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

Goods and services tax amendments relating to first aid or life saving courses

Schedule 1 to this bill amends the GST Act to:

•

enable the supplier of an education course that is an eligible life saving course to treat the supply as GST-free if the supplier uses instructors for the course that are suitably qualified; and

•

remove the requirement that a supplier must be an entity that is a 'body' to be eligible to treat the supply of an education course that is a first aid or life saving course as a GST-free supply.

Date of effect: 1 July 2000.

Proposal announced: These measures have not been previously announced.

Financial impact: The revenue cost of this measure is expected to be $9 million in 2003-2004, $3 million in each of 2004-2005, 2005-2006 and 2006-2007.

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

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

Schedule 2 to this bill amends the IT(TP) Act 1997 to modify the General Value Shifting Regime so that, to ease compliance costs on the transition to consolidation, the consequences arising under that regime do not apply to most indirect value shifts involving services.

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

•

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

•

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

Proposal announced: This measure was announced by the Minister for Revenue and Assistant Treasurer's Press Release No. C14/03 of 6 March 2003. The measure was previously introduced in Taxation Laws Amendment Bill (No. 6) 2003.

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

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

Amendments relating to personal services income

Schedule 3 to this bill inserts section 61G in the FBTAA 1986 to reduce the taxable value of a fringe benefit by the same amount as is made non-deductible to the provider by virtue of the personal services income provisions.

The Schedule also amends the personal services income provisions in Part 2-42 of the ITAA 1997 to ensure that an individual, working through a personal services entity, can deduct a net personal services income loss in an income year.

Date of effect: The amendments to the FBTAA 1986 apply to fringe benefits provided after 30 June 2000. The amendments to the ITAA 1997 apply to assessments made for the 2000-2001 income year and each subsequent income year.

Proposal announced: The measure was announced on 13 May 2003 in the 2003-2004 Federal Budget.

Financial impact: Nil

Compliance cost impact: Nil

Sugar industry exit grants

Schedule 4 to this bill amends the ITAA 1997 to specify the taxation treatment of sugar industry exit grants made under the Sugar Industry Reform Program. The amendments will:

•

exempt from income tax sugar industry exit grants that are paid to taxpayers who leave the agricultural industry altogether; and

•

include in assessable income sugar industry exit grants that are paid to taxpayers who leave the sugar industry but continue to carry on another agricultural enterprise.

Date of effect: The amendments will apply to sugar industry exit grants received on or after 1 February 2003.

Proposal announced: This measure was announced by the Minister for Agriculture, Fisheries and Forestry's Press Release No. AFFA02/300WT of 29 October 2002.

Financial impact: This measure is expected to have a revenue cost of $1 million in 2003-2004, $3 million in 2004-2005, $3 million in 2005-2006 and $2 million in 2006-2007.

Compliance cost impact: The compliance cost impact of this measure is expected to be negligible.

Foreign resident withholding - application to alienated personal services payments

Schedule 5 to this bill amends the TAA 1953 so that the foreign resident withholding rules will apply to alienated personal services payments that are payments of a kind prescribed in the regulations to be covered by foreign resident withholding.

Date of effect: The amendments will commence on Royal Assent.

Proposal announced: The measure has not been announced.

Financial impact: The amendment will have no impact on revenue.

Compliance cost impact: Nil. The measure merely ensures the original intent of the foreign resident withholding rules is achieved.

Demutualisation of friendly societies

Schedule 6 to this bill amends the ITAA 1936 to ensure that mutual friendly societies that are life insurance companies can benefit from the taxation framework that applies to other mutual life insurance companies that demutualise.

Date of effect: The amendments will commence from 1 July 2000.

Proposal announced: This measure was announced in the Minister for Revenue and Assistant Treasurer's Press Release No C97/03 of 16 October 2003.

Financial impact: The revenue impact of this measure is expected to be insignificant.

Compliance cost impact: The compliance cost impact of this measure is expected to be negligible.

Roll-over relief for partnerships that are simplified tax system taxpayers

Schedule 7 to this bill amends Division 328 of the ITAA 1997 to allow, under certain circumstances, balancing adjustment roll-over relief for partnerships that are STS.

Date of effect: These changes will be effective from 1 July 2001, the start date of the STS.

Proposal announced: This measure was announced in the Minister for Revenue and Assistance Treasurer's Press Release C13/03 of 4 March 2003.

Financial impact: The measure will have a cost to revenue of $1 million in 2003-2004 and $2 million in each of 2004-2005, 2005-2006 and 2006-2007.

Compliance cost impact: Taxpayers will only incur a small increase in their compliance costs where they elect for roll-over relief.

Summary of regulation impact statement

Regulation impact on business

Main points:

•

As roll-over relief is optional, taxpayers will be required to make a choice for roll-over relief to apply. The choice must be made in writing, and be made within 6 months after the end of the relevant income year. In addition, they will be required to retain the choice, or a copy of it, for 5 years after the relevant year.

•

There will also be a cost to taxpayers that have already lodged their tax returns, but who wish to request amendments to enter the STS as a result of the change.

•

As roll-over relief is optional, taxpayers will only make a choice for roll-over relief if the benefits exceed the compliance costs.

This measure is favourable to taxpayers as it will remove a disincentive for entry into the STS.

Consolidation: revocation of certain choices and R&D tax offset

Schedule 8 to this bill amends the IT(TP) Act 1997 to allow certain choices under the consolidation regime to be revoked prior to 1 January 2005.

Amendments to the ITAA 1936 will ensure that the rules dealing with eligibility for the R&D tax offset apply appropriately in cases where companies join or leave a consolidated group part-way through an income year.

Date of effect: 1 July 2002.

Proposal announced: The changes to the R&D provisions were announced in Minister for Revenue and Assistant Treasurer's Press Release C67/03 of 30 June 2003.

Financial impact: The amendments are expected to have an insignificant effect on revenue.

Compliance cost impact: The ability to change certain choices will provide taxpayers with additional flexibility. The R&D measures are intended to ensure that the rules apply to consolidated groups in a way that is consistent with the existing policy. As such, there is not expected to be a significant compliance cost impact.

Chapter 1 - Goods and services tax amendments relating to first aid or life saving courses

Outline of chapter

1.1 Schedule 1 to this bill amends the GST Act to:

•

enable the supplier of an education course that is an eligible life saving course to treat the supply as GST-free if the supplier uses instructors for the course that are suitably qualified; and

•

remove the requirement that a supplier must be an entity that is a 'body' to be eligible to treat the supply of an education course that is a first aid or life saving course as a GST-free supply.

Context of amendments

1.2 Under section 38-85 of the GST Act, the supply of an education course is GST-free. An education course includes a 'first aid or life saving course' that satisfies certain criteria.

1.3 The supply of an eligible first aid or life saving course may be treated as a GST-free supply only if the supplier is registered or approved by a relevant State or Territory body or authority to provide such courses.

1.4 Currently, there are no State or Territory bodies or authorities that register or approve suppliers of life saving courses. Therefore, contrary to the intended GST treatment, the supply of a life saving course cannot be treated as a GST-free supply.

1.5 In addition, the supply of an eligible first aid or life saving course may be treated as a GST-free supply only where the entity making the supply is a body. The term 'body' is not defined in the GST Act and may inadvertently exclude other entity types that make such supplies.

Summary of new law

1.6 This bill will amend the definition of a 'first aid or life saving course' within the GST Act to:

•

insert additional criteria which, if satisfied, the supplier of an eligible life saving course will be able to treat the supply as a GST-free supply; and

•

to permit any entity type to be able to make a GST-free supply of an eligible first aid or life saving course.

Detailed explanation of new law

1.7 The definition of a first aid or life saving course in section 195-1 of the GST Act is amended to include three additional criteria relevant to suppliers of life saving courses.

1.8 The additional criteria are inserted into paragraph (b) of the definition of a first aid or life saving course. The criteria, if satisfied, will permit the supplier of an eligible life saving course to treat the supply as a GST-free supply. [Schedule 1, items 2, 4 and 5, section 195-1]

1.9 A supply of an eligible life saving course will be a GST-free supply if the supplier uses an instructor that holds a training qualification that was issued by either of Austswim Limited, Surf life Saving Australia Limited or The Royal Life Saving Society - Australia.

