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

Consolidation: providing greater flexibility

Schedule 1 to this bill provides greater flexibility, clarifies certain aspects of the consolidation regime and ensures that the regime interacts appropriately with other aspects of the income tax law.

Date of effect: These amendments have retrospective effect to 1 July 2002, which is the date of commencement of the consolidation regime. The amendments clarify the operation of the consolidation regime and the interaction of the regime with other areas of the tax law and as such are beneficial to taxpayers and do not have the potential to act to the detriment of any persons.

Proposal announced: All these amendments were foreshadowed in the former Minister for Revenue and Assistant Treasurer's Press Release No. C116/03 of 4 December 2003.

Financial impact: The financial impact in relation to the amendment dealing with capital gains or capital losses arising from changes in the value of deferred tax liabilities is unquantifiable as it depends on the future level of activity in disposals of assets which is not possible to determine. However, this change is designed to reduce compliance costs associated with keeping track of changes in the value of deferred tax liabilities. All of the other changes are not expected to impact on revenue.

Compliance cost impact: The amendments in this bill will provide taxpayers with additional flexibility in the transition to consolidation and are not expected to impact on compliance costs.

Copyright collecting societies

Schedule 2 to this bill amends the Income Tax Assessment Act 1997, the Income Tax (Transitional Provisions) Act 1997 and the Taxation Administration Act 1953 to:

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ensure that copyright collecting societies are not taxed on any copyright income that they collect and hold on behalf of members, pending allocation to them;

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minimise compliance costs for copyright collecting societies by ensuring that they are not taxed on the non-copyright income they derive, provided that the amount of non-copyright income derived falls within certain limits; and

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ensure that any copyright and non-copyright income collected or derived by copyright collecting societies that is exempt from income tax in their hands, is included in the assessable income of members upon distribution.

Date of effect: The amendments will generally apply from 1 July 2002. However, under a transitional option, societies may elect to have the amendments apply from 1 July 2004.

Proposal announced: This measure was announced in the former Minister for Revenue and Assistant Treasurer's Press Release No. C081/02 of 1 August 2002.

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

Compliance cost impact: The measure is expected to have a minimal effect on the compliance costs of copyright collecting societies.

Simplified imputation system - consequential and other amendments

Schedule 3 to this bill:

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makes consequential amendments to the income tax laws which will:

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replace references to the former imputation provisions in Part IIIAA of the Income Tax Assessment Act 1936 (ITAA 1936) to those of the simplified imputation system (SIS) in Part 3-6 of the Income Tax Assessment Act 1997 (ITAA 1997); and

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update terminology of the former imputation system to equivalent terms of the SIS;

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makes various technical amendments in relation to the SIS and other imputation related provisions; and

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inserts into Division 207 of the ITAA 1997 anti-avoidance rules that apply in relation to certain tax exempt entities that are entitled to a refund of franking credits. These rules were previously in Division 7AA of Part IIIAA of the ITAA 1936.

Date of effect: The amendments will generally apply to events occurring on or after 1 July 2002, the commencement date of the SIS.

The amendment to section 46FB of the ITAA 1936 will generally apply to dividends paid after 30 June 2003, subject to the transitional rule allowing groups to consolidate either before 30 June 2003 or on the first day of the first income year after 30 June 2003 and before 1 July 2004.

The amendments to re-insert the definition of 'controller (for CGT purposes)' will apply to assessments for the 2002-2003 income year and later income years.

For assessments for the 2002-2003 income year, section 109ZC of the ITAA 1936 has effect as if the references in subsection 109ZC(3) to amounts that are not assessable income and are not exempt income were instead a reference to income that is not exempt.

For the period starting 1 July 2002 and ending 30 June 2004 the following apply:

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section 128TB of the ITAA 1936 has effect as if the reference to 'general company tax rate' in subsection 128TB(2) was amended to 'corporate tax rate'; and

•

section 377 of the ITAA 1936 has effect as if the references in paragraph 377(1)(e) to the former imputation provisions were references to the SIS.

Proposal announced: The consequential amendments form part of the SIS, which was announced as part of the Government's business tax reform package. The proposal was announced in the Treasurer's Press Release No. 058 of 21 September 1999. On 14 May 2002, the former Minister for Revenue and Assistant Treasurer announced in Press Release No. C057/02 the Government's program for delivering the next stage of business tax reform measures including the SIS.

Financial impact: Nil.

Compliance cost impact: The SIS is designed to reduce compliance costs incurred by business by providing simpler processes and increased flexibility.

Deductible gift recipients

Schedule 4 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to update the lists of specifically listed deductible gift recipients (DGRs). It also amends the ITAA 1997 to add a new category of DGRs for government special schools.

Date of effect: The new category of DGRs for government special schools applies from 1 April 2004.

Deductions for gifts to organisations listed as DGRs under Schedule 4 apply as follows:

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State and territory fire and emergency services from 23 December 2003; with the exception of the ACT Rural Fire Service and the ACT State Emergency Service which apply from 1 July 2004, reflecting that these organisations only began operating under these names from that date;

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International Social Service - Australian Branch from 18 March 2004;

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Victorian Crime Stoppers Program from 23 April 2004;

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Australian Ex-Prisoners of War Memorial Fund from 20 October 2003 to 19 October 2005;

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Albert Coates Memorial Trust from 31 January 2004 to 30 January 2006;

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Coolgardie Honour Roll Committee Fund from 2 June 2004 to 1 June 2006;

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Tamworth Waler Memorial Fund from 20 April 2004 to 19 April 2006;

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Australian Business Week Limited from 9 December 2003;

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St Patrick's Cathedral Parramatta Rebuilding Fund from 25 February 2004 to 30 June 2004;

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St Paul's Cathedral Restoration Fund from 23 April 2004 to 22 April 2006;

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CFA and Brigades Donations Fund from 1 July 2004;

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City of Onkaparinga Memorial Gardens Association Inc. from 29 April 2004 to 25 April 2005;

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Mount Macedon Memorial Cross Trust from 14 August 2004 to 15 August 2005;

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Shrine of Remembrance Foundation from 3 July 2004 to 30 June 2006;

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Shrine of Remembrance Restoration and Development Trust from 1 July 2005 to 30 June 2007;

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Finding Sydney Foundation from 27 August 2004 to 26 August 2006;

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The Clontarf Foundation from 31 August 2004;

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Lord Somers Camp and Powerhouse from 5 March 2004;

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The Lowy Institute for International Policy from 14 August 2003; and

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St George's Cathedral Restoration Fund from 28 September 2004 to 27 September 2006.

Proposal announced: The new DGR category for certain government special schools was announced in the Treasurer's Press Release No. 32 of 11 May 2004. The deductibility of gifts to rural fire and emergency services authorities was announced in the Treasurer's Press Release No. 114 of 23 December 2003.

Financial impact: The cost to revenue of creating a new category of DGR for certain government special schools is unquantifiable, but likely to be small.

The DGR listings and extensions to DGR listings have the following financial impacts:

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St Paul's Cathedral Restoration Fund: $2 million for the period of the extension;

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St Patrick's Cathedral Parramatta Rebuilding Fund: $0.1 million for the period of the extension;

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the Shrine of Remembrance Foundation and the Shrine of Remembrance Restoration and Development Trust: $0.6 million over the period of the extension;

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Finding Sydney Foundation: $1 million over the life of the project; and

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St George's Cathedral Restoration Fund: $0.9 million over the two year period.

The cost to revenue of the remaining DGR listings and extensions is unquantifiable but insignificant.

Compliance cost impact: Nil.

Debt and equity interests - at call loans

Schedule 5 to this bill amends the Income Tax Assessment Act 1997 so that the transitional period for at call loans under the debt/equity rules will extend to 30 June 2005.

Date of effect: These amendments will commence on Royal Assent. They apply to loans entered into at any time on or before 30 June 2005.

Proposal announced: This measure was announced in the former Minister for Revenue and Assistant Treasurer's Press Release No. C045/04 of 24 May 2004.

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

Compliance cost impact: The amendments will give taxpayers extra time to assess existing loans and adjust their arrangements, if need be, in light of the Government's decision to carve out certain small business at call loans from the debt/equity rules (the former Minister for Revenue and Assistant Treasurer's Press Release No. C045/04 of 24 May 2004). The amendments are expected to assist in reducing compliance costs.

Irrigation water providers

Schedule 6 to this bill amends the water facilities and landcare tax concession provisions in the Income Tax Assessment Act 1997 to provide irrigation water providers and rural land irrigation water providers access to these concessions.

Date of effect: From 1 July 2004 for expenditure incurred on, or after, that date.

Proposal announced: This measure was announced in the former Minister for Revenue and Assistant Treasurer's and the Minister for Agriculture, Fisheries and Forestry's Press Release No. C040/04 of 11 May 2004.

Financial impact: The impact of this measure is estimated to cost $15 million over the forward estimate period.

Compliance cost impact: Compliance costs could be slightly lower.

Summary of regulation impact statement

Regulation impact on business

Impact: This measure is expected to impact favourably on irrigation water providers and rural land irrigation water providers and assists in renewing water supply infrastructure in rural Australia.

Main points:

The amendments will allow irrigation water providers and rural land irrigation water providers to claim accelerated decline in value deductions for eligible capital expenditure.

These amendments will have a small positive impact on compliance costs.

This measure will have a minor negative impact on the Australian Government's revenue collections.

Fringe benefits tax - broadening the exemption for the purchase of a new dwelling as a result of relocation

Schedule 7 to this bill amends the provisions for accessing the fringe benefits tax exemption for incidental purchase costs associated with the acquisition of a dwelling as a result of relocation.

Date of effect: 1 April 2004.

Proposal announced: This measure was announced in the former Minister for Revenue and Assistant Treasurer's Press Release No. C031/04 of 11 May 2004.

Financial impact: An insignificant cost to revenue.

Compliance cost impact: Nil.

CGT event G3

Schedule 8 to this bill extends the scope of CGT event G3 so that an administrator (in addition to a liquidator) of a company can declare shares and financial instruments in the company to be worthless for capital gains tax (CGT) purposes. The declaration permits taxpayers who hold those shares or financial instruments to choose to make a capital loss.

Date of effect: These amendments apply to declarations made by liquidators or administrators after the date of Royal Assent of this bill.

Proposal announced: This measure was announced in the 2004-2005 Budget and in the former Minister for Revenue and Assistant Treasurer's Press Release No. C029/04 of 11 May 2004.

Financial impact: These amendments have an unquantifiable but insignificant cost to revenue.

Compliance cost impact: These amendments will reduce compliance costs for affected taxpayers.

Summary of regulation impact statement

Regulation impact on business

Impact: The main impact will be on individuals, superannuation funds, trusts and companies that are shareholders and holders of financial instruments in companies under external administration.

Main points:

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Taxpayers who hold worthless shares in companies that appoint an administrator (rather than a liquidator), or who hold financial instruments that have become worthless, will not have to create a trust over those shares or financial instruments to be able to claim capital losses.

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Liquidators and administrators will incur additional costs in determining whether there are reasonable grounds to declare shares and financial instruments to be worthless and in making the appropriate declarations. These costs are not expected to be significant.

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The Australian Taxation Office may incur some implementation costs. These costs are not expected to be significant.

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The measure will reduce compliance costs for affected taxpayers at little cost and therefore is supported.

GST - supplies to offshore owners of Australian real property

Schedule 9 to this bill amends the A New Tax System (Goods and Services Tax) Act 1999 to remove an anomaly that allows supplies of certain services made to owners of residential property to be GST-free if the owner is not in Australia at the time of the supply. This amendment will result in the same goods and services tax (GST) treatment applying to both non-resident and resident entities whether or not they are in Australia at the time of the supply.

Date of effect: The amendments will apply to supplies made on or after the first day of the first quarterly tax period that commences after the day on which this bill receives Royal Assent.

Proposal announced: This proposal has not previously been announced.

Financial impact: The gain to GST revenue from this measure is estimated to be as follows:

Compliance cost impact: This measure is expected to reduce compliance costs, especially for real estate agents who will not be required to apportion supplies they make on behalf of owners located overseas.

Baby Bonus (first child tax offset) and adoption

Schedule 10 to this bill amends the first child tax offset provisions affecting adoption.

Date of effect: 1 July 2001.

Proposal announced: This measure was announced in the 2003-04 Mid-Year Fiscal and Economic Outlook.

Financial impact: An insignificant cost to revenue.

Compliance cost impact: Nil.

Technical correction to the Taxation Laws Amendment Act (No. 8) 2003

Schedule 11 to this bill corrects a technical defect in the citation of an Act in the commencement provision applying to the franking deficit tax offset provisions for life insurance companies in Schedule 7 to the Taxation Laws Amendment Act (No. 8) 2003.

Date of effect: The amendment commences immediately after the Taxation Laws Amendment Act (No. 8) 2003 received Royal Assent (21 October 2003).

Proposal announced: This measure has not previously been announced.

Financial impact: Nil.

Compliance cost impact: The amendment in this bill makes a technical correction to the citation of an Act and is not expected to impact on compliance costs.

Transfer of life insurance business

Schedule 12 to this bill amends the income tax law to alleviate unintended tax consequences that arise when a life insurance company transfers some or all of its life insurance business to another life insurance company under Part 9 of the Life Insurance Act 1995 or under the Financial Sector (Transfers of Business) Act 1999.

Date of effect: These amendments apply to transfers of life insurance business that take place on or after 1 July 2000.

Proposal announced: This measure was announced in the former Minister for Financial Services and Regulation's Media Release No. FSR/069 of 12 October 2000.

Financial impact: Negligible.

Compliance cost impact: This measure is expected to have a minimal impact on compliance costs.

Chapter 1 - Consolidation: providing greater flexibility

Outline of chapter

1.1 Schedule 1 to this bill contains the following modifications to the consolidation regime:

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membership rules to ensure that when a member is in liquidation or under administration that member is not precluded from being a member of a consolidated group;

•

cost setting rules to ensure that entities which are subject to a finance lease and enter a consolidated group are provided an appropriate tax cost in order to obtain the appropriate deductions under the uniform capital allowance regime;

•

cost setting rules to ensure that appropriate allowance is given for expenditure relating to mining or quarrying activities;

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cost setting rules to ensure that entities that have low-value pools and software development pools receive the appropriate tax costs to enable them to maintain their entitlement to deductions for those pools;

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source of profit distributions in working out the allocable cost amount (ACA) and cost setting process;

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ensuring that the undistributed profits of a joining entity are appropriately included in working out the ACA;

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adjusting for changes in deferred tax liabilities in working out the ACA and for capital gains tax (CGT) purposes;

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technical amendments to clarify the application of certain trust cost setting provisions;

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inter-entity loss multiplication rules to alleviate notice requirements; and

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allowing entities to revoke irrevocable choices or elections when they consolidate, join consolidated groups and/or leave consolidated groups. The rules provide a number of distinct treatments for these choices or elections which act as modifications to the entry history and exit history rules.

1.2 All references to legislative provisions in this chapter are references to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

1.3 Unless otherwise stated, a reference in this chapter to a consolidated group should be read as including a multiple entry consolidated group.

Context of amendments

1.4 With the introduction of the consolidation regime, a number of modifications, are being made to provide greater flexibility, further clarify certain aspects of the regime and to ensure that it interacts appropriately with other areas of the income tax law.

Summary of new law

Clarifying beneficial ownership for consolidation membership rules

1.5 Part 2 of Schedule 1 to this bill clarifies the meaning of beneficial ownership in section 703-30 for the purposes of the consolidation membership rules. The amendment ensures that entities under external administration will not be prevented from being or remaining members of consolidated groups.

Cost setting rules for assets subject to a finance lease

1.6 Part 3 of Schedule 1 to this bill provides special rules for setting the tax cost of assets where an entity that is subject to a finance lease becomes a member or ceases to be a member of a consolidated group. These rules ensure that the cost setting rules apply appropriately taking into account the different treatment of finance leases under accounting standards and the income tax law.

Application of cost setting rules to certain types of mining expenditure

1.7 Part 4 of Schedule 1 to this bill contains rules that clarify the operation of the cost setting rules and the inherited history rules for assets that have arisen from allowable capital expenditure, transport capital expenditure or exploration and prospecting expenditure.

Low-value pools

1.8 Part 5 of Schedule 1 to this bill amends the income tax law dealing with low-value pools to ensure that the head company of a consolidated group receives the appropriate allowances for the decline in value of these pools. The rules also ensure that the head company and a leaving entity receive the appropriate allowances for the decline in value of the pools where the leaving entity takes part of the pool with it upon leaving the consolidated group.

Software development pools

1.9 Part 5 of Schedule 1 to this bill also amends the income tax law dealing with software development pools to ensure that the head company of a consolidated group receives the appropriate allowances for the decline in value of these pools. The rules also ensure that the head company and a leaving entity receive the appropriate allowances for the decline in value of the pools where the leaving entity takes part of the pool with it upon leaving the consolidated group.

Source of certain distributions for allocable cost amount purposes

1.10 Part 7 of Schedule 1 to this bill contains rules to simplify the method of working out the ACA by accepting a last-in-first-out method of accounting for profits in appropriate circumstances where the entity must determine which prior year's profits were used to pay a particular dividend.

Adjustment to step 3 of allocable cost amount to take account of certain losses

1.11 Part 8 of Schedule 1 to this bill contains rules to ensure that the full amount of undistributed profits, that have accrued to a consolidated group before the joining time, is included when calculating the ACA for a joining entity.

Transitional treatment of deferred tax liabilities

1.12 Part 9 of Schedule 1 to this bill contains rules that reduce compliance costs in applying the consolidation cost setting rules for transitional entities which have a change in the amount of deferred tax liabilities associated with assets that have their tax cost reset.

Technical amendments to certain trust cost setting rules

1.13 Part 11 of Schedule 1 contains minor technical amendments to the method of working out the ACA where a discretionary trust joins a consolidated group. It also clarifies the application of section 713-25 by making it clear that this section applies to both discretionary and non-discretionary trusts.

Inter-entity loss multiplication rules

1.14 Part 6 of Schedule 1 to this bill amends the income tax law to alleviate the notice requirements under the inter-entity loss multiplication rules during the consolidation transitional period for entities that are in the same consolidatable group. The amendments also give the Commissioner of Taxation (Commissioner) a discretion to extend the time for giving notices or to waive the notice requirement in appropriate circumstances.

Treatment for irrevocable entity-wide elections

1.15 Part 10 of Schedule 1 to this bill provides special rules for irrevocable elections or choices made by entities in respect of:

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attribution of income in respect of controlled foreign corporations, foreign investment funds and foreign limited partnerships;

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valuation of interests in foreign investment funds that are trading stock;

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functional currency rules;

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reinsurance with non-residents;

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short-term forex realisation gains and losses; and

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rules about disregarding certain forex realisation gains and losses.

1.16 The rules set out three distinct treatments for these elections which act as modifications to the entry and exit history rules in Part 11-90.

Comparison of key features of new law and current law

Detailed explanation of new law

Clarifying beneficial ownership for consolidation membership rules

1.17 The meaning of 'beneficial ownership' in section 703-30 is clarified for the purposes of the consolidation membership rules. The amendment ensures that entities under external administration will not be prevented from being or remaining members of consolidated groups. [Schedule 1, item 2, subsection 703-30(3)]

1.18 Section 703-30 outlines when an entity is a wholly-owned subsidiary of another entity. A fundamental requirement is that all the membership interests of that subsidiary be 'beneficially owned' by:

•

the holding entity;

•

one or more wholly-owned subsidiaries of the holding entity; or

•

the holding entity and one or more wholly-owned subsidiaries of the holding entity.

1.19 The terms 'beneficially owned' and 'beneficial ownership' are not defined terms for the purposes of the ITAA 1997. Therefore, they have their ordinary meaning.

1.20 Provisions in the Corporations Act 2001 may have the effect of vesting the property of an externally administered entity in the person undertaking the external administration (e.g. section 474 of the Corporations Act 2001). Where such provisions operate it may be arguable that ownership of the beneficial interest and the legal interest in the property of the insolvent entity are potentially alterable.

1.21 Case law has considered beneficial ownership as meaning the real owner of the property and, in a case where the legal and equitable ownership is divided, the owner of the property in equity.

1.22 While Santow J in Mineral & Chemical Traders Pty Ltd v T Tymczyszyn Pty Ltd (1995)
13 ACLC 40 held that the appointment of a liquidator did not operate to divest the insolvent company of its assets, later cases have referred to the line of reasoning first espoused in Re Oriental Inland Steam Company (1874) LR9 ChApp 557 that there is a notional vesting of the beneficial ownership of property in the liquidator.

1.23 The intent of this amendment is to ensure that the appointment of an external administrator will not force the exit of the entity from the consolidated group. In Review of Business Taxation: A Platform for Consultation Discussion Paper 2: Building on a strong foundation Volume II it was contemplated that members of consolidated groups could enter liquidation without causing changes to the membership of the group. Consolidation is intended to ease corporate restructures by allowing a company to be liquidated without triggering a deemed dividend, or a capital gain or loss.

1.24 This amendment operates to ensure that beneficial ownership is not affected by a member of a consolidated group being or becoming an externally administered body corporate, or having similar status under a foreign law.

1.25 'Externally-administered body corporate' is defined in section 9 of the Corporations Act 2001 to mean a body corporate:

•

that is being wound up, whether voluntarily or by court order;

•

with property to which a receiver, or a receiver and manager, has been appointed (whether or not by a court) and is acting;

•

that is under administration;

•

that has executed a deed of company arrangement that has not yet terminated; or

•

that has entered into a compromise or arrangement with another person the administration of which has not been concluded.

1.26 This means that where a subsidiary entity is, for example, being wound up, it will remain a wholly-owned subsidiary of another entity. The effect of this is that the entity remains a member of the consolidated group and is not forced to deconsolidate.

1.27 The amendment also extends to non resident entities who may wholly-own membership interests in members of consolidated or multiple entry consolidated (MEC) groups, such as top companies of MEC groups or interposed non resident entities. [Schedule 1, item 2, paragraph 703-30(3)(b)]

1.28 The amendment clarifies the meaning of 'beneficial ownership' for the consolidation membership rules only and not for any other purposes. The concept of beneficial ownership is used elsewhere in the tax laws however, this amendment does not imply that beneficial ownership has any meaning other than its ordinary meaning where it is used elsewhere in the tax law. This amendment is not intended to impact on the meanings associated with those concepts.

Cost setting rules for assets subject to a finance lease

1.29 Part 3 of Schedule 1 to this bill amends the cost setting rules to enable the lessor and lessee, that are subject to a finance lease recognised under accounting standards, to determine which assets and liabilities are recognised and which assets are not recognised for cost setting purposes.

1.30 The interaction of the treatment of finance leases under the accounting standards and its treatment under the income tax law raised a number of issues for the operation of the cost setting rules in Division 705. These issues arise because the tax law, depending on the circumstances, may provide that either the lessor or lessee of an asset that is subject to a finance lease is entitled to deductions for the decline in value of the asset. Under the accounting standards, the lessee under a finance lease recognises the leased asset not the lessor.

1.31 An asset, for the purposes of the cost setting rules, represents anything of economic value, which is brought into a consolidated group when an entity becomes a subsidiary member of a consolidated group. In working out the amount of tax cost to allocate to the assets of the joining entity, step 2 of the calculation of the ACA adds amounts that can or must be recognised as liabilities in accordance with the accounting standards.

1.32 Under Accounting Standard AASB 1008 (Leases) and AAS 17 (Accounting for Leases), a lessor of an item of plant which is leased under a finance lease is effectively treated as having sold the plant to the lessee and provided finance for the acquisition. The lessor does not, therefore, recognise the plant as an asset but rather, recognises it as an asset consisting of the right to receive lease payments equal to the aggregate of the present value of the minimum lease payments and the present value of any unguaranteed residual value.

1.33 For income tax purposes, deductions for the decline in value of a depreciating asset are only available to the person who 'holds' the depreciating asset for the purposes of Division 40. The general rule for depreciating assets that are subject to a lease is that the owner is the 'holder of the asset' (i.e. the lessor) under certain items in the table in section 40-40. However, the lessee can also be the 'holder of the asset' under other items in the table in section 40-40.

What happens when the joining entity is the lessor or lessee and 'holds' the asset under Division 40?

1.34 Where an entity that is a lessor or lessee, under a finance lease, joins a consolidated group there was uncertainty as to what assets they have for cost setting purposes. In relation to the lessor, does the lessor, in determining the tax cost, have two assets (being the actual plant and the right to receive lease payments). In relation to the lessee, it was uncertain whether the lessee should have an amount included in step 2 of the ACA calculation in respect of the lease liability, as recognised under accounting standards, and whether the lessee also has an asset recognised under the finance lease to which the ACA needs to be allocated. Amendments are made to Division 705 (the general cost setting rules) to ensure that they apply appropriately where the joining entity is a lessor or lessee subject to a finance lease. Amendments are also made to the calculation of the ACA where a subsidiary member that is a party to a finance lease ceases to be a member of a consolidated group.

1.35 These rules ensure that the cost setting rules apply appropriately to an entity that is either the lessor or lessee under a finance lease by specifying which:

•

assets in relation to the lessor or lessee will have their tax cost set when the entity joins a consolidated group;

•

liabilities arising from a finance lease will be taken into account in step 2 of the ACA calculation; and

•

tax cost is applied when the leaving entity is a lessor or lessee.

[Schedule 1, item 5, section 705-56]

1.36 The rules contained in this bill do not deal with how assets subject to an operating lease should be treated under the cost setting rules. It is limited to assets subject to a finance lease in accordance with accounting standards.

What happens when an entity that is subject to a finance lease joins a consolidated group?

1.37 The object of the amendments is to clarify how the tax cost setting amount is calculated for certain types of assets that are subject to a finance lease. How this is achieved depends on whether at the joining time, the joining entity is:

•

a lessor who is the holder of the asset; or

•

a lessee who is the holder of the asset.

[Schedule 1, item 5, subsections 705-56(2) to (4)]

1.38 Subsection 705-56(1) ensures that the amendments only apply to underlying assets subject to a finance lease which give rise to deductions for decline in value under Division 40. This then ensures that an entity which holds the underlying asset for the purposes of Division 40 is able to allocate the ACA to the underlying asset. [Schedule 1, item 5, subsection 705-56(1)]

1.39 This subsection is also consistent with paragraph 5.1 of Accounting Standard AASB 1008 which states that a lease must be classified either as an operating lease or as a finance lease at the inception of the lease. The new rules will also cover arrangements subject to Division 240 in circumstances where the hire purchase agreement is also a finance lease. [Schedule 1, item 5, subsection 705-56(1)]

Modifications where the joining entity is a lessor

Where a lessor 'holds' a depreciating asset

1.40 Where a lessor 'holds' a depreciating asset, that is subject to a finance lease for Division 40 purposes, the underlying asset (i.e. depreciating asset) will be recognised for cost setting purposes. ACA will be allocated to the underlying asset and the asset consisting of the right to receive lease payments is not taken into account in setting the tax cost of assets and is taken to have a tax cost of nil. [Schedule 1, item 5, subsections 705-56(2) and (5)]

1.41 The asset that is the joining entity's right to receive lease payments under the finance lease reflects paragraph 12.1 of Accounting Standard AASB 1008 which requires that "where a lease is classified by the lessor as a direct financing lease, the lessor must recognise, as at the beginning of the lease term, an asset (lease receivable) at an amount equal to the aggregate of the present value of the minimum lease payments and the present value of any unguaranteed residual value expected to accrue to the benefit of the lessor at the end of the lease term". The amendments provide a consistent treatment.

