House of Representatives

Supplementary Explanatory Memorandum

Amendments to be moved on behalf of the Government (Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

General outline and financial impact

Net capital losses of earlier income years

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Inserts items 10A and 28A into Parts 1 and 3 of Schedule 9 to the Taxation Laws Amendment Bill (No. 8) 1999 (TLAB 8) to include non-resident information gathering rules for the concessional tracing rules for carrying forward net capital losses of earlier income years in the Income Tax Assessment Act 1936 (ITAA 1936).

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Amends the application rules contained in items 16 and 36 of Parts 1 and 3 of Schedule 9 to TLAB 8 so that the concessional tracing rules for carrying forward net capital losses of earlier income years operate consistently between the ITAA 1936 and the Income Tax Assessment Act 1997 (ITAA 1997).

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Amends item 19 of Part 2 of Schedule 9 to TLAB 8 (which amends the trust loss measures contained in Schedule 2F to the ITAA 1936) to provide another circumstance where a company owned by a non-resident discretionary trust(s) will be liable for family trust distribution tax.

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Amends item 3 of Schedule 10 to TLAB 8 to allow a trust to make a family trust election for the 1996-1997 and 1997-1998 income years so that a company will be able to use the family trust concession to apply a net capital loss incurred in the 1996-1997 income year against a net capital gain derived in the 1997-1998 income year.

Alternative condition

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Amends the alternative condition in items 23, 28 and 35 in Part 3 of Schedule 9 to the TLAB 8 to ensure that it is available to companies on the same basis that it is available to fixed trusts under the trust loss measures.

Technical amendments

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Makes other technical amendments to items 14, 16 and 36 of Parts 1 and 3 of Schedule 9 and an amendment to Schedule 10 to correct minor drafting errors.

Date of effect : These amendments do not affect the date of effect of the TLAB 8 concessional tracing rules.

Proposal announced : The original proposal was announced in the 1996-1997 Budget and the Treasurers Press Release No. 79 of 20 August 1996.

Financial impact : These amendments do not affect the original estimates as contained in the Regulation Impact Statement (RIS).

Cost of compliance impact : The compliance costs for taxpayers and administrative costs to the Australian Taxation Office will increase if the consequential amendments to the net capital loss rules are not made. The amendment to the alternative condition will have no compliance cost impact.

Summary of Regulation Impact Statement

Impact : The consequential amendments to the net capital loss rules will affect companies owned by discretionary trusts that wish to apply a net capital loss incurred in the 1996-1997 income year against a net capital gain derived in the 1997-1998 income year. The amendment to the alternative condition will ensure that the measures will operate as intended.

Main points : The amendments do not change the RIS contained in the Explanatory Memorandum to the TLAB 8.

Policy Objective : The amendments also do not change the RIS contained in the Explanatory Memorandum to the TLAB 8.

Chapter 1 - Concessional tracing rules for company loss etc. provisions

Overview

1.1 Parts 1 and 3 of Schedule 9 to the Taxation Laws Amendment Bill (No. 8) 1999 (TLAB 8) contain amendments to both the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) to make 2 concessional tracing rules (the family trust concession and the alternative condition) available to trusts under the trust loss measures also available to companies.

Net capital losses of earlier income years

1.2 Amendments to Parts 1 and 3 of Schedule 9 to the TLAB 8 are necessary to ensure that the concessional tracing rules which are to be made available to companies which seek to apply a net capital loss incurred in the 1996-1997 income year against a net capital gain derived in the 1997-1998 income year operate as intended. Amendments also need to be made to the application rules to ensure that there is consistency between the ITAA 1936 and the ITAA 1997. Specifically, the amendments will:

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insert items 10A and 28A to include non-resident information gathering rules which are needed for the concessional tracing rules in the ITAA 1936 to be made available to a company which seeks to apply a net capital loss incurred in the 1996-1997 income year against a net capital gain derived in the 1997-1998 income year;

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amend the application rules contained in items 16 and 36 to ensure the concessional tracing rules apply as follows:

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in relation to the rules for carrying forward net capital losses of earlier income years in the ITAA 1936

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to a net capital loss incurred in the 1996-1997 income year applied against a net capital gain derived in the 1997-1998 income year; and

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in relation to the rules for carrying forward net capital losses of earlier income years in the ITAA 1997

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to a net capital loss incurred in the 1996-1997 income year or later income year applied against a net capital gain derived in the 1998-1999 income year or later income year.

