House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Glossary

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

General outline and financial impact

GST amendments to third party payment adjustment provisions

Schedule 1 to this Bill amends the A New Tax System (Goods and Services Tax) Act 1999 to ensure the third party payment adjustment provisions operate appropriately where there are third party payments relating to a supply by the payer that is not taxable or a supply to the payee that is goods and services tax (GST)-free, not connected with Australia or subject to a refund under the Tourist Refund Scheme.

Date of effect: 1 July 2010.

Proposal announced: This measure was announced in the then Assistant Treasurer's Media Release No. 119 of 26 May 2010.

Financial impact: Nil.

Compliance cost impact: Low.

Capital gains tax treatment of water entitlements and termination fees

Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 to provide a capital gains tax (CGT) roll-over for taxpayers who replace an entitlement to water with one or more different entitlements.

This Schedule will also allow taxpayers to include any termination fees they incur in relation to an asset in the asset's cost base.

Date of effect: The water entitlement roll-over applies to CGT events that happen in the 2005-06 and later income years. However, taxpayers will be able to choose whether they obtain the roll-over if the relevant transactions qualifying for the roll-over happen in the period from the 2005-06 income year to the day that the amendments receive Royal Assent.

The termination fee cost base changes apply to CGT events happening on or after 1 July 2008. However, taxpayers will be able to choose whether they include a termination fee in the asset's cost base if the relevant CGT event happens in the period from 1 July 2008 to the day that the amendments receive Royal Assent.

The retrospective date of effect ensures that taxpayers who have undertaken specific transactions before the amendments receive Royal Assent may qualify for the relief. However, the optional nature of these rules ensures that this retrospectivity does not disadvantage taxpayers.

Proposal announced: On 27 February 2009, the then Assistant Treasurer and Minister for Competition Policy and Consumer Affairs announced in Media Release No. 011 that the Government would provide a CGT roll-over for transformation arrangements and allow termination fees to be included in an asset's cost base.

On 2 December 2009, the then Assistant Treasurer and the then Minister for Climate Change and Water jointly announced in Media Release No. 102 that the Government would extend the CGT roll-over for transformation arrangements to water entitlements more generally.

Financial impact: These amendments will have a small but unquantifiable revenue impact.

Compliance cost impact: Low. This impact comprises a low implementation impact and a low decrease in ongoing compliance costs relative to the affected group.

Amendments to the taxation of financial arrangements provisions

Part 1 of Schedule 3 to this Bill amends Division 230 of the Income Tax Assessment Act 1997 (ITAA 1997) and the consequential and transitional provisions inserted by the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 (TOFA Act 2009) to make minor policy refinements and technical amendments and corrections to the provisions.

Part 2 of Schedule 3 to this Bill extends the transitional arrangements relating to the application of the debt/equity rules made by the New Business Tax System (Debt and Equity) Act 2001 (Debt and Equity Act 2001) to 1 July 2010 for Upper Tier 2 instruments issued before 1 July 2001.

Date of effect: The amendments to Division 230 of the ITAA 1997 and other provisions inserted by the TOFA Act 2009 apply for income years commencing on or after 1 July 2010, unless a taxpayer elects to apply Division 230 for income years commencing on or after 1 July 2009.

The amendments to the debt/equity transitional provisions commence from Royal Assent and apply to Upper Tier 2 instruments that are issued before 1 July 2001.

Proposal announced: The amendments to Division 230 of the ITAA 1997 and other provisions inserted by the TOFA Act 2009 were announced in the then Assistant Treasurer's Media Release No. 043 of 4 September 2009.

The amendments to the debt/equity transitional provisions were announced in the then Assistant Treasurer's Media Release No. 066 of 20 April 2010.

Financial impact: The revenue impact of the TOFA Act 2009 was unquantifiable. As these amendments make minor policy refinements to the provisions inserted by the TOFA Act 2009 and otherwise ensure the provisions operate as intended, the revenue impact is unquantifiable but not expected to be significant.

Compliance cost impact: Division 230 of the ITAA 1997 lowered ongoing compliance costs by providing greater coherency, clarity and certainty, using financial accounting concepts from relevant financial accounting standards, basing the tax treatment of financial arrangements on the functional purpose, and removing uncertainties about relevant tax timing treatments. These amendments are intended to further clarify the law, make refinements and correct minor errors in Division 230 and will contribute to the lowering of ongoing compliance costs.

Amendments to the foreign currency gains and losses provisions

Part 3 of Schedule 3 to this Bill amends Division 775 (foreign currency gains and losses provisions) of the Income Tax Assessment Act 1997 (ITAA 1997) to extend the scope of a number of compliance cost saving measures, and to make technical amendments to ensure that the provisions operate as intended.

Date of effect: These amendments apply from 17 December 2003.

Proposal announced: The Treasurer and the then Assistant Treasurer and Minister for Competition Policy and Consumer Affairs, announced in Media Release No. 054 of 13 May 2008 that the Government would proceed with these amendments. The amendments were initially announced by the previous government on 5 August 2004, and were to have effect from 1 July 2003.

Financial impact: The revenue impact of these amendments is unquantifiable but they are expected to have a low or no revenue impact.

Compliance cost impact: These amendments extend the scope of a number of compliance cost saving measures in the law and make technical amendments to ensure that the provisions operate as intended. Therefore, these amendments will contribute to the lowering of compliance costs. The amendments were developed following extensive industry consultation on the implementation of the provisions.

Scrip for scrip alignment

Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 to make it easier for takeovers and mergers regulated by the Corporations Act 2001 to qualify for the capital gains tax (CGT) scrip for scrip roll-over.

Date of effect: These amendments apply to CGT events that happen on or after 6 January 2010.

Proposal announced: This measure was announced in the then Assistant Treasurer's Media Release No. 004 of 6 January 2010.

Financial impact: These amendments are expected to have an insignificant revenue impact.

Compliance cost impact: Low. This impact comprises a low implementation impact and a low decrease in ongoing compliance costs relative to the affected group.

Increase in the medical expenses tax offset claim threshold

Schedule 5 to this Bill amends the Income Tax Assessment Act 1936 to increase the threshold above which a taxpayer may claim the medical expenses tax offset and commence annually indexing the threshold to the consumer price index.

Date of effect: These amendments apply to the income year starting on or after 1 July 2010.

Proposal announced: This measure was announced by the Treasurer on 11 May 2010 as part of the 2010-11 Budget.

Financial impact: This measure will have these revenue implications:

Compliance cost impact: Low. This comprises a low implementation impact and no change to the ongoing compliance costs relative to the affected group.

Deductible gift recipients

Schedule 6 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to update the list of deductible gift recipients (DGRs) to make two entities deductible gift recipients, extend the period of listing of one entity and change the name of another entity.

Date of effect: The changes generally apply to gifts received after the day the organisation is notified of its specific listing or changes to its specific listing.

Proposal announced: The listing of One Laptop per Child Australia Ltd as a DGR was announced in the then Assistant Treasurer's Media Release No. 122 of 27 May 2010. The listing of the Mary MacKillop Canonisation Gift Fund as a DGR was announced by the Prime Minister, the then Parliamentary Secretary for Social Inclusion and Parliamentary Secretary for the Voluntary Sector and the then Assistant Treasurer in a joint Press Release on 5 August 2010. The extension of the listing of Xanana Vocational Educational Trust was announced in the 2010-11 Budget.

Financial impact: This measure will have the following revenue implications:

Compliance cost impact: Negligible.

Extending gift deductibility to volunteer fire brigades

Schedule 7 to this Bill adds three new general deductible gift recipient (DGR) categories into the Income Tax Assessment Act 1997.

This measure widens the accessibility of tax deductible donations to all entities providing volunteer based emergency services, including volunteer fire brigades. This measure also extends DGR status to all state and territory government bodies that coordinate volunteer fire brigades and State Emergency Services.

Date of effect: These amendments commence from the date of Royal Assent.

Proposal announced: This measure was announced in the then Assistant Treasurer's Media Release No. 032 of 28 February 2010.

Financial impact: This measure is estimated to have the following revenue implications:

Compliance cost impact: Low.

Chapter 1 - GST amendments to third party payment adjustment provisions

Outline of chapter

1.1 Schedule 1 to this Bill amends the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) to ensure the third party payment adjustment provisions operate appropriately where there are third party payments relating to a supply by the payer that is not taxable or a supply to the payee that is goods and services tax (GST)-free, not connected with Australia or subject to a GST refund under the Tourist Refund Scheme.

Context of amendments

1.2 Where a registered entity supplies a thing to another entity (intermediary) and that intermediary on sells that thing to a third party, the original supplier of the thing (the payer), sometimes makes a payment (a third party payment), to the third party (the payee). Under Division 134 (that is, the third party payment adjustment provisions), which comes into effect on 1 July 2010, the payer remits GST based on the price for which it sells the thing to the intermediary but can also claim a decreasing adjustment for the third party payment. If the payee is a registered entity, it is required to make an increasing adjustment to reflect the effective decrease in the consideration paid for the thing. No increasing adjustment arises if the payee is not registered for GST. The net outcome should be that the appropriate amount of GST is collected throughout the supply chain - that is, in the case of taxable supplies, one-eleventh of the final (GST-inclusive) purchase price.

1.3 The third party payment adjustment provisions can result in inappropriate outcomes where the supply by the payer to another entity is taxable but the eventual supply to the payee is GST-free (such as exports or pharmaceuticals), or not connected with Australia (such as sales by an overseas retailer to its customers overseas). If third party payments are made and a decreasing adjustment is claimed, the net GST payable through the supply chain may be negative for supplies that should have a net GST amount of zero over the supply chain.

1.4 By increasing the price charged to an interposed entity but using rebates to maintain the same price to the payee, a payer could use the payment of rebates to produce a more favourable GST outcome, thereby obtaining an advantage over competitors who were paying an appropriate amount of GST. This is shown in Example 1.1.

Example 1.1 : Impact of third party payment adjustments on GST outcomes where supply to the payee is GST-free or not connected with Australia

CWA: connected with Australia

ITC: input tax credit

In this example in Diagram A, the manufacturer is originally making supplies to the wholesaler for $550. As the supply is a taxable supply the manufacturer remits GST of $50. The wholesaler adds a $220 margin and sells the items to their customer (who may or may not be registered for GST) for $770. The supply by the wholesaler to its customer is GST-free so no GST is remitted and the wholesaler has an input tax credit of $50. Hence no net GST is collected on the supply - the appropriate outcome for a GST-free supply.

In Diagram B, the manufacturer now pays a $110 rebate to the final customers and covers this cost by increasing the price to the wholesaler by $110 to $660. The manufacturer has a GST liability of $60 in relation to the supply but is also entitled to a $10 decreasing adjustment in relation to the rebate so their net GST liability is $50. As the wholesaler acquires the items for $660 it has an input tax credit of $60. As before, it adds a margin of $220 and sells the items to its customers for $880. The effective price to these customers remains $770 due to the rebate received from the manufacturer. The net GST on the supply is a loss to the revenue of $10.

1.5 The third party payment adjustment provisions can also result in inappropriate GST outcomes where the supply to the payee is subject to a refund of GST under the Tourist Refund Scheme, as this has a similar outcome to where the supply is GST-free. By increasing the price charged to an interposed entity but using rebates to maintain the same price to a payee who was eligible to obtain a refund of GST under the Tourist Refund Scheme, a payer could use the payment of rebates targeted specifically to those customers to produce a more favourable GST outcome in this situation, thereby obtaining an advantage over competitors who were paying an appropriate amount of GST.

1.6 This is shown in Example 1.2.

Example 1.2 : Impact of third party payment adjustments on GST outcomes where supply to the payee is eligible for a GST refund under the Tourist Refund Scheme

ITC: input tax credit

In this example in Diagram A, the wholesaler is originally making a supply of an opal ring to a retailer for $1,100. As the supply is a taxable supply the wholesaler remits GST of $100. The retailer adds a $550 margin and sells the items to their customer (who is not registered for GST) for $1,650. The retailer has a GST liability of $150 and an input tax credit of $100 so it remits net GST of $50. A total of $150 of GST has been remitted in respect of the ring. The purchaser presents the ring and their tax invoice on leaving Australia and receives a refund of $150 under the Tourist Refund Scheme. Effectively no net GST is collected on the supply - the appropriate outcome for a supply subject to a refund of GST under the Tourist Refund Scheme.

In Diagram B, the wholesaler now pays a $1,100 rebate to the final customer and covers this cost by increasing the price to the retailer by $1,100 to $2,200. The wholesaler has a GST liability of $200 in relation to the supply but is also entitled to a $100 decreasing adjustment in relation to the rebate so its net GST liability is $100. As the retailer acquires the items for $2,200 it has an input tax credit of $200. As before, the retailer adds a margin of $550 and sells the items to its customers for $2,750. It has a GST liability of $250 and an input tax credit entitlement of $200 so remits net GST of $50. The total GST collected in respect of the ring is $150 and the effective price to the customers is $1,650 due to the $1,100 rebate received from the wholesaler. However, the purchaser presents the ring and their tax invoice on leaving Australia and receives a refund of $250 under the Tourist Refund Scheme. The effective net GST on the supply is a loss to the revenue of $100.

1.7 It is also possible for there to be an inappropriate outcome where the initial supply by the payer is not taxable but the final supply is taxable. In these cases, if an increasing adjustment were to apply to the payee receiving the third party payment, too much GST would be remitted through the supply chain. This is shown in Example 1.3.

Example 1.3 : Impact of third party payment adjustments on GST outcomes where supply by the payer is non-taxable but supply to the payee is a creditable acquisition

ITC - input tax credits

In this example a manufacturer sells wheelchairs to a wholesaler as a GST-free supply. Normally, when the manufacturer on sells the wheelchairs they remain GST-free. However, the wholesaler sells some of those wheelchairs to an airline which uses them as an input into making taxable supplies - that is, the supply of travel services to its customers. To simplify its GST reporting, the airline has agreed with the wholesaler that these supplies will be treated as taxable, which section 38-45 of the GST Act allows.

In Diagram A, the manufacturer originally makes the supply to the intermediary for $550. As this supply is a not a taxable supply the manufacturer does not remit GST. The wholesaler adds a $220 margin and sells the items to the airline (which is registered for GST) for $770. The supply by the wholesaler to the airline is treated as taxable so the wholesaler remits GST of $70 and has no input tax credit. The acquisition of the wheelchairs by the airline is a creditable acquisition so an input tax credit of $70 is claimed. Hence no net GST is collected on the supply of the wheelchairs to the airport, which is the appropriate outcome for a business input.

In Diagram B, the same effective transaction is taking place but the manufacturer is paying a $110 rebate to the final customers and the price it charges the wholesaler is $660. As the sale to the wholesaler is not a taxable supply, the manufacturer has no GST liability and is not entitled to a decreasing adjustment in relation to the rebate, so its net GST liability is $0. The wholesaler acquires the items for $660 and has no input tax credit entitlement. As in Diagram A, it adds a margin of $220 and sells the items to its customers for $880. The effective price to its customers is $770 due to the rebate received from the manufacturer. As the supply to the airline is treated as a taxable supply the wholesaler has a GST liability of $80. The airline has a corresponding input tax credit of $80 but is required to make an increasing adjustment of $10. As a result there is $10 of embedded GST through the supply chain on these business inputs.

Summary of new law

1.8 From 1 July 2010 third party payment adjustments will not arise where there are payments which would give rise to such adjustments, but the supply by the payer is not taxable or the supply to the payee is GST-free, not connected with Australia or subject to a GST refund under the Tourist Refund Scheme.

Detailed explanation of new law

1.9 Subsection 134-5(1A) provides that a decreasing adjustment for a third party payment will not arise if the supply by an intermediary to the payee, which would otherwise give rise to such an adjustment, is a GST-free supply, is not connected with Australia or is subject to a refund of GST under the Tourist Refund Scheme, and the payer knows, or had reasonable grounds to suspect this.

1.10 In some cases the payer may have information from which it may conclude that a supply to the payee is likely to be GST-free, not connected with Australia or is subject to a refund under the Tourist Refund Scheme. For example, where the nature of the product is such that its final supply may be GST-free (such as pharmaceuticals), where the receipt provided by the payee indicates payment of a refund under the Tourist Refund Scheme or where the payee provides details to the payer to facilitate the payment which indicate that the payee is located outside of Australia. In these cases, the payer would have reason to suspect that the supply is GST-free, not connected with Australia or subject to a refund under the Tourist Refund Scheme. Accordingly, it could not make a decreasing adjustment, unless it takes steps which establish that the supply to the payee is not in fact a GST-free supply, a supply not connected with Australia or a supply for which the payee obtained a refund of GST under the Tourist Refund Scheme.

1.11 Where there are no circumstances that indicate to the payer that the supply to the payee may be GST-free, not connected with Australia or a supply subject to a refund of GST under the Tourist Refund Scheme, it is not intended that the supplier would need to make any specific inquiries to determine the GST treatment of the supply to the payee.

1.12 Subsection 134-10(1A) provides that an increasing adjustment for a third party payment will not arise if the supply to an intermediary by the payer, which would give rise to such an adjustment, is not a taxable supply.

1.13 However, paragraph 134-10(1A)(b) provides that where the supply to an intermediary by the payer, is not a taxable supply only because the payer and the intermediary are members of the same GST group, or GST religious group, or the payer is the joint venture operator for a GST joint venture and the intermediary is a participant in the GST joint venture, the increasing adjustment will nevertheless arise.

1.14 The following examples show the impact of these amendments on the situations outlined in the previous examples.

Example 1.4 : Impact of the new law on GST outcomes where supply to the payee is GST-free or not connected with Australia

CWA - connected with Australia

ITC - input tax credits

In Diagram C, the manufacturer pays a $110 rebate to the final customers and covers this cost by increasing the price to the wholesaler by $110 to $660. The manufacturer has a GST liability of $60 in relation to the supply but, because the supply to the payee is a GST-free supply and it knows or has reason to expect this, it is not entitled to a decreasing adjustment in relation to the rebate so its net GST liability is $60. As the wholesaler acquires the items for $660 it has an input tax credit of $60. The net GST collected on the supply over the supply chain is zero - the correct outcome for a GST-free supply.

Example 1.5 : Impact of the new law on GST outcomes where supply to the payee is subject to a GST refund under the Tourist Refund Scheme

ITC - input tax credits

TRS - Tourist Refund Scheme

In this scenario a wholesaler introduces a cash-back arrangement that is targeted at tourists who are about to travel overseas. The tourists are required to provide a copy of their tax invoice, which is stamped as having received a refund under the Tourist Refund Scheme. As the wholesaler is aware that the supply to the payee is subject to a refund under the Tourist Refund Scheme the decreasing adjustment is not available to the payer.

However, there may be circumstances in which the payer would not know, nor could they reasonably be expected to know, that a supply to a payee was subject to a refund under the Tourist Refund Scheme. For example, a distributor of laptop computers may offer a rebate on sales of a soon to be superseded line of laptops to end customers. They are sold through a range of retail outlets. Customers are able to claim the rebate by sending a copy of their receipt together with details such as a postal address or a bank account number to the distributor to enable payment to be made. If the purchaser supplied a copy of the receipt together with an Australian address or Australian bank account number, the distributor would not be expected to consider that the supply had been subject to a claim under the Tourist Refund Scheme.

If the copy of the receipt provided, showed that the receipt had been stamped as being subject to a refund under the Tourist Refund Scheme, the distributor would know this. If the address or bank details provided were not for an Australian address or an Australian bank, the distributor would need to ascertain whether the supply to the payee was subject to a refund under the Tourist Refund Scheme before claiming a decreasing adjustment in respect of the rebate.

1.15 Example 1.6 shows the impact of these amendments in situations where the supply by the payer is not a taxable supply.

