House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon. P.J. Keating, M.P.)

GENERAL OUTLINE

Taxation Laws Amendment Bill (No. 2) 1986

This Bill will amend -

•

the Income Tax Assessment Act 1936 -

•.

to tax each year the income accruing to resident investors from discounted and other deferred interest securities, including capital indexed securities, issued after 16 December 1984, and to generally allow, on a parallel basis, a deduction for the discount or "interest" component to issuers of such securities (proposal announced on 16 December 1984 and modified rules on 20 December 1985);

•.

to strengthen the application of the interest withholding tax provisions in relation to discounted debt obligations, capital indexed or deferred interest securities, certain payments made in relation to bank accepted bills and financing by way of hire purchase and similar arrangements (proposal announced on 14 December 1984);

•.

to make it clear that certain actions taken or statements made by persons affected by the above amendments are to be regarded, for additional tax purposes, as having been taken or made for a purpose in connection with the operation of the income tax law;

•.

to remedy a technical defect in the rebate provisions that effectively limit the rate of tax payable on certain employment termination payments (proposal announced on 11 March 1986);

•.

to allow income tax deductions for gifts to the Pearl Watson Foundation Limited;

•.

to permit the Commissioner of Taxation to communicate relevant information to certain persons for purposes connected with the supervision or regulation of superannuation funds, approved deposit funds or similar funds;

•.

to exempt from income tax those parts of the Commonwealth Formal Training Allowance that correspond to exempt social security allowances;

•.

to remove the need for the signing of receipts, invoices or similar documentary evidence that will be required after 30 June 1986 to substantiate deductions claimed for employment-related expenses and certain car and travel expenses.

•

the Taxation Administration Act 1953 -

•.

to make it clear that certain actions taken or statements made by persons affected by the proposed amendments of the Income Tax Assessment Act are to be regarded, for prosecution purposes, as having been taken or made for a purpose in connection with the operation of a taxation law.

This Bill will also make a number of technical amendments of the Taxation Laws Amendment Act (No. 4) 1985 to ensure that various references to particular Repatriation statutes are correctly cited in the income tax law. The amendments will not affect the practical operation of the income tax law.

Income Tax (Securities and Agreements)(Withholding Tax Recoupment) Bill 1986

This Bill will impose on a resident a liability to pay an amount of tax, referred to in the Bill as the "avoided withholding tax amount", in two situations. The Bill operates in conjunction with proposed section 128NA of the Assessment Act, which is contained in the Taxation Laws Amendment Bill (No. 2) 1986. That section contains anti-avoidance measures to cover arrangements designed to circumvent the new withholding tax measures in that Bill.

The first situation where this Bill has effect is where a resident buys a qualifying security from a non-resident and the Commissioner of Taxation is satisfied that the resident and the non- resident were not dealing with each other at arm's length and the amount of the withholding tax arising from the sale is less than the amount that would have arisen if the parties were dealing with each other in an arm's length manner. In this situation, the resident will be liable for the extra withholding tax.

The other case where this Bill will impose a liability for avoided withholding tax arises as the changes to the interest withholding tax provisions contained in the Taxation Laws Amendment Bill (No. 2) are only to affect payments made after the date the amendments come into operation Parties to agreements affected by the amendments may pre-pay, during this intervening period, interest that could otherwise have been payable after the commencement of the amendments. If this loading of payments or pre-paying of interest is done for the sole or dominant purpose of avoiding withholding tax, proposed sub-section 128NA(2) provides that there is to be taken to be an avoided withholding tax amount in relation to the person making the payment. This Bill will impose a liability on that person to pay that avoided withholding tax amount.

FINANCIAL IMPACT

Taxation Laws Amendment Bill (No. 2) 1986

The accruals method for taxing the income accruing to resident investors from discounted and other deferred interest securities, by bringing forward the taxing point of this income, will redress the tax deferral advantages that such securities offer. The new taxing basis will result in some unquantifiable gains to revenue.

The amendments being made to strengthen the interest withholding tax provisions of the income tax law in relation to discounted and other deferred interest securities will prevent a continued loss of revenue. The impact on revenue of prior exploitation cannot be measured.

The proposed amendments of the rebate provisions applicable to certain employment termination payments are not expected to have any significant effect on revenue.

The revenue cost of extending the income tax gift provisions to admit the Pearl Watson Foundation Limited is estimated at less than $10,000 in a full financial year.

The amendment of the income tax secrecy provisions is for administrative purposes only and should have no effect on revenue.

The estimated cost of exempting from tax certain allowances paid under the Formal Training Allowance is nil in 1985- 86, $100,000 in 1986-87 and $200,000 in a full year.

MAIN FEATURES

Taxation Laws Amendment Bill (No. 2) 1986

Discounted and other deferred interest securities (Clauses 16, 26-28)

This Bill will implement the proposal, announced on 16 December 1984, to tax each year as it accrues part of the overall yield on discounted and other deferred interest securities, including securities of the indexed capital type, issued after that date. Some modifications of the proposal were announced on 20 December 1985.

Under the existing law, the gain to a taxpayer from investing in these kinds of securities is taxed only at maturity or earlier redemption, i.e., when it is received in cash. This treatment has created tax deferral advantages associated with the use of these securities by comparison with traditional interest-bearing securities. The amendments proposed in this Bill are designed to eliminate those tax deferral advantages. By the amendments, a resident taxpayer holding one of these securities will be taxed annually on that part of the income accruing on the security that is attributable to the period the taxpayer held the security during a year of income. Taxing the accruing income in this way should also ensure that the after-tax effective yield on the types of securities concerned reasonably equates with that from a traditional security having the same nominal yield.

Subject to certain exceptions, parallel treatment is to be accorded in relation to deductions to issuers of these securities for the discount or other "interest" component payable.

Three basic tests will need to be satisfied before a security is affected by the new measures -

(a)

it will need to have been issued after 16 December 1984;

(b)

its expected term will, or is likely to, exceed one year; and

(c)

the sum of all payments (other than payments of periodic interest) under the security will exceed its issue price.

A further basic test is that where the amount of the excess in paragraph (c) can be established at the time a security is issued, e.g., in the case of a zero-coupon discounted security, the new measures will not apply unless the excess is greater than 1.5 per cent of the sum of those payments multiplied by the number of years and part years in the term of the security.

The accruals method is not to apply to prescribed securities within the meaning of section 26C of the Income Tax Assessment Act 1936.

It is expected that in most cases the securities affected will be readily identifiable as such. However, to enable a holder or potential holder of a security who is unaware of its status for purposes of the new measures to determine this fact, the legislation provides for the holder of a security to apply to the issuer for a notice as to whether or not the security is an affected security and, if so, for details of the issue price.

The actual treatment, for income tax purposes, of a security affected by the new measures depends on whether it is to be regarded as a fixed or variable return security. A fixed return security is one where the yield consists of a specified amount or amounts, e.g., a zero-coupon discounted security or where the calculation of the amount or amounts payable under the security does not involve the use of an interest or indexation rate that may vary over its term e.g. a security that pays interest only at maturity or earlier redemption and has a fixed coupon rate or where the security is some combination of these two characteristics. A variable return security is any security that is not a fixed return security. One example is a capital-indexed bond.

For a fixed return security, the holder will be required to calculate a yield to redemption for the security. This yield is, broadly, the compound interest rate per six monthly "notional accrual period" at which the sum of the present values of the payments to be made under the security equal its issue or transfer price, as the case requires. This compound interest rate is then used to gross-up the value of the security for each such period, to calculate the amount to be included in the holder's assessable income as the income accruing under the security for any year of income.

This method will also form the basis generally for determining the annual deductions allowable to the issuer of an affected security in respect of the discount or deferred interest payable under the security. The allowance of deductions to an issuer on an annual accruals basis will not apply, however, in relation to issues of bearer securities. or to offshore issues of affected securities. Relevant deductions will continue to be allowed in these cases only in the year in which the discount or deferred interest is paid.

Where a variable return security is involved, it will not always be possible to calculate in advance the overall yield to redemption under the security. Therefore, it is proposed to have regard to the actual terms of the security to ascertain the income accruing under the security for a year of income, e.g., in the case of a capital-indexed bond, this would be the capital indexation amount for that year, in addition to any interest payments received during that year. If, for any reason, the terms of a security do not enable the amount of the income to be accurately determined for any year, the Commissioner will be able to determine an amount to be included in a taxpayer's assessable income for that year.

If a variable return security is issued at a discount, e.g., a Treasury capital-indexed bond, the amount of that discount is to be included in the assessable income of the purchaser on a straight-line basis over the period the taxpayer holds the security. The amount to be so included for the first purchaser is to be calculated by reference to the term of the security. For example, if a capital-indexed security with a term of 10 years and a face value on issue of $1,000 is issued for $950, in addition to the proportion of the overall yield on the security that is to be included in assessable income for each year under the procedures outlined in the previous paragraph (i.e., any interest payments received and the capital indexation amount for that year), the taxpayer will be required to include $5 per year as the accrual of the issue discount. Similarly, if a taxpayer acquires, otherwise than on issue, a variable return security for less than its accrued value, the taxpayer will be required to include the "purchase discount" on a straight-line basis over the remaining term of the security. As noted earlier, the exclusion from the new measures of securities issued with an annual discount yield not exceeding 1.5 per cent will not apply to a variable return security.

Should a taxpayer sell or otherwise dispose of either a fixed or variable return security, adjustments are to be made where the realised gain from the security does not equal the sum of the amounts included in the taxpayer's assessable income under the accruals method. Where the gain from the sale exceeds the accrual amounts already included in the taxpayer's assessable income in previous years, that excess is to be assessed in the year the security is transferred. Conversely, where the gain is less than the sum of the accrual amounts previously assessed, that deficiency is to be an allowable deduction in the year of transfer. Similar provisions exist where the security is redeemed or partially redeemed.

In the case of a purchaser of a fixed return security on the secondary market, it has already been indicated that the purchase or transfer price paid will form the basis for determining the purchaser's yield to redemption and thus the amount to be included in assessable income each year under the accruals basis of assessment. On the other hand, a purchaser of a variable return security on the secondary market will be required to include any purchase discount, i.e., the excess of the security's accrued value over the purchase price as assessable income and will be entitled to an allowable deduction for any purchase premium.

The amendments proposed in this Bill are designed to only affect securities issued after 16 December 1984. However, as an anti-avoidance measure, provision exists for subjecting a security issued on or before that date to the accruals method if its terms are so varied after 22 May 1986 so that. if the security was issued on those terms on the date the variation took place, it would be subject to the proposed amendments. A variation that will trigger the operation of this provision is one that has the effect of transforming the security into a discounted or other deferred interest security or one that has the opposite effect. In both cases, the security is to be treated as having been issued as varied on the date its terms were altered.

One assumption underlying the arrangements for taxing each year the accruing income on an affected security is that this income will eventually be received by the holder of the security at redemption. This may not always be the case. Where it becomes clear that the issuer will be unable to meet its liability under the security because, for example, the issuer becomes insolvent, the holder of the security will be able to claim, as a bad debt, a deduction for the sum of the amounts previously included in assessable income under the accruals method and written-off as a bad debt, even though the payment of the accrued interest may not be then due. Where the allowance if such a deduction gives rise to a carry- forward loss, the usual tests for deductibility of losses will apply.

The application of the annual accruals method of assessing the gain on an affected security in the case of a private company raises particular implications when determining the company's distributable income for the year for the purposes of calculating its liability or otherwise for undistributed profits tax under Division 7 of Part III of the Income Tax Assessment Act 1936. If the accrued income included in the company's taxable income for the year is included in the distributable income calculation the company would not only be required to finance the primary tax payable on the accrued income out of its other resources (a feature common to all holders of affected securities), but might also be required to fund a dividend in respect of the after-tax component of the income out of these other resources if Division 7 tax were to be avoided. The company would, therefore, be disadvantaged by the accruals method compared with other taxpayers. For this reason, the accrued income included in a private company's taxable income for a year of income is to be excluded from the distributable income of the private company for Division 7 tax calculation purposes until such time as the security is sold by the company or is redeemed. At that time, given that the income will have been received in cash, the accruals amounts excluded in prior years are to be then added to the distributable income of the company for Division 7 tax calculation purposes.

The amendments contained in the Bill also cover "stripped securities", such as DINGO Bonds and similar securities. These securities separately market the entitlements to principal and interest on another security, usually a Commonwealth bond. The amendments deal with two types of these securities - the one where the interest coupons are physically separated from the principal component and both are sold singularly; the other where the holder of the "underlying security" creates new securities to match the timing and face value of the interest entitlements and the principal entitlement of the underlying security.

The amendments in relation to stripped securities have two broad aims. The first is to ensure that, regardless of when the underlying security was issued, where the holder of that security physically separates an interest entitlement or interest entitlements from the principal entitlement and markets them individually after 16 December 1984, the stripped components are to be regarded as having been issued as separate qualifying securities after that date. Therefore, where, as is usual, those stripped components are sold at a discount, they will be subject to the provisions contained in this Bill for taxing the deferred yield on a discounted security.

Secondly, for purposes of determining relevant deductions allowable to the issuer of stripped securities the amendments are designed to allocate the cost of the underlying security across the range of the stripped securities, and not just to the coupon or new security or securities that relate to the entitlement to the principal on the underlying security. This aspect of the amendments is designed to prevent issuers of stripped securities from creating artificial losses where they have unsold interest coupons on hand at the end of a year of income.

Interest withholding tax (Clauses 12-15, 19-28)

The amendments contained in this Bill will give effect to the proposal announced on 14 December 1984 to strengthen the interest withholding tax provisions of the income tax law to prevent a continued loss of revenue through a particular avoidance device and by the use of what may be described as non-traditional methods of finance. The amendments will also clarify the application of the law in relation to certain payments made in respect of bank accepted bills. In general terms the amendments will deal with three situations -

(a)

where a non-resident sells a qualifying security, as defined in the amendments dealing with discounted and other deferred interest securities, to a resident;

(b)

where a resident has entered into or enters into a hire-purchase agreement or finance lease arrangement after 16 December 1984 with a non-resident; and

(c)

where a resident, in relation to a bill of exchange drawn or issued after the amendments become law and accepted and discounted overseas, indemnifies or reimburses the offshore acceptor of the bill in respect of the discount due under the bill at its maturity, with like provisions relating to promissory notes.

In relation to paragraph (a), the avoidance device referred to in the announcement of 14 December 1984 was one where a non- resident sold a discounted or other deferred interest security to a resident and no part of any profit derived by the non-resident from the sale was subject to Australian tax. This was in direct contrast to the situation where the non-resident held the security until maturity. In the latter instance, the non-resident was liable to withholding tax on the discount or deferred interest element of the redemption payment. Further, as these sales were arranged so as to give the profit an ex-Australian source, the non-resident was not able to be taxed on the profit by assessment.

By the amendments contained in this Bill, the profit on these transfers to residents by non-residents is to be deemed to be income that consists of interest. As such, the profit will be subject to withholding tax under the existing provisions of Division 11A of Part III of the Income Tax Assessment Act.

The proposed amendments will apply to relevant transfer payments made in respect of affected securities issued after 16 December 1984 but will not affect payments made on or before the date on which those amendments become law.

The profit to be subject to withholding tax is to be calculated, primarily, by reference to the security's issue price and the sale or transfer price. Where a non-resident acquired the security other than on its issue, i.e., by purchasing it from another person, no account is to be taken of the purchase price that the non-resident paid for the security unless he or she can show that it was purchased directly from a resident. In that case, the non-resident will be able to obtain from the Commissioner of Taxation a certificate which will show, among other things, the price paid for the security by the non-resident. By presenting the certificate to a resident transferee before the sale, the deemed interest on the sale is to be calculated as if the purchase price specified in the certificate was the security's issue price. The certificate must be presented to the resident transferee at the time of transfer to be effective. Otherwise the resident transferee would be required to withhold from the transfer price withholding tax on the difference between that price and the issue price of the security. To enable the orderly issue of these certificates, a non-resident may apply to the Commissioner at any time after he or she buys the security.

The certificate will also be effective should the security be redeemed in the hands of the non-resident. If an issuer is given one of these certificates at redemption, the issuer will be able to substitute the purchase price specified in the notice for the security's issue price for purposes of determining the non-resident's liability for withholding tax.

To cover the situation where a non-resident fails to produce such a certificate to a resident purchaser and the original issue price is not known or evident to the purchaser, or it is not apparent that the security is affected by the proposed amendments, the legislation proposes that the holder of a security may apply to the issuer for a notice as to whether or not the security is a qualifying security for those purposes, and, if so, for details of its issue price.

As indicated in the notes which follow on the Income Tax (Securities and Agreements) (Withholding Tax Recoupment) Bill 1986, provision is made for a resident who purchases an affected security from a non-resident to be liable for extra withholding tax, formally imposed by that Bill, where the Commissioner is satisfied that the parties were not dealing with each other at arm's length and that the resulting withholding tax liability is less than the withholding tax that would have been payable under an arm's length dealing.

The changes proposed by this Bill as they affect bank accepted bills of exchange are designed to ensure that offshore acceptors of the bills are exposed to liability for withholding tax in respect of the bill discount where, under an indemnification agreement or otherwise, a resident reimburses or indemnifies the non-resident acceptor for the amount of the face value of the bill at its maturity. A common arrangement is for a resident to draw a bill for acceptance by an offshore bank which may then either discount the bill itself or sell it on the open market. At the same time, the bank enters into an arrangement (be it formal or informal) with the drawer whereby the drawer agrees to either have sufficient funds on deposit with the bank to meet the bill or to reimburse the bank after it has paid the bill.

To remove any possible doubt as to whether withholding tax is payable on these reimbursement type payments - even though, if the resident drawer had met the bill directly, withholding tax would have been payable on the discount element of the bill - the amendments will specify that withholding tax is payable on that part of any reimbursement amount or amounts that constitute the discount or interest component of the bill of exchange.

Similar provisions are contained in this Bill in relation to promissory notes and the amendments concerned will apply in relation to relevant payments made in respect of bills of exchange and promissory notes issued or drawn after the date the amendments proposed by this Bill become law.

The Bill also contains provisions designed to subject to withholding tax the charges paid by a resident under hire-purchase and similar agreements, such as "terms purchase" and "lease with option to purchase" arrangements. These arrangements are becoming more common as alternative means of financing the purchase of plant or equipment from overseas. The charges under these arrangements have not been classed as interest for withholding tax purposes, although, in reality, the charges are a return for the provision of finance.

The amendments proposed by this Bill will both deem the charges under these arrangements to be interest for withholding tax purposes and provide the formula for allocating a portion of the interest to each payment under the contract. To avoid complexity and enable the "interest" component of each payment to be readily determined, the formula is based broadly on the so-called Rule of 78 that is well known in commercial circles. It assumes, of course, an even payment flow over the term of the contract. However, the situation could arise where the amount of a payment is less than the amount of interest attributed to that payment. This could arise because of a fluctuating payment stream or simply a low level of payments. In such cases, the formula specified in the legislation assumes that the interest is paid first, i.e., the whole of the payment will be taken to consist of interest and any "excess" interest is to be carried forward to the following payment. The amount of interest deemed to be payable in the succeeding payment will thus be the sum of the interest attributed to that payment by the formula and any excess interest brought forward from the preceding payment.

When the extension of the interest withholding tax provisions to hire purchase and similar arrangements was announced, it was pointed out that the interest component under the contract was to be regarded as the amount by which the sum of the payments exceeds the cost price of the item of plant or equipment. For the purposes of the amendments, this cost price is to be the market value of the property at the time the agreement commences or commenced to apply to that item of property.

The amendments also cover variations to the contract as well as situations where the contract is extended for any reason.

While securities and contracts issued or entered into after 16 December 1984 are affected by the proposed amendments, withholding tax is only to be deducted from relevant payments made or liable to be made after the date the amendments come into operation.

Rebate of tax in respect of certain employment termination payments (Clause 17)

The Bill proposes amendments of section 160AA of the Income Tax Assessment Act 1936 - which applies to limit the rate of tax payable in respect of certain payments made on termination of employment - to remove an unintended effect.

The post-June 1983 component of a lump sum superannuation or kindred termination payment is subject to a maximum rate of tax of 30% and, where the taxpayer is aged 55 or more, the first $55,000 is taxed at a maximum rate of 15%. Where the tax that would otherwise be payable at normal rates exceeds the tax at these maximum rates, section 160AA applies to allow an offsetting rebate of tax. Similarly, the section limits to 30% the rate of tax payable in respect of lump sum employment termination payments made in lieu of accrued annual leave and/or long service leave entitlements.

