losing entity in connection with the scheme (the lesser benefits).

2.8 Where there is an indirect value shift that leads to inappropriate tax outcomes, Division 727 requires adjustments either to the adjustable value of interests held by affected owners or to losses or gains arising when the interests are realised.

2.9 A wide range of transactions and dealings are excluded from Division 727. This ensures that the indirect value shifting rules are appropriately targeted with a view to identifying only significant and material value shifts, while at the same time containing compliance costs. In particular, there are 2 specific exclusions for indirect value shifts involving services.

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The first exclusion relates to benefits consisting of services provided by a losing entity to a gaining entity for a price equal to at least the direct cost to the losing entity of providing the services. The exclusion applies where at least 95% of the market value of the economic benefits provided by the losing entity consist of services.

•

The second exclusion relates to services that are not reasonably considered to be overcharged (that is, the services must be considered to be provided for no more than a commercially realistic price). The exclusion applies where at least 95% of the market value of the economic benefits provided by the gaining entity consist of services.

2.10 The services covered by these 2 exclusions are defined in section 727-240 of the ITAA 1997 and include, among other things:

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doing work (including professional work and giving professional advice or any other kind of advice); and

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lending money or providing any other form of financial accommodation (such as providing interest free loans).

2.11 The amendments broaden the exclusions from the indirect value shifting rules for services where the 'IVS time' for the scheme that results in the indirect value shift is before:

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the beginning of a losing entity's 2003-2004 income year; or

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if a losing entity's 2002-2003 income year ends before 30 June 2003, the beginning of the losing entity's 2004-2005 income year.

[Schedule 2, item 1, subsection 727-230(1)]

2.12 The 'IVS time' is defined in subsection 727-150(2) of the ITAA 1997 to mean, broadly, the time when all the parameters of the indirect value shift under a scheme are known.

2.13 The amendments ensure that the indirect value shifting rules do not apply to indirect value shifts where the 'IVS time' happens during this exclusion period and at least 95% of the market value of the benefits provided by the losing entity to the gaining entity (the greater benefits) consist entirely of services. [Schedule 2, item 1, subsection 727-230(1)]

2.14 Division 727 also applies to presumed indirect value shifts. A presumed indirect value shift arises in circumstances that are similar to an indirect value shift and is determined on the basis of certain specified assumptions (see Subdivision 727-K of the ITAA 1997). These assumptions will be modified so that they reflect the transitional provisions to broaden the exclusion from the indirect value shifting rules for services. [Schedule 2, item 1, subsection 727-230(2)]

2.15 In order to qualify for the transitional exclusion the affected entities must be capable of determining that the greater benefits under the scheme include services that comprise at least 95% of the total market value of the benefits. That is, as the transitional exclusion provides that the indirect value shift does not have any consequences, the affected entities must be able to establish that there is an indirect value shift that satisfies the conditions for the transitional exclusion.

2.16 However, if an indirect value shift or presumed indirect value shift results from a scheme that is entered into or carried out for the sole or dominant purpose of obtaining a tax benefit under the transitional exclusion, then Part IVA of the ITAA 1936 may apply to the scheme to cancel that tax benefit.

Example 2.1

Two controlled companies that are not part of a consolidated group enter into a scheme prior to 1 July 2003 which involves a service agreement and interest free loan arrangement. More than 95% of the market value of the greater benefits under the scheme consist entirely of rights to have services provided directly by the losing entity to the gaining entity.

The service agreement and interest free loan arrangement are normal commercial arrangements that would have been entered into in the same way if the transitional exclusion had not existed. Therefore, the transitional exclusion will ensure that there will be no requirement to make adjustments to reflect any indirect value shifts arising under the scheme.

Example 2.2

A wholly-owned group of companies that has not consolidated is contemplating the sale of a subsidiary company to a related party. Prior to the sale, the group saddles the subsidiary with obligations under various agreements to provide services with nominal returns to group members over a 5 year period. This depresses the market value of the subsidiary company's shares with the result that it can be sold at a loss.

A dominant reason for entering into the service agreements was to obtain the benefit of the transitional exclusion to avoid any value shifting adjustment so that the loss on sale would arise. Therefore, Part IVA of the ITAA 1936 may apply to this arrangement to cancel the tax benefit of the loss.

Application and transitional provisions

2.17 The amendments apply where the 'IVS time' for the scheme that results in the indirect value shift is before:

•

the beginning of a losing entity's 2003-2004 income year; or

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if a losing entity's 2002-2003 income year ends before 30 June 2003, the beginning of the losing entity's 2004-2005 income year.

[Schedule 2, item 1, paragraphs 727-230(1)(c) and (d)]

Chapter 3 Consolidation: refinements

Outline of chapter

3.1 Schedules 3 to 8 to this bill make the following refinements to the consolidation regime:

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cost setting rules for linked assets;

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cost setting rules for partners and partnerships;

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membership rules for subsidiaries of MEC groups held through an interposed non-resident entity; and

•

minor technical amendments and number sequencing.

3.2 All references to sections, Divisions and Parts are references to sections, Divisions and Parts of the ITAA 1997 unless otherwise stated.

Context of amendments

3.3 With the introduction of the consolidation regime, a number of refinements, mentioned in paragraph 3.1, are being made to further clarify, among other things, the consolidation cost setting rules and the membership rules.

Summary of new law

Linked assets and liabilities

3.4 Schedule 3 to this bill amends the cost setting rules to enable a netting-off treatment of assets and liabilities if the accounting standards set-off those assets and liabilities against each other and only record the net value in the balance sheet.

Cost setting rules for partnerships

3.5 Schedule 4 to this bill provides special rules for setting the tax cost of assets where an entity that is a partner in a partnership becomes a member of a consolidated group and where a partnership becomes a member of a consolidated group. These rules ensure that the cost setting rules apply appropriately taking into account the different treatment of partnerships (compared to companies) under the income tax law.

MEC groups and foreign-held membership structures

3.6 Schedules 5, 6 and 7 to this bill amend the membership rules contained in Division 719 to limit the circumstances in which non-resident entities can be interposed between members of a MEC group.

3.7 Broadly, only those MEC groups that consolidate with effect before 1 July 2004 are eligible to have non-resident entities interposed between members of the group. Further, there are on-going rules that restrict what entities can join a MEC group and ensure that members of a MEC group continue to satisfy the membership requirements whilst a member of the group.

Number sequencing of Parts 3-90 and 3-95

3.8 A technical amendment is made to correct the placement of Parts 3-90 and 3-95.

Comparison of key features of new law and current law

Detailed explanation of new law

Linked assets and liabilities

3.9 Schedule 3 to this bill amends the tax cost setting rules to enable a netting-off treatment of assets and liabilities if the accounting standards set-off those assets and liabilities against each other and only record the net value in the balance sheet.

3.10 In some circumstances the Australian accounting standards require an asset and a liability to be set-off and only the net amount recorded in the balance sheet (e.g. see AASB 1014, section 9). In broad terms, these cases involve both a legally recognised right of set-off, so that only the net amount has to be paid or received, and an intention to settle the asset and the liability at the same time. For example, the accounting standards would apply the set-off rules if 2 parties agreed to provide services to each other throughout a period, with the net debtor paying only the difference at the end of the period.

3.11 In most respects, the consolidation regime treats these linked assets and liabilities as if they were separate things. So, for instance, they would be treated as separate things when an entity left a consolidated group and the tax cost of the group's interest in the entity was worked out. [Schedule 3, item 3, section 705-58]

3.12 However, there are special rules for setting the tax cost of a joining entity's assets if, immediately before it joins a consolidated group, it has a set of linked assets and liabilities that must be set-off against each other under the accounting standards. [Schedule 3, item 3, subsection 705-59(1)]

3.13 A set of linked assets and liabilities consists of at least one asset and at least one liability that the accounting standards (or statements of accounting concepts) require to be:

•

set-off against each other in preparing an entity's statement of financial position; and

•

presented in that statement as a net amount.

[Schedule 3, item 3, subsection 705-59(2)]

3.14 The special rules for linked assets and liabilities start by comparing the amount of the liabilities to the value of the asset. In doing that, they don't use the raw amount of the liabilities. Instead, they use the amount that step 2 of the rules for working out the ACA would take into account for the liabilities if you ignored both the special rules for linked assets and liabilities and the accounting standards that apply to them. This modified amount is called 'the available amount'. [Schedule 3, item 3, paragraphs 705-59(3)(a) and (5)(a)]

3.15 The available amount can differ from the raw amount of the liabilities because it relies on step 2 of the ACA rules, which factors in future tax effects (see section 705-75) and differences in timing between accounting and the tax law (see section 705-80).

Reset cost base assets

3.16 The rules distinguish between cases where the liabilities are being set-off against a single reset cost base asset and cases where they are being set-off against more than one asset. They are not affected by whether there is only one liability or several.

Only one linked asset

3.17 In cases where there is only one linked asset that is a 'reset cost base asset' (i.e. almost any asset that isn't a retained cost base asset), a table explains the effect on the ACA and the asset's tax cost.

3.18 If the asset's market value is less than or equal to the total available amount of the liabilities:

•

the asset's tax cost setting amount is its market value; and

•

only any excess amount of the liabilities is included at step 2 of the rules for working out the ACA.

[Schedule 3, item 3, paragraph 705-59(3)(b), item 1 in the table]

3.19 The asset in that case does not share in the distribution of the ACA and does not affect how the ACA is distributed among the other assets of the joining entity. [Schedule 3, item 3, paragraph 705-59(3)(b), item 1 in the table]

Example 3.1: The value of a reset cost base asset is less than an available amount

Antigonas Enterprises has to work out its ACA when it joins a consolidated group. It has a reset cost base asset with a market value of $5,000 which is being set-off in its balance sheet against a liability that has an 'available amount' of $7,000.

The special rules about linked assets and liabilities will set the asset's tax cost at its $5,000 market value and increase the ACA by the $2,000 excess available amount. The asset will not share in that ACA, which will be apportioned among the joining entity's other assets.

3.20 Essentially, what is happening here is that, instead of increasing the ACA to be distributed generally among the entity's reset cost base assets, the linked liability is being dedicated first to setting the tax cost of the asset to which it is linked. Only the excess is added to the ACA for use in increasing the tax cost of other assets. This limits the transfer of value to or from the linked assets, and so prevents the distortion that is the target of these special rules.

3.21 If the linked asset's market value is greater than the total available amount of the liabilities:

•

the asset's tax cost setting amount is worked out as if the asset's market value were equal to the difference, then increased by the available amount; and

•

nothing is included for the liability at step 2 of the ACA rules.

[Schedule 3, item 3, paragraph 705-59(3)(b), item 2 in the table]

Example 3.2: The value of a reset cost base asset exceeds an available amount

Seleucus Grinding Machines is taken over by a consolidated group. At the joining time, it has a reset cost base asset with a market value of $8,000 that is set-off against a $6,500 liability. Its balance sheet records the $1,500 net asset value. It has other reset cost base assets with market values totalling $25,000 and an ACA that works out at $30,000.

If the liability's available amount is the full $6,500, the asset's tax cost setting amount would be worked out as if its market value were equal to the $1,500 excess (i.e. $8,000 - $6,500). That would give it a $1,698 share of the ACA (i.e. $1,500 ? ($1,500 ? $25,000) ? $30,000), which would be increased by the $6,500 available amount to set the asset's tax cost at $8,198.

3.22 This is the other side of the coin. Here, the asset has a greater market value than the liability to which it is linked, so the full amount of the liability is dedicated to setting the tax cost of the asset. The asset also gets a proportionate share of the ACA but based only on the difference between its market value and the available amount of the liability rather than on its full market value. Again, for cases where the asset's accounting value is lower because of a liability to which it is linked, this appropriately limits any distortion from value moving between assets.

Multiple assets

3.23 There would usually be only one asset being set-off against one liability. However, the accounting standards are not limited to those cases. They also cover a set of several assets and liabilities.

3.24 If 2 or more assets (including at least one reset cost base asset) are linked to the liabilities, then a second table explains how the ACA and the assets' tax costs are affected.

3.25 If all the linked assets are reset cost base assets, and the total of their market values is less than or equal to the total available amount of the liabilities:

•

each linked asset's tax cost setting amount is its market value; and

•

only any excess amount of the liabilities is included at step 2 of the ACA rules.

[Schedule 3, item 3, paragraph 705-59(5)(b), item 1 in the table]

3.26 The linked assets do not share in the distribution of the ACA and do not affect how the ACA is distributed among the other assets of the joining entity. [Schedule 3, item 3, paragraph 705-59(5)(b), item 1 in the table]

3.27 This is just a variant of the case where there is only a single linked asset with a lower value than the liabilities to which it is linked. It produces exactly the same results.

3.28 If all the linked assets are reset cost base assets, and the total of their market values is greater than the available amount of the liabilities:

•

each linked asset's tax cost setting amount is equal to a proportionate share of the available amount (based on the assets' market values) plus a share of the ACA (based on a 'market value' equal to its actual market value reduced by its share of the available amount); and

•

nothing is included for the liabilities at step 2 of the ACA rules.

[Schedule 3, item 3, paragraph 705-59(5)(b), item 2 in the table]

Example 3.3: The value of multiple reset cost base assets exceeds an available amount

Eumenes Financial Wizardry Pty Ltd joins a consolidated group. Its balance sheet sets off a number of liabilities against 2 reset cost base assets, and records only a single net figure for the whole set. The 'available amount' of the liabilities is $150,000. One of the linked assets is worth $120,000 and the other $240,000.

As they are worth more than the liabilities, the assets will split the available amount of the liabilities between them in proportion to their market values. As it represents a third of the assets' total market values, the first asset will get $50,000 of the available amount (i.e. a third of $150,000) and the second asset will get the other $100,000.

The first asset will also get a share of the ACA based on a 'market value' of $70,000 (i.e. its actual $120,000 market value less its $50,000 share of the available amount). The second asset will use a value of $140,000 (i.e. $240,000 - $100,000) in working out its share of the ACA.

Each of the assets will have a tax cost equal to its share of the available amount plus its share of the ACA.

3.29 This is a variant of the case where there is only a single linked asset with a higher value than the liabilities it is linked to. In that case, the rules dedicated the liabilities to setting the tax cost of the asset and also gave the asset a share of the ACA based on the difference. In this case, the liabilities are dedicated to several assets in proportion to their market values. Each of the assets still also claims a share of the ACA based on the difference.

3.30 If some of the assets are retained cost base assets whose total tax cost equals or exceeds the available amount of the liabilities, the liabilities are factored into the ACA in the normal way, and the tax costs of both the retained and the reset cost base assets are determined normally. [Schedule 3, item 3, paragraph 705-59(5)(b), item 3 in the table]

3.31 This reflects the fact that all of the liabilities in the set of linked assets and liabilities should be dedicated to funding the tax cost of the retained cost base assets in the set and none used for the reset cost base assets. However, the normal rules for distributing the ACA (see section 705-35) already achieve that, so special rules are not necessary.

3.32 If some of the assets are retained cost base assets whose total tax costs are less than the available amount of the liabilities, then the same rules that apply if there are only reset cost base assets in the linked set are applied as if:

•

the set contained only the reset cost base assets; and

•

the available amount of the liabilities was equal to the excess of the actual available amount over the tax costs of the retained cost base assets.

[Schedule 3, item 3, paragraph 705-59(5)(b), item 4 in the table]

3.33 In effect, this recognises that removing the tax costs of the retained cost base assets from both the assets side and the liabilities side of a linked set will reduce the set to one of the cases dealt with in items 1 and 2 in the table, where there are only reset cost base assets.

Example 3.4: The available amount exceeds the value of retained cost base assets in a multiple assets set

When Peithon Shoes Ltd joins a consolidated footwear group, it has a set of linked assets and liabilities. It is owed $12,000 (a retained cost base asset) and also has a reset cost base asset worth $7,000. These are offset in its balance sheet against a liability with an available amount of $15,000.

Since the available amount of the liability exceeds the $12,000 tax cost of the retained cost base asset, the case is treated in the same way as one of a reset cost base asset worth $7,000 and a linked liability with an available amount of $3,000 (i.e. $15,000 - $12,000). In fact, that would be dealt with by item 2 in the table.

3.34 A further consequence in this case is that the retained cost base asset is not counted in distributing the ACA among the reset cost base assets [Schedule 3, item 3, paragraph 705-59(5)(b), item 4 in the table] . Normally, the ACA is applied first to funding the joining entity's retained cost base assets and only the remainder is available to set the tax costs of its reset cost base assets. However, in this linked asset case, the part of the linked liability counted towards the ACA has already been reduced by the amount of the retained cost base asset. To apply the ACA to funding that retained cost base asset would give the asset an inappropriate double effect.

Other tax cost setting provisions

3.35 Some other provisions limit the tax cost of some of an entity's assets when it joins a consolidated group. For example, the tax cost of trading stock cannot be set above both its market value and its 'terminating value' (essentially the trading stock value it had in the joining entity's hands).

3.36 Those provisions (sections 705-40, 705-45 and 705-50) are intended to prevent inappropriate tax benefits arising from consolidating. They are not affected by any of the rules about linked assets and liabilities. That means that a linked asset might have its tax cost initially set by the linked asset rules but then be reduced to conform to the limits imposed by those provisions. [Schedule 3, item 3, subsection 705-59(7)]

Retained cost base assets

3.37 The linked asset rules do not affect how the tax cost of retained cost base assets (essentially money and rights to money) is set. That is always done by section 705-25.

3.38 If a set of linked assets and liabilities only has retained cost base assets, the liabilities will be dealt with under step 2 of the allocable cost calculation in the normal way. That the liabilities are linked to the assets will not affect their treatment at all. [Schedule 3, item 3, subsection 705-59(4)]

3.39 In that case, there was no need to dedicate the liabilities to funding the tax costs of the retained cost base assets because the normal rules for distributing the ACA achieve the same result.

Excluded assets

3.40 Excluded assets in a set of linked assets and liabilities are ignored in working out the tax costs of the other assets in the set. So, for example, a set of linked assets and liabilities that contained a reset cost base asset and an excluded asset would be treated as if it only contained the reset cost base asset. [Schedule 3, item 3, subsection 705-59(6)]

3.41 'Excluded assets' are assets that do not have a tax cost set for them. Essentially, they are rights to future tax benefits (e.g. a right to a tax deduction). Those tax benefits can affect tax liability but the rights themselves do not, so those rights do not need a tax cost and should not affect the ACA available for distribution to assets that do need a tax cost. Excluded assets are described in subsection 705-35(2).

Consequential amendments

CGT event L3

3.42 CGT event L3 provides for a capital gain equal to the excess of the tax cost setting amounts of a joining entity's retained cost base assets (mostly, rights to receive money) over its ACA. In short, it aims to bring to account immediately any part of the tax cost of the entity's assets that cannot be funded from the ACA.

3.43 A problem can arise here, if a retained cost base asset is linked to a liability, because the full tax cost setting amount of the asset is counted in the CGT event L3 calculation even though the linked liability is not fully counted towards the ACA.

Example 3.5: An inappropriate result under CGT event L3

Craterus Pty Ltd joins a consolidated group. It has a set of linked assets and liabilities with one retained cost base asset (worth $10,000), one reset cost base asset (worth $6,000) and one liability (of $12,000). The group might have paid $4,000 for Craterus (which is its net value). Assuming that the 'available amount' of the liability is also $12,000, the ACA for Craterus would be $6,000 (i.e. the $4,000 purchase price + the $2,000 of the liability not used to set retained cost base asset's tax cost - see item 4 in the table in subsection 705-59(5)).

CGT event L3 would now identify a $4,000 capital gain because the $10,000 tax cost setting amount of the retained cost base asset exceeds the $6,000 ACA by that much. That would be the wrong result because the tax cost of the retained cost base asset was fully funded by the linked liability, so there was no actual shortfall. The mismatch arises because the calculation counts the full amount of the retained cost base asset even though only $2,000 of the $12,000 liability has been counted towards the ACA.

3.44 The amendment changes the calculation of CGT event L3 to exclude the tax cost setting amount of retained cost base assets that are not taken into account in the process of working out the tax cost of reset cost base assets. [Schedule 3, item 1, paragraph 104-510(1)(b)]

3.45 That solves the problem because the linked asset provisions only exclude the amount of a retained cost base asset from that process if they also reduce the liability linked to it in working out the ACA (see item 4 in the table in subsection 705-59(5)).

Example 3.6: Solving the CGT event L3 problem

Continuing from Example 3.5.

The retained cost base asset is not counted in working out how much of the ACA is available to set the tax cost of the reset cost base asset (see item 4 in the table in subsection 705-59(5)). Therefore, CGT event L3 will not count that retained cost base asset in working out any capital gain when Craterus joins the group. As there are no other retained cost base assets in this case, there will be no capital gain.

Note for readers

3.46 A note is added to subsection 705-35(1) (which usually sets the tax cost for reset cost base assets) to draw readers' attention to the effect of the linked asset provisions on tax cost. It also notes that there can be a consequent effect for CGT event L3. [Schedule 3, item 2, note 1A to subsection 705-35(1)]

Dictionary signpost to a new definition

3.47 The income tax law's dictionary is amended to include a pointer to the place where the new term, 'linked assets and liabilities', is defined. [Schedule 3, item 4, definition of 'linked assets and liabilities' in subsection 995-1(1)]

Cost setting rules for partners and partnerships

3.48 Subdivision 713-E introduced in Schedule 4 to this bill contains special cost setting rules for partners and partnerships. These rules are explained under the following topics:

•

where an entity that is a partner in a partnership becomes a member of a consolidated group; and

•

where a partnership becomes a member of a consolidated group (this will occur where all the partners in a partnership are members of the consolidated group).

