Senate

Replacement Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P)

General Outline and Financial Impact

The Taxation Laws Amendment Bill (No. 4) 1992 will amend the income tax law by making the following changes:

Disability Support Pension, Special Needs Support Pension, Bereavement Payments and Textile, Clothing and Footwear Special Allowance

•

Restore a provision of the Principal Act whereby disability support pensions and special needs disability support pensions will be taxable where the recipient is of pension age.

•

Amend the exempt bereavement payments calculators in sections 24ABZB and 24ACX of the Principal Act to restore a provision whereby the proportion of bereavement payments which is exempt is calculated in relation to social security and service pensions.

•

Amend the Principal Act to extent eligibility for a rebate of income tax to recipients of Textile, Clothing and Footwear Special Allowance.

Proposed announced: Not previously announced.

Financial impact: Insignificant.

Offshore Banking - Income Tax Concessions

•

Provide concessional income tax treatment at a tax rate of 10% on profits from offshore banking activities carried on in Australia.

Proposed announced: One Nation Statement of 26 February 1992. However, the scope of the tax concessions is wider than that announced in the Statement.

Financial impact: The direct cost to revenue of the measures is likely to be around $30 million in a full financial year from 1993-94.

It is possible, however, that additional revenue from business which is not presently conducted in Australia will offset this cost to some extent.

Capital Gains Tax Amendments

•

Clarify the operation of subsections 160M(6) and 160M(7) to provide that, where a person creates an incorporeal asset (such as rights under an agreement) for another person, any consideration (less incidental costs) received by the person creating the asset will be a capital gain.

•

Clarify the situations in which subsections 160M(6) and 160M(7) apply to non-residents.

•

Provide that subsection 160M(7) does not apply between 20 September 1985 and 22 May 1986 (inclusive) where the asset referred to in subsection 160M(7) is owned by a person other than the taxpayer.

Proposal announced: Not previously announced

Financial impact: These amendments are not expected to have any significant impact on revenue.

Penalties for Late Payment of Tax and Related Penalties

•

This Bill will reduce late payment penalty and related penalties from 20% per annum to 16% per annum to reflect lower market interest rates. The lower rate is to be effective from 1 October 1992.

Proposal announced: Treasurer's Press Release of 26 May 1992

Financial impact: It is estimated that the cost to revenue of the reduction in the rate of penalty for late payment of tax and related penalties from 20% to 16% per annum is $16 million in 1992-93 and $25 million in each subsequent year.

Chapter 1 Disability Support Pension, Special Needs Disability Support Pension, Bereavement Payments, and Textile, Clothing and Footwear Special Allowance

This Chapter is divided into three Parts. Each Part explains the amendments proposed in Division 2, 3 and 5 in Part 2 of the Bill.

Part A: Amendments relating to disability support pension and special needs disability support pension (Division 2)

Summary of proposed amendments

This Bill proposes to amend the Income Tax Assessment Act 1936 (Principal Act) to restore the provision whereby disability support pension and special needs disability support pension derived by persons above pension age are taxable. The Bill also proposes to restore provisions to apply to the tax treatment of related bereavement payments.

Background to the legislation

Disability support pension

Generally, when they attain pension age, disability support (formerly invalid) pensioners go on to the age pension and their pension becomes taxable but subject to a pensioner rebate. The rebate is sufficient to free a full-rate pensioner from tax on pension income and a certain amount of non-pension income. However, some recipients of disability support pension (DSP) who are unable to qualify for age pension because, for example, of residential status, remain on the DSP after they have attained pension age. Under the provisions of section 23AD of the Principal Act, DSP paid to a person of pension age was taxable but subject to a tax rebate. In 1991, section 23AD was repealed and replaced by Division 1AA.

When the Social Security Act 1947 was rewritten as the Social Security Act 1991 (SSA91) the new Act inadvertently did not provide for persons to continue to receive invalid pension after attain pension age. This situation was remedied in the Social Security (Disability and Sickness Support) Amendment Act 1991 which repealed the then existing Part 2.3 of SSA91 (invalid pension) and replaced it with a new Part 2.3.

Because the SSA91 did not provide for continued payment of the DSP to persons of pension age, section 23AD of the Principal Act was translated into Division 1AA without provision for taxing the payment. It is therefore necessary to:

(a)

provide that DSP derived by persons of pension age be taxable; and

(b)

restrict existing tax provisions relating to DSP to persons under pension age.

Bereavement payments are derived by the surviving member of a pensioner couple where the other partner dies. Where there is no partner the payment may be made, at the discretion of the Secretary of the Department of Social Security, to another person. Where the surviving member of a couple dies before he or she derives the bereavement payment related to the death of the partner, the payment may be made to a third person. In certain circumstances the payment may be made in a lump sum, and in such an instance, the exemption from tax of a proportion of the lump sum is determined by an Exempt Bereavement Payment Calculator A (Calculator A) in section 24ABZB of the Principal Act. Calculator A takes into account the tax status of payments the couple would have derived if the deceased had not died.

Subsection 24ABC(5) of the Principal Act provides that a taxpayer is excluded from receiving bereavement payment if the amount of the taxpayer's pension following a partner's death is greater than what the bereavement payment would be. For example, the husband is employed and, because of his income, the pension entitlement for he and his partner is $100 each. Suppose that, following the death of the husband, the surviving partner is entitled to a single-rate pension of $300. This sum would normally be assessable. However, a further provision entitles her to an exemption from income tax on the difference between the amount of her pre-death pension ($100) and her post-death pension amount ($300). This exemption applies for 7 pension paydays after the date of death. In addition, supplementary amounts, such as payments for rent assistance, are exempt.

The amendments insert provisions, relating to bereavement payments in regard to persons of pension age who derive DSP, which parallel the provisions for age pensioners.

Special Needs Disability Support Pension

Section 23AD of the Principal Act also provided that payments of Special Needs Disability Support Pension to persons over the pension age were taxable. However, when section 23AD was rewritten as Division 1AA, no provision was made for payments of this pension to persons of pension age to be taxable. It is therefore necessary to:

(a)

provide that special needs DSP derived by persons of pension age is taxable; and

(b)

restrict existing tax provisions relating to special needs DSP to persons under pension age.

The amendments insert provisions, relating to bereavement payments in regard to persons of pension age who derive special needs DSP, which parallel the provisions for special needs age pensioners.

Explanation of the proposed amendments

The Bill will amend Division 1AA to:

(a)

ensure that the existing provisions relating to taxability of disability support pension and related bereavement payments apply only to payments to a person who is under pension age [Clause 6 - new subsection 24ABD(1A)]

Both categories of disability support pension at pension age or over will be entitled to the tax rebate to which other recipients of taxable pensions are entitled under section 160AAA of the Principal Act.

Commencement date

The amendments apply to receipt of pension on or after 1 July 1991 [Clause 10].

Clauses involved in the proposed amendments

Clause 4(a): adds new section 24ABDAA to the index of social security payments covered in Subdivision B of Division 1AA of the Principal Act. This section, which is entered in the index against "disability support pension", is that which relates to pension age recipients.

Clause 4(b): adds new section 24ABRA to the index of social security payments covered in Subdivision B of Division 1AA of the Principal Act. This section, which is entered in the index against "special needs disability support pension", is that which relates to pension age recipients.

Clause 5(a): inserts the term "disability support pension" in the table in subsection 24ABA(1) which sets out the taxable pensions and references to the relevant supplementary amounts. Provisions elsewhere in Division 1AA of the Principal Act make these supplementary amounts exempt.

Clause 5(b): inserts the term "special needs disability support pension" in the table in subsection 24ABA(1) which sets out the taxable pensions and references to relevant supplementary amounts. Provisions elsewhere in Division 1AA of the Principal Act make these supplementary amounts exempt.

Clause 6: inserts new subsection 24ABD(1A) to ensure that section 24ABD applies only to payments of DSP to a person who is under pension age.

Clause 7: inserts a new section 24ABDAA which details the tax treatment of payments of DSP and related bereavement payments to a person who is of pension age.

Clause 8: inserts new subsection 24ABR(1A) to ensure that section 24ABR applies only to payments of special needs DSP to a person who is under pension age.

Clause 9: inserts a new section 24ABRA which details the tax treatment of payments of special needs DSP and related bereavement payments to a person who is of pension age.

Clause 10: provides that amendments made by the above clauses apply to payments derived on or after 1 July 1991.

Part B: Amendments relating to bereavement payments (Division 3)

Summary of proposed amendments

This Bill will make minor technical amendments to sections 24ABZB and 24ACX of the Principal Act.

Background to the legislation

Where, because of illness or infirmity, the members of a married pension couple have to live apart, they derive pension at the single-rate rather than the lower married-rate. Similar provisions apply where a member of the couple has to enter respite care.

Under the SSA91, when a member of a pensioner couple dies the surviving member is entitled to a payment in respect of the deceased. In effect, the surviving partner is entitled to receive an amount for 7 pension paydays equal to the amount that would have been payable to the couple if the partner had not died. However, if immediately before the death, the couple were living apart as a result of illness or infirmity, this entitlement is calculated at the ordinary married rate. In certain circumstances, the bereavement payment is paid to the surviving partner as a lump sum.

The Social Security Act 1947 (which was replaced by the SSA91) provided that, if the couple were receiving the illness-separated level of pension because they were living apart due to illness or infirmity, bereavement payment was to be calculated as if the couple had been living together. This also applied to respite care couples. Initially this provision with regard to both illness-separated and respite care couples was not included in SSA91. The Social Security Legislation Amendment Act (No. 4) 1991 amended SSA91 to reinstate the provision. As a result the bereavement payment derived by the surviving member of such couples is now calculated as if the couple had been living together immediately before the death.

Section 24ABZB of the Principal Act contains Exempt Bereavement Calculator A (Calculator A) which provides the means to calculate the "tax-free amount" relating to a bereavement payment made in a lump sum under SSA91 following the death of a member of a pensioner couple.

Step 2 in Calculator A provides for working out the amount of payments that would have been derived by the taxpayer on each of the relevant pension paydays. The amount is that which would have been exempt if the partner had not died and, in certain circumstances, subject to the partner's age.

Step 4 in the calculator provides for working out the amount that would have been derived by the deceased on each of the 7 pension paydays if the deceased had not died. This amount, "the pension payday notional partner amount" for each payday is summed to arrive at the "notional partner amount". This amount is added to the "exempt notional taxpayer amount" calculated in accordance with Steps 2 and 3 of Calculator A and relating to the surviving partner. The sum of the two amounts is referred to as the "tax free amount". The tax-free amount is exempt from tax under the relevant provisions of Division 1AA of Part III of the Principal Act.

Because SSA91 initially did not provide for the adjustment of the bereavement payment where the couple were living apart because of illness or infirmity, it had not been taken up in the Principal Act when Division 1AA replaced former section 23AD. This applies also to a respite care couple.

A provision, similar to that initially made in the SSA91, for adjusting the bereavement payment was contained in Part III of the Veterans' Entitlements Act 1986 (VEA) which was rewritten in the Veterans' Entitlements Amendment Act 1991. The provision was retained in the rewritten part III. However, when the Principal Act was amended to take account of the rewriting of Part III of the VEA, the provision relating to these couples was not taken up in section 24ACX which contains Exempt Bereavement Calculator B (Calculator B). Calculator B provides the means to calculate the "tax-free amount" relating to a bereavement payment made under the VEA.

Explanation of the proposed amendments

The amendments propose to modify the application of Steps 2 and 4 of the Exempt Bereavement Payment Calculators A and B so that lump sum bereavement payments relating to illness-separated pensioners and respite-separated pensioners are worked out as though the members of the couple has been living together immediately before the death [Clauses 11 and 12] .

