Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)General outline and financial impact
Amendments related to net capital losses
Amends Part IIIA of the Income Tax Assessment Act 1936 to ensure that:
- •
- net capital losses will attach to the year of income in which they are incurred and are recouped or transferred within a company group in the order in which they are incurred; and
- •
- where a net capital loss is transferred within a company group, the transferee company is required to satisfy the same recoupment tests (for example, the continuity of ownership test or the same business test) that apply to the transferor company.
Date of effect: The amendments relating to the transfer of net capital losses will affect transfer agreements resulting in net capital losses being recouped by transferee companies in the 1996-97 year of income or a subsequent year. The other amendments will apply in respect of the 1996-97 year of income and subsequent years.
Proposal announced: 1996-97 Budget, 20 August 1996
Financial impact: Increased revenue of $20 million in 1996-97, $80 million in 1997-98 and $55 million in 1998-99 and 1999-2000 is expected.
Compliance cost impact: It will be particularly necessary for corporate taxpayers who incur net capital losses to maintain detailed records showing the years in which losses were incurred. This is to ensure that those losses are recouped or transferred in the appropriate order.
In addition, companies may be required to keep records evidencing beneficial ownership of shares and the nature of their business over a longer period of time than was previously required. This is to ensure that relevant recoupment tests are satisfied when the net capital losses are recouped or transferred. However, these requirements should not result in additional compliance costs because such records are already required to be kept under the existing law relating to the recoupment and transfer of revenue losses.
To the extent that the measures clarify the operation of the law, there will be a reduction in compliance costs.
Withholding tax avoidance
Amends the withholding tax provisions and Part IVA of the income tax law to:
- •
- extend the general anti-avoidance provisions of the Act - Part IVA -so that they apply to non-resident interest, dividend and royalty withholding tax;
- •
- address arrangements which attempt to convert an interest income stream into another income form which it is argued is not 'interest' or 'in the nature of interest';
- •
- impose withholding tax where royalties are derived by a resident in similar circumstances to those by which interest is subjected to withholding tax under subsection 128B(2A) of the Act;
- •
- ensure that withholding tax is payable where tax exempt bodies are interposed between an Australian resident payer and a non-resident recipient; and
- •
- remove any doubt that the withholding tax provisions apply to dividends paid out of capital reserves.
Date of effect: The measures will apply to interest, dividend and royalty payments made after 7.30 pm Eastern Standard Time on 20 August 1996.
Proposal announced: 1996-97 Budget, 20 August 1996.
Financial impact: The impact of these measures is a gain to the revenue of $85 million in 1996-97 and then $100 million per annum from 1997-98.
Compliance cost impact: Entities who previously avoided the payment of withholding tax will now have to bear the costs associated with complying with the withholding tax collection provisions.
This involves accounting costs and the cost of deducting and remitting withholding tax to the Australian Taxation Office.
Dual resident companies
Amends the provisions of the Income Tax Assessment Act 1936 (the Act) in respect to certain dual resident companies (and non-individual entities that are treated as companies) to deny specified benefits that are available in respect to resident companies and ensure the application of specified anti avoidance measures that are targeted at non-resident companies.
Date of effect: Applies on or after 1 July 1997.
Proposal announced: 1996-97 Budget, 20 August 1996.
Financial impact: Estimated revenue savings of $50-100 million per year from the 1997-98 income year.
Compliance cost impact: Nil.
Removal of standard superannuation contribution limit
This measure removes the right of employers to elect to use a standard contribution limit to calculate the upper limit of deductions allowable in relation to superannuation contributions they make for the benefit of their employees. To calculate the upper limit all employers will be required to use their employees' age based limits.
Date of effect : 7.30pm Eastern Standard Time on 20 August 1996.
Proposal announced: 1996-97 Budget, 20 August 1996.
Financial impact: This measure will result in savings of $35 million in 1997-98, $40 million in 1998-99 and $40 million in 1999-2000.
Compliance cost impact: This measure will result in a slight increase in compliance costs for affected taxpayers. Affected taxpayers will need to calculate their deduction limit on the basis of each of their employees' age based limits. Therefore, employers will need to know how many employees fit into the three age based limits: under 35 years of age, between 35 and 49, and over 50. This, however, would usually be information the employer has readily available.
Interest withholding tax and related provisions
Amends the interest withholding tax provisions of the Income Tax Assessment Act 1936 (the Act) to:
- •
- extend the section 128F exemption to wholesale borrowings by Australian companies by replacing the existing wide distribution test with a public offer test;
- •
- repeal the use of funds in an Australian business requirement in the existing section 128F;
- •
- restrict the section 128F non-resident borrowing subsidiary exemption to subsidiaries resident in countries listed in the Income Tax Regulations;
- •
- provide that the section 128F exemption will not be available if the company pays interest to an associate where the company issuing the debentures is aware or should have been aware that the interest was paid to an associate; and
- •
- introduce self assessment procedures for claiming the section 128F exemption.
Amends the income tax collection provisions of the Act to prevent an income tax deduction being claimed in respect of interest which is subject to interest withholding tax where the tax has not been deducted from the interest payment.
Amends the bearer debenture tax provisions of the Act to:
- •
- provide an exemption for bearer debentures issued by an Offshore Banking Unit; and
- •
- subject interest in relation to bearer debentures which are issued overseas by an Australian company and where interest is paid overseas, to taxation under the interest withholding tax provisions.
Amends the foreign bank branch provisions (Part 111B) of the Act to define the term 'interest' as having the same meaning as in the interest withholding tax provisions.
Amends the Income Tax (Bearer Debentures) Act 1971 to restrict the rate of tax to the top marginal rate.
Amends the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 to ensure that it will deal with the transitional period in relation to the section 128F interest withholding tax exemption.
Date of effect: As foreshadowed by the Treasurer in his Press Release, No 36 of 25 June 1996 titled 'Interest Withholding Tax Measures':
- •
- the amendments to bearer debenture provisions will be effective from the date the amending legislation receives Royal Assent;
- •
- the amendments to the interest withholding tax provisions will take effect from 1 January 1996.
The amendments to the foreign branch bank provisions (Part IIIB) will apply from Royal Assent.
Proposal announced: The interest withholding and bearer debenture proposals were announced by the Treasurer in his Press Release No 36 of 25 June 1996 titled 'Interest Withholding Tax Measures' and Press Release No 129 of 16 December 1996 titled 'Implementation of Certain International Tax Measures'.
The amendments to Part IIIB have not been previously announced.
Financial impact: There will be a negligible cost to the revenue.
- •
- In relation to the section 128F exemption, compliance costs should be reduced because of the self assessment system for claiming the exemption.
- •
- In relation to the bearer debenture tax provisions the compliance costs should not vary because the procedure for determining tax liability will remain unchanged.
- •
- The compliance cost of the foreign bank branch amendments will be minimal as this will involve taxpayers converting amounts in the nature of interest into an interest rate.
Leases of luxury cars
Inserts a new Schedule into the income tax law that provides a legislative framework for the taxation treatment of leases of luxury cars. The lessor is treated as having loaned the lessee the money to acquire the car. The lessor is taxed on the finance charge component of the lease payments, but not the lease payments themselves. The lessee is able to deduct the finance charge component of the lease payments, but not the lease payments. The lessee is also treated as the owner of the car entitled to relevant depreciation deductions.
Date of effect: Applies to leases entered into after 7.30 pm by legal time in the Australian Capital Territory on 20 August 1996.
Proposal announced: 1996-97 Budget, 20 August 1996.
Financial impact: This measure will increase revenue by approximately $2 million in 1996-97, $30 million in 1997-98, $45 million in 1998-99 and $60 million in 1999 -2000.
Compliance cost impact: The tax accounting methodology contained in the new Division broadly reflects existing financial accounting standards for finance leases. Leasing companies should have little additional compliance difficulty. Individual lessees may not be familiar with the relevant lease accounting standards, but in most instances their tax position will simply be the reverse of the lessor's. Leasing companies ought to be in a position to inform lessee clients of the proportion of each year's lease payments that represents a deductible finance charge, as well as the cost of luxury cars for depreciation purposes.
Chapter 1 - Amendments related to net capital losses
Overview
1.1 Part 1 of Schedule 1 of the Bill will amend Part IIIA of the Income Tax Assessment Act 1936 ('the Act') to rectify defects in the capital gains tax ('CGT') provisions dealing with the carry forward and transfer of net capital losses.
1.2 The amendments will ensure that:
- •
- net capital losses attach to the year of income in which they are incurred and are recouped or transferred in the order in which they are incurred; and
- •
- where a net capital loss is transferred within a company group, the transferee company is required to satisfy the same recoupment tests (for example, the continuity of ownership test or the same business test) that apply to the transferor company.
Summary of the amendments
1.3 The purpose of the amendments is to prevent capital losses incurred by a corporate taxpayer from being recouped (or transferred) where there has been a substantial change in the beneficial ownership of the company (or the transferee company where the loss is transferred) since the losses were incurred and the same business test is not satisfied.
1.4 The amendments relating to the transfer of net capital losses will affect transfer agreements resulting in net capital losses being recouped by transferee companies in the 1996-97 year of income or a subsequent year [item 22 - new subsection (3)] . The other amendments will apply in respect of the 1996-97 year of income and subsequent years [item 22 - new subsections (1) and (2)] [see paragraphs 43 and 44 below for further discussion].
Background to the legislation
1.5 Under the existing CGT provisions, a net capital loss arises in respect of a year of income where the sum of the capital losses incurred during the year of income and any net capital loss in respect of the immediately preceding year of income exceeds the capital gains accrued in the year of income.
1.6 The mechanism of calculating a net capital loss, specified in the existing subsection 160ZC(3), results in any unrecouped amount of a net capital loss being reincurred in each subsequent year. That is, prior year losses lose their identity and are absorbed into a taxpayer's current year net capital loss, which is then carried forward for recoupment or transfer in future years.
1.7 The mechanism has unintended consequences for corporate taxpayers. By subsection 160ZC(5), the carry forward of capital losses for corporate taxpayers is subject to a number of recoupment tests. Broadly, by section 80A, the majority of beneficial owners in the company must be the same throughout the year the loss was incurred and the year the loss is sought to be recouped. This test is subject to a same business test in section 80E. In addition, the conditions in section 80DA must also be satisfied.
1.8 However, these tests do not achieve their intended purpose where the year the loss was incurred and the year of recoupment are not consecutive years. Where there is a break between the two years, the effect of the above anomaly is that the company only has to satisfy the recoupment tests by comparing the year of recoupment and the immediately preceding year. This is because until recouped or transferred, net capital losses are reincurred in each subsequent year, provided the recoupment tests are met in each of those years.
1.9 In addressing the anomaly it has also been necessary to amend the provisions permitting the transfer of net capital losses between resident companies within the same 100% owned group ('group companies'). Broadly, the transfer of net capital losses is subject to a condition that the transferee and transferor companies be group companies in relation to:
- •
- the year the loss was incurred;
- •
- the year ('gain year') in which the transferee company would have derived a net capital gain but for the loss transfer; and
- •
- any intervening year.
1.10 However, the anomaly (resulting in net capital losses being reincurred in each subsequent year) has meant that the provisions governing the transfer of net capital losses operate defectively. More specifically, the transferee and transferor companies only have to be group companies for the whole of the gain year even where the loss was initially incurred in a year of income before the gain year.
1.11 A further defect in the net capital loss transfer provisions is that in certain circumstances, the recoupment tests applying to the transferee company are less stringent than those applying to the transferor company. This contrasts with the revenue loss transfer provisions which require both companies to satisfy the same recoupment tests.
1.12 To illustrate, where a capital loss is transferred in a year of income after the loss was incurred, the amount of a transferred net capital loss is deemed to be a capital loss incurred by the transferee company in the gain year. This means that the transferee company does not have to satisfy the recoupment tests in a year other than the gain year. In contrast, the transferor company does have to satisfy the recoupment tests and in the gain year is required to do so by comparing the gain year and the immediately preceding year. (The amendments in the Bill seeking to prevent the annual reincurrence of net capital losses would effectively require the recoupment tests to be satisfied by both the transferor and transferee companies by comparing the loss year and the gain year.)
1.13 The combined effect of the transferee company being deemed to incur a capital loss in the gain year and the anomaly resulting in the annual reincurrence of net capital losses is that a capital loss may be transferred to a company whose shareholders were not the beneficial owners of the transferor company when the capital loss was incurred.
1.14 The amendments will rectify these anomalies in the CGT provisions to ensure that they operate appropriately as originally intended.
Explanation of the amendments
Definition of 'net capital gain' and 'net capital loss'
1.15 New subsection 160ZC(1) describes in five steps how to work out, for the purposes of Part IIIA, if a net capital gain accrues to a taxpayer in respect of a year of income and the amount of that gain where applicable. Under step one, all of the capital gains accrued during the year of income are added together (' total capital gains '). Under step two, all of the capital losses incurred by the taxpayer during the year of income are added together (' total capital losses '). Under step three, total capital losses are subtracted from total capital gains. There will be no net capital gain where total capital losses exceed total capital gains. If there is a balance remaining after step three, it is reduced by applying net capital losses from previous years of income under step four. If this reduces the balance to nil, there is no net capital gain in respect of the year of income. If the balance is not reduced to nil, the balance is a net capital gain in respect of the year of income. [Item 1]
1.16 The provision basically reflects the existing law except that a net capital gain under the new provision takes into account not only a net capital loss of the immediately preceding year but also net capital losses of earlier years. This ties into the amended definition of a net capital loss. [Refer to transitional rules discussed in paragraphs 43 and 44 below.]
1.17 A net capital loss will be taken for the purposes of Part IIIA to have been incurred by a taxpayer in respect of a year of income where the sum of any capital losses incurred by the taxpayer during the year of income exceeds the sum of any capital gains that accrued to the taxpayer during the year of income. The net capital loss is equal to the excess [item 1 - new subsection 160ZC(2)] . Unlike under the existing law, a net capital loss of the immediately preceding year is no longer taken into account in determining the net capital loss of a current year. Under the amendment definition, a net capital loss is no longer a cumulative amount incorporating unrecouped net capital losses of earlier years.
Application of net capital loss
1.18 In a particular year of income, if there is a balance remaining after subtracting total capital losses from total capital gains for the year, a net capital loss in respect of an earlier year of income must be applied in reduction of that balance in determining the amount of a net capital gain in respect of the particular year (step 4 of new subsection 160ZC(1)). The application of the net capital loss is, however, subject to the following rules.
1.19 The first rule is that if there are two or more net capital losses, they are applied in the order in which the taxpayer incurred them [item 1 - new subsection 160ZC(3)] . Further, a net capital loss can only be applied to the extent that the loss has not already been applied in an earlier year of income [item 1 - new subsection 160ZC(3A)] . Finally, if all or part of a net capital loss cannot be applied in a year of income, the unapplied amount can be carried forward to the next year of income [item 1 - new subsection 160ZC(3B)] . The unapplied amount will attach to the year of income it was incurred.
1.20 For a corporate taxpayer, however, these rules are subject to the taxpayer not being prevented from applying a net capital loss by the recoupment tests in subsection 160ZC(5) (as amended by this Bill). Amended subsection 160ZC(5) prevents a net capital loss from being applied where, if the net capital loss were a revenue loss (within section 79E of the existing law), the loss would have been denied because of sections 80A or 80DA [item 8] . For example, a net capital loss would be prevented from being applied where a taxpayer's beneficial ownership has changed substantially and the same business test is not satisfied.
1.21 The application rules discussed above are also subject to amended subsection 160ZC(4A) . The provision applies in respect of a year of income where a taxpayer becomes bankrupt in the year of income, or has been released from any debts by the operation of an Act relating to bankruptcy. Currently in this situation, any net capital loss ('denied loss') incurred by the taxpayer in the preceding year of income cannot be taken into account in determining whether the taxpayer incurred a net capital loss or accrued a net capital gain in the year of income. The underlying policy of subsection 160ZC(4A) is to deny any capital losses incurred in respect of a year of income before bankruptcy or release from debts. To maintain this policy outcome, amended subsection 160ZC(4A) provides that any net capital loss from an earlier year of income cannot be applied in determining whether a net capital gain accrued to the taxpayer in the year of income or a later year of income. This change reflects the amended definition of a net capital loss outlined above. [Item 2]
1.22 Nevertheless, subsection 160ZC(4C) operates to restore the whole or a part of a denied loss by deeming the taxpayer to have incurred a capital loss if the taxpayer makes a payment in respect of a debt which was taken into account in determining the denied loss. Subsection 160ZC(4D), which provides for the calculation of the amount of a capital loss, ensures that the sum of capital losses deemed to have been incurred does not exceed the amount of the denied loss. Subsections 160ZC(4C) and 160ZC(4D) have been amended to ensure that they operate appropriately having regard to the amended definition of a net capital loss. [Items 3 to 7]
1.23 If a taxpayer makes a payment in respect of a debt in a year ('payment year'), only the unrecouped amount of a net capital loss can be recouped. New paragraph 160ZC(4C)(d) operates to ensure that the only amount that can be recouped post bankruptcy is that part of the net capital loss ( 'denied amount' ) that has not been recouped pre bankruptcy [item 6] . Amended subsection 160ZC(4D) ensures that the only amount that can be recouped post bankruptcy is that part of the denied amount that has not been recouped post bankruptcy, either in a year prior to the payment year or by a previous payment in that payment year [item 7] .