3.49 The object of Subdivision 713-E is to set the tax cost setting amount (hereafter referred to as 'tax cost') of certain types of assets that relate to a partnership. How this is achieved depends on whether at the joining time:

•

a partner in a partnership becomes a subsidiary member of the consolidated group; or

•

a partnership becomes a subsidiary member of the consolidated group (including because a partner also becomes a subsidiary member of the group at that time).

[Schedule 4, item 1, subsections 713-205(1) and (2)]

3.50 In either case the tax cost of these assets is set by applying specified cost setting provisions with some modifications, as contained in Subdivision 713-E. Those specified provisions are:

•

section 701-10, which is the core rule that sets the tax cost of assets that an entity brings into the group;

•

Subdivision 705-A, which provides the detailed rules to be able to work out at what amount an asset's tax cost should be reset; and

•

any other provision that modifies Subdivision 705-A.

[Schedule 4, item 1, subsection 713-205(3)]

3.51 A summary of the rules for partners and partnerships is contained in Table 3.1.

3.52 The rules contained in this bill do not deal with the case where a partner leaves a consolidated group and as a consequence the partnership also leaves the group. Further refinements, consistent with the refinements made in this Subdivision, will be required.

What happens when an entity that is a partner in a partnership becomes a member of a consolidated group?

3.53 Where an entity becomes a member of a consolidated group the tax costs for the assets of the joining entity will generally be reset as a consequence of the core rules in Division 701 and the cost setting rules in Division 705. Special rules are contained in Subdivision 713-E to ensure that the general cost setting rules apply appropriately where the entity is a partner in a partnership. [Schedule 4, item 1, subsection 713-220(1)]

3.54 These special rules:

•

ensure that the partnership is not treated as an entity for the purposes of applying the cost setting rules;

•

specify what assets in relation to the partnership will have their tax cost reset (the 'partnership cost setting interests');

•

specify how the tax cost for the assets (being the 'partnership cost setting interests') is set; and

•

specify what modifications are made in determining and allocating the ACA, to take account of the entity being a partner in a partnership.

3.55 These special rules also apply where, as a consequence of an entity joining a consolidated group, a partnership in which that entity is a partner becomes a member of the consolidated group (see paragraph 3.97).

3.56 A partnership is not treated as an entity for the purposes of the cost setting rules and consequently no tax cost is set for membership interests in the partnership. This is consistent with the CGT approach to the taxation of partnerships. By not treating the partnership as an entity for the purposes of the cost setting rules, the ACA calculated for an entity (being the partner) is allocated to the entity's individual share in the assets of the partnership as well as any other assets of the entity. [Schedule 4, item 1, paragraph 713-220(2)(c)]

Example 3.7: A partner joins a consolidated group

If Head Co acquires all of the shares in Partner A Co then the cost setting rules (as modified by Subdivision 713-E) will apply to set the tax cost for the assets of Partner A Co including the assets consisting of the partner's individual share in the assets of the partnership. Consequently, Head Co will hold assets consisting of a partnership cost setting interest in each of the assets of the partnership (e.g. trading stock, depreciating asset and land).

No tax cost is set for either the interest in the partnership as a whole (i.e. membership interests in the partnership) or the underlying assets of the partnership.

What assets are recognised for the purposes of cost setting?

3.57 The assets that are recognised and which consequently have their tax cost set are called 'partnership cost setting interests'. Partnership cost setting interests are identified in relation to a particular partnership in which an entity is a partner. These interests consist of:

•

an interest in an asset of a partnership; or

•

an interest in the partnership that is not an interest in an asset of the partnership.

However, an asset that consists of a membership interest in the partnership is not a partnership cost setting interest . [Schedule 4, item 1, section 713-210; item 2, definition of 'partnership cost setting interest' in subsection 995-1(1)]

3.58 An underlying asset of the partnership (as distinct from an interest in such an asset) is not a partnership cost setting interest. Consequently, where the tax cost of a partnership cost setting interest is reset it will have no effect on the tax cost of the underlying asset of the partnership.

3.59 The cost for the underlying assets of the partnership (e.g. trading stock, depreciating assets) are the costs that are relevant in determining the net income, exempt income or loss of the partnership. Resetting the costs of all underlying assets (other than retained cost base assets), whilst consistent with the operation of the general cost setting rules, would result in significant compliance costs as individual partners could consequently have different costs for assets of the partnership. This could require each partner to undertake separate calculations of net income, exempt income and partnership loss. For this reason, the cost for the underlying assets of the partnership are not reset.

3.60 The concept of 'partnership cost setting interest' draws upon the recognition for CGT purposes of CGT assets in paragraphs 108-5(2)(c) and 108-5(2)(d). However, the assets referred to in the definition of 'partnership cost setting interest' are not limited to CGT assets and can therefore comprise assets consisting of anything of economic value (as per the general cost setting rules).

3.61 Consistent with the CGT rules, a partner, such as the head company, can have more than one cost setting interest in an asset of the partnership. This may arise because of the incremental acquisition of partnership interests by the one entity or through the operation of the single entity principle (e.g. where more than one of the subsidiary members is a partner in the partnership).

Working out the terminating value of a partnership cost setting interest

3.62 In setting the tax cost for a partnership cost setting interest in a partnership it is often necessary to work out the interest's terminating value (e.g. in applying provisions which restrict the tax cost to an interest's terminating value). Section 713-215 has effect by modifying the general rule for working out the terminating value of an asset in section 705-30. [Schedule 4, item 1, subsection 713-215(1)]

3.63 The terminating value of a partnership cost setting interest at a particular time (e.g. the joining time) is:

•

where the partnership cost setting interest relates to an asset of the partnership - the partner's individual share of the terminating value of that asset (worked out by applying section 705-30 as though certain assumptions discussed below were made); or

•

in any other case - the terminating value of the interest worked out under section 705-30.

[Schedule 4, item 1, subsection 713-215(2)]

3.64 In the first instance mentioned above, section 705-30 is applied as though:

•

the joining time for the purposes of section 705-30 was the time the entity that is a partner in a partnership becomes a member of the group; and

•

the joining entity for the purposes of section 705-30 was the partnership in which the entity is a partner.

[Schedule 4, item 1, subsection 713-215(3)]

3.65 Section 713-215 also applies in working out the terminating value of a partnership cost setting interest in an asset that is over-depreciated (see paragraphs 3.76 to 3.80).

Example 3.8: Terminating value of a partnership cost setting interest

Sheffield Co is a partner in United Partnership and has a 50% share in an asset of the partnership consisting of trading stock. The trading stock has a value for partnership purposes of $100. If Sheffield Co was to join a consolidated group then the head company would have a partnership cost setting interest in the partnership consisting of the head company's interest in the trading stock. The terminating value for the interest in the trading stock would be $50 consisting of the head company's individual share (being 50%) of the terminating value of the trading stock.

How is the tax cost of a partnership cost setting interest set?

3.66 Where an entity that is a partner in a partnership becomes a member of a consolidated group, the general cost setting rules which apply to set the tax cost for the assets of the partner will also set the tax cost for each partnership cost setting interest in that partnership. [Schedule 4, item 1, paragraph 713-220(2)(a)] .

3.67 The operation of section 713-220 will not set the tax cost for the 'underlying' assets of the partnership. However, where the partnership becomes a member of the consolidated group as a consequence of the entity joining the group the tax cost set for the partnership cost setting interests will be relevant in setting the tax cost for the underlying assets of the partnership (section 713-220 in these circumstances is applied having regard to the effect of section 713-235 (see paragraph 3.97)). [Schedule 4, item 1, paragraph 713-220(2)(b)]

3.68 The ACA for the joining entity is allocated amongst its assets (including those consisting of partnership cost setting interests) in accordance with the general cost setting rules subject to certain modifications. [Schedule 4, item 1, subsection 713-225(1)]

Character rule

3.69 The tax cost setting amount for each partnership cost setting interest is worked out as if the partnership cost setting interest was an asset of the same kind as the asset of the partnership to which it relates (being the underlying asset of the partnership). [Schedule 4, item 1, subsection 713-225(2)]

3.70 This rule enables the cost setting rules for partnership cost setting interests to be applied appropriately by reference to the nature of the underlying asset. For example, in setting the tax cost for assets it is necessary to determine whether an asset is of a type that should be treated as a retained cost base asset, a reset cost base asset that is held on revenue account, or any other reset cost base asset. Without the 'character rule' the cost setting rules may treat all partnership cost setting interests as reset cost base assets and therefore not achieve the appropriate allocation of ACA to the assets of the partner.

Excluded assets

3.71 A tax cost is not set for a partnership cost setting interests if in working out the tax cost for the underlying assets of the partnership the asset would be an 'excluded asset' under subsection 705-35(2). An asset is an excluded asset if an amount is deducted in respect of the asset in working out the ACA for a joining entity. [Schedule 4, item 1, subsection 713-225(3)]

3.72 The purpose of not attributing a tax cost to excluded assets is because the ACA calculation has already been reduced to take account of these assets. In order to ensure that ACA is not allocated to these assets in setting the tax cost for partnership cost setting interests it is necessary to determine whether an underlying asset of the partnership would be an excluded asset if those assets had their tax cost set.

Special rule for interests in underlying assets that are trading stock or depreciating assets

3.73 To reduce compliance costs partnership cost setting interests in the underlying assets of the partnership that are trading stock or depreciating assets are not treated as reset cost base assets but are instead treated as retained cost base assets and given a value equal to the partner's individual share of the underlying assets terminating value. The tax cost of these assets is not reset as the value of these assets in the books of the partnership is the relevant figure for determining the partnership's net income or net loss. The extent to which the partner is subject to residual CGT is limited by the operation of sections 118-24 and 118-25. Consequently, as there is limited scope for the reset tax cost to be relevant in working out the taxable income of the partner it is appropriate that these assets be treated as retained cost base assets. [Schedule 4, item 1, subsection 713-225(4)]

Interaction with general cost setting rules which adjust the tax cost of certain assets

3.74 Section 705-40 will apply in appropriate circumstances to restrict the tax cost for partnership cost setting interests in assets of the partnership that are held on revenue account by the partnership (as a consequence of the character rule in subsection 713-225(2)). The circumstances in which this restriction will arise will be limited because of subsection 713-225(4) which treats partnership cost setting interests in assets of the partnership that are trading stock or depreciating assets as retained cost base assets.

3.75 The operation of subsection 713-225(4) will also ensure that section 705-45 will not have application in adjusting the tax cost of a partnership cost setting interest in an asset of the partnership that is a depreciating asset because its tax cost cannot exceed its terminating value.

Special rule for partnership cost setting interests in an underlying asset that is an over-depreciated asset

3.76 Where an underlying asset of a partnership is an over-depreciated asset (within the meaning of section 705-50) then a special rule applies to reduce the group's ACA for the joining entity (being a partner in the partnership). A special rule is required because subsection 713-225(4) will ensure that section 705-50 does not have effect in adjusting the tax cost of a partnership cost setting interest relating to an asset of the partnership that is a depreciating asset because its tax cost cannot exceed its terminating value. [Schedule 4, item 1, subsection 713-225(5)]

3.77 The rationale for reducing the ACA in these cases is to ensure that the intent of section 705-50 is achieved where the over-depreciated asset is held by a partnership and a partner in that partnership becomes a member of a consolidated group. Section 705-50 applies under the general cost setting rules to reduce the tax cost setting amount of an over-depreciated asset to ensure that there is not indefinite tax deferral.

3.78 To determine whether a reduction in ACA will arise it is necessary to identify whether there are any partnership cost setting interests in over-depreciated assets. A reduction in ACA is only determined in respect of those interests. As a result of the character rule in subsection 713-225(2) a partnership cost setting interest in an asset may be taken to be an over-depreciated asset. [Schedule 4, item 1, subsections 713-230(1) and (2)]

3.79 The amount of the reduction in ACA is worked out in accordance with section 705-50 assuming certain modifications were made. The modifications require:

•

applying the cost setting rules as though there was no reduction for the over-depreciated assets [Schedule 4, item 1, paragraph 713-230(3)(a)] ;

•

the operation of subsection 713-225(4) which treats partnership cost setting interests in depreciating assets of the partnership as retained cost assets to be ignored [Schedule 4, item 1, paragraph 713-230(3)(b)] ;

•

the adjustable value and cost for the partnership cost setting interests in over-depreciated assets to be calculated by working out the partner's individual share of the underlying depreciating asset's adjustable value or cost [Schedule 4, item 1, paragraphs 713-230(3)(c) and (d)] ; and

•

the operation of subsection 705-50(4) (which relates to assets transferred with roll-over relief) to be ignored [Schedule 4, item 1, paragraph 713-230(3)(e)] .

3.80 In applying section 705-50 the reference to joining entity relates to the partner. Therefore, in determining whether one or more unfranked or partly franked dividends were paid it is necessary to examine the dividends paid by the partner (if any). It is also necessary to determine the extent to which dividends were paid out of profits that were sheltered from tax because of the deductions for decline in value which were available to the partnership and which reduced the partner's share of net income of the partnership or increased the partner's share of a net loss of the partnership.

Utilising the transitional cost setting rules

3.81 A consolidated group that forms during the transitional period (generally between 1 July 2002 and 1 July 2004) may elect to retain the existing tax values for the assets of a joining entity including those consisting of a partner's individual share in the assets of a partnership. This election will allow those entities that are partners in a partnership which want to reduce compliance costs to do so by not having to incur the costs of obtaining market valuations in respect of the partnership assets.

Modifications in working out ACA

3.82 The calculation of ACA for an entity that becomes a member of a consolidated group is modified where that entity is a partner in a partnership in the following manner:

•

step 2 of the ACA calculation is modified to include the partner's share of the liabilities of the partnership [Schedule 4, item 1, subsection 713-225(6)] ; and

•

step 7 of the ACA calculation is modified where the consolidated group, in effect, becomes entitled to deductions of the partnership through its share of the partnership net income or partnership loss [Schedule 4, item 1, subsection 713-225(7)] .

Modification to step 2 - liabilities of the joining entity

3.83 Step 2 operates on the basis of adding to the ACA calculation the amount of liabilities that can or must be recognised in a joining entity's statement of financial position in accordance with accounting standards or statements of accounting concepts made by the AASB.

3.84 As a partnership will not be treated as a joining entity, each partner therefore must add their share of the partnership liabilities to their ACA calculation. As it is possible for partnership liabilities to be reflected in either the books of account of the partners or the partnership (depending on the circumstances), subsection 713-225(6) only adds an appropriate share of those liabilities that would otherwise be recognised in the partnership's book of account at step 2 of the ACA calculation for the partner. [Schedule 4, item 1, subsection 713-225(6)]

Modification to step 7 - certain deductions to which the head company becomes entitled

3.85 Step 7 reduces the ACA by the joined group's 'owned' deductions and the tax benefit attaching to its 'acquired' deductions. Essentially, step 7 reduces the cost to the head company of acquiring an entity by the amount of certain deductions to which the head company will become entitled. This has the effect of denying the head company a double deduction for the one expense. It does this by preventing a head company getting an indirect deduction in the form of an inflated cost base for its assets, which reduces/increases any gains/losses on the disposal of those assets.

3.86 The double deduction can also arise in partnership cases, regardless of whether the partnership or partner becomes a subsidiary member of the group. The double deduction can be realised at the partner level because, given the flow-through nature of partnerships, each partner effectively recognises those deductions through a reduced share of the partnership's net income or an increased share of the net loss (under section 92 of the ITAA 1936). As such, a proportion of those deductions will be realised by the head company whenever a partner joins the group.

3.87 An interest in a deduction will be of the same kind as the underlying deduction, both in the sense that the interest would take on:

•

the attributes of the deduction necessary to be classified as an 'owned' or 'acquired' deduction; and

•

the context in which the deductions to the partnership arose (e.g. in terms of whether the amount was a general or specific deduction or whether the deduction added to an element of the cost base of an asset).

Working out the pre-CGT factor for partnership cost setting interests

3.88 Where a partner in a partnership becomes a subsidiary member of a consolidated group, the assets of the entity consisting of partnership cost setting interests in the partnership (in addition to the other assets of the entity) may receive a pre-CGT factor through the operation of section 705-125. The character rule in subsection 713-225(2) also applies to ensure that a pre-CGT factor is only worked out for partnership cost setting interests in an underlying asset that is not a current asset in accordance with the accounting standards.

What happens when a partnership becomes a member of a consolidated group?

3.89 A partnership will become a subsidiary member of a consolidated group when all of the partners of that partnership are members of the same consolidated group (see item 2 in the table at subsection 703-15(2), section 703-30 and Subdivision 960-G). A consequence of the partnership becoming a subsidiary member of the group is that the single entity rule in section 701-1 will not require the partnership to lodge partnership returns for periods when the partnership is a subsidiary member of the group.

3.90 The cost setting rules, however, will not apply where all partnership interests held outside the group are acquired directly by the head company of a consolidated group. This is because under the approach of recognising a partner's individual share of the assets of the partnership, the head company has not acquired the remaining interests in the partnership as a joining entity, but rather directly acquired interests in each of the partnership assets.

Example 3.9: A partnership joins a consolidated group

This example follows on from Example 3.7.

Assume Head Co and Partner A Co are members of a consolidated group. The partnership may become a subsidiary member of the consolidated group in a number of ways, for example as a result of the head company acquiring the 40% interest in the partnership held by Partner B Co directly or alternatively through acquiring all of the shares in Partner B Co.

As a consequence of the partnership joining the consolidated group the head company ceases to recognise the partnership cost setting interests in the partnership (i.e. the interest in each of the underlying assets) and instead recognises the underlying assets of the partnership.

Cost setting where a partner joins the consolidated group at the same time as the partnership

In setting the tax cost for the underlying assets it is first necessary to set the tax cost for any partnership cost setting interests in the partnership that are held by an entity that joins the consolidated group. For example, if the head company acquires all of the shares in Partner B Co then the partnership will join the group and before setting the tax cost for the underlying assets of the partnership it is necessary to set the tax cost for the partnership cost setting interests in the partnership. The tax cost for the underlying assets is determined by reference to the tax cost set for the partnership cost setting interests in the assets of the partnership.

Cost setting where a head company acquires an interest in a partnership from a partner directly and the partnership joins the consolidated group

If Head Co acquires the 40% interest in the partnership held by Partner B directly then the partnership cost setting interests in the partnership that are acquired do not have their tax cost reset but instead have a tax cost that arises under the CGT provisions. It is still, however, necessary to determine the tax cost for the underlying assets by reference to the tax cost set for the partnership cost setting interests in the assets of the partnership.

Setting the tax cost of assets of the partnership

3.91 Where a partnership becomes a member of a consolidated group, the underlying assets of the partnership become assets of the head company and the partnership ceases to be recognised as a separate entity for income tax purposes. The tax cost for the underlying assets of the partnership (other than 'excluded assets') is set in accordance with the general cost setting rules as modified by section 713-240 [Schedule 4, item 1, subsection 713-235(1) and paragraph 713-235(2)(b)] .

3.92 In working out the tax cost for the underlying assets of the partnership you do not work out an ACA for the partnership. Instead a 'partnership cost pool' is worked out based on the cost base/tax costs for the partnership cost setting interests in the partnership. [Schedule 4, item 1, paragraph 713-235(2)(a)]

3.93 A tax cost is also not set for an asset of the partnership that is an excluded asset under subsection 705-35(2) on the assumption that the general cost setting rules were applied without the modifications that apply because of section 705-240. [Schedule 4, item 1, subsection 713-235(3)]

3.94 The partnership cost setting interests in the partnership that are held by the head company cease to be recognised once the partnership becomes a subsidiary member. These interests are, however, relevant in setting the tax cost for the underlying assets to which they relate as they are included in working out the partnership cost pool.

3.95 In setting the tax cost for each asset (other than an excluded asset) of a partnership that becomes a subsidiary member at the joining time:

•

first, add up all the tax costs for partnership cost setting interests in the partnership (the result is the partnership cost pool):

-

this includes partnership cost setting interests in the partnership that became held by the consolidated group when an entity that was a partner in the partnership became a subsidiary member of the group before the joining time;

-

as well as partnership cost setting interests that are held by an entity that becomes a subsidiary member at the joining time; and

-

as well as partnership cost setting interests that did not have their tax cost set by the cost setting rules, for example, because they were acquired by the head company of a consolidated group directly;

•

second, work out the tax cost for assets that are retained cost base assets (in accordance with section 705-25); and

•

lastly, allocate the remaining partnership cost pool (after subtracting the amount allocated to retained cost base assets) to work out the tax cost for the remaining assets in accordance with certain rules.

[Schedule 4, item 1, subsection 713-240(1)]

Adding up the tax costs for interests in the underlying partnership assets - the aggregation rule

3.96 Each cost base/tax cost for the partner's individual share in the assets of the partnership is effectively a store of tax cost. Once the partnership becomes a member of the consolidated group the underlying assets of the partnership which are taken to be assets of the head company have their tax cost reset. This is achieved by aggregating:

•

the cost base for all the partnership cost setting interests which were acquired directly by the head company; and

•

the tax cost setting amounts for each of the partnership cost setting interests which were acquired indirectly by the head company when an entity that was a partner in the partnership joined the consolidated group.

The total represents the partnership cost pool. [Schedule 4, item 1, paragraph 713-240(1)(a)]

3.97 In the case where a partnership becomes a subsidiary member of a consolidated group because a partner in that partnership becomes a subsidiary member of the group, then it is necessary to first determine the tax cost for the assets of that entity (including the tax cost of the entity's individual share in the assets of the partnership). Consequently, it is necessary to apply the rules discussed in paragraphs 3.53 to 3.87 to set the tax cost for the partnership cost setting interests in the partnership. This process is required even though those partnership costs setting interests will cease to be recognised and only the underlying assets of the partnership will be ultimately recognised as assets of the head company. [Schedule 4, item 1, paragraph 713-240(1)(a)]

3.98 Only partnership cost setting interests in the partnership at the joining time are taken into account. Where, before joining a consolidated group the partnership has disposed of an underlying asset in which the group had a partnership cost setting interest that related to the underlying interest, then this interest will not exist at the joining time.