Example 1.6 : Impact of the new law on GST outcomes where supply by the payer is non-taxable but supply to the payee is a creditable acquisition

ITC - input tax credits

In this scenario the airline can establish, by reference to the nature of the goods and its agreement with the wholesaler to treat the supply of the wheelchairs as a taxable supply, that the supply by the payer to an intermediary was not a taxable supply. Consequently the airline is not required to make an increasing adjustment with regard to the rebate it receives from the payer. As before, the wholesaler has a GST liability of $80 and the airline has a corresponding input tax credit of $80. Zero GST is collected through the supply chain to that point, which is the correct outcome for a business input.

Application and transitional provisions

1.16 These amendments apply to third party payments made on or after 1 July 2010, which is the date on which third party payment adjustment provisions contained in Division 134 of the GST Act take effect.

Chapter 2 - Capital gains tax treatment of water entitlements and termination fees

Outline of chapter

2.1 Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide a capital gains tax (CGT) roll-over for taxpayers who replace an entitlement to water with one or more different entitlements.

2.2 This Schedule will also allow taxpayers to include any termination fees they incur in relation to an asset in the asset's cost base.

2.3 All references to legislative provisions in this chapter are references to the ITAA 1997 unless otherwise stated.

Context of amendments

2.4 Irrigators may own an entitlement to water directly in the form of a statutory licence or they may own it indirectly in the form of a right against a third party such as an irrigation infrastructure operator (an operator).

•

In these latter situations, the operator typically owns an entitlement to water in the form of a statutory licence.

•

The irrigator typically owns a membership interest in the operator (such as shares) which gives them an entitlement to water in the form of a legal or equitable right against the operator. This entitlement may also include a right to have the operator deliver the water.

2.5 The Water Market Rules 2009 (Water Market Rules), made under the Water Act 2007 (Water Act), have the purpose of freeing up the trade of water entitlements within the Murray-Darling Basin. The rules do this by ensuring that operator policies or administrative requirements do not represent a barrier to trade. The Water Market Rules came into effect on 23 June 2009 with a transitional period to 31 December 2009. The Water Market Rules state that operators must not prevent or unreasonably delay the transformation or trade from 1 January 2010.

2.6 Transformation is the process by which an irrigator permanently changes (transforms) their right to water against an operator into a statutory licence held by an entity other than the operator. In most cases, it will be the individual irrigator who will own the statutory licence. The Water Market Rules refer to an irrigator's right to water against an operator as being the irrigator's irrigation right. Consequently, it is the irrigator's irrigation right that is transformed.

2.7 Operators may also have to undertake pre-transformation transactions to facilitate the transformation process and ensure member irrigators are treated equitably.

CGT water entitlement roll-over

2.8 In the absence of specific CGT relief, the transformation process is likely to trigger immediate CGT consequences for the irrigator and may trigger CGT consequences for the operator. This is because the irrigator's entitlement to water against the operator ends and part of the operator's statutory licence is cancelled. Depending on how the operator is structured, the transactions may also trigger CGT consequences for other member irrigators. This is likely to be the case if the operator is a partnership and the member irrigators own their water entitlements as joint tenants.

2.9 Subdivision 124-C provides an automatic CGT roll-over on the cancellation of a taxpayer's statutory licence if another statutory licence replaces it. However, this roll-over is not available when either the original entitlement to water or the replacement entitlement does not take the form of a statutory licence. An irrigator's right against an operator is not a statutory licence.

Example 2.1

Water Drip Ltd (Water Drip) is an operator within the Murray-Darling Basin that owns a statutory licence with a 200 megalitre (ML) entitlement to water. There are 200 shares in Water Drip that each contain an entitlement to have up to 1 ML of water delivered. Bob owns 10 shares in Water Drip and so is entitled to delivery of up to a total of 10 ML of water.

•

Bob has a total entitlement to 10 ML of water in the form of legal rights against Water Drip. (This entitlement is not a statutory licence.)

•

For the purposes of the Water Market Rules, Bob's entitlement to 10 ML of water is an irrigation right against Water Drip.

•

Should Bob choose to transform his 10 ML entitlement to water against Water Drip into a statutory licence and a separate delivery entitlement then, in the absence of this roll-over, the following CGT consequences would typically arise:

•

Bob triggers a CGT taxing point when his 10 ML entitlement to water against Water Drip ends (typically CGT event C2); and

•

Water Drip triggers a CGT taxing point when part of its statutory licence is cancelled and reissued to Bob (typically CGT event C2).

2.10 This roll-over will therefore facilitate transformation arrangements.

2.11 While the Water Market Rules apply only to the water resources of the Murray-Darling Basin, this roll-over applies more widely. This will also facilitate other forms of water entitlement restructuring without immediate CGT consequences. Consequently, the concept of an entitlement to water for the purposes of this roll-over needs to be wider than the terminology of the Water Market Rules.

Including termination fees in an asset's cost base

2.12 The CGT rules allow for the recognition of a taxpayer's costs of acquiring, owning and disposing of an asset when calculating a capital gain or capital loss on the asset. The rules do this by including these costs in the asset's cost base and reduced cost base.

2.13 The current CGT provisions allow some incidental costs of owning an asset to be included in the asset's cost base. However, these incidental costs do not include termination fees.

2.14 Although this cost base change applies to all CGT assets, it will have particular importance for irrigators who choose to sell a newly transformed water entitlement and end their delivery entitlement with their operator. This is because operators may charge the irrigator a termination fee when the irrigator terminates their delivery entitlement. The Water Charge (Termination Fees) Rules 2009 (Water Charge Rules) apply to termination fees in relation to water resources in the Murray-Darling Basin.

2.15 These rules do not modify the treatment of termination fees in the hands of the entity that receives the fee.

Summary of new law

2.16 Part 1 of Schedule 2 amends the ITAA 1997 by inserting Subdivision 124-R. This Subdivision provides a CGT roll-over for taxpayers who replace a water entitlement with one or more different water entitlements (including by transformation). It also provides a roll-over when a taxpayer owns a number of water entitlements and there is a reduction in the number of entitlements but not in the value of the total entitlement.

2.17 The concept of a water entitlement broadly encompasses any legal or equitable right relating to water, including its delivery.

2.18 Subdivision 124-R also provides a roll-over for consequential transactions arising as a direct result of this replacement.

2.19 Part 2 of Schedule 2 amends Division 110 of the ITAA 1997 by allowing taxpayers to include any termination fees they incur in relation to an asset in the second element of the asset's cost base and reduced cost base as an incidental cost.

Comparison of key features of new law and current law

Detailed explanation of new law

Water entitlement roll-overs

2.20 There are two types of water entitlement roll-over.

•

The first applies if a taxpayer replaces a water entitlement with one or more new water entitlements (replacement roll-over). This roll-over may also apply when a taxpayer replaces multiple water entitlements. Paragraphs 2.29 to 2.60 provide further information about this roll-over.

•

The second applies if a taxpayer has a total water entitlement made up of individual entitlements and their ownership of some of those entitlements ends but the total market value of the remaining entitlements remains the same as the total market value of the original entitlements (reduction roll-over). Paragraphs 2.61 to 2.77 provide further information about this roll-over.

2.21 Transactions that qualify for the replacement roll-over may also have CGT consequences for other taxpayers. There is also a roll-over for these consequences if they happen as a direct result of a transaction that qualifies for the replacement roll-over (variation roll-over). Paragraphs 2.78 to 2.83 provide further information about this roll-over.

What is a water entitlement?

2.22 For the purpose of these roll-overs, a water entitlement is any legal or equitable right that relates to water. This could include groundwater. There is no restriction in the form that an entitlement may take. [Schedule 2, item 6, subsection 124-1105(4)]

2.23 For example, a water entitlement could take the form of a contractual right against a third party, such as an operator. Alternatively, it could take the form of a statutory licence against a state or territory government. A share in a company would also be a water entitlement, if it has rights attaching to it that relate to water. Similarly an interest in a trust or a partnership interest would also be a water entitlement if the interest has attached rights relating to water.

2.24 For example, the following rights relate to water:

•

a right to receive water;

•

a right to take water from a water resource;

•

a right to have water delivered; or

•

a right to deliver water.

[Schedule 2, item 6, subsection 124-1105(4)]

2.25 A right to take water from a water resource, such as a water allocation, would be a water entitlement. A water use licence would also be a water entitlement.

2.26 A separate identifiable right relating to the conveyance of water, such as a conveyance licence, would also be a water entitlement.

2.27 There are three key rights in the Water Act that relate to water and are relevant for transformation. These are:

•

a water access right;

•

a water delivery right; and

•

an irrigation right.

For the purposes of these roll-overs, an asset that is such a right, or consists of such a right, will be a water entitlement.

Example 2.2

The Wet Water Company Ltd (Wet Water) is an operator. It has 200 shares on issue. Each share consists of a bundle of rights, including the right to vote at Wet Water's annual general meeting, receive dividends from the company and the right to receive up to two ML of water and have it delivered by Wet Water.

Wally owns 20 shares in Wet Water. Each of Wally's shares is a water entitlement.

Wet Water owns a statutory entitlement to take up to 450 ML of water from the Wet Creek. As this entitlement allows Wet Water to take water from a water resource (Wet Creek), it is a water entitlement.

Example 2.3

Jack and Jill form a partnership to jointly construct a well and take water from it. Each interest in the partnership includes the right to take 20 ML of water each year.

Each of Jack's and Jill's interest in the partnership is an entitlement to water.

Example 2.4

The Rainy Day Trust (Rainy Day) is an operator that owns a 300 gigalitre (GL) statutory licence. Rebecca has an equitable interest in Rainy Day which entitles her to delivery of up to 100 GL of water.

Rebecca's interest in the trust is an entitlement to water.

If Rebecca held a right to have her water delivered that was separate from her interest in the trust entitling her to 100 GL of water, she would own two separate water entitlements.

2.28 In some circumstances, a taxpayer may only be entitled to own a contractual water entitlement against another entity if they also own a membership interest in that entity, such as a share. The membership interest may or may not relate to water. However, even if it does not, it will still be a water entitlement if it is a prerequisite for owning a water entitlement. [Schedule 2, item 6, subsection 124-1105(4)]

Replacement of water entitlements

2.29 Two alternative replacement roll-overs are available when a taxpayer replaces a water entitlement with one or more water entitlements:

•

The default replacement roll-over operates on a single asset basis (single entitlement roll-over). This roll-over applies when a taxpayer replaces a single water entitlement with one or more different water entitlements [Schedule 2, item 6, subsection 124-1105(1)] .

•

However, taxpayers may have more than one water entitlement, each of which is replaced in the one transaction. In these situations, the taxpayer may choose an alternative replacement roll-over that operates on a multiple asset basis (multiple entitlement roll-over). This roll-over applies when a taxpayer replaces more than one water entitlement with one or more different water entitlements [Schedule 2, item 6, subsection 124-1105(2)] .

2.30 The two alternative replacement roll-overs accommodate the different ways taxpayers may structure their arrangements.

2.31 Specifically, providing the multiple entitlement roll-over on an optional basis allows taxpayers to deal separately with part of a water entitlement that is not replaced.

Example 2.5

Claire owns a 100 ML water entitlement which she replaces with a 95 ML water entitlement.

Claire qualifies for the single entitlement roll-over in respect of her 100 ML entitlement. She disregards any capital gain or capital loss arising from this exchange.

Alternatively, Claire could split her original 100 ML water entitlement into two separate water entitlements - a 95 ML entitlement and a 5 ML entitlement.

If Claire splits her entitlement in this way and her new 95 ML water entitlement is cancelled and replaced with a new 95 ML water entitlement, she qualifies for the single entitlement roll-over in respect of her replaced 95 ML entitlement. Consequently, Claire disregards any capital gain or capital loss arising from this exchange.

As Claire does not replace her 5 ML water entitlement with another water entitlement, this entitlement does not need to qualify for the single entitlement roll-over.

2.32 The way the taxpayer prepares their tax return is sufficient evidence of them making this choice.

2.33 A statutory licence that relates to water may qualify as a water entitlement. However, there is an existing automatic CGT roll-over within Subdivision 124-C that applies to statutory licences. A water entitlement that is a statutory licence and that qualifies for the roll-over in Subdivision 124-C will not qualify for the water entitlement roll-over. Consequently taxpayers that own a statutory licence that is also a water entitlement should first check whether they qualify for the roll-over in Subdivision 124-C before seeing if they qualify for the water entitlement roll-over. [Schedule 2, item 6, subsection 124-1105(3)]

Example 2.6

Ron owns a statutory licence to 500 ML of general security water from the Running River. This statutory licence is a water entitlement as it allows Ron to take water from a water resource.

The state government cancels Ron's statutory licence triggering CGT event C2. However, as a result of that cancellation, the state government issues Ron with a new statutory licence with an entitlement to 300 ML of high security water from the Running River.

Ron qualifies for the statutory licence roll-over. Consequently, he does not qualify for the replacement roll-over.

Example 2.7

Rapid Water Ltd (Rapid Water), an operator, owns a 20 GL bulk water entitlement which is a statutory licence. Each year, this statutory licence expires and the state government issues Rapid Water with a new statutory licence to reflect changes in water availability.

Rapid Water's 20 GL statutory licence expires and the state government issues Rapid Water with a 19 GL statutory licence.

Rapid Water qualifies for the statutory licence roll-over in relation to this exchange. Rapid Water therefore does not qualify for the replacement roll-over.

Example 2.8

Further to Example 2.7.

Rapid Water's member irrigators receive a total of up to 15 GL of water from Rapid Water. The remaining 4 GL of Rapid Water's bulk water entitlement is accounted for by conveyance losses that occur when Rapid Water delivers this water to its member irrigators.

Rapid Water wishes to separate its bulk water entitlement into two entitlements, one reflecting the amount of water its member irrigators receive and the other, the water used to deliver its members' entitlements.

Assume that the state government cancels Rapid Water's 19 GL statutory licence and issues it with a 15 GL bulk water entitlement and an additional 4 GL water entitlement to cover the conveyance losses. As these replacement entitlements are both statutory licences, Rapid Water qualifies for the statutory licence roll-over in relation to this exchange. Rapid Water therefore does not qualify for the replacement roll-over.

Qualifying transactions

Single entitlement roll-over

2.34 A taxpayer (such as an irrigator or an operator) whose ownership of one water entitlement ends will qualify for this roll-over if they acquire one or more new water entitlements as a result of their ownership of the original entitlement ending.

•

A taxpayer that sells a water entitlement in exchange for a cash payment and later chooses to acquire a new water entitlement will typically not qualify for the replacement roll-over. This is because the taxpayer did not acquire the new entitlement as a result of their ownership of the original entitlement ending. Instead the acquisition of the new entitlement is an independent event.

•

However, a taxpayer who disposes of a water entitlement with the expectation of acquiring a replacement water entitlement may qualify for the replacement roll-over when they acquire the replacement entitlement. In this situation, there is a relationship between the disposal of the original entitlement and the acquisition of the replacement entitlement.

[Schedule 2, item 6, paragraphs 124-1105(1)(a) and (b)]

2.35 It does not matter how the taxpayer's ownership ends. For example, the taxpayer may dispose of their water entitlement or may have it cancelled. Similarly, it does not matter whether the replacement water entitlement is of the same nature as the original entitlement. The roll-over simply requires the taxpayer to acquire one or more water entitlements to replace the original entitlement.

2.36 If the taxpayer chooses that the multiple entitlement roll-over applies to an original water entitlement in relation to a specific transaction, then that entitlement will not also qualify for the single entitlement roll-over. However, the replacement water entitlement will be a separate asset and so may later qualify for a single entitlement roll-over or as part of a multiple entitlement roll-over. [Schedule 2, item 6, paragraph 124-1105(1)(d)]

2.37 If the taxpayer is a foreign resident for tax purposes (including a trustee of a foreign trust), then they will only qualify for this roll-over if the original water entitlement and each of the replacement water entitlements is taxable Australian property. [Schedule 2, item 6, paragraph 124-1105(1)(c)]

2.38 Paragraphs 2.42 to 2.60 set out the consequences of this roll-over applying.

Multiple entitlement roll-over

2.39 A taxpayer whose ownership of more than one water entitlement ends will qualify for this roll-over if they acquire one or more new water entitlements as a result of the ownership of the original entitlements ending and they choose to obtain this roll-over. [Schedule 2, item 6, paragraphs 124-1105(2)(a), (b) and (d)]

2.40 If the taxpayer is a foreign resident for tax purposes (including a trustee of a foreign trust), then they will only qualify for this roll-over if each of the original water entitlements and replacement water entitlement(s) is taxable Australian property. [Schedule 2, item 6, paragraph 124-1105(2)(c)]

2.41 Paragraphs 2.42 to 2.60 set out the consequences of this roll-over applying.

Roll-over consequences

Disregard capital gain or capital loss attributed to replacement entitlement(s)

2.42 If the taxpayer satisfies the conditions for this roll-over (either the single entitlement roll-over or the multiple entitlement roll-over), then they disregard any capital gains or capital losses arising from their ownership of each original water entitlement ending. [Schedule 2, item 6, section 124-1110]

Example 2.9

Andy, Ben, Courtney, Dean and Emma each own 100 Class A shares issued by Liquid Water Irrigation Ltd (Liquid Water). Liquid Water is an operator within the Murray-Darling Basin that owns a statutory licence with an 800 ML entitlement to water. Each Class A share entitles its owner to 1 ML of water, have Liquid Water deliver the water, one vote at the annual general meeting and the right to receive dividends.

Andy chooses to transform his 100 ML entitlement against Liquid Water. Consequently he exchanges each of his 100 Class A shares for a replacement 100 ML statutory licence and 100 Class B shares, each of which has the same rights as the Class A shares, except the right to 1 ML of water. As the replacement statutory licence and each Class B share relates to water, each asset is a water entitlement.

Andy qualifies for the single entitlement roll-over in relation to each of his 100 Class A shares. (Alternatively, Andy may choose to access the multiple entitlement roll-over.)

Andy disregards any capital gains and capital losses arising from this exchange.

Realise capital gain or capital loss attributed to ineligible proceeds

2.43 However, if the taxpayer receives additional proceeds that do not take the form of a replacement water entitlement or entitlements, then the taxpayer will realise a partial capital gain or capital loss in relation to these additional proceeds. These additional proceeds (ineligible proceeds) do not qualify for the replacement roll-over, as they represent a realisation of part of the original water entitlement. [Schedule 2, item 6, subsection 124-1115(1)]

2.44 In this situation the taxpayer calculates a capital gain by attributing part of the cost base of each of the original water entitlements to the ineligible proceeds they receive. The taxpayer may do this on a reasonable basis having regard to the number and market value of the replacement water entitlement(s) relative to the market value of the ineligible proceeds. [Schedule 2, item 6, subsections 124-1115(2) and (4) and paragraph 124-1115(5)(a)]

Example 2.10

Further to Example 2.9.

Assume Courtney's 100 Class A shares in Liquid Water have a cost base of $50 each. The total cost base of her shares is $5,000.

Like Andy, Courtney exchanges her 100 shares in Liquid Water for a 100 ML statutory licence. However, rather than receive 100 Class B shares, Courtney chooses to receive a cash payment of $10,000.

The 100 ML statutory licence has a market value of $90,000.

Courtney qualifies for the replacement roll-over in relation to the 100 ML statutory licence. However the cash payment is ineligible proceeds.

It would be reasonable for Courtney to calculate her capital gain as follows:

•

The total market value of Courtney's proceeds from her 100 Class A shares is $100,000. That is, $90,000 for the statutory licence plus $10,000 for the cash payment.

•

Consequently, the cash payment represents 10 per cent of her capital proceeds. That is, $10,000 divided by $100,000.

•

Therefore, 10 per cent of the cost base of Courtney's Class A shares is attributable to the cash payment. That is, $5 per share.

•

The total cost base of the Class A shares that is attributable to the $10,000 cash payment is $500.

•

Assuming Courtney incurs no other costs in relation to the Class A shares, she realises a capital gain of $9,500. That is, $10,000 capital proceeds less a $500 cost base.