However, because of a technical deficiency in section 160AA, the full benefit of the rebate may not be provided, in certain limited circumstances, where some part of the relevant termination payments is subject to tax at the lowest marginal rate (25% for 1985-86 and 26.67% for 1984-85). That defect is to be remedied by this Bill. The proposed amendments, to first apply in respect of income tax assessments for the 1984-85 year of income, will ensure that the appropriate rebate of tax is available to recipients of the relevant termination payments.

Gifts to Pearl Watson Foundation (Clause 7)

The Bill will also admit the Pearl Watson Foundation Limited to those provisions of the Income Tax Assessment Act 1936 that authorise income tax deductions for gifts of the value of $2 or more made to certain specified organisations. Gifts made to the Foundation after 22 May 1986 will qualify for deduction.

Income tax secrecy provisions (Clause 4)

The Bill will also amend the secrecy provisions of the Income Tax Assessment Act 1936 to allow the Commissioner of Taxation to communicate information to the Secretary to the Department of the Treasury, or to the prescribed holder of an office established under Commonwealth law, for purposes related to the supervision or regulation of superannuation funds, approved deposit funds or other similar funds.

Exemption of components of Formal Training Allowance (Clauses 5, 8, 18 and 30)

This Bill will exempt from tax certain components of the Formal Training Allowance payable to qualifying trainees from 1 January 1986 by the Commonwealth Department of Employment and Industrial Relations. The basic allowance comprises a living component, a training component and other additional components, where necessary to cover costs such as living away from home. These amounts are income on ordinary concepts and form part of the trainee's assessable income. The living component of the allowance is equivalent to the social security pension or benefit entitlement for which a trainee may otherwise have qualified, and may include payments of mother's/guardian's allowance, additional assistance for a dependent child, rent assistance or a remote area allowance. Other payments are also made to cover additional costs such as travel expenses, fees and tutorial assistance, but these do not form part of assessable income.

Social security pensioners or beneficiaries in receipt of the mother's/guardian's allowance, additional assistance for a dependent child, rent assistance or a remote area allowance are currently exempt from tax on those payments in accordance with the provisions of section 23AD of the Principal Act. The amendments proposed by the Bill will exempt from tax those components of the Formal Training Allowance corresponding to the exempt social security pension or benefit entitlements. The assessable component of the allowance will be subject to tax instalment deductions under the pay-as-you-earn system.

Documentary evidence of certain expenses (Clause 9)

Subdivision F of Division 3 (Ed Note: the reference 'Division III' appeared in the original text) of Part III of the Principal Act contains rules for the substantiation of employment-related expenses and certain car and travel expenses. These rules require, as from 1 July 1986, that receipts, invoices or similar documentary evidence be obtained by a taxpayer as proof of expenses for which deductions are claimed, and that the documentary evidence so obtained be signed and supplied by or on behalf of the person or business that supplied the relevant goods or services. The Bill proposes to remove the requirement that the receipt be signed by the supplier.

Repatriation legislation consequential amendments (Clauses 33 to 40)

On 16 October 1985, the Veterans' Entitlements Bill 1985 (the main Bill) and the Veterans' Entitlements (Transitional Provisions and Consequential Amendments) Bill 1985 (the transitional Bill) were introduced into the Parliament.

The main Bill was designed to rationalise and simplify the burgeoning body of Repatriation legislation by replacing various Repatriation statutes with one consolidated Act - the Veterans' Entitlements Act 1985. The transitional Bill was to provide arrangements for the transition from the Repatriation Act 1920 and other supplementary legislation to the main Bill.

Originally it was expected that both the main Bill and the transitional Bill would come into operation on 5 December 1985. However, the passage of the Bills through the Parliament was delayed following amendments of the main Bill in the Senate. The amended Bills have recently passed through the Parliament and received the Royal Assent. It is expected that the Acts - the Veterans' Entitlements Act 1986 and the Veterans' Entitlements (Transitional Provisions and Consequential Amendments) Act 1986 will operate on and from 22 May 1986.

As a consequence of, and in anticipation of, the changes proposed by the above-mentioned Bills, several provisions of the Income Tax Assessment Act 1936 (the 'Assessment Act') were amended by the Taxation Laws Amendment Act (No. 4) 1985 (the 'Amending Act') to ensure that references to repealed Repatriation statutes were replaced by references to the statutes, e.g., the Veterans' Entitlements Act 1985. Of course, the references to the Veterans' Entitlements Act 1985 subsequently inserted in the Assessment Act are incorrect as the correct title for that Act is the Veterans' Entitlements Act 1986.

The Bill will amend several provisions of the amending Act to ensure that the Veterans' Entitlements Act 1986 and the Veterans' Entitlements (Transitional Provisions and Consequential Amendments) Act 1986 are correctly cited in the Assessment Act. These amendments are not substantive in nature, will not affect the operation of the relevant provisions of the income tax law and will operate on and from 22 May 1986.

Amendment of the Taxation Administration Act 1953 (Clauses 31 and 32)

Amendments proposed by this Bill will add to the interpretative provisions contained in the Taxation Administration Act 1953 additional matters that are to be regarded as statements made in connection with the operation of the income tax law. These matters relate to the warranting of information shown on notices and certificates issued to holders of discounted and certain other securities affected by proposed amendments of the Assessment Act relating to the introduction of an accruals basis of assessment and the application of interest withholding tax in relation to those securities.

Under those amendments, the holder of an affected security may apply to the issuer of the security for a notice providing details of the security. The notice concerned will affect the application of the accruals basis of assessment in the case of a resident holder, and the relevant withholding tax liability for a non-resident holder. In addition, certain non-resident purchasers of affected securities may apply to the Commissioner for a certificate evidencing the purchase price paid. That certificate will affect the holder's liability for withholding tax on realisation or redemption of the security concerned.

By virtue of the proposed amendments of the Taxation Administration Act, where a holder of an affected security presents such a notice or certificate to another person, or advises another person of the contents of a notice or certificate, and where an issuer of an affected security gives a notice to the holder, the holder or issuer (as the case may be) shall be regarded as having made a statement in connection with the operation of a taxation law. Accordingly, the issuer or holder concerned will be liable to prosecution action for the making of any false or misleading statement in the notice, certificate or advice.

Amendments also proposed to the penalty provisions of the Assessment Act will ensure that, should a holder or issuer of a notice, or the holder of a certificate, make a false or misleading statement about the notice or certificate or the contents of the notice or certificate, the issuer or holder concerned will be exposed to penalty additional tax.

Income Tax (Securities and Agreements)(Withholding Tax Recoupment) Bill 1986

The second Bill, the Income Tax (Securities and Agreements)(Withholding Tax Recoupment) Bill 1986, will, in certain circumstances, formally impose a liability for interest withholding tax on a resident who buys a qualifying security from a non-resident. The circumstances are those where the Commissioner of Taxation is satisfied that the resident and the non- resident were not dealing with each other at arm's length and the amount of withholding tax that the non-resident was liable to pay in relation to the sale of the security is less than the amount which the non-resident would have been liable for if the parties were dealing with each other in an arm's length manner.

In such cases, by provisions being inspected by the Taxation Laws Amendment Bill (No. 2) 1986, the resident transferee will be liable for the extra withholding tax. This Bill formally imposes this tax - known as the avoided withholding tax amount - and declares the rate of the tax to be equal to the amount of the avoided withholding tax.

The Bill will also impose a liability for IWT on a resident where, as part of an arrangement that has as its sole or dominate purpose the avoidance of withholding tax, parties to an agreement affected by the proposed amendments to the withholding tax provisions agree to the pre-payment of interest attributable to the period of the agreement after the commencement of the amendments. This pre-payment of the interest could occur by either making additional payments to or larger payments than, those required under the contract.

Where these payments have the effect of reducing the amount of withholding tax that would otherwise have been payable on the interest component of the contract, the person making the payment will be liable for the avoided withholding tax amount. This Bill formally imposes the tax on the person making the payments, and declares the rate of tax to be equal to the amount of withholding tax sought to be avoided.

A more detailed explanation of the provisions of the Bills is contained in the following notes.

NOTES ON CLAUSES

TAXATION LAWS AMENDMENT BILL (NO. 2) 1986

PART 1 - PRELIMINARY

Clause 1: Short title

This clause provides for the amending Act to be cited as the Taxation Laws Amendment Act (No. 2) 1986.

Clause 2: Commencement

Under sub-clause 2(1), the Principal Act, except as provided in sub-clauses 2(2) and 2(3), is to come into operation on the day on which it receives the Royal Assent. But for this clause, the amending Act would, by virtue of sub-section 5(1A) of the Acts Interpretation Act 1901, come into operation on the twenty-eighth day after the date of Assent.

Subclauses 2(2) and (3) will ensure that the amendments proposed by clauses 34 to 40, which are of a technical nature arising as a consequence of the passage of legislation on 22 May 1986 that rationalised and simplified the earlier body of Repatriation laws, will be deemed to have come into operation immediately after the commencement on that date of that legislation.

PART II - AMENDMENTS OF THE INCOME TAX ASSESSMENT ACT 1936

Clause 3: Principal Act

This clause facilitates references to the Income Tax Assessment Act 1936 which, in Part II, is referred to as "the Principal Act".

Clause 4: Officers to observe secrecy

The Government has under consideration the possible establishment of a new authority with specific responsibility for the supervision and regulation of the operations of superannuation funds, approved deposit funds and similar funds. The amendment proposed by this clause will enable the Commissioner of Taxation to provide certain information concerning those funds, that is obtained under provisions of the Principal Act, to any new authority or to the Secretary to the Department of the Treasury, in the event that such an authority or the Secretary is given any relevant responsibilities.

For this purpose, the clause will insert a new paragraph (4)(hc) in section 16 (the secrecy provisions) of the Principal Act. The new paragraph will permit the communication of income tax information, such as copies of trust deeds, to the Secretary to the Department of the Treasury (sub- paragraph (i)) or to the holder of any office established under Commonwealth law who is prescribed for the purposes of paragraph (4)(hc) (sub- paragraph (ii)), where it is for purposes connected with the supervision or regulation of provident, benefit, superannuation or retirement funds (sub-paragraph (iii)), approved deposits funds within the meaning of Subdivision AA, Division 2, Part III of the Principal Act (sub-paragraph (iv)) or other similar funds (sub- paragraph (v)). In terms of sub-section 16(5) of the Principal Act, a person to whom information is communicated under new paragraph 16(4)(hc), and any person or employee under that person's control, will be subject to the same non-disclosure requirements to which taxation officers are subject.

Clause 5: Exemptions

This clause will amend section 23 of the Principal Act which specifies a range of circumstances in which income is exempt from tax.

The amendment proposed by clause 5 will exempt from income tax those parts of a Formal Training Allowance paid by the Commonwealth to a trainee that correspond to the exempt components of social security pension and benefit entitlements. Amounts paid under the trainee scheme are of an income nature and form part of the trainee's assessable income.

New sub-paragraph 23(jca)(i) proposes to exempt from tax the part of a Formal Training Allowance paid to a trainee by reason that the trainee has a dependent child within the meaning of the Social Security Act 1947 or is making regular contributions to the maintenance of a child. Similarly, new sub-paragraph 23(jca)(ii) will exempt from tax the part of the allowance paid to a trainee by reason that, within the meaning of Part IIA of the Social Security Act the trainee was physically present in, and had his or her usual place of residence in, a remote area. "Remote area" is defined in Part IIA of the Social Security Act to include only Income Tax Zone A (including Special Zone A).

By new sub-paragraph 23(jca)(iii) it is proposed to exempt the part of a Formal Training Allowance paid to a trainee by reason that the trainee or his or her spouse paid rent within the meaning of section 6 of the Social Security Act 1947.

By sub-clause 30(2) of the Bill the amendment proposed by clause 5 will apply to assessments of the 1985-86 and subsequent income years.

An amendment proposed by clause 17 of this Bill ensures that the Formal Training Allowance, to the extent it is to be included in a trainee's assessable income, will be subject to pay-as- you-earn tax instalment deductions.

Clause 6: Bad debts

This clause, which will amend section 63 of the Principal Act, is associated with the proposed introduction of the new basis of taxing each year income accruing on discounted and other deferred interest securities (clause 16).

Section 63 of the Principal Act allows a deduction for a bad debt that has been written off as such during the year of income and has been brought to account as assessable income of any year. Clause 6 will amend section 63 by inserting a new sub-section - sub- section(1A) - that will apply where the holder of a discounted or other deferred interest security will not realise the amount of any gain on the security that has been subjected to tax under the proposed new accruals basis of assessment that is to apply to such securities, e.g., because of the liquidation of the issuer, and has written-off that amount as a bad debt.

Sub-section 63(1A) will ensure, for the purposes of existing sub-section 63(1), that a holder of a security in the above situation, will be taken to have brought to account as assessable income an amount equal to the net amount, in relation to the security, included in assessable income of the taxpayer of any year or years under the accruals basis of assessment.

As explained in the notes on new sections 159GQ and 159GR that are proposed by clause 16, the net amount that will be included in assessable income of a taxpayer will be that part of the deferred yield on the particular security that was attributable to the period the taxpayer held the security, including the relevant proportion of any issue on purchase discount, less any deduction or deductions that have been allowed to the taxpayer in relation to that security on account of -

•

its purchase at a premium over its accrued value; or

•

the excess of any amounts that have been included in assessable income of the taxpayer under the accruals basis of assessment, over any payments that have actually been received by the taxpayer under that security.

Where a taxpayer subsequently receives any amount on account of a debt for which a deduction has been allowed in the circumstances described above, existing sub-section 63(3) of the Principal Act will require that amount to be included in assessable income of the year in which it is received.

Clause 7: Gifts, pensions, & c.

This clause will amend the provisions of the Principal Act that authorise income tax deductions for gifts of the value of $2 or more of money - or of certain property other than money - made to the funds, authorities and institutions that are listed in the provisions. The amendment proposed by clause 7 will insert new sub-paragraph 78(1)(a)(1xxxv) in the Principal Act to name the Pearl Watson Foundation Limited as an organisation relevant gifts to which are to qualify for deduction.

By the operation of sub-clause 30(5), gifts made to the Foundation after 22 May 1986 will qualify for deduction.

Clause 8: Rebates for residents of isolated areas

Section 79A of the Principal Act authorises a rebate of tax for individual taxpayers who are residents of certain areas that are isolated, subject to uncongenial climatic conditions or high costs of living. The amount of any rebate allowable under this section in a taxpayer's assessment is reduced by the amount of any "prescribed allowance" paid to the taxpayer in the year of income.

The term "prescribed allowance" is defined in sub-section 79A(4) of the Principal Act to mean a remote area allowance payable under either social security or repatriation legislation to certain welfare recipients living in Income Tax Zone A (including Special Zone A). The remote area allowance is exempt from tax.

The Veterans' Entitlements Bill 1986 will repeal the Repatriation Acts presently referred to in that definition, and the remote area allowance will be payable under proposed section 57 of the Veterans' Entitlements Act 1986.

Clause 8 of the Bill will omit from sub-section 79A(4) of the Principal Act the present definition of "prescribed allowance" and substitute a new definition. The new definition is to the same effect as the former definition, except in so far as it refers to remote area allowances paid under the Veterans' Entitlements Act 1986 and includes the component of a payment by the Commonwealth of a Formal Training Allowance that was paid by reason that the recipient was physically present in, or had his or her usual place of residence situated in, a remote area. By clause 5 of the Bill this component of the Formal Training Allowance will be exempt from tax.

By the operation of sub-clause 30(3) of this Bill remote area allowances paid during the 1985-86 financial year under recently repealed Repatriation legislation will be within the terms of the definition of "prescribed allowance" for the purposes of section 79A.

Clause 9: Documentary evidence

This clause will effect amendments to section 82KU of the Principal Act, which defines the meaning of documentary evidence for the purpose of substantiation rules that will apply after 30 June 1986 in relation to deductions claimed for employment-related expenses and certain car and travel expenses.

The amendments will remove from the definition the requirement that receipts, invoices or similar documentary evidence be signed by or on behalf of the person or business who supplies the relevant goods or services.

By sub-clause 30(6), the amendments will apply to relevant expenses incurred during a year of income commencing on or after 1 July 1986.

Clause 10: Interpretation

This clause, which is also associated with the proposed introduction by clause 16, of the new accruals basis of taxing gains on discounted and other deferred interest securities, will amend section 103 of Division 7 of Part III of the Principal Act.

The purpose of Division 7 is to require a private company to distribute a certain proportion of its after-tax income - called "the distributable amount" which is, broadly, the taxable income less income tax payable on that income and the amount - called "the retention allowance" - that a company may, in accordance with Division 7 retain out of that income depending on the character of that income. Where a company does not make a sufficient distribution of its distributable income, the amount by which dividends paid fall short of the required distribution is subject to tax under Division 7 at the rate of 50 per cent of the undistributed amount.

Clause 10 will insert a new sub-section - sub-section (1A) - in section 143 to modify the definition of "the distributable income" to exclude from the calculation of that amount, any amount included in the company's taxable income by virtue of the new basis of taxing income accruing on certain securities under proposed Division 16E (see notes on clause 16), but not the amount of any income tax payable on such accrued income.

The purpose of this modification is to ensure that the accruals basis of assessment that is to apply in relation to net assessable gain on discounted or other deferred interest securities under new Division 16E, will apply, in the case of a private company, in relation to the determination of the primary tax payable on its taxable income, but will not otherwise effect the determination of its undistributed profits tax liability under Division 7.

Clauses 11-16: Changes to the liability for interest withholding tax and the timing of the taxation of income under discounted and other deferred interest securities and certain financial arrangements

Introductory note

Clauses 11-15 of this Bill will amend the interest withholding tax provisions of the Principal Act in relation to the use of various financial securities and instruments, and certain methods of financing the purchase of plant and equipment overseas e.g., hire-purchase or similar financing arrangements, such as leases. The securities concerned are those of the discounted and other deferred interest kind, including capital-indexed securities. The amendments will also make clear the application of the law in relation to certain payments made in respect of bank accepted bills.

Clause 16 will insert a new Division - Division 16E - in the Principal Act that will tax, each year as it accrues, part of the overall yield on the securities referred to above.

In general terms, the amendments to the interest withholding tax provisions will apply to payments arising from or under -

•

the sale, by a non-resident to a resident, of a discounted or other deferred interest security issued after 16 December 1984;

•

a hire-purchase agreement or finance lease arrangement entered into with a non-resident after 16 December 1984; and

•

arrangements to indemnify or reimburse an offshore acceptor of a bill of exchange drawn or accepted after the proposed amendments become law, or an issuer of a promissory note issued after that date.

Discounted and other deferred interest securities

Interest derived by a non-resident (whether directly or indirectly) is subject to withholding tax under the present law, subject to certain business outgoings tests. The definition of "interest" for this purpose is contained in section 128A of the Principal Act and includes amounts in the nature of interest. Where a non-resident holds a discounted or other deferred interest security until maturity, he or she would be subject to withholding tax on that part of the redemption payment attributable to the discount, or interest, under the security. However, under the present law, should the non-resident sell that security to a resident prior to maturity, no part of any profit derived by the non-resident is subject to withholding tax. As such sales are usually arranged so as to give the profit an ex-Australian source, the non-resident is also unable to be taxed on the profit by assessment processes.

The amendments contained in this Bill will deem part of the consideration payable on the transfer by a non-resident of a qualifying security to a resident of Australia to be income that consists of interest, thereby exposing such amounts to the withholding tax provisions of the income tax law.

The amount to be subject to withholding tax is to be calculated basically by reference to the difference between the security's issue price and the sale or transfer price. However, the price paid by a non-resident for a security may be substituted for its issue price where the non-resident purchased the security directly from a resident. In such instances, the non-resident will be able to obtain a certificate from the Commissioner of Taxation setting out details of the purchase price paid by the non-resident. By presenting that certificate to the resident buyer of the security, or to the issuer of the security in a case where it is to be redeemed, the amount of the transfer or redemption payment to be subject to interest withholding tax will be the excess of the transfer or redemption price over the purchase price, as shown on the certificate. A non-resident may apply to the Commissioner for this certificate at any time after he or she buys the security, and will be able to obtain a refund of excess withholding tax deducted in certain cases.

