House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

General outline and financial impact

CFCs and capital gains tax

This Bill contains provisions to amend the controlled foreign company (CFC) measures in the Income Tax Assessment Act 1936 to correct anomalies in the interaction of the CFC measures and the capital gains tax (CGT) provisions of the income tax law.

Date of effect: The amendments will apply in determining the attributable income of a CFC if a tainted asset is deemed to be disposed of because the CFC ceased to be a member of a group (and had previously benefited from CGT roll-over relief) after 7.30pm, by legal time in the Australian Capital Territory, on 13 May 1997.

Proposal announced: The proposal was announced in the Treasurers Press Release No. 51 on 13 May 1997 as part of the 1997-98 Budget Statement.

Financial impact: The measure will protect the revenue base used for the forward estimates by removing opportunities for significant future expansion of tax minimisation practices. In the absence of the measure, to the extent that the revenue base would not be protected, there would be a significant revenue loss compared to the forward estimates.

Compliance cost impact: The initial and recurrent compliance costs of the measure are not expected to be significant (that is, less than $1 million per annum).

Summary of Regulation Impact Statement

Impact: Low.

Main points:

•

the taxpayers affected by this measure will be those Australian residents that have an attributable interest in a CFC that has obtained roll-over relief in relation to a tainted asset and is subsequently deemed to have disposed of the asset;

•

the proposed amendments are unlikely to significantly affect taxpayers unless a company group has been intending to make use of the identified anomalies to avoid the payment of Australian tax;

•

it is envisaged that the majority of the increase in compliance costs will arise for those Australian taxpayers that undertake complex arrangements to dilute their interest in a CFC that holds a tainted asset that has received roll-over relief;

•

the compliance costs will mainly result from record keeping and anticipated increased adviser fees but are not expected to be significant; and

•

the compliance costs will not increase for all CFCs only those that have received roll-over relief and mainly where the CFC ceases to be a member of a wholly-owned company group.

Policy objective: To remove anomalies preventing the intended Australian taxation of capital gains arising on tainted assets deemed to be disposed of because the CFC ceased to be a member of a group (and had previously benefited from CGT roll-over relief).

Amendments to exempt certain post-judgment interest

This Bill amends the Income Tax Assessment Act 1997 and the Income Tax Assessment Act 1936 to exempt from income tax post-judgment interest in personal injury compensation cases. The amendments ensure that post-judgment interest payable in personal injury cases that accrues between the time of the original award of damages by a court and the time at which the original judgment is finalised either when any right to appeal has expired or when the matter is finally determined on appeal or otherwise settled between the parties will be exempt from income tax.

Date of effect: The amendments will apply to the 1992-1993 and later years of income.

Proposal announced: Assistant Treasurers Press Release No. 13 of 24March 1999.

Financial impact: It is estimated that the cost to the revenue will be $14million in the 1999-2000 year of income and $2 million in each later year of income.

Compliance cost impact: Affected taxpayers are expected to incur only minimal compliance costs in determining the extent of their entitlement to exemption from income tax for post-judgment interest they receive.

Summary of Regulation Impact Statement

The Office of Regulation Review has been consulted and a Regulation Impact Statement is not required.

Franking of dividends

This Bill amends the Income Tax Assessment Act 1936 to make a number of changes to the franking credit trading and dividend streaming rules in Part IIIAA. These changes make corrections to these rules to ensure that they operate as intended.

Date of effect: These changes will apply from the commencement of the relevant measures.

Proposal announced: These changes have not been previously announced.

Financial impact: Extending the scope of a transitional concession for the general anti-avoidance rule and the specific anti-streaming rule will result in a loss to revenue that cannot be quantified but may be exceed $31million from one known case. The other changes will result in a negligible loss to revenue or have no revenue impact.

Compliance cost impact: These changes will have a negligible impact on compliance costs.

Summary of Regulation Impact Statement

The Office of Regulation Review has advised that a Regulation Impact Statement is not required for these changes.

Non-deductibility of bribes

This Bill amends the Income Tax Assessment Act 1997 to disallow deductions for bribes to foreign public officials.

Date of effect: The amendments will apply to the 1999-2000 and later years of income.

Proposal announced: Joint statement by the Deputy Prime Minister and Minister for Trade, Treasurer and Attorney-General dated 16 May 1997.

Financial impact: Insignificant.

Compliance cost impact: The amendments will impose minimal compliance costs. Details of the compliance cost impact are incorporated into the Regulation Impact Statement in Chapter 4 of this Explanatory Memorandum.

Summary of Regulation Impact Statement

Impact: Low.

Main points: The measure will marginally increase compliance costs of some taxpayers involved in international trade. Only those taxpayers who incur expenditure for bribes or facilitation payments to foreign public officials will be affected.

Policy objective: The policy objective is to give effect to a recommendation by the Organisation for Economic Co-operation and Development Council that member countries deny tax deductibility for bribes to foreign public officials.

Philanthropy

Schedule 5 of Taxation Laws Amendment Bill (No. 8) 1999 (this Bill) amends the Income Tax Assessment Act 1997 and the Income Tax Assessment Act 1936 to implement the Governments response to the report on philanthropy in Australia by the Business and Community Partnerships Working Group on Taxation Reform by:

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allowing an income tax deduction for a gift of property to certain funds, authorities and institutions and to political parties worth more than $5,000, regardless of when or how the property was acquired;

•

providing a capital gains tax (CGT) exemption for testamentary gifts of property to certain funds, authorities and institutions and to political parties unless the property is reacquired for less than market value by the estate, a beneficiary of the estate or an associate;

•

providing a CGT exemption for gifts of property under the Cultural Gifts Program unless the property is reacquired for less than market value by the donor or an associate;

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allowing concessional taxation treatment for specified private funds which will not be required to seek donations from the public but will be subject to the other requirements applying to public funds; and

•

allowing the apportionment of deductions for gifts made under the Cultural Gifts Program over a period of up to 5 years.

Date of effect: The amendments will apply from 1 July 1999:

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Deductions will be allowable for gifts of property to certain funds, authorities and institutions and to political parties made on or after 1 July 1999 where the value of the property exceeds $5,000, regardless of when or how the property was acquired.

•

Deductions will be allowable for gifts to specified private funds made on or after 1 July 1999.

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CGT exemption will apply to property donated under the Cultural Gifts Program on or after 1 July 1999.

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CGT exemption will apply to testamentary gifts of property donated on or after 1 July 1999.

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Deductions for donations to the Cultural Gifts Program made on or after 1 July 1999 may be apportioned over a period of up to 5 income years.

Proposal announced: The proposal was announced on 26 March 1999 by the Prime Minister, the Treasurer, the Minister for Family and Community Services, the Minister for Communications, Information Technology and the Arts, and the Minister for the Arts and the Centenary of Federation.

Financial impact: This measure is expected to cost the revenue $5.5million in the 1999-2000 income year, $51 million in the 2000-2001 income year, $56 million in the 2001-2002 income year and $71 million in the 2002-2003 income year.

Compliance cost impact: There will be a minimal increase in compliance costs for taxpayers as a result of the need to make an election to apportion deductions in certain circumstances.

Summary of Regulation Impact Statement

The Office of Regulation Review has advised that a Regulation Impact Statement is not required for these changes.

Rate of tax for friendly societies etc.

Amends the Taxation (Deficit Reduction) Act (No. 2) 1993 so that the rate of tax imposed on the eligible insurance business of friendly societies and other registered organisations will be retained at 33% for the 1999-2000 income year. The trustee rate will increase to 39% for the 2000-2001 and subsequent income years unless other relevant amendments to the taxation treatment of friendly societies are made prior to that time.

Date of effect: 1999-2000 income year.

Proposal announced: Tax Reform: not a new tax, a new tax system: The Howard Governments Plan for a New Tax System on 13August1998.

Financial impact: The estimated cost to the revenue is $20million in 1999-2000 income year.

Compliance cost impact: The proposed amendments are not expected to impose any additional compliance costs because they ensure that the existing tax arrangements remain unchanged until the 2000-2001 income year.

Summary of Regulation Impact Statement

A Regulation Impact Statement is not required for these changes.

Company Law Review Amendments

Amends the Income Tax Assessment Act 1936 (ITAA 1936) and associated tax laws to:

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provide for the necessary machinery provisions to collect untainting tax;

•

ensure that distributions from share premium accounts are within the ambit of the capital streaming and dividend substitution rules;

•

make some minor technical changes to rectify certain incorrect references; and

•

ensure that bonus shares deemed to be a dividend under section 45C have a cost base of the dividend amount where the shares are held on revenue account.

Date of effect: The amendment to include distributions of share premium within the ambit of the capital streaming and dividend substitution rules will apply from the date of introduction of the Bill. The other amendments will apply from 1 July 1998, the date of commencement of the Taxation Laws Amendment (Company Law Review) Act 1998.

Financial impact: The amendments, other than the amendment to include distributions of share premium in the anti-avoidance rules, have no revenue impact. The revenue cost of the amendment to the anti-avoidance rules is unquantifiable but there is the potential for significant revenue loss if the amendment is not made.

Compliance cost impact: There are no compliance costs.

Summary of Regulation Impact Statement

The Office of Regulation Review has advised that a Regulation Impact Statement is not required for these changes.

Technical amendments

This Bill makes minor technical amendments to the Income Tax Assessment Act 1997 that improve signposting to provisions in the Act dealing with excess tax offsets.

Date of effect: Royal Assent.

Proposal announced: Not previously announced.

Financial impact : Nil.

Compliance cost impact: Nil.

Summary of Regulation Impact Statement

A Regulation Impact Statement is not required for these changes.

Concessional tracing rules for company loss etc. provisions

The company loss and bad debt and debt/equity swap deduction provisions of the income tax law will be amended to extend to companies 2 concessional tracing rules available to trusts under the trust loss measures which are contained in Schedule 2F to the Income Tax Assessment Act 1936. The amendments are as follows:

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A family trust concession will apply where the relevant interests in a company are held, directly or indirectly, by a family trust. The trustee of the family trust will be treated as an individual holding the interests for its own benefit.

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An alternative condition will apply for the purpose of testing continuity of majority beneficial ownership of a company. If the company is held by non-fixed trusts such that it is not able to pass the continuity of ownership test, the company will still be able to deduct its losses or debts if certain conditions are satisfied.

The legislation was first introduced into Parliament in October 1997 in the Taxation Laws Amendment Bill (No. 6) 1997 and lapsed when Parliament was prorogued for the election. To ensure taxpayers are not disadvantaged by the delay in implementation, the legislation will continue to apply to losses and debts first incurred in the 1996-97 year of income.

Date of effect: The amendments will apply to losses and debts incurred in the 1996-97 year of income or later years of income.

Proposal announced: 1996-97 Budget, 20 August 1996.

Financial impact: Details on the financial impact of the amendments are included in the Regulation Impact Statement (see paragraph 9.121).

Compliance cost impact: The Compliance Cost Impact Statement is incorporated into the Regulation Impact Statement at the end of Chapter 9 of this Explanatory Memorandum.

Summary of Regulation Impact Statement

Impact: Low

Main points

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The only viable option for this measure involves amending the company loss and bad debt and debt/equity swap deduction provisions in the tax law to make the special tracing rules that are available to trusts under the trust loss measures available to companies.

•

The rules will create certainty in the application of the law to companies in respect of tracing interests through non-fixed trusts. Companies that will be affected are those which have deductions including prior year losses.

•

The family trust concession will result in some initial compliance costs as trusts will need to make a family trust election. For the alternative condition , there will be some costs for companies in monitoring whether non-fixed trusts which hold interests in a company will pass the tests that apply to non-fixed trusts under the trust loss measures.

Policy objective: To extend to companies 2 concessional tracing rules (the family trust concession and the alternative condition ) that are available to trusts under the trust loss measures.

Extension of transitional family trust and interposed entity election provisions

Amends Schedule 1 to the Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998 (the Trust Loss Act) to extend the deadline for making family trust and interposed entity elections for the purpose of the family trust concessional tracing rule that applies to companies and the franking credit trading provisions in Division 1A of Part IIIAA of the Income Tax Assessment Act 1936.

Date of effect: These amendments will apply from the day this Bill receives Royal Assent.

Proposal announced: These changes have not been previously announced.

Financial impact: These changes will result in a negligible loss to revenue.

Compliance cost impact: These changes will have a negligible impact on compliance costs.

Summary of Regulation Impact Statement

The Office of Regulation Review has advised that a Regulation Impact Statement is not required for these changes.

Chapter 1 - CFCs and capital gains tax

Overview

1.1

Schedule 1 to this Bill will amend the controlled foreign company (CFC) measures contained in Part X of the Income Tax Assessment Act 1936 (ITAA 1936) to give effect to the changes to the interaction of the CFC measures and capital gains tax (CGT) provisions that were announced in the 1997-98 Budget Statement.

1.2

The CFC measures use (after modification) the CGT rules in the ITAA 1936 and the Income Tax Assessment Act 1997 (ITAA 1997) to work out the attributable income of a CFC. For assessments for the 1998-99 and later income years, the CFC provisions apply the CGT rules in Parts 3-1 and 3-3 of the ITAA 1997. For earlier years of income, the CGT provisions in Part IIIA of the ITAA 1936 are applied. The amendments made by this Bill only apply to deemed disposals after 7.30pm, by legal time in the Australian Capital Territory, on 13 May 1997. As this is prior to the 1998-99 year of income, the CFC provisions in the ITAA 1936 will need to be amended so that the CGT rules in the ITAA 1936 and the ITAA 1997 are modified to give effect to the announced measures.

1.3

Part 1 of Schedule 1 amends Part X of the ITAA 1936. The amendments will modify references to the CGT provisions in the ITAA1936 so as to give effect to the proposed changes to the interaction between the CFC and CGT rules.

1.4

Part 2 of Schedule 1 to this Bill makes consequential changes to Part X to reflect the inclusion of the CGT provisions in the ITAA 1997. The amendments replace references to the CGT provisions in the ITAA1936 with the appropriate provisions in the ITAA 1997. In addition, some minor wording changes are also made.

Summary of amendments

Purpose of amendments

1.5 The purpose of the amendments is to remove anomalies preventing the intended Australian taxation of capital gains arising on deemed disposals of tainted assets of a CFC where that CFC ceases to be a member of a group and has previously benefited from CGT roll-over relief.

1.6 The amendments will modify the CFC rules to:

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include in attributable income of a CFC tainted income consisting of capital gains on tainted assets deemed to have been disposed of by a CFC on ceasing to be a member of a group, or where it ceases to be a CFC;

•

ensure that capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group are taken into account in applying the active income test to a CFC;

•

include in designated concession income of a CFC capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group;

•

ensure that, when working out the amount to be included in attributable income, the taxation of capital gains on the deemed disposal of tainted assets is not avoided or minimised by arrangements designed to dilute the Australian taxpayers attribution percentage in the CFC that holds tainted assets that have received CGT roll-over relief; and

•

ensure that, when working out the amount to be included in attributable income, a company that ceases to be a CFC in relation to a particular attributable taxpayer does not avoid the taxation of capital gains on the deemed disposal of tainted assets that have received CGT roll-over relief.

Date of effect

1.7 The amendments made by Part 1 of Schedule 1 will apply in determining the attributable income of a CFC if a deemed disposal occurred due to a CFC ceasing to be a member of a group after 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 1997.

1.8 The amendments made by Part 2 of Schedule 1 will apply to the 1998-99 and later income years.

Background to the legislation

Broad overview of the operation of the CFC measures

1.9 The CFC measures require Australian taxpayers to pay tax, on a current year basis, on income or gains earned by foreign companies in which they have a controlling interest, even though the income or gains have not yet been derived by the taxpayers. The Australian controllers of a CFC are called attributable taxpayers .

1.10 An attributable taxpayer is required to include in assessable income its share of the attributable income of the CFC (section 456 of the ITAA 1936). Subject to some modifications, the attributable income of a CFC is calculated using the same tax rules applying to Australian resident companies. The amount of a CFCs attributable income depends on whether the CFC is resident of a broad-exemption listed country or a non-broad exemption listed country and on whether the CFCs activities are such that it may take advantage of the exemption for active income.

1.11 Generally, all income of a tainted nature derived by a CFC resident in a non-broad exemption listed country is attributable if the CFC fails the active income test. In contrast, the attributable income of a broad-exemption listed country CFC normally includes only concessionally taxed amounts of narrowly defined tainted income (ie. designated concession income or eligible designated concession income EDCI) that is also tainted under the broader definition of tainted income in the CFC measures (ie. adjusted tainted income). Gains made on the disposal of tainted assets are included in the definition of adjusted tainted income. The rules for determining whether an amount is EDCI are provided in section 317 of the ITAA 1936 and Part 8A of the Income Tax Regulations.

Interaction of the CFC measures and CGT provisions

1.12 The CFC measures include capital gains on the disposal of tainted assets in the attributable income of a CFC. The CGT provisions are modified by Subdivision 7C of Part X of the ITAA 1936.

1.13 Under the CGT provisions in the ITAA 1936, in certain circumstances, a CGT liability may be deferred on the disposal of an asset from one member of a wholly owned group of companies to another. This is known as roll-over relief. Under the current CGT arrangements, the company acquiring the asset is taken to have done so at the cost base, indexed cost base or reduced cost base that applied to the company disposing of the asset. The company disposing of the asset will not be subject to CGT liability because of the transfer.

1.14 If a company holding an asset that has received this roll-over relief ceases to be a member of a group, the company is deemed to have disposed of the asset and immediately re-acquired it for its market value. The deemed disposal and re-acquisition means that any gains made on the asset at the time the company ceases to be a member of the group would be subject to tax at that time.

1.15 These CGT roll-over rules are contained in sections 160ZZO and 160ZZOA of the ITAA 1936 for the 1997-98 and earlier income years. For later years, equivalent roll-over rules are contained in Subdivision 126-B and CGT event J1 (section 104-175) of the ITAA 1997.

1.16 It is intended that these rules would apply to CFCs that roll-over assets within a wholly owned group of companies. Accordingly, section419 of ITAA 1936 modifies the operation of the normal CGT roll-over rules to ensure that they apply appropriately to CFCs. For example, the availability of roll-over relief under the CFC measures will depend on the place of residence of both the company disposing of the asset and the company receiving the asset. In certain situations the availability of roll-over relief also depends on whether the asset has been used in connection with a permanent establishment of a CFC.

1.17 For the purposes of the CFC measures, it has been argued that a disposal of an asset does not include deemed disposals arising for a CFC under section 160ZZOA of the ITAA 1936 or because of CGT event J1 of the ITAA 1997 on its ceasing to be a member of a group.

1.18 If this argument were correct, capital gains accruing on the deemed disposal of tainted assets (when a CFC ceases to be a member of a group) may not be included in the attributable income of a CFC. A CFC may cease to be a member of a group as a result of a restructuring of the group, or by issuing shares to persons outside the group.

1.19 This outcome would be inconsistent with the general operation of the CGT provisions under which Australian residents and the non-resident holders of taxable Australian assets (assets that have a necessary connection with Australia) may be subject to capital gains accruing when an asset is rolled-over to a member of a company group that subsequently leaves that group.

1.20 The amendments proposed in this Bill will ensure that the deemed disposals under section 160ZZOA of the ITAA 1936 or CGT event J1 of the ITAA 1997 are applied to work out attributable income of a CFC that holds a rolled-over tainted asset and has ceased to be a member of a group.

1.21 In addition, the amendments will prevent deliberate abuse of the CFC rules by preventing taxpayers avoiding taxation of capital gains on the disposal of tainted assets by using arrangements designed to dilute the Australian taxpayers attribution interest in the CFC that holds tainted assets that have received CGT roll-over relief.

Explanation of the amendments

1.22 The amendments are contained in 2 parts to Schedule 1. Part 1 of Schedule 1 amends Part X of the ITAA 1936 to modify references to the CGT provisions in the ITAA 1936. These amendments will apply to deemed disposals occurred due to a CFC ceasing to be a member of a group after 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 1997.

1.23 Part 2 of Schedule 1 to this Bill makes consequential changes to Part X of the ITAA 1936 to reflect the inclusion of the CGT provisions in the ITAA 1997. The amendments in Part 2 of Schedule 1 replace references to the CGT provisions in the ITAA 1936 with the appropriate provisions in the ITAA 1997. In addition, some minor wording changes are also made. These will apply to the 1998-99 and later income years.

Attributable income of a CFC to include tainted income from capital gains on tainted assets deemed to be disposed of by a CFC on ceasing to be a member of a group

1.24 Schedule 1 ensures that tainted income consisting of capital gains on tainted assets deemed to be disposed of by a CFC on its ceasing to be a member of a group (as a result of the operation of section 160ZZOA of the ITAA 1936 or because of CGT event J1 of the ITAA 1997) is included in the attributable income of the CFC.

1.25 The need for this amendment arose because the definition of disposal in Part X of the ITAA 1936 arguably does not include a deemed disposal (under section 160ZZOA of the ITAA 1936 or because of CGT event J1 of the ITAA 1997) of a tainted asset of a CFC that ceases to be a member of a group after receiving CGT roll-over relief.

1.26 Part 1 of Schedule 1 to this Bill will repeal the definition of disposal in section 317 of the ITAA 1936 and insert a new definition which specifically includes a disposal that would be taken to occur under section 160ZZOA of the ITAA 1936. A CFC, in working out the attributable income, can be taken to have disposed of an asset under section 160ZZOA of the ITAA 1936 because of the assumption in paragraphs 383(a) to (c) of the ITAA 1936 that the company is a taxpayer and a resident. [Item 2]

1.27 Consistent with the amendment of the definition of disposal the definitions of tainted commodity gain [item 3] and tainted commodity loss [item 4] in section 317 are both amended so that the CFCs attributable income will include any such gains or losses if there is a deemed disposal under section 160ZZOA of the ITAA 1936.

1.28 The amendment to the definition of disposal in section 317 of the ITAA 1936 will also operate to amend the definition of disposal for the purposes of Part 8A of the Income Tax Regulations (see Income Tax Regulation 152A). This ensures that references to disposal in the Income Tax Regulations will be consistent with that contained in the ITAA 1936.

1.29 Items 15 to 18 of Part 2 of Schedule 1 modify the amendments made by Part 1 of Schedule 1 to replace references to the CGT provisions in the ITAA 1936 with corresponding references in the CGT provisions in the ITAA 1997.

Capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group taken into account when applying the active income test

1.30 The active income test (section 432 of the ITAA 1936) provides a threshold test to determine whether certain tainted income and gains of the CFC will be attributed back to its Australian resident shareholders. However, certain income of a CFC will be attributed regardless of whether the CFC passes or fails the active income test.

1.31 The active income test is determined by using the CFCs recognised accounts. If there is no actual disposal, but a deemed disposal of assets, an amount from the deemed disposal may not be reflected in the CFCs accounts and therefore may not be included in applying the active income test.

1.32 The new section 317 (definition of disposal) (discussed above) will enable paragraphs 434(1)(b) and 434(1)(c) of the ITAA 1936 to include deemed disposals in accordance with section 160ZZOA of the ITAA 1936 (or because of CGT event J1 of the ITAA 1997). However, as section 434 refers to the recognised accounts, amounts in respect of gains from a deemed disposal may not be reflected in the accounts of the CFC. Accordingly, Part 1 of Schedule 1 inserts new subsection 434(1A) which will apply to include gains and losses of the kind specified in paragraphs 434(1)(b) and 434(1)(c) that may arise because of the operation of section 160ZZOA of the ITAA 1936 in the calculation of gross turnover. [Item 6]

1.33 It is also necessary to ensure that deemed gains or losses are taken into account in determining the gross tainted turnover of a CFC. Gross tainted turnover is so much of the gross turnover of the CFC as consists of passive income, tainted sales income and tainted services income. Passive income is defined in section 446 of the ITAA 1936 and includes under paragraph 446(1)(k) net gains that accrued to the company in the statutory accounting period in respect of the disposal of tainted assets. Part 1 of Schedule 1 inserts new subsection 445(2) to ensure that gains or losses arising from the operation of section 160ZZOA of the ITAA 1936 are included in the calculation of net gains. [Item 7]

1.34 Items 21 and 22 of Part 2 of Schedule 1 ensures that the amendments made by Part 1 of Schedule 1 apply the CGT provisions in the ITAA 1997 for the 1998-99 and later income years. Item 21 includes gains and losses of the kind specified in paragraphs 434(1)(b) and 434(1)(c) of the ITAA 1936 that may arise because of the happening of CGT event J1 of the ITAA 1997 in the calculation of gross turnover. Item 22 ensures that gains or losses arising because of the happening of CGT event J1 of the ITAA 1997 are included in the calculation of net gains.

Inclusion of amounts in notional assessable income to be subject to the active income test

1.35 Income will only be included in the attributable income of a CFC because of a deemed disposal under either section 160ZZOA of the ITAA 1936 or CGT event J1 of the ITAA 1997 if the CFC fails the active income test in section 432 of the ITAA 1936.

Capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group are included in designated concession income

1.36 The attributable income of a broad-exemption listed country CFC normally includes only concessionally taxed amounts of narrowly defined tainted income (ie. designated concession income or EDCI) that is also tainted under the broader definition of tainted income in the CFC measures (ie. adjusted tainted income). Gains made on the disposal of tainted assets are included in the definition of adjusted tainted income. The rules for determining whether an amount is EDCI are provided in section 317 of the ITAA 1936 and Part 8A of the Income Tax Regulations.

1.37 The new definition of disposal contained in Schedule 1 will ensure that capital gains arising from deemed disposals in accordance with section 160ZZOA of the ITAA1936 or because of CGT event J1 of the ITAA 1997 will be included in the kinds of capital gains specified as designated concession income.

1.38 The current definition of designated concession income broadly deals with income that is not taxed or is concessionally taxed in the overseas country because of a feature of that countries tax laws. Because a deemed disposal under section 160ZZOA of the ITAA 1936 creates a gain under Australian tax law, it is unlikely the current definition of designated concession income would apply.

1.39 Item 1 of Part 1 of Schedule 1 replaces the existing definition of designated concession income with a new definition that includes deemed capital gains arising from the operation of section 160ZZOA of the ITAA 1936.

1.40 Items 12 to 14 of Part 2 of Schedule 1 apply these amendments to the CGT provisions of the ITAA 1997 for the 1998-99 and later income years.

Reductions in attribution percentage to be ignored in certain circumstances

Effect of reducing section 160ZZOA or CGT event J1 amount

1.41 Arrangements have been identified where an attributable taxpayer may enter schemes or arrangements to reduce their attribution percentage in a CFC that holds tainted assets that have received CGT roll-over relief. Where a capital gain accrues from a deemed disposal of a tainted asset under section 160ZZOA of the ITAA 1936 or because of CGT event J1 of the ITAA 1997, the attribution percentage of the attributable taxpayer or attributable taxpayers may have reduced since the roll-over of the asset. Where the attribution percentage in the CFC is less than the attribution percentage in the CFC at the time the asset was originally rolled-over the total amount of Australian tax that was deferred on the roll-over of the asset will not be recouped.

1.42 Part 1 of Schedule 1 inserts new section 460A that will prevent the taxation of capital gains on the deemed disposal of tainted assets being avoided or minimised by attributable taxpayers (or their associates) entering schemes or arrangements that have the effect of and are intended to dilute the Australian taxpayers attribution percentage in the CFC that holds tainted assets that have received CGT roll-over relief. [Item8]

1.43 New section 460A also ensures that a company that ceases to be a CFC (regardless of any intention to reduce their attribution percentage) in relation to a particular attributable taxpayer does not avoid the taxation of capital gains on the deemed disposal of tainted assets that have received CGT roll-over relief.

When will section 460A apply?

1.44 New section 460A will apply if there has been a deemed disposal under section 160ZZOA of the ITAA 1936 and either of the following apply:

•

the attributable taxpayer or an associate of the attributable taxpayer enters one or more schemes or arrangements that have the effect of reducing the attribution percentage of the attributable taxpayer in a CFC, and are intended by the attributable taxpayer or their associate to have that effect; or

•

a company ceases to be a CFC in relation to the attributable taxpayer.

Schemes or arrangements

1.45 The new section 460A will apply in determining the attribution percentage that will be used in working out the amount of attributable income of a CFC to be included in the assessable income of an attributable taxpayer as a result of a deemed disposal under section 160ZZOA of the ITAA 1936. It applies to ignore any reductions in the attribution percentage since the time of roll-over that are the result of a scheme or arrangement intended to reduce the attribution percentage.

1.46 If at any time after the roll-over relief was obtained one or more schemes or arrangements have the effect, and are intended to have the effect, of reducing the attribution percentage of the attributable company in relation to the CFC, those reductions are to be ignored for the purposes of determining the attribution percentage of the attributable taxpayer. This will ensure that attribution of the amount of any capital gain that was deferred on obtaining roll-over relief is not subsequently avoided from being included in the attributable income of the CFC.

Company ceases to be a CFC

1.47 New section 460A will also apply where a CFC that has obtained CGT roll-over relief ceases to be a CFC before the end of the statutory accounting period in relation to a particular accounting period, whether or not there was an intention to reduce the attribution percentage.

1.48 Any reduction in the attribution percentage of an attributable taxpayer that results in the CFC ceasing to be a CFC in relation to that attributable taxpayer is to be ignored for the purposes of determining their attribution percentage to be used in working out the amount of the attributable income of the CFC to be included in their assessable income as a result of a deemed disposal under section 160ZZOA of the ITAA1936.

1.49 New subsection 460A(2) also requires the attributable taxpayer to ignore any reductions in the attribution percentage that have occurred since the roll-over of the tainted asset that are a result of a scheme or arrangement that is covered by new paragraph 460A(1)(a) .

1.50 New section 460A enables section 456 of ITAA 1936 to operate in relation to the attributable income arising from the operation of section 160ZZOA of ITAA 1936 at the end of the statutory accounting period as though the CFC had not ceased to exist.

1.51 Without the operation of new section 460A the attributable taxpayer would not have any amount included in the attributable income because at the end of the statutory accounting period the taxpayer would no longer be an attributable taxpayer in relation to the company.

1.52 Items 23 and 24 of Part 2 of Schedule 1 ensure that the new section 460A introduced by Part 1 of Schedule 1 apply the CGT provisions of the ITAA 1997 for the 1998-99 and later income years.

Reduction of disposal consideration where attributed income not distributed

1.53 Sections 401 and 461 of the ITAA 1936 currently prevent potential double taxation when an attributable taxpayer disposes of an interest in an attribution account entity (as defined in section 363 of the ITAA1936) such as a CFC that holds tainted assets. Broadly, section 461 reduces the consideration from the disposal of the interest in a CFC to the extent that profits of the CFC have been previously attributed. Section 401 provides a similar result in determining the attributable income of a CFC.

1.54 Sections 401 and 461 of the ITAA 1936 currently reduce the consideration in such cases by reference to the attribution surplus immediately before the disposal. Broadly, the attribution surplus is the amount of profits that have previously been included in assessable income of the attributable taxpayer.

1.55 Sections 401 and 461 of the ITAA 1936 will be amended so that the attribution of an amount due to a disposal under section 160ZZOA of the ITAA 1936 will be included in the attribution surplus that is used to work out the reduction in the disposal consideration from the sale of an interest in the CFC. [Part 1 of Schedule 1 Items 5 and 9]

1.56 The amendments ensure that any amount included in an attributable taxpayers assessable income because of the application of section 160ZZOA of the ITAA 1936 will be included in any attribution surplus existing immediately before the disposal for the purposes of sections 401 and 461 of the ITAA 1936.

1.57 Where the attribution percentage in a CFC is reduced proportionally both sections 401 and 461 of the ITAA 1936 operate to include only that proportion of the attribution surplus in determining the amount of the reduction of the consideration.

1.58 Items 19 and 20 of Part 2 of Schedule 1 ensure that the amendments to section 401 of the ITAA 1936 introduced by Part 1 of Schedule 1 apply the CGT provisions of the ITAA 1997 for the 1998-99 and later income years. Also, Items 25 and 26 of Part 2 of Schedule 1 ensure that the amendments to section 461 of the ITAA 1936 introduced by Part 1 of Schedule 1 apply the CGT provisions of the ITAA 1997 for the 1998-99 and later income years.

Transitional application of section 460A

1.59 The proposed measures will require attributable taxpayers to work out their attribution percentage in a CFC at the time of roll-over of assets within a group. The current rules generally only require this percentage to be worked out at the end of the statutory accounting period.

1.60 To minimise the record keeping requirements on taxpayers Part 1 of Schedule 1 introduces a transitional measure that will apply to assets that have received group roll-over relief prior to the time of announcement of these measures (7.30pm, by legal time in the Australian Capital Territory, on 13May1997). [Item 11]

1.61 Taxpayers may elect to work out any reductions in their attribution percentage (for the purposes of new section 460A ) by reference to the attribution percentage at the end of the statutory accounting period in which the roll-over occurred, rather than the attribution percentage at the time of roll-over.

1.62 For CGT roll-overs occurring after the time of announcement taxpayers will be required to work out their attribution percentage at the time of the roll-over when applying new section 460A .

Regulation Impact Statement

1. Specification of policy objective

1.63 The policy objective of the amendments (announced in the 1997-98 Budget) is to remove anomalies preventing the intended Australian taxation of capital gains arising on certain deemed disposals of tainted assets of a CFC. The anomalies arise when a CFC has taken advantage of roll-over relief in the CGT provisions.

Background

1.64 Several anomalies have been identified in the interaction of the CFC and the CGT provisions. These anomalies result in uncertainty as to how the CGT and CFC provisions apply to capital gains made by a CFC on the disposal or deemed disposal of a tainted asset. In some cases the anomalies could result in the avoidance of Australian taxation. These anomalies arise because:

•

there is uncertainty as to whether tainted income consisting of capital gains on assets deemed to be disposed of by a CFC on its ceasing to be a member of a group, or ceasing to be a CFC, is included in the attributable income of the Australian resident controllers;

•

capital gains on the deemed disposal of tainted assets are not taken into account in determining whether a CFC passes the active income test;

•

it is uncertain whether designated concession income of a CFC includes capital gains on the deemed disposal of assets by a CFC on ceasing to be a member of a group; and

•

the taxation of capital gains on disposal of tainted assets can be avoided or minimised by arrangements intended to dilute an Australian taxpayers attribution interest in a CFC holding tainted assets that have received roll-over relief.

2. Identification of implementation option(s)

1.65 It is necessary to amend the ITAA 1936 to correct these anomalies. The proposed amendments are the only viable option for implementing the Governments policy objective (announced in the 1997-98 Budget).

1.66 The CFC provisions are contained in Part X of the ITAA 1936. These provisions use (after modification) the CGT rules in the ITAA 1936 and the ITAA 1997 to work out the attributable income of a CFC. For assessments for the 1998-99 and later income years, the CFC provisions apply the CGT rules in Parts 3-1 and 3-3 of the ITAA 1997. For earlier years of income, the CGT rules in Part IIIA of the ITAA 1936 are applied.

1.67 The proposed amendments apply to disposals (including deemed disposals) of tainted assets occurring after 13 May 1997. As this is prior to the 1998-99 year of income, the CFC provisions in the ITAA 1936 will need to be amended so that the CGT rules in the ITAA 1936 and the ITAA 1997 are modified to give effect to the announced measures.

1.68 The substantive CGT rules in the ITAA 1936 and the ITAA 1997 are not proposed to be amended. The proposed amendments will only modify the application of those rules for the purposes of the CFC measures.

Amendment to include certain deemed capital gains in attributable income

1.69 This amendment will apply to deemed disposals of tainted assets which have previously received roll-over relief under the CGT provisions under section 160ZZO of the ITAA 1936 or section 126-45 of the ITAA 1997 because the tainted asset was transferred within a wholly-owned company group. The amendment will ensure that tainted assets that have previously received this roll-over relief will be included in the notional assessable income of a CFC (under section 384 or 385 of the ITAA 1936) if the CFC ceases to be a member of that company group. This amendment will effectively bring the CFC treatment of these deemed disposals in line with the taxation treatment given to domestic companies.

Amendment to include certain deemed capital gains in the active income test

1.70 This amendment applies to CFCs that have received roll-over relief for tainted assets that are transferred within a wholly-owned group of companies. This proposed amendment will ensure that the active income test will include capital gains arising from the deemed disposal of those tainted assets if the CFC ceases to be a member of a wholly-owned group of companies.

Amendment to include certain deemed capital gains in designated concession income

1.71 This amendment also only applies to CFCs that have received roll-over relief for tainted assets that are transferred within a wholly-owned group of companies. A CFC that is resident in a broad-exemption listed country must include tainted income that is also eligible designated concession income in its notional assessable income if it fails the active income test. Eligible designated concession income is broadly designated concession income that has not been comparably taxed in another broad-exemption listed country.

1.72 The proposed amendment will ensure that capital gains arising from the deemed disposal of tainted assets when a CFC ceases to be a member of the wholly-owned group of companies will be included in designated concession income in section 317 of the ITAA 1936. This will mean that these deemed gains are capable of being included in the notional assessable income of a CFC resident in a broad-exemption listed country in accordance with section 385 of the ITAA 1936.

Amendment to ensure that the taxation of certain deemed gains is not avoided or minimised by either arrangements designed to dilute the Australian taxpayers attribution percentage or where the CFC ceases to be a CFC in relation to the attributable taxpayer

1.73 These amendments ensure that taxation of capital gains on disposal of tainted assets is not avoided or minimised by arrangements designed to dilute the Australian taxpayers attribution interest in the CFC that holds tainted assets that have received roll-over relief.

1.74 In addition, it is also proposed to ensure that the taxation of capital gains on disposal of these tainted assets is not avoided or minimised by the CFC ceasing to be a CFC (in relation to the attributable taxpayer) due to the reduction in the attribution percentage of Australian resident shareholders.

1.75 The proposed amendments also provide a transitional arrangement that applies to CFCs that have had a group roll-over disposal (within the meaning of section 160ZZOA of the ITAA 1936) before the time the measures were announced. Attributable taxpayers can elect to work out their attribution percentage at the time of roll-over under section 160ZZOA using either the actual attribution percentage at that time, or the attribution percentage at the end of the statutory accounting period in which the roll-over happened. This ensures that taxpayers will be able to identify whether there has been a dilution, if any, of their attribution percentage for the purposes of these amendments.

3. Assessment of impacts (costs and benefits) of each option:

Impact group identification

1.76 The primary impact of the amendments will be on Australian residents that have an attribution interest in a CFC that has obtained roll-over relief for the inter group transfer of tainted assets, and the CFC is subsequently deemed to have disposed of those tainted assets when it ceases to be a member of that wholly-owned company group. Taxpayers who are to be subject to the changes could broadly be described as Australian based multinationals.

1.77 The issues may arise in corporate reconstructions involving CFCs where roll-over relief is utilised. These reconstructions are relatively uncommon. The proposed amendments are unlikely to significantly affect taxpayers unless a group had been intending to make use of the identified anomalies to avoid payment of Australian tax.

1.78 Other impact groups that may be affected include the Australian Taxation Office (ATO) and taxpayers and their advisers who need to have an understanding of the proposed amendments and their application.

Amendment to include certain deemed capital gains in attributable income

1.79 Capital gains made on tainted assets deemed to be disposed of by a CFC on its ceasing to be a member of a wholly-owned group are to be included in the calculation of attributable income. This will achieve consistent treatment with the requirement for resident companies to value their assets and determine whether a capital gain or capital loss has arisen on the deemed disposal of assets which have received roll-over relief on ceasing to be a group company.

Amendment to include certain deemed capital gains in the active income test

1.80 The inclusion of the capital gains on assets deemed to be disposed of by a CFC on its ceasing to be a member of a group in the active income test provides equitable treatment with other gains and profits that are included in the active income test for the purpose of determining whether or not the test is passed. CFCs will now be required to keep additional records so that they can include these gains in applying the active income test.

Amendment to include certain deemed capital gains in designated concession income

1.81 The amendment to include capital gains on assets deemed to be disposed of by a CFC on its ceasing to a be a member of a wholly-owned group will be achieved by including those capital gains in the definition of designated concession income in the ITAA 1936. CFCs will now be required to keep additional records so that they can include these gains in the designated concession income of the CFC.

Amendment to ensure that the taxation of certain deemed gains is not avoided or minimised by either arrangements designed to dilute the Australian taxpayers attribution percentage or where the CFC ceases to be a CFC in relation to the attributable taxpayer

1.82 These amendments may lead to some increased compliance costs for those Australian taxpayers undertaking complex arrangements to dilute their interest or avoid the taxation of tainted assets. Under the proposed measure taxpayers will be required to determine their attribution percentage at the time of the roll-over of the asset in order to be in a position to determine whether the attribution percentage has subsequently been reduced. In addition, Australian taxpayers that have an attribution percentage (interest) in a CFC that subsequently ceases to be a CFC in relation to that attributable taxpayer will have additional costs working out and keeping records of their attribution percentage at the time of roll-over.

1.83 A transitional measure is proposed to apply to assets transferred prior to the issue of the Treasurers Press Release No. 51 on 13 May 1997 to enable taxpayers to use the attribution percentage at the end of the statutory accounting period in which the asset was rolled-over. This will ensure that taxpayers are not required to create records that may not have been recorded at the time of the roll-over.

Compliance costs

1.84 The initial and recurrent compliance cost of the 4 amendments are not expected to be significant (that is, less than $1 million per annum). The compliance costs will mainly result from record keeping and anticipated increased adviser fees but are not expected to be significant. Compliance costs will not increase for all CFCs only those that have received roll-over relief and mainly where the CFC subsequently ceases to be a member of a group. Further, most of the costs will arise for companies which fail the active income test and therefore derive significant amounts of tainted income.

1.85 It is possible that the need to value assets in the company which ceases to be a member of a group will increase compliance costs. However, assets are likely to be revalued to determine the sale price of the company. Moreover, resident companies generally value their assets on ceasing to be a group company.

1.86 It could also be argued that the need to determine the attribution percentage at the time of roll-over would increase compliance costs. This compliance cost is not expected to be significant as the CFC receiving the roll-over relief will be a member of a wholly-owned group, making the calculation of the attribution percentage easier. The proposed transitional measure will operate to reduce these compliance costs for assets rolled-over prior to the announcement of the measures.

Taxation revenue

1.87 The measures will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of tax minimisation practices. In the absence of the measure, to the extent that the revenue base would not be protected, there would be a significant revenue loss compared to the forward estimates.

1.88 The proposed amendment to ensure the taxation of capital gains on disposal of tainted assets is not avoided or minimised, by arrangements designed to dilute the Australian taxpayers attribution interest in the CFC that holds tainted assets that have received CGT roll-over relief, will protect the revenue base by removing opportunities for tax minimisation practices.

Consultation

1.89 Consultation has been undertaken through the National Tax Liaison Group subcommittee on foreign source income. A number of submissions have also been received in relation to the Treasurers Press Release No.51 on 13 May 1997.

4. Conclusion

1.90 The proposed amendments will improve the effectiveness of the rules for the accrual taxation of foreign source income by removing anomalies that prevent the intended interaction of the CFC measures and the CGT provisions.

1.91 The additional compliance burden will be borne by those Australian taxpayers with interests in CFCs that hold tainted assets and which have taken advantage of roll-over provisions.

1.92 The Treasury and the ATO will continue to monitor the rules for taxation of foreign source income to ensure the rules are operating appropriately. The ATO's existing consultative arrangements include the National Tax Liaison Group.

Chapter 2 - Amendments to exempt certain post judgment interest

Overview

2.1 Schedule 2 to this Bill will amend the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) to exempt from income tax post-judgment interest received in personal injury compensation cases.

Summary of the amendments

Purpose of the amendments

2.2 The purpose of the amendments is to exempt from income tax post-judgment interest received in personal injury compensation cases. This will ensure that individuals who have suffered personal injuries, and who face a delay in receiving the compensation that they are awarded as a result of those injuries, will not bear the burden of income tax on interest payable to them for any delay that occurs until all avenues of appeal have been exhausted.

2.3 The proposed amendments will provide a fair and equitable taxation treatment for post-judgment interest awarded in personal injury compensation cases. The amendments provide an equivalent or more generous taxation treatment than currently exists in other comparable jurisdictions.

Date of effect

2.4 The amendments to the ITAA 1936 will apply to the 1992-93 and later years of income up to, and including, the 1996-97 year of income [subitem 4(1), Schedule 2] . The amendments to the ITAA 1997 will apply to the 1997-98 and later years of income [subitem 4(2), Schedule 2] .