2.45 The taxpayer calculates a capital loss by attributing part of the reduced cost base of each of the original water entitlements to the ineligible proceeds they receive in the same way. [Schedule 2, item 6, subsections 124-1115(3) and (4) and paragraph 124-1115(5)(b)]

Replacement of pre-CGT water entitlements

2.46 If the taxpayer acquired their original water entitlement (or all of their entitlements) before 20 September 1985, then they will be taken to have acquired each of their replacement water entitlements before 20 September 1985. [Schedule 2, item 6, section 124-1125]

2.47 Assets acquired before 20 September 1985 are known as pre-CGT assets. Capital gains and capital losses realised on these assets are generally disregarded.

Example 2.11

Further to Example 2.9.

Assume Emma purchased her 100 Class A shares on 3 August 1984.

Emma exchanges her 100 Class A shares for a 100 ML statutory licence and 100 Class B shares.

As Emma's shares were acquired before 20 September 1985, she is taken to have acquired her statutory licence and each of her Class B shares before 20 September 1985.

Replacement of post-CGT water entitlements

2.48 If the taxpayer acquired their original water entitlement (or all of their entitlements) on or after 20 September 1985, then they will acquire each of their replacement water entitlements on the actual date of acquisition of those entitlements.

2.49 Assets acquired on or after 20 September 1985 are typically known as post-CGT assets.

2.50 However, for the purposes of the CGT discount, the ownership period of each of the replacement water entitlements includes the period of ownership of the original water entitlement(s) (see paragraph 2.100). [Schedule 2, item 2]

2.51 The taxpayer calculates the first element of the cost base of each replacement water entitlement on a reasonable basis having regard to:

•

the total cost bases of the original water entitlement(s);

•

the number and market value of the original entitlement(s); and

•

the number and market value of the replacement entitlement(s).

[Schedule 2, item 6, paragraphs 124-1120(1)(a) and (b) and (2)(a) to (c)]

2.52 Taxpayers should calculate the market values at the time of the relevant events. Division 116 sets out various principles for calculating these market values in different circumstances. [Schedule 2, item 6, subsection 124-1120(4)]

2.53 However, there is no need for the taxpayer to obtain a detailed valuation from a qualified valuer as to the relevant market values. Taxpayers may choose to obtain such a valuation. However, taxpayers may alternatively choose to calculate their own valuation based on reasonably objective and supportable data.

Example 2.12

Further to Example 2.9.

Dean also chooses to exchange his 100 Class A shares for a 100 ML statutory licence and 100 Class B shares. Assume each of Dean's 100 Class A shares has a cost base of $750. The total cost base of these shares is $75,000.

It would be reasonable for Dean to calculate the cost base of his statutory licence and his 100 Class B shares as follows.

At the time of exchange, Dean's replacement 100 ML statutory licence has a market value of $100,000. Each of Dean's Class B shares has a market value of $100. (The combined market value is $10,000.)

Based on these values, Dean's statutory licence represents 90.91 per cent of the total proceeds he receives (rounded to two decimal places). This is calculated as follows:

•

The value of the total proceeds received is $110,000; that is $100,000 (for the statutory licence) plus $10,000 (for the Class B shares).

•

The value of the statutory licence relative to the total proceeds is calculated by dividing the value of the statutory licence by the total value of the proceeds; that is $100,000 divided by $110,000.

The first element of the cost base of Dean's statutory licence is $68,183 (rounded to the nearest dollar). This is calculated as follows:

•

90.91 per cent of the $75,000 total cost base of the original 100 Class A shares is $68,183.

The 100 Class B shares that Dean receives represent the other 9.09 per cent of the total proceeds. Consequently the first element of the cost base of each of these shares is $68.18. This is calculated as follows:

•

9.09 per cent of the $75,000 total cost base of the original shares is $6,817.50.

•

$6,817.50 total cost base value divided by 100 shares is $68.18 (rounded to two decimal places).

2.54 In addition, if the taxpayer has to pay an amount (including giving other property) to acquire the replacement water entitlement or entitlements, then they can include that amount in the cost base of each replacement entitlement on a reasonable basis. [Schedule 2, item 6, paragraphs 124-1120(1)(c) and (2)(d)]

Example 2.13

Further to Example 2.12.

Assume Dean had to pay a $2,000 administrative fee to acquire the statutory licence. Dean includes this fee in the cost base of his replacement statutory licence.

Assuming Dean incurs no other costs in relation to the statutory licence, it has a cost base of $70,183. That is, the first element of $68,183 plus the second element of $2,000.

2.55 The first element of the reduced cost base of each of the replacement water entitlements is calculated in the same way, taking into account:

•

the total reduced cost bases of the original water entitlement(s);

•

the number and market value of the original entitlement(s);

•

the number and market value of the replacement entitlement(s); and

•

any amount (including other property) to acquire the replacement entitlement(s).

[Schedule 2, item 6, subsections 124-1120(3) and (4)]

Replacement of pre-CGT and post-CGT water entitlements

2.56 As the single entitlement roll-over applies on an asset-by-asset basis, only taxpayers who choose to apply the multiple entitlement roll-over will have a combination of pre-CGT and post-CGT water entitlements. [Schedule 2, item 6, subsection 124-1130(1)]

2.57 In these situations, the taxpayer calculates how many of the replacement water entitlement(s) will be taken to have been acquired prior to 20 September 1985 (pre-CGT) on a reasonable basis having regard to:

•

the number and market value of the original water entitlements; and

•

the number and market value of the replacement entitlement(s).

[Schedule 2, item 6, subsection 124-1130(2)]

Example 2.14

Further to Example 2.9.

Ben purchased 25 of his Class A shares in Liquid Water in 1984 and the remaining 75 Class A shares in 2000. The cost base of each of the post-CGT shares is $800.

Ben exchanges his 100 Class A shares for a 100 ML statutory licence and 100 Class B shares. At the time of this exchange, each of Ben's Class A shares has a market value of $1,000.

Ben's replacement 100 ML statutory licence has a market value of $90,000. Each of Ben's Class B shares has a market value of $100. (The combined market value is $10,000.)

Ben is taken to have acquired two statutory licences - one pre-CGT and the other post-CGT.

Reflecting the number and market value of his pre-CGT Class A shares, it would be reasonable for Ben to be taken to have acquired a 25 ML pre-CGT statutory licence and a 75 ML post-CGT statutory licence.

Similarly, Ben will be taken to have acquired 25 of his Class B shares pre-CGT.

2.58 The taxpayer then calculates the first element of the cost base of each replacement post-CGT water entitlement on a reasonable basis having regard to:

•

the total cost bases of the original post-CGT water entitlement(s); and

•

the number and market value of the replacement post-CGT entitlement(s).

[Schedule 2, item 6, paragraphs 124-1130(3)(a) and (b)]

Example 2.15

Further to Example 2.14.

It would be reasonable for Ben to calculate the first element of the cost base of his 75 ML (post-CGT) statutory licence as follows:

•

The total market value of all his replacement post-CGT water entitlements is $75,000. Of this, his 75 ML statutory licence has a market value of $67,500 and each of his 75 post-CGT Class B shares has a market value of $100 (and a combined market value of $7,500).

•

Consequently, his 75 ML represents 90 per cent of his total post-CGT proceeds. That is, $67,500 divided by $75,000.

•

Therefore, Ben apportions 90 per cent of the total cost base of his post-CGT Class A shares to the 75 ML statutory licence. The total cost base of his post-CGT Class A shares is $60,000. That is, 75 shares multiplied by an $800 cost base.

•

The first element of the cost base of Ben's 75 ML statutory licence is $54,000. That is, 90 per cent of $60,000.

It would be reasonable for Ben to calculate the first element of the cost base of each of his post-CGT Class B shares as follows:

•

Ben's post-CGT Class B shares represent 10 per cent of his total post-CGT proceeds.

•

Therefore, Ben apportions 10 per cent of the total cost base of his post-CGT Class A shares to the 75 Class B shares. The total cost base of his post-CGT Class A shares is $60,000.

•

The total cost base of the 75 Class B shares is $6,000.

•

The first element of the cost base of each of Ben's 75 Class B shares is $80. That is, a $6,000 total cost base divided by 75 shares.

2.59 In addition, if the taxpayer has to pay an amount (including giving other property) to acquire the replacement water entitlement(s), then they can include that amount in the cost base of the replacement entitlement on a reasonable basis. [Schedule 2, item 6, paragraph 124-1130(3)(c)]

2.60 The taxpayer calculates the first element of the reduced cost base of the replacement post-CGT water entitlement in the same way. [Schedule 2, item 6, subsection 124-1130(4)]

Reduction in water entitlements

2.61 A taxpayer may own a number of individual water entitlements that together form their total entitlement to water. This entitlement may include a conveyance loss component that the taxpayer never receives. Conveyance losses represent the water lost in the operator's network due to factors such as evaporation and seepage. There may be changes to the taxpayer's individual water entitlements to effectively remove this conveyance component that have no effect on the total amount of water the taxpayer is entitled to receive.

2.62 Although the taxpayer's remaining water entitlements effectively replace the taxpayer's original water entitlements, these transactions will not qualify for the replacement roll-over if the taxpayer does not acquire a replacement water entitlement. The reduction roll-over addresses this scenario.

2.63 This roll-over does not provide specific consequences for taxpayers who acquired all of their original water entitlements before 20 September 1985, as capital gains and capital losses realised on these assets are generally disregarded.

Qualifying transactions

2.64 A taxpayer who owns more than one water entitlement will qualify for the reduction roll-over if, under a single arrangement:

•

their ownership of at least one of the original water entitlements ends but they retain at least one of the original entitlements; and

•

the total market value of all the original entitlements is substantially the same as the retained entitlements.

[Schedule 2, item 6, section 124-1135]

2.65 Paragraphs 2.69 to 2.77 set out the consequences of this roll-over applying.

2.66 If there is a close nexus between particular elements of a broader transaction, then those elements form part of the same arrangement. Interrelated and interdependent transactions typically form a single arrangement. Typically transactions will be interrelated if they happen as part of achieving a broader objective. Alternatively, transactions will typically be interdependent if they are contingent on other transactions happening.

2.67 If the taxpayer is entitled to receive the same total amount of water following this reduction, then theoretically the sum of the remaining water entitlements' market values should be equal to the sum of the original water entitlements' market values. However, the substantially the same market value test recognises that there may be small changes in value simply arising as a result of the changes. It also allows for rounding and other small adjustments.

2.68 More significant changes in value will result in the taxpayer failing this test.

Example 2.16

River Irrigation Ltd (River Irrigation) is an operator that owns a statutory licence with a 100 GL entitlement to water. River Irrigation has 100 member irrigators, each with a contractual right to water. The size of this entitlement depends on the number of shares they own in River Irrigation. Each share in River Irrigation entitles its owner to 1 ML of water.

However, each member's contractual right to water includes a conveyance component of 20 per cent. Consequently, each member only receives up to 80 per cent of their contractual entitlement.

Julie, a member of River Irrigation, owns 500 shares (that she acquired in 1994) and consequently has a 500 ML entitlement to water. However, due to the conveyance component Julie only ever receives up to 400 ML of water.

River Irrigation reorganises its affairs and cancels 20 per cent of each member's shares on a pro-rata basis. River Irrigation, with the agreement of its member irrigators, also cancels each member irrigator's contractual right and reissues a new contractual right without a conveyance component. (This cancellation and reissue of the contractual rights qualifies for the replacement water entitlement roll-over.) These transactions ensure that each member's contractual entitlement and shareholding accurately reflects the amount of water they receive.

Julie is one of River Irrigation's member irrigators. Julie has her total water entitlement reduced to 400 ML through the cancellation of 100 shares. However, as Julie continues to receive the same amount of water, the total market value of Julie's original water entitlements is the same as her retained water entitlements.

Roll-over consequences

Disregard capital gain or capital loss attributed to retained entitlement

2.69 If the taxpayer satisfies the conditions for this roll-over, then they disregard any capital gains or capital losses arising from their ownership of the original water entitlement or entitlements ending. [Schedule 2, item 6, section 124-1140]

Example 2.17

Further to Example 2.16.

Julie disregards any capital gains or capital losses arising from the cancellation of her 100 shares.

Retained post-CGT entitlements

2.70 If the taxpayer acquired all of their original water entitlements on or after 20 September 1985, then they will have the following consequences for the cost base of their retained water entitlements.

2.71 The taxpayer calculates the first element of the cost base of each retained water entitlement on a reasonable basis having regard to:

•

the total cost bases of the original water entitlement(s);

•

the number and market value of the original entitlement(s); and

•

the number and market value of the retained entitlement(s).

[Schedule 2, item 6, subsections 124-1145(1) and (2)]

Example 2.18

Further to Example 2.17.

Each of Julie's 500 shares has a cost base of $500. Her total cost base is $250,000.

At the time of the cancellation, each of her shares has the same market value of $8,000.

It would be reasonable for Julie to calculate the first element of the cost base of each of her 400 retained entitlements by apportioning the total cost base of $250,000 over the 400 shares.

That is, $250,000 divided by 400 shares equals $625. As the total market value of the retained entitlements has not changed, Julie need only apportion the total cost base between her retained shares according to the number of shares.

The first element of the cost base of each of Julie's retained shares is $625.

2.72 Taxpayers need to calculate the market values at the time of the relevant events and, as noted in paragraph 2.52 according to the principles set out in Division 116. [Schedule 2, item 6, subsection 124-1145(4)]

2.73 The taxpayer calculates the reduced cost base of each retained water entitlement in the same way. [Schedule 2, item 6, subsection 124-1145(3)]

Retained pre-CGT and post-CGT entitlements

2.74 A taxpayer may have acquired some of their original water entitlements before 20 September 1985 and the remainder of their entitlements on or after 20 September 1985. [Schedule 2, item 6, subsection 124-1150(1)]

2.75 In these situations, the taxpayer calculates how many of the retained water entitlement(s) will be taken to have been acquired prior to 20 September 1985 (pre-CGT) on a reasonable basis having regard to:

•

the number and market value of the original water entitlements; and

•

the number and market value of the retained entitlement(s).

[Schedule 2, item 6, subsection 124-1150(2)]

2.76 The taxpayer then calculates the first element of the cost base of each retained post-CGT water entitlement on a reasonable basis having regard to:

•

the total cost bases of the original post-CGT water entitlement(s); and

•

the number and market value of the retained post-CGT entitlement(s).

[Schedule 2, item 6, subsection 124-1150(3)]

2.77 The taxpayer calculates the first element of the reduced cost base of each retained post-CGT water entitlement in the same way. [Schedule 2, item 6, subsection 124-1150(4)]

Consequential variations to other CGT assets

2.78 Transactions that qualify for the replacement roll-over may have consequential effects on other taxpayers. For example, one member of an operator may transform their water entitlements against their operator and this can affect the water entitlements of the operator and other members.

Qualifying transactions

2.79 A taxpayer that has a CGT event happen to any asset they own as a direct result of circumstances that qualify for the replacement roll-over will qualify for the variation roll-over when they continue to own the asset. [Schedule 2, item 6, section 124-1155]

Example 2.19

Further to Example 2.9.

Andy exchanges each of his 100 Class A shares in Liquid Water for a replacement 100 ML statutory licence and 100 Class B shares. As a result, Liquid Water's 800 ML statutory licence is reduced to 700 ML and it cancels Andy's 100 Class A shares.

This reduction arises as a direct result of Andy transforming his entitlement, an exchange that qualifies for the replacement entitlement roll-over.

As Liquid Water continues to own its statutory licence, it qualifies for the variation roll-over in respect of this reduction.

Roll-over consequences

Disregard capital gain or capital loss attributed to the retained asset

2.80 If the taxpayer satisfies the conditions for this roll-over, then they disregard any capital gains or capital losses arising from the CGT event happening. [Schedule 2, item 6, section 124-1160]

Example 2.20

Further to Example 2.19.

As Liquid Water does not receive any other proceeds, it disregards any capital gains or capital losses arising from this reduction.

Realise capital gain or capital loss attributed to ineligible proceeds

2.81 However, if the taxpayer receives proceeds other than their retained asset (ineligible proceeds), then they will realise a partial capital gain or capital loss in relation to those proceeds. [Schedule 2, item 6, subsection 124-1165(1)]

2.82 In this situation the taxpayer calculates a capital gain by attributing part of the cost base of the original asset to the ineligible proceeds they receive. The taxpayer may do this on a reasonable basis having regard to the market value of the retained asset relative to the market value of the ineligible proceeds. [Schedule 2, item 6, subsections 124-1165(2) and (4)]

2.83 The taxpayer calculates a capital loss by attributing part of the reduced cost base of the original asset to the ineligible proceeds they receive in the same way. [Schedule 2, item 6, subsections 124-1165(3) and (4)]

Termination fees

2.84 Typically, termination fees (and exit fees) are contractual fees imposed by one party on the other as a result of the second party breaking the contract.

2.85 An asset's cost base and reduced cost base consist of five elements. The second element consists of specific incidental costs that a taxpayer incurs in relation to the asset. These incidental costs are set out in section 110-35.

2.86 A taxpayer that incurs a termination or a similar fee (such as an exit fee) as a direct result of their ownership of an asset ending includes that fee in the second element of the asset's cost base and reduced cost base as an incidental cost. [Schedule 2, item 200]

Example 2.21

Linda enters a contract with Gold Property Development Ltd (Gold) to build a residential investment property for $500,000.

The contract provides that if Linda does not arrange the necessary approvals so that Gold can commence building within four months of signing the contract, the contract will be terminated and Linda must pay Gold a termination fee equal to 2 per cent of the contract price.

Six months later, Linda has still not arranged the necessary approvals. Her contract with Gold is terminated and she pays Gold a termination fee of $10,000 in accordance with the terms of the contract.

Linda includes the amount of the termination fee in the second element of the cost base and reduced cost base of the contract as an incidental cost.

2.87 The party that imposes a termination fee may impose that fee by withholding part of the proceeds due to the other party. In this situation the taxpayer that has to pay the termination fee cannot reduce their capital proceeds by the amount of the withheld fee.

2.88 In the context of the irrigation industry, a termination fee is typically any fee or charge payable to an operator for either terminating access or surrendering a water delivery right. The Water Charge Rules provide further information about these fees.

Example 2.22

Further to Example 2.12.

Dean sells his statutory licence to an irrigator outside Liquid Water's irrigation district and elects to terminate his access to Liquid Water's irrigation network, through the cancellation of his 100 Class B shares.

Liquid Water charges Dean a $5,000 termination fee to cancel his shares.

Dean includes the $5,000 fee in the cost base and reduced cost base of the shares as an incidental cost on a pro-rata basis. That is, $50 per share.

The first element of the cost base and reduced cost base of each share is $68.18. Assuming Dean incurs no other costs in relation to these shares, the second element of the cost base and reduced cost base is $50.

The cost base and reduced cost base of each share is $118.18.

2.89 Irrigators may choose to transform an irrigation right and subsequently trade their water entitlement and terminate their delivery entitlement. These subsequent transactions may occur at different times.

2.90 Should an irrigator wish to offset a capital gain they realise on the sale of their water entitlement with a capital loss they realise on their delivery entitlement, then they may wish to ensure that these transactions occur in the same income year. This is because taxpayers can offset existing and future capital gains with any realised capital losses. However, taxpayers cannot carry back capital losses to prior income years.

Application and transitional provisions

2.91 Part 1 applies to CGT events that happen in the 2005-06 and later income years. [Schedule 2, item 300]

2.92 However, once the amending legislation receives Royal Assent, taxpayers can choose not to obtain the roll-over if the relevant transactions qualifying for the roll-over happen in the period from the 2005-06 income year to the day that the amendments receive Royal Assent. [Schedule 2, subitems 305(1) and (2)]

2.93 If a taxpayer chooses not to obtain the roll-over, then they can make this choice within 12 months of the amendments receiving Royal Assent or within the time period set out in section 170 of the Income Tax Assessment Act 1936 (ITAA 1936). [Schedule 2, subitem 305(3)]

2.94 A taxpayer may choose not to obtain the roll-over in situations when they realise a capital loss from the relevant transactions.