Example 1.1

Assume a joining entity (Lessor Co) that has entered into a finance lease has two assets which consist of plant and right to receive lease payments, which it brings into a consolidated group. The head company of the consolidated group will recognise for cost setting purposes the underlying asset of plant because it 'holds' the asset for Division 40 purposes. However the right to receive lease payments will not be recognised for cost setting purposes.

Where a lessor does not 'hold' a depreciating asset

1.42 Where a joining entity that is a lessor does not hold a depreciating asset, for Division 40 purposes, that is subject to a finance lease at joining time, there is no recognition of the underlying asset under subsection 705-56(5). However, there is recognition of the asset consisting of the right to receive lease payments. The tax cost for the right to receive lease payments is set equal to its market value. [Schedule 1, item 5, subsections 705-56(3) and (5)]

Example 1.2

Assume a joining entity (Lessor Co) that has entered into a finance lease has two assets consisting of plant and the right to receive lease payments, which it brings into a consolidated group. The head company (Head Co) will not recognise for cost setting purposes the underlying asset (plant) because it no longer holds the asset for Division 40 purposes. However, Head Co is required to allocate the ACA to the right to receive lease payments. The tax cost for the right to receive lease payments will be its market value.

1.43 Paragraph 705-56(3)(b) ensures consistency between the tax cost of the right to receive lease payments when the lessor joins the group, and the tax cost for the right to receive lease payments at their market value when a lessor exits a group under subsection 711-30(3). [Schedule 1, item 5, paragraphs 705-56(3)(a) and (b); item 6, section 711-30]

1.44 A note is inserted into subsection 705-25(5) to alert the reader that a right to receive lease payments under a finance lease may, in some circumstances, be treated as a retained cost base asset. [Schedule 1, items 3 and 4]

Modifications where the joining entity is the lessee

Where the lessee 'holds' the depreciating asset

1.45 Where the lessee holds a depreciating asset that is subject to a finance lease the lessee will, for cost setting purposes, recognise the underlying asset (as an asset that has its tax cost set) and the obligation to make lease payments will be a liability for the purposes of step 2 in working out the ACA. The obligation to make lease payments under a finance lease is a liability that is recognised in accordance with Accounting Standard AASB 1008 or AAS 17. [Schedule 1, item 5, subsection 705-56(3)]

Example 1.3

Assume a joining entity (Lessee Co) that has entered into a finance lease has an asset consisting of plant together with an obligation to make lease payments, which it brings into the consolidated group. The head company (Head Co) of the consolidated group will recognise for cost setting purposes the underlying asset of plant as it holds the asset for the purposes of Division 40. Head Co will add at step 2 of the ACA calculation an amount for the liability to make lease payments. Head Co will allocate ACA to the plant.

Where the lessee does not 'hold' the depreciating asset

1.46 Where the lessee does not hold the depreciating asset that is subject to a finance lease the lessee will not recognise the underlying asset for tax cost setting purposes and the liability to make lease payments is not taken into account under step 2 in working out the ACA. [Schedule 1, item 5, subsections 705-56(3) and (4)]

Example 1.4

Assume, a joining entity (Lessee Co) that has entered into a finance lease has an asset which consist of, plant and an obligation to make lease payments, which it brings into the consolidated group. The head company (Head Co) of the consolidated group will not recognise for cost setting purposes the underlying asset of plant because it does not hold the depreciating asset for the purposes of Division 40, and will not recognise the obligation to make lease payments.

What happens when an entity that is subject to a finance lease leaves a consolidated group?

Modifications where the leaving entity is the lessor

1.47 Section 711-30 specifies how to work out the head company's 'terminating value' for any asset a leaving entity takes with it when it ceases to be a subsidiary member of a consolidated group. In circumstances where paragraph 705-56(3)(b) has applied subsection 711-30(3) ensures that if an entity does not 'hold' an underlying asset, that is the subject of a finance lease, the cost base of the right to receive lease payments is set at their market value when the entity exits. This is because when the entity leaves, some payments may already have been received and it would no longer be appropriate to use the original tax cost for the right to receive lease payments that was set when the entity joined the group. [Schedule 1, item 6, subsection 711-30(3)]

Modifications where the leaving entity is the lessee

1.48 Subsection 711-45(2) ensures that a liability consisting of an obligation to make lease payments, in certain circumstances, is not included in step 4 in working out the old group's ACA. Section 711-45 reduces the old group's ACA by the amount of liabilities which an entity takes with it when it leaves a consolidated group. In the circumstances where subsection 705-56(4) has applied, an issue arises on exit because the liability under the finance lease will be taken into account in reducing the old group's ACA. This is because the liability under the lease will be recognised for accounting purposes and therefore is included in subsection 711-45(1). However, there is no corresponding asset that will be taken into account under step 1 of the old group's ACA calculation on leaving (in relation to the corresponding asset of the entity under the lease) because this asset did not have its tax cost set due to paragraph 705-56(4)(b). [Schedule 1, item 7, section 711-45]

Application of cost setting rules to certain types of mining expenditure

1.49 Part 4 of Schedule 1 to this bill contains rules that clarify the operation of the cost setting rules and the inherited history rule for assets that have arisen from allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure. Specifically, the rules will:

•

determine the cost, adjustable value and terminating value of an asset created from allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure to enable its tax cost to be set appropriately;

•

determine the remaining effective life of depreciating assets that have resulted from allowable capital expenditure or transport capital expenditure where the tax cost setting amount of such assets does not exceed their terminating value;

•

deem any previous deductions in relation to the cost of allowable capital expenditure, transport capital expenditure and exploration or prospecting assets to have been calculated under the prime cost method;

•

deem any previous deductions in relation to the cost of allowable capital expenditure, transport capital expenditure and exploration or prospecting assets to be deductions for the decline in value of the depreciating asset;

•

allow the head company any to choose to reduce the tax cost of an allowable capital expenditure or transport capital expenditure asset to an amount equal to its terminating value in order to retain the concessional rates of depreciation previously available to the joining entity in respect of the asset;

•

reduce the adjustable value of the head company's notional asset if that notional asset has resulted in a depreciating asset that has had its tax cost reset; and

•

reduce the adjustable value of the head company's notional asset if a leaving entity takes with it some or all of a notional asset relating to 'other property'.

Prime cost method for working out decline in value of certain exploration or prospecting assets

1.50 Subject to satisfying certain criteria, section 40-80 allows a deduction for the decline in value of an asset, that is used for exploration and prospecting, equal to the asset's cost.

1.51 Where an entity joins a consolidated group, the cost setting rules apply such that the head company is taken to have purchased, at the joining time, all of the joining entity's depreciating assets for their tax cost. This includes exploration or prospecting assets for which the joining entity did (or could) deduct the decline in value under subsection 40-80(1).

1.52 Section 701-55 applies to set out for the head company a depreciating asset's tax cost, effective life and method for working out its decline in value. If the head company satisfies the criteria in subsection 40-80(1) for such an asset (e.g. the head company's first use of the asset after the joining time is for exploration or prospecting), it will be entitled to a deduction for a decline in value equal to the asset's tax cost.

1.53 If the head company does not satisfy subsection 40-80(1), it may be entitled to deductions for decline in value of the asset worked out using the effective life of the asset under other parts of Subdivision 40-B (such as section 40-70 or 40-75). In these circumstances, paragraphs 701-55(2)(c) to (e) become relevant.

1.54 In order for paragraphs 701-55(2)(c) to (e) to work appropriately, the joining entity would need to have used either the prime cost method or diminishing value method to calculate the asset's decline in value before the joining time. As section 40-80 does not require a taxpayer to choose a method for calculating the decline in value of the asset, it could be argued that no method applied for working out the asset's decline in value before the joining time.

1.55 Section 716-300 ensures that, where an asset's decline in value was deducted under subsection 40-80(1), section 701-55 applies as if the joining entity had applied the prime cost method for working out the decline in value of the asset just before the joining time [Schedule 1, item 8, section 716-300]. This means that, depending on whether the asset's tax cost exceeds its terminating value at the joining time, paragraph 701-55(2)(c) or (d) will apply to these assets to set their effective life. Further, paragraph 701-55(2)(b) will operate so that the prime cost method applies for working out any future deductions for the decline in value of such assets.

1.56 Section 716-300 only applies to assets whose decline in value is deducted under section 40-80. Therefore, if a joining entity deducted the decline in value of an exploration or prospecting asset under any other part of Subdivision 40-B (such as section 40-70 or 40-75), section 716-300 does not override the method previously used under that section. Section 716-300 is only intended to apply where section 40-80 did not require the joining entity to apply a particular method. [Schedule 1, item 8, paragraph 716-300(1)(c)]

Allowable capital expenditure, transport capital expenditure and exploration or prospecting assets - tax cost setting amount

Background

1.57 Prior to 1 July 2001, expenditure formerly known as allowable capital expenditure and transport capital expenditure was previously deducted through a pooling mechanism under Division 330, and prior to this under Divisions 10, 10AA and 10AAA of the Income Tax Assessment Act 1936 (ITAA 1936). For expenditure incurred after 30 June 2001, allowable capital expenditure (now known as mining capital expenditure) and transport capital expenditure are now deducted under Division 40 of the ITAA 1997.

1.58 Allowable capital expenditure and transport capital expenditure may have resulted in the creation or acquisition of assets, such as roads, fixtures, plant and equipment. Alternatively, the expenditure may have related to other capital advantages that are not such assets.

1.59 To facilitate the transition from Division 330 to Division 40 (which commenced on 1 July 2001), each 'pool' of expenditure was deemed to be a depreciating asset (called a 'notional' asset). The adjustable value of the notional asset is deemed to be equivalent to the undeducted allowable capital expenditure or transport capital expenditure as at 30 June 2001 and deductions for the decline in value of the notional asset are claimed under Division 40 (based on the concessional write-off period available under Division 330, generally 10 or 20 years). Additionally, any 'depreciating' assets that are reflected in the allowable capital expenditure or transport capital expenditure (e.g. roads, fixtures) are deemed to have a cost and adjustable value of nil at the start of 1 July 2001. Further transitional provisions were introduced to ensure that capital expenditure incurred after 30 June 2001 on such depreciating assets (held on 1 July 2001) would be included in the asset's cost and be eligible for decline in value deductions under Division 40 based on the assets' concessional write-off period.

1.60 Expenditure on exploration or prospecting assets incurred after 30 June 2001 is immediately deductible under Division 40 where those assets meet certain criteria as set out in subsection 40-80(1). However, prior to 1 July 2001, expenditure was immediately deductible under Division 330 and prior to this under Division 10 or 10AA of the ITAA 1936 (regardless of whether the expenditure was capital or revenue). If the expenditure related to depreciable plant, and the taxpayer elected, the asset could have been depreciated under Division 42 (for expenditure incurred between 1 July 1997 and 30 June 2001).

1.61 Since expenditure on exploration or prospecting assets was immediately deductible under the former Division 330 (or its predecessor provisions), there was no need to transition this expenditure into Division 40. However, in order to ensure that expenditure incurred after 30 June 2001 on exploration or prospecting assets held at 1 July 2001 continued to be immediately deductible, transitional provisions were introduced. These transitional provisions also have the effect of setting the cost and adjustable value of such exploration or prospecting assets at zero (this is to ensure that the correct balancing adjustments can be calculated for these assets).

1.62 Sections 705-40, 705-50 and 705-57 require a head company to adjust the tax cost of a reset cost base asset where certain conditions are satisfied. However, in order for these sections to apply, the reset cost base asset must have a cost, adjustable value and terminating value greater than nil. Additionally, section 705-50 will only apply if an entity has claimed deductions for the decline in value in respect of the depreciating asset.

1.63 To ensure that these provisions operate as intended with respect to the depreciating assets created from allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure, it is necessary to determine the cost, adjustable value and terminating value of these assets (which are deemed, under the transitional provisions, to be nil at the start of 1 July 2001). It is also necessary to deem deductions for allowable capital expenditure, transport capital expenditure and exploration or prospecting expenditure that relate to a depreciating asset to be deductions for the decline in value of that asset. By giving the depreciating assets these attributes, the rules in sections 705-40, 705-50 and 705-57 apply appropriately to the depreciating assets.

1.64 In addition to determining the cost, adjustable value, terminating value and decline in value of the depreciating asset, the new rules will also determine the effective life and method of depreciation for the depreciating assets. The rules ensure that subsection 701-55(2) operates appropriately with respect to the depreciating assets. The new rules also allow a head company to retain the concessional rates of depreciation available to the joining entity prior to it consolidating in respect of allowable capital expenditure and transport capital expenditure assets, provided the tax cost of the depreciating asset does not exceed its terminating value. This aligns the treatment of allowable capital expenditure and transport capital expenditure assets with that available to other accelerated depreciation assets whose tax cost does not exceed its terminating value.

1.65 When a leaving entity ceases to be a subsidiary member of a consolidated group and, as a consequence of the exit history rule, takes with it some or all of the head company's notional asset, the new rule in Subdivision 712-E requires the head company to reduce the adjustable value of its notional asset by the adjustable value of the leaving entity's notional asset. This rule ensures that only one entity (the leaving entity) gets a deduction for the notional asset that leaves the old group.

Application and object of Subdivision 705-E

1.66 The rules in Subdivision 705-E of the Income Tax (Transitional Provisions) Act 1997 apply to a joining entity to which section 40-75 of the Income Tax (Transitional Provisions) Act 1997 applied [Schedule 1, item 9, subsection 705-300(1)]. This means that, if a joining entity has incurred expenditure on an asset and that expenditure was, or could have been deducted under Division 330 as allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure (assuming it had been incurred prior to 1 July 2001), the rules in new Subdivision 705 E of the Income Tax (Transitional Provisions) Act 1997 will apply (regardless of when the expenditure was actually incurred). Examples of such expenditure include (but are not limited to):

•

expenditure on a depreciating asset fully deducted under Divisions 10, 10AA or 10AAA that would have been deductible under Division 330 as either allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure;

•

expenditure on the depreciating asset that was actually deducted under Division 330 as allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure; and

•

expenditure on a depreciating asset that was deducted under Subdivision 40-B as part of a 'notional asset' created under section 40-35, 40-37, 40-40 or 40-43 of the Income Tax (Transitional Provisions) Act 1997.

1.67 The main object of Subdivision 705-E is to:

•

clarify the interaction between the cost setting rules and the inherited history rules with respect to depreciating assets and any related notional assets arising from allowable capital expenditure or transport capital expenditure;

•

ensure that the rules in sections 705-40, 705-50 and 705-57 apply appropriately to depreciating assets that have arisen from allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure; and

•

ensure that the treatment of a joining entity's allowable capital expenditure and transport capital expenditure depreciable assets is aligned, where appropriate, with other depreciable assets.

[Schedule 1, item 9, subsection 705-300(2)]

Consequences for the head company of recognising depreciating allowable capital expenditure, transport capital expenditure and exploration or prospecting assets

1.68 The main object of section 705-305 is to:

•

provide rules to set the cost, adjustable value and terminating value of a depreciating asset that has resulted from allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure;

•

provide rules to set the effective life of allowable capital expenditure and transport capital expenditure depreciating assets, which may allow a head company to maintain the concessional rates of depreciation available to the joining entity prior to it joining the consolidated group (where the asset's tax cost does not exceed its terminating value);

•

provide a method of depreciation for depreciating assets that have arisen from allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure; and

•

ensure that the adjustable value of a head company's notional asset is reduced by an appropriate amount if a depreciating asset has resulted from the notional asset.

[Schedule 1, item 9, subsection 705-305(1)]

Working out the cost of a depreciating asset

1.69 As discussed above, under the transitional provisions, the cost of any depreciating asset that arose from pre 1 July 2001 allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure was deemed to be nil at the start of 1 July 2001. Therefore, in order for the tax cost setting rules to apply appropriately to these depreciating assets, a 'cost' must be determined for these assets.

1.70 Subsection 705-305(5) provides that, if the joining entity incurred expenditure that would have been included in the cost of the depreciating asset under Division 40, assuming it was incurred just before the joining time, this expenditure increases the cost of the depreciating asset. In order to apply this section, the joining entity is assumed to have incurred the expenditure after 30 June 2001 under a contract entered into after 30 June 2001, regardless of when the expenditure was actually incurred. However, if the expenditure was already included in the asset's cost under Division 40, it is not included under this section again. [Schedule 1, item 9, subsection 705-305(5)]

1.71 It may be the case that a joining entity has incurred expenditure under a number of different provisions in respect of the one depreciating asset. Further, it may be the case that any such expenditure has been fully deducted prior to the joining time. In either case, if the expenditure reasonably relates to the depreciating asset, it will increase the depreciating asset's cost.

Example 1.5: Amounts to be included in the cost of a depreciating asset

The original expenditure may have given rise to deductions for different income years under different provisions of the ITAA 1997 and the ITAA 1936. For example, allowable capital expenditure incurred in the 1995-1996 income year may have given rise to deductions:

•

for the 1995-1996 and 1996-1997 income years under section 122DG of the ITAA 1936;

•

for the 1997-1998, 1998-1999, 1999-2000 and 2000-2001 income years under former section 330-80 of the ITAA 1997; and

•

for the 2001-2002 and 2002-2003 income years under Subdivision 40-B of the ITAA 1997 for the decline in value of a notional asset that arose under section 40-35 of the Income Tax (Transitional Provisions) Act 1997 from the amount of the original allowable capital expenditure that had not been recouped by the end of 30 June 2001.

1.72 It is important to note that, in order to test whether expenditure is included in the cost of the depreciating asset, the test time is just before the joining time, not the time the expenditure was actually incurred. This means that, even if at the time the expenditure was actually incurred it did not relate to a depreciating asset, it can still be included in the cost of a depreciating asset, provided it would be able to be included in the cost under Division 40 if it was incurred just before the joining time. This is particularly relevant for expenditure that forms part of a notional asset under sections 40-37 and 40-43 of the Income Tax (Transitional Provisions) Act 1997, as those sections do not apply to expenditure on a depreciating asset. It is recognised that expenditure deducted under these sections may relate to a depreciating asset, even though at the time of the deduction there was no such asset.

Working out the adjustable value of a depreciating asset

1.73 As discussed above, in order for the tax cost setting rules to apply appropriately to depreciating assets created from allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure, an adjustable value and a terminating value must be established for the asset. Section 705-30 defines a depreciating asset's terminating value to be equal to its adjustable value just before the joining time. Therefore, it is only necessary to determine the depreciating asset's adjustable value.

1.74 If the expenditure that gave rise to the depreciating asset has been fully deducted, then it follows that the adjustable value of the depreciating asset is nil. Therefore, a depreciating asset will only have an adjustable value greater than nil if there is still some amount of expenditure relating to the asset yet to be deducted by the joining entity. Accordingly, the adjustable value of the depreciating asset just before and at the joining time is increased by so much of any notional asset (that arose because of section 40-35, 40-37, 40-40 or 40-43 of the Income Tax (Transitional Provisions) Act 1997) that the joining entity holds at the joining time that reasonably relates to the depreciating asset. [Schedule 1, item 9, subsections 705-305(3) and (4)]

1.75 If a joining entity does not hold any notional asset(s) at the joining time, the adjustable value of any associated depreciating asset would not be increased.

Earlier deductions for decline in value of a depreciating asset

1.76 Once the cost and adjustable value of an allowable capital expenditure, transport capital expenditure, exploration or prospecting asset have been calculated, subsection 705-305(6) is necessary so that any deductions claimed by the joining entity, prior to joining, that were in relation to the asset's cost, are taken to be deductions for the decline in value of the depreciating asset [Schedule 1, item 9, subsection 705-305(6)]. This is to ensure that the tax cost setting rules, in particular section 705-50 (the over depreciation adjustment), apply appropriately to the depreciating asset.

1.77 Examples of deductions for expenditure claimed by the joining entity that would be covered by this section include:

•

deductions under former Subdivision 330-A, 330-C or 330-H of the ITAA 1997, or a corresponding previous law, for the expenditure;

•

deductions under Subdivision 40-B for the decline in value of a notional asset that arose under section 40-35, 40-37, 40-40 or 40-43 of the Income Tax (Transitional Provisions) Act 1997; and

•

deductions under subsection 40-75(2) of the Income Tax (Transitional Provisions) Act 1997) for expenditure incurred after 30 June 2001 on exploration or prospecting assets held at 1 July 2001.

Prime cost method of working out decline in value of a depreciating asset

1.78 In order to apply subsection 701-55(2), it is necessary for the joining entity to have been applying either the prime cost method or diminishing value method immediately before the joining time in respect of a depreciating asset. There may be circumstances because of the way deductions are claimed for expenditure on allowable capital expenditure, transport capital expenditure and exploration or prospecting assets, where the joining entity may not have applied either the prime cost or diminishing value method prior to the joining time. Consequently, subsection 705-305(2) deems the prime cost method to have applied just before the joining time to the depreciating assets that have arisen from allowable capital expenditure, transport capital expenditure, exploration or prospecting expenditure [Schedule 1, item 9, subsection 705-305(2)]. As a result, paragraphs 701-55(2)(c) to (e) will apply appropriately to these depreciating assets and any future deductions will be calculated based on the prime cost method. As discussed above, paragraphs 701-55(2)(c) to (e) will not be relevant if the head company satisfies subsection 40-80(1) for an exploration or prospecting assets.

Effective life of a depreciating asset where its tax cost setting amount does not exceed its terminating value

1.79 In order to ensure that the rules in subsection 701-55(2) work correctly and to allow a head company the ability to retain the concessional rates of depreciation available to the joining entity in respect of allowable capital expenditure and transport capital expenditure assets prior to consolidating (where appropriate), an effective life must be set for such depreciating assets.

1.80 If the tax cost of an allowable capital expenditure, transport capital expenditure, exploration or prospecting asset is greater than its terminating value (as determined under subsections 705-305(3) and (4)), the head company will be required (except where it satisfies subsection 40-80(1)) to determine an effective life for the asset at the joining time in accordance with subsections 40-95(1) and (3). This is the same as any other depreciating asset.

1.81 If the tax cost of an allowable capital expenditure or a transport capital expenditure asset is equal to or less than its terminating value, the head company is required to choose an effective life for the asset equal to the remainder of the effective life of the asset just before the joining time. However, as discussed above, allowable capital expenditure and transport capital expenditure assets will generally not have a 'remaining effective life' as these assets were never depreciated in the 'normal' way. Instead, the expenditure that gave rise to them was deducted over a concessional period (generally 10 or 20 years).

1.82 In these circumstances subsection 705-305(7) sets the effective life of the depreciating asset as being such a period as is reasonable having regard to:

•

the remainder of the effective life of the depreciating asset just before the joining time where capital expenditure has been incurred on the asset after 30 June 2001 and the asset's effective life was set under subsection 40-75(4) of the Income Tax (Transitional Provisions) Act 1997;

•

the remainder of the effective life of any related notional asset; and

•

any other relevant factors (for example, the proportion of the adjustable value of the depreciating asset that is reflected in each of the related notional assets.

[Schedule 1, item 9, subsection 705-305(7)]

1.83 The intention of this subsection is to allow the head company the ability (where the asset's tax cost does not exceed its terminating value) to maintain the same effective life for the depreciating asset as that which would have applied to the asset prior to the joining entity joining the consolidated group. This ensures that allowable capital expenditure and transport capital expenditure assets receive the same treatment as other depreciating assets in this respect.

Example 1.6: Setting the effective life of an allowable capital expenditure or transport capital expenditure asset whose tax cost does not exceed its terminating value

Assume that Sub A incurred the following expenditure in each of the following income years and that it joined a consolidated group on 1 July 2003:

(i)

$1,000 incurred in the 1999-2000 income year, of which $600 remains undeducted at 30 June 2003. All of this expenditure relates to a transport capital expenditure asset which has its tax cost reset when Sub A joins a consolidated group. As at 1 July 2003 the notional asset has a remaining effective life of six years.

(ii)

$5,000 incurred in the 2000-2001 income year, of which $3,500 remains undeducted at 30 June 2003. Of this undeducted expenditure, $2,000 reasonably relates to the same transport capital expenditure asset. As at 1 July 2003, the notional asset's remaining effective life is seven years.

(iii)

$600 incurred in the 2002-2003 income year on improvements to the same transport capital expenditure asset. The effective life of this 'asset' worked out under subsection 40-75(4) of the Income Tax (Transitional Provisions) Act 1997 at the time the expenditure was incurred was 10 years. As at 1 July 2003, the remaining effective life of this asset is nine years and the undeducted amount is $540.

In order to work out the remaining effective life of the transport capital expenditure asset, regard will need to be had to the remaining effective lives of all three of the above 'assets'. An example of an acceptable method of calculating its effective life may be to use a weighted average approach (note that other methods may be acceptable, provided they are reasonable). If a weighted average approach were used the effective life of the above asset would be:

(($600 / $3,140)) * 6 years) + (($2,000 / $3,140) * 7 years) + (($540 / $3,140) * 9 years) = approximately 7 years.


Therefore the remaining effective life of the transport capital expenditure asset would be seven years. This is a logical outcome as the majority of the undeducted expenditure in relation to the asset relates to the 2000-2001 year and as such the remaining effective life of the true asset should equate to the remaining effective life of the 2000-2001 'notional asset' that is, seven years.

Choosing to reduce the tax cost setting amount of a depreciating asset

1.84 In order to preserve accelerated depreciation, a head company has the ability under section 705-45 to choose to reduce the tax cost of an asset to equal its terminating value (any tax cost 'foregone' is not reallocated to other reset cost base assets). A similar rule is required for allowable capital expenditure and transport capital expenditure assets so that a head company has the ability to maintain the concessional write-off period (generally 10 or 20 years) available to the joining entity for these assets prior to consolidation.

1.85 Subsection 705-305(8) is the allowable capital expenditure and transport capital expenditure asset equivalent of section 705-45. This rule allows the head company to reduce the tax cost of the allowable capital expenditure, transport capital expenditure, exploration and prospecting asset to equal its terminating value (as determined under subsection 705-305(3)) [Schedule 1, item 9, subsection 705-305(8)]. As a result, the head company can apply subsection 705-305(7) which allows the head company to maintain the concessional write-off period for the depreciating asset that would have applied to the joining entity had it not joined the consolidated group. However, as for the rule for accelerated depreciation assets, any tax cost that is foregone is not reallocated to other reset cost base assets.

1.86 Subsection 705-305(9) has been inserted so that the ordering rule in section 705-55 works appropriately. Subsection 705-305(9) has the effect of including subsection 705-305(8) in section 705-45, and therefore including it within section 705-55. [Schedule 1, item 9, subsection 705-305(9)]

Adjustable value of head company's notional asset on entry

1.87 In order to ensure that a consolidated group only deducts an appropriate amount in respect of expenditure incurred on an allowable capital expenditure or transport capital expenditure asset, section 705-310 reduces the adjustable value of the head company's notional asset by an amount that is reasonably attributable to the depreciating asset [Schedule 1, item 9, subsection 705-310(3)]. The amount of the adjustment under this subsection is equal to the increase in the depreciating asset's adjustable value determined under subsection 705-305(3).