Background to the legislation

2.5 The amendments represent the Governments response to the Full Federal Court decision in Whitaker v Federal Commissioner of Taxation (1998)
98 ATC 4285;
38 ATR 219.

2.6 In that case, the Full Federal Court decided that post-judgment interest is income according to ordinary concepts and is assessable in the year in which it is received.

2.7 As a general rule, unless the court orders otherwise, post-judgment interest is payable on the amount of a judgment debt at a prescribed rate from the date that the judgment or order of the court comes into effect until the amount of the judgment debt is paid. For example, see section 95 of the Supreme Court Act (NSW) 1970.

2.8 When a plaintiff is unsuccessful at first instance, but obtains judgment from the relevant appeal court, post-judgment interest generally applies only from the date of the order of the appeal court, unless the court orders otherwise. Similarly, where a plaintiff is successful only on an appeal to the High Court, post-judgment interest will generally only be payable from the date of the judgment of the High Court, unless the court orders otherwise.

2.9 However, when the effect of a judgment of the High Court is to restore a judgment of the court of first instance (eg. a single judge of the Supreme Court of a State or Territory) which was reversed by a judgment of an appeal court, the judgment of the court of first instance remains standing from the date when it was originally made. In that situation, post-judgment interest generally will be payable from the date of the judgment at first instance.

2.10 Where the judgment given at first instance is not set aside on appeal, but the amount of the judgment is varied, either by increasing or decreasing it, post-judgment interest on the varied amount generally is payable from the date of the judgment at first instance.

Explanation of the amendments

2.11 This Bill will amend the ITAA 1936 and the ITAA 1997 to make post-judgment interest in personal injury compensation cases exempt from income tax. [Items 1 and 3, Schedule 2]

Period to which exemption applies

2.12 The exemption will apply to post-judgment interest payable to an individual who is awarded damages for personal injury. The interest that accrues from the time a judgment debt arises from the judgment of a court (the original judgment) until the time that judgment is finalised will be exempt. [New subsection 23GA(1) of the ITAA 1936 and new subsection 51-55(1) of the ITAA 1997]

2.13 In some situations, the original judgment that gives rise to a judgment debt will be the judgment given by an appeal court, where the taxpayer who is seeking compensation is unsuccessful at first instance.

2.14 If a judgment debt is taken to have arisen earlier than the time of the original judgment, the exemption will apply to the post-judgment interest that accrues from the earlier time [new subparagraphs 23GA(1)(b)(i) and 51-55(1)(b)(i)] . An example of this is where the plaintiff is not successful at first instance, but obtains judgment from an appeal court which orders that post-judgment interest is payable from the date of the judgment at first instance.

2.15 For the purposes of calculating the amount of post-judgment interest that is exempt from income tax, the original judgment is regarded as finalised at whichever of the following times is applicable:

•

if the period for lodging an appeal against either the original judgment or a subsequent related judgment expires without an appeal being lodged, the original judgment is finalised when the period for lodging an appeal expires [new paragraphs 23GA(2)(a) and 51-55(2)(a)] ;

•

if an appeal has been lodged against either the original judgment or a subsequent related judgment and a final judgment is given by a court, the original judgment is finalised when the final judgment (see paragraphs 2.17 to 2.20) takes effect [new paragraphs 23GA(2)(b) and 51-55(2)(b)] ;

•

if an appeal has been lodged against either the original judgment or a subsequent related judgment but is settled or discontinued, the original judgment is finalised at the time the settlement between the parties or the discontinuance takes effect [new paragraphs 23GA(2)(c) and 51-55(2)(c)] .

Expiry of appeal period

2.16 When a judgment is given by the Supreme Court of a State or a Territory, the parties have a limited period to lodge an appeal or seek leave to appeal to a higher court. If that appeal period expires without an appeal or application for leave to appeal having been lodged, post-judgment interest that accrues until the date on which the appeal period expires will be exempt from income tax. [New paragraphs 23GA(2)(a) and 51-55(2)(a)]

Example 1

A court awards David an amount of compensation for personal injuries that he suffers as a result of an accident. No appeal is lodged against that judgment. The amount of post-judgment interest that is exempt from income tax is the amount that accrues on the judgment debt until the time at which the right to appeal against the judgment expires.

Example 2

Mark is awarded damages by a court to compensate him for personal injuries he receives as a result of an accident. He is dissatisfied with the amount that he is awarded and appeals against the judgment. The appeal court gives judgment in his favour and increases the amount of the damages awarded. No appeal is lodged against that judgment. In Marks case, post-judgment interest is payable on the increased amount of damages from the date of the judgment at first instance. The amount of post-judgment interest that is exempt from income tax is the amount that accrues until the time at which any right to appeal or to seek special leave to appeal against the judgment of the appeal court expires.

Final judgment

2.17 A judgment will be regarded as a final judgment for the purposes of new paragraph 23GA(2)(b) of the ITAA 1936 or new paragraph 51-55(2)(b) of the ITAA 1997 if:

•

no appeal can be lodged against the judgment [new paragraphs 23GA(3)(a) and 51-55(3)(a)] ; or

•

leave to appeal against the judgment has been refused [new paragraphs 23GA(3)(b) and 51-55(3)(b)] .

2.18 For example, if a personal injury compensation claim has been the subject of an application for leave to appeal to the High Court of Australia and that application is refused, then the original judgment is finalised on the date that special leave is refused.

2.19 Alternatively, if the High Court grants leave to appeal, the original judgment is finalised when the judgment of the High Court takes effect.

2.20 In either situation, all avenues of appeal have been exhausted. Consequently, the exemption will apply to any post-judgment interest that accrues up to the date on which the High Court either refuses to grant leave to appeal or gives judgment in a matter for which it has granted leave to appeal.

Example 3

Betty suffers personal injuries as a result of an accident. She sues for damages and is unsuccessful at first instance. She appeals against that decision and is awarded damages by the appeal court. The High Court grants leave to appeal and subsequently confirms the decision of the appeal court.

In Betty's case, post-judgment interest is payable on the judgment debt that arises from the judgment of the appeal court. That is the original judgment for the purposes of new subsection 23GA(1) of the ITAA 1936 and new subsection 51-55(1) of the ITAA 1997. Consequently, any post-judgment interest that accrues on that judgment debt until the time that the judgment of the High Court takes effect will be exempt from income tax.

Settlements

2.21 If the original judgment which gave rise to a judgment debt is the subject of an appeal, and the appeal proceedings are subsequently settled or discontinued, the amount of post-judgment interest that has accrued on the judgment debt from the time of the original judgment until the time the settlement or discontinuance takes effect will be exempt from income tax. [New paragraphs 23GA(2)(c) and 51-55(2)(c)]

2.22 The expression by way of interest in new subsections 23GA(1) and 51-55(1) extends the exemption to situations where payment of post-judgment interest does not arise directly from a judgment debt. For example, the exemption will apply to an amount, payable under the terms of a settlement, that represents post-judgment interest, to the extent that it does not exceed the amount that a personal injury compensation recipient would have received if the amount of the settlement had been the amount of the judgment debt.

Example 4

Mike is injured in a car accident. A court awards him damages of $100,000. He is entitled to post-judgment interest at the relevant prescribed rate from the date the judgment debt comes into existence. The defendant appeals against the judgment but subsequently discontinues the appeal proceedings before the appeal court hearing. Post-judgment interest that accrues up to the date the appeal proceedings are formally discontinued will be exempt from income tax.

Example 5

A court awards Peter $250,000 damages in a personal injury compensation case. The defendant is dissatisfied with the amount of damages awarded to Peter and lodges an appeal against the judgment. The matter is settled before the appeal court hearing. The terms of the settlement are that Peter is to receive a lump sum of $200,000 by way of compensation, together with interest payable on that amount from the date of the original judgment at the rate prescribed for post-judgment interest. The amount of interest payable on the $200,000 from the date of the original judgment until the date the settlement takes effect will be exempt from income tax.

Assessable post-judgment interest

2.23 Post-judgment interest that accrues between the time at which all avenues of appeal have been exhausted and the time of the actual payment of the damages awarded to a taxpayer will continue to be assessable in the year in which it is received. As a general rule, in a personal injury case, payment will be made immediately after the litigation between the parties has been finally determined.

Meaning of personal injury

2.24 An entitlement to exemption for post-judgment interest does not extend to non-personal injury cases. The exemption applies only to post-judgment interest in personal injury cases. [New paragraphs 23GA(1)(a) and 51-55(1)(a)]

2.25 The term personal injury is not defined by the amendments but rather takes its ordinary meaning. The ordinary meaning of the term is an injury suffered to a person as opposed to the persons property, character or reputation. It covers physical injury (internal and/or external) and mental injury that is clearly discernible to a qualified medical practitioner (see Graham v Robinson
[1992] 1 VR 279).

Signposts

2.26 Division 11 of the ITAA 1997 lists the classes of exempt income and then links each class to the relevant section in the ITAA 1936 and the ITAA 1997. Section 11-10 is amended by inserting interest on a judgment debt for personal injury in the table of exempt income, with a reference to new section 51-55 of the ITAA 1997 and new section 23GA of the ITAA 1936 . [Item 2, Schedule 2]

Application

2.27 The amendment in item 1 of Schedule 2 applies to the 1992-93 year of income and later years of income until and including the 1996-97 year of income [subitem 4(1), Schedule 2] . The amendments in items 2 and 3 of Schedule 2 apply to the 1997-98 year of income and later years of income [subitem 4(2), Schedule 2] .

Period of amendment

2.28 As a general rule, the Commissioner of Taxation (the Commissioner) cannot amend an assessment to reduce the liability of a taxpayer after the end of four years from the date on which the tax became due and payable under the assessment.

2.29 Clause 4 of this Bill will allow the Commissioner to amend an assessment at any time to give effect to these amendments. This is necessary because the amendments apply to the 1992-93 year of income and later years. Without this provision the Commissioner could only give effect to amendments that were requested by taxpayers within 4 years of the date that tax became due and payable under their assessments.

Chapter 3 - Franking of dividends

Overview

3.1 Schedule 3 to this Bill will amend Part IIIAA of Income Tax Assessment Act 1936 (ITAA 1936) to make a number of changes to the franking credit trading and dividend streaming rules. Changes to the 45 day rule will:

•

make a correction to section 45ZB;

•

allow a deduction where franking rebates exceed the ceiling imposed under the benchmark portfolio ceiling method; and

•

treat shares and interests in shares held by a bare trust as if they were held by the beneficiaries of the trust.

3.2 A change to the limiting the source rule will remove the restrictions on exempting credits for dividends paid by former exempting companies for natural persons where all the shares are owned by natural persons and there has been no change in ownership of the company.

3.3 Schedule 3 will also amend the Taxation Laws Amendment Act (No.3) 1998 to extend the scope of a transitional concession for the general anti-avoidance rule in section 177EA of the ITAA 1936 and the specific anti-streaming rule in section 160AQCBA of the ITAA 1936 .

Summary of amendments

Purpose of amendments

3.4 The purpose of these changes is to make corrections to the franking credit trading and dividend streaming rules to ensure that they operate as intended.

Date of effect

3.5 These changes will apply from the commencement of the relevant measures.

Background to the legislation

3.6 The franking credit trading and dividend streaming rules restrict the benefits of franking credits and the franking rebate (franking benefits) or the intercorporate dividend rebate to taxpayers who are the economic owners of shares. These changes affect the following rules:

•

the 45 day rule, which applies to shares acquired from 1 July 1997, requires a shareholder to hold shares for at least 45 days at risk to be eligible for franking benefits or the intercorporate dividend rebate for dividends paid on the shares;

•

the related payments rule, which applies to arrangements entered into from 13May 1997, denies franking benefits and the intercorporate dividend rebate to a shareholder who is under an obligation to make related payments on substantially similar property;

•

the limiting the source rule, which applies from 13 May 1997, restricts the use of franking credits of companies effectively wholly owned by non-resident or tax-exempt persons;

•

a general anti-avoidance rule set out in section 177EA of the ITAA 1936, which applies to schemes entered into from 13 May 1997 for the disposition of shares with a non-incidental purpose of conferring a franking advantage; and

•

an anti-streaming rule set out in section 160AQCBA of the ITAA 1936, which applies from 13 May 1997, prevents companies streaming franking credits to shareholders most able to benefit from franking.

Explanation of the amendments

Correction to section 45ZB

3.7 A trust, or a partnership if prescribed by regulations, may make an election under 160APHR of the ITAA 1936 to have a franking credit or rebate ceiling applied against shares or interests in shares managed in a discrete fund. Section 45ZB caps the intercorporate dividend rebate available to corporate beneficiaries or partners that receive dividends indirectly through one or more interposed trusts or partnerships.

3.8 Item 1 makes a correction to paragraph 45ZB(6)(d) , which sets out the formula for calculating the amount of the rebate where a companies average rate of tax is not the general rate of tax. [Item 1]

Treatment of bare trusts under the 45 day rule

3.9 Under new subsection 160APHH(6) , bare trustees and nominees holding shares (but not interests in shares) for a single beneficiary are to be ignored for the purposes of Division 1A ; instead, the shares are to be treated as if they are held by the beneficiary. [Item 2, new subsection 160APHH(6)]

3.10 This will be an exception to the rule in subsection 160APHU(1), which otherwise requires trustees to be qualified persons before beneficiaries may be qualified persons. The object of this change is to reduce compliance costs for nominees and custodians. Item 4 amends subsection 160APHU(1) accordingly. [Item 4]

3.11 This exception will apply to a trust where there is a single beneficiary under the trust and that beneficiary is absolutely entitled to the shares held by the trustee. A person is absolutely entitled to trust property if he or she is able to direct the trustee how to deal with trust property and to give the trustee a good receipt for anything with which the trustee has parted; that is, the beneficiary must be sui juris, and have a vested, indefeasible, and absolute interest in the trust property so that the trustee may be compelled to convey the trust property to the beneficiary if so requested. In such a case, there is an identity of interest between the trust and the beneficiary; indeed, the trustee is effectively an agent of the beneficiary; and it is therefore unnecessary to apply the provisions in the new Division to the trustee.

3.12 New paragraph 160APHH(6)(c) will therefore require the Division to be administered as if the shares or interests held by the trustee were held directly by the beneficiary, including, of course, the act of deriving income from the shares. This will effectively exempt bare trustees from the Division and render it unnecessary for them to be qualified persons in relation to a dividend. (However, the beneficiary must still satisfy the relevant requirements.)

3.13 Properly, a trustee is not a bare trustee if there are duties to be performed under the trust. However, it is not uncommon for nominees and custodians to be authorised or required by their beneficiaries to perform duties on their behalf, which may include hedging. Accordingly, the exception does not exclude a trustee merely because the trustee has duties to perform. Anything done in the performance of those duties by the trustee, such as entering into hedges, is automatically attributed to the beneficiary under new subparagraph 160APHH(6)(c)(ii) .

3.14 Since the shares held by the trustee are treated as being held by the beneficiary, transfers of the shares between trustee and beneficiary are disregarded under new paragraphs 160APHH(6)(d) and (e) . This means, for example, that if shares are transferred from one to the other, any days during which either of them held shares at risk are counted in determining whether the beneficiary has satisfied the holding period rule.

3.15 If new subsection 160APHH(6) ceases to apply to a trust, new section 160APHH(7) specifies what occurs. Subject to some special rules for trusts which become widely-held trusts, new subsection 160APHH(6) is treated, from that time on, as never having applied: the ordinary rules in new Division 1A regarding trusts will therefore apply. Consequently, from that time on, the trustee must be a qualified person in relation to a dividend if franking benefits are to be passed to the beneficiaries of the trust, and in determining whether, from that time on, the trustee is a qualified person, regard is to be had to the acts previously imputed to the beneficiary by new paragraph 160APHH(6)(c) . Except for trusts which become widely-held trusts, that means the trustee will be treated as having held its shares from the times they were acquired, or would have been taken to have been acquired, but for new subsection 160APHH(6) ; likewise, the beneficiary will be treated as having held its interest or interests in shares from the time which would, but for new subsection 160APHH(6) , have been treated as the acquisition dates. [Item 2, new subsection 160APHH(7)]

3.16 For widely-held trusts the situation is different: when a bare trust to which new subsection 160APHH(6) formerly applied becomes a widely-held trust, the beneficiary is deemed to dispose of the shares to the trustee at the time of conversion, and then acquire an interest in the shares; and the trustee is taken to acquire the shares at that time. Widely-held trusts receive special treatment under new subsection 160APHH(7), because, unlike other trusts, the new rules do not look through the trust to see if the beneficiary has a continuing interest in particular shares; it only requires a continuing interest in the trust property as a whole.

3.17 The respective positions of the trustee and beneficiary in relation to the shares or interest in shares are determined accordingly. Thus in deciding whether the trustee or beneficiary of a non widely-held trust has held a share or interest at risk for the requisite number of days, regard is had to their positions after conversion, because the trust is only taken to acquire its shares, and the beneficiary its interest in shares, after conversion. (The positions of the trustee may, of course, result from acts done before conversion and previously imputed to the beneficiary.)

3.18 For example, if the trust has actually held shares for 20 days before new subsection 160APHH(6) ceased to apply, its positions in that period would be examined to see if risk was materially diminished; if it held the shares without materially diminishing risk, and did not become a widely-held trust, that holding would count with any subsequent holding. Thus if the trust held the shares for a further 25 days during the primary qualification period, the first 20 days would count with the later 25days for the purposes of determining whether the trustee is a qualified person. But if the trust becomes a widely-held trust, the first 20 days would not count because the trustee would be taken to acquire the shares only on conversion.

3.19 When a trust to which new subsection 160APHH(6) ceases to apply does not become a widely-held trust, there is no deemed disposal of shares by the beneficiary; instead the beneficiary is treated as always having had an interest in shares. However, generally there will be an actual disposal of an interest in shares by the beneficiary to a third party. That is because the entitlement of the beneficiary in the shares held by the trust could not cease to be absolute unless the beneficiary has alienated an interest in the shares, or consented to a resettlement; nor, generally speaking, could a beneficiary be added to the trust with the alienation of an interest in the shares held on trust. If there is an actual disposal by the beneficiary of an interest in shares it will be relevant to the question of whether the beneficiary is a qualified person.

3.20 New subsection 160APHH(7) cannot apply, it should be observed, to the divestment of an interest owing to the happening of any contingency, or the failure of a condition, because contingent and defeasible interests are incapable of constituting an absolute entitlement to the trust property.

Deduction for excess franking rebates

3.21 Where a taxpayer has elected under section 160APHR of the ITAA 1936 to use the benchmark portfolio ceiling method instead of the 45 day rule to determine the entitlement to franking benefits, section 160AQZF of the ITAA 1936 places a ceiling on the franking rebates or intercorporate dividend rebates to which the taxpayer is entitled. Under the current benchmark ceiling method rules, the assessable income of a taxpayer who is denied franking rebates in excess of the ceiling amount will be increased inappropriately under the grossing up rules. As a result, a taxpayer would be required to pay tax on the grossed up amount but would not receive a corresponding franking rebate.

3.22 New subsection 160AQZF(6) provides that, where the sum of the rebates of tax to which the electing taxpayer is entitled under Part IIIAA of the ITAA 1936 (ie. the franking rebates) exceeds the ceiling amount calculated under subsection 160AQZF(2) of the ITAA 1936, the excess will be allowable as deduction from the taxpayers assessable income of the year of income. [Item 6 ; new subsection 160AQZF(6)]

3.23 Item 3 amends subsection 160APHR(8) to clarify that a taxpayer who makes an election to use the benchmark portfolio ceiling method will be a qualified person in relation to dividends paid on shares held by the taxpayer to which the election applies. [Item 3]

Change to transitional rule for general anti-avoidance rule and specific anti-streaming rule

3.24 The general anti-avoidance rule in section 177EA of the ITAA 1936 and the specific anti-streaming rule in section 160AQCBA of the ITAA 1936 generally apply to dividends paid, or distributions made in respect of dividends, after 7.30 pm on 13 May 1997 when they were announced. However, as a concession, the measures do not apply to dividends paid by a listed public company after this time if the dividends were declared before this time, or to distributions related to such dividends made after this time. This concession is set out in subitem 26(3) of Schedule 8 to the Taxation Laws Amendment Act (No. 3) 1998.

3.25 However, this concession does not extend to distributions made after this time related to dividends declared and paid before this time. To remove this anomaly, item7 amends paragraph 26(3)(b) in Schedule 7 to the Taxation Laws Amendment Act (No. 3) 1998 to extend the concession to all distributions made after 7.30 pm on 13 May 1997 if the related dividends were declared before this time. [Item 7, new paragraph 26(3)(b) in Schedule 7 to Taxation Laws Amendment Act (No. 3) 1998]

Limiting the source rule: access to exempting credits for dividends paid by former exempting companies for natural persons who regain their resident status

3.26 New subsection 160AQTB(4) is intended to deal with the rare case where a company becomes an exempting company because the individuals who own it leave Australia and cease to be residents, and then becomes a former exempting company because the owners return to Australia. If this change was not made, individuals in this position would be unable to claim a franking rebate for their own franking credits. To prevent unnecessary complexity, new subsection 160AQTB(4) addresses only the simplest scenario; other cases would be very rare indeed. [Item 5, new subsection 160AQTB(4)]

3.27 For new subsection 160AQTB(4) to apply to an exempted dividend distributed by a former exempting company, each of the following conditions must be satisfied:

•

all the shares in the company must be owned, directly or indirectly, by natural persons who are residents. Indirect ownership includes ownership through fixed trusts and partnerships, but not discretionary trusts since discretionary objects of a trust do not have an ownership interest in the trust property;

•

the company must become an exempting company because some or all of the individual owners cease to be residents (and not, for example, by reason of a sale of shares to non-residents);

•

the company must become a former exempting company because all and not merely some of the original owners are once more residents; and

•

all the shares in the company must continue to be owned by the original owners (though not necessarily in the same proportions) from the day the company became an exempting company to the day the relevant distribution is received.

3.28 Where these conditions are satisfied, the exempting credit attached to the distribution is treated as if it were a franking credit, and the individual receiving the distribution accordingly receives a franking rebate. New subsection 160AQTB(4) does not include anti-avoidance provisions but section 177EA of the ITAA 1936 will apply to arrangements which amount to a disposal of shares for a purpose of conferring a franking benefit.

