House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Glossary

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

General outline and financial impact

Medicare levy low-income threshold for families

Schedule 1 to this Bill amends the Medicare Levy Act 1986 to increase the Medicare levy low-income threshold for families and the dependent child-student component of the threshold.

Date of effect: This measure applies to the 2013-14 income year and later income years.

Proposal announced: This measure was announced in the 2014-15 Budget on 13 May 2014.

Financial impact: This measure has the following revenue implications:

Human rights implications: This Bill is compatible with human rights. See Statement of Compatibility with Human Rights - Chapter 1, paragraphs 1.18 to 1.22.

Compliance cost impact: Nil.

Protection for anticipation of certain discontinued announcements

Schedule 2 amends the Income Tax Assessment Act 1936 (ITAA 1936) to ensure outcomes are preserved in relation to tax assessments where:

•

taxpayers have reasonably and in good faith anticipated the impact of identified announcements made by a previous government that the tax law would be amended with retrospective effect; and

•

the current Government has now decided that the announced proposal to change the law will not proceed.

Date of effect: The availability of protection will be based on statements made by or on behalf of a taxpayer that relate to the period an identified announcement was 'on foot'. An announcement is 'on foot' from the day on which it was originally announced by a previous government until 14 December 2013, which is the day the current Government announced that the measure would not proceed. Accordingly, the amendments have a retrospective impact, although the effect of the amendments can only benefit taxpayers. This is because outcomes under tax assessments will only be preserved where any changes to those outcomes would lead to a less favourable result for the taxpayer. More specifically, the amendments apply to a taxpayer in relation to an identified announcement where:

•

the taxpayer has given a statement to the Commissioner of Taxation while the announcement was 'on foot' that anticipates the impact of the announcement, provided that the statement is not in a return that was due to be lodged before the announcement was 'on foot'; or

•

the taxpayer has given an original return to the Commissioner of Taxation which anticipates the impact of the announcement after 14 December 2013, and, on or before 14 December 2013:

-

the events or circumstances that enable the impact of the announcement to be anticipated have happened or existed; or

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the taxpayer had definitively committed to the happening or existence of events or circumstances that enable the impact of the announcement to be anticipated.

Proposal announced: The measure was announced in the Treasurer's and then Assistant Treasurer's Joint Media Release of 6 November 2013, 'Restoring integrity in the Australian tax system'.

Financial impact: The financial impact of this initiative is minimal.

Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights - Chapter 2, paragraphs 2.107 to 2.110.

Compliance cost impact: There will be a minor compliance cost saving as a result of these amendments. This is because costs that would have otherwise been borne by taxpayers in revising and adjusting their tax positions in relation to discontinued announcements will not be incurred. The amount of the compliance cost saving is unquantifiable.

Preventing dividend washing

Schedule 3 to this Bill will amend the Income Tax Assessment Act 1997 (ITAA 1997) to introduce an integrity rule to limit the ability of taxpayers to obtain a tax benefit from 'dividend washing'.

Broadly, dividend (or distribution) washing is a form of scheme by which a taxpayer can obtain multiple franking credits in respect of a single economic interest by selling an interest after an entitlement to a franked distribution has accrued and then immediately purchasing an equivalent interest with a further entitlement to a corresponding franked distribution.

Date of effect: This measure applies to distributions made on or after 1 July 2013.

Proposal announced: The former government announced this measure in Media Release No. 70 of 14 May 2013. On 6 November 2013, in a Media Release titled Restoring Integrity in the Australian tax system, the Treasurer and Assistant Treasurer announced the Government intended to proceed with this measure.

Financial impact: This measure has the following fiscal impact ($m):

Human rights implications: This Schedule does not raise any human rights issues. See Statement of Compatibility with Human Rights - Chapter 3, paragraphs 3.91 to 3.102.

Compliance cost impact: The additional compliance costs in connection with this measure are minor.

Chapter 1 - Medicare levy low-income threshold for families

Outline of chapter

1.1 Schedule 1 to this Bill amends the Medicare Levy Act 1986 (ML Act) to increase the Medicare levy low-income threshold for families and the dependent child-student component of the threshold in line with movements in the consumer price index (CPI).

Context of amendments

1.2 The ML Act provides that no Medicare levy is payable by low-income individuals and families where their taxable income or combined taxable family income does not exceed the stated threshold amounts.

1.3 In recent years, all of the low-income thresholds in the ML Act have been indexed annually in line with positive movements in the CPI.

1.4 The Clean Energy (Tax Laws Amendments) Act 2011 amended the low-income thresholds for:

•

single taxpayers with no dependants;

•

single senior Australians; and

•

single pensioners with no dependants,

in response to the increase in effective tax-free thresholds introduced by that Act and the Clean Energy (Income Tax Rates Amendments) Act 2011. As the increased thresholds introduced by that Act remain in excess of the notional CPI indexed thresholds for 2013-14, no further changes are required to those low-income thresholds.

1.5 This Bill increases the low-income threshold for families and the dependent child-student component of the threshold in line with movements in the CPI for the 2013-14 income year.

Summary of new law

1.6 This Bill amends subsections 8(5) to (7) of the ML Act to increase the family income threshold amount and the dependent child-student component of the 'family income threshold'.

Comparison of key features of new law and current law

Detailed explanation of new law

Medicare levy family income threshold

1.7 This Bill increases the family income threshold amount and the dependent child-student component of the family income threshold for the 2013-14 income year in line with movements in the CPI.

1.8 Section 5 of the ML Act imposes the Medicare levy, and section 6 specifies the rate of the Medicare levy, being 1.5 per cent of taxable income for 2013-14 (increasing to 2 per cent for 2014-15 and later tax years).

1.9 Section 8 specifies the formula for calculating the amount of the Medicare levy for a person who has a spouse or dependents. The calculation applies where the family income in relation to the relevant person exceeds the 'family income threshold'.

1.10 The 'family income threshold' specified in subsections 8(5) to (7) will increase from $33,693 to $34,367. [Schedule 1, items 2, and 5]

1.11 The dependent child-student component of the family income threshold in subsection 8(5) will also increase from $3,094 to $3,156 for each dependent child-student. [Schedule 1, item 3]

Summary of Medicare levy low-income threshold amounts and phase-in ranges for families

1.12 The increased threshold amounts and phase-in ranges for the 2013-14 income year and future income years are summarised in Table 1.1.

1.13 The Medicare levy phases in at a rate of 10 cents in the dollar where the taxable income or combined family taxable income exceeds the threshold amounts (section 7).

Technical amendments

1.14 The Bill also makes minor technical amendments to the ML Act and Income Tax Assessment Act 1936 in order to clarify the operation of the family income threshold and the definition of dependant. [Schedule 1, items 1 and 4, subsection 251R of the Income Tax Assessment Act 1936 and the definition of 'family income threshold' in subsection 8(5) of the ML Act]

1.15 This ensures that there is no doubt about the interaction between the Medicare levy provisions and the rules for eligibility for the dependency offset in the Income Tax Assessment Act 1936.

Application and transitional provisions

1.16 The core amendments made by this Bill apply to assessments for the 2013-14 income year and later income years. [Schedule 1, subclause 6(2)]

1.17 The technical amendments made by this Bill apply to assessments for the 2012-13 income year and later income years. While these technical amendments are retrospective, they operate to the benefit of taxpayers and in a manner consistent with how the law is being administered by the Commissioner of Taxation. [Schedule 1; subclause 6(1)]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Tax and Superannuation Laws Amendment (2014 Measures No. 2) Bill 2014 - Medicare levy low-income threshold for families

1.18 Schedule 1 to this Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

1.19 This Bill amends the Medicare Levy Act 1986 to increase the Medicare levy low-income threshold for families and the dependent child-student component of the threshold in line with movements in the CPI.

1.20 This will ensure that low-income families who were exempt from the Medicare levy in the 2012-13 income year will continue to be exempt in the 2013-14 income year if their incomes have increased in line with or less than the CPI.

Human rights implications

1.21 This Bill engages the following human rights: 'Right to Health

Article 12(1) of the International Covenant on Economic, Social and Cultural Rights (ICESCR) recognises the right to the enjoyment of the highest attainable standard of physical and mental health.

While ICESCR contains no definition of health, the United Nations Committee on Economic, Social and Cultural Rights has stated that the right to health is not to be understood as a right to be healthy.^[6] The Committee has stated that the right to health contains both freedoms and entitlements, and the entitlements include the right to a system of health protection which provides equality of opportunity for people to enjoy the highest attainable level of health.^[7]

Increasing the low income threshold for families promotes the right to health by ensuring that low-income families who were exempt from the Medicare levy in 2012-13 income year will continue to be exempt in the 2013-14 income year if their incomes have increased in line with or less than the CPI, promoting their access to the health care system.'

Conclusion

1.22 This Bill is compatible with human rights because it promotes the right to health by ensuring that those families on lower incomes are not liable to pay the Medicare levy, therefore providing equality of opportunity for people to enjoy access to the health care system without additional financial burden.

Chapter 2 - Protection for anticipation of certain discontinued announcements

Outline of chapter

2.1 Schedule 2 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to introduce a one-off protection provision, which ensures in broad terms that outcomes are preserved in relation to income tax assessments where:

•

taxpayers have reasonably and in good faith anticipated the impact of identified announcements made by a previous government that the tax law would be amended with retrospective effect; and

•

the current Government has now decided that the announced proposal to change the law will not proceed.

Context of amendments

2.2 The protection provision introduced by this Schedule applies in respect of particular past announcements that proposed a change to the tax law which the Government has decided not to proceed with. The primary purpose of the protection provision is to provide certainty for taxpayers that were impacted by an unenacted announcement, in the event that they self-assessed based on the announcement (often with the comfort of the Commissioner of Taxation (Commissioner) having published an administrative treatment that he would not dedicate resources to enforce compliance with the law that related to the matter subject to the announcement).

2.3 On 6 November 2013, the Treasurer and the then Assistant Treasurer announced (Joint Media Release, 'Restoring integrity in the Australian tax system') a process under which decisions would be made on how the Government would proceed with a backlog of 92 announced but unenacted tax and superannuation measures that were outstanding at the time of the Government coming to office. Under that process, the Government indicated that it had a disposition not to proceed with 64 of those 92 measures, but that final decisions on what would occur with these measures would be the subject of consultation.

2.4 Following this consultation, the then Assistant Treasurer confirmed by way of further Media Release on 14 December 2013 ('Integrity restored to the Australian tax system') that the Government had decided not to proceed with 48 of the 64 measures that were considered in the consultation process.

2.5 As a matter of practice, taxpayers may in many cases anticipate the impacts of an announced proposal to change the law prior to its enactment, where that proposed change is intended to have a beneficial impact for taxpayers prior to the date on which it is enacted.

2.6 ATO Practice Statement PS LA 2007/11 (the Practice Statement), which outlines the Commissioner's administrative treatment of taxpayers affected by announced but unenacted legislative measures which will apply retrospectively when enacted, contemplates that taxpayers might anticipate the impact of such measures. Consistent with this Practice Statement, the Commissioner has in many cases published administrative treatments that advised that the Commissioner would not dedicate resources to enforce compliance with the law where the announcement might reasonably be anticipated to apply in a favourable way to a taxpayer. The practical effect of publishing these treatments is to provide some comfort for taxpayers should they choose to anticipate the proposed change to the law when self-assessing their position.

