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

Second World War payments

Schedule 1 to this bill amends the income tax law to provide income tax and CGT exemptions for payments relating to persecution suffered and loss of, or damage to, property during the Second World War.

Date of effect: The amendments apply to assessments for the 2001-2002 income year and later years.

Proposal announced: The amendments were announced in the 2003-2004 Federal Budget and in Minister for Revenue and Assistant Treasurer's Press Release No. C37/03 of 13 May 2003.

Financial impact: The revenue cost of this measure is unable to be quantified but is expected to be insignificant.

Compliance cost impact: Nil.

Gifts and covenants

Schedule 2 to this bill amends the ITAA 1997 to update the lists of specifically-listed DGRs.

Schedule 3 to this bill amends the ITAA 1997 from 1 July 2003:

•

to simplify the listing in the tax law of specifically-listed DGRs; and

•

to allow deductions for cash donations to DGRs to be spread over a period of up to 5 years.

Date of effect

Deductions for gifts to specifically-listed DGRs under Schedule 2

•

the Australian Literacy and Numeracy Foundation Limited from 11 October 2002;

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Crime Stoppers Western Australia Limited from 31 October 2002;

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New South Wales Crime Stoppers Limited from 31 October 2002;

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Crime Stoppers Tasmania from 28 November 2002;

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Crime Stoppers Queensland Limited from 23 January 2003;

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the Australian-American Educational Foundation from 30 April 2003;

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Crime Stoppers Australia Limited from 4 June 2003; and

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the Alcohol Education and Rehabilitation Foundation Limited from 5 June 2003.

Schedule 2 also limits deductions for gifts to the Stolen Children's Support Fund to gifts made before 4 February 2003 (when the dissolution of the fund was confirmed).

The amendments under Schedule 3 apply to gifts made and covenants entered into on or after 1 July 2003.

Proposal announced: The new specifically-listed DGRs contained in Schedule 2 were announced by the Minister for Revenue and Assistant Treasurer in press releases during 2002 and 2003. The measure in Schedule 3 to simplify the listing in the tax law of specifically-listed DGRs was announced in Treasurer's Press Release No. 49 of 29 August 2002. The measure in Schedule 3 to allow deductions for cash donations to DGRs to be spread over a period of up to 5 years was announced in Prime Minister's Press Release of 11 December 2002.

Financial impact: The amendments in Schedule 2 have an unquantifiable, but insubstantial, cost to revenue. The measure in Schedule 3 to simplify the listing in the tax law of specifically-listed DGRs involves no cost to revenue. The measure in Schedule 3 to allow deductions for cash donations to DGRs to be spread over a period of up to 5 years involves a cost to revenue of $1 million in 2005-2006.

Compliance cost impact: Nil.

Amendment of the Crimes (Taxation Offences) Act 1980

Schedule 4 to this bill amends the Crimes (Taxation Offences) Act 1980 to correct a technical deficiency with the deeming mechanism in the Act, and to include Criminal Code harmonisation amendments to clarify the interpretation of offences under the Criminal Code.

Date of effect: These amendments will apply from the day following Royal Assent.

Proposal announced: These amendments have not previously been announced.

Financial impact: Nil.

Compliance cost impact: Nil.

Consolidation: transitional foreign loss makers

Schedule 5 to this bill makes amendments to the IT(TP) Act 1997 to allow certain entities with foreign losses to be excluded from a consolidated group for a transitional period.

Date of effect: 1 July 2002.

Proposal announced: This measure was announced on 27 November 2002 in the Mid-Year Economic and Fiscal Outlook 2002-2003.

Financial impact: This measure essentially allows entities with foreign losses to maintain their existing tax treatment for a transitional period. The revenue impact is therefore not expected to be significant.

Compliance cost impact: This measure is not expected to impact significantly on compliance costs as it essentially allows entities with foreign losses to maintain their existing tax treatment for a transitional period.

Goods and services tax: interaction with consolidation regime

Schedule 6 to this bill amends the GST Act to ensure that certain supplies made as a result of the consolidation regime, specifically those made as a result of:

•

the statutory operation of the consolidation provisions;

•

entering into a tax sharing agreement;

•

leaving a consolidated group clear of group liability; or

•

entering into a tax funding agreement,

will not be taxable supplies.

Date of effect: The amendments apply, and are taken to have applied, in relation to net amounts for tax periods starting or that started on or after 1 July 2002.

Proposal announced: Not previously announced.

Financial impact: Nil.

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

Imputation for life insurance companies

Schedule 7 to this bill amends the ITAA 1997 to include imputation rules for life insurance companies. The rules generally replicate the former imputation rules that applied to life insurance companies in Part IIIAA of the ITAA 1936. Broadly, the provisions set out the circumstances when franking credits and debits arise in franking accounts of life insurance companies, complementing the core SIS rules already introduced into the ITAA 1997.

Date of effect: 1 July 2002.

Proposal announced: The proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 as a component of the unified entity regime. On 14 May 2002, the Minister for Revenue and Assistant Treasurer announced in Press Release No. C57/02, the Government's program for delivering the next stage of business tax reform measures. In that press release, the Minister confirmed that the simplified imputation system will commence on 1 July 2002.

Financial impact: The financial impact of the amendments is expected to be negligible.

Compliance cost impact: The new amendments are designed to reduce compliance costs incurred by business by providing for simpler processes and increased flexibility.

Overseas forces tax offsets

Schedule 8 to this bill amends the overseas forces tax offset provisions of the ITAA 1936 to exclude periods of service for which an income tax exemption for foreign employment income is available.

Date of effect: The amendments will apply from 1 July 2001.

Proposal announced: The measures were announced on 22 May 2001 in the 2001-2002 Federal Budget and in former Assistant Treasurer's Press Release No. 28 of 28 June 2001.

Financial impact: Negligible.

Compliance cost impact: Nil.

Roll-over for financial services reform transitions

Schedule 9 to this bill amends the ITAA 1997 to provide an automatic CGT roll-over for financial service providers on transition to the FSR regime when, during the FSR transitional period:

•

an existing statutory licence, registration or authority is replaced with an Australian financial services licence;

•

a qualified Australian financial services licence is replaced with an Australian financial services licence; and

•

an intangible CGT asset is replaced with another intangible CGT asset.

The CGT roll-over will ensure that the capital gain or capital loss that would otherwise be made when the original asset comes to an end is deferred until a CGT event happens to the replacement asset.

Date of effect: The CGT roll-over will apply to CGT events that happen during the FSR transitional period (i.e. from 11 March 2002 to 10 March 2004 inclusive).

Proposal announced: The measure was announced in Minister for Revenue and Assistant Treasurer's Press Release No. C10/03 of 21 February 2003.

Financial impact: The measure is expected to result in a small revenue deferral.

Compliance cost impact: The measure is being introduced to assist the transition to the FSR regime and will result in minimal additional compliance costs.

Foreign hybrid

Schedule 10 to this bill amends the ITAA 1936 and the ITAA 1997 to treat foreign hybrids as partnerships for all purposes of the income tax law. Foreign hybrid is defined to include limited partnerships, limited liability companies in the USA and other similar entities that are taxed on a partnership basis in their country of formation. However, limited partners will only be able to claim losses of the foreign hybrid to the extent of their exposure to economic loss through the foreign hybrid.

Certain foreign hybrids will be excluded from this treatment where they:

•

are residents of Australia; or

•

in general, where they would otherwise be dealt with under the FIF regime and not the CFC regime.

Other amendments will be made to allow deductions or tax credits to be claimed for Australian or foreign taxes paid by the investors on income that is attributed to them under the CFC or FIF provisions, for a limited number of years. Amendments will also be made to provide greater certainty as to the foreign hybrid's country of residence for CFC purposes for those same years.

Date of effect: This measure will apply from the start of the 2003-2004 income year, with taxpayers having an option to apply the amendments from the start of the 2002-2003 income year. The amendments providing double tax relief will apply, in general, to income years for which amended assessments can still be made.

Proposal announced: This measure was announced in Minister for Revenue and Assistant Treasurer's Press Release No. C26/03 of 8 April 2003.

Financial impact: There are minimal costs associated with these amendments because they do not alter the income that would have otherwise been attributed under the CFC rules.

Compliance cost impact: Compliance costs will be reduced in certain areas (e.g. application of the CFC rules), but be increased in others. The CGT rules as they apply to partnerships will impose greater compliance costs than current treatment under the CGT rules.

Summary of regulation impact statement

Regulation impact on business

Impact: These measures will have a minimal net impact, mainly on large businesses which invest in these foreign hybrids, but have been introduced to improve global competitiveness, provide certainty to taxpayers and consistency in compliance. There is no evidence to suggest that the measure will have a noticeable impact on small business.

Main points:

•

The amendments will apply to taxpayers with interests in non-resident limited partnerships (and other foreign hybrids such as US LLCs). Taxpayers will be treated as having a partnership interest where they have an interest in a foreign hybrid.

•

These amendments:

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address business concerns avoiding the unintended consequences;

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provide clear rules increasing certainty about the operation of the law;

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meet the policy intent of the anti-deferral measures (CFC and FIF measures); and

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promote a consistent method of compliance.

Technical amendments

Schedule 11 to this bill makes a number of technical amendments to the ITAA 1936, the ITAA 1997 and other tax-related legislation.

Date of effect: The amendments have various dates of effect. The amendments are of a minor or machinery of government nature and do not substantially alter existing arrangements. They do not affect the rights or liabilities of taxpayers.

Proposal announced: Not previously announced.

Financial impact: Nil.

Compliance cost impact: Nil.

Chapter 1 - Second World War payments

Outline of chapter

1.1 Schedule 1 to this bill amends the ITAA 1936 and the ITAA 1997 to extend the current income tax and CGT exemptions for certain Second World War payments to payments relating to persecution suffered or property lost during the Second World War.

1.2 For the purposes of this chapter:

•

payments for any wrong or injury or for any other detriment are referred to as payments for persecution suffered during the Second World War;

•

payments for any loss of, or damage to, property are referred to as payments for property lost during the Second World War; and

•

an Australian resident individual, the individual's legal personal representative or a trustee of a deceased estate (including a corporate trustee) who is eligible for, and receives a payment in connection with persecution suffered or property lost during the Second World War from, a foreign Second World War fund is referred to as the 'eligible claimant'.

Context of amendments

1.3 A number of foreign funds are making payments relating to persecution suffered or property lost during the Second World War to victims of the Second World War or to the deceased victims' surviving relatives, descendants or beneficiaries named in a will. The payments may be income or capital in nature. Under current tax law some of these payments are subject to income tax or to CGT.

1.4 Examples of the foreign Second World War funds are provided in paragraph 1.20.

Summary of new law

1.5 The amendments extend the current income tax exemption for certain foreign pensions, annuities and allowances relating to the Second World War to payments of an income nature in connection with persecution suffered or property lost during the Second World War that are received by an eligible claimant from a foreign Second World War fund.

1.6 The amendments also extend the current CGT exemption for certain capital payments relating to the Second World War to payments of a capital nature in connection with persecution suffered or property lost during the Second World War that are received by an eligible claimant from a foreign Second World War fund.

Comparison of key features of new law and current law

Detailed explanation of new law

Income tax exemption

1.7 A payment of an income nature received by an eligible claimant from a foreign fund in connection with persecution suffered or property lost during the Second World War is exempt from income tax. [Schedule 1, item 1, section 23AL]

CGT exemption

1.8 A payment of a capital nature, or property, received by an eligible claimant from a foreign fund in connection with persecution suffered or property lost during the Second World War is exempt from CGT. [Schedule 1, item 3, subsection 118-37(5)]

Eligible claimants

1.9 Each of the foreign Second World War funds has its own eligibility criteria to determine who is eligible for a payment in connection with persecution suffered or property lost during the Second World War. The funds make the payments to the Second World War victim in the first instance.

1.10 Where the Second World War victim has died, some of the funds make the payments to the deceased victim's surviving relatives or descendants, for example the deceased victim's spouse or children, or to a beneficiary named in a will. Some of the funds make the payments to the victim's legal personal representative, for example, the trustee of the deceased victim's estate.

1.11 The payments from a foreign Second World War fund are exempt from income tax or CGT when they are paid to the eligible claimant.

1.12 An eligible claimant includes:

•

the Second World War victim;

•

the victim's legal personal representative;

•

a deceased victim's surviving relatives, descendants or beneficiaries named in a will;

•

the executor, administrator or trustee of a deceased victim's estate; and

•

the trustee of a trust established by the will of a deceased victim.

Nature of payments

1.13 The various foreign Second World War funds describe their payments in connection with persecution suffered or property lost during the Second World War as compensation, restitution or reparation. For the purposes of this chapter all such payments are generally referred to as compensation.

1.14 The payments may be of an income nature, such as:

•

a pension, annuity or allowance;

•

a regular payment (e.g. monthly);

•

interest or compensation for lost interest; or

•

compensation for lost rent, earnings or profits.

1.15 The payments may be of a capital nature, for example, a lump sum payment as compensation for lost property. A lump sum payment includes interim payments or instalment payments of the final entitlement.

1.16 In very limited circumstances a payment of a capital nature may be restitution of the lost property itself, for example, the return of a stolen work of art.

1.17 The CGT exemption applies only to the receipt of the capital payment or property. The exemption does not apply to any capital gains on the later disposal of the property.

Foreign Second World War funds

1.18 For the income tax or CGT exemption to apply, the payments in connection with persecution suffered or property lost during the Second World War must be received from a source in a foreign country.

1.19 The source of the payments include (but are not limited to):

•

a fund established in a foreign country by a foreign government or whose payments are made under a law of a foreign government;

•

a fund established in a foreign country by a foreign legal settlement; or

•

a fund established in a foreign country by a foreign business or a group of foreign businesses or industries.

1.20 Examples of foreign Second World War funds include (but are not limited to):

•

Commission de dédommagement de la Communauté juive de Belgique (Indemnification Commission for the Belgian Jewish Community's Assets), a Belgian fund established to compensate Jewish victims for assets plundered, surrendered or abandoned during the Second World War;

•

Stichting Maror-gelden Overheid (the Maror fund), a Dutch fund established to compensate Jewish victims for persecution suffered or property lost during the Second World War;

•

Réparation pour les orphelins dont les parents ont été déportés (Compensation for Orphans of Deported Parents), a French fund which makes payments to orphans whose parents were deported from France during the Second World War;

•

Commission pour l'indemnisation des victimes de spoliations intervenues du fait des législations antisémites en vigueur pendant l'Occupation, (Compensation of Victims of Financial Spoliation), a French fund established to compensate victims and their families for property loss resulting from anti-semitic legislation in force during the Occupation;

•

Holocaust Victim Assets Litigation (Swiss Banks), a legal settlement intended to resolve Holocaust-related bank claims; and

•

International Commission on Holocaust Era Insurance Claims (ICHEIC), a commission established to resolve Holocaust-related insurance claims.

Reasons for payments

1.21 Each of the foreign Second World War funds has its own criteria to determine what the payment in connection with persecution suffered or property lost during the Second World War is for.

1.22 Payments for any wrong or injury include payments for:

•

persecution on the basis of religion, race, physical or mental disabilities or sexual orientation;

•

involuntarily performing work for little or no pay (e.g. slave or forced labourers);

•

being refused entry into, or deported from, another country;

•

the deportation of a child's parents; or

•

an illness, injury or disability suffered as a result of persecution, participation in a resistance movement, slave or forced labour, or internment in a concentration camp.

1.23 Payments for any loss of, or damage to, property include payments for:

•

property confiscated, stolen, looted, hidden or otherwise lost;

•

real estate (e.g. residences, business premises, commercial property and agricultural land);

•

businesses, including business assets;

•

financial assets, including money, bank deposits, safety deposit box contents and securities;

•

moveable assets, such as gold or other precious metals, works of art, and cultural property; and

•

personal effects, such as furniture, antiques and jewellery.

1.24 Payments for any other detriment is intended to include payments which do not fall into either the wrong or injury category or the property damage or loss category. This could include, for example, a payment for unpaid insurance policies.

Second World War

1.25 For the purposes of this provision, the following terms used in connection with the Second World War apply.

1.26 The National Socialist period means the period beginning on 30 January 1933 (the date of Hitler's appointment as Chancellor) and ending at the end of the Second World War in Europe (8 May 1945).

1.27 The Second World War means the period beginning on 3 September 1939 and ending in Europe on 8 May 1945 (the date of Germany's unconditional surrender) and against Japan on 15 August 1945 (the date of Japan's unconditional surrender).

1.28 The duration of the Second World War also includes periods immediately before and after the War. The purpose of this provision is to ensure that payments in connection with persecution suffered or property lost that occurred just before 3 September 1939 or just after 8 May 1945 (in Europe) or 15 August 1945 (against Japan) are exempt from income tax or CGT.

1.29 An enemy of the Commonwealth during the Second World War means an enemy of the Commonwealth of Australia, that is a country on which Australia declared war at the beginning of, or during, the Second World War.

1.30 An enemy-associated regime during the Second World War means:

•

countries which were officially allied with Germany (e.g. Italy and Japan);

•

countries which were invaded, occupied, governed or administered directly or indirectly by the National Socialist regime of Germany (e.g. Belgium, France and the Netherlands); and

•

countries which were neutral but surrounded by enemy-associated regimes (e.g. Switzerland).

1.31 Participation in a resistance movement during the Second World War means resistance against the National Socialist regime of Germany and resistance against the forces of any other enemy of the Commonwealth. This would include, for example, the French resistance and the resistance movement against Japan in the former Dutch East Indies.

Payments from associates

1.32 For the income tax or CGT exemption to apply, the payments in connection with persecution suffered or property lost during the Second World War must not be received from an associate of the eligible claimant.

1.33 An associate of a natural person (otherwise than in the capacity of trustee) is defined in subsection 318(1) of the ITAA 1936 and, in broad terms, is a person or an entity that, by reason of family or business connections, might be regarded as being an associate of a particular person. For the purposes of this provision, an associate includes:

•

a relative of the eligible claimant;

•

a partner of the eligible claimant, the partner's spouse or child, or a partnership of which the eligible claimant is a partner;

•

a trustee of a trust under which the eligible claimant benefits; and

•

a company significantly influenced by the eligible claimant, or in which the eligible claimant holds a majority voting interest.

1.34 This provision is an integrity measure intended to ensure that the income tax and CGT exemptions cannot be used as a means to direct otherwise taxable foreign payments to Australian resident individuals.

1.35 This provision is not intended to deny the exemption where the payment was made to the legal personal representative of a Second World War victim or to the trustee of a trust established by the deceased victim's will. The associate test applies to the legal personal representative or the trustee in the same way as it would have applied to the Second World War victim had the victim not died.

Application and transitional provisions

1.36 The amendments are to apply to payments in connection with persecution suffered or property lost during the Second World War from foreign Second World War funds received by the eligible claimant in 2001-2002 and subsequent income years.

1.37 The amendments are retrospective to ensure that Australian resident individuals who received payments in connection with persecution suffered or property lost during the Second World War in the 2001-2002 income year are entitled to the tax exemptions. Taxpayers will not be adversely affected by the retrospective commencement of the amendments.

Consequential amendments

1.38 The provision is included in a checklist of exempt income. [Schedule 1, item 2]

Chapter 2 - Gifts and covenants

Outline of chapter

2.1 Schedule 2 to this bill amends the ITAA 1997 to update the lists of specifically-listed DGRs.

2.2 Schedule 3 to this bill amends the ITAA 1997 from 1 July 2003:

•

to simplify the listing in the tax law of specifically-listed DGRs; and

•

to allow deductions for cash donations to DGRs to be spread over a period of up to 5 years.

Context of amendments

2.3 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 specifically listed under that Division.

2.4 The addition of organisations to the lists of specifically-listed DGRs will assist these organisations to attract public support for their activities.

2.5 The Treasurer has proposed an amendment to the ITAA 1997, with effect from 1 July 2003, to allow specifically-listed DGRs to be prescribed by regulation (Treasurer's Press Release No. 49 of 29 August 2002). The measure is part of the Government's response to the Report of the Inquiry into the Definition of Charities and Related Organisations. It will allow continued scrutiny by the Parliament but will make legislative amendments concerning specifically-listed DGRs less administratively costly and more timely.

2.6 Deductions for all gifts of property valued at more than $5,000 and made from 1 July 2002 can be spread over a period of up to 5 years.

2.7 The Prime Minister has proposed an amendment to the ITAA 1997 to allow deductions for cash donations made from 1 July 2003 to DGRs to be spread over a period of up to 5 years (Prime Minister's Press Release of 11 December 2002). The measure will ensure that cash and property gifts are treated similarly. It will make it more attractive for taxpayers to make donations to DGRs sooner. DGRs that receive funds earlier from donors will benefit from the measure.

Summary of new law

Schedule 2

2.8 The amendments will allow income tax deductions for certain gifts to the value of $2 or more made to the funds and organisations listed in Table 2.1 from, and including, the day of announcement.

2.9 The ITAA 1997 is also amended so that deductions for gifts made to the Stolen Children's Support Fund be limited to gifts made before 4 February 2003, as the dissolution of the Fund was confirmed on this date.

Schedule 3

Simplifying the listing in the tax law of specifically-listed DGRs

2.10 The ITAA 1997 will be amended to simplify the listing in the tax law of specifically-listed DGRs.

2.11 The amendments are designed to allow all existing specifically-listed DGRs to be transferred from the ITAA 1997 to regulations to the ITAA 1997, and to allow any new specifically-listed DGRs to be prescribed in regulations.

2.12 The amendments will add regulation-making provisions to Division 30 of the ITAA 1997 to allow both existing and any new specifically-listed DGRs to be specified in regulations. A 'first set' of regulations will be made under the regulation-making provisions providing DGR status for all existing specifically-listed DGRs.

2.13 The amendments will remove specific references to existing specifically-listed DGRs from the Division. The amendments have been designed so that this removal dovetails with the 'first set' of regulations, which will ensure that the DGR status of each existing specifically-listed DGR is unaffected by the process.

Spreading deductions for cash donations to DGRs

2.14 The amendments will allow deductions for cash gifts made from 1 July 2003 to DGRs to be spread, in instalments chosen by the taxpayer, over a period of up to 5 years.

2.15 The amendments will also simplify the gift provisions of the ITAA 1997 by replacing the 4 Subdivisions in Division 30 relating to the spreading of deductions with one Subdivision.

Comparison of key features of new law and current law

Detailed explanation of new law - Schedule 2

2.16 The funds, authorities and institutions discussed in paragraphs 2.17 to 2.21 have been included in the gift provisions of the ITAA 1997. Gifts of $2 or more to these organisations will allow a donor to claim the gift as an income tax deduction.

2.17 The Australian Literacy and Numeracy Foundation was established:

•

to provide financial assistance to those suffering from illiteracy;

•

to work towards ensuring a practical and measurable decrease in the severity of illiteracy; and

•

to gain the support of the Australian community.

The Foundation principally engages in the direct provision of speech, numeracy and literacy services as well as developing, teaching and training others in sound methods of teaching literacy and numeracy skills and facilitating both professional and public access to information about literacy and numeracy. [Schedule 2, item 1, subsection 30-25(2)]

2.18 Crime Stoppers Western Australia Limited, New South Wales Crime Stoppers Limited, Crime Stoppers Tasmania, Crime Stoppers Queensland Limited and Crime Stoppers Australia Limited encourage community involvement in the apprehension and conviction of criminals, and the reduction in crime by the provision of information to the proper authorities. [Schedule 2, item 2, subsection 30-45(2)]

2.19 The Australian-American Educational Foundation was established to promote educational and cultural exchange between Australia and the USA in order to enhance mutual understanding and goodwill between the 2 countries. The principal activity of the Foundation is to administer the Australian-American Fulbright Awards. [Schedule 2, item 1, subsection 30-25(2)]

2.20 The Constitution Education Fund will administer a nationwide competitive prize scheme commencing in 2004 that involves participants engaging in debates, public speaking and essay writing. The primary object of the Fund is to educate students of all ages about the Australian Constitution and the workings of all levels of government. [Schedule 2, item 1, subsection 30-25(2)]

2.21 The principal activity of the Alcohol Education and Rehabilitation Foundation is to administer funding grants for the benefit of the treatment, research and prevention of alcohol and other licit substance misuse. The Foundation makes a significant contribution towards the prevention of alcohol and other licit substance misuse. [Schedule 2, item 2, subsection 30-45(2)]

Establishing an end date for deductibility

2.22 The Stolen Children's Support Fund has been dissolved, with the Chairman of the Fund confirming the dissolution on 4 February 2003. Accordingly, Schedule 2 limits deductions for gifts to the Fund to gifts made before 4 February 2003. [Schedule 2, item 3, subsection 30-70(2)]

Application provisions - Schedule 2

2.23 The amendments to include organisations in the gift provisions of the ITAA 1997 apply from the dates of the press releases shown in Table 2.1.

2.24 The amendment relating to the Stolen Children's Support Fund limits deductions for gifts to the Fund to gifts made before 4 February 2003.

Detailed explanation of new law - Schedule 3 - simplifying the listing in the tax law of specifically-listed DGRs

2.25 The ITAA 1997 will be amended to simplify the listing in the tax law of specifically-listed DGRs.

2.26 The amendments are designed to allow any new specifically-listed DGRs to be prescribed in regulations. The amendments are also designed to allow all existing specifically-listed DGRs to be transferred from the ITAA 1997 to regulations to the ITAA 1997.

2.27 The amendments will add regulation-making provisions to Division 30 of the ITAA 1997 to allow both existing and any new specifically-listed DGRs to be specified in regulations. A 'first set' of regulations will be made under the regulation-making provisions providing DGR status for all existing specifically-listed DGRs.

2.28 The amendments will remove specific references to existing specifically-listed DGRs from the Division. The amendments have been designed so that this removal dovetails with the 'first set' of regulations, which will ensure that the DGR status of each existing specifically-listed DGR is unaffected by the process.

2.29 This process is set out under the heading below entitled "Changing the DGR definition".

2.30 The amendments will insert Subdivision 30-FA into the ITAA 1997. This Subdivision relates to regulations made under Division 30. It provides for a number of variations from the treatment of regulations outlined under the Acts Interpretation Act 1901. These variations are discussed under the heading below entitled "Special provisions about regulations".

Changing the DGR definition

2.31 Prior to the amendments, DGRs were defined as entities that were:

•

endorsed as DGRs (endorsement being a requirement for entities that seek DGR status and that fall under general DGR categories);

•

prescribed private funds;

•

mentioned by name in Subdivision 30-B; or

•

mentioned by name in the table in section 30-15.

2.32 The amendments affect only those DGRs mentioned by name in Subdivision 30-B or mentioned by name in the table in section 30-15. As such, entities that are endorsed as DGRs under a general DGR category and prescribed private funds are unaffected by the amendments.