Chapter 4 - Non-deductibility of bribes

Overview

4.1 Schedule 4 to this Bill will amend the Income Tax Assessment Act 1997 (ITAA 1997) to disallow a deduction for bribes made to foreign public officials. A taxpayer will be regarded as having made a bribe to a foreign public official to the extent that:

•

an amount is incurred in providing a benefit to another person; and

•

the benefit is not legitimately due to that person; and

•

the amount is incurred with the intention of influencing a foreign public official in the exercise of the officials duties in order to obtain or retain business or an advantage in the conduct of business.

Summary of the amendments

Purpose of the amendments

4.2 The amendments will implement the recommendation of the Organisation for Economic Co-operation and Development (OECD) Council that member countries should deny tax deductibility for bribes made to foreign public officials.

Date of effect

4.3 The amendments will apply to the 1999-2000 income year and later income years. [Item 6, Schedule 4]

Background to the legislation

Non-deductibility of bribes

4.4 On 27 May 1994, the OECD Council made a recommendation that its member countries take effective measures to deter, prevent and combat the bribery of foreign public officials in connection with international business transactions. The OECD Council also recommended that each member country examine its tax legislation, regulations and practices, insofar as they may indirectly favour bribery.

4.5 Following further negotiations between member countries, on 11April 1996 the OECD Council made a further recommendation that member countries which do not disallow deductions for bribes made to foreign public officials should re-examine their taxation laws with the intention of denying deductibility for such expenditure.

4.6 Although the Government considers that the Australian business community has high ethical standards, it is supportive of OECD efforts to combat bribery in international business transactions. It shares the concerns of other member countries that the payment of bribes to foreign public officials causes economic and trade distortion. The Government, therefore, supports the recommendation to disallow deductions for bribes paid to foreign public officials.

4.7 The taxation amendments are consistent with recent amendments to the Criminal Code which make it a criminal offence to pay bribes to foreign public officials. The Criminal Code amendments are designed to ensure that Australia complies with the key feature of the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, which came into force in Australia on 15 February 1999.

Current law

4.8 Section 8-1 of the ITAA 1997 allows deductions for losses and outgoings that are incurred in the gaining or producing of assessable income, or are necessarily incurred in the carrying on of a business for the purpose of gaining or producing assessable income. Section 8-1 does not differentiate between expenditure incurred in pursuing an illegal or a legal income-producing activity. Therefore, currently the payment of a bribe to a foreign public official may be an allowable deduction if the payment otherwise satisfies the requirements of section 8-1.

Benefits of the proposed legislation

4.9 Allowing tax deductions for bribes to foreign public officials contributes to the perception that such payments are an acceptable practice for those trading in the international business community.

4.10 The introduction of legislation disallowing tax deductions for such payments is conducive to creating a more level playing field in international trade and investment. Bribery distorts international competitive conditions and contributes to the misallocation of resources.

4.11 The taxation laws of many OECD member countries already deny a tax deduction for bribes paid to foreign officials. These amendments will align Australia's taxation position with the majority of other OECD member countries.

4.12 However, the amendments will not put Australian businesses at a disadvantage compared with other OECD countries, as the scope of the amendment will be similar to the revenue laws of our main trade competitors. For example, the United Kingdom (UK) does not allow deductions for bribes paid to foreign public officials if the bribe is a criminal offence. The United States (US) law adopts the same approach, but specifically excludes facilitation payments that expedite or secure the performance of routine government actions. The proposed amendments have a similar exclusion for facilitation payments.

Explanation of the amendments

4.13 Item 2 of Schedule 4 inserts new section 26-52 which deals with bribes to foreign public officials. Item 4 of Schedule 4 inserts the definition of bribe to a foreign public official into subsection 995-1(1) of the ITAA 1997.

4.14 New subsection 26-52(1) specifically denies a deduction for any loss or outgoing that is incurred by a taxpayer if it is a bribe to a foreign public official.

4.15 New subsection 26-52(2) lists the elements that constitute a bribe to a foreign public official. They are that:

•

an amount is incurred by a taxpayer in, or in connection with providing a benefit to another person [new paragraph 26-52(2)(a)] ; and

•

the benefit is not legitimately due to the other person [new paragraph 26-52(2)(b)] ; and

•

the amount is incurred with the intention of influencing a foreign public official in the exercise of the officials duties in order to obtain or retain business, or to obtain or retain an advantage in the conduct of business [new paragraph 26-52(2)(c)] .

4.16 The following chart explains the operation of the new provisions.

Overview of the operation of new section 26-52

Providing a benefit to another person

4.17 The first matter to consider in determining whether or not an amount is a bribe to a foreign public official is whether the amount is incurred in, or in connection with:

•

providing or causing a benefit to be provided to another person [new subparagraphs 26-52(2)(a)(i) and (ii)] ; or

•

offering or promising to provide a benefit to another person [new subparagraph 26-52(2)(a)(iii)] ; or

•

causing an offer or promise of the provision of a benefit to be made to another person [new subparagraph 26-52(2)(a)(iv)] .

4.18 Benefit is defined to include any advantage and is not limited to a benefit that is in the form of property. For example, it could include the provision of services. [New Subsection 26-52(2)]

4.19 It is not necessary under new paragraph 26-52(2)(a) that the taxpayer who bribes a foreign public official actually provides a benefit to that official or to another person. It will be sufficient if the taxpayer causes a benefit to be provided to another person; offers or promises to provide a benefit to another person; or causes an offer or promise of a benefit to be made to another person.

Benefit not legitimately due

4.20 The second matter to consider in determining whether or not an amount is a bribe to a foreign public official is whether or not the benefit is legitimately due to the other person.

4.21 New paragraph 26-52(2)(b) will be satisfied only if the benefit provided is not legitimately due to that person. There may be situations under the law or regulations of the foreign officials country where the recipient will have a legal right to remuneration for services rendered.

4.22 Accordingly, these amendments ensure that such a payment is not considered to be a bribe to a foreign official. However, if the payment exceeds the amount that is legitimately due to an official in a particular situation, it may be considered to be a bribe to the extent of the excess payment.

4.23 For the purposes of working out if a benefit is not legitimately due to the other person in a particular situation, no regard can be given to:

•

the fact that the benefit may be customary, or perceived to be customary, in the situation [new paragraph 26-52(6)(a)] ;

•

the value of the benefit [new paragraph 26-52(6)(b)] ;

•

any official tolerance of the benefit [new paragraph 26-52(6)(c)] .

4.24 In other respects, the term not legitimately due will take its ordinary meaning.

4.25 For example, it might be argued that amounts paid to foreign public officials that are not lawful under local law might qualify as allowable deductions because such payments are commonly made and, therefore, are customary. Alternatively, it might be argued that no action is likely to be taken against an official who receives a bribe and, therefore, such behaviour is tolerated at an official level. New subsection 26-52(6) will preclude such arguments being raised by a taxpayer who wishes to claim a deduction for a bribe.

4.26 Similarly, the requirement to disregard the value of the benefit ensures that even a relatively small payment, when compared with the overall resources of an individual or organisation, may still meet the definition of a bribe, if the other requirements of new subsection 26-52(2) are satisfied.

Influencing a foreign public official

4.27 The third matter to be considered in determining whether or not an amount is a bribe to a foreign public official is whether the amount has been incurred with the intention of influencing a foreign public official in the exercise of that officials duties in order to:

•

obtain or retain business [new subparagraph 26-52(2)(c)(i)] ; or

•

obtain or retain an advantage in the conduct of business that is not legitimately due to the person who incurred the amount, or another person, as the recipient, or intended recipient, of the business advantage [new subparagraph 26-52(2)(c)(ii)] .

4.28 It is not necessary that the person who benefits or who may benefit is the foreign public official who the taxpayer is seeking to influence. For example, the new provisions may apply if a benefit is provided, or an offer or promise is made to provide a benefit to a relative or associate of the foreign public official, or any other person.

4.29 New subsection 26-52(8) provides that duties of a foreign public official are any authorities, duties, functions or powers that:

•

are conferred on the official [new paragraph 26-52(8)(a)] ; or

•

the official holds himself or herself out as having [new paragraph 26-52(8)(b)] .

4.30 This means that an amount incurred by a taxpayer to influence a foreign public official may be a bribe even though it is not within the scope of the officials duties to ensure that the taxpayer obtains or retains the business or the business advantage being sought.

Obtaining or retaining business

4.31 New subparagraph 26-52(2)(c)(i) covers the situation where an amount is incurred with the intention of influencing an official in the performance of the officials duties in order to obtain or retain business. The focus is firmly on benefits provided with the intention of influencing international business or trade.

4.32 The provision of a bottle of wine to a foreign public official each Christmas by a person who is frequently engaged in business dealings with the official during the year generally would not be considered to have been made to obtain or retain business. However, the provision of a holiday package to a foreign public official by a taxpayer who has tendered for some form of business, prior to the officials decision on the awarding of the tender, is highly likely to be regarded as having been provided with the intention of influencing the official.

Business advantage not legitimately due

4.33 New subparagraph 26-52(2)(c)(ii) deals with the situation where the intention to influence the official was in order to obtain or retain an advantage in the conduct of business that is not legitimately due to the person who incurs the amount, or another person, as the recipient, or intended recipient, of the business advantage. In other words, there must be a legitimate basis for obtaining or retaining the business advantage.

4.34 For example, the provisions will apply if a payment is made to obtain an operating permit for a new factory where the usual requirements for the issue of such a permit have not been satisfied. This is a clear example of a situation where a business advantage, being the permit, is not legitimately due.

4.35 In working out if a business advantage is not legitimately due to a person in a particular situation, no regard can be given to:

•

the fact that the advantage may be customary, or perceived to be customary, in the situation [new paragraph 26-52(7)(a)] ;

•

the value of the advantage [new paragraph 26-52(7)(b)] ;

•

any official tolerance of the business advantage [new paragraph 26-52(7)(c)] .

4.36 The factors in new subsection 26-52(7) to be disregarded in working out if a business advantage is not legitimately due are the same as the factors to be disregarded in determining if a benefit is not legitimately due under new paragraph 26-52(2)(b) . In other respects the meaning of an advantage in the conduct of business that is not legitimately due is to have its ordinary meaning.

Payments that are legal in the foreign public officials country

4.37 New subsection 26-52(3) provides that an amount is not a bribe to a foreign public official if no person would have been guilty of an offence against the law of the foreign public officials country, if the benefit had been provided, and all related acts had been done, in that country.

4.38 This provision is intended to ensure that a deduction will not be disallowed if the provision of a benefit was lawful in the foreign public officials country.

Facilitation payments

4.39 New subsection 26-52(4) provides that an amount is not a bribe to a foreign public official if it is incurred for the sole or dominant purpose of securing or expediting the performance of a routine government action of a minor nature. In other words, a payment to a foreign public official for that purpose will be regarded merely as a facilitation payment.

4.40 This exception is similar to the exception provided under US law for a payment that is made to facilitate or expedite a routine government action. For example, it may be necessary in some situations to make a payment to a foreign official, political party, or party official to secure the performance of a routine government action. In some countries, such payments must be made to induce public officials to perform their routine functions. However, it is unlikely that a small facilitation payment would constitute a payment that is made in order to obtain or retain business or a business advantage.

Routine government action of a minor nature

4.41 New subsection 26-52(5) sets out a range of matters that will be considered in determining whether or not a particular action is a routine government action. For something to be a routine government action, it must be an action that is ordinarily and commonly carried out by the foreign public official [new paragraph 26-52(5)(a)] .

4.42 The term routine government action is intended to include the following actions or any actions of a similar nature:

•

granting a permit, licence or other official document that qualifies a person to do business in a foreign country or in a part of a foreign country [new subparagraph 26-52(5)(b)(i)] ;

•

processing government papers such as a visa or work permit [new subparagraph 26-52(5)(b)(ii)] ;

•

providing police protection, or mail collection or delivery [new subparagraph 26-52(5)(b)(iii)] ;

•

scheduling inspections associated with contract performance or related to the transit of goods [new subparagraph 26-52(5)(b)(iv)] ;

•

providing telecommunications services, power or water [new subparagraph 26-52(5)(b)(v)] ;

•

loading and unloading cargo [new subparagraph 26-52(5)(b)(vi)] ;

•

protecting perishable products, or commodities, from deterioration [new subparagraph 26-52(5)(b)(vii)] .

4.43 An action of a foreign public official will not be regarded as a routine government action if it involves a decision or involves encouraging a decision about:

•

whether to award new business [new subparagraphs 26-52(5)(c)(i) and (d)(i)] ; or

•

whether to continue existing business with a particular person [new subparagraphs 26-52(5)(c)(ii) and (d)(ii)] ; or

•

the terms of new business or existing business [new subparagraphs 26-52(5)(c)(iii) and (d)(iii)] .

4.44 New subsection 26-52(5) provides a basis for distinguishing between a situation where a payment would be regarded as merely a facilitation payment and a situation where a payment is likely to be regarded as a bribe.

4.45 For example, a manager in Australia authorises a payment to a foreign public official for the sole or dominant purpose of expediting the connection of a single phone in an office that already has 50 phones. The telephone connection is required to enable the business to carry on its normal business functions. The usual waiting time is three months, but as a result of paying a fee to the official, the telephone is connected almost immediately. In this situation, the payment would be regarded as having been made to secure the performance of a routine government action of a minor nature hence, the payment would be a facilitation payment.

4.46 Another example of a payment made to secure a routine government action of a minor nature is where, upon arriving in a foreign country, a business person is informed that his or her visa is invalid and that a fee must be paid to a foreign public official for the sole purpose of expediting the issue of a new visa.

4.47 The use of the term minor nature is intended to ensure that the exclusion will apply only to comparatively small payments, while at the same time overcoming the practical difficulty of specifying a monetary threshold in the legislation which would be appropriate in all circumstances. It is unlikely that a significant benefit would be provided merely to facilitate a routine government action of a minor nature.

4.48 An example of a routine government action that is not of a minor nature would be where an international banking corporation wishes to set up a banking operation in a foreign country and seeks to obtain a banking licence. The process is complicated and the waiting period is substantial, but a significant amount of money is paid to a foreign official to facilitate or expedite the process. In that situation, although it may be argued that the government action is routine, it would not be regarded as action of a minor nature and, therefore, the payment would not be a facilitation payment.

4.49 In accordance with existing requirements under section 262A of the Income Tax Assessment Act 1936, persons carrying on a business will need to keep records of any facilitation payments incurred.

Definition of foreign public official

4.50 The term foreign public official takes the same meaning that is used in section 70.1 of the Criminal Code [item 5, Schedule 4] . The Criminal Code defines the term widely to mean:

•

an employee or official of a foreign government body;

•

an individual who performs work for a foreign government body under a contract;

•

an individual who holds or performs the duties of an appointment, office or position under a law of a foreign country or of part of a foreign country;

•

an individual who holds or performs the duties of an appointment, office or position created by custom or convention of a foreign country or of part of a foreign country;

•

an individual who is otherwise in the service of a foreign government body (including service as a member of a military force or police force);

•

a member of the executive, judiciary or magistracy of a foreign country or of part of a foreign country;

•

an employee of a public international organisation or an individual who performs work for such an organisation under a contract;

•

an individual who holds or performs the duties of an office or position in a public international organisation;

•

an individual who is otherwise in the service of a public international organisation;

•

a member or officer of the legislature of a foreign country or of part of a foreign country; or

•

an individual who is an authorised intermediary (or holds himself or herself out to be an authorised intermediary) of a foreign public official.

4.51 The term foreign public official would include representatives of a foreign country who are present in Australia.

4.52 Employees or officers of public international organisations are included in the definition of foreign public official because foreign public officials can include persons who are officials of public international organisations.

4.53 The term public international organisation is also defined in section 70.1 of the Criminal Code. It is defined to mean an organisation of which two or more countries or the governments of two or more countries are members, or which has been established by an organisation of which two or more countries or governments of countries are members, or which is a sub-group established by such an organisation.

4.54 Foreign country is also defined in section 70.1 of the Criminal Code to include colonies or overseas territories, territories outside Australia whose international relations are, to any extent, the responsibility of another country and other territories outside Australia which are partly self-governing but are not recognised by Australia as sovereign states.

Expenditure not to form part of cost base

4.55 New subsection 110-25(9) provides that, to the extent that expenditure incurred is a bribe to a foreign public official, it does not form part of the cost base of any relevant asset for capital gains purposes [item 3, Schedule 4] . This will ensure that a taxpayer cannot gain any tax advantage as a result of giving a bribe to a foreign public official.

Capital Allowances

4.56 New subsection 26-52(1) ensures that no deduction is allowable under the ITAA 1997 for any loss or outgoing incurred by a taxpayer that is a bribe to a foreign public official. The effect of this is that bribes cannot form part of any capital expenditure that qualifies for a deduction under Part 2-10 of the ITAA 1997.

Signpost

4.57 Item 1 of Schedule 4 inserts a reference to bribes in the table of rules about specific types of deductions contained in section 12-5 of the ITAA 1997.

Application

4.58 The amendments made by Schedule 4 apply to losses, outgoings or expenditure incurred in the 1999-2000 and later income years. [Item 6, Schedule 4]

Commencement

4.59 Schedule 4 to this Bill commences immediately after the commencement of the Criminal Code Amendment (Bribery of Foreign Public Officials) Act 1999 (the CCA Act) [subclause 2(8)]. This is necessary because:

•

the definition of foreign public official that this Bill inserts in subsection 995-1(1) of the Act has the same meaning as in section 70.1 of the Criminal Code; and

•

the CCA Act, which introduces that definition and other related definitions into the Criminal Code will commence on the earlier of the date on which it is proclaimed, or, if there is no proclamation, the first day after the expiry of six months from Royal Assent.

4.60 If Schedule 4 to this Bill was to commence prior to the commencement of the CCA Act, the reference to the definition of foreign public official in item 5 of Schedule 4 would not be effective until the commencement of the CCA Act.

Regulation Impact Statement - Non-deductibility of bribes made to foreign public officials

Policy objective

4.61 The policy objective is to give effect to a recommendation by the OECD Council that member countries deny tax deductibility for bribes to foreign public officials.

4.62 This recommendation was initiated by the US which was concerned about the competitive disadvantage faced by its businesses which could not claim tax deductions under US revenue laws.

Implementation options

4.63 The implementation of the Governments policy objective involves three options.

Option 1 Deny deductions for all bribes made to foreign public officials

4.64 This option would require amendments to the ITAA 1997 to disallow deductions for all bribes made to foreign public officials. A bribe is a payment made with the intention of influencing an official in order to obtain or retain business or a business advantage that is not legitimately due. For example, this would be the case where an amount is paid in order to receive an operating permit for a factory where the person has failed to satisfy the statutory requirements for issue of such a permit.

4.65 The proposed amendments would apply in respect of amounts incurred in the 1999-2000 and later income years. There are no transitional arrangements.

4.66 The administration costs will be minimal as changes to Australian Taxation Office (ATO) administrative procedures will not be required. However, the ATO may need to allocate resources to ensure that bribes are not being claimed as tax deductions. ATO auditors would, in the course of an audit, check to see if any expenditure being claimed as a deduction constitutes a bribe to a foreign public official.

4.67 There is no indication of what it would cost to enforce the measure because the ATO does not keep records of businesses that are paying bribes to foreign public officials. Also it is not possible to ascertain how much trade depends on the payment of bribes to foreign public officials.

4.68 Taxpayers will be advised of the new provisions via consultative forums with businesses and tax agents, and through ATO publications.

4.69 No additional information will be required from taxpayers as part of the implementation of this measure.

Option 2 Deny deductions for bribes made to foreign public officials other than facilitation payments

4.70 This option would require amendments to the ITAA 1997 to disallow bribes made to foreign public officials, but it would allow deductions for facilitation payments made to foreign public officials. This option is similar to the deductibility rules applying under the US revenue laws.

4.71 A facilitation payment is a payment to expedite or to secure the performance of a routine government action by a foreign public official. For example, a manager in Australia authorises a payment to a foreign public official to expedite the connection of a single phone in an office that already has 50 phones. The telephone connection is required to enable the business to carry on its normal business functions. The normal waiting time is three months, but by paying a fee, the telephone is connected almost immediately.

4.72 The proposed amendments would apply in respect of amounts incurred in the 1999-2000 and later income years. There are no transitional arrangements.

4.73 The administration costs will again be minimal as changes to ATO administrative procedures will not be required. Resource costs may be higher than Option 1 because more checking may need to be done to ensure that bribes are not being claimed or disguised as facilitation payments.

4.74 It is anticipated that the distinction between a bribe and a facilitation payment is clear enough so that costs involved in contesting the issue will be kept to a minimum.

4.75 Taxpayers will be advised of the new provisions through consultative forums with businesses and tax agents and through ATO publications.

4.76 No additional information will be required from taxpayers as part of the implementation of this measure.

Option 3 Deny a deduction for all bribes made other than facilitation payments

4.77 This option would require amendments to the ITAA 1997 to disallow all bribes whether made to foreign public officials or to domestic public officials. However, facilitation payments made to foreign public officials would still be an allowable deduction.

4.78 The proposed amendments would apply in respect of amounts incurred in the 1999-2000 and later income years. There are no transitional arrangements.

4.79 The administration costs will be minimal as changes to ATO administrative procedures will not be required. However, the ATO may need to allocate resources to ensure that bribes are not being claimed as tax deductions.

4.80 Taxpayers will be advised of the new provisions via consultative forums with businesses and tax agents, and through ATO publications.

4.81 No additional information will be required from taxpayers as part of the implementation of this measure.

Assessment of impacts (costs and benefits)

Impact groups

4.82 The groups impacted by the disallowance of bribes made to foreign public officials are as follows:

Government

•

the Commonwealth Government will gain revenue as bribes will not be claimed as a deduction;

•

Australia's reputation in the international community will be enhanced;

•

bribery raises business costs, creates uncertainty and distorts international trade and investment. Consequently, trade may be adversely affected when Australian exporters and other companies have to compete with countries that continue to allow a deduction for bribe payments.

Taxpayers

•

the net cost of paying a bribe to obtain or retain business in foreign countries will increase;

•

Australian taxpayers operating overseas may be disadvantaged as they will no longer be able to claim bribes as an expense of doing business in foreign countries. In particular, firms in the engineering and construction sectors, infrastructure providers, defence contractors and manufacturers are likely to be most affected by the proposed changes. Also service providers such as lawyers and accountants may also face increased costs as a result of the proposed amendment.