1.10 The issue of a training qualification by one of the three life saving organisations to the course instructor represents an acceptable alternative to the need for the supplier of the relevant life saving course to be registered or approved by a State or Territory body or authority to conduct the relevant course.

1.11 What constitutes a 'training qualification' is not specified in the GST Act. The three life saving organisations conduct a number of training courses that enable persons to obtain a qualification suitable to the conduct of life saving courses. An example of a relevant qualification is the Austswim Teacher of Swimming and Water Safety award issued by Austswim Limited.

1.12 The training qualification held by the instructor must directly relate to a life saving course to which paragraph (a) of the definition of first aid or life saving course in section 195-1 of the GST Act applies. For example, the supplier of an aquatic survival skill course would need to use an instructor that holds a training qualification relevant to that course in order to treat the supply of the course as a GST-free supply.

1.13 The term 'body' within the definition of a first aid or life saving course in section 195-1, is replaced with the term 'entity'. An entity is defined in section 184-1 of the GST Act and includes individuals, partnerships and others that may not constitute a body. Replacing the term 'body' with that of 'entity' means that any entity type that makes a supply of an education course that is an eligible first aid or life saving course may be able to treat the supply as a GST-free supply. [Schedule 1, items 1 and 3, section 195-1]

Application and transitional provisions

1.14 The amendments apply, and are taken to have applied, in relation to net amounts for tax periods starting on or after 1 July 2000. The application date ensures that supplies of eligible first aid or life saving courses are treated as GST-free supplies from 1 July 2000 in accordance with the original policy intent. [Schedule 1, item 6]

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

Outline of chapter

2.1 Schedule 2 to this bill amends the IT(TP) Act 1997 to modify the General Value Shifting Regime so that, to ease compliance costs on the transition to consolidation, the consequences arising under that regime do not apply to most indirect value shifts involving services where those value shifts occur before:

•

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

•

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

Context of amendments

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

•

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

•

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

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

2.4 Therefore, to facilitate the transition to consolidation, most indirect value shifts involving services will be excluded from the General Value Shifting Regime where those value shifts occur before:

•

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

•

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

2.5 The amendments will:

•

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

•

allow groups that do not consolidate extra time to establish systems to track service related indirect value shifts that may require adjustments under the General Value Shifting Regime.

Summary of new law

2.6 Most indirect value shifts involving services will be excluded from the consequences of the General Value Shifting Regime if those value shifts occur before:

•

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

•

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

Detailed explanation of new law

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

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

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

•

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

•

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

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

•

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

•

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

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

•

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

•

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

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

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

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

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

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

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

Example 2.1

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

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

Example 2.2

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

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

Application and transitional provisions

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

•

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

•

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

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

Chapter 3 - Amendments relating to personal services income

Outline of chapter

3.1 Schedule 3 to this bill inserts section 61G in the FBTAA 1986 to reduce the taxable value of a fringe benefit by the same amount as is made non-deductible to the provider by virtue of the PSI provisions.

3.2 The Schedule also amends the PSI provisions in Part 2-42 of the ITAA 1997 to ensure that an individual, working through a PSE, can deduct a net PSI loss in an income year.

Context of amendments

Fringe benefits and personal services income provisions

3.3 Under the PSI provisions, an individual or PSE is denied a deduction for certain payments relating to personal services income that would not be deductible if an individual derived the personal services income as an employee. These payments may also be a fringe benefit within the meaning of the FBTAA 1986 and, as such, may give rise to FBT and therefore effectively be subject to double taxation. The amendments address the potential for double taxation by reducing the taxable fringe benefit amount to the extent the payment is non-deductible by virtue of the PSI provisions.

Personal services income losses

3.4 The PSI provisions prevent individuals from reducing their tax liabilities by alienating their personal services income to an associated entity or by claiming inappropriate 'business' deductions that would otherwise not be available if the individual were directly employed.

3.5 Under the PSI provisions, where an individual works through a PSE, such as a company, partnership or trust, the amount of their PSI is generally treated as their own assessable income (except where the PSE qualifies as a personal services business). This is achieved by attributing the personal services income of the PSE to the individual whose personal efforts or skills generated the income.

3.6 The amount of personal services income attributed to an individual can be reduced by certain deductions relating to the PSI that would otherwise be available to the PSE. However, under the current provisions, the attributed PSI cannot be reduced below zero. For a company or trust, this means that a net PSI loss for an income year cannot be attributed to the individual, but is instead, used in the PSE. (If the PSE is a partnership, the partners in the partnership may be allowed a deduction for the net PSI loss, to the extent of each partner's interest in the partnership.)

3.7 Consistent with the PSI provisions generally, the amendments aim to put an individual subject to the PSI provisions in the same situation had the individual been an employee, by allowing the individual, rather than the PSE, to deduct a net PSI loss.

Summary of new law

Fringe benefits and personal services income provisions

3.8 Amendments to the FBT legislation will ensure that the taxable value of a fringe benefit amount is reduced by the amount of the payment that is non-deductible to the provider because of the PSI rules. The provider of the fringe benefit can be either an individual operating as a sole trader or a PSE. This will remove the potential for double taxation.

Personal services income losses

3.9 Amendments to the PSI provisions will allow the relevant individual, rather than the PSE, to deduct the net PSI loss from other income for an income year. If the individual does not have sufficient other income to absorb the loss, they will be able to carry forward the loss under the normal carry forward loss rules contained in Division 36 of the ITAA 1997.

3.10 To the extent that the net PSI loss is attributed to the individual, the amendments will ensure that the PSE will not be able to deduct the loss in the current year or take it into account in calculating any carry forward tax losses.

Detailed explanation of new law

Fringe benefits and personal services income provisions

3.11 Amendments to the FBTAA 1986 will provide for a reduction in the taxable value of a fringe benefit in relation to the year of tax if:

•

a fringe benefit is provided in the year of tax in relation to the employment of an employee; and

•

the provider of the benefit is denied a deduction for the benefit under the PSI provisions (specifically sections 85-15, 85-20 or 86-60 of the ITAA 1997).

3.12 Section 85-20 denies an individual deductions for payments made to an associate, relating to gaining or producing personal services income unless the payment is related to the individual's principal work that produces the personal services income. Section 85-15 denies an individual deductions for rent, mortgage interest, rates and land tax relating to gaining the individual's personal services income. Section 86-60 is a general rule which denies a PSE a deduction for amounts relating to gaining or producing an individual's personal services income unless the individual could have deducted the amount if the circumstances giving rise to the deduction had applied to the individual (unless the PSE is conducting a personal services business).

3.13 The taxable value of the fringe benefit is reduced by the amount that cannot be deducted under the above sections. [Schedule 3, item 1, section 61G]

Personal services income losses

3.14 Amendments will allow an individual to deduct a net PSI loss from other income. An individual will be able to deduct an amount equal to the excess of the individual's 'personal services deduction amount' over the individual's 'unreduced personal services income'. This excess (i.e. the net PSI loss) can be deducted from the individual's other income or, in the case where the individual's current income cannot absorb the loss, it can be carried forward and deducted against future income. [Schedule 3, item 3, paragraph 86-27(1)]

3.15 The individual's personal services deduction amount is the sum of:

•

the amount of allowable PSE deductions relating to the individual's PSI; and

•

the entity maintenance deductions less any non-PSI income of the PSE, if this amount is greater than zero.

[Schedule 3, item 3, paragraph 86-27(1)(a)]

3.16 The individual's unreduced personal services income is the amount of personal services income that would have been included in the individual's assessable income if there had been no reduction under section 86-20. [Schedule 3, item 3, paragraph 86-27(1)(b)]

3.17 The deductions that the PSE is entitled to are reduced by the amount of the net PSI loss that the individual, whose personal services income is income of the PSE for that income year, can deduct under the new provisions. This ensures that the PSE and the individual cannot both deduct the net PSI loss. For example, where the PSE is a partnership, it will not be able to distribute a net PSI loss to its partners. [Schedule 3, item 4, section 86-87]

Example 3.1

Michael is a computer contractor that provides services through a company, J&M Pty Ltd. In the 2002-2003 year of income, J&M Pty Ltd's accounts are as follows:

PSI	$120,000
PSI deductions	$110,000
Other PSE income	$5,000
Entity maintenance deductions	$20,000
Investment related deductions	$10,000

Michael's unreduced personal services income is $120,000 and his personal services deduction amount is $125,000 ($110,000 + (20,000 - 5,000)). Michael's section 86-27 deduction for the net PSI loss is ($5,000).