3.99 If, at the joining time, the market value of the partnership cost setting interest is greater than or equal to its cost base, the cost base is the relevant amount for the purposes of working out the partnership cost pool. Otherwise, the relevant amount is the greater of the market value of the interest or the reduced cost base of the interest. [Schedule 4, item 1, paragraph 713-240(1)(a), subsection 713-240(2)]

3.100 The partnership cost pool (representing the store of tax cost) is then allocated to the underlying assets of the partnership in a similar manner to the general cost setting rules.

Setting the tax cost for retained cost base assets

3.101 Where the underlying assets of the partnership are retained cost base assets the asset's tax cost will be set in accordance with section 705-25. Consequently, these assets broadly have their tax cost set equal to the partnership's cost for those assets at the joining time. [Schedule 4, item 1, paragraph 713-240(1)(b)]

3.102 Where the total of the amount allocated to retained cost base assets exceeds the partnership cost pool then the head company of the consolidated group will make a capital gain equal to the excess. This is consistent with the result that occurs under the general cost setting rules. To achieve this outcome, section 104-510 (CGT event L3) is applied as though the reference to the group's allocable cost amount in that section was a reference to the partnership cost pool. [Schedule 4, item 1, subsection 713-240(4)]

Setting the tax cost for remaining assets of the partnership

3.103 The remaining assets have their tax cost set in accordance with the general cost setting rules in sections 705-35, 705-40 and 705-45. A number of assumptions are made in applying these sections to ensure that they apply appropriately. These assumptions are:

•

that the partnership was, at the joining time, the joining entity referred to in those sections;

•

those sections only apply to underlying assets of the partnership (other than 'excluded assets'); and

•

the ACA mentioned in paragraph 705-35(1)(a) was the partnership cost pool.

[Schedule 4, item 1, paragraph 713-240(1)(c) and subsection 713-240(3)]

3.104 Broadly, the consequences of these assumptions is that the amount remaining, after the allocation of the partnership cost pool to retained cost base assets, is allocated to the reset cost base assets in accordance with their relative market values. The reset cost of certain assets held on revenue account may be restricted under section 705-40 where the asset's tax cost exceeds the greater of the asset's market value and its terminating value. Also there may be a reduction in the tax cost for certain assets which are entitled to accelerated rates of depreciation where the tax cost would be greater than the asset's terminating value and the head company elects to retain access to accelerated depreciation.

Working out the pre-CGT factor for assets of the partnership

3.105 As discussed in paragraph 3.88 assets of an entity consisting of partnership cost setting interests in a partnership may receive a pre-CGT factor through the operation of section 705-125 when that entity becomes a member of a consolidated group.

3.106 Where a partnership joins a consolidated group then the underlying assets of the partnership are taken to be assets of the head company and these assets may be given a pre-CGT factor. A pre-CGT factor is determined for the underlying assets of the partnership (other than excluded assets) by identifying the partnership cost setting interests in the partnership relating to assets of the partnership which have a pre-CGT factor at the joining time. These interests are called the 'pre-CGT interests'. [Schedule 4, item 1, subsections 713-245(1) and (2)]

3.107 The pre-CGT factor for each of the underlying assets is determined by:

•

step 1 - for each pre-CGT interest, multiplying its market value at the joining time by its pre-CGT factor;

•

step 2 - adding up the results of step 1;

•

step 3 - adding up the market values of all the assets of the partnership at the joining time; and

•

step 4 - dividing the result of step 2 by the result of step 3.

[Schedule 4, item 1, subsection 713-245(3)]

Dictionary signpost to a new definition

3.108 The income tax laws dictionary is amended to include a pointer to the place where the new term 'partnership cost setting interest' is defined. [Schedule 4, item 2]

Changes to the MEC group membership rules regarding when non-resident entities can be interposed between members of a group

Introduction

3.109 Schedule 5 to this bill amends the membership rules contained in Division 719 of both the ITAA 1997 and the IT(TP) Act 1997 to limit the circumstances in which non-resident entities can be interposed between members of a MEC group.

3.110 Broadly, only those MEC groups that consolidate with effect before 1 July 2004 are eligible to have non-resident entities interposed between members of the group. Further, there are on-going rules that restrict the entities that can join a MEC group and ensure that members of a MEC group continue to satisfy the membership requirements whilst a member of the group.

3.111 Modifications to the membership rules for consolidated groups were made in the New Business Tax System (Consolidation and Other Measures) Act 2003 and provide the circumstances in which an entity may be eligible to be a subsidiary member of a consolidated or consolidatable group where there are one or more non-resident entities interposed between that entity and the head company of the group. Modifications were also made to the rules that set the tax cost of assets of those subsidiary members on joining and leaving a consolidated group.

3.112 The amendments contained in Schedule 5 to this bill align the membership rules for consolidated groups and MEC groups. This alignment ensures that the MEC membership rules reflect the same policy as that which applies to consolidated groups.

MEC group membership rules

3.113 The aim of this measure is to clarify the circumstances in which a foreign-held resident entity can become a member of a MEC group. Such entities will only be able to become members of a MEC group on formation of the group and that particular membership structure must be in existence as at the MEC group formation time. The formation time of the MEC group must be before 1 July 2004.

Example 3.10

Assuming the MEC group consolidated with effect before 1 July 2004, its members would comprise the eligible tier-1 companies (these being Companies A and B) and the subsidiary members (these being Companies C, D and E as well as F Trust).

If the MEC group consolidated on or after 1 July 2004, Company E and F Trust would not be able to join the group because Company G, being a non-resident entity owns Company E and F Trust.

Determining whether a foreign-held resident entity can be a member of a MEC group

3.114 In determining whether a foreign-held resident entity can be a member of a MEC group, there are two test times that must be considered, one on formation of the MEC group and an on-going rule that tests the entities to ensure that they remain eligible to be members of the MEC group.

First test time - formation of the MEC group

3.115 Because the rules allowing non-resident entities to be interposed between group members are transitional only, a group wishing to consolidate with such subsidiary members must do so with effect before 1 July 2004. If it does not consolidate until after that date it cannot include as a subsidiary member those entities that are held through non-resident entities. [Schedule 5, item 10, section 719-10]

3.116 As with consolidated groups, a subsidiary member of a MEC group that has non-resident entities interposed between it and other members of the group is either a 'transitional foreign-held subsidiary' or a 'transitional foreign-held indirect subsidiary'. These terms are defined in section 701C-20 of the IT(TP) Act 1997 and apply to MEC groups because of the application of section 719-2 of the IT(TP) Act 1997. [Schedule 5, item 4, note to section 701C-1; item 5, note to subsection 701C-10(1); item 6, note to subsection 701C-15(1)]

3.117 In brief, a transitional foreign-held subsidiary is a company that has one or more of its membership interests held by:

•

a non-resident company;

•

a non-resident trust;

•

a nominee of one or more entities each of which is a non-resident company or a non-resident trust; or

•

a partnership, where each of the partners is a non-resident company or a non-resident trust.

A transitional foreign-held indirect subsidiary is a company, trust or partnership that:

•

is not a transitional foreign-held subsidiary; and

•

has one or more of its membership interests held by:

•

an entity that is a transitional foreign-held subsidiary; or

•

an entity that is a foreign-held indirect subsidiary.

For further information about these entities see paragraphs 4.28 to 4.33 of the Explanatory Memorandum to the New Business Tax System (Consolidation and Other Measures) Bill (No. 2) 2002.

Example 3.11

Assuming the MEC group consolidated with effect before 1 July 2004, Company E is a transitional foreign-held subsidiary and Company F is a transitional foreign-held indirect subsidiary. Companies A and B are eligible tier-1 companies and Companies C and D are subsidiary members of the group (along with companies E and F).

The non-resident interposed entities (Company G and H Trust) must be wholly-owned subsidiaries of the group and must satisfy the requirements found in subsections 701C-10(3) to (5) of the IT(TP) Act 1997.

Of note, a transitional foreign-held subsidiary cannot be an eligible tier-1 company. This is because either it does not satisfy the definition of 'tier-1 company' found in paragraph 719-20(1)(b) (item 2, column 4 in the table) or, if it does, it will not satisfy the definition of 'eligible tier-1' found in section 719-15.

Example 3.12

Assuming the MEC group consolidated with effect before 1 July 2004, Company E is a transitional foreign-held subsidiary and F Trust is a transitional foreign-held indirect subsidiary. It does not matter that Company G does not wholly own Company E. To be a transitional foreign-held subsidiary, Company E merely must be a company that has one or more of its membership interests held by:

•

a non-resident company;

•

a non-resident trust;

•

a nominee of one or more entities each of which is a non-resident company or a non-resident trust; or

•

a partnership, where each of the partners is a non-resident company or a non-resident trust.

Companies A and B are eligible tier-1 companies and Companies C and D are subsidiary members of the group (along with Company E and F Trust).

3.118 Another amendment to section 719-10 is needed to achieve the desired outcome. Subsection 719-10(4) (resident companies that are held through interposed non-residents) and subsection 719-10(5) (resident trusts and partnerships that are held through interposed non-resident entities) have been repealed [Schedule 5, item 2, subsections 719-10(4) and (5)] . In their place reference has now been made to the transitional provisions dealing with the membership requirements for subsidiaries held through interposed non-resident entities [Schedule 5, item 1, subparagraphs 719-10(1)(b)(ii) and (iii)] . Further, references to subsections 719-10(4) and (5) found in subsections 719-10(1) and (6) have been repealed, these being replaced by a reference to the relevant transitional provisions [Schedule 5, item 1, subparagraphs 719-10(1)(b)(ii) and (iii) and item 3, paragraphs 719-10(6)(c) and (d)] .

Second test time - on-going rules

3.119 If a MEC group has consolidated with effect before 1 July 2004 and one or more of its members is a transitional foreign-held subsidiary or a transitional foreign-held indirect subsidiary, on-going rules must be satisfied to ensure that these subsidiaries remain eligible to be members of a MEC group. These rules are found in sections 701C-10 and 701C-15 of the IT(TP) Act 1997 and apply to MEC groups because of the application of section 719-2 of the IT(TP) Act 1997.

3.120 Section 701C-10 of the IT(TP) Act 1997 contains the relevant test that applies to transitional foreign-held subsidiaries and transitional foreign-held indirect subsidiaries that are companies. Section 701C-15 contains the relevant test that applies to transitional foreign-held indirect subsidiaries that are trusts and partnerships.

3.121 If these tests are not satisfied at any time the entity will no longer remain eligible to be a member of the MEC group.

Rules that restrict entities joining a MEC group

3.122 The amendments made in this bill also clarify which entities that can join a MEC group, the objective being to prevent an entity from joining an existing MEC group where a new foreign-held membership structure is introduced to or created within the MEC group. For example, an entity will not qualify to be a member of an existing MEC group in the following circumstances where a MEC group:

•

acquires another MEC group or consolidated group that contains a foreign-held structure;

•

acquires another MEC group or consolidated group through a non-resident entity interposed between a subsidiary and the head company of the MEC group and the acquired group;

•

acquires linked entities where there is a foreign-held membership structure that forms part of the link. In this circumstance the link will be broken at the resident entity that owns membership interests in the interposed non-resident;

•

acquires a non-resident that wholly owns Australian resident subsidiaries;

•

changes it membership structure to create a foreign-held membership structure within the group. This could occur where a resident subsidiary becomes a non-resident entity, and that subsidiary holds membership interests in other subsidiaries; or

•

converts to a consolidated group and the MEC group had previously been formed including a foreign-held membership structure (see also paragraphs 3.123 to 3.124).

Conversion events

3.123 Following formation of a MEC or a consolidated group these groups may 'convert' to a consolidated or a MEC group respectively (see sections 703-55 and 719-40).

3.124 Allowing non-resident entities to be interposed between members of a MEC or consolidated group is transitional, and as such, on the occurrence a MEC group 'converting' to a consolidated group or a consolidated group 'converting' to a MEC group, such a structure will not be able to be included in the new group after 1 July 2004.

Technical amendment to sections 701C-30 and 701C-35 of the IT(TP) Act 1997

3.125 An error in sections 701C-30 and 701C-35 of the IT(TP) Act 1997 is corrected. The term 'transitional foreign-held entity' found in these sections should have read 'transitional foreign-held joining entity', in keeping with the description of the term found in section 701C-25. [Schedule 5, item 7, section 701C-30; item 8, note 2 to section 701C-30; item 9, section 701C-35]

Application of rules to MEC groups

3.126 Schedule 6 to this bill amends the ITAA 1997 and the IT(TP) Act 1997 to provide for the application of the rules to MEC groups.

3.127 Section 719-2 of the IT(TP) Act 1997 provides that, other than Divisions 703 and 719, Part 3-90 has effect in relation to a MEC group in the same way it has effect in relation to a consolidated group (for further information see paragraphs 2.7 to 2.13 of the Explanatory Memorandum to New Business Tax System (Consolidation and Other Measures) Bill (No. 2) 2002). This provision has been expanded so as to ensure that a reference in Part 3-90 (excepting Divisions 703 and 719) to a provision in Division 703 of the IT(TP) Act 1997 or Division 703 applies as if it referred instead to the corresponding provision in Division 719 of the IT(TP) Act 1997 or Division 719 [Schedule 6, item 1, subsection 719-2(3) of the IT(TP) Act 1997] .

3.128 This expansion of section 719-2 enables the MEC group equivalent found in subparagraph 719-10(1)(b)(ii) of the ITAA 1997 to be used instead of item 2, column 4, of the table in subsection 703-15(2) that is referred to in subsection 701C-10(1) of the IT(TP) Act 1997 (see the note that is found in Schedule 5, item 5 subsection 701C-10(1)). This enables the requirements in section 719-5 to be satisfied.

Application of amendments to the IT(TP) Act 1997

3.129 Schedule 7 to this bill amends the IT(TP) Act 1997 to ensure that amendments made by this bill apply on or after 1 July 2002. [Schedule 7, item 1, subsection 700-1(1)]

Number sequencing of Parts 3-90 and 3-95

3.130 A technical amendment is made to place Part 3-90 before Part 3-95, as originally intended. Part 3-95 was placed before Part 3-90 due to the commencement provisions of the New Business Tax System (Consolidation) Act (No. 1) 2002 and the New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Act 2002. [Schedule 8, items 1 and 2]

Application provisions

3.131 The amendments discussed in this chapter will take effect on 1 July 2002, along with the other aspects of the consolidation regime. [Schedule 8, item 3]

Chapter 4 Release from particular liabilities in cases of serious hardship

Outline of chapter

4.1 Schedule 9 to this bill amends the ITAA 1936, FBTAA 1986, TAA 1953, ITAA 1997 and the Administrative Appeals Tribunal Act 1975 to streamline the procedures under which an individual taxpayer can be released from a tax liability where payment would entail serious hardship. The existing authority to grant release will be transferred from tax relief boards to the Commissioner.

4.2 The amendments will also introduce a new right to have tax relief decisions reviewed internally under the ATO objections process, and externally by the AAT sitting as the Small Taxation Claims Tribunal. Also, the scope of the release arrangements will be expanded to cover instalments of PAYG and FBT.

Context of amendments

4.3 Tax relief boards are established under section 265 of the ITAA 1936 and section 133 of the FBTAA 1986. The boards have discretion to release taxpayers from their liabilities under those Acts if payment would entail serious hardship. Boards comprise the Commissioner, the Secretary of the Department of Finance and Administration and the Chief Executive Officer of the Australian Customs Service - although, in practice, substitutes generally represent the 3 office holders.

4.4 Other important features of the relief procedures are:

•

the Commissioner takes the place of the boards for debts up to $500;

•

boards may refer any relief application to the AAT, but only to examine and report on a taxpayer's affairs. Referral is mandatory for debts exceeding $10,000; and

•

there is no provision for merits appeals on board decisions.

4.5 The current arrangements, with their requirement for convening regular meetings of tax relief boards, are unduly resource intensive and inflexible. A significant ongoing commitment by the 3 represented agencies is required in order to avoid the recurrence of backlogs and the associated delays in responding to applicants.

4.6 Further, the single stage relief board process is out of step with contemporary review practices. The interests of applicants are better served by a genuinely independent merits review.

4.7 The scope of the release arrangements needs to be updated to cover the instalment system applying under A New Tax System. The current release arrangements apply principally to tax assessments; however, for instalment payers seeking release, the bulk of their tax liabilities would usually be instalment debts.

Summary of new law

4.8 The tax relief boards will be abolished, along with the AAT's role of investigating and reporting to the boards on certain release applications. The Commissioner will receive applications and make the initial decision on applications for release. Serious hardship will remain the sole criterion for deciding whether release can be granted. Release will become available for instalments of PAYG and FBT (and any associated penalties and charges).

4.9 Applicants dissatisfied with the Commissioner's decision will have a right of objection and consequent review of the decision by the Commissioner. This objection and review process would be the same as that for objections to other taxation decisions, as provided in Part IVC of the TAA 1953.

4.10 Applicants will have a further right to apply for an independent merits review by the AAT, sitting as the Small Taxation Claims Tribunal.

4.11 The new arrangements will commence on the later of 1 September 2003 and the date when the amending legislation receives Royal Assent. All applications undecided at that time will be treated under the new arrangements.

Comparison of key features of new law and current law

Detailed explanation of new law

4.12 A new Part 4-50, consisting of Division 340, is inserted into Schedule 1 of the TAA 1953, to provide a new process by which individuals facing serious hardship can seek release from certain tax liabilities [Schedule 9, item 1] . The existing provisions in the ITAA 1936 and FBTAA 1986 are repealed [Schedule 9, items 5 and 15] .

4.13 Applications will be considered in the first instance by the Commissioner. Dissatisfied applicants will be entitled to an internal ATO review, with further recourse to a merits review by the AAT, sitting as the Small Taxation Claims Tribunal.

Eligibility

From which tax liabilities can release be granted?

4.14 The following are liabilities from which an individual may be released:

•

income tax - including Medicare levy, Medicare levy surcharge, withholding tax and tax payable where an infrastructure borrowing certificate is cancelled;

•

FBT;

•

an FBT instalment;

•

a PAYG instalment;

•

penalties associated with the above liabilities; and

•

charges associated with the above liabilities.

[Schedule 9, item 1, section 340-10]

4.15 For ease of explanation, these liabilities will be referred to in this chapter as releasable liabilities.

4.16 In order to determine the amount of releasable liability, the Commissioner might need to determine which, among a number, of a taxpayer's liabilities have been paid. This will require payments to be matched against particular tax liabilities that existed at the time of the payment.

4.17 It should not be assumed that payments would be pro-rated across outstanding liabilities, as taxpayers would be expected to remit to the Commissioner amounts collected on behalf the Commissioner (e.g. tax withheld from employees' wages and GST) before paying their own personal liabilities (e.g. their own PAYG instalments).

Example 4.1

John Smith owns a bike store as a sole trader. His first quarter BAS identifies tax withheld from his employee's wages of $3,000 and a GST net amount due of $10,000. In addition, his PAYG instalment for the quarter is $6,000.

He sends a cheque for $15,000.

The payment would be applied firstly to the tax withheld and GST amounts, leaving $2,000 to be applied against his PAYG instalment.

4.18 In order to determine the amount of releasable liability, the Commissioner might also need to decide that particular amounts of interest charges that a taxpayer has incurred derive from particular tax liabilities.

4.19 Taxpayers cannot apply under the release provisions for the return of taxes previously paid.

Who can apply for release?

4.20 An individual taxpayer can apply for release from a releasable liability where they would suffer serious hardship were they required to pay the liability. [Schedule 9, item 1, subsection 340-5(3), item 1 in the table]

4.21 A taxpayer who is a trustee of the estate of a deceased person can apply where those dependents would suffer serious hardship were payment of the liability required. [Schedule 9, item 1, subsection 340-5(3), item 2 in the table]

4.22 An application must be in the form required by the Commissioner. [Schedule 9, item 1, subsection 340-5(2)]

4.23 A taxpayer's circumstances - including their tax liabilities - can change quite rapidly. Accordingly, taxpayers are not prevented from applying merely because they have previously been unsuccessful or partially successful in seeking release, including release for the same liabilities. This applies even where the taxpayer has unsuccessfully objected to a decision or undertaken further appeals. [Schedule 9, item 1, subsection 340-5(4)]

Considering applications

What is the basis for granting release?

4.24 As under the current legislation, the sole criterion for granting release will be that serious hardship would result from requiring payment of the releasable liability. [Schedule 9, item 1, subsection 340-5(3)]

4.25 Release can be wholly or in part [Schedule 9, item 1, subsection 340-5(3)] . Release from the full amount of the liability would not generally be appropriate where partial release is sufficient to avert hardship.

4.26 Release would not normally be granted where it would not relieve hardship. A common example would be where the existence of other creditors made bankruptcy inevitable and granting release from tax liabilities would merely assist those other creditors at the expense of the Commonwealth.

Who decides whether to grant release?

4.27 The Commissioner may release an eligible taxpayer (wholly or in part) from a releasable liability where the hardship criterion is satisfied. [Schedule 9, item 1, subsection 340-5(3)]

4.28 The onus will be on an applicant to furnish sufficient information for the Commissioner to be satisfied that a release from liabilities would be appropriate. [Schedule 9, item 2]

4.29 The Commissioner must notify the applicant of the decision in writing within 28 days of making the decision [Schedule 9, item 1, subsection 340-5(5)] . Failure to give the notification does not affect the validity of that decision [Schedule 9, item 1, subsection 340-5(6)] .