As an anti-avoidance measure, a resident who purchases an affected security from a non-resident in circumstances where the Commissioner of Taxation is satisfied that the parties were not dealing with each other at arm's length, and that the resulting withholding tax liability is less than the withholding tax that would have been payable under an arm's length dealing will be liable to pay tax equivalent to the withholding tax avoided. That liability is imposed by the proposed Income Tax (Securities and Agreements) (Withholding Tax Recoupment) Bill 1986.

Although these measures apply to relevant securities issued after 16 December 1984, they will not, subject to other appropriate anti-avoidance measures, affect transactions in those securities before the proposed amendments become law.

Hire purchase and similar arrangements

The provisions designed to subject to withholding tax changes paid by a resident under hire-purchase and similar agreements, such as "terms purchase" and "lease with option to purchase" arrangements will deem such charges to be interest for withholding tax purposes. A formula - based on the so-called Rule of 78 - is provided for allocating a portion of the interest to each payment under the relevant contract. In the event that the amount of any payment is insufficient to pay the interest allocated to that payment by the formula, the legislation assumes that the interest is paid first i.e. the whole of the payment will be regarded as interest and the interest allocated to that payment but unpaid will be carried forward to the following payment. Anti-avoidance provisions have been included to prevent the "loading" of payments with the aim of circumventing the allocation method contained in the legislation.

For the purposes of these amendments, the interest component under these contracts is to be regarded as the amount by which the sum of the payments exceeds the market value of the item of plant or equipment that is the subject of the contract at the time the agreement commences or commenced to apply to that item of property.

The amendments also cover vacations to an affected contract as well as situations where a contract is extended for any reason.

While contracts entered into after 16 December 1984 are affected by the amendments, withholding tax is only to be payable in respect of payments made or liable to be made under the contract after the date the amendments come into effect.

Bills of exchange and promissory notes

The changes proposed by this Bill as they affect bank accepted bills of exchange are designed to ensure that offshore acceptors of the bills are exposed to liability for withholding tax in respect of the bill discount where, under an indemnification agreement or otherwise, a resident reimburses or indemnifies the non-resident acceptor for the amount of the face value of the bill at its maturity.

Similar provisions are contained in this Bill in relation to promissory notes. The amendments concerned will apply in relation to relevant payments made in respect of bills of exchange and promissory notes issued or drawn after the date the amendments proposed by this Bill become law.

Clauses 19-28, 31 and 32, and 41-43 of this Bill deal with consequential amendments to the income tax law from these changes to the withholding tax provisions.

Accruals basis of assessment for discounted and other deferred interest securities

As mentioned earlier, clause 16 of the Bill will insert new Division 16E in Part III of the Principal Act to alter - from a realisations to an accruals method - the basis of taxing the yield on certain discounted or deferred interest securities, including capital indexed securities, issued after 16 December 1984 - called a qualifying security. This treatment will overcome the tax deferral advantages associated with the use of such securities, and will tax the yield on those securities on a basis broadly comparable to the way in which the income derived from traditional interest-bearing securities is taxed.

The actual treatment that will apply in relation to a qualifying security under new Division 16E will depend upon whether it is a fixed return security, or a variable return security, within the respective meanings of those expressions for the purposes of the Division. Very broadly, a fixed return security will be one where the yield to redemption can be determined at the time of issue, whereas a variable return security is a security where the yield is not so determinable at the time of issue.

In general terms, when a resident taxpayer acquires a fixed return security (either on issue or by transfer), the taxpayer will be required to calculate the security's yield to redemption. This yield is the compound interest rate per accrual period at which the sum of the present values of all payments to be made under the security equal its issue or transfer price. By using the compound rate to gross-up the value of the security for each such period, the amount to be included in the holder's assessable income as the income accruing under the security for any year can be calculated.

For a variable return security, the provisions of Division 16E require that account be taken of the actual terms of the security when determining the income accruing under the security for a year of income. If the terms of the security do not enable the amount of income to be accurately determined for any year, the Commissioner of Taxation is authorised to determine an amount to be included in the holder's assessable income for that year.

These methods of assessing the accruing income on qualifying securities will also form the general basis for determining the annual deductions allowable to the issuer of such securities in respect of the discount or deferred benefits payable under them. The allowance of deductions to an issuer on an annual accruals basis will not apply, however, in relation to issues of bearer securities, or to offshore issues of qualifying securities. Relevant deductions will continue to be allowed in these cases only in the year in which the discount or deferred interest is paid.

There are two occasions where the income accruing on a qualifying security will not be taxed on the accruals basis. These are where the security forms part of the trading stock of the taxpayer, or when the security is held by a non-resident to whom the withholding tax provisions described earlier will apply. Securities to which section 26C of the Principal Act apply will also be excluded from the accruals basis of assessment.

Adjusting provisions have been included to deal with circumstances where the realised gain from holding a qualifying security does not equal the sum of the amounts included in the taxpayer's income by the accruals method. Other provisions will deal with variable return securities that have been issued at a discount or have been acquired otherwise than on issue at a discount or premium. The Division also includes provisions to take account of variations in the terms of a security after issue so that, if the security was issued on those varied terms on the day the variations took effect, it will be a qualifying security subject to Division 16E from that day.

Finally, the Division contains provisions to cover "stripped securities", such as DINGO bonds and similar securities. These amendments deal with two kinds of arrangements involving those securities - where the interest coupons are physically separated from the principal entitlement and each is sold separately, or where the holder of what may be described as the "underlying security" creates and issues new securities to match the timing and face value of the whole or a part of the interest entitlements or the principal entitlement of the underlying security.

These amendments will do two things. The first is to ensure that where a person strips an interest coupon or coupons from the principal entitlement and markets either or both the coupons or the principal entitlement separately after 16 December 1984, the stripped components are to be regarded as separate securities issued after that date. Secondly, the amendments will require issuers of stripped securities or new securities to allocate the cost of the underlying security across the range of the stripped or new securities for determining relevant deductions, and not just to the entitlement to the principal on the underlying security. This will prevent issuers of such securities from creating artificial losses where there are unsold interest coupons on hand at the end of a year of income.

Notes on the individual provisions of these clauses follow.

Clause 11: Interpretation

This clause will amend section 128A of the Principal Act by inserting a new sub-section - sub-section (1A). Section 128A contains the definitions and interpretative provisions of Division 11A of Part III of the Principal Act, which establishes a non- resident's liability for withholding tax. The procedures for collecting the tax are contained in Division 4 of Part VI of the Principal Act, and in the Income Tax Regulations.

New sub-section 128A(1A) is also an interpretative measure, the purpose of which is to bring within the scope of the withholding tax provisions, as proposed to be expanded in their operation by the amendments contained in clauses 12-15 in relation to discounted and other deferred interest securities, terms used in those amendments which are to be defined for purposes of the accruals basis of assessment for residents in the new Division 16E (proposed by clause 16).

Paragraph (1A)(a) gives meaning to the phrase "reduced issue price" in relation to a security that has been partially redeemed. The term "partial redemption" is defined in proposed new section 159GP in Division 16E (see notes on clause 16) to be a repayment of a part, other than the final balance, of the issue price of a security. Thus, the term "reduced issue price" will, for withholding tax purposes mean the original issue price of the security as reduced by any partial redemption payments. This definition will be relevant to the determination of the liability of a holder of a qualifying security in circumstances explained in the notes below on clause 12.

Paragraph (1A)(b) is the drafting measure that insets in the withholding tax provisions contained in Division 11A, as proposed to be extended by clauses 12-15 of this Bill, the definitions in new Division 16E proposed by clause 16 to the extent such definitions are common to the securities affected by both measures. These definitions are explained in the notes on that clause (in relation to new section 159GP) but, insofar as they are relevant to the withholding tax provisions, are, for ease of reference, repeated below -

"fixed return security" is basically any qualifying security (see later definition) under which the amount payable upon redemption may be readily calculated at the time the security is issued. The definition of the term specifies three characteristics for determining the amount or amounts payable under the security. These are -

(a)

that the yield consists of a specified amount or amounts, e.g. a zero-coupon discounted security;

(b)

that the amount or amounts payable are calculated by reference to an interest, indexation or other rate that will not vary over the term of the security, e.g. a capital-indexed security that is to be indexed by a constant percentage over its term; or

(c)

some combination of the above two features.

The yield on a fixed return security is to be assessed to a taxpayer under proposed section 159GQ (see later notes);

"holder", in relation to a security at a particular time, is the person who would be entitled to receive the amount or amounts payable under the security if those amounts were to be paid at the time. The term is used extensively in the assessability provisions of the Division as the means of identifying the taxpayer who is to be taxed on the accruing income on a security;

"issue" required a particular definition because the definition of "security" in this sub-section refers not only to items like negotiable instruments but also to contracts. As such, the term is defined by reference to the creation of the liability under the security, rather than simply the selling of a negotiable instrument from one person to another. The definition excludes bills of exchange because of the particular way such instruments come into existence and the fact that bills may be dealt with in several ways, e.g., discounting after acceptance.

"issue price", in relation to a security, is defined to refer to the consideration, if any, for the issue of the security. Given the different items covered by the term "security" there may be no consideration payable where a contract is involved or, where a negotiable instrument is issued, the security may have a specific issue price. In any event, it should be remembered that the Commissioner of Taxation has the power to adjust any specified issue price where the Commissioner considers that the parties involved were not dealing with each other in an arm's length manner - proposed sub-section 159GP(2);

"qualifying security" is a term that is central to both the operation of this Division and the amendments to the interest withholding tax provisions of the income tax law that are contained elsewhere in this Bill. A qualifying security is one that has the five characteristics specified in the definition. These are -

(a)

the security must have been issued (as defined) after 16 December 1984. This is the date the Government announced that the accruals method was to take effect;

(b)

the security is not a prescribed security within the meaning of section 26C. Briefly, section 26C applies to Commonwealth securities that doe not bear interest, as in a coupon note. The section was inserted in the Principal Act in 1959 to remove any doubt that the discount element or Commonwealth zero-coupon securities was an amount in the nature of interest and, therefore, assessable income. It is not expected that this exclusion will affect many securities that would otherwise have been regarded as qualifying securities;

(c)

the term of the security, as anticipated at the time the security is issued, will exceed, or is likely to exceed, one year. Provisions have been included later in the Division to overcome the arrangement whereby a security is "issued" for a period of one year or less but, through the exercise of an option or right, the term is subsequently extended;

(d)

the security must have an "eligible return", which is defined in proposed sub-section 159GP(3). Briefly, a security will be taken to have an "eligible return" if the sum of the payments (other than payments of periodic interest) to be made under the security will exceed its issue price; and

(e)

where it is possible to calculate the precise amount of the eligible return at the time the security is issued, the amount of the eligible return must exceed 1.5% of the result obtained by multiplying the sum of the payments (other than periodic interest) by the term, in years and any fraction of a year, of the security. It is expected that this calculation will be used only for fixed return securities (as defined);

"redemption" refers to the discharging of all liability under a security to return the issue price of the security, whether that discharging occurs at the same time as the payment of the accrued income or the security. This definition, along with the definition of "partial redemption", is necessary so as to distinguish the components of any payment made under a security for the purposes of the later provisions that deal with the assessability of payments made under a qualifying security;

"security" has been defined very widely, and includes items that may not be usually regarded as securities, e.g., contracts. The term has been drafted in this manner so as to encompass as many financial transactions as possible where there may be a deferral in the payment of income. Another reason for the drafting of the term in this manner is to avoid the requirement to refer, in the operative provisions of the Division, to all the arrangements designed to be covered by the Division each time a reference could be more easily made to a "security".

Paragraph (a) of the definition refers to items that are usually taken to be a security. These are stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other form of a security. Paragraph (b) refers to deposits with financial institutions. It is not uncommon for banks, etc., to offer "deferred interest accounts" or "deferred interest investments" under which the interest is not payable until the day the investment matures. Paragraph (c) brings loans with the scope of a security. For example, it is not uncommon for development loans to have no payments of either principal or interest for the early part of the development project. By paragraph (c) these kinds of arrangements will fall within the definition of a security. Finally, paragraph (d) ensures that other forms of contractual arrangements whereby one person is required to pay an amount or amounts to another come within the term "security". It is equally possible for a deferral of income to occur under contractual arrangements as it is under "ordinary" securities;

"transfer" has been defined to include not only the actual transfer of a security. It will also mean sell, assign or dispose of in any way the security itself or any right under a security to receive a payment. This latter aspect of the definition is important when considering the disposal of stripped securities or any dealing in rights under a contract. The only limit on the definition is a partial redemption or redemption, which, though technically are a disposal of the security or rights under a security, are not to be regarded as a transfer for the purposes of the Division;

"transfer price" is the consideration (if any) payable in respect of a transfer of a qualifying security. It should be noted that by virtue of sub-section 159GP(2), the Commissioner of Taxation has the power to specify, for the purposes of this Division, another figure for the transfer where the Commissioner considers that the parties to the transfer were not dealing with each other at arm's length and that it is appropriate that the transfer price should be altered;

"variable return security" is any qualifying security that is not a fixed return security. By defining a variable return security in this way, there can be no argument that the security is neither a fixed nor variable return security and not covered by the new Division;

As explained in the notes on clause 16, new section 159GV will bring within the scope of the accruals method of assessment to be introduced by new Division 16E, a security that would not otherwise be subject to these measures, where the terms of the security are so varied that, if it had been issued on those terms at the time of variation, it would be a qualifying security within the meaning of new Division 16E. Section 159GZ will, broadly, ensure that where the principal and interest components of any security are "stripped" and sold at a discount after 16 December 1984, the various components will be subject to new Division 16E, regardless of the date of issue of the security that was or is stripped.

By paragraph (1A)(c), securities that are brought within the scope of the proposed accruals method by the operation of proposed section 159GV or 159GZ, will also be brought within the scope of the new withholding tax provisions.

Clause 12: Interest withholding tax

Clause 12 will insert 4 new sections - sections 128AA, 128AB, 128AC and 128AD - in Division 11A of Part III of the Principal Act. Briefly, new section 128AA will expose to withholding tax the proceeds derived by a non-resident from the sale of a qualifying security to a resident to the extent that the sale price exceeds the issue price of the security. New section 128AB provides for the issue of a certificate by the Commissioner of Taxation where a non-resident is able to show that the security was purchased direct from a resident at a price above its issue price. The certificate will authorise the substitution of that purchase price paid for the security's issue price when calculating the amount to be subject to withholding tax as a result of the sale. New section 128AC will attribute, for interest withholding tax purposes, an interest element to each payment made by a resident to a non-resident under a hire-purchase agreement or similar finance lease arrangement. Finally, by proposed new section 128AD, withholding tax will be payable on that part of a reimbursement or indemnification payment made by a resident to a non-resident acceptor of a bill of exchange or to the issuer of a promissory note that represents the discount or interest component of such a payment.

Section 128AA : Deemed interest in respect of transfers of certain securities

Under existing income tax law, if a non-resident transfers a discounted or other deferred interest security to a resident prior to the redemption of the security, no part of any gain derived by the non-resident can be regarded as interest or an amount in the nature of interest. Accordingly no withholding tax is payable in relation to such gains. This is in direct contrast to the situation where the non-resident holds the security until maturity or earlier redemption. In this latter situation, the non-resident is liable to withholding tax on the interest proportion of the redemption payment.

To address that situation, sub-section 128AA(1) specifies that in any case where -

•

a non-resident transfers a security to a resident (paragraph (a)); and

•

the transfer price exceeds the issue price on the reduced issue price of the security (paragraph (b)),

the amount of that excess is deemed to be income that consists of interest. By this means, the existing provisions of section 128B of the Principal Act will operate to make liable to withholding tax the amount of that excess.

Sub-section 128AA(2) enables the resident purchaser of a security from a non-resident in circumstances where sub-section 128AA(1) applies, to ignore the possible application of new sub-section 159GP(2) of Division 16E to the transfer and thus to deduct withholding tax on the basis of the relevant issue and transfer prices. As explained in the notes on clause 16, new sub-section 159GP(2) authorises the Commissioner of Taxation in certain circumstances to adjust the issue transfer price of a qualifying security subject to the new accruals method of assessment. As such an adjustment would generally not take place until after the transaction has been completed, sub-section 128AA(2) allows the purchaser to rely on the actual issue price, or reduced issue price, as the case requires, and transfer price for the purposes of determining the withholding tax liability of the non-resident. Other provisions in this Bill provide for the recovery of any avoided withholding tax from the resident transferee where, after the transfer, the Commissioner adjusts the security's transfer or issue price or both.

Section 128AB : Certificates relating to issue price of certain securities

Section 128AB allows for the portion of the transfer price of a qualifying security otherwise subject to withholding tax under section 128AA to be reduced in a situation where the non-resident transferor of the security purchased the security from a resident after its issue and at a price above its issue price. Where the necessary tests are met, the withholding tax liability will be calculated, on the basis of the operation of section 128AA, as if the purchase price paid by the non- resident for the security was its issue price. To obtain the benefit of this concession, the non-resident must obtain a certificate from the Commissioner that, amongst other things, identifies the security concerned and shows the price the non-resident paid for it. On presentation of this certificate to a resident purchaser, or to a resident issuer where the security is to be redeemed or partially redeemed, the resident purchaser or issuer is required to substitute the price paid for the security by the non-resident for its issue price and to calculate the withholding tax liability accordingly.

Sub-section 128AB(1) allows a transferee of a qualifying security to apply to the Commissioner for a certificate under this section at any time after acquisition of the security, including a time after its disposal, provided two conditions are satisfied. These conditions are that -

•

the security is a qualifying security issued after 16 December 1984 that is or was acquired at any time after that date by transfer (that is, by purchase or other means) (paragraph (a)); and

•

the security was either -

•.

transferred to the non-resident by a resident (sub- paragraph (b)(i)); or

•.

the transferor was a non-resident but the transfer price was derived from a source (e.g., by way of a sale) in Australia (sub-paragraph (b)(ii)).

To avoid a situation where the discount or deferred interest component of a qualifying security might otherwise be subject to tax on the accruals basis of assessment in the hands of a resident holder under new Division 16E until sold to a non-resident, as well as being subject to withholding tax on the sale back of the security to a resident or on redemption, these two conditions effectively limit the availability of the certificate to holders who have purchased qualifying securities from persons who would be subject to the accruals method of assessment while they held the security.

Where there is insufficient time between the purchase and sale or redemption of a qualifying security by a non- resident for that person to obtain the certificate, a certificate may be sought after the sale or redemption has taken place. Where a certificate is obtained in such circumstances, the non-resident may then apply to the Commissioner for a refund of the withholding tax deducted on the sale or redemption in excess of the amount that would have been the withholding tax if the certificate had been obtained before that sale or redemption.

Sub-section 128AB(2) requires any application under sub-section (1) to be in the form required by the Commissioner. To enable holders to comply with this requirement, the sub-section directs the Commissioner to have that form notified in the Gazette, so that interested parties have definitive notice of the information requirements of the Commissioner for this purpose.

By sub-section 128AB(3), the Commissioner is required to issue a certificate under this section where he is satisfied that the security has been transferred under the circumstances specified in sub- section 128AB(1) and that the details shown in the application relating to the date of transfer and the transfer price are correct. Where he is not so satisfied, the Commissioner may refuse to issue the certificate but, as explained later in these notes, the applicant is entitled to seek a review of such a refund. The sub- section also specifies the information that is to be included on the certificate.

By paragraph (3)(a), the certificate is to be expressed to have been issued under section 128AB. This requirement will ensure that the certificate and its purpose is not confused with other certificates and notices that are issued under other provisions of the Principal Act. Also, a certificate issued under this section will have no other use for the purposes of the income tax law.

Paragraph (3)(b) provides for the certificate to identify the security concerned and will enable a transferee or issuer who is presented with one of these certificates to ascertain whether the certificate was issued in respect of the security that is to be transferred or redeemed.

By paragraph (3)(c) the certificate will specify the date of the transfer of the security to the non-resident and will evidence the Commissioner's satisfaction that the security was transferred on that date in circumstances giving rise to the modified application of section 128AA as described earlier in these notes.