2.7 The Commissioner is required to administer the existing law, and expects taxpayers and others to behave in accordance with that law. Nevertheless, the Commissioner's justification for adopting the approach set out in the Practice Statement is partly grounded on a reasonable assumption on his part that a government announcement of an intention to change the law will lead to legislation being enacted in due course. In this event, enforcing compliance with the existing law would not be an efficient and effective use of the Commissioner's resources when it is likely that any changes made to the taxpayer's position would require readjustment when that announced change is enacted.

2.8 Accordingly, the protection provision provides certainty for taxpayers and ensures that taxpayers in like assessment positions are treated similarly by:

•

ensuring that the Commissioner cannot amend or adjust a taxpayer's position if he becomes aware in a specific case that a discontinued measure has been anticipated reasonably and in good faith; and

•

providing a continuing justification for the Commissioner to not dedicate resources to examining cases where announcements that have now been discontinued were likely to be anticipated reasonably and in good faith in the past.

2.9 It follows that, in the event the Commissioner decides to not dedicate resources to examining cases that were potentially impacted by discontinued announcements in the past, the practical application of these amendments will be limited only to those cases where the Commissioner becomes aware of a taxpayer's anticipation of an announcement by some other means.

2.10 The Practice Statement also outlines the ATO's policy on penalties and interest where taxpayers anticipate a proposed retrospective change. Where announcements are not enacted, that policy provides penalty and interest relief provided that taxpayers have 'acted reasonably' in anticipating the announcement and have sought amendments or revisions to their position within a reasonable time. The protection provision will ensure that taxpayers need not seek amendments or revisions in these circumstances in relation to the announcements that are identified for the purposes of the provision. In broad terms, the need for anticipation to be reasonable and in good faith for the purpose of the protection provision seeks to give legislative expression to the 'acted reasonably' test in the Practice Statement. In the event that taxpayers have not acted reasonably and in good faith on the basis of the announcement, the Commissioner's usual amendment and recovery powers will apply.

2.11 The relief provided by the protection provision is intended to be a one-off initiative, reflecting the need for the Government, on being elected, to take stock of the considerable number of announced but unenacted tax and superannuation measures that were on hand. The decision to provide protection on this occasion in part reflects the Government's commitment to provide certainty for taxpayers by not proceeding with a significant number of these measures. Accordingly, the provision is intended to be limited to those measures that were considered as part of the process announced on 6 November 2013 (see paragraphs 2.3 and 2.4 above), and then only to those measures that are not proceeding as a result of this process.

Summary of new law

2.12 Schedule 2 introduces a protection provision to deal with cases where taxpayers have anticipated, reasonably and in good faith, the impact of an identified announcement (listed in the provision) made by a previous government of a proposed change to the tax law with retrospective effect, where the Government has now decided that the proposed change will not proceed.

2.13 This protection is primarily provided by placing a statutory bar on the Commissioner amending an income tax assessment about a particular to the extent that the particular reflects a taxpayer's anticipation of the impact of an announcement that meets the conditions set out in the provision.

2.14 In addition, where a taxpayer's anticipation of the impact of an announcement would otherwise allow the Commissioner to recover an overpayment he made to the taxpayer, protection will be provided by treating the taxpayer as being entitled to that amount if the conditions set out in the provision are satisfied.

2.15 These conditions are to be met for protection to be available:

•

A particular of a taxpayer's assessment is ascertained on the basis of a statement made by or on behalf of the taxpayer that reasonably and in good faith anticipated an announcement of a proposal to change the law which is specifically listed for the purposes of the provision;

•

One of the following timing conditions are met:

-

the statement was made by or on behalf of the taxpayer in a return while the announcement was 'on foot', provided the return was not required to be lodged before the announcement was 'on foot'; ^[8]

-

the statement was made by or on behalf of the taxpayer other than in a return while the announcement was 'on foot';

-

the events happened or the circumstances existed on or before 14 December 2013 that enabled the taxpayer to anticipate the announced proposal to change the law, and the statement that relates to that anticipation is in an original return lodged by or on behalf of the taxpayer after 14 December 2013, provided that the return was not required to be lodged before that date; or

-

the taxpayer was definitively committed on or before 14 December 2013 to events happening or circumstances existing that would enable the taxpayer to anticipate the announced proposal to change the law, and the statement that relates to that anticipation is in an original return lodged by or on behalf of the taxpayer after 14 December 2013, provided that the return was not required to be lodged before that date; and

•

The taxpayer would have a less favourable outcome if the Commissioner were to amend or adjust the position of the taxpayer to reflect the fact that the announced proposal to change the law has not been enacted.

2.16 It is only necessary to provide protection in relation to income tax assessments, as the only announcements that may meet the conditions, as listed in the provision, involved proposals to amend the income tax law.

2.17 Taxpayers can choose not to have eligible positions protected. In these circumstances, the Commissioner may amend the taxpayer's position on request to reflect the ongoing operation of the law.

2.18 The operation of the protection provision can also be overridden in circumstances where:

•

the Commissioner is amending an assessment in relation to a protected particular to give effect to an objection decision, or a decision of the Administrative Appeals Tribunal (AAT) or Court on review or appeal; or

•

the taxpayer makes a statement for a later income year that is inconsistent with an earlier anticipation of an announcement, where continuing to anticipate the announcement would give rise to a less favourable outcome in that later income year.

Comparison of key features of new law and current law

Detailed explanation of new law

2.19 This explanation of the protection provision has been organised in the following way:

•

Means of providing protection (paragraphs 2.20 to 2.42);

•

Conditions under which positions will be protected (paragraphs 2.43 to 2.92);

•

Exceptions (paragraphs 2.93 to 2.102);

•

Definitions (paragraphs 2.103 to 2.105); and

•

Application and transitional provisions (paragraph 2.106).

Means of providing protection

Self-assessment context

2.20 The drafting approach adopted in the protection provision reflects that anticipation by a taxpayer of an announced proposal to change the law occurs in a self-assessment setting. Under a self assessment system, statements of taxpayers are most often accepted on face value and reflected in assessments that are made by the Commissioner. In some cases (for example, in relation to income tax for companies and superannuation funds), returns lodged by taxpayers for an income year are deemed to be an assessment for that year.^[9] More generally, once a return for an income year is lodged, the Commissioner may accept statements of a taxpayer (including those on behalf of a taxpayer) in the return or otherwise in making an assessment for the taxpayer in that income year.^[10]

2.21 The Commissioner's administrative treatment of announced but unenacted legislative measures which will apply retrospectively when enacted (explained at paragraphs 2.6 and 2.7 above) is based on this self-assessment context.

2.22 The drafting approach adopted in the protection provision also reflects the Government's decision not to proceed with the majority of announced but unenacted measures that were outstanding when the Government came to office and provides certainty for taxpayers where they have acted reasonably and in good faith while the announcement was current. The position of taxpayers that have acted in this way will be reflected in an assessment. In contrast, the purpose of the provision is not to effectively enact the measures that the Government has decided not to proceed with for a limited period of time.

2.23 Given this, the law does not allow taxpayers that previously did not anticipate the impact of listed announcements in their returns to now seek an amendment or adjustment of their position.

Primary means of protection: Preventing amendment of assessments in relation to anticipated particulars

2.24 The primary means by which protection is provided to a taxpayer meeting the conditions for protection (see paragraphs 2.43 to 2.92 below for an explanation of these conditions) is to prevent the Commissioner from amending assessments in relation to protected positions in a way that would produce a less favourable result for the taxpayer. [Schedule 2, item 2, subsection 170B(1)]

2.25 Importantly, the protection provided is limited to the particulars of an assessment that reflect the taxpayer's anticipation of the impact of an announcement that is listed for the purposes of the provision. In an income tax context, a 'particular' of an assessment is a specific or definite constituent element in an assessment of taxable income (or that there is no taxable income) or tax payable on taxable income (or that there is no tax payable). All other particulars of the assessment are subject to the usual rules governing amendment of assessments. [Schedule 2, item 2, subsection 170B(1)]

Less favourable result

2.26 The operation of the concept of a 'less favourable result' is intended to mirror the 'more favourable result' concept that is used in the existing tax rulings provisions (see subsection 357-70(1) of Schedule 1 to the Taxation Administration Act 1953). [Schedule 1, item 2, subsection 170B(1)]

2.27 In an income tax context, a 'less favourable result' would be most clearly reflected in an amendment to an assessment that establishes a liability to tax by increasing income tax payable.

2.28 However, a 'less favourable result' is also intended to contemplate an amendment to an assessment that increases taxable income without increasing income tax payable. Such a scenario might arise because of the application of the tax-free threshold to the taxpayer or of the application of tax offsets that the taxpayer is entitled to against tax payable. While an immediate exposure to an income tax liability may not arise in relation to such an amendment, the increase in taxable income nevertheless gives rise to a greater exposure to an income tax liability in the future in the event that there is a further amendment of the assessment. Given this possibility, an amendment that only increases taxable income without increasing tax payable is considered to produce a 'less favourable result' for the taxpayer.

Example 2.1

Bronwyn was impacted by a natural disaster in December 2012 and anticipated the 'CGT relief for natural disasters' announcement (listed at item 3 of the table in subsection 170B(8)). This anticipation, which meets all of the necessary conditions for protection, has the effect of reducing her net capital gain for the 2012-13 income year under section 102-5 of the Income Tax Assessment Act 1997 by $30,000.

Taking this $30,000 reduction in her net capital gain into account, Bronwyn reports in her income tax return that her assessable income for the 2012-13 income year is $150,000, and the total of her deductions for that income year is $175,000. Accordingly, Bronwyn has a tax loss for the year of $25,000 and the Commissioner makes an assessment of nil taxable income and nil tax payable for the income year.

In the absence of the protection provision, the Commissioner may make an amended assessment for Bronwyn that increases her taxable income to $5,000. (This would reflect an increase in her net capital gain of $30,000, which would in turn increase her assessable income for the income year to $180,000. Her taxable income would be $5,000 after subtracting her deductions of $175,000.). Nevertheless, the operation of the tax-free threshold would ensure that no income tax liability would immediately arise from such an amendment.

However, if this amendment was made, Bronwyn would be exposed to a greater liability in the event that a further amendment to her assessment was made that increased her income tax liability. Accordingly, any amendment to increase her taxable income to $5,000 produces a less favourable result for her. As her anticipation of the listed announcement meets the conditions for protection, the Commissioner is prevented from making this amendment.

2.29 It is also possible that anticipation of an announced proposal to change the law which is initially reflected in a statement in an income year could give rise to a 'less favourable result' for a taxpayer in a later income year if that anticipation were to be reversed.

2.30 In particular, this can occur where a tax loss arises in the initial income year, and any reversal of that anticipation would not immediately result in an amended assessment in that income year. Under the law, there can only be an amended assessment for an income year if the amounts of taxable income or tax payable on that taxable income for that year change. Accordingly, there would be no amendment of an assessment where an anticipated position might be reversed on the basis that the announcement was discontinued, but the impact of that anticipation is less than the amount of a tax loss. As Example 2.2 below illustrates, the protection provision may nevertheless take effect at a later time where:

•

There are adjustments to other particulars of the loss year assessment within the time limits set out in subsection 170(1) of the ITAA 1936 that, together with any reversal of the anticipated position, would result in an amended assessment; or

•

The tax loss is sought to be applied as a deduction in a later income year.