1.24 A consequential amendment has been made to section 245-125 of the commercial debt forgiveness provisions contained in Schedule 2C of the Act. Paragraph 245-125(a) currently defines a deductible net capital loss, for the purposes of the provisions, as a net capital loss which has been incurred by the debtor in respect of the year of income immediately preceding the forgiveness year of income and which would be taken into account in determining whether a net capital gain accrued to the debtor or the debtor incurred a net capital loss in respect of the forgiveness year of income.
1.25 Amended paragraph 245-125(a) reflects the proposed changes to the calculation of a net capital loss in section 160ZC [item 21] . Specifically, amended subparagraph 245-125(a)(i) states that a 'deductible net capital loss' is a net capital loss that has been incurred in respect of a year of income earlier than the forgiveness year of income. Also, a 'deductible net capital loss' is a net capital loss that would be applied in determining whether a net capital gain accrued to the debtor in respect of the forgiveness year of income if the taxpayer derived sufficient capital gains. [Item 21 - amended subparagraph 245-125(a)(ii)]
1.26 Part 2 of Schedule 1 of the Bill will make a consequential amendment to item 4 of Schedule 5 of the Taxation Laws Amendment Act (No. 1) 1997. Schedule 5 introduced roll-over relief provisions for disposals of small business assets. Item 4 inserted a note at the end of subsection 160ZC(4), advising that an amount of a net capital loss referred to in subsection 160ZC(4) may be reduced under subsections 160ZZPR(2) or 160ZZPS(2) of the roll-over relief provisions. Subsection 160ZC(4) currently determines the amount of a net capital loss that was incurred by a taxpayer in respect of a year of income.
1.27 New subsection 160ZC(2) will replace current subsection 160ZC(4) and consequently the note described above will appear at the end of new subsection 160ZC(2). As a result, item 4 of Schedule 5 will be omitted. [Item 23]
1.28 Part 3 of Schedule 1 of the Bill will make a consequential amendment to item 238 of Schedule 1 of the Income Tax (Consequential Amendments) Act 1997. The amendment will align the amended wording of subsection 160ZC(5) (as discussed in paragraph 20 above) to the amendment to the subsection by the Income Tax (Consequential Amendments) Act 1997 [item 24] . The amendment will be effective immediately after the commencement of the Income Tax (Consequential Amendments) Act 1997 [subclause 2(2)] .
Transfer of net capital losses
1.29 Amended subsection 160ZP(7) provides some of the conditions to be satisfied before a net capital loss can be transferred between two companies. [Items 9 to 14]
1.30 New paragraph 160ZP(7)(a) requires the transferor company ( 'loss company' ) to be a resident and to have incurred a net capital loss in respect of a year of income ( 'loss year' ) [item 10] . Amended paragraph 160ZP(7)(b) requires a net capital gain to have accrued to a resident transferee company ( 'gain company' ) in a gain year that is either the same as the loss year or a later year of income [item 11] .
1.31 Where the gain year is a year of income after the loss year, a net capital loss can only be transferred if the loss could have been applied in working out a net capital gain if the loss company had derived sufficient capital gains during the gain year [item 12 - new paragraph 160ZP(7)(baa)] . This requirement would not be satisfied if, for example, there was a substantial change in the beneficial ownership of the loss company during the gain year and the same business test is not satisfied. In these circumstances, subsection 160ZC(5) (as amended) would prevent the net capital loss from being applied in the gain year because the recoupment tests in section 80A would not be satisfied.
1.32 Where the gain year and the loss year are the same year, no specific provision is necessary to ensure that the loss company satisfies the recoupment tests in the year of income. By virtue of paragraph 160Z(9)(b), a net capital loss could not arise in respect of the year of income unless the relevant recoupment tests were satisfied throughout the year. (Paragraph 160Z(9)(b) operates in certain circumstances to deny all capital losses incurred during a year of income.)
1.33 New paragraph 160ZP(7)(c) requires the loss company and gain company to agree to the transfer of a part or the whole of the net capital loss ( 'transferred amount' ) from the loss to the gain company. [Item 13]
1.34 As the amendments to section 160ZC mean that a net capital loss will no longer be reincurred in each subsequent year but instead will attach to the year in which it is initially incurred, paragraphs 160ZP(7)(d) and (e) will operate as intended. That is, where the gain year is a year of income after the loss year, the loss company will have to be a group company in relation to the gain company for the loss year, the gain year and any intervening years of income.
1.35 Where the conditions for transfer are met, new subsection 160ZP(7AAA) specifies some of the consequences of the transfer of the whole or part of a net capital loss ('transferred amount') [item 15] . The loss company's net capital loss in respect of the loss year is reduced by the transferred amount thus preventing a loss from being recouped more than once.
1.36 If the gain year is the same year of income as the loss year, the transferred amount is taken to be a capital loss incurred by the gain company during the gain year. This provision is subject to paragraph 160Z(9)(b) so that the capital loss would be denied to the gain company if the company does not satisfy the recoupment tests throughout the gain year. [Item 15 -new subparagraph 160ZP(7AAA)(b)(i)]
1.37 If the gain year is a year of income after the loss year, the transferred amount is taken to be a net capital loss incurred by the gain company in respect of the loss year [item 15 - new subparagraph 160ZP(7AAA)(b)(ii)] . This is to ensure that, like the loss company, the gain company is required to satisfy the recoupment tests in subsection 160ZC(5)(as amended).
Maximum amount that can be transferred
1.38 Where the gain year is a year of income after the loss year, the transferred amount cannot exceed the amount referred to in new subsection 160ZC(3B) as the 'unapplied amount' [item 17 - new subsection 160ZP(8A)] . In other words, an amount of a net capital loss already recouped by the loss company cannot be transferred.
1.39 Further, the maximum amount of a net capital loss that can be transferred cannot exceed the amount of a net capital gain that would have accrued to the gain company in the gain year after taking into account losses previously transferred to the gain company in the gain year [item 17 - amended subsection 160ZP(8)] . That is, the gain company cannot incur a net capital loss by virtue of the net capital loss being transferred. If the amount specified in the agreement between the loss company and the gain company exceeds the maximum amount, only the maximum amount is deemed to have been transferred [item 17 - new subsection 160ZP(8B)] .
1.40 An amendment of the assessment of either the gain company or the loss company is one possible reason why the amount specified in an agreement might exceed the amount of a net capital loss that can be transferred [item 17 - new subsection 160ZP(8C)] . For example, where a net capital loss has been transferred in a year of income and the assessment of the gain company for the gain year is subsequently amended to reduce the capital gains accrued to the company, it is possible that the amendment may cause the net capital loss to exceed the maximum amount. If this is the case, the amount deemed to have been transferred is the amount of the net capital gain (as reduced by the amendment) that would have accrued to the gain company but for the loss transfer, net of any previous loss transfers.
1.41 Where two or more net capital losses of a loss company are able to be transferred under section 160ZP, those net capital losses must be transferred in the order in which they were incurred. [Item 17 - new subsection 160ZP(8D)]
1.42 Consequential amendments have been made to reflect the operation of new subsection 160ZP(7AAA) so that, where a loss is transferred to a gain company, the gain company will be taken to incur either a capital loss or a net capital loss depending on whether the gain year is the same year as the loss year or a later year of income. [Items 18 and 19 - amended subsections 160ZP(11) and (12); item 20 - amended subsection 160ZP(15)]
1.43 The amendments relating to the determination of net capital gains and net capital losses will apply in respect of the 1996-97 year of income and all later years of income [item 22 - new subitem (1)] . In determining a taxpayer's net capital gain for those years, the taxpayer's net capital loss for the 1995-96 year of income is to be calculated as if these amendments (excluding the amendments relating to loss transfers - see below) had not been made [item 22 - new paragraph (2)(a) of subitem (2)] . In addition, the taxpayer will be taken not to have incurred a net capital loss for any year of income prior to the 1995-96 year of income ('earlier net capital loss'), except for the purposes of calculating a 1995-96 net capital loss [item 22 - new paragraph (2)(b) of subitem (2)] . That is, all earlier net capital losses will neither be separately available for recoupment nor transfer in a 1996-97 year or a later year. This is because any unrecouped amount of an earlier net capital loss is reflected in a net capital loss in respect of the 1995-96 year of income. This prevents an earlier net capital loss from being utilised more than once.
1.44 The amendments to section 160ZP will apply to transfer agreements where the gain year is the 1996-97 year of income or a later year [item 22 - new subitem (3)] . For example, where an amount of a net capital loss in respect of the 1995-96 year of income is transferred and the gain year is the 1996-97 year of income or a later year, the loss company's net capital loss in respect of the 1995-96 year is reduced by the transferred amount and this amount is deemed to be a net capital loss of the gain company for the 1995-96 year.
Chapter 2 - Withholding tax avoidance
Overview
2.1 The proposed amendments in Schedule 2 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to:
- •
- extend Part IVA so that it can apply to non-resident interest, dividend and royalty withholding tax;
- •
- address avoidance arrangements which attempt to convert an interest income stream into another income form which it has been argued is not 'interest' or 'in the nature of interest';
- •
- impose royalty withholding tax on royalties derived from Australia by a resident of Australia in the course of carrying on business through an offshore permanent establishment;
- •
- impose withholding tax in situations where tax exempt bodies are interposed between an Australian resident payer of interest, dividend or royalties and a non-resident recipient; and
- •
- remove any doubt that withholding tax is payable where dividends are paid out of capital reserves.
Summary of the amendments
2.2 The purpose of these amendments is to provide a mechanism within the Act to effectively counter withholding tax avoidance arrangements in a general and comprehensive way, to address certain specific tax avoidance arrangements which are currently being entered into and to make it clear that withholding tax is payable where dividends are paid from capital reserves.
2.3 The measures will apply to interest, dividend and royalty payments made after 7.30pm EST on 20 August 1996.
Background to the legislation
2.4 The taxation of Australian sourced interest, dividends and royalties paid or credited to non-residents is subject to the provisions contained in Division 11A of the Act. These provisions provide, in conjunction with the relevant Rates Act, that the non-resident recipient is subject to withholding tax on the gross amount paid or credited. A rate of 10% is imposed in relation to interest and 30 % in the case of dividends and royalties. However, the rates for dividends and royalties are generally reduced if Australia has concluded a Double Tax Agreement with the recipient's country of residence. The obligation for the collection of withholding tax is placed on the person making the payment.
2.5 Although the general intent of Division 11A is to impose tax on non-residents deriving Australian sourced interest, dividend and royalty income, the Division also imposes withholding tax on interest paid to a resident of Australia operating through an offshore permanent establishment (for example, a branch) - subsection 128B(2A).
Collection of withholding tax and additional liabilities
2.6 Under section 221YL of the Act, the payer of interest, dividends or royalties is required to deduct from that payment, an amount of withholding tax which is determined by the percentage specified in the Income Tax Regulations (Regulations 136, 137 and 137A).
2.7 Section 221YQ imposes a liability for the failure by a payer of interest, dividends or royalties to make a deduction as specified under section 221YL. The payer is liable for the amount of withholding tax which was not deducted. However, the payer may claim the amount from the recipient after the withholding tax has been remitted to the Taxation Office. A second liability imposed under this section is an amount of additional tax determined under subsection 128C(3), which imposes a penalty, on the person liable to pay the tax, for the late payment of that tax to the Taxation Office. This amount cannot be reimbursed from the non-resident.
Withholding tax and the general anti-avoidance provisions
2.8 Part IVA is a provision intended to prevent tax avoidance. It was introduced in 1981 to replace the previous general anti-avoidance provision (section 260).
2.9 The operation of Part IVA (unlike section 260) is confined to situations which give rise to a tax benefit, in the form of an amount not included in assessable income, or in the form of an amount of deduction from assessable income, gained as a result of a scheme as defined in Part IVA (specifically section 177D).
2.10 The non-resident withholding tax provisions for interest, dividends and royalties stand apart from the provisions of the law that deal with tax by assessment. Part IVA does not apply to schemes to avoid withholding tax.
2.11 Prior to the introduction in 1993 of a final withholding tax for royalties paid to non-residents, royalty income was subject to income tax by the normal assessment method and Part IVA applied.
2.12 In order to protect the non-resident withholding tax base from emerging tax avoidance practices and to provide a mechanism within the Act to effectively counter withholding tax avoidance schemes in a comprehensive way, it has become necessary to expand the effect of Part IVA to include avoidance of withholding tax on an amount of interest, dividends or royalties because of a scheme as defined in Part IVA.
Penalties in relation to Part IVA
2.13 Since 1992, section 226 has been in place to provide for the imposition of the liability for an amount of additional tax by way of penalty where an amount has been subject to a determination by the Commissioner of Taxation under section 177F of Part IVA. The liability for the additional tax falls upon the taxpayer in relation to whom the determination was made. The amount of additional tax is a penalty percentage of the amount of tax which was avoided by the use of a Part IVA scheme. The penalty percentage is either 25% or 50% of the amount of tax avoided, depending upon whether or not the taxpayer has a reasonably arguable case against the application of Part IVA.
2.14 For the purposes of the withholding tax provisions, the term 'interest', which is currently defined in subsection 128A(1), includes amounts which are 'interest' within the ordinary meaning of the term and amounts which are 'in the nature of interest'.
2.15 The courts have formulated general principles for determining whether specific amounts fall within the ordinary meaning of interest, such as, 'interest is regarded as flowing from the principal sum' and to be 'compensation to the lender for being kept out of the use and enjoyment of the principal sum'. Interest is also said to be calculated by reference to a period of time and that it accrues on a daily basis.
2.16 The existing definition in subsection 128A(1), being an inclusive definition, ensures that the withholding tax provisions apply to amounts such as discounts on bills which, while in the nature of interest, may not have fallen within the ordinary meaning of interest.
2.17 The proposed amendment to the definition of the term 'interest' contained in the Bill is designed to address certain arrangements which attempt to change the character of the income from interest to something else. The main feature of these arrangements is the purported conversion of an interest income stream into another income form, through a transaction or a series of transactions. It is argued that the effect of the conversion is that withholding tax is not payable. Although these arrangements are considered ineffective the Bill seeks to amend the definition of the term 'interest' to remove any possible doubt that, notwithstanding the purported conversion of the interest income stream, the amounts paid are interest or in the nature of interest.
2.18 The proposed amendments are designed to give effect to the policy intent of the existing withholding tax provisions. Financial products which have never been subject to withholding tax are not intended to be captured by the expanded definition. Examples of transactions which would not generally be considered as falling within the existing withholding tax provisions are forward foreign exchange transactions, forward rate agreements, swaps and reciprocal purchase agreements. Broadly speaking, these transactions do not involve the provision of finance. In the case of swaps, this is consistent with the Australian Taxation Office's long held view which is expressed in Income Tax Ruling IT2050.
2.19 On the other hand, financial products are continually being developed and refined and, accordingly, there may be products developed in the future which, although they incorporate some of the features of an existing product, may fall within the proposed new definition.
2.20 Similarly, an arrangement which converts an interest income stream into another income form would not be excluded from the proposed measures merely because it includes one of the above mentioned transactions.
Royalties paid to a resident operating through an offshore permanent establishment
2.21 Subsection 128B(2B) currently provides that there is a liability to royalty withholding tax:
- •
- under subparagraph 128(2B)(b)(i), on a royalty paid by an Australian resident that is not an outgoing wholly incurred in carrying on business outside Australia through an offshore permanent establishment (PE) eg. a branch; and
- •
- under subparagraph 128(2B)(b)(ii), on a royalty paid by a non-resident that is incurred in carrying on business through a PE in Australia.
2.22 The proposed legislation is designed to counter arrangements which attempt to exploit a technical deficiency in the law where royalty withholding tax is not payable in circumstances where royalties, which would be subject to withholding tax if paid directly to a non-resident, are paid to a resident of Australia carrying on business through an offshore PE and the PE in turn pays the royalties to a non-resident. The proposed legislation will impose royalty withholding tax on the Australian resident in these cases. Subsection 128B(2A) together with subsections 128B(8) and 128B(9) deal with similar situations where interest is paid. These provisions were introduced some years ago as an anti-avoidance measure.