1.88 This section will only apply if the joining entity holds a notional asset at the joining time that arose under section 40-35, 40-37, 40-40 or 40-43 of the Income Tax (Transitional Provisions) Act 1997 and, as a consequence, the head company is taken to hold such an asset (because of the entry history rule). [Schedule 1, item 9, subsection 705-310(1)]

1.89 The intention of section 705-310 is to prevent a head company from deducting both the tax cost of the allowable capital expenditure or transport capital expenditure asset as well as the related notional asset. [Schedule 1, item 9, subsection 705-310(2)]

Adjustable value of head company's notional asset on exit

1.90 Where an entity (the leaving entity) leaves a consolidated group, it is possible for the leaving entity to take with it allowable capital expenditure or transport capital expenditure assets. As these assets have had their tax costs set on entry and have subsequently been depreciated under Division 40, the exit rules in Division 711 will apply appropriately to these assets and no modifications are required.

1.91 It is also possible for a leaving entity to take with it 'other property' that was part of the head company's notional asset. These are assets that are not depreciating assets but were part of the notional asset that arose because of section 40-35, 40-7, 40-40 or 40-43 of the Income Tax (Transitional Provisions) Act 1997.

1.92 If a leaving entity takes with it any of the 'other property' when it exits the group and, as a consequence, some or all of the head company's notional asset relating to the other property also leaves, the adjustable value of the head company's notional asset is reduced [Schedule 1, item 10, section 712-305]. This ensures that the head company and the leaving entity both do not get a deduction for the same notional asset.

Low-value pools

1.93 Pooling of depreciating assets was first introduced to reduce compliance costs in the 1997-1998 income year. The current low-value pools were introduced as part of the uniform capital allowances regime, which started on 1 July 2001.

1.94 In order to reduce compliance costs companies can elect to form a low-value pool for depreciating assets whose cost is less than $1,000. Once a company elects to form a low-value pool, it must allocate each asset that costs less than $1,000 to the pool. The pool is then effectively 'written off' for tax purposes at a particular rate. Compliance costs are reduced because once an asset goes into the pool, the entity is no longer required to track the asset for tax purposes, it simply tracks the pool balance from year to year in order to depreciate the pooled assets. Each year the pool balance will vary to reflect the addition of new assets, deductions for decline in value and disposal of assets that were in the pool.

1.95 Generally, when an entity joins a consolidated group, it is required to reset the tax cost of each of its assets. Without these amendments contained in this bill, companies would be required to pull apart their low-value pools when they join a consolidated group and set the tax cost for each asset in the pool. This would undo the compliance savings that these pools were designed to achieve. In order to maintain the policy underlying low-value pools, the entire low-value pool of a joining entity will be treated as a single 'hypothetical asset' for cost setting purposes.

1.96 These amendments also ensure an appropriate cost setting outcome when low-value assets leave a consolidated group. This is achieved by amending the law in order to remove the potential for both the head company and the leaving entity to claim deductions for the decline in pool value in the leaving year.

1.97 This could happen in the leaving year because the head company can deduct an amount for assets that have been purchased in the leaving year that subsequently leave with the leaving entity (because the amount of the head company's deduction is not based on assets being 'on hand' at the end of the year). The leaving entity may also be able to claim a deduction for any assets it takes with it (despite the fact that the head company has also included these assets when calculating its own deduction). In this regard, there is no balancing adjustment event in relation to assets that cease to be in a head company's low-value pool because an entity ceases to be a subsidiary member.

1.98 The amendments change the cost setting rules so that only the head company can claim a deduction in the leaving year in respect of the leaving assets that were purchased by the group in the leaving year. The leaving entity will, however, be entitled to deductions for assets it purchases after the leaving time. The leaving entity will then be entitled to deductions as normal in future years.

Low-value pools - entry

Setting the tax cost setting amount of assets in low-value pools

1.99 The operation of certain cost setting provisions are modified where an entity becomes a subsidiary member of a consolidated group after having allocated a depreciating asset (a 'previous pool asset') to its low-value pool. Compliance costs associated with setting the tax cost of these assets are reduced by treating all the previous pool assets in the joining entity's low-value pool as a single depreciating asset (the hypothetical asset). The hypothetical asset is also used to simplify how the head company's deductions for the decline in value of the pooled assets are worked out. [Schedule 1, item 11, subsections 716-330(1) and (2)]

1.100 Sections 701-10 and 701-60 and Division 705 operate as if all the previous pool assets are combined to form the single hypothetical asset. Section 701-10 sets the head company's tax cost for assets that a joining subsidiary brings with it into the group. Section 701-60 determines how the asset's tax cost is worked out. Broadly, Division 705 sets the tax cost of assets where entities become subsidiary members of consolidated groups. Modifications are made to sections 705-40 and 705-57 within Division 705 in order to apply appropriately to the hypothetical asset. These sections are about reducing an asset's tax cost to an amount that may be affected by the joining entity's terminating value for the asset.

1.101 Specifically, the operation of sections 705-40 and 705-57 are modified depending on when the joining time occurs. If the joining time is the first day of an income year of the joining entity, sections 705-40 and 705-57 operate as if the joining entity's terminating value for the hypothetical asset were the closing pool balance for the joining entity's low-value pool for the previous income year. Where the joining time is not the first day, sections 705-40 and 705-57 operate as if the joining entity's terminating value for the hypothetical asset were the closing pool balance for the joining entity's low-value pool for the non membership period described in section 701-30 that ends just before the joining time. [Schedule 1, item 11, subsections 716-330(7) and (8)]

1.102 To reduce the cost of compliance, no adjustments need to be made for over-depreciation in setting the tax cost for the assets in the low-value pool. [Schedule 1, item 11, subsection 716-330(9)]

Allocating assets to the head company's low-value pool

1.103 The previous pool assets are allocated to a low-value pool in the head company's income year in which the joining time occurs for the purpose of allocating depreciating assets to a low-value pool and in working out the decline in value of assets allocated to a low-value pool. This will occur in both situations where the head company already has an existing low-value pool and where the head company must create a low-value pool if one does not exist. At any one time the head company can only operate one low-value pool.

1.104 Treating the assets in the low-value pool as a hypothetical asset is designed to reduce compliance costs on setting the tax cost of assets. However, each asset is then recognised and allocated to the low-value pool at the joining time in order to work out the decline in value of the pool and the closing pool balance. Each asset is treated as being allocated to the head company's low-value pool at the joining time (not when the asset was originally allocated to the joining entity's pool). [Schedule 1, item 11, subsection 716-330(3)]

1.105 When an asset is allocated to the low-value pool a reasonable estimate of the percentage of taxable use must be made for each asset as set out under section 40-435. This percentage affects the amount allocated to the pool and consequently the decline in value for the pool under the method statement in subsection 40-440(1). In determining the taxable use percentage for each asset in a low-value pool on entry it would be appropriate, having regard to compliance costs, to make an estimate for each asset based on a reasonable estimate of the taxable use of the pool of assets. This taxable use percentage (i.e. for the pool of assets) is required for the purposes of applying the method statement in subsection 40-440(1).

1.106 The requirement to allocate all low-cost assets to the pool once the taxpayer chooses to allocate one low-cost asset to the pool is not limited by the hypothetical asset. Each low-cost asset that the head company starts to hold in the joining or later income years are allocated to a low-value pool whether or not the asset is the hypothetical asset and whether or not the head company began to hold the asset because of the single entity rule. Low cost assets are added to the low-value pool going forward regardless of whether or not they arise on the first day of an income year of the joining entity as either a low-cost or a low-value asset. [Schedule 1, item 11, subsection 716-330(4)]

Determining the decline in value deductions

1.107 To determine the decline in value deductions the operation of section 40-440 is modified depending on when the joining entity joins the consolidated group.

1.108 If the joining time is the first day of an income year of the joining entity, section 40-440 operates as if all the previous pool assets were low-value assets and the sum of their opening adjustable values at the joining time equalled the tax cost for the hypothetical asset. Where the joining time is the first day of an income year these modifications allow the head company to depreciate the hypothetical asset at 37.5% in the first and subsequent income years. [Schedule 1, item 11, subsection 716-330(5)]

1.109 If the joining time is not the first day of the joining entity's income year section 40-440 operates as if all the previous pool assets were low-value assets and the sum of their costs equalled the total of the tax cost for the hypothetical asset and any expenditure incurred after the joining time (but in the income year that includes that time) and included in the second element of the costs of the previous pool assets. Where the joining time is not the first day of an income year these modifications allow the hypothetical asset to be depreciated at 18.75% in the first year and 37.5% in later years. The lower percentage in the first year is a simple way of apportioning the first year's deduction given that it is not a full income year. [Schedule 1, item 11, subsection 716-330(6)]

Low-value pools - exit

An asset leaving the head company's low-value pool when an entity leaves the group

1.110 Where an entity disposes of an asset that was part of a low-value pool, the value of the pool is reduced by the asset's terminating value. However, where an entity leaves a consolidated group and takes with it assets that were part of the head company's low-value pool special rules apply. These special rules affect the head company and the leaving entity of a consolidated group at the leaving time if a depreciating asset becomes an asset of the leaving entity at that time because the single entity rule ceases to apply and where the asset was in the head company's low-value pool. [Schedule 1, item 11, subsection 716-335(1)]

1.111 The special rules are required to ensure that the decline in value of assets in the head company's and leaving entity's low-value pools are worked out so that:

•

for the leaving year, the depreciating asset is only taken into account in working out the decline in value of assets in the head company's low-value pool; and

•

for later income years, the depreciating asset is only taken into account in working out the decline in value of assets in the leaving entity's low-value pool.

The adjustable value of the depreciating assets just before the leaving time is specified in order to perform the push-up process within the leaving entity. [Schedule 1, item 11, subsection 716-335(2)]

Consequences for the head company of assets leaving the low-value pool

1.112 In working out the cost to the head company of membership interests in an entity that leaves the group, the adjustable value (as discussed in the next paragraph) of the leaving assets just before and at the leaving time, is the amount of the reduction to the head company's closing pool balance for the leaving year reduced to reflect the taxable use percentage estimated for the depreciating asset by the head company under section 40-435. For each membership interest the head company holds in the leaving entity, the interest's tax cost is set just before the leaving time at the interest's tax cost by reference to the head company's terminating value of the asset. This is worked out by reference to the adjustable value of the asset for the head company just before the leaving time. The adjustable value of the asset for the leaving entity at the leaving time is the same as the adjustable value of the asset for the head company under section 701-40. [Schedule 1, item 11, subsection 716-335(5)]

1.113 Where an asset, that had been allocated a taxable use percentage of less than 100%, leaves a low-value pool in a leaving entity that asset will be allocated its full value upon pushing-up the asset's tax cost in setting the tax cost for the interests in the leaving entity. For example, an asset with a tax cost of $100 is purchased by a consolidated group and allocated a taxable use percentage of 80%. The next day the asset leaves the group with a leaving entity, the push up value will be $100 for the purposes of setting the tax cost for interests held by the consolidated group in the leaving entity.

1.114 In order to achieve a tax neutral consequence for the head company when reducing the low-value pool balance where a leaving entity takes assets from the pool, an amount that reasonably relates to the leaving assets will be deducted from the closing pool balance. The head company may take into account the leaving assets in working out deductions for the decline in value of the low-value pool in the leaving year (rather than the leaving entity). This means that the head company's low-value pool deductions will not be reduced until the next year to reflect the assets which have left the pool. In doing this, companies will work out the decline in value of assets in the head company's low-value pool, in later years, as if the closing pool balance for the leaving year were reduced by an amount that reasonably relates to the depreciated asset. [Schedule 1, item 11, subsection 716-335(4)]

Consequences for the leaving entity of assets leaving the low-value pool

1.115 As a result of each asset being recognised in the pool under subsection 716-330(3), leaving entities will receive an adjustable value via the exit history rule (section 701-40) for the purposes of working out the cost to the entity upon leaving the consolidated group.

1.116 A leaving entity cannot deduct an amount for the leaving year for the assets it is taken to have allocated to the low-value pool that it brought from the head company's pool. The leaving entity may take the leaving asset into consideration in later income years for the purpose of working out the decline in value of its low-value pool. The leaving entity may also deduct any second elements of cost incurred after the leaving time in respect of the assets it brought from the head company's pool.

1.117 The leaving entity may also deduct the decline in value of new assets purchased after the leaving time in the leaving year. The exit history rule gives the leaving entity the information needed to continue depreciating the leaving assets. This occurs because the leaving assets were allocated the same cost, taxable use percentage and prior depreciation deductions as they had for the head company. For example, the exit history rule treats the asset as having been allocated to the leaving entity's low-value pool, with the taxable use percentage estimated by the head company, for the income year for which the head company allocated the asset to the head company's low-value pool. [Schedule 1, item 11, subsection 716-335(3)]

1.118 Where the leaving entity immediately joins another consolidated group the above mentioned entry rules will apply, including the hypothetical asset provisions in such a way so that the acquiring consolidated group would depreciate its hypothetical asset at 18.75% in the first year and 37.5% in later years.

Software development pools

Depreciating assets arising from expenditure in the joining entity's software development pool

1.119 Part 5 of Schedule 1 to this bill ensures that the operation of certain consolidation cost setting provisions and certain capital allowance provisions operate correctly so that the head company of a consolidated group can deduct an appropriate amount for assets arising from expenditure on in-house software development.

1.120 Under Subdivision 40-E of the uniform capital allowance regime, an entity may elect to allocate amounts of expenditure on in-house software to a software development pool where that expenditure relates to developing, or having another entity develop, computer software. The entity is entitled to deductions for the expenditure over a period of three years following the year in which the expenditure is made. A separate pool is created for each income year in which the expenditure is made.

Modifications where an entity that has a software development pool joins a consolidated group

1.121 Certain consolidation cost setting provisions and certain capital allowance provisions relevant to software development are modified if:

•

an entity had incurred expenditure which it allocated to a software development pool;

•

that entity becomes a subsidiary member of a consolidated group at the joining time; and

•

some or all of the expenditure reasonably relates to the in-house software asset that became an asset of the head company at the joining time because of the single entity rule.

[Schedule 1, item 11, subsection 716-340(1)]

1.122 The modified provisions are:

•

Subdivision 40-B provides for deductions for the decline in value of depreciating assets;

•

section 40-455 provides for the deduction of expenditure allocated to a software development pool;

•

section 701-10 provides that, for each asset the joining entity has at the joining time, the asset's tax cost is set at the joining time;

•

section 701-55, amongst other things, specifies how to work out the head company's deductions for the decline in value of depreciating assets that became assets of the head company;

•

section 701-60 defines the 'tax cost' of an asset; and

•

Division 705 works out the tax cost for assets that a subsidiary member brings into a consolidated group.

1.123 Where an entity that has at least one software development pool joins a consolidated group, the head company will be entitled to continue to deduct the remaining pool balances as a result of the entry history rule (section 701-5).

1.124 The amendments will ensure that to the extent that the expenditure has resulted in the creation of in-house software assets then those assets will have their tax cost set on becoming assets of the head company and the balance of the software development pools will be reduced to the extent that the expenditure in the pools relates to those in-house software assets. In setting the tax cost for the in-house software assets, regard is also had to deductions for the expenditure on the asset that were allowed under the pool to ensure that the over depreciation adjustment in section 705-50 is able to apply.

Setting the tax cost setting amount for in-house software assets

1.125 In-house software assets arising from expenditure in a software development pool are given a tax cost under Division 705 upon becoming assets of the head company of a consolidated group. Paragraph 701-55(2)(a) deems the in-house software to have been acquired at the joining time for a payment equal to its tax cost.

1.126 The tax cost is calculated to take account of deductions for the period before the joining time for the expenditure reasonably related to the in-house software. Previously, the head company's deductions would have been worked out under section 40-455 on the basis of the entry history rule treating the expenditure on the software as being the head company's expenditure. [Schedule 1, item 11, subsection 716-340(2)]

1.127 In applying certain cost setting provisions, it is necessary to determine the cost and deductions for the decline in value in relation to certain depreciating assets. Subsections 716-340(6) to (8) ensure that appropriate amounts are worked out in relation to in-house software assets. For the purposes of doing these calculations, the cost of the in-house software asset is equal to the total amount of the joining entity's expenditure that reasonably relates to the software and that was allocated to a software development pool. A reasonable approach will be accepted in determining the amount of expenditure that relates to an in-house software asset. This recognises the fact that the expenditure may have been allocated to separate software development pools over a number of years. [Schedule 1, item 11, subsections 716-340(6) to (8)]

1.128 In order for sections 705-40, 705-50 and 705-57 to apply appropriately to an in-house software asset, the joining entity must have claimed deductions for the decline in value of the asset. Due to the nature of software development pools, any deductions associated with the pool are not deductions for the 'decline in value' of the pool, but are instead deductions for 'expenditure allocated to the pool'. Therefore, without amendment, sections 705-40, 705-50 and 705-57 will not apply appropriately to in-house software assets.

1.129 It is therefore necessary to determine the decline in value and deductions for the decline in value of in-house software assets for a period before the joining time. This is done having regard to the amount of deductions available under section 40-455 that reasonably relate to the software. Given that these amounts may arise from a number of software development pools, it may be necessary to add up the relevant amounts from each pool. This calculation is required to enable such things as the terminating value of the software to be determined (via the application of section 40-85 to work out the adjustable value of the asset).

Working out the decline in value of in-house software assets for the head company

1.130 The head company will work out deductions for in-house software under Subdivision 40-B based on the reset cost for the depreciating assets. Subsection 716-340(4) assumes the prime cost method is used. Therefore, paragraphs 701-55(2)(c) and (d) will specify how deductions are to be determined. In working out the deductions for decline in value of the in-house software, an effective life for the in-house software equal to the period specified for in-house software in subsection 40-95(7) is to be used. [Schedule 1, item 11, subsections 716-340(4) and (5)]

Working out deductions for the remaining software development pool balance

1.131 The amount of the inherited software development expenditure is reduced by the amount that reasonably relates to the in-house software. This prevents a deduction being claimed for the decline in value of the software development expenditure pool in addition to the decline in value of the in-house software. This does not prevent the head company from deducting under section 40-455 expenditure that is not reasonably related to the in-house software and that the head company is treated by section 701-5 as having incurred and allocated the expenditure to a software development pool. [Schedule 1, item 11, subsection 716-340(3)]

Modifications where an entity that leaves a consolidated group takes with it a software development pool

1.132 Where an entity (the leaving entity) exits a consolidated group and, because of the exit history rule, is taken to have allocated expenditure to a software development pool (at the same time that the head company allocated such expenditure), rules have been inserted that affect both the leaving entity's deduction for its software development pool in the leaving year and the head company's deduction for its software development pool for income years after the leaving year. [Schedule 1, item 11, subsection 716-345(1)]

1.133 For the leaving year, the leaving entity cannot deduct amounts for expenditure that have been allocated to a software development pool [Schedule 1, item 11, subsection 716-345(3)]. Instead, the head company is entitled to these deductions in the leaving year. This ensures that a deduction is only available to the head company of the consolidated group and not to both the head company and the leaving entity in the leaving year.

1.134 For income years after the leaving year, the leaving entity can continue to deduct amounts for expenditure in its software development pool(s) in the usual manner. However, the head company will no longer be entitled to deduct an amount for the software development pool that leaves with a leaving entity for income years after the leaving year. The head company is treated as if it never incurred these deductions. [Schedule 1, item 11, subsection 716-345(2)]

Source of certain distributions for allocable cost amount purposes

1.135 Part 7 of Schedule 1 to this bill contains rules that simplify the method of working out the ACA by accepting a last-in-first-out method of accounting for profits in appropriate circumstances where the entity must determine which prior year's profits were used to pay a particular dividend.

1.136 Sourcing dividends to the profits of individual years is important in working out the ACA because steps 3 and 4 of the cost allocation process require identification of the retained profits accruing to membership interests that were held continuously by the consolidated group. Sourcing dividends to the profits of individual years is also an important part of the ACA process that limits the deferral of tax on profits that were not subject to tax because of over-depreciation. Steps 3 and 4 together with the over-depreciation adjustment are explained below.

1.137 Continuously held profits must be identified because profits earned by an entity before it becomes a subsidiary member of the consolidated group are treated differently in allocating cost to the assets of the subsidiary that earned the profits.

1.138 Historical records that would precisely identify profits that should be included in cost allocation calculations may not be available to the consolidated group. The cost setting rules recognise that the necessary records may not be available and therefore provide for taxpayers to use the most reliable basis for estimation that is available.

1.139 A last-in-first-out approach will simplify determining what proportion of a dividend was sourced from profits earned by a subsidiary while it was owned by the group. It does this by allocating an entity's most recent profits to the dividend before allocating the next most recent year's profits and so on until all available profits earned by the group have been included in the calculation.

1.140 The last-in-first-out approach is to be applied in allocating profit between the years over which the profits were earned. Where it is necessary to identify the source of profits within a year a proportional (or pooling) approach is to be applied.

1.141 Steps 3 and 4 in working out a group's ACA for a joining entity require identification of the retained profits at the joining time that accrued to membership interests held continuously by a consolidated group.

1.142 Step 3 involves adding the sum of fully franked dividends the head company would have received from the joining entity. The purpose of this step is, consistent with the imputation system, to prevent double taxation by allowing a consolidated group a cost for retained taxed profits that accrued to membership interests when the consolidated group held the membership interests.

1.143 Step 3 will be amended by modifying section 705-90 to allow for a last-in-first-out method. Under this method the amount of profit that accrued to the joined group during a particular period is worked out by assuming that profits were distributed in order from the most recent to the earliest income years. Once profits are allocated between years for which distributions were made it is first assumed that unfranked distributions are sourced from untaxed profits. This rule provides consistency between steps 3 and 4 and the over-depreciation adjustment by ensuring that taxpayers allocate profits in a consistent way regardless of which step is being applied. [Schedule 1, item 22, subsection 705-90(10)]

1.144 Step 4 subtracts distributions to the head company by the joining entity, out of profits that did not accrue to membership interests continuously held by members of the joined group, until joining time.

1.145 The purpose of step 4 is to prevent the resetting of costs for a joining entity's assets reflecting an amount paid for the membership interests in the entity that was later recovered through distributions.

1.146 The provision that determines how to calculate step 4 (paragraph 705-95(b)) refers to subsection 705-90(7) which allows for a most reliable basis for estimation to be used. The insertion of subsection 705-90(10) will allow a last-in-first-out basis to be used under step 4. A note is inserted after paragraph 705-95(b) to explain that subsection 705-90(7), paragraph 705-90(9)(b) and subsection 705-90(10) are relevant to working out whether or not profits accrued to the joined group before the joining time under step 4. [Schedule 1, item 23, note at the end of paragraph 705-95(b)]

1.147 The over-depreciation adjustment limits the deferral of tax on profits (that were not subject to tax because of the over-depreciation of assets) that were distributed to recipients untaxed because of their entitlement to the inter-corporate dividend rebate. The deferral of income tax is limited by reducing the tax cost setting amount allocated to the over-depreciated asset where certain conditions are satisfied.

1.148 Subsection 705-50(3A) allows for a last-in-first-out method to be used in calculating the over-depreciation adjustment. [Schedule 1, item 21, subsection 705-50(3A)]

Adjustment to step 3 of allocable cost amount to take account of certain losses

1.149 Section 705-90 (step 3 of the ACA calculation) provides that undistributed profits accruing to direct or indirect membership interests that the consolidated group held continuously in a joining entity are to be added when working out the joining entity's ACA. This amount is known as the joining entity's 'step 3 amount'.

1.150 For the purposes of section 705-90, undistributed profits of the joining entity is defined as being the retained profits of the entity as at the joining time (as determined by Australian Accounting Standards) that could be recognised in the joining entity's statement of financial position if that statement was prepared at the joining time.

1.151 Where profits have accrued to the consolidated group before the joining time and pre-acquisition accounting losses have also been incurred, the joining entity's retained profits balance will be understated (as it will have been reduced by the pre-acquisition losses). Accordingly, the retained profits balance at the joining time will not accurately reflect the amount of profit that has accrued to the joined group. This could result in the joining entity's ACA being understated and consequently reduce the tax cost of the joining entity's assets.

1.152 Amendments contained in Part 8 of Schedule 1 to this bill ensure that the full amount of undistributed profits that have accrued to a consolidated group before the joining time are included when calculating the joining entity's ACA.

1.153 Subsection 705-90(2A) provides that, where an accounting loss has arisen prior to the consolidated group acquiring membership interests in the joining entity, and that loss would normally be taken into account in working out the joining entity's undistributed profits amount under section 705-90, that loss is not taken into account. [Schedule 1, item 24, subsection 705-90(2A)]

1.154 However, it is only those losses that have reduced the joining entity's undistributed profits amount that are able to be disregarded. In other words, if there are unrealised (accounting) losses that have not reduced the undistributed profits amount, the disregarding of those losses will not affect the balance of retained profits.

1.155 Further, the new rule does not mean that every accounting loss ever incurred by the joining entity that did not accrue to the consolidated group will be disregarded under subsection 705-90(2A). Instead, it is the accumulated retained losses that did not accrue to the consolidated group that are disregarded when working out the step 3 amount for the joining entity.

Example 1.7: Retained losses that have not accrued to membership interests and the subsidiary member has retained profits at the joining time

30 June 2000 - retained loss = $100 of Entity A

1 July 2000 - Head Co purchases 100% membership interests in Entity A

30 June 2001 - retained profit = $200 of Entity A

30 June 2002 - retained profit = $400 of Entity A

1 July 2002 - group consolidates (Entity A becomes a subsidiary member)

In this example, Entity A has accumulated retained losses at 30 June 2000 of $100. None of this loss accrued to the consolidated group because the group did not hold membership interests in Entity A (subsection 705-90(8) states what it means for a loss to accrue to the joined group). On 1 July 2000, Head Co purchased 100% of the membership interests in Entity A. Assume Entity A made a net accounting profit in the year ended 30 June 2001 of $300. As a consequence, the accumulated retained profits balance at 30 June 2001 would be $200 ($300 - $100). Assume also that in the year ended 30 June 2002, Entity A made a net accounting profit of $200, giving a retained profits balance at 30 June 2002 of $400. Head Co and Entity A form a consolidated group on 1 July 2002.

Prior to applying subsection 705-90(2A), the group's step 3 amount would be $400, being the undistributed retained profits of the joining entity at the joining time. However, this amount is understated because the pre-acquisition retained loss of $100 has been taken into account (it was offset against later year profits that accrued to the consolidated group).

As the $100 loss did not accrue to the joined group (it is a pre-acquisition loss) and it would otherwise be taken into account in working out the undistributed profits of Entity A, subsection 705-90(2A) will apply. As a result the $100 loss is not taken into account when determining the undistributed profits amount of Entity A. In other words, the joined group's step 3 amount is $500, representing the total profits that have accrued to the joined group during the 2000-2001 and 2001-2002 financial years ($300 and $200 respectively).

Example 1.8: Retained losses that have not accrued to membership interests and the subsidiary member has retained losses at the joining time

30 June 2000 - retained loss = $200 of Entity B

1 July 2000 - Head Co purchases 100% membership interests in Entity B

30 June 2001 - retained loss = $100 of Entity B

30 June 2002 - retained loss = $50 of Entity B

1 July 2002 - group consolidates (Entity B becomes a subsidiary member)

In this example, Entity B has a retained loss at 30 June 2000 of $200. None of this loss accrued to the consolidated group because the group did not hold membership interests in Entity B (subsection 705-90(8) states what it means for a loss to accrue to the joined group). On 1 July 2000, Head Co purchased 100% of the membership interests in Entity B.