Giving effect to release

4.30 The Commissioner may take such action as is necessary to give effect to a decision taken under subsection 340-5(3) to grant release to a liability covered by section 340-10 [Schedule 9, item 1, subsection 340-15(1)] . This may include amending an assessment [Schedule 9, item 1, subsection 340-15(2)] .

4.31 Where an individual is released (wholly or in part) from liabilities arising from an assessment, that release will be final (subject to the overriding power of the Commissioner to amend assessments - see paragraph 4.40).

4.32 Where an individual is released (wholly or in part) from instalment liabilities, the instalment liabilities are extinguished, but permanent release from the amounts in question will require further consideration of the full year's assessment against the taxpayer's circumstances at that time. This treatment recognises the interaction between the instalment system and the assessment system. [Schedule 9, item 1, sections 340-20 and 340-25]

4.33 Normally, instalment liabilities are offset by a credit against the ultimate assessment for the tax year in question. This prevents 'double taxation' by ensuring that the amount the taxpayer is required to pay upon assessment is net of the amount collected through the instalment system. The amount due at assessment is often referred to as the 'washup' amount. Ideally, this amount will be small, because the total of the instalments for the income year is intended to reflect the ultimate assessment (see section 45-5 of Schedule 1 of the TAA 1953).

Example 4.2

John Smith has quarterly PAYG instalments of $6,000. His final year assessment is $25,000.

The 4 instalments are credited against the annual assessment, leaving him with a washup amount of $1,000.

4.34 Instalment liabilities are not extinguished by the final assessment. Where instalments are unpaid, a taxpayer would still face instalment debts, along with the liability for the washup amount.

4.35 Even where an instalment liability is unpaid, the credit still applies against the assessment. This ensures that the taxpayer is not pursued twice for the same amount, through both the instalment and assessment collection systems.

Example 4.3

After losing a court case with a neighbour, John Smith is only able to pay $2000 against his first 3 quarterly PAYG instalments of $6,000, and nothing against his 4th instalment. His final year assessment is $25,000.

The 4 instalment liabilities total $24,000 and (whether paid or not) are credited against the annual assessment, leaving him with a washup amount of $1,000.

His outstanding tax debts would then total $19,000 comprising $18,000 of instalment liabilities (i.e. $4,000 + $4,000 + $4,000 + $6,000) and a washup amount of $1,000 (i.e. $25,000 - 4 x $6000).

4.36 However, where hardship 'release' is granted from a PAYG or a FBT instalment, the credit against the assessment will be disallowed to the extent of that release [Schedule 9, item 1, note in subsection 340-20(2); item 1, note in subsection 340-20(3); item 1, note in subsection 340-25(2); item 1, note in subsection 340-25(3)] . The absence of instalment credits means the amount due at assessment time would be more than a washup amount. Effectively, this means that the liability to pay the amount in the instalment is deferred until assessment time.

Example 4.4

Continuing from Example 4.3, suppose John Smith were to receive partial hardship release of $4,000 (the unpaid amount) on each of his first 3 quarterly instalments and full release on his 4th instalment.

At assessment time, his washup amount would be $19,000 (i.e. $25,000 - $2000 - $2000 - $2000 -$0).

His outstanding tax debts would then total $19,000 comprising no unpaid instalment liabilities and a washup amount of $19,000.

4.37 The taxpayer is then potentially able to apply for release from the overall liability arising from the year's assessment.

4.38 Where a person is still in a position of hardship at the time the ultimate assessment is issued, permanent release could then be available from the assessed liability, including amounts originally reflected in the released instalment.

Example 4.5

Continuing from Example 4.4, John Smith faces ongoing hardship and receives full release from his outstanding income tax of $19,000 (i.e. the washup amount). The unpaid instalment amounts would then have effectively been given permanent release, albeit in the form of assessed income tax.

4.39 It is not intended to grant permanent release from the amount in the instalment prior to consideration of the full year's assessment against the taxpayer's circumstances at that time. Where a person's circumstances have improved by the time the final assessment is issued - such that the year's assessment can then be paid without hardship - then it is expected that the full assessment would be paid. In these circumstances, temporary relief - by removing the liability to pay at the usual instalment date - will have been sufficient to alleviate hardship.

Example 4.6

As an alternative to Example 4.5, John Smith wins an appeal on the court case with his neighbour, and no longer faces hardship.

He is now expected to pay his outstanding income tax of $19,000 (i.e. the washup amount).

When John Smith pays this amount he will have paid a total of $25,000 in tax for the year (i.e. $2000 + $2000 + $2000 + $0 + $19,000). The total amount paid for the year will equal that paid under 'normal' circumstances in Example 4.2.

The release provisions have provided the temporary relief he needed, by releasing him from the obligation to pay the full instalment amounts at the times they would normally have been due.

4.40 Granting release under these hardship provisions does not limit the power of the Commissioner to amend an assessment in accordance with any provision of the ITAA 1936 or FBTAA 1986 (e.g. where a deduction was disallowed following a tax audit). [Schedule 9, item 1, subsection 340-15(3)]

Reviewing decisions

Objecting to the Commissioner's decision (internal review)

4.41 If a taxpayer is dissatisfied with the decision the Commissioner makes on their application, they may object to the decision. Such objections would be made in the usual manner, set down in Part IVC of the TAA 1953 for taxation objections, reviews and appeals [Schedule 9, item 1, subsection 340-5(7)] . Section 14ZW(1)(c) of Part IVC of the TAA 1953 requires such objections to be lodged within 60 days of the Commissioner serving notice of the decision.

AAT review

4.42 If a taxpayer is dissatisfied with the decision the Commissioner makes on their objection, then, under Division 4 of Part IVC of the TAA 1953, they may request the AAT, sitting as the Small Taxation Claims Tribunal, to review the merits of that decision. The Administrative Appeals Tribunal Act 1975 is amended to allow the Small Taxation Claims Tribunal to review hardship release cases, including where the liabilities in question exceed the Small Taxation Claims Tribunal's usual ceiling of $5,000. [Schedule 9, items 3 and 4]

Application and transitional provisions

4.43 The new release provisions will commence on the later of 1 September 2003 or the date the amending legislation receives Royal Assent.

4.44 Applications made, but not finally determined, prior to that commencement date will be considered under the new provisions. [Schedule 9, item 18]

4.45 Taxpayers dissatisfied with decisions made by Tax Relief Boards under the old arrangements will be free to lodge fresh applications for consideration by the Commissioner under the new arrangements. [Schedule 9, item 19]

Consequential amendments

Repeal of existing hardship release provisions

Tax Relief Boards

4.46 The existing hardship release provisions in section 265 of the ITAA 1936 and section 133 of the FBTAA 1986 are repealed. [Schedule 9, items 5 and 15]

4.47 References in the ITAA 1936 to the repealed hardship release arrangements are deleted. [Schedule 9, items 6 and 9 to 14]

Rebates under Division 6AA - Income of Certain Children

4.48 Division 6AA of the ITAA 1936 may increase the tax payable on the income of certain children.

4.49 Section 102AJ of ITAA 1936 currently allows the Commissioner to rebate that extra tax where it would cause serious hardship. By not requiring consideration by a tax relief board, this rebate provision provided an alternative, streamlined route by which those liable to this extra tax could obtain hardship release. Applicants could not receive release under both provisions.

4.50 The amendments now provide the same streamlined route to all applicants for hardship release. Accordingly, the section 102AJ rebate provision and references to it are repealed. [Schedule 9, items 7, 8, 16 and 17]

4.51 The new hardship provisions should not diminish the rights of those who would have been eligible to seek release under section 102AJ, as release will continue to be available from the Commissioner against the criterion of serious hardship.

Appeals to the Administrative Appeals Tribunal sitting as the Small Taxation Claims Tribunal

4.52 The Administrative Appeals Tribunal Act 1975 is amended to allow the Small Taxation Claims Tribunal to review Commissioner decisions on applications (following internal ATO review - see paragraph 4.41). The Small Taxation Claims Tribunal will be able to review a decision regardless of the amount involved. [Schedule 9, items 3 and 4]

Chapter 5 Trans-Tasman (triangular) imputation

Outline of chapter

5.1 Schedule 10 to this bill will amend the imputation rules in Part 3-6 of the ITAA 1997 so that NZ companies may choose to enter the Australian imputation system. The Australian imputation rules will generally apply to a NZ company in the same way as they apply to an Australian company. This means that a NZ company will be able to maintain an Australian franking account and attach Australian franking credits to dividends.

5.2 Where a NZ company receives a franked dividend from an Australian company or pays income tax or withholding tax, the NZ company will receive a franking credit and be able to frank dividends to its shareholders. Accordingly, Australian shareholders of NZ companies with Australian operations may receive franking credits and therefore be eligible for a tax offset reflecting Australian tax paid on Australian-sourced income (see Diagram 5.1).

Diagram 5.1

5.3 A NZ company may choose to operate an Australian franking account from 1 April 2003. However, a NZ company will not be able to make distributions with Australian franking credits until 1 October 2003.

Context of reform

5.4 Australian shareholders of NZ companies that earn Australian income are currently unable to access Australian franking credits arising from company tax paid on that income. The same problem exists with NZ shareholders of Australian companies that earn NZ income. In effect, both groups of shareholders are taxed twice on such income. This is known as 'triangular taxation'. The problem arises because Australia and NZ allow only resident companies to maintain imputation accounts.

5.5 'Triangular taxation' has been a subject of consultation between the Australian and NZ Governments. In a joint announcement on 19 February 2003 by the Australian Commonwealth Treasurer and NZ's Minister for Finance and Revenue, both Governments announced measures to resolve the 'triangular tax' problem (Treasurer's Press Release No. 7 of 19 February 2003). Australia and NZ will extend their imputation systems to include companies resident in the other country. Australian and NZ companies will be able to attach both Australian franking credits and NZ imputation credits to dividends.

Summary of new law

5.6 The Australian imputation rules will generally apply to a NZ company that chooses to enter the imputation system in the same way as they apply to an Australian company. This is achieved by providing that a NZ company will be treated as though it is resident in Australia.

5.7 However, some special rules are required to ensure that the imputation rules operate appropriately and to preserve the integrity of the imputation system. These rules, set out in new Division 220 in Part 3-6, will:

•

require a NZ company that wishes to enter the imputation system to notify the Commissioner accordingly;

•

enable the Commissioner to cancel a NZ company's choice to enter the Australian imputation system if the company does not pay its franking deficit tax or over-franking tax liability by the due date or fails to provide a franking return to the Commissioner;

•

allow franking credits to arise in the franking account held by NZ companies for dividend, interest and royalty withholding taxes deducted in Australia;

•

change the 'look-through' provisions in the exempting entity rules so Australian ownership can be traced through NZ companies and, in limited circumstances, companies that are not resident in Australia or NZ;

•

provide that a NZ listed company or a 100% subsidiary of a NZ listed company will not be an exempting entity even if it does not have more than 5% effective Australian ownership;

•

transfer franking credits and debits from the Australian subsidiary of a company not resident in Australia or NZ to the NZ company holding the non-resident company in the case of a wholly-owned group with a NZ parent company;

•

treat supplementary dividends or conduit tax relief additional dividends arising under NZ law as unfrankable dividends for Australian tax purposes;

•

reduce the tax offset that would otherwise arise in respect of a franked dividend paid by a NZ company to the extent of any supplementary dividend paid by the NZ company in relation to the dividend; and

•

impose joint and several liability on Australian and NZ companies in a wholly-owned trans-Tasman group for the payment of franking deficit tax, over-franking tax, related GIC and related administrative penalties where a NZ company defaults on its franking deficit tax or over-franking tax liability.

5.8 Under a transitional rule, an Australian subsidiary of a NZ company that becomes a former exempting entity will be allowed to retain franking credits accumulated before commencement, provided certain conditions are met.

Detailed explanation of new law

Main rules for NZ companies

5.9 The main rules for NZ companies are set out in new Division 220. These rules relate to:

•

how a NZ company may enter the Australian imputation system;

•

franking distributions of NZ companies;

•

franking accounts of NZ companies;

•

transfer of franking credits and debits where a group includes a non-Tasman company;

•

effects of a supplementary dividend from a NZ franking company;

•

rules about exempting entities; and

•

joint and several liability for NZ company's unpaid franking liabilities.

Elections by a NZ company to enter the Australian imputation system

5.10 The imputation rules contained in Part 3-6 of the ITAA 1997 will apply to a NZ company that has chosen to enter the Australian imputation system in the same way as the rules apply to a company that is an Australian resident. This rule applies subject to certain modifications. This means, for example, that:

•

franking credits and debits will arise in the NZ company's franking account in accordance with the rules in Division 205;

•

the benchmark rule in Division 203 will apply so that franking credits can only be allocated in proportion to the shareholder's ownership in the company;

•

a NZ company must give shareholders a distribution statement on the payment of a franked dividend setting out information about the dividend; and

•

the exempting entity and former exempting entity rules in Division 208 will generally apply to a NZ company.

[Schedule 10, item 1, section 220-25]

NZ franking company

5.11 A NZ company will enter the Australian imputation system if it is a 'NZ franking company'. The concept of 'NZ franking company' is central to these amendments. A company will be a NZ franking company if, at a particular time, the company:

•

is a NZ resident; and

•

has a NZ franking choice in force.

[Schedule 10, item 1, section 220-30]

Residency test

5.12 'NZ resident' is defined in a similar manner as resident for Australian income tax purposes (see subsection 6(1) of the ITAA 1936) [Schedule 10, item 1, section 220-20] . The definition for both a company and an individual is summarised in Table 5.1.

5.13 A person is not a NZ resident if the person is an Australian resident. This means that a company that is resident in both Australia and NZ will not be treated as a NZ resident for the purpose of these rules, avoiding any overlap between the general imputation rules and the specific rules applying to NZ companies. [Schedule 10, item 1, subsection 220-20(5)]

NZ franking choice

5.14 A NZ company that chooses to enter the Australian imputation system must make an election (called a 'NZ franking choice') by notifying the Commissioner in the approved form. [Schedule 10, item 1, section 220-35]

5.15 A NZ franking choice will generally be in force from the start of the income year in which the notice was given to the Commissioner. If a later income year is specified by a company, the company's NZ franking choice will be in force from the start of the specified income year. A NZ franking choice will continue in force until it is revoked by the company or cancelled by the Commissioner. [Schedule 10, item 1, section 220-40] .

5.16 A company can revoke a franking choice by notifying the Commissioner in the approved form. [Schedule 10, item 1, section 220-45]

5.17 Because of the potential difficulties involved in recovering a tax liability from a non-resident company, the Commissioner will be able to cancel a company's franking choice by written notice if the company does not:

•

pay its franking deficit tax or over-franking tax liability by the due date; or

•

provide a franking return to the Commissioner as required.

[Schedule 10, item 1, subsection 220-50(1)]

5.18 A company which has had its franking choice cancelled will only be able to make another franking choice if the Commissioner consents. [Schedule 10, item 1, subsection 220-50(4)]

5.19 A company will be able to object against the cancellation of its NZ franking choice under Part IVC of the TAA 1953. [Schedule 10, item 1, subsection 220-50(3)]

Franking distributions of NZ companies

5.20 An entity must generally satisfy the residency requirement in section 202-20 to make a franked distribution. This requirement also applies for an entity franking a distribution with exempting credits. A NZ company will satisfy this requirement because of the application of new section 220-25. The general residency requirement will be modified for NZ companies. The residency requirement will only be satisfied if a distribution is made at least one month after a NZ franking choice is made. [Schedule 10, item 1, section 220-100]

5.21 A NZ company will be able to attach both Australian franking credits and NZ imputation credits to the same dividend. This means that, for example, a dividend paid by a NZ company may be both fully franked and fully imputed.

Unfrankable distributions

5.22 A payment by a NZ company that is a 'conduit tax relief additional dividend' or a 'supplementary dividend' under section OB1 of the Income Tax Act 1994 (NZ) will be treated as an unfrankable distribution, consistent with the NZ tax treatment of these payments. These 'dividends' are, in general terms, payments by a NZ company to a non-resident shareholder (i.e. a shareholder not resident in NZ) that represent either a refund or an exemption from NZ company tax. [Schedule 10, item 1, section 220-105]

Maximum franking credit

5.23 The maximum franking credit that can be attached to a distribution is generally the maximum amount of corporate tax that can be paid on the amount of the distribution grossed up by the maximum amount of corporate tax. This amount is calculated using the formula set out in subsection 202-60(2).

5.24 A NZ company might inadvertently breach this rule because of a fluctuation in the exchange rate between the time a company decides the amount of the franking credit to be attached to a distribution and the time the distribution is made.

5.25 To avoid this outcome, the general rule will be modified so that, for distributions made in another currency (e.g. NZ$), the maximum franking credit for a distribution will be calculated using the exchange rate applicable at the time of the decision to make the distribution. [Schedule 10, item 1, section 220-110]

Example 5.1

NZ Co decides to pay a dividend in NZ$ to an Australian shareholder. Under the exchange rate applicable on that day, the distribution converts to A$70. The NZ company decides to fully frank the distribution, so a A$30 franking credit is attached. Under subsection 202-60(2) of the ITAA 1997 this is the maximum franking credit that can be allocated to the distribution.

On the day the dividend is paid, the exchange rate is such that the dividend is worth A$65. However, the distribution will not be over-franked because of new section 220-110.

Franking account of a NZ company

Franking account to be in Australian currency

5.26 A NZ company is required to maintain its franking account in Australian currency. [Schedule 10, item 1, section 220-200]

Franking credits for withholding taxes

5.27 A NZ franking company will receive a franking credit for the payment of Australian dividend, interest or royalty withholding tax which is imposed by section 128B of the ITAA 1936 [Schedule 10, item 1, section 220-205] . The amount of the franking credit will be equivalent to the amount of withholding tax paid. The franking credit will arise at the time the withholding tax is paid. This franking credit recognises that withholding taxes, like company tax, represent an additional layer of Australian tax on Australian income received by Australian shareholders.

Effect of franked distributions made to a NZ franking company

5.28 A non-resident entity is not entitled to a tax offset in respect of a franked dividend. Such dividends are exempt from withholding tax, which represents a final tax liability. The operation of new section 220-25 would result in a NZ franking company being treated as a resident for the purpose of the residency requirement in section 207-75, and therefore cause a tax offset to arise. A specific rule is required to cancel the tax offset that would otherwise arise. This rule is set out in new section 220-210. [Schedule 10, item 1, section 220-210]

Effect on franking account if NZ franking choice ceases to be in force

5.29 If a NZ franking choice is revoked or cancelled, the following consequences, which are equivalent to the consequences of a company ceasing to be a franking entity, will arise:

•

if a company's franking account balance is in surplus, the balance will be cancelled by a franking debit equal to the amount of the surplus; and

•

if a company's franking account balance is in deficit, a franking deficit liability will arise under section 205-45. [Schedule 10, item 1, subsections 220-215(1) to (3)]

5.30 In working out whether the company's franking account is in surplus or deficit it will be necessary to take into account any franking debits that arise under new section 220-605. This section provides that a franking debit arises in a NZ company's franking account that is a former exempting entity where the franking choice ceases to be in force and the company's exempting account is in deficit. [Schedule 10, item 1, subsection 220-220(5)]

Transfer of franking credits and debits where a group includes a non-Tasman company

5.31 Where a company that is not resident in Australia or NZ is interposed between an Australian or NZ subsidiary company, the Australian subsidiary or another NZ company would generally not be able to pass on franking credits to the NZ holding company.

5.32 However, a special rule will apply in the case of wholly-owned groups with a NZ parent company if all NZ companies in the group have made a NZ franking choice. In general terms, franking credits and debits that would otherwise arise in the franking account of the subsidiary (the 'franking donor company') will be transferred to the franking account of the NZ company (the 'recipient company') that holds the shares in the interposed company. [Schedule 10, item 1, subsection 220-300(1)]

5.33 This rule will only apply from the time that all NZ companies in the group have made a NZ franking choice, that is, it will not apply from the start of the income year to which a NZ franking choice applies. A NZ company that has made a NZ franking choice is referred to as a 'post-choice NZ franking company' to reflect this timing requirement. [Schedule 10, item 1, subsection 220-300(2)]

5.34 If the franking account of the franking donor company is in surplus when these conditions are satisfied:

•

a franking debit will arise in the franking account of the franking donor company equal to the surplus in the franking account; and

•

a franking credit equal to the surplus will arise in the franking account of the NZ recipient company. [Schedule 10, item 1, subsection 220-300(3)]

5.35 If the franking account of the franking donor company is in deficit when these conditions are satisfied, the company will incur a franking deficit tax liability in the same way as if the company had ceased to be a franking entity. [Schedule 10, item 1, subsection 220-300(4)]

5.36 If franking credits or debits arise in the franking account of the franking donor company after the time the above conditions are first met, the credits or debits arise in the franking account of the NZ recipient company. [Schedule 10, item 1, subsection 220-300(5)]

5.37 The Australian subsidiary will continue to be able to frank distributions but the franking debit will arise in the NZ company's franking account. The benchmark franking percentage of the company transferring the franking credits will not be affected because of franking debits or credits arising instead in the NZ companies' account. [Schedule 10, item 1, subsection 220-300(7)]

5.38 Diagram 5.2 illustrates how franking credits and debits will be transferred from the franking account of the franking donor company to the franking account of the NZ recipient company.