2.23 A further amendment will be made in order to clarify the circumstances in which royalties can be said to have been incurred in carrying on a business through an offshore PE. The amendment will link the location of the outgoing royalty payment with the location of the income resulting from the use of the property which gave rise to the royalty payment. If a royalty payment is not incurred in gaining income of an offshore PE, for example where the property is used in Australia, the effect of the amendment will be to preclude any argument that the royalty was an outgoing wholly incurred in carrying on business outside Australia, and thus not subject to withholding tax.
2.24 A similar linking provision will be included to cover the case of a non-resident who carries on business in Australia through a PE. In such cases, withholding tax is imposed on royalties paid by that non-resident to another non-resident in circumstances where the property which is the subject of the royalty payments is acquired by the non-resident who carries on business in Australia through a PE for use in that Australian business. This provision will guard against the argument that a royalty paid as an expense of an Australian business is not an outgoing incurred in carrying on a PE of that business in Australia.
2.25 As a deterrent, residents who are subject to withholding tax on royalties derived through an offshore PE will also have the royalties included in their assessable income. The withholding tax paid will not, of course, be deductible in calculating their assessable income.
2.26 Paragraph 128B(3)(a) provides an exemption from withholding tax in relation to interest, dividend and royalty income derived by non-residents who are exempt from income tax by virtue of paragraphs 23(e), (ea), (f), (g), (h), (j) and (jb) and who are also exempt from income tax in the country in which they reside.
2.27 Some arrangements attempt to interpose withholding tax exempt bodies between an Australian resident payer of interest, dividend or royalty income and a non-resident recipient. A payment, which would be subject to withholding tax if paid directly to a non-resident, is paid to the tax exempt body which in turn makes a payment to a non-resident. This relieves the non-resident from the liability to withholding tax.
2.28 The proposed legislation amends the Act to insert a specific anti-avoidance provision which deems amounts paid through tax exempt interposed entities to have been paid by the resident directly to the non-resident.
Dividends paid out of capital reserves
2.29 The amendment relates to a view that, as the law is currently framed, dividend withholding tax does not apply if a dividend is paid out of a capital reserve. For example, where the dividend consists of bonus shares paid from an asset revaluation reserve. It has been argued, relying on tenuous technical argument, that the withholding tax provisions can only apply if the dividend payment is income according to ordinary concepts.
2.30 Although it is considered that the current law is effective and withholding tax applies to these payments, the proposed legislation will amend the Act to make it perfectly clear that withholding tax is payable where dividends are paid out of capital reserves.
Explanation of the amendments
The terms 'taxpayer' and 'payer'
2.31 In these amendments, the 'taxpayer' is the entity to whom payments of interest, dividends or royalties are made. The 'payer' is the entity which makes these payments of interest, dividends or royalties.
2.32 These amendments applying Part IVA in cases of avoidance of the payment of withholding tax parallel the existing provisions of Part IVA.
2.33 New section 177CA will be inserted into Part IVA. This section will extend the operation of Part IVA to arrangements which avoid an amount of withholding tax which would otherwise be levied under section 128B. The amount on which withholding tax is not paid is termed a tax benefit for the purposes of Part IVA.
2.34 New subsections 177F(2A), (2B), (2C), (2D), (2E), (2F) and (2G) will allow the Commissioner to make a determination that an amount of tax benefit is subject to withholding tax and to take necessary action to implement that determination .
2.35 New section 221YQ(1A) will remove any doubt that the provisions of section 221YQ apply to make payable by the payer, the amount of withholding tax calculated on the tax benefit determined under new subsection 177F(2A) , together with the applicable amount of additional tax for late payment of withholding tax.
2.36 New subsection 226(1A) will impose a penalty in the form of an amount of additional tax calculated as a percentage of the amount of withholding tax due on the tax benefit determined under new subsection 177F(2A) . Liability for this penalty initially falls on the taxpayer.
2.37 New section 221YQA will operate to shift the liability for payment of the subsection 226(1A) penalty from the taxpayer to the payer.
2.38 New subsection 177CA(1) will specify a particular amount (of interest, dividends or royalties paid to the taxpayer) to which section 177CA is to apply. Such an amount will have both of the following characteristics:
- •
- as a result of the entering into or the carrying out of a scheme, the taxpayer is not liable to pay withholding tax on the amount. (The existing definition of 'scheme' contained in section 177A(1) applies to this subsection); and
- •
- there is a reasonable expectation that, if the scheme had not been entered into or carried out, then a liability to the taxpayer for withholding tax on that amount, would have arisen. [Item 12]
2.39 Where there is a ' new subsection 177CA(1) amount' new subsection 177CA(2) will apply to designate that amount to be a tax benefit. New subsection 177CA(2) further specifies that the tax benefit is taken to have been obtained by the taxpayer. [Item 12]
2.40 New section 177CA will apply to payments made after 7.30 pm, Eastern Standard Time on 20 August 1996 (whether or not the arrangement was entered into before that date). [Item 19]
Schemes to which Part IVA applies
2.41 Section 177D outlines certain criteria which must be satisfied before the scheme is one to which Part IVA applies. The proposed legislation makes no amendments to section 177D. Its provisions therefore apply without alteration to new section 177CA in the same way as to section 177C.
Determination in relation to a tax benefit
2.42 Where an amount of tax benefit has been identified by the application of new section 177CA , and section 177D has been applied to determine that the scheme which produced that benefit is a Part IVA scheme, new subsection 177F(2A) will apply to that tax benefit as follows:
- •
- it is open to the Commissioner to determine that the taxpayer is liable to withholding tax (by the operation of section 128B) on that amount or such part of that amount as the Commissioner may decide (the determination); and
- •
- where the Commissioner does determine that there is such an amount, the Commissioner must take such action considered necessary to give effect to that determination. [Item 13]
2.43 New subsection 177F(2B) will mandate that where the Commissioner makes a determination, advice of such determination must be given in writing. [Item 13]
2.44 New subsection 177F(2C) will require that the written notice of the determination specified in new subsection 177F(2B) be given to both the taxpayer and the payer. [Item 13]
2.45 New subsection 177F(2D) will allow the inclusion of more than one determination in a single written notice. This provision is included to allow for the fact that a liability for withholding tax arises under section 128B on the basis of each payment of interest, dividends or royalties and the withholding tax becomes due and payable on a monthly basis (under subsection 128C(1)), rather than on an annual basis as is the case with taxes which are assessed. This provision, therefore, allows the inclusion in a single written notice of more than one determination of a monthly withholding tax liability. [Item 13]
2.46 New subsection 177F(2E) will specify that a determination is not rendered invalid if the notice, required by new subsection 177F(2C) , is not issued to both or either of the taxpayer and the payer [item 13] . This provision is necessary as it is possible the Tax Office may not have the taxpayer's address.
2.47 New subsection 177F(2F) will specify that where a determination is made the amount is deemed to have been subject to withholding tax at all times. This will allow penalties to be imposed on the amount from the time the original liability would have arisen. [Item 13]
2.48 New subsection 177F(2G) will allow the taxpayer to object to a subsection 177F(2A) determination. This right to object does not extend to the payer. [Item 13]
2.49 Item 14 will insert a reference to new subsection 177F(2A) in subsection 177F(3) to authorise the Commissioner, in cases where she or he has made a determination, to make a compensating adjustment in favour of either the taxpayer against whom the determination has been made, or any other taxpayer, if the Commissioner is of the opinion that the person concerned has suffered a taxation disadvantage as a result of the scheme and that it is fair and reasonable that the adjustment be made. The Commissioner again is empowered to take whatever action is necessary to give full and proper reconstructive effect to the determination.
2.50 New subsection 221YQ(1A) will be inserted into section 221YQ to avoid doubt that that section will operate in relation to a determination. Thus, the payer, having not made a deduction in relation to withholding tax, will become liable to pay the amount of withholding tax due to the Commissioner (paragraph 221YQ(1)(a)). Further, the payer will be liable to pay to the Commissioner an amount of additional tax calculated in accordance with subsection 128C(3), by way of penalty for late payment of withholding tax (paragraph 221YQ(1)(b)). [Item 15]
2.51 New section 226(1A) will provide for the calculation of additional tax by way of penalty applicable to the amount of withholding tax calculated by the Commissioner as a result of his or her determination. The amount of additional tax is calculated by the application of the 'penalty percentage' specified in subsection 226(2) to the amount of withholding tax liability of the taxpayer as determined under the proposed amendments to Part IVA. [Item 17]
2.52 The provisions of subsection 226(2) will apply to new subsection 226(1A) in the same way as they apply to subsection 226(1). The penalty percentage of the amount of withholding tax calculated is 25% if there is a reasonably arguable case that Part IVA does not apply to the transactions under scrutiny (paragraph 226(2)(b)). If there is no such reasonably arguable case, then the applicable percentage is 50% (paragraph 226(2)(a)). [Items 17 and 18]
2.53 The term 'reasonably arguable' is defined in section 222C. This provision is not amended by the proposed legislation.
2.54 New subsection 221YQA(1) will operate to transfer liability for the amount of penalty imposed under new subsection 226(1A) to the payer. [Item 16]
2.55 New subsection 221YQA(2) will allow the payer to recover from the taxpayer, the amount paid to the Commissioner by way of penalty under new subsection 221YQA(1) . [Item 16]
2.56 New subsection 221YQA(3) will specify that where a payment has been made by the payer under new subsection 221YQA(1) ,a credit of that amount is available against the taxpayer's liability under new section 226(1A) . [Item 16]
2.57 New subsection 221YQA(4) will provide that after an amount of penalty has been paid to the Commissioner, if that amount or part of that amount, is remitted by the Commissioner, a refund of the remitted amount is to be paid to the payer of the penalty. Further, any amount of credit allowed to the taxpayer under new subsection 221YQA(3) is to be reduced by the amount of any penalty remitted by the Commissioner. [Item 16]
2.58 The existing definition of interest will be repealed by item 1 and a new definition will be inserted by item 3 .
2.59 The new definition in new subsection 128A(1AB) defines interest in a similar way as the existing definition, that is, it includes amounts which are 'in the nature of interest' . However, itwill also provide an expanded definition to make it clear that:
- •
- amounts which can reasonably be regarded as having been converted into a form that is 'in substitution for' interest are interest for the purposes of withholding tax; and
- •
- amounts which can reasonably be regarded as having been received in exchange for interest in connection with a 'washing arrangement' are also interest for the purposes of withholding tax.
2.60 The amendments also restate the common law to make it clear that the interest component of certain transactions fall within both the existing definition of interest and the proposed new definition for the purposes of the withholding tax provisions. [Item 3 - new subsections 128A(1AE) and 128A(1AF)]
2.61 New subsection 128A(1C) provides an example of an amount which is 'in the nature of interest' for the purposes of new paragraph 128A(1AB)(a) . [Item 3]
2.62 The provisions imposing withholding tax were inserted by Income Tax Assessment Act (No. 4) 1967. The explanatory memorandum which accompanied that Act stated that an example of an amount in the nature of interest is a discount fee on bills of exchange. The view has been put that, notwithstanding the example given in the explanatory memorandum, some discounts on securities are not amounts in the nature of interest.
2.63 New subsection 128A(1AC) has the effect of deeming, and will put it beyond any possible doubt, that an amount representing a discount on a security is an amount 'in the nature of interest' and is, therefore, interest for the purposes of the withholding tax provisions. [Item 3]
2.64 Similarly, new subsection 128A(1AD) provides an example of an amount that is in substitution for interest for the purposes of new paragraph 128A(1AB)(b) . [Item 3]
2.65 New subsection 128A(1AD) has the effect of deeming that lump sum payments made instead of payments of interest are amounts in substitution for accrued interest and are, therefore, interest for the purposes of the withholding tax provisions. [Item 3]
An example of an amount which could reasonably be regarded as having been converted into a form that is 'in substitution for' interest - new paragraph 128A(1AB)(b)
2.66 A resident borrows $1 million at an interest rate of 10% per annum from a non-resident lender. Interest is payable at the end of 12 months.
2.67 Prior to the date upon which interest is payable under the loan agreement, the resident borrower issues a promissory note, with a face value of $100,000, to the non-resident lender to evidence its interest liability at the end of the 12 months.
2.68 Prior to the date upon which interest is payable the non-resident lender negotiates the promissory note to a third party for valuable consideration. The resident borrower pays the third party on presentation of the promissory note.
2.69 Although it is considered that the current law is effective and withholding tax applies to these payments, new subsection 128A(1AB)(b) will make it clear that the payment received through the third party, that is through the negotiation of the promissory note, is interest for the purposes of Division 11A.
An example of a lump sum payment made instead of payments of interest which are 'in substitution for' interest - new subsections 128A(1AB)(b) and 128A(1AD)
2.70 An example of a lump sum payment made instead of payments of interest would include the interest component of a lump sum payment made in relation to a loan where the borrower is unable to meet his or her commitments under the loan.
2.71 For instance, a resident borrows $10 million from a non-resident lender. The resident defaults on the repayments and the non-resident lender agrees to accept a lump sum settlement of $6.4 million. The actual amount outstanding is $6 million principle and $800,000 in accrued interest. However, under the terms of the settlement the non-resident agrees to waive a portion of the outstanding debt.
2.72 In this example the $400,000 lump sum payment made instead of the accrued interest would be subject to withholding tax.
2.73 The term 'washing arrangement' is defined in new paragraph 128A(1AB)(c) to mean an arrangement under which title to a security is transferred to a resident shortly before an interest payment is made pursuant to the security and the sole or dominant purpose of the arrangement is to reduce the amount of withholding tax payable.
2.74 A simple example of a washing arrangement is shown at paragraphs 2.81-87.
Outline of a typical washing arrangement
2.75 Washing arrangements are used by non-resident businesses investing in securities issued by resident companies or governments. Prior to the time that the interest payment is due (coupon day), the non-resident sells the security to an unrelated resident third party at market prices. The price incorporates the forthcoming interest payment. Just after the coupon date the non-resident purchases the same security on the open market. It is immaterial whether or not a right to reacquire that security is obtained (by options, forward purchases or the like) by the non-resident.
2.76 The re-purchase price of the resident participant in the scheme is lower than the sale price because of the intervening interest payment. The scheme, in effect, allows the non-resident to convert interest income into business profits. If the non-resident is from a country with which Australia has a double tax agreement (DTA) and does not have a permanent establishment (eg. a branch) in Australia, the non-resident's profit on the transaction is not taxable in Australia.
2.77 The definition of 'washing arrangement' contemplates situations where the arrangement is undertaken with more than one purpose in mind. New paragraph 128A(1AB)(c) requires that where more than one purpose exists for entering into the arrangement, the purpose of reducing the amount of withholding tax payable must be the dominant purpose.
2.78 The words 'dominant purpose' are not defined in the proposed legislation. However, these words have been the subject of judicial consideration in the context of Part IVA of the Act. It has been held that 'in its ordinary meaning dominant indicates that purpose which was the ruling, prevailing, or most influential purpose'.
2.79 Whether a person has entered into an arrangement for the sole or dominant purpose of reducing the amount of withholding tax payable will be a question of fact to be determined objectively from the surrounding circumstances.
2.80 Accordingly, an arrangement will be considered to fall within new paragraph 128A(1AB)(c) if the 'ruling, prevailing, or most influential purpose' for entering into the arrangement was, on an objective view, to reduce the amount of withholding tax payable. This will be the case notwithstanding that there may be a commercial reason or reasons for entering into the arrangement.
A simple example of a washing arrangement
2.81 Assume the following facts:
- •
- A non-resident investor, from a country with which Australia has a DTA, purchases bonds with the intention of selling the bonds before interest is paid in order to avoid the withholding tax payable on the interest income. The non-resident does not have a permanent establishment in Australia.
- •
- The purchase price of the bonds is $10 million and interest, at a rate of 10% per annum, is payable yearly by coupons.
- •
- The underlying value of the security does not change.
- •
- The first coupon is due on the 31 March 1998.
2.82 The non-resident sells the bonds in March 1998 to a resident for $10.95 million. The Australian resident purchaser receives interest income of $1 million on 31 March 1998 and sells the security on 1 April 1998 for $10 million to a non-resident. On 1 April 1998 the non-resident repurchases the same type of bonds in the market for $10 million.
2.83 This process may be repeated several times or only undertaken once.
Effect of the arrangement
2.84 By selling the bonds the non-resident has derived $950,000 which has been converted from interest income into business profits which, by virtue of the DTA, are not taxable in Australia. If the non-resident had held the bonds at coupon date, the interest income of $1 million would have been subjected to interest withholding tax of $100,000.
2.85 The resident has derived gross income of $11 million (interest income of $1 million and proceeds from the sale of $10 million). The resident will have an allowable deduction of $10.95 million against this income. The taxable income is $50,000 and using the company rate of tax (36%), the tax payable is $18,000.
2.86 The net loss to the Australian revenue as a result of the washing arrangement is $82,000, that is, $100,000 (withholding tax that would have been payable because the interest is $1 million and the withholding tax is 10 per cent) less $18,000 (actual tax paid).