The following example illustrates the proposed operation of Calculator A:

A social security pensioner couple were living apart because of illness of the husband. They each received pension of $300 per pension payday (that is, fortnightly). Both pensioners are exempt from tax on their pension. The husband dies. Assume that the first available pension payday is the first pay day after the death of the husband. (The married-rate pension is $250 each per pension payday).

Calculator A will work as follows:

Step 1: The number of pension paydays is 7.

Step 2: As the wife's pension is exempt the pension payday exempt notional taxpayer amount is $250. (Step 2 of the calculator will provide that the partners are to be treated as though they have been living together immediately before the death; the married-rate pension of $250 is therefore relevant).

Step 3: Exempt notional taxpayer amount is $1.750 [$250 x 7]

Step 4: Pension pay day notional partner amount is $250.

If the partner had not died he would have receive a pension of $300 on each of the relevant pension paydays. However, as Step 2 will provide that they are to be treated as though the partners had been living together immediately before the death, the married-rate pension is relevant.

Step 5: Notional partner amount is $1,750. [$250 x 7]

Step 6: Tax-free amount is $3,500. [Step 3 + Step 5]

Commencement date

The amendments to section 24ABZB will apply to payments derived on or after 13 December 1991 [Clause 13(1)].

The amendments to section 24ACX will apply to payments derived on or after 1 July 1991 [Clause 13(2)].

Clauses involved in the proposed amendments

Clause 11(a): will insert new paragraph (c) in Step 2 of Calculator A in section 24ABZB. New paragraph (c) will provide that, where immediately before the partner's death the couple were an illness separated couple or a respite care couple, they are not to be treated as such a couple.

Clause 11(b): will substitute a new Step 4 of Calculator A in section 24ABZB in place of the existing Step 4. The new Step 4 will add a paragraph (b) to provide that, where immediately before the partner's death the couple were an illness separated couple or a respite care couple, they are not to be treated as such a couple.

Clause 12(a): will insert new paragraph (d) in Step 2 of Calculator B in section 24ACX. New paragraph (d) will provide that, where immediately before the partner's death the couple were an illness separated couple or a respite care couple, they are not to be treated as such a couple.

Clause 12(b): will substitute a new Step 4 of Calculator B in section 24ACX in place of the existing Step 4. The new Step 4 will add a paragraph (b) to provide that where immediately before the partner's death the couple were an illness separated couple or a respite care couple they are not to be treated as such a couple.

Clause 13(1): provides that the amendments made by clause 11 will apply to social security bereavement payments derived on or after 13 December 1991.

Clause 13(2): provides that the amendments made by clause 12 will apply to service bereavement payments derived on or after 1 July 1991.

Part C: Amendment relating to rebates in respect of Textile, Clothing and Footwear (TCF) Special Allowance (Division 5).

Summary of proposed amendments

This Bill will amend the Principal Act to extend eligibility for a rebate of income tax to recipients of the TCF Special Allowance.

Background to the legislation

Section 160AAA of the Principal Act provides for rebates in respect of certain pensions, benefits and allowances. Subsection 160AAA(1) contains a definition of the term "rebatable benefit" which lists the benefits and allowances which satisfy the definition. Subsection 160AAA(3) provides that, where the assessable income of a taxpayer of a year of income includes an amount of rebatable benefit, the taxpayer is entitled to a rebate of tax of an amount ascertained in accordance with the regulations.

Retrenchees from the textile clothing and footwear industries may be eligible to participate in one of two training programs: the TCF Special Allowance or the Formal Training Assistance programs. The basic allowance under the former is not a rebatable benefit while under the latter it is. This amendment will ensure the basic allowance under the TCF Special Allowance is rebatable also.

The TCF Special Allowance is provided under the Textile Clothing and Footwear Labour Adjustment Package. The allowance is designed to encourage employees retrenched from the textile, clothing and footwear industries to undertake training to fit them for employment elsewhere. It includes two main components:

(a)

a basic allowance which corresponds in amount to the Job Search Allowance and the New Start Allowance paid under the SSA91 to single persons aged 21 or above without dependants; and

(b)

a training allowance.

Both components are taxable under existing tax law.

Some retrenchees of the textile, clothing and footwear industries are eligible for Formal Training Assistance. This program provides a basic allowance which is, in effect, Job Search Allowance or New Start Allowance payable under Parts 2.11 and 2.12 of SSA91 respectively. These allowances have replaced the Unemployment Benefit. Under Formal Training Assistance, retrenchees aged 21 or above also derive a training allowance payable at the same rate as the training allowance derived under the TCF Special Allowance. The basic allowance under Formal Training Assistance is eligible for a rebate of income tax as a result of the operation of section 160AAA of the Principal Act and Part 8 of the Income Tax Regulations.

Explanation of the proposed amendments

This Bill will amend subsection 160AAA(1) to add to the definition of "rebatable benefit" the term, an amount paid by way of TCF Special Allowance. Thus, by the operation of subsection 160AAA(3) of the Principal Act, entitlement to a tax rebate will be extended to recipients of the TCF Special Allowance [Clause 21] .

Commencement date

These amendments will apply to payments of the TCF Special Allowance on or after 26 September 1991 [Clause 22] .

Clauses involved in the proposed amendment

Clause 21: will amend subsection 160AAA(1) by adding to the definition of "rebatable benefit" the term "paid by way of Textile, Clothing and Footwear Special Allowance". This effectively extends eligibility for the rebate to recipients of Textile, Clothing and Footwear Special Allowance.

Clause 22: will provide that the amendment of subsection 160AAA(1) will apply to payments of Textile, Clothing and Footwear Special Allowance made on or after 26 September 1991.

Chapter 2 Offshore Banking - Background to the proposed amendments

What is an offshore banking unit?

The term offshore banking broadly refers to the intermediation by institutions operating in Australia of financial transactions between non-resident borrowers and non-resident lenders.

An offshore banking unit (OBU) is a licensed bank or foreign exchange dealer approved by the Treasurer by notice in the Gazette as an institution entitled to withholding tax concessions in respect of its borrowing from non-residents where the funds are used to make loans to non-residents. Under existing Australian law, an OBU may also borrow from residents in foreign currencies but its lending is restricted to non-residents and other OBUs.

Following its consideration of the Report of the Commonwealth/State Working Party on Offshore Banking, the Government decided in 1986 to provide an interest withholding tax (IWT) exemption for interest paid to non-residents by OBUs where their deposits/borrowings were on-lent to non-residents. At the same time it decided that no company tax concession would be provided to OBUs.

Why is the Government extending the concession?

Given that the existing IWT concession has not promoted any significant offshore banking activity, the Government has now decided to reduce the company income tax rate on OBUs to 10%. In the One Nation economic statement of 26 February 1992 it was announced that the taxable income derived from pure offshore banking transactions by an authorised OBU would be taxed at the reduced rate from 1 July 1992.

The statement went on to say that the taxable income eligible for the 10% tax rate will be that arising from the borrowing and lending of money in the circumstances necessary to gain the IWT exemption specially provided for OBUs in the existing law.

After extensive consultation with Industry, however, the Government has decided to extend the scope of the activities that will be eligible for the concessional tax rate.

Most of the activities that will attract the concessional tax treatment can be classified as either financial intermediation between non-residents (including foreign branches of Australian residents) or the provision of financial services to non-residents in respect of transactions/business occurring outside Australia.

Chapter 3 Offshore Banking - Summary of proposed amendments

This Bill will amend the Income Tax Assessment Act 1936 to provide income tax concessions for profits of offshore banking activities carried out in Australia.

Income Tax Concession

The Bill will give effect to the Government's decision to provide concessional tax treatment for profits from offshore banking activity in Australia. The concession will take the form of a tax rate of 10% on those profits.

Announcement - One Nation Economic Statement

The One Nation economic statement of 26 February 1992 announced the concession. It stated that the concession would be confined to pure offshore banking transactions by an authorised OBU. The concession was to apply from 1 July 1992.

Pure Offshore Banking Transactions

The traditional concept of offshore banking is:

•

the borrowing of money in any currency from non-residents; and

•

on-lending of the funds to non-residents.

This concept, referred to as pure offshore banking, is embodied in the exemption from interest withholding tax (IWT) provided in the current law for offshore banking units. OBUs are generally exempt from IWT on the interest paid on these borrowings.

The aim of the OBU tax concessions

The tax concessions for OBUs are designed to facilitate the growth of Australia as a viable offshore banking centre.

The existing withholding tax concessions have not promoted any significant offshore banking.

After the announcement in the One Nation Economic Statement, extensive consultations were held with the banking and finance industry. An objective evaluation was made of the scope of the tax concessions needed to achieve the desired outcome.

Scope of the offshore banking activities

The studies have shown that the activities of the OBU centres in other countries in the region cover a wide range extending beyond the traditional concept of borrowing and lending. These wider activities are seen as integral to the establishment of an offshore banking centre in Australia.

The extended activities include:

•

dealing in financial or treasury instruments, like currency and interest rate swaps, hedges and futures;

•

securities and futures trading;

•

foreign exchange trading;

•

a range of fee-based activities such as funds management for non-residents and the provision of investment advice to non-residents; and

•

borrowing from and lending to offshore branches of Australian residents.

Extended coverage of the tax concessions

It has been accepted that the viability of an Australian offshore banking regime depends on Australia's ability to compete on an even footing with other offshore banking regimes of the region. These regimes provide a broad range of concessions for offshore banking having regard to the width of operations of this sector.

The wide range of activities can be classified as either:

•

financial intermediation with non-residents (including foreign branches of Australian residents); and

•

the provision of financial services to non-residents in respect of transactions and business occurring outside Australia.

Some activities outside the concept of 'pure' offshore banking will also attract concessional tax treatment. These are:

•

dealings with foreign branches of residents;

•

foreign currency dealings with residents; and

•

trading in non-Australian dollar (non-AUD) futures contracts on the Sydney Futures Exchange.

Dealings with foreign branches of Australian residents

The Australian banking industry has a network of foreign branches, operating as separate profit centres, similar to non-residents. The overseas profits of these centres are generally exempt from Australian tax when derived in listed (comparable tax) countries.

Other Australian multinationals have significant levels of foreign currency assets that can be accessed by OBUs.

The Bill will extend the tax concession to OBU's dealings with foreign branches of Australian residents. As a revenue-protection measure and to restrict domestic funding of offshore banking, the borrowing and lending transactions with branches of Australian residents are limited to non-AUD transactions.

Foreign currency dealing with residents

The concessional tax treatment will also apply to spot or forward foreign currency trading that does not involve the Australian dollar on either side of the transaction. The concession will extend to trading in options or rights in respect of currency.

Dealing with residents is to be permitted because it would not be administratively feasible to confine non-AUD foreign exchange dealings to non-resident counterparties. This will enable OBUs to access the large amounts of foreign currency assets held overseas by Australian exporters and multinationals.

Sydney Futures Exchange

The Bill also extends the tax concessions to trading by OBUs in non-AUD futures contracts and options on futures contracts (including on behalf of offshore persons) on the Sydney Futures Exchange.

The rate of tax and treatment of OBU losses

The Bill provides for the taxation of the profits of the OBU from qualifying transactions at a tax rate of 10%. Rather than providing a special tax rate for this purpose, the assessable income and allowable deductions are adjusted down by a factor of 10/39 to achieve the same results.

This factoring down also enables any loss that results after the adjustment of the income and deductions to be offset against any other income of the taxpayer since the adjustment will give the loss the same tax value as the normal rate of tax.

Amendments to the withholding tax provisions

The Bill will also align, as far as is practicable, the exemptions from interest withholding tax provided to OBUs in the current law with the transactions in relation to which income tax concessions are provided.