Diagram 5.2

5.39 If the franking donor company becomes a former exempting entity when the conditions are satisfied, adjustments will be made so the franking account of the company has a nil balance. This will ensure that franking credits or debits that arise in relation to the company's transition from an exempting entity to a former exempting entity will not be inappropriately transferred to the NZ company. [Schedule 10, item 1, subsection 220-300(8)]

Effects of supplementary dividend from a NZ franking company

5.40 If a NZ company pays a supplementary dividend in relation to a franked dividend, the tax offset that a taxpayer would otherwise receive because of the franking credit attached to the dividend will be reduced by the amount of the supplementary dividend if the taxpayer also receives a foreign tax credit. [Schedule 10, item 1, section 220-400]

5.41 A supplementary dividend is a payment paid by a NZ company to a non-resident shareholder as part of NZ's foreign investor tax credit regime. A supplementary dividend, in effect, represents a refund of the NZ company tax paid in respect of the underlying income to ensure that the effective tax rate for a non-resident investor does not exceed the NZ company tax rate.

5.42 When combined with an imputation tax offset, a supplementary dividend could result in a taxpayer gaining an undue tax advantage by investing in Australia indirectly through a NZ company rather than directly through an Australian company. The tax offset will be reduced by the amount of the supplementary dividend to prevent this outcome.

5.43 Where this rule applies, the 'gross-up amount' to be included in the taxpayer's assessable income under subsection 207-20(1) because of the franking credit will be reduced by the amount of the supplementary dividend. The tax offset will be reduced by the same amount. [Schedule 10, item 1, subsections 220-400(2) and (3)]

5.44 If a taxpayer's entitlement to a tax offset is to be reduced under paragraph 207-150(2)(b) because of manipulation of the imputation system, the amount by which the offset is to be reduced because of the manipulation is to be calculated using the reduced tax offset reflecting the supplementary dividend. [Schedule 10, item 1, subsection 220-400(4)]

Example 5.2

Kiwi Co pays a franked dividend to Bob, an Australian shareholder, with a value of A$70. The dividend is fully franked, that is, a A$30 franking credit is attached. Kiwi Co also pays a supplementary dividend with a value of A$5 to Bob. NZ non-resident withholding tax is applied at the rate of 15%. Bob receives a cash dividend of A$63.75 net of NZ non-resident withholding tax.

The consequences for Bob receiving a franked dividend from Kiwi Co which includes a supplementary dividend are set out below:

Income
Distribution	A$63.75
Foreign tax paid	A$11.25
Franking credit	A$30.00
Less supplementary dividend	( A$5.00 )
Assessable income	A$100.00
Tax payable (assume rate of 48.5%)	A$48.50
Less
Foreign tax credit	(A$11.25)
Tax offset reduced by supplementary dividend	( A$25.00 )
Tax payable by Bob	A$12.25

5.45 An equivalent rule will apply in relation to indirect distributions, that is through a trust or partnership. In this case, a deduction will be required rather than a reduction in the 'gross-up amount'. [Schedule 10, item 1, section 220-405]

Franking credit reduced if tax offset reduced

5.46 If a corporate tax entity's tax offset in relation to a dividend is reduced because a supplementary dividend is paid in connection with the dividend, the franking credit arising in that entity's franking account because of the distribution will be equal to the reduced tax offset. [Schedule 10, item 1, section 220-410]

Distributions franked with an exempting credit

5.47 If a NZ franking company that is a former exempting entity franks a dividend with an exempting credit, and a supplementary dividend is paid in relation to the dividend, the tax effects of the exempting credit that arise under Subdivision 208-H will be adjusted in the same way. [Schedule 10, item 1, section 220-700]

Rules about exempting entities

5.48 Some changes to the exempting entity rules are required to accommodate trans-Tasman (triangular) imputation reform. Under the exempting entity rules set out in Division 208 of the ITAA 1997, franked dividends paid by a company that is not more than 5% effectively owned by prescribed persons (broadly, non-exempt Australian residents) generally do not convey franking benefits to resident shareholders. Such companies are called exempting entities.

5.49 Effective Australian ownership of an Australian company cannot be traced through a non-resident company. Unless changes were made to the exempting entity rules, an Australian or NZ subsidiary of a NZ company would be an exempting entity regardless of the extent of Australian ownership of its NZ parent company.

5.50 The law will be amended so that a NZ franking company will not be automatically treated as a prescribed person under section 208-40. This means that a NZ franking company can be looked through to find effective Australian ownership, so that an Australian or NZ subsidiary of a NZ franking company that has more than 5% effective Australian ownership will not be an exempting entity. This rule is illustrated in Diagram 5.3. [Schedule 10, item 1, section 220-505]

Diagram 5.3

5.51 It is possible that a NZ listed company would be an exempting entity notwithstanding the look-through approach, that is because it has less than 5% effective Australian ownership. A NZ listed company that is a NZ franking company, together with any Australian or NZ 100%-owned subsidiaries, will not be treated as exempting entities. [Schedule 10, item 1, subsection 220-500(2)]

5.52 This concession is intended to assist NZ companies that wish to increase their Australian shareholder base. The application of the general exempting entity rules to NZ listed companies would be inappropriate in the context of triangular reform. The concession is confined to NZ listed companies to maintain the integrity of the exempting entity rules.

5.53 The third change to the exempting entity rules is to provide that a company that is a member of a wholly-owned group with a parent company that is a NZ franking company that includes a company not resident in Australia or NZ will not be an exempting entity if the parent company is not an exempting entity. [Schedule 10, item 1, section 220-510]

5.54 This rule complements the rule in new section 220-300, which provides for the transfer of franking credits and debits from the franking account of an Australian or NZ subsidiary of a company not resident in Australia or NZ to the franking account of the NZ company that holds the non-resident company. The Australian or NZ subsidiary would otherwise be an exempting entity.

5.55 If an Australian or NZ company becomes a former exempting entity because one or more NZ companies become NZ franking companies, it will generally become a former exempting entity at the time that the NZ companies make a NZ franking choice. The company would not become a former exempting entity from the start of the income year to which the NZ franking choice relates. This outcome is achieved by the concept of 'post-choice NZ franking company', which is explained in paragraph 5.33. This is illustrated in Diagram 5.4.

Diagram 5.4

NZ companies' exempting accounts

5.56 As for franking accounts, an exempting account of a NZ franking company must be kept in Australian currency. [Schedule 10, item 1, section 220-600]

5.57 Where a NZ franking company that is a former exempting entity ceases to be a NZ franking company, the exempting account of the company will be treated in the same way as if the company had ceased to be a corporate tax entity. The following exempting credits and debits are made if a NZ company is a former exempting entity and its NZ franking choice ceases to have effect:

•

if the exempting account is in surplus - an exempting debit arises in the exempting account equal to the amount of the surplus; or

•

if the exempting account is in deficit - an exempting credit equal to the deficit arises in the exempting account at the relevant time (and an equal franking debit arises).

[Schedule 10, item 1, section 220-605]

Joint and several liability for NZ resident company's unpaid franking liabilities

5.58 Joint and several liability will be imposed on members of a trans-Tasman group to overcome the potential difficulty of recovering an Australian tax liability from a NZ company. If a NZ company that is a member of a wholly-owned group fails to meet its franking-related tax obligations on time, the Commissioner will be able to seek to recover the franking-related liability of the NZ company directly from an Australian entity or another NZ company that is a member of the same wholly-owned group. [Schedule 10, item 1, section 220-800]

5.59 There will be an exception for entities prohibited by an Australian or NZ law from entering into such an arrangement. This exception recognises prudential requirements that apply, for example, to the banking and finance industry.

5.60 Joint and several liability will be imposed on all members of a wholly-owned group that includes a NZ franking company. There will be an exception for entities prohibited by an Australian or NZ law from entering into such an arrangement.

5.61 Joint and several liability under these rules will be confined to a NZ company's franking-related liabilities:

•

franking deficit tax, imposed on a company that has a deficit balance in its franking account at the end of the income year;

•

over-franking tax, imposed on a company that attaches a franking credit to a distribution in excess of the company's benchmark franking percentage, in breach of the benchmark rule;

•

the GIC payable in respect of franking deficit tax and over-franking tax incurred by the NZ company; and

•

an administrative penalty relating to another franking-related liability.

5.62 The liability of resident entities will be determined in a similar way as for members of a consolidated group under Division 721 of the ITAA 1997:

•

a NZ company will be solely liable, in the first instance, for its franking deficit tax and over-franking tax liability. If the NZ company fails to meet its franking deficit tax or over-franking tax liability by the time the liability becomes due and payable, each resident or NZ entity that was a member of the group at any time during the income year for which the liability arose would become jointly and severally liable for the liability together with the NZ company;

•

the joint and several liability will arise immediately after the defaulting NZ company's liability became due and payable;

•

the joint and several liability of a particular member will become due and payable 14 days after the member is given notice of the liability by the Commissioner; and

•

the franking-related liability will be treated as an income tax liability for the purposes of section 254 of the ITAA 1936, which provides for the recovery of a tax liability from an agent or trustee.

Related amendments

Consequential amendments

5.63 A number of minor consequential amendments will be made to the ITAA 1997:

•

section 200-45 will be amended to include a reference to the new imputation rules for NZ companies [Schedule 10, item 2] .

•

section 202-45, which lists unfrankable distributions, will be amended to also include distributions which section 220-105 lists as unfrankable [Schedule 10, item 3] .

•

amendments will be made to subsection 995-1(1) to include new dictionary terms and also to update existing definitions to take account of the new measures [Schedule 10, items 4 to 11] .

5.64 A consequential amendment will also be made to the TAA 1953 to insert a note to subsection 250-10(2) of Schedule 1. [Schedule 10, item 12]

Amendments contingent on imputation for co-operative companies

5.65 A number of technical contingent amendments relating to the imputation rules for co-operative companies contained in Taxation Laws Amendment Bill (No. 8) 2002^[F6] may be required if that bill receives Royal Assent after this bill. [Schedule 10, items 13 to 16]

Amendments contingent on taxation of financial arrangements

5.66 A number of technical amendments will be made which are contingent on the proposed reform of the income tax law concerning foreign exchange gains and losses^[F7]. These amendments will be required to ensure consistency with those rules. [Schedule 10, items 17 to 23]

Income Tax (Transitional Provisions) Act 1997

Application of Division 220

5.67 Division 220 of the ITAA 1997 and the related amendments will apply on and after 1 April 2003. [Schedule 10, item 24, section 220-1]

Residency requirement

5.68 In determining whether a NZ franking company meets the residency requirement for the income year including 1 April 2003 things that happen before that time can be taken into account. This means that the residency test will generally apply in relation to the whole of the income year including 1 April 2003, not merely to the period from 1 April 2003 until the end of the income year. [Schedule 10, item 24, section 220-5]

A NZ company cannot frank before 1 October 2003

5.69 A NZ franking company will not be able to frank a distribution (including with an exempting credit) made before 1 October 2003. [Schedule 10, item 24, section 220-10]

Extended time to make a NZ franking choice

5.70 A company that is a NZ resident may make a NZ franking choice that comes into force at the start of the company's income year including 1 April 2003 by giving notice in the approved form to the Commissioner before the end of the next income year. This rule will enable a NZ resident company to make the choice at any time before 1 July 2004 and that choice will apply from 1 April 2003. [Schedule 10, item 24, section 220-35]

Franking and exempting accounts of former exempting entities

5.71 As a transitional measure, an Australian subsidiary of a NZ franking company will be allowed to retain franking credits accumulated before the subsidiary becomes a former exempting entity. This rule will apply if the subsidiary becomes a former exempting entity as a result of the NZ company making a NZ franking choice that comes into force at the start of the NZ company's income year that includes 1 April 2003. [Schedule 10, item 24, subsection 220-501(1)]

5.72 The subsidiary will become a former exempting entity at the time that the NZ company makes a NZ franking choice. This time is called the 'switch time'.

5.73 A subsidiary will be entitled to retain franking credits accumulated before the switch time provided that the subsidiary would have not been an exempting entity if the changes to the exempting entity rules had applied retrospectively. In other words, the subsidiary will retain credits accumulated before the switch time if, during the period starting on 13 May 1997 (when the exempting entity rules commenced) and ending on the switch time, either:

•

effective Australian ownership of the company, determined using the look-through approach, was always greater than 5%; or

•

the company was a 100% subsidiary of a NZ listed company. [Schedule 10, item 24, subsections 220-501(2) and (3)]

5.74 If the subsidiary satisfies one of these conditions for a shorter period ending on the switch time, it will retain franking credits accumulated during that period. Credits accumulated during the period will be determined by subtracting the franking account balance at the start of that period from the franking account balance at the switch time. [Schedule 10, item 24, subsections 220-501(2) and (3)]

5.75 Under the general exempting entity rules, the franking account balance of a company is transferred to the company's exempting account when it becomes a former exempting entity. To ensure that a subsidiary will retain the relevant franking credits, an exempting debit and a franking credit will arise to reverse the transfer. [Schedule 10, item 24, subsection 220-501(7)]

Example 5.3

Ausco is sold on 1 January 1998 to NZ Co, a NZ listed company. Ausco consequently becomes an exempting entity because it is 100% owned by a prescribed person as described in section 208-40 of the ITAA 1997. There are no further changes in ownership between the time of acquisition and 1 April 2003.

On 1 March 2004, NZ Co makes a franking choice which is in force for the NZ income year commencing 1 April 2003. Ausco consequently becomes a former exempting entity on 1 March 2004.

If new section 220-500 had been in operation between 1 January 1998 and 1 March 2004, Ausco would not have been an exempting entity as it is a subsidiary of a NZ listed company.

Ausco has a franking surplus of $2 million at 1 January 1998 and a franking surplus of $5 million on 1 March 2004. A franking credit will arise in Ausco's franking account and an exempting debit will arise in its exempting account immediately after it becomes a former exempting entity. The amount of the franking credit and exempting debit will be $3 million, the difference between Ausco's franking surplus on 1 January 1998 and its franking surplus on 1 March 2004.

REGULATION IMPACT STATEMENT

Policy objective

5.76 Trans-Tasman (triangular) imputation reform is designed to improve the ease of trans-Tasman capital flows by reducing an additional layer of tax on those flows by providing relief to Australian (or NZ) investors from the residence taxation imposed on income that has already been taxed at source through company and withholding taxes by Australia (or NZ).

5.77 The proposal is also designed to further strengthen the important bilateral relationship between Australia and NZ, which is formalised under the Closer Economic Relations agreement.

5.78 The problem of triangular taxation arises because Australian shareholders of a NZ company earning Australian income are unable to access Australian franking credits arising from the payment of Australian tax on that income because the credits are unable to flow through the NZ company. (A similar problem applies for NZ shareholders of Australian companies earning NZ income).

Implementation options

5.79 The triangular reform proposal arose directly from a recommendation of the Review of Business Taxation. The implementation option that forms the basis of this reform proposal can be found in Recommendation 20.6 of A Tax System Redesigned.

"That the Australian Government propose to the NZ Government that discussions be held with a view to introducing a mechanism to allow franking credits to flow through trans-Tasman companies on a pro-rata basis to Australian and NZ investors."

5.80 On 6 March 2002, the Australian and NZ governments jointly released a discussion paper on triangular taxation to serve as a basis for business consultation on the feasibility of implementing a pro-rata solution to triangular taxation.

5.81 Although the discussion paper focused primarily on issues concerning the possible implementation of a pro-rata solution to triangular taxation, there are a number of other options (noted in the paper) that could be used to achieve the policy objective identified above including:

•

mutual recognition of franking credits;

•

triangular (dividend) streaming; and

•

apportionment.

5.82 Mutual recognition involves the provision of franking credits for company taxes paid in another country. In the case of Australia and NZ, it would mean allowing a franking credit generated in NZ (by the payment of NZ company tax) to accompany a dividend distributed to an Australian resident shareholder and vice versa. The credit would remain attached to the dividend and could be used as a rebate against the Australian resident's tax liability.

5.83 Triangular (dividend streaming) involves distributing dividends with franking credits attached to those shareholders for whom the credits are of maximum value. Australian franking credits are of no value to a NZ parent's NZ shareholders, and the converse applies for NZ imputation credits. As such, the NZ parent would direct all its Australian franking credits to its Australian shareholders and all its NZ imputation credits to its NZ shareholders. Australian shareholders therefore receive more than their pro-rata entitlement of franking credits.

5.84 Apportionment involves attaching credits to dividends split into Australian and NZ franking credit components according to the ratio of income earned in either country and in equal proportions for all shareholders. This method is similar to pro-rata allocation except that the credits are allocated not only in proportion to the residence of the shareholder, but also in proportion to the country in which the income is earned. It would give the same result as pro-rata allocation when a company had no previous balances of credits and fully distributed all tax-paid income.

5.85 These other options were briefly discussed in the discussion paper, which clearly stated that the pro-rata option was the only one being considered for implementation. Although business have indicated in submissions and in consultation that they would prefer the more generous options of mutual recognition or triangular (dividend) streaming, these options exceed what is required to solve triangular taxation. The apportionment approach was strongly rejected by business because of its high compliance costs and because the outcome under apportionment was not as generous as under the pro-rata proposal.

5.86 The underlying principle used in developing a mechanism to facilitate the pro-rata reform proposal is that Australian shareholders who invest in a NZ company that earns Australian income should be neither better off nor worse off in taxation terms than if they had earned that income directly from an Australian company. This implies that NZ companies maintaining an Australian franking account should be subject to the same imputation rules as Australian companies.

5.87 This was the starting point in developing the mechanism but some changes to Australia's imputation rules were required to make triangular workable for NZ companies.

Assessment of impact

5.88 Although the direct cost to revenue of the triangular reform can be estimated, the dynamic gains to revenue from the reform proposal cannot be reliably quantified. This is because there is no reliable information on the extent to which the reform will ease trans-Tasman capital flows and free up the dividend distribution policies of trans-Tasman companies. Estimating these effects accurately would require information on the behavioural responses of trans-Tasman companies and shareholders to the reform. Behavioural responses are intrinsically difficult to model and they are made more so when the effects have to be considered in more than one country.

Impact group identification

5.89 The reform proposal will have an impact on NZ companies that earn income in Australia, have Australian shareholders and have made a NZ franking choice. NZ companies that wish to pass franking credits to their Australian shareholders will make a choice to maintain Australian franking accounts and these changes will have an impact on these companies. The changes will have no impact on those NZ companies that do not make the choice.

5.90 Data on the number of NZ companies that earn Australian income and have Australian shareholders is not generally available. However, it is anticipated that between 500 to 1,000 NZ companies may elect into triangular reform. There are between 50 to 100 large Australian companies that pay tax in NZ and have NZ shareholders who may benefit from triangular reform albeit from changes to NZ's imputation system. It is not known how many smaller Australian enterprises pay tax in NZ and have NZ shareholders.

Analysis of costs / benefits

Compliance costs

5.91 NZ companies that make a choice to enter the Australian imputation system will incur a minor increase in compliance costs in complying with Australia's imputation rules. Australian companies that elect into triangular reform will incur a similar increase in costs in having to comply with NZ's imputation rules.

5.92 NZ companies will have to maintain an Australian franking account in addition to a NZ imputation account. This will involve an up-front cost in setting up a system to monitor the Australian franking credit balance and amending distribution statements to include information about Australian franking credits attached to a dividend. There will also be an ongoing cost that would be similar to the cost of maintaining a NZ imputation account. Data is not available to make an accurate assessment of the quantum of these costs but it is expected that they would be minimal.

Administration costs

5.93 There will be an increase in administrative costs for the ATO. Forms and systems changes will be required to support the election mechanism and also the collection of tax from NZ companies. Information booklets and promotional material will be prepared to advise NZ companies and Australian shareholders about the new rules.

5.94 There will also be a need for the ATO to undertake specific compliance activities in relation to NZ companies. These activities will include the exchange of information with NZ's Department of Inland Revenue.

Government revenue

5.95 The recommendations are estimated to have a revenue cost of $5 million in 2003-2004, $20 million in 2004-2005, $20 million in 2005-2006 and $25 million in 2006-2007.

Economic benefits

5.96 Although the Closer Economic Relations agreement has made significant inroads towards creating a single market between Australia and NZ, the capital market remains the least integrated part of the trans-Tasman market and taxation disincentives may be impeding the flow of capital. Reform of triangular taxation will improve the ease of trans-Tasman capital flows by reducing an additional layer of tax on those flows.

5.97 Triangular reform will reduce the incentive for trans-Tasman companies to establish a separate structure in the other jurisdiction and seek shareholders in the other jurisdiction. This option is costly and is only effectively open to large companies with significant operations in both countries.

Other benefits

5.98 The reform will further strengthen the important bilateral relationship between the 2 countries.

Consultation

5.99 The discussion paper released in March 2002 called for submissions on the pro-rata reform proposal. Submissions were generally supportive of the more generous options of mutual recognition or triangular (dividend) streaming to solve the triangular problem.

5.100 A consultation workshop was held in June 2002 to discuss issues raised in submissions to the discussion paper. As a result of the consultation process, changes were made to aspects of the reform proposal as outlined in the discussion document. There was also further consultation in March/April 2003 on a detailed description of the proposed triangular rules.

5.101 A number of concessions sought by taxpayers in consultations were accepted:

•

franking credits accumulated by the Australian subsidiaries of NZ companies before commencement of the measure will not be 'quarantined' as exempting credits, so that the franking credits may be passed to NZ parent companies;

•

NZ companies within a wholly-owned group will be able to access franking credits accumulated by an Australian subsidiary of a company that is not an Australian or NZ resident; and

•

joint and several liability for franking deficit tax and other imputation-related taxes that a NZ company fails to pay will be imposed on related companies only in the case of a wholly-owned group.