2.95 Part 2 applies to CGT events happening on or after 1 July 2008. [Schedule 2, item 310]

2.96 However, once the amending legislation receives Royal Assent, taxpayers can choose not to include a termination or similar fee in the asset's cost base and reduced cost base if the relevant event happens in the period from 1 July 2008 to the day that the amendments receive Royal Assent. [Schedule 2, subitem 315(1)]

2.97 If a taxpayer chooses not to include the fee in the asset's cost base, then they can make this choice within 12 months of the amending legislation receiving Royal Assent or within the time period set out in section 170 of the ITAA 1936. [Schedule 2, subitem 315(2)]

Consequential amendments

2.98 A number of consequential amendments will be made to the ITAA 1997 to reflect the availability of the water entitlement roll-over in Subdivision 124-R.

2.99 References to this roll-over will be added to Subdivision 112-B. Subdivision 112-B lists situations when the general cost base and reduced cost base rules are modified. [Schedule 2, item 1]

2.100 A reference to the water entitlement roll-overs will be added to the table of replacement asset roll-overs in section 112-115. This ensures that the ownership period of a replacement water entitlement includes the period of ownership of the original entitlement for the purposes of the CGT discount. [Schedule 2, item 2]

2.101 References to Subdivision 124-R will be added to Division 124. [Schedule 2, items 3 to 5]

2.102 The definition of a 'water entitlement' will be inserted into section 995. [Schedule 2, item 7]

Chapter 3 - Amendments to the taxation of financial arrangements provisions

Outline of chapter

3.1 Part 1 of Schedule 3 to this Bill amends:

•

Division 230 of the Income Tax Assessment Act 1997 (ITAA 1997); and

•

the consequential and transitional provisions inserted by the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 (TOFA Act 2009).

3.2 Part 2 of Schedule 3 to this Bill extends the transitional arrangements relating to the application of the debt/equity rules made by the New Business Tax System (Debt and Equity) Act 2001 (Debt and Equity Act 2001) for Upper Tier 2 instruments to 1 July 2010, for instruments issued before 1 July 2001.

3.3 All references to legislative provisions in this chapter are references to the ITAA 1997 unless otherwise stated.

Context of amendments

3.4 The TOFA Act 2009, which received Royal Assent on 26 March 2009, inserted Division 230 into the ITAA 1997. Division 230 modernises the financial taxation system by better reflecting the economic and commercial substance of financial arrangements.

3.5 Division 230 applies for income years commencing on or after 1 July 2010, unless a taxpayer elects to apply the Division for income years commencing on or after 1 July 2009.

3.6 Division 230 represents a major legislative reform that affects a wide range of financial arrangements, including those of a complex nature. The amendments to Division 230, announced by the then Assistant Treasurer in Media Release No. 043 on 4 September 2009, follow the Government's monitoring of the implementation of this reform.

3.7 The Debt and Equity Act 2001 contains a transitional measure that allowed taxpayers to apply the tax rules prior to the introduction of Division 974 to instruments issued before 1 July 2001 (unless taxpayers elect to bring those instruments within the scope of Division 974).

Summary of new law

Amendments to Division 230 and the consequential and transitional provisions inserted by the TOFA Act 2009

3.8 The amendments to Division 230 and the consequential and transitional provisions inserted by the TOFA Act 2009 include:

•

minor policy refinements;

•

technical amendments to clarify and give better effect to the policy intention of Division 230; and

•

minor technical corrections to address drafting oversights.

3.9 These amendments mandatorily take effect for income years starting on or after 1 July 2010. The amendments take effect for income years starting on or after 1 July 2009, if an election is made to have the TOFA Act 2009 apply from that earlier time, except for items 95, 131 and 135 which have different commencement dates as set out in this Bill.

Minor policy and technical amendments

Core rules

3.10 This Schedule amends the scope of the term 'cash settlable', in respect of a financial arrangement, so that if a financial benefit is readily convertible into money or money equivalent and there is a market for the financial benefit that has a high degree of liquidity, then a right to receive, or an obligation to provide the financial benefit is cash settlable if:

•

the amount of the money, or money equivalent, in the hands of the entity who has the right to receive the financial benefit(s), is not subject to a substantial risk of substantial decrease in value; or

•

the purpose of entering into the arrangement, under which the financial benefit is received or provided, is to receive or provide the financial benefit to raise or provide finance, or so that the financial benefit may be liquidated or converted into money or money equivalent (other than as part of a taxpayer's expected purchase, sale or usage requirements).

3.11 This Schedule clarifies that a dividend on certain shares that are 'debt interests', as defined in Division 974, may be deductible in certain circumstances, consistent with the corresponding deductibility provision in section 25-85.

Accruals/Realisation

3.12 This Schedule clarifies that:

•

for the purposes of the accruals tax timing methodology in Subdivision 230-B, it is only that part of a financial benefit which is, at the relevant time, fixed or determinable with reasonable accuracy that is to be treated as 'sufficiently certain';

•

a pro-rata basis for attribution of a gain or loss in relation to the effective interest method or portfolio treatment of fees is not necessarily unreasonable; and

•

for the purposes of determining if a financial benefit is sufficiently certain, where all the financial benefits provided and received under a financial arrangement are in a particular foreign currency, they are not to be translated into Australian currency or a taxpayer's applicable functional currency.

Hedging

3.13 This Schedule ensures that:

•

a financial arrangement can qualify as a hedging financial arrangement where it hedges a risk in relation to multiple hedged items;

•

a hedging financial arrangement can exist where an arrangement that hedges a risk in relation to foreign currency is recorded as a hedging instrument in an entity's own financial reports; and

•

consequences arise where an entity ceases to have one or more, but not all, hedged items and provides reasonable attribution rules to ensure that appropriate gains and losses are brought to account when this occurs.

Foreign currency retranslation

3.14 This Schedule amends the foreign currency retranslation provisions to ensure that the wording of the provisions is consistent with the relevant accounting standards.

Scope and exceptions

3.15 This Schedule clarifies that:

•

an interest in a partnership or trust is subject to Division 230 where a fair value or reliance on financial reports election has been made. This is despite the fact that an interest in a partnership or trust is carved out of Division 230 for all other purposes; and

•

certain guarantees and indemnities, although subject to an exception to Division 230, are subject to Division 230 where a fair value or reliance on financial reports election has been made.

3.16 This Schedule amends the assets threshold test so that it applies to regulated superannuation funds and unregulated superannuation funds on the same basis.

Amendments to consequential and transitional amendments in the TOFA Act 2009

3.17 This Schedule makes the following technical amendments to the consequential and transitional amendments in the TOFA Act 2009 to:

•

put it beyond doubt that the net income of a transferor trust disregards Division 230;

•

modify the references to 'accounting standards' in Division 230 so that they extend to accounting standards formulated or made by the Australian Accounting Standards Board (AASB); and

•

modify the references to 'auditing standards' in Division 230 so that they encompass auditing standards formulated or made by the Auditing and Assurance Standards Board.

3.18 This Schedule reinstates the anti-overlap rule that ensures that the tax exempt asset financing provisions have priority over the capital gains tax (CGT) provisions.

3.19 This Schedule extends the application of the transitional provisions in the TOFA Act 2009 to include paragraph 230-165(1)(b). An entity can then apply the portfolio treatment of premiums and discounts, notwithstanding the entity held the financial arrangement prior to the income year in which an election was made under section 230-150.

Minor technical corrections

3.20 The minor technical corrections include:

•

correcting referencing, including the use of asterisks;

•

correcting typographical errors; and

•

re-inserting provisions which were incorrectly repealed by the TOFA Act 2009.

Amendments to transitional provisions in the Debt and Equity Act 2001

3.21 Part 2 of this Schedule extends the debt/equity transitional period to 1 July 2010 for Upper Tier 2 instruments that were issued before 1 July 2001, to allow transition to the proposed regulations that will facilitate the debt tax treatment of certain Upper Tier 2 instruments.

Comparison of key features of new law and current law

Detailed explanation of new law

Amendments to Division 230 and the consequential and transitional provisions inserted by the TOFA Act 2009

Minor policy and technical amendments

Core rules

Amendments to the definition of 'cash settlable' rights or obligations

3.22 This Schedule amends paragraph 230-45(3)(c) and inserts new subsections 230-45(4) and (5) so that if:

•

a financial benefit is readily convertible into money or money equivalent; and

•

there is a market for the financial benefit that has a high degree of liquidity; and

-

the amount of the money or money equivalent that the financial benefit(s) can be converted into is not subject to a substantial risk of substantial decrease in value (for example, the investment amount is guaranteed) in the hands of the entity who has the right to receive the financial benefit(s) [Schedule 3, item 7, subsection 230-45(4)] ; or

-

the taxpayer's purpose for entering into the arrangement (under which the financial benefit is to be provided or received) is to receive or deliver the financial benefit either:

•

to raise or provide finance; or

•

in other situations, so that it may be liquidated or converted into money or money equivalent (other than as part of the taxpayer's expected purchase, sale or usage requirements) [Schedule 3, item 7, subsection 230-45(5)],

then a right to receive, or an obligation to provide the financial benefit, is cash settlable under paragraph 230-45(2)(f).

3.23 Section 230-45 defines 'financial arrangement' for the purposes of Division 230. Central to the meaning of 'financial arrangement' is the definition of 'cash settlable' rights or obligations in subsection 230-45(2). Subsection 230-45(3), together with either subsection 230-45(4) or (5), seeks to bring within the scope of 'cash settlable' rights or obligations, a right to receive, or an obligation to provide, a certain type of financial benefit that is not in a formal sense money or money equivalent but is money-like.

3.24 One way in which a financial benefit is considered to be money-like is where, in broad terms:

•

it is convertible to money or money equivalent;

•

it is liquid; and

•

its value in monetary terms is not subject to a substantial risk of substantial decrease in value.

3.25 As indicated above, a right to receive, or an obligation to provide, a financial benefit which is liquid and convertible into money is 'cash settlable' if the recipient of the financial benefit(s) is entitled to receive at least a predetermined money equivalent amount of the financial benefit(s). An example of this would be a right to receive $100 worth of Big Bank shares. In this case, while the Big Bank shares are not money or money equivalent and the right to receive and the obligation to provide Big Bank shares are not to be settled in money or money equivalent, the monetary value of the financial benefits is at least $100. Assuming that the Big Bank shares are readily convertible into money and there is a liquid market for Big Bank shares, the right to receive or the obligation to provide $100 of Big Bank shares is economically akin to a right to receive, or an obligation to provide, $100.

3.26 These amendments provide that a right or obligation is 'cash settlable' if the value to the recipient of relevant cash-convertible, liquid financial benefits is not subject to a substantial risk of substantial decrease in value. Consistent with ordinary tax principles, the assessment of this risk should be done in nominal terms. [Schedule 3, item 7, subsection 230-45(4)]

3.27 These amendments seek to address, among other things, uncertainty about whether the rights and/or obligations under certain deferred purchase agreements are 'cash settlable'. The intention of the amended definition is to ensure that substantially capital protected deferred purchase agreements are 'cash settlable' financial arrangements. It also clarifies that convertible and similar instruments will generally be financial arrangements. More broadly, it is consistent with the notion that in substance debt, even with upside potential (whether through convertibility or otherwise), should as a general principle be treated as a financial arrangement.

Example 3.1 : Deferred purchase agreement - capital protected

AEHR Co pays $10,000 to enter into an investment product, commonly referred to as a deferred purchase agreement, issued by Big Bank, on 1 July 2011. The terms of the deferred purchase agreement entitles AEHR Co to an unspecified number of shares in Edward Finance Co. They are deliverable on 30 June 2015. Assume that Edward Finance Co shares are listed on the Australian Securities Exchange (ASX) and the market for them has a high degree of liquidity.

Under the terms of the deferred purchase agreement, AEHR Co is entitled to receive, on 30 June 2015, 95 per cent of the initial investment (the $10,000) in the form of Edward Finance Co shares. This is the basis of the capital protection. AEHR Co is entitled to a further amount, the value of which is contingent on changes in the level of a nominated market index over the term of the deferred purchase agreement. Thus AEHR Co receives shares in Edward Finance Co at least equal in value to $9,500.

The requirements in subsections 230-45(3) and (4) are satisfied for both Big Bank and AEHR Co as Edward Finance Co shares are readily convertible into money, the market for Edward Finance Co shares is highly liquid and the financial benefits AEHR Co is entitled to receive under the arrangement are not subject to a substantial risk of substantial decrease in value. As such, AEHR Co's right to receive, and Big Bank's obligation to provide, the Edward Finance Co shares are 'cash settlable' rights and obligations.

Example 3.2 : Convertible note

On 1 January 2011 Nourt Co issued a converting note to Nanfam Co, with a face value of $1,000 maturing on 31 December 2019. The convertible note entitles Nanfam Co to annual payments of 10 per cent of the face value. At maturity the note will convert into shares in Nourt Co. Assume that shares in Nourt Co are listed on the ASX and the market for them is highly liquid.

Nanfam Co's right to receive shares in Nourt Co is a cash settlable right. The requirements in subsections 230-45(3) and (4) are satisfied as Nourt Co shares are readily convertible into money, the market for them is highly liquid and the value of the financial benefits Nanfam Co will receive under the arrangement (that is, $1,000 of Nourt Co shares) is not subject to a substantial risk of substantial decrease in value.

3.28 A right to receive, or an obligation to provide a cash convertible and liquid financial benefit is also 'cash settlable' if the taxpayer's purpose for entering into the arrangement (under which the financial benefits are to be provided or received) is to either:

•

raise or provide finance; or

•

receive or deliver the financial benefit, so they it may be converted into money or money equivalent (other than as part of the taxpayer's expected purchase, sale or usage requirements).

3.29 These amendments are intended to cover cash convertible and liquid financial benefits that are not money-like as described above, but are intended to be used by taxpayers in a money-like manner.

3.30 That is, a financial benefit such as a commodity can be considered to be money-like in certain situations. One such situation would be where the financial benefit meets the convertibility and liquidity criteria in paragraphs 230-45(3)(a) and (b), and the purpose of obtaining the financial benefit is to convert it into money, other than as part of the taxpayer's purchase, sale or usage requirements. That is, while the financial benefit in this case is not in the form of money, the dealing in it is money-like.

3.31 Similarly, the receipt of a cash-convertible and liquid commodity could be used to raise finance and thereby be used in a money-like way. So a right to receive, or an obligation to provide financial benefits which are convertible into money, is cash settlable if the purpose of the financial arrangement under which the financial benefits are to be provided or received is financing. In such a situation, the financial benefits are intended to be liquidated or converted into money or money equivalent in a liquid market or otherwise to be used as money or money equivalent. [Schedule 3, item 7, paragraph 230-45(5)(a)]

Example 3.3 : Gold loan

GI & L Co, a mining company, seeks to expand its operations. To finance this, the company enters into an arrangement under which it borrows 100 ounces of gold from Avlis Co with an agreement to repay 120 ounces in two years time. For GI & L Co, this arrangement consists of a right to receive 100 ounces of gold and an obligation to provide 120 ounces of gold.

The right to receive, and the obligation to provide, the gold are cash settlable. The requirements in subsection 230-45(3) are satisfied as the gold is readily convertible into money, there is a market for the gold which has a high degree of liquidity and paragraph 230-45(5)(a) is satisfied as the arrangement is for the purpose of obtaining finance.

3.32 A right to receive, or an obligation to provide, financial benefits which are convertible into money, is cash settlable if the purpose of the financial arrangement under which the financial benefits are to be provided or received is to receive or deliver the financial benefits so that they may be converted into money or money equivalent (other than as part of the taxpayer's ordinary business requirements). [Schedule 3, item 7, paragraph 230-45(5)(b)]

3.33 Depending on the purpose of the parties to a transaction, a right to receive, or an obligation to provide financial benefits, which may be converted into money, may be cash settlable for one party but not the other. From the recipient's perspective, for the right to receive the financial benefit (assuming it meets the convertibility criterion) to be cash settlable, the recipient's purpose for receiving the financial benefit has to be to convert the financial benefit obtained into money or money equivalent and the conversion is not to satisfy the recipient's ordinary business requirements. From the provider's perspective, for the obligation to provide the financial benefit to be cash settlable, the provider's purpose of delivering the financial benefit has to be that the financial benefit may be converted into money or money equivalent and the conversion is not part of the provider's ordinary business requirements.

Example 3.4 : Derivatives

RI & CE Co, a wheat company, enters into a deliverable forward contract to acquire 50 ounces of gold in one year for $50,000. The contract provides that it must be settled by way of delivery of the gold.

The right to receive the gold in one year's time is a cash settlable right for RI & CE Co. The requirements in subsection 230-45(3) are satisfied as the gold is readily convertible into money, the market for gold is highly liquid and paragraph 230-45(5)(b) will be satisfied if the purpose of the arrangement for RI & CE Co is to receive the gold in order to convert it into money and not as part of its expected purchase, sale or usage requirements.

Deductibility of dividends on debt interests

3.34 Subsection 230-15(4) is intended to broadly reflect the effect of section 25-85 in respect of financial benefits provided or received under financial arrangements that are debt interests. However, there have been doubts as to whether legal form dividends from debt interests can be deductible under Division 230, given the absence of a rule that replicates subsection 25-85(3). Subsection 25-85(3) allows for deductibility of such dividends in certain circumstances.

3.35 Accordingly, this Schedule inserts a new subsection 230-15(4A) to allow, under certain conditions, for the deductibility of a dividend to the extent that it would have been a deductible loss under subsection 230-15(2). The timing of the deductibility is to be determined in accordance with Division 230 [Schedule 3, item 6, subsection 230-15(4A)] . The conditions are that:

•

the payment of the amount of the dividend were the incurring of a liability to pay the same amount as interest [Schedule 3, item 6, paragraph 230-15(4A)(a)] ;

•

the interest was incurred in respect of the finance raised by the taxpayer and in respect of which the dividend was paid or provided [Schedule 3, item 6, paragraph 230-15(4A)(b)] ; and

•

the debt interest retains its character as a debt interest for the purposes of subsection 230-15(4). In other words, the interest continues to satisfy the debt interest test in section 974-20 [Schedule 3, item 6, paragraph 230-15(4A)(c)] .

Accruals/Realisation

Allowing financial benefits to be sufficiently certain to an extent

3.36 This Schedule amends subsection 230-115(1) so that, in deciding whether it is sufficiently certain at a particular time that a taxpayer will make a gain or loss from a financial arrangement, regard should be had only to financial benefits that the taxpayer is sufficiently certain to receive or provide, to the extent that the amount or value of the benefit is, at that time, fixed or determinable with reasonable accuracy. [Schedule 3, item 11, subsection 230-115(1)]

3.37 These amendments clarify that, for the purposes of Subdivision 230-B, a financial benefit can be sufficiently certain even if not all of the financial benefit is, at the relevant time, fixed or determinable with reasonable accuracy. To the extent that only part of the financial benefit is, at the relevant time, fixed or determinable with reasonably accuracy, only that part is treated as sufficiently certain.

Example 3.5 : Financial benefits sufficiently certain to an extent

Investor Co has an investment that is a Division 230 financial arrangement under which it has a right to a financial benefit, the amount of which is fixed at $100, with a further amount of between $0 and $30 that is wholly dependent on the profits of a company.

For the purpose of subsection 230-115(2), assume that:

•

it is reasonably expected that Investor Co will receive the financial benefit (assuming that it continues to have the financial arrangement for the rest of its life); and

•

at least some of the amount or value of the benefit, namely the $100 (and only the $100), is fixed or determinable with reasonable accuracy.

Accordingly, the financial benefit is one that Investor Co is sufficiently certain to receive.