The income position of J&M Pty Ltd would be as follows:

PSI	$120,000
PSI deduction	$110,000
Other PSE income	$5,000
Entity maintenance deductions	$20,000
Investment related deductions	$10,000
Section 86-87 reduction	$5,000
Net loss of company	$10,000

The $5,000 net PSI loss attributed to Michael reduces the company's net loss from $15,000 to $10,000 due to the operation of section 86-87.

Application and transitional provisions

3.18 The amendments to the ITAA 1997, which will benefit taxpayers, apply to assessments made for the 2000-2001 income year and each subsequent income year. [Schedule 3, item 6]

3.19 The amendments to the FBTAA 1986, which will benefit taxpayers, apply to fringe benefits provided after 30 June 2000. [Schedule 3, item 5]

Chapter 4 - Sugar industry exit grants

Outline of chapter

4.1 Schedule 4 to this bill amends the ITAA 1997 to specify the taxation treatment of sugar industry exit grants made under the Sugar Industry Reform Program. The amendments will:

•

exempt from income tax sugar industry exit grants that are paid to taxpayers who leave the agricultural industry altogether; and

•

include in assessable income sugar industry exit grants that are paid to taxpayers who leave the sugar industry but continue to carry on another agricultural enterprise.

Context of amendments

4.2 On 10 September 2002 the Hon Warren Truss MP, Minister for Agriculture, Fisheries and Forestry, announced an assistance package for the Australian sugar industry.

4.3 The assistance package is part of a comprehensive Sugar Industry Reform Program that is designed to assist the sugar industry in the short term and to promote rationalisation of the industry to ensure its long-term economic, social and environmental sustainability.

4.4 One component of the Sugar Industry Reform Program is Commonwealth Government assistance for cane growers who wish to leave the sugar industry. The assistance consists of a one-off payment (a sugar industry exit grant) of up to $45,000 for growers who satisfy certain income and assets tests.

4.5 The recipient of a sugar industry exit grant must, as a condition of receiving the grant:

•

execute a deed undertaking not to become an owner or operator of any agricultural enterprise within 5 years of receiving the exit grant (in which case the grant is exempt from income tax); or

•

execute a deed undertaking not to become an owner or operator of a sugar industry enterprise within 5 years of receiving the exit grant (in which case the grant is included in assessable income).

Summary of new law

4.6 The amendments will:

•

exempt from income tax sugar industry exit grants that are paid to taxpayers who execute a deed undertaking not to become an owner or operator of any agricultural enterprise within 5 years of receiving the grant; and

•

include in assessable income sugar industry exit grants that are paid to taxpayers who execute a deed undertaking not to become an owner or operator of a sugar industry enterprise within 5 years of receiving the grant.

4.7 The amendments will also ensure that income tax assessments can be amended if a taxpayer breaches an undertaking not to become an owner or operator of any agricultural enterprise or a sugar industry enterprise (as the case may be) within 5 years of receiving a sugar industry exit grant.

Detailed explanation of new law

4.8 A taxpayer who receives a sugar industry exit grant must, as a condition of receiving the grant:

•

execute a deed undertaking not to become an owner or operator of any agricultural enterprise within 5 years of receiving the exit grant; or

•

execute a deed undertaking not to become an owner or operator of a sugar industry enterprise within 5 years of receiving the exit grant.

What are the taxation consequences if the taxpayer undertakes not to become an owner or operator of any agricultural enterprise?

The sugar industry exit grant is exempt from income tax

4.9 A sugar industry exit grant paid under the Sugar Industry Reform Program is exempt from income tax if, as a condition of receiving the grant, the taxpayer executes a deed undertaking not to become an owner or operator of any agricultural enterprise within 5 years. [Schedule 4, item 5, section 53-10, item 4B in the table]

4.10 In addition, to ensure that the grant is not included in assessable income as a capital gain, any capital gain or capital loss made from a CGT event relating directly to a sugar industry exit grant paid under the Sugar Industry Reform Program is disregarded. [Schedule 4, item 8, paragraph 118-37(1)(f)]

4.11 The purpose of making sugar industry exit grants paid in these circumstances exempt from income tax is to provide additional assistance to cane growers whose business is no longer viable and who need help in making the transition to new employment.

Consequences of breaching the undertaking by re-entering the sugar industry

4.12 If a taxpayer breaches an undertaking not to become an owner or operator of any agricultural enterprise within 5 years and becomes an owner or operator of a sugar industry enterprise within that period, the sugar industry exit grant will be repayable to the Commonwealth. In most cases, no taxation consequences arise.

4.13 However, in these circumstances, once the taxpayer has repaid the sugar industry exit grant, section 59-30 will apply to ensure that the grant is not regarded as exempt income. Therefore, if the grant has been applied against a taxpayer's tax losses, he or she will be able to seek amendments to affected income tax assessments.

4.14 In this regard, subsection 170(10AB) of the ITAA 1936 generally allows the Commissioner to issue an amended assessment at any time to give effect to excluding an amount from a taxpayer's exempt income under section 59-30.

Consequences of breaching the undertaking by re-entering the agricultural industry (other than the sugar industry)

4.15 If a taxpayer breaches an undertaking not to become an owner or operator of any agricultural enterprise within 5 years and becomes an owner or operator of an agricultural enterprise (other than a sugar industry enterprise) within that period, the sugar industry exit grant will be included in the taxpayer's assessable income in the year it was received. [Schedule 4, items 4, 6 and 7, subsections 15-65(2) and (3), notes to section 53-10]

4.16 The Commissioner will be able to issue an amended assessment at any time to include a sugar industry exit grant in a taxpayer's assessable income under subsection 15-65(2). [Schedule 4, item 1, subsection 170(10AA), item 1A in the table]

What are the taxation consequences if the taxpayer undertakes not to become an owner or operator of a sugar industry enterprise?

The sugar industry exit grant is included in assessable income

4.17 A sugar industry exit grant paid under the Sugar Industry Reform Program is included in assessable income if, as a condition of receiving the grant, the taxpayer executes a deed undertaking not to become an owner or operator of a sugar enterprise within 5 years. [Schedule 4, item 4, subsection 15-65(1)]

4.18 However, to ensure that the grant is not included in assessable income as a capital gain, any capital gain or capital loss made from a CGT event relating directly to a sugar industry exit grant paid under the Sugar Industry Reform Program is disregarded. [Schedule 4, item 8, paragraph 118-37(1)(f)]

Consequences of breaching the undertaking by re-entering the sugar industry

4.19 If a taxpayer, in breach of an undertaking, becomes an owner or operator of a sugar industry enterprise within 5 years, the sugar industry exit grant will be repayable to the Commonwealth.

4.20 Section 59-30 will exclude the sugar industry exit grant from the taxpayer's assessable income when he or she repays the grant. [Schedule 4, item 4, note to section 15-65]

4.21 In this regard, subsection 170(10AB) of the ITAA 1936 generally allows the Commissioner to issue an amended assessment at any time to give effect to excluding an amount from a taxpayer's assessable income under section 59-30.

Application and transitional provisions

4.22 The amendments apply to sugar industry exit grants received on or after 1 February 2003. [Schedule 4, item 9]

Consequential amendments

4.23 To assist readers of the legislation, this bill inserts a reference to sugar industry exit grants in the checklists of assessable income and exempt income. [Schedule 4, items 2 and 3, sections 10-5 and 11-10]

Chapter 5 - Foreign resident withholding - application to alienated personal services payments

Outline of chapter

5.1 Schedule 5 to this bill amends section 12-7 of Schedule 1 to the TAA 1953 to ensure that the foreign resident withholding rules will apply to alienated personal services payments that are payments of a kind prescribed to be covered by the foreign resident withholding rules. The purpose of the amendment is to facilitate the efficient collection of tax.