Entities mentioned by name in Subdivision 30-B

2.33 An entity will no longer be defined as a DGR by way of being mentioned by name in Subdivision 30-B. [Schedule 3, item 52, subparagraph 30-227(2)(a)(ii)]

2.34 As a result, references where an entity is mentioned by name in Subdivision 30-B would be of no effect. Accordingly, these references are repealed. [Schedule 3, items 14, 16, 30-95 and 30-105, subsections 30-20(2), 30-25(2), 30-40(2), 30-45(2), 30-50(2), 30-18, 19, 20, 23, 25, 27, 29, 30, 32, 34, 37, 40, 42, 44, 46, sections 30-60, 30-65, 30-90, 55(2), 30-70(2), 30-80(2) and 30-100(2), paragraphs 30-30(1)(b), 30-30(1)(c) and 30-30(1)(d)]

2.35 An intention of the amendments is for these entities to continue to be DGRs.

2.36 To provide for this, the DGR definition will be amended so that an entity mentioned by name in regulations made for the purposes of section 30-105 will be a DGR [Schedule 3, item 52, subparagraph 30-227(2)(a)(ii)]. In place of the repealed section 30-105, a section is inserted setting out that a fund, authority or institution may be specified in regulations under the section [Schedule 3, item 46, section 30-105].

2.37 Regulations will be made under section 30-105 specifying all entities that were mentioned by name in Subdivision 30-B immediately prior to the repeal of these references. This will ensure that the DGR status of each entity is unaffected.

2.38 Under subsection 46(2) of the Acts Interpretation Act 1901, where an authority has a power to make a regulation prescribing a thing, the authority may identify the thing by referring to a class or classes of things. However, when prescribing an entity as a specifically-listed DGR, a reference to a class or classes of entities is neither necessary nor appropriate. Accordingly, the amendments provide that subsection 46(2) of the Acts Interpretation Act 1901 does not apply to regulations made for the purposes of section 30-105. Regulations made under section 30-105 will be required to refer to specific entities, rather than a class or classes of entities. [Schedule 3, item 46, subsection 30-105(7)]

Special conditions

2.39 Some entities that were mentioned by name in Subdivision 30-B prior to the repeal of these references were subject to special conditions. These conditions had to be satisfied in order for deductions to arise for gifts made to the entity. For example, a special condition was attached to the Young Endeavour Youth Scheme Public Fund whereby, in order for a deduction to arise, a gift to the Fund would need to be made after 24 September 2001.

2.40 These special conditions attached to particular entities will be replicated in the relevant regulations made under section 30-105 so that the DGR status of each entity is unaffected.

2.41 Special conditions may require that:

•

the gift must be made after a specified date, before a specified date, or during a specified period (all of which may be before the regulation takes effect - see paragraph 2.67);

•

the gift must be made for a specified purpose;

•

the conditions set out in section 30-30 (including the requirement that the gift is for a purpose that relates solely to tertiary education) must be satisfied; or

•

the conditions set out in section 30-110 (requiring the entity to agree to provide statistical information about gifts made to it, and requiring the entity to not be merely a conduit for donations to other entities) must be satisfied.

[Schedule 3, item 46, section 30-105]

Transitional provisions relating to special conditions

2.42 Section 30-30 outlines a special condition that applies to certain entities that includes a requirement that certain declarations specific to the entity be made.

2.43 Prior to the amendments, section 30-30 made specific reference to the Marcus Oldham Farm Management College. This reference has been repealed (see paragraph 2.33). A regulation will be made under section 30-105 for the College (see paragraph 2.36) and that this regulation will specify that the College is subject to the condition set out in section 30-30.

2.44 Despite the repeal of the specific reference in section 30-30 to the Marcus Oldham Farm Management College, declarations specific to the College that were in force immediately prior to 1 July 2003 have effect as if the declarations had been made under section 30-30 as amended. [Schedule 3, item 73]

2.45 Prior to the amendments, section 30-60 outlined a special condition on certain entities, that included a requirement that certain agreements be made. This section has been repealed [Schedule 3, item 30, section 30-60]. Under the amendments, the special condition is outlined in section 30-110 [Schedule 3, item 46, section 30-110].

2.46 Regulations will be made under section 30-105 for all entities that were subject to the special condition outlined in section 30-60 prior to its repeal. These regulations will specify that the entities are subject to the special condition outlined in section 30-110. This will ensure that these entities will continue to be subject to the special condition.

2.47 Despite the repeal of section 30-60, agreements that were in force under section 30-60 immediately prior to 1 July 2003 have effect as if the agreements had been made under section 30-110. [Schedule 3, item 74]

Entities mentioned by name in the table in section 30-15

2.48 Entities are mentioned by name in items 4 and 6 of the table in section 30-15.

2.49 An entity will no longer be defined as a DGR solely because it is mentioned by name in the table in section 30-15. [Schedule 3, item 52, subparagraph 30-227(2)(a)(ii)]

2.50 As a result, references where an entity is mentioned by name in items 4 and 6 of the table in section 30-15 would be of no effect. Accordingly, these references are omitted or repealed. [Schedule 3, items 6 to 8, section 30-15 (item 4 in the table, paragraph (a) in the column headed "Recipient" and paragraph (ba) in the column headed "Special Conditions") and section 30-15 (item 6 in the table, column headed "Recipient")]

2.51 An intention of the amendments is for these entities to continue to be DGRs.

2.52 To provide for this, the DGR definition will be amended so that an entity specified in regulations made for the purposes of item 4 or 6 of the table in section 30-15 will be a DGR [Schedule 3, item 52, subparagraph 30-227(2)(a)(ii)]. References to "a fund, authority or institution specified in regulations made for the purposes of this item" will be added in place of the omitted and repealed references in items 4 and 6. [Schedule 3, items 6 to 8, section 30-15 (item 4 in the table, paragraph (a) in the column headed "Recipient" and paragraph (ba) in the column headed "Special Conditions") and section 30-15 (item 6 in the table, column headed "Recipient")]

2.53 Regulations will be made for the purposes of item 4 or 6 in the table in section 30-15 specifying all entities that were mentioned by name in items 4 and 6 immediately prior to the repeal of these references. This will ensure that the DGR status of each entity is unaffected.

2.54 Under subsection 46(2) of the Acts Interpretation Act 1901, where an authority has a power to make a regulation prescribing a thing, the authority may identify the thing by referring to a class or classes of things. However, when prescribing an entity as a specifically-listed DGR, a reference to a class or classes of entities is neither necessary nor appropriate. Accordingly, the amendments provide that subsection 46(2) of the Acts Interpretation Act 1901 does not apply to regulations made for the purposes of item 4 or 6 of the table in section 30-15. Regulations made for the purposes of item 4 or 6 will be required to refer to specific entities, rather than a class or classes of entities. [Schedule 3, item 9, subsection 30-15(4)]

An exception for the Commonwealth (for the purposes of Artbank)

2.55 Item 5 in the table in section 30-15 relates solely to gifts accepted for the purposes of Artbank. The sole recipient under this item, namely the Commonwealth (for the purposes of Artbank), is mentioned by name. This entity is inherently related to the item, and no other entity is likely to be related to the item in future. As such, maintaining specific reference to this entity in the ITAA 1997 is consistent with the intention to simplify the listing in the tax law of specifically-listed DGRs.

2.56 To provide for this, the DGR definition will be amended so that the Commonwealth (for the purposes of Artbank) will be a DGR. [Schedule 3, item 52, subparagraph 30-227(2)(a)(ii)]

Consequential amendments

2.57 A number of minor consequential amendments arise from the insertion of section 30-105 (setting out that a fund, authority or institution may be specified in regulations under the section), the repeal of references where an entity is mentioned by name in Subdivision 30-B, and the associated change in the DGR definition. [Schedule 3, items 1, 3, 4, 5, 11, 13, 15, 17, 21, 22, 24, 26, 28, 31, 33, 35, 36, 38, 39, 41, 43, 45, 50, 59, 62, 64, 65, 66, 67, 68, 69, 70 and 71, section 30-15, item 1 in the table, paragraphs (aa) and (c) in the column headed "Special conditions", item 2 in the table, paragraph (a) in the column headed "Recipient", group headings before sections 30-65, 30-90, 30-95 and 30-105, at the end of section 50-60, subsections 30-5(3), 30-35(1), 30-75(1), 30-85(1), 30-125(2), 31-10(2) and 50-75(2), note to subsections 30-20(1), 30-25(1), 30-40(1), 30-45(1), 30-50(1), 30-55(1), 30-70(1), 30-80(1), 30-100(1) and 31-10(2), subsections 207-130(4A) and(4B), note to subsection 30-315(2), subsection 30-315(2) (numerous items in the table contained in the index to the Division), paragraphs 30-17(1)(a), 30-30(1)(a), 31-10(1)(a), 50-60(b), 207-130(4)(a), 207-130(4)(b) and 207-130(4)(c)]

2.58 A number of minor consequential amendments arise from the insertion of reference to entities specified in regulations made for the purposes of item 4 or 6 in the table in section 30-15, the repeal of references where an entity is mentioned by name in items 4 and 6, and the associated change in the DGR definition. [Schedule 3, items 12, 49, 55 and 56, subsections 30-125(2) and 30-230(2A), paragraphs 30-17(1)(c) and 30-230(2)(a)]

2.59 A number of minor consequential amendments arise from both of the changes referred to in paragraphs 2.56 and 2.57. [Schedule 3, items 10, 47, 48, 51, 53, 54 and 60, sections 30-115 and 30-228, subsection 30-17(1), subsection 30-315(2) (numerous items in the table contained in the index to the Division), paragraphs 30-227(2)(a) and 30-227(2)(b), subparagraphs 30-125(1)(b)(i) and (ii)]

Special provisions about regulations

2.60 The amendments will insert Subdivision 30-FA into the ITAA 1997 [Schedule 3, item 58]. This Subdivision relates to regulations made under Division 30 [Schedule 3, item 58, section 30-311]. It provides for a number of variations from the treatment of regulations outlined under the Acts Interpretation Act 1901.

2.61 The Subdivision has effect despite the following sections of the Acts Interpretation Act 1901:

•

section 48, entitled "Regulations";

•

section 48A, entitled "Regulations not to be re-made while required to be tabled";

•

section 48B, entitled "Regulations not to be re-made while subject to disallowance"; and

•

section 49, entitled "Disallowed regulations not to be re-made unless resolution rescinded or House approves".

[Schedule 3, item 58, section 30-314A]

'First set' of regulations to take effect on 1 July 2003

2.62 A 'first set' of regulations will be made under the regulation-making provisions for all existing specifically-listed DGRs to ensure that the DGR status of each is unaffected by the process.

2.63 The regulation-making provisions will require that this first set of regulations take effect on 1 July 2003. Accordingly, if this first set survives the disallowance period, it will take effect on 1 July 2003. This would represent a seamless transfer of specifically-listed DGRs from the ITAA 1997 to regulations to the ITAA 1997. [Schedule 3, item 58, paragraph 30-312(4)(a)]

Subsequent regulations to take effect after the risk of disallowance passes

2.64 The regulation-making provisions will require that the regulations (other than the 'first set' of regulations discussed above) take effect on the day immediately after the last day on which a resolution disallowing the regulations could have been passed. [Schedule 3, item 58, paragraph 30-312(4)(b)]

2.65 Without this requirement, these regulations could take effect before the risk of disallowance passes. This would open up the possibility of an entity being recognised under law as a specifically-listed DGR, only to have this recognition removed shortly thereafter by the Parliament. This could inconvenience both the entity and donors to it.

2.66 This provision will only affect the regulation's date of effect, not the regulation's date of application (e.g. the date from which a regulation may allow deductions for gifts made to a particular entity).

Application dates of regulations

2.67 The regulations do not apply to gifts made before 1 July 2003 [Schedule 3, item 58, subsection 30-313(1)]. Paragraph 2.100 outlines how the specific references to specifically-listed DGRs in the ITAA 1997 (which are repealed) will nonetheless continue to apply for gifts made before 1 July 2003.

2.68 Unless the contrary intention appears in a regulation, the regulation applies to gifts made on or after 1 July 2003. As such, a regulation may apply retrospectively. [Schedule 3, item 58, subsection 30-313(2)]

2.69 However, the capacity for regulations to apply retrospectively is limited for amending regulations that have the effect of terminating or limiting the DGR status of a particular entity after a particular time (the termination/limitation time). [Schedule 3, item 58, section 30-314]

2.70 Such amending regulation may be made if it does not apply retrospectively. That is, if the termination/limitation time occurs at or after the time when the amending regulation takes effect. [Schedule 3, item 58, paragraph 30-314(1)(a)]

2.71 Where such amending regulation is to apply retrospectively, it may be made only if the following conditions are met.

•

The amending regulation must give effect to a public announcement made by the Treasurer, or another Minister, at or before the termination/limitation time. A copy of the announcement must be published on the Internet.

•

The termination/limitation time must not be earlier than 60 days before the day on which the amending regulation is made.

[Schedule 3, item 58, paragraph 30-314(1)(b) and subsection 30-314(2)]

2.72 These conditions would accommodate an instance where the Treasurer considers that an immediate termination/limitation of an entity's DGR status is appropriate, such that an announcement of immediate termination/limitation is required before the amending regulation is drafted and made.

Notification and disallowance

2.73 Notification of a regulation must be made in the Gazette within 21 days after the regulation is made. [Schedule 3, item 58, subsection 30-312(1)]

2.74 The Treasurer must cause a copy of a regulation to be tabled in each House of the Parliament within 15 sitting days (of that House) after the regulations are made. [Schedule 3, item 58, subsection 30-312(2)]

2.75 Each House may, following a motion upon notice, pass a resolution disallowing a regulation. To be effective, the resolution must be passed within 15 sitting days (of that House) after the copy of the regulation was tabled in that House. [Schedule 3, item 58, subsection 30-312(3)]

Detailed explanation of new law - Schedule 3 - allowing deductions for cash donations to DGRs to be spread over a period of up to 5 years

2.76 The amendments will allow deductions for cash gifts made from 1 July 2003 to DGRs to be spread, in instalments chosen by the taxpayer, over a period of up to 5 years.

2.77 The amendments will also simplify the gift provisions of the ITAA 1997 by replacing the 4 Subdivisions in Division 30 relating to the spreading of deductions with one Subdivision.

Cash gifts

2.78 Deductions for cash gifts are allowed for gifts to a fund, authority or institution covered by item 1 or 2 in the table in section 30-15. The amendments will allow taxpayers to make a written election to spread these deductions over the current income year and up to 4 of the immediately following income years. [Schedule 3, item 57, section 30-248, subparagraph 30-247(1)(a)(i)]

2.79 The conditions on, and the effects of, this election are the same as for elections relating to gifts of property valued at over $5,000 (other than environmental, heritage and certain cultural property gifts) and conservation covenants. The conditions and effects are set out below.

2.80 In the election, the taxpayer must specify the percentage (if any) of the deduction that will be deducted in each of the income years. [Schedule 3, item 57, subsection 30-248(2)]

2.81 The election must be made before the lodgment of the taxpayer's income tax return for the income year in which the gift was made. [Schedule 3, item 57, subsection 30-248(3)]

2.82 The taxpayer may vary an election at any time. However, the variation can only change the percentage that will be deducted in respect of income years for which an income tax return has not yet been lodged. [Schedule 3, item 57, subsection 30-248(4)]

2.83 The election and any variation must be in the form approved in writing by the Commissioner. [Schedule 3, item 57, subsection 30-248(5)]

2.84 As a result of the election, the taxpayer cannot deduct the amount that the taxpayer otherwise would have been able to deduct in the income year in which the gift was made [Schedule 3, item 57, subsection 30-249(2)]. Instead, in each of the income years specified in the election, the taxpayer can deduct the amount corresponding to the percentage specified for that year [Schedule 3, item 57, subsection 30-249(1)].

Replacing 4 Subdivisions with one

2.85 The amendments repeal Subdivisions 30-DB to 30-DE, and substitute Subdivision 30-DB. [Schedule 3, item 57]

2.86 The effect of the repealed Subdivisions is preserved. As such, elections to spread deductions will continue to be allowed for:

•

gifts of property valued by the Commissioner at more than $5,000 and made to a fund, authority or institution covered by item 1 or 2 in the table in section 30-15;

•

gifts covered by item 4 or 5 in the table in section 30-15;

•

gifts covered by item 6 in the table; and

•

entering into a conservation covenant under Division 31.

[Schedule 3, item 57, section 30-247 and subsection 30-248(1)]

2.87 The conditions and effects outlined in paragraphs 2.79 to 2.81, and in paragraph 2.83, continue to apply for these gifts and covenants. [Schedule 3, item 57, sections 30-248 and 30-249]

2.88 Environmental property gifts, heritage property gifts, and certain cultural property gifts will continue to be excepted from the condition requiring elections and any variation to be in the form approved in writing by the Commissioner, and will continue to be subject to additional requirements instead (see paragraphs 2.89 to 2.96). Other property gifts will continue to be subject to the condition requiring elections and any variation to be in the form approved in writing by the Commissioner. [Schedule 3, item 57, subsection 30-248(5)]

2.89 Conservation covenants will continue to be subject to the condition requiring elections and any variation to be in the form approved in writing by the Commissioner [Schedule 3, item 57, subsection 30-248(5)]. Conservation covenants will also continue to be subject to additional requirements (see paragraphs 2.97 to 2.98).

Additional requirements - environmental property gifts

2.90 An election for a gift of property is subject to additional requirements if the gift is made to a fund, authority or institution:

•

covered by section 30-55; or

•

specified in regulations for the purposes of the additional requirement.

[Schedule 3, item 57, subsection 30-249A(1)]

2.91 Regulations for these purposes will be made specifying the entities listed from items 6.2.1 to 6.2.12 and from 6.2.22 to 6.2.23 in subsection 30-55(2) immediately prior to the repeal of this subsection. This will ensure that these entities continue to be subject to the additional requirements.

2.92 The additional requirements are as follows:

•

a copy of the election must be given to the Secretary to the Department of Environment and Heritage before lodgment of the income tax return for the income year in which the gift is made [Schedule 3, item 57, subsection 30-249A(2)];

•

if the election is varied, a copy of the variation must be given to the Secretary to the Department of Environment and Heritage before lodgment of the income tax return for the income year to which the variation applies [Schedule 3, item 57, subsection 30-249A(3)]; and

•

the election and any variation must be in a form approved in writing by the Secretary to the Department of Environment and Heritage [Schedule 3, item 57, subsection 30-249A(4)].

Additional requirements - heritage property gifts

2.93 An election for a gift of property is subject to additional requirements if the gift is made to a fund, authority or institution:

•

covered by item 6 in the table in section 30-15; or

•

specified in regulations for the purposes of the additional requirement.

[Schedule 3, item 57, subsection 30-249B(1)]

2.94 Regulations for these purposes will be made specifying the entities listed from items 6.2.13 to 6.2.21 in subsection 30-55(2) immediately prior to the repeal of this subsection. This will ensure that these entities continue to be subject to the additional requirements.

2.95 The additional requirements are as follows:

•

a copy of the election must be given to the Secretary to the Department of Environment and Heritage before lodgment of the income tax return for the income year in which the gift is made [Schedule 3, item 57, subsection 30-249B(2)];

•

if the election is varied, a copy of the variation must be given to the Secretary to the Department of Environment and Heritage before lodgment of the income tax return for the income year to which the variation applies [Schedule 3, item 57, subsection 30-249B(3)]; and

•

the election and any variation must be in a form approved in writing by the Secretary to the Department of Environment and Heritage [Schedule 3, item 57, subsection 30-249B(4)].

Additional requirements - certain cultural property gifts

2.96 An election for a gift of property is subject to additional requirements if the gift is made to a fund, authority or institution covered by item 4 or 5 in the table in section 30-15. [Schedule 3, item 57, subsection 30-249C(1)]

2.97 The additional requirements are as follows:

•

a copy of the election must be given to the Secretary to the Department of Communications, Information Technology and the Arts before lodgment of the income tax return for the income year in which the gift is made [Schedule 3, item 57, subsection 30-249C(2)];

•

if the election is varied, a copy of the variation must be given to the Secretary to the Department of Communications, Information Technology and the Arts before lodgment of the income tax return for the income year to which the variation applies [Schedule 3, item 57, subsection 30-249C(3)]; and

•

the election and any variation must be in a form approved in writing by the Secretary to the Department of Communications, Information Technology and the Arts [Schedule 3, item 57, subsection 30-249C(4)].

Additional requirements - conservation covenants

2.98 An election related to a conservation covenant is subject to the additional requirements. [Schedule 3, item 57, subsection 30-249D(1)]

2.99 The additional requirements are as follows:

•

a copy of an election relating to a conservation covenant must be given to the Secretary to the Department of Environment and Heritage before lodgment of the income tax return for the income year in which the gift is made [Schedule 3, item 57, subsection 30-249D(2)]; and

•

if the election is varied, a copy of the variation must be given to the Secretary to the Department of Environment and Heritage before lodgment of the income tax return for the income year to which the variation applies [Schedule 3, item 57, subsection 30-249D(3)].

Consequential amendments

2.100 A number of minor consequential amendments arise from the simplification of the gift provisions involving the replacement of 4 Subdivisions relating to the spreading of deductions with one Subdivision. [Schedule 3, items 2, 61, 63, subsection 30-5(4B), subsection 30-315(2) (item 112AA in the table, column headed "Provision"), note to subsection 31-5(3)]

Application and transitional provisions - Schedule 3

2.101 Despite the amendments made by Schedule 3, Division 30 continues to apply, in relation to gifts made before 1 July 2003, as if those amendments had not been made. Despite the amendments made by Schedule 3, Subdivision 30-DE continues to apply, in relation to covenants entered into under Division 31 before 1 July 2003, as if those amendments had not been made. [Schedule 3, item 72]

2.102 This transitional provision ensures that the removal of specific references to specifically-listed DGRs will not affect the deductions arising from gifts made before 1 July 2003.

2.103 A first set of regulations will be made under the regulation-making provisions for all existing specifically-listed DGRs. If this first set survives the disallowance period, it will take effect on 1 July 2003 (see paragraph 2.62). As a result, the DGR status of each existing specifically-listed DGR will be unaffected.

2.104 The transitional provision ensures that deductions for cash gifts can be spread only for cash gifts made on or after 1 July 2003.

2.105 It also ensures that the replacement of 4 Subdivisions relating to the spreading of deductions with one Subdivision does not affect the spreading of deductions for gifts made and covenants entered into before 1 July 2003. The repealed Subdivisions applied to gifts made and covenants entered into from different dates. These dates of application continue to apply.

2.106 To ensure that arrangements prior to 1 July 2003 are unaffected, further transitional provisions apply to a number of minor consequential amendments outside of Division 30. [Schedule 3, items 75 to 77]

Chapter 3 - Amendment of the Crimes (Taxation Offences) Act 1980

Outline of chapter

3.1 Schedule 4 to this bill amends the Crimes (Taxation Offences) Act 1980 to correct the deeming provisions and to harmonise the offence provisions with the Criminal Code.

Context of amendments

3.2 The Criminal Code provides a uniform interpretation for offence provisions in all Commonwealth legislation. It commenced to apply to newly enacted offences from 1 January 1997 and to all Commonwealth offences from 15 December 2001.

3.3 All Commonwealth offence provisions were required to be reviewed and amended if necessary, to ensure that the operation of the Criminal Code would not alter the existing interpretation of the offences.

3.4 While legislation in the Treasury portfolio was harmonised in 2001, amendments to the Crimes (Taxation Offences) Act 1980 were inadvertently omitted from this project. Amendments necessary to harmonise the Crimes (Taxation Offences) Act 1980 with the Criminal Code are contained in Part 2 of Schedule 4 to this bill.

3.5 In addition, Part 1 of Schedule 4 to this bill makes amendments to the deeming provisions contained in the Crimes (Taxation Offences) Act 1980. Part II of the Crimes (Taxation Offences) Act 1980 sets out offences in relation to 'old sales tax', and the deeming provisions in Parts III to X then purport to apply these offences to other taxes and charges (such as income tax, FBT, superannuation guarantee charge and GST). When the sales tax laws were streamlined in 1992, the references in Part II were changed from 'sales tax' to 'old sales tax'. However, the consequential amendments to the deeming provisions in Parts III to X were overlooked, and they still refer to 'sales tax', rather than to 'old sales tax'.

3.6 It is possible that a court would be able to correctly interpret the Crimes (Taxation Offences) Act 1980 to apply the offences in Part II to other taxes and charges. However, to put the interpretation beyond doubt, amendments are being made to correct the references to 'sales tax' in the deeming provisions, replacing them with 'old sales tax'.

Detailed explanation of new law

Amendments to deeming provisions

3.7 This bill amends the Crimes (Taxation Offences) Act 1980 to ensure that the offences apply as intended.

3.8 The offences in Part II of the Crimes (Taxation Offences) Act 1980 enable the prosecution of persons who enter into arrangements to avoid, or aid and abet persons to avoid, payment of old sales tax. Parts III to X apply these same offences to income tax, FBT, petroleum resource rent tax, training guarantee charge, superannuation guarantee charge, GST, WET and LCT.

3.9 This bill amends the deeming provisions in Parts III to X of the Crimes (Taxation Offences) Act 1980, amending references to 'sales tax' to read 'old sales tax'. This ensures that the correct terminology is used when these Parts refer to Part II. This is necessary because Part II no longer uses the phrase 'sales tax' but 'old sales tax'. For the same reason references in Parts III to X to 'future sales tax' and 'sales tax moneys' are amended to refer to 'future old sales tax' and 'old sales tax moneys' respectively. [Schedule 4, item 2, paragraphs 13(1)(a), (b) and (d); item 3, paragraphs 14(1)(a), (b) and (d); item 4, paragraphs 15(1)(a), (b) and (d); item 5, paragraphs 16(1)(a), (b) and (d); item 6, paragraphs 17(1)(a), (b) and (d); item 7, paragraphs 18(1)(a), (b) and (d); item 8, paragraphs 19(1)(a), (b) and (d); item 9, paragraphs 20(1)(a), (b) and (d)]

3.10 This bill also amends references to 'sales tax' in the interpretation section of the Crimes (Taxation Offences) Act 1980 to read 'old sales tax'. Again, this ensures that the correct terminology is used, for the purpose of making reference to this section. [Schedule 4, item 1, paragraph 3(2)(a)]

Criminal Code harmonisation amendments

3.11 The Treasury Legislation Amendment (Application of the Criminal Code) Act (No. 2) 2001 contained amendments to offences in taxation legislation within the Treasury portfolio, to ensure the offences would continue to be interpreted in the same way after the Criminal Code was applied to them from 15 December 2001. However, when these amendments were made, amendments to the Crimes (Taxation Offences) Act 1980 were inadvertently left out.

3.12 Therefore, this bill amends the Crimes (Taxation Offences) Act 1980 to harmonise it with the Criminal Code.

3.13 This bill makes amendments to the Crimes (Taxation Offences) Act 1980 in relation to penalties. These amendments do not change the penalties. They merely express the existing monetary penalties in terms of penalty units rather than dollar amounts, and place the penalty for each offence at the foot of each provision. [Schedule 4, item 14, section 5; item 17, section 6; item 18, subsections 7(1) and (2); item 20, section 8]

3.14 The conversion of penalties expressed in dollar amounts into penalty units is an element of harmonisation of the Crimes (Taxation Offences) Act 1980 with the Criminal Code.

3.15 It is desirable from a criminal law policy point of view that each provision which creates an offence should state the applicable penalty at the foot of the provision. This is more transparent and clearly identifies the penalty for each particular offence.