Separate record keeping requirements

The Bill will require an OBU to maintain separate records of its transactions as though the OBU was itself a separate bank. This extends to the new measures the current requirement for OBUs in relation to the interest withholding tax exemptions.

Where an eligible financial institution is declared by the Treasurer to be an OBU, any OB transactions undertaken by that institution have to be recorded and maintained in accounts and records separate from the accounts and records for other business activities conducted by the institution.

It will also be necessary to maintain separate bank accounts for offshore banking activities.

Chapter 4 Offshore Banking - The Concessional Tax Regime

The Concessional Tax Regime

The income from the offshore banking (OB) activities of an OBU will, generally, be taxed at a rate of tax of 10%. In the explanations that follow, the assessable income from OB activities of an OBU will be referred to as assessable OB income. The meaning of 'OB activities' is explained in Chapter 5.

Where a separate company is set up for offshore banking activities

An OBU will be required to keep accounts for its OB activities. [Clause 18]

In broad terms, the income from OB activities of an OBU will be taxed at a rate of tax of 10%. As explained in Chapter 2, rather than providing a special rate of tax for this purpose, the assessable income and allowable deductions are adjusted downwards to achieve the same result. Where the assessable income has been adjusted downwards, the amount remaining will not be considered to be exempt income. Any prior year losses, therefore, will not be offset against the remaining amount. [section 121EG to be inserted by Clause 15]

(Editor's Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 28])

Each amount of income derived by the OBU from its OB activities and each amount of allowable deduction in relation to those activities is to be reduced by a fraction referred to as the 'eligible fraction'. The fraction is as follows:

10 / the general company tax rate applicable to the year of income


As the company rate is currently 39% the fraction is effectively 10/39.

An exception is provided where the accounts kept by the OBU for its OB activities show that more than 10% of the assessable income of the OBU from those activities was derived by using non-OB money. [New section 121EH]

In this event, all the income from the OB activities of the OBU will be subject to the general rate of company tax (ie the tax concession for OB income will be lost).

Where a company carries on offshore banking activities and other activities

The company will be required to keep accounts separately for its OB activities. The concessional tax treatment will apply to the transactions for which separate accounts are kept as though those transactions were undertaken by a separate company.

The company will have two classes of assessable income - offshore banking income taxed at an effective rate of 10% and other income taxed at 39% - provided that the OB activities are accounted for separately. If this is not done, all of the income will be subject to tax at the general company rate of 39%.

As in the case of a separate company set up to carry on only offshore banking activities, the tax concession will not be available if the accounts kept for the offshore banking activities show that more than 10% of the assessable income of the OBU from those activities was derived by using non-OB money.

Although the overall tax concession will still be available where less than 10% of assessable income was derived by using non-OB money, any income derived from the use of non-OB money will be taxed at the normal rate of tax.

Where a company carries on OB activities and other business and the OB activities are accounted for separately, there will be two classes of assessable income:

•

OB income taxed at an effective rate of 10 per cent;

•

other income taxed at 39 per cent;

If separate accounts are not kept for the OB activities, all of the income of the company will be subject to the general company tax rate of 39 per cent.

Where a company has more than one permanent establishment

Proposed subsection 121EB(1) introduces a concept of separate entities for branches of the same entity. This concept applies for the purposes of proposed sections 121D to 121EA (inclusive).

An OBU may consist of:

(a)

one or more permanent establishment in Australia through which qualifying offshore banking activities are carried out; and

(b)

other permanent establishments whether in or out of Australia.

In this case the permanent establishments in Australia referred to in (a) are to be treated as one person. The other permanent establishments are to be treated as separate persons. [Section 121EB]

The definition of 'permanent establishment' in subsection 6(1) of the ITAA applies equally to residents and non-residents. The term has been used in this context to denote branches of both resident and non-resident companies.

By treating permanent establishments as different persons, domestic banking is separated from offshore banking.

This notion is necessary for the concept of 'offshore person' as it applies to a bank. When conducting OB activities, it enables an OBU to deal with an offshore permanent establishment of the same bank as a separate person. Without this provision, Australian law would require intra-entity transactions to be ignored.

The anti-avoidance provisions also make use of the treatment of permanent establishments as separate persons in relation to:

•

the concept of non-OB money (eg where a domestic banking branch provides funds to an offshore banking branch);

•

OB activity (eg there are limitations in certain provisions to dealings with offshore persons and in others to non-residents, for example, investment activity).

Non-OB Money

Non-OB money is all the money an OBU receives other than money:

•

derived from the OB activities of the OBU; or

•

OBU resident-owner money. [New section 121C]

OBU resident-owner money applies only to money paid by a resident parent to the OBU by way of capital subscription. Any other moneys made available to the OBU by its parent will be non-OB money. [New section 121EC]

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 5])

The term 'owner' is defined, in relation to a company, to mean a person who, alone or together with an associate or associates, is the beneficial owner of all of the shares in the company. [New section 121C]

Non - OB money cannot be used to derive concessionally-taxed income.

Source of Income

The source of an item of income is a practical, hard matter of fact to be determined separately in each case. The source of business profits, including OB income, would generally be the country where the business activities are performed. The tax concessions are provided to OBUs on the basis that the business activities of the OBUs will be carried on in Australia. Moreover, it is internationally accepted practice in Double Tax Treaties to treat the presence of a permanent establishment (branch) in a country as sufficient economic connection with that country to give rise to a taxing right to that country on the basis of source.

To make this clear, however, the Bill will deem the offshore banking income of Australian OBUs to have an Australian source. [Section 121EJ]

Capital Gains

Capital gains will not to be taxed at the concessional rate. They will not be considered as attributable to non-OB activities for purposes of the 10 per cent of gross income test for the OBU. [Subsection 121EE(2)]

Allocation of expenses between OB and non-OB activity

Where a company carries on both offshore banking (OB) and non-OB activity, it will be necessary to allocate expenses between these two types of activity. This will be done by allowing three classes of deductions from the income generated by OB activity:

•

exclusive OB deductions;

•

general OB deductions; and

•

apportionable OB deductions. [Section 121EF]

Exclusive OB deductions

Exclusive OB deductions are any deductions, other than carry forward losses, that relate exclusively to assessable OB income, eg interest payments on borrowings from a non-resident which are on-lent to a non-resident.

General OB deductions

These deductions relate to both OB and non-OB activities, but do not carry forward losses. For example, rent on a building used for both offshore banking and normal domestic banking. These are apportioned between OB and non-OB activities using the following formula [Subsection 121EF(4)]:

deduction * (adjusted assessable OB income / adjusted total assessable income)
where:

•

'adjusted assessable OB income' is the assessable OB income less interest deductions (including a discount in the nature of interest) exclusively incurred in deriving OB income; and

•

'adjusted total assessable income' is the OBU's assessable income, OB and non-OB, less interest (including a discount in the nature of interest) exclusively incurred in deriving that income.

The reason for taking interest expenses into account and using adjusted OB income and adjusted total income is that OBU business generally has large volume and low profit margin. If the approach to expense allocation used assessable income, the large volume in the OBU activity would have distorted the allocation of expenses.

Including discounts in the nature of interest will result in a fairer allocation of expenses given that a significant amount of commercial borrowing and lending is done through the issue and purchase of discounted bills of exchange.

(Editor's Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendments 25-26])

Apportionable OB deductions

Apportionable OB deductions are amounts allowed without having any connection with the production of assessable income (these are defined in subsection 6(1) of the Assessment Act and would mainly relate to gifts). These deductions have to be apportioned in accordance with the following formula [subsection 121EF(5)]:

apportionable deductions * assessable OB income - [sum of exclusive OB deductions and general OB deductions]/sum of the OBU's taxable income and apportionable deductions
where:

•

'apportionable deductions', 'exclusive deductions' and 'general deductions' are as described above; and

•

'assessable OB income' is the total of the assessable income derived by the OBU from OB activities or included in the assessable income because of such activities other than net capital gains and income derived from the use of non-OB money.

Treatment of Losses

Losses will be adjusted to reflect the concessional tax rate applicable to offshore banking income. Thus, if the loss was calculated as for any other business, only 10/39ths should be recoupable against income subject to the normal 39% rate of tax.

Because of the way the legislation is structured, the reduction of the loss occurs automatically as each item of the assessable OB income and allowable OB deductions is reduced by the fraction 10/39. [Section 121EG]

Where more than 10% of the total assessable income comes from the use of non-OB money a special formula will, in broad terms, have the effect that any losses from OB activities in that financial year will have a tax value of 10%. This is to prevent manipulation in cases where the OBU knows it will make a loss and seeks to breach the 10% "purity test" to give the loss a tax effect of 39%.

Treatment of Foreign Tax

Under the foreign tax credit system (FTCS), a foreign tax credit is available only to residents for foreign tax paid on foreign income.

A foreign tax credit, therefore, will not be available for offset against Australian tax payable on OB income because that income is deemed to have an Australian source.

Instead, a tax deduction will be available in a year of income for the amount of foreign tax paid in that year of income. This deduction will also be available to non-residents. [Section 121EI]

As in the case of other expenses, the amount of the foreign tax paid will be reduced by the proportion 10/39.

Activities Giving Rise to Non-Concessional Income

To ensure that OBUs will engage principally in the business activities for which they are licensed, they will lose the tax concession (resulting in tax at 39% on all income) where more than 10% of the assessable OB income of the OBU is derived from the use of non-OB money. The test will apply to an OBU established as a separate company as well as where offshore banking is only part of a more comprehensive banking or financial business conducted by an entity. [Section 121EH]

Chapter 5 Offshore Banking - OB Activities

Meaning of 'OB activity'

The meaning of 'OB activity' set out in new sections 121D, 121E and 121EA. Broadly, OB activities that will qualify for concessional tax treatment are:

•

borrowing or lending money;

•

providing certain types of guarantees;

•

eligible contract activity;

•

trading in certain contracts, securities, non-resident shares or trust units, gold, silver or platinum bullion or rights in respect of such bullion and foreign currency;

•

making and managing certain investments;

•

providing financial advice; and

•

hedging against interest rate and currency exposure risks in respect of borrowing and lending activities. [New subsection 121D(1)]

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendments 3, 9, and 14])

Each of these activities is described below in more detail.

To be an 'OB activity':

•

the OBU must, at the time of the activity, be either:

-

a resident and the activity must not be done as part of its business outside Australia at or through a permanent establishment; or

-

a non-resident and the activity must be done in carrying on business in Australia at or through a permanent establishment; and

•

the other party to the transaction must be an 'offshore person', ie a person who is:

-

a non-resident whose involvement in the activity must not occur in carrying on business in Australia at or through its permanent establishment; or

-

a resident whose involvement in the activity must occur in carrying on business outside Australia at or through its permanent establishment; or

-

another OBU which has received a statement from the first OBU to the effect that any money received by the second OBU is not non-OB money.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendments 21-22])

If the other party to the transaction is also a 'related person' , then a further condition, that the currency involved cannot be Australian currency, may also apply. A related person, in relation to an OBU means:

•

an associate of the OBU; or

•

any permanent establishment of the OBU through which activities other than OB activities are carried on.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 7])

The term "related person" and "associate" are defined in new section 121C.

The various OB activities that qualify for concessional tax treatment, together with any conditions that relate to those activities, are discussed in more detail below.