1.3 Part 2 of Schedule 9 to the TLAB 8 contains amendments to section 271-60 of Schedule 2F of the ITAA 1936. This provision contains special rules which provide that family trust distribution tax imposed by the Family Trust Distribution Tax (Secondary Liability) Act 1997 is payable in certain circumstances.

1.4 An amendment is necessary to item 19 of Part 2 of Schedule 9 to the TLAB 8 to ensure that:

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a company owned by a non-resident discretionary trust(s);

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which is able to apply a net capital loss incurred in the 1996-1997 income year against a net capital gain derived in the 1997-1998 income year; and

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is only able to do so because the trust was a family trust;

will be liable for family trust distribution tax if it is not paid by the non-resident family trust(s). .5 Schedule 10 to the TLAB 8 contains transitional rules to extend deadlines for making family trust elections (and interposed entity elections) for the family trust concessional tracing rule. An amendment is necessary to item 3 of this Schedule to allow a trust to make a family trust election in respect of the 1996-1997 and 1997-1998 income years to carry forward a net capital loss incurred in the 1996-1997 income year against a net capital gain derived in the 1997-1998 income year.

Alternative condition

1.6 Part 3 of Schedule 9 to the TLAB 8 contains amendments to both the ITAA 1936 and the ITAA 1997 to ensure that the alternative condition is available to companies. Amendments are necessary to Part 3 to ensure that the alternative condition is available to companies on the same basis that it is available to fixed trusts under the trust loss measures.

Technical corrections

1.7 Technical corrections will be made to items 14, 16 and 36 of Schedule 9 and a correction to Schedule 10 to the TLAB 8 to correct minor drafting errors.

Background

Net capital losses of earlier income years

1.8 Schedule 9 to the TLAB 8 introduces amendments to the company loss and debt deduction rules in both the ITAA 1936 and the ITAA 1997 so that 2 concessional tracing rules (i.e. the family trust concession and the alternative condition that are available to trusts under the trust loss measures contained in Schedule 2F to the ITAA 1936) will also be available to companies. These amendments will apply to losses and debts incurred by companies in the 1996-1997 and later income years.

1.9 Under the ITAA 1936, a company which seeks to carry forward a net capital loss of an earlier income year under subsection 160ZC(5) is able to rely on the concessional tracing rules if it satisfies the same tests for carrying forward revenue losses. However, in the case of a company which seeks to apply a 1996-1997 net capital loss against a 1997-1998 net capital gain^[F1], the tests for carrying forward revenue losses are contained in the ITAA 1997 as part of the Tax Law Improvement Project Rewrite.

1.10 As the amendments made by the TLAB 8 make available concessional tracing rules for the revenue loss provisions in the ITAA 1997, these rules will also be available to a company seeking to apply a net capital loss of the 1996-1997 income year against a net capital gain of the 1997-1998 income year.

1.11 There are currently technical omissions in Schedule 9 to the TLAB 8 in relation to the concessional tracing rules that apply to a company seeking to apply a net capital loss of an earlier income year. There is also a technical omission in Schedule 10 to the TLAB 8 which contains transitional rules to extend deadlines for making family trust elections (and interposed entity elections) for the purpose of the family trust concession.

The alternative condition

1.12 Under the trust loss measures contained in Schedule 2F to the ITAA 1936, the alternative condition is available to fixed trusts which are unable to satisfy the 50% stake test because the majority of fixed entitlements are held by non-fixed trust(s) in which there are no fixed entitlements. Under the trust loss measures fixed trusts have been defined as a trust in which persons have fixed entitlements to all of the income and capital of the trust.