Assume Entity B made a net accounting profit in the year ended 30 June 2001 of $100. As a consequence, Entity B would have a retained loss at 30 June 2001 of $100 ($200 - $100). Assume also that in the year ended 30 June 2002, Entity B made a net accounting profit of $50, giving a retained loss at 30 June 2002 of $50. Head Co and Entity B form a consolidated group on 1 July 2002.

Prior to applying subsection 705-90(2A), the group's step 3 amount would be nil as Entity B has no retained profits at the joining time. However, as the $200 loss incurred in the year ended 30 June 2000 did not accrue to the joined group and it has been taken into account in working out the undistributed profits of Entity B (i.e. it reduced them), subsection 705-90(2A) will apply.

As a result of not taking the pre-acquisition loss into account, Entity B's retained profits are increased to $150. This amount correctly reflects the profits that have accrued to the joined group in the 2000-2001 and 2001-2002 years ($100 and $50 respectively).

Transitional treatment of deferred tax liabilities for allocable cost amount and capital gains tax purposes

1.156 Part 9 of Schedule 1 to this bill contains rules to reduce compliance cost in applying the consolidation cost setting rules for transitional entities which have a change in the amount of deferred tax liabilities associated with assets that have their tax cost set.

1.157 Step 2 in working out the ACA adds the value of all accounting liabilities at the time an entity joins a consolidated group. This includes the amount of deferred tax liability under section 705-70(1A) associated with assets of a joining entity as recognised under the accounting standards.

1.158 Where an entity joins a consolidated group, the amount of deferred tax liability is added in working out the ACA of the joining entity. However, it is the amount of the deferred tax liability arising for the head company rather than the amount of the deferred tax liability recorded by the joining entity that is taken into account. This is because when a head company acquires an entity, it will adjust its purchase price to take into account any change in the deferred tax liability as a result of the consolidation cost setting rules.

1.159 In the case of a consolidated group forming during the transitional period (i.e. between 1 July 2002 and 30 June 2004), it is unlikely that the head company will have adjusted the purchase price to take into account the change in the deferred tax liability as a consequence of consolidation. This is because the purchase is likely to have occurred before the introduction of the consolidation regime.

1.160 Section 701-32 of the Income Tax (Transitional Provisions) Act 1997 reduces compliance costs in applying the cost setting rules by excluding entities that join a consolidated group during the transitional period from having to adjust the ACA calculation for changes in the amount of deferred tax liability associated with assets that have their tax cost reset. [Schedule 1, item 25, section 701-32]

1.161 Section 701-34 of the Income Tax (Transitional Provisions) Act 1997 reduces compliance costs by not requiring the consolidated group to determine a capital gain or capital loss (under CGT event L7) arising from changes in the value of a deferred tax liability of entities that join a consolidated group during the transitional period. [Schedule 1, item 25, section 701-34]

1.162 Without the amendments taxpayers would have to compare the value of the liability at the time the entity became a member of a consolidated group with the value when the liability is discharged. Requiring entities to track these changes would result in significant compliance costs.

Technical amendments to certain trust cost setting rules

1.163 Part 11 of Schedule 1 to this bill contains technical amendments to clarify the application of certain cost setting provisions applying to trusts which become members of a consolidated group.

1.164 Section 713-25 includes an amount in the ACA calculation for undistributed, realised profits that accrue to the joined group before joining time that could be distributed tax-free in respect of both discretionary and non-discretionary trusts.

1.165 A technical change to the wording of subparagraph 713-25(1)(c)(ii) ensures that non-discretionary trusts that have profits which could be distributed tax-free prior to joining a consolidated group are allocated cost on joining the group. This is achieved by removing a reference to non-assessable parts that would "...not be taken into account..." in working out whether or not a capital gain had been made because of CGT event E4. Instead, the subparagraph will refer to non-assessable parts that would be disregarded in working out whether or not a capital gain had been made because of CGT event E4. This technical correction ensures consistency with the references to disregarding certain amounts in sections 104-70 and 104-71. [Schedule 1, item 32, subparagraph 713-25(1)(c)(ii)]

1.166 A minor technical correction is made to the heading to section 713-25 to remove the reference to profits that could be distributed tax-free "...in respect of discretionary interests..." in order to appropriately reflect the scope of section 713-25 which applies to both discretionary and non-discretionary trusts. [Schedule 1, item 31, section 713-25]

1.167 Similar references have been removed from step 3 in the table within section 705-60. [Schedule 1, items 29 and 30, section 705-60]

Inter-entity loss multiplication rules

1.168 Part 6 of Schedule 1 to this bill amends the notice requirements under the inter-entity loss multiplication rules. Subdivision 165-CD prevents inter-entity loss multiplication by reducing tax attributes (i.e. cost bases, reduced cost bases or allowable deductions) for significant equity and debt interests in a loss company that has an alteration. Broadly, an alteration arises if there is a change in the company's ownership or control or a liquidator declares that the company's shares are worthless.

1.169 Depending on the circumstances, subsections 165-115ZC(4) and (5) require an entity that has a controlling stake in the loss company, or the loss company itself, to give a notice to associates that have a relevant interest in the loss company. The notice must contain information on the nature and extent of the loss company's losses. Failure to give the notice is a criminal offence.

1.170 Currently, the notice must be given within six months of the alteration time. However, if the alteration time was before 24 October 2002, the notice was not required to be given until 24 April 2003.

1.171 The purpose of the notice is to ensure that recipients have sufficient information to comply with their obligations under Subdivision 165-CD. The recipient entity is required to comply with Subdivision 165-CD even though it does not receive the notice.

Notice requirement waived or notice period extended for members of the same consolidatable group

1.172 A key feature of consolidation is that transactions between entities within a consolidated group are ignored for income tax purposes. When an entity joins a consolidated group, the cost bases and reduced cost bases of its assets are generally reset. In these circumstances, the notice requirements under Subdivision 165-CD are unnecessary and impose significant compliance costs.

1.173 Therefore, the notice requirements will be alleviated during the consolidation transitional period for entities that are in the same consolidatable group. That is, the notice requirements in subsections 165-115ZC(4) and (5) will be modified if:

•

the alteration time is between 10 November 1999 and 1 July 2004;

•

apart from these amendments, an entity (the notifying entity) would be required to give a notice to another entity (the receiving entity) in relation to the alteration time; and

•

just before the alteration time, the notifying entity and the receiving entity were members of the same consolidatable group.

[Schedule 1, item 20, subsection 165-115ZC(4) of the Income Tax (Transitional Provisions) Act 1997]

1.174 The notice requirements will not apply if the notifying entity and the receiving entity become members of the same consolidated group before 1 July 2004. [Schedule 1, item 20, subsection 165-115ZC(5) of the Income Tax (Transitional Provisions) Act 1997]

1.175 If the notifying entity and the receiving entity do not become members of the same consolidated group before 1 July 2004, a notice must be given before the end of six months after the date of Royal Assent of this bill. [Schedule 1, item 20, subsection 165-115ZC(6) of the Income Tax (Transitional Provisions) Act 1997]

1.176 The amendments will also insert a note at the end of subsection 165-ZC(1) to guide readers to these modifications to the notice requirements in the Income Tax (Transitional Provisions) Act 1997. [Schedule 1, item 13, subsection 165-115ZC(1)]

Commissioner of Taxation's discretion to extend the notice period or waive the notice requirement

1.177 The notice that is required to be given under subsection 165-115ZC(4) or (5) is essentially an administrative mechanism for providing information to affected taxpayers. Failure to give the notice within the specified time period is a criminal offence.

1.178 Unforeseen or unusual circumstances might arise where the notice requirements cannot be reasonably complied with. For example, the notifying entity may be having particular difficulty in obtaining the required information to complete the notice within the specified time frame due to circumstances beyond its control (such as a fire or other unforeseen event that destroys or damages the necessary records). Currently in these circumstances, failure to provide the notice within the specified time period will result in the notifying entity being subject to a criminal penalty.

1.179 In addition, there may be some circumstances when the information required to be given in the notice is already known by the intended recipient. In these circumstances, to avoid a criminal penalty, a notice must still be given even though it serves no useful purpose.

1.180 Therefore, to allow some flexibility in relation to the notice requirements, the Commissioner may:

•

extend the period within which a notice must be given by specifying, in writing, a later time than the alteration time as the start of the six month period within which the notice is required to be given; or

•

by written declaration, waive the notice requirement in relation to a particular alteration time.

[Schedule 1, items 14 to 18, subsections 165-115ZC(4), (5), (7A) and (7B)]

1.181 In making a decision, the Commissioner must consider the consequences of extending the period for giving a notice or of waiving the notice requirement for both the notifying entity and the receiving entity and any other factors that are relevant. [Schedule 1, item 18, subsection 165-115ZC(7C)]

1.182 The Commissioner's decision to extend the notice period or waive the notice requirement is not subject to review by the Administrative Appeals Tribunal. The information contained in the notice is required to assist the receiving entity to meet its taxation obligations. It is not directly connected to the imposition of tax on either the notifying entity or the receiving entity. A taxpayer who is dissatisfied with the Commissioner's decision can pursue any complaint through the Australian Taxation Office's internal dispute handling process or by taking the matter up with the Commonwealth Ombudsman.

Treatment for irrevocable entity-wide elections

Head company's choice overrides the entry history rules

1.183 The standard entry history rules result in a choice by any entity which joins a consolidated group, either at consolidation or by later joining, being attributed to the head company. The new rules allow the head company to modify elections/choices that are irrevocable or not immediately revocable to suit the circumstances of the consolidated group.

1.184 The first treatment is the resettable elections treatment (i.e. it allows the head company to reset the elections or choices) where irrevocable choices subject to these provisions made by entities that join a consolidated group are not inherited by the head company under the entry history rule contained in section 701-5. Instead, the head company may decide whether or not to make the irrevocable elections/choices at the joining /consolidation time according to its preferences rather than be bound by decisions made by joining entities over which it may have had no control at the time those decisions were made. Any choices thus made are effective from the consolidation time or joining time.

1.185 This treatment is applicable to choices made in respect of irrevocable or not immediately revocable elections:

•

A provision of Part X or XI of the ITAA 1936 - attribution of income in respect of controlled foreign corporations, foreign investment funds and FLPs.

•

Subsection 70-70(2) - valuing interests in foreign investment funds that are trading stock.

•

Item 1 in the table in subsection 960-60(1) - choosing to use a functional currency.

•

Any other matter prescribed by regulations.

1.186 This is intended to be a list and it is expected that additional items will be added to this list as more elections are recognised which require this treatment. It is envisaged that companies and groups going through consolidation transitions will be able to refer to this list (along with the lists for other treatments) to determine what elections they may need to remake at consolidation.

1.187 Part X of the ITAA 1936 ensures Australian shareholders are taxed on their share of a controlled foreign corporation's 'tainted income' as it is earned, unless that income is comparably taxed offshore. In particular, taxpayers can elect how they wish to treat income from investments or arrangements such as dividends, interest, royalties or amounts arising from related party transactions. Part XI of the ITAA 1936 is similar to Part X except it ensures Australian shareholders are taxed on their share of a foreign investment fund's income. In particular, taxpayers can elect how they wish to treat their interest in the foreign investment fund.

1.188 Subsection 70-70(2) provides for the valuation of an interest in a foreign investment fund. In particular, it provides that an interest in a foreign investment fund that is an item of trading stock can be valued at market value. Once made, an election to use market value applies to the taxpayer in respect of all later years of income. Item 1 in the table in subsection 960-60(1) allows an Australian resident that is required to prepare financial reports under section 292 of the Corporations Act 2001 to work out its taxable income or loss using a functional currency.

What happens when entities form a consolidated group or an entity joins a consolidated group

General rule

1.189 On consolidation or joining, certain irrevocable elections/choices made by entities prior to the notification of consolidation or prior to the time an entity joins a consolidated group (excluding the head company) are disregarded for head company core purposes and the head company is permitted to make a new election should it choose to do so. The provisions allow the head company in some cases to modify the time the election/choice takes effect and also extends the time the head company has to make the election/choice. [Schedule 1, item 26, subsections 715-660(2) and (3)]

1.190 The irrevocable elections/choices of the joining entities that are disregarded ought to have been relevant to these entities' taxation affairs for the income year prior to consolidation/joining. That is, the entities must have been eligible to make such election/choice under the relevant provisions. A choice covers both where a decision is made to have the relevant election provision apply to it as well a decision not to make a choice under the election provisions. [Schedule 1, item 26, paragraph 715-660(1)(a)]

Exception - functional currency

1.191 An exception to this rule is the choice/election made under item 1 of the table in subsection 960-60(1) - functional currency. This election is designed as a compliance cost saving measure and as such it only applies to the whole of the income year and has effect for the income year following that in which the choice is made unless the choice is a backdated start-up choice. Therefore, an election/choice made by the head company at consolidation/joining time in regard to functional currency will have effect from the start of the income year following the one in which the choice is made unless the choice is a backdated start-up choice. [Schedule 1, item 26, paragraph 715-660(1)(b)]

Example 1.9

On 16 January 2004 Company A elects to make an item 1 in the table in a subsection 960-60(1) election, under which its applicable functional currency is Japanese Yen. The election does not take effect until 1 July 2004 (income year 2004-2005). On 1 April 2004, Company A joins a consolidated group with Company C as the head company. At Company A's joining time, Company C makes a valid functional currency election under which the group's applicable functional currency is US$. The head company's choice, although made in April 2004, will take effect for the income year 2004-2005.

1.192 The head company will not, however, be permitted to make a choice if it is prevented from making such a choice. In other words, the election or choice provisions listed under paragraph 1.185 ought to be relevant to the head company at the joining time or at consolidation.

Time for making elections

1.193 Making a choice will be permitted even if, for example, the time period for making the underlying election has lapsed or a contradictory election had previously been made by one of the entities joining the group. For example, a head company may (if otherwise permitted) elect to adopt US$ as its functional currency even if a joining member had selected earlier in the year to use NZ$ as a functional currency. The making of such an election sets a new effective time for the election/choice - the choice starts to have effect from the joining or the consolidation time.

1.194 The head company is given 90 days from the joining time or the notification of consolidation within which to make the choice. However, the Commissioner has the discretion to extend this period. The 90 days time limit is not intended to limit the rights of the entities involved, but extend their ability to make the relevant election/choice. It is acknowledged that extra time is necessary for the head company after consolidation or joining time as the choice/election to be dealt with will often be a choice/election which it is not currently possible for the members of the consolidated group to make independently. Where the head company of the consolidated group is otherwise eligible to make a choice, this rule will not derogate from its right to do so. [Schedule 1, item 26, subsection 715-660(4)]

1.195 If the notification took effect prior to the commencement of these provisions then the head company is given 90 days from the date of effect of these provisions within which to make a choice. [Schedule 1, item 26, subsection 715-659(2)]

1.196 The choice the head company makes takes effect from the joining/consolidation time or if the choice relates to one or more whole income years - from the income year in which the consolidation/joining took effect. This ensures that for prospective elections (e.g. the functional currency choice) where the availability of the election is at an unconventional time (i.e. a time other than the beginning of the income year), the election is allowed independently of the election status of the joining entities (consistent with the treatment at consolidation). [Schedule 1, item 26, subsection 715-660(5)]

Choices a leaving entity can make ignoring the exit history rule

1.197 All irrevocable choices/elections made by, or taken to have been made by, the head company for the purposes of elections listed in paragraph 1.185 do not become the elections/choices of the leaving entity under the exit history rule contained in section 701-40. Any irrevocable election/choice made by the head company, or taken to have been made by the head company, is disregarded for leaving entity core purposes. This allows the leaving entity to make an irrevocable election/choice as to whether it wants the underlying election to apply to it once it becomes a separate entity for income tax purposes. [Schedule 1, item 26, subsections 715-700(1) to (3)]

1.198 The leaving entity will not, however, be permitted to make a choice if it is prevented from making such a choice by some other factors. In other words, the election or choice provisions as listed under paragraph 1.185 ought to apply to the leaving entity at that time to enable it to make a choice at the leaving time. [Schedule 1, item 26, subsection 715-700(4)]

1.199 An entity leaving a consolidated group is given 90 days after the leaving time within which to make an election. It is possible that at the leaving time an entity may not be aware that it could make a fresh election/choice and so fails to make an election within the allowed time limit. Therefore, provision has been made for the Commissioner to permit an election to be made beyond 90 days where the loss of an election at leaving was an unintended consequence. Where an entity has left a group prior to the commencement of these provisions the entity can make a choice within 90 days of the commencement of these provisions. Again, this time limit is not intended to in any way limit the rights of the entities involved, to make these choices/elections under the existing provisions. [Schedule 1, item 26, subsections 715-700(5) and 715-699(2)]

Choices a head company can make ignoring the entry history rule to overcome inconsistencies

Head company's choice overrides inconsistency

1.200 The second treatment is the limited resettable elections which permits the choice attributed to the head company of a consolidated group, or to an entity leaving a consolidated group, to change only in circumstances where there would otherwise be inconsistency. The rule to be applied is that when all entities in the group that are eligible to make an election have made a uniform election prior to the notification of consolidation, that election will continue to be in force for the consolidated entity. It is only when elections conflict that a new election/choice is available. [Schedule 1, item 26, subsection 715-665(2)]

1.201 This treatment is applicable to irrevocable elections/choices made in respect of:

•

section 148 of the ITAA 1936 - reinsurance with non-residents;

•

section 775-80 - forex realisation gains and losses; and

•

any other matter prescribed by regulations.

1.202 This is intended to be a list and it is expected that additional items will be added as more elections are recognised which appropriately use this treatment. It is envisaged that companies and groups going through a transition to consolidation will be able to refer to the list (along with those for other treatments) to determine what elections they may need to remake at consolidation or joining time.

1.203 Subsection 148(1) denies a deduction for reinsurance premiums paid by an Australian insurance company to a non-resident reinsurer. Consequently, reinsurance recoveries received from the non-resident reinsurer are not assessable income. However, an Australian insurance company can change this outcome by making an election under subsection 148(2). If an election is made, the Australian insurance company is entitled to a deduction for reinsurance premiums it pays to a non-resident reinsurer and is assessable on reinsurance recoveries received. In addition, the Australian insurance company is liable to tax on 10% of the gross premiums paid to the non-resident reinsurer.

1.204 A subsection 148(2) election made by an Australian insurance company is irrevocable. The election applies to relevant reinsurance contracts that are entered into after the election is made. This ensures that the approach taken in relation to relevant reinsurance arrangements in a particular year has an appropriate impact on the treatment of reinsurance recoveries in subsequent years.

1.205 Section 775-80 allows an entity to elect to not have sections 775-70 and 775-75 (dealing with tax consequences of certain short-term forex realisation gains and losses) apply. Once the election has been made it cannot be revoked.

What happens when entities form a consolidated group or an entity joins a consolidated group?

General rule

1.206 If the choices in force for the head company and the joining entities are inconsistent, the choices of the head company and all the entities joining the consolidated group are disregarded. Likewise, where one or more entities join an existing consolidated group, any choices made by the joining entities prior to the joining time that are inconsistent with the group are disregarded and the head company is allowed to make a new choice. However, a pre-existing choice made by the head company for the group will override the choices of any entities joining the group. In other words, where the head company of an existing consolidated group is eligible to make a choice and the election is relevant to the group (i.e. the head company is taken to have made a considered decision as to whether or not a choice is appropriate) - that choice will override the choices made by any joining entities. [Schedule 1, item 26, subsection 715-665(1)]

1.207 A choice is permitted only in circumstances where there is an inconsistency between the choices of the entities joining the group (including the future head company at consolidation) immediately prior to those companies notifying the Commissioner of their choice to consolidate. Therefore, if there is an inconsistency, all prior elections/choices are disregarded and a new choice permitted. As with the first resettable elections treatment, a choice is permitted when the only things that would prevent a choice being made, apart from these provisions, are the issues of timing and history - beyond this the head company must be eligible to make an election. [Schedule 1, item 26, subsection 715-665(3)]

Exception - foreign reinsurance

1.208 An exception to the above rule is where a subsection 148(2) election is made. These elections are irrevocable and continue to have application in regard to their respective reinsurance contracts with non-resident reinsurers. Basically, the rule is that all subsection 148(2) elections made prior to joining time/consolidation, are taken to have been made by the head company for head company core purposes even though the head company has chosen not to make a subsection 148(2) election at consolidation/joining time. This means that if the head company chooses not to make a subsection 148(2) election, then the head company's choice not to elect applies to only the new reinsurance contracts entered into after the joining time/consolidation with non-resident reinsurers.

[Schedule 1, item 26, subsections 715-665(4) and (7)]

Example 1.10

Head company (H Co) has two wholly-owned subsidiaries (Subsidiaries A and B) that are general insurance companies and the entities form a consolidated group. Prior to consolidation, only Subsidiary A had made a subsection 148(2) election - hence there is an inconsistency at consolidation.

If H Co chooses to make a subsection 148(2) election at consolidation, then the impact of making the election will apply to all reinsurance contracts with non-resident reinsurers entered into after consolidation by H Co.

If H Co chooses not to make a subsection 148(2) election, then the choice not to elect applies to all reinsurance contracts with non-resident reinsurers entered into after consolidation by H Co. However, the impact of the subsection 148(2) election will continue to apply to Subsidiary A's contracts that were entered into prior to consolidation.

1.209 If the head company is not eligible to make a choice under the underlying election either at the joining time or at the time consolidation is notified, it can make a choice within 90 days of notification or joining time, or such longer time as the Commissioner permits, effective from either the joining time or the time consolidation took effect. Where the consolidation or joining time took effect prior to the commencement of these provisions, the extended time for making a choice is 90 days from the commencement of these provisions. The time limit is necessary as the elections/choices to be dealt with will often be choices which it is not currently possible for the members of the consolidated group to make independently. The 90-day limit may be shorter than the period of time permitted to make the election when it was first available. Some flexibility is permitted by the Commissioner's discretion to allow further time to those entities who fail to make the choice in this time. Where the head company is otherwise eligible to make a choice, this rule will not derogate from its right to do so. [Schedule 1, item 26, subsections 715-665(5) and 715-659(2)]

1.210 The head company's choice (or no choice) made at the joining/consolidation time takes effect from the joining time or the income year in which the joining/consolidation took effect where the choice relates to one or more whole income years. [Schedule 1, item 26, subsection 715-665(6)]

What is meant by inconsistent choices?

1.211 Inconsistency will occur when consolidating entities have made conflicting choices, when some consolidating entities have made a choice and others have chosen not to in circumstances where they would be expected to have considered doing so. Inconsistency will also occur where the election status an entity would have on leaving a consolidated group would be different to the status it had just before joining the group.

1.212 An inconsistency will occur any time when these relevant companies which are eligible to make the election have not all made the same choice. This may occur because:

•

they have made different choices under an election where more than one option is possible;

•

they have made the same choice, but due to circumstances the choices have different effects; or

•

where one or more companies choose to make a choice under the election and one or more others have not done so despite the fact that the election was available and relevant to them. For instance, where a group contains two insurance companies, one of which has chosen to include offshore reinvestment amounts in its tax returns and the other has not.

1.213 Two or more choices will result in an 'inconsistency' if the entities making the choices have chosen different things, or at least one of them has made a choice, while others to which the election has been relevant at times when they were able to make a choice have not done so. The existence or otherwise of an inconsistency will generally be judged at the time the entities notify the Commissioner that they are consolidating. However, where there is evidence that the members of the group were making choices under the relevant election on a consolidated basis prior to the notification time, the existence of a conflict will be judged immediately prior to the time at which they began making decisions on a consolidated basis.

Choices a leaving entity can make ignoring the exit history rule to overcome inconsistencies

General rule

1.214 At leaving, the irrevocable election/choice status of the head company will be disregarded for the leaving entity core purposes and a new irrevocable election/choice made available, only if the irrevocable election/choice status of the head company at leaving is inconsistent with the status that the leaving entity had prior to joining the group. This means that, where the leaving entity has only ever been a member of the group (i.e. it did not have a choice in place prior to joining the group), it will adopt the election status of the head company. Also, if the head company had an election in place that was consistent with the election the leaving entity had in place prior to joining the group, that election/choice will be applied to the leaving entity. [Schedule 1, item 26, subsections 715-705(1) and (2)]

1.215 This treatment is considered necessary in so much as it accepts that, while a particular choice may be appropriate as a compromise for a consolidated entity that does not mean that it will continue to be appropriate for each entity that has been part of the group when that entity is operating separately.

Exception - foreign reinsurance

1.216 An exception to the above rule applies when a subsection 148(2) election is made by the head company. At leaving, any subsection 148(2) election/choice status of the head company will not be disregarded for the leaving entity core purposes. This is because these elections are irrevocable and, where made, continue to have effect in regard to their respective reinsurance contracts with non-resident reinsurers. For example, if at leaving the head company did not have any subsection 148(2) election in place, but the leaving entity had a subsection 148(2) election prior to the joining/consolidation time, then the reinsurance contracts in respect of which the leaving entity had made an election prior to joining/consolidating will continue to have effect as if the leaving entity had never joined a consolidated group. [Schedule 1, item 26, subsections 715-705(4) and (8)]

1.217 If the leaving entity is not, at the leaving time, eligible to make a choice under the underlying election, it may, within 90 days after the leaving time or such longer time as the Commissioner permits, make a fresh choice. However, where an entity leaves a group prior to the commencement of these provisions, the entity has 90 days from the commencement of these provisions to make a choice. The 90-day limit is seen to be adequate when an entity leaves a group. This time limit is not to derogate from the right of the leaving entity to make a choice at any time when it would be able to disregarding this 90-day period. [Schedule 1, item 26, subsections 715-705(6 ) and 715-699(2)]

1.218 The leaving entity will not, however, be permitted to make a choice if it is prevented from making such a choice by some other factors. In other words, the election or choice provisions as listed in paragraph 1.201 ought to be relevant to the leaving entity and the leaving entity eligible at the time to make such a choice. [Schedule 1, item 26, subsection 715-705(5)]

1.219 An election/choice made by the leaving entity takes effect from the time it left the group, or if the choice relates to one or more whole income years, it takes effect for the income year and later income years in which it left the group. [Schedule 1, item 26, subsection 715-705(7)]

Choices with ongoing effect

1.220 This treatment deals with irrevocable elections/choices that are made entity wide but essentially affect the entity's assets and liabilities and/or transactions. The head company is taken to have made the same choice as the entity that held the asset, right, liability or obligation immediately prior to consolidation. Therefore, despite consolidation, all assets of the head company which were held prior to consolidation will be treated as though the head company had made the same choice, (or as applicable not made a choice) as that made by the entity that held the asset/right/liability/obligation immediately prior to consolidation. [Schedule 1, item 26, subsection 715-670(1)]

1.221 This treatment is designed to prevent a choice/election ceasing to be in place with respect to a specific asset/liability/obligation, as this could potentially mean that that asset/obligation/liability ceases to be within the scope of the election that has previously governed its taxation. Elections of the type mentioned in paragraph 1.222 essentially 'see through' consolidation and continue to apply to assets, obligations or liabilities as they did prior to consolidation. That is, the election continues to apply with respect to assets, obligations or liabilities that, before consolidation, were held by entities that had made a choice, but not to assets/obligations/liabilities that were held by entities that had not made a choice. This treatment will govern transitional choices/elections, so there is no need to determine the status of assets, obligation or liabilities that come to be held or entered into subsequent to consolidation.

1.222 The irrevocable elections/choices to which this treatment is applicable are those that are made under:

•

section 775-150; and

•

any other matter prescribed by regulations.