2.87 The proposed amendment will ensure that the accrued interest component received from the resident purchaser will be subject to withholding tax. In this example, the accrued interest component was $950,000.
2.88 Section 128B currently provides that there is a liability to interest withholding tax:
- 1.
- under subparagraph 128B(2)(b)(i), on interest paid by an Australian resident that is not an outgoing wholly incurred in carrying on business outside Australia through an offshore permanent establishment (PE) eg. a branch;
- 2.
- under subparagraph 128B(2)(b)(ii), on interest paid by a non-resident that is incurred in carrying on business through a PE in Australia; and
- 3.
- under subsection 128B(2A) on interest paid to an Australian resident carrying on business through an offshore PE and the interest is paid by either an Australian resident falling within point 1 above or a non-resident falling within point 2 above.
2.89 New subsection 128A(1AE) restatesthe common law to make it clear that where a lender, that is an entity to whom subsection 128B(2) applies, assigns a loan, or the right to interest under a loan, to a non-resident or to an Australian resident carrying on business through an offshore PE, any payments from the borrower to the assignee that would have been interest but for the assignment are interest for the purposes of the withholding tax provisions. [Item 3]
2.90 A similar provision is inserted by item 3 which merely restates the common law and will operate in relation to the acquisition of securities. The amendment relates to a view that, in certain circumstances, where securities are purchased on a cum interest basis, interest withholding tax does not apply to payments made after the sale because no debtor/creditor relationship exists between the issuer of the security and the purchaser. The Australian Taxation Office's long held view is that withholding tax applies to these payments at present; the proposed legislation will make it perfectly clear. That is, where a non-resident, or an Australian resident carrying on business through an offshore PE, acquires a security or the right to receive interest under the security any payments from the issuer of the security to the non-resident or Australian resident holder mentioned above, that would have been interest but for the acquisition, are payments of interest subject to withholding tax. [New subsection 128A(1AF)]
2.91 Items 4, 10 and 11 will make consequential amendments as a result of the amendment described above by omitting references to subsection 128A(1) in paragraph 128AB(4)(b) and sections 159GZA and 159GZY and substituting references to new subsection 128A(1AB) . These amendments will incorporate the new definition of interest into those provisions.
Royalties paid to a resident operating through an offshore permanent establishment
2.92 Item 6 proposes that new subsection 128B(2C) be inserted in section 128B. New subsection 128B(2C) will impose a liability to royalty withholding tax where an Australian resident derives royalty income in carrying on business through an offshore permanent establishment (PE) eg. a branch and the royalty is paid:
- •
- by an Australian resident where the payment is not an outgoing wholly incurred in carrying on business through an offshore PE; or
- •
- by a non-resident where the payment is an outgoing incurred in carrying on business through a PE in Australia.
2.93 New subsection 128B(9A) will be inserted by item 7 to clarify, for the purposes of subparagraph 128(2B)(b)(i) and new subparagraph 128(2C)(b)(i) the circumstances in which royalties can be said to have been incurred by an Australian resident in carrying on a business through an offshore PE. New subsection 128B(9A) is similar to subsection 128B(8) which currently applies to interest. A royalty will be deemed not to be an outgoing incurred in carrying on business through an offshore PE where:
- •
- the royalty is incurred by the Australian resident in gaining or producing income or for the purpose of gaining or producing income that is derived otherwise than in carrying on business through the offshore PE; or
- •
- the royalty is incurred by the Australian resident in carrying on business for the purpose of gaining or producing income but the royalty is not reasonably attributable to income derived in carrying on business through the offshore PE.
2.94 This amendment will link the location of the outgoing royalty with the location of the income resulting from the use of the property which gave rise to the royalty payment.
2.95 New subsection 128B(9B) will be inserted by item 7 to clarify, for the purposes of subparagraph 128(2B)(b)(ii) and new subparagraph 128(2C)(b)(ii) , the circumstances in which royalties can be said to have been incurred by a non-resident in carrying on a business through a PE in Australia. New subsection 128B(9B) is similar to subsection 128B(9) which currently applies to interest. A royalty will be deemed to be an outgoing incurred in carrying on business through a PE in Australia where:
- •
- the royalty is incurred by the non-resident in gaining or producing income or for the purpose of gaining or producing income that is derived in carrying on business through the PE in Australia; or
- •
- the royalty is incurred by the non-resident in carrying on business for the purpose of gaining or producing income and the royalty is reasonably attributable to income derived in carrying on business through the PE in Australia.
2.96 This amendment will also link the location of the outgoing royalty with the location of the income resulting from the use of the property which gave rise to the royalty payment.
2.97 Item 8 amends subsection 128B(11) to provide that the withholding tax payable by a resident as a result of new subsection 128B(2C) is in addition to any ordinary income tax that may be payable on the royalty income, and that the withholding tax paid is not deductible in calculating that other income tax.
2.98 Section 128D will be amended, as a companion measure to that proposed by item 8 , to ensure that a resident who is subject to withholding tax on royalties derived through an offshore PE by virtue of new subsection 128B(2C) will also have the royalty income included in assessable income. [Item 9]
2.99 New section 128AF will be inserted to deem amounts paid through tax exempt interposed entities to have been paid by the resident directly to the non-resident. New section 128AF will apply when:
- •
- a payment of dividends, interest or royalties is received by a non-resident through one or more interposed companies, partnerships, trusts or other persons; and
- •
- one or more of the interposed entities is exempt from income tax at the time at which the payment was received by the non-resident. [Item 5]
Dividends paid out of capital reserves
2.100 The definition of income in subsection 128A(1AA) will be amended by item 2 to include dividends. The amendment will make it clear that withholding tax is payable where dividends are paid out of capital reserves.
2.101 The amendments proposed by this Schedule apply in relation to apply to interest, dividend and royalty payments made after 7.30pm EST on 20 August 1996. [Item 19]
Transitional provisions - regulations
2.102 Item 20 will insert a transitional provision which will allow a regulation to be made which takes effect from a date before the notification of the regulations. The regulation will prescribe, for the purposes of section 221YL, the amount of withholding tax to be deducted from royalty payments which are caught by virtue of new subsection 128B(2C) .
Chapter 3 - Dual resident companies
Overview
3.1 Schedule 3 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to change the tax treatment in respect to certain dual resident companies (and non-individual entities treated as companies) to deny specified benefits that are available in respect to resident companies and ensure the application of specified anti avoidance measures that are targeted at non-resident companies.
3.2 The purpose of the amendments is to change the tax treatment in respect to companies that are residents of both Australia and another country for income tax purposes, but are either in effect treated as a non-residents of Australia for the purposes of a double taxation agreement (DTA), or that while qualifying as residents of Australia solely under the central management and control test in subsection 6(1) of the Act, also have central management and control outside Australia.
3.3 The amendments will deny these dual resident companies access to the intercorporate dividend rebate, CGT roll-over relief for certain assets, and the group transfer of income and capital losses, which are available only in respect to resident companies. The amendments will also subject these dual resident companies to thin capitalisation rules, debt creation rules, and restrictions on access to deductions for accrued liabilities on securities held by offshore associates, which are anti avoidance measures applying in respect to non-resident companies.
3.4 Similar arrangements will apply to corporate limited partnerships, corporate unit trusts and public trading trusts.
3.5 The amendments will take effect on or after 1 July 1997 (see also 'Application' below).
Background to the legislation
3.6 Subsection 6(1) of the ITAA provides that a company is a resident of Australia if it is incorporated in Australia, or carries on business in Australia and either has its central management and control in Australia, or its voting power controlled by shareholders who are resident of Australia. Under the ITAA a resident company is generally subject to tax on its world wide income and a non-resident company is subject to tax only on its Australian sourced income.
3.7 A company that is a resident under subsection 6(1) may be treated as a resident solely of another country for the purposes of a DTA while remaining a resident for domestic law purposes. As a resident of the other country under the DTA, Australia's taxing rights would be limited to the Australian source income of the company, whereas Australian residents are normally taxable on their worldwide income. However, since the company continues to qualify as a resident under domestic law, it would still be able to claim tax concessions available under that law to resident companies and would not be subject to anti-avoidance measures targeted at non-residents.
3.8 Companies that are essentially non-resident companies may also qualify as residents within the meaning of the central management and control test in our domestic law while continuing to have substantial central management and control, as interpreted by the Courts, and residence outside Australia. For example, under the present central management and control test a non-resident company may gain Australian residence merely by shifting some of its high level decision makers or decision making functions to Australia while retaining substantial central management and control offshore.
3.9 The amendments will ensure that both these types of dual resident companies, which are in substance non-resident companies, are effectively treated as non-residents for the purposes of specified benefits and anti avoidance measures.
Explanation of the amendments
What companies do the amendments apply to?
Companies covered under certain double taxation agreements
3.10 The amendments will apply to two distinct types of companies (to be called 'prescribed dual residents') that qualify as residents of Australia under subsection 6(1) of the ITAA. The first type of companies are those that have their Australian residence status effectively revoked for the purposes of the application of a bilateral DTA applying to Australia and another country [Item 1; definition of a 'prescribed dual resident', paragraph (a)] .
3.11 A DTA generally allocates taxing rights for the purpose of avoiding juridical double taxation, whereby the same taxpayer may be liable for taxation on the same income in more than one jurisdiction. One method of avoiding double taxation where a company is resident in both countries for their respective domestic law purposes is the use of a tie breaker provision, which has the effect of treating the company as a resident of only one of the countries for the purposes of the DTA. The residence is usually allocated under such a tie breaker provision according to the place of effective management of the company, but can also be based on the place of incorporation, or variations or combinations of these two elements.
Multiple central management and control companies
3.12 The second type of resident companies covered by the amendments are those whose central management and control forms the only basis for their Australian residence, but which also have central management and control and residence outside Australia. In other words, they are residents of Australia because they satisfy the carrying on of a business and central management and control test of subsection 6(1) of the ITAA, and no other test in that definition, while also having central management and control in another country. They would also be resident in a foreign country, although not necessarily the same foreign country in which the foreign central management and control exists. [Item 1; amendment to subsection 6(1), definition of a 'prescribed dual resident', paragraph (b)]
3.13 Central management and control is a common law concept that is determined by the particular facts of each case. The term has generally been interpreted to cover high level (as opposed to day-to-day) management and control. The Courts have held that multiple places of central management and control may arise where there is more than one place where substantial controlling power and authority are exercised.
3.14 The dual resident tie breaker test of place of effective management in DTAs is generally considered to be similar to the central management and control test in the domestic definition of residence and this would certainly be the case in most practical situations.
3.15 The measures relating to multiple places of central management and control may also apply where a double tax agreement operates. For example, the double tax agreement may not apply to dual residents, may not have a tie breaker provision for companies, or because 'central management and control' is generally synonymous with the tie breaker test of 'place of effective management', it may not operate to treat the company as a resident solely of one of the contracting states in cases of multiple central management and control.
3.16 The amendments will also apply in respect to other non-individual entities that are treated as companies under the ITAA. These are corporate limited partnerships, corporate unit trusts and public trading trusts. The provisions dealing with these entities ensure that they will be automatically caught by the amendments without requiring further amendment of the ITAA (section 94J, subsection 102L(2) and subsection 102T(2) respectively). While an entity must be treated as a company under Australian law to qualify as a 'prescribed dual resident', the entity does not also have to be teated as a company under the law of the foreign country or another country for the purposes of subparagraphs (a)(iii), (a)(iv), (b)(ii) and (b)(iii).
What tax measures do the amendments apply to?
Intercorporate dividend rebate
3.17 The amendments will apply in relation to section 46, which requires both the dividend paying company and the recipient company shareholder to be Australian residents for the intercorporate dividend rebate to operate. A similar arrangement applies in respect of subsection 46A for dividends paid as part of a dividend stripping operation.
3.18 Companies that are prescribed dual residents and that qualify for the rebate as shareholders will still be entitled to the rebate in respect to the franked component of the dividends, but will be denied the rebate (and therefore subject to company tax) in respect to the unfranked component of the dividends. This is similar to the treatment of private companies that are not part of a wholly owned company group (section 46F(2)) and will ensure that economic double taxation does not arise in respect to the portion of the dividends that has been taxed in the hands of the transferor company. [Item 2 - new subsection 46F(2A)]
3.19 Where the dividend paying company is a prescribed dual resident, Australian resident shareholder companies that would otherwise qualify for the full rebate, will also be denied the rebate in respect to the unfranked component of the dividends. [Item 2 - new subsection 46F(2B]
3.20 The amendments will also apply in relation to the loss grouping provisions, which require the loss making company to be a resident in respect to a year of income in which the loss is incurred and the loss acquiring company to be a resident in respect to a year of income which has taxable income (subsection 80G(6)).
3.21 The amendments will exclude a prescribed dual resident from the operation of the loss grouping provisions either as a loss making company (the 'loss company') or a loss acquiring company (the 'income company'). [Items 3, 4, 15, 16 and 17]
Discounted or deferred interest securities
3.22 The amendments will also apply to section 159GT, which provides deductibility on an accruals basis in respect of certain qualifying discounted or deferred interest securities issued by the taxpayer for amounts that would have been assessable income of the taxpayer if the securities had been issued to the taxpayer rather than by the taxpayer. Subsection 159GT(6) operates as an anti-avoidance mechanism to deny the accrued deductibility where the qualifying security is issued directly or indirectly to a non-resident associate of the taxpayer.
3.23 The amendments provide that the anti avoidance mechanism of subsection 159G(6) will also apply where the associate of the taxpayer is a prescribed dual resident. [Item 5]
3.24 The amendments will apply to section 159GZE, which requires a company to be a non-resident for the purposes of determining whether it is a foreign controller for purposes of the thin capitalisation purposes.
3.25 The amendments will provide that a prescribed dual resident will also be considered when determining whether a company is a foreign controller under section 159GZE. In practice, it is likely that this amendment would impact mainly on prescribed dual residents that are not part of a non-resident group. Prescribed dual residents that are part of a non-resident group would generally already be caught under the 'associates' provisions of the thin capitalisation rules (section 159GZC) and the amendments, while altering the entities in the foreign group to which the thin capitalisation rules will apply, will generally not alter the overall result in relation to that group. [Items 6 and 7]
3.26 Similar to the thin capitalisation provisions, the amendments will apply to section 159GZZA, which requires a company to be a non-resident for the purposes of determining whether it is a foreign controller for purposes of the debt creation provisions.
3.27 The amendments will provide that a prescribed dual resident will also be considered when determining whether a company is a foreign controller under section 159GZE. [Item 8]
3.28 The amendments will also apply to the CGT loss grouping provisions, which require the loss making company to be a resident in respect to a year of income in which the loss is incurred and the loss acquiring company to be a resident in respect to a year of income in which a gain is made (subsection 160ZP(7)).
3.29 The amendments will exclude a prescribed dual resident from the operation of the CGT loss grouping provisions either as a capital loss making company (the 'loss company') or a capital loss acquiring company (the 'gain company'). [Items 9 and 10]
Capital gains tax roll-over relief
3.30 The amendments will also apply to the capital gains tax provisions contained in section 160ZZO. Subparagraph 160ZZO(1)(a)(i) requires both the transferor and the transferee of an asset to be residents for capital gains tax roll over relief to apply in respect to related companies. Subparagraph 160ZZO(1)(a)(ii) requires the transferee to be a resident for the purposes of roll-over relief for transfers of a taxable Australian asset from a non-resident company.
3.31 The amendments will exclude a prescribed dual resident that is a either a transferor or a transferee from the operation of subparagraph 160ZZO(1)(a)(i). The amendments will also exclude a prescribed dual resident that is a transferee from the operation of subparagraph 160ZZO(1)(a)(ii). This will ensure that CGT roll-over relief will not be available for transfers involving a prescribed dual resident in respect to assets that are not, or do not continue to be, taxable Australian assets. [Items 11, 12 and 13]
3.32 The amendments will apply to:
- •
- the intercorporate dividend rebate provisions in respect to dividends received or paid by a prescribed dual resident on or after 1 July 1997.
- •
- the thin capitalisation and debt creation provisions, and subsection 159GT(6) in respect to interest expense incurred or accrued on or after 1 July 1997. This will apply on a pro rata basis for companies with substituted accounting periods in relation to their first affected year of income.
- •
- the loss grouping provisions in relation to a year of income where a company is a 'prescribed dual resident' at any time during that year of income and is a 'prescribed dual resident' on or after 1 July 1997. The company will not qualify as a 'loss company' or an 'income company' for the whole of that particular year of income, including the year of income of a company with a substituted accounting period.
- •
- the CGT roll over relief provisions in respect to asset transfers undertaken on or after 1 July 1997 involving a prescribed dual resident. [Items 14 and 18]
Chapter 4 - Removal of standard superannuation contribution limit
Overview
4.1 The amendments contained in Schedule 4 to the Bill will ensure that employers, in calculating their maximum allowable deductions in relation to superannuation contributions they make for the benefit of their employees, use the age based limits specified in subsection 82AAC(2A) of the Income Tax Assessment Act 1936 (the Act) rather than the standard contribution limit specified in subsection 82AAC(2D). The amendments achieve this by repealing subsection 82AAC(2D).