3.16 As a consequence of the above amendments, subsection 9(1) is repealed. This provision previously stated the penalty for offences against the Crimes (Taxation Offences) Act 1980. It is no longer required due to the amendments to ensure that the penalty for each offence is stated at the foot of each provision. [Schedule 4, item 21, subsection 9(1)]

3.17 This bill makes amendments to ensure that the use of phrases relating to 'purpose' are clarified. These amendments do not change the legal effect of the provisions. They merely ensure that the provisions are interpreted in the same way after the application of the Criminal Code as they were prior to its application. [Schedule 4, item 11, paragraphs 3(2)(a) and (b); item 12, subsection 5(1); item 13, paragraph 5(2)(a); item 15, subsection 6(1); item 16, paragraph 6(2)(a); item 19, paragraph 7(3)(b); item 22, subsections 13(2), 14(2), 15(2), 16(2), 17(2), 18(2), 19(2) and 20(2)]

3.18 The term 'purpose' may be ambiguous as to whether it creates an additional fault element of an offence, or whether it is part of the physical element of result. These amendments replace phrases relating to 'purpose' with phrases relating to 'intention'. This makes it clear that this is an additional fault element of the offence, and not part of the physical element of result. These amendments ensure consistency with the Criminal Code.

Application and transitional provisions

3.19 These amendments will apply from the day following Royal Assent. This will ensure that these amendments do not have any retrospective application.

3.20 These amendments will only apply to acts or omissions after this date of commencement. [Schedule 4, items 10 and 23]

Chapter 4 - Consolidation: transitional foreign loss makers

Outline of chapter

4.1 Schedule 5 to this bill makes amendments to the IT(TP) Act 1997 to allow certain entities with foreign losses to be excluded from a consolidated group for a transitional period.

Context of amendments

4.2 The consolidation regime allows groups of wholly-owned resident entities to elect to be treated as a single entity for income tax purposes. If a group consolidates, all of a head company's eligible subsidiaries must generally be included in the consolidated group.

4.3 Where an entity becomes a member of a consolidated group, an unused carry forward loss (including a foreign loss) may be transferred to the head company if it satisfies the relevant tests (e.g. continuity of ownership test, same business test) at the time of transfer.

4.4 Consolidation maintains the existing rule that a foreign loss incurred in respect of a particular class of assessable foreign income can only be offset against assessable foreign income of the same class.

4.5 The rate at which transferred losses (of any type) can be used by a head company is restricted by the joining entity's available fraction. The available fraction is basically the proportion that the loss entity's market value at the joining time bears to the value of the whole group at that time and serves as a proxy for the proportion of the group's income that would have been generated by the joining entity.

4.6 The available fraction is intended to ensure that the rate of loss recoupment inside consolidation approximates that which would have occurred in the absence of consolidation. However, the available fraction mechanism may impact harshly in situations where an entity with a particular class of foreign loss generates all, or most, of the group's foreign income of that class.

4.7 Providing more concessional rules for the recoupment of transferred foreign losses by consolidated groups would involve a significant cost to revenue and/or increase the complexity of the consolidation loss rules. Instead, a concession is provided to allow an entity that could become a subsidiary member of a consolidated group to utilise a foreign loss during a transitional period, rather than have the head company utilise the loss.

4.8 The amendments have retrospective effect to 1 July 2002 which is the date of commencement of the consolidation regime. As the amendments provide a concessional treatment for entities with foreign losses the amendments will have no adverse impacts.

Summary of new law

4.9 The amendments allow a subsidiary with an unrecouped foreign loss to be excluded from a consolidated group for up to 3 years, subject to certain conditions. An entity excluded from a consolidated group under this rule is defined as a transitional foreign loss maker.

Comparison of key features of new law and current law

Detailed explanation of new law

Object

4.10 The object of the provisions is to enable an entity that has foreign losses to remain outside a consolidated group for a period of up to 3 years, or until its foreign losses are utilised, rather than being subject to the loss utilisation restrictions of Subdivision 707-C. [Schedule 5, item 1, section 701D-1]

Eligibility

4.11 The head company of a consolidated group may elect to exclude from the group a subsidiary entity that has an unrecouped foreign loss incurred prior to the entity's 2002-2003 income year. The loss must be one that would have been transferred to the head company had the subsidiary become a subsidiary member of the consolidated group at its formation time (i.e., the relevant transfer tests contained in Division 707 must have been able to be satisfied at that time). [Schedule 5, item 1, subsection 701D-10(3)]

4.12 Additional eligibility conditions include:

•

the consolidated group must come into existence before 1 July 2004 [Schedule 5, item 1, paragraph 701D-10(1)(a)];

•

the entity must have been continuously wholly-owned by the head company from the start of 1 July 2002 (the continuous ownership condition) [Schedule 5, item 1, subsection 701D-10(2)] :

-

this condition ensures that the measure only applies where the entity was a member of a group that existed prior to the commencement of the consolidation regime; and

•

the entity must not hold a membership interest in another entity that, but for these provisions, would be a subsidiary member of the consolidated group (the no-subsidiary condition) [Schedule 5, item 1, subsection 701D-10(4)] :

-

this condition ensures that the transitional foreign loss maker provisions can not exclude from a consolidated group an entity that does not itself meet the conditions to be a transitional foreign loss maker.

Effect of being excluded from a consolidated group

4.13 A transitional foreign loss maker may be excluded from a consolidated group for a maximum of 3 years from the time the group consolidates. The entity may become a member of the consolidated group before the end of the three year period if the relevant foreign losses are fully recouped (in which case the entity will become a member of the group at the commencement of its next income year), or if it fails the no-subsidiary condition at any time. A consequence of excluding a transitional foreign loss maker from a consolidated group is that when it subsequently becomes a member of the group it will not be eligible for transitional concessions that are only available in respect of entities that become members of a group at the formation time. [Schedule 5, item 1, section 701D-10]

4.14 Specific amendments are made to Subdivision 707-C of the IT(TP) Act 1997 to ensure that certain transitional loss rules (the 'value donor' rules and the option for a consolidated group to recoup certain transferred losses over 3 years) cannot apply where the transitional foreign loss maker is owned by an entity that exits to form a new consolidated group. [Schedule 5, item 2, paragraph 707-325(1)(c); item 3, paragraph 707-350(1)(d)]

4.15 While a transitional foreign loss maker is excluded from a consolidated group, it remains a member of the relevant consolidatable group. This means that a transitional foreign loss maker is not eligible for loss transfer, asset roll-over and thin capitalisation grouping concessions that are provided for groups that include certain non-resident entities. This is consistent with the policy that such grouping benefits should be denied where resident members of a group are eligible to consolidate but choose not to. [Schedule 5, item 1, subsection 701D-10(5)]

4.16 A transitional foreign loss maker that is excluded from a consolidated group does, however, continue to be a wholly-owned subsidiary of the head company. This may be relevant for the purposes of the indirect value shifting rules in Division 727.

Making the choice for the transitional foreign loss maker provisions to apply

4.17 The head company must make the choice to exclude a transitional foreign loss maker by the end of the period allowed for a head company to elect to consolidate, or 30 days after Royal Assent, whichever is later. [Schedule 5, item 1, subsection 701D-15(3)]

4.18 A head company cannot elect to apply the transitional foreign loss maker provisions to an entity that has previously been excluded from a consolidated group under these rules - for example, where the transitional foreign loss maker is owned by an entity that exits to form a new consolidated group. [Schedule 5, item 1, subsection 701D-15(2)]

MEC groups

4.19 An entity is able to be excluded from a MEC group under the transitional foreign loss maker provisions if it meets the general eligibility conditions. The one difference is that all the membership interests in the entity must have been beneficially owned from 1 July 2002 by an entity that became an eligible tier-1 company of the group at the formation time, but not necessarily by the eligible tier-1 company that became the head company. [Schedule 5, item 4, section 719-10]

Chapter 5 - Goods and services tax: interaction with consolidation regime

Outline of chapter

5.1 Schedule 6 to this bill amends the GST Act to ensure that certain supplies made in relation to the consolidation regime will not be taxable supplies.

Context of amendments

5.2 As a direct result of the consolidation regime, supplies for the purposes of the GST Act may be made both as a consequence of the statutory operation of the consolidation provisions and as a result of contractual arrangements that are entered into because of consolidation.

5.3 Some of the potential supplies that may occur as a direct result of the statutory operation of the consolidation law include:

•

the transfer of tax attributes such as losses, franking credits, foreign tax credits, foreign dividend accounts and attribution account surpluses;

•

the transfer of the ability to claim certain deductions and offsets such as capital allowance deductions;

•

the transfer of the ability to make certain elections or declarations such as a foreign dividend account declaration; and

•

the release from an obligation of joint and several liability as a result of being covered by a tax sharing agreement.

5.4 Under the current legislation, supplies resulting from the operation of the consolidation law may be taxable supplies for GST purposes in some circumstances. Even where the supply is not made for consideration, it may still be subject to GST under Division 72 of the GST Act as the supply is made between associates. The value of such supplies may be difficult to determine.

5.5 In a pre-consolidation environment, similar supplies made as a result of the operation of income tax provisions were not taxable supplies due to the operation of sections 110-5 and 110-10 of the GST Act.

5.6 In addition to statutory supplies, GST consequences may also arise in relation to agreements that directly relate to consolidation. One such type of agreement is a tax sharing agreement, as outlined in Division 721 of the ITAA 1997. Broadly speaking, a tax sharing agreement is one that allocates the group liability between the members of the group on a reasonable basis.

5.7 If an entity is party to a valid tax sharing agreement, that entity will be liable to the Commonwealth for the amount allocated under the agreement (known as the contribution amount) and will not be subject to an imposition of joint and several liability. Division 721 of the ITAA 1997 also allows for an entity to leave a consolidated group clear of the group liability if certain conditions are met, including the payment of the contribution amount to the head company of the group.

5.8 Both entering into a tax sharing agreement and leaving a group clear of the group liability may give rise to statutory supplies. These supplies will include the release from statutory obligations of joint and several liability or the obligation to pay a contribution amount should the head company default. However, entities may also make other supplies in relation to the agreement such as the entry into or the release from non-statutory obligations. The value of such supplies may be difficult to determine.

5.9 Under the consolidation regime, the head company is responsible for paying consolidated group liabilities to the Commonwealth. However, it is the activities and attributes of the subsidiary entities as well as the head company that result in the group liabilities. To reflect this, many consolidated groups will enter into agreements, commonly referred to as tax funding agreements, for subsidiaries to contribute to the group liability of the head company. Tax funding agreements may also provide for payments to be made to subsidiaries if those entities have caused an overall reduction in the group liability (e.g. if a subsidiary would have made a tax loss had it been taxed as a separate entity).

5.10 The entry into obligations under a tax funding agreement may give rise to taxable supplies for GST purposes, although this will depend to a large extent on the terms of the agreement. Prior to the introduction of the consolidation regime, GST would not have applied if a subsidiary entity paid its income tax liability directly to the Commonwealth. GST would also not have been applicable if another company made a payment to the subsidiary in respect of a transfer of its tax losses.

5.11 Both the statutory and non-statutory supplies that are made as a consequence of the consolidation regime may be made between consolidated entities that are also members of the same GST group. In these circumstances, any such supplies will not be subject to GST. However, there are a variety of reasons why the members of a consolidated group will not necessarily be members of the same GST group. The potential GST consequences of consolidation may present difficulties for entities in this situation.

5.12 Entities should be afforded similar GST treatment under the consolidation regime as the treatment they received in a pre-consolidation environment. If no amendments were made, GST may be a potential impediment for some entities that wish to enter the consolidation regime.

Summary of new law

5.13 This bill will amend the GST Act to ensure that certain supplies made as a result of the consolidation regime, specifically those made as a result of:

•

the statutory operation of the consolidation provisions;

•

entering into a tax sharing agreement;

•

leaving a consolidated group clear of group liability; or

•

entering into a tax funding agreement,

will not be taxable supplies.

Comparison of key features of new law and current law

Detailed explanation of new law

Supplies under operation of the consolidated group regime

5.14 Section 110-15 ensures that where a supply occurs because of the operation of the provisions of the consolidation law as set out in Part 3-90 of the ITAA 1997 and Part 3-90 of the IT(TP) Act 1997, that supply will not be a taxable supply for the purposes of the GST Act. These amendments should not be taken to imply that all transfers that occur as a result of the statutory operation of the consolidation regime would be taxable supplies apart from the operation of the new provision. Rather, they ensure that if such transfers could be taxable supplies, no GST consequences will result. [Schedule 6, item 1, subsections 110-15(1) and (3)]

5.15 The concept of 'the operation of these provisions' in subsection 110-15(1) is intended to be broad, as the consolidation provisions will operate in a variety of ways. The concept will include an operation of the consolidation provisions that results from an action undertaken by an entity. [Schedule 6, item 1, subsection 110-15(2)]

5.16 One such action is a choice that an entity may make under the provisions of the consolidation law [Schedule 6, item 1, paragraph 110-15(2)(a)]. These choices will include the choice to consolidate as either a consolidated group or a MEC group and various choices made under the transitional provisions. Other voluntary actions provided for under the consolidation law, such as entering into a tax sharing agreement, are also included [Schedule 6, item 1, paragraph 110-15(2)(b)].

Tax sharing agreements

5.17 Section 110-15 will apply to some of the supplies that may be made in relation to tax sharing agreements, such as the statutory release from joint and several liability or from liability in respect of contribution amounts when an entity leaves a group clear of the group liability. However, there may also be non-statutory supplies that are made in relation to tax sharing agreements. These supplies are dealt with in sections 110-20 and 110-25. It is envisaged that some supplies will be covered under more than one of these provisions.

Entering into the agreement

5.18 Section 110-20 deals with supplies, including the entry into non-statutory obligations, that may be made when entering into a tax sharing agreement. The section will have application if an entity makes a supply because it enters into a new agreement or becomes party to an existing agreement that meets the requirements for a tax sharing agreement as stipulated in subsections 721-25(1) and (2) of the ITAA 1997. The satisfaction of the requirements in those subsections is to be tested at the time the entity enters into or becomes party to the agreement. The agreement must relate to an existing or future group liability of the head company of a consolidated group (or a MEC group). [Schedule 6, item 1, subsection 110-20(1)]

5.19 A supply that is made by an entity because it enters into a tax sharing agreement will not be a taxable supply to the extent to which that supply relates to the fact that the agreement satisfies the requirements of subsections 721-25(1) and (2) of the ITAA 1997. If the agreement partially concerns meeting the requirements of subsections 721-25(1) and (2) and partially concerns other matters, the concessional treatment will only apply to that part of the supply that relates to meeting the requirements. [Schedule 6, item 1, subsections 110-20(2) and (3)]

5.20 Definitions of the terms consolidated group, group liability, head company and MEC group are inserted in the GST dictionary by reference to section 703-5, paragraph 721-10(1)(a), subsection 995-1(1) and section 719-5 of the ITAA 1997 respectively. [Schedule 6, items 2, 4 to 6, section 195-1]

Leaving the group clear of group liability

5.21 Section 110-25 deals with certain supplies, including non-statutory supplies, that may be made when an entity leaves a consolidated group. It provides that if:

•

an entity, known as a TSA contributing member, has left a consolidated group (or a MEC group) clear of the group liability for the purposes of subsection 721-30(3) of the ITAA 1997; and

•

a supply of a release of an obligation relating to a contribution amount in relation to a group liability of the head company is made to that exiting entity,

then that supply will not be a taxable supply. [Schedule 6, item 1, section 110-25]

5.22 Definitions of the terms contribution amount and TSA contributing member are inserted in the GST dictionary by reference to paragraphs 721-25(1)(b) and 721-25(1)(a) of the ITAA 1997 respectively. [Schedule 6, items 3 and 10, section 195-1]

Tax funding agreements

5.23 Section 110-30 provides that a supply made because an entity enters into a new agreement or becomes party to an existing agreement that:

•

is in writing [Schedule 6, item 1, paragraph 110-30(1)(a)];

•

deals with the distribution of economic burdens and benefits that directly relate to consolidated group tax-related liabilities of a head company amongst members (and former members) of the group [Schedule 6, item 1, paragraph 110-30(1)(b)]; and

•

complies with any requirements that may be set out in the regulations to the GST Act [Schedule 6, item 1, paragraph 110-30(1)(d)],

will not be a taxable supply to the extent to which the supply relates to the fact that the agreement deals with the 'distribution' outlined in paragraph 110-30(1)(b). If the supply is an input taxed supply, section 110-30 will not alter that treatment. [Schedule 6, item 1, subsections 110-30(2) and (4)]

5.24 The agreement may be made prior to the formation of a consolidated or MEC group. In this circumstance, the agreement must be made in contemplation that the parties to the agreement will become members of such a group. [Schedule 6, item 1, paragraph 110-30(1)(c)]

5.25 The concept of 'distribution of economic burdens and benefits directly related to tax-related liabilities' as set out in paragraph 110-30(1)(b) is intended to encompass a range of arrangements put in place to allocate the income tax liabilities of the head company across the group. The most common form of distribution would involve subsidiaries making contributions to assist the head company with payment of the liabilities of the group [Schedule 6, item 1, paragraph 110-30(3)(a)]. Another potential type of distribution is where payments are made to subsidiaries in recognition that their activities or attributes have caused an overall reduction in the consolidated group tax-related liabilities of the head company [Schedule 6, item 1, paragraph 110-30(3)(b)].

Example 5.1

Alexander Co. is the head company of the Conquest consolidated group. The subsidiary members of that group are Caesar Co. and Napoleon Co. During the 2005-2006 income year, Napoleon Co. is involved in the disastrous Waterloo Project that results in that company making substantial losses that have the effect of reducing the overall income tax liability for the Conquest consolidated group. Alexander Co., Caesar Co. and Napoleon Co. have entered into an agreement that makes provision for Alexander Co. to make a payment to Napoleon Co. in respect of the effect of these losses on the tax-related liabilities of the head company. This aspect of the agreement will meet the criteria for dealing with the distribution described in paragraph 110-30(1)(b) of the GST Act.

5.26 The distribution can also take into account distributions made to or from former members of the group, as far as they concern the consolidated group tax-related liabilities of the head company.

Example 5.2

During the 2006-2007 income year, 100% of the membership interests in Caesar Co. are bought in a hostile takeover by Brutus Ltd. After Caesar Co. has left the Conquest consolidated group, an amended assessment is raised in respect of Caesar Co.'s activities when it was a member of the group. The agreement provides that Caesar Co. pay an amount to Alexander Co. in respect of the amended assessment. This aspect of the agreement will meet the criteria for dealing with the distribution described in paragraph 110-30(1)(b) of the GST Act.

5.27 Definitions of the terms member of a consolidated group and tax-related liabilities are inserted in the GST dictionary by reference to section 703-15 of the ITAA 1997 and section 255-1 in Schedule 1 to the TAA 1953 respectively [Schedule 6, items 7 and 9, section 195-1]. The note at the end of the definition of a taxable supply is amended to include references to sections 110-15, 110-20, 110-25 and 110-30 [Schedule 6, item 8, section 195-1].

Application and transitional provisions

5.28 The amendments apply, and are taken to have applied, in relation to net amounts for tax periods starting or that started on or after 1 July 2002, which is the commencement date for the consolidation regime. [Schedule 6, item 11]

Chapter 6 - Imputation for life insurance companies

Outline of chapter

6.1 Schedule 7 to this bill amends Part 3-6 of the ITAA 1997 to include imputation rules for life insurance companies. The rules generally replicate the former imputation rules that applied to life insurance companies in Part IIIAA of the ITAA 1936.

6.2 Broadly, the provisions are concerned with setting out the circumstances when franking credits and debits arise in franking accounts of life insurance companies from:

•

the payment and refund of tax; and

•

the receipt of franked dividends.

6.3 The provisions also include some special rules to handle the transition from the old imputation system to the new SIS.

Context of amendments

6.4 These rules have been developed to complement the core SIS rules introduced in the New Business Tax System (Imputation) Act 2002 which applied from 1 July 2002.

6.5 These amendments reflect the rules and terminology of the SIS, and use clearer and more accessible drafting techniques developed as part of the tax law improvement project. They also condense the ITAA 1936 provisions whilst retaining the key features of the imputation system for life insurance companies. While this bill contains the core imputation rules for life insurance companies, further rules dealing with venture capital franking and franking deficit tax offset entitlements will be introduced as soon as practicable.

Summary of new law

6.6 Schedule 7 amends Part 3-6 of the ITAA 1997 to deal with the entries made by life insurance companies to their franking accounts. As a general principle, the new provisions replicate the provisions of the former imputation system relating to life insurance companies. However, the main departures from the former rules include:

•

the removal of the over-estimation penalty that applied where life insurance companies over-estimated the total number of franking credits they were entitled to receive during the income year;

•

the removal of the holding period requirement in respect of franking credits arising from the receipt of franked dividends; and

•

clarification of the franking credits or debits that arise from an amended assessment that alters the proportion of income tax attributable to shareholders.

[Schedule 7, item 4, section 219-55]

6.7 In addition, this bill:

•

clarifies the residency requirement in subparagraph 205-25(1)(a)(i) in respect of events that occur before the end of the income year [Schedule 7, item 3, subsection 205-25(1)];

•

provides some transitional provisions ensuring the correct application of the rules in the income year ending, or straddling, 1 July 2002 [Schedule 7, item 9];

•

provides a simpler mechanism for franking credits and debits when a PAYG instalment variation credit is claimed and applied by a life insurance company;

•

clarifies the method of determining the amount of income tax that is considered to be attributable to shareholders [Schedule 7, item 4, section 219-50]; and

•

clarifies the timing of a franking credit in circumstances where a company receives a franked distribution indirectly through a partnership or trust [Schedule 7, item 2, section 205-15; item 4, subsection 219-15(3)].

6.8 The provisions apply from 1 July 2002, consistent with existing provisions comprising the SIS. Although the rules are retrospective, they do not adversely effect life insurance companies or their shareholders. If the rules did not apply from this date, life insurance companies would not have an imputation regime applying to their individual circumstances. Furthermore, the rules have been developed in consultation with the life insurance industry. Industry support the amendments, including the application date.

Conversion of old provisions into equivalent new provisions

6.9 One of the main features of the new rules is the simplification benefit gained from collapsing 14 different franking credit and debit provisions that existed under the old rules, into a single set of rules provided in 2 different tables. The conversion of the old provisions to the equivalent new provision is set out in Table 6.1.

Detailed explanation of new law

Background

6.10 Australia's dividend imputation system is designed to prevent the double taxation of company profits. Without such a system, company profits could potentially be taxed at the company level and taxed again when those profits are distributed to individual shareholders in the form of dividends.

6.11 The imputation system prevents the double taxation of company profits by allowing the company to impute to its shareholders (as an imputation credit attached to a franked dividend) the tax that it has paid on the income that it distributes to them. In the case where a company makes a distribution to another company, the imputation system provides a mechanism to allow the receiving company to record the amount of tax that has been paid by the dividend paying company so that it can, in turn, impute that tax to its own individual shareholders. This mechanism is referred to as a franking account.

6.12 Life insurance companies differ from ordinary companies in that, under the imputation system, some components of their income is treated as if it is the final individual taxing point, while other income is treated as though it is available for distribution to the ultimate individual shareholders of the company.

6.13 Because of this unique treatment, franking credits and debits only arise in the franking account of life insurance companies to the extent that the payment or refund of tax or the receipt of franked dividend income is attributable to the shareholders of the company.

6.14 However, life insurance companies are not able to determine the extent to which a payment or refund of tax or the receipt of franked dividend income is attributable to shareholders until assessment, which occurs after the end of the income year.

6.15 To allow life insurance companies access to franking credits before assessment, life insurance companies can estimate the extent to which certain transactions are reasonably attributable to the shareholders of the company. Upon assessment, the estimated franking credits and debits are reversed and reinstated in accordance with the actual extent to which tax is attributable to shareholders.

6.16 This general scheme, which is inserted as Division 219 of the ITAA 1997, is explained in further detail below.

Initial franking credits arising from PAYG instalments

6.17 Franking credits arise from the payment of PAYG instalments as set out in item 1 in the table contained in subsection 219-15(2). This provision is the equivalent of section 160APVJ of the ITAA 1936. [Schedule 7, item 4, subsection 219-15(2), item 1 in the table]

6.18 In order for a franking credit to arise under item 1, the following 4 conditions must be satisfied:

•

the company pays a PAYG instalment;

•

the company satisfies the residency requirement;

•

the payment is made before the company's assessment day; and

•

the company is a franking entity.

[Schedule 7, item 4, subsection 219-15(2), item 1 in the table]

What is a PAYG instalment?

6.19 Section 205-20 defines when a company pays a PAYG instalment. Importantly, a PAYG instalment will only be taken to have been made if a liability to pay a PAYG instalment has arisen. The amount of that liability is the full PAYG instalment reduced by the amount of any PAYG instalment variation credit applied by the company. These rules have been simplified, with the application of an instalment variation credit no longer considered to be a payment of a PAYG instalment. The application of this rule is shown in Example 6.2.

What is the residency requirement?

6.20 The residency test is set out in section 205-25. In summary, this section provides that a life insurance company will satisfy the residency requirement for an income year if the company:

•

is an Australian resident for more than a half of the immediately preceding 12 months, where the payment occurs within the relevant income year;

•

is an Australian resident at all times during the income year, where the payment occurs after the relevant income year; or

•

is an Australian resident for at least 6 months of the year.

[Schedule 7, item 3, subsection 205-25(1)]

When is the company's assessment day?

6.21 Section 219-45 sets out when a company's assessment day will be taken to occur. This will be the earlier of:

•

the day on which the company furnishes its income tax return for the relevant income year; or

•

the day on which the Commissioner makes such an assessment (including an assessment that the company has no income tax liability).

[Schedule 7, item 4, section 219-45]

What is a franking entity?

6.22 The test for what is a franking entity is contained in the core SIS rules that apply to ordinary companies. These rules explain that life insurance companies that are not mutual life insurance companies will be franking entities.

What is the amount of the franking credit?

6.23 If the 4 conditions in paragraph 6.18 are satisfied, a franking credit will arise in the franking account of the company. To work out the amount of the franking credit the life insurance company must:

•

estimate that part of the payment that is attributable to the shareholders' share of the income tax liability of the company for the income year; and

•

determine that part of the payment that is attributable to the period during which the company was a franking entity.

[Schedule 7, item 4, subsection 219-15(2), item 1 in the table]

6.24 The method statement contained in section 219-50 must be used by life insurance companies to estimate that part of the PAYG payment that is attributable to the shareholders' share of the income tax liability. The method statement sets out in 3 steps how this must be calculated.

•

The first step requires companies to make a reasonable estimate of the amount of income tax that will be attributable to shareholders at assessment. This is referred to as the 'shareholders' share'.

•

The second step requires life insurance companies to divide the shareholders' share by the total income tax liability, the resulting amount is referred to as the 'shareholders' ratio'.

•

The third and final step is to apply the shareholders' ratio to the amount of the PAYG instalment.

[Schedule 7, item 4, section 219-50]

6.25 The result of this calculation provides the amount of the franking credit that arises. A comprehensive example illustrating this process is set out in Example 6.1. When using the method statement, the life insurance company must consider their accounting records. [Schedule 7, item 4, subsection 219-50(4)]

When does the franking credit arise?

6.26 Item 1 in the table in subsection 219-15(2) explains that a franking credit arises on the day on which the payment is made.