1.223 As part of the transitional arrangements for the introduction of the foreign currency provisions in Division 775, section 775-150 allows an entity to elect to disregard certain forex realisation gains and losses in accordance with sections 775-160 and 775-165. The election must be made within 60 days after the applicable commencement date or within 30 days after the commencement of subsection 775-150(3). The election may not be revoked.

1.224 As stated earlier, this is intended to be a list and it is expected that additional items may be added as either more elections are added or recognised that should appropriately use this treatment. It is envisaged that companies and groups going through a transition to consolidation will be able to refer to this list (along with those for other treatments) to determine what elections/choices they may need to remake at consolidation.

1.225 If prior to the time consolidation is notified, any member of the consolidated group had made a choice under the irrevocable election, the head company may, within 90 days of that time or such longer time as the Commissioner allows, make an irrevocable choice to treat all assets, liabilities, rights or obligations it holds as being covered by the underlying election. Where the notification of consolidation was given prior to the commencement of these provisions, the head company is given 90 days from the commencement of these provisions within which to make a choice. Such a choice will continue to have effect if any further entities join the group - applying the election to the liabilities, assets, rights or obligations of those entities even if they have not previously chosen to do so. When an entity leaves a consolidated group, the choices/elections continue to apply to assets, liabilities, rights or obligations as they applied prior to leaving. If the election was made originally by the head company, the leaving entity will simply inherit the election status of the head company per the normal exit history rule. [Schedule 1, item 26, subsections 715-675(1) and 715-659(2)]

1.226 Where the head company of a consolidated group joins another consolidated group, this choice will itself be treated as a choice with ongoing effect. That is, the choice will continue to apply to those companies which, prior to the consolidated group joining another such group, were members of a consolidated group the head company of which had made a choice under this section. [Schedule 1, item 26, subsection 715-675(2)]

Application and transitional provisions

1.227 Part 1 of Schedule 1 to this bill provides that the amendments discussed in this chapter will take effect on 1 July 2002 (being the commencement date of the consolidation regime). Having the amendments apply from this date will provide maximum certainty and minimise the risk of arbitrary outcomes which may arise if a later commencement date is chosen. [Schedule 1, item 28]

1.228 All of the amendments are either beneficial to taxpayers or correct unintended outcomes. The amendments to address unintended outcomes are consistent with the original policy intent for the consolidation regime and therefore have the same commencement date as the consolidation regime.

Software development pools

Modifications where expenditure incurred before 1 July 2001

1.229 The amendments that this bill makes under sections 716-340 and 716-345 operate in relation to the former software development pool provisions in the same way that they operate for the provisions in Subdivision 40-E. Former section 46-90 that dealt with calculating deductions for pooled expenditure on software operated in a similar manner to the current section 40-455. The former provisions that created a software pool, determined what expenditure would go into a software pool, and calculated deductions for pooled expenditure on software which are within former Subdivision 46-D operate in the same way as under sections 716-340 and 716-345. [Schedule 1, item 12, section 716-340 of the Income Tax (Transitional Provisions) Act 1997]

Inter-entity loss multiplication rules

1.230 The amendments relating to the notice requirements under the inter-entity loss multiplication rules will apply to notices in relation to alteration times that happen after 10 November 1999. This will ensure that amendments apply to any notice required under those rules. [Schedule 1, item 19]

Chapter 2 - Copyright collecting societies

Outline of chapter

2.1 Schedule 2 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997), the Income Tax (Transitional Provisions) Act 1997 and the Taxation Administration Act 1953 (TAA 1953) to modify the tax treatment of copyright collecting societies and their members.

Context of amendments

2.2 Copyright collecting societies are organisations that administer certain rights of copyright on behalf of copyright owners (including authors and composers) who generally become members of the societies. Income received in relation to copyrights is held by societies pending identification of, and allocation to, the appropriate copyright owners.

2.3 In response to recommendations of the Simpson Report into copyright collecting societies (1995), the Australian Taxation Office (ATO) conducted a review of the tax treatment of such societies. The ATO concluded that, due to the nature of the arrangements in place for the collection, administration and distribution of royalties and licence fees, and the fact that the societies have the power to deal with their members' funds, a trust relationship exists between the societies and their members. Accordingly, the societies are considered discretionary trusts for income tax purposes, the trustees of which are the directors of the societies and the beneficiaries of which are the members/copyright owners. The ATO determined that the societies would be taxed as discretionary trusts from 1 July 2002.

2.4 Under section 99A of the Income Tax Assessment Act 1936 (ITAA 1936), where there is a part of the net income of a trust estate to which no beneficiary has been made presently entitled, the trustee is assessed and is liable to pay tax on that income at the top personal tax rate. As a matter of administrative practice, Taxation Ruling IT 328 generally allows until two months after the end of the income year for a beneficiary to be made presently entitled to a share of the trust income. Due to practical difficulties in matching payments to members, a significant percentage of income derived by copyright collecting societies is generally not allocated within this time frame. Therefore, in the absence of legislative amendments, a substantial proportion of the income of copyright collecting societies would face tax at the top personal tax rate.

2.5 On 1 August 2002, the former Minister for Revenue and Assistant Treasurer announced that the tax law would be amended, effective from 1 July 2002, to ensure that copyright collecting societies are not taxed on income they collect on behalf of copyright owners. Amendments to give effect to this announcement, contained in this bill, have been developed in consultation with representatives of the copyright collecting societies.

Summary of new law

2.6 These amendments will:

•

ensure that copyright collecting societies are not taxed on any copyright income that they collect and hold on behalf of members, pending allocation to them;

•

minimise compliance costs for copyright collecting societies by ensuring that they are not taxed on the non-copyright income they derive, provided that the amount of non-copyright income derived falls within certain limits; and

•

ensure that any copyright and non-copyright income collected or derived by copyright collecting societies that is exempt from income tax in their hands, is included in the assessable income of members upon distribution.

Comparison of key features of new law and current law

Detailed explanation of new law

Exemption for certain types of income of copyright collecting societies

2.7 Certain types of income collected or derived by copyright collecting societies that are operating under a trust relationship with their members will be exempt from income tax at the society level. The definition of a 'copyright collecting society' is discussed in paragraphs 2.20 and 2.21.

Exemption for copyright income

2.8 'Copyright income' collected or derived by a copyright collecting society to which the trust provisions in the ITAA 1936 apply will be exempt from income tax at the society level. [Schedule 2, item 5, paragraph 51-43(2)(a)]

2.9 Copyright income is defined to mean ordinary or statutory income of the following kinds: royalties and interest on royalties collected or derived by the society; and such other amounts relating to copyright that are derived by the society as are prescribed by the regulations. [Schedule 2, item 8 and the definition of 'copyright income' in subsection 995-1(1)]

2.10 The term 'royalty' is already defined in subsection 995-1(1) of the ITAA 1997, by reference to the definition in the ITAA 1936. This definition is broad, and encompasses equitable remuneration collected by societies under statutory licences, as this is in effect remuneration received as consideration for the use of copyright.

Exemption for certain non-copyright income

2.11 'Non-copyright income' means any income derived by a copyright collecting society other than copyright income [Schedule 2, item 10 and the definition of 'non-copyright income' in subsection 995-1(1)]. Examples of non-copyright income would include consulting fees, fees received for the provision of administrative services to smaller societies and grant income.

2.12 Non-copyright income derived by a copyright collecting society to which the trust provisions in the ITAA 1936 apply will also be exempt from income tax, to the extent that this non-copyright income does not exceed the lesser of:

•

five per cent of the total amount of the copyright collecting society's copyright income and non-copyright income for the income year; and

•

$5 million or such other amount as is prescribed by the regulations (no other amount has been prescribed at this time).

[Schedule 2, item 5, paragraph 51-43(2)(b)]

2.13 This de minimis rule is designed to minimise compliance costs for collecting societies by exempting relatively small amounts of non-copyright income ancillary to the copyright collecting business. Currently, societies distribute non-copyright income to members in conjunction with distributions of copyright income. In the absence of the exemption, societies wanting to avoid tax at the top personal income tax rate would be required to incur considerable costs in revising their existing systems for distributing non-copyright income to members. Non-copyright income exempt at the collecting society level will be included in the assessable income of members when it is distributed.

2.14 Any non-copyright income that a society derives in excess of the de minimis threshold will be subject to the normal provisions applying to trusts in Division 6 of the ITAA 1936. This means, for example, that any non-copyright income above the de minimis threshold will be assessed to the directors of the societies, as trustees, under section 99A, if no members of the society are made presently entitled to it within two months of the end of the income year.

Example 2.1

A copyright collecting society collects $84 million of copyright income and derives $6 million of non-copyright income in an income year. The $84 million of copyright income will be exempt from income tax in the hands of the copyright collecting society.

The total income of the society is $90 million. Five per cent of $90 million is $4.5 million. As this is less than $5 million, only $4.5 million of non-copyright income is exempt from tax. The remaining $1.5 million of non-copyright income will be dealt with under the trust provisions in Division 6 of the ITAA 1936.

Assessable income of members of copyright collecting societies

2.15 When a copyright collecting society makes a payment of certain amounts of copyright and non-copyright income to a member of the society, the amount of the payment is included in the member's assessable income except to the extent that it represents an amount on which the directors of the society, as trustees, are assessed, or have been assessed, and are liable to pay tax under section 98, 99 or 99A of the ITAA 1936. This ensures that there is no double taxation on any amounts of income collected or derived by copyright collecting societies [Schedule 2, item 4, section 15-22]. This provision applies instead of the provisions contained in Division 6 of the ITAA 1936 [Schedule 2, item 4, subsection 15-22(1)].

2.16 Where this provision applies, section 15-20 of the ITAA 1997, which would ordinarily include payments of royalties in the assessable income of members, will not apply. [Schedule 2, item 3, subsection 15-20(2)]

2.17 A member of a copyright collecting society is defined as any person who has been admitted as a member under the society's constitution or any person who has authorised the society to license the use of his or her copyright material. [Schedule 2, item 9 and the definition of 'member' in subsection 995-1(1)]

Notice of payment to members

2.18 To assist members of societies to determine how much of a payment to include in their assessable income, societies are required to provide notices to members each time they make a payment to them. The notice must be in writing and set out:

•

the name of the society and the member;

•

the total amount of the payment;

•

that amount of the payment on which the directors of the society, as trustees, are or have been assessed and are therefore liable to pay tax under sections 98, 99 and 99A of the ITAA 1936; and

•

the amount of the payment which the member has to include in his or her assessable income.

[Schedule 2, item 6, section 410-5]

2.19 Failure to provide a notice, or to provide a notice in the manner required, will result in an administrative penalty of 20 penalty points. [Schedule 2, item 12, section 288-75]

Definition of a copyright collecting society

2.20 A copyright collecting society may be declared under the Copyright Act 1968 to have the statutory right to collect copyright income under schemes that fall within that Act. Alternatively, societies may be voluntarily established to assist certain groups of copyright holders to manage their rights (i.e. non-declared societies).

2.21 For income tax purposes, a copyright collecting society is defined to include both declared and non-declared societies, subject to certain conditions. The conditions ensure that, to be eligible for the income tax exemptions discussed in paragraphs 2.8 and 2.12, non-declared societies must broadly meet the same requirements that declared societies must meet under the Copyright Act 1968. In addition, the definition provides additional integrity in relation to the way societies distribute income to members. In particular, no member can direct a society to pay them an amount of income at a particular time, and societies must distribute amounts of income as soon as is reasonably possible to members once amounts have been allocated to them. These conditions ensure that the timing of payments cannot be manipulated to achieve tax advantages and that tax cannot be indefinitely deferred by societies retaining tax exempt amounts for significant periods of time. [Schedule 2, item 7 and the definition of 'copyright collecting society' in subsection 995-1(1)]

Application and transitional provisions

2.22 The amendments apply from 1 July 2002 to all copyright and non-copyright income collected or derived by copyright collecting societies, and to all payments of copyright and non-copyright income made by copyright collecting societies to members.

2.23 Due to the possibility of some societies being disadvantaged by the retrospective operation of the amendments, societies may elect to defer entry into the new taxation regime until 1 July 2004. In order for such an election to be valid, it will need to be made to the Commissioner of Taxation in writing within 28 days of this bill receiving Royal Assent. Societies making a valid election will only be exempt on relevant copyright and non-copyright income collected or derived on or after 1 July 2004. [Schedule 2, item 11, section 410-1]

2.24 To avoid imposing retrospective obligations on copyright collecting societies, the requirement for societies to provide a notice to members outlining details of payments (see paragraph 2.18) will only apply from the income year following the income year in which this bill receives Royal Assent. [Schedule 2, item 13]

Chapter 3 - Simplified imputation system - consequential and other amendments

Outline of chapter

3.1 Schedule 3 to this bill makes consequential amendments to the income tax laws which:

•

replace references to the former imputation provisions in Part IIIAA of the Income Tax Assessment Act 1936 (ITAA 1936) with those of the simplified imputation system (SIS) in Part 3-6 of the Income Tax Assessment Act 1997 (ITAA 1997); and

•

updates terminology of the former imputation system to equivalent terms of the SIS.

3.2 This Schedule also makes various technical amendments to the SIS and other imputation related provisions.

3.3 In addition, this Schedule inserts into Division 207 of Part 3-6 of the ITAA 1997 anti-avoidance rules that apply in relation to certain tax exempt entities that are entitled to a refund of imputation credits. These rules were previously in Division 7AA of Part IIIAA of the ITAA 1936.

3.4 All subsequent legislative references are to the ITAA 1997 unless otherwise stated.

Context of amendments

3.5 The implementation of the SIS arose out of a recommendation of the Review of Business Taxation. The Treasurer's Press Release No. 058 of 21 September 1999 announced the Government's proposal to implement the SIS which aims to reduce compliance costs incurred by business by providing simpler processes and increased flexibility. The former Minister for Revenue and Assistant Treasurer's Press Release No. C057/02 of 14 May 2002 announced that the SIS would commence on 1 July 2002. The SIS replaced the former imputation system in Part IIIAA of the ITAA 1936.

3.6 As a result of the introduction of the SIS, a number of consequential amendments are required to other areas of the income tax law. The income tax laws that need to be updated are:

•

the ITAA 1997;

•

the ITAA 1936 (including the Schedules); and

•

the Taxation Administration Act 1953 (TAA 1953).

3.7 The amendments will ensure the correct operation of the tax system following the commencement of the SIS from 1 July 2002.

3.8 The Schedule will also make various technical amendments to the SIS and other imputation related provisions.

3.9 Division 207 is part of the core SIS rules introduced in the New Business Tax System (Imputation) Act 2002 which deals with the tax effect of receiving a franked distribution.

Summary of new law

3.10 The new law will make consequential amendments to the income tax laws to:

•

replace references to the former imputation system with those of the SIS; and

•

update terminology of the former imputation provisions to equivalent terms of the SIS.

3.11 The technical amendments will ensure that the various provisions operate as intended.

Detailed explanation of new law

Technical amendments to the simplified imputation system

Amendment to section 46FB of the Income Tax Assessment Act 1936

3.12 Section 46FA of the ITAA 1936 provides for a deduction for on-payments of unfranked (or partly franked) dividends made by a resident company to its wholly-owned foreign parent. The deduction was inadvertently made inoperative with the removal of the intercorporate dividend rebate under sections 46 and 46A of the ITAA 1936 for unfranked dividends paid within wholly-owned groups generally after 30 June 2003. This defect is to be rectified by amendments in the Tax Laws Amendment (2004 Measures No. 1) Bill 2004.

3.13 Section 46FB provides that a resident company may establish an unfranked non-portfolio dividend account in order to track the amount of unfranked non-portfolio dividends available for on-going distribution. In order to receive the deduction under section 46FA, an amount must be paid out of this account.

3.14 The Tax Laws Amendment (2004 Measures No. 1) Bill 2004 did not include similar amendments to paragraph 46FB(4)(c). Paragraph 46FA(1)(c) is now amended to ensure that a resident company can credit its unfranked non-portfolio dividend account to the extent that it has received an unfranked non-portfolio dividend. This will then entitle the company to a deduction for any amounts paid out of this account to its wholly-owned foreign parent under section 46FA. [Schedule 3, Part 2, item 26, paragraph 46FB(4)(c)]

Amendments to exempting entity rules

3.15 Division 208 contains rules designed to prevent franking credit trading for entities with controlling shareholders for whom franking credits have limited or no value (i.e. non-residents and tax exempt entities). Under these rules, dividends paid by these entities (known as exempting entities) to resident shareholders are generally treated as unfranked dividends. When an exempting entity becomes a former exempting entity (e.g. when the entity ceases to be more than 95% owned by non-residents and tax exempt shareholders), the exempting account is quarantined so that distributions franked with exempting credits only confer a franking benefit for eligible continuing substantial shareholders or under an employee share scheme as referred to in those provisions.

Consequential amendment to paragraph 128B(3)(ga) of the Income Tax Assessment Act 1936

3.16 Subsection 160AFQA(4) of the former imputation rules in Part IIIAA of the ITAA 1936 contained the requirement that a dividend is only taken to be franked with an exempting credit if it is paid to an eligible continuing substantial shareholder or an employee to whom a dividend has been paid on a share acquired under an eligible employee share scheme. This requirement was not replicated under the SIS. To ensure an equivalent outcome is achieved, paragraph 128B(3)(ga) of the ITAA 1936 is amended by providing that a dividend franked with an exempting credit is exempt from dividend withholding tax to the extent that it is paid to a non-resident that is either:

•

an eligible continuing substantial member (i.e. the SIS equivalent of an eligible continuing substantial shareholder); or

•

a shareholder to whom the dividend had been paid on a share acquired under an employee share scheme.

[Schedule 3, Part 2, item 43, paragraph 128B(3)(ga)]

Amendment to sections 208-165 and 208-170

3.17 Sections 208-165 and 208-170 are amended by including an additional formula to ensure that the correct amount of franking credits arises in the case where an exempting entity makes a distribution franked with franking credits to another exempting entity. Currently, these provisions only provide for the correct outcome in the case where the recipient receives a distribution franked with exempting credits paid by a former exempting entity. The existing formula in section 208-170 is also amended to include an appropriate reference to a recipient of the distribution. [Schedule 3, Part 2, items 93 to 97, sections 208-165 and 208-170]

3.18 As a result of these changes, the references to sections 208-165 and 208-170 in the table in sections 208-115 and 208-130 are updated to the relevant subsection in amended sections 208-165 and 208-170. [Schedule 3, Part 2, items 87 to 92; items 2 and 3 in the table in section 208-115; items 2, 3, 5 and 6 in the table in section 208-130]

Amendment to section 67-30

3.19 Section 67-30 is amended to ensure that the priority rule for refundable tax offsets interacts properly with the franking deficit tax offset rules. [Schedule 3, Part 2, items 80 and 110, section 67-30]

Amendment to section 210-170

3.20 Section 210-170 sets out the conditions that a recipient of a distribution franked with venture capital credits must satisfy before they are entitled to a tax offset. Under the current law, one of these conditions is that the recipient is not a qualified person in relation to the distribution for the purposes of Division 1A of Part IIIAA of the ITAA 1936. It was intended that the person be a qualified person (i.e. broadly, a person who is not a party to a franking credit trading arrangement). To ensure that this is the case an amendment is made to paragraph 210-170(1)(e) to remove the word 'not'. [Schedule 3, Part 2, item 98, paragraph 210-170(1)(e)]

Consequential amendments to the simplified imputation system

3.21 The consequential amendments made in this Schedule are summarised in Table 3.1.

Anti-avoidance rules

3.22 Section 207-125 (to be renumbered as section 207-110 when the Tax Laws Amendment (2004 Measures No. 2) Bill 2004 receives Royal Assent) entitles certain income tax exempt charities and deductible gift recipients to a tax offset making them eligible for a refundable tax offset under Division 67.

3.23 The allowance of a tax offset to these exempt institutions is subject to anti-avoidance rules which may apply to deny the tax offset where this concession is abused. The details outlining when these rules apply are explained in the explanatory memorandum to the New Business Tax System (Miscellaneous) Act (No. 1) 2000 (Act No. 79 of 2000).

3.24 These anti-avoidance rules, included in new Subdivision 207-E, will replicate the outcomes provided for under the former rules with two minor changes that will:

•

correct a technical defect in the former provisions to ensure that the maximum amount the Commissioner of Taxation (Commissioner) may recover from the exempt entity and the controller(s) of the exempt entity does not exceed the amount that the exempt entity is liable to pay in respect of the incorrectly claimed refund of imputation credits; and

•

ensure that all decisions made by the Commissioner under the anti-avoidance rules are reviewable under Part IVC of the TAA 1953.

[Schedule 3, Part 1, item 4, sections 207-119, 207-120, 207-122, 207-124, 207-126, 207-128, 207-130, 207-132, 207-134 and 207-136]

3.25 As part of this replication, the definition of 'controller (for capital gains tax (CGT) purposes)' is re-inserted in the ITAA 1997 into Subdivision 975-A. This amendment is necessary because the definition of 'controller (for imputation purposes)' in proposed section 207-130 relies on the definition of a 'controller (for CGT purposes)' in section 140-20. However, Division 140 was repealed from 24 October 2002 as part of the introduction of the new general value shifting regime. [Schedule 3, Part 1, item 5, sections 976-155 and 976-160]

3.26 The concepts defined in Subdivision 207-E are cross-referenced in the dictionary in subsection 995-1(1). [Schedule 3, Part 1, items 6 to 13, subsection 995-1(1)]

3.27 Table 3.2 cross-references the former provisions in the ITAA 1936 to the new provisions incorporated into the SIS.

Application and transitional provisions

3.28 The consequential amendments and the anti-avoidance provisions will generally apply to events on or after 1 July 2002, the commencement date of the SIS. [Schedule 3, Part 3, subitems 111(1) and (3)]

3.29 The amendments to re-insert the definition of 'controller (for CGT purposes)' will apply to assessments for the 2002-2003 income year and later income years. This will ensure that there is a definition for this concept for the purposes of the anti-avoidance rules from when the value shifting rules in Division 140 were repealed. [Schedule 3, Part 3, subitem 111(2)]

3.30 The amendment to paragraph 46FB(4)(c) will generally apply to dividends paid after 30 June 2003. For taxpayers that are subject to the provisions in section 46AC of the ITAA 1936, this amendment applies to dividends paid on or after the consolidation day referred to in that section. [Schedule 3, Part 3, subitems 111(4) and (5)]

3.31 For assessments for the 2002-2003 income year, section 109ZC of the ITAA 1936 has effect as if the references in subsection 109ZC(3) to amounts that are not assessable income and are not exempt income were instead a reference to income that is not exempt. This is needed because these new concepts of income were not introduced until the 2003-2004 income year and later income years. [Schedule 3, Part 3, item 112]

3.32 For the period starting 1 July 2002 and ending 30 June 2004, section 128TB of the ITAA 1936 has effect as if the reference to 'general company tax rate' in subsection 128TB(2) was amended to 'corporate tax rate'. This modified application provision is necessary because section 128TB is being repealed from 1 July 2004 by the New International Tax Arrangements (Participation Exemption and Other Measures) Bill 2004 if this bill passed. [Schedule 3, Part 3, item 113]

3.33 For the period starting 1 July 2002 and ending 30 June 2004, section 377 of the ITAA 1936 has effect as if the references in paragraph 377(1)(e) to the former imputation provisions were references to the SIS. Again, this modified application provision is necessary because section 377 is being repealed from 1 July 2004 by the same bill that repeals section 128TB. [Schedule 3, Part 3, item 114]

Chapter 4 - Deductible gift recipients

Outline of chapter

4.1 Schedule 4 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to:

•

create a new general category of deductible gift recipient (DGR) for certain government special schools;

•

update the lists of specifically listed DGRs; and

•

extend the periods for which deductions are allowed for gifts to certain funds and organisations that have time limited DGR status.

Context of amendments

4.2 The income tax law allows taxpayers to claim income tax deductions for gifts of $2 or more 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.

4.3 The amendments in Schedule 4 will assist relevant funds and organisations to attract public support for their activities.

Summary of new law

4.4 These amendments create a new category of DGRs for certain government special schools that provide education solely to students with a disability. This gives effect to the Treasurer's announcement in Press Release No. 32 of 11 May 2004.

4.5 These amendments also add certain fire and emergency services authorities as specifically listed DGRs. The Government announced in the Treasurer's Press Release No. 114 of 23 December 2003 that it would legislate to ensure that the Country Fire Authority, the Victoria State Emergency Service and equivalent coordinating bodies in other states and territories could benefit from being able to receive tax deductible gifts.

4.6 The remaining amendments add certain other organisations as specifically listed DGRs and extend the period for which deductions are allowed for gifts to certain funds and organisations that have time limited DGR status.

Detailed explanation of new law

New deductible gift recipient category for special schools

4.7 The amendments will extend DGR status to all government schools that:

•

provide special education for students with a disability that is permanent or is likely to be permanent; and

•

do not provide education for students without a disability.

[Schedule 4, item 1]

4.8 Some special schools had previously been granted DGR status after being endorsed by the Commissioner of Taxation (Commissioner) as public benevolent institutions (PBIs). The Commissioner has now determined that these organisations are government bodies and so cannot be PBIs. It is a well established principle of common law that a government body is not a PBI. The amendments will ensure that special schools that previously had PBI status can continue to receive tax deductible gifts.

4.9 The amendments do not extend DGR status to those mainstream schools that also provide some education to students with disabilities. Non-government special schools operating on a non-profit basis will continue to be able to seek DGR endorsement as a PBI.

4.10 Under the new law, a government special school may apply to the Commissioner to be endorsed as a DGR under the new general category. An organisation may only be endorsed after it has satisfied the Commissioner that it meets certain integrity standards, known as the gift fund requirements, which are set out in the Australian Taxation Office (ATO) Public Ruling TR 2000/12: Income tax: deductible gift recipients - the gift fund requirements and the ATO's Fact Sheet: Gift fund requirements.

Deductible gift recipient listing for state and territory fire and emergency services

4.11 Schedule 4 also lists as DGRs the state and territory coordinating bodies for fire and emergency services listed in Table 4.1. [Schedule 4, item 13]

4.12 Some of these organisations had previously been granted DGR status after being endorsed by the Commissioner as a PBI. The Commissioner has now determined that these organisations are government bodies and so cannot be PBIs. The amendments will ensure that these coordinating bodies can continue to receive tax deductible gifts.

4.13 On 1 July 2004, the Emergencies Act 2004 came into effect establishing the ACT Rural Fire Service and the ACT State Emergency Service to replace the Rural Firefighting Service and the ACT Emergency Service respectively. As a result, four fire and emergency service bodies are listed for the Australian Capital Territory.

4.14 Generally, an organisation is specifically listed only after it has satisfied the Commissioner that it meets integrity standards, known as the public fund requirements. The coordinating bodies that have met the public fund requirements are being specifically listed in this bill. Further, any coordinating bodies which meet the public fund requirements at a later date will be legislated at that time.