Paragraph (3)(d) requires the Commissioner to specify in the certificate either the actual consideration paid by the non-resident transferee for the security, or the transfer price that, by virtue of new sub-section 159GP(2), the Commissioner determines to be the transfer price. As explained in more detail in the notes on clause 16, sub-section 159GP(2) authorises the Commissioner to adjust the transfer price in the case of any transfer of a qualifying security where he considers that the parties to the transaction were not dealing with each other at arm's length, and that the sub-section should be applied in relation to the transfer to determine an appropriate price for the transfer of the security (this sub-section will be dealt with in more detail later in these notes). By operation of this paragraph, in combination with new sub-section 159GP(2) the Commissioner may specify one of 3 prices -

(i)

the actual transfer price;

(ii)

the arm's length price in relation to the transfer, should that price be able to be ascertained; or

(iii)

in the event an arm's length price cannot be ascertained, the price the Commissioner determines to be the transfer price.

Paragraph (3)(e) which requires that the certificate specify the name of the applicant, as the transferee, is a safeguarding measure aimed at preventing persons other than the person to whom the certificate is issued from gaining any benefit associated with it. Any certificate issued under this section can only be validly used by the person to whom it was issued.

Sub-section 128AB(4) is the operative sub-section that will, where a certificate has been issued in accordance with this section, operate to reduce the excess otherwise determined under section 128AA as the amount subject to withholding tax.

By paragraph (a), the transfer price specified in the certificate will be substituted for the issue price of the security in the event that the security is subsequently sold by the transferee to whom the certificate was issued. Because this concession applies only to that transferee, paragraph (a) is expressed to apply only to the first transfer of the security after the issue of the certificate. By sub- paragraph (a)(i) the transfer price specified in the certificate will be substituted for the issue price of the security so that, by the application of section 128AA, the withholding tax liability of the non-resident will be calculated by reference to the excess, if any, of the transfer price to the resident over the amount of the consideration paid by the non-resident for the security.

As the price specified in the certificate is to be taken to be the issue price of the security for the purposes of the first subsequent transfer, any partial redemptions that may have occurred before the issue of the certificate will be ignored. Sub- paragraph (a)(ii) is to this effect, and reflects the fact that the transfer price indicated in the certificate will already have been adjusted on account of any partial redemption that occurred before the applicant for the certificate became the holder of the relevant security. However, any partial redemptions of the security after the date specified in the certificate as the transfer date will be taken into account for determining the reduced issue price of the security at the time it is transferred by the non-resident to a resident - see earlier notes on sub- section 128A(1A).

With one important difference paragraph (4)(b) mirrors paragraph (a) in its operation, except that it deals with situations where the security, instead of being sold or otherwise transferred by the non-resident prior to redemption is redeemed or partially redeemed. As mentioned earlier in these notes, where a security is redeemed in the hands of a non-resident, the non-resident is liable, under the existing withholding tax provisions, for tax on that part of the redemption payment that is interest or an amount in the nature of interest that is, on the part of the redemption payment that exceeds the issue price of the security.

Reflecting that situation, paragraph (b) operates to determine an amount of "interest" subject to withholding tax for the purposes of the existing provisions of the Principal Act, rather than an amount that is to be so subject by the application of those provisions as they are being extended by section 128AA explained earlier in these notes. Subject to that difference in purpose, however, paragraph (b), also specifies that the transfer price stated in a certificate issued in relation to a qualifying security is to be taken as the issue price of the security for determining the withholding tax liability of the non-resident an redemption or partial redemption of the security, and sub-paragraphs (b)(i) and (ii) have a corresponding operation to sub-paragraphs (a)(i) and (ii) explained above.

Sub-section 128AB(5) imposes on the Commissioner the usual requirement to notify an applicant for a certificate under this section of a decision not to issue the certificate. Such a refusal would be based on the fact that the Commissioner is not satisfied, in terms of sub-section (3), as to the accuracy of the information contained in the application. By virtue of existing section 128P of the Principal Act, as proposed to be amended by clause 15 of the Bill (see notes on that clause), an applicant who has been refused a certificate may seek a review of the decision through the channels provided in the Principal Act.

Section 128AC : Deemed interest in respect of hire-purchase and certain other agreements

Section 128AC, like section 128AA, operates to extend the scope of the existing withholding tax provisions of the Principal Act. It will subject to withholding tax the charges paid by a resident under a hire-purchase or similar contract, such as a "term purchase" or "lease with option to purchase" agreement.

The effect of section 128AC is two-fold. First, it deems the charges under these kinds of agreements to be income that consists of interest thereby imposing those charges when paid to a non-resident to withholding tax under existing provisions of the Principal Act. Secondly, specifies the formula that is to be used to determine the amount of the charges, to be subject to withholding tax, that are included in each payment under the contract. On that purpose, the total charges treated as the interest component of the contract is the excess of the payments due under the contract, over the market value of the item of property at the time the relevant contract commenced or commences in relation to that item of property. The formula allocating the interest is based on the so-called "rule of 78". While this formula assumes an even payment flow over the term of a contract, provision is made for cases where there is a fluctuating payment schedule, or where a payment is less than the amount of interest attributed to that payment. In such cases, the interest is deemed to have been paid first, and any excess interest is to be carried forward to the next payment. Provision also exists to cater for any variations in the term of an agreement subject to the new section.

While section 128AC will apply to contracts entered into after 16 December 1984, as with the other amendments being made to the withholding tax provisions, withholding tax is only to be payable in relation to payments made or liable to be made after the date the section enters into force.

Sub-section 128AC(1) contains the definitions of the terms which are used throughout the section -

"agreement" is given a broad meaning common to other provisions of the Principal Act to include any agreement, arrangement or understanding. It need not be a formal "agreement" legally enforceable, nor, indeed, even intended to be legally enforceable under the law;

"attributable agreement payment" is the term that is central to the operation of this section. It is defined to be so much of any payment made or liable to be made under a relevant agreement (also a defined term used to identify the agreements, or the parts of an agreement, to which the section applies - see below) that constitutes the consideration for the use, sale or disposal of the relevant agreement property, also a defined term discussed below. The combined effect of these terms, together with new sub-section 128AC(2), enable payments under an agreement relating to several items of plant and equipment to be apportioned over each such item and treated as if each portion was a separate agreement. As explained below, it is basically the formula interest component of each attributable agreement payment that is to be subject to withholding tax;

"carry forward interest" is a term used to identify the amount of interest (if any) allocated to an attributable agreement payment that exceeds the amount of that payment. The interest allocated is defined as the "notional interest" (see later notes) which is the sum of the basic "formula interest" and any such interest allocated to an earlier payment that has not in fact been paid. In cases where the notional interest exceeds the amount of the payment, that excess is to be carried forward to the next succeeding payment and becomes part of the notional interest of that payment;

"eligible value" is defined as the market value of the relevant agreement property (as also defined) at the time the relevant agreement commences where the property is the subject of the agreement from the outset, or the market value of the property at the time the agreement commences to apply in relation to that property. This latter application is relevant for a situation where further property is brought within the terms of an existing agreement that may be varied for that purpose. It is the excess of the total attributable agreement payments over the market value that is taken to be the interest component of the agreement in relation to a particular item of property - see later notes on the definition of "total interest";

"formula interest" is that part of the "notional interest" (see later notes) of each attributable agreement payment that represents the portion of the total interest under the agreement that is allocated to the payment by the formula contained in the section. The formula is based on the so-called Rule of 78, that is familiar in financial circles. The formula is specified in the section as -

(2AC)/(B(B+1))


, where -

A

is the total interest payable under the agreement;

B

is the total number of the payments to be made under the agreement in relation to the relevant item of property; and

C

is the number of payments remaining under the agreement, including the current payments.

By way of a simple example, assume that the agreement will run for 10 years and payments are to be made at 1/2 yearly intervals - 20 payments in all. Further, assume that the total interest under the contract is $5,000. The "interest" attributable to payment number 12 has to be determined.

In the example, there are 9 payments (including the twelfth payment) remaining for the purposes of the formula. The interest attributable to payment 12 would be :

(2 * 5000 * 9)/(20(20 + 1))


= (90,000)/(420)


= $214.29


This amount would then be added to any "carry forward interest", (a defined term - see earlier notes) brought forward from the previous payment to ascertain the amount subject to withholding tax when payment 12 is made.

"notional interest" is the amount of interest that, for the purposes of section 128AC, is deemed to be contained in an attributable agreement payment (see earlier notes on this term). It is the sum of any "formula interest" and any "carry forward interest". The "notional interest" of each payment under an agreement is to be subject to withholding tax by the operation of sub- section 128AC(5) (see later notes on that sub-section);

"relevant agreement" is the term used throughout the section to refer to agreements that are to be covered by the proposed amendments. A relevant agreement is any agreement entered into after 16 December 1984 (the date the measures are effective from) that is either a hire-purchase agreement (paragraph (a)) or a lease or other agreement under which a person is entitled to use property that is owned by another person (paragraph (b)). Before being subject to the section, an agreement that is not a hire- purchase agreement must contain one of two characteristics.

By sub-paragraph (b)(i), the lessee or a person other than the lessee using the property must be entitled to purchase or require the transfer of the item of property covered by the agreement when the agreement expires or is terminated. Alternatively, by sub-paragraph (b)(ii), the agreement must be for all of the effective life of the property, or a substantial part thereof. What constitutes the effective life of the property, or a substantial part of that effective life, will be a question of fact in each case;

The purpose of paragraph (b) is to identify agreements that are similar to hire-purchase agreements in that the lessee can ultimately acquire the property or have the use of it for a considerable part of its effective life.

"relevant agreement property" is the term used to refer to an item of property that is the subject of a particular relevant agreement (a defined term). The term is defined by reference to the type of agreement that is involved. Where a hire-purchase agreement is the relevant agreement", the relevant agreement property is defined by paragraph (a) of the definition of that term to be the property that is the subject of the hire-purchase agreement. If a lease or other agreement is involved, paragraph (b) identifies the property by reference to the relevant paragraph of the definition of "relevant agreement". Thus, where the agreement provides that, on the termination or expiration of the agreement, a particular item of property is to be dealt with as the leasee or person using the property so directs, that item of property is the relevant agreement property. Similarly, if the lease or other agreement is for all, or substantially all, of the effective life of an item of property, that item is the relevant agreement property for the purposes of this section.

"total interest" under an agreement that is subject to proposed section 128AC is defined to be the excess of the total of all attributable agreement payments (see earlier notes on that defined term) under the agreement over the eligible value (also a defined term) of the property that is the subject of the agreement. The amount of this total interest is used in the formula that allocates a proportion of the interest to each payment under the agreement - see notes on definition of "formula interest".

Sub-section 128AC(2) is an interpretative provision that deals with the case where the one agreement relates to the use of 2 or more items of property. In such cases, each item of property is to be regarded as being the subject of a separate agreement, having such of the terms of the agreement as are relevant to the lease or use of the particular item of property. The sub-section removes the need to "carve-up" the one agreement to try to determine which parts of that agreement pertain to each item of property. By notionally creating separate agreements for each item of property, the apportionment of the lease payment across the various items of property is simplified.

Where the terms of a relevant agreement are altered, or the liability to make payments under a relevant agreement is changed, sub-section 128AC(3) dictates that the existing agreement is to be regarded as having been terminated at the time the alteration or change takes effect (paragraph (a)) and a new agreement is deemed to have commenced at that time. By paragraph (b), the new agreement is to be treated as having the same terms as the agreement it replaces, but including the changes that triggered the operation of the sub-section.

Sub-section 128AC(4) deals with the effect of the exercise of any right or option to vary the terms of a relevant agreement or extend the period of the agreement. The sub-section specifies that the exercise of any such right or option shall be regarded as a variation of the terms of the agreement and so, by virtue of the operation of sub-section 128AC(3), will result in the deemed termination of the existing agreement and its replacement with a new agreement.

Sub-section 128AC(5) is the operative sub-section, and has the effect of attributing to each attributable agreement payment the notional interest, as defined, in relation to that payment. The sub-section also specifies that the notional interest portion of the payment is to be deemed, for the purposes of the withholding tax provisions, as being income that consists of interest. The sub-section does not impose any liability to interest withholding tax on the notional interest in the payment - that follows from the other operative provisions of Division 11A of Part III of the Assessment Act, in particular, section 128B.

As outlined earlier in these notes, the total interest under a relevant agreement is to be allocated to each attributable agreement payment by means of a formula based on the "rule of 78". This allocation method could give rise to the avoidance of withholding tax as the formula does not take into account the size of any particular payment. By making large payments at the start of an agreement and smaller payments thereafter, it may turn out that the amount of the remaining payments is insufficient to cover the interest allocated to the payment by the formula. Sub-section 128AC(6) deals with such payment arrangements. The sub-section compares, at the commencement of the relevant agreement, the amount of total interest by virtue of the agreement with the sum of the amounts that would be deemed to be interest by virtue of sub-section 128AC(5). If there is any excess of total interest over "deemed interest", that excess is to be added to the notional interest for the first payment under the arrangement. In this way, the liability for paying withholding tax, if any, in relation to the interest remains with the non- resident and the whole of the total interest is subjected to the new withholding tax measures.

Sub-section 128AC(7) is a drafting measure designed to remove any doubt about how much of an attributable agreement payment is to be excluded from the assessable income of a person under section 128D of the Principal Act where withholding tax is payable in respect of that payment. Section 128D provides for the exclusion from assessable income amounts that are subject to withholding tax or would be so except for statutory exemptions. However, under section 128AC, only a part of any payment - the notional interest - is subject to withholding tax. It may be that the whole of the payment could be regarded as assessable income of the recipient, e.g., a lease payment. Sub-section 128AC(7) will ensure that, if only a part of that lease payment is subject to withholding tax, i.e., the notional interest, the remainder of the payment will not be subject to tax by assessment because it is outside the exclusion contained in section 128D. It does this by deeming, for the purposes of section 128D, the withholding tax to have been payable in respect of the whole of the attributable agreement payment.

Section 128AD : Indemnification, & C., agreements in relation to bills of exchange and promissory notes

The purpose of this section is to remove any doubt as to whether withholding tax is payable in respect of any amount remitted offshore by a resident drawer of a bill of exchange to indemnify or reimburse an offshore acceptor of the bill for its face value at maturity. A common arrangement is for a resident to draw a bill for acceptance by an offshore bank, which may then either discount the bill to itself or sell it overseas on the open market, with the discounted proceeds being paid to, or applied for the benefit of, the residual drawer of the bill. At the same time, the bank enters into an arrangement (which may be formal or informal) with the drawer whereby the drawer agrees to either have sufficient funds on deposit with the bank to meet the bill or to reimburse the bank after it has discharged its liability as acceptor of the bill to the holder of the bill.

Claims have been made that no part of the amount or amounts remitted to the acceptor bank under such arrangements, i.e. the bill discount, are interest or amounts in the nature of interest for withholding tax purposes. This is in direct contrast to the situation if the resident drawer had met the bill direct, where, because of the definition of "interest" in section 128A of the Principal Act, withholding tax would clearly have been payable on the discount element of the bill payments. Part of the amount or amounts remitted by the resident drawer of the bill to the offshore acceptor in the circumstances described represent, however, a payment in return for the provision of finance through the discounting of the bill. Accordingly, to remove any doubt in this area, section 128AD specifies that withholding tax is payable on that part of any reimbursement amount or amounts that constitute a discount or interest element.

The section also contains comparable provisions in relation to promissory notes.

The section will apply only in relation to relevant payments made in respect of bills of exchange or promissory notes drawn or issued after the section comes into operation.

Sub-section 128AD(1) deals with bills of exchange. Paragraph (a) refers to the factual situation necessary for the section to apply to the transaction. These facts may be grouped as follows: the bill of exchange must be issued after the day on which the section comes into operation; the drawer of the bill pays an amount to the acceptor of the bill, referred to in the paragraph as the "indemnification amount"; and, the amount is paid to reimburse, indemnify or otherwise compensate the acceptor for the whole or a part of the amount the acceptor has or will become liable to pay under the bill on presentment, referred to in the paragraph as the "eligible presentment amount". The indemnification amount may thus be remitted to the acceptor either before or after the bill has been met. Also, it need not be for the whole of the face value of the bill to be subject to withholding tax. Any instalment on the face value of the bill is to be subject to withholding tax on that part of the instalment that reimburses or indemnifies or otherwise compensates the acceptor for interest under the bill (see notes on paragraph (c)).

Paragraph 128AD(1)(b) is designed to prevent the double taxing of the indemnification amount. If some part of this amount is, or will be, included in the assessable income of the acceptor, then the amount is to be taxed by assessment and is not to be subject to withholding tax. This will avoid the acceptor being subjected to withholding tax on one part of the indemnification amount and taxed by assessment on the same or some other part of that amount.

A key facet of the operation of section 128AD is that the acceptor will be paying out some discount component, or interest for withholding tax purposes, upon presentment of the bill of exchange, i.e., the whole or a part of the "eligible presentment amount" consists or will consist of interest for those purposes. This facet of the operation of the section is referred to in paragraph (c). For example, if the acceptor has only assumed responsibility for the net amount for which the bill was discounted and the drawer of the bill is obliged to pay the bill discount direct to the holder of the bill at maturity, no part of the amount remitted by the drawer to the acceptor in reimbursement of the amount for where the bill was discounted will be subject to withholding tax.

Where paragraphs (a), (b) and (c) are satisfied, section 128AD deems, for the purposes of the withholding tax provisions, that part of any amount remitted to an acceptor as reimbursement, indemnification or other compensation for the discount or interest payable under the bill to be income that consists of interest. As with proposed sub-section 128AC(5), this deeming, of itself, does not subject the deemed interest component of the "indemnification amount" to withholding tax. It brings that interest component within the ambit of the withholding tax provisions of the Principal Act.

Sub-section 128AD(2) refers to the use of promissory notes, and is virtually a mirror image of sub-section (1). However, a separate sub-section is required as the legal relationships between parties to a promissory note are different from those of a bill of exchange. Paragraph (a) describes the background to the operation of the sub- section, i.e., the note is issued after the section comes into effect; a person (who could be expected to be the person on whose behalf the note was issued) pays an amount - the "indemnification amount" - to the issuer of the note; and that amount is by way of indemnification, reimbursement or other compensation for the whole or a part of the amount the issuer will be required to pay out on presentment of the note, i.e., the "eligible presentment amount". Again, paragraph 128AD(2)(b) will ensure that a relevant indemnification amount is subject either to withholding tax or tax by assessment, but not to both. Finally, paragraph (c) requires that some part of the "eligible presentment amount" consists or will consist of interest for withholding tax purposes, i.e., that the issuer of the note will be liable, on presentment, for the discount or interest component of the note.

Where these conditions are satisfied, sub-section 128AD(2) will deem that part of the indemnification amount or amounts that is referable to the discount or interest paid or payable by the issuer on presentment to be income that consists of interest. As with sub- section 128AD(1), the overall effect of this sub-section will be to clarify that the discount component of a relevant indemnification payment is subject to the existing interest withholding tax provisions.

Clause 13: Payment of withholding tax

Clause 13 will amend section 128C of the Principal Act by inserting a new sub-section - sub-section (4AA). Section 128C specifies the time limit within which withholding tax must be remitted to the Commissioner of Taxation, as well as specifying the consequences where the tax is not paid within that time frame. In this latter regard, the section imposes additional tax on outstanding amounts as well as providing the means for recovering the unpaid tax. New sub-section (4AA) will direct the Commissioner to remit an amount of additional tax where the conditions set out in the three paragraphs of the sub-section are satisfied.

Paragraph (a) specifies that additional tax must be payable under existing sub-section (3) for late remittance or non-remittance of withholding tax and that it must be in relation to an amount that is deemed to be interest by virtue of section 128AA in respect of a transfer or sale of a qualifying security by a non- resident to a resident. This paragraph refers to the amount of tax that should have been collected on the transfer if the circumstances contained in paragraph (b) of the sub-section (whereby an incorrect statement made in a notice referred to in the sub-section resulted in a deficiency in withholding tax) were absent (see later notes).

Paragraph (b) identifies the circumstances under which the incorrect amount of withholding tax was deducted at the time of the transfer. Sub-paragraph (i) refers to the use of a notice expressed to be issued under new sub-section 265B(3) (to be inserted by clause 28) in relation to the transfer. While the details of new section 265B will be explained further later in these notes, the section allows a non-resident holder of a qualifying security to seek and obtain a notice containing certain specified information from the issuer of the security for supply to a resident buyer of the security from the non-resident and for the buyer to rely on the information in the notice for the purposes of calculating the withholding tax liability of the non- resident in relation to the sale.