Context of amendments

5.2 Section 12-7 of Schedule 1 to the TAA 1953 provides that Division 12 of Schedule 1, which includes the foreign resident withholding rules in Subdivision 12-FB, does not apply to alienated personal services payments.

5.3 An alienated personal services payment is a payment received by an entity that relates to an amount that is included in the assessable income of an individual under Division 86 of the ITAA 1997. These payments may also be payments of a kind prescribed to be covered by the foreign resident withholding rules.

5.4 Currently, it is arguable that no tax will be collected through withholding from an alienated personal services payment due to the operation of section 12-7. The entity receiving the payment may be liable to pay an amount to the Commissioner under Division 13 of Schedule 1.

5.5 The intention is to remove any doubt that the foreign resident withholding rules apply to alienated personal services payments. The amendment will achieve this result.

Summary of new law

5.6 This amendment to the TAA 1953 will ensure the foreign resident withholding rules apply to payments made to entities receiving personal services income, in addition to the alienated personal services rules in Division 13. The rules collect different tax liabilities. Division 13 collects the liability of the service provider under the personal services income rules. Subdivision 12-FB will collect the tax liability of the personal services entity.

Detailed explanation of the amendments

5.7 Section 12-7 currently excludes all provisions of Division 12 from applying to alienated personal services payments. To ensure that certain withholding rules can apply to these payments, the introductory paragraph of section 12-7 is amended to except from the broad exclusion the provisions of Division 12 that are specified in subsection 12-7(2). [Schedule 5, item 1]

5.8 Subsection 12-7(2) is inserted to specify the provisions of Division 12 that will apply to alienated personal services payments. Paragraph 12-7(2)(a) specifies Subdivision 12-FB, the foreign resident withholding rules. Section 12-7 also currently prevents the operation of general rules in Division 12, some of which are necessary for the proper application of Subdivision 12-FB. Paragraph 12-7(2)(b) is inserted to ensure the general rules of Division 12 will apply to the extent that they apply in relation to Subdivision 12-FB. The amendment will ensure that, for example, section 12-15 will apply to require amounts withheld under Subdivision 12-FB to be expressed in Australian currency. [Schedule 5, item 2]

5.9 The amendments commence on Royal Assent and will apply to payments made after commencement.

Chapter 6 - Demutualisation of friendly societies

Outline of chapter

6.1 Schedule 6 to this bill amends the ITAA 1936 to ensure that mutual friendly societies that are life insurance companies can benefit from the taxation framework that applies to other mutual life insurance companies that demutualise.

Context of amendments

6.2 Division 9AA of Part III of the ITAA 1936 provides a taxation framework for mutual insurance companies that demutualise. That taxation framework, among other things:

•

ensures that any capital gain or capital loss that arises from a CGT event that happens to members who exchange membership rights in a demutualising entity for shares in the demutualised entity (demutualisation shares) is disregarded so that no CGT liability arises until a subsequent CGT event happens to the demutualisation shares; and

•

establishes a cost base for the demutualisation shares for CGT purposes that broadly reflects the market value of the demutualisation shares.

6.3 Some mutual friendly societies that qualify as life insurance companies have restructured by demutualising. However, due to technicalities in the law, the taxation framework under Division 9AA does not apply to those friendly societies.

6.4 The proposed amendments will ensure that members of friendly societies that are life insurance companies which restructure by demutualising receive the same taxation benefits as members of other life insurance companies which restructure by demutualising.

Summary of new law

6.5 The amendments will modify the definition of a mutual insurance company under subsection 121AB(1) so that it includes a mutual friendly society that qualifies as a life insurance company.

6.6 This will ensure that mutual friendly societies that are life insurance companies can benefit from the taxation framework that applies to other mutual life insurance companies which demutualise.

6.7 Therefore, if a mutual friendly society that is a life insurance company demutualises:

•

any capital gain or capital loss arising from a CGT event that happens to members who receive demutualisation shares in exchange for giving up membership rights in the demutualising friendly society will be disregarded;

•

no CGT liability will arise for those members until a subsequent CGT event happens to the demutualisation shares; and

•

those members will receive an enhanced cost base for the demutualisation shares for CGT purposes that broadly reflects the market value of the demutualisation shares.

Detailed explanation of new law

6.8 The taxation framework contained in Division 9AA applies to a company that is a mutual insurance company as defined in subsection 121AB(1).

6.9 The definition of a mutual insurance company in subsection 121AB(1) will be modified so that it includes an insurance company that:

•

was a friendly society as at 7.30 pm (by legal time in the Australian Capital Territory) on 9 May 1995;

•

was an insurance company on 1 July 1999; and

•

does not have capital divided into shares.

[Schedule 6, items 1 and 2, paragraph 121AB(1)(c)]

6.10 A friendly society will be a mutual insurance company that qualifies for the Division 9AA taxation framework if it satisfies each of the three conditions.

The first condition - the friendly society must have been a friendly society on 9 May 1995

6.11 The first condition that a friendly society must satisfy to be a mutual insurance company is that it must have been a friendly society as at 7.30 pm (by legal time in the Australian Capital Territory) on 9 May 1995. [Schedule 6, item 2, subparagraph 121AB(1)(c)(i)]

6.12 This condition ensures that the application of Division 9AA to mutual friendly societies that carry on life insurance business is consistent with its application to other mutual insurance companies.

6.13 In this regard, Division 9AA applies to mutual insurance companies that existed at 7.30 pm (by legal time in the Australian Capital Territory) on 9 May 1995. The Division defines an insurance company to mean a life insurance company or a general insurance company. A life insurance company is defined to mean a company registered under the Life Insurance Act.

6.14 Friendly societies that carry on life insurance business did not satisfy the definition of a life insurance company in 1995 because, at that time, they were not required to be registered under the Life Insurance Act. Rather, they were regulated under State and Territory legislation.

The second condition - the friendly society must be an insurance company

6.15 The second condition that a friendly society must satisfy to be a mutual insurance company is that:

•

it must have been registered under the Life Insurance Act (and therefore was an insurance company) as at 1 July 1999 [Schedule 6, item 2, subparagraph 121AB(1)(c)(ii)] ; and

•

it must be registered under the Life Insurance Act (and therefore is an insurance company) at the time of demutualisation (subsection 121AB(1)).

6.16 In this regard, the Financial Sector Reform (Amendments and Transitional Provisions) Act (No. 1) 1999 brought friendly societies that carry on life insurance business within the regulatory regime that applies to other life insurance companies. Consequently, friendly societies that carry on life insurance business have been registered under the Life Insurance Act since 1 July 1999.

The third condition - the friendly society must not have capital divided into shares

6.17 A mutual friendly society that restructures by demutualising does not lose its status as a friendly society. Therefore, the third condition that a friendly society must satisfy to be a mutual insurance company is that, immediately before the time of the demutualisation, it must not have capital divided into shares. [Schedule 6, item 2, subparagraph 121AB(1)(c)(iii)]

6.18 This condition will distinguish mutual friendly societies from non-mutual friendly societies for the purposes of Division 9AA.

Application and transitional provisions

6.19 The amendments discussed in this chapter will commence on 1 July 2000. [Subclause 2(1), item 3 in the table]

6.20 This will ensure that the Division 9AA taxation framework will apply to mutual friendly societies that have already demutualised. Consequently:

•

any capital gain or capital loss arising from a CGT event that happened to members who received demutualisation shares in the exchange for giving up membership rights in those friendly societies that have demutualised will be disregarded;

•

no CGT liability will arise for those members until a subsequent CGT event happens to the demutualisation shares; and

those members will receive an enhanced cost base for the demutualisation shares for CGT purposes that broadly reflects the market value of the demutualisation shares.

Chapter 7 - Roll-over relief for partnerships that are simplified tax system taxpayers

Outline of chapter

7.1 Schedule 7 to this bill amends Division 328 of the ITAA 1997 to allow, under certain circumstances, optional roll-over relief for balancing adjustments arising from a partial change in ownership of a partnership operating under the STS.