Summary of the amendments
4.2 The amendments will remove the ability for employers to elect to use the standard contribution limit in calculating the upper limit of deductions allowable in relation to superannuation contributions they make for the benefit of their employees.
4.3 The amendments will effectively apply to contributions made after 7.30 pm by legal time in the Australian Capital Territory on 20 August 1996. The amendments achieve this by:
- •
- repealing the relevant provisions with effect from the 1997-98 year of income (or the 1996-97 year of income where a taxpayer uses a substituted accounting period that has 20 August 1996 falling in his or her 1995-96 year of income); and
- •
- applying a transitional arrangement to the 1996-97 year of income (or the 1995-96 year of income where a taxpayer uses a substituted accounting period that has 20 August 1996 falling in that year). [Items 3 and 4]
4.4 The effect of the application and transitional provisions on taxpayers will generally be that they will not be able to use the standard contribution limit to calculate the maximum amount of deduction they can claim for superannuation contributions they make for the benefit of their employees for the 1996-97 year of income. The effect of the transitional provision is explained in greater detail in paragraph 4.14 below.
Background to the legislation
4.5 The Taxation Laws Amendment (Superannuation) Act 1992 (Act No. 208 of 1992) amended the Act to specify the maximum deduction allowable to employers for contributions paid to superannuation funds for the benefit of their employees.
4.6 Act No. 208 of 1992 provided two methods for employers to calculate their maximum deduction. The first, specified in subsection 82AAC(2A) of the Act, was an aged based limit for each employee. That is, deductions would be allowable up to certain limits which vary depending upon the employee's age.
4.7 The second method, provided for in subsection 82AAC(2D) of the Act, allowed the employer to elect to determine the maximum amount of the allowable deduction by using the standard contribution limit. The standard contribution limit was only available to employers who have ten or more employees and provides that an employer's maximum possible deduction is a standard amount (irrespective of the age of employees) multiplied by the number of employees.
4.8 The Act does not prescribe how this total amount should be allocated between employees. This provides the opportunity for employer contributions made on behalf of a selected employee or selected employees to exceed the age based deduction limits. That is, the standard contribution limit allows some employees to receive employer superannuation contributions well in excess of the age based limits provided the total of such deductions does not exceed the standard amount multiplied by the number of employees.
4.9 The Government considers that the standard contribution limit has been subject to abuse by some employers. In these cases some employees are benefiting from employer contributions well in excess of the applicable age based limits. Accordingly, in the 1996-97 Budget the Government announced that, given this abuse and the cost to revenue, the standard contribution limit could no longer be justified.
Explanation of the amendments
4.10 Schedule 4 of the Bill removes the right of employers to calculate the maximum limit of their allowable deduction in relation to superannuation contributions made for the benefit of their employees using the standard contribution limit. It does this by repealing subsection 82AAC(2D), which is the provision allowing employers to elect to use the standard contribution method. [Item 2]
4.11 Employers will need to use the age based limits specified in subsection 82AAC(2A) to calculate the maximum deduction allowable for superannuation contributions made by them for the benefit of their employees, except where they meet the conditions specified in the transitional arrangements (outlined in paragraph #.14 below).
4.12 As a consequence of repealing subsection 82AAC(2D), subsections 82AAC(2E), (2F), (2G) and (2H) are also repealed as they are all explanatory provisions for subsection 82AAC(2D). [Item 2]
4.13 A minor cross-referencing amendment is necessary to subsection 82AAC(2) to reflect the repeal of subsection 82AAC(2D). [Item 1]
4.14 The transitional provision will largely have the effect of denying employers the option of using the standard contribution limit for the year of income in which 20 August 1996 occurs (usually the 1996-97 year of income). However, the transitional provision will allow a deduction to an employer using the standard contribution limit method provided certain conditions are met. These conditions are:
- (i)
- the employer has made a contribution for the benefit of an employee or employees that exceeds the applicable age based limit for that employee but is within the standard contribution limit; and
- (ii)
- the contribution was made at or before 7.30pm on 20 August 1996; and
- (iii)
- the employer elects to use the standard contribution limit method for the year of income. [Item 4]
4.15 Where the employer makes such a contribution or contributions and such an election, the total amount of deductions allowable to the employer under subsection 82AAC(1) cannot exceed the standard contribution limit.
4.16 The following examples illustrate the operation of the transitional arrangements. For the purpose of the examples the following assumptions are made:
- (i)
- an employer has 10 employees comprising six under 35 years (employees A, B, C, D, E & F), three aged 35 to 49 years (employees G, H & I) and one over 50 years (employee J); and
- (ii)
- the employer elects that subsection 82AAC(2D) applies for the year of income in which 20 August 1996 falls.
4.17 The standard contribution limit for the 10 employees for the income year would be $271 700 (as calculated under subsection 82AAC(2D) of the Act).
4.18 Age based limits for the 1996-97 income year are:
- •
- under 35 years $9 782
- •
- 35 to 49 years $27 170
- •
- 50 years and over $67 382
Example 1
The employer made a contribution of $100 000 for employee J at or before 7.30 pm by legal time in the Australian Capital Territory on 20 August 1996, and made contributions for J and the other employees after that date.
The $100 000 is an allowable deduction because that contribution was made by the employer at or before 7.30pm on 20 August 1996 and, even though it is in excess of J's age based limit, it is within the standard contribution limit. But the employer will have no further entitlement to a deduction for employee J for the rest of the income year because employee J's age based limit has been exceeded.
The age based limits will apply to employees A to I, subject to the total claim for the income year (including contributions made on behalf of J) being within the maximum standard contribution limit of $271 700.
Example 2
The employer made a total contribution of $200 000 ($20 000 for each employee) at or before 7.30 pm by legal time in the Australian Capital Territory on 20 August 1996.
Because the amount is within the standard contribution limit, it is allowable.
The employer will have no further entitlement to a deduction for employees A to F for the rest of the income year because the employer has been allowed more than their age based limit.
The employer will be entitled to a further deduction of $7 170 each for employees G, H & I, and a further deduction of $47 382 for employee J, as the total contributions for the year by the employer would be within the standard contribution limit, and the individual contributions for employees G, H, I and J within their age based limits.
Example 3
The employer made a contribution of $271 700 to J only, at or before 7.30 pm by legal time in the Australian Capital Territory on 20 August 1996.
The $271 700 is deductible because the amount is within the standard contribution limit. However, the employer will not be entitled to any further deduction for any other contributions made during the year because the standard contribution limit for the year has been reached.
Chapter 5 - Interest withholding tax and related provisions
Overview
5.1 The amendments contained in Schedule 5 of the Bill will:
- •
- amend Division 11 of Part III (Bearer Debentures) to restrict its operation to interest paid in Australia on bearer debentures and provide an exemption for bearer debentures issued by an Offshore Banking Unit;
- •
- amend Division 11A (Interest Withholding Tax (IWT)) to reform the requirements for exemption from IWT under section 128F;
- •
- extend paragraph 221YRA(1)(a) of Division 4 which denies an income tax deduction to non-residents for the non-payment of interest withholding tax to residents paying interest to overseas persons; and
- •
- amend Part IIIB (Foreign Bank Branches) to define the term 'interest' for the purposes of Part IIIB as having the same meaning as in the IWT provisions of the income tax law.
Summary of the amendments
5.2 Division 11 will be amended to discontinue its application to interest paid overseas by a company on bearer debentures issued overseas. Such interest will be subject to IWT under Division 11A. Division 11 will also be amended to provide an exemption for bearer debentures issued by Offshore Banking Units.
5.3 Section 128F of Division 11A will be amended to:
- •
- extend the exemption to wholesale borrowings by Australian companies by replacing the existing wide distribution test with a public offer test;
- •
- repeal the existing use of funds in an Australian business requirement;
- •
- provide that the exemption will not be available if the company pays interest to an associate where the company issuing the debentures is aware or should have been aware that the interest was paid to an associate;
- •
- restrict the non-resident borrowing subsidiary exemption to subsidiaries resident in countries listed in the Income Tax Regulations; and
- •
- introduce self assessment procedures for claiming the exemption.
5.4 Section 221YRA of Division 4 of Part VI will be amended to extend its application to interest paid overseas by a resident of Australia. The section will therefore deny both residents and non-residents an income tax deduction in respect of a payment of interest overseas if they have neither deducted nor remitted IWT to the Australian Taxation Office.
5.5 Part IIIB will be amended to define the term 'interest' for the purposes of Part IIIB as having the same meaning as in the IWT provisions of the income tax law.
5.6 The amendments to Division 11 will be effective from Royal Assent [item 11] . The amendments to Division 11A will be effective from 1 January 1996 [item 15] . The amendment to section 221YRA of Division 4 of Part VI of the Act will be effective from Royal Assent and will apply to interest paid on or after 1 January 1996 [item 18] . The amendment to Part IIIB affecting section 160ZZY will apply to foreign tax paid after the commencement of Part 4of Schedule 5 [item 21] .
Background to the legislation
Interest paid by companies on bearer debentures
5.7 Division 11 imposes tax on companies paying interest on bearer debentures to debenture holders who have not been identified to the Commissioner of Taxation. Section 126 imposes a penalty rate of tax on the issuer of a debenture in respect of the interest paid on bearer debentures. Section 126 is a longstanding anti-avoidance measure to counter the avoidance of taxation by persons receiving interest on bearer debentures. Where a debenture is issued overseas by a company resident in Australia and the interest is paid overseas, the Income Tax (Bearer Debentures) Act 1971 imposes income tax on the issuer of the debenture at the rate of 10 per cent. In all other cases income tax on the interest is imposed on the issuer of the debenture at 47 per cent, the top marginal rate of tax.
5.8 Section 125 provides an exemption from the application of Division 11 in relation to interest to which sections 128EA, 128F, 128G or 128GA provide an exemption from IWT. This section also exempts interest that is excluded from assessable income through the application of section 159GZZZZE.
What is interest withholding tax?
5.9 Division 11A of the Act imposes IWT on interest paid to a person outside Australia by a resident of Australia. It also applies to interest paid to a person outside Australia by a non-resident, to the extent that the interest relates to a business carried on by the non-resident in Australia. IWT is a flat and final tax of 10 per cent imposed on interest paid to overseas lenders. The obligation for the collection of IWT is placed on the Australian entity paying interest overseas.
What is the section 128F interest withholding tax exemption?
5.10 Section 128F of the Act provides an exemption from IWT for interest paid overseas on debentures issued overseas by an Australian company. The main requirements of the existing section 128F are that the debentures be widely distributed and the funds raised be used in an Australian business.
5.11 The term 'debenture, in relation to a company' is defined in section 6 of the Act as including stock, bonds, notes and any other securities of the company, whether constituting a charge on the assets of the company or not. This definition would include promissory notes or bills of exchange.
What is a non-resident borrowing subsidiary for the purposes of subsection 128F(6)?
5.12 Subsection 128F(6) extends the section 128F exemption from IWT to borrowings undertaken by an Australian parent company through a wholly owned non-resident subsidiary. Such a subsidiary is restricted to carrying on the business of borrowing money for its Australian parent. If the non-resident subsidiary raises a loan outside Australia through the issue of debentures and the subsidiary lends the funds raised to its parent company on terms that do not result in a profit to the subsidiary, the parent is treated for the purposes of section 128F as the borrower.
5.13 As a complementary measure, section 159GZL of the Act excludes amounts owing by an Australian company to its non-resident borrowing subsidiary from the definition of 'foreign debt' for the purposes of the thin capitalisation rules in Division 16F. This is achieved by treating the interest payable by the company to its non-resident borrowing subsidiary as being payable to the holder of the debenture.
Interest and royalty withholding tax collection procedures
5.14 Section 221YRA of Division 4 of Part VI of the Act applies to deny a person an income tax deduction if the requirements of Division 11A have not been satisfied in respect of an interest or royalty payment. Subsection 221YRA(1) denies a non-resident person (borrower) an income tax deduction for interest paid overseas if the borrower has neither made a deduction from interest as required by subsection 221YL(2A) nor paid the IWT in respect of the interest. The existing section 221YRA does not apply to interest paid overseas by residents of Australia.
5.15 In relation to royalty withholding tax, an income tax deduction is denied irrespective of whether a resident or non-resident either fails to deduct or to remit withholding tax.
Australian branches of foreign banks
5.16 Part IIIB of the Act provides assistance in calculating that part of a foreign bank's taxable income that is referable to certain activities of its Australian branch. It also makes it clear that IWT applies to amounts that are treated as being interest paid by a branch to the bank. For the purposes of calculating the taxable income of a foreign bank branch under Part IIIB, the branch is treated as being a separate entity for the purposes of the following notional transactions between the branch and the bank: loans, derivative transactions and foreign exchange transactions.
5.17 LIBOR is an acronym for the London Inter Bank Offer Rate. The term LIBOR for the purposes of section 160ZZZB of Part IIIB of the Act is defined in paragraph 160ZZZA(3)(a) as meaning a reference to the rate of interest applicable at a particular time in relation to banks in the London inter bank market as determined by reference to the Reuter Money Rates Service or any other published source.
What is an offshore banking unit?
5.18 The term offshore banking broadly refers to the intermediation by institutions operating in Australia in financial transactions between non-resident borrowers and non-resident lenders. It also includes the provision of financial services to non-residents in respect of transactions or business occurring outside Australia.
5.19 Declaration as an OBU is confined to certain financial entities being authorised banks subject to the Banking Act 1959, wholly owned subsidiaries of banks which are already registered as OBUs, State banks and other financial institutions that the Treasurer is satisfied are appropriately authorised to carry on business as dealers in foreign exchange.
5.20 Income derived by an OBU from 'OB activities' is effectively taxed at a concessional rate of 10%. The meaning of an 'OB activity' is set out in sections 121D, 121E and 121EA of the Act. The proposed amendments impact on two of these activities. These are 'borrowing or lending activity' as defined in subsection 121D(2) and 'investment activity' as defined in subsection 121D(6).
Explanation of the amendments
Part 1: Interest paid by companies on bearer debentures
Interest paid by companies on bearer debentures
5.21 Division 11 of the Act will be amended to effectively restrict its application to interest paid in respect of bearer debentures which are issued in Australia or where the interest is payable in Australia and where the company has not provided the Commissioner with the name and address of the holder of the debenture. [Items 1 to 11]
5.22 The existing subsection 126(1) will be repealed and replaced with new subsections 126(1) and (1A). Under the new section 126, a company will be subjected to tax if it fails to advise the Commissioner of Taxation of the name and address of the holders of bearer debentures which it has issued. The Income Tax (Bearer Debentures) Act 1971 will impose tax on the company at 47 per cent, the top marginal rate of tax for individuals. [New section 126]
5.23 Division 11 will not apply to interest paid by a company in respect of a bearer debenture which is subject to taxation under Division 11A. If a resident company issues a bearer debenture, satisfies the tests in new subsection 128F(1), other than the public offer test, and does not disclose the names and addresses of the debenture holders to the Commissioner, the interest will be treated as being paid to a non-resident and therefore subject to taxation under Division 11A [new subsection 128B(9C)] . The tests in new subsection 128F(1) that must be met for Division 11A to apply are:
- •
- the company was a resident of Australia when it issued the debentures (new paragraph 128F(1)(a));
- •
- the company was a resident of Australia when it paid the interest (new paragraph 128F(1)(b));
- •
- the company issued the debenture outside Australia for the purpose of raising finance outside Australia (new paragraph 128F(1)(c)); and
- •
- the interest is paid outside Australia (new paragraph 128F(1)(d)).
5.24 If a resident or the Australian permanent establishment of a non-resident acquires a bearer debenture and receives interest that has been subjected to IWT under section 128B, the interest will nonetheless be subject to income tax [item 7] . Credit for any IWT deducted by the issuer in respect of the interest is provided by subsection 221YS(1). The recipient's liability for income tax in relation to the interest is correspondingly reduced by the amount of IWT payable under section 128B [new paragraph 128B(9C)(d)] . If, however, an offshore permanent establishment of a resident acquires the bearer debenture thenparagraph 128B(9C)(d) will have no operation and the resident will be subject to taxation in accordance with subsection 128B(11) [items 6 and 7] . If IWT is imposed on a non-resident, other than in the course of carrying on business through a permanent establishment in Australia, the IWT is a final tax under section 128D.