Example 2.2

Assume the same facts as Example 2.1, where Bronwyn has a tax loss of $25,000, except now:

•

her assessable income for the income year is $170,000 because the impact of anticipation on her net capital gain for the 2012-13 income year is a reduction of $10,000 rather than $30,000; and

•

her deductions for that income year are $195,000 rather than $175,000.

In this case, the operation of the protection provision would not have an immediate impact for Bronwyn's assessment. Increasing her net capital gain by $10,000 alone would not result in an amendment of her assessment as her taxable income and tax payable would both remain nil. Her tax loss that is available to be carried forward would be reduced from $25,000 to $15,000.

However, if the Commissioner also came to the view (prior to the time limits for amendment expiring) that Bronwyn was not entitled to a deduction of $50,000 that had been allowed in her 2012-13 income year assessment, the protection provision would have an impact. The protection provision would prevent the Commissioner from making an amendment about the $10,000 net capital gain particular, even though the Commissioner could still make an amendment about the $50,000 deduction particular.

Accordingly, in the absence of the protection provision, Bronwyn's taxable income may be increased by amendment to $35,000. This would reflect assessable income for the income year of $180,000 (increased by $10,000 to take account of the change to her net capital gain) less deductions of $145,000 (decreased by $50,000 to take account of the over-claimed deduction).

With the protection provision, Bronwyn's taxable income may only be increased by amendment to $25,000. This would reflect assessable income for the income year of $170,000 (reflecting the net capital gain Bronwyn reported in her income tax return) less deductions of $145,000.

Alternatively, if Bronwyn was in a position to claim a deduction for her 2012-13 tax loss in the 2013-14 income year prior to the Commissioner becoming aware of the over-claimed deduction of $50,000, the protection provision would prevent an amendment of her 2013-14 income year assessment to reduce her prior year tax loss deduction from $25,000 to $15,000.

2.31 The concept of a 'less favourable result' also ensures that the Commissioner retains the ability to amend an assessment to reverse the anticipation of the impact of an announcement by a taxpayer where amending the assessment would produce a more favourable result for the taxpayer.

Anticipated amendments

2.32 The design of the protection provision has explicitly taken scenarios such as the one illustrated in Example 2.2 into account by distinguishing between the statements of the taxpayer that reflect anticipation on the one hand, and particulars of an assessment that are made on the basis of those statements on the other.

2.33 The concept of 'anticipated amendments' is the means of identifying which statements made by a taxpayer in a self-assessment context can form the basis of particulars of an assessment that will be protected. A taxpayer must have 'anticipated amendments' before protection will be provided. [Schedule 2, item 2, paragraph 170B(1)(a) and subsection 170B(3)]

2.34 The conditions that must be met for protection to be provided are contained within the definition of 'anticipated amendments' (see paragraphs 2.43 to 2.92 below for an explanation of these conditions). That definition establishes a connection between one or more hypothetical amendments to the law and statements made by the taxpayer that are consistent with those hypothetical amendments. [Schedule 2, item 2, subsection 170B(3)]

Protection of particulars ascertained on the basis of anticipated amendments

2.35 If the conditions are met for these hypothetical amendments to be 'anticipated amendments', a particular of an assessment that is ascertained on the basis of those amendments will be protected. [Schedule 2, item 2, paragraphs 170B(1)(b) and 170B(1)(c)]

2.36 The anticipated amendments may only be one element in ascertaining the relevant particular of an assessment.

2.37 The scenarios in Examples 2.1 and 2.2 illustrate this point. In these examples, the direct and immediate impact of the reduction of Bronwyn's net capital gain is to move her into a tax loss position (in Example 2.1) or increase the amount of her tax loss (in Example 2.2) for the 2012-13 year.

2.38 If Bronwyn seeks to deduct her 2012-13 tax loss in a later income year, the amount of her tax loss ($25,000) will have been worked out on the basis of her anticipated amendments. The particular in the later income year - being the deduction for a prior year tax loss - will still have been ascertained on the basis of her anticipated amendments having been made. Accordingly, the condition in paragraph 170B(1)(b) can apply to this particular.

2.39 However, under paragraph 170B(1)(c), the protection offered by the provision only extends to an amendment that would instead ascertain the particular on the basis of the anticipated amendments having not been made. This means that the amount of Bronwyn's tax loss deduction is protected to the extent that it is increased by her anticipated amendments. However, if there is another basis on which Bronwyn's tax loss deduction would be denied, subsection 170B(1) will not prevent the Commissioner from amending the assessment to deny the deduction.

Further means of protection: Preventing recovery of administrative overpayments

2.40 There may also be circumstances where a taxpayer may be immediately exposed to a 'less favourable result' without there being an amended assessment. An example is where, on the basis of an original assessment reflecting an anticipation of the impact of an announced proposal by the taxpayer (such as the announcement listed in item 13 of the table in subsection 170B(8)), excess refundable tax offsets (such as tax offsets for franked distributions) are refunded. In such cases, an administrative overpayment may arise for the taxpayer without any amendment being made to the underlying assessment.

2.41 Provided the conditions for 'anticipated amendments' are met in these circumstances, the law ensures that the taxpayer is not exposed to a liability for an administrative overpayment under section 8AAZN of the Taxation Administration Act 1953. Instead, the taxpayer will be taken to be entitled to the amount that reflects the anticipation of the impact of the announcement. [Schedule 2, item 2, subsection 170B(2)]

Priority of the protection provision

2.42 To ensure the protection provision has its intended impact, the effect of the provision will override any other provision in the taxation law. This priority rule is subject to the specific exceptions listed in the provision, which are discussed further at paragraphs 2.93 to 2.102 below. [Schedule 2, item 2, subsection 170B(5)]

Conditions under which positions will be protected: Definition of 'anticipated amendments'

2.43 In conjunction with the 'less favourable result' concept explained at paragraphs 2.26 to 2.31 above, the definition of 'anticipated amendments' in subsection 170B(3) sets out the other conditions that must be satisfied before protection will be available. Specifically, to be eligible for protection, statements made to the Commissioner by or on behalf of the taxpayer must:

•

Be consistent with one or more hypothetical amendments to the law that, if made, would reasonably reflect an announcement listed for the purposes of the provision. [Schedule 2, item 2, paragraph 170B(3)(a) and subparagraph 170B(3)(b)(i)];

•

Be made in good faith [Schedule 2, item 2, subparagraph 170B(3)(b)(ii))];

•

Meet at least one of these timing requirements relating to when the announcement that was anticipated was 'on foot': [Schedule 2, item 2, subparagraph 170B(3)(b)(iii)]

-

the statement is made in a return for an income year that was lodged on or before 14 December 2013 and while the announcement was 'on foot', provided that return was not required to be lodged before the original announcement was made [Schedule 2, item 2, item 1 of the table in subsection 170B(3)];

-

the statement is made other than in a return while the announcement was 'on foot' [Schedule 2, item 2, item 2 of the table in subsection 170B(3)];

-

the statement is made in an original return for an income year that is lodged after 14 December 2013 and was not required to be lodged before that date, and relates to the application of the taxation law to events that happened or circumstances that existed prior to the announcement being discontinued on 14 December 2013 [Schedule 2, item 2, paragraph (a) in column 2 of item 3 of the table in subsection 170B(3)]; or

-

the statement is made in an original return for an income year that is lodged after 14 December 2013 and was not required to be lodged before that date, and relates to the application of the taxation law to the happening or existence of events or circumstances to which the taxpayer had definitively committed prior to the announcement being discontinued on 14 December 2013 [Schedule 2, item 2, paragraph (b) in column 2 of item 3 of the table in subsection 170B(3)].

Statement consistent with hypothetical amendments that reasonably reflect an announcement

2.44 For protection to be available, it is necessary for the taxpayer's statements that anticipate the announcement to be consistent with amendments to the law that would reasonably reflect a listed announcement. [Schedule 2, item 2, paragraph 170B(3)(a) and subparagraph 170B(3)(b)(i)]

Statement made by or on behalf of the taxpayer

2.45 As discussed earlier (at paragraphs 2.20 to 2.23), protection is available under the provision in a self-assessment context. Accordingly, taxpayer positions that are eligible for protection will be reflected in statements made by or on behalf of the taxpayer. [Schedule 2, item 2, paragraph 170B(3)(b)]

2.46 The provision is intended to apply to circumstances where, consistent with an announcement, amounts or items are omitted from a taxpayer's return or other statement. A common example where this might occur is where the law would require an amount to be included in a taxpayer's assessable income, but that amount would not have been included in assessable income had the announced proposal to change the law been enacted (Examples 2.1 and 2.2 above are cases in point). Any statement made by the taxpayer must be read as a whole. An omission of the amount from a taxpayer's return or other statement would be consistent with hypothetical amendments that reflect the announcement.

2.47 It is not necessary that the statement relate to a quantifiable amount. 'Statement' is not limited to any particular type of information that is contained within it.

2.48 It is also not necessary for the anticipation of the announcement to be readily apparent in the statement. Given the Commissioner's administrative treatment of announced but unenacted legislative measures which will apply retrospectively when enacted, as set out in ATO Practice Statement PS LA 2007/11, it is expected that the anticipation would not be readily apparent. Section 169A of the ITAA 1936 allows the Commissioner to take statements made by or on behalf of a taxpayer on face value for the purpose of making an assessment in relation to the taxpayer.

Statement consistent with amendments that would reasonably reflect an announcement

2.49 To provide a benchmark against which protection can be provided, the law hypothesises amendments that may have been made to the law that would 'reasonably reflect' a listed announcement. Statements made by or on behalf a taxpayer that are consistent with such amendments become the taxpayer's 'anticipated amendments'. [Schedule 2, item 2, paragraph 170B(3)(a) and subparagraph 170B(3)(b)(i)]

2.50 The 'reasonable reflection' test recognises that the exact amendments that would give effect to the announcement may well not be known with precision. This means that the test can contemplate differences in how different taxpayers might anticipate an announced proposal to change the law, provided that the anticipation in any given case is reasonable. Nevertheless, there would need to be sufficient detail associated with an announced proposal to change the law to provide a basis on which to reasonably anticipate its likely impact. [Schedule 2, item 2, paragraph 170B(3)(a)]

2.51 The following factors are to be taken into account in applying the 'reasonable reflection' test in paragraph 170B(3)(a):

•

the terms of the announcement, which will generally be set out in Budget Papers and associated media releases, as identified in the table of listed announcements in subsection 170B(8) [Schedule 2, item 2, paragraph 170B(4)(a)];

•

any related document published after the announcement on behalf of the Commonwealth Government, the Department of the Treasury or the Commissioner, including discussion papers and exposure drafts [Schedule 2, item 2, paragraph 170B(4)(b)];

•

any specific schemes or practices to which the announcement was proposed to apply, which will contemplate more specifically whether the taxpayer has entered into such schemes or engaged in such practices, making it more likely that the taxpayer's hypothetical amendments would reasonably reflect the announcement [Schedule 2, item 2, paragraph 170B(4)(c)]; and

•

comparable provisions in the existing taxation law that, in relation to another matter, produce the same or a substantially similar result as that proposed by the announcement. [Schedule 2, item 2, paragraph 170B(4)(d)]

2.52 An example of where the last of these factors will be relevant is where an announcement contemplated that there would be a CGT roll-over in a particular set of circumstances. There are a number of precedents in the current law that provide for a CGT roll-over that might reasonably form a basis for anticipating what amendments could have been made to the law to give effect to such an announcement.