Context of amendments

7.2 The STS, which commenced on 1 July 2001, was introduced as a result of recommendations in the Ralph Review of Business Taxation to reduce the disproportionate tax compliance burden that falls on small business. This is achieved by providing eligible small businesses with simpler depreciation rules as an alternative to the UCA regime, a cash basis for recognising income and deductible expenses, and easier trading stock rules.

7.3 The UCA regime, contained in Division 40 of the ITAA 1997, allows taxpayers deductions for the decline in value of a depreciating asset over that asset's effective life. The Division provides a set of general rules to calculate deductions for the decline in value of most depreciating assets. It also provides pooling mechanisms, under which small expenditures are pooled and deductions determined by reference to the decline in the pool.

7.4 Under the UCA provisions, when a BAE occurs, the taxpayer is usually required to make a balancing adjustment. This includes situations where there is a variation in the constitution of a partnership or in the interests of the partners in a partnership. Such changes can trigger taxable gains in relation to the depreciating assets held by the partnership. Under certain circumstances, however, this taxing point can be deferred, via roll-over relief, so that the taxing point arises at a later time, when the partnership ultimately disposes of the assets.

7.5 Roll-over relief is not currently available for reconstitutions of partnerships operating under the STS (i.e. STS partnerships), deterring some taxpayers from joining the STS. This measure will allow optional roll-over relief for STS partnerships subject to certain conditions.

7.6 These amendments were announced in the Minister for Revenue and Assistant Treasurer's Press Release C13/03 of 4 March 2003.

Summary of new law

7.7 Amendments to Subdivision 328-D, which deals with capital allowances for STS taxpayers, will be made to allow roll-over relief for depreciating assets when there is a partial ownership change of an STS partnership.

7.8 Under the new provisions, optional roll-over relief will be available if both the partnership immediately prior to the ownership change and the partnership immediately after the ownership change jointly elect for roll-over relief.

7.9 Roll-over relief will benefit STS partnerships by removing the balancing adjustment, or taxing point, that would otherwise arise in relation to depreciating assets at the time the ownership change occurs. This will ensure that a taxable gain or loss will only arise when the partnership ultimately disposes of its depreciating assets.

7.10 When roll-over relief is chosen, the capital allowance deductions for the decline in value of depreciating assets will be split equally amongst the partnerships involved.

Detailed explanation of new law

Roll-over relief for partnership changes

7.11 The amendments will allow partnerships involved in the partial ownership change of an STS partnership the choice of roll-over relief. Roll-over relief will be available if:

•

a BAE occurs due to a change in the constitution of a partnership or in the interests of the partners on a day (i.e. the BAE day) and the partners or one of the partners that had an interest in the depreciating assets before the change has an interest in it after the change (i.e. there is only a partial change in the ownership of the partnership). All future references in this chapter to balancing adjustment events refer to events where there is a change in the constitution of a partnership or in the interests of the partners, unless otherwise stated;

•

capital allowance deductions for the assets are calculated under Subdivision 328-D, which deals with capital allowances for STS taxpayers;

•

the partnership before the BAE occurs (the transferor) and the partnership immediately after the BAE (the transferee) make a joint choice for roll-over relief; and

•

the transferee becomes an STS taxpayer for the BAE year and the depreciating assets allocated to the transferor's general STS pool or long life STS pool just before the BAE event occurs are held by the transferee immediately after the change. This will restrict the circumstances under which roll-over relief is available to STS partnerships.

[Schedule 7, item 8, subsection 328-240(1) and section 328-243]

Making the choice for roll-over relief

7.12 The choice for roll-over relief must be made in writing, contain sufficient information about the transferor's holding of the depreciating assets, and be made within six months after the end of the transferee's income year in which the BAE event occurs. However, the Commissioner may extend the period within which the choice must be made. [Schedule 7, item 8, subsection 328-240(2)]

7.13 In cases where a partner dies before the end of the time allowed for choosing roll-over relief, then the trustee of the partner's estate may be a party to the choice. [Schedule 7, item 8, subsection 328-240(3)]

7.14 The transferor and transferee must keep the choice or a copy of it for five years after the end of the income year in which the BAE occurs. A penalty of 30 units will be imposed if this requirement is not met. [Schedule 7, item 8, subsections 328-240(4) to (5)]

General consequences of roll-over relief

7.15 If roll-over relief is chosen then the transferor does not subtract an amount:

•

from its closing pool balance (under paragraph (a) of step 2 in the method statement in section 328-200) for the taxable purpose proportions of the termination values of depreciating assets allocated to either the general STS pool or the long life STS pool, due to the BAE event;

•

under subsection 328-210(2) (low pool values) for the sum of the taxable purpose proportions of the termination values of depreciating assets allocated to either the general STS pool or the long life STS pool, due to the BAE event.

[Schedule 7, item 8, subsection 328-245(1)]

7.16 The consequences of roll-over relief for STS partnerships will ensure that the transferor ignores the balancing adjustment amount at the time of the partnership change so that an amount is not included in its assessable income if the pool balance would otherwise have been less than zero.

7.17 In addition, the transferor will not include the taxable purpose proportion of a low cost asset in its assessable income due to the BAE event under subsection 328-215(4). [Schedule 7, item 8, subsection 328-245(2)]

7.18 If the transferor carries on a primary production business and makes a choice for a depreciating asset to be deducted under Subdivision 328-D (which deals with capital allowances for STS taxpayers), under Subdivision 40-F (about primary production depreciating assets) or 40-G (about capital expenditure of primary producers and other land holders) then the choice also applies to the transferee as if the choice had been made by the transferee. [Schedule 7, item 8, subsection 328-245(3)]

Deductions for pooled assets

7.19 The capital allowance deductions for pooled assets that the transferor, transferee and the other partnerships are entitled to during the BAE year are calculated under new subsection 328-247(1). The amount that can be deducted from the transferor's general STS pool or life long STS pool for the BAE year will be split equally:

•

between the transferor and transferee where there is only one BAE for the BAE year and roll-over relief is chosen; or

•

among the partnerships concerned where there are two or more BAEs for the BAE year and roll-over is chosen for each BAE.

[Schedule 7, item 8, subsection 328-247(1)]

Example 7.1

Jill and Bob run a mixed farming business as a partnership (the transferor). They elected into the STS for the 2001-2002 income year. The partnership decides that on 1 December 2001 their son will become a partner, forming a new partnership (the transferee). The new partnership also elects into the STS for the 2001-2002 income year. There are no further variations in the constitution of the partnership or in the interests of the partners during the BAE year.

The opening balance of the transferor's general STS pool and long life STS pool at 1 July 2001 are $20,000 and $100,000 respectively. The Jill and Bob partnership would have been able to deduct an amount equal to $6,000 ($20,000 ? 30%) and $5,000 ($100,000 ? 5%) from its general STS pool and long life STS pool respectively under subsections 328-190(1) and 328-210(1) for the BAE year.

The deductions are split equally between the two partnerships and each receives a deduction of $5,500 ($3,000 ? $2,500).

7.20 For income years after the BAE year, the transferor will not be able to continue to deduct amounts from its general STS pool or long life STS pool. [Schedule 7, item 8, subsection 328-247(2)]

Deductions for low cost assets and assets to be pooled

7.21 The capital allowance deductions for low cost assets, and assets that will be pooled at the end of the BAE year that a partnership begins to use, or installs ready for taxable purpose during the BAE year are calculated under new section 328-250. Table 7.2 sets out how the capital allowance deductions will be split among the transferor, transferee and other partnerships under this section. [Schedule 7, item 8, subsections 328-250(1) to (3)]

Example 7.2

Continuing Example 7.1, during the 2001-2002 income year Jill and Bob purchase a $10,000 asset with an effective life of less than 10 years, and a $15,000 asset with an effective life of 30 years. Both of these assets are to be pooled at the end of the year. The partnership also purchases a $900 asset during the year.

The total capital allowance deductions that the partnerships are entitled to split for the BAE year are equal to

$7,500 ($20,000 * 30% + $10,000 * 15%)


for the general STS pool and

$5,375 ($100,000 * 5% + 15,000 * 2.5%)


for the long life STS pool. The partnerships are also entitled to split the immediate write off of $900 for the low cost asset.