Subsection 230-115(1) provides that, for the purpose of deciding whether it is sufficiently certain that Investor Co will make a gain from the financial arrangement, only $100 is to be taken into account.

Pro-rata attribution of gain or loss not necessarily unreasonable for accruals

3.38 When the effective interest method is used in applying the compounding accruals tax timing methodology but the taxpayer's income year and financial reporting year are different, section 230-145 allows the results from more than one audited financial report that covers the income year to be attributed - using a reasonable methodology - to the income year.

3.39 While pro-rata attribution is not appropriate for the fair value, retranslation and reliance on financial reports elections (because of the unsystematic nature of the gains and losses that they cover), a pro-rata basis for attribution of an accruals methodology may be reasonable, particularly if the methodology uses straight-line accruals appropriately. This Schedule repeals subsection 230-145(5) so that for the purposes of paragraph 230-145(4)(a), a methodology that attributes the gain or loss on a pro-rata basis is not necessarily unreasonable. [Schedule 3, item 14, subsection 230-145(5)]

Pro-rata attribution of portfolio treatment of fees not necessarily unreasonable

3.40 In a similar vein to the repeal of subsection 230-145(5), subsection 230-155(5) is repealed so that, for the purposes of paragraph 230-155(4)(a), a methodology that attributes the portfolio treatment of fees on a pro-rata basis is not necessarily unreasonable. [Schedule 3, item 21, subsection 230-155(5)]

Foreign currency arrangements

3.41 This Schedule amends subsection 230-115(8) so that where all the financial benefits under a financial arrangement are denominated in a particular foreign currency they are not to be translated into Australian currency for the purpose of determining whether the financial benefits are sufficiently certain, even if the taxpayer does not have an applicable functional currency. This ensures that the law gives effect to the original policy intention of the subsection. [Schedule 3, item 12, subsection 230-115(8)]

Hedging

Enabling one hedging financial arrangement to hedge more than one hedged item

3.42 This Schedule inserts 'or items' after 'hedged item' in paragraph 230-335(1)(a). This amendment is made to remove doubt about whether the tax hedge rules in Subdivision 230-E can apply when multiple hedged items are hedged by a single hedging financial arrangement. The intention is that they can (subject to the various requirements of Subdivision 230-E being satisfied) apply in this situation. This amendment is intended to provide clarity for this paragraph only and is not intended to affect the interpretation of the rest of Division 230. [Schedule 3, item 65, paragraph 230-335(1)(a)]

Hedged item recorded in own financial reports

3.43 This Schedule inserts 'your financial report or' before 'the financial report of a consolidated entity' in subparagraph 230-335(1)(c)(ii). [Schedule 3, item 68, subparagraph 230-335(1)(c)(ii)]

3.44 This amendment ensures that the hedging item is, as intended, able to be recorded in an entity's own financial reports.

Circumstances where an entity ceases to have one or more but not all hedged items

3.45 This Schedule inserts 'events' into the table in section 230-305 where the entity ceases to have some, but not all, of the hedged items. These events are:

•

the entity ceases to have one or more, but not all, of the hedged items;

•

the entity ceases to expect that one or more, but not all, of the hedged items will come into existence; or

•

the entity ceases to expect that the entity will have one or more, but not all, of the hedged items.

[Schedule 3, item 54, section 230-305 (after item 2 in the table)]

3.46 These amendments ensure that the allocation of gain or loss from a hedging financial arrangement as worked out under subsection 230-300(5) occurs where these events occur. [Schedule 3, items 50 and 52, subsections 230-300(5) and (11)]

3.47 Amendments are also made to section 230-305 to require that the gain or loss from a hedging financial arrangement is attributed, on a reasonable basis, to a particular hedged item that the hedging financial arrangement hedges. [Schedule 3, items 53 and 55, section 230-305]

3.48 The extent to which the gain or loss from a hedging financial arrangement, as worked out under subsection 230-300(5), is reasonably attributable to a particular hedged item that the hedging financial arrangement hedges, must be determined on a reasonable and objective basis, having regard to the following:

•

the fair value of the particular hedged item;

•

the length of time the entity has held the hedged item;

•

commercially accepted valuation principles; and

•

any other relevant factors.

Example 3.6

An entity that has a 30 June income year acquires a floating rate loan portfolio on 1 July 2015. The entity enters into a 10 year interest rate swap in order to hedge the interest rate risk in relation to the loans in the portfolio. At that time, the swap has a nil value.

The portfolio has two loans, one worth $900,000 and the other one worth $100,000.

On 1 July 2020, the entity disposes of the loan that is worth $100,000. At that time, the interest rate swap has a fair value of $10,000.

On 1 July 2022, the entity disposes of the swap for its fair value of $30,000.

On 1 July 2020, the gain from the swap as worked out under subsection 230-300(5) is its fair value at the time, that is, $10,000. In the absence of other factors relevant to subsection 230-300(5), it would be reasonable to attribute 10 per cent of the gain ($1,000) to the loan being disposed of, given the relative values of the loans in the portfolio.

3.49 The gain or loss that is reasonably attributable to the one or more hedged items being disposed of is allocated to the income year in which the event occurs, and the gain or loss that is reasonably attributable to the remaining hedged item or items is allocated over income years according to the basis determined under subsection 230-360(1).

3.50 The above amendments make subsection 230-300(6) redundant as the situation in which a taxpayer ceases to have one or more, but not all, of the hedged items, is dealt with by the above amendments. As such, the regulation-making power is no longer needed. [Schedule 3, item 51, subsection 230-300(6)]

Foreign currency retranslation

Ensuring consistency with accounting standards

3.51 This Schedule amends the wording of some provisions to ensure consistency with the Australian Accounting Standards (AAS) and the equivalent International Accounting Standards. The following changes are made:

•

the words 'an amount in profit' in subsection 775-305(2) are replaced by the words 'an amount of gain in profit or loss' [Schedule 3, item 127, subsection 775-305(2)] ; and

•

the words 'an amount in loss' in subsection 775-305(3) are replaced by the words 'an amount of loss in profit or loss' [Schedule 3, item 128, subsection 775-305(3)] .

Exceptions

Asset test applies to both regulated and unregulated superannuation funds

3.52 This Schedule amends subparagraph 230-445(1)(a)(ii) to ensure that the asset threshold test in subsection 230-455(2) applies to both regulated and non-regulated superannuation funds on the same basis. [Schedule 3, items 5 and 106, subparagraphs 230-5(2)(a)(ii) and 230-455(1)(a)(ii)]

3.53 Section 230-455 provides that Division 230 does not apply to the financial arrangement gains or losses of certain taxpayers.

3.54 One such exclusion is contained in subparagraph 230-455(1)(a)(ii) and relates to superannuation entities.  The exclusion applies where the value of a superannuation entity's assets for an income year is less than $100 million.

3.55 Section 10 of the Superannuation Industry (Supervision) Act 1993 defines a superannuation entity as a regulated superannuation fund or an approved deposit fund or a pooled superannuation trust. A regulated superannuation fund has the meaning given by section 19 of the Superannuation Industry (Supervision) Act 1993. A non-regulated superannuation fund is not covered by this definition. Therefore, the non-regulated fund's financial arrangement gains or losses are excluded from Division 230 essentially if:

•

the value of the entity's aggregated turnover is less than $100 million;

•

the value of its financial assets is less than $100 million; and

•

the value of its assets is less than $300 million.

3.56 Without these amendments, a non-regulated superannuation fund is therefore excluded from Division 230 if the value of the entity's assets is less than $300 million. This is anomalous where the comparable threshold for regulated superannuation funds is $100 million.

3.57 Accordingly, the threshold test that applies to regulated superannuation funds is extended so that it also applies to non-regulated superannuation entities.

Interests in partnerships and trusts subject to fair value or financial reports elections are Division 230 financial arrangements

3.58 This Schedule amends subsection 230-460(4) to correct an anomaly that prevents the subsection from operating as intended.

3.59 By subsection 230-460(3), Division 230 does not apply to gains and losses from specified interests in a partnership or trust. This means that such interests are not Division 230 financial arrangements.

3.60 Subsection 230-460(4) is intended to be a carve-out to the subsection 230-460(3) exception. Subsection 230-460(4) is intended to allow the fair value election or the election to rely on financial reports to apply to an otherwise excluded interest in a partnership or trust. However, for either election to apply, the financial arrangement has to be a Division 230 financial arrangement. The carve-out to the exception cannot operate as such interests are not Division 230 financial arrangements.

3.61 To correct this anomaly and to enable the original intention of subsection 230-460(4) to be restored, this Schedule amends subsection 230-460(4) to allow a taxpayer to assume that the financial arrangement is a Division 230 financial arrangement for the purposes of subsection 230-460(4). If the fair value election or the election to rely on financial reports applies to the entity, subsection 230-460(3) does not apply to the financial arrangement. [Schedule 3, item 108, subsection 230-460(4)]

Guarantees and indemnities subject to fair value or financial reports elections are Division 230 financial arrangements

3.62 Similar to the above situation in relation to subsection 230-460(4), subsection 230-460(8) operates so that Division 230 does not apply to the gains and losses from a financial arrangement in relation to a right or obligation under a guarantee or indemnity. As such, the financial arrangement is not a Division 230 financial arrangement.

3.63 Paragraph 230-460(8)(a) is intended to be a carve out to the exception in subsection 230-460(8). Paragraph 230-460(8)(a) allows the fair value election or the election to rely on financial reports to apply to an otherwise excluded guarantee or indemnity. However, for either election to apply, the financial arrangement has to be a Division 230 financial arrangement. Paragraph 230-460(8)(a) is amended so that the guarantee or indemnity is assumed to be a Division 230 financial arrangement for the purposes of paragraph 230-460(8)(a). [Schedule 3, item 109, paragraph 230-460(8)(a)]

Amendments to consequential and transitional amendments in the TOFA Act 2009

Anti-overlap rule for tax exempt asset financing

3.64 This Schedule reinstates the effect of the previous section 118-27 so as to give priority to Subdivision 250-E (relating to tax exempt asset financing) over the CGT provisions. At the same time, the effect of the new section 118-27 is retained. [Schedule 3, items 3 and 4, section 118-27(heading) and subsection 118-27(4)]

3.65 The original section 118-27 was an anti-overlap provision which ensured that there was no double counting between financial arrangements to which both Subdivision 250-E and the CGT provisions apply.

3.66 Item 76 of the TOFA Act 2009 repealed section 118-27 and replaced it with a new one that deals with Division 230 financial arrangements only. As a consequence there is now the potential for overlap between Subdivision 250-E and the CGT provisions. The amendments remove this overlap.

Amendments to 'accounting standards' references

3.67 This Schedule changes all references to 'accounting standards' and related references in Division 230 to 'accounting principles' and related references.

3.68 The term 'accounting standards' is defined in subsection 995-1(1), to have the same meaning as under the Corporations Act 2001 (Corporations Act). Section 9 of the Corporations Act limits accounting standards to those the AASB makes for the purposes of the Corporations Act. However, the Australian Securities and Investments Commissions Act 2001 (ASIC Act) provides for the AASB to formulate accounting standards for 'other purposes'. As these standards do not fall within the definition of 'accounting standards' in the Corporations Act, they do not satisfy the definition of 'accounting standards' for the purposes of Division 230.

3.69 AAS 25 is such a standard, and is therefore not an accounting standard within the meaning of Division 230 without these amendments. AAS 25 is, however, the standard used by superannuation funds that are reporting entities, to prepare their financial reports. Consequently, the superannuation funds that use AAS 25 are unable to make elections under Division 230 that depend on the entity preparing a financial report in accordance with the accounting standards.

3.70 The definition of 'accounting principles' was introduced in the Tax Laws Amendment (2010 Measures No. 1) Act 2010 and is defined in subsection 995-1(1) to include accounting standards and other authoritative pronouncements of the AASB. This Schedule amends the Tax Laws Amendment (Measures No. 1 2010) Act 2010 to ensure that the definition of 'accounting principles' applies from the commencement of the TOFA Act 2009. [Schedule 3, item 132, subsection 2(1) (item 11 in the table) of the Tax Laws Amendment (2010 Measures No. 1) Act 2010]

3.71 Amendments are made to Division 230 to replace various references to 'accounting standards' with references to 'accounting principles'. These amendments are:

•

'accounting standards' are replaced with 'accounting principles' [Schedule 3, items 15, 22, 26, 27, 34, 41, 56, 57, 58, 73, 74, 75, 77, 80, 83, 92, 107, 113, 119 and 122, subparagraphs 230-150(1)(a)(i) and 230-185(2)(e)(i), subsection 230-190(8), subparagraphs 230-210(2)(a)(i), 230-220(1)(c)(i) and 230-255(2)(a)(i), subsection 230-310(4), paragraph 230-310(5)(a), subparagraph 230-315(2)(a)(i), paragraphs 230-335(10)(c) to (e), and 230-355(1)(b), subparagraph 230-365(c)(i), 230-395(2)(a)(i) and 230-410(1)(d)(i), paragraphs 230-455(5)(b) and 230-500(a), subparagraphs 230-530(3)(d)(i) and 230-530(4)(e)(i)] ;

•

'those standards' are substituted by 'the accounting principles' [Schedule 3, items 16, 23, 28, 35, 42, 59, 84, 93, 120 and 123, subparagraphs 230-150(1)(a)(ii), 230-185(2)(e)(ii), 230-210(2)(a)(ii), 230-220(1)(c)(ii), 230-255(2)(a)(ii), 230-315(2)(a)(ii ), 230-395(2)(a)(ii), 230-410(1)(d)(ii), 230-530(3)(d)(ii) and 230-530(4)(e)(ii)] ; and

•

'comparable accounting standards' are substituted by 'comparable standards for accounting' [Schedule 3, items 17, 24, 29, 36, 43, 60, 85, 94, 121 and 124, subparagraphs 230-150(1)(a)(ii), 230-185(2)(e)(ii), 230-210(2)(a)(ii), 230-220(1)(c)(ii), 230-255(2)(a)(ii), 230-315(2)(a)(ii), 230-395(2)(a)(ii), 230-410(1)(d)(ii), 230-530(3)(d)(ii) and 230-530(4)(e)(ii)] .

3.72 The amendments broaden the definition so that superannuation funds can make Division 230 elections.

Amendments to 'auditing standards' references

3.73 Similar to the above paragraphs, the term 'auditing standards', as defined in subsection 995-1(1), is confined only to auditing standards that are made under the Corporations Act. However, the ASIC Act also confers power to the Auditing and Assurance Standards Board to formulate auditing and assurance standards for 'other purposes' not included in the Corporations Act.

3.74 Auditing Standard ASA 300 is an auditing standard prepared under the power given to the Auditing and Assurance Standards Board in section 227B of the ASIC Act, to formulate auditing and assurance standards for 'other purposes'. Therefore, it is not an auditing standard to which the definition in subsection 995-1(1) applies.

3.75 This Schedule inserts a new definition of 'auditing principles' in subsection 995-1(1) which includes 'auditing standards' and other authoritative pronouncements of the Auditing and Assurance Standards Board. [Schedule 3, item 129, subsection 995-1(1)]

3.76 Amendments are made to Division 230 to replace various references to 'auditing standards' with references to 'auditing principles'. These amendments are:

•

'auditing standards' are replaced with 'auditing principles' [Schedule 3, items 18, 19, 30, 31, 44, 45, 61, 62, 86, 87 and 114, subparagraphs 230-150(1)(b)(i) and (ii), 230-210(2)(b)(i) and (ii), 230-255(2)(b)(i) and (ii), 230-315(2)(b)(i) and (ii), 230-395(2)(b)(i) and (ii) and paragraph 230-500(b)] ; and

•

'comparable auditing standards' are replaced by 'comparable standards for auditing' [Schedule 3, items 20, 32, 46, 63 and 88, subparagraphs 230-150(1)(b)(ii), 230-210(2)(b)(ii), 230-255(2)(b)(ii), 230-315(2)(b)(ii) and 230-395(2)(b)(ii)] .

3.77 The amendments are intended to broaden the definition so that superannuation funds can make Division 230 elections.

3.78 Consequential to the above amendments, the following amendments are also made:

•

'Australian accounting and auditing standards' are substituted by 'Australian accounting and auditing principles' to reflect the intentions outlined above [Schedule 3, items 33, 47, 64 and 89, subsections 230-210(2) (note), 230-255(2)(note), 230-315(2)(note) and 230-395(2)(note 1)] ;

•

'those standards' are replaced with 'those principles or standards'; 'the standards' are replaced with 'the principles or standards'; and 'standards' are replaced with 'principles or standards' [Schedule 3, items 25, 37 to 40, 66, 69 to 72, 78, 79, 81, 90, 91, 96, 99 to 104 and 112, paragraphs 230-185(2)(e), 230-230(1)(a) to (c), subsection 230-230(3), paragraph 230-335(1)(b), subparagraph 230-335(3)(c)(i), paragraph 230-335(5)(b), subsections 230-335(8) and (9), subparagraph 230-355(5)(a)(ii), paragraphs 230-365(a) and (c) and 230-405(2)(a) and (b), subsection 230-410(2), paragraphs 230-420(1)(a) to (c), subsection 230-420(3), paragraphs 230-430(4)(a) and (c) and 230-495(1)(d)] ; and

•

the heading to section 230-495 is amended and 'the relevant standards' in paragraph 230-495(1)(b) is replaced by 'the relevant principles or standards' [Schedule 3, items 110 and 111, section 230-495 (heading), paragraph 230-495(1)(b)] .

Net income of a transferor trust disregards Division 230

3.79 To put the matter beyond doubt, this Schedule amends subsection 102AAW(2) of the Income Tax Assessment Act 1936 (ITAA 1936) to ensure that Division 230 is disregarded for the purposes of the transferor trust provisions in Division 6AAA of Part III of the ITAA 1936. [Schedule 3, items 1 and 2, paragraphs 102AAW(2)(a) and (b) of the ITAA 1936]

Transitional election for portfolio discounts and premiums

3.80 This Schedule amends the transitional provisions in the TOFA Act 2009 to allow a taxpayer to make an election for portfolio treatment of fees, discounts and premiums in relation to pre-existing financial arrangements provided certain conditions are satisfied.

3.81 Under section 230-150, an entity can make an election under that section if it satisfies the requirements of that section. The effect of making such an election is that the entity satisfies both paragraphs 230-160(1)(a) and 230-165(1)(a) so that it can use the portfolio treatment of fees as per section 230-160 and premiums and discounts as per section 230-165.

3.82 An additional requirement in paragraphs 230-160(1)(b) and 230-165(1)(b) is that the entity must have started to have the financial arrangement that is the subject of the portfolio treatment in the income year in which the election is made, or a subsequent income year. In other words, the portfolio treatment of fees, discounts and premiums can only apply in relation to financial arrangements that entities start to have in the income year in which they make the election or subsequent income years.

3.83 Subitem 104(7) of the TOFA Act 2009 provides an exception to the above requirement. Subitem 104(7) is intended to have the effect of allowing entities that have made an election under section 230-150 to apply the portfolio treatment of fees, premiums and discounts in relation to financial arrangements they started to have prior to the income year in which the election is made, notwithstanding the limitation in paragraphs 230-160(1)(b) and 230-165(1)(b). A technical amendment to insert paragraph 230-165(1)(b) is needed to achieve the intended outcome. [Schedule 3, item 133, subitem 104(7) of Schedule 1 to the TOFA Act 2009]

3.84 This Schedule also inserts a new provision in item 104 of the TOFA Act 2009 to provide that an election made under section 230-150 extends to a financial arrangement that the entity started to have in the income years preceding the making of the election only if:

•

the election is made on or before the entity's first lodgement date that occurs after the start of the first Division 230 applicable income year;

•

the requirements in subsection 230-160(3) or 230-165(3) are satisfied, at the time of making the election; and

•

the requirements in subsection 230-160(4) or 230-165(4) are satisfied at, or soon after the time, the election is made.