5.25 Interest paid by a company will be exempt from taxation under Division 11 if the interest is exempt from taxation under Division 11A because of the exemptions provided in sections 128EA, 128F, 128G, 128GA and 128GB. This list of exemptions has been expanded to include interest paid by an Offshore Banking Unit (section 128GB) in respect of a bearer debenture. [New paragraph 126(1)(c)]
5.26 A company's liability to pay income tax is not affected by the application of the new subsection 126(1). [New subsection 126(1A)]
Consequential amendments resulting from the amendments to Division 11
5.27 Section 125 will be repealed. [Item 1]
5.28 Subsection 126(3) will be amended to delete the reference to amounts taxed under Division 11 as there will be no overlap between Division 11 and Division 11A. [Item 3]
5.29 Subsection 127(2) will be repealed. This subsection is no longer necessary as a result of the amendments in Part 1 of Schedule 5. [Item 4]
5.30 Subparagraph 128B(3)(h)(iii) will be repealed. This subparagraph will be unnecessary as there will be no overlap between Division 11 and Division 11A. [Item 5]
5.31 References to subparagraph 128B(3)(h)(iii) will be deleted from section 128D and paragraph 202EE(1)(d). [Items 8 and 9]
Amendment of the Income Tax (Bearer Debentures) Act 1991
5.32 Subsection 6 of the Income Tax (Bearer Debentures) Rates Act 1971, will be repealed and replaced with a new subsection 6 [Item 10] . New subsection 6 maintains the rate of tax currently imposed by the Income Tax (Bearer Debentures) Rates Act 1971 at 47 per cent where interest is paid in respect of a bearer debenture to a person resident in Australia or to a non-resident carrying on business in Australia.
5.33 The amendments made by Part 1 of Schedule 5 apply to interest paid or credited after the commencement of this Part which will be Royal Assent. [Item 11]
Part 2: Interest withholding tax exemption under section 128F
Replacement of the existing section 128F with a new section 128F
5.34 The existing section 128F will be replaced with a new section 128F [item 12] . The main changes are:
- •
- the replacement of the wide distribution of debentures requirement in the existing section 128F with a public offer test;
- •
- the repeal of the use of funds in an Australian business requirement;
- •
- the repeal of the requirement under existing paragraph 128F(1)(e) that the Commissioner of Taxation issue a certificate under subsection 128F(4); and
- •
- the restriction of the existing subsection 128F(6) non-resident borrowing subsidiary exemption to countries listed in the Income Tax Regulations. It is proposed that the United States of America will be listed in the Regulations.
5.35 Interest paid by a company in respect of a debenture issued by the company will not be subject to IWT under Division 11A [new subsection 128F(2)] if the following conditions are satisfied:
- •
- the company that issued the debenture was a resident of Australia at the time it issued the debenture [new paragraph 128F(1)(a)] ;
- •
- the company was a resident of Australia at the time it paid interest in respect of the debenture [new paragraph 128F(1)(b)] ;
- •
- the company issued the debenture outside Australia for the purpose of raising finance outside Australia [new paragraph 128F(1)(c)] ; and
- •
- the company paid interest outside Australia [new paragraph 128F(1)(d)] ;
- •
- the issue of the debenture meets the requirements of the proposed public offer test contained in new subsection 128F(3) [new paragraph 128F(1)(e)] .
5.36 For the purposes of new subsection 128F(1)(c) the term 'issued' is not defined. In considering an agreement to issue debentures in Levy v Abercorris Slate and Slab Company (1887) 37 Ch 260, Chitty J of the Chancery Division stated at p 264 that:
'[I]ssued is not a technical term, it is a mercantile term well understood; 'issued' here means the delivery over by the company to the person who has the charge ...
The Macquarie Dictionary (Second Edition) defines the term as meaning:
22. to put out; deliver for use, etc; put into circulation.
Although the term 'issue' is not defined in the proposed legislation the term will be taken to mean 'to put out or deliver debentures to subscribers or purchasers in an offshore market'.
5.37 There are five public offer tests. An Australian company will need to satisfy one of the tests in order to qualify for the section 128F exemption. The purpose of the public offer test is to ensure that lenders on overseas capital markets are aware that an Australian company is offering debentures for issue. The first and fourth public offer tests provide for the section 128F exemption to be extended to debentures offered on overseas wholesale capital markets.
The first public offer test - approach 10 financiers operating in an overseas capital market
5.38 Under the first public offer test, the debentures must be offered for issue to at least 10 persons who were each carrying on the business of providing finance, or investing or dealing in securities, as participants in an overseas financial market [new paragraph 128F(3)(a)] . For example, if the Australian company offers its debentures to 10 banks or pensions funds operating in an overseas financial market, the public offer test will be satisfied. It is a requirement of this test that the persons approached must not be known or suspected by the issuing company to be associates of each other. The company offering the debentures for sale does not need to undertake a detailed examination of the parties to whom the debentures are offered. It cannot, however, ignore companies that are generally known to be associates.
The second public offer test - offering debentures for issue to 100 overseas investors
5.39 The second public offer test will be satisfied if at least 100 investors receive an offer of debentures for issue [new paragraph 128F(3)(b)] . This test is to accommodate financing operations undertaken in overseas retail capital markets and is directed at individual investors and businesses. For example, this test may be satisfied by an issuer of debentures sending letters to persons who it may reasonably regard as having acquired debentures from time to time. Similarly, if offers are made to 100 customers of a stock broker who have previously purchased debentures this test will clearly be satisfied. Offers made to persons who have not previously purchased debentures from a stock broker but whom the broker has reason to believe may be interested in acquiring debentures or other securities will be counted for the purposes of the second public offer test. It will also be satisfied where an agent acting on behalf of the company approaches customers with an offer of the debentures for issue. The second test will not be satisfied where 100 persons receive an offer of debentures for issue who have not previously acquired debentures and in respect of whom the issuer has no reasonable basis for believing that they may be interested in acquiring debentures.
The third public offer test - listing on a stock exchange
5.40 The third public offer test will be satisfied if the company offers debentures for issue where the debentures have been accepted for listing by an overseas stock exchange and the company has agreed with its dealers, managers or underwriters to have the debentures listed on the stock exchange following issue. [New section 128F(3)(c)]
The fourth public offer test - quoted in a published source
5.41 The fourth public offer test will be satisfied if the debentures are offered for issue as a result of negotiations commencing by the company announcing in an electronic source, or other sources, of information, monitored by overseas capital markets its intention to raise funds by issuing debentures [new paragraph 128F(3)(d)] . For example, the public offer test will be met where negotiations between an investor and the issuing company commenced because the investor became aware of the company's intention to raise funds through seeing a computer information source or offering circular. In relation to electronic quotation, the public offer test will be satisfied if the Australian company's offer of debentures for issue is quoted on an electronic financial information source such as Reuter financial services or Bloomberg. The details that are required to be included in the electronic quotation are the name of the company issuing the debentures and the name of the program. The quotation may include the names of the dealers or managers.
5.42 In relation to hard copy publications, the debenture offer will have to be published in a publication monitored by financial markets as a source of information. For example, publication of an offer of debentures for issue in a leading financial newspaper in London or New York will satisfy this test. The test, however, will not be satisfied if the debenture offer is published in a source not used by overseas financial markets for dealing in debentures. A prospectus or offering circular that is publicly available in capital markets will also meet this test.
5.43 The fifth public offer test will be satisfied if a debenture is issued to a dealer, manager or underwriter for the purpose of placement of the debenture [new paragraph 128F(3)(e)] . In this process the debenture is sold to a dealer, manager or underwriter on the basis that it will place the debenture in an overseas market. If a dealer, manager or underwriter satisfies one of the other public offer tests, then the public offer test will be treated as being satisfied in respect of that debenture. The dealer, manager or underwriter is required to offer the debenture for sale within 30 days. The dealer, manager or underwriter which undertakes to satisfy the public offer test must provide written advice to the company stating the public offer test which has been satisfied. It is only necessary that one public offer test be satisfied by the dealer, manager or underwriter.
Issues of debentures that always fail the public offer test
5.44 Certain issues of debentures do not satisfy the public offer test [new subsection 128F(5)] . A company will fail the public offer test if it was aware, at the time of issue, that the debentures would be acquired by a resident of Australia or an associate of the company issuing the debentures. This provision applies to acquisitions of debentures by such persons both directly from the issuer or indirectly from an interposed trust or entity and to the acquisition of beneficial interests in the debentures by such persons. This rule also applies where the company issuing the debentures should have known that the debentures would be acquired either by an associate or a resident of Australia. For example, if the Australian company issuing debentures was aware that a resident of Australia was proposing to acquire the debentures through an interposed overseas entity, the public offer test will not be satisfied for those debentures. Similarly if the issuing company should have been aware at the time of issue of debentures that an associate was acquiring the debentures, the public offer test will not be satisfied in respect of those debentures.
5.45 A global bond is defined as having all of the following features [new subsection 128F(10)] :
- •
- the debenture must be described as a global bond or note [new paragraph 128F(10)(a)] ;
- •
- the global bond must be issued by the company to a clearing house, as defined in new subsection 128F(9), or to another person, such as a common depository, on account of or on behalf of one or more clearing houses [new paragraph 128F(10)(b)] ;
- •
- as a result of the issue, an investor must obtain contractual or other rights in relation to the global bond which are recorded in the books of the clearing house [new paragraph 128F(10)(c)] ;
- •
- before the issue of the global bond, the company or a dealer, manager, or underwriter acting on behalf of the company must have announced that such rights would be created in relation to the global bond and sought subscriptions in relation to the global bond [new paragraph 128F(10)(d)] ;
- •
- the announcement must satisfy the requirements of the public offer test in new subsection 128F(3) [new paragraph 128F(10)(e)] ; and
- •
- the global bond must on its terms be exchangeable in certain circumstances for definitive debentures [new paragraph 128F(10)(f)] .
5.46 If a company issues a global bond as defined above the public offer test will be satisfied. [New subsection 128F(4)]
No exemption for interest paid to associates of the company issuing debentures
5.47 The section 128F exemption will not be available if the company which issued the debenture was aware that interest in respect of the debenture was paid to an associate of the company. The denial of the exemption will also occur if the company should have been aware that it was paying interest to an associate. It would be prudent for companies intending to issue debentures that qualify for the section 128F exemption to direct related parties not to acquire the company's debentures. This measure will not apply if an Australian company issuing debentures was not aware and could not have been expected to know that an associate was receiving interest in respect of a debenture. [New subsection 128F(6)]
Meaning of the term 'associate' for the purpose of new section 128F
5.48 For the purposes of section 128F, the term 'associate' has the same meaning as in Division 16F of the Act, 'Thin Capitalisation by Non-Residents' with a modification. Section 159GZA of Division 16F defines associate as having the meaning given by section 159GZC. The references in section 159GZC to companies who are partners will be treated as being deleted for the purposes of Division 11A. Partners of a company will not treated as associates for the purposes of Division 11A. [New subsection 128F(9)]
Meaning of the term 'clearing house' for the purpose of new section 128F
5.49 For the purposes of section 128F, the term 'clearing house' is defined in new subsection 128F(9). A clearing house is a clearance facility which provides buyers and sellers of debentures with a method of dealing in debentures. Examples of two major international clearing houses are Euroclear and CEDEL. [New subsection 128F(9)]
Meaning of the term 'debenture' for the purpose of new section 128F
5.50 For the purposes of section 128F, the term 'debenture' has the same meaning as in the rest of the Act. The term 'debenture' is defined in section 6 of the Act and without limiting that definition, for the purpose of new section 128F debenture includes a promissory note or bill of exchange. [New subsection 128F(9)]
Debentures issued through certain non-resident borrowing subsidiaries
5.51 A resident company may raise finance through a non-resident borrowing subsidiary [new subsection 128F(8)] . The finance must be raised by the issue of debentures in a country listed in the income tax regulations [new paragraph 128F(8)(c)] . The non-resident borrowing subsidiary must also be treated as a resident of the country in which the debentures are issued for the purposes of that country's tax law at the time the debentures are issued [new paragraph 128F(8)(ca)] . The term 'tax law' for the purposes of new paragraph 128F(8)(ca) is defined in new subsection 128F(9). The requirements of this exemption are that the subsidiary is wholly owned by an Australian resident company and that the sole business of the subsidiary is to raise finance for its parent. If the non-resident subsidiary meets the requirements of section 128F, the parent company will be treated as having raised finance and eligible for the exemption from IWT.
Australian public bodies treated as Australian resident companies
5.52 Certain public bodies are treated as Australian resident companies for the purposes of section 128F [new subsection 128F(7)] . This provision enables public bodies to qualify for the section 128F exemption in respect of their debentures issued overseas. The public bodies that are eligible to use the exemption are:
- •
- an authority of the Commonwealth [new paragraph 128F(7)(a)] ; or
- •
- a State or an authority of a State [new paragraph 128F(7)(b)] .
Consequential amendment of the thin capitalisation rules (Division 16F of the Act)
5.53 Paragraph 159GZL(a) of the Act will be amended to reflect the proposed non-resident borrowing subsidiary exemption in new section 128F(8). [Item 13]
Consequential amendment of the Financial Corporations (Transfer of Assets and Liabilities) Act 1993
5.54 The existing section 128F will be treated as being retained for the purposes of subsection 23(2) of the Financial Corporations (Transfer of Assets and Liabilities) Act 1993. This is a consequential amendment to ensure that the effect of section 23(2) is not altered by the amendments proposed in this Bill. [Item 14]
5.55 The amendments made by Part 2 of Schedule 5 apply to debentures issued on or after 1 January 1996. [Item 15]
Transitional provisions - continued application of old law to pre-commencement debentures
5.56 The Government announced that there will be a transitional period between I January 1996 and the Bill receiving Royal Assent during which the new section 128F will operate concurrently with the existing section 128F. During the transitional period, companies will have the choice of using either the existing section 128F or the new section 128F. [Item 16]
Part 3: Denial of deduction for non-payment of interest withholding tax
Amendment of paragraph 221YRA(1)(a) - deduction of IWT
5.57 The reference in paragraph 221YRA(1)(a) to a person not being a resident will be deleted [item 17] . Paragraph 221YRA(1)(a) will deny both residents and non-residents of Australia an income tax deduction in respect of a payment of interest overseas if those persons have neither deducted nor remitted IWT to the Australian Taxation Office.
5.58 The amendments proposed by this part apply to interest paid on or after 1 January 1996. [Item 18]
Part 4: Australian branches of foreign banks
5.59 Australian branches of foreign banks have the option of being taxed under Part IIIB of the Act or they may opt to be taxed under the general law subject to any relevant double tax treaty. In accordance with Part IIIB the thin capitalisation rules do not apply to a branch and instead, 4 per cent of a branch's interest deduction (which is treated as notional equity - the notional equity rule) is disallowed.
5.60 Foreign bank branches are ineligible for the section 128F exemption from IWT. However, foreign banks operating in Australia through branches are entitled to have an associated Australian company raise funds overseas under the section 128F exemption. New section 128F does not have an end use test and these Australian companies will be entitled to provide funds to the Australian branches of the foreign banks.
5.61 If Australian branches obtain finance from associated companies by way of discounted debentures, such as promissory notes or bills of exchange, the notional equity rule may be avoided. Accordingly, to prevent the new section 128F being used to circumvent the notional equity rule the term 'interest', for the purposes of Part IIIB of the Act, will be defined as having the same meaning as in the IWT provisions of the income tax law. This amendment will also prevent the notional equity rule being avoided by Australian branches of foreign banks financing their operation through non-interest borrowings. [Item 19; new section 160ZZV]
5.62 This measure will apply from the time the Bill receives Royal Assent. For example, if the Bill receives Royal Assent on 31 December 1997 then for the year of income ending 30 June 1998 the former meaning of interest will apply for the purposes of Part IIIB from 1 July 1997 to 31 December 1997 and the new definition for the period from 1 January 1998 to 30 June 1998.
5.63 The definition of the term 'interest' for the purposes of Division 11A is being amended in this Bill. For a discussion of the amended definition of interest see Chapter 2.
5.64 The term 'calculated' will be deleted from paragraph 160ZZZA(1)(c) to make it clear that the LIBOR ceiling applies to interest or amounts in the nature of interest. In respect of amounts that are in the nature of interest, the taxpayer will have to determine the effective interest rate in order to apply the LIBOR ceiling. An Australian branch of a foreign bank will not be able to claim a deduction for interest if the rate of return on the notional borrowing exceeds the LIBOR ceiling. [Item 20]
5.65 The amendments made by Part 4 that affect section 160ZZY apply to foreign tax paid after the bill receives Royal Assent. [Item 21]
Chapter 6 - Leases of luxury cars
Overview
6.1 Part 1 of Schedule 6 of the Bill will insert a new Schedule 2E into the Income Tax Assessment Act 1936 (the Act) to provide that lease arrangements involving cars whose cost is more than the depreciation cost limit applicable under section 57AF will be treated as sale and loan transactions. The new schedule is inserted to fit within the proposed new structure of the Act under the tax law improvement program.
Summary of the amendments
6.2 The amendments have the following broad features:
- •
- The lessor is treated as having disposed of the luxury car at the commencement of the lease to the lessee for a consideration generally equal to the cost of the vehicle and is thereafter denied deductions for depreciation.