Sub-paragraph (4AA)(b)(ii) provides the explanation for why the wrong amount of withholding tax was deducted in respect of the transfer. That is that one or more of the statements contained in the notice were incorrect. However, by sub-paragraph (4AA)(b)(iii), to gain the benefit of the remittance of additional tax provided by the sub-section, the non- resident vendor must not have known, when the security was transferred, of the errors in the notice. In other words, the non- resident must be relying on the notice in good faith and not in the knowledge that some or all of the information contained in the notice is incorrect.

Paragraph (c) requires that there be an under-deduction of withholding tax, i.e., if the correct information had been shown in the notice the amount of the withholding tax deducted (the "proper amount") in relation to the transfer would have been more than the amount that was deducted.

Where all these conditions are satisfied, sub- section(4AA) directs the Commissioner to remit the additional tax that may have been imposed under sub-section (3) on that part of the withholding tax liability that was not deducted because of reliance on the incorrect information shown in the notice. The reason for this is that the non-resident vendor should not be penalised for acting in good faith on information (albeit incorrect) supplied by another person.

Clause 14: Special tax payable in respect of certain securities and agreements

This clause will insert section 128NA in the Principal Act as an anti-avoidance provision. The section will impose a liability for tax on participants (usually residents) in arrangements aimed at circumventing or frustrating the operation of the new withholding tax measures contained in this Bill. Associated with this section is the Income Tax (Securities and Agreements)(Withholding Tax Recoupment) Bill 1986 (the imposition Bill) which imposes the tax concerned and declares the rate of this tax. The imposition Bill is discussed in more detail in later notes on that Bill.

The section refers to two avoidance arrangements - one involving section 128AA; the other section 128AC. Sub-section (1) relates to the situation where a non-resident has sold a qualifying security to a resident and the Commissioner of Taxation concludes that, in relation to the sale, the resident and the non-resident were not dealing with each other at arm's length and that the issue price and/or transfer price (which govern the amount of withholding tax liability of the non-resident vendor in that situation) is not the price or are not the prices that could be reasonably expected if the resident and non-resident had been dealing with each other in an arm's length manner. By virtue of sub-section 159GP(2), the Commissioner may substitute another issue price and/or transfer price in that situation. In the absence of a determination of a substituted price or substituted prices under sub-section 159GP(2), sub-section 128AA(1) would operate to specify that the excess of the transfer price over the issue price or, where the security has been partially redeemed, the reduced issue price, is to be the amount of interest to be subject to withholding tax and sub-section 128AA(2) specifies that for the purposes of references to the transfer price, issue price or reduced issue price in sub-section 128AA(1), any application of sub-section 159GP(2) is to be disregarded.

The two situations that will trigger the operation of sub-section (1) are set out in paragraphs (a) and (b) of the sub-section. Both situations involve an increased liability for withholding tax that may arise as a result of the exercise of the Commissioner's discretion in sub-section 159GP(2). Paragraph (a) refers to the case where no amount of withholding tax is payable by reason of the operation of section 128AA, but if the parties had been dealing at arm's length, a liability would have existed. Paragraph (b) refers to where some withholding tax was paid in relation to the transfer but additional withholding tax would be payable on the transfer had the dealing been an arm's length one. In both circumstances, the sub-section designates that the withholding tax or extra withholding tax payable is to be the avoided withholding tax amount in relation to the transfer. That avoided withholding tax amount is payable by the resident transferee. This is because a determination under sub- section 159GP(2) is generally likely to take place after conclusion of the relevant transfer and thus it would not be practicable to recover the avoided withholding tax from the non-resident transferor.

When the proposed changes to the withholding tax provisions were announced on 14 December 1984 as having application only in relation to affected payments made from the time of enactment of the amending legislation, the announcement included a reference to safeguarding provisions. Such provisions are required to prevent parties to agreements likely to be affected by the amendments from "loading" payments made before the commencement of the legislation with interest that is referable to the period of the agreement after commencement. Sub- section (2) of section 128NA has been drafted against that background.

By paragraph (a), sub-section (2) is expressed to apply to payments made under relevant agreements, i.e., payments made under hire-purchase and similar agreements to which new section 128AC applies, made before the commencement of that section, i.e., payments made before this Bill receives Royal Assent in respect of relevant agreements that were entered into after 16 December 1984 and before that day.

Paragraph (b) provides that if the Commissioner is of the opinion that such payments were made, or that larger such payments were made for the sole or dominant purpose of reducing the amount of withholding tax payable in respect of payments to be made after the commencement day, the sub-section will have general application to the person who made the payment or payments. This person, therefore, will be liable for the avoided withholding tax amount. This amount will be the difference between the two relevant amounts of potential, or, in some instances, actual withholding tax amounts.

The first of these two amounts of withholding tax (referred to as the "actual withholding tax" in paragraph (b)) is the amount of withholding tax potentially payable under section 128AC following the making of the early payment or payments, or the loading of pre- commencement payment or payments. The other amount that is to form part of the calculation of the avoided withholding tax amount is the potential amount of withholding tax payable (referred to as the "notional withholding tax") that would have been payable in the absence of the pre-payments or loading. By the operation of sub- section 128NA(2), the avoided withholding tax amount in relation to such alterations of payments is the amount by which the notional withholding tax exceeds the actual withholding tax. In other words, the amount of withholding tax that was avoided by the early payment or payments or the loading of scheduled payments.

The liability for this avoided withholding tax amount is placed on the person who made the payments (the resident) and not the recipient (non-resident) of those payments, as would have been the situation if the alterations had not been made to the relevant payment schedule. It would be impracticable to collect the extra tax direct from the non-resident.

Sub-section 128NA(3) is simply a drafting measure designed to ensure that, where terms that are defined or used in section 128AC are also used in sub-section 128NA(2). those terms are to have common meanings. This sub-section saves the repetitious re-drafting of terms that are common to both provisions.

Sub-section 128NA(4) is the formal mechanism whereby the "person" identified in sub-sections (1) and (2) in relation to an avoided withholding tax amount is made liable for income tax in relation to that avoided amount. The income tax is imposed by clause 5 of the Income Tax (Securities and Agreements)(Withholding Tax Recoupment) Bill 1986.

Clause 15: Reviews and Appeals

This clause will amend section 128P of the Principal Act to provide a right of appeal where the Commissioner refuses to issue a certificate relating to the transfer price paid for a security under section 128AB (see earlier notes) or specifies in such a certificate a different value for the transfer price of the security than the price paid by the applicant. Section 128P provides for the review of decisions by the Commissioner to refuse the issue of other certificates in relation to the existing withholding tax provisions. It is necessary to amend section 128P to provide for the review of the amounts specified by the Commissioner, which will be the effect of the amendments contained in paragraph (a) of this clause. Paragraphs (b) and (c) have much the same effect by amending the scope of the review and appeal rights contained in sub-section 128P(1) so that those rights encompass not only the refusal by the Commissioner to issue a certificate, but also to review the amount set out in that certificate as the transfer price of the security.

The amendment of sub-section 128P(2) to be made by paragraph (d) of clause 15 relates to the powers of a review tribunal and will enable that tribunal to direct the variation of the amount specified as the transfer price of the security in a certificate issued under section 128AB.

Clause 16: Accruals assessability, & c., in respect of certain security payments

Introductory note

Clause 16 will insert new Division 16E in Part III of the Principal Act. Division 16E will alter, for taxpayers who are resident of Australia for purposes of the Principal Act, the method of taxing income accruing on discounted and other deferred interest securities from a realisation basis (when the income is received in cash or credited) to an accruals basis, i.e., the income will be taxed each year as it accrues. Subject to certain exceptions, deductions are to be allowed on a parallel basis to issuers of these securities for the discount or other "interest" payable on an affected security.

The basic tests which need to be satisfied before a security (referred to as a "qualifying security" in Division 16E) is affected by the new measures are set out in the "Main Features" section of the memorandum.

The actual treatment under this Division of a qualifying security will depend on whether the security is a "fixed return security" for the purposes of the Division or "variable return security" for those purposes. Again, the differences between a fixed and variable return security are broadly described in the "Main Features" section of this memorandum.

Where a fixed return security is issued to or purchased by a taxpayer, the amount to be included in assessable income of the holder for each year will be determined on a compounding accrual basis having regard to the yield to redemption for the security. This yield is the compound interest rate per 6-monthly "notional accrual period" at which the sum of the present values of the payments to be made under the security equal its issue or transfer price, as the case may be. This compound interest rate is then used to gross-up the value of the security for each notional accrual period to calculate the amount to be included in the taxpayer's assessable income as the income accruing under the security for a year of income.

For a variable return security, the legislation provides that the income accruing is to be ascertained in accordance with the actual terms of the security, e.g., for a capital-indexed bond, the accrued income will be the increase by indexation in the capital value of the security. If, for any reason, the terms of the security do not enable the amount of income accruing under a variable return security to be accurately determined for any year, the Commissioner may determine an amount to be included in a taxpayer's assessable income for that year.

These procedures will also form the basis generally for determining the annual deductions allowable to the issuer of a qualifying security for the discount or deferred interest payable under the security. The allowance of deductions to an issuer on the accruals basis will not apply, however, in relation to issues of bearer securities or to offshore issues of qualifying securities. Relevant deductions will continue to be allowed, in these cases, in the year in which the discount or deferred interest is paid.

Provisions are included in new Division 16E for adjustments to be made where the realised gain from the security differs from the sum of the amounts included in the taxpayer's assessable income under the accruals method. Other provisions deal with the taxing of issue or purchase discounts as well as the deductibility of premiums paid on the purchase of a qualifying security on the secondary market. The Division has also been drafted to take account of variations in the terms of a security so that, if the security was issued on the varied terms on the date the variations took effect, the security would be a qualifying security.

Finally, the Division contains provisions to cover "stripped securities", such as DINGO bonds and similar securities, which separately market the entitlements to principal and interest of an underlying security.

The amendments in relation to these stripped securities will ensure that where a person strips an interest coupon or coupons from the principal entitlement and markets the coupons and/or the principal entitlement separately after 16 December 1984 at a discount, the stripped components are to be regarded as separate qualifying securities for the purposes of the accruals basis of assessment introduced by new Division 16E. Also, the amendments will require issuers of stripped securities to allocate the cost of the underlying security across the range of the stripped securities for determining relevant deductions, and not just to the entitlement to the principal on the underlying security. This will prevent issuers from creating artificial losses where there are unsold interest coupons on hand at the end of a year of income.

Notes on the individual provisions of proposed new Division 16E follow.

Section 159GP : Interpretation

As the section heading implies, section 159GP contains the definitions of the terms which have general use in the Division as well as interpretative provisions. As mentioned earlier in the notes on new sub-section 128A(1A) - to be inserted by clause 11 - the defined terms will generally also have the same meanings for the purposes of the existing and proposed interest withholding tax provisions of the Principal Act as they relate to affected security. Each defined term is to have the given meaning unless the contrary intention appears.

"adjusted term" refers to the situation where a taxpayer purchases a qualifying security on the secondary market, or otherwise than on issue. The "adjusted term" in such cases is the part of the term of the security remaining after the taxpayer purchases the security. The term is relevant when calculating the yield to redemption on a fixed return security (see following notes);

"eligible notional accrual period" is also a term that is referable to a fixed return security. Basically, the term refers to any "notional accrual period" (see later definition) or a part of such a period that occurs after the taxpayer purchases the security either on issue or on the secondary market. Broadly, it will mean the portion of a six monthly notional accrual period that the security was held by the taxpayer. It is the period used to gross-up the value of a fixed return security to ascertain the portion of the income accruing under the qualifying security that is to be included in the holder's assessable income for the year;

"fixed return security" is basically any qualifying security (see notes below on the definition of that expression) under which the amount payable upon redemption may be readily calculated at the time the security is issued. The definition of the term specifies three characteristics for determining the amount or amounts payable under the security. These are -

(a)

that the yield consists of a specified amount or amounts, e.g., a zero-coupon discounted security;

(b)

that the amount or amounts payable are calculated by reference to an interest, indexation or other rate that will not vary over the term of the security, e.g., a capital-indexed security that is to be indexed by a constant percentage over its term; or

(c)

some combination of the above two features.

The yield on a fixed return security is to be assessed to a taxpayer under proposed section 159GQ (see later notes in relation to that section);

"holder", in relation to a security at a particular time, is the person who would be entitled to receive the amount or amounts payable under the security if those amounts were to be paid at that time. The term is used extensively in the assessability provisions of the Division as the means of identifying the taxpayer who is to be taxed on the accruing income on a security;

"issue" requires a particular definition because the definition of "security" in this sub-section refers not only to items like negotiable instruments but also to contracts. As such, the term is defined by reference to the creation of the liability under the security, rather than simply the selling of a negotiable instrument from one person to another. The definition excludes bills of exchange because of the particular way such instruments come into existence and the fact that bills may be dealt with in several ways, e.g., by discounting taking place after acceptance rather than at time of issue.

"issue price", in relation to a security, is defined to refer to the consideration, if any, for the issue of the security. The issue price of a security will, in many instances, be one of the critical factors for determining the annual assessable amount under the accruals basis of assessment to be introduced by new Division 16E and for purposes of determining the amount of interest withholding tax payable under the amendments to the withholding tax provisions proposed by the Bill. Given the different items covered by the term "security" (as described below) there may be no consideration payable where a contract is involved or, where a negotiable instrument is issued, the security may have a specific issue price. The Commissioner of Taxation is to have the power to adjust any specified issue price where he considers that the parties involved were not dealing with each other in an arm's length manner - proposed sub-section 159GP(2), which is discussed below, refers;

"issuer", like "holder", is defined in relation to a security in terms of a particular point in time. An "issuer" is the person who would be liable to make the payment or payments under a security if the payment or payments were due to be made at that time. The definition thus allows for a change of "issuer" during the term of the security, e.g., where someone buys rights under a contract. The term is used particularly in proposed section 159GT, which allows deductions on an accruals basis to an issuer of a security (see later notes). In line with the definition of "issue", the definition of "issuer" is not relevant to bills of exchange;

"non varying element" is used when ascertaining whether there is an issue discount, or purchase discount or premium, in relation to the issue or transfer of a security that falls within the definition of a "variable return security" in the sub-section. It is that part of the expected payment or payments under such a security that consists of a specified amount or amounts. In other words, if the security was redeemed at the instant after the taxpayer acquired it, the non-varying element is the amount that the taxpayer would be entitled to receive at that instant, other than any amount of periodic interest. The non-varying element may include interest that accrued under the security prior to the time the taxpayer purchased the security on the secondary market, where this accrued interest will be paid to the holder of the security at the time the interest is due and payable;

"notional accrual amount", in relation to a security that is defined in the sub-section as a "fixed return security", is the amount of the income accruing on the security that is attributable to an "eligible notional accrual period" within the meaning of that expression as described above. It is ascertained by means of the formula set out in the definition, i.e., the value of the security at the start of the "eligible notional accrual period" multiplied by the yield to redemption under the security, less any amounts paid as periodic interest during the period. For the purposes of this calculation the value of the security at the commencement of the period depends on whether it is the first eligible notional accrual period after the taxpayer acquired the security. If it is the first such period, this value is defined as the issue price or transfer price, as the case may be, of the security. If it is a subsequent period, the value is the sum of the issue or transfer price, whichever is relevant, plus the notional accrual amount or amounts for all such periods since the taxpayer acquired the security prior to the current accrual period. When calculating the notional accrual amount for the first accrual period, regard must be taken of the length of that period compared with the length of a full accrual period. This facet is referred to in the explanation below of component A of the formula. Broadly, the relevant mathematical adjustments to the yield to redemption should be made, therefore, where the length of the eligible notional accrual period is less than six months;

"notional accrual period" is a further term used in connection with the calculation of the accruing income on a fixed return security. The term is required in order to calculate the yield to redemption on a security for a specified period. For the purposes of Division 16E, that period is to be a period of six months.

Under the definition, a notional accrual period is to be determined by having regard to the period specified in paragraph (a), being the period of six months that ends on the expiry of the expected term of the security, i.e., the anticipated maturity date. For earlier accrual periods, paragraph (b) provides that it is to be the period of six months that ends immediately before the start of the period specified in paragraph (a) or a period of six months that ends immediately before a period that precedes that 6-monthly period. This method of defining the notional accrual period means that taxpayers will be required to count back by 6-monthly intervals from the expected maturity date of the security rather than forward from the date of purchase of the security. This will mean that any period that is less than 6 months will fall at the beginning of a taxpayer's holding of the security, rather than at the end;

"partial redemption" has relevance both for the purposes of this Division as well as the changes to the interest withholding tax provisions that are discussed earlier in these notes. A partial redemption will be taken to occur upon the payment of an amount, or other discharging of a liability to pay an amount, under the security that represents or is referable to the return of the issue price of the security, other than the discharging of the final part of the liability to return the issue price;

"partial redemption payment" is simply defined as any payment that has the effect of partially redeeming a security, as outlined above;

"qualifying security" is a term that is central to both the operation of the Division and the amendments to the interest withholding tax provisions of the income tax law that are contained elsewhere in this Bill. A qualifying security is one that has the five characteristics specified in the definitions. These are -

(a)

the security must have been issued (as defined) after 16 December 1984. This is the date the Government announced the proposal to introduce the accruals method of assessment. The withholding tax measures in the Bill will also only apply in relation to relevant securities issued after that date;

(b)

the security is not a prescribed security within the meaning of section 26C of the Principal Act. Briefly, section 26C applies to Commonwealth securities that do not bear interest. The section was inserted in the Principal Act in 1959 to remove any doubt that the discount element on Commonwealth zero-coupon securities was an amount in the nature of interest and, therefore, assessable income. The discount or other gain on any such securities will remain subject to tax on an assessment basis at the time of realisation, whether held by a person who is a resident of Australia or a non-resident for the purposes of the Principle Act:

(c)

the term of the security, as anticipated at the time the security is issued, will exceed, or is likely to exceed, one year. Provisions have been included later in this Division to overcome arrangements whereby a security is issued for a period of one year or less but, through the exercise of an option or right, the term is subsequently extended beyond one year. By other provisions of the Bill, this paragraph of the definition will be disregarded when determining whether a security is a qualifying security for the purpose of the withholding tax provisions (and related provisions) proposed in relation to the transfer of such securities by a non-resident holder to a resident;

(d)

the security must have an "eligible return", which is defined in proposed sub-section 159GP(3). Briefly, a security will be taken to have an "eligible return" if the sum of the payments (other than payments of periodic interest) to be made under the security will exceed its issue price; and

(e)

where it is possible to calculate the precise amount of the eligible return at the time the security is issued, the amount of the eligible return must exceed 1.5 per cent of the result obtained by multiplying the sum of the payments (other than periodic interest) by the term, in years and any fraction of a year, of the security. This condition will only apply in practice in relation to an otherwise qualifying security that is a "fixed return security" (as defined);

"redemption" refers to the discharging of all liability under a security so far as it relates to return of the issue price of the security, whether or not that discharging occurs at the same time as the payment of the accrued income on the security. This definition, along with the definition of "partial redemption", is necessary so as to distinguish the "principal and interest" components of any payment made under a security for the purposes of the later provisions that deal with the assessability of payments made under a qualifying security;

"redemption payment" is defined to be any payment that has the effect of redeeming a security within the meaning ascribed to the expression "redemption";

"security" has been defined very widely, and includes items that may not be usually regarded as securities, e.g., contracts, so as to encompass various arrangements that may give rise to a deferral in the payment of income. Another reason for the drafting of the term in this manner is to avoid the requirement to refer, in the operative provisions of the Division, to all the arrangements designed to be covered by the Division each time a reference could be more easily made to a "security".