The deductions are split equally between the two partnerships and each receives a deduction of $6,887.50 ($3,750 ? $2,687.50 ? $450).

7.22 If a transferor starts to use, or has installed ready for use, a low cost asset during the BAE year and a BAE occurs (other than a variation of the constitution of a partnership or interests in the partners - for example, the asset is sold) before the BAE day, then the transferee is not entitled to a deduction for this asset and the taxable purpose proportion of the asset's termination value is not included in the transferee's assessable income. In this case the transferor receives the full deduction. [Schedule 7, item 8, subsections 328-250(4) to (5)]

Deductions for cost addition amounts

7.23 The capital allowance deductions for expenditure incurred by the transferor and/or transferee during the BAE year that are included in the second element of cost of a depreciating asset are calculated under new section 328-253. Table 7.2 sets out how the capital allowance deductions will be split among the transferor, transferee and other partnerships under this section. [Schedule 7, item 8, subsections 328-253(1) to (3)]

Example 7.3

Continuing Example 7.2, during the 2001-2002 income year, the transferor spends $5,000 on its $10,000 asset purchased during that year which will form part of its second element of cost. In addition, it spends $2,000 on its $15,000 asset purchased during that year.

The capital allowance deductions that the partnerships are entitled to split for the BAE year are

$8,250 ($20,000 * 30% + $10,000 * 15% + $5,000 * 15%)


for the general STS pool and

$5,425 ($100,000 * 5% + $15,000 * 2.5% + $2,000 * 2.5%)


for the long life STS pool.

The deductions are split equally between the two partnerships and each receives a deduction of $7287.50 ($4,125 ? $2,712.50 ? $450).

7.24 If a transferor incurs expenditure in relation to a low-cost asset and a BAE occurs (other than a variation of the constitution of a partnership or interests in the partners - e.g., the asset is sold) before the BAE day, the transferee cannot deduct an amount for the expenditure for the BAE year and the taxable purpose proportion of the asset's termination value is not included in the transferee's assessable income. In this case the transferor receives the full deduction. [Schedule 7, item 8, subsections 328-253(4) to (5)]

Closing pool balance below zero

7.25 If the transferor's pool balance, either for its general STS pool or long life pool, for the BAE year is less than zero, the amount included in assessable income under subsection 328-215(2) is:

•

where one BAE occurs during the BAE year, split equally between the transferor and transferee; or

•

where two or more BAEs occur during the BAE year, split equally among the transferor, transferee and the other partnerships.

[Schedule 7, item 8, section 328-255]

Taxable use

7.26 For a depreciating asset that is held by the transferor just before the BAE event, the transferee does not make a new estimate of the taxable purpose proportion for the depreciating asset for the BAE year but, instead, uses either:

•

the transferor's estimate of the taxable purpose proportion for the depreciating asset estimated under subsection 328-205(1) where only one estimate is made; or

•

the transferor's most recent estimate of the taxable purpose proportion for the depreciating asset where the transferor makes one or more estimates for the asset under subsection 328-225(1) that resulted in a change in business use under section 328-225.

[Schedule 7, item 8, subsections 328-257(1) and (2)]

7.27 For income years after the BAE year, section 328-225 operates as if the transferee had held the depreciating asset during the period that the transferor held it. Furthermore, estimates about the taxable proportion amount made by the transferor for the asset under that section are taken to have been made by the transferee. [Schedule 7, item 8, subsection 328-257(3)]

Notes

7.28 Various notes have been inserted to confirm that optional roll-over relief will be available in relation to depreciating assets where there is a variation in the constitution of an STS partnership or in the interests of the partners in an STS partnership. The notes also clarify the capital allowance deductions available to the transferor and transferee partnerships when roll-over relief is chosen. [Schedule 7, items 1 to 7]

Application and transitional provisions

7.29 The amendments made by this Schedule, which will benefit taxpayers, will apply for BAEs occurring on or after 1 July 2001, the start date for the STS provisions. [Schedule 7, item 9]

Chapter 7 cont'd - Regulation impact statement

Background

7.30 The UCA regime contains concessional rules that can apply in certain circumstances, such as where there is a change in ownership in a partnership. Broadly, these rules allow taxpayers to ignore any balancing adjustment amounts which are potentially assessable. Roll-over relief avoids taxation of the unrealised capital gains of partners not selling their interests.

7.31 The provisions allowing roll-over relief do not apply to assets held under the STS rules. Representations made to the Government raised the absence of roll-over relief in the STS as an issue.

Policy objective

7.32 The objective of the measure is to provide optional roll-over relief for balancing adjustments arising from the partial changeover of ownership of depreciating assets, for partnerships in the STS.

Implementation options

7.33 Roll-over relief could commence prospectively or retrospectively.

7.34 The advantages of retrospective commencement from 1 July 2001 (the commencement date of the STS) is that this would enable small business to access the maximum benefit of the STS.

7.35 The disadvantage of retrospective commencement is that the ATO would incur additional administrative costs in publicising the change and educating those affected by the change. It would also need to process amendment requests for taxpayers who have already lodged their income tax returns but who wish to enter the STS as a result of the change. The inability of taxpayers to do so would be the main disadvantage of prospective commencement.

Analysis of costs/benefits

Benefits

7.36 Incorporating roll-over relief into the STS will remove a disincentive to entry to the STS. Also, the absence of roll-over relief has tax consequences for STS taxpayers where assets are transferred to, within or from the STS. STS partnership taxpayers may face an unexpected increase in their tax liability in a year when a variation in the partnership occurs. Partners who did not trigger the liability are taxed on unrealised capital gains, while other owners of assets are not taxed until realisation. This can cause cash flow problems. More importantly, roll-over relief is used to introduce the next generation into family businesses without adverse tax consequences. This is of particular significance to small businesses and primary producers.

Compliance costs

7.37 As roll-over relief is optional, taxpayers will be required to elect for roll-over relief to apply. They will do so in writing, within six months of the end of the relevant income year. They will also be required to retain this election for five years.

7.38 There will also be a cost for taxpayers preparing amendment requests where they have already lodged their income tax returns but wish to enter the STS as a result of the change. As it is not known how many taxpayers will seek an amendment, this compliance cost is difficult to quantify.

Administration costs

7.39 The ATO will incur additional administrative costs in publicising the change and educating those affected.

7.40 The ATO will also face resource costs to process amendment requests for taxpayers who have already lodged their income tax returns but who wish to enter the STS as a result of the change. Again, as it is not known how many will seek an amendment, this administrative cost is difficult to quantify.

Equity issues

7.41 The current arrangements are inequitable as taxpayers carrying on a business through a partnership face different tax consequences under the UCA regime and the STS. Introducing roll-over relief to the STS will remove this inequity.

Economic benefits

7.42 The STS is intended to reduce the disproportionate tax compliance burden that falls on small businesses. Removing a disincentive to entry to the STS will benefit those businesses. Also, STS partnership taxpayers will benefit from a reduction in their tax liability in a year when a variation in the partnership occurs.

Consultation

7.43 The National Tax and Accountant's Association and the National Farmers' Federation both sought the introduction of roll-over relief to the STS to allow changes in ownership in partnerships without adverse tax consequences. Taxpayers within and outside the STS also made representations to the Government seeking the introduction of roll-over relief.

Conclusion and recommended option

7.44 It is recommended that optional roll-over relief for partial changes in ownership of STS partnerships be provided from 1 July 2001, the start date of the STS. This will enable small business to access the maximum benefit of the STS.

Chapter 8 - Consolidation: revocation of certain choices and R&D tax offset

Outline of chapter

8.1 Schedule 8 to this bill:

•

amends the consolidation provisions in the IT(TP) Act 1997 to allow certain choices to be revoked before 1 January 2005;

•

amends the provisions in the ITAA 1936 dealing with eligibility for the R&D tax offset to ensure that they apply appropriately to consolidated groups; and

•

makes minor technical amendments to the ITAA 1997 and the IT(TP) Act 1997.

Context of amendments

Revocation of certain choices

8.2 The consolidation regime provides for a number of choices that may be made by a head company in setting the tax cost of its assets or determining its ability to deduct losses. Once made, these choices are irrevocable. The rationale for making choices irrevocable is to minimise compliance costs and maximise certainty for taxpayers.