Reversing franking debits arising upon assessment

6.27 Upon assessment, when the actual component of tax attributable to shareholders becomes known, the initial franking credits that arose under item 1 in the table in subsection 219-15(2) are reversed with a franking debit under item 1 in the table in subsection 219-30(2). This provision is the equivalent of section 160AQCNCB of the ITAA 1936. [Schedule 7, item 4, subsection 219-30(2), item 1 in the table]

6.28 In order for a franking debit to arise under item 1, a franking credit must have first arisen under item 1 in the table in subsection 219-15(2) (i.e. for the payment of a PAYG instalment).

6.29 If so, a franking debit of the amount of the credit that arose under item 1 in the table in section 219-15 will arise in the franking account of the life insurance company on their assessment day. [Schedule 7, item 4, subsection 219-30(2), item 1 in the table]

Reinstating franking credits for PAYG instalments upon assessment

6.30 After the initial franking credits arising from PAYG instalments have been reversed in accordance with item 1 in the table in subsection 219-30(2), it is necessary to reinstate franking credits reflecting the assessed component of income tax liability attributable to shareholders. These franking credits are provided for in item 2 in the table in subsection 219-15(2), replicating section 160APVK of the ITAA 1936. [Schedule 7, item 4, subsection 219-15(2), item 2 in the table]

6.31 In order for these franking credits to arise, the equivalent conditions contained in item 1 (pays a PAYG instalment, the residency requirements, and franking entities) must also be satisfied. Further, the method statement contained in section 219-50 must be applied to calculate the amount of franking credit that arises. The resulting franking credit arises in the franking account of the life insurance company on the company's assessment day. [Schedule 7, item 4, subsection 219-15(2), item 2 in the table]

Franking credits for PAYG instalments after assessment

6.32 In cases where PAYG instalments are made after the company's assessment day (i.e. late payments), franking credits will arise under item 3 in the table in subsection 219-15(2), the equivalent of section 160APVL of the ITAA 1936. Unlike credits under item 1 in the table in subsection 219-15(2), these credits are not reversed because payment occurs on or after assessment when the tax attributable to shareholders will be known. [Schedule 7, item 4, subsection 219-15(2), item 3 in the table]

6.33 In order for the franking credit to arise, the equivalent conditions in item 1 in the table in subsection 219-15(2) must also be satisfied and the method statement contained in section 219-50 must be applied. The franking credit will arise on the day on which the company pays the PAYG instalment. [Schedule 7, item 4, subsection 219-15(2), item 3 in the table]

Franking credits arising for tax paid on or after assessment

6.34 If a life insurance company is required to pay any form of income tax after their assessment day, a franking credit will arise under item 4 in the table in subsection 219-15(2), the equivalent of section 160APVM of the ITAA 1936. The payment of income tax would include an additional payment related to an income tax assessment, payments made as a result of an amended assessment, or the payment of excess foreign tax credits. [Schedule 7, item 4, subsection 219-15(2), item 4 in the table]

6.35 The franking credit that arises on the day the payment of income tax is made is subject to the equivalent conditions relating to residency and franking entities in item 1 in the table in subsection 219-15(2). When calculating the franking credit that will be generated by the payment, the life insurance company must apply the method statement in section 219-50. [Schedule 7, item 4, subsection 219-15(2), item 4 in the table]

6.36 In the case of an amended assessment that alters the proportion of income tax attributable to shareholders (i.e. amends the shareholders' ratio), and where the franking account would have a different balance if the new ratio had been used, then a franking credit or debit (as appropriate), will arise in the franking account of the company on the date of the amended assessment. [Schedule 7, item 4, section 219-55]

Franking credits arising for the receipt of franked dividends (both direct and indirect)

6.37 If a life insurance company receives a franked distribution either directly or indirectly through a partnership or trust, a franking credit will arise in the company's franking account under item 5 or 6 in the table in subsection 219-15(2), the equivalent of subsections 160APP(5) and 160APQ(3) of the ITAA 1936. [Schedule 7, item 4, subsection 219-15(2), items 5 and 6 in the table]

6.38 In order for franking credits to arise under these items, the following conditions must be met:

•

the company receives a distribution;

•

the company is entitled to a tax offset under Division 207; and

•

the tax offset the company is entitled to is not subject to the refundable tax offset rules in Division 67.

[Schedule 7, item 4, subsection 219-15(2), items 5 and 6 in the table]

6.39 In addition, the equivalent conditions in item 1 in the table in subsection 219-15(2) (the residency requirement and franking entity requirement) must be satisfied.

When is a company entitled to a tax offset under Division 207?

6.40 The distribution the life insurance company receives must satisfy all the requirements under Division 207. Division 207 generally provides that if a corporate tax entity makes a franked distribution to one of its members, then an amount equal to the franking credit on the distribution is included in the member's assessable income and the member is entitled to a tax offset of the same amount. This Division contains a residency requirement in section 207-75 that the member receiving the distribution must satisfy to obtain the tax offset.

When is the tax offset not subject to the refundable tax offset rules in Division 67?

6.41 Division 67 sets out circumstances in which a life insurance company can obtain a refundable tax offset. Broadly, the rules apply where a distribution is made to a membership interest that is held on behalf of policyholders.

What is the amount of the franking credit?

6.42 The franking credit that arises will be the amount of the tax offset. [Schedule 7, item 4, subsection 219-15(2), items 5 and 6 in the table]

When does the credit arise?

6.43 Where a life insurance company receives a distribution directly, the franking credit will arise on the day on which the distribution is made.

6.44 In the case of a franked distribution received indirectly through a partnership or trust, subsection 219-15(3) establishes that the franking credit will arise at the end of the income year in which the franked distribution flows to the life insurance company, that is an income year of the last partnership or trust interposed between:

•

the life insurance company; and

•

the corporate tax entity that made the distribution.

[Schedule 7, item 4, subsection 219-15(3)]

6.45 To clarify the operation of this rule for ordinary companies, an equivalent provision for companies other than life companies has been inserted into section 205-15 of the ITAA 1997. [Schedule 7, item 2, section 205-15]

Franking credits arising for the payment of franking deficit tax

6.46 Consistent with the rules that apply to ordinary companies, life insurance companies receive a franking credit for a liability to pay franking deficit tax under item 7 in the table in subsection 219-15(2). The franking credit is equal to the amount of the liability and will arise in the franking account immediately after the liability is incurred. [Schedule 7, item 4, subsection 219-15(2), item 7 in the table]

Franking debits for refunds of tax occurring on or after assessment

6.47 When a life insurance company receives a refund of income tax, franking debits will arise under item 2 in the table in subsection 219-30(2), the equivalent of section 160AQCNCD of the ITAA 1936. [Schedule 7, item 4, subsection 219-30(2), item 2 in the table]

6.48 In order for franking debits to arise under this item the company must receive a refund of income tax and the equivalent conditions contained in item 1 in the table in subsection 219-15(2) must be satisfied. The method statement contained in section 219-50 must be applied in calculating the amount of the franking debit. The franking debit arises in the franking account on the day the refund is received. [Schedule 7, item 4, subsection 219-30(2), item 2 in the table]

Comprehensive examples

Example 6.1: General application of rules

Instalment 1

X Co is a life insurance company whose instalment income for the first quarter is $1,000,000, with a PAYG instalment rate of 10%. As such, X Co pays a PAYG instalment of $100,000 (their instalment liability for the first instalment period). Using the method statement in section 219-50 it estimates that the amount of this payment that will be attributable to the shareholders' share of income tax liability will be $80,000. This is a result of the following calculation.

•

Under step 1 of the method statement, X Co estimates, after considering its accounting records, that for this income year, $384,000 will be attributable to shareholders (the shareholders' share).

•

Under step 2 of the method statement, X Co estimates that its total income tax liability for this income year will be $480,000. Therefore, the shareholders' ratio will be 0.8 ($384,000 ? $480,000).

•

Step 3 of the method statement then requires X Co to multiply the shareholders' ratio by the amount of the payment. As such, the amount of the first PAYG instalment for this year that is attributable to shareholders, will be $80,000.

Therefore the payment of $100,000 will generate $80,000 in franking credits.

The balance of the company's franking account is $80,000.

Instalment 2

X Co's PAYG instalment liability for the second quarter of the income year is $110,000, and the company remains satisfied that the shareholders' ratio should remain unchanged, at 0.8. Under step 3 of the method statement, X Co will calculate a franking credit of $88,000.

The balance of the franking account is $168,000.

Instalment 3

X Co's PAYG instalment liability for the third quarter of the income year is $112,000, with the shareholders' ratio unchanged at 0.8. Under step 3 of the method statement, X Co will calculate a franking credit of $89,600.

The balance of the franking account is $257,600.

Instalment 4

X Co's PAYG instalment liability for the final quarter of the income year is $148,000, with the shareholders' ratio unchanged at 0.8. Under step 3 of the method statement X Co will calculate a franking credit of $118,400.

The balance of the franking account is $376,000.

Assessment

On assessment, the company determines that its income tax liability for the income year is $500,000 and of this amount $450,000 is attributable to shareholders.

On assessment, the credits that had arisen in relation to payment of PAYG instalments will be reversed, and reinstated reflecting the shareholders' ratio determined on assessment.

A franking debit of $376,000 will arise under item 1 in the table in subsection 219-30(2) reversing the franking credits that arose under item 1 in the table in subsection 219-15(2).

In order to reinstate the franking credits in accordance with the shareholders' ratio as determined on assessment, X Co applies the method statement.

•

Step 1: $450,000 of the total income tax liability is attributable to shareholders.

•

Step 2: Given the total income tax liability of $500,000, the shareholders' ratio is 0.9. This differs from the estimated shareholders' ratio of 0.8.

•

Step 3: This ratio is applied to the total PAYG instalment payments and provides a franking credit under item 2 in the table in subsection 219-15(2) of $423,000.

As the company will also be required to pay a wash-up payment of $30,000 on assessment, a further franking credit of $27,000 arises at the time of assessment under item 4 in the table in subsection 219-15(2).

Example 6.2: Variation of a PAYG instalment rate

X Co is a life insurance company whose instalment income for the first quarter is $1,000,000, with a PAYG instalment rate of 15%. As such, X Co pays a PAYG instalment of $150,000 (their instalment liability for the first instalment period).

Using the method statement in section 219-50, X Co estimates that the shareholders' ratio is 0.8 and, as such, a franking credit will arise of $120,000 under item 1 in the table in subsection 219-15(2).

Following the first instalment, X Co varies its instalment rate to 10% and consequently applies for a PAYG instalment variation credit of $50,000. No franking debit will arise as a result of the application of the PAYG instalment variation credit.

This PAYG instalment variation credit is then used to reduce the second PAYG instalment, with an additional payment made of $50,000 (as the company remains satisfied that the shareholders' ratio should remain unchanged at 0.8, then $40,000 of this amount is attributable to shareholders). A franking credit of $40,000 will then arise under item 1 in the table in subsection 219-15(2). No franking credit arises as a result of the application of the PAYG instalment variation credit.

The third and fourth PAYG instalments are payments of $100,000 in each quarter (with the shareholders' ratio unchanged at 0.8, $80,000 is attributable to shareholders). A franking credit of $80,000 will then arise in each quarter under item 1 in the table in subsection 219-15(2).

On assessment a franking debit will arise under item 1 in the table in subsection 219-30(2) of $320,000 (the total of franking credits arisen under item 1 in the table in subsection 219-15(2)). In accordance with the method statement in section 219-50, the shareholders' ratio determined on assessment was 0.8. A credit of $320,000 will therefore arise under item 2 in the table in subsection 219-15(2) of the ITAA 1997.

The balance of the franking account with respect to this income year is $320,000.

Example 6.3: Amendment of the proportion attributable to shareholders

X Co, a life insurance company, paid 4 PAYG instalments of $100,000 with respect to an income year.

Applying the method statement in section 219-50, X Co estimates that their shareholders' ratio is 0.85. A franking credit of $85,000 would therefore have arisen with respect to each quarter.

One year later, an amendment to X Co's assessment reflects that only 0.8 of the total income tax liability was attributable to shareholders.

Therefore $80,000 of franking credits should have arisen for each PAYG instalment (totalling $320,000). A franking debit of $20,000 will therefore arise under section 219-55 on the day the Commissioner made the amended assessment.

	Franking credit	Franking debit
PAYG instalment 1 paid: $100,000.	$85,000
PAYG instalment 2 paid: $100,000.	$85,000
PAYG instalment 3 paid: $100,000.	$85,000
PAYG instalment 4 paid: $100,000.	$85,000
Balance in franking account on assessment.	$340,000
Debit on amended assessment.		$20,000
Balance on amended assessment.	$320,000

Application

6.49 These rules apply from the commencement of the SIS regime (i.e. 1 July 2002).

Transitional provisions

6.50 In order to allow the new law to interface with the previous rules for life insurance companies, 2 transitional provisions have been included specifically for life insurance companies.

6.51 The first transitional rule is needed to take into account that the SIS rules moved to a 'tax paid' franking account from 1 July 2002 and the reversal of franking credit entries that occurred prior to this date will not be expressed in the equivalent currency.

6.52 The first rule applies to all franking credits arising before 1 July 2002 in respect of an income year under section 160APVJ of the ITAA 1936 in relation to a PAYG instalment, where the assessment day for that income year occurs on or after 1 July 2002.

•

These credits are reversed on the assessment day, by a franking debit equal to the franking credits (on a tax paid basis).

•

The provision also applies item 2 in the table in subsection 219-15(2) to reinstate the credits, as if the PAYG instalments had occurred after 1 July 2002.

[Schedule 7, item 9, section 219-40]

6.53 For example, if a company generates $210,000 in franking credits under section 160APVJ before 1 July 2002, those franking credits will be reversed on assessment with an equivalent franking debit of $90,000.

6.54 The second transitional rule reverses, on a tax paid basis, a franking debit that has arisen before 1 July 2002 under section 160AQCNCE of the ITAA 1936 in relation to a PAYG instalment variation credit, where the assessment day for that income year occurs on or after 1 July 2002.

•

This transition rule is required as section 160APVN of the ITAA 1936 has not been replicated as a result of simplifying the law. That provision reversed a franking debit that had arisen under section 160AQCNCE on assessment.

•

The franking credit will arise on 1 July 2002.

[Schedule 7, item 9, section 219-45]

Example 6.4: Transitional provisions regarding PAYG instalment variation credits

Note: for ease of explanation this example assumes that franking accounts were maintained on a tax-paid prior to 1 July 2002.

X Co is a life insurance company whose income year ends on 30 June. In respect of its 2002 income year, it has paid 3 PAYG instalments prior to 1 July 2002, and one after 1 July 2002. X Co's instalment income for each quarter was $1,000,000 and the initial PAYG instalment rate was 11%.

On the payment of the first instalment of $110,000, X Co estimated that 80% of the instalment was attributable to shareholders funds income. As such, a franking credit of $88,000 arose in X Co's franking account under section 160APVJ of the ITAA 1936.

Following the first instalment, X Co varied its instalment rate to 10% and claimed a PAYG instalment variation credit of $10,000. As X Co's estimate that 80% was attributable to shareholders funds income remained unchanged, a franking debit of $8,000 arose under section 160AQCNCE of the ITAA 1936.

This PAYG instalment variation credit was then used to reduce the second PAYG instalment, with an additional payment made of $90,000. Again, 80% of the payment was estimated to be attributable to shareholders funds income, and a franking credit of $80,000 arose under section 160APVJ of the ITAA 1936, in relation to both the use of the PAYG instalment variation credit and the additional payment.

The third PAYG instalment was a payment of $100,000, with 80% estimated to be attributable to shareholders funds income. A franking credit of $80,000 arose under section 160APVJ of the ITAA 1936.

On 1 July 2002, a credit arises under section 219-45 of the IT(TP) Act 1997. This franking credit of $8,000 is equal, on a tax-paid basis, to the debit that previously arose under section 160AQCNCE of the ITAA 1936.

As the fourth PAYG instalment was paid after 1 July 2002, a credit of $80,000 arises under item 3 in the table in subsection 219-15(2) of the ITAA 1997.

On assessment day:

a debit will arise of $248,000, under section 219-40 of the IT(TP) Act 1997, reversing the credits that have previously arisen under section 160APVJ of the ITAA 1936 with respect to PAYG instalments;

a further debit of $80,000 will arise under item 1 in the table in subsection 219-30(2), reversing the credit that has previously arisen under item 3 in the table in subsection 219-15(2) with respect to the fourth PAYG instalment; and

a credit of $320,000 will arise under item 2 in the table in subsection 219-15(2) of the ITAA 1997. This credit is with respect to the PAYG instalments paid before 1 July 2002 (through the operation of subsection 219-40(3) of the IT(TP) Act 1997), and with respect to the PAYG instalment paid after 1 July 2002.

The following entries arose in the franking account of X Co:

	Franking credit	Franking debit
Instalment 1. Credit arises under section 160APVJ of the ITAA 1936.	$88,000
PAYG instalment variation credit of $10,000 issued. Debit arises under section 160AQCNCE of the ITAA 1936.		$8,000
Instalment 2. Credit arises under section 160APVJ of the ITAA 1936.	$80,000
Instalment 3. Credit arises under section 160APVJ of the ITAA 1936.	$80,000
1 July 2002 - credit arises under section 219-45 of the IT(TP) Act 1997	$8,000
Instalment 4. Credit arises under item 3 in the table in subsection 219-15(2) of the ITAA 1997.	$80,000
Assessment day - debit arises under section 219-40 of the IT(TP) Act 1997		$248,000
Assessment day - debit arises under item 1 in the table in subsection 219-30(2) of the ITAA 1997.		$80,000
Assessment day - credit arises under item 2 in the table in subsection 219-15(2) of the ITAA 1997.	$320,000
Balance in franking account	$320,000

Chapter 7 - Overseas forces tax offsets

Outline of chapter

7.1 Schedule 8 to this bill amends the overseas forces tax offset provisions of the ITAA 1936 to exclude periods of service for which an income tax exemption for foreign employment income is available.

Context of amendments

7.2 Under the overseas forces tax offset provisions, periods of service that entitle a taxpayer to either the overseas defence force tax offset or the UN armed forces tax offset exclude any period of service for which an income tax exemption applies for periods of 'warlike service' under section 23AC or 23AD of the ITAA 1936, or for service with the UN in Cambodia under section 23ADA of the ITAA 1936.

7.3 However, periods of service that entitle a taxpayer to either the overseas defence force tax offset or the UN armed forces tax offset do not exclude a period of service for which an income tax exemption for foreign employment income is available under section 23AG of the ITAA 1936.

7.4 The amendments rectify this inconsistency and provide equitable treatment to taxpayers entitled to an exemption under section 23AG of the ITAA 1936 and to taxpayers entitled to an exemption under sections 23AC, 23AD or 23ADA.

Summary of new law

7.5 The amendments ensure that a period of service that entitles a taxpayer to either the overseas defence force tax offset or the UN armed forces tax offset excludes a period of service for which an income tax exemption for foreign employment income is available under section 23AG of the ITAA 1936.

Detailed explanation of new law

7.6 Schedule 8 removes the entitlement to the UN armed forces tax offset for a period of service where an income tax exemption for foreign employment income is available under section 23AG of the ITAA 1936 for the same period of service. [Schedule 8, item 1, subsection 23AB(8A)]

7.7 For example, a taxpayer may qualify for an exemption under section 23AG of the ITAA 1936 for a period of service in East Timor. Currently, this period of service may also qualify as service for the purposes of the UN armed forces tax offset under section 23AB of the ITAA 1936. The amendment ensures that the taxpayer cannot claim both the tax offset and the tax exemption for the same period of service.

7.8 Schedule 8 also removes the entitlement to the overseas defence force tax offset for a period of service where an income tax exemption for foreign employment income is available under section 23AG of the ITAA 1936 for the same period of service. [Schedule 8, item 2, subsection 79B(3A)]

7.9 For example, an ADF member serving overseas in a declared locality in a 'non-warlike' situation may qualify for an exemption under section 23AG of the ITAA 1936. Currently, this period of service may also qualify for the overseas defence force tax offset under section 79B of the ITAA 1936. The amendment ensures that the ADF member cannot claim both the tax offset and the tax exemption for the same period of service.

Application provisions

7.10 The amendments apply from 1 July 2001 as announced in former Assistant Treasurer's Press Release No. 28 on 28 June 2001.

7.11 The amendments were first announced by the Government on 22 May 2001 in the 2001-2002 Federal Budget. The Government's proposal to rectify the inconsistency in the tax law was announced before the former Assistant Treasurer announced the prospective application date. The amendments are to apply from 1 July 2001 to ensure that taxpayers do not seek to take advantage of the inconsistency in the tax law contrary to the Government's announced measure.

Chapter 8 - Roll-over for financial services reform transitions

Outline of chapter

8.1 Schedule 9 to this bill amends the ITAA 1997 to provide an automatic CGT roll-over for financial service providers on transition to the FSR regime when, during the FSR transitional period:

•

an existing statutory licence, registration or authority is replaced with an Australian financial services licence;

•

a qualified Australian financial services licence is replaced with an Australian financial services licence; and

•

an intangible CGT asset is replaced with another intangible CGT asset.

8.2 The CGT roll-over will ensure that the capital gain or capital loss that would otherwise be made when the original asset comes to an end is deferred until a CGT event happens to the replacement asset.

Context of amendments

8.3 The FSR regime aims to reform and consolidate regulation of the financial services sector and affects most financial services and products. The objective of the FSR regime is to ensure that:

•

comparable financial products are subject to the same rules;

•

providers of financial services are subject to the same licensing regime;

•

the same disclosure standards apply to similar products; and

•

financial markets are each subject to a single licensing regime.

8.4 The FSR regime generally came into effect on 11 March 2002. However, financial service providers who were operating under the pre-FSR regime have a 2 year period for the transition of diverse licensing arrangements, services and products to the FSR framework.

8.5 Financial service providers have raised concerns that the potential CGT consequences arising on the transition to the FSR regime are an impediment to moving to the FSR regime. The amendments will remove that impediment.

Summary of new law

8.6 An automatic CGT roll-over will apply when, during the period from 11 March 2002 to 10 March 2004 inclusive (the FSR transitional period):

•

an existing statutory licence, registration or authority is replaced with an Australian financial services licence;

•

a qualified Australian financial services licence is replaced with an Australian financial services licence; and

•

an intangible CGT asset is replaced with another intangible CGT asset.

8.7 The replacement Australian financial services licence or intangible CGT asset can be held by:

•

the owner of the original licence, registration, authority, qualified Australian financial services licence or intangible CGT asset;

•

a company or trust in the same consolidatable group as the owner of the original licence, registration, authority, qualified Australian financial services licence or other intangible CGT asset; or

•

a company or fixed trust that is wholly-owned by the owner of the original licence, registration, authority, qualified Australian financial services licence or other intangible CGT asset.

8.8 The effect of the CGT roll-over is that:

•

the capital gain or capital loss that would otherwise be made when the original asset (i.e. the statutory licence, registration, authority, qualified Australian financial services licence or other intangible CGT asset) comes to an end is disregarded - recognition of the accrued gain or loss is deferred until a CGT event happens to the replacement asset; and

•

if the original asset was acquired before 20 September 1985, the asset's pre-CGT status is attributed to the replacement asset.

Comparison of key features of new law and current law

Detailed explanation of new law

8.9 Schedule 9 to this bill inserts new Subdivision 124-O into the ITAA 1997. The new Subdivision provides 6 automatic CGT roll-overs for financial service providers on transition to the FSR regime:

•

the old licence roll-over (same owner) - that is, when an existing statutory licence, registration or authority is replaced during the FSR transitional period with an Australian financial services licence that is held by the owner of the original licence, registration or authority;

•

the old licence roll-over (new owner) - that is, when an existing statutory licence, registration or authority is replaced during the FSR transitional period with an Australian financial services licence that is held by:

-

a company or trust in the same consolidatable group as the owner of the original licence, registration or authority; or

-

a company or fixed trust that is wholly-owned by the owner of the original licence, registration or authority;

•

the qualified licence roll-over (same owner) - that is, when a qualified Australian financial services licence is replaced during the FSR transitional period with an Australian financial services licence that is held by the owner of the original qualified licence;

•

the qualified Australian financial services licence roll-over (new owner) - that is, when a qualified Australian financial services licence is replaced during the FSR transitional period with an Australian financial services licence that is held by:

-

a company or trust in the same consolidatable group as the owner of the original qualified Australian financial services licence; or

-

a company or fixed trust that is wholly-owned by the owner of the original qualified Australian financial services licence;

•

the rights roll-over (same owner) - that is, when an intangible CGT asset is replaced during the FSR transitional period with another intangible CGT asset that is held by the owner of the original intangible CGT asset; and

•

the rights roll-over (new owner) - that is, when an intangible CGT asset is replaced during the FSR transitional period with another intangible CGT asset that is held by:

-

a company or trust in the same consolidatable group as the owner of the original intangible CGT asset; or

-

a company or fixed trust that is wholly-owned by the owner of the original intangible CGT asset.

Old licence roll-over (same owner)

8.10 A key feature of FSR is that it imposes a new uniform licensing regime for financial service providers. Consequently, existing statutory licences, registrations or other authorities issued to financial service providers under various laws will be replaced with Australian financial services licences.

8.11 An Australian financial services licence is defined to have the meaning given by section 761A of the Corporations Act 2001. [Schedule 9, item 16, definition of 'Australian financial services licence' in subsection 995-1(1)]

8.12 Section 761A of the Corporations Act 2001 defines an Australian financial services licence to mean a licence issued under section 913B that authorises a person who carries on a financial services business to provide financial services. Such a licence may be granted either to an applicant seeking to commence a financial services business or to an applicant who already conducts such a business.

8.13 Prior to the granting of an Australian financial services licence, an applicant who conducts a financial services business is subject to regulation under the relevant old legislation (as defined in section 1430 of the Corporations Act 2001). Licences, registrations or authorities issued under the relevant old legislation, as in force at any time before 11 March 2002, cease to have effect when an Australian financial services licence is issued.

8.14 A licence, registration or authority issued under the relevant old legislation is an intangible CGT asset that may come to an end when it ceases to have effect because an Australian financial services licence is issued to the licence holder. If an intangible CGT asset does come to an end, there is a disposal of a CGT asset (CGT event C2) that may give rise to a capital gain or capital loss.

8.15 In some cases part of an old licence may continue to have effect after the Australian financial services licence is granted to the licence holder. That is, the Australian financial services licence may cover only some of the activities of the licence holder. In this event, it will be a question of fact as to whether CGT event C2 happens because the old licence, or part of the old licence, comes to an end.

Conditions for an old licence roll-over (same owner)

8.16 The old licence roll-over (same owner) applies if an old licence or licences held by the licence holder cease to have effect (whether wholly or partly) because that licence holder:

•

is granted an Australian financial services licence during the FSR transitional period; or

•

applies for an Australian financial services licence during the FSR transitional period and, as a result of the application, is subsequently granted an Australian financial services licence.

[Schedule 9, item 13, section 124-880]

8.17 In addition, to qualify for the old licence roll-over, the Australian financial services licence must cover some or all of the activities that the old licence or licences authorised the licence holder to carry on. [Schedule 9, item 13, paragraph 124-880(d)]

8.18 An old licence is any licence, registration, approval, authority or other similar thing that gave the holder the status of a regulated principal within the meaning of section 1430 of the Corporations Act 2001. [Schedule 9, item 13, paragraph 124-880(b)]

8.19 A regulated principal is essentially a person who conducts a financial services business and includes the holder of a dealers licence, investment advisers licence, futures brokers licence or future advisers licence and a registered insurance broker before the transition to FSR. A regulated principal also includes a person who is listed in Regulation 10.2.38 of the Corporations Regulations 2001.