OB activity means the following:

Borrowing Money

•

borrowing in any currency from unrelated non-residents (excluding Australian branches of non-residents) and other unrelated OBUs;

•

borrowing by a branch in Australia of a non-resident in non-AUD from its overseas head office, other offshore branches of the non-resident head office or related non-resident companies;

•

borrowing from related non-residents or offshore branches of the head office of the OBU in non-AUD;

N.B. Borrowing includes raising finance by the issue of securities

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendments 2-4])

Lending Money

•

Lending in any currency to non-residents (excluding Australian branches of non-residents) and other OBUs, and in non-AUD to overseas branches of Australian residents;

N.B. Lending includes providing finance by the purchase of securities.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendments 2-4])

Hedging

•

Hedging with non-residents (excluding Australian branches of non-residents), foreign branches of Australian residents and OBUs of interest rates and currency in order to manage exposure to risk from borrowing and lending activities. However, if the other party is a related person, any money payable under the contract must not be in Australian currency.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendments 18, 19 and 20])

Guarantee-type Activities

•

Activities which involve fee income for:

-

the provision of a guarantee or letter of credit to an offshore person;

-

syndicating a long for an offshore person (where a single loan is made by a number of lenders to the offshore person);

-

underwriting risks for an offshore person where the property is outside Australia or the event being underwritten can only happen outside Australia; or

-

issuing a performance bond to an offshore person (bonds which provide financial protection to the offshore person if another party fails to fulfil its obligation to the offshore person under a contract).

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment10])

•

If the other party to the transaction is a related person, any money payable under the guarantee-type activity must not be payable in Australian currency.

N.B. Activities which fall within the normal meaning of a guarantee (such as bid bonds) would also constitute "guarantee-type activities".

Eligible Contract Activity

•

Entering into a futures contract, a forward contract, an options contract, a swap contract, a cap, collar, floor or similar contract with an offshore person under which any money payable is not Australian currency.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendments 3, 9, and 14])

Trading Activities

•

Trading by an OBU on its own behalf with an offshore person in securities (being bonds, debentures, bills of exchange, promissory notes or similar instruments) issued by non-residents provided the securities are not denominated in Australian currency.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 8])

•

Trading by an OBU on its own behalf with an offshore person in futures contracts, forward contracts, options contracts, swap contracts, caps, collars, floors or similar contracts or loan contracts provided that any amounts payable under the contracts are payable by non-residents and are not payable in Australian currency.

N.B. For present purposes, new section 121EA treats permanent establishments as separate persons. Accordingly, all or part of a portfolio of offshore loans entered into by a foreign branch of an Australian resident could be traded to the Australian OBU provided the above requirements on trading are met.

•

Trading by an OBU on its own behalf with an offshore person in non-resident company shares or non-resident trust units provided that the shares or units are not denominated in Australian currency.

•

Trading by an OBU on its own behalf with an offshore person in options or rights associated with any of the above instruments.

•

Trading in futures contracts or options contracts on its own behalf as well as on behalf of an offshore person on the Sydney Futures Exchange provided that any money payable under either type of contract is not Australian currency.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 11])

•

Trading on its own behalf in spot or forward foreign currency, or options or rights in respect of foreign currency, with residents or non-residents provided that the currency is not Australian currency.

N.B. Although this activity is outside the concept of "pure" offshore banking, paragraph 121D(4)(e) will not allow an OBU to transact with the domestic part of the bank so as to translate "positions" back to Australian dollars.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 12])

•

Trading with an offshore person in gold, silver or platinum bullion, or in options or rights in respect of such bullion, where any money payable or receivable is not Australian currency.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 13])

Investment Activities (Funds Management)

•

Fee income from making and/or managing investments (as a broker, an agent or a trustee) for non-residents other than Australian branches of non-residents. If investments are purchased they must be shares in non-resident companies, units in non-resident unit trusts, land and buildings outside Australia or other foreign assets.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendments 15-16])

The investments must be with non-residents other than Australian branches of non-residents. The currency in which investments are made cannot be Australian dollars.

Advisory Activities

•

Fee income from advisory services for an offshore person.

Services are restricted to the giving of investment or other financial advice to an offshore person. The advice cannot relate to any property or transactions in Australia, other than advice in relation to an Australian investment where the advice is incidental to a proper comparison of commercially related investments inside and outside Australia to enable a proper assessment of the investment outside Australia.

(Editors Note: **Amended during passage through Parliament**

This text reflects the amendment(s) made by House of Representatives. Refer Summary of amendments [amendment 17])

OB activities that qualify for the concessional tax treatment are summarised in general terms below with relevant currency restrictions:

Type of Activity	Other unrelated OBUs	Non-Resident (Other Than Related Party)	Related Party	Offshore Branch of Resident
Borrowing	any currency	any currency	non-AUD	non-AUD
Lending	any currency	any currency	any currency	non-AUD
Guarantees	any currency	any currency	non-AUD	any currency
Trading	non-AUD	non-AUD	non-AUD	non-AUD
Eligible Contract Activity	non-AUD	non-AUD	non-AUD	non-AUD
Investment	non-AUD	non-AUD	non-AUD	non-AUD
Advising	N/A	N/A	N/A	N/A
Hedging	any currency	any currency	non-AUD	any currency

Chapter 6 Offshore Banking - Anti-avoidance provisions

It should be noted that since each amount of assessable OB income and each amount of allowable OB deductions is included in assessable income or allowed as an income tax deduction in the normal way (after being factored down), the general anti-avoidance provisions, including Division 13 and Part IVA, apply to offshore banking activities.

OBU resident-owner money

Without the inclusion of a specific anti-avoidance provision, it would be possible to avoid tax by using borrowed funds to capitalise an OBU subsidiary. For example, the parent company could borrow funds for which it obtains an interest deduction at the 39% tax rate, inject those funds into the OBU by way of equity and the OBU could then on-lend the funds and pay tax on its interest income at 10%.

Since money is fungible (that it, it loses its identify when mixed in a pool of funds) it would be difficult to trace which funds provided to an OBU subsidiary have actually been borrowed.

The legislation assumes that 90% of any funds provided by way of share capital to an OBU subsidiary by a resident parent (known as OBU resident-owner money) have come from borrowings for which tax deductions for interest expense are available. Since this will be the case only where the provider of funds to the OBU is a resident, a non-resident owner is excluded from the assumption.

The legislation goes on to provide that 90% of the money provided is to be regarded as a loan at 2% above the 90 day bank accepted bill rate. This notional interest is then included in the assessable income of the owner and a deduction allowed to the OBU for the deemed interest.

Because an OBU will be taxed at an effective tax rate of 10%, the deduction for the deemed interest will also have a tax effect of 10%.

90% has been set as the percentage of an OBU subsidiary's share capital to be regarded as a loan on the basis that the funds of the subsidiary OBU should be regarded as having the same proportion of debt and equity as the pool of funds out of which the amount was made available. The Reserve Bank of Australia's (RBA) 8% minimum for capital adequacy has been taken as a benchmark and increased to take account of the fact that some banks operate with a capital adequacy ratio higher than the RBA requirement. [Section 121EK]

OBU resident-owner money is defined as money paid by a resident parent to the OBU by way of capital subscription, except where:

•

the shares are redeemable preference shares; or

•

the amount paid is a share premium.

Since redeemable preference shares have many of the characteristics of loans they have been excluded. Share premiums have also been excluded in order to limit tax avoidance opportunities. [Section 121EC]

The term 'owner' is defined, in relation to a company, to mean a person who (alone or together with an associate or associates) is the beneficial owner of all of the shares of the company. Each associate will be the beneficial owner of so much of the shares of the company in which that associate has a beneficial interest. [Section 121C]

Loss of special treatment were excessive use of non-OB money

The Bill also contains anti-avoidance provisions to prevent an OBU taking undue advantage of a full deduction for losses where any income would have been effectively taxed at 10%. [Section 121EH]

For example, during an accounting year, an OBU may be able to forecast a loss in relation to its OB activities for that year. It would then arrange to 'fail' the test for availability of the OBU concessions. This could be done by obtaining non-OB money and using those funds to derive more than 10% of its assessable OB income. This would result, in the absence of anti-avoidance provisions, in the OBU losses being available in full to reduce other income.

The Bill provides, in effect, that where an OBU fails the test for the availability of tax concessions because of the 10% of assessable OB income test, its 'losses' will continue to be reduced to 10/39 of the losses. This is done by reducing each deduction, to the extent that it exceeds a specific limit, to 10/39 of the amount of the deduction.

The limit on each deduction is provided by the formula:

allowable OB deduction * (assessable OB income / sum of allowable OB deductions)


Example

Facts:

Assessable OB income derived from non-OB money (taxable at 39%)	$50M
Assessable OB income derived from OB activities (normally taxable at 10%, however, now taxable at 39% because more than 10% of the assessable OB income has been derived from the use of non-OB money)	$240M
Exclusive OB deductions made up of two separate amounts - one of $120M and one of $840M - Total	$960M
(Note: The full amount of an exclusive OB deduction is an "allowable OB deduction" for the purposes of the formula).
Exclusive deduction relating to assessable OB income derived from the use of non-OB money (taxable at 30%)	$5M

Calculation 1:

120 * (240/960) = 30


That is, $30M of the exclusive OB deduction of $120M is allowable at 39% and $90M will be carried forward as a prior-year loss allowable at a taxable value of 10%.

Calculation 2:

840 * (240/960) = 210


That is, $210M of the exclusive OB deduction of $840M is allowable at 39% and $630M will be carried forward as a prior-year loss allowable at a taxable value of 10%.

[Section 121EH]

Chapter 7 Offshore Banking - Miscellaneous

Registration of a subsidiary of a bank as an OBU

Under the present law the only entities that can be registered as OBUs are savings and trading banks as defined by subsection 5(1) of the Banking Act 1959, State banks and other financial institutions which the Treasurer is satisfied are appropriately authorised to deal in foreign exchange (in effect this last category means entities approved as foreign exchange dealers by the Reserve Australia).

An amendment to subsection 128AE(2) will extend the range of entities which can be registered as an OBU to include a wholly owned subsidiary of a bank which is already registered as an OBU. Sub-sidiaries will also be able to be registered as OBUs as long as all the shares are beneficially owned by an OBU which is a bank. [Clause 16]

Record Keeping where the OBU is not a separate entity

Companies will be required to maintain a separate pool of funds and to keep separate identifiable records in respect of the OB activities. These records have to be maintained as though the OBU were a bank conducting banking activities with another person.

This will require separate books of account and an additional requirement that funds move through separate bank accounts (including nostro/vostro accounts). [Clause 18]

Penalties for Tax Avoidance

Under the present law (section 128NB), an OBU may be liable for special income tax at a penal rate where funds that are subject to the withholding tax exemption are dealt with by the OBU in an unintended manner, eg where lent directly or indirectly to an Australian resident or used for general banking activities or other purposes by the financial institution of which the OBU is a part. The tax is imposed at a rate of 300% of the 'lost withholding amount'.

The level of penalties associated with the new self-assessment provisions will apply where profit shifting has occurred between classes of income with different taxing rates. Under this regime the maximum penalty will be 75% where a taxpayer intentionally excludes income or claims a deduction, rebate or credit, knowing that it is neither assessable or allowable. Should the taxpayer hinder the Tax Office from discovering the tax shortfall a further penalty of 15% may be imposed. Where this level of penalty is reached, the OBU may also lose its registration (see below). [Clause 16(g)]

Instances where loss of registration could occur

The bill will empower the Treasurer, in certain circumstances, to declare by notice published in the Gazette that a person is no longer an OBU. These circumstances are: [Clause 16(g)]

•

the maintenance after all objection and appeal rights have been exhausted of the maximum 90% penalty under the self assessment regime for underpayment of tax;

•

conviction as a result of a prosecution under the following sections of the Taxation Administration Act 1953:

-

section 8L - incorrectly keeping records;

-

section 8N - recklessly making false or misleading statements;

-

section 8P - knowingly making false or misleading statements;

-

section 8Q - recklessly or knowingly keeping incorrect records;

-

section 8T - incorrectly keeping records with the intention of deceiving or misleading; or

-

section 8U - falsifying or concealing identity with the intention of deceiving or misleading.