Assessment of costs Option 1

4.83 The compliance cost to affected taxpayers of this change will be minimal and will be limited to learning about the new legislation. There may be a small compliance cost imposed on taxpayers having to categorise outgoings according to the definition of a bribe payment. Businesses that cease paying bribes may lose some business as a result. Alternatively, businesses that continue to pay bribes will no longer be entitled to a deduction for the expenditure incurred.

4.84 Compliance levels should increase over time as international community tolerance to bribery decreases. However, Australian businesses may face a competitive disadvantage against US businesses, which are entitled to claim a deduction for facilitation payments.

Assessment of benefits Option 1

4.85 As the ATO does not collect data on bribery payments, it is not possible to quantify the impact on revenue. However, the Government considers that Australian businesses are not significantly involved in bribing foreign public officials. Accordingly, any increase in revenue resulting from this measure should be minimal.

4.86 Australia's standing internationally will improve as bribery distorts international competitive conditions, and contributes to the misallocation of resources.

4.87 The present system of allowing bribes to be claimed as a deduction against income tax contributes to the perception that such payments are an acceptable practice for those trading in the international business community. The proposed changes will discourage that perception and will be seen to enhance the integrity of the taxation system. It will also align Australia's taxation position with the majority of OECD member countries.

Assessment of costs Option 2

4.88 The compliance costs to taxpayers of this change will be similar to Option 1. Some additional costs may be incurred by some taxpayers who would have to determine whether an amount incurred is a bribe to a foreign public official or is merely a facilitation payment.

Assessment of benefits Option 2

4.89 The benefits from denying deductions for bribes will be the same as in Option 1. However, there are a number of added benefits from excluding facilitation payments from the definition of a bribe.

4.90 Taxpayers will still be able to claim a deduction for facilitation payments made to foreign public officials. This exclusion will allow a deduction for expenses incurred in order to facilitate or expedite the performance of a routine government action of a minor nature in the course of conducting business in foreign countries.

Assessment of costs Option 3

4.91 The compliance costs of this option will be higher than the previous two options as the measure will affect many more taxpayers. The total compliance costs, however, are still not expected to be large as they will be limited to taxpayers learning about the change.

Assessment of benefits Option 3

4.92 The benefits are considered to be similar to Options 1 and 2. The gain to the revenue is considered to be minimal as it is not considered that taxpayers would generally be claiming a deduction for such expenses.

Consultation

4.93 The OECD also endorsed criminalising bribery of a foreign public official. Consequently, the ATO and the Attorney-Generals Department have liaised on a number of aspects in relation to this matter.

4.94 A number of large corporations and several government agencies were consulted in developing this proposal, together with representatives from professional bodies and academic institutions. The measure has also been examined by the Joint Committee on Treaties.

4.95 Option 2 is the preferred option of small business.

Conclusion

4.96 The preferred option for implementing the Governments policy objective is Option 2; that is, to disallow deductions for bribes made to foreign public officials, but to exclude facilitation payments from the definition of a bribe.

4.97 The proposed amendments will implement the recommendation of the OECD Council. That recommendation is supported by the Australian Government. The exclusion of facilitation payments from the definition of a bribe is consistent with the commentaries on the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions.

4.98 It is a longstanding principle that Australia's tax law allows deductions for expenditure incurred in deriving assessable income, irrespective of whether the expenditure relates to legal or illegal activities. Although disallowing bribes paid to foreign public officials would be an exception to this principle, it can be justified on the grounds that it will enable Australia to implement the OECD recommendation and align itself with the majority of OECD countries. To take the restriction further (eg. to implement Option 3) would raise broader tax policy issues that require further consideration.

4.99 Option 2 will satisfy Government and community expectations by contributing to a more equitable and efficient world market.

4.100 Treasury and the ATO will monitor this taxation measure, as part of the whole taxation system on a continuing basis. In addition, the ATO has consultative arrangements in place to obtain feedback from professional and small business associations and through other taxpayer consultation forums.

4.101 The OECD Committee on Fiscal Affairs in cooperation with the Committee on International Investment and Multilateral Enterprises will continue to monitor the implementation of the recommendation.

Chapter 5 - Philanthropy

Overview

5.1 Schedule 5 to this Bill will amend the Income Tax Assessment Act 1997 (ITAA 1997) and the Income Tax Assessment Act 1936 to implement the Governments response to the report on philanthropy in Australia by the Business and Community Partnerships Working Group on Taxation Reform. On 26 March 1999, the Prime Minister, the Treasurer, the Minister for Family and Community Services, the Minister for Communications, Information Technology and the Arts, and the Minister for the Arts and the Centenary of Federation announced income tax measures to encourage greater corporate and personal philanthropy in Australia.

5.2 The amendments will:

•

allow an income tax deduction to certain funds, authorities and institutions and to political parties for a gift of property worth more than $5,000, regardless of when or how the property was acquired;

•

provide a capital gains tax (CGT) exemption for testamentary gifts of property to certain funds, authorities and institutions and to political parties unless the property is reacquired by the estate, a beneficiary of the estate or an associate;

•

provide a CGT exemption for gifts of property made under the Cultural Gifts Program unless the property is reacquired for less than market value by the donor or an associate;

•

allow concessional taxation treatment for specified private funds which will not be required to seek donations from the public but will be subject to the other requirements applying to public funds; and

•

allow the apportionment of deductions for donations made under the Cultural Gifts Program over a period of up to 5 income years.

5.3 These measures are explained in the following Sections:

Section 1: Deduction for gifts of property valued at more than $5,000

Section 2: Deduction for gifts to private funds

Section 3: Apportionment of donations made under the Cultural Gifts Program

Section 4: CGT exemption for gifts of property made under the Cultural Gifts Program and testamentary gifts of property to gift deductible organisations

Summary of the amendments

Purpose of the amendments

5.4 The purpose of the amendments is to encourage greater corporate and personal philanthropy in Australia by providing taxation incentives for donors.

5.5 The amendments will provide incentives by extending the existing gift deductibility provisions, providing CGT exemptions and allowing an apportionment of deductions in certain cases. Specifically:

•

The existing gift deductibility provisions will be extended to gifts of property to certain funds, authorities and institutions and to political parties worth more than $5,000, regardless of when or how the property was acquired, and to specified private funds, which must satisfy the requirements of public funds except for the requirement of seeking and receiving public contributions.

•

CGT exemption will be extended to gifts of property made under the Cultural Gifts Program and to testamentary gifts of property to certain funds, authorities and institutions and to political parties unless the property is reacquired by the estate of the deceased, a beneficiary or an associate.

•

Deductions for donations made under the Cultural Gifts Program will be apportionable over periods of up to 5 income years.

Date of effect

5.6 The amendments will apply from 1 July 1999:

•

Deductions will be allowable for gifts of property to certain funds, authorities and institutions and to political parties made on or after 1 July 1999 where the value of the property exceeds $5,000, regardless of when or how the property was acquired.

•

Deductions will be allowable for gifts to specified private funds made on or after 1 July 1999.

•

CGT exemption will apply to property donated under the Cultural Gifts Program on or after 1 July 1999.

•

CGT exemption will apply to testamentary gifts of property donated on or after 1 July 1999.

•

Deductions for donations under the Cultural Gifts Program made on or after 1 July 1999 may be apportioned over a period of up to 5 income years.

Background to the legislation

Current law

Gifts or contributions

5.7 Taxpayers are entitled to income tax deductions for certain gifts or contributions. The rules relating to these deductions are contained in Division 30 of the ITAA 1997. The structure of the Division is as follows:

5.8 Under section 30-15 certain donations made to listed recipients are eligible for tax deductibility. The table in section 30-15 specifies the type of recipient, the type of gift or contribution, how much can be deducted and any special conditions that apply. The type of recipient includes public hospitals, public libraries, public museums and charitable institutions. The recipients are commonly known as "gift deductible organisations".

Cultural Gifts Program

5.9 The Cultural Gifts Program encourages gifts of significant cultural items to public art galleries, public museums and public libraries by offering donors a tax deduction. The recipients of deductible gifts under the Cultural Gifts Program are listed at items 4 and 5 of the table in section 30-15.

5.10 The Department of Communications, Information Technology and the Arts administers the program with the advice of the Committee on Taxation Incentives for the Arts (an expert Committee appointed by the Minister for the Arts and the Centenary of Federation). The Committee advises the Minister on matters relating to the program, advises the Secretary of the Department on the approval of valuers for the program and examines donations made under the program to ensure they conform with the requirements of the program.

Capital gains and losses

5.11 Taxpayers can only make a capital gain or capital loss if a CGT event happens in relation to a CGT asset. The types of CGT assets that potentially may be donated include land, buildings, shares, collectables (for example, artwork) and personal use assets (for example, property that is used or kept mainly for personal use or enjoyment). The capital gain or capital loss is disregarded or reduced when an exemption applies.

5.12 Subdivision 118-A of the ITAA 1997 deals with general exemptions from CGT. Collectables are exempt assets if the collectable was acquired for $500 or less (subsection 118-10(1)) and personal use assets are exempt assets if acquired for $10,000 or less (subsection 118-10(3)). Gifts of property that are made under the Cultural Bequests Program do not give rise to a capital gain or capital loss under section 118-60.

Explanation of the amendments

Section 1: Deduction for gifts of property valued at more than $5,000

Gifts to certain funds, authorities and institutions

5.13 Schedule 5 of this Bill amends the table of deductible gifts or contributions in section 30-15 of ITAA 1997. The proposed amendments will allow a tax deduction for gifts of property valued by the Commissioner of Taxation (the Commissioner) at more than $5,000 to recipients listed at items 1 and 2 of the table. The deduction will apply to gifts made on or after 1 July 1999 [item 26] .

5.14 Item 1 of the table relates to recipients that are funds, authorities or institutions listed by name or by type in subdivision 30-B. Item 2 of the table relates to public funds; broadly, funds that are open for subscription by the public and to which the public contributes. The Commissioners view of what is a public fund is contained in Taxation Ruling TR 95/27. (Note that item 2 of the table is amended to include specified private funds by item 6 . See Section 2 of this Chapter for an explanation.)

5.15 The type of gift that may be tax deductible is amended to include property valued by the Commissioner at more than $5,000 [items 2 and 7] . The amount deductible is the value of the property as determined by the Commissioner [items 4 and 9] . Where the property is valued at more than $5,000 and is purchased within the 12 months before making the gift, the existing rules apply [items 3, 4, 8 and 9] ; that is, the amount deductible is the lesser of the market value of the property and the amount paid for the property.

5.16 An amendment is made to the special conditions relating to gifts to recipients listed at Items 1 and 2 of the table. For gifts valued by the Commissioner at more than $5,000 to be tax deductible, the valuation requirements of new section 30-212 must be satisfied [items 5 and 10] .

Valuations by the Commissioner of Taxation

5.17 New section 30-212 provides valuation rules for gifts valued by the Commissioner of Taxation at more than $5,000 [item 11] . Valuations for these gifts must be made by the Commissioner for a tax deduction to be allowable. The Commissioner may charge a valuation fee for the service in accordance with the Income Tax Assessment Regulations [newsubsection 30-212(2)] .

5.18 The Australian Valuation Office, which forms a part of the Australian Taxation Office, will advise the Commissioner of appropriate property valuations.

Consequential amendments

5.19 An amendment is made to the index to Division 30 in section30-315 to include a reference to new section 30-212 [item 18] .

Example 1

Alexis donates her farm in the Australian Capital Territory (ACT) to the Royal Society for Prevention of Cruelty to Animals (ACT) Incorporated on 1September1999. She has owned the property since 1979. She has the farm valued by the Commissioner at $200,000. She is entitled to a deduction for the amount of the valuation, that is, $200,000.

Example 2

Enrico donates his 4-wheel drive vehicle to Amnesty International. The Commissioner values the vehicle at $35,000. Enrico has a friend who is a car salesman and he says that the value of the vehicle is $33,000. Enrico is entitled to a deduction for the amount of the Commissioners valuation of $35,000.

Gifts and contributions to political parties

5.20 Schedule 5 also amends the deductions for political contributions and gifts to allow deductions for property valued by the Commissioner at more than $5,000. A deduction will be allowable for contributions or gifts made on or after 1 July 1999 [item 26] .

5.21 The Taxation Laws Amendment (Political Donations) Bill 1999 (Political Donations Bill) rewrites the provisions relating to political donations that are currently listed in the table in section 30-15. New section 30-242 of the Political Donations Bill replaces and modifies Item3 of the table. Subsection 30-242(2) is amended by this Bill to allow a contribution or gift of property valued by the Commissioner at more than $5,000 to qualify for a deduction [item 12] .

5.22 The amount of the deduction that is allowable for political contributions and gifts is also amended (new section 30-243 of the Political Donations Bill). Where a contribution or gift of property is valued by the Commissioner at more than $5,000, the deduction allowed is $1,500 [items 13 and 14] . The deduction is limited to $1,500 rather than the value of the property as determined by the Commissioner because deductions for political contributions and gifts cannot exceed $1,500 [newsubsection 30-243(2A)] .

5.23 The valuation requirements of new section 30-212 also apply to political contributions and gifts of property valued by the Commissioner at more than $5,000 (see paragraph 5.17).

Section 2: Deduction for gifts to private funds

5.24 Schedule 5 to this Bill amends section 30-15 of the ITAA 1997 to allow deductions for gifts made to specified private funds from 1 July 1999. This is achieved by extending the application of item 2 in the table to prescribed private funds [items 6 and 26] . Item 2 of the table deals with gifts to public funds established and maintained under a will or trust instrument solely for:

•

the purpose of providing money, property or benefits to a fund, authority or institution covered by Subdivision 30-B; or

•

the establishment of such a fund, authority or institution.

5.25 To be eligible to receive gift deductible donations, prescribed private funds will need to comply with most of the requirements of public funds (see Taxation Ruling TR 95/27).

What is a public fund?

5.26 Public fund is not defined in the ITAA 1997 but the decision in Bray v FC of T
78 ATC 4179;
8 ATR 569 establishes that a fund will be public where:

•

it is the intention of the promoters or founders that the public will contribute to the fund;

•

the public, or a significant part of it, does in fact contribute to the fund; and

•

the public participates in the administration of the fund.

5.27 Therefore, a public fund is one to which the public is invited to contribute and in fact does contribute. The fund must be controlled or administered by persons or institutions with a degree of responsibility to the community as a whole.

What is a prescribed private fund?

5.28 Prescribed private funds will not have to comply with the requirement of public funds to seek and receive contributions from the public, but will have to comply with all the other requirements of a public fund. This means that individuals and corporations will be able to establish funds for philanthropic purposes without advertising for public contributions.

5.29 Prescribed private fund is defined in subsection 995-1(1) to be a fund that is prescribed by the Income Tax Assessment Regulations but does not include a fund that is declared in writing by the Treasurer not to be a prescribed fund [item 24] . Private funds seeking to be prescribed in the Regulations will need approval from the Government. Where a prescribed private fund no longer complies with the requirements, the Treasurer may declare in writing that the fund is not a prescribed private fund. From the date of declaration, donations to that fund will not be tax deductible under section 30-15.

Section 3: Apportionment of donations made under the Cultural Gifts Program

5.30 New Subdivision 30-DB is inserted in Division 30 of the ITAA 1997 to allow apportionment of deductions for gifts made under the Cultural Gifts Program over a maximum of 5 income years [item 16] . The apportionment applies to deductions for gifts made on or after 1 July 1999 [item 26] .

5.31 The Cultural Gifts Program is administered by the Department of Communications, Information Technology and the Arts. The program encourages the donation of significant cultural gifts to the recipients of deductible gifts listed at Items 4 and 5 of the table in section 30-15. These recipients are:

•

the Australiana Fund;

•

a public library in Australia;

•

a public museum in Australia;

•

a public art gallery in Australia;

•

an institution in Australia consisting of a public library, a public museum and a public art gallery or any 2 of them; and

•

the Commonwealth for the purposes of Artbank.

New Subdivision 30-DB is structured as follows:

Making an election

5.32 New subsection 30-247(1) provides that a taxpayer may elect to spread a deduction for a gift made under the Cultural Gifts Program over up to 5 income years. If the taxpayer makes this election, the apportionment must commence in the income year in which the gift is made and cannot exceed 100% of the original deduction.

5.33 When a taxpayer makes an election, they must specify the percentage, if any, to be deducted in each income year [newsubsection30-247(2)] .

5.34 The election must be made before the taxpayer lodges the income tax return for the income year in which the gift was made. [New subsection 30-247(3)]

5.35 A copy of the election must be given to the Arts Secretary by the taxpayer prior to lodging the income tax return for the year in which the gift was made [new subsection 30-247(4)] .

5.36 New subsection 30-247(5) provides that the taxpayer may vary the election at any time. The variation will apply to the percentage of the original deduction that is to be claimed in income years for which an income tax return has not yet been lodged. The taxpayer must give the Arts Secretary a copy of the variation before lodging the income tax return for the first income year to which the variation applies.

5.37 Under new subsection 30-247(6) the election and any variation must be made in a form approved in writing by the Arts Secretary.

5.38 The Arts Secretary is defined in subsection 995-1(1) to mean the Secretary of the Department administering the National Gallery Act 1975 [item 23] . The responsible department is currently the Department of Communications, Information Technology and the Arts.

Example 1

Sarah donates a Norman Lindsay painting to the National Gallery of Australia in April 2000 under the Cultural Gifts Program. Sarah decides to spread the deduction over 5 income years. The first income year in which she can claim a portion of the deduction is the 1999-2000 income year.

Sarah decides to apportion her deduction for the painting in the following manner:

Example 2

Thomas donates rare manuscripts written by Captain Cook on his voyage on the Endeavour to the National Library of Australia in September 2000. Thomas elects to apportion the deduction over 3income years. The first income year in which Thomas will be able to claim a deduction is the 2000-2001 income year. Thomas apportions his deduction in the following manner:

Effect of election

5.39 The effect of this election is that the taxpayer must claim the deduction in the manner specified in the election. By making an election, the taxpayer forgoes the opportunity to claim the full amount of the deduction in the income year in which the donation was made. [New section 30-248]

Consequential amendments

5.40 Section 30-5, which provides a guide to Division 30, is amended to include a reference to the apportionment of certain gifts under new Subdivision 30-DB [item 1] . An amendment is made to the index to Division 30 in section 30-315 to include a reference to new Subdivision 30-DB [item 17] . These 2 amendments are to assist the reader of the Division.

Section 4: CGT exemption for gifts of property made under the Cultural Gifts Program and testamentary gifts of property to gift deductible organisations

5.41 Currently, under section 118-60 of the ITAA 1997, gifts of property made under the Cultural Bequests Program are exempt from CGT; that is, a capital gain or a capital loss made from the gift is disregarded. Schedule 5 of this Bill amends section 118-60 to extend the exemption to:

•

testamentary gifts of property made to gift deductible organisations [item 20] ; and

•

gifts of property made under the Cultural Gifts Program [item22] .

5.42 Capital gains and capital losses will be disregarded on gifts donated under these circumstances on or after 1 July 1999 [item 26] . To ensure that this measure is not abused, an anti-avoidance provision has been included in the amendments.

Testamentary gifts

5.43 New subsection 118-60(1) provides that a capital gain or capital loss made from a testamentary gift to a gift deductible organisation is disregarded [item 20] . The amendment is designed to encourage people to make testamentary gifts to the recipients listed in section 30-15. Under the current law, there is no tax concession available for testamentary gifts because testamentary gifts are specifically excluded from gift deductibility by subsection 30-15(2).

5.44 New subsection 118-60(4) provides that if a testamentary gift is reacquired for less than market value by either:

•

the estate of the deceased person; or

•

a person who is an associate of the deceased persons estate; or

•

a person who was an associate of the deceased person just before the person died;

then the rules relating to the effect of death on CGT assets apply (section 128-15). This treats the asset in the same way as if it had been bequested directly to the beneficiary or associate. That is, instead of the beneficiary or associate having a cost base for the asset of the amount that they paid for it, the first element of the assets cost base will be either:

•

the cost base of the asset on the day of death of the donor where the donor acquired the asset on or after 20 September 1985; or

•

the market value of the asset on the day of death of the donor where the donor acquired the asset before 20 September 1985; or

•

the market value of the asset on the day of death of the donor where the asset was the donors main residence just before death and was not used to produce assessable income; or

•

the market value of the asset on the day of death of the donor where the asset is trading stock.

Cultural gifts

5.45 New subsection 118-60(2) provides that a capital gain or capital loss made from a gift of property to the recipients covered by items 4 and 5 of the table in section 30-15 is disregarded. Items 4 and 5 relate to the Cultural Gifts Program. Income tax deductions are available for gifts of property to these recipients, except for a gift of an estate or an interest in land or in a building or part of a building. The amendments will provide additional incentive for gifts of property under the Cultural Gifts Program and will align the program more closely with the Cultural Bequests Program.

5.46 Under new subsection 118-60(3) , the CGT exemption will not apply when the person who donated the gift under the Cultural Gifts Program reacquires the property for less than market value. Similarly, when an associate of the donor reacquires the property for less than market value, the CGT exemption will not apply to the original donor.

Consequential amendments

5.47 New section 112-48 is inserted in the finding tables for special CGT rules in Subdivision 112-B. New section 112-48 guides the reader to subsections 118-60(1) and (2) for the special rules for gifts acquired by associates. [Item 19]

5.48 An amendment is made to subsection 304(4) of the Income Tax Assessment Act 1936 to reflect the extension of the CGT exemption to testamentary gifts to gift deductible organisations and gifts made under the Cultural Gifts Program. [Item 25]

Chapter 6 - Rate of tax for friendly societies etc.

Overview

6.1 Schedule 6 to this Bill will amend the Taxation (Deficit Reduction) Act (No. 2) 1993 so that the rate of tax imposed on the eligible insurance business of friendly societies and other registered organisations will be retained at 33% for the 1999-2000 income year. The trustee rate will increase to 39% from the 2000-2001 income year unless other relevant amendments to the taxation treatment of friendly societies are made prior to that time.

Summary of the amendments

Purpose of the amendments

6.2 In Tax Reform: not a new tax, a new tax system: The Howard Governments Plan for a New Tax System, the Government announced changes to the taxation treatment of life insurers that are proposed to commence from the 2000-2001 income year. The details of the changes to the taxation of life insurers are being developed as part of the Review of Business Taxation. The main objectives of the proposed changes are to improve the efficiency of the taxation treatment of life insurance companies and friendly societies, and the equity of their investors, to ensure a more neutral taxation outcome for competing investment products.