8.20 The old licence or licences are taken to have authorised the regulated principal to carry on certain activities if they had the effect of making those activities lawful under the relevant old legislation. For example, registration of an insurance broker under the Insurance (Agents and Brokers) Act 1984, which made it lawful for a person to carry on business as an insurance broker, is taken to have authorised that person to carry on that business.

Consequences of an old licence roll-over (same owner)

8.21 The consequences of same owner roll-overs are set out in section 124-895. That section applies separately to:

•

old licence roll-overs (same owner);

•

qualified licence roll-overs (same owner); and

•

rights roll-overs (same owner).

8.22 Section 124-895 provides that the consequences of an old licence roll-over (same owner) are generally set out in Subdivision 124-A (with 2 modifications). [Schedule 9, item 13, subsection 124-895(1)]

8.23 The general Subdivision 124-A consequences that apply to an old licence roll-over (same owner) are:

•

the capital gain or capital loss made when the old licence comes to an end is disregarded - recognition of the accrued capital gain or capital loss is deferred until a CGT event happens to the replacement Australian financial services licence;

•

if the old licence or licences were acquired by the licence holder on or after 20 September 1985, then the cost base and reduced cost base of the old licence or licences is attributed to the first element of the cost base and reduced cost base of the replacement Australian financial services licence; and

•

if the old licence or licences were acquired by the licence holder before 20 September 1985, then the replacement Australian financial services licence will be taken to have been acquired before that day - that is, the pre-CGT status of the old licence or licences will be preserved.

8.24 The first modification to the general Subdivision 124-A consequences is that any amount paid (including the giving of property) to get the replacement Australian financial services licence will be included in the first element of the cost base and reduced cost base of the replacement asset. This will include any incidental costs, such as fees paid on application for the Australian financial services licence. [Schedule 9, item 13, subsection 124-895(2)]

8.25 The second modification to the general Subdivision 124-A consequences is that, if the licence owner has more than one licence and some of those licences were acquired before 20 September 1985, then:

•

to the extent that part of the replacement Australian financial services licence relates to one or more old licences acquired by the licence holder before 20 September 1985, that part is taken to be a separate asset that is acquired before 20 September 1985 - that is, it will be taken to be a pre-CGT asset; and

•

the first element of the cost base and reduced cost base of the asset which represents the remaining part of the replacement Australian financial services licence includes:

-

the cost base and reduced cost base of the old licence or licences acquired by the licence holder on or after 20 September 1985; and

-

such part of any amount paid to get the replacement Australian financial services licence as is reasonably attributed to the part of the asset that is taken to be acquired by the licence holder on or after 20 September 1985.

[Schedule 9, item 13, subsections 124-895(3) to (7)]

8.26 If an old licence that was acquired on or after 20 September 1985 ceases to only partly have effect, then the amount of cost base or reduced cost base that is attributed to the replacement Australian financial services licence is such part of the cost base of the old licence that is reasonably attributable to the part of the old licence that ceases to have effect. [Schedule 9, item 13, subsection 124-895(8)]

Old licence roll-over (new owner)

8.27 Under the FSR regime, in certain circumstances, financial service providers may provide financial services under the authority of an Australian financial services licence held by another person. In this event, the original licence holder is exempt from holding an Australian financial services licence. However, the original licence holder's old licence, registration or authority will cease to have effect and is effectively replaced with an Australian financial services licence that is held by that other person.

8.28 A licence, registration or authority issued under the relevant old legislation is an intangible CGT asset that may come to an end when it ceases to have effect because the original licence holder is covered by an exemption from holding an Australian financial services licence. If an intangible CGT asset does come to an end, there is a disposal of a CGT asset (CGT event C2) by the original licence holder that may give rise to a capital gain or capital loss.

8.29 In some cases, part of an old licence may continue to have effect after the Australian financial services licence is granted. That is, the Australian financial services licence may cover only some of the activities of the original licence holder. In this event, it will be a question of fact as to whether CGT event C2 happens because the old licence, or part of the old licence, comes to an end.

Conditions for an old licence roll-over (new owner)

8.30 The old licence roll-over (new owner) applies if:

•

a person (the new owner) applies for an Australian financial services licence during the FSR transitional period;

•

at the time the application is made, another person (the original owner) holds one or more old licences; and

•

the original owner and the new owner are appropriately connected.

[Schedule 9, item 13, subsection 124-900(1)]

8.31 In addition, if the Australian financial services licence is granted to the new owner during the FSR transitional period, the old licence roll-over (new owner) will apply only if an old licence or licences held by the original owner cease to have effect (whether wholly or partly) because, as a result of the Australian financial services licence being granted to the new owner, the original owner starts to be covered by an exemption under subsection 911A(2) of the Corporations Act 2001 in respect of the original owner's regulated activities. [Schedule 9, item 13, paragraph 124-900(1)(d)]

8.32 Alternatively, if the Australian financial services licence is granted to the new owner after the end of the FSR transitional period, the old licence roll-over (new owner) will apply provided that:

•

the old licence or licences held by the original owner cease to have effect (whether wholly or partly) at the end of the FSR transitional period; and

•

if the Australian financial services licence had been granted to the new owner during the FSR transitional period, the old licence or licences held by the original owner would have ceased to have effect (whether wholly or partly) because the original owner would have started to have been covered by an exemption under subsection 911A(2) of the Corporations Act 2001 in respect of the original owner's regulated activities.

[Schedule 9, item 13, paragraph 124-900(1)(e)]

8.33 An old licence is any licence, registration, approval, authority or other similar thing that gave the holder the status of a regulated principal within the meaning of section 1430 of the Corporations Act 2001. [Schedule 9, item 13, paragraph 124-900(1)(b)]

8.34 A regulated principal is essentially a person who conducts a financial services business and includes the holder of a dealers licence, investment advisers licence, futures brokers licence or future advisers licence and a registered insurance broker before the transition to FSR. A regulated principal also includes a person who is listed in Regulation 10.2.38 of the Corporations Regulations 2001.

8.35 The original owner may be exempt from holding an Australian financial services licence under subsection 911A(2) of the Corporations Act 2001 in respect of a financial service they provide where they provide that service as a representative of the new owner. The new owner must carry on a financial services business and, generally, hold an Australian financial services licence that covers the provision of the service.

8.36 If the original owner is a company or trust, the original owner and the new owner will be appropriately connected if, at the time the new owner acquires the Australian financial services licence, the original owner and new owner are members of the same consolidatable group. [Schedule 9, item 13, subsection 124-900(2)]

8.37 A consolidatable group is defined in section 703-10 of the ITAA 1997 and consists broadly of a head entity and its wholly-owned subsidiaries. A wholly-owned subsidiary includes a company or trust where all the membership interests are wholly-owned by other members of the consolidatable group.

8.38 If the original owner is an individual, the original owner and the new owner will be appropriately connected if, at the time the new owner acquires the Australian financial services licence:

•

the new owner is a company that is wholly-owned by the original owner; or

•

the new owner is a trust where:

-

CGT event E4 is capable of applying to all the units and interests of the trust (i.e. broadly, where the trust is a fixed trust); and

-

all the membership interests in the trust are wholly-owned by the original owner.

[Schedule 9, item 13, paragraph 124-900(3)(a)]

8.39 In addition, at the same time as or just after the new owner acquires the Australian financial services licence, the original owner must become:

•

an authorised representative of the new owner - an authorised representative is defined in section 761A of the Corporations Act 2001 to be a person authorised in accordance with section 916A or 916B of that Act to provide a financial service or financial services on behalf of the financial services licensee;

•

an employee of the new owner; or

•

a director (within the meaning of the Corporations Act 2001) of the new owner - a director is defined in section 9 of that Act to mean, broadly, a person who is appointed to the position of a director or alternate director (regardless of the name given to their position).

[Schedule 9, item 13, paragraph 124-900(3)(b)]

Consequences of an old licence roll-over (new owner) where one original old licence comes to an end

8.40 The consequences of new owner roll-overs where one CGT asset comes to an end are set out in section 124-915. That section applies separately to:

•

old licence roll-overs (new owner);

•

qualified licence roll-overs (new owner); and

•

rights roll-overs (new owner).

8.41 Section 124-915 provides that the consequences of an old licence roll-over (new owner) where the original owner's ownership of a single old licence comes to an end and is replaced with an Australian financial services licence are:

•

the capital gain or capital loss made by the original owner when the old licence comes to an end is disregarded - recognition of the accrued capital gain or capital loss is deferred until a CGT event happens to the replacement Australian financial services licence held by the new owner;

•

if the original owner acquired the old licence on or after 20 September 1985, then the first element of the cost base and reduced cost base of the replacement Australian financial services licence held by the new owner includes:

-

the cost base and reduced cost base of the old licence; and

-

any amount paid (including the giving of property) to get the replacement Australian financial services licence. This will include any incidental costs, such as fees paid on application for the Australian financial services licence; and

•

if the original owner acquired the old licence before 20 September 1985, then the replacement Australian financial services licence will be taken to have been acquired before that day - that is, the pre-CGT status of the old licence will be preserved.

[Schedule 9, item 13, subsections 124-915(1) to (6)]

8.42 If the old licence was acquired on or after 20 September 1985 and ceases to only partly have effect, then the amount of cost base or reduced cost base that is attributed to the replacement Australian financial services licence is such part of the cost base of the old licence that is reasonably attributable to the part of the old licence that ceases to have effect. [Schedule 9, item 13, subsection 124-915(7)]

Consequences of an old licence roll-over (new owner) where 2 or more old licences come to an end

8.43 The consequences of new owner roll-overs where 2 or more CGT assets come to an end are set out in section 124-920. As qualified licence roll-overs (new owner) involve only a single CGT asset coming to an end, section 124-920 has no relevance to those roll-overs. However, section 124-920 applies separately to:

•

old licence roll-overs (new owner); and

•

rights roll-overs (new owner).

8.44 Section 124-920 provides that the consequences of an old licence roll-over where the original owner's ownership of 2 or more old licences come to an end and is replaced with an Australian financial services licence are:

•

the capital gain or capital loss made by the original owner when each old licence comes to an end is disregarded - recognition of the accrued capital gain or capital loss is deferred until a CGT event happens to the replacement Australian financial services licence held by the new owner;

•

if the original owner acquired all the old licences on or after 20 September 1985, then the first element of the cost base and reduced cost base of the replacement Australian financial services licence held by the new owner includes:

-

the cost base and reduced cost base of all of the old licences; and

-

any amount paid (including the giving of property) to get the replacement Australian financial services licence. This will include any incidental costs, such as fees paid on application for the Australian financial services licence; and

•

if the original owner acquired all the old licences before 20 September 1985, then the replacement Australian financial services licence will be taken to have been acquired before that day - that is, the pre-CGT status of the old licences will be preserved.

[Schedule 9, item 13, subsections 124-920(1) to (6)]

8.45 In addition, if the original owner acquired some (but not all) of the old licences before 20 September 1985, then the replacement Australian financial services licence is taken to be 2 assets. That is:

•

to the extent that it relates to old licences that were acquired before 20 September 1985, part of the replacement Australian financial services licence is taken to be a separate asset that was acquired before 20 September 1985 - that is, the pre-CGT status of those old licences will be preserved; and

•

to the extent that it relates to old licences that were acquired on or after 20 September 1985, part of the replacement Australian financial services licence is taken to be a separate asset that was acquired on or after 20 September 1985. The first element of the cost base or reduced cost base of this separate asset is the sum of:

-

the total cost base or bases of the old licence or licences that were acquired on or after 20 September 1985; and

-

that part of any amount paid (including the giving of property) to get the replacement Australian financial services licence that is reasonably attributable to that part of the licence that is taken to be acquired on or after 20 September 1985. This will include an appropriate share of any incidental costs, such as fees paid on application for the Australian financial services licence.

[Schedule 9, item 13, subsections 124-920(7) to (10)]

8.46 If an old licence that was acquired on or after 20 September 1985 ceases to only partly have effect, then the amount of cost base or reduced cost base that is attributed to the replacement Australian financial services licence is such part of the cost base of the old licence that is reasonably attributable to the part of the old licence that ceases to have effect. [Schedule 9, item 13, subsection 124-920(11)]

Qualified licence roll-over (same owner)

8.47 A special qualified Australian financial services licence may be issued to an insurance multi-agent during the FSR transitional period.

8.48 An insurance multi-agent is defined in section 1434 of the Corporations Act 2001 to mean a person who is an insurance intermediary (but not an insurance broker) within the meaning of the Insurance (Agents and Brokers) Act 1984 and who has agreements with 2 or more different insurers under that Act.

8.49 The qualified licence gives insurance multi-agents additional time to meet the competency requirements imposed on holders of Australian financial services licences during the FSR transitional period. The qualified licences are limited to dealing and providing financial advice only in relation to risk insurance and investment life insurance products.

8.50 A qualified Australian financial services licence issued to an insurance multi-agent ceases to be in force (unless earlier revoked) at the end of the FSR transitional period. The qualified licence is revoked before the end of the FSR transitional period if it is replaced with an Australian financial services licence during that period.

8.51 A qualified Australian financial services licence issued to an insurance multi-agent is an intangible CGT asset that comes to an end when it is revoked or ceases to be in force. This constitutes a disposal of a CGT asset (CGT event C2) that may give rise to a capital gain or capital loss.

Conditions for a qualified licence roll-over (same owner)

8.52 The qualified licence roll-over (same owner) applies if a qualified Australian financial services licence issued to an insurance multi-agent is revoked because that insurance multi-agent:

•

is granted an Australian financial services licence during the FSR transitional period; or

•

applies for an Australian financial services licence during the FSR transitional period and, as a result of the application, is subsequently granted an Australian financial services licence.

[Schedule 9, item 13, section 124-885]

Consequences of a qualified licence roll-over (same owner)

8.53 The consequences of same owner roll-overs are set out in section 124-895. That section applies separately to:

•

old licence roll-overs (same owner);

•

qualified licence roll-overs (same owner); and

•

rights roll-overs (same owner).

8.54 Section 124-895 provides that the consequences of a qualified licence roll-over (same owner) are generally set out in Subdivision 124-A (with one modification). [Schedule 9, item 13, subsection 124-895(1)]

8.55 The general Subdivision 124-A consequences that apply to a qualified licence roll-over (same owner) are:

•

the capital gain or capital loss made when a qualified licence comes to an end is disregarded - recognition of the accrued capital gain or capital loss is deferred until a CGT event happens to the replacement Australian financial services licence; and

•

the cost base and reduced cost base of the qualified licence is attributed to the first element of the cost base and reduced cost base of the replacement Australian financial services licence.

8.56 In addition, any amount paid (including the giving of property) to get the replacement Australian financial services licence will be included in the first element of the cost base and reduced cost base of the replacement asset. This will include any incidental costs, such as fees paid on application for the Australian financial services licence. [Schedule 9, item 13, subsection 124-895(2)]

Qualified licence roll-over (new owner)

8.57 Under the FSR regime, in certain circumstances, insurance multi-agent's may provide financial services under the authority of an Australian financial services licence held by another person. In this event, the insurance multi-agent is exempt from holding an Australian financial services licence. However, the qualified Australian financial services licence will be revoked and is effectively replaced with an Australian financial services licence that is held by that other person.

8.58 In these circumstances, the qualified Australian financial services licence is an intangible CGT asset that comes to an end when it is revoked because the original qualified licence holder is covered by an exemption from holding an Australian financial services licence. This constitutes a disposal of a CGT asset (CGT event C2) by the insurance multi-agent (the original owner) that may give rise to a capital gain or capital loss.

Conditions for a qualified licence roll-over (new owner)

8.59 The qualified licence roll-over (new owner) applies if:

•

a person (the new owner) applies for an Australian financial services licence during the FSR transitional period;

•

at the time the application is made, another person (the original owner) holds a qualified Australian financial services licence; and

•

the original owner and the new owner are appropriately connected.

[Schedule 9, item 13, subsection 124-905(1)]

8.60 In addition, if the Australian financial services licence is granted to the new owner during the FSR transitional period, the qualified licence roll-over (new owner) will apply only if the qualified Australian financial services licence is revoked as a result of the Australian financial services licence being granted to the new owner. [Schedule 9, item 13, paragraph 124-905(1)(d)]

8.61 Alternatively, if the Australian financial services licence is granted to the new owner after the end of the FSR transitional period, the qualified licence roll-over (new owner) will apply provided that:

•

the qualified Australian financial services licence held by the original owner ceases to have effect at the end of the FSR transitional period; and

•

if the Australian financial services licence had been granted to the new owner during the FSR transitional period, the qualified Australian financial services licence held by the original owner would have been revoked as a result of the Australian financial services licence being granted to the new owner.

[Schedule 9, item 13, paragraph 124-905(1)(e)]

8.62 If the original owner is a company or trust, the original owner and the new owner will be appropriately connected if, at the time the new owner acquires the Australian financial services licence, the original owner and new owner are members of the same consolidatable group. [Schedule 9, item 13, subsection 124-905(2)]

8.63 A consolidatable group is defined in section 703-10 of the ITAA 1997 and consists broadly of a head entity and its wholly-owned subsidiaries. A wholly-owned subsidiary includes a company or trust where all the membership interests are wholly-owned by other members of the consolidatable group.

8.64 If the original owner is an individual, the original owner and the new owner will be appropriately connected if, at the time the new owner acquires the Australian financial services licence:

•

the new owner is a company that is wholly-owned by the original owner; or

•

the new owner is a trust where:

-

CGT event E4 is capable of applying to all the units and interests of the trust (i.e. broadly, a trust that is a fixed trust); and

-

all the membership interests in the trust are wholly-owned by the original owner.

[Schedule 9, item 13, paragraph 124-905(3)(a)]

8.65 In addition, at the same time as or just after the new owner acquires the Australian financial services licence, the original owner must become:

•

an authorised representative of the new owner - an authorised representative is defined in section 761A of the Corporations Act 2001 to be a person authorised in accordance with section 916A or 916B of that Act to provide a financial service or financial services on behalf of the financial services licensee;

•

an employee of the new owner; or

•

a director (within the meaning of the Corporations Act 2001) of the new owner - a director is defined in section 9 of that Act to mean, broadly, a person who is appointed to the position of a director or alternate director (regardless of the name given to their position).

[Schedule 9, item 13, paragraph 124-905(3)(b)]

Consequences of a qualified licence roll-over (new owner)

8.66 The consequences of new owner roll-overs where one CGT asset comes to an end are set out in section 124-915. That section applies separately to:

•

old licence roll-overs (new owner);

•

qualified licence roll-overs (new owner); and

•

rights roll-overs (new owner).

8.67 Section 124-915 provides that the consequences of a qualified licence roll-over (new owner) are:

•

the capital gain or capital loss made by the original owner when the qualified Australian financial services licence comes to an end is disregarded - recognition of the accrued capital gain or capital loss is deferred until a CGT event happens to the replacement Australian financial services licence held by the new owner; and

•

the first element of the cost base and reduced cost base of the replacement Australian financial services licence held by the new owner includes:

•

the cost base and reduced cost base of the qualified Australian financial services licence; and

•

any amount paid (including the giving of property) to get the replacement Australian financial services licence. This will include any incidental costs, such as fees paid on application for the Australian financial services licence.

[Schedule 9, item 13, subsections 124-915(1) to (6)]

Rights roll-over (same owner)

8.68 A consequence of FSR is that existing contracts that created rights (such as a right to income or other intangible CGT assets) held by financial services providers may expire and be replaced with new contracts during the FSR transitional period. This constitutes a disposal of a CGT asset (CGT event C2) that may give rise to a capital gain or capital loss.

Conditions for a rights roll-over (same owner)

8.69 The rights roll-over (same owner) applies if:

•

one or more intangible CGT assets held by a person who carries on financial services business cease to exist during the FSR transitional period;

•

the asset or assets cease to exist because of the termination of one or more contracts;

•

the termination is directly connected with Chapter 7 of the Corporations Act 2001 beginning to apply to the person - that is, the termination must be connected with (but not necessarily required by) the person's transition to the FSR regime; and

•

the person acquires one or more intangible CGT assets by entering into one or more contracts which wholly or partly replace the contract or contracts that were terminated - in this regard the replacement contract could be with a different party to the original contract.

[Schedule 9, item 13, section 124-890]

Consequences of a rights roll-over (same owner)

8.70 The consequences of same owner roll-overs are set out in section 124-895. That section applies separately to:

•

old licence roll-overs (same owner);

•

qualified licence roll-overs (same owner); and

•

rights roll-overs (same owner).

8.71 Section 124-895 provides that the consequences of a rights roll-over (same owner) are generally set out in Subdivision 124-A (with 2 modifications). [Schedule 9, item 13, subsection 124-895(1)]

8.72 The general Subdivision 124-A consequences that apply to a rights roll-over (same owner) are:

•

the capital gain or capital loss made when the original asset comes to an end is disregarded - recognition of the accrued capital gain or capital loss is deferred until a CGT event happens to the replacement asset;

•

if the original asset or all the original assets were acquired on or after 20 September 1985, then the cost base and reduced cost base of the original asset or assets is attributed to the first element of the cost base and reduced cost base of the replacement asset or assets; and

•

if the original asset or all the original assets were acquired before 20 September 1985, then the replacement asset or assets will be taken to have been acquired before that day - that is, the pre-CGT status of the original asset or assets will be preserved.

8.73 The first modification to the general Subdivision 124-A consequences is that any amount paid (including the giving of property) to get the replacement asset or assets will be included in the first element of the cost base and reduced cost base of the replacement asset or assets. [Schedule 9, item 13, subsection 124-895(2)]

8.74 The second modification to the general Subdivision 124-A consequences is that, where 2 or more original intangible CGT assets come to an end and some of those assets were acquired before 20 September 1985, then:

•

to the extent that each replacement asset (or part of a replacement asset) relates to one or more original assets acquired before 20 September 1985, that replacement asset (or part of a replacement asset) is taken to be a separate asset that is acquired before 20 September 1985 - that is, it will be taken to be a pre-CGT asset; and

•

the first element of the cost base and reduced cost base of any remaining assets includes the cost base and reduced cost base of the original assets acquired on or after 20 September 1985 and either:

•

any amount paid (including the giving of property) to get the replacement asset; or

•

for a replacement asset, part of which is treated as a separate asset and taken to be acquired before 20 September 1985, such part of any amount paid to get the replacement asset as is reasonably attributed to the part of the asset that is taken to be acquired on or after 20 September 1985.

[Schedule 9, item 13, subsections 124-895(3) to (7)]

Rights roll-over (new owner)

8.75 The original owner of rights (such as a right to income or other intangible CGT asset) may choose for another person (the new owner) to conduct their financial services business after the original owner's transition to FSR.

8.76 In this event, the existing contracts that create intangible CGT assets that are held by the original owner may expire during the FSR transitional period and be replaced by contracts held by the new owner. This constitutes a disposal of a CGT asset (CGT event C2) by the original owner that may give rise to a capital gain or capital loss.

Conditions for a rights roll-over (new owner)

8.77 The rights roll-over (new owner) applies if:

•

one or more intangible CGT assets owned by a person who carries on financial services business (the original owner) cease to exist during the FSR transitional period;

•

the asset or assets cease to exist because of the termination of one or more contracts;

•

the termination is directly connected with the original owner choosing that another person (the new owner) will conduct the original owner's financial services business that is regulated under Chapter 7 of the Corporations Act 2001 - that is, the termination must be connected with (but not necessarily required by) the original owner's transition to the FSR regime;

•

the new owner acquires one or more intangible CGT assets by entering into one or more contracts which wholly or partly replace the contract or contracts that were terminated - in this regard the replacement contract could be with a different party to the original contract; and

•

the original owner and the new owner are appropriately connected.

[Schedule 9, item 13, subsection 124-910(1)]

8.78 If the original owner is a company or trust, the original owner and the new owner will be appropriately connected if, at the time the new owner acquires the intangible CGT asset, the original owner and new owner are members of the same consolidatable group. [Schedule 9, item 13, subsection 124-910(2)]

8.79 A consolidatable group is defined in section 703-10 of the ITAA 1997 and consists broadly of a head entity and its wholly-owned subsidiaries. A wholly-owned subsidiary includes a company or trust where all the membership interests are wholly-owned by other members of the consolidatable group.

8.80 If the original owner is an individual, the original owner and the new owner will be appropriately connected if, at the time the new owner acquires the intangible CGT asset:

•

the new owner is a company that is wholly-owned by the original owner; or

•

the new owner is a trust where:

-

CGT event E4 is capable of applying to all the units and interests of the trust (i.e. broadly, where the trust is a fixed trust); and

-

all the membership interests in the trust are wholly-owned by the original owner.

[Schedule 9, item 13, paragraph 124-910(3)(a)]

8.81 In addition, at the same time as or just after the new owner acquires the Australian financial services licence, the original owner must become:

•

an authorised representative of the new owner - an authorised representative is defined in section 761A of the Corporations Act 2001 to be a person authorised in accordance with section 916A or 916B of that Act to provide a financial service or financial services on behalf of the financial services licensee;

•

an employee of the new owner; or

•

a director (within the meaning of the Corporations Act 2001) of the new owner - a director is defined in section 9 of that Act to mean, broadly, a person who is appointed to the position of a director or alternate director (regardless of the name given to their position).

[Schedule 9, item 13, paragraph 124-910(3)(b)]

Consequences of rights roll-over (new owner) where one CGT asset comes to an end

8.82 The consequences of new owner roll-overs where one CGT asset comes to an end are set out in section 124-915. That section applies separately to:

•

old licence roll-overs (new owner);

•

qualified licence roll-overs (new owner); and

•

rights roll-overs (new owner).

8.83 Section 124-915 provides that the consequences of a rights roll-over (new owner) where the original owner's ownership of a single original CGT asset comes to an end are:

•

the capital gain or capital loss made by the original owner when the original asset comes to an end is disregarded - recognition of the accrued capital gain or capital loss is deferred until a CGT event happens to the replacement asset held by the new owner;

•

if the original owner acquired the original asset on or after 20 September 1985, then the first element of the cost base and reduced cost base of the replacement asset or assets includes:

-

the cost base and reduced cost base of the original asset that is attributed to the first element of the cost base and reduced cost base of the replacement asset or assets; and

-

any amount paid (including the giving of property) in entering into a new contract or contracts or other incidental costs to get the replacement asset or assets; and

•

if the original owner acquired the original asset before 20 September 1985, then the replacement asset or assets will be taken to have been acquired before that day - that is, the pre-CGT status of the original asset will be preserved.

[Schedule 9, item 13, subsections 124-915(1) to (6)]

Consequences of a rights roll-over (new owner) where 2 or more CGT assets come to an end

8.84 The consequences of new owner roll-overs where 2 or more CGT assets come to an end are set out in section 124-920. As qualified licence roll-overs (new owner) involve only a single CGT asset coming to an end, section 124-920 has no relevance to those roll-overs. However, section 124-920 applies separately to:

•

old licence roll-overs (new owner); and

•

rights roll-overs (new owner).