The Bill also provides that the Treasurer must declare, by notice published in the Gazette, that a person is no longer an OBU in the event of the loss of a banking or foreign exchange dealer's licence. The loss of licence could occur, for example, as a result of Reserve Bank intervention.

Where an OBU, which has been registered under new paragraph 128AE(2)(ba) solely because it is a wholly owned subsidiary of a bank which is already an OBU, loses its registration because of serious default, the parent OBU which wholly owns the subsidiary will also lose its registration. The loss of registration will extend to any wholly owned subsidiaries interposed between the parent and the subsidiary. [New subsection 128AE(2B)]

If this provision was not present, the subsidiary that lost its registration because of serious default could simply transfer its OBU business to its parent.

Because of the operation of proposed paragraph 128AE(2)(ba) if the parent lost its OBU registration any subsidiaries that were registered OBUs solely because they were subsidiaries would automatically lose their registration. [Clause 16]

Continuation of OBU status

An OBU will continue to enjoy OBU status provided it does not lose its banking or foreign exchange dealer's licence and provided it is not declared by the Treasurer to no longer be an OBU because of serious default. [New subsection 128AE(2D)]

Special tax payable in respect of certain dealings by current and former offshore banking units

Subsection 128NB(1) of the Assessment Act provides that a special income tax imposed by the Income Tax (Offshore Banking Units) (Withholding Tax Recoupment) Act 1988 is payable by a person who is or has been an OBU on the "lost withholding tax amount" in respect of certain transfer of money.

As a consequence of extending the exemption from IWT to OB activities other than offshore borrowing for on-lending offshore subsection 128NB(1) is also being amended to extend its operation to all OB activities [Clause 17]

Review of the Treasurer's decision will be available under the Administrative Decisions (Judicial Review) Act 1977.

Secrecy Provisions

The Bill will enable the Commissioner to transmit necessary information to the Treasurer to enable the Treasurer to exercise the powers granted in relation to the withdrawal of an OBU's registration. [Clause 14]

Exemption of income of OBU offshore investment trusts

Fee income from funds management is included in the range of OB activities that will qualify for concessional tax treatment as long as the investors are non-residents other than Australian branches of non-residents and the investments are made with the same class of non-residents and are not in Australian currency.

The income and capital gains derived through the investment activities of the OBU on behalf of non-residents are specifically exempted from Australian income tax provided that the only persons who can benefit from the trust are non-residents (not being Australian branches of non-residents), the investments are made in non-AUD and all the assets are foreign assets of the types listed in proposed section 121D(6). [New section 121EL]

Chapter 8 Offshore Banking - Amendments to the current interest withholding tax provisions

As a result of the initiatives contained in the proposed Division 9A concerning the concessional tax rate for income of an OBU, it is necessary, to maintain consistency, to amend the OBU interest withholding tax provisions of Division IIA. [Clause 16]

The definition of 'offshore borrowing' in subsection 128AE(1) will be amended to provide that an OBU can obtain an interest withholding tax exemption were it to:

•

borrow in any currency from an unrelated non-resident;

•

borrow in non-Australian currency from:

-

an offshore branch (a permanent establishment) of a resident company; or

-

an offshore branch (a permanent establishment) of a related non-resident; or

-

a non-resident parent company. [Clause 16]

One or more permanent establishments

Proposed section 128AE(13) introduces a concept of separate entities for branches. It is identical to that in proposed section 121EB introduced for the purposes of proposed sections 121D to 121EA inclusive.

An OBU may consist of:

(a)

one or more permanent establishments in Australia through which qualifying offshore banking activities are carried out; and

(b)

other permanent establishments whether in or out of Australia.

In this case the permanent establishments in Australia referred to in (a) are to be treated as one person. The other permanent establishments are to be treated as separate persons. [Clauses 15 and 16]

The definition of 'permanent establishment' in subsection 6(1) of the ITAA applies equally to residents and non-residents. The term has been used in this context to denote branches of both resident and non-resident companies.

By treating permanent establishments as different persons, domestic banking is separated from offshore banking.

This notion is necessary for the concept of 'offshore person' as it applies to a bank. When conducting OB activities, it enables an OBU to deal with an offshore permanent establishment of the same bank as a separate person. Without this provision, Australian law would require intra-entity transactions to be ignored.

The anti-avoidance provisions in the interest withholding tax regime also make use of the treatment of permanent establishments as separate persons in relation to the imposition of special tax in cases of default.

Extension of the Interest Withholding Tax (IWT) exemption

The law presently provides an exemption from withholding tax for an OBU where the funds are on-lent to a non resident. A series of amendments to section 128AE of the Assessment Act will have the effect of extending the exemption to offshore borrowings used to fund the extended OB activities. This means, for example, that if an OBU borrowed funds from a non-resident and used those funds for trading in accordance with the requirements of proposed subsection 121D(4) it would be entitled to an exemption from IWT in respect of the borrowings. [Clause 16]

Chapter 9 Offshore Banking - Commencement date

The tax concessions for offshore banking activities will apply to assessable income derived and allowable deductions of losses and outgoings incurred after 30 June 1992.

The deductions allowed in calculating assessable offshore banking income for foreign tax paid will also apply to foreign tax paid after 30 June 1992.

The provisions that deem assessable OB income to be sourced in Australia will apply to assessable OB income derived after 30 June 1992.

The provisions that relate to deemed interest on OBU resident-owner money apply to deemed interest for any period beginning after 30 June 1992 irrespective of when the money was provided.

The provisions relating to the transmission of information to the Treasurer and the requirement to keep records and amendments to the measures that deal with exemptions from interest withholding tax apply after the date of commencement.

The exemption of income etc of OBU offshore investment trusts applies to income derived and capital gains or losses which occur after 30 June 1992. [Clause 19]

Transitional - 1 July 1992 to commencement

This Bill was first introduced into the House of Representatives on 24 June 1992. Subsequently a number of amendments and new clauses were moved by the Government in the House to clarify certain aspects bearing on the scope of the measures and to make it consistent with business practices. Certain anti-avoidance provisions have also been tightened.

Some of the amendments proposed would have a possible adverse effect on an OBU. Wherever this could happen a transitional provision will have the effect of applying the rules as set out in the Bill as originally introduced for the period from 1 July 1992 to date of commencement. [Clause 20]

The following provisions will operate as originally introduced for the transitional period:

•

the definition of "non-OB money" (proposed section 121C);

•

the definition of "related person" (proposed section 121C);

•

the amendment to guarantee-type activity (proposed paragraph 121D(3)(b));

•

the requirement that any money payable or receivable in respect of gold bullion trading is not Australian currency (proposed paragraph 121D(4)(f));

•

restricting hedging activities to borrowing and lending activities (proposed paragraphs 121D(8)(a) and (b));

•

the requirement for an OBU to make a statement that money paid to another OBU is not non-OB money (proposed paragraph 121E(c));

•

the meaning of "OBU owner money" (proposed section 121EC); and

•

deemed interest to be based on the original definition of "OBU owner money" (proposed subsection 121EK(1)).

Chapter 10 Offshore Banking - Clauses involved in the proposed amendments

Clause 14: will amend the secrecy provisions of the Income Tax Assessment Act (ITAA) to enable the Commissioner to transmit to the Treasurer information relevant to a decision whether to withdraw a registration to carry on OB activities (see Chapter 7).

Clause 15: will insert a new Division - Division 9A - in the ITAA that deals with the new tax concessions for OB activities.

Section 121A: will set out the object of proposed Division 9A which is to provide a concessional tax regime for income of an OBU.

Section 121B: will set out, in simple terms, the main concepts of the concessional tax regime and how the provisions fit together.

Section 121C: is an interpretation provision that explains the meaning of terms used in Division 9A.

Section 121D: outlines the kinds of activities qualifying for the concessions as OB activities. These are 'borrowing or lending activity', 'guarantee-type activity', 'trading activity', 'eligible contract activity', 'investment activity', 'advisory activity' and 'hedging activity' (see Chapter 5).

Section 121E: explains the different 'offshore persons' that an OBU may deal with in order to obtain the concession (see Chapter 5).

Section 121EA: limits the concessional tax treatment to OB activities performed within Australia (see Chapter 5).

Section 121EB: deals with the situation where an OBU consists of more than one permanent establishment. If these are in Australia and carry on OB activities, they are to be treated as one person; otherwise, they are to be treated as separate persons (see Chapter 4).

Section 121EC: gives the meaning of 'OBU resident-owner money'. This is money paid by the resident owner of the OBU by way of share capital. (see Chapter 6).

Section 121ED: is a drafting technique to facilitate the meaning of 'trading activities' in section 121D. It defines 'trade with a person' to be acquisition on issue or purchase from or sale to the other person.

Section 121EE: defines the terms 'assessable OB income', 'adjusted assessable OB income' and 'adjusted total assessable income' (see Chapter 4).

Section 121EF: defines a number of different types of deductions. These are 'allowable OB deduction', 'exclusive OB deduction', 'general OB deduction', 'apportionable OB deduction', 'exclusive non-OB deduction' and 'loss deduction' (see Chapter 4).

Section 121EG: provides a method to reduce assessable OB income and allowable OB deductions to effectively tax taxable income from OB activities at 10% (see Chapter 4).

Section 121EH: an anti-avoidance measure which explains the loss of special treatment where there is excessive use of 'non-OB money' (see Chapter 6).

Section 121EI: provides a deduction for foreign tax paid on amounts included in assessable OB income (see Chapter 4).

Section 121EJ: deems the source of income derived from OB activities to be in Australia (see Chapter 4).

Section 121EK: an anti-avoidance measure which deals with the situation where funds have been injected into an OBU subsidiary (see Chapter 6).

Section 121EL: exempts an OBU's offshore investment trust from Australian income tax.

Clause 16: will make certain amendments to the provisions that deal with IWT exemptions for offshore banking transactions of offshore banking units. These amendments will generally align the IWT exemptions with the new income tax provisions. It also provides for the withdrawal of the offshore banking status in specified circumstances (see Chapters 7 and 8).

Clause 17: extends existing section 128NB to all OB activities and not just to offshore loans. The section provides a special tax to be payable where transactions by OBUs disqualify it from an interest withholding tax exemption.

Clause 18: provides for the maintenance of separate accounting records (including separate bank accounts) in relation to money used for offshore banking activities (see Chapter 7).

Clause 19: contains the provisions relating to the application of the amendments (see Chapter 9).

Clause 20: contains transitional provisions for the period 1 July 1992 to the commencement date of Division 9A.

Chapter 11 Capital Gains Tax Amendments

Summary of proposed amendments

The Bill will amend the capital gains tax (CGT) provisions (Part IIIA) of the Income Tax Assessment Act 1936 (the ITAA) to clarify the operation of subsections 160M(6) and 160M(7). In particular, the amendments will provide that where a person creates a right in another person, the CGT provisions can apply to tax any consideration the person receives for creating the right. For example, the amendments will make it clear that a payment received by a person for entering into a restrictive covenant, exclusive trade tie or similar agreement can be taxable under the CGT provisions.

The Bill will make other technical amendments associated with the operation of subsections 160M(6) and 160M(7). It will also:

•

clarify the circumstances in which subsections 160M(6) and 160M(7) apply to non-residents; and

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provide that subsection 160M(7) does not apply between 20 September 1985 and 22 May 1986 (inclusive) where the asset referred to in subsection160M(7) is owned by a person other than the taxpayer.