8.3 Allowing a period of time during which certain choices are able to be revoked will provide taxpayers with greater flexibility in the transition period while aspects of the consolidation regime are being bedded-down.

Research and development tax offset

8.4 A company may be eligible to choose the R&D tax offset if it meets certain threshold tests. Some of these tests measure the turnover and R&D activity of the company and other taxpayers with which it is grouped.

8.5 The amendments ensure that the grouping rules used to determine eligibility for the R&D offset apply appropriately in cases where an entity joins or leaves a consolidated group part-way through an income year.

Minor technical amendments

8.6 Two minor technical errors are corrected.

Summary of new law

Revocation of certain choices

8.7 Part 1 of Schedule 8 to this bill amends the consolidation rules to allow the following irrevocable choices to be revoked before 1 January 2005.

8.8 The choice to:

•

retain the existing tax cost of a subsidiary's assets;

•

utilise certain losses over three years rather than under the available fraction;

•

utilise 'value donor' concessions to increase the available fraction for a bundle of losses;

•

waive the 'capital injection' rules;

•

cancel the transfer of a loss by the head company of a consolidated group; and

•

cancel a loss by the head company of a MEC group.

Research and development tax offset

8.9 Part 2 of Schedule 8 to this bill amends the ITAA 1936 to ensure that the rules governing eligibility for the R&D tax offset apply appropriately in cases where an entity is a member of a consolidated group for only part of an income year.

Minor technical amendments

8.10 Technical amendments are made by adding an asterisk before a defined term in paragraph 721-25(3)(b) of the ITAA 1997 and correcting the heading to Division 707 of the IT(TP) Act 1997.

Detailed explanation of new law

Revocation of certain choices

The choice to retain the existing tax cost of assets or reset their tax cost ('stick' or 'spread')

8.11 Section 701-5 of the IT(TP) Act 1997 allows a head company to elect that an entity is a 'chosen transitional entity'. The assets that a chosen transitional entity brings into the group retain their existing tax costs instead of having these reset under the general consolidation cost setting provisions. Subsection 701-5(2) requires this choice to be made by the time the head company is required to notify of its choice to consolidate. Subsection 701-5(3) states that this choice is irrevocable.

8.12 An amendment allows the head company to revoke this choice before 1 January 2005 [Schedule 8, item 2, subsection 701-5(2)]. To ensure that taxpayers are provided with genuine flexibility, an amendment also provides an equivalent extension of time for making this choice [Schedule 8, item 2, subsection 701-5(4)].

8.13 Extending the period for making this and other choices covered in this bill is necessary to ensure that taxpayers are provided with genuine flexibility in the transitional period to consolidation. For example, without extending this time frame, a head company submitting its first consolidated return on the basis that it has chosen to retain the existing tax costs of a subsidiary's assets would be able to revoke this choice before 1 January 2005. However, a head company that submits its consolidated tax return on the basis that a subsidiary's asset tax costs have been reset would not have equivalent flexibility to vary the basis on which its tax costs are set.

8.14 A condition for revoking this choice, or making the choice after the period of time allowed for giving the Commissioner the choice to consolidate, will be that any entity that owns an asset, the tax cost of which is affected by the choice, must have agreed [Schedule 8, item 1, subsection 701-5(1); item 2, subsections 701-5(3) and (5)]. This condition is designed to protect the interests of any entity that has left the group with an asset that has its tax cost affected by the choice.

The choice by the head company of a consolidated group to cancel the transfer of a loss

8.15 Subsection 707-145(1) of the ITAA 1997 allows a head company to choose to cancel the transfer of a loss. A head company may wish to make this choice in order to avoid having to recalculate available fractions for its existing bundles of losses when a new loss entity joins the group or to avoid a possible detrimental impact under the cost setting rules.

8.16 Amendments allow the choice to be revoked before 1 January 2005. Because this choice may also affect the cost of assets held by entities that have left the group, a decision to revoke this choice must be agreed to by all entities that hold assets which have their tax cost affected by the choice. [Schedule 8, item 3, section 707-145]

The choice to utilise 'value donor' concessions to increase the available fraction for a bundle of losses

8.17 Subsection 707-325(5) of the IT(TP) Act 1997 allows a head company to choose to include all or part of the modified market value of a 'value donor' to increase the available fraction for a bundle of losses.

8.18 Amendments allow the choice to be amended or revoked before 1 January 2005 and provide an equivalent extension of time for the choice to be made. [Schedule 8, item 4, subsections 707-325(5) and (6)]

8.19 Where the value donor rules are used, section 707-327 of the IT(TP) Act 1997 allows the head company to also treat certain losses made by the value donor as being included in the real loss maker's bundle. Amendments also allow this choice to be revoked before 1 January 2005 and provide an equivalent extension of time for the choice to be made. [Schedule 8, item 5, subsection 707-327(5)]

8.20 Because a choice to apply the value donor rules in section 707-325 is a necessary condition for the choice in section 707-327, revoking the choice in section 707-325 will automatically invalidate a choice to apply section 707-327.

The choice to waive the 'capital injection' rules

8.21 Section 707-325 of the ITAA 1997 contains rules designed to prevent manipulation of the consolidation loss rules via a capital injection or non-arm's length transaction prior to consolidating (the capital injection rules).

8.22 Section 707-328A of the IT(TP) Act 1997 allows these rules to be waived in cases where the entities involved are eligible to use the value donor rules to achieve the same result upon entry to consolidation. The capital injection rules may be waived if the transferee chooses for section 707-328A to apply to the real loss maker.

8.23 Amendments allow this choice to be amended or revoked before 1 January 2005 and provide an equivalent extension of time for making a choice to waive the capital injection rules. [Schedule 8, item 6, subsection 707-328A(4)]

The choice to utilise certain losses over three years rather than under the available fraction

8.24 Section 707-350 of the IT(TP) Act 1997 contains an alternative regime for the utilisation of certain losses transferred to the head company. Under this regime, certain pre- 21 September 1999 losses that have satisfied the continuity of ownership test may be utilised by the head company over three years rather than in accordance with the available fraction methodology in Subdivision 707-C of the ITAA 1997. A head company can choose to apply this alternative regime where certain conditions are met.

8.25 Amendments allow this choice to be revoked before 1 January 2005 and provide an equivalent extension of time for the choice to be made. [Schedule 8, item 7, subsections 707-350(5) and (6)]

The choice by the head company of a MEC group to cancel a loss

8.26 When a new eligible tier-1 company joins a MEC group, the ongoing head company is required to calculate an available fraction for its prior group losses and adjust the available fractions of loss bundles previously transferred to it. In addition, the group's available fractions and transferred losses are capped so that their total does not exceed what would otherwise have been the available fraction for the group losses under section 719-315 of the ITAA 1997.

8.27 Subsection 719-325(1) of the ITAA 1997 allows the ongoing head company to choose to cancel all the losses in its group loss bundle and any of its existing bundles. Making this choice may enable the head company to achieve a better outcome under the capping mechanism or avoid the rule altogether if it cancels its group loss bundle.

8.28 An amendment allows this choice to be revoked before 1 January 2005. [Schedule 8, item 8, section 719-310]

Research and development tax offset

8.29 Under section 73J of the ITAA 1936, a company may be eligible to choose the R&D tax offset subject to the following threshold tests:

•

the company's aggregate R&D amount (aggregate) for the tax offset year must exceed $20,000;

•

the aggregate for the company for the tax offset year, and those taxpayers with which it is grouped (while they are grouped in that year), must not exceed $1 million; or

•

the company's R&D group turnover for that year must be less than $5 million. The R&D group turnover is defined in section 73K of the ITAA 1936. Broadly, it is the value of supplies made by the company in the year of income and the value of the supplies made in the year of income by other persons while they were grouped with the company, reduced by intra group supplies.

8.30 The policy aim of the latter two of the three threshold tests above is to ensure that the R&D offset is targeted towards 'small' companies, or companies that are in groups regarded as small in the relevant income year. The requirements for a person (including a company) to be grouped with another person are set out in section 73L of the ITAA 1936.