Conclusion

5.102 Triangular reform will result in a minor increase in compliance costs for those Australian and NZ companies that choose to enter into the Australian imputation system.

5.103 The triangular reform proposal is expected to improve the ease of trans-Tasman capital flows and further strengthen the bilateral relationship between Australia and NZ. The benefits of the reform are expected in the longer term to outweigh the revenue costs.

Chapter 6 GST amendments relating to compulsory third party schemes

Outline of chapter

6.1 Schedule 11 to this bill amends the GST Act to:

•

modify the GST insurance provisions to apply to an insurer that makes payments or supplies in relation to CTP insurance policies and to apply similar provisions to payments and supplies that are made in relation to CTP compensation and other CTP non-insurance policy related matters; and

•

ensure that the GST insurance provisions apply to payments and supplies made by CTP insurers pursuant to settlement sharing arrangements.

Schedule 11 also amends the GST Transition Act to ensure that no adjustment or taxable supply arises in relation to a settlement of a claim under a CTP insurance policy or from a claim for compensation under a CTP scheme, to the extent the event giving rise to the claim happened before 1 July 2000.

Context of amendments

6.2 Each State and Territory has a CTP motor accident injury insurance or compensation scheme that operates in conjunction with motor vehicle registration processes. The CTP schemes vary in structure and operation to each other. Some CTP schemes operate as insurance schemes, while other schemes operate as compensation schemes. In addition, some CTP schemes operate through a single entity, being either a government enterprise or a private insurer, while other schemes operate through a number of private insurers.

6.3 If the supplier is registered for GST, the supply of insurance, including CTP insurance, may be a taxable supply. Where the insurance is acquired for a creditable purpose, an entity that is registered, or required to be registered, for GST would normally be entitled to claim an input tax credit. Insurers are entitled to a decreasing adjustment for payments or supplies made in settlement of claims under insurance policies, but only to the extent that there is no entitlement to an input tax credit for the premium. The insurance provisions contained within Division 78 of the GST Act apply in a modified form to payments and supplies made in settlement of claims for compensation in a similar manner to how they apply to the settlement of claims under insurance policies.

6.4 However, after consultation with members of the CTP industry, it has been established that the GST insurance provisions do not apply as intended to some payments or supplies made in settlement of claims under a CTP scheme. Furthermore, there are a number of other insurance related payments or supplies made by CTP insurers that should be subject to the GST insurance provisions. For example, these include payments of hospital and ambulance charges that arise for services that have been provided directly to injured persons involved in motor vehicle accidents, that are paid by an insurer via CTP scheme wide bulk-billing arrangements.

6.5 CTP schemes operate to ensure that people injured in motor vehicle accidents are able to obtain compensation and other benefits as a result of the injuries they have suffered. All the CTP schemes are established and governed by a State or Territory law that imposes on insurers or scheme operators various obligations. Whether the CTP schemes operate through insurance polices issued by private insurers, or operate through a single state agency, the nature and purpose of the schemes remain unchanged.

6.6 Therefore, some of the transactions and obligations that arise for CTP insurers and operators of CTP compensation schemes do not necessarily arise for many other types of insurers. These obligations can include: settling claims by injured persons without necessarily having any contact with an insured; using rights of recovery other than rights of subrogation (or being limited in the use of those rights); and being required to make payments for services provided directly to an injured person, without a claim being made by any person under the scheme.

6.7 Payments or supplies made by CTP insurers or operators of CTP compensation schemes in settlement of claims made under CTP schemes should be subject to the same GST provisions, or similar provisions, to those that apply to settlements of claims under insurance policies.

6.8 In some CTP schemes that operate through multiple insurers, such as those schemes currently operating within New South Wales and Queensland, the insurers participate in settlement sharing arrangements. Under these arrangements, accidents that involve more than one vehicle and more than one insurer, require one of the insurers to manage all claims arising from the accident. The other insurers involved in the arrangement for that accident, contribute a share of the settlement payment.

6.9 In addition to settlement sharing arrangements that operate between CTP insurers, claims made against the Nominal Defendant in New South Wales are also subject to sharing. This typically involves sharing a claim that arises from an accident involving an uninsured owner or driver. There are also some sharing arrangements between insurers that operate across different CTP schemes, such as where there is an accident involving vehicles from different States or Territories.

6.10 In a multi-vehicle accident, a claimant may choose not to claim against every vehicle driver involved in the accident. No matter which insurer receives the claim, the settlement of the claim will be shared by all insurers subject to the sharing arrangement for that particular accident. Through the sharing arrangement, an insurer may be required to contribute to the settlement of the claim without a claim being made by its insured. Therefore, as the payments made by the insurer are not made in settlement of a claim under an insurance policy, the payment may not be subject to the GST insurance provisions. This is also the case where the claim that is subject to a sharing arrangement is a claim made for a payment of compensation against a nominal defendant.

6.11 As the payments or supplies made by insurers under a sharing agreement form part of the settlement of a claim under a CTP scheme, the payments or supplies should be treated for GST purposes, as though they are payments or supplies made in settlement of a claim under an insurance policy or in settlement of a claim for compensation.

6.12 Under the GST, CTP insurers and nominal defendants that enter into settlement sharing arrangements may be making taxable supplies relating to their obligations under the arrangement. They may also be making creditable acquisitions from other insurers that enter into the agreement. The value of these supplies may be difficult to determine in the circumstances of a settlement sharing arrangement. In addition, insurers may be required to participate in sharing arrangements under the laws that govern the operation of the scheme. Therefore, entering into a settlement sharing arrangement should not result in a taxable supply or creditable acquisition arising for either the insurers or a nominal defendant.

Summary of new law

6.13 This bill will:

•

include Division 79 into the GST Act to modify the GST insurance provisions to apply to an insurer that makes payments or supplies in relation to CTP insurance policies and to apply similar provisions to payments and supplies that are made in relation to CTP compensation and other CTP non-insurance policy related matters;

•

include Division 80 into the GST Act to ensure that the GST insurance provisions apply to payments and supplies made by CTP insurers pursuant to settlement sharing arrangements; and

•

amend the GST Transition Act to ensure that no adjustment or taxable supply arises in relation to a settlement of a claim under a CTP insurance policy or of a claim for compensation under a CTP scheme, to the extent the event giving rise to the claim happened before 1 July 2000.

Comparison of key features of new law and current law

Detailed explanation of new law

Division 79

6.14 Division 79 is inserted into the GST Act. This Division modifies the application of Division 78 to some insurance policy payments and supplies made under a CTP scheme. Division 79 also applies to payments and supplies made in connection with, but not under, insurance policies. For other settlements and payments, including settlements of claims for compensation, provisions similar to Division 78 apply. [Schedule 11, item 18, section 79-1]

6.15 A compulsory third party scheme is defined within the GST dictionary. A CTP scheme is a scheme or arrangement that is established by an Australian law and is specified in the GST Regulations. These schemes will consist of each of the State and Territory motor vehicle CTP schemes. [Schedule 11, item 21, section 195-1]

6.16 Division 79 replaces the application of Division 78 to payments or supplies made by an operator of a CTP scheme in relation to compensation matters. Therefore, CTP schemes have been removed from the definition of a statutory compensation scheme as set out in section 78-105, which previously allowed for the application of the insurance provisions within Division 78 to CTP compensation schemes. [Schedule 11, item 16, section 78-105]

6.17 The removal of CTP schemes from the definition of a statutory compensation scheme, does not affect the operation of the GST Regulations as they apply to statutory compensation schemes that are not CTP schemes. [Schedule 11, item 17]

6.18 The provisions of Division 79 apply to an operator of a CTP scheme. The GST dictionary has been amended to include a definition of operator. An operator of a CTP scheme means an entity that is required under an Australian law to make payments or supplies in settlement of claims under the scheme. This definition encompasses insurers that make payments and supplies in settlement of claims under CTP insurance policies. It also encompasses an entity that is responsible for the settlement of claims for compensation made under a CTP scheme. [Schedule 11, item 38, section 195-1]

Subdivision 79-A

6.19 Subdivision 79-A modifies the application of Division 78 to certain CTP payments and supplies that are made under insurance policies.

Premium selection test

6.20 An operator may be able to determine its entitlement to a decreasing adjustment under section 78-10 for a payment or supply that it makes in settlement of a claim under an insurance policy, by treating the entity that acquires the policy as having, or not having, an entitlement to an input tax credit on the premium. However, the operator can only apply these rules where the premium selection test is satisfied. [Schedule 11, item 18, subsection 79-5(1)]

6.21 The term premium selection test is satisfied is referred in the GST dictionary as having the meaning given in subsection 79-5(2). Applying the premium selection test rules to determine if an operator is entitled to a decreasing adjustment for a payment or supply made in settlement of a claim under an insurance policy, will simplify an operator's dealing with its policyholders, and should lower overall compliance costs for the operator. [Schedule 11, item 39, section 195-1]

6.22 Under subsection 79-5(2), if an operator offers an insurance policy with a selection of premiums, and an entity acquiring the policy selected a premium that was offered by the operator on the basis that the entity is entitled to an input tax credit for some or all of the premium, the operator will treat the entity as being entitled to a full input tax credit for the premium. This means that the operator will not be entitled to claim a decreasing adjustment under section 78-10 for any payment or supply it makes in settlement of a claim under that insurance policy. [Schedule 11, item 18, subsections 79-5(2) and 79-5(3)]

6.23 If an operator offers an insurance policy with a selection of premiums and an entity acquiring the policy selected a premium that was offered by the operator on the basis that the entity is not entitled to an input tax credit for the premium, the operator will treat the entity, for the purposes of determining its entitlement to any decreasing adjustment under section 78-10, as not being entitled to an input tax credit for the premium. Subject to the operator satisfying all the other tests within section 78-10, the operator will be entitled to claim a full decreasing adjustment on any payment of supply it makes in settlement of a claim under that insurance policy. [Schedule 11, item 18, subsections 79-5(2) and 79-5(4)]

Example 6.1

LBK Pty Ltd offers Jan a CTP policy with a choice of two premiums. If Jan is entitled to claim an input tax credit for the premium, she will pay $105. If she is not entitled to claim an input tax credit for the premium, she will pay $100. Jan selects the premium of $100. LBK Pty Ltd will treat Jan as not being entitled to an input tax credit for the premium.

6.24 If an operator is not entitled to a decreasing adjustment for a payment or supply it has made in settlement of a claim under an insurance policy because of the application of the premium selection test, and the operator later becomes aware that there was no input tax credit entitlement for the premium, the operator will, subject to continuing to satisfy the tests in section 78-10, have a decreasing adjustment. Any decreasing adjustment is reduced by the notional increasing adjustments that would have applied in relation to any recoveries made by the operator in respect of the settlement of a claim under the relevant insurance policy. [Schedule 11, item 18, subsection 79-10(1)]

6.25 If an operator has treated an entity as having no input tax credit entitlement for the premium because of the application of the premium selection test, and it later becomes aware that the entity did have an entitlement to an input tax credit for the premium, the operator will have an increasing adjustment. The increasing adjustment equals the amount of the original decreasing adjustment claimed by the operator, reduced by any increasing adjustments that applied in relation to recoveries made by the operator in respect of the settlement of a claim under the relevant insurance policy. [Schedule 11, item 18, subsection 79-10(2)]

Example 6.2

Jan makes a claim under a policy she acquired from LBK Pty Ltd. An amount of $1100 is paid by LBK Pty Ltd in settlement of the claim. As Jan selected the premium for the policy on the basis that she is not entitled to an input tax credit on the premium, LBK Pty Ltd calculates its entitlement to a decreasing adjustment as $100 which is one eleventh of the $1100.

LBK Pty Ltd is later informed by Jan that she is entitled to claim an input tax credit for the premium. LBK Pty Ltd has an increasing adjustment of $100, which is the amount of the original decreasing adjustment it has claimed.

If LBK Pty Ltd had made a recovery of $220 of the settlement amount, and calculated an increasing adjustment of $20 in relation to the recovery prior to Jan advising of her entitlement to claim an input tax credit, the increasing adjustment of $100 would be reduced by the $20. LBK Pty Ltd would have a net increasing adjustment of $80.

6.26 If an operator does not offer a choice of premiums for the supply of an insurance policy within the circumstances to which the premium selection test applies, the operator will continue to determine its entitlement to a decreasing adjustment for any payment or supply made in settlement of a claim under the policy, unless the sole operator election rules apply, using the actual input tax credit entitlement for the premium.

Sole operator election

6.27 Where a CTP scheme has a sole operator that is responsible for the issue of insurance policies, the operator may elect to apply the average input tax credit fraction in the calculation of any decreasing adjustment to which it is entitled under section 78-10. Once a valid election has been made, the actual input tax credit entitlement for the premium, or the assumed input tax credit entitlement where the premium selection test is satisfied, is irrelevant in determining if the operator is entitled to a decreasing adjustment, or to the amount of the adjustment. The average input tax credit fraction is discussed further in relation to the operation of Subdivision 79-D. [Schedule 11, item 18, subsection 79-15(1)]

6.28 An election only applies to settlements of claims under insurance policies. This is because operators that make payments or supplies in settlement of claims for compensation will already use the average input tax credit fraction in the calculation of any decreasing adjustment to which they are entitled. In a CTP scheme that has multiple operators, in order to determine if it has a liability in respect of a claim, the operator needs to determine if a claim relates to an insurance policy that was issued by it, or relates to a policy issued by another operator. The election is available to sole operators of CTP schemes because they, unlike multiple operator schemes, are responsible for the settlement of all claims made in respect of insurance policies issued under the CTP scheme. Sole operators are therefore able to settle claims under insurance policies in the same way they would settle claims for compensation.

6.29 An operator must continue to satisfy all of the tests within section 78-10 to be entitled to a decreasing adjustment using the average input tax credit entitlement fraction. The test in paragraph 78-10(2)(b) is assumed to be satisfied for the purposes of determining an operator's entitlement to a decreasing adjustment. [Schedule 11, item 18, subsection 79-15(2)]

6.30 For a valid election to be made, the election must be made in writing. In addition, the election must specify the financial year from which the election will take effect and must be made before the commencement of that financial year. Once the election has been made, it remains in force until the end of the financial year in which it is revoked. [Schedule 11, item 18, subsections 79-15(4), 79-15(5) and 79-15(7)]

Example 6.3

LBK Pty Ltd is the sole operator of a CTP scheme.

At a board meeting on 16 June 2009 the directors of LBK Pty Ltd make an election, in writing, to apply the averaged input tax credit fraction to settlements of claims under insurance policies. The election is to apply for the financial year commencing 1 July 2010.

At a board meeting on 15 January 2015, the directors revoke the election of 16 June 2009. The original election will remain in force until 30 June 2015.

6.31 For an election to be valid for the financial year commencing on 1 July 2003, an operator must have made the election within 30 days after the day on which the election provisions commence. The operator will need to specify that the election applied from 1 July 2003. This section recognises that the election provisions may not be operational as at 1 July 2003. [Schedule 11, item 18, subsection 79-15(6)]

6.32 While some CTP operators will continue to require an insured's actual input tax credit entitlement information to determine their entitlement to a decreasing adjustment for a settlement amount, an entity that acquires CTP insurance will no longer be subject to a possible GST liability under section 78-50, upon the making of a settlement of a claim, where that entity has not informed the operator of its input tax credit entitlement for the premium. This requirement has been removed for a number of reasons. Under a CTP insurance scheme, the CTP insurance transfers with the ownership of the vehicle and the entity that originally acquired the policy may be unaware of any subsequent claim made by the new owner under the policy. In addition, it is understood that many claims by injured persons are settled by operators without the necessity for a claim being made by the insured. The CTP premium selection rules, sole operator election rules and the application of an averaged input tax credit fraction to calculations of decreasing adjustments in respect to settlements of claims for compensation, alleviate in all but limited circumstances, the need for an insured or other entity, to inform an operator of their input tax credit entitlement for a premium. [Schedule 11, item 15, paragraph 78-50(1)(c)]

Recoveries

6.33 Several sections within Division 78 only apply to an insurer exercising its rights of subrogation under an insurance policy. Under a CTP scheme, an operator may be restricted in the exercising of its rights of subrogation or be granted other rights under the scheme. Section 79-20 extends the operation of the Division 78 provisions to apply in circumstances where the operator exercises rights other than rights of subrogation. For instance, where the operator exercises statutory rights of recovery under a law governing a CTP scheme. The modification of the provisions in Division 78 extends to circumstances where the recovery is made under a court order, but does not extend to include payments or supplies obtained by an operator making a claim under a policy of reinsurance. Similar provisions within Subdivision 79-C apply for recoveries made by an operator in relation to settlements of claims for compensation. [Schedule 11, item 18, section 79-20]

Subdivision 79-B

6.34 Subdivision 79-B extends Division 78, as modified by Subdivision 79-A, to apply to certain CTP payments and supplies that are connected with, but not made under, insurance policies.

6.35 A payment or supply made by an operator that is connected with, but not made under, an insurance policy is referred to as a CTP hybrid payment or supply. The GST dictionary has been amended to include a reference to this term, which has the meaning given in subsection 79-25(1). A CTP hybrid payment or supply arises where an entity other than the operator's insured, notifies the operator of its intention to seek payment of damages from the insured. Such claims may be claims for compensation. Pursuant to the CTP scheme, the operator may settle the claim without requiring a claim to be made under the insured's insurance policy. [Schedule 11, item 18, subsection 79-25(1); item 29, section 195-1]

Example 6.4

Jan acquires CTP insurance from LBK Pty Ltd. Jan has an accident in her vehicle in which Bob is a passenger. Bob is injured in the accident. In accordance with the normal requirements of the CTP scheme, Bob notifies LBK Pty Ltd of his claim for damages against Jan. Jan does not make a claim under her policy.

LBK Pty Ltd accepts the claim made by Bob and proceeds to make a settlement payment in satisfaction of the claim. LBK Pty Ltd would not have accepted the claim from Bob but for the identification of Jan as a policyholder of LBK Pty Ltd. The payment to Bob is a CTP hybrid payment, as Jan does not make a claim under her insurance policy in relation to the settlement of Bob's claim.

6.36 A payment or supply is not a CTP hybrid payment or supply where the entity that paid the premium for the insurance policy has not notified the operator of its entitlement to an input tax credit for the premium, and cannot be located in order to obtain such notification. Payments or supplies made under these circumstances may be payments or supplies in settlement of a claim for compensation to which Subdivision 79-C applies. This means that the operator may be able to apply the averaged input tax credit fraction in the calculation of any decreasing adjustment arising from the settlement of the claim. [Schedule 11, item 18, subsection 79-25(2)]

Example 6.5

Jan acquires CTP insurance from LBK Pty Ltd. LBK Pty Ltd offers a single premium for the policy. Jan does not advise LBK Pty Ltd at the time of acquiring the policy of her entitlement to claim an input tax credit for the premium.

Jan's motor vehicle is involved in an accident. Bob was injured as a result of the accident. Bob notifies LBK Pty Ltd of his claim for damages against Jan. LBK Pty Ltd attempts to contact Jan and establishes she has left the country and cannot be located.

LBK Pty Ltd proceeds to settle Bob's claim. LBK Pty Ltd will treat the settlement payment as a payment of compensation as there is no claim made by Jan under her policy. LBK Pty Ltd will apply the average input tax credit fraction in any calculation of its decreasing adjustment for the settlement as it cannot establish what Jan's input tax credit entitlement is for the premium.

6.37 However, a payment or supply made by an operator in settlement of a claim that is made in relation to an insurance policy that was offered by the operator applying the premium selection test, is not a CTP hybrid payment or supply. This is because the operator can use the premium selection test rules to determine its entitlement to a decreasing adjustment for any payment or supply made in settlement of a claim under the policy. [Schedule 11, item 18, subsection 79-25(2)]

6.38 A payment or supply will not be a CTP hybrid payment or supply where the operator making the payment or supply was required to do so by law because of the bankruptcy or insolvency of another operator who is an insurer. This is because any decreasing adjustment that may arise from the settlement of a claim under an insurance policy remains with the operator that issued the insurance policy. [Schedule 11, item 18, subsection 79-25(3)]

6.39 Division 78, as modified by Subdivision 79-A, will apply to a CTP hybrid payment or supply that is made by an operator in settlement of a claim under a CTP scheme, as if the payment or supply was made in settlement of a claim by an insured under an insurance policy. [Schedule 11, item 18, section 79-30]

Subdivision 79-C

6.40 Subdivision 79-C applies to a CTP compensation payment or supply and to a CTP ancillary payment or supply. Together, these are termed a CTP compensation or ancillary payment or supply. The GST dictionary has been amended to include a reference to this term, which is defined in subsection 79-35(1). [Schedule 11, item 18, subsection 79-35(1); item 26, section 195-1]

6.41 A CTP compensation payment or supply is a payment or supply that is made in settlement of a claim for compensation under a CTP scheme. The GST dictionary has been amended to include a reference to a CTP compensation payment or supply which has the meaning given in subsection 79-35(2). What constitutes 'compensation' is not defined within the GST Act and the term has its ordinary meaning. [Schedule 11, item 18, subsection 79-35(2); item 27, section 195-1]

6.42 A CTP compensation payment or supply does not include a payment or supply to which Division 78 applies or is a CTP hybrid payment or supply. It also does not include a CTP dual premium or election payment or supply. The GST dictionary has been amended to include a definition of this term, which is a payment or supply to which sections 79-5 or 79-15, concerning payments or supplies in relation to the settlement of a claim under an insurance policy, apply. A CTP compensation payment or supply also excludes a payment or supply that an operator is required to make by law because of the bankruptcy or insolvency of another operator who is an insurer. [Schedule 11, item 18, subsection 79-35(2); item 28, section 195-1]

6.43 A CTP ancillary payment or supply is a payment or supply of a kind that is specified in the GST Regulations. The GST dictionary includes a reference to this term, which has the meaning given by subsection 79-35(3). It does not include a payment or supply that is made in settlement of a claim under an insurance policy or in settlement of a claim for compensation. In addition, a payment or supply is not a CTP ancillary payment or supply where it is consideration for a creditable acquisition, or it is made by an operator under the law governing the scheme because of the bankruptcy or insolvency of another operator. [Schedule 11, item 18, subsection 79-35(3); item 25, section 195-1]

6.44 Under CTP schemes, operators may be required to either pay, or make a contribution to, the cost of providing medical care and rehabilitation services, or to enable such services to be provided, to injured persons. These services include those provided to the families or representatives of injured or deceased persons. For example, in some CTP schemes, this involves bulk-billing arrangements between operators and hospital and ambulance service providers. These types of payments are required to be made by an operator even where no actual claim is made by an injured person under the scheme as the result of an accident. However, a CTP ancillary payment or supply does not extend to include payments or supplies that an operator makes in relation to the general administration of the operator's CTP enterprise.