Background to the legislation

The broad scheme of the CGT provisions is that capital gains made upon the realisation of assets will be included in assessable income and subject to income tax. The provisions generally apply where a person disposes of an asset which he or she acquired after 19 September 1985. However, subsections 160M(6) and 160M(7) were intended to apply in situations where there was not an actual disposal of an asset.

Subsection 160M(6) applies where a person disposes of an asset that did not exist (either by itself or as part of another asset) before the disposal, but is created by the disposal. Examples of the situations to which subsection 160M(6) is intended to apply include where a person creates an asset by granting a lease or by granting an option; the person is taken to acquire and then dispose of the lease or option.

Subsection 160M(7) seeks to tax as capital gains certain capital payments not received in respect of the disposal of an asset. It applies where an act or transaction takes place in relation to an asset or an event affecting an asset occurs. Where a person receives or is entitled to receive an amount of money or other consideration by reason of that act, transaction or event, the amount of that consideration (less incidental costs) is deemed to be a capital gain to that person. To provide for the acquisition and disposal of an asset to which Part IIIA can apply, the person is deemed to have disposed of a fictional asset for a consideration equal to the amount of the money or other consideration received. The cost base of the fictional asset includes only the incidental costs of its disposal.

Both subsections have been the subject of recent consideration by the courses. However, the question of which (if either) provision applies in a particular situation where there is no disposal of an asset has largely remained uncertain. In particular, the meaning and application of subsection 160M(6), including the extent to which it applies to the creation of a new asset, have remained unresolved.

The Bill will amend Part IIIA to provide a clear scheme for the taxing of capital payments not received in respect of the disposal of an asset or of part of an asset. The principal amendment proposed by the Bill will clarify the operation of subsection 160M(6). The effect of the amendment will be that where a person creates an incorporeal asset (an asset other than a form of corporeal property) in another person, any consideration received by the first-mentioned person for creating the asset, less incidental costs, will be a capital gain to that person. Subsection 160M(7) will have a residual operation to tax payments not received in respect of the disposal or creation of an asset.

By taxing these payments under the CGT provisions rather than under the general income provisions of the ITAA, taxpayers will be able to offset unused capital losses incurred in the same or earlier years against a capital gain accruing as a result of the receipt of the capital payment. Also, any tax payable on that capital gain will be calculated using the notional averaging provided for by the Income Tax Rates Act 1986.

Explanation of the proposed amendments

What will be an asset for CGT purposes?

Under the existing provisions, an asset for the purposes of Part IIIA is defined to mean any form of property, and to include specified things, such as options, debts, choses in action, other rights and goodwill. The Bill will amend the reference to an option, a debt, a chose in action and any other right in two respects [Clause 23(a) - new paragraph 160A(a)].

First, it will be made clear that an option, debt, chose in action or other right will be an asset, whether it is legal or equitable.

Not all things often referred to as "rights" will be assets for CGT purposes. To be an asset, a right must be recognised and protected by law - a court of law or equity will assist in enforcing it. Personal liberties and freedoms, such as the freedom to work or trade or to play amateur sport, are not legal or equitable rights and accordingly will not be assets for CGT purposes. [But this does not mean that money or other consideration received in relation to personal liberties and freedoms can not be taxed under the CGT provisions - see later notes.]

Secondly, it will be made clear that a legal or equitable option, debt, chose in action or right will not have to be a form of property to be an asset. That is, while the primary meaning of asset for CGT purposes is any form of property, it is extended to include things which are not a form of property.

A form of property is generally regarded as something that is capable of assignment or transmission. The amendment will make it clear that an option, a debt, a chose in action or a right will not need to be forms of property if they are to be assets for CGT purposes. They will be assets even if they are not assignable or transmissible.

Accordingly, a legal right of a personal character which is not capable of assignment, such as the rights under a contract of personal services, will be an asset. Other examples might include the rights of a party to a restrictive covenant or exclusive trade tie agreement, and the rights of a sporting club under an agreement that a sportsperson play for that club.

The Bill will also remove from the definition of "asset" the reference to any form of property which is created or constructed or which otherwise comes to be owned without being acquired [Clause 23(b)] . The amendments proposed by the Bill will serve the same purpose. Clause 25 will clarify the CGT consequences of the construction or creation of all assets, including [as a result of the amendments proposed by clause 23(a)] those assets which are not a form of property.

Creation of an incorporeal asset in another person.

Existing subsection 160M(6) will be replaced with provisions which apply where a person creates an asset which is not a form of corporeal property and which is vested in another person on its creation. The amount of the consideration received for creating the asset, less incidental costs of the creation, will be a capital gain to the person who creates the asset. [Clause 25(b)]

Corporeal property is any property which has a physical or tangible existence, such as land or material goods. An incorporeal asset (an asset other than a form of corporeal property), therefore, is any asset (as defined in section 160A) of a non-physical or intangible nature. Examples include rights under a contract, a patent and goodwill. As a result of the amendment proposed to the definition of "asset", new subsection 160M(6) will also apply to the creation of legal or equitable rights that are not a form of property.

The new provisions are intended to apply to a wide range of circumstances where a person receives consideration for creating incorporeal assets in another person. It is not practicable for the legislation to refer specifically to all those circumstances. Rather, the new subsection 160M(6) will provide the general criteria for the application of the new provisions; that a person creates an asset, the asset is not a form of corporeal property, and on its creation the asset is vested in another person. Hence it is to apply in much the same way as subsection 25(1) of the ITAA applies to include "gross income" in assessable income.

Where a particular fact situation fits within these general criteria, the new provisions will then operate in the following manner:

In relation to the person creating the asset:

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The person creating the asset will be taken to acquire the asset and to commence to own it [New paragraph 160M(6A)(a)]

Where the asset is created under a contract, the time of acquisition by that person will be immediately before the time of the making of the contract [New subparagraph 160U(6)(a)(ii)] . In any other case, the time of acquisition will be immediately before the time the asset vests in the other person [New subparagraph 160U(6)(b)(ii)].

•

The person creating the asset will be taken to have subsequently disposed of the asset to the person in whom it is vested on its creation [New paragraph 160M(6A)(b)].

Where the asset is created under a contract, the time of the disposal will be the time of the making of the contract [New subparagraph 160U(6)(a)(iii)] , or in any other case, the time when the asset vests in the other person [New subparagraph 160U(6)(b)(iii)] .

•

The person who created the asset will have included in the cost base of the asset only expenditure incidental to the disposal of the asset. [New paragraph 160M(6A)(c)]

Because that person will be taken to acquire and then immediately to dispose of the asset, it may not be possible to determine which costs are incidental to the disposal (as opposed to the acquisition) of the asset. To clarify the issue, the incidental costs of the disposal of the asset are specified to be (non-deductible) expenditure incurred in connection with the creation of the asset, such as legal fees, costs of registration of any instrument and stamp duty. [Clause 30(b) - new subsections 160ZH(7A) and 160ZH(7B)]

•

Where the person who created the asset receives no consideration in respect of that creation, the rule in paragraph 160ZD(2)(a) will not apply [New paragraph 160M(6A)(d)] . [Paragraph 160ZD(2)(a) provides for the market value of the asset to be taken as the consideration received by the person disposing of an asset.] This will ensure that the person who creates the asset will only have a capital gain if he or she actually receives as consideration an amount of money or property for creating that asset. [NOTE: Market value will be substituted for the actual consideration, if the consideration received is greater or less than the market value and the transaction is not an arm's length transaction.]

In relation to the person in whom the asset is vested on its creation:

•

The person in whom the asset is vested on its creation will be taken to have acquired the asset from the person who created it, and to commence to own it [New paragraph 160M(6B)(a)].

Where the asset is created under a contract, that person is taken to acquire the asset at the time of making of the contract [New subparagraph 160U(6)(a)(i)]. In any other case, the person is taken to acquire the asset at the time it vests in him or her [New subparagraph 160U(6)(b)(i)].

•

Where the person does not give any consideration in respect of the creation of the asset, the rule in paragraph 160ZH(9)(a) will not apply [New paragraph 160M(6B)(b)]. [In these circumstances, paragraph 160ZH(9)(a) would otherwise have provided for the market value of the asset to be taken as the consideration paid by the person acquiring the asset.] This ensures that the cost base of the person in whom the asset is vested on its creation will not include any amount as consideration in respect of the acquisition of the asset if that person does not pay or give any money or property for the creation of the asset. [NOTE: Market value will be substituted for the actual consideration, if the consideration paid is greater or less than the market value and the transaction is not an arm's length transaction.]

In practical terms, these provisions will only have an impact where a person receives consideration for creating an incorporeal asset in another person, and where a person incurs some incidental costs of creating the asset. The following examples illustrate the practical application of the new provisions:

Example 1 - Consideration is received for creating an incorporeal asset

On 7 July 1992, Mary Smith enters into a restrictive covenant agreement with her employer, Hi-Tech Ltd. Mary agrees not to work for a competitor of Hi-Tech Ltd in the same State for a period of three years. Mary receives $50,000 for entering into the agreement, and incurs $250 in legal fees in connection with the agreement.

Mary has created an asset (viz, the rights of Hi-Tech Ltd under the agreement) which, on its creation, is vested in Hi-Tech Ltd. Under the new provisions, Mary will be taken to acquire and to own the asset immediately before the time the agreement is made on 7 July 1992; and then to have disposed of it to Hi-Tech Ltd at the time the agreement is made. The consideration Mary receives in respect of the disposal of the asset is $50,000, and the cost base to Mary of the asset is $250 (the legal fees which are not deductible under any provision of the ITAA). Accordingly, a capital gain of $49,750 will accrue to Mary on 7 July 1992.

Hi-Tech Ltd will have an asset (its rights under the agreement) which it acquired on 7 July 1992. Its consideration in respect of the acquisition of the asset is $50,000. If Hi-Tech Ltd incurs legal fees of $1,000 in connection with the agreement and has no other costs included in the cost base of the asset, it may incur a capital loss of $51,000 on 7 July 1995 when the agreement expires. The expiry of an asset (in this case the agreement) will be taken by paragraph 160M(3)(b) to be a disposal of the asset. [NOTE: If Hi-Tech Ltd was entitled to a deduction for the $50,000 it paid to Mary, that amount will not be taken into account in determining the amount of any capital loss available to it -section 160ZK.]

Example 2 - No consideration is received for creating an incorporeal asset, and no costs are incurred in creating the asset

On 23 July 1992, John Jones contracts with Brown Manufacturing Pty Ltd that he be the manager of Brown's sales division for a period of two years on a commission basis. John receives no inducement or other payment for entering into the contract, nor does he incur any expenses in connection with the creation of the asset.

John has created an asset (viz, the rights of Brown under the contract to require John to perform his duties as sales manager for the period of two years) which, on its creation, vests in Brown. John is taken to acquire, own and then dispose of the asset to Brown. However, as John receives no consideration in respect of the disposal and the cost base to him of the asset is nil, he will not have a capital gain or a capital loss as a result of creating the asset.

Example 3 - Consequences where the person in whom the asset is created incurs costs in respect of the asset

On 15 August 1992, Smallco Pty Ltd contracts with CMR Management Services Pty Ltd for CMR to provide management services to Smallco for a period of four years. No consideration is paid in respect of the making of the contract. Smallco incurs non-deductible legal expenses of $2,000 in respect of its rights under the contract. CMR does not incur any legal or other incidental expenses.