1.13 In the case of a company, there is no requirement that persons hold fixed entitlements to all the income and capital of the company. This means that the alternative condition would be available to a company in which persons do not hold fixed entitlements to all of the income and capital. Under the alternative condition, non-fixed trusts are only required to hold fixed entitlements to a 50% or greater share of the income and capital of the company. This has the unintended consequence of allowing a company to deduct its losses, bad debts or debt/equity swap deductions via the alternative condition even though there is less than 50% continuity of ownership.

Date of effect

1.14 These amendments do not affect the date of effect of the TLAB 8 concessional tracing rules. That is, they will apply to company losses and debts incurred in the 1996-1997 income year or later income years.

Explanation of the amendments

Schedule 9

1.15 There are 3 technical omissions that need to be corrected in relation to the concessional tracing rules that apply to the rules for carry forward of net capital losses. An amendment is also required to the alternative condition to ensure that this condition will be available to companies on the same basis that it is available to fixed trusts under the trust loss measures.

Net capital losses of earlier income years

Amendments 1 and 17

1.16 The provisions in the ITAA 1936 for carrying forward net capital losses do not contain similar non-resident information gathering rules that apply to the concessional tracing rules to be included elsewhere in the law. These amendments will insert 2 additional items to include non-resident information gathering rules. [Items 10A and 28A; new sections 160ZCA, 160ZCB, 160ZCC, 160ZCD, 160ZCE and 160ZCF]

Amendments 4, 6, 7, 10, 11, 12, 13 and 22

1.17 The existing application rules contained in items 16 and 36 are deficient. They do not provide that the concessional tracing rules that are in the ITAA 1997 are available for net capital losses incurred in the 1996-1997 and later income years. The amendments therefore, make corrections so that these rules can apply to a net capital loss incurred in the 1996-1997 income year or later income year which is applied against a net capital gain derived in the 1998-1999 income year or later income year^[F2]. [Paragraphs (ba) and (c) of subitem 16(3); paragraphs (ba) and (c) of subitem 16(4); paragraphs (c) and (ca) of subitem 16(5); paragraphs (ba) and (c) of subitem 16(6) and subitems 36(4A) and (5)]

Amendment 14

1.18 An amendment needs to be made to extend the scope of section 271-60 of the trust loss measures contained in Schedule 2F to the ITAA1936to include another circumstance where a company owned by a non-resident discretionary trust(s) will be liable for the family trust distribution tax. The amendment will ensure that:

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a company owned by a non-resident discretionary trust(s);

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which is able to apply a net capital loss incurred in the 1996-1997 income year against a net capital gain derived in the 1997-1998 income year; and

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is only able to do so because the non-resident trust was a family trust;

will be liable for the family trust distribution tax if it is not paid by the non-resident family trust(s). [Item 19; new paragraph 271-60(5)(ba) of Schedule 2F to the ITAA 1936]

Alternative condition

Amendments 15, 16, 18, 19, 20

1.19 An amendment is necessary to items 23, 28 and 35 of Part 3 of Schedule 9 to the TLAB 8 to ensure that the alternative condition is only available to a company where persons have fixed entitlements to all the income and capital of the company at all times in the loss year and the income year.

Schedule 10

Amendment 24

1.20 Schedule 10 to TLAB 8 contains transitional rules to extend deadlines for making family trust elections (and interposed entity elections) for the family trust concessional tracing rule. There is a technical omission in this Schedule in relation to the concessional tracing rules as they apply to a company seeking to apply a 1996-1997 net capital loss against a 1997-1998 capital gain.

1.21 An amendment is necessary to allow a trust to make a family trust election in respect of the 1996-1997 and 1997-1998 income years so that a net capital loss incurred in the 1996-1997 year of income can be carried forward and applied against a net capital gain derived in the 1997-1998 income year. [Item 3; new paragraph (ia) of subitem 22(2) to Schedule1 of the Taxation Laws Amendment (Trust Loss and Other Deductions) Act 1998]

Technical amendments

Amendments 2, 3, 5, 8, 9, 10, 21 and 23

1.22 A number of technical amendments also need to be made to the concessional tracing rules in the TLAB 8 to correct minor drafting errors. These amendments are summarised in the table below.