8.85 Section 124-920 provides that the consequences of a rights roll-over (new owner) where the original owner's ownership of 2 or more original CGT assets come to an end are:

•

the capital gain or capital loss made by the original owner when each original asset comes to an end is disregarded - recognition of the accrued capital gain or capital loss is deferred until a CGT event happens to the replacement asset or assets held by the new owner;

•

if the original owner acquired all the original assets on or after 20 September 1985, then the first element of the cost base and reduced cost base of the replacement asset or assets held by the new owner includes:

-

the cost base and reduced cost base of all of the original assets; and

-

any amount paid (including the giving of property) to get the replacement asset or assets; and

•

if the original owner acquired all the original assets before 20 September 1985, then the replacement asset or assets will be taken to have been acquired before that day - that is, the pre-CGT status of the original assets will be preserved.

[Schedule 9, item 13, subsections 124-920(1) to (6)]

8.86 In addition, if the original owner acquired some (but not all) of the original assets before 20 September 1985, then:

•

to the extent that each replacement asset (or part of a replacement asset) relates to one or more original assets acquired before 20 September 1985, that replacement asset (or part of a replacement asset) is taken to be a separate asset that is acquired before 20 September 1985 - that is, it will be taken to be a pre-CGT asset; and

•

the first element of the cost base and reduced cost base of any remaining assets includes the cost base and reduced cost base of the original assets acquired on or after 20 September 1985 and either:

-

any amount paid (including the giving of property) to get the replacement asset; or

-

for a replacement asset, part of which is treated as a separate asset and taken to be acquired before 20 September 1985, such part of any amount paid to get the replacement asset as is reasonably attributed to the part of the asset that is taken to be acquired on or after 20 September 1985.

[Schedule 9, item 13, subsections 124-920(7) to (10)]

Capital improvements to pre-CGT assets

8.87 Section 108-75 of the ITAA 1997 provides that, in certain circumstances, capital improvements to certain pre-CGT assets (including statutory licences) for which a roll-over is available are treated as separate assets for CGT purposes.

8.88 The amendments ensure that section 108-75 applies to Australian financial services licences acquired as the result of a roll-over under new Subdivision 124-O in the same way that it applies to other statutory licences acquired as a result of a roll-over under Subdivision 124-C. [Schedule 9, item 2, subsection 108-75(2)]

CGT small businesses concessions

8.89 Division 152 of the ITAA 1997 provides 4 CGT concessions to small businesses.

8.90 Subdivision 152-A outlines the basic conditions for relief under Division 152. One of those conditions is the active asset test in section 152-35, which requires the CGT asset to be an active asset both at a particular time and for half a particular period. That is, if the business has not ceased and the asset has been owned for less than 15 years, the CGT asset must be an active asset just before the CGT event and for at least half the period of ownership. If the asset has been owned for more than 15 years, it only needs to be an active asset for at least half of the 15 year period ending at the time of the CGT event or the small business ceasing if earlier.

8.91 The time periods for the active asset test are modified for assets acquired as a result of an FSR transition roll-over to ensure that, for the purposes of applying these tests, the replacement asset is taken to be acquired at the time the original asset was acquired. [Schedule 9, item 14, subsections 152-45(1A) and (1B)]

8.92 Subdivision 152-B provides small businesses with an exemption from a capital gain arising on a CGT asset that has been owned continuously for at least 15 years provided certain conditions are met. The time periods for applying the 15-year test are modified for assets acquired as a result of an FSR transition roll-over to ensure that the replacement asset is taken to be acquired at the time the original asset was acquired. [Schedule 9, item 15, subsections 152-115(1A) and (1B)]

Discount capital gains

8.93 Section 115-25 provides that capital gains arising from a CGT event happening to a CGT asset after 21 September 1999 that was acquired at least 12 months before the CGT event are treated as discount capital gains.

8.94 Section 115-30 contains special rules about the time of acquisition for these purposes. Item 2 in the table in section 115-30 provides that a CGT asset acquired as a replacement asset for a replacement-asset roll-over (including an FSR transition roll-over) is taken to be acquired at the time the original asset was acquired.

Application and transitional provisions

8.95 The FSR transition roll-overs are available only if a CGT event happens to a relevant CGT asset during the FSR transitional period - that is, between 11 March 2002 and 10 March 2004 (inclusive). [Schedule 9, items 13 and 17, sections 124-880, 124-885, 124-890, 124-900, 124-905 and 124-910]

Extension of the FSR transitional period

8.96 Subsection 1437(3) of the Corporations Act 2001 gives ASIC the power to make a declaration to extend the FSR transitional period.

8.97 If ASIC makes a declaration to extend the FSR transitional period, the FSR transition roll-overs will be available for relevant CGT events that happen before the end of the last day of the period declared by ASIC. [Schedule 9, item 13, sections 124-925 and 124-930]

Consequential amendments

Separate CGT assets

8.98 Section 108-50 of the ITAA 1997 provides some guide material on when building and structures, adjacent land and capital improvements to a CGT asset are treated as separate CGT assets. The note in section 108-50 makes reference to the additional circumstances in which separate CGT asset treatment can apply. As sections 124-895, 124-910 and 124-915 contain separate CGT asset treatment for the FSR transition roll-overs, the relevant note in section 108-50 is amended to make a reference to these sections. [Schedule 9, item 1, section 108-50]

Acquisition rules

8.99 Section 109-55 of the ITAA 1997 contains a table which outlines CGT acquisition rules which apply in specific situations and which are dealt with in specific provisions covering those situations. This table has been amended to make reference to the FSR transition roll-overs with respect to a replacement asset or part of a replacement asset that relates to a pre-1985 original asset in sections 124-895, 124-915 and 124-920. [Schedule 9, items 3 and 4, section 109-55]

General rules for replacement-asset roll-overs

8.100 Each of the FSR transition roll-overs involve an existing CGT asset being replaced with a new CGT asset - that is, the roll-overs are replacement-asset roll-overs.

8.101 Therefore, the table in section 112-115 of the ITAA 1997, which contains a list of replacement-asset roll-overs, is amended to make a reference to the FSR transition roll-overs in new Subdivision 124-O. [Schedule 9, item 5, section 112-115]

8.102 Section 124-5, which provides some guide material for replacement-asset roll-overs, is amended to make a reference to the FSR transition roll-overs in new Subdivision 124-O. [Schedule 9, item 6 subsection 124-5(1)]

8.103 The notes in subsections 124-5(1) and (2) are also amended to make reference to the FSR transition roll-overs for new owners in Subdivision 124-O. [Schedule 9, items 7 to 9, subsections 124-5(1) and (2)]

8.104 Section 124-10 outlines the general consequences of replacement-asset roll-overs. Notes in section 124-10 make references to variations to those general consequences for some specific replacement-asset roll-overs. As new Subdivision 124-O makes variations to the general consequences for specific replacement-asset roll-overs for each of the FSR transition roll-overs, the relevant notes in section 124-10 are amended to make a reference to new Subdivision 124-O. [Schedule 9, items 10 and 11, subsection 124-10(3)]

8.105 Subsection 124-15(5) provides a rule where there is more than one original asset, some of those assets were acquired before 20 September 1985 to determine whether the replacement assets are taken to pre-CGT assets. A note is inserted into this section to indicate that section 124-895 provides a different rule for FSR transition roll-overs. [Schedule 9, item 12, subsection 124-15(5)]

Chapter 9 - Foreign hybrids

Outline of chapter

9.1 Schedule 10 to this bill contains amendments to change the taxation treatment of investments in foreign limited partnerships and other foreign hybrids such as US LLCs. The amendments also deal with issues that arise where an entity becomes a foreign hybrid and where it ceases to be one. This chapter explains these amendments, concluding with a discussion of when the new rules apply and of some modifications to the law for past years.

Context of amendments

9.2 The entities affected by the amendments are collectively referred to as foreign hybrids (e.g. UK and US limited partnerships and limited liability partnerships, US LLCs and other companies to be listed in regulations). Typically, a foreign hybrid is effectively treated for foreign tax purposes as a partnership (i.e. the partner or member is subject to tax) but it is taxed as a company under Australia's current taxation laws.

9.3 The current corporate tax treatment for foreign hybrids means that taxpayers with interests in them may be subject to the CFC rules or FIF rules. The CFC rules, and to a lesser extent the FIF rules, do not effectively cater for foreign hybrids because those rules are based on a company model and, in particular, assume that the company and not the member is taxed by other countries.

9.4 The CFC rules broadly include requirements that the CFC be subject to foreign tax (as one of many rules for assigning residency) and pay the foreign tax (in calculating attributable income). The FIF rules include the latter requirement. However, these requirements are unable to be met in the case of a foreign hybrid as it is the partner (or member) that is subject to the foreign tax.

9.5 The application of these rules has led to the attribution of a wider range of income than is intended (because the active income test cannot be used and through attribution of comparably taxed income), the risk of double taxation (through failure to provide relief) and significant compliance costs (e.g. including increased uncertainty).

9.6 In the Minister for Revenue and Assistant Treasurer's Press Release C26/03 of 8 April 2003, the Government announced the change to the taxation treatment of certain foreign hybrids. They will be treated as partnerships (instead of as companies) for the purposes of Australia's income tax laws. Because of this change in treatment for many existing entities, rules are required to deal with that transition, especially to avoid it becoming a taxable event and to transfer asset values from the entity to the new partners. Other amendments will be made to deal with the income years prior to the start date for partnership treatment to help clarify the application of the law in those years.

9.7 These amendments will provide certainty and remove unintended consequences for taxpayers that result from the current taxation treatment of investments in foreign hybrids under the CFC regime, and to a lesser extent the FIF regime.

9.8 With the change to partnership treatment, limited partners in a limited partnership or the members of a US LLC would be able to claim deductions for tax losses to which they were not exposed economically because of their limited liability. For this reason, rules are introduced to limit foreign hybrid related losses which can be used by a limited partner to offset against any other assessable income from sources outside of the foreign hybrid. Similar loss limitation rules were introduced for venture capital limited partnerships. Other jurisdictions, including Canada, New Zealand, the UK and the USA, also have rules to limit the pass through of losses to partners with limited liability.

9.9 The modifications to the tax law for certain past income years are intended to deal with the significant long-standing uncertainty that has existed around the application of the CFC rules (and to a lesser extent the FIF rules) for taxpayers with interests in foreign hybrids. This is particularly so in relation to the residence of the foreign hybrid, which is a central issue in the application of the CFC rules.

9.10 Another significant problem with the current law concerns the inability of attributable taxpayers to claim deductions or credits for the foreign tax paid on the amount which is attributed to them.

9.11 A more comprehensive solution to deal with the problem will generally operate from the 2003-2004 income year. This solution will align with commercial practices and better aligns the Australian tax treatment with that of the foreign jurisdiction.

Summary of new law

9.12 For a limited partnership that, under Division 5A of Part III of the ITAA 1936 (Division 5A), is a corporate limited partnership and following the amendments in this bill, satisfies the definition of a foreign hybrid limited partnership, the corporate tax treatment overlay of Division 5A will be removed for the purposes of the income tax law. These limited partnerships will therefore be treated as partnerships and subject to Division 5 of Part III of the ITAA 1936 (Division 5).

9.13 Similarly, US LLCs that satisfy the definition of foreign hybrid company and certain companies declared by the regulations to be foreign hybrid companies will be given partnership treatment for the purposes of the income tax law.

9.14 Where the taxpayer's interest in the foreign limited partnership or US LLC would be a FIF interest rather than an interest in a CFC, the taxpayer will have the right to choose whether partnership treatment is to apply to it. The default treatment will be that the interest is still an interest in a FIF.

9.15 One particular outcome from partnership treatment is in the application of the CGT provisions. Under these provisions, the partner has a proportional interest in the assets of the partnership and may have a residual CGT asset because of its interest in the partnership. On application of the new rules, a partner/member must assign a reasonable approximation of a share of the cost for an asset to its interest in each of the foreign hybrid's assets.

9.16 An important feature of the new partnership treatment of foreign hybrids is the inclusion of loss limitation rules. These rules place a limitation on certain losses that may be used by limited partners to offset income from sources other than the foreign hybrid, unlike for ordinary partnerships. Losses subject to the rules will be partnership losses and any net capital loss attributable to the foreign hybrid. The limit will be based on the limited partner's contributions to the foreign hybrid. Where the losses exceed that limit the excess will not be taken into account in calculating taxable income. The limit is adjusted annually for additional contributions or withdrawals and for previous losses taken into account.

9.17 Special rules are inserted to deal with the application of various provisions of the ITAA 1936 and the ITAA 1997, that deal with assessable income or deductions arising from holding assets, when an entity becomes or ceases to be a foreign hybrid. These provisions include those dealing with capital allowances and capital gains and losses. The special rules establish tax values for the partners' interests in the foreign hybrid's assets on it becoming a partnership, and for the foreign hybrid's interest in the assets when it ceases to be a partnership.

9.18 The amendments will apply from the start of the 2003-2004 income year, with taxpayers given an option of an earlier application from the start of the 2002-2003 income year. They will also apply in calculating the attributable income of CFCs for statutory accounting periods commencing on or after 1 July 2003 or their substitutes. Attributable taxpayers will also be able to apply the new treatment from the preceding statutory accounting period by choice.

9.19 Other changes will modify the application of Parts X (about CFCs) and XI (about FIFs) of the ITAA 1936 in relation to foreign hybrids for some past income years by:

•

adding an additional rule to assign the residence of a CFC that is a foreign hybrid to its country of formation; and

•

treating the foreign tax paid by a partner of a foreign hybrid as being paid by the foreign hybrid.

9.20 The modified application of these rules will apply for any years for which an assessment may still be amended. Generally, this is within 4 years after the date of an assessment.

9.21 Taxpayers that have returned income on the basis that their foreign hybrid CFCs are not residents of any particular country will have the option of amending prior-year returns, but will not be required to do so.

Comparison of key features of new law and current law

Detailed explanation of new law

What is a foreign hybrid?

9.22 Foreign hybrid is the term to be used to describe a foreign hybrid limited partnership or a foreign hybrid company, both of which are also defined terms. This definition is relevant for both the purposes of the amendments to treat the foreign hybrid as a partnership (see paragraphs 9.23 to 9.119), and the amendments for past income years (see paragraphs 9.120 to 9.136). [Schedule 10, item 15, section 830-5]

What is a foreign hybrid limited partnership?

9.23 Limited partnerships are already dealt with in the income tax law and are defined in the ITAA 1936 as partnerships where the liability of at least one of the partners is limited. Generally, a limited partnership will be a foreign hybrid limited partnership only if it satisfies 5 conditions. [Schedule 10, item 15, subsection 830-10(1)]

9.24 Firstly, the limited partnership must be formed in a foreign country. What this means is discussed in the explanation of the amendments that give residency for the CFC rules to the place where the entity was formed for some past income years (see paragraphs 9.120 and 9.121). If formed in Australia (and governed by partnership law in Australia), the limited partnership would generally be a resident corporate limited partnership and will not be a foreign hybrid limited partnership. [Schedule 10, item 15, paragraph 830-10(1)(a)]

9.25 Secondly, the limited partnership must be treated, for the purposes of the tax law of the foreign jurisdiction in which it was formed, as a partnership (i.e. foreign tax must be imposed on the partners). It is the fact that the limited partnership is treated on a flow-through basis in the foreign jurisdiction (i.e. as a partnership) which causes the mismatch problems for the application of the CFC and FIF provisions. It is only these limited partnerships that are to be afforded foreign hybrid limited partnership treatment. Therefore, where a limited partnership elects for entity treatment in the foreign jurisdiction, it will not meet this condition and will not be a foreign hybrid. It will continue to be treated as a corporate limited partnership and would in all likelihood be a resident of that country for tax purposes and there would be none of the CFC/FIF problems. [Schedule 10, item 15, paragraph 830-10(1)(b)]

9.26 Thirdly, at no time during the year of income is the limited partnership, for the purposes of the tax law of any foreign country, treated as a resident of that country. This condition ensures that if there is another foreign country (apart from the country of formation) which taxes the limited partnership as a resident entity, it will not qualify as a foreign hybrid. Again where this condition is not met there is no problem for the CFC or FIF rules. [Schedule 10, item 15, paragraph 830-10(1)(c)]

9.27 Fourthly, the limited partnership must not be an Australian resident at any time. Therefore, the limited partnership cannot carry on business in Australia during an income year and qualify as a foreign hybrid limited partnership for that year. [Schedule 10, item 15, paragraph 830-10(1)(d)]

9.28 Finally, the limited partnership must be a CFC with at least one attributable taxpayer having an attribution percentage greater than nil. Generally, this means that there must be at least one Australian taxpayer who has a direct or indirect interest of at least 10% in the limited partnership. Whether the limited partnership is a CFC is tested at the end of its statutory accounting period (as defined in the CFC provisions) that ends in the same year of income for the attributable taxpayer. The effect of this provision is that, as a general rule, only those limited partnerships from which income could be attributed currently under the CFC regime will, subject to meeting the other tests, be foreign hybrids. [Schedule 10, item 15, paragraph 830-10(1)(e)]

What is a foreign hybrid company?

9.29 US LLCs are broadly similar to limited partnerships in terms of tax treatment in the USA and have members with limited liability in the company. US LLCs are clearly companies under Australian tax law, are generally not Australian residents and so would be FIFs or even CFCs. However, because of their ability to elect for partnership treatment for tax purposes in the USA the same problems arise in applying the CFC and FIF provisions to them.

9.30 As a general rule, there are 4 conditions to be met for a US LLC to be a foreign hybrid company. Three of those conditions are identical to requirements for a limited partnership to be a foreign hybrid limited partnership. These are that the US LLC must not be treated as a resident of any foreign country nor can it be an Australian resident and it must qualify as a CFC with an attributable taxpayer having an attribution percentage greater than nil. The requirement to have a non-zero attribution percentage means that those cases where a US LLC (or a limited partnership) is a CFC only because of the interests held by foreign resident associates of an attributable taxpayer will not be foreign hybrids. [Schedule 10, item 15, paragraphs 830-15(1)(b) to (d)]

9.31 The other condition is that the US LLC is treated as a partnership or as a disregarded entity for US income tax purposes. [Schedule 10, item 15, paragraph 830-15(1)(a) and subsection 830-15(2)]

9.32 It is possible that in the future certain other foreign companies that are treated as partnerships by the income tax laws of foreign countries in which they are formed will be prescribed by regulation to be foreign hybrid companies. The requirements to be satisfied to be a foreign hybrid company will not relate to an income year before the one in which the regulations are made. [Schedule 10, item 15, subsections 830-15(3) and (4)]

Election to treat an interest in other limited partnerships or in other companies as an interest in a foreign hybrid

9.33 Although these amendments also deal with entities that are currently dealt with only under the FIF regime, they do not treat such an entity as a foreign hybrid in its own right, but rather treat the interest in the entity as an interest in a foreign hybrid. This is consistent with the policy intent only to change the treatment of taxpayers with FIF interests where they elect for foreign hybrid treatment on a case by case basis. [Schedule 10, item 5, section 485AA of the ITAA 1936]

9.34 For the taxpayer to make the election not to treat its interest in the entity as an interest in a FIF, the limited partnership or company must satisfy several of the conditions discussed in paragraphs 9.24 to 9.31. The entity must not be an Australian resident, it must be treated as a partnership under the tax laws of its country of formation and not as a resident entity by any foreign country. [Schedule 10, item 5, subsections 485AA(1) and (2) of the ITAA 1936]

9.35 Where a taxpayer chooses to make this election, the election should be made before lodgement of the taxpayer's return for the income year (subject to any extensions allowed by the Commissioner) so that no income is attributed from the FIF under Part XI of the ITAA 1936. The election is irrevocable and applies to that income year and all future income years during which the taxpayer has the FIF interest. [Schedule 10, item 5, subsections 485AA(3), (4) and (7) of the ITAA 1936]

9.36 The effect of the election is not to attribute any income from the FIF to the taxpayer for that and future income years [Schedule 10, item 5, subsection 485AA(5) of the ITAA 1936]. Because of this election, the interest in the limited partnership or company becomes an interest in a foreign hybrid for the taxpayer [Schedule 10, item 15, subsections 830-10(2) and 830-15(5)]. However, the election in relation to a particular interest by a taxpayer does not have any effect, including for the purposes of Part XI of the ITAA 1936, in relation to any other interest of this or any other taxpayer in a FIF [Schedule 10, item 5, subsection 485AA(6) of the ITAA 1936].

What is the new tax treatment for a foreign hybrid?

9.37 A foreign hybrid limited partnership will no longer be treated as a company because of Division 5A. The partnership will be dealt with under Division 5 of Part III of the ITAA 1936 with the important modification that deductions for losses of the partnership will be subject to limitation (see paragraphs 9.51 to 9.79). Because it is no longer treated as a company, neither the CFC provisions nor the FIF provisions (for those who so elect) will apply to it, distributions will not be significant for tax purposes and the CGT provisions will apply only to the partners and not to the partnership. [Schedule 10, item 3, subsections 94D(4) and (5) of the ITAA 1936]

9.38 New Subdivision 830-B provides partnership treatment for foreign hybrid companies with the same consequences as for foreign hybrid limited partnerships. [Schedule 10, item 15, Subdivision 830-B]

Partnership tax modifications for foreign hybrid companies

9.39 Broadly, companies to which these provisions apply - foreign hybrid companies - are treated as partnerships for the purposes of the income tax law. They are not treated as companies. Most provisions of the income tax law do not need changes to deal with foreign hybrid companies; the existing provisions generally apply without modification. However, in some areas changes are needed.

9.40 If a company is a foreign hybrid company in relation to a year of income, the income tax law has effect subject to the changes set out in the provisions of the new Subdivision 830-B. The actual parts of the law which are affected are referred to as the foreign hybrid tax provisions and are listed in a definition of that term. It is useful to note that these foreign hybrid tax provisions do not include the new Subdivisions defining foreign hybrids or modifying the law for foreign hybrid companies or for limited partnerships. Where those provisions apply to partnerships they will apply to foreign hybrids. Conversely, a reference in those provisions to a company no longer includes a reference to a foreign hybrid company. In particular, the CFC, and possibly for some taxpayers the FIF provisions, won't apply nor will any provisions dealing with dividends (e.g. sections 23AI and 23AJ of the ITAA 1936). [Schedule 10, item 15, section 830-20 and item 26, definition of 'foreign hybrid tax provisions' in subsection 995-1(1)]

A partner includes a shareholder in the foreign hybrid company

9.41 A reference in the income tax law to a partner in a partnership includes a reference to a shareholder in a foreign hybrid company. Based on the broad meaning of 'share' in the ITAA 1997, shareholder includes a member of a US LLC. Apart from a company listed in the regulations, a US LLC is the only type of company that can qualify as a foreign hybrid company. A US LLC is owned by its members and may not in fact issue shares. However, the members are equivalent to stockholders of a corporation. Such an interest-holder will fall within the definition of a 'shareholder' and be treated as partners in a partnership. [Schedule 10, item 15, section 830-25]

9.42 All shareholders, resident in Australia or not, in a foreign hybrid company will be treated as partners. While these amendments for companies are directed primarily at Australian resident members of a US LLC, in the case where the US LLC is a foreign hybrid company because of subsection 830-15(1), any non-resident members will also become partners for Australian tax purposes. This may result in direct Australian taxation of these members (dependent on any relevant taxation treaty), but they will still be taxed only on any Australian source income derived by the company (to the extent that the company itself would have previously been subject to Australian taxation). However, partnership treatment will not be something new to the members, in general terms, because that is how they are currently taxed in the USA.

Individual interest of a partner in the net income

9.43 The shareholder's right to a distribution of profits from the foreign hybrid company will determine its individual interest in the net income or loss of the partnership. In calculating that share the shareholder needs to determine the amount it would reasonably expect to receive from the company if the profits of the company for the year of income were distributed. That amount would be converted to a percentage of the total distribution. The shareholder would need to take into account the rights of the members of the company to distributions under the constitution of the foreign hybrid company (such as the operating agreement of an LLC). In the usual case, the shareholder would use its percentage entitlement to a distribution made by the company. [Schedule 10, item 15, section 830-30]

Example 9.1

A and B (Australian resident companies) are each members of a US LLC. Under the operating agreement of the US LLC, A has a preferential interest in the first $10,000 of the profits of the US LLC, and both A and B have a right to 50% of any further profits.

In the 2003-2004 income year US LLC has a profit of $50,000, after US tax. If all the profits for that year were distributed at year end, A would receive $30,000 ($10,000 and 50% of the remaining $40,000), and B would receive $20,000 under the operating agreement. Applying section 830-30, A's individual interest in the net income of the US LLC would be 60% (calculated as the $30,000 share of the $50,000 total distributable profits), and B's would be 40%.

In the 2004-2005 income year A sells its interest to C. The operating agreement of the US LLC is amended so that B and C receive 50% each of the profits. If the US LLC has a profit of only $10,000, each of B's and C's individual interest in the net income would be 50% (as per the operating agreement).

Control and disposal of share in partnership income

9.44 Section 94 of the ITAA 1936 imposes a penal rate of tax on any uncontrolled partnership income, for example on the share of net partnership income over which the partner entitled to it does not have any real and effective control or disposal of that share.

9.45 In determining whether or not a shareholder of a foreign hybrid company has real and effective control or disposal over its share of the foreign hybrid's profits, regard should be given to any rights the shareholder has under the constitution, the operating agreement or any other rules of the foreign hybrid company. [Schedule 10, item 15, section 830-40]

Extended meaning of when income or profits will be subject to tax in a listed country

9.46 Any capital gain/loss from a CGT event happening in relation to a foreign hybrid or one of its CGT assets will be made by the partners individually (section 106-5). Each admission of a partner/member to a foreign hybrid may result in a CGT event for each existing partner/member, in relation to their respective interests in each asset of the foreign hybrid. The same may occur when an existing partner/member increases its proportional interest in the foreign hybrid.

9.47 Where either event is by means other than the acquisition of some or all of another partner's/member's interest, there may be no equivalent taxing point in the foreign jurisdiction and foreign tax may not be imposed on anyone at that time. However, where the foreign jurisdiction imposes tax once a partnership asset is actually disposed of, there is the potential for double taxation in respect of any unrealised capital gains in the assets of the foreign hybrid at the time the new partner was admitted or the partnership interest was increased.

9.48 Alternatively, where these events are coupled with an actual disposal by another existing partner/member of some or all of its interest in the foreign hybrid, there still is potential for double taxation. This may occur because the foreign country treats this as the disposal of some or all of the member's interest in the foreign hybrid, rather than as a disposal of the underlying assets of the foreign hybrid. Double taxation may arise because the 2 countries are taxing different events.