- •
- The lessor is taken to have made a loan (the notional loan ) to the lesseeof an amount generally equal to the cost of the luxury car for a term equal to the lease term stipulated in the lease contract. The lessee is treated as a borrower and is taken to have borrowed the same amount.
- •
- The lesseeis treated as the owner of the car from the time the lease commences and is therefore entitled to claim depreciation deductions.
- •
- Actual lease payments , except to the extent that they are taken into account in calculating the lessor's income and the lessee's deductions under the notional loan, will be neither assessable to the lessor nor deductible to the lessee.
- •
- The lessor's assessable income and lessee's allowable deductions will be determined by reference to the lessor's return on funds (the " finance charge " under the notional loan), being the difference between the notional loan and the sum of the periodic lease paymentsand any other amounts payable under the lease or on termination of the lease (including, for example, the agreed residual value or the value of the luxury car at the end of the lease term).
- •
- The amount of the finance charge to be brought to account as assessable income of the lessor in each income year will be calculated on a compounding accruals basis by applying the implicit interest rate under the lease to the notional loan principal outstanding at the beginning of each lease payment period ( accrual period ). The sum of the accrual amounts calculated for each of the accrual periods, including part periods, occurring during the income year will be included in the lessor's assessable income.
- •
- An equivalent amount calculated on a corresponding basis will be allowable as a deduction to the lessee to the extent to which the lessee otherwise would have been entitled to a deduction in respect of losses or outgoings incurred under the lease in the income year.
- •
- Upon expiry or termination of the lease the taxation treatment of the luxury car depends upon whether possession is retained by the lesseeor reverts to the lessor. If the lesseeretains possession, the lessee will continue to be treated as the owner entitled to taxation depreciation allowances. Any termination amount payable will be treated as a payment in discharging the loan and will be neither deductible to the lesseenor assessable to the lessor. If possession reverts to the lessor (or goes to a third party) the lessee is treated as having sold the vehicle. The consideration receivable for the sale broadly equals the amount credited to the lesseeunder the terms of the lease for the return of the car. If the car is returned without a specified amount being credited, the amount that is taken to be credited to the lesseefor the return of the car is generally the value of the car at the time of termination.
- •
- On expiry or termination of the lease an adjustment may be necessary to correct for any overstatement or understatement of assessable income or allowable deduction arising from any change in the basis of the calculation of the accrual amounts, for example, due to early termination without full payment of the agreed lease instalments, the imposition of penalty payments or variations to estimated residual values.
- •
- These rules will apply where luxury cars are sub-leased, but will not apply to hire purchase agreements .
6.3 The amendments apply toleases (including extensions of pre-existing leases) of new or second hand motor vehicles entered into after 7.30 pm by legal time in the Australian Capital Territory on 20 August 1996.
Background to the legislation
6.4 Section 57AF of the Act applies a cost limit for tax depreciation purposes on certain motor cars and station wagons (referred to as 'luxury cars') and requires that balancing adjustments on disposal of luxury cars be calculated by reference to that limit. A related provision, section 26AAB, brings within assessable income certain profits made on the disposal of a previously leased luxury car.
6.5 Leasing arrangements have been developed which circumvent the effect of the limit, primarily by ensuring the lessor is a tax exempt or tax preferred entity. The arrangements effectively allow end-users to obtain greater tax deductions than would otherwise be the case if the car was purchased.
6.6 The scope of these amendments is to treat lease arrangements involving luxury cars as if they are sale and loan transactions. The amendments will apply to all leases of luxury cars, irrespective of whether the luxury car is new or second-hand, other than genuine short-term hiring agreements . The amendment does not have effect for the purpose of Division 11A of Part III of the Act.
| Topic | Paragraph |
|---|---|
| Exclusions | 6.7 |
| Notional sale of car, and notional loan, to the lessees | |
| Application of this Division | 6.8-9 |
| Notional sale of car by lessor and notional acquisition of car by lessee | 6.10 |
| Consideration for notional sale, cost of notional acquisition, and depreciated value, of the car | 6.11-12 |
| Notional loan by lessor to lessee | 6.13-15 |
| Amounts to be included in lessor's assessable income | 6.16-19 |
| Lease payments not to be included in lessor's assessable income | 6.20 |
| Deductions allowable to lessee | |
| Extent to which deductions are allowable to the lessee | 6.21 |
| Lease payments not to be allowable deductions | 6.22 |
| Adjustments if total amount assessed to lessor differs from amount of finance charge | |
| Adjustments for lessor | 6.23-27 |
| Adjustments for lessee | 6.28-29 |
| What happens when the lease expires | |
| What happens if the lease term is extended or the lease is renewed | 6.30-31 |
| What happens if an amount is paid by or on behalf of the lessee to acquire the car | 6.32 |
| What happens if the lessee ceases to have the right to use the car | 6.33-37 |
| What happens if the lease is terminated before the end of the lease term | |
| What happens if an amount is paid by or on behalf of the lessee to acquire the car | 6.38 |
| What happens if the lessee ceases to have the right to use the car | 6.39-44 |
| Interpretation | |
| Consecutive short-term hiring agreements | 6.45-48 |
| Finance Charge | 6.49 |
| Lease payment periods | 6.50-51 |
| Accrual periods and accrual amounts | 6.52-53 |
| Outstanding notional loan principal | 6.54 |
| Implicit Interest Rate | 6.55-56 |
| Consequential amendment | 6.57-58 |
| Example |
6.7 The proposed rules will not apply in respect of arrangements involving genuine short-term hiring agreements [refer to section 42A-115: definition of 'lease' ], hire purchase agreements [refer to section 42A-115: definition of 'lease'] and to luxury cars that constitute trading stock of the lessee . [New section 42A-10]
Notional sale of car, and notional loan, to the lessee
6.8 The rules will apply where a person (the lessor ) has leased a luxury car to another person (the lessee) under a lease contract entered into after 7.30 pm by legal time in the Australian Capital Territory on 20 August 1996. [New section 42A-10]
6.9 A car will be a luxury car where the cost of the car exceeds the depreciation limit specified in section 57AF. In determining whether or not section 57AF applies, or would apply, the relevant luxury car depreciation limit is that applicable to the financial year in which the lease commences. For that purpose, the cost of the car is the amount for which the lesseeis taken to have purchased the car. See definition of luxury car in new section 42A-120 .
Notional sale of car by lessor and notional acquisition of car by lessee
6.10 The lessor is to be treated as having disposed of the luxury car to the lessee. The time of disposal will be the time of commencement of the lease term under the lease. The lessee will be treated as the owner of the car during the term of the lease(but will cease to be the owner if the lessee subleases the car while it is a luxury car). [New section 42A-15]
Consideration for notional sale, cost of notional acquisition, and depreciated value, of the car
6.11 Where the lessor and lessee are dealing at arm's length and the lease contract specifies an arm's length price of the luxury car, that amount will be taken to be the consideration on disposal and the lessee's cost of the luxury car. In other cases, the consideration will be equal to the amount that the lessee could have been expected to pay to purchase the luxury car under an arm's length transaction. [New subsection 42A-20(1)]
6.12 If a lessee subleases a luxury car to an associate the cost of the car to the sublessee for depreciation purposes will be the depreciated value (under section 62) applicable to the lesseeat the date the sublease commences and any balancing adjustment included in the lessee's assessable income under subsection 59(2) as a result of the notional disposal of the car under new section 42A-15 by the lessee to the associated sub-lessee [new subsection 42A-20(2)] . In this context, associate is defined in new section 42A-115 to have the same meaning as in section 318 of the Act, but to include as well persons who are in an employer/employee relationship.
Notional loan by lessor to lessee
6.13 The lease transaction is to be treated as if it were a loan made by the lessor to the lessee for a period equal to the lease term and subject to the payment of a finance charge .
6.14 The amount of the notional loan principal will be equal to the amount which is treated as the consideration for the disposal of the luxury car from the lessor to the lesseereduced by any non-lease advance or immediate payments by the lessee made at, or prior to, the commencement of the lease. The reduction would reflect, for example, the value allowed for a traded-in vehicle or a deposit paid by the lessee.
6.15 Lease payments will be treated as payments of principal and finance charge under the loan. [New section 42A-25]
Amounts to be included in lessor's assessable income
6.16 The finance charge is assessable income of the lessor on an accruals accounting basis during the lease term.
6.17 The amount which the lessor is required to include in assessable income in the income year is the sum of the accrual amounts for each of the accrual periods in the income year [new subsection 42A-35(1)] . The accrual period as defined in new section 42A-140 is the lease payment period as defined in new section 42A-135 .
6.18 Where an accrual period falls into more than one income year the assessable amount includes that portion of the accrual amount referable to the relevant period within the income year, apportioned under generally accepted accounting principles. [New paragraph 42A-35(1)(b)]
6.19 The assessable income of the lessor also includes the difference between the acquisition cost of the car to the lessor and the consideration for the car under the notional sale to the lessee [new subsection 42A-35(2)] .(See example 'Profit on sale of car'). Where the car is returned to the lessor (ie a notional re-acquisition under new subsection 42A-90(2) or 42A-105(2) by the lessee and subsequently sold, the assessable income of the lessor will also include any excess of the selling price over the cost of re-acquisition. [New subsection 42A-35(3)]
Lease payments not to be included in lessor's assessable income
6.20 Lease rental payments received or receivable by the lessor will not be assessable income to the lessor but are taken into account in calculating the accrual amount. [New section 42A-40]
Deductions allowable to lessee
Extent to which deductions are allowable to the lessee
6.21 Where the lessee would have been entitled to a deduction in respect of losses or outgoings incurred under the lease in the income year, the lesseecan deduct the finance charge component of the lease payments, calculated in the same way as the lessor's assessable amount. The deduction will be limited to the extent to which the lessee would, but for the non-deduction rule contained in new section 42A-55 , have been able to deduct the lease paymentsincurred in the income year. [New section 42A-50]
Lease payments not to be allowable deductions
6.22 Lease payments made by the lesseewill not be allowable deductions to the lesseeexcept to the extent they are taken into account in calculating the accrual amount. [New section 42A-55]
Adjustments if total amount assessed to lessor differs from amount of finance charge
6.23 The calculation of the accrual amounts included in the lessor's assessable income may in some cases be based on estimated amounts or amounts that have been varied by the time the notional loan is taken to have been repaid. The notional loan can be considered to be repaid when the lease expires, is terminated, extended or renewed. As a result, there may be a need to make an adjustment to income assessed.
6.24 Such variation may be due, for example, to an early termination without full payment of lease rentals or to a termination amount on expiry of the lease which varies from an estimated amount that was used to calculate the accrual amounts.
6.25 The adjustment is to be made by adding an amount to, or subtracting an amount from, the lessor's taxable income in the income year in which the termination or expiry etc of the lease occurs.
6.26 The adjustment to the lessor's taxable income is calculated as the sum of all amounts paid or payable to the lessor under the lease contract (including the termination amount) adjusted by the following formula:
Notional loan principal + Assessed accrual amounts
where: Notional loan principal is the notional loan principal at the commencement of the lease andAssessed accrual amounts is the aggregate of the accrual amounts included in the lessor's assessable income.
6.27 Where the sum of all amounts paid or payable to the lessor under the lease contract (including the termination amount) exceeds the amount calculated using the formula, the amount of the excess is to be included in the assessable income of the lessor in the income year in which the lease is terminated [new subsection 42A-65(2)] . If that sum is less than the amount calculated using the formula, the difference is allowable as a deduction to the lessor in the income year in which the lease is terminated [new subsection 42A-65(3)] .
6.28 Where an adjustment amount is or would be included in the lessor's assessable income and the lesseeis entitled to deductions, an amount calculated in a similar manner is allowable as a deduction to the lesseein the income year of the lessee in which the lease terminates or expires [new subsection 42A-70(1)] . Correspondingly, if an adjustment amount is or would be allowable as a deduction to the lessorand the lesseehas claimed deductions, an amount calculated in a similar manner is included in the lessee's assessable income in the lessee's income year [new subsection 42A-70(2)] .
6.29 The lessee's deduction or assessable amount, as the case requires, is reduced to the extent to which lease payments made under the lease would not have been deductible to the lessee e.g. because the car in question was only partly used in income producing activities. [New subsection 42A-70(3)]
What happens when the lease expires
What happens if the lease term is extended or the lease is renewed
6.30 If the lesseecontinues to retain possession of the car (which includes temporary loss of possession prior to renewal or extension of the lease) because the lease is extended or renewed:
- (i)
- the lessee's continuing ownership for depreciation purposes is not disturbed (provided the lessee has not subleased the car) [new subsections 42A-80(1), (2) and (3)] ; and
- (ii)
- the lessor is to be treated as providing a new notional loan for the new lease period. The notional loan in relation to the previous lease is treated as being repaid [new subsections 42A-80(4) and (5)] .
6.31 Where the lessor and lesseeare dealing at arm's length and the new lease contract specifies a cost or value of the luxury car, the new notional loan principal will be taken to be equal to the specified amount. In other cases, the amount of the new notional loan principal will be equal to the amount that the lesseecould have been expected to pay to purchase the luxury car under an arm's length transaction [new subsection 42A-80(7)] . An adjustment on termination of the previous lease may be necessary under new section 42A-65, treating the new notional loan as a termination amount under that lease.
What happens if an amount is paid by or on behalf of the lessee to acquire the car
6.32 If the lessor is paid an amount by the lesseeor on behalf of the lessee to acquire the luxury car:
- (i)
- the amount is neither an allowable deduction to the lesseenor assessable income of the lessor;
- (ii)
- the lessee 's ownership of the luxury car for the purposes of the depreciation provisions is not disturbed; and
- (iii)
- transfer of legal title to the luxury car from the lessor to the lessee is not to be treated as a disposal of the car.
What happens if the lessee ceases to have the right to use the car
6.33 If the lesseeceases at the end of the lease to hold the luxury car and does not otherwise acquire legal ownership of it, the car is to be treated for the purposes of the depreciation provisions as being disposed of by the lessee and acquired by the lessor. [New subsections 42A-90(1) and (2)]
6.34 For depreciation purposes, the consideration for the disposal is calculated according to the following formula:
Balance of notional loan - Payable amount + Refundable amount
where:
'Payable amount' is any additional amount payable by the lessee because the value of the car is less than the balance of notional loan, as defined.
'Refundable amount' is any amount payable to the lessee by the lessor because the value of the car is more than the balance of notional loan, as defined.
6.35 If it is not practicable to calculate the amount using this formula (e.g. if no amount is payable to or by the lessee), the value of the car at the time the lease expires is the consideration for the sale. [New paragraph 42A-90(3)(b)]
6.36 The lessor is treated as having acquired the vehicle for the same amount the lesseeis taken to have disposed of it for. [New subsection 42A-90(3)]
6.37 New subsection 42A-90(4) contains special rules which apply where a previously leased car is acquired by an associate of the lessee. The special rules will apply where the associate either acquires ownership of the car or, as lessee, is taken by new section 42A-15 to have acquired the car at the start of the lease term. The cost of the carfor calculating the associate's entitlement to depreciation deductions is taken to be the lesser of:
- (i)
- the depreciated value applicable to the associated lesseeas if it had remained the lesseeof the car, adjusted for any balancing charge that applies because the car is taken to have been disposed of by the associated lessee; and
- (ii)
- the acquisition cost of the car to the associate .
What happens if the lease is terminated before the end of the lease term
What happens if an amount is paid by or on behalf of the lessee to acquire the car
6.38 If the lease is terminated and an amount is paid to the lessor by the lessee or on behalf of the lesseeto acquire the car:
- (i)
- the amount is neither an allowable deduction to the lessee nor assessable income of the lessor;
- (ii)
- the lessee's ownership of the luxury car for the purposes of the depreciation provisions is not disturbed; and
- (iii)
- transfer of legal title to the luxury car from the lessor to the lessee is not to be treated as a disposal of the car.
What happens if the lessee ceases to have the right to use the car
6.39 Where the lease contract is terminated before the expiry of the lease term such that the lessee ceases to hold the luxury car, the lessee is treated as having disposed of the luxury car to the lessor at the time the lease is terminated. [New subsections 42A-105(1) and (2)]
6.40 For the purpose of calculating adjustments on disposal under section 59, the disposal will be treated as being by way of sale, and the consideration calculated according to the following formula:
Balance of notional loan - Payable amount + Refundable amount
6.41 The formula has the same effect as that contained in new subsection 42A-90(6) in relation to cases where a lessee ceases to have the right to use a car when the lease term expires. [New subsection 42A-105(5)]
6.42 If it is not practicable to calculate the amount using this formula, the value of the car at the end of the term of the lease is the consideration for the sale. [New paragraph 42A-105(3)(b)]
6.43 The lessor is taken to have acquired the vehicle for the same amount for which the lesseeis taken to have disposed of it. [New subsection 42A-105(3)]
6.44 New subsection 42A-105(4) contains special rules which apply where a previously leased car is acquired by an associate of the lessee . The rules are the same as those contained in new subsection 42A-90(4) , the effect of which is explained above.