6.45 Specifying within the GST Regulations those types of services or supplies, payment for which will constitute a CTP ancillary payment or supply, will facilitate potential changes to the types of services or supplies made under the various CTP schemes.

6.46 The remaining sections within Subdivision 79-C apply similar provisions to those within Division 78 that operate in respect to policies of insurance, to CTP compensation and ancillary payments or supplies.

6.47 Section 79-40 ensures that the value of a taxable supply for which the price includes an amount of a CTP premium is worked out as if the price for the supply were reduced by the amount of any stamp duty payable in respect of the supply. This section is consistent with the operation of sections 78-5 and 78-95 that relate to insurance premiums and levies imposed under statutory compensation schemes. [Schedule 11, item 18, section 79-40]

6.48 The GST dictionary has been amended to include a definition of CTP premium . It includes and encompasses a payment of a premium or of a levy in connection with a CTP scheme. [Schedule 11, item 30, section 195-1]

6.49 Like section 78-115 in its application to statutory compensation schemes, section 79-45 ensures that the appropriate Subdivision 79-C provisions do not apply to a CTP scheme that is an excluded scheme. [Schedule 11, item 18, section 79-45]

6.50 Under section 79-50, an operator that makes a CTP compensation or ancillary payment or supply is, subject to satisfying a number of tests within that section, entitled to a decreasing adjustment for the payment or supply. The operator must be registered, or required to be registered, for GST, and any CTP premium charged by the operator must be consideration for a taxable supply. Any decreasing adjustment is calculated using the average input tax credit fraction. [Schedule 11, item 18, section 79-50]

6.51 Under section 79-55, an operator will have an increasing adjustment if there is a payment of an excess to the operator in relation to a CTP compensation payment or supply that it has made, and the operator has made creditable acquisitions directly for the purpose of making the CTP compensation payment or supply. This section is similar to section 78-18 that operates in relation to insurance policies. [Schedule 11, item 18, section 79-55]

6.52 Section 79-60 ensures, that in respect to a CTP compensation or ancillary payment or supply that is made by an operator, the payment or supply is not treated as consideration for an acquisition made by the operator or consideration for a supply made by the entity to whom the payment or supply was made. This means that no taxable supplies or creditable acquisitions arise for either party. This section is similar to sections 78-20, 78-25, 78-65 and 78-70 in respect of insurance polices. [Schedule 11, item 18, section 79-60]

6.53 Section 79-65 applies where an operator exercises its rights under the CTP scheme to make a recovery from another entity. Any payment or supply made by a third party to the operator is not treated as consideration for a supply made by the operator or consideration for an acquisition made by the entity making the payment or supply. This section is similar to sections 78-35 and 78-75 as modified by Subdivision 79-A, that operate in respect to insurance policies. [Schedule 11, item 18, section 79-65]

6.54 Section 79-70 provides an adjustment under Division 19 for an operator that receives a payment or supply from another entity in exercising its rights to recover from that entity in relation to a CTP compensation or ancillary payment or supply it has made. This section is similar to section 78-40 as modified by Subdivision 79-A, that operates in respect of insurance policies. [Schedule 11, item 18, section 79-70]

6.55 Section 79-75 provides for an adjustment under Division 19 to be made in relation to an increasing adjustment the operator has had under section 79-55, where the amount of the excess payment has changed. This section is similar to section 78-42 that operates in relation to insurance policies. [Schedule 11, item 18, section 79-75]

6.56 Section 79-80 ensures that payments of an excess by an entity to an operator of a CTP scheme, are not treated as consideration for a supply made to the entity or to any other entity. This means that no taxable supply can arise for the entity making the excess payment. This section is similar to section 78-55 that operates in relation to insurance policies. [Schedule 11, item 18, section 79-80]

6.57 Section 79-85 ensures that the supply of goods is not a taxable supply if it is solely a supply made under a CTP scheme to an operator in the course of settling a claim for compensation under the scheme. If the supply of goods to the operator is only partly supplied in the course of settling a claim for compensation under the scheme, that part of the consideration that relates to the supply of the goods is disregarded in working out the value of the taxable supply. This section is similar to section 78-60 that operates in relation to insurance policies. [Schedule 11, item 18, section 79-85]

6.58 Section 79-90 deals with a payment or supply made in compliance with a judgment or court order relating to a claim for compensation under a CTP scheme or where the operator is exercising its rights of recovery in respect of a settlement made under the scheme. If in absence of the judgment or order, the payment or supply would have been a CTP compensation or ancillary payment or supply, the payment or supply is treated as having been a CTP compensation or ancillary payment or supply. This section is similar to section 78-110 which operates in respect of polices of insurance and claims for compensation under a statutory compensation scheme. [Schedule 11, item 18, section 79-90]

Subdivision 79-D

6.59 Subdivision 79-D sets out how an operator is to calculate its decreasing adjustment using the average input tax credit fraction. An operator that makes a CTP compensation or ancillary payment or supply, or a payment or supply in settlement of a claim under an insurance policy to which the election rules apply, will use the average input tax credit fraction in the calculation of any decreasing adjustment to which the operator is entitled. [Schedule 11, item 18, section 79-95]

6.60 There are a series of steps that an operator undertakes in order to calculate its decreasing adjustment. The first step is that the operator determines the payment or supply amount using the method statement set out in subsection 79-95(3). This method statement is similar to that used for determining the settlement amount under subsection 78-15(4) in relation to the settlement of a claim under an insurance policy. However, CTP ancillary payments or supplies are not subject to the grossing up in step 3 of the method statement as they are payments or supplies that are akin to acquisitions rather than settlement payments. [Schedule 11, item 18, subsection 79-95(3)]

6.61 Once the payment or supply amount is determined, the operator calculates the amount of the decreasing adjustment by applying the formula set out in subsection 79-95(2). This formula is similar to that within subsection 78-15(2) that operates in relation to the settlement of a claim under an insurance policy. [Schedule 11, item 18, subsection 79-95(2)]

6.62 The average input tax credit fraction that applies in the calculation of a decreasing adjustment in relation to a CTP compensation payment or supply, or the settlement of a claim under an insurance policy to which an election has been made, is the fraction that applies in the financial year in which the accident or other incident to which the claim relates happened. [Schedule 11, item 18, subsection 79-95(2)]

6.63 A reference to an accident or other incident, is a reference to the physical event that occurred which leads to the operator making payments or supplies in settlement of a claim. For instance, a collision between two vehicles is the accident or incident which will determine the relevant fraction to be used depending upon the financial year in which the accident or incident occurred.

Example 6.6

Jan has an accident in her motor vehicle on 7 January 2010. The relevant average input tax fraction applicable to the CTP scheme under which Jan is covered for the financial year commencing on 1 July 2009 is 30%. For the financial year commencing 1 July 2010, the fraction is changed to 40%.

LBK Pty Ltd, as the sole operator of the relevant CTP scheme, has made an election to apply the fraction to settlements of claims. No matter when LBK Pty Ltd makes a payment or supply in settlement of a claim made by Jan under her insurance policy, it will apply the 30% rate that is applicable to the financial year commencing 1 July 2009 in the calculation of its decreasing adjustments. This is because the 2009-2010 financial year is the year in which the accident occurred that led to the claim.

6.64 However, if the payment or supply is a CTP ancillary payment or supply, then the average input tax credit fraction that applies to the calculation of the decreasing adjustment is the fraction that applies in the financial year in which the payment is made. This is because a CTP ancillary payment or supply is not connected to a claim for compensation or a claim under an insurance policy, that is linked to a particular accident or incident. [Schedule 11, item 18, subsection 79-95(2)]

Meaning of average input tax credit fraction

6.65 The meaning of average input tax credit fraction is set out in section 79-100. The GST dictionary has also been amended to incorporate a reference to this definition. [Schedule 11, item 18, subsection 79-100(1); item 20, section 195-1]

6.66 The average input tax credit fraction that applies for the financial years beginning 1 July 2000, 1 July 2001 and 1 July 2002 is nil. This is because under section 23 of the GST Transition Act, no entity is entitled to claim an input tax credit for a premium or levy that relates to CTP cover commencing before 1 July 2003. [Schedule 11, item 18, subsection 79-100(1)]

6.67 Where an operator makes a payment or supply in settlement of a claim for compensation that is made in the years commencing 1 July 2000, 1 July 2001 and 1 July 2002, the operator should, subject to satisfying the tests in section 79-50, be entitled to a full decreasing adjustment. Where the operator makes a payment or supply that is a CTP ancillary payment or supply in those same years, it will be entitled to a full decreasing adjustment.

6.68 Where an operator makes an election under section 79-15 to apply the average input tax credit fraction to the calculation of decreasing adjustments, and the cover under the insurance policy commenced prior to 1 July 2003, the operator will be entitled to continue to claim a full decreasing adjustment for any payment or supply made in settlement of a claim under that policy. [Schedule 11, item 18, subsection 79-100(7)]

6.69 However, under section 22 of the GST Transition Act, an operator is not entitled to claim a decreasing adjustment for a payment or supply that is made in settlement of a claim under an insurance policy, or a claim for compensation, where the event giving rise to the claim happened before 1 July 2000. This is discussed further in relation to the amendment to the GST Transition Act.

6.70 For financial years other than those commencing 1 July 2000 to 1 July 2002 inclusive, the average input tax credit fraction is equivalent to the business vehicle use fraction as determined by the Treasurer. The business vehicle use fraction is defined in subsection 79-100(4). It is the business vehicle use expressed as a fraction of the total vehicle use in a State or Territory as determined from Australian Bureau of Statistics information. The use of Australian Bureau of Statistics information is discussed below. [Schedule 11, item 18, subsection 79-100(4)]

6.71 As soon as practical after the commencement of the provisions, the Treasurer will determine a business vehicle use fraction for each CTP scheme to apply from 1 July 2003. The Treasurer will use the Australian Bureau of Statistics Survey of Motor Vehicle Use data, covering the period 1 November 1999 to 31 October 2000, that was published on 27 June 2001. Any revision of the survey data is disregarded in making the determination, thus providing certainty for operators using a fraction that it will not change retrospectively. [Schedule 11, item 18, subsections 79-100(2) and 79-100(5)]

6.72 Following the initial determination made by the Treasurer, the Treasurer will review the fraction using the relevant Australian Bureau of Statistics data on a periodical basis. The first review will occur as soon as practical after the end of the 2006-2007 financial year. If there has been a significant change in the fraction when compared to the previous fraction, as determined by the Treasurer, the Treasurer will determine that a new fraction is to apply from the financial year immediately following the year in which the determination is made. If there has been no significant change, then the previous fraction continues to apply. [Schedule 11, item 18, subsection 79-100(3)]

6.73 Each determination made by the Treasurer is to be published in the Commonwealth of Australia Gazette. [Schedule 11, item 18, subsections 79-100(6)]

Determining the average input tax credit fraction

6.74 The average input tax credit fraction for each CTP scheme is represented by the total actual input tax credit entitlement for all of the eligible entities within the CTP scheme, expressed as a fraction of the total GST payable for the supply of CTP cover under the scheme. Assuming the information on actual input tax credits could be collected, the information required to determine the fraction would need to be collected over time and at some cost to the operator or operators of the scheme.

6.75 Each CTP scheme operates on a State or Territory wide basis. Each vehicle that is registered within a State or Territory must have CTP cover under the relevant scheme. Therefore, the vehicle population of the State or Territory will closely represent the vehicle population of the corresponding CTP scheme. While the actual average input tax credit entitlement for a particular scheme cannot easily be determined directly, it may be derived indirectly via an acceptable survey or sampling technique using the CTP vehicle population information. Any survey or sampling technique would need to be uniformly applied to all of the CTP schemes.

6.76 The Australian Bureau of Statistics has undertaken a Survey of Motor Vehicle Use for each State and Territory. The Australian Bureau of Statistics survey determined by way of sample, the number of kilometres travelled by vehicles within that State or Territory for business or private purposes. The Australian Bureau of Statistics survey was conducted on a uniform basis for all States and Territories.

6.77 An entity that is registered for GST maybe entitled to claim an input tax credit for the GST included in payment of a CTP premium to the extent that the entity acquires and applies the CTP cover in the course of carrying on their enterprise. Essentially, this means that the entity has used the vehicle to which the CTP cover relates, in the course of carrying on their business. Therefore, the total business kilometres travelled in a vehicle for business purposes, may approximate the extent that the vehicle is used in carrying on an entity's enterprise for GST purposes.

6.78 On a whole of State or Territory basis, the business kilometres travelled will approximate the extent of entitlement to claim input tax credits for the CTP premium under the CTP scheme for the State or Territory. The total kilometres travelled within a State or Territory will approximate the total GST payable on CTP premiums under the State or Territory CTP scheme. The business kilometres travelled, expressed as a percentage of total kilometres travelled, will equate to the average input tax credit entitlement of vehicle owners for that State or Territory CTP scheme. Thus, the Australian Bureau of Statistics survey data can be used in determining an approximation of the average input tax credit entitlement for each CTP scheme.

Division 80

6.79 Division 80 is inserted into the GST Act. This Division sets out the GST consequences for certain payments or supplies made by operators under CTP settlement sharing arrangements. Division 80 ensures that Divisions 78 and 79 apply to payments or supplies made in settlement of claims via the operation of settlement sharing arrangements. [Schedule 11, item 18, section 80-1]

Subdivision 80-A

6.80 Subdivision 80-A applies to settlement sharing arrangements where payments or supplies are made in settlement of a claim under an insurance policy. However, this does not extend to circumstances involving the sharing of the cost of creditable acquisitions made by an operator.

6.81 An insurance policy settlement sharing arrangement is an arrangement between the operators of a CTP scheme or schemes where settlements of claims are shared in relation to an accident or incident, and those operators have issued insurance policies to owners or drivers involved in the accident or incident. A CTP settlement sharing arrangement includes those arrangements that are contractual in nature, or are subject to an industry deed, or made under an Australian law governing a CTP scheme. The GST Dictionary has been amended to include a reference to the definition of an insurance policy settlement sharing arrangement, which has the meaning given in section 80-5. An insurance policy settlement sharing arrangement extends to arrangements that involve operators from different CTP schemes, such as when an operator in one State scheme is part of an arrangement in respect of a particular accident with an operator in a different State scheme. [Schedule 11, item 18, section 80-5; item 34, section 195-1]

6.82 A managing operator of a CTP scheme or schemes is an entity that makes payments or supplies in settlement of claims on behalf of itself and other operators under an insurance policy settlement sharing arrangement. The GST dictionary refers to the definition of managing operator as including the meaning given in paragraph 80-5(1)(c)(i). [Schedule 11, item 18, subparagraph 80-5(1)(c)(i); item 35, section 195-1]

6.83 A payment or supply made by a managing operator, if it is not a CTP ancillary payment or supply, is a managing operator's payment or supply. The GST dictionary refers to this term as having the meaning given in subsection 80-5(2). A managing operator's payment or supply does not include a CTP ancillary payment or supply, as the payments are not part of settlement payments or supplies. [Schedule 11, item 18, subsection 80-5(2); item 36, section 195-1]

6.84 A contributing operator of a CTP scheme or schemes is an operator that makes contributing payments to the managing operator in respect of settlements made by the managing operator. The GST dictionary refers to the definition of contributing operator as including the meaning given in subparagraph 80-5(1)(c)(ii). [Schedule 11, item 18, subparagraph 80-5(1)(c)(ii); item 23, section 195-1]

6.85 The payment made by a contributing operator is referred to as the contributing operator's payment . The GST dictionary refers to the definition of this term as including the meaning given in subsection 80-5(3). Any contribution payment made by a contributing operator is reduced by any fees paid, or payable, to the managing operator for managing settlements under an insurance policy settlement sharing arrangement. [Schedule 11, item 18, subsection 80-5(3); item 24, section 195-1]

6.86 Section 80-10 ensures that no taxable supply arises for entering into, or becoming party to an insurance policy settlement sharing arrangement, or becoming party to an industry deed for sharing purposes created by or under a State law or Territory law establishing a CTP scheme. State law or Territory law has the present meaning given in the GST dictionary. [Schedule 11, item 18, section 80-10]

6.87 Section 80-15 ensures that a contributing operator's payment is not treated as consideration for a supply by the managing operator, or for an acquisition by the contributing operator. This means that no taxable supply or creditable acquisition can arise for the contributing operator making payments that form part of the settlement amount of the managing operator. Payments made by a contributing operator to a managing operator that do not form part of the settlement amount may continue to be consideration for a supply made by the managing operator or an acquisition made by the contributing operator. [Schedule 11, item 18, section 80-15]

6.88 For the purposes of Divisions 78 and 79, if a managing operator issued one insurance policy that was subject to an insurance policy settlement sharing arrangement, the managing operator's payment or supply is treated as a payment or supply in settlement of a claim under the insurance policy issued by the managing operator. Insurance policy has the present meaning given in the GST dictionary. [Schedule 11, item 18, section 80-20]

Example 6.7

Katerina and Angela had a motor vehicle accident. Katerina had a CTP insurance policy with ABC Insurance Pty Ltd and Angela had a CTP insurance policy with XYZ Insurance. Katerina makes a claim against Angela and notifies XYZ Insurance of the claim.

Pursuant to an insurance policy settlement sharing arrangement, XYZ Insurance is appointed as the managing operator and makes a payment to settle the claim made by Katerina. The payment is treated as a payment made under the insurance policy issued by XYZ Insurance.

6.89 If a managing operator issued more than one insurance policy that is subject to an insurance policy settlement sharing arrangement that relates to a particular accident or incident, the payment or supply made by the managing operator is treated as a payment or supply in settlement of claims under those insurance policies. Where there is more than one insurance policy the payment or supplies made by the managing operator is allocated in equal proportions to each of the policies. [Schedule 11, item 18, section 80-20]

Example 6.8

Three vehicles are involved in an accident. One vehicle was driven by Georgi and another vehicle was driven by Katerina. Each had a policy of insurance with XYZ Insurance. The third vehicle was driven by Joe, who had a policy with LBK Pty Ltd. Katerina makes a claim for damages against Georgi for injuries sustained in the accident.

XYZ Insurance is appointed as managing operator under a settlement sharing arrangement with LBK Pty Ltd. XYZ Insurance makes a payment in settlement of Katerina's claim. The settlement payment is divided among the 2 insurance policies issued by XYZ Insurance in equal proportions.

Therefore, half of the payment is treated as being made in settlement of a claim under Katerina's insurance policy and the other half as being made in settlement of a claim under Georgi's insurance policy.

XYZ Insurance later shares the overall settlement amount with LBK Pty Ltd.

6.90 For the purposes of Divisions 78 and 79, if a contributing operator issued one insurance policy that was subject to a settlement sharing arrangement, then the contributing operator's payment is treated as a payment or supply in settlement of a claim under the insurance policy issued by the contributing operator. [Schedule 11, item 18, section 80-25]

6.91 If the contributing operator issued more than one insurance policy that is subject to a sharing arrangement that relates to a particular accident or incident, the contributing operator's payment is treated as a payment or supply in settlement of claims under those insurance policies. Where there is more than one insurance policy the contributing operator's payment will be allocated in equal proportions to each of the policies. [Schedule 11, item 18, section 80-25]

6.92 As a payment or supply made by a managing operator under an insurance policy settlement sharing arrangement is treated as a payment or supply in settlement of a claim under an insurance policy, the managing operator may be entitled to a decreasing adjustment for the payment or supply. The managing operator applies the relevant Division 78 or 79 rules to determine its entitlement to a decreasing adjustment relevant to its insurance policies subject to the sharing arrangement.

6.93 If the managing operator was entitled to a decreasing adjustment on the payment or supply it made in settlement of a claim under the sharing arrangement, it may have an increasing adjustment if it receives a payment from a contributing operator under that arrangement. [Schedule 11, item 18, section 80-30]

6.94 The managing operator calculates its increasing adjustment by determining the managing operator's settlement amount using the method statement set out in subsection 80-30(2) and then applying this amount to the formula in subsection 80-30(1). The method statement in subsection 80-30(2) is similar to that of subsections 78-15(4) and 79-95(3) concerning settlement of a claim under an insurance policy or for compensation respectively, but includes modifications for the purposes of Subdivision 80-A. [Schedule 11, item 18, section 80-30]

Example 6.9

An amount of $550 is paid by XYZ Insurance to settle a claim made by Katerina. Katerina selected the premium for the policy on the basis that she is not entitled to claim an input tax credit for the premium. XYZ Insurance is entitlement to a decreasing adjustment of $50, which is one eleventh of $550.