Other specifically listed deductible gift recipients

4.15 Schedule 4 lists as DGRs the organisations in Table 4.2. [Schedule 4, items 3, 4, 10 to 13 and 16]

4.16 The CFA and Brigades Donations Fund was established by the Country Fire Authority of Victoria to raise and collect donations from the public specifically for distribution to the Country Fire Authority volunteer fire brigades in Victoria. [Schedule 4, item 13]

4.17 The Australian Branch of International Social Service is a non-government, not-for-profit organisation offering professional social work services to people in Australia and overseas. The organisation offers assistance to those with social or socio-legal problems arising from migration. [Schedule 4, item 4]

4.18 The Victorian Crime Stoppers Program encourages community involvement in the apprehension and conviction of criminals, and the reduction in crime by the provision of information to the proper authorities. [Schedule 4, item 4]

4.19 The Coolgardie Honour Roll Committee was established to erect the Honour Roll Memorial to remember the men and women of Coolgardie who fought for Australia in all wars. [Schedule 4, item 10]

4.20 The Tamworth Waler Memorial Fund was established to erect the Waler War Memorial to recognise the important contribution of the stock horse to Australia's military commitment in the Boer War and the Great War, along with the men who rode them. [Schedule 4, item 10]

4.21 Australian Business Week Limited has the principal objective of educating Australian students to foster interest in entrepreneurial and enterprise development. [Schedule 4, item 11]

4.22 The City of Onkaparinga Memorial Gardens Association Inc. was established to develop memorial gardens and grounds in Morphett Vale, South Australia, to serve as a war memorial to honour and commemorate the sacrifices made by Australians who served in all wars from the Great War of 1914-1918 to the Gulf War and those serving in peacekeeping forces. [Schedule 4, item 10]

4.23 The Finding Sydney Foundation has as its principal objective the search for the HMAS Sydney II and the German auxiliary cruiser HSK Kormoran, that disappeared off the Western Australian coast on 19 November 1941, and establish a virtual memorial to the sailors and the engagement. The loss of the Sydney with its crew of 645 remains one of Australia's greatest wartime mysteries. [Schedule 4, item 10]

4.24 The Clontarf Foundation seeks to improve the health, employment, education and life skills of disadvantaged youths (predominantly indigenous boys) through a number of Australian Rules football academies in Western Australia. The Foundation now seeks to expand its operations into the Kimberley region, the Northern Territory and Queensland. [Schedule 4, item 3]

4.25 Lord Somers Camp and Powerhouse runs programs providing opportunities for youths to develop leadership and personal skills. Various programs are run throughout the year, such as programs aimed at 16 to 18 year olds to develop teamwork, self-confidence, tolerance and leadership skills, and programs for youths with chronic illness or physical disabilities to promote their self-esteem and confidence. [Schedule 4, item 16]

4.26 The Lowy Institute for International Policy was previously known as the Institute for International Policy. The institute was established to provide independent and policy oriented research on international issues and, through its work, inform public debate on economic and foreign policy issues, international affairs and matters of national importance. [Schedule 4, item 12]

4.27 St George's Cathedral Restoration Fund assists St George's Anglican Cathedral in Perth to raise money for restoration and refurbishment of the Cathedral building, Burt Memorial Hall and the Deanery. [Schedule 4, item 16]

Extending periods for which gifts are deductible

4.28 Schedule 4 extends the period for which deductions are allowed for gifts to certain organisations as outlined in Table 4.3. The extensions will support the further work of the relevant organisations. [Schedule 4, items 5 to 9, 14 and 15]

4.29 The Australian Ex-Prisoners of War Memorial was built to pay tribute to the sacrifice and service since Federation, of approximately 35,000 Australian prisoners of war and serve as a place of remembrance for the families and friends of Australians who have died in captivity. [Schedule 4, item 6]

4.30 The Albert Coates Memorial Trust raises funds to establish 'living memorials' to honour Sir Albert Coates who served with distinction in the two World Wars. Among other activities, the Trust provides scholarships each year to medical graduates and to students in the Ballarat community. [Schedule 4, item 7]

4.31 The St Patrick's Cathedral Parramatta Rebuilding Fund assists the Parramatta community to rebuild St Patrick's Cathedral which was destroyed by fire on 19 February 1996. [Schedule 4, item 14]

4.32 The St Paul's Cathedral Restoration Fund assists St Paul's Anglican Cathedral in Melbourne to raise money for restoration and refurbishment of the Cathedral building. [Schedule 4, item 15]

4.33 The Mount Macedon Memorial Cross Trust was established to undertake development and restoration of the Mount Macedon Memorial Cross and the surrounding land. The Cross, which was built in honour of those killed in World War I, is recognised as one of the most significant war memorials in Victoria. [Schedule 4, item 8]

4.34 The Shrine of Remembrance in Melbourne built during the depression, is a memorial of national significance and commemorates the sacrifices made by Victorians during World War I, World War II and the conflicts in Korea, Malaya, Borneo, Vietnam and the Persian Gulf. [Schedule 4, items 5 and 9]

Application and transitional provisions

4.35 The amendments creating a new category of DGRs for certain government special schools apply from 1 April 2004. [Schedule 4, item 2]

4.36 The amendments specifically listing state and territory fire and emergency services in Table 4.1 apply from 23 December 2003, with the exception of the ACT Rural Fire Service and the ACT State Emergency Service which apply from 1 July 2004, reflecting that these organisations only began operating under these names from that date. [Schedule 4, item 13]

4.37 The amendments specifically listing the organisations in Table 4.2 apply from the dates of effect shown in that table. [Schedule 4, items 3, 4, 10 to 12 and 16]

4.38 The amendments to extend the listings for the organisations in Table 4.3 apply for the periods shown in that table. [Schedule 4, items 5 to 9, 14 and 15]

Chapter 5 - Debt and equity interests - at call loans

Outline of chapter

5.1 Schedule 5 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) so that the transitional period for at call loans under the debt/equity rules will extend to 30 June 2005.

Context of amendments

5.2 The debt/equity rules in Division 974 of the ITAA 1997 set out what is debt and what is equity for various income tax purposes. These rules can apply from 1 July 2001.

5.3 A transitional rule deems certain related party at call loans entered into on or after 21 February 2001, and on or before 31 December 2002, to be a debt interest. These are typically loans by small business owners to their business, have no fixed term and are repayable on demand.

5.4 The former Minister for Revenue and Assistant Treasurer announced that the Government would extend this transitional period to 30 June 2004 (Press Release No. C131/02 of 16 December 2002) and later announced a further extension to 30 June 2005 (Press Release No. C045/04 of 24 May 2004).

Summary of new law

5.5 At call loans made to a company by a connected entity of the company and entered into on or before 30 June 2005 will be treated as debt interests under the debt/equity rules.

Comparison of key features of new law and current law

Detailed explanation of new law

5.6 A financing arrangement entered into on or before 30 June 2005 will be treated as a debt interest when:

•

it takes the form of a loan to a company by a connected entity;

•

it has no fixed term; and

•

it is repayable on demand.

[Schedule 5, item 3, subsection 974-75(4)]

5.7 This applies even if the arrangement was entered into before 21 February 2001. [Schedule 5, item 2, paragraph 974-75(4)(d)]

5.8 'Connected entity' is a defined term in the income tax law: broadly, it is an associate or member of the same corporate group.

5.9 The purpose of these amendments is to give taxpayers extra time to assess existing loans and adjust their arrangements, if need be, in light of the Government's decision to carve out certain small business at call loans from the debt/equity rules (the former Minister for Revenue and Assistant Treasurer's Press Release No. C045/04 of 24 May 2004).

Consequential amendments

5.10 To assist readers, this bill will amend the heading of the relevant provisions to reflect the changes to the law. [Schedule 5, item 1, paragraph 974-75(4)(d)]

Chapter 6 - Irrigation water providers

Outline of chapter

6.1 Schedule 6 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to allow irrigation water providers in Australia who are primarily and principally in the business of supplying water to primary producers access to the water facilities tax concession. It will also amend the ITAA 1997 to allow rural land irrigation water providers in Australia who are primarily and principally in the business of supplying water to primary producers or to businesses using rural land, access to the landcare tax concession.

6.2 This chapter discusses the amendments to the water facilities provisions (in Subdivision 40-F of the ITAA 1997) and to the landcare provisions (in Subdivision 40-G of the ITAA 1997).

Context of amendments

6.3 Primary producers are allowed to deduct amounts for capital expenditure on depreciating assets that are water facilities. One-third of the expenditure on water facilities is deductible in the year in which it is incurred, and one-third in each of the following two years. Examples of a water facility include dams, tanks, wells, irrigation channels, pumps and windmills. This concession is designed to encourage primary producers to undertake expenditure on water management to increase their capacity to withstand drought and to improve their on-farm water management.

6.4 Primary producers and businesses (except mining businesses) using rural land are also allowed to have an outright deduction for capital expenditure on a landcare operation. Examples of a landcare operation include fences to exclude animals from land affected by land degradation, constructing a levee on land, constructing drainage works to control salinity and expenditure associated with eradicating pests and destroying plant growth detrimental to the land. The concession is designed to encourage primary producers and users of rural land to undertake capital expenditure that assists the long-term sustainability of their use of land.

Summary of new law

6.5 This bill will allow:

•

irrigation water providers in Australia to have access to the water facilities taxation concession, if they are primarily and principally in the business of supplying water to primary producers; and

•

rural land irrigation water providers in Australia to have access to the landcare taxation concession, if they are primarily and principally in the business of supplying water to primary producers or to businesses using rural land.

6.6 The meaning of a 'water facility' and a 'landcare operation' will also be amended to improve certainty for irrigation water providers, rural land irrigation water providers and primary producers by including repairs of a capital nature and structural items reasonably incidental to conserving or conveying water (in the case of the water facilities tax concession) and reasonably incidental to certain assets under landcare operation.

6.7 The policy rationale for the amendments is to improve equity by aligning the deductions available to primary producers and businesses using rural land with deductions available to irrigation water providers and rural land irrigation water providers which supply those primary producers and businesses with water. Therefore, extending the water facilities and landcare taxation concessions to irrigation water providers and rural land irrigation water providers respectively ensures that the tax concessions apply indirectly to work done by the water providers, as well as directly, to work done by those provided with water for their businesses.

6.8 The amendments also assist irrigation water providers and rural land irrigation water providers to renew water supply infrastructure with a view to enhancing the efficiency of water delivery to primary producers and to carry out landcare work on land affected by delivery of this water.

Comparison of key features of new law and current law

Detailed explanation of new law

Water facilities

Irrigation water provider

6.9 An irrigation water provider is defined as an entity whose business is primarily and principally the supply of water to primary production businesses on land in Australia. The basic functions of an irrigation water provider include the storage of water in headworks, providing infrastructure (channels and pipes) through which irrigation water can flow, managing and monitoring the flow of this water, pumping water into reservoirs, controlling drainage of water from users of this water and providing access across irrigation and drainage channels and pipes.

6.10 However, an irrigation water provider does not include businesses that use a vehicle or vehicles to transport water, or a business that is not primarily and principally supplying water to primary producers because of the extent to which it supplies water to businesses using rural land or to towns and residences. [Schedule 6, item 2, subsection 40-515(6)]

Eligible capital expenditure

6.11 Capital expenditure incurred by an irrigation water provider must be incurred primarily and principally for the purpose of conserving or conveying water for use in primary production businesses. This is consistent with the current law as it applies to primary producers. Eligible capital expenditure incurred by an irrigation water provider is deductible over three years. One-third of the expenditure is deductible in the income year in which it is incurred and one-third in each of the following two years. This is also consistent with the current law as it applies to primary producers. [Schedule 6, item 4, subsection 40-525(1)]

6.12 The term water facility is defined in subsection 40-520(1) as plant or structural improvement, or an alteration, addition or extension to plant or a structural improvement that is primarily and principally for the purpose of conserving or conveying water. It is used to determine eligible capital expenditure for the water facilities tax concession. Typical examples of eligible capital expenditure include dams, tanks, wells, irrigation channels, pumps and windmills.

6.13 An amendment will be made to ensure that the definition of a 'water facility' includes repairs of a capital nature to a water facility, as well as alterations, additions and extensions to a water facility. Repairs are, in general, immediately deductible, but 'initial' repairs may be treated as part of the cost of a depreciating asset for taxation purposes. This proposed amendment addresses an anomaly in that there is no policy reason to exclude such expenditure from the water facilities tax concession.

6.14 Another amendment will be made to subsection 40-520(1) to clarify the term 'water facility'. This is because of uncertainty with the interpretation of the current provision in respect of whether the test of conserving or conveying water applies to capital expenditure on each individual component of a water facility or to the water facility as whole. Consequently, the term 'water facility' will be amended to include a structural improvement, or repair of a capital nature, or alteration, addition or extension to a structural improvement that is reasonably incidental to the purpose of conserving or conveying water. This amendment will apply to both water irrigation providers and primary producers. The test 'primarily and principally for the purpose of conserving or conveying water' is intended to apply to the expenditure itself rather than the purpose of the asset that may be modified to convey or conserve water.

6.15 The question of whether an item of capital expenditure is reasonably incidental to conserving and conveying water depends on the facts and circumstances. However, typical examples of expenditure meeting the reasonably incidental test could include a bridge over an irrigation channel, a culvert (a length of pipe or multiple pipes (usually concrete) that are laid under a road to allow the flow of water in a channel to pass under the road), or a fence preventing livestock entering an irrigation channel. An example of capital expenditure not falling within the reasonably incidental test is a bulldozer used to dig irrigation channels. [Schedule 6, item 3, subsection 40-520(1)]

Reduction of deduction

6.16 The current law (paragraph 40-515(4)(a)) indicates that the amount of the deduction is reduced where the water facility is not wholly used in carrying on a primary production business on land in Australia. An amendment will be made to the effect that this provision does not apply to water irrigation providers. This means that if the water facility is primarily and principally for the purpose of conserving or conveying water for use in primary production businesses, then the whole amount is deductible. However, if the water facility is primarily and principally for the purpose of conserving or conveying water for use in non-primary production businesses, then the whole amount is non-deductible. An example of this is a water facility used primarily and principally to supply town water.

6.17 The current law (paragraph 40-515(4)(b)) indicates that the amount of the deduction is reduced where the water facility is not wholly used for a taxable purpose. This provision applies to water irrigation providers, in the same way it applies to primary producers. [Schedule 6, item 2, subsection 40-515(5)]

Consequential amendments

6.18 After 1 July 2004 (the commencement date), certain capital expenditures undertaken by irrigation water providers will be a water facility for the purposes of Subdivision 40-F. Further, water irrigation providers may have depreciating assets created before 1 July 2004 and may incur capital expenditure that is a water facility for the purposes of Subdivision 40-F on these assets post-1 July 2004. In the case of assets created pre-1 July 2004, water irrigation providers can claim decline in value deductions under Subdivision 40-B. These decline in value deductions are over the effective live of the asset which is typically longer than the three years specified in the water facilities tax concession. If irrigation water providers incur any expenditure on or after 1 July 2004 on altering, adding, extending or repairing assets created pre-1 July 2004, this expenditure will be subject to Subdivision 40-F. However, this expenditure may also satisfy the words in section 40-50 "...amounts for it..." because the amounts would (under normal circumstances) be a second element cost (for the purposes of section 40-190) of any pre-July 2004 asset. Therefore, there is a possibility that decline in value deductions for any pre-1 July 2004 asset (which is altered, added, extended or repaired) could be disallowed by section 40-50.

6.19 For example, assume an irrigation water provider incurs capital expenditure to widen an irrigation channel (which is eligible for the water facilities tax concession). Further, assume that the original irrigation channel was constructed in 1999 (five years ago). This irrigation channel is not a 'water facility' because it was constructed prior to 1 July 2004 (which is the commencement date of this measure), making it ineligible for the water facilities tax concession. The irrigation water provider has been claiming decline in value deductions in relation to the original irrigation channel over the past five years based on an effective life of 70 years. In this case, the irrigation water provider can claim decline in value deductions over a three year period in the case of expenditure incurred widening the irrigation channel, but decline in value deductions over the next 65 years relating to the original irrigation channel may be denied.

6.20 A new subsection 40-53(1) will be inserted to ensure that decline in value deductions are not denied by the operation of section 40-50 when a water facility is altered, added to, extended or repaired. Using the example in paragraph 6.19, the amendment will ensure that decline in value deductions to the original depreciating asset (i.e. the irrigation channel) are not denied. A consequential change flowing from the proposed subsection 40-53(1) is to repeal subsection 40-555(2). [Schedule 6, item 1, section 40-53; item 5, subsection 40-555(1); item 6, subsection 40-555(2)]

Landcare

Rural land irrigation provider

6.21 A rural land irrigation water provider is defined as an entity whose business is primarily and principally supplying water to primary production businesses on land in Australia and businesses using rural land in Australia for a taxable purpose. Examples of businesses using rural land in Australia may include an abattoir and a wool scour. [Schedule 6, item 7, subsection 40-630(1B)]

Eligible capital expenditure

6.22 Capital expenditure incurred by a rural land irrigation water provider must be incurred on land used by another entity carrying on a primary production business, or rural land used by another entity carrying on a business for a taxable purpose. This is consistent with current law as it applies to primary producers and users of rural land. Eligible expenditure on a landcare operation qualifies for an outright deduction in the year the expenditure is incurred. This is also consistent with current law as it applies to primary producers and users of rural land. [Schedule 6, item 7, subsection 40-630(1A)]

Landcare operation

6.23 The term 'landcare operation' is defined in subsection 40-635(1). It is used to determine eligible capital expenditures for the landcare tax concession. Examples of landcare operations may include the construction of a levee or a similar improvement on the land, or the construction of drainage works for the purpose of controlling salinity or assisting in drainage control.

6.24 The definition of a 'landcare operation' will be amended to include repairs of a capital nature to a landcare operation, as well as alterations, additions and extensions to a landcare operation. This is consistent with the proposed amendment to the definition of a 'water facility'. [Schedule 6, item 10, paragraph 40-635(1)(f)]

6.25 Another amendment to the definition of a 'landcare operation' will be made to include a structural improvement, repairs of a capital nature, or alteration, addition or extension that is reasonably incidental to certain assets deductible under a landcare operation. The types of landcare operations to which this amendment will apply are constructing a levee or a similar improvement on land, and constructing drainage works on land for the purpose of controlling salinity or assisting in drainage control. The amendment will apply to rural land irrigation water providers, primary producers and users of rural land. This is consistent with the proposed amendment to the definition of a 'water facility'.

6.26 The question of whether an item of capital expenditure is reasonably incidental to the relevant landcare operation depends on the facts and circumstances. However, typical examples of expenditure meeting the reasonably incidental test could include a bridge constructed over a drain that was constructed to control salinity and a fence constructed to prevent livestock entering a drain that was constructed to control salinity. An example of capital expenditure not falling within the reasonably incidental test is a bulldozer used to dig a drain to control salinity. [Schedule 6, item 11, subsection 40-635(1)]

Tie breaker provision

6.27 In general, distinguishing whether a particular expenditure falls within the water facilities or landcare tax concession depends on the primary and principal purpose of the expenditure. However, there could be instances where it is difficult to determine the primary and principal purpose of a particular expenditure. Consequently, an amendment will be made to the effect that where an entity can deduct expenditure under both the water facilities and landcare tax concessions, the expenditure will be eligible for deduction under the water facilities tax concession only. The purpose of this amendment is to remove any uncertainty.

6.28 For example, a rural land irrigation water provider constructs a channel that both drains excess irrigation water or rainfall from primary producers' properties and supplies the drainage water back to the primary producers at a discounted fee. Assume that neither of these purposes can be said to be the primary and principal purpose. The channel is therefore being used both to conserve or convey water and to control salinity or assist in drainage control. The amendment will allow the eligible expenditure to be deducted under the water facilities tax concession rather than the landcare tax concession. [Schedule 6, item 8, subsection 40-630(2B)]

Reduction in deductions

6.29 The current law (subsection 40-630(3)) states that the amount of the landcare deduction is reduced where the landcare operation is not used for the purpose other than a primary production business or a business for the purpose of gaining assessable income from the use of rural land. An amendment will be made to ensure that this provision does not apply in the case of rural land irrigation water providers. However, a rural land irrigation water provider will be required to reduce the amount of its landcare operation where the expenditure is incurred for a non-taxable purpose. This is consistent with the current law as it applies to primary producers and businesses using rural land. [Schedule 6, item 9, subsection 40-630(4)]

Consequential amendments

6.30 Paragraph 40-635(1)(f) allows a rural land irrigation water provider to incur expenditure for making an alteration, addition or extension to an existing landcare operation. Similar to the water facilities, a new provision will be inserted to ensure that the decline in value of deductions is not denied when the original depreciating asset is repaired, altered, added to or extended. [Schedule 6, item 10, paragraph 40-630(1)(f)]

6.31 Subsection 40-630(2) indicates that amounts cannot be deducted as a landcare operation for capital expenditure on plant except certain items of plant covered by paragraphs 40-45(1)(c) and (d). The definition of plant (paragraph 45-40(c)) includes, inter alia, fences, dams and other structural improvements which are constructed on "...land that is used for agricultural and pastoral operations.". An amendment will be made to ensure that the requirement to construct these items of plant on land that is used for agricultural and pastoral operations does not apply to rural water irrigation providers. This amendment ensures that expenditure on landcare operations (e.g. drainage works to control salinity) undertaken by a rural land water provider falls within the landcare tax concession (i.e. Subdivision 40-F). [Schedule 6, item 8, subsection 40-630(2A)]

Application and transitional provisions

6.32 The amendments will apply from 1 July 2004 for expenditure incurred on, or after, that date.

Regulation impact statement

Background

6.33 Primary producers are allowed to deduct amounts for capital expenditure on depreciating assets that are water facilities. One-third of the expenditure on water facilities is deductible in the year in which it is incurred, and one-third in each of the following two years. This concession is designed to encourage primary producers to undertake expenditure on water management to increase their capacity to withstand drought and to improve their on-farm water management.

6.34 Primary producers and businesses (except mining) using rural land are also allowed to have an outright deduction for capital expenditure on a landcare operation. The concession is designed to encourage primary producers and users of rural land to undertake capital expenditure that assists the long-term sustainability of rural industries by encouraging the development and maintenance of improved land management practices.

Policy objective

6.35 The policy objectives are to:

•

improve equity by aligning the deductions available to primary producers and businesses using rural land with deductions available to irrigation water providers and rural land irrigation water providers which supply those primary producers and businesses with water; and

•

assist irrigation water providers and rural land irrigation water providers to renew water supply infrastructure with a view to enhancing the efficiency of water delivery to primary producers and to carry out landcare work on land affected by delivery of this water.

6.36 An irrigation water provider is an entity whose business is primarily and principally the supply of water to primary production businesses on land in Australia. A rural land irrigation water provider is an entity whose business is primarily and principally supplying water to primary production businesses on land in Australia and businesses using rural land in Australia for a taxable purpose.

Implementation options

Option 1

6.37 Option 1 has three key characteristics. First, this option applies to expenditure incurred on or after 1 July 2004. This date is chosen because it represents the commencement of a financial year. As is typically the case with new taxation measures, the measure applies prospectively.

6.38 Second, the tax treatment of expenditure on capital works has dual purposes - for example, supplying water to primary producers for primary production activities and to non-primary producers such as town water. In this case, expenditure on capital works either falls within or outside the water facilities and landcare taxation concessions based on whether the primary and principal purpose of such expenditure falls within the existing provisions. For example, a pipe that primarily and principally supplies water to primary producers, but provides some water for residential use would fall within the water facilities and landcare tax concessions. However, a pipe that primarily and principally supplies town water would fall outside the water facilities and landcare tax concessions.

6.39 The third characteristic of option 1 relates to the type of capital expenditures covered by the water facilities and landcare tax concessions. This option extends the type of capital expenditure to include repairs that are of a capital nature, and to include a structural improvement, or repair, alteration, addition or extension to a structural improvement that is reasonably incidental to the stated purpose of the water facilities and landcare tax concessions. This option also improves certainty and ensures that all relevant capital expenditure is included within the scope of the water facilities and landcare tax concessions.

Option 2

6.40 In contrast to the second characteristic referred to in paragraph 6.38, option 2 apportions the expenditure between that relating to primary production or rural land use, and other purposes. That part of the expenditure relating to primary production or rural land use would fall within the water facilities and landcare taxation concessions and the remaining part would fall outside the concessions. The first and third characteristics referred to in paragraphs 6.37 and 6.39 remain the same.

Assessment of impacts

Impact group identification

6.41 Any amendments to the water facilities and landcare tax concessions will directly affect irrigation water providers and rural land irrigation water providers that are subject to the ITAA 1997. This could be around 20 entities. Primary producers and businesses using rural land will also be directly and indirectly affected from the proposed amendments to the water facilities and landcare tax concessions.

Analysis of costs / benefits

Assessment of benefits

Improving the efficiency of water delivery and services

6.42 Both options 1 and 2 impact positively on water irrigators because they are being provided access to the water facilities and landcare tax concessions which allow accelerated decline in value deductions for eligible capital expenditure. This in turn will facilitate the renewal of water supply infrastructure and enhance the delivery of water to primary producers and users of rural land. The exact level of benefits is unclear, but is expected to be an on-going benefit.

Assessment of costs

Compliance costs

6.43 Irrigation water providers are currently required to claim deductions on capital expenditures over the effective life of the depreciating asset. Consequently, the amendments, in general, are likely to reduce the compliance costs incurred by irrigation water providers and rural land irrigation water providers as they are able to write-off expenditure over three years (in the case of the water facilities tax concession) and a year (in the case of the landcare tax concession), rather than over the effective life of the capital item. That is, lower compliance costs arise because the effective life of many capital items is a much longer period of time than three years under the water facilities and one year under the landcare tax concessions (perhaps 40 years or longer).

6.44 Both options identified include amending the meaning of a water facility and a landcare operation to include structural items that are reasonably incidental to conserving or conveying water. This is expected to lower compliance costs relative to the current law by providing greater certainty in the interpretation of the current water facilities and landcare provisions. However, option 2 could involve higher compliance costs relative to option 1 because it could be difficult and time consuming for taxpayers to determine the amount of apportionment. Option 2 also adds complexity to the law.

6.45 The level and extent of the compliance cost reduction from the proposed amendments are unclear, but this cost is likely to be slightly lower compared to the existing provisions.

Administrative costs

6.46 In the context of option 1, there are likely to be no additional administrative costs for the Australian Taxation Office (ATO) relative to the costs of administering the current law. If anything, there could be lower administrative costs over the long term as the proposed law is more certain relative to the old law. However, there could be some relatively small transitional costs associated with internal training, informing taxpayers of the new law and answering taxpayer questions on interpretation of the new law.

6.47 Relative to option 1, option 2 may involve slightly higher administrative costs because it may be difficult and time consuming for the ATO to determine a methodology or approach to apportion expenditure (in the case of preparing a taxation ruling).

6.48 The level and extent of administrative costs identified in paragraphs 6.46 and 6.47 are unclear, but are likely to be negligible compared to existing administrative costs for the water facilities and landcare provisions.

Government revenue

6.49 The options are expected to have a minor impact on the Government's revenue. Specifically, option 1 is estimated to cost $15 million over the period 2004-2005 to 2007-2008. Option 2 is expected to have the same or slightly lower cost revenue as option 1.

Consultation

6.50 The response arises from various consultations with irrigation water providers and rural land irrigation providers over a period commencing as early as 1995. Other interested parties have also been consulted throughout the policy formulation process, including the Department of Agriculture, Fisheries and Forestry and the ATO.