9.49 Subsections 830-75(1) and (2) deal with the first case, where a comparable-tax country would have taxed a capital gain made if the foreign hybrid had disposed of its assets. In this case, the capital gain will be treated for the purposes of section 23AH and Part X of the ITAA 1936 as having been subject to tax in a listed country when the deemed disposal took place. Subject to the other conditions in section 23AH being met, any capital gain made by an Australian company member of the foreign hybrid will be exempt from Australian tax at that time. Any capital loss will be ignored in the same circumstances. Similarly, under the CFC provisions the capital gain/loss will not be included in calculating the attributable income of an interposed CFC. If no listed country would have taxed the hypothetical foreign hybrid gain, the gain will remain taxable in Australia. [Schedule 10, item 15, subsections 830-75(1) and (2)]

9.50 Where there is an actual disposal of some or all of an existing partner's/member's interest in the foreign hybrid resulting in a capital gain, and the gain is subject to tax in a listed country, the capital gain under Australian law will be treated as being subject to tax in the listed country at that time. This again may result in the gain being exempt, or a loss ignored, under section 23AH or not taken into account under the CFC provisions. Where the gain is not taxed by any listed country, it would remain taxable in Australia. [Schedule 10, item 15, subsections 830-75(3) and (4)]

Loss limitation rules

9.51 As mentioned in paragraph 9.37, the amendments contain rules limiting the tax losses that may be claimed by a limited partner in a foreign hybrid, reflecting that the partner is not economically exposed to greater losses. Important elements of the loss limitation rules are that:

•

they apply only to limited partners;

•

they apply to both revenue losses of the foreign hybrid and the limited partner's net capital losses in relation to the foreign hybrid; and

•

they use the limited partner's at-risk, net contributions to the foreign hybrid as a benchmark to test whether the above losses may be utilised by the partner.

9.52 This limitation applies to each separate foreign hybrid in which the taxpayer or a CFC is a limited partner.

The rules only apply to a limited partner

9.53 The loss limitation rules only apply to limited partners of a foreign hybrid. This is consistent with the policy principle of limiting deductions for losses to amounts to which a partner is exposed. There is no need to apply the rules to general partners in limited partnerships as their liability is unlimited. All shareholders/members of a hybrid company that have limited liability become limited partners in a partnership and so these rules apply to them. These limited partners may be Australian taxpayers, foreign residents or CFCs. [Schedule 10, item 15, subsection 830-45(1)]

To which losses do the new rules apply?

9.54 The loss limitation rules apply in an income year to the following foreign hybrid losses:

•

any revenue losses of the foreign hybrid for that income year (this is the partner's share of a partnership loss for the year calculated under section 90 of the ITAA 1936 before the application of these rules; note that foreign losses do not form part of a partnership loss because of section 79D of the ITAA 1936);

•

any net capital loss of the limited partner for that income year that relates to the foreign hybrid. A foreign hybrid net capital loss arises where:

-

the partner's capital losses exceed its capital gains arising from CGT events happening during the income year in relation to the foreign hybrid or assets held by the foreign hybrid [Schedule 10, item 15, section 830-55]; and

•

any of the limited partner's unapplied revenue losses of the foreign hybrid, or unapplied foreign hybrid net capital loss, from a prior income year (these are referred to in the legislation as outstanding foreign hybrid revenue loss amounts and outstanding foreign hybrid net capital loss amounts) [Schedule 10, item 15, sections 830-65 and 830-70].

9.55 The new rule applies equally to foreign hybrid revenue losses and foreign hybrid net capital losses for integrity and neutrality reasons. There is no need to apply them to foreign losses of the foreign hybrid because these losses are not deducted in calculating the net income or partnership loss and cannot be deducted by a partner.

What is the limited partner's liability to loss?

9.56 Under the new rules, a limited partner's liability to loss from investment in a foreign hybrid is referred to as the partner's loss exposure amount. The limited partner's loss exposure amount is calculated in accordance with the method statement in subsection 830-60(1). The ability of a limited partner to utilise losses from investments in relation to the foreign hybrid in an income year (or carried over from a prior income year) is dependent on this liability for loss amount.

9.57 The limited partner's liability for loss is calculated by deducting the following from the amount or market value of contributions made by the partner to the foreign hybrid, or amounts held for the credit of the partner by the foreign hybrid, and which have not been repaid:

•

all limited recourse debts owed by the partner, to the extent that the borrowings were used by the partner to make contributions and the debts are secured by the partner's interest in the foreign hybrid;

•

the total of all deductions allowed to the partner for partnership losses allowed in previous years; and

•

the total of all net foreign hybrid capital losses allowed in previous years.

[Schedule 10, item 15, subsection 830-60(1)]

What are a limited partner's contributions to the foreign hybrid?

9.58 Contributions made by the limited partners are their capital contributions, which are reflected in the various partners' capital accounts of the foreign hybrid. Contributions may be made in a variety of different forms. Typical capital contributions include cash, goods, or marketable assets like land and buildings.

9.59 Other amounts considered to contribute to a limited partner's liability to loss in the foreign hybrid are:

•

the partner's share of undrawn profits in the foreign hybrid; and

•

subordinated debt contributed by the partner which is not a debt interest issued by the foreign hybrid and which, in the event of liquidation, ranks after claims by all other creditors (both secured and unsecured).

[Schedule 10, item 15, step 1 in subsection 830-60(1)]

9.60 All contributions must be made to and have been held in the foreign hybrid for at least 180 days at the end of the income year in which the partnership loss or foreign hybrid net capital loss is made. To ensure that genuine, long-term contributions are not caught by a strict 180-day rule, contributions that remain in the foreign hybrid for 180 days or more will satisfy the requirement. [Schedule 10, item 15, step 1(b) in subsection 830-60(1)]

What contributions do shareholders purchasing their interest in a foreign hybrid company make?

9.61 A shareholder acquiring shares in a foreign hybrid company from another shareholder is not ordinarily considered to be making a contribution to the foreign hybrid company. The new rules will treat such an acquisition by a shareholder in the foreign company to be a contribution by a partner to the foreign hybrid. [Schedule 10, item 15, subsection 830-60(2)]

9.62 Contributions by shareholders of a foreign hybrid company may be reflected differently in the foreign hybrid's accounts: they may appear as paid-up capital or shareholders' funds. Using only the shareholder's interest in the paid-up capital amount to determine the amount at risk may place them at a disadvantage. For example, the consideration given by the shareholder for shares in the foreign hybrid company may have a different cost per share than paid-up capital. In effect the shareholder may have acquired something other than paid-up share capital, including an interest in retained earnings.

9.63 Therefore, initial contributions by a shareholder acquiring their interest in the foreign hybrid company from another shareholder will be the payment or other consideration for those shares for as long as they hold them. [Schedule 10, item 15, subsection 830-60(2)]

9.64 When calculating their liability to loss these particular limited partners need to make adjustments to their initial contributions for:

•

any amounts repaid to them which represent a return of capital by the foreign hybrid during the time they hold the share [Schedule 10, item 15, paragraph 830-60(2)(f)];

•

movements in the balance of retained earnings (e.g. the partner pays $100 for shares in a foreign hybrid company with a paid-up capital amount of $80. Assume that the partner's interest in retained earnings at that time is $15. If in 3 years the partner's interest in the foreign hybrid's retained earnings has risen to $100 (assume all other factors are unchanged), the step 1 total for that income year would be $185 ($100 + ($100 - $15))); and

•

additional contributions or further acquisition of shares in the foreign hybrid company.

9.65 These contributions will also be subject to the 180-day rule. [Schedule 10, item 15, step 1(b) in subsection 830-60(1)]

A partner's financing arrangements, which reduce its liability to loss from investment in the foreign hybrid, are deducted from contributions.

9.66 Certain financing arrangements may effectively reduce or transfer a limited partner's liability for loss from investment in the foreign hybrid to another party. [Schedule 10, item 15, step 2(a) in subsection 830-60(1)]

Example 9.2: Calculating the limited partner's loss exposure amount

A partner borrows $80,000 to finance its contribution of $100,000 in the foreign hybrid. The lender secures the loan against the partner's interest in the foreign hybrid valued at $70,000 (and probably some other assets of the partner). Under terms of the loan agreement the limited partner is only exposed to a loss of $10,000 if the loan were to be in default and the market value of the partner's interest in the foreign hybrid falls below $70,000. Thus the limited partner has effectively reduced its liability from $80,000 to $10,000. Of the $100,000 contributed to the foreign hybrid, $70,000 of it is at risk for the lender to the partner.

The partner's loss exposure amount worked out under the method statement is:

Partner's contribution	$100,000
Contributions repaid	($0)
Less: limited recourse debts to the extent secured by partner's interest in foreign hybrid	($70,000)
Deductions allowed for previous revenue losses	($0)
Previous foreign hybrid net capital losses allowed	($0)
Partner's loss exposure amount	$30,000

Diagram 9.1: How the loss limitation rules apply

Testing the deductibility or otherwise of partnership losses or a foreign hybrid net capital loss.

9.67 A limited partner's share of a foreign hybrid's losses or a foreign hybrid net capital loss that may be used in calculating the partner's taxable income may not exceed the partner's loss exposure amount. The limited partner's share of these losses will either exceed the amount or not. [Schedule 10, item 15, section 830-45]

What happens where current year losses do not exceed the loss limit?

9.68 There will be no reduction of the limited partner's current year losses where the loss exposure amount is not exceeded (assuming the limited partner does not have any outstanding loss amounts from previous years). In such a case, section 830-45 does not apply.

What happens where the loss limit is exceeded?

Example 9.3

Following on from Example 9.2, in the 2003-2004 income year the partner's share of the foreign hybrid revenue loss is $40,000. The partner also has a foreign hybrid net capital loss for the year of $10,000. Therefore the limited partner has exceeded the loss exposure amount by $20,000.

9.69 Under the new rules, if the partner's losses exceed the loss exposure amount (as in Example 9.3), subsection 830-45(2) reduces the allowable losses so that in total they equal the partner's loss exposure amount. Where the limited partner has both a revenue loss and a foreign hybrid net capital loss for the year, the partner must choose how much of the reduction is applied to which loss. [Schedule 10, item 15, subsection 830-45(2)]

9.70 To the extent that the reduction is applied to a revenue loss, the deduction allowed under subsection 92(2) of the ITAA 1936 is reduced [Schedule 10, item 1, subsection 92(2) of the ITAA 1936]. Where subsection 830-45(2) requires the limited partner to reduce a foreign hybrid net capital loss the reduction will impact on the partner's net capital gain or loss amount for the income year (i.e. including any other capital gains and losses made by the partner). When calculating either a net capital gain or loss for the year, the limited partner must use the reduced foreign hybrid net capital loss amount in place of the actual capital gains and/or losses taken into account when calculating the foreign hybrid net capital loss amount in section 830-55 [Schedule 10, item 15, subsection 830-45(3)].

9.71 Using Example 9.3, if the limited partner chose to reduce only the revenue loss the partner would be able to use the following losses:

•

allowable deduction under subsection 92(2) of the ITAA 1936 for the revenue loss is reduced from $40,000 to $20,000; and

•

the full $10,000 foreign hybrid net capital loss is available to reduce capital gains of the partner.

9.72 Alternatively, the limited partner may choose to claim the whole allowable $30,000 as a revenue loss and not use any of the foreign hybrid net capital loss amount. In that case, when calculating the partner's overall net capital gain or loss for the year, the partner would include nothing on account of its investment in this foreign hybrid.

Are the 'undeducted' losses carried-forward?

9.73 Limited partners may carry forward the amount a loss has been reduced by in accordance with subsection 830-45(2):

•

if the loss reduced was a revenue loss it is carried-forward by the partner under section 830-65; and

•

if the loss reduced was a foreign hybrid net capital loss it is carried-forward by the partner under section 830-70.

The carried-forward amounts are referred to as outstanding loss amounts and may be available to the limited partner in later years.

How do outstanding losses become available again to the limited partner?

9.74 Any losses (including net capital loss) in relation to the foreign hybrid are carried-forward by the limited partner from prior years (because they have been reduced under these rules). They are then tested against the partner's loss exposure amount in a later income year to determine if they can be utilised in that income year. The limited partner's loss exposure amount may have increased through additional contributions or undrawn profits that have remained or are intended to remain in the foreign hybrid for 180 days or more. [Schedule 10, item 15, section 830-50]

Example 9.4

Following on from the Example 9.3, in the 2004-2005 income year the limited partner has the following losses:

•

an 'outstanding foreign hybrid revenue loss amount' of $20,000; and

•

a share of the foreign hybrid revenue loss of $5,000 for that year.

During that year the limited partner made a further contribution of $40,000 financed from the partner's own funds. This contribution has been held in the foreign hybrid for greater than the required 180 days by the end of the income year. There has been no change in the amount of debt or the value of the security provided. To determine which losses are available the partner must again calculate its loss exposure amount under the method statement:

Partner's contribution	$140,000
Contributions repaid	($0)
Less: limited recourse debts secured by partner's interest in foreign hybrid	($70,000)
Deductions allowed for previous revenue losses	($20,000)
Previous foreign hybrid net capital losses allowed	($10,000)
Partner's loss exposure amount	$40,000
Less: current year revenue loss	($5,000)
Available loss exposure amount	$35,000
Outstanding section 830-65 revenue loss amount	$20,000

As the limited partner's revenue loss for the year ($5,000) does not exceed the partner's loss exposure amount and the partner has an outstanding revenue loss amount, section 830-50 applies and the partner's available loss exposure amount is $35,000. The outstanding losses are then tested against the partner's available loss exposure amount to determine their availability.

The partner will be able to deduct the outstanding revenue loss amount as it does not exceed the available loss exposure amount (see subsection 830-50(2)). The limited partner will therefore be able to claim a deduction for $25,000 ($5,000 under subsection 92(2) of the ITAA 1936 and $20,000 under paragraph 830-50(2)(a)) in the 2004-2005 income year.

9.75 Division 36 of the ITAA 1936 provides for the deduction of tax losses incurred in previous years of income. The losses represented by the partner's outstanding foreign hybrid revenue loss amount will not be able to form part of a partner's tax loss that would be deductible under Division 36. These losses are deductible only where the conditions in section 830-50 are met. [Schedule 10, item 15, subsection 830-65(3)]

How are outstanding foreign hybrid net capital losses made available?

9.76 As mentioned above, carried-forward losses (including net capital losses) in relation to the foreign hybrid may be available in future years. Where the total outstanding losses, including any foreign hybrid net capital loss amounts, are less than the limited partner's available loss exposure amount the outstanding foreign hybrid net capital loss amount may be used by the partner.

9.77 In this situation, the limited partner makes a new capital loss under CGT event K12 equal to the outstanding foreign hybrid capital loss amount. The new CGT event K12 allows the limited partner to use this capital loss in calculating its net capital gain or loss for the income year. [Schedule 10, item 12, section 104-270 and item 15, paragraph 830-50(2)(b)]

What happens where outstanding losses exceed the partner's available loss exposure amount?

9.78 If the partner's available loss exposure amount is exceeded, the sum of the partner's deductions for outstanding revenue losses and the capital loss under section 104-270 must be reduced so that they equal the available loss exposure amount [Schedule 10, item 15, subsection 830-50(3)]. This is a similar reduction process to that carried out under subsection 830-45(2). The limited partner must choose which losses are to be used and to which particular outstanding amount they relate [Schedule 10, item 15, subsection 830-50(4)].

Example 9.5

A foreign hybrid limited partner has an available loss exposure amount of $10,000 and the following outstanding losses:

•

an outstanding foreign hybrid revenue loss of $8,000; and

•

an outstanding foreign hybrid net capital loss of $7,000.

The sum of the deduction for outstanding revenue losses and the section 104-270 capital loss must equal the available loss exposure amount of $10,000. The partner also must choose which of these losses to reduce and to which outstanding amount they relate. For example, the partner may choose the following combination:

•

deduct $5,000 of the outstanding foreign hybrid revenue loss amount; and

•

have a $5,000 section 104-270 capital loss.

9.79 The limited partner may carry forward any remaining outstanding foreign hybrid revenue losses and outstanding foreign hybrid net capital losses. [Schedule 10, item 15, subsections 830-65(2) and 830-70(2)]

Special rules when an entity becomes or ceases to be a foreign hybrid

9.80 The new Subdivision 830-D provides special rules to:

•

ensure that the change of tax status of a 'share' in a foreign hybrid to an interest in each of the assets of the foreign hybrid (or vice-versa) on an entity becoming (or ceasing to be) a foreign hybrid will not be a CGT event or any other disposal. The effect of this is that there will not be a taxing point at these times for the partner or the entity;

•

deny the use of any tax losses by a foreign hybrid which were incurred in a year before it became a foreign hybrid;

•

end a CFC's statutory accounting period for the purposes of determining the attributable income of the CFC in respect of a taxpayer's year of income preceding the year an entity becomes a foreign hybrid;

•

determine the timing of the acquisition of the member's interest in each of the assets of an entity when it becomes a foreign hybrid company, and for certain assets held by the entity on ceasing to be a foreign hybrid company;

•

ensure the partner in the entity assigns a reasonable approximation of a share of the foreign hybrid's tax cost to its interest in each of the assets of the entity when an entity becomes a foreign hybrid; and

•

ensure that the entity assigns a reasonable approximation of the partners' tax costs to the foreign hybrid's assets when an entity ceases to be a foreign hybrid. [Schedule 10, item 15, Subdivision 830-D]

Each of these rules is discussed in turn. Attention is focused on the case of an entity becoming a foreign hybrid (as at the commencement of this legislation). The considerations are similar when an entity ceases to be a foreign hybrid and is treated as a company.

The change of tax status of a share

9.81 On becoming a foreign hybrid, the importance of the new partnership treatment for a partner in a foreign hybrid is that the partner will hold an interest in each of the assets of the partnership, and not a share in a company. On an entity ceasing to be a foreign hybrid, for tax purposes the partner/member will hold a share in the entity, where previously this was treated as an interest in each of the assets of the entity.

9.82 The shift in tax treatment from a share to an interest in each underlying asset of the foreign hybrid (and vice-versa) would not appear to result, under current law, in a deemed disposal of an asset.

9.83 However, to avoid any doubt, where an entity becomes or ceases to be a foreign hybrid, no CGT event happens to any CGT asset, and no disposal or other event happens to any other asset. This avoids any possibility that tax could be imposed on any unrealised capital gains or profits on the application of the new rules. It also ensures that any unrealised losses are not crystallised. [Schedule 10, item 15, section 830-110]

Tax losses cannot be transferred to a foreign hybrid

9.84 If an entity incurred a tax loss before it became a foreign hybrid, the tax loss is not deductible to the foreign hybrid in calculating its net income or partnership loss. [Schedule 10, item 15, subsection 830-115(1)]

9.85 However, if it ceases to be a foreign hybrid any tax loss that occurred before it became a foreign hybrid will still be eligible to qualify for deduction as a tax loss under Division 36 of the ITAA 1997, subject to the usual loss recoupment rules. [Schedule 10, item 15, subsection 830-115(2)]

Ending a CFC's statutory accounting period before it becomes a foreign hybrid

9.86 The last statutory accounting period for which an entity is a CFC before it becomes a foreign hybrid will be taken to end at the end of the attributable taxpayer's income year preceding the income year in which the CFC becomes a foreign hybrid. [Schedule 10, item 15, section 830-120]

9.87 This will address the potential problem where there could be periods of time where neither the CFC rules nor the partnership treatment subject appropriate amounts to Australian tax, or where there could be double counting. This problem could arise because a CFC's statutory accounting period and the attributable taxpayer's year of income are not the same period.

Timing of acquisition of assets, and interests in the assets, of a foreign hybrid company

On becoming a foreign hybrid

9.88 On the application of the new rules to a member of a foreign hybrid company, the asset held by the member will no longer be treated as a share in a company, but will be treated as a fractional interest in each asset of the foreign hybrid company. [Schedule 10, item 15, section 830-35]

9.89 A provision dealing with the timing of the acquisition has been inserted to complement this provision. The member will be treated as having acquired an interest in an asset of the company as a partner at the later of:

•

the time the asset was acquired by the company; or

•

the time the member acquired its interest or became a member in the company.

[Schedule 10, item 15, subsection 830-125(1)]

9.90 The effect of this is that the pre-CGT status of any asset acquired by the company will not be affected by the change in tax treatment of the company. In addition, this acquisition time will be relevant in applying the CGT discount rules (within Subdivision 115-A of Part 3-1) which rely, in part, on the acquisition of an asset being 12 months prior to any CGT event.

9.91 The limited application of this rule to only a foreign hybrid company differs from the remaining rules in the new Subdivision 830-D which apply more broadly to all foreign hybrids (including limited partnerships).

9.92 A similar rule is not required for partners in a foreign hybrid limited partnership because on becoming a foreign hybrid, there is no change in the ownership attributes of the assets of the partnership. There is simply a removal of the existing corporate treatment of Division 5A of Part III of the ITAA 1936. The acquisition time of the assets for such partners would be the time they acquired their legal interest in the partnership asset even when the asset was acquired by the limited partnership while it was treated as a company.

On ceasing to be a foreign hybrid

9.93 Any asset that is actually held by the company when it ceases to be a foreign hybrid company will be treated as being held by the company, rather than the members being treated as collectively owning the asset.

9.94 Therefore, a timing rule provides that, for an asset that is acquired while the company was a foreign hybrid, and is still held by the company when it ceases to be a foreign hybrid, the company is treated as acquiring the asset from the time the partners acquired their interests in the asset. [Schedule 10, item 15, subsection 830-125(2)]

9.95 If the company acquired an asset before it became a foreign hybrid, no such rule is needed and the asset will retain its original acquisition date.

9.96 The effect on the pre-CGT status of any asset and on the operation of the CGT discount rules is similar to when a company becomes a foreign hybrid. Again, there is no corresponding rule for entities that cease to be foreign hybrid limited partnerships, for the same reason.

Assigning a cost to the interest in each asset of an entity that becomes a foreign hybrid

Why is it necessary to assign a cost?

9.97 Various provisions of the ITAA 1936 and the ITAA 1997 dealing with assets (referred to as asset-based income tax regimes in the legislation) require a taxpayer to calculate income, deductions and gains in relation to such assets using some value of the asset as the basis for determination. Different regimes use different concepts in determining this value. As an example, the provisions dealing with capital allowances use 'adjustable value', provisions dealing with trading stock use 'value' and the CGT provisions use 'cost base' or 'reduced cost base'. When an entity becomes a foreign hybrid, it is necessary to make sure that those rules work appropriately for the partnership. [Schedule 10, item 15, section 830-105]

9.98 The value that is being reset is referred to in the legislation as the 'tax cost' and these take their meanings from the respective provisions. The tax cost that is set will be used by the partner or the partnership in applying the relevant provisions of the ITAA 1936 and the ITAA 1997 in relation to the asset. [Schedule 10, item 15, section 830-100]

9.99 On a limited partnership becoming a foreign hybrid, there is no change in the legal ownership of the assets of the partnership. The partner may have details of the date(s) and cost(s) of the acquisition of the partner's interest in the assets of the partnership. However, if actual acquisition costs were used on application of the new rules, the cost of acquisition of the partner's interest in the assets would have to be adjusted to take into account any income tax deductions that have been claimed or any non-assessable recoupment of expenditure that has been received by either the partner or the partnership in relation to the assets.

9.100 Instead of requiring each partner to make these calculations, under the new law each partner must assign a reasonable approximation of a share of the foreign hybrid limited partnership's cost for each asset to the partner's interest in each of the assets. This rule will also cater for circumstances where partners do not have access to the necessary information that would be required for a reconstruction of the partnership accounts. The same rules will also apply to the members in a foreign hybrid company which will be treated as having proportional interests in each of the assets of the foreign hybrid. [Schedule 10, item 15, sections 830-80 and 830-90 and subsections 830-95(1) and (2)]

9.101 The tax cost setting rule is not required in relation to an entity beginning its existence as a foreign hybrid. In such a case there is no history of that entity for tax purposes. It simply begins operation as a partnership for tax purposes and the normal rules apply for determining particular tax costs for a partner in the partnership.

What method is used to assign a reasonable approximation of the tax cost?

9.102 The tax cost of a partner's interest in an asset of an entity that becomes a foreign hybrid is set at what the legislation refers to as the partner's tax cost setting amount. [Schedule 10, item 15, section 830-90]

9.103 Broadly, the effect of the method used to assign a reasonable approximation of the tax cost of an asset is to distribute, across the partners, the entity's tax cost for each asset that it holds when it becomes a foreign hybrid. The important steps in applying the method to determine the partner's tax cost setting amount for each asset are:

Step 1:

Determine what would have been the entity's tax cost if, hypothetically, it were not a foreign hybrid at the start of the year it becomes a foreign hybrid. The relevant tax cost depends on which set of provisions is being applied.

Step 2:

Multiply the result from step 1 by the partner's percentage interest in the asset of the partnership.

Step 3:

Adjust the result from step 2 for any premium paid or discount received in respect of the acquisition by the partner of any shares (in the company) or interests in the assets (of the limited partnership).

[Schedule 10, item 15, subsection 830-95(1)]

Step 1: What would have been the entity's tax cost?

9.104 The logical amount to use as a starting point in distributing a cost to the partners is the amount that would have been the entity's tax cost at the time if it did not change its status to a foreign hybrid. This is purely a hypothetical calculation, therefore, the legislation refers to it as the tax cost of an asset of the entity at the start of the foreign hybrid year. [Schedule 10, item 15, subsection 830-95(1) and section 830-100]

Step 2: Determining the partner's interest in the asset

9.105 The result in step 1 is then multiplied by the partner's interest in the assets of the partnership. The effect of this is to distribute the entity's tax cost for an asset across the partners according to their respective proportional interests in the asset. [Schedule 10, item 15, subsection 830-95(1)]

9.106 The partner's interest in the asset is the individual interest in the asset of the partnership (in the case of a foreign hybrid limited partnership), and is the percentage provided in the new subsection 830-35(2) (in the case of a foreign hybrid company). For foreign hybrid companies, this percentage is to be the percentage of the capital of the foreign hybrid company that the shareholder/partner would be reasonably expected to receive on a winding-up of the company at the end of the income year.

Step 3: Adjusting for the premium paid or discount received

9.107 The purpose of the adjustment in step 3 is to account for any premium paid or discount received in relation to the acquisition of the partner's interest in the entity that becomes a foreign hybrid. If a premium has been paid, an amount is added to the result from step 2 for each asset. Conversely, if a discount was received, an amount is deducted from that result for each asset, but not so as to give a negative result (which would not make any sense). [Schedule 10, item 15, subsection 830-95(1)]

9.108 There are 2 important elements involved in determining any adjustment required by step 3. The first is to calculate if the partner paid a premium or received a discount in relation to the partner's interest in the foreign hybrid. The second is to apportion this premium or discount across the assets which the foreign hybrid holds at the start of the year it became a foreign hybrid. [Schedule 10, item 15, subsection 830-95(2)]

9.109 This method of apportionment avoids the need for any market valuations for the foreign hybrid's assets to be obtained. It also does not require each partner to reconstruct the entity's accounts as if it were always a partnership in order to account for any premium(s) and/or discount(s) on acquisition of any interest(s) in the entity before it becomes a foreign hybrid.

9.110 Although this method does not give the same result as if the entity were always treated as a partnership, it provides a reasonable approximation of the cost of the partner's interest in each asset and avoids the higher compliance costs that would otherwise be encountered.

9.111 The premium paid (or discount received) is the excess (or deficit) of:

•

the total amount paid by the partner for its interests in the foreign hybrid that the partner holds at the start of the year in which the entity becomes a foreign hybrid; over

•

the amount that the partner would receive on a hypothetical distribution of capital (but not unrealised or undistributed profits or gains) on a winding-up or dissolution of the foreign hybrid immediately before it became a foreign hybrid.