6.3 The rate of tax on the eligible insurance business of friendly societies is scheduled to increase from 33% to 39% for the 1999-2000 and subsequent income years. Therefore, to ensure that the present taxation treatment of friendly societies is undisturbed prior to the commencement of the new arrangements for taxing life insurers, the Government also announced that the trustee rate of tax for the eligible insurance business of friendly societies and other registered organisations would be retained at 33% for the 1999-2000 income year. Subject to the recommendations of the Review of Business Taxation, that rate will be changed so that it is the same as the company tax rate for the 2000-2001 and subsequent income years.

Date of effect

6.4 The amendments will apply to the 1999-2000 income year.

Background to the legislation

6.5 Paragraph 23(4)(b) of the Income Tax Rates Act 1986 declares that the rate of tax on the eligible insurance business component of the taxable income of a company that is a registered organisation (that is, a friendly society, a trade union or certain employee associations) is 33%. Section19 of the Taxation (Deficit Reduction) Act (No.2) 1993 increases that rate to 39% for the 1999-2000 and subsequent income years.

6.6 Section 26AH of the Income Tax Assessment Act 1936 (ITAA1936) includes in the assessable income of a policyholder bonuses on life insurance policies that are surrendered within 10 years. If such an amount is included in a policyholders assessable income, a rebate is available under section 160AAB of the ITAA 1936 to compensate the policyholder for the tax paid by the insurance company or registered organisation.

6.7 The rebate on bonuses paid from life insurance policies issued by friendly societies and other registered organisations is currently 33% of the amount included in assessable income under section26AH (see paragraph (a) of the definition of statutory percentage in subsection 160AAB(1)). Section 15 of the Taxation (Deficit Reduction) Act (No.2) 1993 increases the rebate to 39% for the 2000-2001 and subsequent income years.

Explanation of the amendments

6.8 The rate of tax imposed on the eligible insurance business of friendly societies and other registered organisations will be retained at 33% for the 1999-2000 income year. [Items2and3]

6.9 The rate will increase to 39% for the 2000-2001 and subsequent income years. [Items4and5]

6.10 The provisions to increase the rate of tax imposed on the eligible insurance business of friendly societies and other registered organisations to 39% in the 2000-2001 and subsequent income years will commence on 1July2000. [Item1]

Chapter 7 - Company Law Review Amendments

Overview

7.1 The amendments to the Income Tax Assessment Act 1936 (ITAA1936) and associated tax laws:

•

provide for the necessary machinery provisions to collect untainting tax;

•

ensure that distributions from share premium accounts are within the ambit of the capital streaming and dividend substitution rules;

•

make some minor technical changes to rectify certain incorrect references; and

•

ensure that bonus shares deemed to be a dividend under section 45C have a cost base of the dividend amount where the shares are held on revenue account.

Summary of amendments

Purpose of amendments

7.2 The purpose of the amendments is to make some technical and clarificatory amendments to the ITAA 1936 and associated tax laws and to ensure that distributions of share premium are within the ambit of the capital streaming and dividend substitution rules.

Date of effect

7.3 The amendment to include distributions of share premium in the capital streaming and dividend substitution rules will apply from the date of introduction of this Bill. The other amendments apply from 1 July 1998, the date of commencement of the Taxation Laws Amendment (Company Law Review) Act 1998 (TLA(CLR) 1998).

Background to the legislation

7.4 The TLA(CLR) 1998 made various amendments to the tax laws as a result of changes to the company law which included the abolition of par value for shares and the related concepts of share premium and paid-up capital. In addition, the TLA(CLR) 1998 also introduced several anti-avoidance rules including:

•

rules that prevent companies from providing shareholders with bonus shares or other capital benefits in lieu of unfranked dividends (the capital streaming rules); and

•

a rule that applies where a capital benefit is provided under an arrangement where the company or a taxpayer has a purpose, other than an incidental purpose, of conferring or obtaining a tax advantage in connection with the capital benefit (the dividend substitution rule).

7.5 Companies not incorporated under the Corporations Law (that is, some statutory companies) are also subject to the anti-avoidance rules. These companies continue to have par value shares and share premium accounts in respect of those shares. As a result, these companies can make an equivalent distribution of share capital by distributing share premiums. However, the anti-avoidance rules as currently drafted only apply to distributions of share capital.

7.6 Moreover, the TLA(CLR) 1998 also introduced a share capital tainting rule that treats distributions from a tainted share capital account as unfrankable and unrebatable dividends unless the company elects to untaint that account. In this regard the Income Tax (Untainting Tax) Act 1998 imposes a liability to untainting tax in certain circumstances where a company elects to untaint its share capital account.

Explanation of the amendments

Outline of amendments

Anti-avoidance rules

7.7 To ensure that distributions of capital in the guise of share premiums can attract the operation of the capital streaming and dividend substitution rules, certain amendments have been made to sections 45A, 45B and 45C of the ITAA 1936. Broadly speaking these amendments extend current references to share capital and distributions of share capital to share premiums and distributions of share premiums. In this way capital streaming or dividend substitution arrangements that rely on the use of share premiums can attract the operation of the anti-avoidance provisions contained in sections 45A and 45B of the Income Tax Assessment Act 1936. [Items 4 to 9 of Schedule 7 ; amended paragraphs 45A(3)(b), 45B(4)(b), 45B(5)(b), 45B(5)(h) and 45C(4)(c)]

Technical and clarificatory amendments

7.8 To ensure that certain amendments made by the TLA(CLR) 1998 operate as intended some minor technical and clarificatory amendments have also been made to:

•

correct misquoted cross-references and remove erroneous terms; and [Items 2, 3 and 10 to 16 of Schedule 7 ; amended subsections 6BA(4), 6BA(5), 45D(2) and 109-55(1) of the Income Tax Assessment Act 1997 and amended paragraphs 159GZG(6)(e), 159GZG(6)(f), 160ARDW(2)(a) and 160ARDW(2)(b) of the ITAA 1936]

•

insert machinery provisions for the proper collection of untainting tax. [Item 17 of Schedule 7 ; new sections 160ARDZ, 160ARDZA, 160ARDZB, 160ARDZC and 160ARDZD of the ITAA 1936]

7.9 It is expressly provided in paragraph 130-20(2)(a) that bonus shares deemed to be a dividend under section 45C have a cost base of the dividend amount for capital gains tax purposes. However, section 6BA the corresponding provision for shares which are held on revenue account, does not expressly refer to section 45C. Amended subsection 6BA(2) provides that if bonus shares are taken to be a dividend including under section 45C, the cost of the shares is so much of the dividend as is included in the relevant taxpayers assessable income. [Item 1 of Schedule 7 ; amended subsection 6BA(2)]

Chapter 8 - Technical amendments

Overview

8.1 Schedule 8 to this Bill will make minor technical amendments to the Income Tax Assessment Act 1997 (ITAA 1997) to ensure that notes about excess tax offsets are included in the most appropriate provisions.

Summary of the amendments

Purpose of the amendments

8.2 The purpose of the amendments is to improve the signposting in the ITAA 1997 to direct readers to the relevant provisions of the income tax law that deal with the treatment of excess tax offsets.

Date of effect

8.3 The amendments in Schedule 8 to this Bill will apply from the date of Royal Assent of the Bill [subclause 2(1)] .

Explanation of the amendments

8.4 Items 1 and 3 of Schedule 8 improve the signposting in section 4-10 of the Act by consolidating two existing notes in subsections 4-10(3) and (3A) into one note in subsection 4-10(3A) that directs readers to Division 65 of the ITAA 1997 and section 160AFE of the Income Tax Assessment Act 1936. The new note more effectively directs readers to relevant provisions of the income tax law that deal with the treatment of excess tax offsets.

8.5 Items 2 and 4 of Schedule 8 will amend the ITAA 1997 by inserting appropriate headings before subsections 4-10(3A) and 4-10(4).

Chapter 9 - Concessional tracing rules for company loss etc. provisions

In this Chapter, the following Acts are referred to by the abbreviations indicated:

Income Tax Assessment Act 1936 ITAA 1936

Income Tax Assessment Act 1997 ITAA 1997

Overview

9.1 Schedule 9 to this Bill will amend the company prior year, current year and capital loss rules, and rules for bad debt and certain debt/equity swap deductions (referred to in this Chapter as debt deductions). The amendments will make available to companies 2 concessional tracing rules that are available to trusts under the trust loss measures which are contained in Schedule 2F to the ITAA 1936.

9.2 These amendments were originally introduced into Parliament in Taxation Laws Amendment Bill (No. 6) 1997 and lapsed when Parliament was prorogued for the election. The reintroduced measures have been modified to take into account the Tax Law Improvement Project (TLIP) rewrite of the bad debt and capital loss rules (ie. Subdivisions 165-CA, 165-CB, 165-C, 166-C, 175-CA, 175-CB and 175-C of the ITAA 1997). The rewritten provisions were included in Taxation Law Improvement Act (No.1) 1998. The reintroduced measures also include a transitional rule which will allow a trust to make a family trust election for the purpose of the family trust concession for earlier income years. Similarly, entities wishing to be members of the same family group as the trust making the family trust election will be able to make interposed entity elections for those same income years. (See Chapter 10 of this Explanatory Memorandum).

9.3 The Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998 inserted Schedule 2F into the ITAA 1936. Schedule 2F contain rules to restrict the recoupment of prior year and current year losses and debt deductions of trusts in order to prevent the transfer of the tax benefit of those losses or deductions. References to Schedule 2F in this Chapter refer to Schedule 2F to the ITAA 1936.

Summary of the amendments

Purpose of the amendments

9.4 The amendments will extend to companies 2 concessional tracing rules which are available to trusts under the trust loss measures. The concessions are referred as the family trust concession and the alternative condition .

Date of effect

9.5 The amendments will apply to company losses and debts incurred in the 1996-97 year of income or later years of income.

Background to the legislation

Outline of the provisions

9.6 Under the income tax law, a tax loss incurred by a taxpayer in a year of income may generally be carried forward and deducted from the taxpayers assessable income in a later year. Losses incurred in the 1989-90 and later income years may be carried forward indefinitely until recouped. The relevant provisions are sections 79D, 79E, 80 and 160AFD of the ITAA 1936 and Division 36 of the ITAA 1997.

Prior year loss rules

In the case of companies there are provisions in the law which limit the deductibility of prior year losses (sections 80A to 80F of the ITAA 1936 and Divisions 165, 166 and 175 of the ITAA 1997).

9.8 These provisions contain tests that need to be satisfied by a company before losses can be recouped in a later income year. These tests have the effect that a company can carry forward a loss if there is continuity of majority beneficial ownership of certain dividend, capital and voting rights of the company. Where there is a change in the beneficial ownership of shares in the company or another company which has resulted in that continuity not being satisfied, the company can, nevertheless, carry forward a loss if, among other things, it carries on the same business as it carried on at the time of the change in ownership.

9.9 There are rules which modify the way the above rules apply to listed public companies and their wholly owned subsidiaries. These rules, which are contained in Division 166 of the ITAA 1997, make it easier for these companies to trace ownership interests for the purpose of meeting the requirements of the continuity of majority beneficial ownership test for the 1997-98 year of income and later years of income.

9.10 Also there are rules that deal with arrangements (eg. income injection arrangements) to use company losses to avoid tax. These rules operate to deny a deduction even though the continuity of beneficial ownership test is satisfied but the benefits from the allowance of the deductions would flow wholly or mainly to persons who were not shareholders in the company when the losses or deductions were incurred. The rules may not apply in certain circumstances where the Commissioner of Taxation (the Commissioner) considers the benefits received by a person are reasonable having regard to the persons shareholding interest in the company.

Current year loss rules

9.11 There are also provisions which limit deductibility of current year losses of companies (sections 50A to 50N of the ITAA 1936 and Divisions 165, 166 and 175 of the ITAA 1997). A company may be required to calculate its taxable income and tax loss for an income year in a special way if an event occurs during the income year which is similar to those events which result in the company not being able to deduct a prior year loss (see paragraph 9.8). Under this system, the income year is divided into periods on the basis of when a specified event (eg. a change in beneficial ownership) occurs. In effect, a taxable income or tax loss is calculated separately for each period.

9.12 There are also rules that deal with arrangements (eg. income injection arrangements) similar to those described in paragraph 9.10 which use company deductions to avoid tax.

Debt deduction rules

9.13 Provisions are contained in sections 63A to 63C of the ITAA 1936 and Divisions 165, 166 and 175 of the ITAA 1997 which limit the deductibility of certain debt deductions^[F1]. These provisions are similar to the prior year loss provisions applying to companies, but apply for different periods relating to the incurring and writing off of the relevant debt.

9.14 There are also rules that deal with arrangements that bring together in the same company, assessable income and bad debts that would not otherwise be used or would be used at a later time.

Capital loss rules

9.15 There are provisions which limit the ability of a company to set off a net capital loss of an earlier income year against capital gains derived in a later income year. The company must satisfy the same tests that it would have to satisfy before it can deduct a tax loss of an earlier income year, ie. the tests explained at paragraph 9.8 (Divisions 165, 166 and 175 of the ITAA 1997). The rules dealing with the carry forward of net capital losses were amended by Taxation Laws Amendment Act (No. 2) 1997 to ensure their proper application from the 1996-97 income year and later income years. The amendments were made so that any unrecouped losses for earlier years are reflected in a net capital loss in respect of the 1995-96 income year^[F2].

9.16 There are also rules which require a company to work out its net capital gain and net capital loss differently for a year in which it has not had the same majority ownership and control and does not satisfy the same business test. The company must work out its net capital gain and net capital loss under the special rules if it is required to calculate its taxable income and tax loss for an income year in a special way (see paragraph 9.10) but only if it had a notional net capital loss in a period.

9.17 There are also rules that deal with arrangements (eg. where a capital gain is injected into a company with unused capital losses) to avoid a capital gains tax liability.

Relationship between the ITAA 1936 and ITAA 1997

9.18 The company prior and current year loss provisions were rewritten, with effect from the 1997-98 income year, as part of the Tax Law Improvement Project and are included in the ITAA 1997. For income years before 1997-98, the ITAA 1936 provisions are applicable. The company capital loss and debt deduction rules have also been re-written and were passed by Parliament in Taxation Law Improvement Act (No. 1) 1998. The redrafted debt deduction and capital loss rules which were inserted into Divisions 165, 166 and 175 of the ITAA 1997 take effect from the 1998-99 income year^[F3]. For income years before 1998-99 income year the ITAA 1936 provisions are applicable.

Tracing rules

9.19 The continuity of ownership tests in the above provisions contain tracing rules so that where, at any time during the relevant period, the shares in a company are held otherwise than by natural persons, voting, dividend and capital interests can be traced through the interposed entities to the ultimate natural persons who have beneficial ownership.

9.20 Tracing through interposed entities to underlying beneficial owners cannot occur through a discretionary trust as beneficiaries of discretionary trusts do not have fixed interests in the income or capital of the company or interposed entity. Tracing rules can only be applied in circumstances where the beneficial owners have fixed quantifiable interests in the things being traced.

9.21 Thus, in the absence of special tracing concessions, a company could not carry forward losses or deduct debts where 50% or more of the interests in the company are held by a discretionary trust or trusts (including family discretionary trusts).

9.22 The same business test is unavailable to a company in which a majority of the shares are held by discretionary trusts. This test is only available if there has been a change in the beneficial ownership of a loss companies shares which has resulted in failure of the continuity of beneficial ownership test.

9.23 The trust loss measures contain 2 special tracing rules which modify the rule that there is no tracing through non-fixed trusts. These rules are as follows:

•

The family trust concession applies where a fixed interest in a loss trust is held, directly or indirectly, by a family trust. The family trust is treated as an individual holding the interest for its own benefit.

•

The alternative condition applies for the purpose of the ownership test (50% stake test) that applies to fixed trusts. If the interests in a fixed trust are held by non-fixed trusts such that it is not able to pass the 50% stake test, the fixed trust can still deduct its losses if certain conditions are satisfied.

9.24 There are no special tracing rules for companies which are held by discretionary trusts (including family trusts) similar to those that are included in the trust loss measures for tracing interests in trusts.

Amendments to the ITAA 1936 and the ITAA 1997

9.25 Because of the application date of the changes, amendments will be made to both the ITAA 1936 and the ITAA 1997.

9.26 Amendments will be made to the ITAA 1936 for the purpose of the current year loss rules and the debt deduction provisions. The amendments to the current year loss rules will only apply for the 1996-97 income year.

9.27 Amendments will also be made to the ITAA 1997 for the purpose of the prior year and current year loss, capital loss and debt deduction rules.

9.28 It is not necessary to make amendments for the purpose of the prior year loss rules contained in sections 80A to 80F of the ITAA 1936. This is because, under the application rules, the amendments apply only to losses incurred in the 1996-97 income year and later income years. The earliest time a tax loss from the 1996-97 income year can be deducted is in the 1997-98 income year. The ITAA 1997 applies from this income year. Because of transitional provisions included in the Income Tax (Transitional Provisions) Act 1997, a loss incurred in the 1996-97 income year will be a tax loss for the purposes of the ITAA 1997.

Administrative arrangements for losses and debts incurred in income years before 1996-97

9.29 For losses incurred in the 1995-96 income year or earlier years of income, the Commissioner has advised the Government that he will interpret the existing continuity of beneficial ownership test consistently with the broad principles that have been adopted in relation to section 160ZZS of the ITAA 1936. That is, where in the context of a family discretionary trust, the trustee continues to administer the trust for the benefit of members of a particular family, the Commissioner will accept that, for all practical purposes, there has been a continuity of beneficial ownership for the purposes of the ITAA 1936. If there are non-family trust arrangements which fall outside this interpretation, the Commissioner will look at the arrangements on a case by case basis to see whether the continuity of beneficial ownership test can be satisfied. The Commissioners preliminary, though considered, view on this matter is outlined in draft Taxation Determination TD 96/D17.

Information provisions

9.30 The trust loss measures contain information-gathering provisions to ensure that the company prior and current year loss and debt deduction rules cannot be avoided where a non-resident entity is taking advantage of the 2 concessional tracing rules. Under these provisions the Commissioner can obtain information to ensure that the family trust concession or conditions associated with the alternative condition are complied with. It is also necessary to include information gathering provisions for the purpose of the company rules.

Explanation of the amendments

First concession family trust concession

9.31 This Bill will make amendments to the ITAA 1936 and the ITAA 1997 so that the family trust tracing concession available to trusts under the trust loss measures will also be available to companies. The concession that applies to trusts is contained in subsection 272-30(2) of Schedule 2F. Broadly, the concession will apply for the purposes of the company rules so that where the relevant interests in a company are held by a family trust, the trustee of the family trust will be taken to own the interests as an individual. [Part 1 of Schedule 9]

9.32 Amendments will be made to the ITAA 1936 for the purpose of the current year loss provisions (sections 50A to 50N) and the debt deduction provisions (sections 63A to 63C). Amendments will be made to the ITAA 1997 for the purpose of the current and prior year loss, capital loss and debt deduction provisions which are found in Divisions 165, 166 and 175.

What if a trust is interposed between a company and a family trust?

9.33 Amendments have been made which refer to the trustee of a family trust owning shares or an interest in shares. A trust may be interposed between the company and the family trust. In these circumstances, the trustee of a family trust will be treated as owning the shares or the interest in shares in the necessary sense provided that the trustee has a vested and indefeasible interest in the shares held by the interposed trust. Although the trustee is not the legal owner, it is an equitable, although not beneficial owner, of the shares.

What is a family trust?

9.34 The term family trust which is used in the amendments takes on the same meaning as in section 272-75 of Schedule 2F. Under this provision, a trust will be a family trust where the trustee of the trust has made an election (known as a family trust election) that the trust be a family trust and the election is in effect. A consequence of making a family trust election is that any distributions (broadly defined) outside the family group of the family trust by the trust will be taxed at the top marginal rate applying to individuals plus the Medicare levy.

Amendment of the ITAA 1936

Current year loss rules

Shareholding interests

9.35 Subsection 50H(1) identifies disqualifying events that are taken to have occurred for the purpose of the current year loss rules. A disqualifying event is the type of event or circumstance discussed at paragraph 9.8. The disqualifying events that are taken to have occurred under paragraphs 50H(1)(e), (f) and (g) deal with some of the tax avoidance arrangements described at paragraph 9.10. Under subsections50H(3), (4) and (6) a disqualifying event will be taken not to have occurred under those paragraphs where the Commissioner considers that benefits received by a person referred to in those subsections are reasonable having regard to their shareholding interests. Subsection50H(7) defines when a person has a shareholding interest.

9.36 This Bill will replace paragraph 50H(7)(a) so that a person will be taken to have a shareholding interest in a company if:

•

the person is the beneficial owner of, or of an interest in, any shares in the company (this reflects the existing paragraph50H(7)(a)); or

•

the person is the trustee of a family trust who owns or has an interest in any of the shares of the company (this incorporates the family trust concession). [Item 1]

9.37 As a result of this amendment, a company may be able to meet the conditions set out in subsection 50H(3), (4) or (6) because the trustee of a family trust holds a shareholding interest.

Continuity of beneficial ownership

9.38 Section 50H (which sets out when a disqualifying event is taken to have occurred) and subsection 50D(2) (which determines whether an amount can be taken into account in determining an eligible notional loss in the income year) contain continuity of beneficial ownership tests. These provisions refer to natural persons who beneficially own shares in a company. A provision will be inserted into section 50K (which contains special provisions relating to the ownership tests) to provide that where the trustee of a family trust owns shares in a company, the trustee will be taken to beneficially own the shares [item 2, new subsection50K(1A)] . Section 50K also applies for the purpose of section 50J which specifies when a natural person is (or under subsection 50J(6) is taken to be) the beneficial owner of shares in a company where the interests in the shares are held through an interposed company or companies.

9.39 The trustee of a family trust may not be a natural person or persons but a company. If the trustee of the family trust is a company which is taken to be the beneficial owner of shares as a result of new subsection 50K(1A) or subsection 50J(6) (or both those subsections), the company trustee will be taken to be a natural person [item 3, new section 50KA] . As a result of this provision, a company trustee of a family trust will be treated as having the same ownership rights as a natural person.