[Schedule 3, item 134, subitem 104(7A) of Schedule 1 to the TOFA Act 2009]

3.85 These amendments ensure that the transitional arrangements for the application of portfolio treatment of fees, premiums and discounts are consistent with the rest of the transitional arrangements and are consistent with the integrity measures in sections 230-160 and 230-165.

Minor technical corrections

Amendments to correct asterisks in various provisions

3.86 This Schedule removes asterisks in front of terms that are not defined in section 995-1 and inserts asterisks where the term is defined but no asterisk was inserted by the TOFA Act 2009.

3.87 The word 'cease' is not defined in section 995-1. This Schedule removes the asterisks in front of 'cease', 'ceases' and 'ceasing' in:

•

paragraph 230-70(1)(b);

•

paragraph 230-75(1)(b);

•

paragraph 230-110(1)(c);

•

subparagraph 230-130(5)(b)(ii); and

•

subsection 230-435(5).

[Schedule 3, items 8 to 10, 13 and 105, paragraph 230-70(1)(b), 230-75(1)(b) and 230-110(1)(c), subparagraph 230-130(5)(b)(ii), and subsection 230-435(5)]

3.88 The term 'foreign currency' is defined in section 995-1. This Schedule inserts an asterisk in front of 'foreign currency' in subsection 230-115(8), subparagraph 230-335(1)(c)(ii) and subsection 230-530(1). [Schedule 3, items 12, 67 and 118, subsection 230-115(8), subparagraph 230-335(1)(c)(ii) and subsection 230-530(1)]

3.89 The term 'direct value shift' is defined in section 995-1. This Schedule amends the asterisked reference in paragraph 230-520(1)(b) from value shift to 'direct value shift'. [Schedule 3, item 115, paragraph 230-520(1)(b)]

Amend provisions which were incorrectly amended or repealed.

3.90 The TOFA Act 2009 incorrectly amended or repealed some provisions within the ITAA 1997. To correct these errors, the following provisions are amended:

•

the original text of subsections 230-275(1) and 230-275(2) is to be restored because the subsequent changes made to those provisions should have been made to subsection 230-380(1) [Schedule 3, items 48, 49 and 82, subsections 230-275(1) to (3) and 230-380(1)] ;

•

the original paragraph (aa) of the definition of 'special accrual amount' in section 995-1 is to be reinstated as it was incorrectly repealed by item 28 of the TOFA Act 2009. Paragraph (aa) was repealed on the basis that Subdivision 250-E would be repealed. However, Subdivision 250-E has not been repealed [Schedule 3, item 130, subsection 995-1(1)] ; and

•

current paragraph (aa) of the definition of 'special accrual amount' referring to Subdivision 230-A is to be renumbered as paragraph (ab) [Schedule 3, item 130, subsection 995-1(1)].

3.91 The Tax Laws Amendment (Transfer of Provisions) Bill 2010 proposes to undo the amendments mentioned in paragraph 1.90. The original paragraph (aa) which refers to Subdivision 250-E needs to be reinstated if the Tax Laws Amendment (Transfer of Provisions) Bill 2010 is enacted. [Schedule 3, item 131, subsection 995-1(1)]

Correcting typographical errors in the TOFA Act 2009

3.92 Some typographical errors were made in the TOFA Act 2009. This Schedule corrects these errors by:

•

reversing the sequence of the words 'financial' and 'hedging' in the heading of section 230-340. The heading of section 230-340 will read: 'Generally whole arrangement must be hedging financial arrangement' [Schedule 3, item 76, section 230-340(heading)] ;

•

making the reference in paragraph 775-295(1)(c) a reference to paragraph 230-255(2)(a), not paragraph 230-255(1)(a) [Schedule 3, item 125, paragraph 775-295(1)(c)] ;

•

making the reference in paragraph 775-305(1)(b) a reference to paragraph 230-255(2)(a), not paragraph 230-255(1)(a) [Schedule 3, item 126, paragraph 775-305(1)(b)] ;

•

making the reference in subparagraph 230-410(1)(e)(ii) to subsection (1) a reference to 'this subsection' [Schedule 3, item 95, subparagraph 230-410(1)(e)(ii)] ;

•

making the reference in subsection 230-410(5) to paragraph (3)(b) a reference to subsection (3) [Schedule 3, item 97, subsection 230-410(5)] ; and

•

making the reference in subsection 230-410(6) to paragraph 3(b) a reference to subsection (3) [Schedule 3, item 98, subsection 230-410(6)] .

Addressing incorrect references to provisions in Division 230

3.93 This Schedule corrects the following incorrect references in Division 230:

•

the reference in subsection 230-520(2) to paragraph 230-520(1)(d) is incorrect and is removed. The 'realisation event' definition did not apply to the repealed value shifting provisions [Schedule 3, item 117, subsection 230-520(2)] ; and

•

the reference to Division 723 contained in paragraph 230-520(1)(d) is removed. That Division is about a type of value shifting that was not dealt with under the repealed provisions [Schedule 3, item 116, paragraph 230-520(1)(d)] .

Amendments to transitional provisions in the Debt and Equity Act 2001

3.94 Part 2 of this Schedule extends the debt/equity transitional period to 1 July 2010 for Upper Tier 2 instruments that were issued before 1 July 2001, provided the issuer does not make an election under paragraph 118(6)(b) of the Debt and Equity Act 2001 to have the debt/equity rules in Division 974 apply from 1 July 2001. [Schedule 3, Part 2, item 135]

3.95 Upper Tier 2 instruments are instruments known as Upper Tier 2 capital instruments for prudential regulation purposes.

3.96 For the purposes of determining whether an Upper Tier 2 instrument was issued before 1 July 2001, minor alterations that do not affect rights and obligations in relation to the interest are disregarded. So are alterations that permit or require any deferred payments under the instrument to accumulate.

3.97 Issuers of Upper Tier 2 instruments have an opportunity to amend their instruments so as to come within the terms of the proposed Upper Tier 2 regulations prior to the first transaction in relation to the interest on or after 1 July 2010.

Application and transitional provisions

3.98 The amendments to Division 230 and the consequential and transitional provisions inserted by the TOFA Act 2009 (except for items 95, 131 and 132) apply for income years commencing on or after 1 July 2010, unless a taxpayer elects to apply Division 230 for income years commencing on or after 1 July 2009. [Clause 2, items 2, 4 and 7 in the table]

3.99 Item 95 commences on Royal Assent. [Clause 2, item 3 in the table]

3.100 Item 131 commences immediately after the commencement of Part 2 of Schedule 3 to the Tax Laws Amendment (Transfer of Provisions) Bill 2010. However, the item does not commence at all if Part 2 of Schedule 3 to the Tax Laws Amendment (Transfer of Provisions) Bill 2010 does not commence. [Clause 2, item 5 in the table]

3.101 Item 132 commences immediately after the commencement of section 2 of the Tax Laws Amendment (2010 Measures No. 1) Act 2010. [Clause 2, item 6 in the table]

3.102 The amendments to the debt/equity transitional provisions commence on Royal Assent and apply to Upper Tier 2 instruments issued before 1 July 2001. [Clause 2, items 1 and 8 in the table]

Chapter 4 - Amendments to foreign currency gains and losses provisions

Outline of chapter

4.1 Part 3 of Schedule 3 to this Bill amends Division 775 (foreign currency gains and losses provisions) of the Income Tax Assessment Act 1997 (ITAA 1997) to extend the scope of a number of compliance cost saving measures in the law, and to make technical amendments to ensure that the provisions operate as intended.

4.2 All references to legislative provisions in this chapter are references to the ITAA 1997 unless otherwise stated.

Context of amendments

4.3 The foreign currency gains and losses provisions contained in Division 775, Subdivision 960-C and Subdivision 960-D of the ITAA 1997 bring to account, for income tax purposes, gains and losses made by taxpayers due to exchange rate movements. They also provide for the translation of amounts of foreign currency into Australian currency or into the taxpayer's applicable functional currency.

Summary of new law

4.4 This Schedule amends Division 775 to ensure that:

•

'forex realisation gains' (of a private or domestic nature) from ceasing to have a right to receive foreign currency are assessable where, apart from Division 775, the gain would be taken into account under Part 3-1 or 3-3 of the ITAA 1997;

•

forex realisation gains are exempt income or non-assessable non-exempt income to the extent that, if the gain had been a loss, the loss would have been made in gaining or producing exempt income or non-assessable non-exempt income and would have been disregarded under the loss provisions in Division 775;

•

there is consistent treatment of 'forex realisation losses' made in the course of producing exempt income and non-assessable non-exempt income;

•

forex realisation event 3 occurs when an obligation to receive foreign currency ceases if the obligation is under an option to sell foreign currency;

•

forex realisation event 4 occurs when an obligation to pay foreign currency ceases if the obligation is under an option to buy foreign currency;

•

forex realisation event 5 occurs when a right to pay foreign currency ceases if the right is under an option to sell foreign currency; and

•

forex realisation gains or losses from forex realisation event 2 are disregarded on the conversion or exchange of a 'traditional security' into ordinary shares.

Detailed explanation of new law

Certain foreign exchange gains from forex realisation event 2 should not be excluded from assessable income

4.5 Part 3 of Schedule 3 amends the table under paragraph 775-15(2)(b), to ensure that forex realisation gains (of a private or domestic nature) arising from ceasing to have a right to receive foreign currency are assessable where, apart from Division 775, the gain would be taken into account under Part 3-1 or 3-3 of the ITAA 1997. [Schedule 3, item 138, paragraph 775-15(2)(b) (item 1 in the table, column 2)]

4.6 The basic rule in Division 775 is that a forex realisation gain that is of a private or domestic nature is not included in an entity's assessable income.

4.7 However, if the forex realisation gain would have been taken into account under the capital gains tax (CGT) provisions (disregarding Division 775), then, generally speaking, the forex realisation gain should be included in the entity's assessable income, regardless of whether the gain is of a private or domestic nature.

4.8 Note, in this regard, that private gains that do not qualify for the personal use asset exclusions in the CGT provisions are taxable. Examples include collectables that are artwork, jewellery, rare folios and postage stamps, if the asset's acquisition value is more than $500.^[1]

4.9 The amendments are intended to ensure that certain forex realisation gains of a private or domestic nature that would have been taken into account under the CGT provisions (disregarding Division 775), are included in an entity's assessable income under Division 775. These gains are those in respect of:

•

an entity ceasing to have a right to receive foreign currency (but not disposing of that right); and

•

the right having been created or acquired in return for the entity paying, or agreeing to pay, an amount of Australian currency or foreign currency (forex realisation event 2).

An example of this scenario would be the withdrawal of an amount from a foreign currency denominated bank account.

Ensuring forex realisation gains are assessable where they are made in relation to deductible obligations that were incurred in gaining or producing exempt income or non-assessable non-exempt income

4.10 Part 3 of Schedule 3 inserts a new section 775-27 to ensure that forex realisation gains are only exempt income or non-assessable non-exempt income, if the gain had been a forex realisation loss, the loss would have been disregarded under section 775-35. [Schedule 3, item 141, section 775-27]

4.11 Forex realisation gains and losses can be made in gaining or producing exempt income or non-assessable non-exempt income. Usually, losses made in gaining or producing exempt income or non-assessable non-exempt income are not deductible. As such, any forex realisation gain or loss in respect of those losses should not be included in assessable income, or allowable as a deduction.

4.12 In this regard, a forex realisation gain made by an entity is exempt income where, if the gain had been a loss, the loss would have been made in gaining or producing exempt income (see section 775-20).

4.13 Similarly, under section 775-25 a forex realisation gain an entity makes is non-assessable non-exempt income where, if the gain had been a loss, the loss would have been made in gaining or producing non-assessable non-exempt income.

4.14 However, some losses that are made in gaining or producing exempt income or non-assessable non-exempt income are deductible (under, for example, section 25-90). Reflecting this, forex realisation losses in respect of losses made in gaining or producing exempt income or non-assessable non-exempt income that are nonetheless deductible, are deductible under Division 775. In this situation, forex realisation gains made in respect of those losses should be included in assessable income.

4.15 Under subsection 775-35(2), a forex realisation loss an entity makes from forex realisation event 3, 4 or 6 is disregarded if it is made in gaining or producing exempt income or non-assessable non-exempt income, unless the obligation that ceases or is discharged gives rise to a deduction.

4.16 The amendments ensure that a forex realisation gain made in this situation is included in assessable income so that such forex realisation gains and losses receive consistent treatment.

Example 4.1 (a)

An entity borrows US$1,000,000 for 20 years. The borrowing requires the entity to make interest payments of 10 per cent per annum, with complete repayment of the principal due in 20 years.

The entity uses the US$1,000,000 to finance the purchase of shares. That investment produces dividends which are non-assessable non-exempt income by virtue of section 23AJ of the Income Tax Assessment Act 1936 (ITAA 1936).

Assume that the interest payments of 10 per cent are deductible by virtue of section 25-90.

When the entity borrows the US$1,000,000, it incurs an obligation to pay foreign currency (being the US$100,000 interest payments). When the entity actually makes an interest payment, forex realisation event 4 occurs. If the amount the entity deducted under section 25-90 in relation to the interest payment is less than the amount the entity actually pays (say due to an increase in the value of the USD relative to the AUD), the entity will have made a forex realisation loss which it can then deduct. The amount of the deduction is equal to the extent that the difference between the amount initially deducted and the amount paid relates to a currency exchange rate effect (subsection 775-55(5)).

So, while the forex realisation loss is made in gaining or producing non-assessable non-exempt income, the loss is not prevented from being deductible because the obligation that gave rise to the loss (being the obligation to make interest payments) is deductible by virtue of section 25-90 (the loss is also not disregarded under paragraph 775-35(2)(b)).

Example 1.1(b)

Assume the same scenario as above except that the amount the entity deducted under section 25-90 is more than the amount it actually paid (say the value of the USD decreased). In this case, the entity will make a forex realisation gain to the extent that the difference between the amount initially deducted and the amount actually paid relates to a currency exchange rate effect (subsection 775-55(3)).

However, this is arguably a gain to which section 775-25 applies. This is because, if the forex realisation gain mentioned above had been a loss, the loss would have been made in gaining or producing non-assessable non-exempt income.

Therefore, without the amendment, the forex realisation gain is not included in the entity's assessable income by virtue of section 775-25. This is despite the fact that a forex realisation loss made in exactly the same situation is deductible by virtue of paragraph 775-35(2)(b).

Ensuring losses are disregarded where they are made from forex realisation event 1, 2 or 5 if the loss is made in gaining or producing non-assessable non-exempt income

4.17 Part 3 of this Schedule amends subsection 775-35(1) to ensure that a forex realisation loss is disregarded for the purposes of Division 775 if the loss is made:

•

as a result of forex realisation event 1, 2 or 5 happening; and

•

in gaining or producing non-assessable non-exempt income.

[Schedule 3, item 142, subsection 775-35(1)]

4.18 Subsection 775-35(1) disregards forex realisation losses where they are made:

•

as a result of forex realisation event 1, 2 or 5 happening; and

•

in gaining or producing exempt income.

4.19 Subsection 775-35(2) disregards forex realisation losses where they are made:

•

as a result of forex realisation event 3, 4 or 6 happening;

•

in gaining or producing exempt income or non-assessable non-exempt income; and

•

in respect of an obligation that does not give rise to a deduction.

4.20 Without the amendment, there is no provision in Division 775 that has the effect of disregarding a forex realisation loss that is made:

•

as a result of forex realisation event 1, 2 or 5 happening; and

•

in gaining or producing non-assessable non-exempt income.

Recognising forex realisation gains on the expiration of foreign currency put options

4.21 Part 3 of this Schedule amends section 775-50 to ensure that forex realisation event 3 occurs when:

•

an entity ceases to have an obligation to receive foreign currency; and

•

the obligation is under an option to sell foreign currency.

[Schedule 3, item 144, subparagraph 775-50(1)(b)(iii)]

4.22 While Division 775 is primarily concerned with gains and losses that are attributable to currency exchange rate effects, the Division also brings to account gains and losses that are made when an option to buy or sell foreign currency expires without being exercised.

4.23 If:

•

an entity ceases to have an obligation, or a part of an obligation, to receive foreign currency;

•

the event happens because an option to sell foreign currency (a foreign currency put option) expires without having been exercised, or is cancelled, released or abandoned; and

•

had the option been exercised immediately before the event, the entity would have been obliged to buy the foreign currency,

then the entity should have a forex realisation gain equal to the premium or amount received in return for granting the option.

Recognising forex realisation gains on the expiration of foreign currency call options

4.24 Part 3 of this Schedule amends section 775-55 to ensure that:

•

forex realisation event 4 occurs when an entity ceases to have an obligation to pay foreign currency, and that obligation is under an option the entity issued to buy foreign currency [Schedule 3, item 145, subparagraph 775-55(1)(b)(xi)] ; and

•

a forex realisation gain is made in respect of any premium received on such an option upon that option expiring without being exercised, or is cancelled, released or abandoned [Schedule 3, item 146, paragraph 775-55(4)(a)] .

4.25 A foreign currency call option gives the option holder the right but not the obligation to buy foreign currency.

4.26 From the issuer's perspective, the foreign currency call option gives it:

•

a right to receive consideration for entering into the option;

•

an obligation to pay the foreign currency to the holder of the foreign currency call option, which is contingent on the holder exercising its option; and

•

in exchange for paying the foreign currency to the holder if the option is exercised, the receipt of either another foreign currency, or Australian currency.

4.27 Where an entity receives a premium to grant a foreign currency call option, and that option expires without being exercised, a forex realisation gain should happen to the entity. Section 775-55 is amended to ensure that this is the outcome. The amount of the gain should be the premium the entity received on the expired option.

Recognising forex realisation losses on the expiration of foreign currency put options

4.28 Part 3 of this Schedule amends section 755-60 to ensure that forex realisation event 5 happens when a put option expires, provided that the option was acquired in exchange for a right to receive foreign currency or Australian currency. [Schedule 3, item 147, subparagraph 775-60(1)(b)(iii)]

4.29 A foreign currency put option gives the option holder:

•

an obligation to pay a premium to the issuer; and

•

the right but not the obligation to sell foreign currency to the issuer, and receive either foreign currency or Australian currency in exchange.

4.30 Where an entity pays a premium in order to be granted a foreign currency put option, and that option expires without it being exercised (or is cancelled, released or abandoned), a forex realisation loss should happen to the entity. The amount of the loss should be the premium the entity paid in order to acquire the now expired option.

Disposal or redemption of traditional securities

4.31 Part 3 of this Schedule inserts a new section 775-168 to ensure that a forex realisation gain or loss an entity makes as a result of forex realisation event 2 occurring, is disregarded if the event happened because of a disposal or redemption that occurred under the circumstances described in subsections 26BB(4) and (5) and 70B(2B) and (2C) of the ITAA 1936. [Schedule 3, item 148, section 775-168]

4.32 Sections 26BB and 70B of the ITAA 1936 generally provide that certain gains or losses made upon the disposal or redemption of a 'traditional security' are included in an entity's assessable income.

4.33 Subsections 26BB(4) and (5) and 70B(2B) and (2C) of the ITAA 1936 provide that this rule does not apply under certain circumstances.

4.34 However, without the amendment, there is nothing in Division 775 that prevents a forex realisation gain or loss occurring in these circumstances from being brought to account in respect of a gain or loss made from the disposal or redemption of a traditional security.

4.35 This is inconsistent with the broad aim of subsections 26BB(4) and (5) and 70B(2B) and (2C), which is to ensure that subsections 26BB(2) and 70B(2) do not apply in respect of gains and losses made in the circumstances described in subsections 26BB(4) and (5) and 70B(2B) and (2C).