2.53 Any other relevant matters may also be taken into account in applying the 'reasonable reflection' test. [Schedule 2, item 2, paragraph 170B(4)(e)]

2.54 From this basis, the condition in subparagraph 170B(3)(b)(i) considers whether the taxpayer's statement is consistent with one or more hypothetical amendments that would reasonably reflect the announcement. Any statement made by or on behalf of a taxpayer that anticipates an announced proposal to change the law must necessarily be consistent with some amendments being made to the law. However, if the amendments that are consistent with the taxpayer's statement do not reasonably reflect the relevant announcement, it follows that the statement cannot meet the condition in subparagraph 170B(3)(b)(i). [Schedule 2, item 2, subparagraph 170B(3)(b)(i)]

2.55 Two particularly important aspects of an announcement to take into account in the application of the condition in subparagraph 170B(3)(b)(i) are:

•

the proposed start date for the announced proposal to change the law; and

•

whether the announced proposal to change the law would reasonably apply to the taxpayer's circumstances.

2.56 For the purposes of this provision, statements that anticipate the impact of an announcement for an income year prior to the proposed start date will not be consistent with amendments that reasonably reflect that announcement.

2.57 Similarly, a reasonable reflection of an announced proposal to change the law must necessarily contemplate its scope, both in terms of the class of entities and the class of arrangements to which it may reasonably apply. If the taxpayer or taxpayer's circumstances fall outside of these classes, statements that anticipate otherwise will not be consistent with amendments that reasonably reflect the announcement.

2.58 Nevertheless, it is not necessary for the taxpayer to be aware of an announced proposal to change the law for the conditions in paragraph 170B(3)(a) and subparagraph 170B(3)(b)(i) to be satisfied. Collectively, these conditions merely require the taxpayer's statement to be consistent with amendments that, if made, would reasonably reflect an announcement listed for the purposes of the provision.

Announcements listed for the purposes of the provision

2.59 Of the 48 measures that the Government has decided not to proceed with as part of the process described in paragraphs 2.3 and 2.4, the provision lists those announcements where the protection provision is relevant. The protection provision will not apply to any discontinued announcement that is not listed for the purposes of the provision. [Schedule 2, item 2, paragraph 170B(3)(a) and subsection 170B(8)]

2.60 In broad terms, the criteria applied in listing the announcements in subsection 170B(8) are as follows:

•

The announcement was unenacted at the time the current Government was elected and was considered as part of the process described in paragraphs 2.3 and 2.4;

•

The Government expressly decided to not proceed with the announcement as part of that process;

•

At some point in the period while the announcement was 'on foot', the announced proposal to change the law or a particular aspect of it had a proposed start date that would have been retrospective had the announcement been enacted at that point; and

•

The announced proposal to change the law or a particular aspect of it had an intended operation that would have been beneficial for taxpayers (that is, it had the potential to reduce a liability or increase an entitlement of a taxpayer under the law if it had been enacted).

2.61 Some of the listed announcements had potential impacts that would have been favourable to taxpayers, as well as other potential impacts that would not have been favourable to taxpayers. An example is the related party bad debts announcement listed at item 1 of the table in subsection 170B(8). Provided all of the other conditions required for protection to be available are satisfied, the protection provision may apply to the extent that these announcements would have had favourable impacts that were anticipated by taxpayers. The 'less favourable result' concept, discussed at paragraphs 2.26 to 2.31 ensures this outcome is achieved.^[11]

2.62 Some of the 37 measures^[12] in the original backlog that the Government has decided should proceed are intended to have a beneficial impact for taxpayers prior to their enactment. The protection provision does not apply to measures that are currently proposed to proceed. Accordingly, any taxpayer that anticipates such a measure will need to consider their position in accordance with the Commissioner's administrative treatment in Practice Statement PS LA 2007/11 in the event that the measure is enacted. However, if any of these measures are discontinued for any reason, they may potentially be added to the list of announcements for the purposes of the protection provision.

Statements made in good faith

2.63 Statements made by taxpayers that are the source of protected positions must also be made in 'good faith'. This condition more specifically contemplates whether the taxpayer's anticipation of the impact of the listed announcement is bona fide given their particular circumstances. [Schedule 2, item 2, subparagraph 170B(3)(b)(ii)]

2.64 The 'good faith' test broadly contemplates honesty in belief or purpose; observance of reasonable standards of dealing in relation to an announcement; and an absence of intent to seek an unconscionable advantage. Including this condition is intended to be a counter-balance against overly aggressive conduct by or on behalf of a taxpayer.

2.65 To adapt judicial statements about 'good faith' to the current context, the good faith condition offers a warning that game playing at the margins of anticipation may attract a finding that there will be no protection afforded to the taxpayer.^[13]

2.66 Given the context in which the 'good faith' condition is being applied here, the anticipation of an announcement of itself cannot lead to a conclusion that the statement in the income tax return was made other than in good faith.

2.67 However, if the taxpayer's anticipation of the impact of the announced proposal to change the law is such that it reflects a statement of facts that are known to be untrue, then that statement would not be made in good faith. Similarly, if the taxpayer or its agent knows that the announcement would not apply to the taxpayer's circumstances, or is reckless as to whether this would be the case, then any statement that anticipates that there would be an impact for the taxpayer would not be in good faith.^[14]

2.68 Consistent with the way that the concept of 'good faith' has been interpreted in other similar statutory contexts, this condition also allows for a consideration of whether the taxpayer's statement reflects an arbitrary anticipation of the impact of the announcement, or the absence of reasonable caution and diligence in this regard. Accordingly, the extent to which the taxpayer or its agent was aware of an announcement and its likely impact will be relevant to whether the 'good faith' condition is met.

2.69 An example of where the 'good faith' condition might not be met is where a statement is made by or on behalf of a taxpayer very shortly after a proposal to change the law is announced, and there is little detail on how that proposal might be enacted at that time, either in the terms of the announcement itself or having regard to any other relevant matters. All relevant surrounding circumstances would need to be taken into account in determining whether the good faith test has been met in such a case.

2.70 Unlike some other cases that are dealt with explicitly in the provision (see paragraphs 2.93 to 2.102 below), there is no specific exception that applies in relation to the ability of the Commissioner to amend an assessment if he is of the opinion there has been fraud or evasion (see item 5 of the table in subsection 170(1) of the ITAA 1936). If a taxpayer's anticipation of an announcement has been tainted by fraud or evasion, the statement of the taxpayer would not be in good faith.^[15]

2.71 In addition, given the standards that a 'good faith' test more broadly contemplates, the condition may not be met if the general anti-avoidance provision in Part IVA would have applied to cancel the anticipated benefit had the announced proposal to change the law been enacted.

Timing conditions: Statements made or relating to events while the announcement was 'on foot'

2.72 The application rules for the protection provision are effectively contained in timing requirements for the statements made by or on behalf of the taxpayer, which relate to the period during which the announcements listed in subsection (8) were current or 'on foot'. For a taxpayer to be eligible for protection, it is necessary for the statement made by it or in its behalf to meet at least one of four timing requirements. [Schedule 2, item 2, subparagraph 170B(3)(b)(iii)]

2.73 These four timing requirements can be grouped into two categories, namely:

•

Lodgment-based eligibility: Either:

-

The taxpayer's statement is contained in a return for an income year lodged during the period while the announcement was 'on foot', provided that return was not required to be lodged before the original announcement was made. [Schedule 2, item 2, item 1 of the table in subsection 170B(3)]; or

-

The taxpayer's statement is made otherwise than in a return and is made while the announcement was 'on foot'. [Schedule 2, item 2, item 2 of the table in subsection 170B(3)].

•

Event-based eligibility: The statement is made in an original return for an income year that is lodged after 14 December 2013 (the end of the 'on foot' period), where the return is not required to be lodged on or before that date, and the statement relates to the application of the taxation law (as hypothetically amended) to:

-

events or circumstances that happened or existed on or before 14 December 2013 [Schedule 2, item 2, paragraph (a) in column 2 of item 3 of the table in subsection 170B(3)]; or

-

the happening or existence of events or circumstances to which the taxpayer had definitively committed on or before 14 December 2013 [Schedule 2, item 2, paragraph (b) in column 2 of item 3 of the table in subsection 170B(3)].

Lodgment-based eligibility: General

2.74 Any anticipation of a listed announcement will ultimately be reflected in information provided in a statement made by or on behalf of the taxpayer and given to the Commissioner. Once an announcement is 'live', the potential for taxpayers to anticipate it through such statements, on the assumption that a proposed change to the law will be enacted by Parliament with retrospective effect, is enlivened. For the listed announcements, such an assumption continued until 14 December 2013, when the Government announced it had decided not to proceed with those announcements.

2.75 Any statement that anticipates an announced proposal to change the law must be in relation an income year to which the proposal to change the law would have applied. However, it is not necessary for that income year to have started or ended after the original announcement was made. In addition, provided the statement is given while the announcement is on foot, it is also not necessary for the relevant events or circumstances (that is, the events or circumstances that allow anticipation to take place) to have happened or existed while the announcement is on foot. In some cases, an announced proposal to change the law will contemplate the application of the proposed change well before the announcement is made, so these events and circumstances may have happened or existed before the original announcement was made.

Lodgment-based eligibility: Statements in returns

2.76 The most common way for a taxpayer to anticipate an announced proposal to change the law is through the lodgment of its tax return for an income year impacted by the announcement. As a general rule, a statement that anticipates an announcement in a tax return will meet the timing requirement if the return is lodged while the announcement was 'on foot'. [Schedule 2, item 2, item 1 in the table in subsection 170B(3)]

2.77 However, to avoid the potential for compliant taxpayers that lodge returns in a timely fashion being be disadvantaged, the timing requirement will not be met for a statement in a tax return lodged while an announcement was 'on foot' if that return was due to be lodged before the original announcement was made. [Schedule 2, item 2, item 1 in the table in subsection 170B(3)]

Lodgment-based eligibility: Other statements

2.78 Other statements made by or on behalf of a taxpayer in relation to an income year will meet the timing requirement if they are made in the period while the announcement was 'on foot'. [Schedule 2, item 2, item 2 in the table in subsection 170B(3)]

2.79 In some circumstances, taxpayers may only be in a position to reasonably anticipate an announced proposal to change the law for the first time in relation to a particular income year after an assessment has been made that does not reflect the proposed change to the law. For example, this may occur where the assessment is made before the original announcement is made. It may also occur where there is insufficient detail at the time an announcement is originally made to allow for the taxpayer to anticipate in good faith.

2.80 A statement made to the Commissioner that seeks to amend assessments so as to anticipate announcements in these types of circumstances will meet the timing requirement in item 2 of the table in subsection 170B(3), provided the statement is made in the period while the announcement is 'on foot'. In contrast, statements that seek an amendment of an assessment after 14 December 2013 will not meet any timing requirement.

Event-based eligibility: General

2.81 Alternatively, taxpayers may have entered into transactions, or other events or circumstances may have happened or existed on or before 14 December 2013, which allow for anticipation of the announced proposal. The timing requirement will be met in these circumstances, even if an original income tax return that seeks to anticipate an announcement for the first time is lodged after the announcement was discontinued on 14 December 2013.