Debt deduction rules

Continuity of beneficial ownership

9.40 This Bill inserts a new provision into section 63A so that for the purposes of the continuity of ownership tests in subsections 63A(2) and 63A(6), the trustee of a family trust that owns shares in the company will be taken to beneficially own the shares [item 6, new subsection 63A(6A)] . Because this amendment applies only for the purposes of subsections 63A(2) and (6), the trustee of a family trust that is a company will not be taken to beneficially own the shares for the purposes of the tracing rules in subsections 63A(3) and (7)^[F4].

9.41 Subsection 63A(9) provides rules to trace rights to dividends and capital through interposed companies and trusts for the purpose of subsections 63A(4) and 63A(8) (see paragraph 9.42). This is done by looking at who would have beneficially received the dividends or capital if they were distributed through the interposed companies and trusts. The operation of this provision will be modified so that the requirement that a person must have received the amount otherwise than in the capacity of trustee is to be disregarded in the case of a trustee of a family trust [item8, subsection 63A(9A)] . This amendment, together with that discussed in paragraph 9.42, will ensure that the trustee of a family trust will be taken to indirectly receive the amounts as a person for his or her own benefit.

9.42 Paragraphs 63A(4)(b) and (c) and 63A(8)(b) and (c) refer to the right of a person or persons (not being a company) to directly or indirectly receive dividends or distributions of capital from a company for his or her own benefit. For this purpose, a trustee of a family trust will be taken to have that right for his or her own benefit. In relation to the right to indirectly receive dividends or distributions of capital, subsection 63A(9) will apply in accordance with new subsection 63A(9A) as described above. If the trustee of a family trust is a company it will be taken not to be a company. [Item 8, new subsection 63A(9B)]

Shareholding interests

Section 63B is directed at the tax avoidance arrangements discussed at paragraph 9.10. Subsection 63B(5) defines the term shareholding interest.

9.44 This Bill will replace paragraph 63B(5)(a) so that a person will be taken to have a shareholding interest in a company for the purposes of subsection 63B(4) if:

•

the person is the beneficial owner of or has an interest in any shares in the company (this reflects the existing paragraph63B(5)(a)); or

•

the person is the trustee of a family trust who owns or has an interest in any of the shares of the company (this incorporates the family trust concession). [Item 9]

9.45 As a result of this amendment, a company may be able to deduct a debt, where the deduction may otherwise be disallowed by the Commissioner under section 63B, because a family trust has a shareholding interest.

Related amendments

9.46 This Bill amends subsections 63A(2), (4), (6) and (8) by inserting a reference to new section 63CB after the reference to section63C. The amendment ensures that those subsections are subject to the operation of new section 63CB . This section operates to disallow a company a deduction for a debt where the company has not given the Commissioner certain information in respect of a non-resident family trust that holds an interest in a company [items 5 and 7] . The information requirements are explained at paragraphs 9.72 to 9.83.

Amendment to the ITAA 1997

Continuity of beneficial ownership

9.47 The beneficial ownership rules for the prior year, current year and capital loss and debt deduction rules are contained in the primary and alternative tests set out in Subdivision 165-D (sections 165-150 to 165-160) of the ITAA 1997. This Bill will insert a new section into Subdivision 165-D of Division 165 to provide as follows:

•

for the purposes of the primary test, the trustee of a family trust who owns shares in a company is taken to be the beneficial owner of the shares;

•

for the purposes of the alternative test, the trustee of a family trust who has the right to receive, directly or indirectly, any dividend or distribution of capital is taken to have the right to receive the dividend or distribution for the trustees own benefit. If the trustee of a family trust is a company, the trustee will be taken not to be a company. [Item 11, new section 165-207]

9.48 This Bill inserts a definition of the term family trust in the Dictionary at subsection 995-1(1). It is defined as having the same meaning as in section 272-75 of Schedule 2F^[F5]. [Item 15]

9.49 Special tracing rules that apply to listed public companies are contained in Division 166. Subsection 166-165(1) ensures that certain rules contained in Division 165 also apply for the purpose of Division 166. This subsection will be replaced so that the rule contained in new subsection 165-207(2) will also apply for the purpose of the special tracing rules that apply to listed public companies. [Item 12]

Shareholding interests

9.50 Division 175 of the ITAA 1997 contains the rules that apply to the tax avoidance arrangements discussed at paragraph 9.10, 9.12 and 9.14. It contains rules for prior and current year losses, net capital losses of an earlier income year, current year capital losses and debt deductions. Section 175-95 sets out when a person has a shareholding interest in a company for the purposes of sections 175-15, 175-20, 175-25, 175-30, 175-50, 175-60, 175-65, 175-70 and 175-90^[F6]. This Bill will replace subsection 175-95(1) so that a person will have a shareholding interest in the company not only where the person is the beneficial owner of shares or of an interest in shares in the company but also if the person is the trustee of a family trust which owns shares or an interest in shares in the company. [Item 13]

9.51 The effect of the amendment is that the Commissioner will not be able to disallow a tax loss, net capital loss of an earlier income year, capital loss of the current year or other deduction of a company under the above sections in some additional cases. Broadly, this would be where the benefits referred to in those sections flow to the trustee of a family trust that has a shareholding interest in the company and the extent of the benefit is fair and reasonable having regard to the extent of the family trusts shareholding interest in the company.

Second concession - alternative condition

9.52 This Bill will make amendments to the ITAA 1936 and the ITAA1997 so that the alternative condition that is available to fixed trusts under section 266-45 in Schedule 2F will also be available to companies. [Part 3 of Schedule 9]

9.53 This Bill will make amendments to the ITAA 1936 for the purpose of the current year loss rules and debt deduction rules and amendments to the ITAA 1997 for the purpose of the prior year and current year loss and the debt deduction rules. A special alternative is not required for the capital loss rules because:

•

the ability of a company to set off a net capital loss of an earlier income year is subject to the same conditions that it must satisfy to deduct a tax loss of an earlier income year;

•

the requirement for a company to work out its net capital gain and net capital loss under special rules is subject to whether the company is required to calculate its taxable income and tax loss under special rules for the income year of change.

This Bill will insert Notes after subsection 165-96(1) and paragraph 165-102(a) which deal with capital losses to alert readers to the special alternative condition contained in Subdivision 165-F [items 32 and 33] .

9.54 Certain expressions which have been used in Schedule 2F are also used in the provisions which make the alternative condition available to companies. These terms which include control a non-fixed trust , directly or indirectly , fixed trust , excepted trust , family trusts , fixed entitlement , group , more than a 50% stake and non-fixed trust are given the same meanings as in Schedule 2F [items 22, 23, 28 and 35, new paragraph 50H(1A)(d) and new subsections 50HA(6), 63AA(6) and 63AB(6) of the ITAA 1936 ; new section 165-245 of the ITAA 1997] . A glossary of terms is provided in the Appendix at the end of this Chapter.

9.55 The alternative condition is available for the purpose of the prior and current year loss, capital loss and debt deduction rules if the company satisfies the tests contained in the alternative condition. [Items 22, 23, 28 and 35 ; new subsections 50H(1A), 50HA(1), 63AA(1) and 63AB(1) of the ITAA 1936 ; new subsections 165-215(1), 165-220(1) and 165-230(1) of the ITAA 1997]

When can the alternative condition be applied?

9.56 The condition will apply where individuals do not, directly or indirectly, hold fixed entitlements to more than 50% of the income or capital of the company at the start of the relevant period and either of the 2 conditions below are met.

•

Fixed entitlements to 50% or more of the income or capital of a company must be held, throughout the relevant period, by a non-fixed trust or trusts (other than family trusts).

•

Both of the following are satisfied:

-

fixed entitlements to all the income and capital of the company are held, directly or indirectly and throughout the relevant period, by a fixed trust or another company (the holding entity ); and

-

a non-fixed trust or trusts (other than family trusts) hold, throughout the relevant period, fixed entitlements to a 50% or greater share of the income or capital of the holding entity.

[Items 23, 28 and 35 ; new subsections 50HA(2) and (4), 63AA(2) and (4) and 63AB(2) and (4) of the ITAA 1936 ; new subsections 165-215(2) and (4), 165-220(2) and (4) and 165-230(2) and (4) of the ITAA 1997]

When is the alternative condition met?

9.57 The 2 requirements set out below must be satisfied if the alternative condition is to be met.

•

Where the company is held directly by the non-fixed trusts, there must be no change in the persons directly holding, throughout the relevant period, fixed entitlements to shares of the income or capital of the company nor the percentage of their shares. Where the company is held, directly or indirectly, by a holding entity (see paragraph 9.56), this requirement is instead applied to the holding entity rather than the company [items 23, 28 and 35 ; new subsections 50HA(3), 63AA(3) and 63AB(3) of the ITAA 1936 ; new subsections 165-215(3), 165-220(3) and 165-230(5) of the ITAA 1997] .

•

Every non-fixed trust (that is not a family trust or other excepted trust) that holds, at any time in the relevant period, fixed entitlements in the company, directly or indirectly, must satisfy the relevant tests that apply to non-fixed trusts if they stood in place of the loss company [items 23, 28 and 35 ; new subsections 50HA(5), 63AA(5) and 63AB(5) of the ITAA 1936 ; new subsections 165-215(5), 165-220(5) and 165-230(5) of the ITAA 1997] .

What are the relevant periods for applying the alternative condition?

9.58 The relevant period for the purposes of the conditions discussed in paragraphs 9.56 and 9.57 depends on whether the alternative condition is being applied for prior year loss, current year loss or debt deduction purposes. The following table sets out what the relevant period is.

Tests to be satisfied by non-fixed trusts

9.59 Under the condition discussed in the second dot point at paragraph 9.57, non-fixed trusts which hold, directly or indirectly, a fixed entitlement to a share of the income or capital of the company are required to meet certain tests under Schedule 2F. The loss deductibility tests for non-fixed trusts are a 50% stake test, a control test and a pattern of distributions test. The pattern of distributions test is, however, not applicable for current year loss purposes. The tests that apply for debt deduction purposes depend on whether the debt was incurred in a prior year income or the current income year. For prior year loss purposes, any non fixed trust that holds the interest in the company will have to apply the tests throughout the test period that applies for trust loss purposes (ie. the period from the start of the loss year to the end of the income year) see section 267-20 in Schedule 2F.

Related Amendments

ITAA 1936

9.60 This Bill amends subsections 50H(1) and 63A(2), (4), (6) and (8) of the ITAA 1936 which contain the continuity of ownerships tests for the purpose of the current year loss rules and debt deduction provisions. The amendments insert the section number which contains the alternative condition so that the operation of those subsections are subject to the alternative condition. [Items 21, 24, 25, 26 and 27]

ITAA 1997

9.61 A company cannot deduct a tax loss unless it meets the rules set out in section 165-10. The condition set out in paragraph 165-10(a) provides that a company cannot deduct a tax loss unless it satisfies the ownership tests set out in section 165-12.

9.62 This Bill will insert a Note after paragraph 165-10(a) to direct readers to the alternative condition in new section 165-215 that may be available if a company cannot meet these ownership tests. [Item 29]

9.63 A company must calculate its taxable income and tax loss in a special way if it does not meet the conditions contained in section 165-35. The condition contained in paragraph 165-35(a) requires that persons must meet an ownership test (ie. hold more than a 50% stake in the company) during the whole of the income year.

9.64 This Bill will insert a Note after paragraph 165-35(a) to direct readers to the alternative condition contained in new section 165-220 that may be available to a company if it cannot meet the ownership test. [Item30]

9.65 A company cannot deduct a bad debt unless it meets the rules in section 165-120. The condition set out in paragraph 165-120(1)(a) provides that a company cannot deduct a bad debt unless it satisfies the ownership tests set out in section 165-123.

9.66 This Bill will insert a Note after paragraph 165-120(1)(a) to direct readers to the alternative condition contained in new section 165-230 that may be available to a company seeking to deduct a bad debt if it cannot meet the ownership test. [Item 34]

Special rules for current year losses - dividing the year of income into periods

ITAA 1936

9.67 As outlined in paragraph 9.11 above, the current year loss rules apply where an event described in that paragraph occurs in relation to the company during the income year. Section 50H of the ITAA 1936 lists such events or circumstances which are referred to as disqualifying events. If one or more disqualifying events are deemed to have occurred during the income year, the income year is divided into relevant periods. The start or end of a period is determined according to the time a disqualifying event is deemed to have occurred.

9.68 This Bill will insert new provisions into section 50H which set out when a disqualifying event will be deemed to have occurred where the company satisfies 2 conditions which are set out in new subsections 50HA(2) and (4) [item 23] . These are the conditions that a company must meet before the alternative condition can be applied (see paragraph 9.56 above). If the company satisfies these conditions then, instead of paragraphs 50H(1)(a), (b) and (c) applying, a disqualifying event will be taken to have occurred when:

•

the persons holding the fixed entitlements in the company (or holding entity), or the percentages that the persons hold, changes;

•

a non-fixed trust (other than an excepted trust) that holds a direct or indirect fixed entitlement in the company fails to meet the 50% stake condition;

•

a group begins to control one of the non-fixed trusts (other than excepted trusts) that holds a direct or indirect fixed entitlement in the company. [Item 22 ; new subsection 50H(1B)]

ITAA 1997

9.69 Under section 165-35 of the ITAA 1997 a company must calculate its taxable income or tax loss in a special way if the conditions set out in that section are not satisfied. For the purpose of calculating the companies taxable income under those provisions, the income year must be divided into periods under the rules set out in section 165-45.

9.70 This Bill will insert a Note after section 165-45 which will direct readers to new section 165-225 [item 31] . This section will substitute the rules contained in section 165-45 where:

•

the company does not meet the requirement contained in paragraph 165-35(a);

•

the two requirements that must be satisfied if the alternative condition is to be applied are not satisfied, ie. the requirements contained in new subsections 165-220(2) and (4) (see paragraph 9.56).

9.71 Under the substituted rules a period will end where one of the following events occur:

•

when the persons holding the fixed entitlements in the company (or holding entity), or the percentages that the persons hold, changes;

•

the latest time at which all the non-fixed trusts (other than excepted trusts) holding a direct or indirect fixed entitlement in the company meet the 50% stake condition in relation to the start of the period;

•

the first time a group begins to control one of the non-fixed trusts (other than excepted trusts) that holds a direct or indirect fixed entitlement in the company. [Item 35 ; new section 165-225]

Provisions relating to non-resident trusts

9.72 Provisions are included in this Bill to ensure that the trust loss and company loss measures cannot be avoided where non-resident trusts are concerned. These provisions do not need to be considered by resident taxpayers who are not connected to a non-resident entity.

What is a non-resident trust?

9.73 For the purposes of the explanation in this Chapter, the term non-resident trust means a trust where either a trustee is a non-resident or the central management and control of the trust is outside Australia.

Information about non-resident family trusts with interests in a company

9.74 This Bill includes provisions to allow the Commissioner to require a company to give information in certain cases about conferrals of present entitlement to, or distributions of, income or capital^[F7] of non-resident family trusts that hold interests in the company. If this information is not given, the company will be taken not to have satisfied the relevant requirements that would allow it to deduct a current or prior year loss, apply a net capital loss of an earlier or current year, or to deduct an amount in respect of a debt. [Items 4, 10 and 14 ; new sections 50P, 50Q, 63CA and 63CB of the ITAA 1936 ; new sections180-5, 180-10, 180-15 and 180-20 of the ITAA 1997]

9.75 The information will allow the Commissioner to determine whether any family trust distribution tax is payable in respect of conferrals of present entitlement to, or distributions of, income or capital of the non-resident family trusts. Under the trust loss measures, a liability for family trust distribution tax arises where a trustee of a trust has made a family trust election and the trustee makes conferrals or distributions outside the family group. The rules that apply to the payment of this tax are explained in Chapter 11 of the Explanatory Memorandum that accompanied the Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998.

When can a notice be given?

9.76 The Commissioner can give a notice to a company where the company is able to satisfy the tests for deducting a prior or current year loss, applying earlier or current year capital losses or deducting an amount in respect of a debt only because one or more non-resident trusts that hold the relevant interests in the company are family trusts. [Items 4, 10 and 14 ; new subsections 50P(2) to (4), 63CA(2) and (3) of the ITAA 1936 ; subsections 180-5(2) to (4) and 180-15(2) to (4) of the ITAA 1997]

9.77 The Commissioner must give the notice to the company before the later of :

•

5 years after the income year to which the return relates; and

•

the end of the period in which the company is required to keep records under section 262A of the ITAA 1936 in relation to the income year mentioned above. [Items 4, 10 and 14 ; new subsections 50P(5) and 63CA(4) of the ITAA 1936 ; new subsections 180-5(5) and 180-15(5) of the ITAA 1997]

What information can be requested?

9.78 Under the notice, the Commissioner can require the company to provide information in respect of conferrals of present entitlement to, or distributions of, income or capital of the non-resident family trusts. The Commissioner can require information on conferrals or distributions from the times set out in Table 9.2 below.

9.79 The information need not be within the knowledge of the trustee at the time the notice is given [items 4, 10 and 14; new subsections 50Q(2) and 63CB(2) of the ITAA 1936; new subsections 180-10(2) and 180-20(2) of the ITAA 1997] .

9.80 The notice must specify a time within which the company is to provide the Commissioner with the information. The Commissioner must allow a period of at least 21 days commencing on the date that the notice was given [new subsections 50Q(3) and 63CB(3) of the ITAA 1936; new subsections 180-10(3) and 180-20(3) of the ITAA 1997] . The Commissioner can extend the time for compliance with the notice.

What are the consequences of not giving the information?

9.81 If a company does not comply with the request for information, it will be taken not to have satisfied the relevant tests under the prior or current year loss, capital loss or the debt deduction rules and thus:

•

the company is not entitled to deduct the tax loss or an amount in respect of a debt [item 10 ; new subsection 63CB(4) ; item 14, new paragraphs 180-10(4)(a) and (d) of the ITAA 1997] or the Commissioner is not prevented from disallowing a tax loss or other deduction under Division 175 [item 14 ; new paragraph 180-20(4)(a) of the ITAA 1997] ;

•

the company must calculate its taxable income or tax loss in accordance with the current year loss rules in sections 50A to 50N of the ITAA 1936 or Subdivision 165-B of the ITAA 1997 [items 4 and 14 ; new subsection 50Q(4) of the ITAA 1936 ; new paragraph 180-10(4)(b) of the ITAA 1997] ;

•

the company is not entitled to apply a net capital loss of an earlier income year [item 14 ; new paragraph 180-10(4)(c) of the ITAA 1997] or the Commissioner is not prevented from disallowing a net capital loss of an earlier income year under Division 175-CA [item 14, new paragraph 180-20(4)(b) of the ITAA 1997] ;

•

the company must calculate its net capital gain and net capital loss for the income year under Subdivision 165-CB of the ITAA 1997 [item 14 ; new paragraph 180-10(4)(b) of the ITAA 1997] or the Commissioner is not prevented from disallowing a capital loss under Subdivision 175-CB [item 14, new paragraph 180-20(4)(c) of the ITAA 1997] .

9.82 If the company is required to calculate its taxable income or tax loss under Subdivision 165-B or required to calculate a net capital gain or loss for an income year under Subdivision 165-CB, the provisions are to be applied as if they required the year of income to be divided into such relevant periods as would result in the highest possible taxable income for the year of income or as would result in the highest net capital gain for the current year. [New subsection 50Q(5) of the ITAA 1936 ; new subsections 180-10(5) and (6) of the ITAA 1997]

No offences or penalties

9.83 The mere fact that a company fails to provide the Commissioner with the required information so that the consequences outlined above apply does not mean that the company will be taken to have committed an offence or be liable to any penalty under Part VII of the ITAA 1936 for claiming a loss or debt deduction or for not working out the companies taxable income and tax loss under Subdivision 165-B or not calculating a net capital gain or net capital loss under Subdivision 165-CB on lodging the return. Whether the provisions of Part VII of the ITAA 1936 apply would require a separate finding by the Commissioner. [Items 4, 10 and 14 ; new subsections 50Q(6) and 63CB(5) of the ITAA 1936 ; new subsections 180-10(7) and 180-20(5) of the ITAA 1997]

Information about non-resident non-fixed trusts with interests in company

9.84 This Bill includes provisions to allow the Commissioner to require a company to provide certain information to the Commissioner where the company has satisfied the alternative condition. If the company does not provide the information requested by the Commissioner, it will be taken never to have met the condition that would allow it to deduct a current or prior year loss or an amount in respect of a debt. [Items 23, 28, 35 ; new sections 50HB, 50HC, 63AC and 63AD of the ITAA 1936 ; new sections 165-235 and 165-240 of the ITAA 1997]

9.85 This information is needed for the purposes of determining whether the requirements in relation to any non-fixed trust that holds a direct or indirect fixed entitlement in the company are met. One of the tests of the alternative condition is that every non-fixed trust (that is not a family trust or other excepted trust) that holds a fixed entitlement, directly or indirectly, in the company is required to satisfy the relevant tests that apply to non-fixed trusts if they stood in place of the loss company.

When can a notice be given?

9.86 The Commissioner can give a notice to a company where, in relation to a year of income, a company is:

•

able to deduct a tax loss incurred in a loss year;

•

not required to calculate its taxable income and tax loss in accordance with the current year loss rules in sections 50A to 50N of the ITAA 1936 or Subdivision 165-B of the ITAA 1997;

•

the company has not calculated a net capital gain and net capital loss under Subdivision 165-CB;

•

in working out a net capital gain or net capital loss for a current year the company has applied a net capital loss for an earlier income year;

•

able to deduct a debt that it wrote off as bad in the income year;

only because it met the alternative conditions contained in new sections 50HA, 63AA or 63AB of the ITAA 1936 or new section 165-215, or 165-220 or 165-230 of the ITAA 1997. The non-fixed trusts must be non-resident at the time the Commissioner gives the notice. [Items 23, 28 and 35 ; new subsections 50HB(2) to (4) and 63AC(2) to (4) of the ITAA 1936 ; new subsections 165-235(2) to (4) of the ITAA 1997]

9.87 The Commissioner must give the notice to the company before the later of:

•

5 years after the income year in which the company deducted a tax loss or an amount in respect of a debt, did not work out its taxable income or tax loss in accordance with the current year loss rules in sections 50A to 50N of the ITAA 1936 or Subdivision 165-B of the ITAA 1997 or did not work out its net capital gain and net capital loss under Subdivision 165-CB; and

•

the end of the period in which the company is required to keep records under section 262A of the ITAA 1936 in relation to the income year mentioned above.