Effect of consolidation

8.31 Under the consolidation regime, R&D expenditure by a subsidiary company during its period of membership of a consolidated group is treated for income tax purposes as R&D expenditure of the head company.

8.32 However, issues arise when an entity joins or leaves a consolidated group part-way through an income year, these being that:

•

a separate taxpayer is recognised (being the joining entity for the period prior to joining, or the leaving entity, for the period after leaving) with a less than 12 month year of income (i.e. a 'stub' year);

•

under the 'entry history' rule in section 701-5 of the ITAA 1997, things that happened to the entity before it became a member of the group will be taken to have happened in relation to the head company; and

•

under the 'exit history' rule in section 701-40 of the ITAA 1997, an entity 'inherits' the history in relation to assets, liabilities and businesses that it takes with it on leaving a consolidated group.

8.33 Situations where a threshold is applied to a stub period taxpayer are dealt with in the consolidation provisions by way of a rule in section 716-850 of the ITAA 1997. This rule operates differently depending on whether the non-membership period is before or after the company's period of membership of the consolidated group. A joining entity's eligibility for the pre-consolidation period is determined by grossing-up its amounts for the pre-consolidation stub year to a full year equivalent, without it being required to look forward to what happens after it joins the group. However, a company that has departed a consolidated group looks back to include the history of the business it takes with it on exit from the consolidated group.

8.34 Because the R&D grouping rules are, broadly, based on 50% rather than 100% ownership, entities may be grouped for R&D offset purposes while not being eligible to be members of the same consolidated group.

History for purposes of eligibility for tax offset: joining entity

8.35 Section 73BABA effectively turns-off the operation of the consolidation entry-history rule for the purposes of determining a head company's eligibility for the R&D offset. [Schedule 8, item 9, section 73BAA and item 10, section 73BABA of the ITAA 1936]

8.36 In the absence of this amendment, the entry-history rule will treat a joining entity's turnover and R&D aggregate for the pre-consolidation part of that year as having been incurred by the head company for the purposes of determining the head company's eligibility. This would be inconsistent with the way the R&D grouping rules apply to non-consolidated groups and would result in amounts being double counted in cases where the joining entity was already grouped with the head company under the R&D grouping rules in section 73L of the ITAA 1936.

Example 8.1

Half way through its income year, Head Co acquires all the shares in Sub Co. Head Co and Sub Co were not under common ownership or control before this time. Sub Co's turnover for the year is $2 million, of which half relates to the period before becoming owned by Head Co. Head Co's turnover for the year is $3.5 million.

If Head Co was not the head company of a consolidated group, Head Co's R&D group turnover for the year would be $4.5 million, being its own turnover plus Sub Co's turnover of $1 million for the part of the year when it was owned by Head Co. Subject to it satisfying the other threshold tests, Head Co would be eligible to choose the R&D tax offset for that year.

However, in the absence of section 73BABA, if Head Co was the head company of a consolidated group, the consolidation entry history rule would cause it to 'inherit' Sub Co's R&D history relating to the period before consolidation. Head Co's R&D group turnover would be $5.5 million and it would be ineligible for the R&D tax offset. Under section 73BABA, Head Co's R&D group turnover will be $4.5 million, consistent with the outcome in the absence of consolidation.

Under consolidation, Sub Co's eligibility for the R&D offset will be determined by grossing-up its R&D group turnover and its aggregate R&D amount for the first part of the year, as per section 716-850 of the ITAA 1997. The amendments do not affect this outcome.

Example 8.2

In this example, Sub Co was partially owned by Head Co for the first part of the income year such that the two entities were already grouped for R&D purposes before Sub Co became wholly-owned by Head Co. Head Co's turnover for the year was $2.5 million while Sub Co's turnover was $2 million, half of which related to the period before it became wholly-owned by Head Co.

Head Co's R&D group turnover in the absence of consolidation would be $4.5 million, being its own turnover plus Sub Co's turnover for the full year. Head Co would be eligible to choose the R&D tax offset subject to the other threshold tests being satisfied.

However, in the absence of section 73BABA, if Head Co was the head company of a consolidated group, the entry history rule would cause it to 'inherit' Sub Co's turnover for the pre-consolidation part of the year, notwithstanding that the same amount is already counted towards Head Co's R&D group turnover under the R&D grouping rules. In this case, Head Co's R&D group turnover would be $5.5 million and it would be ineligible for the R&D tax offset. Section 73BABA prevents this double counting.

History for purposes of eligibility for tax offset: leaving entity

8.37 Section 73BACA ensures that the R&D grouping provisions apply appropriately in determining the eligibility for the R&D offset of a company that has left a consolidated group part-way through the income year.

8.38 Under the exit history rule, a subsidiary leaving a consolidated group part-way through an income year will inherit the R&D history of the business it takes with it on exit. However, under the single entity principle, the entity is not regarded as a separate taxpayer while part of the consolidated group. As a result, when determining the leaving entity's eligibility for the R&D offset for the part of the year after it leaves the consolidated group, it would not be treated as having been previously grouped with other entities, including other members of the consolidated group.

8.39 This outcome would be inconsistent with the intent of the R&D grouping rules, under which the turnover and R&D aggregate of the leaving entity would, in the absence of consolidation, be grouped with that of other entities for a part of the year when they were under common ownership or control.

8.40 Section 73BACA disregards the operation of the single entity rule in determining the leaving entity's eligibility so that it is required to include the turnover and R&D aggregate of other entities with which it would be grouped under section 73L of the ITAA 1936 but for the single entity rule. [Schedule 8, item 11, section 73BACA]

8.41 A rule is also needed to ensure that the leaving entity's own history is not double counted. This may occur because the exit history rule, which results in certain things being treated as having happened in relation to the leaving entity, does not mean those same things can not also be treated as happening in relation to an entity with which the leaving entity was grouped (i.e., the head company). To prevent this, things are not counted again where they are already taken into account as a result of the consolidation exit history rule. [Schedule 8, item 11, paragraph 73BACA(d)]

Example 8.3

At the beginning of an income year, Sub Co is a wholly-owned subsidiary of Head Co. Head Co sells its interest in Sub Co part-way through the year. Head Co's turnover for the year is $6 million, half of which relates to the part of the year when it owned Sub Co. Sub Co's turnover is $4 million and this amount is also evenly split between the two parts of the year.

In the absence of consolidation, Head Co's R&D group turnover for the year would be $8 million, being its own turnover plus Sub Co's turnover of $2 million for the part of the year when it was owned by Head Co. Sub Co's R&D group turnover would be $7 million, being its own turnover for the full year plus $3 million, which is the share of Head Co's turnover that relates to the part of the year when it was grouped with Sub Co.

Consolidation would not change the calculation of Head Co's eligibility. However, in the absence of section 73BACA, if Head Co and Sub Co had been a consolidated group for the first part of the year, Sub Co's R&D group turnover would be only $4 million, since the R&D grouping rules would not regard it as having been a separate entity capable of being grouped with the head company during this period. This may enable Sub Co to claim the R&D offset, notwithstanding that it would have been ineligible in the absence of consolidation.

Section 73BACA ensures that, in determining Sub Co's eligibility for the offset, Sub Co is treated as having been grouped with Head Co for the period when they were a consolidated group - consistent with the outcome that would arise in the absence of consolidation.

Minor technical amendments

8.42 Item 12 amends the ITAA 1997 by ensuring that the defined term 'approved form' in paragraph 721-25(3)(b) of the ITAA 1997 is identified by an asterisk. [Schedule 8, item 12, paragraph 721-25(3)(b)]

8.43 Item 13 amends to IT(TP) Act 1997 to correct an error in the heading to Division 707. [Schedule 8, item 13, Division 707 of the IT(TP) Act 1997]

Application and transitional provisions

8.44 The amendments discussed in this chapter will take effect on 1 July 2002 (being the commencement date of the consolidation regime). [Schedule 8, item 14]

8.45 The transitional nature of the provisions allowing revocation of choices that are in this bill (the provisions will only apply until 31 December 2004) will benefit taxpayers by providing additional time to consider the impact of consolidation before being required to make irrevocable choices.

Index