Under a sharing arrangement, ABC Insurance Pty Ltd is to contribute 50% of the settlement amount. ABC Insurance Pty Ltd makes a contributing payment to XYZ Insurance of $275. XYZ Insurance has an increasing adjustment of $25 under section 80-30, which is one eleventh of $275.

6.95 Section 80-35 provides that Division 19 applies in relation to an increasing adjustment that a managing operator has under section 80-30, to account for changes in payments between the operators under the sharing arrangement. [Schedule 11, item 18, section 80-35]

Subdivision 80-B

6.96 Subdivision 80-B applies similar rules to those set out in Subdivision 80-A concerning an insurance policy settlement sharing arrangement, to payments or supplies made under a nominal defendant settlement sharing arrangement.

6.97 A nominal defendant settlement sharing arrangement is an arrangement between the operators of a CTP scheme where the claim being settled is against a driver that is not covered under an insurance policy. For example, where a vehicle involved in an accident is uninsured. In some schemes, an entity referred to as a nominal defendant is responsible for the settlement of claims arising from the operation of uninsured vehicles. In New South Wales, claims made for payments of compensation against the Nominal Defendant are subject to sharing arrangements. The GST dictionary has been amended to refer to the definition of a nominal defendant settlement sharing arrangement, which has the meaning given in subsection 80-40(1). [Schedule 11, item 18, subsection 80-40(1); item 37, section 195-1]

6.98 The remaining provisions within subsection 80-40(1) in respect of a nominal defendant settlement sharing arrangement, are similar in nature to the provisions in subsection 80-5(1) in respect to an insurance policy settlement sharing arrangement, including similar definitions for managing operator, contributing operator, managing operator's payment or supply and contributing operator's payment. [Schedule 11, item 18, section 80-40]

6.99 Section 80-45 ensures that the rules within Subdivision 80-B apply only in relation to the sharing of a settlement of a claim because the driver involved was not covered by an insurance policy. If the accident or incident, that leads to a sharing arrangement, also involves drivers who are covered by insurance policies, then Subdivision 80-C concerning a hybrid settlement sharing arrangement applies. [Schedule 11, item 18, section 80-45]

6.100 Section 80-50 ensures that, despite section 9-5, no taxable supply arises for an entity entering into, or becoming a party to a nominal defendant settlement sharing arrangement, or becoming party to an industry deed for sharing purposes created by or under a State law or Territory law establishing a CTP scheme. This section is similar to section 80-10. [Schedule 11, item 18, section 80-50]

6.101 Section 80-55 has the same effect as section 80-15 in relation to an insurance policy settlement sharing arrangement. That is, the contributing operator's payment under a nominal defendant settlement sharing arrangement is not treated as consideration for a supply made by the managing operator, or for an acquisition made by the contributing operator. [Schedule 11, item 18, section 80-55]

6.102 For the purposes of Division 79, both a managing operator's payment or supply and a contributing operator's payment are treated as a CTP compensation payment or supply. A CTP compensation payment or supply is defined in subsection 79-35(2). [Schedule 11, item 18, sections 80-60 and 80-65]

6.103 Under section 80-70, the calculation of an increasing adjustment that a managing operator has as the result of payments it receives from contributing operators under a nominal defendant settlement sharing arrangement, is undertaken in a similar way to the calculation for a managing operator under an insurance policy settlement sharing arrangement to which section 80-30 applies. [Schedule 11, item 18, section 80-70]

6.104 Section 80-75 provides that Division 19 applies in relation to an increasing adjustment that a managing operator has under section 80-70, to account for changes in the payments between the parties under the nominal defendant settlement sharing arrangement. This section has similar application to that of section 80-35 concerning an insurance policy settlement sharing arrangement. [Schedule 11, item 18, section 80-75]

Subdivision 80-C

6.105 Subdivision 80-C extends Subdivisions 80-A and 80-B to apply to payments or supplies made under a hybrid settlement sharing arrangement. A hybrid settlement sharing arrangement is defined within subsection 80-80(1) and the GST dictionary has been amended to make reference to that definition. [Schedule 11, item 18, subsection 80-80(1); item 31, section 195-1]

6.106 A hybrid settlement sharing arrangement has elements of both an insurance policy settlement sharing arrangement and a nominal defendant settlement sharing arrangement. This will involve the sharing of payments or supplies that are made by an operator in settlement of a claim arising from an accident involving a combination of a driver, or owner, of a vehicle that is not covered by an insurance policy, and a driver, or owner, of a vehicle that is covered by an insurance policy. A hybrid settlement sharing arrangement extends to arrangements that involve operators from different CTP schemes, such as when an operator in a State scheme is part of an arrangement in respect of a particular accident with an operator of a different State scheme. [Schedule 11, item 18, subsection 80-80(1)]

6.107 The remaining provisions within section 80-80 concerning a hybrid settlement sharing arrangement are similar to the provisions in sections 80-5 and 80-40 that apply in relation to an insurance policy settlement sharing arrangement and a nominal defendant settlement sharing arrangement. This includes similar definitions for managing operator, contributing operator, managing operator's payment or supply and contributing operator's payment. [Schedule 11, item 18, section 80-80]

6.108 Where an accident or incident invokes a hybrid settlement sharing arrangement, the arrangement is initially treated as an insurance policy settlement sharing arrangement to which the rules in Subdivision 80-A apply. This permits the operator representing the uninsured owner or driver, to be treated for the purposes of the sharing arrangement, as though it held an insurance policy for that driver or owner. As a result, the operator is able to determine the amount of the payment it has to make under the insurance policy settlement sharing arrangement. Once that amount is determined, the operator shares the amount under a nominal defendant settlement sharing arrangement. [Schedule 11, item 18, section 80-85]

6.109 Section 80-90 applies in the circumstances where an entity is simultaneously the managing operator of a hybrid settlement sharing arrangement and the managing operator of a nominal defendant settlement sharing arrangement. In this situation, the entity responsible for the driver or owner who was not covered by an insurance policy, acts as the managing operator for the insurance policy settlement sharing arrangement. In practice, this means that the operator will settle any claims arising from the accident or incident, and then collect payments from other contributing operators that had drivers or owners involved in the accident and are therefore subject to the sharing arrangement. The operator will then share the net payment with other operators under a nominal defendant settlement sharing arrangement. [Schedule 11, item 18, section 80-90]

6.110 Section 80-95 deals with the reverse situation to which section 80-90 applies. The operator responsible for the driver or owner that was not covered by an insurance policy acts as a contributing operator under an insurance policy settlement sharing arrangement, and then shares the amount it has paid under that arrangement under a nominal defendant settlement sharing arrangement. [Schedule 11, item 18, section 80-95]

6.111 It does not matter whether the operator representing the uninsured driver or owner is required to be the managing operator or a contributing operator under a hybrid settlement sharing arrangement, it will always determine the amount paid, or net payment, under the insurance policy settlement sharing arrangement before it shares the amount under a nominal defendant settlement sharing arrangement.

Example 6.10

Greg, Dan and Sam had a motor vehicle accident. Greg has a CTP insurance policy with XYZ Insurance and Dan has a CTP insurance policy with ABC Insurance Pty Ltd. Sam was driving a vehicle that was not covered by an insurance policy. Under the CTP scheme, LBK Pty Ltd is appointed as the representative of the driver without an insurance policy. All the operators are subject to a settlement sharing arrangement. Dan makes a claim against Greg and notifies XYZ Insurance of the claim.

LBK Pty Ltd is contributing operator

XYZ Insurance is appointed as the managing operator for the purposes of the hybrid settlement sharing arrangement.

XYZ Insurance accept the claim made by Dan and make a payment in settlement of the claim. Subject to the rules in Subdivision 80-A, the payment is a managing operator's payment or supply. Having determined that it is entitled to do so, XYZ Insurance claims a decreasing adjustment using Greg's input tax credit entitlement information, in relation to the settlement.

XYZ Insurance receives a payment representing one third of the settlement amount from each of ABC Insurance Pty Ltd and LBK Pty Ltd. XYZ Insurance has an increasing adjustment in relation to those payments, calculated in accordance with section 80-30.

ABC Insurance Pty Ltd and LBK Pty Ltd each determine that they are entitled to a decreasing adjustment in relation to the contributing operator's payment they have made to XYZ Insurance as the managing operator. ABC Insurance Pty Ltd calculates its decreasing adjustment using Dan's input tax credit entitlement information. LBK Pty Ltd applies the average input tax credit fraction for the CTP scheme to its calculation of the decreasing adjustment.

LBK Pty Ltd will now, subject to the rules in Subdivision 80-B, share the payment it made to XYZ Insurance, with all of the operators within the CTP scheme that are subject to a nominal defendant settlement sharing arrangement. For each payment LBK Pty Ltd receives from another operator, it will have an increasing adjustment calculated in accordance with section 80-70.

LBK Pty Ltd is managing operator

If LBK Pty Ltd had been the managing operator for the hybrid settlement sharing arrangement, it would settle the claim made by Dan and claim a decreasing adjustment in relation to the settlement payment. LBK Pty Ltd would use the average input tax credit fraction for the CTP scheme in the calculation of its decreasing adjustment.

Applying the rules under Subdivision 80-A, LBK Pty Ltd would have an increasing adjustment for each contributing operator's payment received from XYZ Insurance and ABC Insurance Pty Ltd. The increasing adjustments are calculated in accordance with section 80-30.

The net amount that LBK Pty Ltd has paid as managing operator of the hybrid settlement sharing arrangement, is subject to the rules under Subdivision 80-B, shared with all of the operators that are subject to a nominal defendant settlement sharing arrangement. LBK Pty Ltd will have an increasing adjustment calculated in accordance with section 80-70 for each amount it receives from a contributing operator.

Miscellaneous

6.112 Division 72 concerns the application of GST to supplies made between associates that are made for no consideration or for inadequate consideration. Subsection 72-5(3) operates to exclude from the operation of Division 72, a supply that is constituted by an insured entity settling a claim under an insurance policy. Subsection 72-40(3) operates so that an acquisition that is made for no consideration from an associate is not prevented from being a creditable acquisition. Subsections 72-5(3) and 72-40(3) are amended so that they apply to the relevant payments or supplies made under CTP schemes. [Schedule 11, item 12, subsection 72-5(3); item 13, subsection 72-40(3)]

6.113 Section 188-22 ensures that in working out an entity's current annual turnover or projected annual turnover, the entity disregards any supply it has made to the extent that the consideration for the supply is a payment or supply in settlement of a claim under an insurance policy. This section has been amended to extend its application to payments or supplies that are a CTP dual premium or election payment or supply, CTP hybrid payment or supply or a CTP compensation or ancillary payment or supply. [Schedule 11, item 19, paragraph 188-22(a)]

6.114 Section 9-39 is amended to include item 3A to acknowledge Division 79 and to include item 8B to acknowledge Division 80 in the table of special rules relating to taxable supplies. [Schedule 11, item 1, section 9-39; item 2, section 9-39]

6.115 Section 9-99 is amended to include item 2A to acknowledge Division 79 in the table of special rules relating to the amount of GST on taxable supplies. [Schedule 11, item 3, section 9-99]

6.116 Section 11-99 is amended to include item 2A to acknowledge Division 79 and to include item 15 to acknowledge Division 80 in the table of special rules relating to acquisitions. [Schedule 11, item 4, section 11-99; item 5, section 11-99]

6.117 Section 17-99 is amended to include item 4AA to acknowledge Division 79 and to include item 12AA to acknowledge Division 80 in the table of special rules relating to net amounts or adjustments. [Schedule 11, item 6, section 17-99; item 7, section 17-99]

6.118 Section 19-99 is amended to include item 1AA to acknowledge Division 79 and to include item 3 to acknowledge Division 80 in the table of special rules relating to adjustment events. [Schedule 11, item 8, section 19-99; item 9, section 19-99]

6.119 Section 37-1 is amended to include item 8A to acknowledge Division 79 and to include item 29AA to acknowledge Division 80 in the check list of special rules. [Schedule 11, item 10, section 37-1; item 11, section 37-1]

6.120 A note has been placed within section 78-1 to signpost the existence of Divisions 79 and 80. [Schedule 11, item 14, section 78-1]

6.121 The GST dictionary has been amended to update the note to the definition of consideration to include a reference to those sections in Divisions 79 and 80 that affect the meaning of consideration. [Schedule 11, item 22, section 195-1]

6.122 The GST dictionary has been amended to update the definition of decreasing adjustment to include reference to adjustments arising under or in connection with Subdivisions 79-A, 79-B and Division 80. [Schedule 11, item 32, section 195-1]

6.123 The GST dictionary has been amended to update the definition of increasing adjustment to include reference to adjustments arising under or in connection with Subdivisions 79-A, 79-B and Division 80. [Schedule 11, item 33, section 195-1]

6.124 The GST dictionary has been amended to update the note to the definition of taxable supply to include a reference to those sections in Divisions 79 and 80 that affect the meaning of taxable supply. [Schedule 11, item 40, section 195-1]

6.125 The GST dictionary has been amended to update the note to the definition of value to include a reference to those sections in Division 79 that affect the meaning of value. [Schedule 11, item 41, section 195-1]

GST Transition Act

6.126 Under section 22 of GST Transition Act, the settlement of a claim does not give rise to an adjustment and is not a taxable supply under Division 78 of the GST Act to the extent that the event giving rise to the claim happened before 1 July 2000. Subsection 22 is amended so that it will apply in the same way to payments or supplies made in settlement of a claim to which Division 79 or 80 applies. [Schedule 11, item 42, section 22]

Application and transitional provisions

6.127 The amendments apply, and are taken to applied, in relation to the net amounts for tax periods starting on or after 1 July 2000. The application date ensures that operators in a CTP scheme are entitled to appropriate decreasing adjustments from 1 July 2000. [Schedule 11, item 43]

Chapter 7 Register of harm prevention charities

Outline of chapter

7.1 Schedule 12 to this bill amends the ITAA 1997 to establish a new category of DGR, namely, a register of harm prevention charities. Harm prevention charities are charitable institutions whose principal activity is to promote the prevention or the control of behaviour that is harmful or abusive to human beings.

Context of amendments

7.2 The income tax law allows taxpayers to claim income tax deductions for certain gifts to DGRs. To be a DGR, an organisation must fall within a category of organisations set out in Division 30 of the ITAA 1997 (or be listed specifically under that Division).

7.3 The categories include organisations on the register of environmental organisations and organisations on the register of cultural organisations.

7.4 The new register is part of the Government's response to the Report of the Inquiry into the Definition of Charities and Related Organisations. The Treasurer announced the response on 29 August 2002 (Treasurer's Press Release No. 49).

7.5 The register consists of charitable institutions whose principal activity is to promote the prevention or the control of behaviour that is harmful or abusive to human beings. The amendment will assist these institutions to attract public support for their activities.

Summary of new law

7.6 A register of harm prevention charities will be established for charitable institutions whose principal activity is to promote the prevention or the control of behaviour that is harmful or abusive to human beings.

7.7 Harm prevention charities will be entered on the register by direction of the Treasurer and the Minister for Family and Community Services. The register will be kept by the Secretary of the Department of Family and Community Services.

7.8 Institutions on the register will be entitled to apply for endorsement as DGRs.

7.9 The amendments apply to gifts made on or after 1 July 2003.

Detailed explanation of new law

7.10 Section 30-15 of the ITAA 1997 allows a deduction for certain types of gifts or contributions made to particular recipients.

7.11 Item 1 in the table to subsection 30-15(1) provides that certain gifts made to a fund, authority or institution covered by Subdivision 30-B of the ITAA 1997 are deductible, provided certain conditions are met. A special condition under item 1 is that the fund, authority or institution must meet the requirements of section 30-17 (unless it is mentioned by name under Subdivision 30-B). Section 30-17 includes a requirement for a fund, authority or institution to be endorsed by the Commissioner in order to obtain DGR status.

7.12 Subdivision 30-B is amended to include public funds that are on the register of harm prevention charities. These public funds are inserted in the table of general categories of welfare and rights recipients at item 4.1.4 in subsection 30-45(1). [Schedule 12, item 3, subsection 30-45(1)]

7.13 A Subdivision is inserted, as Subdivision 30-EA, to provide for the register. [Schedule 12, item 4, Subdivision 30-EA]

Register of harm prevention charities

7.14 The Secretary of the Department of Family and Community Services will be required to keep the register. [Schedule 12, item 4, section 30-287]

Entering harm prevention charities on the register

7.15 The Secretary will be required to enter on the register each harm prevention charity, and the public fund it maintains, that the Secretary has been directed to enter by the Treasurer and the Minister for Family and Community Services. [Schedule 12, item 4, subsection 30-289B(1)]

7.16 The Treasurer and the Minister may so direct the Secretary only if the Minister has notified the Treasurer in writing that the Minister is satisfied that an institution is a harm prevention charity. [Schedule 12, item 4, subsection 30-289B(2)]

7.17 The direction must be in writing and must specify the day on which the charity and public fund are to be entered on the register. The day must be the day on which the direction is given or a later day. [Schedule 12, item 4, subsection 30-289B(3)]

7.18 The Treasurer and the Minister must have regard to the policies and budgetary priorities of the Commonwealth Government in deciding whether to give a direction. [Schedule 12, item 4, subsection 30-289B(4)]

Removing harm prevention charities from the register

7.19 The Treasurer and the Minister for Family and Community Services may direct the Secretary of the Department of Family and Community Services to remove a harm prevention charity, and the public fund it maintains, from the register. [Schedule 12, item 4, subsection 30-289C(1)]

7.20 The direction must be in writing and must specify the day on which the charity and public fund are to be removed from the register. The day must be the day on which the direction is given or a later day. [Schedule 12, item 4, subsection 30-289C(2)]

Harm prevention charities

7.21 A harm prevention charity must be a charitable institution that is endorsed as exempt from tax under Subdivision 50-B. [Schedule 12, items 4 and 7, section 30-288 and definition of 'harm prevention charities' in subsection 995-1(1)]

7.22 A charitable institution is a charity that is an institution.

7.23 The criteria to decide whether or not an entity is a charity are established in common law. A charity is an entity established for charitable purposes. Charitable purposes are the relief of poverty, the relief of the needs of the aged, the relief of sickness or distress, the advancement of religion, the advancement of education and other purposes beneficial to the community.

7.24 Whether an entity has the character of an institution will depend on a range of features including its activities, size, permanence, purposes and recognition. Incorporation is not enough, on its own, to show that an entity is an institution. A charitable institution would not usually include an entity that is established, controlled and operated by family members and friends.

7.25 In order for an institution to be a harm prevention charity, the principal activity of the institution must be the promotion of the prevention or the control of behaviour that is harmful or abusive to human beings. [Schedule 12, item 4, section 30-288, subsection 30-289(1)]

7.26 'Behaviour that is harmful or abusive' means one or more of the following:

•

emotional abuse;

•

sexual abuse;

•

physical abuse;

•

suicide;

•

self-harm;

•

substance abuse;

•

harmful gambling.

[Schedule 12, item 6, definition of 'behaviour that is harmful or abusive' in subsection 995-1(1)]

7.27 A harm prevention charity must maintain a public fund. Gifts of money or property for its principal activity are to be made to the fund, and any money received because of such gifts is to be credited to the fund. The fund is not to receive any other money or property. [Schedule 12, item 4, section 30-288, subsection 30-289(2)]

7.28 It must use gifts made to the fund, and any money received because of such gifts, only for its principal activity. [Schedule 12, item 4, section 30-288, subsection 30-289(3)]

7.29 It must have agreed to comply with any rules that the Treasurer and the Minister for Family and Community Services make to ensure that gifts made to the fund are used only for its principal activity. [Schedule 12, item 4, section 30-288, subsection 30-289(4)]

7.30 A harm prevention charity must have a policy of not acting as a mere conduit for the donation of money or property to other organisations, bodies or persons. [Schedule 12, item 4, section 30-288, subsection 30-289A(1)]

7.31 It must have rules providing that, if the public fund is wound up, any surplus assets of the fund are to be transferred to another fund that is on the register. [Schedule 12, item 4, section 30-288, subsection 30-289A(2)]

7.32 A harm prevention charity must have agreed to give the Secretary of the Department of Family and Community Services, within a reasonable period after the end of each income year, statistical information about gifts made to the public fund during that income year. [Schedule 12, item 4, section 30-288, subsection 30-289A(3)]

Consequential amendments

7.33 Section 30-5 provides a guide for navigating Division 30. Subsection 30-5(5) is amended as a result of the insertion of the provision for the register of harm prevention charities in Subdivision 30-EA. [Schedule 12, items 1 and 2, subsection 30-5(5)]

7.34 Section 30-315 of the ITAA 1997 contains an index to Division 30. The table in subsection 30-315(2) is amended as a result of the inclusion of harm prevention charities in Subdivision 30-B. [Schedule 12, item 2, subsection 30-315(2)]

Application and transitional provisions

7.35 The amendments apply to gifts made on or after 1 July 2003. [Schedule 12, item 3, subsection 30-45(1)]

Index

Schedule 1: Medicare levy and Medicare levy surcharge low income thresholds

Schedule 2: Value shifting: transitional exclusion for certain indirect value shifts relating mainly to services

Schedule 3: Consolidation: treatment of linked assets and liabilities

Schedule 4: Consolidation: partnerships

Schedule 5: Consolidation: transitional foreign-held membership structures

Schedule 6: Consolidation: application of rules to MEC groups

Schedule 7: Consolidation: general application provision

Schedule 8: Technical corrections

Schedule 9: Release from particular liabilities in cases of serious hardship

Schedule 10: Trans-Tasman triangular imputation

Schedule 11: GST amendments relating to compulsory third party schemes

Schedule 12: New deductible gift recipient category