Smallco's rights under the contract (its rights to require CMR to provide the management services for the period of four years) will be an asset. Smallco is taken to have acquired those rights from CMR. (By creating the rights, CMR is itself taken to have acquired and then disposed of them to Smallco.) Smallco did not give any consideration to acquire that asset, and paragraph 160ZH(9)(a) will not apply. However, the cost base to Smallco of that asset will include the legal fees of $2,000, being incidental costs incurred by Smallco in respect of the acquisition of the asset. When the contract expires on 15 August 1996 and Smallco is taken to have disposed of the asset, it will (assuming no other amounts are included in the cost base) incur a capital loss of $2,000.

Example 4 - Consequences where the person in whom the asset is vested receives consideration on a subsequent disposal of the asset

In example 3, CMR's rights under the contract will be an asset, even if they are not assignable. They were acquired from Smallco on 15 August 1992, when the contract was made. The cost base to CMR of that asset is nil - it paid no consideration to acquire it and paragraph 160ZH(9)(a) does not apply. If after 2 years, Smallco terminates the contract and pays CMR compensation of $40,000, a capital gain of $40,000 will accrue to CMR. It has disposed of an asset with a nil cost base for a consideration of $40,000. [NOTE: If that $40,000 is also assessable under the general provisions of the ITAA, the amount of the capital gain would be reduced to nil by the operation of subsection 160ZA(4).]

Examples of when new subsection 160M(6) will apply

The following is a not exhaustive list of the circumstances in which the new provisions would also apply. In any particular case, consideration will need to be given to the operation of the other provisions of the ITAA. If the consideration received is also included in the taxpayer's assessable income under those provisions, subsection 160ZA(4) may reduce the amount of the capital gain to nil.

•

A person agreeing not to compete with another person for a specified number of years or within a specified location.

•

A person agreeing to enter into an exclusive trade tie agreement with another person.

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A person agreeing to only play sport with a particular club.

•

A person agreeing to play only a particular sport, eg a rugby union footballer agreeing to play rugby league.

•

An actor agreeing with a film company not to appear in a film made by another company.

•

A person agreeing to withdraw an objection to a town-planning application.

•

A property owner who grants management rights over the property.

•

A person agreeing to endorse the use of particular goods and services.

•

The grant of a right to use a trademark.

•

An agreement for the supply of mining information in the possession of the taxpayer.

•

An agreement to vary a contract, where the variation does not amount to a disposal of the whole or of part of the rights under the contract.

•

An agreement for the assignment of an expectancy or of a right which is yet to come into existence, such as an agreement to assign interest which may accrue in the future upon an existing loan repayable without notice.

Matters incidental to the operation of new subsection 160M(6)

The general structure of the CGT provisions is that they apply where there is a disposal of an asset which, immediately before its disposal was owned by a person who acquired it after 19 September 1985. A capital gain or capital loss accrues to the person who owns the asset at the time of its disposal. The new provisions outlined above are designed to fit within that general structure by deeming an asset which is not a form of corporeal property to have been acquired, owned and disposed of by the person who created the asset even though, in fact, the person never owned it - the asset on its creation is vested in another person.

To dispel any suggestion that the new provisions will not have their intended effect because they do not fit within the general structure of the CGT provisions, the amendments make it clear that these provisions apply whether or not the asset is created out of, over or otherwise in connection with an existing asset, and whether or not the person creating the asset owned or disposed of anything at the moment of creation of the asset. [New subsection 160M(6C)]

The CGT provisions apply to a resident of Australia in respect of an asset whether it is "situated in Australia or elsewhere" - subsection 160L(1). In the case of incorporeal assets, it might be argued that the asset is not situated "in Australia or elsewhere". However, several provisions in Part IIIA, including the definition of asset, specifically contemplate that the CGT provisions will apply to incorporeal assets. Given their nature, it would defeat the clear intention of the provisions to say that incorporeal assets are not situated in Australia or elsewhere. However, to remove any uncertainty on the point, subsection 160L(1) will be amended to also refer to assets which are not situated anywhere. [Clause 24]

How will subsection 160M(7) operate under the new provisions?

Subsection 160M(7) will have a residual application where the other CGT provisions, including the new provisions dealing with the creation of incorporeal assets, have not applied to a transaction. While both new subsections 160M(6) and 160M(7) will be subject to the provisions of Part IIIA, subsection 160M(6) [which is not subject to subsection 160M(7)] will apply in precedence to subsection 160M(7). This will mean that subsection 160M(7) will only apply where the receipt of an amount of money or other consideration is not in respect of the disposal of an asset or the creation of an incorporeal asset.

Subsection 160M(7) will generally apply as it does at the moment. However, because most payments originally sought to be taxed under subsection 160M(7) will now fall within the new subsection 160M(6), it will apply in fewer cases. A number of minor technical amendments are proposed to clarify the operation of subsection 160M(7).

Subsection 160M(7) applies when an act or transaction has taken place in relation to an asset, or an event affecting an asset has occurred. The amendments will make it clear that the act or transaction need not affect the asset. Where the act, transaction or event does affect the asset, it will not matter whether the asset is affected adversely or beneficially, or whether it is neither adversely nor beneficially affected. [Clause 25(c) - new subsection 160M(7)(a)]

As presently enacted, it is not necessary that the person who receives the amount of money or other consideration by reason of the act, transaction or event to which subsection 160M(7) applies also owns the asset mentioned in the subsection. Accordingly, subsection 160M(7) will apply to a payment received, for example,. for entering into a restrictive covenant agreement, where the entering into the agreement took place in relation to, or affected, the goodwill of the taxpayer's employer. However, this and most other situations were subsection 160M(7) could presently apply will now fall within the new provisions dealing with the creation of incorporeal assets. Subsection 160M(7) will not need to have such a broad scope. The amendments will therefore provide for subsection 160M(7), in its future operation, to be limited to situations where the act, transaction or event takes place in relation to an asset owned by the taxpayer. [Clause 25(d)]

Paragraph 160M(7)(b) refers to some situations to which the subsection could apply. One such situation is where money or other consideration is receive in return for the forfeiture or surrender of a right. Subsection 160M(7) applies subject to the other provisions of Part IIIA. That is, subsection 160M(7) will not apply where a transaction falls within another provision of Part IIIA. By paragraph 160M(3)(b), the forfeiture or surrender of a right constitutes a disposal of the right. Therefore, subsection 160M(7) can not apply where a taxpayer receives consideration for the forfeiture or surrender of a right. The Bill will remove the ambiguity of the present provisions by omitting from paragraph 160M(7)(b) the reference to the surrender or forfeiture of a right. [Clause 25(e)]

Where subsection 160M(7) applies, the taxpayer is taken to dispose of a fictional asset which is created by the disposal. This deemed creation and disposal of the fictional asset have been interpreted as according with the general structure of the CGT provisions which require the acquisition, ownership and disposal of an asset owned by the taxpayer. However, this interpretation is not readily apparent. To put the issue beyond doubt, the Bill will make it clear that the fictional asset is acquired and owned by the taxpayer immediately before its disposal. [Clause 25(f) - new subsection 160M(7)(e)]

Construction or creation of an asset, other than under new subsection 160M(6)

The amendments proposed by the Bill will clarify the CGT treatment in other circumstances where a person constructs or creates an asset. [Clause 25(a)]

Construction or creation of an asset by a person for himself or herself.

Where a person constructs or creates an asset which, on its construction or creation, does not vest in another person (that is, it vests in the person constructing or creating it), the person who constructs or creates the asset will be taken to acquire it. [New paragraph 160M(5)(b)]

The time of the acquisition of the asset by the person will continue to be the same as under the existing provisions - that is, the time when the construction of the asset commenced or the time when the work on, or work that resulted in, the creation of the asset commenced. [New subsection 160U(5)]

Construction or creation of corporeal property for another person.

Where a person constructs or creates a form of corporeal property which, on its construction or creation, vests in another person (that is, it is constructed or created for another person), that other person will be taken to acquire the asset [New paragraph 160M(5)(c)] . Corporeal property is any property which has a physical or tangible existence, such as land or goods. The proposed new paragraph 160M(5)(c) will apply, therefore, where a person constructs or creates a building, painting, statue or any other physical object for another person.

Where the asset was constructed or created under a contract, the time of acquisition by that other person will be the time of making of the contract [New subparagraph 160U(6)(a)(i)] . In any other case, the time of acquisition by the other person will be the time when the asset vests in that person [New subparagraph 160U(6)(b)(i)]. In this latter case, the time of acquisition will depend on the operation of the general law to the circumstances which gave rise to the construction or creation. For example, where a person constructs a building on another person's land [which was acquired before 20 September 1985, so that the building will be taken to be an asset separate from the land by subsection 160P(2)], the other person will acquire the building when the construction commenced - the building, being a fixture to the land, is acquired by the land owner as soon as it is attached to the land.

Where a person constructs or creates a physical asset for another person, it will often be the case that the payment to the person for constructing or creating the asset will be assessable income under section 25 of the ITAA. For example, a payment to a well known artist for creating a painting. In other cases, the payment may not be assessable as it is received in respect of a hobby.

Vested

The provisions that will deal with the construction or creation of an asset [new paragraphs 160M(5)(b) and 160M(5)(c) and subsection 160M(6)] refer to the asset being vested in a particular person. In some contexts, "vest" has a specific legal meaning. For example, "vest" is often used in the context of creating property in a person - that is, creating a right (for example) which is capable of assignment. "Vested" can also be used in distinction to "contingent" - a contingent interest is capable of being defeated if the contingency does or does not occur, whereas a vested interest cannot be so defeated.

In the context in which "vested" is used in the proposed provisions, it has the broader meaning of the person being placed in possession or control of the asset. The use of this broader meaning is dictated by the fact that "asset" will now include rights which are not forms of property. [New subsection 160M(6D)]

Time of acquisition and disposal where an asset is NOT created or disposed of under new paragraphs 160M(5)(b) or (c) or subsection 160M(6)

Where a specific provision of Part IIIA applies in respect of the construction or creation of an asset, new paragraphs 160M(5)(b) or (c) and subsection 160M(6) will not apply. Section 160U, which provides the time of acquisition and disposal of assets, will be amended by the Bill to provide the time of acquisition and disposal by reference to the new provisions. The time of acquisition and disposal for asset construction and creation cases not covered by those provisions will be determined as if they had applied. [Clause 28 - new subsection 160U(6A)]

The grant of a lease is an example of where new subsection 160U(6A) will apply. If section 160ZS did not apply to the grant (or creation), new subsection 160M(6) would apply. The time of acquisition and disposal of the lease by the lessor will therefore be determined as if new subsection 160M(6) applied to the creation of the lease. The lessor would have been taken to have acquired the lease by virtue of new subsection 160M(6A)(a). The time of acquisition of the lease by the lessor will therefore be the applicable time under new subsection 160U(6) - immediately before the time of making the contract where the lease was granted under a contract [new subparagraph 160U(6)(a)(ii)]. The lessor would also be taken to have disposed of the lease [new paragraph 160M(6A)(b)] at the time of making the contract [new subparagraph 160U(6)(a)(iii)]. The lessee would have been taken to have acquired the lease [new paragraph 160M(6B)(a)] at the time of making the contract [new subparagraph 160U(6)(a)(i)].

Another situation in which new subsection 160U(6A) will provide for the time of acquisition of an asset is where a person creates a debt by borrowing money or obtaining credit. New subsection 160MA(1) provides that new subsection 160M(6) will not apply in these circumstances, but that the person who provided the money or credit will be taken to acquire the debt. Had new subsection 160M(6) applied, this person would have been taken to acquire the asset at the time of the making of the contract under which the money or credit was provided. The person will therefore be taken to acquire the debt at the time of making the contract which created the debt.

Situations in which new subsection 160M(6) and subsection 160M(7) will NOT apply

Where the other provisions of Part IIIA apply.