[Items 23, 28 and 35, new subsections 50HB(5) and 63AC(5) of the ITAA 1936; new subsection 165-235(5) of the ITAA 1997]

What information can be requested?

The notice must set out information that the Commissioner requires. This information need not be within the knowledge of the company at the time the notice is given. [Items 23, 28 and 35 ; new subsections 50HC(1) and (2), 63AD(1) and (2) of the ITAA 1936 ; new subsections 165-240(1) and (2) of the ITAA 1997]

9.89 Under the notice, the Commissioner can seek information on transactions or acts and other matters that would enable him or her to determine whether a non-fixed trust has satisfied the conditions set out in the alternative condition. These are the conditions that need to be satisfied by a non-fixed trust before a prior or current year loss or debt deduction can be deducted. This would include information on distributions of income or capital made by the non-fixed trust, any changes in control of the non-fixed trust and also whether there have been any changes in individuals who hold fixed entitlements in the non-fixed trust. As part of this information-gathering process, the Commissioner may request a copy of the trust deed of the non-fixed trust or other relevant documents relating to the non-fixed trust.

9.90 The notice must specify a time within which the company is to provide the Commissioner with the information. The Commissioner must allow a period of at least 21 days commencing on the date the notice was given [items 23, 28 and 35 ; new subsections 50HC(3) and 63AD(3) of the ITAA 1936 ; new subsection 165-240(3) of the ITAA 1997] . The Commissioner can extend the time for compliance with the notice.

What are the consequences of not giving the information?

9.91 If a company does not comply with the request for information, the company will be taken not to have satisfied the conditions set out in the alternative condition and thus:

•

the company is not entitled to deduct the tax loss [item 35 ; new subsection 165-240(4) of the ITAA 1997] ;

•

the company must calculate its taxable income or tax loss for the year of income in accordance with the current year loss rules in sections 50A to 50N of the ITAA 1936 or Subdivision 165-B of the ITAA 1997 [items 23 and 35 ; new subsection 50HC(4) of the ITAA 1936 ; new subsection 165-240(4) of the ITAA 1997] ;

•

the company must not have calculated a net capital gain and net capital loss under Subdivision 165-CB [item 35 ; new subsection 165-240(4) of the ITAA 1997] ;

•

the company cannot apply a net capital loss for an earlier income year [item 35 ; new subsection 165-240(4) of the ITAA 1997] ;

•

the company is not allowed a deduction for an amount in respect of a debt [items 28 and 35 ; new subsection 63AD(4) of the ITAA 1936 ; new subsection 165-240(4) of the ITAA 1997] .

9.92 If the company is required to work out its taxable income or tax loss under Subdivision 165-B or required to calculate a net capital gain or a net capital loss for an income year under Subdivision 165-CB, the provisions are to be applied as if they required the year of income to be divided into such relevant periods as would result in the highest possible taxable income for the year of income or as would result in the highest net capital gain for the current year. For this purpose, a period could have a minimum length of one day. [Items 23 and 35 ; new subsection 50HC(5) of the ITAA 1936 ; new subsections 165-240(5) and (6) of the ITAA 1997]

No offences or penalties

9.93 The mere fact that a company fails to provide the Commissioner with the required information so that the consequences outlined in paragraph 9.91 apply, does not mean that the company will be taken to have committed an offence or be liable to any penalty under Part VII of the ITAA 1936 for claiming a loss or debt deduction or for not working out the companies taxable income or tax loss under Subdivision 165-B or not working out a net capital gain or net capital loss under Subdivision 165-CB on lodging the return. Whether the provisions of Part VII apply would require a separate finding by the Commissioner. [Items 23, 28 and 35 ; new subsections 50HC(6) and 63AD(5) of the ITAA 1936 ; new subsection 165-240(7) of the ITAA 1997]

Recoupment of family trust distribution tax from companies that have benefited from the family trust concession

9.94 Section 271-60 of Schedule 2F contains special rules to provide that family trust distribution tax imposed by the Family Trust Distribution Tax (Secondary Liability) Act 1997 is payable in certain circumstances. The circumstances arise where a non-resident entity becomes liable for family trust distribution tax under Family Trust Distribution Tax (Primary Liability) Act 1997 and the Commissioner is unable to recover the tax because of territorial limitations.

9.95 Section 271-60 of Schedule 2F essentially provides that if family trust distribution tax is not paid by a non-resident family trust which holds an interest in a resident trust, then the resident trust will be liable for the tax. This will be the case if the resident trust has passed the continuity of ownership (50% stake) test only because the non-resident family trust holds the interest. Chapter 12 of the Explanatory Memorandum to the Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998 provides more detail.

9.96 This Bill will make a consequential amendment to section 271-60 in Schedule 2F to take into account the extension of the family trust tracing concession to companies [Part 2, Schedule 9] . The amendment will provide that if family trust distribution tax is not paid by a non-resident family trust with an interest in a resident company, then the company will be liable for the tax. This will be the case if the company was able to deduct a tax loss or amount in respect of a debt, apply a net capital loss of an earlier income year or was not required to work out its taxable income or tax loss under Subdivision 165-B or did not work out its net capital gain or its net capital loss under Subdivision 165-CB only because the non-resident family trust held the interest. [Items 17, 18, 19]

Commencement and application provisions

9.97 The amendments made by Schedule 9 will commence when this Bill commences. [Subclause 2(1)]

Application of the family trust concession

ITAA 1936

9.98 The amendments made to the ITAA 1936 to introduce the family trust concession will apply as follows:

•

in the case of the current year loss provisions (sections 50A to 50N) for the 1996-97 year of income [subitem 16(1)] ;

•

in the case of the debt deduction provisions (sections 63A to 63C) to debts incurred in the 1996-97 or 1997-98 years [subitem16(2)] .

ITAA 1997

9.99 The amendments made to the ITAA 1997 to introduce the family trust concession will apply as follows:

•

in the case of amendments that affect the prior year loss rules (Subdivisions 165-A and 166-A) where the loss year is the 1996-97 income year or any later income year and the income year is the 1997-98 income year or later income year [subitem16(3)(a))] ;

•

in the case of amendments made to the current year loss rules (Subdivisions 165-B and 166-B) where the income year is the 1997-98 income year or any later income year [subitem 16(3)(b)] ;

•

in the case of amendments that affect the application of net capital losses of an earlier income year or the calculation of net capital gains or losses of an income year (Subdivisions 165-CA and 165-CB) where the current year or income year referred to is the 1998-99 income year or later income year [subitem 16(3)(c)] ;

•

in the case of amendments that affect the debt deduction provisions (Subdivision 165-C) where the debts were incurred in the 1996-97 income year or any later income year and the income year referred to is the 1998-99 income year or any later income year [subitem 16(3)(d)] ;

•

in the case of amendments that affect provisions that deal with tax benefits from unused losses (Subdivision 175-A) where the loss year is the 1996-97 income year or any later income year and the income year is the 1997-98 income year or any later income year [subitem 16(4)(a)] ;

•

in the case of amendments that affect provisions dealing with tax benefits from unused deductions (Subdivision 175-B) where the income year is the 1997-98 income year or any later income year [subitem 16(4)(b)] ;

•

in the case of amendments that affect provisions dealing with tax benefits from unused net capital losses of earlier years or unused capital losses of a current year (Subdivision 175-CA or 175-CB) where the income year is the 1998-99 income year of any later income year [subitem 16(4)(c)] ;

•

in the case of amendments that affect the provisions dealing with tax benefits from unused bad debt deductions (Subdivision 175-C) where the debts were incurred in the 1996-97 income year or any later income year and the income year referred to is the 1998-99 income year or any later income year [subitem16(4)(d)] ;

•

in the case of information gathering rules for Subdivision 165-A (paragraph 180-5(2)(a)) where the loss year is the 1996-97 or later income year and the income year is the 1997-98 income year or any later income year [subitem 16(5)(a)] ;

•

in the case of information gathering rules for Subdivision 165-B (subparagraph 180-5(2)(b)(i)) where the income year is the 1997-98 income year or any later income year [subitem 16(5)(b)] ;

•

in the case of information gathering rules for Subdivision 165-CA or 165-CB (subparagraph 180-5(2)(b)(ii) or paragraph 180-5(2)(c)) where the income year is the 1998-99 income year or any later income year [subitem 16(5)(c)] ;

•

in the case of information gathering rules for Subdivision 165-C (paragraph 180-5(2)(d)) where the debt was incurred in the 1996-97 income year or any later income year and the income year referred to is the 1998-99 income year or any later income year [subitem 16(5)(d)] ;

•

in the case of information gathering rules for Subdivision 175-A (paragraph 180-15(2)(a)) where the loss year is the 1996-97 income year or any later income year and the income year is the 1997-98 income year or any later income year [subitem 16(6)(a)] ;

•

in the case of information gathering rules for Subdivision 175-B (paragraph 180-15(2)(b)) where the income year is the 1997-98 income year or any later income year [subitem 16(6)(b)] ;

•

in the case of information gathering rules for Subdivisions 175-CA or 175-CB (paragraph 180-15(2)(c) or (d)) where the income year is the 1998-99 income year or any later income year [subitem 16(6)(c)] ;

•

in the case of information gathering rules for Subdivision 175-C (paragraph 180-15(2)(e)) where the debt was incurred in the 1996-97 income year or any later income year and the income year referred to is the 1998-99 income year or any later income year [subitem 16(6)(d)] .

Application of the alternative condition

ITAA 1936

9.99 The amendments to the ITAA 1936 to introduce the alternative condition will apply as follows:

•

in the case of the current year loss provisions (sections 50A to 50N) the 1996-97 year of income [subitem 36(1)] ;

•

in the case of the debt deduction provisions (sections 63A to 63C) to debts incurred in the 1996-97 or 1997-98 years of income [subitem 36(2)] .

ITAA 1997

9.100 The amendments made to the ITAA 1997 apply as follows:

•

in the case of amendments affecting the prior year loss rules (Subdivision 165-A) where the loss year is the 1996-97 income year or any later income year and the income year mentioned in that Subdivision is the 1997-98 income year or any later income year [subitem 36(3)] ;

•

in the case of amendments affecting the current year loss rules (Subdivision 165-B) where the income year is the 1997-98 income year or any later income year [subitem 36(4)] ;

•

in the case of amendments affecting the application of net capital losses of earlier income years (Subdivision 165-CA) where the current year is the 1998-99 income year or any later income year [subitem 36(5)] ;

•

in the case of amendments that affect the working out of a net capital gain and net capital loss of an income year (Subdivision 165-CB) where the income year is the 1998-99 income year or any later income year [subitem 36(5)] ;

•

in the case of amendments affecting the debt deduction rules (Subdivision 165-C) to debts incurred in the 1996-97 income year or any later income year and the current year referred to is the 1998-99 income year or later income year [subitem 36(6)] .

9.101 The amendments to the recoupment provisions will apply in the same way as section 271-60 in Schedule 2F will for a trust covered by subsections 271-60(3) and (4), ie. in respect of any family distribution tax that becomes payable under section 271-15. However, the changes will only apply where the determination by the Commissioner that the tax must be paid is made after the commencement of the amendments. [Item20]

Regulation Impact Statement

Specification of policy objective

The purpose of these amendments is to extend to companies 2 concessional tracing rules (the family trust concession and the alternative condition ) that are available to trusts under the trust loss measures.

9.103 The amendments will improve the equity and efficiency of the taxation system as trusts and companies will be treated on a similar basis for the purpose of tracing interests. The amendments will also create certainty in the application of the law to companies in respect of tracing interests through non-fixed trusts.

Implementation

Nature of the amendments

9.104 The implementation of this measure involves amending the company loss and debt deduction rules in the tax law to make the 2 special tracing rules that are available to trusts under the trust loss measures available to companies.

9.105 Companies need to satisfy certain tests before prior year losses can be recouped in a later income year. Broadly, a company cannot deduct a loss incurred in a prior income year unless it satisfies a continuity of majority beneficial ownership test in both the loss year and the recoupment year.

9.106 If a company fails the continuity of ownership test, it may nevertheless be able to deduct the loss if it continues to carry on the same business as it carried on at the time of change. There are also additional rules to prevent the carry forward of a loss in certain circumstances.

9.107 Similar tests apply to limit the deductibility of a companies current year losses or bad debt deductions (including certain debt/equity swap deductions).

9.108 In applying the ownership tests, it may be necessary to trace through interposed entities to the underlying individuals who beneficially own interests in the company. This is also a necessary requirement in applying the ownership tests contained in the trust loss measures.

9.110 In applying the ownership tests that apply to trusts under the trust loss measures, there are 2 special tracing rules. These rules are the family trust concession and the alternative condition.

•

The family trust concession applies where a fixed interest in a loss trust or an entity interposed between the loss trust and underlying individuals is held by a family trust. The family trust is treated as an individual holding the interest for its own benefit.

•

The alternative condition applies for the purpose of the ownership test (50% stake test) that applies to fixed trusts. If the fixed trust is held by non-fixed trusts such that it is not able to pass the 50% stake test, the fixed trust can still deduct its losses if certain conditions are satisfied.

9.111 The company loss rules will be amended so that these tracing rules will be available to companies in the same way that they apply to trusts. For example, if a company is held 50% or more by discretionary trusts it will be able to carry forward its prior year losses if the tests contained in the alternative condition are met.

9.112 The concessions will be made available for the purpose of the company prior year loss provisions, the current year loss provisions and the debt deduction provisions.

Identification of implementation options

9.113 The amendments were considered to be the only viable option for implementing rules, consistent with those in the trust loss measures, to allow companies held by discretionary trusts to deduct losses and debts in appropriate cases.

Assessment of impact (costs and benefits) of the measure

Impact group identification (the following groups will be affected by the proposed amendments)

9.114 Persons who use companies to operate businesses or to carry on investment activities will be affected by the proposed amendments. Some trusts that have interests in companies will also be affected.

9.115 The companies that will be affected are those which have deductions including prior year losses and earlier year net capital losses. The total number of companies with prior year losses in the income year 1996-97 was 162,364 and those with earlier year net capital losses 17,983.

9.116 The measures will also affect the Australian Taxation Office (ATO) which will administer the measures.

Assessment of costs

Compliance costs

9.119 The family trust concession will result in some initial compliance costs as trusts wishing to be a family trust will need to make a family trust election. These costs will be minimal as many such trusts will have made the election for the purposes of the trust loss measures.

9.118 For the alternative condition, there will be some costs for companies in monitoring whether the non-fixed trusts which hold interests in the company will pass the tests that apply to non-fixed trusts under the trust loss measures.

9.119 The initial and recurrent costs of compliance associated with the company tracing rules is estimated to be minimal.

Administrative costs

9.120 The additional administrative costs to the ATO will be minimal.

Estimated costs

9.121 The cost to revenue of extending the family trust tracing concession to companies is estimated to be in the order of $10 million per annum.

9.122 It is estimated that the loss in revenue associated with the alternative condition will be negligible.

Assessment of Benefits

9.123 As indicated above, the proposed measures will not result in any gains to the revenue.

9.124 The benefit is that the changes will allay taxpayer concerns about whether companies held by discretionary trusts can deduct losses and debts. Also, the changes will create consistency between the trust loss provisions and the company loss provisions.

Consultation

9.125 It was not considered necessary to consult on the company tracing rules as extensive consultation took place on the same tracing rules contained in the trust loss measures.

9.126 The concessions were developed in response to taxpayer concerns that it was not possible to trace through discretionary trusts. The submissions received during the consultation process on the trust loss measures were taken into account in developing the rules. Submissions on the trust loss proposals were received from industry and professional bodies, and individual tax professionals and taxpayers.

Conclusion

9.127 The ATO and Treasury will monitor this taxation measure on a continuing basis. The Ato's existing consultative arrangements include the National Tax Liaison Group.

Chapter 10 Extension of transitional family trust and interposed entity election provisions

Introduction

10.1 Schedule 10 to this Bill will amend Schedule 1 to Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998 (the Trust Loss Act) to allow an extended period for making family trust elections and interposed entity elections. This will enable elections to be made for the purpose of:

•

the family trust concessional tracing rule that applies to companies (described in Chapter 9 of this Explanatory Memorandum); and

•

the franking credit trading measures to be implemented by Taxation Laws Amendment Bill (No. 2) 1999.

Summary of amendments

Purpose of amendments

10.2 To extend the deadlines for making family trust and interposed entity elections in earlier income years to enable taxpayers to:

•

make elections to allow a company to take advantage of the family trust tracing concession that will be available under amendments made by this Bill; and

•

make these elections for the purpose of the franking credit trading measures after the relevant amendments have received Royal Assent.

10.3 This requires amendment to the transitional provisions for making family trust and interposed entity elections which are set out in Schedule 1 to the Trust Loss Act.

Date of effect

10.4 These amendments will apply from the day this Bill receives Royal Assent.

Background to the legislation

10.5 Under the existing transitional rule in Schedule 1 to the Trust Loss Act the deadline for making elections for the 1996-97 and the 1997-98 income years is the time for lodging the 1997-98 tax returns which has already passed.

10.6 A trustee of a trust which holds an interest in a company which can benefit from the family trust concession in the 1996-97 or 1997-98 income years which has not made a family trust election for those years may wish to have a family trust election in place for those years. Similarly, companies, trusts or partnerships wishing to be members of the same family group as the trust making the family trust election may wish to make an interposed entity election for those same income years.

10.7 Unless a trust has elected to be a family trust, the 45 day rule, an anti-franking credit trading rule in new Division 1A which will be inserted in Part IIIA of Income Tax Assessment Act 1936 (ITAA 1936) by Schedule 4 to Taxation Laws Amendment Bill (No. 2) 1999, will generally deny beneficiaries of non-fixed trusts the franking rebate and other franking benefits in relation to dividends paid on shares or interests in shares acquired after 3.00 pm on 31 December 1997. However, many taxpayers are understandably reluctant to make an election before the measures are passed by Parliament.

Explanation of amendments

Family trust concessional tracing rule

10.8 This Bill will allow a trustee of a trust which holds an interest in a company which can benefit from the family trust concession to make a family trust election for the 1996-97 and 1997-98 income years. The transitional rule will be available to trusts that pass the family control test (see section 272-87 of the trust loss measures contained in Schedule 2F to the ITAA 1936) at the relevant times ^[F8] and will apply so that:

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taxpayers wishing to make the election for the 1996-97 or 1997-98 income year will be required to do so before taxpayers lodge their 1998-99 tax returns. If no tax return is required for 1998-99, the election will need to be made within 2 months after the end of that income year;

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the election will need to be in a form approved by the Commissioner of Taxation (the Commissioner) but does not need to be lodged with the Commissioner;

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a taxpayer who made the election in 1996-97 or 1997-98 will be required to lodge details of the election as part of their 1998-99 tax return. If no tax return is required for 1998-99, the details will need to be provided within 2 months of the end of the 1998-99 income year or such later day as the Commissioner allows. [Subitems 22(2) (3) and (4) of Schedule 1 to the Trust Loss Act]

10.9 Parallel rules will also allow companies, trusts or partnerships that wish to be a member of the same family group to have interposed entity elections in place for the same income years. [Subitems 23(2) to (4) of Schedule 1 to the Trust Loss Act]

10.10 Alternative transitional rules will come into effect if the amendments to the company loss rules have not been passed by Parliament before the due date for lodging the 1998-99 income tax return. The transitional rule would apply as above except that taxpayers should make the election for the 1996-97, 1997-98 or 1998-99 income year before lodging their return for the 1999-2000 income year and details should be provided as part of their 1999-2000 tax return. [New subitems 22A(1), (3) and (4) and 23A(1) to (3) of Schedule 1 to the Trust Loss Act]

Franking credit trading measures

10.11 A similar transitional rule is required for non-fixed trusts wishing to make family trust elections in the 1997-98 income year if the trust received a franked dividend (within the meaning of Part IIIA of the ITAA 1936) or a distribution attributable to a franked dividend in the 1997-98 income year. The transitional rule will be available where the non-fixed trust passes the family control test at all times in the 1997-98 income year and will apply so that:

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taxpayers wishing to make the election for the 1997-98 income year will be required to do so when lodging their 1998-99 tax returns. If no tax return is required for 1998-99, the election will need to be made within 2 months after the end of that income year or such later day as the Commissioner allows;

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the election will need to be in a form approved by the Commissioner but does not need to be lodged with the Commissioner;

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a taxpayer who made the election in 1997-98 will be required to lodge the election as part of their 1998-99 tax return. If no tax return is required for 1998-99, the details will need to be provided within 2 months of the end of the 1998-99 income year or such later day as the Commissioner allows. [New subitems 22(2A), (3) and (4) of Schedule 1 to the Trust Loss Act]

10.12 Parallel rules will also allow companies, trusts or partnerships that wish to be a member of the same family group to have interposed entity elections in the same income years. [Subitems 23(2) to (4) to Schedule 1 to the Trust Loss Act]

10.13 Alternative transitional rules will come into effect if the franking credit trading measures have not been passed by Parliament before the due date for lodging the 1998-99 income tax return. The transitional rule would apply as above except that taxpayers should make the election for the 1997-98 and 1998-99 income years before lodging their return for the 1999-2000 income year and details should be provided as part of their 1999-2000 tax return. [New subitems 22A(2) to (4) and 23A(1) to (4) of Schedule1 to the Trust Loss Act]

10.14 The above transitional rules contain a special rule to ensure that no family trust distribution tax is payable in earlier income years for which elections are made if the family trust meets a requirement. This is that the trust satisfies, in the income year, the ordinary tests for deductibility of prior or current year losses or debt deductions that will apply to trusts that are not family trusts (ie. the trust is not prevented under the trust loss measures from deducting a tax loss or an amount in respect of a debt, or is not required to calculate its net income and tax loss under Division 268 of Schedule 2F of the ITAA 1936). [New subitems 22(5), 22A(5)]

Continuation of previous transitional provisions

10.15 The repeal of existing items 22 and 23 of Schedule 1 to the Trust Losses Act will not affect a persons right to make elections under those repealed provisions. [Item 11]

Consequential amendment

10.16 Section 262A of the ITAA 1936 is being amended to make it clear that an election made in accordance with the transitional rules must be retained by the taxpayer who made it for 5 years. This is a standard provision for retention of elections of this kind. [Item 1]