2.82 Once these events or circumstances happen or exist on or before 14 December 2013, the taxpayer will have a basis on which to anticipate the announced proposal to change the law in its income tax returns. Allowing events-based eligibility ensures that protection can continue to be provided in a self-assessment context. This will be so even where the lodgment of the taxpayer's return in respect of those events and circumstances occurs after 14 December 2013.

2.83 In broad terms, the intent of event-based eligibility is to provide protection to anticipation that meets all of the other necessary conditions, where the only thing that remains for the taxpayer to anticipate reasonably and in good faith on 14 December 2013 is to reflect that anticipation in a statement in a tax return.

Event-based eligibility: Events or circumstances that happened or existed on or before 14 December 2013

2.84 The core case where the timing requirement will be met based on event-based eligibility is where all necessary events or circumstances allowing for anticipation have happened or existed on or before 14 December 2013. A statement made by or on behalf of the taxpayer in an original return lodged after 14 December 2013 that relates to the application of the taxation law (as hypothetically amended) to those events or circumstances will meet the timing requirement, provided the return was not required to be lodged on or before 14 December 2013. [Schedule 2, item 2, paragraph (a) in column 2 of item 3 in the table in subsection 170B(3)]

2.85 Some of the announcements listed in subsection 170B(8) would necessarily have a deferred impact on the tax affairs of impacted taxpayers. An example is the announcement in item 8 of the table in subsection 170B(8), which dealt with improvements to the company loss recoupment rules. Example 2.3 illustrates how the timing requirement may be met for this announcement via event-based eligibility.

Example 2.3

SCMH Ltd is a large public company that has carry forward tax losses at the start of the 2010-11 income year of $200,000. In February 2011, a holding company is interposed between SCMH Ltd and its shareholders. As a consequence of this, SCMH Ltd would no longer be able to satisfy the 'continuity of ownership' test as a basis for claiming its existing carry forward tax losses as a tax deduction in future income years.

The announcement in item 8 of the table in subsection 170B(8) is made in the 2011-12 Budget on 10 May 2011. With effect from the 2010-11 income year, this announcement proposed that the 'continuity of ownership' test will not be failed in these circumstances.

SCMH Ltd also has tax losses in the 2011-12, 2012-13 and 2013-14 years. In the 2014-15 income year, SCMH Ltd has taxable income of $150,000 prior to the application of prior year tax losses.

SCMH Ltd claims $150,000 of its carry forward tax losses as a deduction in its original 2014-15 tax return, and indicates in the return that these losses are claimed as 'continuity of ownership' losses. These statements meet the timing requirement in paragraph (a) in column 2 of item 3 of the table in subsection 170B(3). If the other conditions in subsection 170B(3) are met, SCMH Ltd has anticipated amendments in relation to the announcement in item 8 of the table in subsection 170B(8).

Event-based eligibility: Happening or existence of events or circumstances to which the taxpayer had definitively committed on or before 14 December 2013

2.86 There may also be cases where, as at 14 December 2013, not all necessary events or circumstances allowing for anticipation have happened or existed, but nevertheless the taxpayer is 'definitively committed' to those events or circumstances happening or existing at that date. The timing requirement will be met in these circumstances if a statement is made in an original return lodged after 14 December 2013 that relates to the application of the taxation law (as hypothetically amended) to those events or circumstances, provided the return was not required to be lodged on or before 14 December 2013. [Schedule 2, item 2, paragraph (b) in column 2 of item 3 in the table in subsection 170B(3)]

2.87 The 'definitive commitment' test is intended to allow for greater flexibility in the application of event-based eligibility where taxpayers are locked-in to arrangements as at 14 December 2013.

2.88 The courts have applied the concept of 'definitively committed' in determining whether losses or outgoings are incurred for the purposes of the general deduction provision in section 8-1 of the Income Tax Assessment Act 1997. In this context, there need not be an actual disbursement for a loss or outgoing to be incurred, provided that a taxpayer is 'definitively committed' to a presently existing liability. Similarly here, the intent is that certain events or circumstances need not have actually happened or existed by 14 December 2013, but nevertheless it is necessary that the taxpayer is 'definitively committed' to them happening or existing.

2.89 The ordinary meaning of a 'commitment' is 'an engagement or obligation that restricts freedom of action'. For a 'commitment' to be 'definitive', as ordinarily understood, it would generally need to be unconditional or final.

2.90 The authorities dealing with the meaning of 'incurred' identify the need for taxpayers to be 'completely subjected' to the loss or outgoing, and that the loss or outgoing needs to be something more than 'impending, threatened or expected'.

2.91 In a similar vein, the events or circumstances here would need to be more than merely contemplated for a definitive commitment to exist. In contrast, a definitive commitment to events or circumstances suggests that it is a matter of legal or commercial certainty that they will happen or exist, and they would not be subject to any contingency which would be regarded as such in the ordinary course of affairs.

Example 2.4

Jill lends securities to Flegs Pty Ltd under a securities lending arrangement on 1 December 2012. The securities are due to be returned to Jill by 30 November 2013. Flegs Pty Ltd becomes insolvent on 1 August 2013 and fails to return the securities to Jill by 30 November 2013 due to the company's insolvency.

At this time, the announcement listed at item 6 of the table in subsection 170B(8) is on foot. Under this proposed change to the law, Jill would have been entitled to roll-over relief in relation to the disposal of her securities to Flegs Pty Ltd, provided that Jill acquired identical securities by 30 December 2013.

Jill seeks advice from her financial planner and tax agent. They recommend that she acquires identical securities to access the benefit of the announced proposal to change the law. Jill places an order with her stockbroker for identical securities using collateral received under the securities lending arrangement on the afternoon of 13 December 2013. The transfer of the securities to Jill is not completed until 17 December 2013, after the announcement was discontinued.

In these circumstances, Jill is definitively committed to the transfer of securities happening. She anticipates the announcement in a statement in an original tax return lodged after 14 December 2013 by claiming the roll-over relief.

This statement meets the timing requirement in paragraph (b) in column 2 of item 3 of the table in subsection 170B(3). If the other conditions in subsection 170B(3) are met, Jill has anticipated amendments in relation to the announcement in item 8 of the table in subsection 170B(8).

Announcements 'on foot'

2.92 The period while a relevant announcement is 'on foot' is relevant to the timing requirements for statements. This period will vary from announcement to announcement. The table of listed announcements identifies the start date of this period for each of these announcements. The end date of this period is 14 December 2013, when the Government announced it had decided not to proceed with the listed announcements. [Schedule 2, item 2, subsection 170B(8)]

Exceptions

2.93 There are three sets of circumstances where the protection that would otherwise be provided by subsections 170B(1) or (2) will not apply. [Schedule 2, item 2, subsection 170B(5)]

Exception 1: Taxpayer chooses not to have an eligible particular protected

2.94 A taxpayer may choose not to have eligible particulars of an assessment protected. Where this choice is made there is no limitation (subject to any other limitations applying to the amendment of assessments, particularly those in subsection 170(1) of the ITAA 1936) on the Commissioner amending an assessment of the taxpayer in relation to those particulars. It is intended that this choice would be accommodated simply by way of the usual process that taxpayers have available to contact the Commissioner to seek an amendment to their assessment. [Schedule 2, item 2, paragraph 170B(6)(a)]

Exception 2: Amendments to give effect to decision on review or appeal

2.95 The operation of the protection provision can be the subject of review or appeal under Part IVC of the Taxation Administration Act 1953. In any circumstances where the application of the protection provision comes to the attention of the Commissioner, and the Commissioner is of the view that the taxpayer's assessment is not protected, he may amend the taxpayer's assessment in relation to the anticipated particular, provided that he is not out of time or otherwise prevented from doing so. The taxpayer can object to this assessment, as amended, under Part IVC.^[16]

2.96 The purpose of item 6 of the table in subsection 170(1) of the ITAA 1936 is to ensure that the Commissioner has the power at any time to amend an assessment to reflect decisions made under Part IVC, which covers objection decisions and decisions made by the AAT and the Courts. Accordingly, this power is to prevail over the protection provision. [Schedule 2, item 2, paragraph 170B(6)(b)]

Exception 3: Later inconsistent statements

2.97 Some of the announcements that are listed for the purposes of the provision contemplated changes to the law that would have a beneficial impact for taxpayers when initially anticipated, but at a later time may have a related or associated impact that is not beneficial.

2.98 For example, a number of the announcements listed in subsection 170B(8) proposed to introduce CGT roll-overs. A CGT roll-over generally involves any capital gains being disregarded when a certain CGT event occurs, but also involves the original cost base of the asset to which that event occurs being maintained and used in relation to a later CGT event that happens to that asset or a replacement asset.

2.99 The deferral of a capital gain on the roll-over transaction would be an anticipated benefit under the protection measure. However, maintaining the original cost base will most likely mean that there is a larger capital gain or smaller capital loss if a later CGT event happens.

2.100 Such situations give rise to the possibility that a taxpayer may rely on the protection provision to ensure that the anticipated benefit is obtained in the first instance, while in a later income year relying on the operation of the law in their return to obtain a further benefit that is inconsistent with their initial anticipation of the announcement.

2.101 To ensure that taxpayers do not obtain a later inconsistent benefit, the protection provided by the provision will cease to be available should a statement be made for a later income year that is inconsistent with the anticipated amendments, where an assessment for the later income year would have a less favourable result for the taxpayer if made on the basis of the anticipated amendments. [Schedule 2, item 2, subsection 170B(7)]

2.102 To facilitate this outcome, the Commissioner will have the power to amend assessments, including the assessments where the taxpayer originally anticipated the announcement, at any time where the conditions for this exception are met. [Schedule 2, item 1, item 27A in the table in subsection 170(10)]

Definitions

2.103 The term 'taxation law' is referred to in various parts of the protection provision. This term has a meaning as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997. That definition includes any Act of which the Commissioner has the general administration. [Schedule 2, item 2, paragraph 170B(9)]

2.104 While the listed announcements in subsection 170B(8) only directly contemplated proposed changes to the income tax law, it is possible that the amendments that would reasonably reflect those announcements may extend to taxation laws other than the income tax law, in particular the Taxation Administration Act 1953.

2.105 In addition, there is the need for the protection provision to explicitly deal with the potential for 'administrative overpayments' (see paragraph 2.40 above), which is a concept that is found in the Taxation Administration Act 1953.

Application and transitional provisions

2.106 The protection provision commences on the day the Act receives the Royal Assent. The application provisions are effectively incorporated in the timing conditions that are discussed at paragraphs 2.72 to 2.92 above.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 Tax and Superannuation Laws Amendment (2014 Measures No. 2) Bill 2014 - Protection for anticipation of certain discontinued announcements

2.107 This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

2.108 This Schedule amends the ITAA 1936 to introduce a one-off protection provision, which ensures in broad terms that outcomes are preserved in relation to income tax assessments where:

•

taxpayers have reasonably and in good faith anticipated the impact of identified announcements made by a previous government that the tax law would be amended with retrospective effect; and

•

the current Government has now decided that the announced proposal to change the law will not proceed.

Human rights implications

2.109 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

2.110 This Schedule is compatible with human rights as it does not raise any human rights issues.

Chapter 3 - Preventing dividend washing

Outline of chapter

3.1 Schedule 3 to this Bill will amend the Income Tax Assessment Act 1997 (ITAA 1997) to introduce an integrity rule to limit the ability of taxpayers to obtain a tax benefit from 'dividend washing'.