Paragraph (a) of the definition refers to items that are usually taken to be a security. Paragraph (b) refers to deposits with financial institutions, because, it is not uncommon for banks, etc., to offer "deferred interest accounts" or "deferred interest investments" under which no interest is payable until the date the investment matures. Paragraph (c) brings loans within the scope of a security. For example, loans under which interest payments are deferred for a period will fall within the definition of a security. Finally, paragraph (d) ensures that other terms of contractual arrangements whereby one person is required to pay an amount or amounts to another come within the term "security". It is equally possible for a deferral of income to occur under contractual arrangements as it is under a security arrangement

"taxpayer's yield to redemption" is an important aspect of the determination of the income accruing on a fixed return security that is to be brought to account as assessable income annually under the accruals basis of assessment. This yield is the compound interest rate per notional accrual period (as defined and referred to earlier) at which the sum of the present values of all payments (including periodic interest payments) equals the issue or transfer price, as the case may be, of the security. In the event that a taxpayer disposes of a security and, at a later stage, re-purchases that security, the yield will be calculated by reference to the transfer price paid at the time the security was re-purchased and the number of notional accrual periods in the adjusted term, as defined previously;

"term" is defined as the period from the time of issue of the security to the time at which the final payment or payments under the security are due. This latter time may not be the moment at which the security is to be redeemed (as defined). Should there be payments to be made after the time at which the issue price is returned to the holder, the "term" of the security extends to the making of the final payment. As the term is to be ascertained at the time of issue, any options for extending the period of the security are to be ignored. The exercise of any option to extend the period of the security will be regarded as a variation of the terms of the security under proposed sub-section 159GV(4), which is explained in detail later in these notes;

"transfer" has been defined to include not only the actual transfer of a security. It will also mean sell, assign or dispose of in any way the security itself or any right under a security to receive a payment. This latter aspect of the definition is important when considering the disposal of stripped securities (to which new section 159GZ, also to be inserted in the Principal Act by the Bill, will apply) or any dealing in rights under a contract. The only limit on the definition is a partial redemption or redemption, which, though technically a disposal of the security or rights under a security, are not to be regarded as a transfer for the purposes of the Division;

"transfer price" is simply the consideration (if any) payable in respect of a transfer of a qualifying security. It should be noted that by virtue of sub-section 159GP(2), which is explained in detail below, the Commissioner of Taxation will have the power to specify, for the purposes of this Division, another figure for the transfer where the Commissioner considers that the parties to the transfer were not dealing with each other at arm's length and that it is appropriate that the transfer price should be altered;

"variable return security" is any qualifying security that is not a fixed return security as defined. This definition and the definition of a fixed return security are important because of the different rules contained in various provisions of the new Division 16E for the application of the accruals basis of assessment in relation to each respective category of security;

"varying element", in relation to a variable return security, is that part of the yield on the security that, over its term, will be calculated by reference to an interest, indexation or other rate, apart from that part of the yield that consists of periodic interest. The term is required in the calculation of a discount or premium on the transfer of a qualifying security (see notes on proposed sub-sections 159GQ(2) and (3).

As mentioned earlier in this memorandum, sub-section 159GP(2) gives the Commissioner power to adjust the issue price and/or transfer price of a qualifying security under certain circumstances, including where there is a transfer of such a security by a non-resident to a resident. This sub-section is designed, so far as it relates to withholding tax, to cover the situation where the Commissioner is satisfied that the issue price and/or transfer price have been manipulated in order to eliminate or reduce the withholding tax liability that would apply on the basis of the difference between those prices pursuant to new sub- section 128AA(1). The circumstances where the Commissioner may adjust the issue price and/or transfer price are set out in paragraphs (a) and (b) of the sub-section and refer to situations where the Commissioner concludes that the parties to the issue or transfer were not dealing with each other at arm's length in relation to the transaction, given any connection between the parties and any other relevant circumstances, and determines that the sub- section should apply in relation to the issue or transfer.

Once the Commissioner determines that the sub-section should apply in relation to the issue or transfer, paragraph (c) provides that, for the purposes of the application of the definition of "issue price" and "transfer price" in sub-section 159GP(1) - and thus the determination of the amount related to the transfer that is to be deemed to be income that consists of interest for withholding tax purposes under sub-section 128AA(1) - the consideration for the issue or transfer is to be the consideration that would have been paid or payable if the parties were dealing with each other at arm's length in relation to the transaction. Where, however, it is not possible for the Commissioner to ascertain the arm's length consideration, paragraph (d) will empower the Commissioner to determine a price in relation to the issue or transfer. The reference in paragraph (d) to there being insufficient information to enable the arm's length consideration to be determined is included to cover the case where there may be no "market" as such for the security on which the Commissioner could base determination of an arm's length consideration. The reference will also cover other situations where there is insufficient information available to enable the Commissioner to decide upon an arm's length amount.

Sub-section 159GP(3) gives meaning to the term "eligible return" as it is used in the definition of qualifying security in sub-section 159GP(1). By the sub-section, a security will contain an eligible return where the sum of all payments (other than periodic interest, as described in sub-section 159GP(6)) to be made under the security is reasonably likely to exceed its issue price. The payments referred to in the sub-section relate, in effect, to redemption and partial redemption payments. The excess could arise because the security was issued at a discount, is to pay interest only at maturity, the capital value is to be indexed or because of a combination of such factors. In any event, the terms of the security prevailing at the time it is issued must be examined to determine whether the security has an eligible return.

This sub-section also sets the amount of the eligible return in relation to the security at the amount by which the sum of all the relevant payments exceeds the issue price.

Proposed sub-section 159GP(4) provides the test for the presence of an issue discount on a variable return security (as defined in sub-section 159GP(1)). The test compares the sum of the non-varying elements (as also defined in sub-section 159GP(1)) of all payments to be made under the security and its issue price. What constitutes a non-varying element of a security will depend very much on the terms of the security. Where the sum of the non-varying elements exceeds the issue price, sub-section (4) specifies that there is an issue discount equal to that excess, and, by proposed sub-section 159GQ(2), that issue discount is to be included in the holder's assessable income on a straight- line basis. An example of the situation envisaged by the sub- section is where a capital-indexed security, e.g., a Treasury capital-indexed bond, is issued for a price that is less than the face value of the security at the time of issue.

Sub-section 159GP(5) deals with the determination of discounts and premiums on the transfer of a variable return security. Paragraph (a) examines whether there is a purchase discount in relation to the transfer. Paragraph (b) refers to purchase premiums. Both situations involve a comparison of the transfer price and the sum of the non-varying elements in relation to future payments under the security and the varying elements of the future payments that are attributable to the period before the taxpayer acquired the security. Where the sum of these elements exceeds the transfer price, these are to be taken to be a purchase discount in relation to the transfer. If the reverse, that is, the transfer price exceeds the sum of the two elements, the taxpayer will be regarded as having purchased the security at a premium. Under proposed sub-section 159GQ, the discount is to be assessed to the taxpayer on a straight-line basis while the taxpayer holds the security and any premium paid in respect of the purchase of a qualifying security in the secondary market is to be allowed as a deduction on the same basis.

By way of a simple example of this concept, assume that a capital- indexed security is issued at its face value on issue of $1000. The capital value of the security is indexed several times and, at the time the taxpayer acquires the security, its indexed value is, say, $1350. Under paragraph 159GP(5)(a), if the taxpayer pays less than $1350 for the security, he or she is to be regarded as having purchased the security at a discount. On the other hand, by paragraph 159GP(5)(b) should the taxpayer pay more than that amount, he or she will be taken to have bought the security at a premium.

There are various references in the provisions of proposed Division 16E to periodic interest payments in relation to a security.

Sub-section 159GP(6) specifies what is to be regarded as periodic interest on a security for the purposes of the Division. Basically, it is any interest that is paid not more than one year after it commences to accrue. The interest may be payable by virtue of a coupon rate attached to the security, or the amounts and the timing of payment may be specified in the terms of the security. To guard against issues specifying low interest rates over the early part of a security's term and much larger rates at the end, sub-section 159GP(7) provides that, where the Commissioner considers that an amount that is expressed to be periodic interest in fact is referable to a period in excess of one year, that amount shall not be taken to be periodic interest and shall be regarded as referable to the period the Commissioner considers appropriate. In such cases, the interest would form part of the deferred return under the security and would fall to be assessed by the accruals method.

Sub-section 159GP(8) is designed to cover cases where, under the one security, some of the amounts payable are to be paid to 2 or more different persons in return for consideration given by those or other persons. It is not necessary, therefore, for the persons receiving the payment to do so in return for consideration given by them. In these cases, rather than attempting to ascertain what parts of the security are relevant to each payment, the amounts payable are to be regarded as payable under separate securities having such of the terms of the one security as are relevant. This sub-section has the effect of applying the accruals provisions to the payments as if the amounts were the only amounts payable under the security. This may result in the allocation of part of the payments to years of income preceding the payment whereas if the payments had remained part of the original security they would only have been assessable in the year payment was made.

Sub-section 159GP(9) makes it quite clear that the accruals method applies only to the current holding of a security. Any prior holdings are to be ignored when such things as balancing adjustments, etc., are being calculated on, for example, the transfer or redemption of the security.

Section 159GQ : Accruals assessability, & c.

This section is the first in a series of sections that deal with the procedural aspects of the accruals method. Section 159GQ covers the assessing of the accruing income, issue and purchase discounts and allowing deductions for purchase premiums. Sub-section (1) deals with the income accruing on a fixed return security, (as defined in sub-section 159GP(1); sub-section (2) covers variable return securities (as also defined in sub-section 159GP(1)) that are issued at a discount: and sub-section (3) refers to variable return securities purchased at a discount or premium. This section only covers years of income during which the taxpayer holds a security. It does not apply to the year of income during which the taxpayer transfers the security. That year is dealt with in new section 159GS, discussed later in this memorandum.

As indicated above, sub-section (1) refers to the assessing of the income accruing on a fixed return security. The sub-section presumes that the taxpayer has already calculated the yield to redemption on the security. Like sub-section (2) and (3), sub-section (1) is examining the period during a year of income that the taxpayer holds the security - referred to in each sub-section as the "'assessability period".

The operation of sub-section (1) is best explained by the use of an example. Assume a taxpayer purchases a zero-coupon discounted security, either on issue or on the secondary market, for $1200. Further assume that the security will mature for $3800 in 3 1/2 years. The taxpayer's yield to redemption on the security is thus approximately 15.5% per notional accrual period. Also assume that the taxpayer purchased the security on 1 November 1986 and that the security will mature on 30 April 1990. The taxpayer's year of income commences on 1 July. Therefore, the two relevant eligible notional accrual periods in relation to the taxpayer's 1986/87 year of income are from 1 November 1986 to 30 April 1987 and from 1 May 1987 to 31 October 1987. The notional accrual amounts for the former period is $186

($1200 * 15.5%)


and for the latter is $215

((1200 + 186) * 15.5%)


.

By the operation of sub-section (1), the taxpayer will be required to include $258 in assessable income for the 1986/87 year of income as that part of the income accruing on the security that is attributable to the period during the 1986/87 year that the taxpayer held the security. Paragraph (a) of the sub- section specifies that, if an entire eligible notional accrual period occurs in the assessability period, the whole of the notional accrual amount in relation to that accrual period is to be included in assessable income. This paragraph includes in the taxpayer's assessable income for the 1986/87 year of income the $186 for the period 1 November 1986 to 30 April 1987. being the first eligible notional accrual period, in the example. Paragraph (b) of the sub-section specifies that if a fraction of an eligible notional accrual period occurs in the assessability period, the relevant faction of the notional accrual amount in relation to that accrual period is to be included in assessable income. In the example above, one-third of the accrual period from 1 May 1987 to 31 October 1987 falls in the 1986/87 year of income. Therefore, one-third of the notional accrual amount of $215 in respect of that period is to be also included in the holder's assessable income of the 1986/87 year of income, i.e., $72 (rounded up), resulting in an overall assessable amount for that year of $258. The balance of that accrual amount, i.e., $143, will be included in the assessable income of the 1987/88 year of income provided the taxpayer does not transfer the security during that year. This process is to be repeated until the security is either transferred or redeemed.

Examples illustrating the application of sub-section 159GQ(1), which relates to fixed return securities, are set out below. Example 1 also illustrates the application of sub-section 159GS(1), which provides for a balancing adjustment on the transfer of a qualifying security.

Example 1

A zero interest discounted security is issued on 30 June 1986 at a purchase price of $55.49, redeemable on 30 June 1991 at face value of $100. Instead of holding it until maturity the original investor sells the security for $68 on 1 July 1988.

The compound yield, before tax, offered by the investment is 6.07% per half- year. Compounding at that rate up to the date of sale by the original holder, the value of the security would change as follows:

The assessable income of the original holder would include the increase in the compounded value of the security during the years he held it. There would be a plus or minus adjustment on sale on account of any difference between the compounded value at the date of sale and the sale price.

The investor's assessable incomes from the investment would be:

The compound yield, before tax, of the purchaser, calculated on the basis of his purchase price of $68 and a receipt of $100 on redemption 3 years later, is 6.64% per half year. Compounding at that rate up to the date of redemption, the value of the security would change as follows:

The purchaser's assessable incomes from the investment would be the increases in the value of the security in each of the three years, shown in the preceding table. There would not be any adjustment on realisation as the amount received on redemption is equal to the compounded amount at redemption date.

Example 2

On 30 September 1985 a 5 year security paying interest on face value of $100 at a rate of 6% per annum at 6 monthly intervals (ie., $3.00 every 31 March and 30 September) is issued at a purchase price of $76.36. The original investor holds the security until maturity.

Under present law the investor would be assessable on:

$3 of interest in 1985-86;

$6 of interest in each of years 1986-87 to 1989-90;

$26.64 (ie $3 of interest plus $23.64 of increase in value) in 1990-91;

$53.64 in total.

The compound yield, before tax, offered by the investment is 6.25% per half-year. The increase in the value of the security between successive Septembers and pro-rated increases for years ended 30 June are:

(a)

September 1985 value equal to purchase price. Subsequent March value obtained by adding 6.25% of preceding September value to itself and deducting $3 of interest (eg value at 31 March 1986 equals

1.0625 * 76.36 - 3


), giving $78.13, and subsequent September value obtained by applying same procedure to March value (eg value at 30 September 1986 equals

1.0625 * 78.13 - 3


).

(b)

Pro-rating between September increases.

Under the new rules, the assessable income in any year would be the interest actually received plus the pro-rated increase in the value of the security in that income year.

Sub-section 159GQ(2) affects a taxpayer who acquires a variable return security on issue. In respect of the period during a year of income that the taxpayer holds the security (the assessability period) the taxpayer will be required, by paragraph (a), to include in assessable income of the year of income a fraction of any issue discount as well as, by paragraph (b), so much of any varying element on a future payment or payments under the security as is attributable to the assessability period by reference to the terms of the security or, where it is not clear from the terms how much of the varying element is attributable to the assessability period, the amount the Commissioner considers may reasonably be attributed to that period. The issue discount is to be included on a simple fractional basis, i.e., the amount of the discount multiplied by the fraction of the term of the security as represented by the assessability period. For example, if the taxpayer held the security for 6 months of the year of income and the term of the security was 5 years, one-tenth of the issue discount is attributable to that year of income.

In relation to the varying element of any future payment under the security, the amount to be included will depend on the terms of the security and the kind of security involved, e.g., a capital-indexed security or a deferred interest security. If a capital-indexed security is held by the taxpayer and that security is to be indexed annually at, say, the end of September each year, the taxpayer will be required to apportion a part of that September-to-September indexation amount to his or her assessable incomes for the respective years of income during which that indexation amount has accrued.

Paragraph (a) of sub-section 159GQ(3) will include the relevant fraction of a purchase discount in the assessable income of the taxpayer holding the security on the same basis as set out in sub-section 159GQ(2) for an issue discount. The method of calculating the amount of this discount is discussed earlier in the notes on proposed sub-section 159GP(5).

Paragraph (b) of sub-section 159GQ(3) allows a taxpayer a deduction on the straight-line basis for any purchase premium paid by the taxpayer on the transfer of a variable return security. The method of calculating the amount of this deduction for a year of income is exactly the same as described earlier in these notes for assessing an issue or purchase discount (see notes on sub-section 159GQ(2) above). The method of calculating the purchase premium has also been already explained in the notes on proposed sub-section 159GP(5).

The assessability of the varying element of any future payment, as set out in paragraph (c) of sub-section 159GQ(3) is the same as the method explained in the notes on paragraph 159GQ(2)(b) above.

Section 159GR : Consequence of actual payments

In its perfect form, the accruals method would only ever expose to taxation annually the exact amount of the income accruing on the security and allow as a deduction on an annual basis the exact amount of any purchase premium. Proposed section 159GR(1) has been drafted on this assumption and specifically excludes from the assessable income of the taxpayer any payments for the accrued interest to the date the payment was made or part of that interest. The same can be said of deductions for purchase premiums.

Paragraphs (a) and (b) respectively of sub-section 159GR(1) specify that no amount of any payment is to be assessable or deductible to a taxpayer otherwise than by virtue of section 159GQ (which assesses the accruing income to a taxpayer and allows deductions for purchase premiums - see earlier notes) or under sub-section (2) of this section.

Sub-section 159GR(2) recognises that differences may occur between the amount that is required to be included by the provisions of Division 16E in the assessable income of a holder of a variable return security and the actual amount of a relevant payment, especially given that, in the absence of precise information about the calculation of accruing income, the Commissioner may determine an amount to be included in a taxpayer's assessable income, e.g., under paragraph 159GQ(2)(b). Broadly, when a taxpayer receives a payment under a variable return security, sub-section (2) looks back over the period during which the payment accrued and compares the "actual taxable amount" included in the taxpayer's assessable income for that period with the "correct taxable amount", i.e., the amount that should have been so included for that period in relation to the payment so that the sum of the amounts included by the accruals method would have equalled the amount of the payment (paragraphs (a) and (b)). In this regard, the "actual taxable amount" is defined in paragraph (b) as the sum of the amounts included in the taxpayer's assessable income by virtue of section 159GQ reduced by the sum of the amounts allowable as a deduction from that income under the same section.

Where the "correct taxable amount", i.e., the amount that should have been included, exceeds the "'actual taxable amount", i.e., the amount that was included, paragraph 159GR(2)(c) includes the excess in the assessable income of the taxpayer for the year in which the payment was made. For the reverse situation, i.e., where the "actual taxable amount" exceeds the "correct taxable amount", paragraph (d) of the sub-section specifies that the excess shall be an allowable deduction in the year the payment is made.

Section 159GS : Balancing adjustments on transfer of qualifying security

To some extent, the purpose of section 159GS is the same as section 159GR, in that both sections deal with a comparison of realised gains under qualifying securities and amounts that have been included in a taxpayer's assessable income by the accruals method under the other provisions of Division 16E in relation to those gains. Section 159GS, though, deals with adjustments arising from the transfer of a qualifying security.

Central to the operation of the section is whether there is a "profit amount" or a "loss amount" in relation to the transfer. Both of these terms are defined in sub- section (3). Their calculation involves a comparison of the transfer price in relation to the "relevant transfer", i.e., the transfer under review, the amount of any payments (other than payments of periodic interest) made to the taxpayer during the period he or she held the security and the issue price of the security, where the taxpayer acquired the security on issue, or the price paid for the security where it was acquired otherwise than on issue. By paragraph (a) of sub-section (3), a profit amount in relation to a relevant transfer arises when the sum of the transfer price and any payments made under the security exceeds its purchase price or issue price, as the case requires. Where the purchase or issue price exceeds the sum of these two amounts, paragraph (b) defines that excess as the "loss amount" in relation to the transfer. The adding back of any payments (other than periodic interest payments) made during the period the taxpayer held the security is necessary to ensure that the issue or purchase price is compared with all realised gains derived by the taxpayer from the investment in the security.

Having established that there is either a profit amount or loss amount in relation to the relevant transfer, it is then a matter of ascertaining whether there is a "net assessable amount" or a "net deductible amount" in relation to the period that the qualifying security was held by the taxpayer. These terms are defined in paragraphs (c) and (d) respectively of sub- section (3). The calculation of these two amounts requires that the sum of the amounts included in the taxpayer's assessable income in relation to the qualifying security under section 159GQ (accruals assessability) and section 159GR (assessability of adjustments on account of actual payments) be compared with the sum of the amounts allowable as deductions under these two sections. Where the assessable amounts exceed the deductible amounts, paragraph (c) specifies that there is a net assessable amount in relation to the relevant transfer of an amount equal to that excess. Conversely, should the sum of the deductible amounts exceed the assessable amounts, paragraph (d) specifies that there is a net deductible amount equal to that excess.