Typographical and miscellaneous amendments

4.36 A number of amendments to include the provisions in Division 775 that cause income to be exempt or non-assessable non-exempt income are made to the relevant provisions of the ITAA 1997 that list the provisions about these types of income. [Schedule 3, items 136 and 137, sections 11-10 and 11-55]

4.37 Another set of amendments add asterisks to defined terms. [Schedule 3, items 139, 140 and 143, sections 775-20, 775-25 and paragraph 775-35(2)(a)]

4.38 A further amendment has been included to ensure that the Commissioner of Taxation (Commissioner) is able to amend an assessment in relation to the foreign currency amendments contained in Part 3 of this Schedule. The amendment provides a period of four years from the date this Bill receives Royal Assent for the Commissioner to amend an assessment that is issued before the date of Royal Assent to give effect to the provisions contained in Part 3 of this Schedule. [Clause 4]

Date of application

4.39 These amendments (apart from clause 4) commence on Royal Assent and apply from 17 December 2003. [Clause 2, item 8 in the table ; Schedule 3, item 149]

4.40 Clause 4 commences on Royal Assent. [Clause 2, item 1 in the table]

Chapter 5 - Scrip for scrip alignment

Outline of chapter

5.1 Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to make it easier for takeovers and mergers regulated by the Corporations Act 2001 (Corporations Act) to qualify for the capital gains tax (CGT) scrip for scrip roll-over.

5.2 All references to legislative provisions in this chapter are references to the ITAA 1997 unless otherwise stated.

Context of amendments

5.3 The exchange of shares in one company for shares in another company as part of a merger or takeover typically triggers a CGT taxing point and the realisation of a capital gain or capital loss. The capital gain or capital loss is generally calculated by reference to the market value of the proceeds - the replacement shares.

5.4 The scrip for scrip roll-over, contained in Subdivision 124-M, ensures that CGT is not an impediment to mergers and takeovers. It allows taxpayers exchanging shares in one company for shares in another to defer the realisation of any capital gains from this transaction. Relief is also available for the exchange of trust interests. A taxpayer that receives cash in addition to replacement interests may qualify for a partial roll-over.

5.5 A merger or takeover arrangement must meet a number of requirements to qualify for the roll-over. These include:

•

that all holders of voting interests in the target entity be able to participate in the arrangement; and

•

that this participation must be on substantially the same terms.

5.6 These participation requirements differ to some extent and duplicate to some extent the requirements in the Corporations Act, the principal legislation for regulating member participation. As a result, a merger or takeover arrangement that meets the requirements of the Corporations Act may not qualify for the scrip for scrip roll-over.

•

The Corporations Act requires that, subject to some limited exceptions, all offers under an off-market takeover bid be the same. This ensures equal participation by members.

•

Schemes of arrangement provide more flexibility than takeovers and may be used for mergers. A scheme of arrangement is an agreement between a company and its members and/or creditors that may be used as an alternative to a takeover. The Corporations Act ensures the arrangement becomes legally binding on the company's members and creditors if a court approves it. The scheme of arrangement process, including the role of the court and the Australian Securities and Investments Commission (ASIC), is aimed at protecting members against the scheme operating unfairly. ASIC has a published policy on its role in relation to schemes of arrangement.

5.7 These amendments ensure that the scrip for scrip roll-over operates more effectively.

Summary of new law

5.8 These amendments carve-out arrangements from having to meet the roll-over requirements, in paragraphs 124-780(2)(b) and (c), that the arrangement be one in which the target company's shareholders can participate on substantially the same terms, if the arrangement includes:

•

a takeover bid that does not contravene key provisions in Chapter 6 of the Corporations Act; and/or

•

a compromise or arrangement approved by a court under Part 5.1 of the Corporations Act (scheme of arrangement).

5.9 These amendments provide a similar carve-out for arrangements involving trusts. Paragraphs 124-781(2)(b) and (c) set out the requirement that the arrangement be one in which the target trust's interest or unit holders can participate on substantially the same terms. However, as trusts cannot undertake schemes of arrangements, this carve-out only applies in relation to takeover bids that do not contravene key provisions in Chapter 6 of the Corporations Act.

5.10 The amendments do not repeal the requirements contained in paragraphs 124-780(2)(b) and (c) and 124-781(2)(b) and (c), which remain as an alternative test.

Comparison of key features of new law and current law

Detailed explanation of new law

Replacement of shares

5.11 A taxpayer that exchanges shares (original interests) in one company (the original entity) for shares in another may qualify for the scrip for scrip roll-over if that exchange is in consequence of a single arrangement that meets a number of requirements. Options and rights to acquire shares in the original entity may also be original interests. Subsection 124-780(1) sets out these rules. [Schedule 4, item 1, paragraph 124-780(1)(b)]

5.12 Broadly, the single arrangement must result in another company (the acquiring entity):

•

if it is not a member of a wholly owned group - becoming the owner of at least 80 per cent of the original interests in the original entity; or

•

if it is a member of a wholly owned group - increasing the percentage of original interests that it owns in the original entity to at least 80 per cent.

Paragraph 124-780(2)(a) sets out these rules. [Schedule 4, item 2, paragraph 124-780(2A)(a)]

Example 5.1

Silver Ltd (Silver) makes a takeover bid that complies with Chapter 6 of the Corporations Act for the voting shares in Gold Ltd (Gold) and subsequently acquires a total of 30 per cent of Gold's voting shares before the takeover bid lapses.

This single arrangement does not qualify for the scrip for scrip roll-over as Silver does not become the owner of at least 80 per cent of Gold's voting shares.

5.13 In addition, the single arrangement must consist of, be part of, or include:

•

a takeover bid for the original interests by the acquiring entity that is not carried out in contravention of the provisions mentioned in section 612 of the Corporations Act (a non-contravening takeover bid); or

•

a compromise or arrangement entered into by the original entity under Part 5.1 of the Corporations Act, approved by a court under paragraph 411(4)(b) of the Corporations Act (an approved scheme of arrangement).

[Schedule 4, item 2, paragraph 124-780(2A)(b)]

5.14 It is a question of fact as to what forms a single arrangement. If there is a close nexus between particular elements of a broader transaction, then those elements would form part of the same arrangement. A scheme of arrangement may include a number of elements where only some of those elements form the single arrangement.

5.15 An arrangement that comprises a non-contravening takeover bid and/or a scheme of arrangement, and some interrelated and/or interdependent transactions not subject to the Corporations Act, will also meet the requirement set out in paragraph 5.13. An arrangement that is part of a broader non-contravening takeover bid or an approved scheme of arrangement will also meet this requirement.

Example 5.2

Green Ltd (Green) and Yellow Ltd (Yellow) jointly announce a proposal to merge where Yellow's voting shares are transferred to Green.

Yellow's shareholders will participate in the merger on the following basis:

•

Green acquires shares owned by a cornerstone shareholder (Blue Ltd) for cash by way of a sale agreement.

•

Owners of the remaining voting shares in Yellow receive one share in Green for each share they hold in Yellow. This acquisition is by way of a scheme of arrangement under Part 5.1 of the Corporations Act.

•

The merger is conditional upon Green successfully completing both acquisitions.

Obtaining court approval under paragraph 411(4)(b) of the Corporations Act will satisfy the requirements of paragraph 124-780(2A)(b).

5.16 If some of the provisions mentioned in section 612 of the Corporations Act do not apply to a takeover bid and the bid does not contravene the remaining provisions (applicable provisions), then that bid will be a non-contravening takeover bid for the purposes of these amendments. For example, paragraph 612(g) of the Corporations Act requires compliance with a number of procedural steps for market bids and therefore would not be applicable for off-market bids.

5.17 Similarly, if a takeover bid does not contravene the applicable provisions mentioned in section 612 of the Corporations Act because of the modification of some or all of those provisions, then that bid will be a non-contravening takeover bid for the purposes of these amendments.

•

For example, ASIC has the power under Part 6.10 of the Corporations Act to modify or exempt compliance with provisions of Chapter 6 (including the provisions mentioned in section 612).

•

The Takeovers Panel also has the power to review ASIC orders and make interim and final orders which may affect the manner in which Chapter 6 applies to a takeover bid (see, for example, sections 656A and B of the Corporations Act).

•

In addition, a court has the power under section 1325D of the Corporations Act to make an order than an act, document or matter is not invalid or has effect as if it was not in contravention of Chapter 6.

5.18 There is no specific form of evidence to show that an arrangement includes a non-contravening takeover bid or an approved scheme of arrangement. The available evidence will depend on the types of transactions.

Replacement of trust interests

5.19 A taxpayer that exchanges trust interests (original interests) in one trust (the original entity) for interests in another may qualify for the scrip for scrip roll-over if that exchange is in consequence of a single arrangement that meets a number of requirements. Options and rights to acquire interests in the original entity may also be original interests. Subsection 124-781(1) sets out these rules. [Schedule 4, item 3, paragraph 124-781(1)(c)]

5.20 Broadly, the arrangement must result in another trust (the acquiring entity) becoming the owner of at least 80 per cent of the trust voting interests or units. Paragraph 124-781(2)(a) sets out this rule. [Schedule 4, item 4, paragraph 124-781(2A)(a)]

5.21 In addition, the arrangement must consist of, be part of, or include, a non-contravening takeover bid for the original interests by the acquiring entity. [Schedule 4, item 4, paragraph 124-781(2A)(b)]

5.22 Section 411 of the Corporations Act does not apply to trusts.

Application and transitional provisions

5.23 These amendments apply to CGT events that happen on or after 6 January 2010.

Chapter 6 - Increase in the medical expenses tax offset claim threshold

Outline of chapter

6.1 Schedule 5 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to increase the threshold (the claim threshold) above which a taxpayer may claim the medical expenses tax offset to $2,000. It also commences annually indexing the claim threshold to the consumer price index (CPI).

Context of amendments

6.2 Currently a taxpayer may claim a tax offset for 20 per cent of net medical expenses exceeding the claim threshold of $1,500 in an income year.

6.3 Net medical expenses are the total medical expenses paid by a taxpayer less available reimbursements which a taxpayer, or any other person, has received or is entitled to receive in respect of those medical expenses. Reimbursements may include refunds from Medicare and/or private health insurers.

6.4 A taxpayer may combine net medical expenses paid in respect of resident dependants as well as themselves in order to reach the claim threshold.

6.5 The claim threshold has been periodically increased in the past. It was last increased in 2002 and since that time both medical costs and wages have increased significantly, making it easier for taxpayers to become eligible to claim the medical expenses tax offset.

6.6 The changes detailed in this Schedule will help reduce the long term cost to the budget of a rapidly growing expenditure and place the medical expenses tax offset on a more sustainable footing.

Summary of new law

6.7 These amendments increase the claim threshold from $1,500 to $2,000 per annum, with effect from 1 July 2010.

6.8 These amendments also commence annually indexing the claim threshold to the CPI. The first indexation adjustment to the claim threshold will occur on 1 July 2011.

Comparison of key features of new law and current law

Detailed explanation of new law

6.9 Currently section 159P of the ITAA 1936 allows a taxpayer to claim a tax offset for 20 per cent of net medical expenses exceeding the claim threshold of $1,500 in an income year.

6.10 This Schedule increases the claim threshold above which a taxpayer can claim the medical expenses tax offset from $1,500 to $2,000. [Schedule 5, item 4]

6.11 This Schedule also inserts provisions to index the claim threshold in future years. It adds the claim threshold to the list of amounts indexed in accordance with the formula specified in section 159HA of the ITAA 1936. [Schedule 5, items 2 and 3]

6.12 The formula in section 159HA indexes specified amounts on the basis of changes in the CPI.

6.13 Should the indexation factor calculated in accordance with subsection 159HA(3) be less than one (meaning the CPI was negative for the year), the claim threshold will continue to be indexed by this amount. This means the claim threshold for an income year can be lower than the claim threshold in respect of the previous income year.

6.14 This Schedule amends the heading to section 159HA to reflect the fact that, from the 2011-12 income year, this section will apply to the indexation of the medical expenses tax offset claim threshold as well as other specified rebate amounts. It also corrects the heading by removing the reference to section 159K, which is no longer indexed. [Schedule 5, item 1]

Application and transitional provisions

6.15 The amendment made by item 4 applies to assessments for the 2010-11 income year and later income years.

6.16 The amendments made by items 1 to 3 apply to assessments for the 2011-12 income year and later income years.

•

This ensures the claim threshold is set at $2,000 for the 2010-11 income year and the indexation of the claim threshold applies for the 2011-12 income year and later income years.

Chapter 7 - Deductible gift recipients

Outline of chapter

7.1 Schedule 6 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to update the list of deductible gift recipients (DGRs) to make two entities deductible gift recipients, extend the period of listing of one entity and change the name of another entity.

7.2 All references to legislative provisions in this chapter are references to the ITAA 1997.

Context of amendments

7.3 The income tax law allows taxpayers who make gifts of $2 or more to DGRs to claim income tax deductions. To be a DGR, an organisation must fall within one of the general categories set out in Division 30 of the ITAA 1997, or be listed by name in that Division.

7.4 DGR status assists eligible funds and organisations to attract public support for their activities.

Summary of new law

7.5 These amendments add One Laptop Per Child Australia Ltd (ABN 34 141 060 586) and the Mary MacKillop Canonisation Gift Fund (ABN 32 551 221 563) to the list of specifically listed DGRs, extend the period of listing of the Xanana Vocational Education Trust (ABN 31 516 142 700) until 30 December 2010 and change the name of a currently listed DGR from 'The Clontarf Foundation Inc.' to 'Clontarf Foundation' (ABN 77 131 909 405).

Detailed explanation of new law

One Laptop per Child Australia Ltd

7.6 Schedule 6 allows taxpayers to claim a deduction for gifts made to One Laptop per Child Australia Ltd after 26 May 2010 and before 1 July 2012. [Schedule 6, item 2, item 2.2.38 in the table in subsection 30-25(2)]

7.7 One Laptop per Child Australia Ltd was established in 2008 and aims to improve the lives of Indigenous children living in disadvantaged communities in rural and remote Australia. It is working to achieve this goal by giving remote Indigenous school children laptops. The laptops are designed to be durable, energy efficient and appropriate for children.

7.8 The listing is conditional on the laptops provided under the scheme remaining school property.

Mary MacKillop Canonisation Gift Fund

7.9 Schedule 6 allows taxpayers to claim a deduction for gifts made to the Mary MacKillop Canonisation Gift Fund after 4 August 2010 and before 1 July 2011. [Schedule 6, item 4, item 13.2.18 in the table in section 30-105]

7.10 The Gift Fund was established to raise funds in relation to the canonisation of Mary MacKillop in Rome on 17 October 2010 and related events in Australia. The canonisation of Mary MacKillop is a unique event as she is Australia's first recognised saint.

Xanana Vocational Educational Trust

7.11 Schedule 6 also extends the period of the specific listing of the Xanana Vocational Educational Trust. Donors will be able to claim a tax deduction in respect of a gift made after 20 July 2005 and before 1 January 2011. [Schedule 6, item 3, item 9.2.17 in the table in subsection 30-80(2)]

Clontarf Foundation

7.12 Schedule 6 changes the name of 'The Clontarf Foundation Inc.' to 'Clontarf Foundation'. [Schedule 6, item 1, item 2.2.32 in the table in subsection 30-25(2]

Application and transitional provisions

7.13 The change to the name of 'The Clontarf Foundation Inc.' has effect from 1 April 2010. The addition of One Laptop per Child Australia Ltd and the Mary MacKillop Canonisation Gift Fund, and the extension to the listing of Xanana Vocational Educational Trust have effect for gifts made after and before the dates outlined in paragraphs 7.6 and 7.11.

Consequential amendments

7.14 Changes have been made to update the index in Division 30 of the ITAA 1997 to add One Laptop per Australia Ltd and the Mary MacKillop Canonisation Gift Fund as well as reflect the change in name of The Clontarf Foundation Inc. [Schedule 6, items 5 to 7, items 31B, 70AA and 81A in the table in section 30-315]

Chapter 8 - Extending gift deductibility to volunteer fire brigades

Outline of chapter

8.1 Schedule 7 to this Bill adds three new general deductible gift recipient (DGR) categories into the Income Tax Assessment Act 1997 (ITAA 1997).

8.2 This measure widens the accessibility of tax deductible donations to all entities providing volunteer based emergency services, including volunteer fire brigades. The measure also extends DGR status to all state and territory government bodies that coordinate volunteer fire brigades and State Emergency Services.

Context of amendments

8.3 Volunteer fire brigades aim to prevent, respond to, and help with recovery from a range of fire-related emergencies. Volunteer brigades have a long history in Australia, providing a clearly recognisable and highly regarded public benefit based on a system of volunteering. The activities of some brigades extend beyond fire-related emergencies into other kinds of emergencies.

8.4 There are currently more than 6,200 rural volunteer brigades in Australia. Approximately 1,800 of these are currently endorsed by the Commissioner of Taxation (Commissioner) as public benevolent institutions (PBIs). PBIs are not-for-profit organisations that provide direct relief to individuals from poverty, sickness, suffering, distress, misfortune, disability, destitution, or helplessness, as arouses compassion in the community. PBIs are eligible for a range of tax concessions, including entitlement to endorsement as DGRs by way of the general DGR category for PBIs.

8.5 Recent legal cases have led the Commissioner to the view that volunteer brigades do not meet the PBI criteria because the main purpose of brigades is to protect property, which is not consistent with the purpose of a PBI.

8.6 Without legislative amendment, 1,800 affected volunteer fire brigades stand to lose their ability to collect tax deductible donations.

8.7 Depending on how they are structured, some volunteer fire brigades can be endorsed as tax concession charities, and will continue to be able to access charitable tax concessions, including income tax exemption, by way of their charitable status. Those operating as government entities will be eligible for income tax exemption as state and territory government bodies and public authorities.

8.8 Targeted consultation undertaken by Treasury also revealed a trend toward the creation of 'hybrid' volunteer brigades - organisations that undertake multiple volunteer based emergency services activities (for example, fire-fighting, as well as general emergency services). The growth is attributable in-part to the efficiency gains in combining these services, particularly in smaller communities.

8.9 The way that volunteer fire brigades are coordinated differs between states and territories. For example, in some states and territories, brigades are coordinated by government departments that oversee several emergency services (such as the Fire and Emergency Services Authority of Western Australia), while in other states and territories volunteer brigades are coordinated by a dedicated fire department. The level of local government oversight of brigades differs between and within states and territories. All states and territories have one or more associations representing volunteer fire fighters in that state or territory.

8.10 The state and territory government agencies coordinating State Emergency Services in all states and territories except for the Northern Territory are specifically listed as DGRs (see the table in section 30-102 of the ITAA 1997). The state and territory government agencies coordinating brigades in Victoria, Queensland, Western Australia, Tasmania and the Australian Capital Territory are also listed (see the table in section 30-102 of the ITAA 1997).

8.11 These listings followed an announcement by the then government on 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.

Summary of new law

8.12 New DGR categories are created for:

•

government entities that have statutory responsibility for coordinating volunteer fire brigades or State Emergency Services;

•

public funds established and maintained by such entities - solely for the purpose of supporting the volunteer based emergency service activities of not-for-profit entities or government entities that principally provide volunteer based emergency services (including fire-related services) that are regulated by a state or territory law; and

•

public funds established and maintained by not-for-profit entities or government entities that principally provide volunteer based emergency services (including fire-related services) that are regulated by a state or territory law - solely for the purpose of supporting the volunteer based emergency service activities of the establishing entity.

Comparison of the key features of the new law and the current law

Detailed explanation of new law

New general categories

8.13 This measure establishes three new general DGR categories.

8.14 New DGR categories are created for:

•

government entities that have statutory responsibility for coordinating volunteer fire brigades or State Emergency Services [Schedule 7, item 1, item 12A.1.1 in the table in section 30-102 of the ITAA 1997] ;

•

public funds established and maintained by such entities - solely for the purpose of supporting the volunteer based emergency service activities (including fire-related services) of not-for-profit entities or government entities that principally provide volunteer based emergency services that are regulated by a state or territory law [Schedule 7, item 1, item 12A.1.2 in the table in section 30-102 of the ITAA 1997] ; and

•

public funds established and maintained by not-for-profit entities or government entities that principally provide volunteer based emergency services (including fire-related services) that are regulated by a state or territory law - solely for the purpose of supporting the volunteer based emergency service activities of the establishing entity [Schedule 7, item 1, item 12A.1.3 in the table in section 30-102 of the ITAA 1997] .