3.2 Broadly, dividend washing (or 'distribution washing') is a type of scheme by which a taxpayer can obtain multiple franking credits in respect of a single economic interest by selling an interest after an entitlement to a franked distribution has accrued and then immediately purchasing an equivalent interest with a further entitlement to a corresponding franked distribution.

Context of amendments

The imputation system

3.3 Under Australian income tax law, corporate tax entities (companies, corporate limited partnerships and certain trusts - see section 960-115 of the ITAA 1997) are subject to income tax on their taxable income. Members of the corporate tax entity (that is, shareholders) are also generally subject to income tax on the economic income of the corporation when it is distributed to them.

3.4 The imputation system set out in Part 3-6 of the ITAA 1997 provides members with relief from tax where they receive distributions that have been subject to tax at the corporate level. Under this system, corporate tax entities can pass on a credit for the tax they pay (a franking credit), when they provide a frankable distribution to their members (see Division 202 of the ITAA 1997).

The consequences of franking

3.5 Members that receive franked distributions are generally entitled to a refundable tax offset equal to the amount of the franking credit allocated to the distribution. They must also include an equivalent amount in their assessable income for the same income year (section 207-20 of the ITAA 1997). This puts the members of the corporation in the same position as if they had earned the corporate income themselves, and that distributed income was subject to withholding prior to being paid to the member. This means that the corporate income distributed to a member is effectively taxed only at the member's marginal tax rate.

3.6 As the tax offset provided is generally refundable, where the tax paid by the corporate tax entity exceeds that payable by the taxpayer this can result in a refund (subject to the other tax liabilities of the taxpayer).

3.7 Special rules apply to particular types of members.

3.8 Where a member is a trust or partnership (and so does not generally pay tax that can be offset), the member must still include the amount of the credit in their income, but does not receive an offset. Instead, the tax offset goes instead to the underlying interest holders, that is the partners or beneficiaries who pay the tax on the income of these flow-through vehicles (Subdivision 207-B of the ITAA 1997).

3.9 Where a member is not an Australia resident, the member is not entitled to a tax offset or required to include the amount of the distribution in their assessable income. Instead, a franked distribution is exempt from dividend withholding tax (Subdivision 207-D of the ITAA 1997). That is, the foreign resident pays no further tax with the corporate tax being the only tax paid on that income.

Imputation and franking credit trading

3.10 Due to the differing treatment of franking credits received by different entities and differing tax rates applied to entities, not all members benefit equally from a distribution being franked. Generally, members who have either a low tax rate or little income and can access a refundable tax offset, benefit most from imputation. These entities, including for example, individuals on low marginal tax rates, charities and complying superannuation funds, may be able to fully offset the tax payable on their income and obtain a payment from the Commissioner of Taxation (Commissioner). The benefits to other types of entities are often focussed on directly preventing double taxation and are therefore more limited or situational.

3.11 As not all shareholders benefit equally from franking credits, there is an incentive to transfer, provide or sell franking credits to those shareholders who will receive a greater benefit.

3.12 Franking credit trading is contrary to the underlying policy of the imputation system, and a number of integrity rules exist to prevent practices that give this result (see Subdivision 207-F of the ITAA 1997).

3.13 These rules include:

•

the holding period rule, which broadly requires that an interest must be held at risk for a period (generally, 45 days) before the interest holder may benefit from franking credits;

•

the last-in first-out rule, which provides that the disposal of an interest will be deemed to be the disposal of the most recently acquired interest (preventing taxpayers from using staggered acquisitions and disposals to avoid the consequences of the holding period rule); and

•

prohibitions on dividend streaming, dividend stripping (under Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936)) and franking credit trading.

3.14 In general, where these rules apply, taxpayers will not receive a tax offset (or be required to include an amount of the associated franking credit in their assessable income) despite receiving a franked distribution.

Distribution washing

3.15 Generally, the entitlement of all interest holders to receive a distribution is fixed at the same point in time. While interests can be traded after this point (referred to as trading ex-dividend), the new interest holder will not be entitled to receive the distribution.

3.16 However, for some shares, a special market for trading in shares with the attached right to the dividend (referred to as trading cum-dividend) will operate for a period between the date on which the entitlement to the dividend is fixed for most interest holders (the ex-dividend date) and the final date of record for dividend entitlements.

3.17 It is also possible to trade shares off market on a cum-dividend basis during this period.

3.18 Such special markets were established to address problems that could otherwise arise for entities that issue call options. As there is a delay between when the option is exercised and when the issuer becomes aware of their obligation to provide a share, cases could arise where entities are obliged to provide shares cum-dividend but cannot obtain such a share on market as the ex-dividend date has passed.

3.19 However, these special markets also provide an opportunity for entities that place a higher value on franking credits to obtain multiple franking credit entitlements in respect of one economic interest.

3.20 Such entities can sell a membership interest on the normal market after becoming entitled to the distribution, and then purchase a substantially identical membership interest on the cum-dividend market. This entitles the entity to a second amount of franking credits in place of someone who places a lesser value on those credits. The acquisition and disposal prices paid and received can be adjusted to share the benefits of the arrangements - that is, a taxpayer who does not benefit as much from franking credits can sell their interest at a price that allows them to obtain some of the benefits of the credit passed on to the other taxpayer.

3.21 An entity engaging in distribution washing is able to satisfy the holding period rule in respect of both interests without breaching the last-in first-out rule. They hold the original interest for at least 45 days prior to the ex-dividend date and the new interest for at least 45 days after its acquisition, without ever holding the two interests at the same time.

Distribution washing and the general anti-avoidance rule

3.22 In some cases, distribution washing arrangements will constitute a scheme subject to the general anti-avoidance rules under Part IVA of the ITAA 1936. In these cases the Commissioner may make a determination to deny the benefit of the scheme to the relevant taxpayer and potentially apply further penalties.

3.23 In October 2013, the Australian Taxation Office identified that it had significant concerns about activities in this area in prior years and would be undertaking compliance activity. This compliance activity is unrelated to the amendments to the law set out in Schedule 3, being based solely on the application of the general anti-avoidance rule.

Summary of new law

3.24 Part 1 of Schedule 3 amends the ITAA 1997 to provide that franked distributions which a taxpayer receives due to distribution washing will not entitle the taxpayer to a tax offset or require a taxpayer to include the amount of the franking credit in their assessable income.

3.25 A distribution will be considered to be one received as a result of distribution washing, where the taxpayer has also received a corresponding distribution in respect of a substantially identical interest that the taxpayer sold before acquiring the current interest.

3.26 These amendments apply from 1 July 2013.

3.27 Part 2 of Schedule 3 amends the ITAA 1997 to make technical corrections to the imputation rules to clarify a number of cross references, with effect from 1 July 2002 (the date when the cross references were first introduced). The technical corrections merely ensure the law operates as intended and are consistent with the current administration of the law.

Comparison of key features of new law and current law

Detailed explanation of new law

3.28 Part 1 of Schedule 3 amends the ITAA 1997 to provide that distributions to which the distribution washing rules apply:

•

do not receive a tax offset; and

•

are not required to include an amount equal to the franking credit in their assessable income.

[Schedule 3, items 1 and 2, paragraphs 207-145(1)(da) and 207-150(1)(ea)]

3.29 The distribution washing rules will apply to a franked distribution in respect of a membership interest (the washed interest) where two requirements have been met.

3.30 First, the washed interest must have been acquired after the member or a connected entity of the member, disposed of a substantially identical membership interest. [Schedule 3, item 3, paragraph 207-157 (1)(a)]

3.31 Secondly, a corresponding distribution must have been made to the member or a connected entity in respect of the substantially identical interest. [Schedule 3, item 3, paragraph 207-157 (1)(b)]

3.32 However, where a connected entity has disposed of the substantially identical interest, the dividend washing rules will only apply if it would be concluded that either the disposal or the acquisition took place only because at least one of the entities expected or believed that the other transaction had or would occur. [Schedule 3, item 3, subsection 207-157(2)]

3.33 Many of these concepts are drawn from the existing holding period rules, in particular the last-in, first-out requirement. Further details of the operations of these rules and the concepts used here can be found in Chapter 4 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 2) 1999.

3.34 Part IVA of the ITAA 1936 continues to allow the Commissioner to make a determination to deny tax and franking benefits in cases where there is activity contrary to the general anti-avoidance rule and these amendments do apply to not negate the benefit.

Substantially identical interest

3.35 Central to both of these requirements is the existence of a substantially identical interest.

3.36 The concept of substantially identical is drawn from the existing law for the holding period rules. The concept is intentionally flexible to accommodate the wide variety of financial instruments that currently exist and as well as new instruments that may be created in future. Without constraining the concept, the amendments identify a number of circumstances in which interests are substantially identical for the purpose of the provisions (drawn from similar provisions relating to the last-in, first-out method under the holding period rules; see the former section 160APHF of the ITAA 1936). [Schedule 3, item 3, subsection 207-157(3)]

3.37 The most important of these is that an interest will be substantially identical where it is fungible with, or economically equivalent to, the washed interest. In this context, it makes clear that the identity that is being examined is the economic substance of the interest not the property rights. The item ensures that interests will be substantially identical where it is reasonable to expect that the interests will provide equivalent economic benefits.

3.38 It does not necessarily matter that the nature of the interest may vary and it is not pertinent if one interest is legal and the other equitable, or if one interest is an interest in another entity that nonetheless provides equivalent benefits indirectly, because, for example, all it holds is interests in a particular corporate tax entity.

3.39 What can matter in determining if an interest is substantially identical is the number or extent of the interests held at each time. Where an entity sells interests ex-dividend and purchases a different number of interests cum-dividend, it is possible that only some of an entity's interests may be substantially identical to the washed interest, as economic equivalency must be considered in the full context of the former and current interests.

3.40 For example, a taxpayer may sell one ordinary share in an entity ex-dividend then later purchases 100 ordinary shares in the same entity cum-dividend. The prior interest here is substantially identical to the washed interest represented by one of the shares purchased cum-dividend. It is not substantially identical to the whole 100 shares. In this case, the taxpayer would not be entitled to the benefits of franking credits in respect of the portion of the distribution relating to one share that is the substantial identical interest, but may still be entitled to franking credits in respect of the 99 additional shares acquired.

Example 3.1

Elizabeth & Co Custodians holds 10,000 ordinary shares in OT Ltd on behalf of GAV Super (an Australian resident taxpayer). On 14 April 2015, OT Ltd declares it will pay a fully franked dividend of 10 cents to all holders of its ordinary shares.

Following a direction from GAV Super, Elizabeth & Co disposes of all 10,000 shares shortly after the shares commence trading ex-dividend. GAV Super retains the right to receive a fully franked dividend in respect of the 10,000 shares that have been sold.

Immediately after disposing of the shares, in response to a further part of the instructions from GAV Super, Elizabeth & Co purchases 20,000 ordinary shares in OT Ltd in a special cum-dividend market. This purchase now means that GAV Super is now also entitled to a fully franked dividend in respect of the 20,000 newly acquired shares.

As Elizabeth & Co has disposed of the original shares then acquired new shares, to the extent that the new shares are substantially identical interests, and the distribution in respect of the original shares is a corresponding distribution, GAV Super will not be entitled to the benefits of the franking credits it has received in respect of the new shares.