Conclusion and recommended option

6.51 Both options 1 and 2 improve equity and assist irrigation water providers and rural land irrigation water providers to renew water infrastructure. For these reasons, the proposed measure is expected to provide net benefits to irrigation water providers and rural land irrigation water providers as well as to primary producers and businesses using rural land that obtain water from these entities. Further, the proposed measure assists with the renewal of water supply infrastructure in rural Australia. However, option 1 is favoured over option 2, as option 2 provides little in terms of revenue savings while increasing complexity as well as adding to compliance and administrative costs.

6.52 The Department of the Treasury and the ATO will monitor this taxation measure, as part of the whole taxation system, on an on-going basis.

Chapter 7 - Fringe benefits tax - broadening the exemption for the purchase of a new dwelling as a result of relocation

Outline of chapter

7.1 Schedule 7 to this bill amends the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) to broaden the fringe benefits tax (FBT) exemption to cover relocating employees who purchase a new dwelling and have their employer pay the incidental purchase costs associated with the new dwelling, before the employee has sold their old dwelling.

Context of amendments

7.2 Section 58C of the FBTAA 1986 allows an FBT exemption for costs incidental to the sale or acquisition of a dwelling as a result of relocation for employment purposes, as long as the employee sells their dwelling at the previous locality within two years, and purchases a dwelling at the new locality within four years, of the commencement date of the new employment position.

7.3 The exemption applies if, within the relevant time limits, an employee:

•

sells their old dwelling before purchasing the new dwelling; or

•

purchases a new dwelling before selling their old dwelling and the employer pays the incidental purchase costs after the old dwelling has already been sold.

7.4 The exemption does not apply if, within the relevant time limits, the employee purchases a new dwelling and the employer pays the incidental purchase costs before the employee sells the old dwelling.

Summary of new law

7.5 The amendment ensures that, when an employee purchases a dwelling in a new locality without having already sold their dwelling at the old locality, the employer is able to access the FBT exemption for costs incidental to the purchase of the new dwelling, provided the employee then sells their dwelling at the old locality within two years of commencing their new employment position.

7.6 The diagram below illustrates three situations (the steps show the chronological order of the sale and purchase of dwellings for each situation). Benefits of the kind provided in Situation One and Situation Two were already exempt under the previous provisions. A benefit of the kind provided in Situation Three is also FBT exempt as a result of this amendment.

7.7 If the employee fails to sell their old dwelling within two years of commencing the new employment position, the FBT liability will be taken to arise once the two-year period has elapsed. Thus the benefit, which was exempt at the time it was provided by the employer, will be treated as being FBT liable if the old dwelling is not sold within the two-year time limit.

Comparison of key features of new law and current law

Detailed explanation of new law

7.8 The amendments make two changes to the pre-conditions for accessing the FBT exemption for costs incidental to the sale or acquisition of a dwelling as a result of relocation for employment purposes.

7.9 Firstly, the employee must either sell their old dwelling or propose to sell their old dwelling. [Schedule 7, item 1, paragraph 58C(1)(b)]

7.10 Secondly, the employee is no longer required to sell the old dwelling before the employer can access the FBT exemption for costs incidental to the sale or acquisition of a dwelling as a result of relocation for employment purposes.

Fringe benefits tax exemption on sale of old dwelling

7.11 The day on which the employee commences to perform the duties of the new employment position is the new employment day. [Schedule 7, item 3, paragraph 58C(2)(a)]

7.12 For the costs associated with the sale of an old dwelling by a relocating employee to be FBT exempt, the employee must sell their old dwelling within two years of the new employment day.

Fringe benefits tax exemption on purchase of new dwelling

7.13 For the costs associated with the purchase of a new dwelling by a relocating employee to be FBT exempt, the employee must:

•

sell their old dwelling within two years of the new employment day; and

•

enter into a contract for the purchase of a dwelling in the new locality within four years of the new employment day.

[Schedule 7, item 4, paragraph 58C(3)(ca)]

7.14 The date the relocating employee enters into a contract for the purchase of the new dwelling is the contract day. [Schedule 7, item 4, paragraph 58C(3)(c)]

7.15 The effect of the amendment is that at the time the employer pays the costs incidental to the purchase of the dwelling in the new locality, it is not necessary for the old dwelling to have already been sold in order for the employer to access the FBT exemption.

Example 7.1

Frances was required to relocate from Geelong to Ballarat in order to perform her duties as a police officer. She commenced her duties in Ballarat on 1 January 2005.

Frances purchases a new house in Ballarat on 12 February 2005. Her employer pays the conveyancing costs associated with the purchase of the new house on 16 February 2005.

Frances then sells her old house in Geelong on 15 October 2006.

The conveyancing costs paid by Frances's employer are FBT exempt. This is because Frances enters into a contract for the sale of her house in Geelong within two years of commencing employment in Ballarat. This is despite the fact that at the time the employer pays Frances's conveyancing costs, Frances has not yet sold her house in Geelong. This benefit would not have been exempt under the previous provisions.

No sale of old dwelling

7.16 In the situation where an employee has not sold their dwelling at the old locality at the time the employer paid the costs incidental to the purchase of the new dwelling, and the employee fails to sell their old dwelling within two years of the new employment day, the benefit provided will become FBT liable in the year of tax in which the period of two years since the new employment day expires. [Schedule 7, item 5, subsection 58C(5)]

Example 7.2

Assume the same situation as in Example 7.1, except that Frances fails to sell her home in Geelong by 1 January 2007.

The conveyancing costs paid by Frances's employer are exempt at the time they are provided. However, as Frances did not sell her dwelling within two years of the new employment day, the benefit provided on 16 February 2005 will now become FBT liable in the 2006-2007 FBT year.

Application and transitional provisions

7.17 These amendments apply to benefits provided in respect of the FBT year of tax beginning on 1 April 2004 and to later FBT years.

Chapter 8 - CGT event G3

Outline of chapter

8.1 Schedule 8 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to extend the scope of CGT event G3 so that an administrator (in addition to a liquidator) of a company can declare shares and financial instruments in the company to be worthless for capital gains tax (CGT) purposes. The declaration permits taxpayers who hold those shares or financial instruments to choose to make a capital loss.

Context of amendments

8.2 Currently, section 104-145 of the ITAA 1997 specifies that CGT event G3 happens if a taxpayer owns a share in a company and its liquidator declares in writing that he or she has reasonable grounds to believe (at the time of the declaration) there is no likelihood that the shareholders in the company, or shareholders of the relevant class of shares, will receive any further distribution in the course of winding up the company. The declaration causes CGT event G3 to happen and permits shareholders to choose to make a capital loss in respect of their shares.

8.3 Financial instruments that are issued by a company, or that are created by or in relation to a company, that has appointed a liquidator may also be worthless. However, the liquidator cannot make a declaration in respect of financial instruments.

8.4 In addition, commercial factors may cause a company to appoint an administrator (rather than a liquidator) to conduct external administration proceedings. An administrator is unable to make a declaration that causes CGT event G3 to happen even though he or she may be in a similar position to a liquidator to make a judgement that shares or financial instruments in the company are worthless.

8.5 Therefore, the amendments will allow administrators to make a declaration that causes CGT event G3 to happen and allow the declaration to cover both shares and financial instruments. This will reduce compliance costs for affected taxpayers and allow them to more easily claim a capital loss in respect of their shares or financial instruments.

Summary of new law

8.6 These amendments will extend the scope of CGT event G3 so that administrators (in addition to liquidators) can make a declaration that shares or financial instruments are worthless for CGT purposes.

Comparison of key features of new law and current law

Detailed explanation of new law

When does CGT event G3 happen?

8.7 CGT event G3 can apply to taxpayers who own:

•

shares in a company; or

•

financial instruments that are issued by a company or that are created by or in relation to a company.

8.8 CGT event G3 will happen if a liquidator or administrator appointed by the company makes a declaration in writing that he or she has reasonable grounds to believe (as at the time of the declaration) that:

•

for shares - there is no likelihood that shareholders in the company, or shareholders of a relevant class of shares, will receive any further distribution for their shares; or

•

for financial instruments - the instruments, or a class of instruments that includes instruments of that kind, have no value or have only negligible value.

[Schedule 8, item 2, subsection 104-145(1)]

8.9 To ensure that a liquidator or administrator does not have to make a separate declaration for each type of share or financial instrument, the liquidator or administrator's declaration can refer to more than one type of share or financial instrument.

8.10 A liquidator is appointed under Chapter 5 of the Corporations Act 2001 to wind up a company.

8.11 An administrator is appointed under Part 5.3A of the Corporations Act 2001 to conduct external administration proceedings. An administrator of a company would require a comprehensive grasp of all of the company's affairs in order to have reasonable grounds to make a declaration for the purposes of CGT event G3. Generally only an administrator appointed in relation to a deed of company arrangement will be in a position to reasonably make this assessment.

What are financial instruments?

8.12 Examples of financial instruments are:

•

debentures, bonds or promissory notes issued by the company;

•

loans to the company; and

•

futures contracts, forward contracts or currency swap contracts relating to the company.

[Schedule 8, item 2, paragraphs 104-145(3)(a) to (c)]

8.13 Rights or options to acquire financial instruments of the type referred to in paragraph 8.11 and rights or options to acquire shares in the company are also financial instruments. [Schedule 8, item 2, paragraphs 104-145(3)(d) and (e)]

What is the effect of a liquidator's or administrator's declaration?

Taxpayers can choose to make a capital loss

8.14 The liquidator's or administrator's declaration causes CGT event G3 to happen at the time the declaration is made and permits affected taxpayers to choose to make a capital loss in respect of any shares or financial instruments covered by the declaration. The amount of the capital loss is equal to the reduced cost base of the shares or financial instruments at the time the declaration is made. [Schedule 8, item 2, subsections 104-145(2) and (4)]

8.15 If a taxpayer chooses to make a capital loss in respect of any shares or financial instruments covered by the declaration, the cost base and reduced cost base of those shares or financial instruments are reduced to nil just after the declaration is made. Consequently, if a subsequent CGT event happens to the shares or financial instruments, the whole of the capital proceeds received will generally be a capital gain. [Schedule 8, item 2, subsection 104-145(5)]

Capital loss not available for pre-CGT assets

8.16 CGT is not generally imposed on assets acquired before 20 September 1985. Therefore, taxpayers cannot choose to make a capital loss if the shares or financial instruments were acquired before 20 September 1985. [Schedule 8, item 2, paragraph 104-145(6)(a)]

Capital loss not available for assets held on revenue account

8.17 Taxpayers cannot choose to make a capital loss if the share or financial instrument is a revenue asset at the time when the declaration is made. [Schedule 8, item 2, paragraph 104-145(6)(b)]

8.18 Section 977-50 defines a CGT asset to be a revenue asset if, broadly:

•

the profit or loss on disposal or other realisation of the asset would be taken into account in calculating the taxpayer's assessable income or tax loss, otherwise than as a capital gain or capital loss; and

•

the asset is neither trading stock nor a depreciating asset.

Capital loss not available for certain shares and financial instruments acquired under an employee share scheme

8.19 Division 13A of Income Tax Assessment 1936 (ITAA 1936), rather than the CGT provisions, applies to specify the taxation consequences of qualifying shares and rights acquired under an employee share scheme.

8.20 Consequently, a taxpayer cannot choose to make a capital loss in respect of a share if:

•

the share is a qualifying share under an employee share scheme;

•

the taxpayer has not made an election under section 139E of the ITAA 1936 for the income year in which the share is acquired; and

•

the declaration by the liquidator or administrator is made no later than 30 days after the cessation time of the share.

[Schedule 8, item 2, subsection 104-145(7)]

8.21 Similarly, a taxpayer cannot choose to make a capital loss in respect of a financial instrument if the financial instrument is:

•

a right acquired under an employee share scheme; or

•

a right that, apart from section 139DD of the ITAA 1936, would have been acquired under an employee share scheme.

[Schedule 8, item 2, subsection 104-145(8)]

Application and transitional provisions

8.22 The amendments apply to declarations made by liquidators or administrators after the date of Royal Assent of this bill. [Schedule 8, item 8]

Consequential amendments

8.23 The table in section 104-5 contains a summary of CGT events. The table will be amended to reflect the modifications to CGT event G3. [Schedule 8, item 1, section 104-5]

8.24 The table in section 112-45 sets out which element of the cost base or reduced cost base of a CGT asset is affected by various situations. The table will be amended to reflect the modifications to CGT event G3. [Schedule 8, item 3, section 112-45]

8.25 Generally, non-residents are subject to CGT if a CGT event happens to a CGT asset that has the necessary connection to Australia. The table in section 136-10 outlines the circumstances in which a CGT asset has the necessary connection to Australia. The table will be amended to reflect the modifications to CGT event G3. [Schedule 8, item 4, section 136-10]

8.26 Subdivision 165-CD requires adjustments to be made to the tax attributes of significant equity and debt interests that entities have in a company that has realised losses or unrealised losses if an alteration time occurs in respect of the loss company. The purpose of the adjustments is to prevent multiple recognition of the losses when the interests are realised. An alteration time happens if, among other things, CGT event G3 occurs. Therefore, amendments will be made to the relevant provisions in Subdivision 165-CD to reflect the modifications to CGT event G3. [Schedule 8, items 5 to 7, paragraph 165-115GB(1)(b), subsection 165-115H(2) and section 165-115N]

Regulation impact statement

Background

8.27 Currently, a liquidator of a company can declare shares in the company to be worthless for CGT purposes. The declaration causes CGT event G3 to happen and permits shareholders to choose to make a capital loss in respect of their shares.

•

Subsection 104-145(1) of the ITAA 1997 specifies that CGT event G3 happens if a taxpayer owns a share in a company and its liquidator declares in writing that he or she has reasonable grounds to believe (at the time of the declaration) there is no likelihood that the shareholders in the company, or shareholders of the relevant class of shares, will receive any further distribution in the course of winding up the company.

8.28 Where a company appoints an external administrator, other than a liquidator, shareholders can only cause a CGT event (CGT event E1) to happen by creating a trust over the shares.

Policy objective

8.29 The objective is to allow taxpayers to more easily claim a capital loss on their worthless shares or financial instruments.

Implementation options

8.30 Given the framework for CGT event G3 and the nature of the representations from taxpayers, only one broad implementation approach was considered. That is, to amend section 104-145 to allow a wider range of insolvency practitioners to be able to make the relevant declaration in relation to shares or financial instruments.

8.31 However, insolvency practitioners other than administrators and liquidators are often appointed for a short period of time or for a specific purpose and are not usually in a position to make a declaration. As a result, it was considered that it would not be viable for practitioners other than administrators and liquidators to make the declaration, so only the option of allowing administrators and liquidators to be able to make the relevant declaration has been considered further.

8.32 These amendments will apply to declarations made by liquidators or administrators after the date of Royal Assent of this bill.

Assessment of impacts

Impact group identification

8.33 These amendments are expected to impact on taxpayers that are shareholders and holders of financial instruments in companies under external administration. The class of taxpayers potentially affected include individuals, superannuation funds, trusts and companies.

8.34 According to statistics provided by the Australian Securities and Investments Commission, in the 2000-2001 to 2002-2003 income years:

•

an average of approximately 2,575 companies per annum appointed a voluntary administrator; and

•

an average of approximately 717 companies per annum entered into a deed of company arrangement.

8.35 The average voluntary administration lasts for 28 days (as required by the Corporations Act 2001) before the company either moves into liquidation, enters a deed of company arrangement or resumes trading. A deed of company arrangement can last for many years.

Analysis of costs

8.36 There will be an unquantifiable cost to revenue which is not expected to be significant.

8.37 As a result of these amendments, liquidators and administrators will incur additional costs in determining whether there are reasonable grounds to declare shares or financial instruments to be worthless and in making the appropriate declarations. The level and extent of these costs is uncertain. However, as some administrators made representations seeking the change, the additional costs involved are not expected to be significant.

8.38 The Australian Taxation Office (ATO) may incur some additional administration costs to implement the amendments. For example, the ATO will need to ensure that call centre staff and provision of advice staff are aware of the changes. In addition, the ATO website, CGT publications, an ATO fact sheet and a tax determination may need to be updated. These costs are not expected to be significant.

Analysis of benefits

8.39 The implementation option will allow a liquidator or administrator to be able to declare shares or financial instruments in a company worthless for CGT purposes. The declaration will enable taxpayers who hold relevant shares and financial instruments to claim a capital loss without having to incur the cost of establishing a trust. This will reduce compliance costs for affected taxpayers. In this regard, commercial organisations who assist taxpayers to establish a trust over worthless shares typically charge an administration fee of between $70 and $150 per transaction.

Consultation

8.40 Representations were made to the Government seeking a modification to the current law to allow administrators to make a declaration that shares and financial instruments are worthless for CGT purposes. The representations were made by individuals who hold shares in companies that have had an administrator appointed, Members of Parliament on behalf of those individuals, media representatives, accountants and administrators.

8.41 Draft legislation to implement the measure was released on a confidential basis to CPA Australia, the Institute of Chartered Accountants in Australia, the National Tax and Accountants' Association, Deloitte Touche Tohmatsu and Ferrier Hodgson.

8.42 Stakeholders generally supported the proposed measure. Some stakeholders suggested that a wider range of insolvency practitioners should be able to make a declaration, but this was not considered to be practical for the reasons indicated earlier.

Conclusion and recommended option

8.43 This measure will reduce net compliance costs for affected taxpayers at little cost to the revenue and therefore is supported.

8.44 The Department of the Treasury and the ATO will monitor this taxation measure, as part of the whole taxation system, on an ongoing basis.

Chapter 9 - GST - supplies to offshore owners of Australian real property

Outline of chapter

9.1 Schedule 9 to this bill amends section 38-190 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) to remove an anomaly that allows supplies of certain services made to owners of residential property to be GST-free if the owner is not in Australia at the time of the supply. This will result in the same goods and services tax (GST) treatment applying to both non-resident and resident entities whether or not they are in Australia at the time of the supply.

Context of amendments

9.2 Broadly, the policy intent of the GST legislation is to tax the supply of goods and services and other things that are consumed in Australia. However, an anomaly has been identified in the GST Act that allows certain supplies relating to real property situated in Australia and made to entities outside Australia to be GST-free. Consequently, these entities receive more favourable tax treatment than entities in Australia.

9.3 The rental or sale of residential properties and certain commercial accommodation in Australia that is owned by residents is input taxed. This means no GST is payable on the supply of the residential premises and the owners are not entitled to input tax credits for acquisitions relating to the supply, such as advertising, trade and property maintenance services. In contrast, non-resident owners and certain resident owners, who are not in Australia when the thing is supplied, can acquire some or all of these services GST-free. This is because of the operation of item 2, 3 or 4 in the table in subsection 38-190(1) of the GST Act:

•

Item 2(a) in the table allows non-residents who are not in Australia to obtain GST-free, a supply that is indirectly connected with real property situated in Australia. Item 2(b) in the table allows unregistered non-resident entities who are not in Australia to obtain GST-free, supplies relating to Australian residential premises as long as they are acquired as part of the enterprise they carry on.

•

Item 3 in the table allows entities who are not in Australia to obtain GST-free, supplies made in relation to Australian real properties (except if they are directly connected with real property situated in Australia).

•

Item 4 in the table allows a supply of rights for use outside Australia or a supply of rights to non-residents who are not in Australia when the thing supplied is done to be GST-free.

Summary of new law

9.4 This bill ensures that a supply which relates (whether directly or indirectly) to making a supply of real property situated in Australia, the supply of which would be input taxed under Subdivision 40-B (residential rent) or 40-C (sales of residential premises), is not GST-free under section 38-190. Therefore the same GST treatment will apply to supplies acquired by both non-resident and resident owners in relation to their Australian residential properties.

Comparison of key features of new law and current law

Detailed explanation of new law

9.5 This bill amends section 38-190 to ensure that supplies covered by items 2 to 4 in the table in subsection 38-190(1) that relate (whether directly or indirectly) to making a supply of real property in Australia, are not GST-free if the supply of the real property would be input taxed under Subdivisions 40-B and 40-C of the GST Act. [Schedule 9, item 1, subsection 38-190(2A)]

9.6 Supplies that would be directly related to the making of supplies of real property include a supply of architectural services for a particular property, real estate property management services, building insurance and legal services in preparing an instrument of mortgage over real property. Supplies that would be indirectly related to the making of supplies of real property in Australia include a supply of public liability insurance and advertising services.

Example 9.1

Jane is a non-resident of Australia who lives in Singapore. She owns a rental property in Brisbane. She hires a local gardener to maintain the garden. She also hires a local real estate agent to advertise the property for rent. The supply of the gardening service is directly related to the property while the advertising is indirectly related to the property. New subsection 38-190(2A) operates to ensure that these services are not GST-free.

Example 9.2

Delia, a non-resident landlord of Australia, owns a rental property on the Gold Coast. She acquires tax advice in the preparation of a tax return from a local tax agent which includes advice on the rental property. The acquisition of the advice is indirectly related to an input taxed supply of the rental property. The supply of this advice is not GST-free under section 38-190 because of the operation of subsection 38-190(2A).

9.7 If the acquisition is related, in whole or in part, to a supply of real property and the supply of the real property would be input taxed to any extent then the acquisition is not a GST-free supply under item 2, 3 or 4 in the table of subsection 38-190(1) because of the operation of subsection 38-190(2A). There is no apportionment available to make the acquisition GST-free to the extent the supply does not relate to real property that would be input taxed. If the supply of the real property would be input taxed to any extent then the entire acquisition is not GST-free.

Example 9.3

David is a non-resident of Australia living in Canada. He is a landlord of a complex consisting of a residential premise above a shop in Melbourne. David is not required to be registered for GST because his annual turnover is under $50,000. He hires a painter to repaint the exterior of the complex before he sells the complex. The entire supply of the painting service is taxable. If David chose to register he could claim input tax credits for the part of the painting service that relates to the shop. However, David would not be entitled to input tax credits for the part of the acquisition that relates to the input taxed supply of the residential premise.

9.8 Subsection 38-190(3) is amended to insert a reference to new subsection 38-190(2A) to ensure that if a supply covered by subsection 38-190(2A) is provided to another entity in Australia, both subsections 38-190(2A) and 38-190(3) will ensure that the supply is not GST-free. [Schedule 9, item 2, subsection 38-190(3)]

Date of application

9.9 The amendments will apply to supplies made on or after the first day of the first quarterly tax period following the day on which this bill receives Royal Assent. Quarterly tax period means a period of three months that commences on 1 January, 1 April, 1 July or 1 October. [Schedule 9, item 3]

Example 9.4

If this bill receives Royal Assent on 2 December 2004, the amendments would apply to supplies made on or after 1 January 2005. However, if this bill receives Royal Assent on 10 February 2005, the amendments would apply to supplies made on or after 1 April 2005.

Chapter 10 - Baby Bonus (first child tax offset) and adoption

Outline of chapter

10.1 Schedule 10 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to:

•

allow adoptive parents, once legally responsible for an eligible child, retrospectively to lodge a claim for the first child tax offset for the period between the date they commenced care of the child and the date they were granted legal responsibility for the child (but not for any period before 1 July 2001); and

•

allow adoptive parents to choose for their 'base year', either the income year in which they commenced care of the child or the income year before they commenced care of the child (but not being an income year earlier than 2000-2001).

Context of amendments

10.2 Section 61-355 of the ITAA 1997 outlines the eligibility criteria for the first child tax offset, including that the taxpayer must be legally responsible for the child. Adoptive parents are considered to be legally responsible for the child when an adoption order is issued. However, this will generally not be issued for at least six to twelve months after the child entered into the care of the adoptive parents, and the period of care prior to legal responsibility can be longer for special needs children or some international adoptions. Adoptive parents are currently not entitled to claim the first child tax offset for the period between commencing care of the child and being granted legal responsibility.

10.3 Section 61-430 of the ITAA 1997 stipulates that the 'base year' is the income year in which the taxpayer gained legal responsibility for the child, or the income year immediately prior to the income year in which the taxpayer gained legal responsibility for the child. The first child tax offset entitlement is calculated based on the size of the reduction in income of a parent from the 'base year' to the 'claim year'. Adoptive parents are currently excluded from claiming the offset in respect of the period between commencing care of the child and being granted legal responsibility - years in which their claim may be the largest.

Summary of new law

10.4 The amendments will ensure that adoptive parents, once they are legally responsible for an eligible child, will now be entitled to the first child tax offset from 1 July 2001 or the date the child entered into their care, or the date they become an Australian resident, whichever is the later date. The date that the taxpayer commenced caring for the child will be the date evidenced as being so by Court documentation or as documented by the relevant State department.

10.5 The amendments will allow adoptive parents to choose as their 'base year', either the income year in which they commenced care of the child or the income year before they commenced care of the child, but not an income year before 2000-2001.

10.6 Adoptive parents who will be disadvantaged by the amendments maintain an entitlement under the law as it was at 30 June 2004. However, adoptive parents claiming a greater entitlement under the old law cannot nominate the year of care or year prior to care as their base years and thus would not be entitled to the tax offset for the period between obtaining care of the child and gaining legal responsibility for the child.

Comparison of key features of new law and current law

Detailed explanation of new law

10.7 An adoptive parent may claim the first child tax offset if a child is in their care before they legally adopt the child, under the following conditions:

•

at the time the child is first in the care of the adoptive parents:

-

the adopted child is less than five years of age;

-

the child is in their care (but they are not legally responsible for the child); and

-

the parent is an Australian resident;

•

the adoptive parent meets the general conditions for eligibility for the first child tax offset in subsection 61-355(3) of the ITAA 1997;

•

the parent becomes legally responsible for the child by adopting the child; and

•

the time adoptive parents became legally responsible for the child is on or after 1 July 2001 but before 1 July 2004.

[Schedule 10, item 20, section 61-440]

10.8 A child is first in the care of the adoptive parents on the date evidenced in writing by a court or relevant department of the relevant State or Territory. [Schedule 10, item 20, section 61-445]

Transferring entitlements

10.9 An adoptive parent can transfer their entitlement to another person. However, where the adoptive parent has an entitlement to the first child tax offset under new section 61-440 (for the period between care and legal responsibility) and also an entitlement under existing section 61-355 (after gaining legal responsibility), both entitlements or neither entitlement can be transferred to another person for a particular income year. [Schedule 10, item 13, paragraph 61-385(1A)]

Base year election

10.10 The amount of first child tax offset to which a parent is entitled is based on the reduction in income from the base year to each subsequent claim year. The default 'base year' for adoptive parents will be the income year prior to the income year when the child was first in their care and they were an Australian resident, or 2000-2001, whichever is later. [Schedule 10, item 20, subsection 61-450(2)]

10.11 Adoptive parents can elect as their 'base year' the year in which the child is first in their care provided they were Australian residents and that this is not before 2000-2001. However, they cannot change this 'base year' election once it is made [Schedule 10, item 20, subsection 61-450(3)]. Moreover, either the choice must be made before a claim under section 61-440 is made or before an entitlement under section 61-440 is transferred under section 61-385 [Schedule 10, item 20, subsection 61-450(4)]. The 'base year' for a transferred entitlement is the income year before the first income year for which the entitlement was transferred [Schedule 10, item 20, subsection 61-450(5)].

Example 10.1

Mary resigned from her $30,000 per year job in October 2001 in preparation for travelling overseas to adopt a child from a country where many young children had been orphaned by war. This country is not a signatory to the Hague Convention on intercountry adoption. On returning to Australia with her child in November 2001, Mary was required to obtain a formal adoption order from an Australian Court which was ultimately not granted until November 2002.

Under the old law, Mary can only claim the first child tax offset from November 2002. Under the new law, Mary will be able to claim the offset from November 2001 until the date when the child turns five years of age. Mary's offset will be based on her reduction in income from $30,000 to nil.