Against this background, sub-section 159GS(1) deals with the situation of where there is a profit amount, i.e., the realised gain from the security exceeds its issue or purchase price, in relation to the relevant transfer. By paragraph (a) of that sub-section, where the profit amount exceeds the net assessable amount, an amount equal to that excess is to be included in the taxpayer's assessable income for the year during which the qualifying security was transferred (sub-paragraph (a)(i)). Should the net assessable amount exceed the profit amount, the taxpayer is to be entitled to an allowable deduction for the excess in the year of transfer (sub- paragraph (a)(ii)). In the event that there is a net deductible amount in relation to the security, paragraph (b) requires the taxpayer to include in assessable income an amount equal to the sum of the profit amount and the net deductible amount. This is on the basis that the accruals method has allowed deductions where, in fact, it should have been assessing income.

The same process is followed in sub-section 159GS(2), except that this sub- section covers the case where the taxpayer incurs a "'loss amount" on the transfer of a qualifying security. By paragraph (a) of this sub-section, if there is a net assessable amount in relation to the transfer of the security, the taxpayer is to be allowed a deduction of an amount equal to the net assessable amount for the year in which the security was sold. This is due to the fact that the accruals method anticipated a profit from the investment but the taxpayer has actually realised a loss. On the other hand, where the amount of any net deductible amount allowed to the taxpayer in prior years is greater than the loss amount on the transfer. an amount equal to the excess is to be included in the taxpayer's assessable income. The reasoning behind this treatment is that the accruals method has allowed as a deduction an amount that is more than the loss actually suffered by the taxpayer. The excess deduction, therefore, should be added back to the taxpayer's income.

The provisions of sub-section 159GS(3) have already been discussed above.

Section 159GT : Deductions allowable to issuer of qualifying security, & c.

Section 159GT will, subject to certain exceptions, allow an issuer of a qualifying security a deduction each year for a proportion of the discount or other deferred interest component of a qualifying security. Proposed sub-section (1) is the operative sub- section and allows an issuer a deduction on the same basis as the income under the security is to be assessed to a taxpayer who purchased the security on issue and did not subsequently sell the security. For this purpose, the sub-section treats the issuer as the holder of the security for the purposes of section 159GQ. Therefore, whatever amount would be assessable under the accruals basis of assessment in a year of income to a holder acquiring the security on issue, that amount is subject to the other provisions of the section, to be allowable as a deduction to the issuer. However, because the assessability of the accruing income is subject to certain exclusions, sub-section (1) specifies that the operation of those exclusions, i.e., sections 159GW, 159GX and 159GY (the effect of these sections is explained later in these notes), is to be disregarded. This means that deductions on an accruals basis are to be allowed to issuers whether or not income under the security is being assessed to the holder.

One test that needs to be satisfied before a deduction on an accruals basis is allowable to an issuer is set out in sub-section 159GT(2). This is that the issuer would already be entitled to a deduction for the payments to be made under the security under section 51 of the Principal Act, other than redemption payments, partial redemption payments or periodic interest payments. This test has been included to ensure that issuers do not obtain deductions for amounts for which they would not otherwise be entitled to a deduction.

Sub-section (3) of this section is designed to prevent issuers from claiming double deductions for the accruing income - once by the accruals method and once when actually paid. The sub- section specifies that when a relevant payment is made, no deduction is to be available for that payment otherwise than in accordance with the provisions of this section.

Proposed sub-section (4) is a balancing provision that is to have a similar effect to sub-section 159GR(3) (see earlier notes). Sub-section (4) examines the amount of deductions allowed to an issuer on the accruals basis in terms of sub-section (1) with the amount of the payment made in relation to those deductions. To this end, the sub-section compares the "actual total deductions", i.e., the sum of the deductions allowed in relation to the security, with the "correct total deductions", i.e., the amount that should have been allowed, if the accruals method had correctly estimated the amount of the payment (paragraph (b)). Where the actual total deductions exceed the correct total deductions, i.e., too much has been allowed in prior years, that excess is to be added to the issuer's assessable income for the year in which the payment is made. Should the correct total deductions exceed the actual total deductions, that excess is to be allowable as a deduction in the year of payment.

Sub-section 159GT(5) specifies the securities for which a deduction is to be allowable on the accruals basis for the deferred income. By paragraph (a), these are any qualifying securities issued on or before 22 May 1986 (being the date of introduction of the Bill) and, by paragraph (b), only registered qualifying securities issued in Australia after that date. Accordingly, bearer securities and securities issued off-shore after 22 May 1986 will not qualify for deductions on the accruals basis.

Section 159GU : Effect of Division on certain transfer profits and losses

This section clarifies the treatment of profits and losses, calculated on a realisation basis, that may arise on the sale or redemption of a qualifying security for the purposes of the other provisions of the Principal Act. The section does not apply to any qualifying security that formed part of a taxpayer's trading stock, as such trading stock is expressly excluded from the scope of the Division by proposed section 159GY.

Sub-section (1) of section 159GU refers to the situation where a resident taxpayer derives a profit from the transfer of a qualifying security. The sub-section excludes that profit from the assessable income of the taxpayer under the general assessment provisions of the income tax law on the basis that the profit will be included in assessable income under this Division.

Sub-section 159GU(2) deals with the circumstances where a loss is made on the transfer of a qualifying security. Under new sub-section 159GS(2), which is discussed earlier in this memorandum, where a taxpayer realises a loss on the transfer of a qualifying security, and the amount of that loss is less than the loss allowed to the taxpayer by the accruals method, the difference is to be added to the assessable income of that taxpayer. By sub-section 159GU(2), where the realised loss on the transfer of a qualifying security exceeds the loss allowed to that time by the accruals method, the application of the other provisions of the Principal Act to any deduction that may be allowable in respect of that loss are only to apply to the amount by which the realised loss exceeds the amount of the loss already allowed to the taxpayer under this Division. The sub-section will therefore ensure that there is no double deduction available for all or part of a realised loss on the transfer of a qualifying security.

Section 159GV : Consequence of variation of terms of security

This section specifies the income tax effect of material variations in the terms of a security after that security has been issued. In this respect, it complements the definition of "qualifying security" in sub-section 159GP(1), which refers to conditions existing at the time the security is issued. The section only applies, however, to variations that are made after 22 May 1986, this being the date of introduction of the amending Bill.

Sub-section (1) specifies the effect of a material variation in the terms of the security for the remaining period in the "term", as defined in sub-section 159GP(1), of that security. Paragraph (a) designates that the security is to be regarded as having been issued on the terms as varied. Where there has been prior variations, those variations remain effective, and the current variation is incorporated in the already varied terms.

Paragraphs (b) and (c) of sub-section (1) refer to instances where consideration has passed between the parties to the arrangement. Paragraph (b) stipulates that where the holder of the security pays or is liable to pay any consideration in respect of the variation, the amount of that consideration is to be added to the security's issue price current at the time the variation is made, i.e., the original issue price as adjusted by virtue of those two paragraphs in relation to any previous variations. Paragraph (c) refers to the situation where any consideration is paid or payable by the issuer in relation to the variation. In this circumstance, the amount of the consideration is to be deducted from the current issue price.

Paragraph (d) operates so that paragraph (d) of the definition of "qualifying security" in sub-section 159GP(1) - which requires that the security be issued after 16 December 1984 - be disregarded, so that the sub-section may apply to securities issued on or before 16 December 1984, where the making of the material variation after 22 May 1986 effectively converts the security to a qualifying security. By paragraph (d), therefore, any security, regardless of its date of issue, is potentially subject to the operation of this sub-section, but only in relation to variations made after the date of introduction of the amending Bill.

Sub-section (2) of section 159GV provides for balancing adjustments to be made in the year of income that the material variation is made to reflect the fact that the security is to be regarded as having been issued on the terms as varied. This may mean, for example, that a security that was not a qualifying security when issued is now to be so regarded, and that some accrual amount or amounts are attributable to prior years of income. To this and, paragraph (b) compares the sum of the actual taxable incomes (referred to as the "total actual taxable income") for the period the taxpayer has held the security, including the year in which the variation is made, with the sum of the taxable incomes (the "total notional taxable income") that would have occurred, if, for the period the taxpayer has held the security, Division 16E had applied to the security and the security had been issued on the varied terms.

By paragraph (c), if the total notional taxable income exceeds the total actual taxable income, i.e., where amounts or extra amounts would have been included in the taxpayer's taxable income under the accruals basis of assessment if the security had been issued on the varied terms, that excess is to be included in the taxpayer's assessable income for the year in which the variation is made. In the reverse situation, where the total actual taxable income exceeds the total notional taxable income, paragraph (d) allows the taxpayer a deduction for the amount of that excess.

Sub-section (3) sets out the changes to the terms of a security that are to be considered a "material variation" for the purposes of this section. Paragraph (a) refers to a change in a security's terms so that, if the security had been issued on those terms (the varied terms) and the 16 December 1984 commencement date is disregarded, the security would be a qualifying security under the definition in sub-section 159GP(1). Paragraph (b) refers to the opposite case of where a security that is a qualifying security would not be a qualifying security if it had been issued on the varied terms. This has the effect of taking the security out of the scope of Division 16E for the remainder of its term. Paragraph (c) covers changes to the amount of any payment, or the timing of a payment, under a security as well as variations in the identity of the holder or issuer of the security. A variation in the holder is not the same as the transfer of a negotiable security. The variations envisaged by this paragraph in relation to the holder or issuer of a security are directed at situations such as the assignment of rights under a contract.

Section 159GW : Effect of Division in relation to non-residents

Section 159GW excludes from the operation of certain parts of Division 16E a security held by a person who, for the whole or a part of a year of income (referred to as "the period of non-residence"), is not a resident for income tax purposes. The exclusion relates, however, only to the period the person is not a resident during a year of income. If that person is a resident for part of a year, the person will be required to include in assessable income that part of the income accruing over the year that represents the proportion of the year that the person was a resident.

Paragraph (a) of sub-section (1) denies the operation of section 159GQ during the period of non-residence. This means that, during this period, no amounts will be included as assessable income and the person will not be entitled to a deduction for any purchase premium. Paragraph (b) excludes the effects of sub-section 159GR(2) in respect of any payment that may be made under a qualifying security while a person is a non-resident. This will mean that the person will not be subject to any balancing adjustments in relation to the comparison of the amount of income assessed by the accruals method and the amount of the payment in respect of those accrual amounts. By paragraph (c), the same exclusion relates to profits or losses realised by a person on the transfer of a qualifying security while the person is a non-resident. Such transfers may have implications, however, for the operation of proposed section 128AA (see notes on clause 12).

Given that the operation of section 159GQ is suspended in relation to the period that the holder of the security is not a resident, an adjusting provision is necessary should the holder be a resident at the time a payment is made, or liable to be made, under the security. Sub-section (2) of section 159GW will apply in relation to amounts that should have been included as assessable income but, due to periods of non-residence, were not so included. Paragraph (a) limits the operation of the sub- section to instances where a payment is made under a qualifying security at a time when the holder is a resident for income tax purposes. Paragraph (b) further limits the application of the sub- section to taxpayers who, at some stage while they held the security, were non-residents for income tax purposes. Paragraphs (c) and (d) then set out the tax effects of the payment.

Paragraph (c) specifies that, in the year the payment is made, amounts that would otherwise have been assessable under section 159GQ in respect of the payment, but which were excluded by the operation of paragraph 159GW(1)(a), are to be brought to account as assessable income. This means that these accrual amounts are effectively taxed on a realisation basis. Paragraph (d) stipulates that the taxpayer is to be entitled to the deductions, if any, under section 159GQ that would have been allowable but for the operation of sub- section 159GW(1), i.e., if the taxpayer had been a resident for the whole of the period that the security was held by that person. Such deductions would be in respect of any purchase premium on the security.

Section 159GX : Effect of Division where certain payments not assessable

Section 159GX is a comparable provision to sub-section 159GT(3). Basically, the section will limit the application of the accruals method to amounts that would constitute assessable income under the ordinary provisions of the income tax law. The effect of section 159GX is to not expose to income tax amounts that would not otherwise be subject to taxation. The reference in the section to disregarding section 128D is necessary as that section excludes from assessable income interest that is subject to withholding tax. But for the exclusion of section 128D, income that should be subject to the accruals method might be excluded on the basis of a possibility of being subject to withholding tax at some time in the future.

Section 159GY : Effect of Division where qualifying security is trading stock

This section will effectively exclude the operation of the accruals basis of assessment where a qualifying security forms part of the trading stock of the taxpayer. The reason for this exclusion is the interaction of section 28 and sections 159GQ, 159GR and 159GS. Briefly, sub-section 28(2) includes in assessable income the excess of the value of trading stock on hand at the end of a year of income over the value of that trading stock at the beginning of that year. Similarly, sub-section 28(3) allows a deduction for the amount by which the value of trading stock at the beginning of a year exceeds the value at the end of the year. To that extent, therefore, gains and losses on the holding of trading stock are already subject to taxation on an accruals basis. Against that background, the application of the accruals method contained in Division 16E is not necessary as it relates to the assessability of income or deductibility of premiums under section 159GQ (paragraph 159GY(a)), the necessity for balancing adjustments under section 159GR in respect of payments made under a qualifying security (paragraph 159GY(b)) or, as a flow-on from the previous two exclusions, balancing adjustments under section 159GS on the transfer of the security (paragraph 159(c)). Profits and losses on qualifying securities held as trading stock remain to be assessed on a realisation basis.

Section 159GZ : Stripped securities

Stripped securities separately market at a discount the entitlements to principal and interest on another security, usually a traditional interest-bearing security such as Commonwealth bonds. Section 159GZ addresses two types of those securities. First, where the interest coupons are physically separated from the principal entitlement and both are sold separately and, secondly, where the holder of the "underlying security" creates its own securities to match the face value and timing of the interest entitlement or entitlements and the principal entitlement of the underlying security.

The section has as its purpose two broad aims. The first is to ensure that, where the holder of an underlying security physically separates an interest entitlement or entitlements from the principal entitlement and markets them individually after 16 December 1984 then, regardless of the issue date of the underlying security, the stripped components are to be regarded as having been issued as separate securities after that date. The second aim is that, for the purposes of determining relevant deductions allowable to the issuer of the stripped securities in respect of the cost of the underlying security, the cost of the underlying security is spread across the range of the stripped securities, and not just to the coupon or new security or securities that relate to the principal entitlement on the underlying security.

Sub-section (1) of section 159GZ is concerned with the circumstance where the holder of an "underlying security" separates "'payment rights" (defined in sub- section (3)) under that security and transfers those payment rights individually, either to one person or to several persons jointly (paragraphs (a) and (b)). Even in this context, the transfer of all the individual payment rights to the one person would constitute the transfer of the security for section 159GS purposes. Paragraph (c) sets out the effect of this separation of payment rights and their individual disposition.

By paragraph (c) a stripped security is to be regarded as having been issued as a "bunch" of separate securities that are referable to each of the payment rights attached to the underlying security. As such, the paragraph considers the separation of an interest entitlement from the security as the removal of one security from this bunch of securities. The sale of that interest entitlement by itself is therefore viewed by sub-paragraph (c)(i) as the disposition of a separate security carrying that payment right. Sub- Paragraph (c)(ii) refers to cases where there is the separation and individual sale of several payment rights on the underlying security. Each time one or more payment rights is transferred, a separate security is considered to have been issued. By this sub-paragraph, where one or more rights are sold to the one person or to persons jointly, a separate security having that payment rights or those payment rights is considered to have been transferred. For example, if 3 interest coupons of the same underlying security are sold to the same buyer at the same time, the vendor is considered by sub-paragraph (c)(ii) to have transferred one security having those 3 payment rights.

Sub-paragraph (c)(iii) refers to the situation where the holder of the underlying security retains some of the payment rights on the underlying security. In such situations, the taxpayer is regarded as having retained the one security that has attached to it the relevant right or rights so retained.

Paragraph (d) is the provision that allocates the cost of the underlying security across those separate securities where the taxpayer acquired the security on issue. The paragraph looks to the time the security was issued when determining how much of the issue price should be allocated to the separate security. This allocation is based on the proportion of the market value of the separate security at the time when the underlying security was issued as bears to the market value of the underlying security as a whole at that time. Paragraph (c) of sub-section (1) is to the same effect as paragraph (b), except that the paragraph covers the circumstances where the underlying security was purchased on transfer. The same allocation method is used however, i.e., the proportion of the transfer price attributed to the separate security is the fraction ascertained by comparing the market value of the separate security against the market value of the underlying security as a whole at the time it was purchased by the taxpayer.

Sub-section (2) ensures that, where one or more of these payment rights is transferred after 16 December 1984, then, for the purposes of ascertaining whether the security deemed to have been transferred at that time is a qualifying security, the requirement that the security be issued after 16 December 1984 is to be disregarded. This alteration to the tests of a qualifying security is necessary as sub-section (1) attributes the same issue date to the separate security as the underlying security. However, unlike other sections in this Division, there are no balancing adjustments in relation to the time the security was deemed to have been on issue prior to its transfer after stripping. Section 159GZ is only directed at any possible application of the Division to the period after the stripped coupon is transferred.

Sub-section (3) defines what is meant by a "payment right" in the preceding sub- sections. A payment right in that context includes any right to receive a payment under the security, be it periodic interest, partial redemption, redemption or other payment under the security.

Sub-section (4) is concerned with the allocation of the cost of an underlying security when, rather than separating the payment rights attached to that security, the taxpayer issues new securities (referred to as "stripped securities" in the sub-section). It could be expected that these new securities would match, either in whole or in part, the face value and timing of payments on the underlying security. Paragraph (a) refers to the fact that the underlying security can be obtained at any time, either on issue or by transfer. Paragraph (b) requires, for the purposes of the application of the sub-section, that the taxpayer issue a qualifying security after 16 December 1984. Such a security is referred to as the "stripped security" in the remainder of the sub-section. Paragraph (c) is the final test in the application of the sub-section and requires that, apart from the sub- section, the taxpayer would be entitled to a deduction for the issue price or transfer price of the underlying security.

Upon the satisfaction of all three tests, sub-section (4) allows a deduction, in relation to the sale of each stripped security, for the issue or transfer price of the underlying security on a proportional basis, i.e., on the proportion that the market value of the stripped security at the time the underlying security was issued or purchased bears to the market value of the underlying security as a whole at that time. This method of allocating the cost of the underlying security is designed to ensure that particular stripped securities are not allocated a disproportionate amount of that cost.

An example that illustrates the determination of deductions allowable to issuers of stripped securities under sub-section (4) follows:

Example

In September 1985 a financier acquired at face value $100 million of Treasury Bonds maturing in 10 years time and paying interest every 6 months at an interest rate of 13.5 per cent per annum. On 30 September 1985 it offered separately at various discounts the entitlements to the principal and to each 6 monthly interest payment.

The yields offered on each entitlement, the consequential issue prices, and the amounts sold by 30 June 1986 were:

Under present law, the issuer's taxable income for 1985-86 would include the proceeds of sales of entitlements in that year ($76.66 million) less the cost of acquiring the underlying Treasury Bonds ($100 million). There would be a net loss of $23.44 million from the transactions, to be set against income from other activities.

Under the new arrangements the $100 million paid to acquire the underlying Treasury Bonds would be broken up and allocated among the sold and unsold portions of each of the entitlements offered, and only the amounts allocated to the entitlements which had been sold would be deducted from the $76.66 million of proceeds of sales.

Provided that the purchase prices at which the entitlements were offered could be taken as their market values, the allocation of the cost of the Treasury Bonds would be as follows:

There would therefore be a profit of $1.88 million from the transactions ($76.66 million less $74.78 million) to be included in taxable income. The $25.22 million of cost allocated to unsold entitlements could be offset against proceeds of sales of those entitlements in later years and the net amount included in taxable incomes in the years the sales were made.

Clause 17: Rebate in respect of annual leave, long service leave and eligible termination payments

This clause will amend section 160AA of the Principal Act. which provides a rebate of tax to limit to no more than 30% the rate of tax on lump sum payments on termination of employment in lieu of unused annual leave and long service leave and on the post-June 1983 component of lump sum superannuation and kindred termination payments (called eligible termination payments). Where the recipient of an eligible termination payment is aged 55 or more, section 160AA further limits the rate of tax on the first $55,000 of the post-June 1983 component to no more than 15%.

Section 160AA operates by first determining -

•

the part of any rebatable termination payment (or payments) included in a taxpayer's taxable income that, having regard to the zero rate threshold (currently $4,595), where appropriate, is actually subject to tax - referred to in the law as the "relevant income amount"; and

•

the tax (the "additional tax amount") that is attributable to, broadly, the "relevant income amount".