8.15 The Commissioner requires that all entities or funds endorsed under these new categories must be established in Australia, and their purposes must be in Australia (this is an interpretation of item 1 in the table in subsection 30-15(2) of the ITAA 1997, which states that any fund, authority or institution covered by any item in the tables in Subdivision 30-B of the ITAA 1997 must be 'in Australia').

New general DGR category for government entities that coordinate volunteer fire brigades and State Emergency Services

8.16 Government entities with statutory responsibility for coordinating volunteer fire brigades or State Emergency Services can seek endorsement to be DGRs. Gifts to these DGRs must be made for the purpose of supporting the entity's coordination of volunteer fire brigades or State Emergency Services. [Schedule 7, item 1, item 12A.1.1 in the table in section 30-102 of the ITAA 1997]

8.17 This part of the measure creates a general DGR category that predominantly captures state and territory government agencies already listed as DGRs in the tax law. This new general category makes the DGR concession available to equivalent entities in the remaining states and territories. Organisations currently listed in the ITAA 1997 as DGRs include volunteer fire brigade coordinating bodies in Victoria, Queensland, Western Australia, Tasmania and the Australian Capital Territory, and State Emergency Services coordinating bodies in all states and territories except the Northern Territory.

8.18 Volunteer fire brigades are entities that aim to prevent, respond to, and help with recovery from a range of fire-related emergencies. The State Emergency Services provide emergency and rescue services dedicated to assisting the community.

8.19 Volunteer fire brigades and State Emergency Services are made up almost entirely of volunteers. Coordination of volunteer fire brigades and State Emergency Services is provided by a central coordinating body that is a state or territory government entity.

8.20 A gift condition has been introduced for donors, that the gift must be made for the purpose of supporting the entity's coordination of volunteer fire brigades or State Emergency Services. Coordination includes registration and oversight responsibilities. Entities whose functions include, but extend beyond, the coordination of volunteer fire brigades or State Emergency Services (for example, some state departments of justice may be said to include those functions) cannot use the deductible donations they receive in support of those unrelated functions. [Schedule 7, item 12A.1.1 in the table in section 30-102 of the ITAA 1997]

8.21 DGR status is restricted to those entities that are Australian government entities with statutory responsibility for coordinating volunteer fire brigades or State Emergency Services. Where legislation places a burden of obligation upon an entity, that entity has statutory responsibility.

8.22 An Australian government entity includes state and territory government departments and agencies responsible for coordinating volunteer fire brigades and State Emergency Services. It does not include non-government organisations nor local governments.

New general DGR category for public funds to support volunteer based emergency services (including volunteer fire brigades)

8.23 A public donation fund can be endorsed as a DGR if it is established and maintained to support volunteer based emergency service activities undertaken by not-for-profit entities or government entities that principally provide volunteer based emergency services that are regulated by a state or territory law. The fund must be established either:

•

by entities that principally provide volunteer based emergency services (including volunteer fire brigades); or

•

by coordinating entities (described in paragraph 1.16).

[Schedule 7, item 1, items 12A.1.2 and 12A.1.3 in the table in section 30-102 of the ITAA 1997]

8.24 This new category gives entities providing emergency services (including volunteer fire brigades) the flexibility to establish a DGR fund in their own right, or to collaborate with their relevant state or territory volunteer fire brigade coordinating body to collect donations through a central fund, taking advantage of gains in efficiency that may arise through a centralised fund model.

8.25 By being open to entities providing volunteer based emergency services more generally, this new category is available to 'hybrid' volunteer fire brigades - organisations that undertake fire-fighting as well as other kinds of volunteer based emergency services activities that are regulated by a state or territory law. Such hybrid brigades can use all funds donated to them to support all their volunteer based emergency activities, not just fire-fighting activities.

8.26 Not all volunteer fire brigades will want or need DGR status. Some will be too small, others will be fully state or territory government supported.

8.27 For volunteer fire brigades that do want to collect tax deductible donations, those that see efficiency, administrative and other advantages in collecting through a central fund such as that which currently exists in Victoria will still have that option - provided that a centralised public fund has been established by the government coordinating body in that particular state or territory. This option may be particularly attractive to smaller volunteer fire brigades that may find it too onerous to meet the accountability requirements to establish their own DGR fund. [Schedule 7, item 1, item 12A.1.2 in the table in section 30-102 of the ITAA 1997]

8.28 Volunteer fire brigades who want DGR status in their own right will need to establish their own public fund. [Schedule 7, item 1, item 12A.1.3 in the table in section 30-102 of the ITAA 1997]

8.29 This new category does not displace the PBI status of those volunteer based emergency service units (for example, State Emergency Services and marine rescue units) that are presently endorsed as PBIs in their own right. A PBI is a not-for-profit institution organised for the direct relief of poverty, sickness, suffering, distress, misfortune, disability or helplessness. The endorsement of PBIs is a responsibility of the Commissioner.

Funds established by brigades

8.30 A public donation fund can be endorsed as a DGR if it is established and maintained:

•

by a not-for-profit entity or government entity that principally provides volunteer based emergency services that are regulated by a state or territory law; and

•

solely for the purpose of supporting the volunteer based emergency service activities of the establishing entity.

[Schedule 7, item 1, item 12A.1.3 in the table in section 30-102 of the ITAA 1997]

8.31 A not-for-profit organisation is one which is not operating for the profit or gain of its individual members, whether these gains would have been direct or indirect. Any profit made by the organisation goes back into the operation of the organisation to carry out its purposes and is not distributed to any of its members. The Commissioner accepts an organisation as not-for-profit where its constituent or governing documents prevent it from distributing profits or assets for the benefit of particular people - both while it is operating and when it winds up. These documents should contain acceptable clauses showing the organisation's not-for-profit character. The organisation's actions must be consistent with this requirement. The Australian Taxation Office (ATO) provides further guidance on acceptable constitutional clauses at the Non-Profit section of its website.

8.32 Examples of the types of not-for-profit entities or government entities that may provide volunteer based emergency services are volunteer fire brigades, State Emergency Services, volunteer marine rescue units, groups of volunteer ambulance officers, and hybrid emergency service units that may cover a combination of these functions.

8.33 The fund can only be used in support of activities that are 'volunteer based emergency service activities' of the establishing entity.

8.34 Volunteer based entities predominantly consist of individuals performing public services for no financial gain. Emergency services are public services that deal with sudden and urgent occasions for action, usually relating to the safety or protection of people or property. To carry out their core objective of providing emergency services, emergency service organisations may undertake activities to prepare for emergencies such as training, as well as activities that seek to prevent imminent or expected emergencies - for example, a volunteer fire brigade may oversee a controlled burn prior to a fire season to reduce the risk of a catastrophic bushfire.

Example 8.1 : Funds can be used for emergency service activities

The Redcliffe Volunteer Fire Brigade decides to purchase fire retardant protective clothing for volunteers to use when fighting fires. Donations to the brigade's public fund can be used to purchase the new clothing because the clothing is a requirement for the brigade in the undertaking of an emergency service activity (fire fighting).

Example 8.2 : Funds cannot be used for other activities

The Redcliffe Volunteer Fire Brigade is planning a dinner for brigade members and their extended families. The dinner is an annual event, held with the general aim of encouraging the social links within the brigade. The dinner is not a fundraising event. Donations to the brigade's DGR fund cannot be used to purchase provisions for the dinner, because the dinner is not an emergency service activity.

8.35 This measure is intended to only capture officially recognised emergency services, such as volunteer fire and State Emergency Services. State or territory law must regulate the provision of those emergency services (the emergency service must be controlled or directed by a set of requirements set out in state or territory legislation).

8.36 If the state or territory law requires minimum qualifying conditions for an entity to provide regulated emergency services, individual entities seeking endorsement must meet those conditions as evidence that the entity provides state or territory regulated services. For example, if a state or territory law requires licensing, then the entity must be licensed before their public fund is endorsed.

Example 8.3 : Emergency services that are regulated by a state law or territory law

A volunteer fire brigade in WA wants to seek DGR endorsement for its public fund, but can only do so if its activities are regulated under a state law.

In WA, the establishment (including registration) and regulation of most volunteer bush fire brigades is done under the authority of the Bush Fires Act 1954 (WA). Establishment and regulation of other kinds of emergency service brigades, including multifunctional (hybrid) volunteer fire service brigades, volunteer marine rescue service units and volunteer State Emergency Services, is provided by the Fire and Emergency Services Authority of Western Australia Act 1998 (WA).

The brigade is registered under the Bush Fires Act 1954 (WA). The brigade is regulated by a state law.

8.37 Local government by-laws are state or territory laws because they are delegated legislation made under a state or territory enactment.

8.38 The ATO will typically provide guidance as to the kinds of organisations covered by a measure.

Funds established by coordinating bodies

8.39 Public DGR donation funds can be established by state or territory government entities that have a statutory responsibility to coordinate volunteer fire brigades or State Emergency Services. [Schedule 7, item 1, item 12A.1.2 in the table in section 30-102 of the ITAA 1997]

8.40 The Victorian Country Fire Authority (CFA) has operated a public fund to support Victorian volunteer fire brigades since 2005, when the CFA & Brigades Donations Fund (CFA Fund) was specifically listed in the tax law (see item 12A.2.4 in the table in section 30-102 of the ITAA 1997). This model was implemented in Victoria to reduce the administrative burden for smaller brigades that still wanted to collect tax deductible donations.

8.41 The model currently operated in Victoria allows the CFA to operate the CFA Fund and act as a centralised accounting body, while giving brigades the freedom to collect tax deductible donations on behalf of the CFA Fund. By agreement between the CFA and individual brigades, the donations collected at a local level by brigades may be used in support of local brigade activities. Under the Victorian arrangement, individual brigades collect donations and bank them into the CFA Fund, also issuing receipts in the name of the CFA Fund. Funds collected by individual brigades are provided back to those brigades by the CFA immediately upon request. Brigades provide relevant information back to the CFA for accounting and auditing purposes. The CFA Fund has seven trustees; two representing the Victorian CFA and five representing Volunteer Fire Brigades Victoria (a representative body for CFA volunteers).

Hybrids

8.42 Some states operate hybrid volunteer fire brigades. Such brigades undertake fire-fighting as well as other kinds of volunteer based emergency services activities.

8.43 Hybrid entities can collect donations through central DGR funds established by a state or territory government entity (coordinating body), or through a DGR fund established by the entity itself. [Schedule 7, item 1, items 12A.1.2 and 12A.1.3 in the table in section 30-102 of the ITAA 1997]

8.44 The entity must be a not-for-profit entity or government entity that principally provides volunteer based emergency services regulated by a state or territory law.

Example 8.4 : Hybrid emergency service entities

The Murrumberg volunteer fire and rescue brigade is a hybrid emergency service entity - providing volunteer fire fighting as well as remote rescue services. Both of these services are emergency services.

It is a not-for-profit volunteer brigade. The brigade is registered and regulated under a State Emergency Service Act.

The brigade is planning to undertake a fundraising campaign to purchase GPS navigation equipment for use in both its remote rescue service and fire-fighting activities. The brigade chooses to establish a public fund for the purposes of supporting its emergency service activities. The public fund is eligible for endorsement by the ATO as a DGR.

The Murrumberg volunteer fire and rescue brigade can use its tax deductible donations to support all their volunteer based emergency activities, not just those activities relating to volunteer fire fighting.

Reporting requirements

8.45 While section 161 of the Income Tax Assessment Act 1936 requires annual reporting, the Commissioner has generally exempted DGRs and charities from this requirement.

8.46 Nevertheless, the tax law requires a DGR public fund to maintain adequate accounting and other records to verify that tax deductible gifts or contributions are used only for the principle purpose of the fund. The Commissioner will consider whether annual reporting of these funds is necessary, and the form any such reporting should take.

8.47 In the case of public funds established by coordinating bodies, it is a decision for those who control the fund to decide:

•

whether volunteer fire brigades can act as agents and issue receipts on behalf of the fund;

•

whether volunteer fire brigades will then be able to retain monies collected by brigades at the local level; and

•

the record keeping and reporting arrangements (including arrangements with volunteer fire brigades acting as agents of the fund) that will best allow it to meet its gift fund and public fund obligations.

Example 8.5 : How the centralised fund model could work in practice

The Queensland Fire and Rescue Service and individual brigades in Queensland enter into agreements about the collection, receipting, accounting and reporting of gift deductible donations collected by local brigades. They discuss their agreement with the ATO to ensure all requirements under the law are met.

Throughout the 2010-11 income year, the Caboolture volunteer fire brigade receives gifts totalling $1,000 from Peter and $2,000 from Teresa.

Under an agreement with the Queensland Fire and Rescue Service (the government coordinating body), a volunteer issues Peter and Teresa with receipts in the name of the central DGR fund at the time of their respective donations.

Under agreement with the Queensland Fire and Rescue Service, the local volunteer brigade in Caboolture retains custody of the funds collected locally to use for appropriate purposes.

At the end of the financial year, the Caboolture brigade reports the total donations ($3,000) to the Queensland Fire and Rescue Service (as overseer of the public fund established by the Service), as well as details of how the funds have been used and if any funds have been retained.

The Queensland Fire and Rescue Service assumes responsibility to the ATO for accounting and any reporting in relation to the central DGR fund.

8.48 Coordinating bodies may wish to make use of independent audits, declarations by individual volunteer fire brigades or explicit annual reporting (e.g. receipt reporting) to meet the accountability, reporting and record keeping requirements.

8.49 Where receipts for gifts are issued, the receipt must specify:

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that the receipt is for a gift,

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the name of the DGR fund receiving the gift, and

•

the Australian Business Number (ABN) of the DGR fund.

Other useful information may include the amount of money donated and the name of the donor.

8.50 Those responsible for the central fund are free to enter into other reporting arrangements with volunteer fire brigades to ensure that gifts to the fund have been used to further the principal purpose of the fund, and that it can explain all transactions and other acts that brigades engage in that are relevant to the public fund's status as a DGR.

8.51 In addition to maintaining proper records, if the fund allows the volunteer brigade to retain the donations they should ensure those in control of the fund have the discretion to call back the donation at any time to be applied in accordance with the purposes of the fund. Whilst this clause may not be applied in practice, it ensures that a sub-fund (which will not have endorsement) is not created.

The gift fund requirements and public fund requirements

8.52 The gift fund requirements apply to coordinating bodies endorsed under the new general DGR category for state and territory government entities that coordinate brigades.

8.53 Both the gift fund and public fund requirements will apply to DGR donation funds established by volunteer emergency service entities (including volunteer fire brigades) and state or territory coordinating bodies under the new general DGR category for public funds to support volunteer based emergency services.

8.54 The public fund and gift fund requirements are explained in the ATO's GiftPack - Guide for deductible gift recipients and donors publication.

8.55 There is some overlap between the gift fund and public fund requirements.

8.56 The existence of a public fund does not necessarily satisfy the gift fund requirement. However, if the public fund only receives gifts or deductible contributions, and the appropriate winding up rules exist, the public fund may itself be the gift fund (in this case there would be no need for a separate gift fund).

Gift fund requirements

8.57 The gift fund requirements are found in section 30-130 of the ITAA 1997.

8.58 A gift fund is a fund, maintained for the principle purpose of the DGR fund, authority or institution. All gifts, and deductible contributions, of money or property for that purpose are made to it and credited to it.

8.59 A gift fund does not receive any other money or property, and the fund is used only for the principal purpose of the fund, authority or institution.

8.60 The DGR fund, authority or institution must be required (by law, its constituent documents or governing rules) to transfer any surplus assets of the gift fund to another similar DGR fund, authority or institution when the fund, authority or institution is wound up or the DGR endorsement is revoked, whichever occurs first.

Public fund requirements

8.61 The basic requirements for public funds are laid out in Taxation Ruling TR 95/27.

8.62 Approximately half of the general DGR categories require that a public fund be established. The public fund requirement ensures that there are administrative and legal frameworks in place which will help safeguard property and moneys donated to the fund, authority or institution, and help ensure that tax deductible donations are used for the purpose for which endorsement was given.

8.63 The basic requirements for public funds include that:

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the fund must be managed by members of a Committee, a majority of whom have a degree of responsibility to the general community (this requirement does not apply to funds established and controlled by a governmental or quasi-governmental authority);

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the objects of the fund must be clearly set out and reflect the purpose of the fund;

•

gifts to the fund must be kept separate from any other funds of the sponsoring organisation;

•

a separate bank account and clear accounting procedures are required to explain all transactions relevant to the DGR status of the fund;

•

receipts must be issued in the name of the fund. Receipts must state the name of the fund to which the gift has been made; the fund's ABN and the fact that the receipt is for a gift;

•

the public must be invited to contribute to the fund;

•

the fund must operate on a not-for-profit basis (that is, moneys must not be distributed to members of the managing committee or trustees of the fund except as reimbursement for out-of-pocket expenses incurred on behalf of the fund or proper remuneration for administrative services);

•

should the fund be wound-up, any surplus money or other assets must be transferred to some other qualifying fund; and

•

the ATO is to be notified of any changes to the fund's constitution or other founding documents.

8.64 While a public fund is required to be controlled by an executive committee made up of a majority of responsible persons, the day-to-day running of the organisation need not be carried out by those persons. The fund must, however, be set up in such a way that it is not possible for public control to lapse for any period.

Ancillary funds

8.65 It remains an option under existing arrangements in the tax law for non-government organisations wishing to support volunteer fire brigades to establish an ancillary fund (a fund established and maintained under will or instrument of trust for the purpose of providing money, property or benefits to DGRs or for their establishment), to collect tax deductible donations in its own right and to give to public funds established to directly support brigades.

Enforcement

8.66 The ATO has a wide range of enforcement powers, including powers to obtain information and revoke DGR status. DGR funds are subject to the ATO's regular compliance program.

What is a gift?

8.67 Gifts of $2 or more of money or property to DGRs are tax deductible to donors, provided that the gift complies with all relevant conditions.

8.68 The donation must be a gift and voluntary. A transaction which is mandatory or where the giver receives a benefit or advantage in return, is not a gift. Accordingly, compulsory levies to pay for fire services are not tax deductible as a gift. Further information on what is a gift can be found in Taxation Ruling 2005/13.

Transitional provisions

8.69 Certain state and territory government entities that coordinate volunteer fire brigades and State Emergency Services, and the CFA & Brigades Donations Fund, are already specifically listed as DGRs in the ITAA 1997. These entities will be taken to have been endorsed by the Commissioner under the new categories. The normal endorsement rules continue to apply after this date. [Schedule 7, item 3, section 30-102 of the Income Tax (Transitional Provisions) Act 1997]

8.70 Entities that were specifically listed as DGRs in the law do not need to seek re-endorsement under the new general DGR category for such organisations.

Application provisions

8.71 The measure commences from Royal Assent, and applies to gifts made after that time. [Schedule 7, item 4]

Consequential amendments

8.72 Specifically listed entities are removed from the index table (in subsection 30-315(2) of the ITAA 1997) in Division 30 of the ITAA 1997. These entities are state and territory government bodies, and the CFA & Brigades Donations Fund, which are treated as endorsed under the new general categories by way of the transitional provisions. [Schedule 7, item 2, subsection 30-315(2) of the ITAA 1997]

Index

Schedule 2: CGT treatment of water entitlements and termination fees

Schedule 3: Taxation of financial arrangements

Schedule 4: Scrip for scrip alignment

Schedule 5: Medical expenses tax offset claim threshold

Schedule 6: Deductible gift recipients

Schedule 7: Extending gift deductibility to volunteer fire brigades