Example 10.2

Martha and Paul applied to adopt a child and were awarded care of a newborn child with special needs at the end of June 2002. The child was assessed by social workers in the new home environment for 12 months before a formal adoption order was made, to ensure that Martha and Paul were able to meet the special needs of the child. As a result, the formal adoption order was not made by the courts until July 2003. Paul gave up his fulltime employment (which earned him $100,000 a year) when they were first given care of the child in June 2002 and is not intending to go back to work until the child goes to school.

Under the amended provisions for adoptive parents, Martha can transfer her first child tax offset to Paul who can then claim the maximum amount of $2,500 for each full year the child is in his care until the child turns five years of age (plus a pro-rata entitlement for part years of care) based on a 'base year' income of $100,000. Under the old law, Paul's 'base year' income of zero at the time they gained legal responsibility for the child will only entitle him to the minimum first child tax offset of $500 per full year of care from the date of gaining legal responsibility in July 2003 until the child is five years old.

Adoptive parents who would be better off under the old law

10.12 Adoptive parents whose greatest fall in income occurs after they have gained legal responsibility for the child could be disadvantaged if they are required to nominate a 'base year' before the year of legal responsibility for the child.

10.13 The amended provisions ensure that no adoptive parent will lose their existing entitlement or have a reduced entitlement to the first child tax offset because of the amendments. [Schedule 10, item 20, section 61-455]

10.14 Adoptive parents who would be entitled to a lesser amount of tax offset under the amended law than they would have been entitled to under the old law retain their entitlement to the first child tax offset under the law as it was in force on 30 June 2004.

10.15 However, adoptive parents claiming the tax offset under the old law would not have an entitlement to the tax offset for the period in which they had care of the child prior to obtaining legal responsibility for the child.

10.16 To ensure that they do not receive a lesser amount of first child tax offset under the new law, adoptive parents may compare the amount they would receive under the new law - potentially five years worth of claims, and the amount they could continue to claim under the old law - which may be a greater annual amount for a shorter period since the old law does not allow retrospective claims from the date of care to the date of legal responsibility. Adoptive parents are not required to make an election to claim under the old law - this is an option that remains open to them while they remain eligible to claim the offset until their child turns five years of age. The Australian Taxation Office will be able to advise adoptive parents on making claims under the old and new laws.

Application and transitional provisions

10.17 The amendments apply from 1 July 2001.

10.18 The amendments are retrospective to ensure that adoptive parents receive the benefit of the amendments from the time the first child tax offset came into effect.

10.19 Taxpayers will not be adversely affected by the retrospective commencement of the amendments because of section 61-455 which allows claimants access to the old law if their entitlement would be for a lesser amount under these amendments.

Chapter 11 - Technical correction to the Taxation Laws Amendment Act (No. 8) 2003

Outline of chapter

11.1 Schedule 11 to this bill corrects a technical defect in the commencement provision applying to the franking deficit tax (FDT) offset provisions for life insurance companies in Schedule 7 to the Taxation Laws Amendment Act (No. 8) 2003.

Context of amendments

11.2 Schedule 7 to the Taxation Laws Amendment Act (No. 8) 2003 amended Part 3-6 of the Income Tax Assessment Act 1997 to insert rules in the simplified imputation system for offsetting of FDT against company tax. Rules were inserted for both ordinary companies and life insurance companies.

11.3 The FDT offset rules that applied to life insurance companies, as currently drafted, commence immediately after the commencement of Schedule 7 to the Taxation Laws Amendment Act (No. 7) 2003 (this Schedule was to introduce imputation rules for life insurance companies). However, the life company imputation rules, which were introduced into Parliament as part of the Taxation Laws Amendment Bill (No. 7) 2003, were later enacted as part of the Taxation Laws Amendment Act (No. 1) 2004.

11.4 Therefore, the citation to the Taxation Laws Amendment Act (No. 7) 2003 in a commencement provision for the Taxation Laws Amendment Act (No. 8) 2003 is incorrect. It should instead refer to Taxation Laws Amendment Act (No. 1) 2004.

Detailed explanation of new law

11.5 Item 1 replaces the citation in item 5 in the table of subsection 2(1) in the Taxation Laws Amendment Act (No. 8) 2003 to the Taxation Laws Amendment Act (No. 7) 2003 with the correct reference to the Taxation Laws Amendment Act (No. 1) 2004. This will ensure that the FDT offset provisions for life insurance companies in the Taxation Laws Amendment Act (No. 8) 2003 commence appropriately following the enactment of the imputation rules for life insurance companies in the Taxation Laws Amendment Act (No. 1) 2004. [Schedule 11, item 1, item 5 in the table in subsection 2(1)]

Application and transitional provisions

11.6 This amendment made by Schedule 11 will commence immediately after the Taxation Laws Amendment Act (No. 8) 2003 received Royal Assent (21 October 2003).

Chapter 12 - Transfer of life insurance business

Outline of chapter

12.1 Schedule 12 to this bill amends the income tax law to alleviate unintended tax consequences that arise when a life insurance company transfers some or all of its life insurance business to another life insurance company under Part 9 of the Life Insurance Act 1995 or under the Financial Sector (Transfers of Business) Act 1999.

Context of amendments

12.2 Division 320 of the Income Tax Assessment Act 1997 (ITAA 1997) contains special rules for taxing life insurance companies. These amendments overcome concerns raised by the life insurance industry about the taxation consequences that arise when life insurance business is transferred under Part 9 of the Life Insurance Act 1995 or under the Financial Sector (Transfers of Business) Act 1999.

Summary of new law

12.3 When a life insurance company (the originating company) transfers some or all of its life insurance business to another life insurance company (the recipient company) under Part 9 of the Life Insurance Act 1995 or under the Financial Sector (Transfers of Business) Act 1999, these amendments ensure that:

•

consideration paid in relation to certain life insurance policies transferred is a life insurance premium for the purposes of Division 320;

•

the originating company and the recipient company are taxed appropriately when risk policies are transferred;

•

segregated assets of the originating company become segregated assets of the recipient company;

•

immediate annuity policies purchased before 10 December 1987 and certain policies issued by friendly societies before 1 January 2003 retain their character for taxation purposes; and

•

assets notionally segregated by the originating company continue to be treated as separate assets.

12.4 In addition, if the originating company and the recipient company are members of the same wholly-owned group, these amendments:

•

ensure that transitional provisions that apply to continuous disability policies and to life insurance policies issued by the originating company before 1 July 2000 continue to apply; and

•

allow a capital gains tax (CGT) roll-over for capital gains and capital losses that arise when life insurance business is transferred.

Comparison of key features of new law and current law

Detailed explanation of new law

12.5 These amendments:

•

insert Subdivision 320-I into Division 320 to ensure that life insurance companies are taxed appropriately when life insurance business is transferred from one life insurance company to another life insurance company; and

•

allow a CGT roll-over for capital gains and capital losses that arise when life insurance business is transferred if the recipient company and the originating company are members of the same wholly-owned group and the transfer occurs before the end of the consolidation period.

12.6 Subdivision 320-I and the new CGT roll-over will apply if all or part of the life insurance business of a life insurance company is transferred to another life insurance company:

•

in accordance with a scheme confirmed by the Federal Court of Australia under Part 9 of the Life Insurance Act 1995; or

•

under the Financial Sector (Transfers of Business) Act 1999.

[Schedule 12, item 5, section 320-305]

Transferring life insurance policy liabilities

Ordinary investment policy liabilities

12.7 An ordinary investment policy is defined in subsection 995-1(1) to be a life insurance policy that is not a virtual pooled superannuation trust policy, an exempt life insurance policy, a policy that provides for participating or discretionary benefits or a risk policy.

12.8 The amount or value of any consideration the recipient company receives from the originating company in respect of ordinary investment policy liabilities transferred will be a life insurance premium for the purposes of Division 320. This will ensure that the recipient company is appropriately taxed on fees and risk premiums that it deducts from ordinary investment policy liabilities transferred from the originating company. [Schedule 12, item 5, section 320-320]

Participating policy liabilities

12.9 Participating policies are policies that provide participating or discretionary benefits. The key feature of participating policies is that policyholders are entitled to share in the profit the company makes on this part of their business.

12.10 The amount or value of any consideration the recipient company receives from the originating company that relates to participating policy liabilities transferred (other than participating policy liabilities that were discharged from the originating company's virtual pooled superannuation trust or segregated exempt assets just before the transfer occurred) will be a life insurance premium for the purposes of Division 320. This will ensure that the recipient company is taxed appropriately when these policy liabilities are transferred from the originating company. [Schedule 12, item 5, subsection 320-320(1)]

12.11 However, the amount or value of any consideration the recipient company receives for the risk component of participating policies that relates to contracts of reinsurance (other than any consideration in respect of a risk in relation to which subsection 148(1) of the Income Tax Assessment Act 1936 (ITAA 1936) applies) will not be a life insurance premium for the purposes of Division 320. [Schedule 12, item 5, paragraph 320-320(2)(b)]

Risk policy liabilities

12.12 Risk policies are policies (other than participating policies, exempt life insurance policies or funeral policies) under which benefits are payable only on the death or disability of a person.

12.13 These amendments ensure that both the originating company and the recipient company are taxed appropriately when risk policy liabilities are transferred.

12.14 If the originating company pays an amount to the recipient company for the risk policy liabilities transferred, then:

•

the originating company can deduct the amount it pays to the recipient company in respect of the liabilities under the net risk components of life insurance policies transferred to the recipient company; and

•

the amount or value of any consideration the recipient company receives from the originating company that relates to the net risk policy liabilities transferred is a life insurance premium for the purposes of Division 320. Consequently, the recipient company will include this amount in its assessable income under paragraph 320-15(1)(a).

[Schedule 12, item 5, subsection 320-310(1) and section 320-320]

12.15 The net risk component of a life insurance policy is defined in subsection 995-1(1) to be so much of the policy's risk component as is not reinsured under a contract of reinsurance (other than a contract of reinsurance to which subsection 148(1) of the ITAA 1936 applies).

12.16 Consequently, the amount paid or received in respect of the liabilities under the net risk components of life insurance policies transferred, includes the amount or value of any consideration in respect of a risk in relation to which subsection 148(1) of the ITAA 1936 applies. [Schedule 12, item 5, paragraph 320-320(2)(b)]

12.17 The recipient company could pay, or in effect pay, an amount to the originating company if the net risk liabilities transferred are negative. The amount the recipient company pays to the originating company includes any amount taken into account for the transfer of these policy liabilities in the agreement between the companies to transfer the business.

12.18 If the recipient company pays, or in effect pays, an amount to the originating company for the risk policy liabilities transferred, then:

•

the originating company will include in assessable income the amount it receives from the recipient company in respect of the liabilities under the net risk components of life insurance policies transferred; and

•

the recipient company can deduct the amount it pays to the originating company in respect of the liabilities under the net risk components of life insurance policies transferred to the recipient company.

[Schedule 12, item 5, subsections 320-310(2) and (3)]

Virtual pooled superannuation trust and exempt life insurance policy liabilities

12.19 Virtual pooled superannuation trust policies are, broadly, complying superannuation policies. Exempt life insurance policies are, broadly, policies that provide immediate annuities. Life insurance companies can discharge these policies from their virtual pooled superannuation trust or segregated exempt assets.

Policies discharged from the originating company's segregated assets

12.20 If the originating company transfers liabilities that relate to virtual pooled superannuation trust policies or exempt life insurance policies to the recipient company, it discharges its liability to pay any amounts under the policies. If, prior to the transfer, the liabilities under these policies were to be discharged from the originating company's virtual pooled superannuation trust or segregated exempt assets, the originating company must pay the full amount required to discharge these liabilities (i.e. transfer the assets) directly from its virtual pooled superannuation trust or segregated exempt assets respectively (subsections 320-195(4) and 320-250(3)).

12.21 To ensure that the recipient company is taxed appropriately when assets relating to these policies are transferred:

•

any assets that were virtual pooled superannuation trust assets or segregated exempt assets of the originating company when the transfer occurred will, immediately after the transfer, be virtual pooled superannuation trust assets and segregated exempt assets of the recipient company respectively; and

•

any part of the consideration received from the originating company that relates to liabilities that, immediately before the transfer occurred, were discharged from the originating company's virtual pooled superannuation trust or segregated exempt assets will not be a life insurance premium.

[Schedule 12, item 5, section 320-315 and paragraph 320-320(2)(a)]

Policies not discharged from the originating company's segregated assets

12.22 The originating company could hold assets that support liabilities under virtual pooled superannuation trust policies and exempt life insurance policies outside of its segregated assets.

12.23 To ensure that the recipient company is taxed appropriately when these policies are transferred, the consideration it receives from the originating company that relates to virtual pooled superannuation trust and exempt life insurance policy liabilities that were not discharged from the originating company's segregated assets will be a life insurance premium. [Schedule 12, item 5, section 320-320]

Liabilities relating to certain policies issued by friendly societies before 1 January 2003

12.24 As a transitional rule, amounts derived by life insurance companies that are friendly societies that are attributable to income bonds, funeral policies, sickness policies or certain scholarship plans issued before 1 January 2003 are treated as non-assessable non-exempt income (paragraph 320-37(1)(d)).

12.25 This transitional rule will continue to apply to these policies when they are transferred to the recipient company if:

•

the originating company and the recipient company are friendly societies immediately before the transfer occurs; and

•

the terms of the replacement policies issued by the recipient company are not materially different to the terms of the original policies issued by the originating company.

[Schedule 12, item 5, section 320-325]

12.26 That is, if these conditions are met, amounts derived by the recipient company that are attributable to income bonds, funeral policies or certain scholarship plans issued by the originating company before 1 January 2003 will continue to be non-assessable non-exempt income.

Immediate annuity policy liabilities

12.27 Generally, immediate annuity policies are exempt life insurance policies only if they satisfy certain conditions. However, as a transitional rule, those conditions do not need to be satisfied for certain immediate annuity policies that were purchased before 10 December 1987 (paragraph 320-246(1)(e)).

12.28 This transitional rule will continue to apply to these policies when they are transferred to a recipient company if the terms of the replacement policies issued by the recipient company are not materially different to the terms of the original policies issued by the originating company. [Schedule 12, item 5, section 320-330]

Liabilities relating to continuous disability policies transferred between companies within the same wholly-owned group

12.29 From 1 July 2000, life insurance companies must use the 'Valuation Standard' (as defined in subsection 995-1(1)) as the basis for valuing liabilities relating to continuous disability policies (section 320-85). As the value of liabilities used before 1 July 2000 was usually higher than the value calculated using the Valuation Standard, transitional arrangements were introduced to spread the impact of the change in values over five years (section 320-30).

12.30 When the originating company transfers all of the liabilities under its continuous disability policies, the balance of the difference in the value of liabilities caused by the change in the basis of valuation is included in its assessable income.

12.31 The outstanding balance of the difference in the value of liabilities for continuous disability policies is not included in the originating company's assessable income in the year of the transfer if:

•

the originating company and the recipient company are members of the same 'wholly-owned group' (as defined in section 975-500) when the transfer occurs;

•

all of the liabilities under the continuous disability policies of the originating company are transferred to the recipient company; and

•

the transfer occurs before the income year in which 1 July 2005 occurs.

[Schedule 12, item 5, subsection 320-340(1)]

12.32 Companies are members of the same wholly-owned group if one of the companies is a 100% subsidiary of the other company, or the companies are a 100% subsidiary of the same third company (section 975-500).

12.33 If the conditions in paragraph 12.31 are satisfied, then:

•

in the income year the transfer occurs:

-

the originating company will include in its assessable income the amount it would have included in the income year if the transfer had not occurred, multiplied by the part of the year that the company held the continuous disability policies; and

-

the recipient company will include in its assessable income the balance of the amount the originating company did not include in its assessable income in the income year; and

•

for each relevant year after the transfer, the recipient company will include in its assessable income the amount the originating company would have included in the income year if the transfer had not occurred.

[Schedule 12, item 5, subsections 320-340(2) to (5)]

Liabilities relating to certain life insurance policies issued before 1 July 2000 transferred between companies within the same wholly-owned group

12.34 As a transitional rule, one-third of specified management fees in respect of life insurance policies entered into before 1 July 2000 are treated as non-assessable non-exempt income (section 320-40). This transitional rule ceases to apply after 30 June 2005.

12.35 This transitional rule will continue to apply to these policies when they are transferred to a recipient company if:

•

the originating company and the recipient company are members of the same 'wholly-owned group' (as defined in section 975-500) when the transfer occurs;

•

the terms of the replacement policies issued by the recipient company are not materially different to the terms of the original policies issued by the originating company; and

•

the transfer occurs before 1 July 2005.

[Schedule 12, item 5, subsections 320-345(1) and (2)]

12.36 That is, if these conditions are satisfied, one-third of specified management fees derived by the recipient company in relation to life insurance policies transferred from the originating company that were issued by the originating company prior to 1 July 2000 will be non-assessable non-exempt income. The amount of specified management fees that will qualify for transitional relief cannot exceed the amount of any fees or charges that the originating company was entitled to make under the terms of the policies as applying immediately before 1 July 2000. [Schedule 12, item 5, subsection 320-345(3)]

Transfer of notionally segregated assets

12.37 Life insurance companies were required to segregate virtual pooled superannuation trust assets and segregated exempt assets with effect from 1 July 2000 (sections 320-170 and 320-225). As a transitional rule, part of a large asset could be certified to be a separate asset for these purposes (sections 320-170 and 320-225 of the Income Tax (Transitional Provisions) Act 1997).

12.38 When the originating company transfers an asset that it notionally segregated to the recipient company, the parts of the asset that the originating company certified to be separate assets, must be treated by the recipient company as separate assets. [Schedule 12, item 5, section 320-335]

CGT roll-over for assets transferred between companies within the same wholly-owned group

12.39 A CGT roll-over will apply to capital gains and capital losses that arise when life insurance business is transferred between companies within the same wholly-owned group. The roll-over is broadly consistent with the CGT roll-over under Subdivision 126-B of the ITAA 1997 that applies to companies that are members of the same wholly-owned group.

Conditions for the CGT roll-over

12.40 When a life insurance company transfers some or all of its life insurance business to another life insurance company under Part 9 of the Life Insurance Act 1995 or under the Financial Sector (Transfers of Business) Act 1999, the originating company can qualify for the CGT roll-over if:

•

the originating company and the recipient company are members of the same wholly-owned group just before the transfer; and

•

the transfer occurs before the end of the consolidation transitional period (i.e. before the later of 30 June 2004 and, if the head company of the consolidated group of which the originating company and the recipient company are members has a substituted accounting period, the end of the head company's income year in which 30 June 2004 occurs).

[Schedule 12, item 8, paragraphs 126-150(1)(a), (b) and (d) of the Income Tax (Transitional Provisions) Act 1997]

12.41 In addition:

•

a CGT asset of the originating company must become an asset of the recipient company;

•

a CGT asset of the originating company must end and the recipient company must acquire an equivalent replacement asset; or

•

the originating company must create a CGT asset in the recipient company.

[Schedule 12, item 8, paragraph 126-150(1)(c) of the Income Tax (Transitional Provisions) Act 1997]

12.42 A CGT asset of the originating company could end and the recipient company could acquire an equivalent replacement asset if, for example:

•

the originating company has rights under a contract that come to an end because under the transfer agreement the contract is novated to the recipient company; or

•

the originating company holds units in a trust which are cancelled and replaced by equivalent units that are issued to the recipient company.

12.43 However, the CGT roll-over will not apply if the asset is trading stock of the recipient company just after the transfer occurs. In addition:

•

if the transfer occurs before 1 July 2001 and the roll-over asset is a right, a convertible note or an option and the recipient company acquires another CGT asset by exercising the right or option, or by converting the convertible note - the CGT roll-over will not apply if the other asset becomes trading stock of the recipient company just after the recipient company acquired it; or

•

if the transfer occurs on or after 1 July 2001 and the roll-over asset is a right, convertible interest, an option or an exchangeable interest and the recipient company acquires another CGT asset by exercising the right or option, by converting the convertible interest or in exchange for the disposal or redemption of the exchangeable interest - the CGT roll-over will not apply if the other asset becomes trading stock of the recipient company just after the recipient company acquired it.

[Schedule 12, items 8 and 9, subsections 126-150(2) and (3) of the Income Tax (Transitional Provisions) Act 1997]

12.44 The CGT roll-over will occur only if the originating company and recipient company both choose in writing to obtain the roll-over and either:

•

the CGT event would have resulted in the originating company making a capital gain, or making no capital loss and not being entitled to a deduction;

•

the originating company acquired the roll-over asset before 20 September 1985; or

•

the CGT event would have resulted in the originating company making a capital loss.

[Schedule 12, item 8, subsections 126-155(1) and (2) of the Income Tax (Transitional Provisions) Act 1997]

12.45 The choice to obtain the roll-over must be made by the latest of:

•

12 months after the date of Royal Assent to this bill; and

•

a later day allowed by the Commissioner of Taxation.

[Schedule 12, item 8, subsection 126-155(3) of the Income Tax (Transitional Provisions) Act 1997]

Consequences of the capital gains tax roll-over

12.46 If a CGT roll-over occurs, the originating company disregards the capital gain or capital loss it makes from the CGT event. [Schedule 12, item 8, subsection 126-160(1) of the Income Tax (Transitional Provisions) Act 1997]

12.47 When the recipient company disposes of a roll-over asset:

•

the first element of the cost base of the original asset or the replacement asset for the recipient company is the cost base of the original asset for the originating company just before the transfer occurred;

•

the first element of the reduced cost base of the original asset or the replacement asset for the recipient company is the reduced cost base of the original asset for the originating company just before the transfer occurred; and

•

if the originating company acquired the original CGT asset before 20 September 1985, the recipient company is taken to have acquired the original asset or the replacement asset before that date.

[Schedule 12, item 8, subsections 126-160(2), (3) and (5) of the Income Tax (Transitional Provisions) Act 1997]

12.48 If, as a result of the transfer, the originating company creates a CGT asset in the recipient company (i.e. CGT event D1, D2, D3 or F1 occurs), the first element of the asset's cost base in the hands of the recipient company is:

•

if the asset is created as a result of CGT event D1 - the incidental costs the originating company incurred that relate to the CGT event;

•

if the asset is created as a result of CGT event D2 - the expenditure the originating company incurred to grant the option;

•

if the asset is created as a result of CGT event D3 - the expenditure the originating company incurred to grant the right; and

•

if the asset is created as a result of CGT event F1 - the expenditure the originating company incurred on the grant, renewal or extension of the lease.

[Schedule 12, item 8, subsection 126-160(4) of the Income Tax (Transitional Provisions) Act 1997]

12.49 The first element of the asset's reduced cost base is worked out similarly. [Schedule 12, item 8, subsection 126-160(4) of the Income Tax (Transitional Provisions) Act 1997]

12.50 For the purposes of working out the asset's cost base, expenditure can include giving property. [Schedule 12, item 8, subsection 126-160(4) of the Income Tax (Transitional Provisions) Act 1997]

Interaction with other parts of the income tax law

12.51 A reference to Subdivision 126-B of the ITAA 1997 in the income tax law will be taken to include a reference to Subdivision 126-B of the Income Tax (Transitional Provisions) Act 1997. This will ensure that the provisions in the income tax law that apply when there is a CGT roll-over under Subdivision 126-B of the ITAA 1997 for companies within the same wholly-owned group also apply to a CGT roll-over under Subdivision 126-B of the Income Tax (Transitional Provisions) Act 1997. [Schedule 12, item 8, section 126-165 of the Income Tax (Transitional Provisions) Act 1997]

12.52 Consequently, for example:

•

the new CGT roll-over will be included in the list of same asset roll-overs in section 112-150;

•

CGT event J1 (section 104-175) may happen if the recipient company subsequently ceases to be a member of the same wholly-owned group;

•

a tax cost setting amount of the recipient company may be affected if it joins a consolidated group (section 705-50); and

•

the allocable cost amount of the recipient company may be affected if it joins a consolidated group (section 705-150).

Interaction with former Division 138

12.53 Former Division 138 contained provisions to prevent tax benefits arising when assets were shifted between companies under common ownership. The effect of Division 138 was to adjust the cost bases and reduced cost bases of shares (and other interests). Division 138 has been repealed and replaced with Part 3-95 with effect from 24 October 2002. However, the Division continues to apply to relevant events that happened before 1 July 2002 or under a scheme entered into before 27 June 2002.

12.54 Division 138 may apply inappropriately when a transfer occurs because the assumption of liabilities by the recipient company may not be taken into account in determining whether value has been shifted from the originating company.

12.55 These amendments ensure that, for the purpose of applying Division 138, the market value of liabilities assumed by the recipient company in respect of the transfer is taken to be money received (and therefore will be 'capital proceeds' as defined in subsection 116-20(1)) by the originating company in respect of the transfer of assets, except to the extent that an amount is already taken into account as capital proceeds. [Schedule 12, item 1, section 138-25]

Interaction with Division 170

12.56 Division 170 contains rules for the transfer of losses between members of a wholly-owned group and supporting integrity measures.

12.57 Subdivision 170-C adjusts the cost base and/or reduced cost base of certain debt and equity interests if a tax loss or net capital loss is transferred between companies in the same wholly-owned group. This Subdivision is designed to prevent the duplication of losses.

12.58 An effective transfer of losses could arise when a life insurance company transfers its life insurance business because the CGT roll-over in Subdivision 126-B of the Income Tax (Transitional Provisions) Act 1997 will allow unrealised capital losses to be transferred from the originating company to the recipient company. The recipient company will be able to realise those losses by disposing of the CGT assets.

12.59 In addition, the value of membership interests held in the originating company may reduce as a result of the fall in value of the asset before its transfer. If the recipient company (or a related company) holds those membership interests, it could duplicate the losses by disposing of the membership interests.

12.60 These amendments ensure that Subdivision 170-C applies to unrealised capital losses disregarded by the originating company because they are rolled over to the recipient company under Subdivision 126-B of the Income Tax (Transitional Provisions) Act 1997. [Schedule 12, item 10, section 170-300 of the Income Tax (Transitional Provisions) Act 1997]

Application and transitional provisions

12.61 These amendments apply to transfers of life insurance business that take place on or after 1 July 2000. [Schedule 12, item 11]

12.62 In this regard, the measure has been actively sought by the life insurance industry and removes unintended taxation consequences that arise under the current law that act as an impediment to transfers of life insurance business. In addition, some life insurance companies have undertaken transfers of life insurance business since 1 July 2000 based upon the announcement of this measure.

Consequential amendments

12.63 Consequential amendments insert various notes to guide readers and modify headings. [Schedule 12, items 2 to 4, 6 and 7, subsections 320-30(1), 320-37(1), 320-40(1), the definition of 'life insurance premium' in subsection 995-1(1) of the ITAA 1997 and Division 126 of the Income Tax (Transitional Provisions) Act 1997]

Index

Schedule 1: Consolidation

Schedule 2: Copyright collecting societies

Schedule 3: Simplified Imputation System

Schedule 4: Deductible gift recipients

Schedule 5: Debt and equity interests

Schedule 6: Irrigation water providers

Schedule 7: FBT housing benefits

Schedule 8: CGT event G3

Schedule 9: GST: Supplies to offshore owners of Australian real property

Schedule 10: Baby bonus adoption amendments

Schedule 11: Technical correction

Schedule 12: Transfer of life insurance business