Ten thousand of the new shares are economically equivalent to the interests represented by the 10,000 original shares and the dividends paid in respect of these two groups of interests clearly correspond.

However, the remaining 10,000 of the new shares Elizabeth & Co has acquired are not substantially identical, given they are interests going beyond the total number of the prior interests held on behalf of GAV Super.

As a result, GAV Super is entitled to the benefit of the franking credits it receives in respect of the 10,000 shares Elizabeth & Co disposed of on its behalf and 10,000 of the new shares purchased on its behalf (assuming no other integrity rules have been engaged). GAV Super is not entitled to any of the benefits of the franking credits attached to the dividends it receives for the remaining 10,000 new shares.

3.41 However, what matters in these cases is the economic equivalency of the interests, rather than the numbers. In cases where there are different classes of shares in an entity or where interests are held indirectly, interests may well be economically equivalent despite taking different forms or involving different numbers of interests.

Example 3.2

Sophie (an Australian resident taxpayer) holds 10 Class A shares in NAFR Ltd. Sophie is already entitled to more than $5,000 in franking credits in the income year as a result of other shares she holds.

On 20 March 2015, NAFR Ltd declares a $5 fully franked dividend on all of its Class A shares and a $1 fully franked dividend on all of its Class B shares (with the ratio between the dividends being a matter of established practice).

Shortly after her shares commence trading ex-dividend, Sophie sells all 10 shares, retaining the $50 fully franked dividend entitlement. Sophie then purchases 65 Class B shares in NAFR Ltd in a special cum-dividend market. She becomes entitled to fully franked dividends in respect of those shares totalling $65.

Sophie has disposed of shares she held and acquired new shares and she is entitled to corresponding dividends in respect of each set of interests. To the extent the shares are substantially identical, Sophie is not entitled to the benefits of franking credits attached to the dividend in respect of the Class B shares.

The Class B shares are not interchangeable with the Class A shares. However, in the circumstances they are in part economically equivalent - 10 Class B shares will provide the same immediate returns and similar expected returns as one Class A share.

As a result, 50 of the Class B shares are substantially identical to the 10 Class A shares Sophie sold. Sophie is entitled to the benefit of the franking credits she receives in respect of her original 10 Class A shares and 15 of her new Class B shares (assuming no other integrity rules have been engaged). She is not entitled to receive the benefit of the franking credits she receives in respect of the remaining 50 of the Class B shares she has acquired.

3.42 The amendments also specify that a number of other types of interest are substantially identical, without limiting the ordinary meaning of the term. These other items deal with a number of more specific interests, including interests in the same or similar classes of interest and those in other classes that are exchangeable at a fixed rate. The more specific provisions are intended to provide clarity in most of the common cases where the rule against distribution washing may apply.

3.43 In some cases, unrelated entities may have share prices that are closely correlated, for example as both entities are competitors in the supply of a class of products and are affected in the same way by broader economic factors. This mere correlation does not make the interests economically equivalent in this context. Interests are not substantially identical securities without something more than broad similarity in prior economic performance.

Example 3.3

Three Pigs Super is a medium sized superannuation fund with an investment focus in infrastructure. Its investments include 10,000 ordinary shares in Straw Constructions Ltd, an infrastructure development firm. Following the declaration of a dividend by Straw Constructions Ltd, and shortly after all of the shares commence trading ex-dividend, Three Pigs sell all 10,000 of their shares.

Immediately following this sale, Three Pigs Super purchases 2,500 shares in STiCs Infrastructure Ltd, another infrastructure development firm that has no relationship with Straw Constructions Ltd.

These interests are not substantially identical and so the distribution washing rules do not apply. Even if the shares have a similar price and have historically provided similar returns the interests are not economically equivalent.

3.44 In considering if interests are substantially identical, the time at which the new interest is acquired is generally not relevant, as this does not affect the nature of the interest. However, that said, it is only in unusual cases where the rules to prevent dividend washing would apply to interests that are not purchased close together. The rules also require that a corresponding dividend is obtained in respect of the substantially identical interest. In most cases this requires obtaining the substantially identical interest on the special cum-dividend trading market which only operates for a short period of time after most shares commence trading ex-dividend.

Disposal and acquisitions

3.45 The rules also require that the entity must dispose of the substantially identical interest before acquiring the washed interest.

3.46 The application of this requirement will generally be a matter of fact. An entity disposes of an interest when the entity ceases to be the legal owner of the interest. Similarly, an entity acquires an interest when it becomes the legal owner of the interest. Acquisitions and disposals will generally occur as a result of the purchase or sale of shares on market. For such on-market transactions, the change in legal ownership generally occurs when the sale or purchase agreement is entered into, rather than at the time of settlement.

3.47 The purpose of the requirement for the acquisition to follow the disposal of the earlier shares is to avoid overlap between this integrity rule and the existing 'last-in, first-out' rule contained within the holding period rules. Where the two interests are held concurrently, the combined effect of the holding period rules and the last-in first-out rule already prevents the entity from benefiting from multiple franking credit entitlements.

Connected entity and intention

3.48 This integrity rule is intended to address any case in which taxpayers may obtain multiple franking credits in respect of a single economic interest.

3.49 To give effect to this, none of the requirements for distribution washing relate to the intention of the taxpayer.

3.50 While deliberate distribution washing is particularly problematic, even inadvertent distribution washing results in taxpayers receiving inappropriate benefits. Additionally, requiring proof of intention would also increase the compliance burden on taxpayers and the Australian Taxation Office and was raised as a concern in consultation.

3.51 As another mechanism to prevent this double benefit, the distribution washing rules look at the actions of connected entities as well as the member, where it would be concluded that either the acquisition or disposal took place because there was an expectation the other transaction had likely taken place or was likely to take place.

3.52 Connected entity is an existing defined term in the ITAA 1997. An entity will be a connected entity where it is either an associate or (if the taxpayer is part of a wholly-owned group) a member of the same wholly-owned group.

3.53 Where entities are connected, they may have common economic interests and be acting as a single economic group. It would therefore be inappropriate should they be permitted to knowingly act to obtain multiple benefits from the imputation system as a result of a single distribution event.

3.54 Given this, where a connected entity disposes of a substantial identical interest, the distribution washing rules can apply to deny the benefit of franking credits on the distribution from the washed interest.

3.55 Taking into account the actions of connected entities prevents related taxpayers from colluding with one-another to obtain the tax benefit indirectly and avoid the restriction.

3.56 This is particularly important where the member receiving the distribution is a trust or partnership. In this case, it is the ultimate beneficiary of the distribution, the beneficiary or partner, rather than the trust or partnership that receives the franking credit. Application of the connected entity rules means that entity to which a franked distribution flows indirectly are treated in the same way as the entity to which a franked distribution is made.

Example 3.4

Giraffe Ltd is a wholly-owned subsidiary of Zoo Ltd.

Zoo Ltd disposes of 1,000 ordinary shares in Hay Co immediately after they go ex-dividend, retaining the fully franked dividend entitlement. Shortly after this disposal, Zoo Ltd arranges for Giraffe Ltd to purchase 1,000 ordinary shares in Hay Co in a special cum-dividend market, obtaining an equivalent entitlement to fully franked dividends.

As Giraffe Ltd is an associate of Zoo Ltd and was acting at the behest of Zoo Ltd, the distribution washing rules will apply to this transaction and deny Giraffe Ltd the benefit of the franking credits it receives in respect of the 1,000 shares it has acquired.

Example 3.5

Walker Custodians provides custodial services, holding shares on behalf of a number of fund management companies, including Dot Investments and Joy Financial Holdings. Dot Investments and Joy Holdings are unrelated entities.

Acting on behalf of Dot Investments, Walker Custodians disposes of an interest in HA (International) shortly after the interest goes ex-dividend. Walker Custodians remains entitled to the full franked dividend in respect of the interest, which will flow indirectly to Dot Investments.

If Walker Custodians were to purchase a substantially identical interest on behalf of Joy Financial Holdings, given Dot Investments and Joy Holdings are unrelated entities the distribution washing rules would not apply.

Walker Custodians would have disposed and acquired the interests in as the trustee of two distinct trusts. The trusts are unrelated and the associate rules do not provide that Walker Custodians acting for one trust is an associate or connected entity of Walker Custodians acting for a different trust.

3.57 However, many entities may be connected entities without having either fully unified economic interests (such two natural persons who are related) or knowledge of one another's activities (such as two companies that are ultimately owned by the same entity but which have no other connection or relationship). In these cases it would be problematic to deny franking credits to one entity based on the actions of a connected entity of which they are completely unaware. It would also impose considerable compliance costs on taxpayers to track the actions of all of their connected entity.

3.58 To address these concerns, the distribution washing rules will only apply in cases involving connected entities where it can be concluded that the acquisition (or disposal) took part at least in part because of an expectation that it was likely that the disposal (or acquisition) had taken place (or would take place).

3.59 This test involves an objective assessment of what would be concluded about the actions of an entity given the particular circumstances. This assessment will need to take into account matters such as the nature of the relationship between the connected entities and the information that could be expected to be available to each entity.

3.60 For example, only in very unusual circumstances could it be concluded that a person acting as a trustee of a publicly traded unit trust would be acting to any extent on the basis of an expectation or belief about the actions of a relative of an individual who benefits under the trust. On the other hand, it may often be reasonable to conclude that a person may be acting on the basis of a belief or expectation about the actions of their spouse or of a company or trust in which they have a significant stake.

3.61 One important factor in this assessment of what can objectively be concluded is the very unusual nature of special cum-dividend markets. These markets are intended to fulfil a very specific purpose around the settlement of options. If an entity makes purchases on such a market outside of this context and there has been a prior disposal by a connected entity, it will often be appropriate to conclude that the acquisition was undertaken at least in part on the basis of a belief about the disposal unless other factors exist demonstrating another reason why the entity would need to enter the special market.

Example 3.6

Rose and Tom are a married couple. Rose, but not Tom, is a beneficiary of Flower Trust. The trustee of Flower Trust is Bloom Ltd.

Bloom Ltd, acting in its capacity as trustee of Flower trust, disposes of 3,000 shares in Sunshine Co shortly after the shares go ex-dividend. It remains entitled to the fully franked dividend on the shares.

Both Rose and Tom are associates of Bloom Ltd in its capacity as trustee, Rose as a beneficiary of the trust, and Tom as an associate of Rose.

If either Rose or Tom purchase a substantially identical interest (which could an interest of the same type in Sunshine Co, but could also be some other type of economically equivalent interest) and receive a corresponding dividend, they may be subject to the distribution washing rules if, on an objective assessment, it could be concluded that their action was undertaken in part on the basis of a belief that Bloom Ltd had or would dispose of the shares.

Neither Rose nor Tom are engaged in the writing of options. Given this, there are only very limited reasons why they would make purchases on the cum-dividend market outside of an intention to engage in distribution washing. Absent evidence of such special reasons, if there was any reasonable basis to give rise to a belief about Bloom Ltd disposal it is likely that it would be concluded that the acquisition was undertaken at least in part because of the belief about the disposal.

A franked dividend received by Rose or Tom in respect of an interest acquired cum-dividend may also be subject to the rules if they make such a purchase and it would be concluded on an objective assessment that Bloom Ltd acted in part based on the expectation that Rose or Tom had or would acquire such an interest.