Both new subsections 160M(6) and 160M(7) will apply subject to the provisions of Part IIIA. This means that if either subsection 160M(6) or 160M(7) and another provision of Part IIIA could apply to a particular transaction, that other provision will apply. Subsection 160M(6) and 160M(7) will not apply. This will be the case, for example, where the transaction constitutes the disposal of the whole or of part of the existing asset for the purposes of Part IIIA, even if the asset was acquired before 20 September 1985.

For example, the owner of a block of land may sell part of his interest in the land to another, thereby creating a tenancy in common. Because the sale constitutes a disposal by the person of part of his land, neither subsection 160M(6) nor 160M(7) will apply.

Sections 160M(6) and 160M(7) will also be subject to section 160ZB, which provides for the exemption of certain capital gains and losses from the CGT provisions. For example, a capital gain is not taken to have accrued to a taxpayer who receives compensation for personal injury.

In addition, a capital gain or capital loss does not arise from betting, a lottery or other forms of gambling or games with prizes [subsections 160ZB(2) and (3)]. However, a capital gain may arise on a subsequent disposal of an asset obtained from these activities. It is not clear that this extends to the receipt of prizes from a competition. To put the issue beyond doubt, subsections 160ZB(2) and (3) will be amended to also refer to a competition with prizes [Clause 29] . However, if the winnings are assessable income under the general provisions of the ITAA, they will continue to be assessed as income.

Creation of a debt.

When a person borrows money or obtains credit, he or she creates an asset (a debt) in the provider of the money or the credit. To preclude any argument that the person has received the amount of money borrowed or credit obtained as consideration for creating the debt, subsection 160M(6) and 160M(7) will not apply to the creation of the debt. However, the person who advanced the money or credit (the person in whom the debt is created) will be taken to have acquired the debt. The time when that person acquired the debt will, by virtue of the operation of new subsection 160U(6A), be the time determined under new subsection 160U(6). [Clause 26 - new subsection 160MA(1)]

Creation of a right to require the disposal of an asset.

When a person, A, agrees to sell property to another person, B, the transaction will give rise to a disposal of that property for CGT purposes. A capital gain could accrue to A, depending on when the property was acquired, its cost base and the amount of consideration received. By entering into the agreement, A has also created in B a right to require A to transfer the property to B.

It would be argued that A has received, as consideration for creating that right, the amount of the consideration payable for the disposal of the property. If that were the case, new subsections 160M(6) and 160M(6A) would apply to deem the whole of the consideration to be a capital gain to A. However, it is unlikely that the consideration for the disposal of the property could also be the consideration for the creation of the right.

To put the issue beyond doubt, subsections 160M(6) and 160M(7) will not apply to the creation of a right to require the disposal of an asset. The other provisions of Part IIIA will continue to apply to the disposal of the asset. [Clause 26 - new subsection 160MA(2)]

Subsection 160MA(2) will apply even though Part IIIA does not apply to the disposal of the asset, eg because the asset was acquired before 20 September 1985. The requirement of new paragraph 160MA(2)(b) is that there be a disposal "for the purposes of this Part" - generally that there be a change of ownership of the asset within section 160M. It is not required that it be a disposal of an asset to which the Part applies.

Some motor vehicles and interests in motor vehicles are not assets for the purposes of Part IIIA - section 160A excludes them from the definition of asset. Part IIIA will therefore not apply to the disposal of those motor vehicles or interests. However, a right to require the transfer of a motor vehicle will be an asset for CGT purposes. As that right is not a right to require the disposal of an asset, proposed subsection 160MA(2) will not otherwise apply. To avoid any possibility that a capital gain can arise from the creation of a right to transfer a motor vehicle or an interest in a motor vehicle, subsections 160M(6) and 160M(7) will also not apply to the creation of such a right. [Clause 26 - new subsection 160MA(3)]

Application of subsections 160M(6) and 160M(7) to non-residents.

The CGT provisions apply to a non-resident in respect of the disposal of a taxable Australian asset, as described in section 160T, owned by the non-resident. Where a non-resident constructs or creates an asset for himself or herself [new paragraph 160M(5)(b)], or another person constructs or creates a corporeal asset for a non-resident [new paragraph 160M(5)(c)], the non-resident will be taken to acquire the asset. The asset will be a taxable Australian asset to the non-resident if it falls within any of the existing paragraphs of section 160T.

Specific rules will determine whether a non-resident will be subject to tax where new subsections 160M(6) or 160M(7) apply to the non-resident [Clause 27].

Where subsection 160M(6) applies to deem a non-resident to have disposed of an asset because that person created an incorporeal asset in another, the non-resident will be subject to tax if consideration received for creating the asset is derived from a source in Australia [new paragraph 160T(1)(l)] . The asset the non-resident is taken to acquire and dispose of by paragraph 160M(6A) will be a taxable Australian asset.

Whether the consideration is derived from a source in Australia is to be determined in the same way as it is for income. For these purposes, if the consideration received for creating the asset is not of an income nature, it is taken to be of an income nature [new subsection 160T(2)] . Whether consideration is derived from a source in Australia will depend on the circumstances of each particular case. Factors which may be taken into account include: where the contract was negotiated and made, the place of payment of the consideration and source of funds used as the consideration; the subject matter of the contract; where the contractual obligations are to be performed.

New subparagraph 160T(1)(l)(iii) also provides for the situation where no consideration is received by a non-resident for creating an incorporeal asset. This allows for a non-resident who has incurred incidental costs in connection with the creation of an asset to be entitled to a capital loss equal to the amount of those incidental costs.

Where subsection 160M(7) applies, the taxpayer is deemed to have disposed of a fictional asset. It has been suggested that subsection 160M(7) will not apply where the taxpayer is a non-resident - because the fictional asset is not a taxable Australian asset. The Government does not accept this view. The context of subsection 160M(7) indicates an intention to assess certain capital payments, including a payment received by a non-resident. Nevertheless, to remove any uncertainty on this point, it will be made clear that the fictional asset is a taxable Australian asset where the underlying asset in respect of which subsection 160M(7) applies is a taxable Australian asset. That underlying asset, because of the amendments proposed by clause 25(d), will be a taxable Australian asset owned by the non-resident. [Clause 27(b) - new paragraph 160T(1)(m)]

Application of existing subsection 160M(7) between 20 September 1985 and 22 May 1986

When the introduction of CGT was announced on 19 September 1985, it was said that the CGT provisions would apply to real gains made on the disposal of assets acquired on or after 20 September 1985. Where subsection 160M(7) applies in relation to assets acquired before 20 September 1985, the effect is to deem the CGT provisions to apply to the disposal of a separate, fictional asset which is taken to be acquired at the time of the relevant act, transaction or event. The consideration received will be subject to tax.

Because it could not have been anticipated from the announcement of 19 September 1985 that the CGT provisions would operate in that way, subsection 160M(7A) was introduced to provide that subsection 160M(7) would not operate in certain circumstances on or before 22 May 1986 (the date of introduction of the CGT legislation into Parliament). Those circumstances are that the taxpayer (the person who received the money or other consideration to which subsection 160M(7) applies) acquired the relevant asset before 20 September 1985, and the act, transaction or event took place between 20 September 1985 and 22 May 1986 (inclusive).

It is now clear that subsection 160M(7) can also apply where an act, transaction or event takes place in relation to an asset not owned by the taxpayer. Hence, it is possible that any consideration received by the taxpayer will be taxed under the CGT provisions, even though the underlying asset was not owned by the taxpayer. Again, the taxpayer could not have anticipated from the 19 September 1985 announcement that the CGT provisions would apply to the money or consideration received. In these circumstances, the Bill will amend subsection 160M(7A) to provide that subsection 160M(7) also does not apply where an act, transaction or event took place in relation to an asset between 20 September 1985 and 22 May 1986 (inclusive), and the asset was acquired by a person other than the taxpayer before 23 May 1986. [Clause 25(g) - new subsections 160M(7A) and 160M(7B)]

Commencement date

New subsections 160M(7A) and 160M(7B) will apply where the relevant act, transaction or event took place between 20 September 1985 and 22 May 1986 (inclusive).

The amendment to section 160ZB will apply to participation in a competition with prizes after 25 June 1992.

The amendments to subsection 160M(7) and new paragraph 160T(1)(m) will apply in relation to an act, transaction or event which takes place after 25 June 1992.

The other amendments apply to the construction or creation of assets after 25 June 1992.

Clauses involved in the proposed amendments

Clause 23: Amends the definition of asset in section 160A.

Clause 24: Amends section 160L to provide for incorporeal assets not situated anywhere.

Clause 25: Amends section 160M to substitute the provisions dealing with the construction and creation of assets, and clarify the operation of subsections 160M(7) and 160M(7A).

Clause 26: Inserts section 160MA to provide for situations where the creation of an asset will not constitute an acquisition and disposal.

Clause 27: Inserts paragraphs 160T(1)(l) and (m) and subsection 160T(2) to clarify the circumstances in which subsections 160M(6) and 160M(7) will apply to non-residents.

Clause 28: Amends section 160U so that the rules for the time of acquisition and disposal of assets is consistent with the new provisions dealing with the construction and creation of assets.

Clause 29: Amends subsection 160ZB to make it clear the CGT provisions apply to prizes from a competition in the same way as a prize from a game.

Clause 30: Inserts new subsections 160ZH(7A) and 160ZH(7B) to describe the costs which will be allowed as incidental costs incurred in connection with the creation of an incorporeal asset.

Clause 31: Sets out the commencement date of the amendments.

Chapter 12 Penalties for Late Payment of Tax and Related Penalties

Clauses 33, 34 and 35 of the Bill will reduce from 20% per annum to 16% per annum the rate at which additional tax is payable as a penalty for not paying various taxes on time and for related matters.

The penalty rate is being reduced for:

Income Tax Assessment Act 1936 - [Clauses 33, 34 and 35]:

•

late payment of income tax, franking deficit tax, provisional tax, company tax payments and certain other amounts [ss.207 and 160 ARW(2) - clause 34];

•

late payment of withholding taxes [ss.128C(3), 221YN(4), 221ZC(4) and 221ZD(1) - clause 34];

•

late payment of, or failure to deduct:

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PAYE deductions [ss.221EAA, 221F(12) and 221G(4A) - clause 34];

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prescribed payment deductions [ss.221YHH, 221YHJ, 221YHZC(3) and 221YHZD(2) - clause 34];

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deductions from amounts withdrawn from film accounts [ss.221ZO and 221ZP - clause 34];

•

non-payment of provisional tax or initial payment of company tax because of incorrect estimates by the taxpayer or because of avoidance arrangements [ss.1221AY(2) and (3), 221AZE(3) and 221YDB - clauses 33 and 35] . This category includes incorrect estimates of provisional tax where the present penalty of 20% flat is being reduced to 16% flat [clause 35].

Fringe Benefits Tax Assessment Act 1986 - [Clause 33]

•

late payment of fringe benefits tax (s. 93);

•

non-payment of fringe benefits tax because of an incorrect estimate (s.112(4)).

Sales Tax Assessment Act (No. 1) 1930 Sales Tax Assessment Act 1992 - [Clause 33]

•

late payment of sales tax (s. 29(1) of the Sales Tax Assessment Act (No. 1) 1930 and s.68(1) of the Sales Tax Assessment Act 1992).

Commencement

For the amendments being made by Clauses 33 and 34 the reduced rate of penalty is to apply in respect of any period during which the relevant amount is overdue that occurs on or after 1 October 1992. In the case of the amendment being made by Clause 35, the reduced rate is to apply to incorrect provisional tax estimates for the 1992-93 year of income and subsequent years of income.