Interpretation
Consecutive short-term hiring agreements
6.45 This Division will not apply in respect of arrangements that are genuine short-term hiring agreements . (See the definition of 'lease' in new section 42A-115 .)
6.46 A short-term hiring agreement as defined in new section 42A-115 is an agreement for the taking of property on hire which is ordinarily entered into by persons taking on hire intermittently as the occasion requires on an hourly, daily, weekly, monthly or other short term basis.
6.47 Where consecutive short-term hiring agreements in respect of the same luxury car extend over a period greater than six months, each of the consecutive agreements is to be treated as a lease which may be subject to the operation of the rules contained in new Schedule 2E .
6.48 Car hiring arrangements will be treated as consecutive provided the car is let on hire by the same person or persons who were associates of each other and the car is hired by the same person or persons who were associates of each other. Consecutive agreements also include arrangements where the commencement of the subsequent agreement is shortly after the expiry or termination of the previous agreement but there is substantial continuity of hiring of the car by the lessee and/or associates of the lessee.
6.49 The lessor's assessable income from a notional loan to a lessee is to be determined by reference to the lessor's finance charge under the lease, which is calculated as:
the sum of:
- (a)
- the aggregate of lease payments under the lease;
- and
- (b)
- any other amounts payable under the lease including any amount payable on the expiry or termination of the lease (see the definition of 'termination amount' in new section 42A-115) .
- reduced by
- the notional loan principal, i.e. the loan that the lessor is taken to have made to the lessee to acquire the car.
6.50 The lease payment period is the period under the lease in respect of which a lease payment is allocated or expressed to be payable, provided the period does not exceed six months. [New subsection 42A-135(1)]
6.51 Where a payment period under the lease exceeds six months (an excessive period), it is divided into lease payment periods of six months duration. Where the payment period is not an exact multiple of six months, the last lease payment period in that payment period is the residual part. For example, a 15 month payment period specified in a lease agreement will be an excessive period and will be divided up into three lease payment periods for the purpose of this Division of six months, six months and three months. [New subsection 42A-135(2)]
Accrual periods and accrual amounts
6.52 The amount of the finance charge to be brought to account as assessable income each income year by the lessor is to be determined on an accruals basis under which a proportion of the finance charge (known as an 'accrual amount') is determined for each accrual period (or part period) in the income year. New subsection 42A-140(1) makes it clear that the lease payment periods defined in new section 42A-135 are accrual periods for this purpose.
6.53 The accrual amount for each accrual period is to be calculated on a reducing balance basis by applying the formula:
- Notional loan principal outstanding at the beginning of the accrual period
- multiplied by
- Interest rate implicit under the lease for the accrual period.
Outstanding notional loan principal
6.54 The formula for the notional loan principal outstanding at beginning of an accrual period is contained in new section 42A-145 and means the sum of
- the notional loan principal
- plus
- the aggregate of all accrual amounts in respect of previous accrual periods
- reduced by
- the aggregate of all payments that the lessee paid or was required to pay under the lease at or before the beginning of the accrual period.
6.55 The implicit interest rate for an accrual period under a lease in respect of which there is a notional loan by the lessor to the lessee is that rate of compound interest for the accrual period which causes the present value of:
- (a)
- the lease payments; and
- (b)
- any termination amount and other amounts payable by the lesseeunder the lease
- to be equal to the notional loan principal. [New subsection 42A-150(1)]
6.56 Where at the start of the lease the lease payments, the termination amount expected to accrue to the lessor or other payments payable under the lease are not known (e.g. because they are subject to indexing) a reasonable estimate may be made at the beginning of the lease term for the purpose of working out the implicit interest rate and used for each year of income . Where a reasonable estimate of the variable cannot be made,an estimate of the amount or amounts is to be made at the end of each income year based on amounts payable to date and whatever reasonable assumptions are necessary in respect of future amounts payable that are not certain at that time. [New subsection 42A-150(2)]
Consequential amendment
6.57 Part 2 of Schedule 6 of the Bill makes an amendment to section 63 of the Act consequential to the enactment of new Division 42A of Schedule 2E relating to leases of luxury cars.
6.58 The amendment will ensure that amounts of lease payments written off as bad debts in relation to a leasing arrangement to which the Division applies are deductible under section 63 only to the extent of the finance charge under the relevant notional loan.
Example
(This example is for the purposes of illustration only and may not precisely reflect industry practice.)
| Lessor's and lessee's balance date | 30 June |
| Cost of the luxury car (to the lessee) | $120,000.00 |
| Purchase price of the luxury car (to the lessor) | $115,000.00 |
| Date of commencement of the lease | 15/12/96 |
| Lease payments | $2,090.15 |
| Lease term | 48 months |
| Payments/Period | Monthly in advance |
| Luxury car depreciation limit (for 1996-97) | $55,134.00 |
| Implicit interest rate per accrual period (Nominal interest rate in the lease - 9.1% p.a.) | .7583% |
| Residual value | $51,063.18 |
It is assumed that the car is wholly used for income producing purposes. The end of year amounts will be rounded off to whole dollars in the taxpayers' returns.
Depreciation
The depreciation allowances, subject to the $55,134.00 limit for the 1996-97 income year (as per section 57AF), at the rate of 22.5% (diminishing balance method) would be:
| Date | Original cost | Cost for depreciation purposes | Opening written down value | Rate % | Depreciation amount | Closing written down value |
|---|---|---|---|---|---|---|
| 30-Jun-97 | $120 000 | $55,134 | $55,134.00 | 22.5 | $6,729.37 | $48,404.63 |
| 30-Jun-98 | $48,404.63 | 22.5 | $10,891.04 | $37,513.59 | ||
| 30-Jun-99 | $37,513.59 | 22.5 | $8,440.56 | $29,073.03 | ||
| 30-Jun-00 | $29,073.03 | 22.5 | $6,541.43 | $22,531.60 | ||
| 15-Dec-00 | $22,531.60 | 22.5 | $2,333.41 | $20,198.19 | ||
| Note: For the purposes of depreciation, it is assumed in this case that the lease expired on 15 December 2000 and the lessee acquired the car. | ||||||
Where the lease is treated as a sale of the car by the lessor to the lessee, any profit on the sale will need to be included in the lessor's assessable income in the year the leaseis granted.
Profit = Selling price (ie cost price to lessee)less Purchase price to lessor$5,000.00 = $120,000.00 - $115,000.00
Accordingly, $5,000.00 will be brought into account as assessable income of the lessor in the 1996-97 income year because the date of sale is the date the lease is entered into - 15/12/96.
| (a) | (b) | (c) | (d) | |
|---|---|---|---|---|
| Date | Lease payment / termination amount (TA) | Finance charge (Accrual amount) | [(a) - (b)] Capital reduction | Notional loan principal outstanding at beginning of the period |
| 15-Dec-96 | $0.00 | $0.00 | $0.00 | $120,000.00 |
| 15-Dec-96 | $2,090.15 | $0.00 | $2,090.15 | $117,909.85 |
| 15-Jan-97 | $2,090.15 | $894.15 | $1,196.00 | $116,713.85 |
| 15-Feb-97 | $2,090.15 | $885.08 | $1,205.07 | $115,508.78 |
| 15-Mar-97 | $2,090.15 | $875.94 | $1,214.21 | $114,294.57 |
| 15-Apr-97 | $2,090.15 | $866.73 | $1,223.42 | $113,071.15 |
| 15-May-97 | $2,090.15 | $857.46 | $1,232.69 | $111,838.46 |
| 15-Jun-97 | $2,090.15 | $848.11 | $1,242.04 | $110,596.42 |
| 15-Jul-97 | $2,090.15 | $838.69 | $1,251.46 | $109,344.96 |
| 15-Aug-97 | $2,090.15 | $829.20 | $1,260.95 | $108,084.01 |
| 15-Sep-97 | $2,090.15 | $819.64 | $1,270.51 | $106,813.50 |
| 15-Oct-97 | $2,090.15 | $810.00 | $1,280.15 | $105,533.35 |
| 15-Nov-97 | $2,090.15 | $800.29 | $1,289.86 | $104,243.49 |
| 15-Dec-97 | $2,090.15 | $790.51 | $1,299.64 | $102,943.85 |
| 15-Jan-98 | $2,090.15 | $780.66 | $1,309.49 | $101,634.36 |
| 15-Feb-98 | $2,090.15 | $770.73 | $1,319.42 | $100,314.94 |
| 15-Mar-98 | $2,090.15 | $760.72 | $1,329.43 | $98,985.51 |
| 15-Apr-98 | $2,090.15 | $750.64 | $1,339.51 | $97,646.00 |
| 15-May-98 | $2,090.15 | $740.48 | $1,349.67 | $96,296.33 |
| 15-Jun-98 | $2,090.15 | $730.25 | $1,359.90 | $94,936.43 |
| 15-Jul-98 | $2,090.15 | $719.93 | $1,370.22 | $93,566.21 |
| 15-Aug-98 | $2,090.15 | $709.54 | $1,380.61 | $92,185.60 |
| 15-Sep-98 | $2,090.15 | $699.07 | $1,391.08 | $90,794.52 |
| 15-Oct-98 | $2,090.15 | $688.53 | $1,401.62 | $89,392.90 |
| 15-Nov-98 | $2,090.15 | $677.90 | $1,412.25 | $87,980.65 |
| 15-Dec-98 | $2,090.15 | $667.19 | $1,422.96 | $86,557.69 |
| 15-Jan-99 | $2,090.15 | $656.40 | $1,433.75 | $85,123.94 |
| 15-Feb-99 | $2,090.15 | $645.52 | $1,444.63 | $83,679.31 |
| 15-Mar-99 | $2,090.15 | $634.57 | $1,455.58 | $82,223.73 |
| 15-Apr-99 | $2,090.15 | $623.53 | $1,466.62 | $80,757.11 |
| 15-May-99 | $2,090.15 | $612.41 | $1,477.74 | $79,279.37 |
| 15-Jun-99 | $2,090.15 | $601.20 | $1,488.95 | $77,790.42 |
| 15-Jul-99 | $2,090.15 | $589.91 | $1,500.24 | $76,290.18 |
| 15-Aug-99 | $2,090.15 | $578.53 | $1,511.62 | $74,778.56 |
| 15-Sep-99 | $2,090.15 | $567.07 | $1,523.08 | $73,255.48 |
| 15-Oct-99 | $2,090.15 | $555.52 | $1,534.63 | $71,720.85 |
| 15-Nov-99 | $2,090.15 | $543.88 | $1,546.27 | $70,174.58 |
| 15-Dec-99 | $2,090.15 | $532.16 | $1,557.99 | $68,616.59 |
| 15-Jan-00 | $2,090.15 | $520.34 | $1,569.81 | $67,046.78 |
| 15-Feb-00 | $2,090.15 | $508.44 | $1,581.71 | $65,465.07 |
| 15-Mar-00 | $2,090.15 | $496.44 | $1,593.71 | $63,871.36 |
| 15-Apr-00 | $2,090.15 | $484.36 | $1,605.79 | $62,265.57 |
| 15-May-00 | $2,090.15 | $472.18 | $1,617.97 | $60,647.60 |
| 15-Jun-00 | $2,090.15 | $459.91 | $1,630.24 | $59,017.36 |
| 15-Jul-00 | $2,090.15 | $447.55 | $1,642.60 | $57,374.76 |
| 15-Aug-00 | $2,090.15 | $435.09 | $1,655.06 | $55,719.70 |
| 15-Sep-00 | $2,090.15 | $422.54 | $1,667.61 | $54,052.09 |
| 15-Oct-00 | $2,090.15 | $409.90 | $1,680.25 | $52,371.84 |
| 15-Nov-00 | $2,090.15 | $397.15 | $1,693.00 | $50,678.84 |
| 15-Dec-00 | $51,063.18 | $384.34 | $50,678.84 | $0.00 |
| Total | $151,390.38 | $31,390.38 | $120,000.00 |
The first accrual period:
- •
- commences with the date of commencement of the lease when the first payment is due and payable; and
- •
- ends with the day immediately preceding the day on which the next succeeding instalment is payable.
An adjustment needs to be made to the accrual / lease payment period at the end/beginning of each income year as it straddles two income years. The accrual amount for inclusion in the relevant income year has to be calculated in a manner consistent with generally accepted accounting principles. For instance, in the income year 1996-97 the following calculation is required.
| Date | Lease payment | Finance charge | Capital reduction | Notional loan principal outstanding |
|---|---|---|---|---|
| 15-Dec-96 | $2,090.15 | $0.00 | $2,090.15 | $117,909.85 |
| 15-Jan-97 | $2,090.15 | $894.15 | $1,196.00 | $116,713.85 |
| 15-Feb-97 | $2,090.15 | $885.08 | $1,205.07 | $115,508.78 |
| 15-Mar-97 | $2,090.15 | $875.94 | $1,214.21 | $114,294.57 |
| 15-Apr-97 | $2,090.15 | $866.73 | $1,223.42 | $113,071.15 |
| 15-May-97 | $2,090.15 | $857.46 | $1,232.69 | $111,838.46 |
| 15-Jun-97 | $2,090.15 | $848.11 | $1,242.04 | $110,596.42 |
| 15-Jul-97 | $2,090.15 | $838.69 | $1,251.46 | $109,344.96 |
The accrual amount for the June/July accrual period of $838.69 may be apportioned as follows for the income year of 1996-97:
* There are 16 days in the month of June 1997 that the payment made on 15 June 1997 refers to.$838.69 x 16/30* = $447.30
$447.30 would form part of the lessee's allowable deductions and the lessor's assessable income in the 1996-97 income year. Therefore, the total accrual amount that will be allowable to the lessee and assessable to the lessor, in the 1996-97 income year, would be $5,674.77.
At the expiry of the lease term on 15 December 2000, the lessee pays to the lessor a termination amount of $57,063.18 to acquire the luxury car. The lessee sells the car to a third party for $63,000.00 on 15 December 2000.
As at the expiry of the lease term the termination amount varies from the residual value used to calculate the accrual amounts($51,063.18), an adjustment needs to be made to the lessor's and lessee's taxable income in the financial year 2000-01. The adjustment to the lessor's taxable income is calculated using the formula
A - (B + C)
where:A = the aggregate of all amounts received or receivable by the lessor (see Repayment Schedule) under the lease contract, including the termination amount;B = the notional loan principal at the commencement of the lease (see Repayment Schedule); andC = the aggregate of the accrual amounts previously included in the lessor's income (see Repayment Schedule).
Therefore, the adjustment amounts to $6,000.00 [$157,390.38* - ($120,000.00 + $31,390.38)]. This amount is included in the lessor's assessable income in the 2000-01 income year and may be an allowable deduction to the lessee in the same year.
[* $157,390.38 (aggregate of lease payments - not including the estimated termination value of $51,063.18) plus $57,063.18 (termination amountpaid)]
As the lessee sells the car for $63,000.00 to a third party a balancing adjustment on disposal would be required. In order to calculate the balancing adjustment on sale, the actual sale price of the car is reduced in the following manner:
Depreciated value as at date of sale = $20,198.19Adjusted sale price = $63,000.00 x $55,134.00/$120,000.00 = $28,945.35
A balancing adjustment of $8,747.16, the difference between the adjusted sale price and the depreciated value of the car as at date of sale, has to be included in the lessee's assessable income in the financial year 2000-01.
At the end of lease term on 15 December 2000 the lessee returns the car after making the final monthly lease payment. The lessee receives a refund of $2,000.00 On 15 December 2000 the market value of the luxury car is $55,000.00.
When the luxury car is returned by the lessee to the lessor, the return is treated as a disposal of the luxury car by the lessee.
The sale price for the purposes of subsection 59(3) is the sum of amounts taken to be credited by the lessor to the lessee for the return of the car. In this instance, as all the lease payments have been made and the car is returned before making the residual payment, the consideration for disposal would be $53,063.18 which is a sum of the balance of notional loan ($51,063.18) and the refundable amount of $2,000.00.
The lessee would make a balancing adjustment on disposal based on a sale price of $53,063.18. In order to calculate the balancing adjustment on sale, the sale price of the car is reduced in the following manner:
Depreciated value as at date of sale = $20,198.19 Adjusted sale price = $53,063.18 x $55,134.00/$120,000.00 = $24,379.88
A balancing adjustment of $4,181.69, the difference between the adjusted sale price (or adjusted termination value) and the depreciated value of the car as at date of sale, has to be included in the lessee's assessable income in the 2000-01 income year.
If the lessor decides to sell the car and receives $55,000.00, then the lessor would include $1,936.82 ($55,000.00 less $53,063.18) in the 2000-01 income year.