Example 3.7

RC Ltd and SC Ltd are two separate wholly-owned subsidiaries of KAS Investments Ltd. While they share an owner and are both involved in investment activities, the two companies are otherwise completely unconnected. No employee or officer of either company has any knowledge of the investment activities of the other company nor any means to reasonably obtain such information.

RC Ltd disposes of an interest in WLC Co shortly after the interest goes ex-dividend. It remains entitled to the fully franked dividend on the shares.

RC Ltd and SC Ltd are associates and hence connected entities as they are both wholly-owned by KAS Investments Ltd. Hence, if SC Ltd purchases a substantially identical interest and receives a corresponding distribution, it would not be entitled to the benefit of the franking credit in respect of that distribution if it would be concluded, on an objective assessment of the circumstance that either the acquisition by SC Ltd or the disposal by RC Ltd was undertaken with an expectation or belief about the actions of the other entity.

However, there was no basis for either party to learn of the other transactions and the relationship between the entities was not one where co-operation in this matter would be objectively expected. Given this it would not be concluded that either party acted based in any part on an expectation or belief about the other's actions.

3.62 In some cases, for example when investing through a trust structure there may be several degrees of separation between the ultimate beneficiary and the entity that has engaged in distribution washing. The loss of the benefit of the franking credit would need to be reflected in the information provided by the trustee at each stage, in the same way as presently applies for interests where the benefit of franking credit is denied due to the application of the holding period rule.

Corresponding distribution

3.63 Like substantially identical interest, the concept of corresponding distribution is also a flexible concept that is drawn from the holding period rules.

3.64 For distributions to correspond, it is not enough that they are of the same amount or from the same entity.

3.65 Correspondence requires the distributions to have ultimately arisen from the same ultimate source, or closely connected sources.

3.66 This will most obviously be satisfied in cases where a company declares a dividend to classes of membership interest including both the washed interest and the substantially identical interest.

3.67 It will also be satisfied where both dividends arise from the company declaring various dividends in respect of different types of membership interest on a common basis, in connected processes or in respect of profits that have arisen over the same period.

3.68 In some cases a dividend may be a corresponding dividend even where it is not paid by the same entity, provided the dividends ultimately arise from the same act. For example, a dividend from one company that was paid for the purposes of passing on a dividend from another company would be a corresponding distribution in respect of other dividends paid out by the other company in the same distribution process.

Example 3.8

Tuba Ltd has two classes of shares, ordinary shares and preference shares.

Its preference shareholders are entitled to receive an annual dividend of a fixed amount, subject to Tuba Ltd having profits available to distribute. Its ordinary shareholders have no fixed entitlement to dividends.

On 10 August 2015, Tuba Ltd declares a dividend in respect of its preference shares. On 11 August 2015, it further declares a dividend in respect of its ordinary shares.

Dividends paid in respect of ordinary shares will be corresponding dividends in relation to the dividends paid on preference shares and vice versa.

While the dividends are not necessarily of the same amounts and the obligations around payment differ, they both come from the same entity and are tied to the profitability of the company over the same period.

Example 3.9

Holding Ltd is a collective investment vehicle which has no assets other than shares in Big Ltd.

On 30 September 2015, Big Ltd declares a fully franked dividend to all shareholders, including Holding Ltd.

On 18 November 2015, Holding Ltd declares a fully franked dividend to its shareholders.

The dividend paid by Big Ltd is a corresponding dividend in relation to the dividend paid by Holding Ltd. The dividend is not paid by the same company or declared at the same time. However, both originate from the same ultimate source.

3.69 As corresponding distributions must generally arise from substantially the same ultimate source, in almost all cases they will be paid at or around the same time. Outside of rare cases involving distributions received through conduit entities or other complex arrangements, the passage of time will generally indicate that distributions do not correspond.

Example 3.10

Bentwood Ltd pays its annual fully franked dividend to its ordinary shareholders on 7 May 2016.

On 17 June 2016, Bentwood Ltd becomes entitled to significant amounts of money as a result of its success in contractual litigation.

It decides to return these amounts to its shareholders by declaring a special dividend.

The annual dividend is not a corresponding dividend in relation to the special dividend. While both are paid by the same entity in close succession, they arise from different sources and as part of separate processes.

Small holdings exception

3.70 Similar to the holding period rules, the amendments provide for an exception to the restrictions on distribution washing for individuals who do not receive more than $5,000 in franking credits in a year. [Schedule 3, item 3, subsections 207-157(4) and (5)]

3.71 Such individuals will generally not be in a position to deliberately engage in distribution washing in respect of those interests they hold directly. They will generally lack the knowledge and expertise to access the special market for cum-dividend trading. In the event that they do become involved in distribution washing, the amounts involved are, by definition, small.

3.72 This exception protects small shareholders from needing to consider the application of the rule to their individual investments.

3.73 However, this exception only applies to distributions made directly to an individual. It does not apply to distributions that may flow indirectly to individuals in respect of an interest held through a trust or partnership.

3.74 As a collective investment vehicle, trusts and partnerships can be in a position to engage in distribution washing on a significant scale even where the investments held on behalf of each individual beneficiary or partner are small. As a result, the considerations supporting an exception for individuals do not apply in this case.

3.75 Despite the small holding exemption, individuals who do not receive more than $5,000 in franking credits in an income year are still potentially subject to the general anti-avoidance rule under section 177EA of Part IVA of the ITAA 1936 if they engage in a distribution washing scheme with the dominant purpose of obtaining an imputation benefit.

Interaction with the general anti-avoidance rule

3.76 As noted earlier, most of the activities that are affected by the rules set out in Schedule 3 would also potentially be subject to the general anti-avoidance rules set out in Part IVA of the ITAA 1936.

3.77 Despite this overlap, it was considered necessary to introduce a specific rule to provide clarity and certainty for taxpayers and the ATO, given the scale of distribution washing activity.

3.78 Data about trading on the special market for cum-dividend interests suggests that as much as 85 per cent, by value, of all trading on this market (around $3 billion of transactions) may have been driven by entities engaging in distribution washing. As many of these transactions were carried out by entities acting for other entities, the number of entities who have benefitted is even more significant than the volume of trading would suggest.

3.79 The application of the general anti-avoidance rules requires a specific determination for each entity and amendments to a taxpayer's liabilities resulting from such a determination are generally not subject to the standard limitation periods. As a result, while the general anti-avoidance rule is a suitable mechanism to address issues with specific conduct, using it to address widespread activities places an inappropriate burden on both taxpayers and the Commissioner.

3.80 In contrast, the specific rule created by Schedule 3 applies automatically and as part of the normal process of assessment. Further, where the specific rule applies, the general anti-avoidance rule is excluded, as it only applies where an entity would otherwise receive a tax or imputation benefit. As a result, taxpayers (other than those who engage in schemes to obtain a benefit despite the specific rule) need not be concerned about both rules applying.

3.81 As noted earlier, nothing in these provisions affects the application of the general anti-avoidance rules prior to the application of these amendments or their application to schemes that are not the subject of the rules introduced by this Schedule.

Technical amendments

3.82 Part 2 of Schedule 3 also makes a number of technical amendments to update a number of references to offsets throughout Division 207 of the ITAA 1997. [Schedule 3, items 5 to 8, paragraphs 207-95(6)(b), 207-145(1)(f), 207-150(1)(g) and 207-150(6)(b)]

3.83 Presently there are a number of provisions in Subdivisions 207-D and 207-F of the ITAA 1997 that refer to taxpayers being 'not entitled to a tax offset under this Subdivision'. While offsets are dealt with throughout Division 207, in substance all entitlements to tax offsets arise under Subdivision 207-A and 207-B. What these sections are clearly intended to convey is that the Subdivision removes the taxpayer's entitlement to an offset, but the wording may leave some ambiguity.

3.84 The law has been applied by the Commissioner and taxpayers in line with intended policy. However, to eliminate any doubt and to provide certainty, this measure amends the existing law so that the references now specify 'not entitled to an offset under this Division'.

Application and transitional provisions

Distribution washing

3.85 The amendments to prevent distribution washing apply from 1 July 2013, the date set out in the original policy announcement of 14 May 2013. [Schedule 3, item 4]

3.86 This may result in the amendments having retrospective application. This retrospectivity is necessary to prevent taxpayers from seeking to benefit from distribution washing after its existence was made publicly available by the Government's announcement. Such activity would likely be subject to the general anti-avoidance rule in section 177EA of Part IVA of the ITAA 1936.

3.87 Further, distribution washing requires highly specific activities (generally selling ex-dividend and buying cum-dividend) that will generally not have a commercial rationale without the availability of the associated tax benefits. Given this, there is relatively little uncertainty arising from taxpayers from this retrospectivity, as it is unlikely taxpayers would be inadvertently affected by the measure or affected in a way that they would not expect from the announcement.

Technical amendments

3.88 The technical amendments to the references to offsets generally apply from 1 July 2002, the date when the current misdescribed cross-references were introduced. [Schedule 3, item 9]

3.89 Backdating the clarification ensures that addressing the ambiguity does not give rise to doubt about the previously settled application of the law.

3.90 As such, it is not in substance retrospective as it merely confirms the existing interpretation and operation of the law.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 Tax Laws Amendment (2014 Measures No. 2) Bill 2014 - Preventing dividend washing

3.91 Schedule 3 to this Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

3.92 Broadly, Part 1 of this Schedule amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide that franked distributions which a taxpayer receives due to engaging in distribution washing will not entitle the taxpayer to tax benefits associated with receiving franking credits.

3.93 Generally, under Australia's imputation system, companies who have paid income tax may provide their members with franking credits when making distributions of profits. Australian residents must include the amount of this credit in their assessable income, but also receive an equivalent tax offset, in effect reducing the tax they pay by the amount of tax the company has paid.

3.94 Not all taxpayers benefit equally from franking credits. A key policy underlying Australia's imputation system is that arrangements to direct franking credits to particular taxpayers are not permitted. A number of existing restrictions are included in the law to prevent various forms of franking credit trading.

3.95 Distribution washing is a new form of franking credit trading that avoids most existing specific restrictions. It takes advantage of special trading arrangements that allow for the creation of a special market on which shares can be purchased with dividend entitlements attached (cum-dividend) after shares traded in the general market have begun to trade with a dividend entitlement (ex-dividend).

3.96 To distribution wash, a taxpayer sells an interest once it has gone ex-dividend, then purchases an equivalent cum-dividend interest on the special market.

3.97 The amendments in Part 1 provide that where an entity obtains multiple franking credits in this way, they only receive a single tax offset (and need only include the amount of one of the credits in their assessable income).

3.98 Part 2 of this Schedule also makes a minor technical amendment to clarify that reference tax offsets in Division 207 of the ITAA 1997 are references to tax offsets provided under that Division. This amendment confirms the existing operation of law with retrospective effect.

Human rights implications

3.99 This Schedule does not engage any of the applicable rights or freedoms.

3.100 Part 1 of this Schedule limits the tax benefits that are available in respect of certain complex financial transactions without any wider impact.

3.101 While the amendments to Part 2 of this Schedule generally apply to events that occur on or after 1 July 2002, this retrospectivity does not engage with any applicable rights or freedoms as it merely clarifies the law to confirm existing practice.

Conclusion

3.102 This Schedule is compatible with human rights as it does not raise any human rights issues.

Index

Schedule 1: Medicare levy thresholds

Schedule 2: Protection for anticipation of certain discontinued announcements

Schedule 3: Preventing dividend washing