[Schedule 10, item 15, subsection 830-95(2)]

9.112 Any premium (or discount) is then apportioned across all of the foreign hybrid's assets on hand at the commencement of the year in which it became a foreign hybrid. This is simply done by multiplying the overall premium paid or discount received by the fraction that each asset's tax cost is of the sum of the tax costs for all of the assets on hand at that time. [Schedule 10, item 15, step 4 in subsection 830-95(2)]

Example 9.6

In year 1, A and B each contribute $100,000 to set up a limited partnership (LP). The LP acquires land to the value of $200,000 (while it is treated as a corporate limited partnership). The LP's cost base of the land is $200,000. In year 3, the market value of the land is $250,000. A acquires a further 20% interest in the LP from B by paying $50,000 to B. The relative interests in the partnership are therefore 70% for A and 30% for B.

In year 4 the LP becomes a foreign hybrid. Both A and B must set the cost base of their respective interests in the land (the cost base being the relevant tax cost for the land which is a CGT asset of the LP). The LP's tax cost at the start of year 4 would have been $200,000 if it had not changed its status to a foreign hybrid.

A's cost base for the interest in the land is set at $150,000. This is calculated as $140,000 (70% of $200,000) plus $10,000 (being the premium paid in respect of the additional interest acquired from B). A's premium is calculated as $150,000 (the total amounts paid for its interest in the LP it holds at the start of year 4) less $140,000 (the amount that A would receive if the capital of the entity were distributed to it on dissolution of the partnership). This last amount is calculated as 70% of the total capital initially contributed to LP, being $200,000. As the land is the only asset of the foreign hybrid, 100% of the premium is apportioned to the land.

B's cost base for its interest in the land is set at $60,000. This is calculated as $60,000 (30% of $200,000) with no adjustment for any premium or discount. B has not paid a premium or received a discount because the amount B paid for the remaining 30% interest in the LP is $60,000 which equals the amount B would receive if the capital of the entity were distributed to it on dissolution of the partnership.

The total of the cost base of each of A and B in respect of their interests in the land is $210,000. If the land was then disposed of at its market value of $250,000 there would be a total capital gain of $40,000 realised by A and B. B has previously realised a capital gain of $10,000 on the earlier disposal of its interest in the LP, resulting in a total gain of $50,000.

Assigning a cost to each asset held by an entity when it ceases to be a foreign hybrid

9.113 Whenever an entity ceases to be a foreign hybrid the ownership of the foreign hybrid's assets changes for tax purposes. However, this will not constitute a taxable event. [Schedule 10, item 15, section 830-110]

9.114 For similar reasons to those set out in paragraphs 9.97 to 9.100, the entity itself, on ceasing to be a foreign hybrid, will have to reset the value of any assets it holds (i.e. reset the tax costs) so that the various sets of provisions dealing with assets can be applied. [Schedule 10, item 15, sections 830-85 and 830-90 and subsection 830-95(3)]

9.115 Broadly, the method used to assign a reasonable approximation of the tax cost of an asset is to attribute the sum of the partners' tax costs for each asset to the entity at the beginning of the income year in which it ceased to be a foreign hybrid. This is simply the sum of the partners' tax costs under the various asset regimes at that time (assuming the entity did not cease to be a foreign hybrid). [Schedule 10, item 15, subsection 830-95(3)]

Application and transitional provisions

Standard application of the foreign hybrid rules

9.116 The new foreign hybrid rules will commence from the start of the partner's 2003-2004 income year. [Schedule 10, items 6 and 38, subsection 830-1(1) of the IT(TP) Act 1997]

9.117 Where the partner in the foreign hybrid is a CFC the new rules will apply from the statutory accounting period of the CFC starting on 1 July 2003. For CFCs which have elected to adopt a different start date for that statutory accounting period, the date of commencement will be that alternative start date. These statutory accounting periods will end in the 2003-2004 income year of an attributable taxpayer. [Schedule 10, item 38, subsection 830-1(2) of the IT(TP) Act 1997]

Election for early application of the foreign hybrid rules

9.118 Taxpayers have an option to apply the foreign hybrid rules in the 2002-2003 income year [Schedule 10, item 38, subsection 830-5(1) of the IT(TP) Act 1997]. While this would involve backdating of the legislation, it is expected that it would only be taken up where it would be to the benefit of the taxpayer. Where a taxpayer is a partner in a foreign hybrid for the 2003-2004 income year by reason only of a foreign company meeting requirements specified in the regulations for a company to be a foreign hybrid, the taxpayer may also choose to treat the foreign company as a foreign hybrid for the 2002-2003 income year [Schedule 10, item 38, subsection 830-5(2) of the IT(TP) Act 1997]. An irrevocable election to have the partnership treatment apply from the 2002-2003 income year must be made by the time the taxpayer's tax return for 2003-2004 is lodged [Schedule 10, item 38, subsections 830-5(3) and (4) of the IT(TP) Act 1997].

9.119 In a similar way, an attributable taxpayer in a CFC which is a partner in a foreign hybrid may elect to apply partnership treatment to the foreign hybrid, from the statutory accounting period preceding that in which it would otherwise first apply, in calculating the CFC's attributable income. As in the preceding paragraph, this election also applies to foreign hybrids that are such only because they meet requirements in regulations. [Schedule 10, item 38, section 830-10 of the IT(TP) Act 1997]

What are the modifications to the application of the ITAA 1936 for past income years?

For CFC purposes where will a foreign hybrid CFC be resident?

9.120 The new law modifies the application of the CFC residence provisions to CFCs that would now be foreign hybrids. According to existing law, the foreign hybrid CFC's residence is unclear and the CFC would be considered to be a resident of no particular unlisted country (including after applying the extended meaning of resident in section 331 of the ITAA 1936). In these cases, the modified application will assign a residence for the foreign hybrid CFC to the particular country under whose laws it was formed, created, registered, incorporated on registration or otherwise constituted. [Schedule 10, item 38, subsection 830-20(2) of the IT(TP) Act 1997]

9.121 For example, a foreign hybrid CFC currently considered to be a resident of no particular unlisted country:

•

being a limited partnership formed and registered under the Limited Partnership Act 1907 (UK) will now be a resident of the UK, a broad exemption listed country;

•

being a limited liability partnership incorporated on registration under the Limited Liability Partnership Act 2000 (UK) will also be a resident of the UK; or

•

being a US LLC formed under the Limited Liability Company Act (Delaware, USA) will now be a resident of the USA, a broad exemption listed country.

9.122 As a consequence, Australian taxpayers will generally benefit through:

•

certainty in the application of the CFC rules to foreign hybrids for these past years; and

•

for those taxpayers who are yet to lodge returns for some past income years, possibly less attributable income and reduced compliance costs through:

•

access to the active income test exemption; and

•

other less onerous compliance requirements, where the foreign hybrid CFCs as a result of the modified rules are residents of broad exemption listed countries (e.g. under paragraph 400(aa) of the ITAA 1936 the modified application of the transfer pricing rules may not apply to the CFC).

Will a deduction be allowed for foreign tax paid by a partner of a foreign hybrid CFC in calculating the attributable income of that CFC?

9.123 Under section 393 of the ITAA 1936, a notional allowable deduction is available for foreign or Australian tax paid by a CFC. In the case of foreign hybrid CFCs the deduction is generally denied because the foreign tax is not paid by the foreign hybrid CFC. Instead, the partner/member of the foreign hybrid pays the foreign tax.

9.124 As no section 393 deduction is allowed, a foreign tax credit will not be available, in accordance with section 160AFCA of the ITAA 1936, for any foreign tax paid on the attributable income of the CFC, where the attributable taxpayer is a company.

9.125 The application of section 393 is modified to allow a deduction for foreign tax paid by a partner/member of the foreign hybrid CFC on amounts included in notional assessable income of the CFC, after it has been grossed up. Note that this grossing-up of the foreign tax paid by the partner/member is different from that undertaken because of subsection 6AC(3) of the ITAA 1936. [Schedule 10, item 38, subsections 830-20(3) and (4) of the IT(TP) Act 1997]

9.126 Furthermore, once the relevant amount of foreign tax paid by the partners/members becomes an allowable deduction, a foreign tax credit will be available on attribution to some attributable taxpayers, under section 160AFCA of the ITAA 1936, thereby avoiding double taxation.

How is this foreign hybrid deduction grossed up?

9.127 The gross-up factor depends on who the partner is that pays the foreign tax:

•

if it is the attributable taxpayer, it will be grossed up by the attributable taxpayer's direct attribution interest (defined in section 356 of the ITAA 1936) in the foreign hybrid; and

•

if the partner is another CFC of the attributable taxpayer, it will be grossed up by the CFC's direct attribution interest in the foreign hybrid.

[Schedule 10, item 38, subsections 830-20(3) and (4) of the IT(TP) Act 1997]

Why is this foreign hybrid deduction being grossed up?

9.128 The grossing-up of the foreign tax payment by the relevant direct attribution interest is necessary as the attributable taxpayer will not usually know the amounts of tax paid by other partners in a foreign hybrid. The full amount of foreign tax paid on the notional assessable income of the CFC by all persons needs to be deducted from the total of the CFC's notional assessable income. It also avoids the potential incidence of double taxation for attributable Australian taxpayers as demonstrated in Example 9.7.

Example 9.7

Facts:

•

Ausco is an attributable taxpayer in relation to both CFC 1 and Foreign hybrid CFC.

•

Tax-exempt is a 50% partner in Foreign hybrid CFC (and unrelated to Ausco).

•

Foreign hybrid CFC's profit for the year is $100 (CFC 1's share of the profit is $50) all of which is notional assessable income.

•

CFC 1 as a partner pays $15 ($50 ? 30%) foreign tax (assuming that the foreign hybrid's taxable profit for foreign tax purposes is also $100) in respect of its share of foreign hybrid's profits. Assume a deduction of $15 will be allowed when calculating Ausco's attributable income.

•

Tax-exempt pays no foreign tax.

Ausco's Australian tax payable calculation in relation to Foreign hybrid CFC using these assumptions is as follows:

Attributable foreign income (section 456 of the ITAA 1936): (100 - 15) * 50%	$42.50
Gross-up for foreign tax credit (subsection 6AC(3) of the ITAA 1936)	$7.50
Amount included in assessable income	$50.00
Australian tax liability ($50 ? 30%)	$15.00
Less allowable foreign tax credit offsets (section 160AFCA of the ITAA 1936)	($7.50)
Australian tax payable	$7.50

Therefore Ausco will have paid an effective tax rate of 45% ($22.50 ? $50) on its share of Foreign hybrid CFC's profits, instead of the 30% it should have paid (30% foreign tax fully credited against Australian tax).

9.129 Using the facts from Example 9.7 and allowing the deduction for foreign tax to be grossed up using CFC 1's direct attribution interest of 50%, the following calculation shows that Ausco would pay total tax at the appropriate rate.

Will a deduction be allowed for foreign tax paid by a partner of a foreign hybrid FIF?

9.130 This bill makes a similar modification (see paragraphs 9.123 to 9.128) to the application of section 573 of the ITAA 1936 within the FIF rules. This modification allows a deduction for foreign tax paid by the partners/members of the foreign hybrid FIF where the calculation method is used to calculate notional FIF income. [Schedule 10, item 38, subsection 830-20(5) of the IT(TP) Act 1997]

Who do the modifications apply to?

9.131 The modifications discussed in paragraphs 9.120 to 9.130 apply in relation to taxpayers who either:

•

are attributable taxpayers in a foreign hybrid CFC with a statutory accounting period that ended in a relevant past income year (see paragraph 9.132); or

•

have a foreign hybrid FIF interest at the end of a relevant past income year.

[Schedule 10, item 38, paragraph 830-15(1)(b) of the IT(TP) Act 1997]

To what past income years do the modifications apply?

9.132 The modifications to Part X and Part XI of the ITAA 1936 will have application to the income years prior to the commencement of the application of Division 830 of the ITAA 1997 in either the 2003-2004 income year or the 2002-2003 income year (see paragraphs 9.116 to 9.119) [Schedule 10, item 38, subsection 830-15(1) of the IT(TP) Act 1997]. They will apply for the purpose of amending an assessment for any of those past years or for making an original assessment for any of them before 1 July 2004 [Schedule 10, item 38, paragraphs 830-15(2)(a) to (c) of the IT(TP) Act 1997]. However, the application of these modifications to these past years is subject to the normal time limits for amendments of assessments [Clause 4].

9.133 Those taxpayers who have not lodged a return for a past income year by 30 June 2004 will be treated as if the assessment for the past income year was made on 1 July 2004 [Schedule 10, item 38, paragraphs 830-15(2)(d) and (e) of the IT(TP) Act 1997]. The application of these modifications to these past years is subject to the normal time limits for amendments to assessments [Clause 4].

Are taxpayers who have treated a foreign hybrid as being a resident of no particular unlisted country required to amend their assessments?

9.134 Taxpayers who have treated foreign hybrids which are CFCs as residents of no particular unlisted country for CFC purposes will have the option of amending prior-year returns prepared on that basis, but will not be required to do so. [Schedule 10, item 38, subsection 830-15(3) of the IT(TP) Act 1997]

9.135 Where the taxpayer chooses to amend such an assessment using the modified rules, the same treatment must be applied to all income years for which those rules apply and for which the returns were prepared in this way. For example, where a taxpayer who treated a foreign hybrid CFC as being resident of no particular unlisted country for the relevant statutory accounting period chooses to amend, so that the foreign hybrid CFC will be a resident of the country under whose laws it was formed, the taxpayer must amend its returns for all the relevant income years. [Schedule 10, item 38, paragraphs 830-15(3)(d) and (e) of the IT(TP) Act 1997]

9.136 An irrevocable election to amend past returns under this subsection must be made before the taxpayer's return for the 2003-2004 income year is lodged, subject to any further time allowed by the Commissioner. [Schedule 10, item 38, subsections 830-15(4) and (5) of the IT(TP) Act 1997]

Consequential amendments

9.137 There are a number of amendments to the CGT provisions consequential upon the creation of the new CGT event K12 for the capital loss arising when a partner is able to take account of a past-year net capital loss made in connection with a foreign hybrid. Two of them simply insert a reference to this event in tables in Part 3-1 [Schedule 10, item 11, section 104-5 and item 13, section 110-10]. To remove any doubt, amendments are also made to section 102-25 making it clear that CGT event K12 happens in addition to the individual CGT events that gave rise in the end to the past-year foreign hybrid net capital loss [Schedule 10, items 9 and 10, subsections 102-25(2) and (2B)]. Finally, there is an addition of an item to the table in section 112-97 (listing provisions which modify the cost base and/or the reduced cost base of assets) referring to the changes made in Subdivision 830-D when an entity becomes or ceases to be a foreign hybrid [Schedule 10, item 14, section 112-97].

9.138 Other consequential amendments are:

•

the inclusion of a reference to the loss limitation rule in the list of provisions dealing with deductions [Schedule 10, item 7, section 12-5];

•

the modification of the meaning of income tax law in Division 5A of Part III of the ITAA 1936 dealing with corporate limited partnerships, to exclude Division 830 of the ITAA 1997 [Schedule 10, item 2, section 94B of the ITAA 1936]; and

•

the addition of definitions of a number of new terms to the Dictionary in the ITAA 1997, which are either terms introduced by this bill or terms taken from the ITAA 1936 [Schedule 10, items 16 to 37, subsection 995-1(1)].

Regulation impact statement

Background

9.139 The current treatment of non-resident limited partnerships (and other non-resident 'foreign hybrids' such as US LLCs) under the CFC regime provides an inappropriate and unintended consequence for taxpayers.

9.140 Typically, foreign hybrids are taxed on a different basis in a foreign jurisdiction as compared to Australia. For example, a foreign hybrid may be treated for tax purposes as a partnership in the foreign jurisdiction but as a company in Australia.

9.141 As Australia considers a foreign hybrid to be a company, taxpayers with interests in them are subject to either the CFC rules or FIF rules, as the case may be.

9.142 However, significant uncertainty exists around the application of the CFC rules, and to a lesser extent the FIF rules, to taxpayers with interests in foreign hybrids as the rules are modelled on companies and they do not effectively cater for foreign hybrids. This is particularly so in relation to the residence of the foreign hybrid, which is a central issue to the application of the CFC rules.

9.143 The view of the ATO on how foreign hybrids should be treated is in accordance with draft tax determination TD 2001/D14 (released December 2001). According to TD 2001/D14, certain foreign hybrids taxed as partnerships are residents of no country. This has resulted in inappropriate and unintended taxing consequences such as:

•

the denial of the active income test exemption causing the immediate attribution of a wider range of income than may be appropriate, and in some cases income that is comparably taxed offshore is being attributed;

•

the denial of deductions/credits for foreign tax paid on attributed income as the foreign hybrid does not pay the tax (tax is paid by the partner); and

•

increased compliance costs.

9.144 As a result, the correct practice has not been widely followed by industry.

Policy objective

9.145 The objective of these measures is to provide greater clarity of treatment of foreign hybrids (especially in relation to the CFC rules) and thereby greater certainty in compliance.

Implementation options

9.146 Two implementation options were considered which would avoid the unintended consequences described above.

Option 1

9.147 In broad terms, option 1 retains company treatment for foreign hybrids and assigns a CFC residence, for foreign hybrids, to the country under whose laws it is formed. However, option 1 also encompasses extensive amendments across the CFC and FIF rules and minor changes to the foreign tax credit rules.

9.148 The necessary amendments would enable taxpayers to comply with the law in a strict sense and give business certainty, while promoting a consistent method of compliance.

Option 2

9.149 Option 2 would treat foreign hybrids as partnerships for all purposes of the income tax law. Partners would be taxed under Division 5 of Part III of the ITAA 1936. Foreign hybrid would be defined to include limited partnerships, US LLCs and other similar entities that are taxed on a flow-through basis in their country of formation (which will be listed in regulations).

9.150 However, certain foreign hybrids would be excluded from this treatment where they:

•

are residents of Australia; or

•

in general, where they would otherwise be dealt with under the FIF regime and not the CFC regime.

9.151 The reason for the final exclusion is to deal with concerns that taxpayers with a relatively smaller holding in a foreign hybrid (otherwise known as retail investors) may not have access to sufficient information to comply if partnership treatment were imposed.

9.152 However, it is intended that taxpayers with FIF interests in these foreign hybrids would be able on a case by case basis to make an irrevocable election to have partnership treatment apply.

New loss limitation rule for option 2

9.153 It is an internationally accepted practice to limit the availability of losses of a foreign hybrid to its member where the liability of the member is limited. Option 2 would contain such a loss limitation rule. This would ensure that where a loss (revenue or capital) is made in relation to a foreign hybrid the deduction available to the limited partner/member in respect of that loss would not exceed the amount of the partner's/member's financial exposure to the loss. Similar loss limitation rules were legislated in the recent changes to the taxation of venture capital limited partnerships.

9.154 These rules would not apply to foreign losses as they do not flow to the partner(s). Rather, these losses are quarantined within the partnership.

Assessment of options

9.155 Both options would:

•

address business concerns avoiding the unintended consequences described above;

•

provide clear rules increasing certainty about the operation of the law;

•

meet the policy intent of the anti-deferral measures (CFC and FIF measures); and

•

promote a consistent method of compliance.

9.156 Both options would add complexity to the law. Option 1 requires substantial amendments to accommodate foreign hybrids, which are likely to be complex. Whereas, option 2 requires new rules to define to which foreign hybrids it applies and requires new loss limitation rules. However, it is likely that in practice the need to apply loss limitation rules would be minimal, as the foreign hybrid would generally not be carrying on a business in Australia and the rules would not apply to a hybrid's foreign losses as these are quarantined in the partnership.

Assessment of impacts

Impact group identification

9.157 We conservatively estimate that at most 100 taxpayers may be affected by the measure. Based on the profile of the submissions received to the ATO's draft tax determination TD 2001/D14, we expect these taxpayers to be large corporate taxpayers with sophisticated investment structures. It should be noted individuals with relatively smaller FIF holdings in a foreign hybrid (otherwise known as retail investors) would not be affected by the recommendation unless they make an irrevocable election to have partnership treatment.

9.158 There is no evidence to suggest that the measure will have a noticeable impact on small business.

Comparative advantages and disadvantages

9.159 Option 2 deals comprehensively with the structural deficiencies with the CFC regime as it applies to foreign hybrids. It provides a clear alignment of the Australian tax rules with those in operation in the foreign territory, which often accords with the way that many of these foreign hybrids are regarded for commercial purposes. Option 1 does not achieve this alignment and would involve many detailed amendments to make the CFC and FIF regimes work properly for foreign hybrids.

9.160 The CFC rules are regarded as being complex to understand and onerous to comply with. Where a taxpayer has a direct controlling interest in a CFC, option 2 provides an avenue to a less complex partnership treatment.

9.161 Current international practice suggests Australia is not compelled to extend treaty benefits to an Australian resident partner of a foreign hybrid. The denial of such benefits may lead to double taxation in certain circumstances. The problem is caused through the mismatched tax treatment between countries. Option 2 overcomes this problem in a systemic way not available under option 1.

9.162 Another advantage of option 2 is that it provides certainty in the operation of the law for Australian businesses who have several billion dollars worth of investments in the UK and the USA through foreign hybrids. Whilst the adoption of a partnership approach is a fundamental change in the treatment of these entities and their interest-holders, the tax treatment of partnerships is understood and operates effectively.

9.163 Although the new rules involve a familiar and well understood tax treatment, there will be one-off transitional issues. The issues are in relation to existing carry forward losses of the foreign hybrid, CGT and issues around gaps in the foreign hybrid's accounting period and the member's income year. Similar carry forward loss transitional rules will apply as those found in the recent venture capital limited partnership measure.

9.164 Some roll-over relief (i.e. deferral) will be required for any unrealised gains in assets from the acquisition by the foreign hybrid to the date of commencement of the new rules.

Analysis of costs

Option 1

Compliance costs

9.165 While business has had difficulty in quantifying the likely compliance costs it is believed that option 1 would increase compliance costs as it does not align Australian tax treatment with that of the foreign jurisdiction and how foreign hybrids are regarded for commercial purposes.

9.166 The likely costs of complying with option 1 for business include costs associated with:

•

system refinement;

•

amendment requests;

•

preparation of ruling requests or requests for other ATO advice on application of the measure; and

•

external advice on the application of option 1 to the taxpayer.

Administration costs

9.167 The ATO is unable to quantify the costs and benefits of this option on the administration as the data is not available. However, the ATO is of the view that option 1 is easier to administer than option 2.

9.168 The ATO does, however, say that the changes are likely to be minimal and do not present a barrier to proceeding.

Government revenue

9.169 The impact on forward estimates is minimal, as this option will not change the types of income intended to be subject to attribution.

Economic benefits

9.170 The economic benefits are nil. Option 1 re-establishes the status quo in the application of the CFC rules prior to the release of the draft tax determination.

Option 2

Risks associated with this option

9.171 A risk specific to option 2 arises in relation to the Government's decision to accept the Board of Taxation's recommendation 3 on the broad treatment of CFCs resident in broad exemption listed countries. In the case of direct investment in a foreign hybrid, these investors may be worse off than if this option did not proceed. However, providing an Australian equivalent relief in respect of foreign branch profits and foreign capital gains under section 23AH of the ITAA 1936 will minimise this risk. This risk was discussed within the consultative group and accepted in the light of the advantages of option 2.

Compliance costs

9.172 While business has had difficulty in quantifying the likely compliance cost savings available under option 2, it is believed to be between $2,000 and $15,000 per entity. Business has indicated the real benefit is from the alignment of the Australian tax treatment with that of the foreign jurisdiction and how foreign hybrids are regarded for commercial purposes.

9.173 Consultations have indicated that compliance costs will be reduced in certain areas, yet be increased in others. For example, moving out of the CFC regime will be a saving, yet complying with partnership treatment will be a cost. In addition, the CGT rules as they apply to partnerships will impose greater costs than current treatment under the CGT rules.

Administration costs

9.174 The ATO is unable to quantify the costs and benefits of this option on the administration as the data are not available. However, where option 2 improves the certainty of the law, there will be increased voluntary compliance (compared to the current compliance environment), better targeted audits on other tax law aspects and less disputes.

9.175 The ATO does, however, say that the changes are likely to be minimal and do not present a barrier to proceeding.

Government revenue

9.176 The impact on forward estimates is minimal because it does not alter the income that would have otherwise been attributed under the CFC rules.

Economic benefits

9.177 This option removes impediments in our international tax arrangements allowing Australians to invest in foreign hybrids with certainty. Presently, Australians are avoiding foreign hybrid structures, if at all possible, for their offshore investments because of tax uncertainty. This may have placed Australians at a competitive disadvantage as they have adopted an alternative, higher cost business structure than the industry norm and, in some cases, are unable to get double tax relief.

9.178 Alternatively, where Australians have had to invest through a foreign hybrid their returns on investment are lower than what they could be as they are incurring significant costs for tax advice.

9.179 Therefore, other things being equal, the measure will allow Australians investing offshore to maximise their returns thus benefiting the Australian economy.

Consultation

9.180 Regular consultation has occurred with taxpayers and their representatives since the Treasurer's approval in April 2002 to discuss, on a confidential basis, the development of a legislative remedy to address taxpayer concerns. Those consulted include, AMP Ltd, Westfield Ltd, Lend Lease Corp, KPMG, Deloitte Touche Tohmatsu Ltd, Ernst & Young (also representing the Institute of Chartered Accountants), PricewaterhouseCoopers, Corporate Tax Association and the Investments & Financial Services Association.

9.181 Resolution of issues raised in consultation continued during drafting of the measure.

9.182 The ATO has been consulted and has provided the Department of the Treasury with an administrative impact statement of the options.

Conclusion and recommended option

9.183 Option 2 is preferred for implementing this measure. In comparison with option 1, option 2 is a more comprehensive approach to dealing with the problem, it is business's preferred option, and aligns the Australian tax treatment with that in the foreign jurisdiction.

Chapter 10 - Technical amendments

Outline of chapter

10.1 Schedule 11 to this bill makes a number of technical amendments to the ITAA 1936, the ITAA 1997 and other tax-related legislation.

Detailed explanation of new law

10.2 A number of minor technical amendments are made to the:

•

Income Tax Assessment Act 1936;

•

Income Tax Assessment Act 1997;

•

Income Tax Rates Act 1986;

•

Superannuation Guarantee (Administration) Act 1992;

•

Superannuation Contributions Tax (Assessment and Collection) Act 1997;

•

Taxation Administration Act 1953;

•

Taxation (Interest on Overpayments and Early Payments) Act 1983; and

•

Income Tax (Transitional Provisions) Act 1997.

[Schedule 11, items 1 to 164]

10.3 The amendments, which are self-explanatory, mainly:

•

repeal redundant provisions;

•

correct terminology;

•

correct incorrect section references; and

•

correct cross references.

Application and transitional provisions

10.4 These technical amendments have various dates of effect, which are detailed in clause 2 of this bill. The amendments are of a minor or machinery of government nature and do not substantially alter existing arrangements. They do not affect the rights or liabilities of taxpayers.

Index

Clauses

Schedule 1: Second World War payments

Schedule 2: Specific gift recipients

Schedule 3: Gifts and covenants

Schedule 4: Amendment of the Crimes (Taxation Offences) Act 1980

Schedule 5: Consolidation: transitional foreign loss makers

Schedule 6: Goods and services tax: interaction with consolidation regime

Schedule 7: Imputation for life insurance companies

Schedule 8: Overseas forces tax offsets

Schedule 9: Roll-over for FSR transitions

Schedule 10: Foreign hybrids

Schedule 11: Technical amendments