The taxpayer's rebate entitlement is then calculated, under existing paragraph 160AA(1)(d), by deducting from the "'additional tax amount" the sum of -

•

15% of the part of the "relevant income amount", if any, to which the 15% maximum rate of tax applies; and

•

30% of the remainder of the "relevant income amount" - i.e., the part which is to be subject to tax at a maximum rate of 30%.

The excess, if any, is allowable as a rebate, so that the tax on the "relevant income amount" at marginal rates of tax is reduced where it exceeds the tax calculated at the maximum 15% and/or 30% rates.

However, because of a combination of the way in which the rebate is calculated - i.e., on the basis that the lowest marginal rate of tax is 30% - and the reduction in the lowest marginal rate (for resident taxpayers) to 25% for 1985-86 (26.67% for 1984-85), the full benefit of the rebate is not available if the taxpayer receives both an eligible termination payment to which the 15% maximum rate applies and a termination payment to which the maximum 30% rate applies and some part of the 30% termination payment is subject to tax at the lowest marginal rate - i.e., it falls within the range of taxable income from (currently) $4,595 to $12,500. The situation may be illustrated by comparing two simple examples:

•

Taxpayer A (aged 55) retires and receives an eligible termination payment (ETP) with a post-June 1983 component of $1,000 (a 15% rebatable amount) and a payment in lieu of unused long service leave of $5,000 (a 30% rebatable amount). A's total taxable income is $13,500. In calculating A's entitlement to a rebate in respect of the termination payments, the income tax of $1,633.50 (at 1984-85 rates) attributable to the rebatable amounts totalling $6,000 is compared to the sum of 15% of the ETP and 30% of the long service leave payment - that is, $1,650. As that tax is less than the latter amount, no rebate is allowable.

•

Taxpayer B (aged 55) retires and receives an ETP with a post-June 1983 component of $1,000 (a 15% rebatable amount) but no other rebatable termination payment. B's taxable income is also $13,500. B's rebate entitlement is calculated as the difference between the income tax of $300 (at 1984-85 rates) attributable to the ETP and $150 (15% of $1,000) - a rebate of $150.

The result is that the tax payable by taxpayer A, with the two rebatable termination payments, is greater than the tax payable by taxpayer B, with the same taxable income but only one rebatable payment.

The amendments proposed by clause 17 will ensure that the appropriate rebate is allowed in cases of the type mentioned in the previous paragraph. By virtue of sub-clause 30(7), the amendments are to apply in respect of income tax assessments for the 1984-85 and subsequent years of income.

By paragraph (a) of clause 17, existing paragraph (d) of sub-section 160AA(1) is to be omitted and replaced by a new paragraph 160AA(1)(d). Under that new paragraph, a taxpayer's rebate entitlement is to be calculated by comparing the "additional tax amount" to the sum of -

•

15% of the "qualifying 15% amount", if any - i.e., the part of the "relevant income amount" to be taxed at a maximum rate of 15% (sub- paragraph (i));

•

25% of the "qualifying 25% amount", if any - i.e., the part of the "relevant income amount", not being a "qualifying 15% amount", that falls to be taxed at the lowest marginal rate (sub-paragraph (ii)); and

•

30% of the remainder of the "relevant income amount" (sub-paragraph (iii)).

with any excess of the "additional tax amount" over that sum being allowed as a rebate of tax. The terms "additional tax amount" and "relevant income amount" are defined in sub-section 160AA(2) of the Principal Act and are discussed in the preceding notes. Definitions of the terms "qualifying 15% amount" and "qualifying 25% amount" are being inserted in sub-section 160AA(2) by paragraph (c) of this clause.

The new rebate calculation takes into account the fact that, in the case of resident taxpayers, part of a 30% rebatable termination amount may lie in the range of taxable income to which the 25% (for 1985-86) tax rate applies. By sub-clause 30(8), references in section 160AA as proposed to be amended are, in relation to 1984-85 income tax assessments, to be read as references to 26.67%.

Paragraphs (b) and (c) of clause 17 will insert four new definitions necessary for the operation of section 160AA as proposed to be amended by paragraph (a) of the clause -

"non-15% taxable income" and "notional (non-lump sum) taxable income" are terms used in the proposed definition of "qualifying 25% amount". The "non-15% taxable income" is the amount by which taxable income exceeds the "qualifying 15% amount" (a new definition - see below) and the "notional (non-lump sum) taxable income" is the amount by which taxable income exceeds the "relevant income amount" (a term already defined to mean, broadly, the part of taxable income representing a rebatable termination payment actually subject to tax - see earlier notes). Those two amounts will enable identification of the part (the "qualifying 25% amount") of a rebatable termination payment, other than the part that is to be subject to tax at a maximum rate of 15%, that falls within the range of taxable income from $4,595 to $12,500, so that for resident taxpayers it attracts the 25% marginal tax rate for 1985-86.

"qualifying 15% amount" is a term used to quantify the part of the post-June 1983 component of an eligible termination payment which is to be taxed at a maximum rate of 15%. It is that part of the post-June 1983 component (or the sum of those components where there are 2 or more payments) as does not exceed the lesser of the "residual amount" and the "relevant income amount". By new sub-paragraph 160AA(1)(d)(i), only 15% of that part will be included in the amount that is compared to the "additional tax amount" for the purpose of calculating any rebate allowable. The "residual amount" is a term already defined to mean, in effect, the available balance of the $55,000 limit on the amount of an eligible termination payment that, where the recipient is aged 55 or more, attracts the 15% maximum rate. The terms "relevant income amount" and "additional tax amount" are discussed in earlier notes.

"qualifying 25% amount" is, as already mentioned, the part of a rebatable termination payment, other than the part that is to be subject to tax at a maximum rate of 15%, that falls within the range of taxable income from $4,595 to $12,500, so that for resident taxpayers it attracts the 25% marginal tax rate for 1985-86. By new sub-paragraph 160AA(1)(d)(ii), only 25% of that part of the payment will be included in the amount that is compared to the "additional tax amount" for the purpose of calculating any rebate allowable. There is a "qualifying 25% amount" only where the taxpayer is a resident and the "notional (non-lump sum) taxable income" (i.e., taxable income other than rebatable termination payments actually subject to tax) does not exceed $12,500. In other words, some part of the rebatable termination payments must attract the 25% marginal rate for 1985-86. In those circumstances, the "qualifying 25% amount" is the excess of $12,500 - or, if the amount of the "non-15% taxable income" (i.e., taxable income other than the component of an eligible termination payment to which a maximum rate of 15% applies) is less than $12,500, the excess of that amount - over the "notional (non-lump sum) taxable income".

The first income year in respect of which the lowest marginal rate of tax for resident taxpayers was less than 30% was the 1984-85 year of income - that rate being 26.67%. A rate of 25% applies for the 1985-86 year of income. Therefore, by sub-clause 30(7). the amendments made by clause 17 are to first apply in income tax assessments for 1984-85 and, by sub- clause 30(8), in applying section 160AA as amended by clause 17 to 1984-85 assessments, references to 25% are to be read as references to 26.67%. Clause 29 provides for assessments made before the Bill receives the Royal Assent to be re-opened to give effect to the amendments.

Clause 18: Interpretation

As part of the pay-as-you-earn system, section 221C of the Principal Act requires an employer to deduct tax instalments from payments of "salary or wages", a term given an extended meaning by the definition contained in section 221A. Clause 18 will amend the definition of "salary or wages" to effectively bring within the scope of the tax instalment deduction system the Commonwealth Formal Training Allowance paid by the Department of Employment and Industrial Relations, other than any component of the allowance corresponding to a mother's/guardian's allowance, additional assistance in respect of a dependent child, remote area allowance or rent assistance that is to be exempt from tax (refer notes on clause 5).

Clause 19: Interpretation

This clause will amend the definition of "interest" in sub- section 221YK(1) of the Principal Act. That sub-section contains the definitions of "dividend" and "interest" for the purposes of the provisions governing the collection of withholding tax. At present. the definition of "interest" in sub-section 221YK(1) refers to the definition of interest in sub-section 128A(1) for the purposes of the existing provisions of Division 11A of Part III of the Principal Act. However, by the new sections to be inserted in that Division by clause 12 of this Bill, other amounts are to be deemed to be income that consists of interest, i.e., profits on transfers of qualifying securities pursuant to new section 128AA; charges under hire-purchase agreements and similar financing arrangements pursuant to new section 128AC and the discount element of indemnification or reimbursement payments to offshore acceptors of bills of exchange and promissory notes pursuant to new section 128AD. With these changes, it is no longer sufficient for the definition of "interest" in the collection provisions to refer only to amounts that are interest or are amounts in the nature of interest. The proposed change in this definition to refer to any amount that is, or is deemed to consist of, interest for the purposes of Division 11A will ensure that the collection provisions, with minor changes set out later in the notes, will be consistent with the liability provisions of Division 11A as proposed to be amended by this Bill.

Clause 20: Deductions from dividends and interest

This clause will amend sub-section 221YL(4) by inserting in this sub- section a reference to amounts deemed to be interest by sections 128AA, 128AC and 128AD. The effect of those new sections is described in the notes earlier in this memorandum.

Sub-section 221YL(4) provides, in effect, that there is no obligation to deduct withholding tax in relation to a dividend that is not paid in money or is not credited to a person. However, sub-section 221YP(1) provides that any such dividend must not be passed on to the non-resident shareholder entitled to it until an amount equal to the withholding tax has been lodged with the Commissioner. The amendment of sub-section 221YL(4) proposed by this clause will place the same requirement on the amounts deemed to be interest by new sections 128AA, 128AC and 128AD.

Clause 21: Effect of section 128AB certificates and section 265B notices

This clause will insert a new section - section 221YMA - in Division 4 of Part VI of the Principal Act. This section will clarify the operation and effect of certificates issued by the Commissioner of Taxation pursuant to new section 128AB (see earlier notes in relation to that section) and notices prepared by issuers of securities pursuant to new section 265B (which is discussed later in this memorandum).

One of the purposes of a section 265B notice is to clarify whether the security is a qualifying security for the purposes of new section 128AA, which will effectively render withholding tax applicable where a non-resident transfers a qualifying security to a resident and require that the amount to be subject to withholding tax be the excess of the transfer price over the issue price of the security. Another purpose of a section 265 notice is to specify the issue price for those purposes. Basically, section 221YMA(1) authorises a resident purchaser of a qualifying security from a non- resident to rely on the information shown in a section 265B notice supplied by the non-resident. Reliance on this information is necessary as withholding tax must be deducted at the time of the transaction and can only be deducted from known amounts.

Proposed sub-section 221YMA(2) refers to the situation where, for some reason, the non-resident has obtained 2 or more notices under section 265B in relation to the security. If the non- resident presents all notices to the resident, sub-section (2) specifies that the resident is to use the notice that was issued last.

Sub-section (3) is concerned with the effect of a certificate issued by the Commissioner under section 128AB. As discussed earlier in these notes, such a certificate may be issued to a non-resident where the Commissioner is satisfied that the security was acquired direct from a resident otherwise than on issue. There are two occasions where these certificates may be used. The first is where the security is transferred to a resident. The other is where the security is to be redeemed or partially redeemed and the non-resident presents the issuer with the certificate (paragraph (b)). The actual effect of the certificate is the same in both cases - the amount specified in the certificate as the transfer price paid by the non-resident is to be substituted, by paragraph (c), for the issue price of the security when determining the withholding tax liability of the non-resident in relation to the transfer or the redemption or partial redemption. Also, as the price specified in the certificate should represent the market price of the security at the time of transfer, paragraph (d) specifies that any partial redemptions of the security that occurred before the date shown on the certificate as the transfer date are to be disregarded.

As with proposed sub-section (2), should a non-resident have 2 or more certificates in relation to the same security, the resident purchaser or issuer is directed by sub-section (4) to have regard only to the certificate that has the latest issue date.

Sub-section (5) is basically an administrative measure designed to provide guidance for resident purchasers or issuers where, although the non-resident has a certificate expressed to be issued under section 128AB the non-resident does not present that certificate at the time of transfer or redemption or partial redemption. In such a situation, the purchaser or issuer is to deduct withholding tax as if no certificate had been issued. A purchaser who does not deduct withholding tax on that basis in those circumstances may be subject to the additional tax and penalty provisions of Division 4 of Part VI. It is not enough that the resident claims to have such a certificate - to be effective, the certificate must be presented either at or before the transfer, redemption or partial redemption.

Sub-section (6) is a drafting measure of an interpretative nature designed to ensure that expressions used in new Division 16E that are also used in this section have common meanings (paragraph (a)) and that the consequences of a variation in the terms of a security or of dealings in stripped securities have the same impact on the operation of this section as they do in Division 16E.

Clause 22: Dividends, & c., not in money not to be paid until payment made to Commissioner on account of tax

Section 221YP of the Principal Act provides, in effect, that dividends not paid in money or credited to a person and that would be subject to withholding tax but for the operation of sub-section 221YL(4) are not to be paid, credited or distributed to the person until an amount equal to the withholding tax has been lodged with the Commissioner. This clause will insert a new sub-section (3A) in section 221YP, so that the section will have like effect in relation to amounts deemed by new sections 128AA, 128AC and 128AD to be interest for interest withholding tax purposes .

Clause 23: Liability of person who fails to make deductions, & c.

This clause will amend sub-section 221YQ(1) so that a person who contravenes new sub-section 221YP(3A) (refer notes above on clause 22) will be liable, in addition to any other penalty to which he may be liable, to pay to the Commissioner an amount equal to the withholding tax involved and any unpaid additional tax payable under sub-section 128C(3).

Clause 24: Credits in respect of deductions made from dividends and interest

This clause will amend sub-section 221YS(2) of the Principal Act as a consequence of the amendment proposed by clause 22 to section 221YP (see notes on that clause above). The amendment of sub-section 221YS(2) to be made by the clause will ensure that a credit is allowed to the person in respect of whom an amount is lodged with the Commissioner under new section 221YP(3A) in relation to a payment other than an amount deemed to consist of interest for withholding tax purposes by new section 128AA, 128AC or 128AD.

Clause 25: Credits in respect of amounts assessed under Division 16E of Part III

This clause will insert new section 221YSA in the Principal Act. This section will deal with circumstances where, for part of the period the taxpayer held the security, he or she was a resident and was taxed on the accruals basis of assessment under new Division 16E on a part of the yield under the security but, at the time any payment was made, the taxpayer was a non-resident liable for withholding tax in relation to that payment.

The operation of the section centres on the presence of what is referred to in the section as a "net Division 16E amount". The amount is defined in sub-section (4) as the excess of the amounts included in the taxpayer's assessable income by virtue of new section 159GQ and new section 159GR over amounts allowed as a deduction under either of those sections. This net Division 16E amount is the amount that would have accrued while the taxpayer was a resident. On becoming a non-resident, the operation of Division 16E is to be suspended by new section 159GN.

Should the taxpayer, on becoming a non-resident, receive a payment in respect of the transfer of the security or simply a payment of accrued interest, withholding tax is required to be deducted from the amount ascertained in accordance with the earlier amendments contained in the Bill. It could be that the taxpayer has already been taxed by the accruals method of assessment under Division 16E, e.g., on the sale of a qualifying security. Section 221YSA is designed to allow the taxpayer a credit for the doubling us in withholding tax paid by the taxpayer as a result of already having paid tax by assessment.

Sub-section (1) set out the conditions that must exist before the taxpayer may apply for a credit of the withholding tax. Paragraph (a) requires that the withholding tax has actually been paid. Paragraph (b) relates the net Division 16E amount to the factual situation. Sub-paragraph (i) refers to transfers of qualifying securities; sub-paragraph (ii) refers to interest being accrued in respect of a payment under a hire-purchase agreement or finance lease arrangement; and sub-paragraph (iii) encompasses other instances where income on a security may be brought to account by the accruals method. Paragraph (c) refers to the position where if the net Division 16E amount was deducted from the deemed interest on the transfer or the payment of interest, the withholding tax payable on that reduced figure would be less than the withholding tax that was paid. Upon these conditions being satisfied, sub-section (1) provides that the taxpayer may apply to the Commissioner for a credit of the amount of excessive withholding tax paid in relation to the transfer or payment.

Sub-section (2) requires any application to be in writing and to set out the circumstances under which the taxpayer considers he or she has been overcharged for withholding tax.

Sub-section (3) directs the Commissioner to allow the credit for the extra withholding tax where he is satisfied as to the accuracy of the information contained in the application. The income tax law permits the Commissioner to offset any credit due to a taxpayer against any other debts the taxpayer may owe to the Commissioner (section 160AN) and the amount of any credit that exceeds the other debts, if any, due by the taxpayer is to be refunded to the taxpayer.

Clause 26: Penalty for false or misleading statement

It is proposed by this clause to amend the penalty tax provisions of section 223 of the Principal Act by adding five additional sub-sections.

Broadly, section 223 imposes a statutory additional tax penalty where a taxpayer, a partner in a partnership or the trustee of a trust estate makes a false or misleading statement or enters into a tax avoidance arrangement for the purpose of reducing a relevant tax liability under the Principal Act.

The need for the additional sub-sections arises, first by the proposal in new section 128AB (to be inserted by clause 12 of the Bill) for a non-resident holder of a security that is a qualifying security for the purposes of that section to obtain from the Commissioner of Taxation a certificate evidencing the purchase price of the security where the holder satisfies the Commissioner that the security was purchased from a resident. The amount shown on such a certificate as the purchase price will govern the withholding tax liability to apply pursuant to new sections 128AA and 128AB on a transfer of the security by a non-resident holder to a resident.

The second reason for the new penalty tax sub-sections is the proposed introduction, by clause 28 of this Bill, of a new section 265B, which will allow the holder of a security to apply to the issuer of the security for the issue of a notice specifying whether the security is a qualifying security (and other relevant information) for the purposes of the new accruals basis of assessment to be introduced by new Division 16E of Part III of the Principal Act (clause 16 of the Bill) or for the purposes of the application of withholding tax in relation to the transfer of such a security by a non-resident to a resident under new section 128AA (where the non-resident does not obtain a certificate from the Commissioner under section 128AB).

The information contained in a section 128AB certificate or a section 265B notice will govern the amount to be subjected to tax under the accruals basis of assessment or by withholding tax. It is also necessary that reliance should be able to be put on the information contained in those certificates or notices. Accordingly, the additional penalty tax sub-sections are directed at ensuring that the existing provisions of section 223 - which, as explained earlier, render a person liable to pay, by way of penalty, additional tax where the person makes a statement, etc. for a purpose in connection with the operation of the Principal Act or the regulations made under that Act that is false or misleading in a material particular - will apply in relation to a section 128AB certificate or section 265B notice or an advice given in relation to such a certificate or notice.

Notes on each of the additional sub-sections to be inserted in section 223 by this clause follow.

New sub-section (9A) will apply where a person to whom a notice has been issued under section 265B gives the notice to another person in connection with the transfer of a qualifying security to that person or where a person gives advice in writing to another person, in connection with the transfer of a qualifying security, of a variation or partial redemption of the qualifying security (either of which will affect the taxable amount in relation to the transfer). Any such statement or advice is to be taken for the purposes of the penalty tax provisions of Part VII of the Principal Act to have been given for a purpose in connection with the operation of the Principal Act, that being a key test for the imposition of statutory additional tax.

Sub-section (9B) will apply where a non-resident transferor of a qualifying security gives, under section 265B, to a resident transferee a notice issued to the holder (which will identify the security as a qualifying security and specify its issue price, thus determining the withholding tax liability of the holder in relation to the transfer under section 128AA) and, after the notice was issued to the holder, the security was varied or partially redeemed (which will affect that withholding tax liability) and the holder did not advise the transferee of the variation or partial redemption. In that case, the holder is, for the purposes of Part VII, to be taken to have made for a purpose in connection with the operation of the Principal Act a statement that the qualifying security was not so varied or partially redeemed - thus attracting the operation of the existing penalty tax provisions of section 223.

Sub-section (9C) relates to the case where a non-resident holder of a qualifying security that was acquired by transfer from a resident and which had previously been acquired by transfer by the holder, subsequently transfers the security to a resident and gives to the resident purchaser a certificate issued by the Commissioner under section 128AB identifying the security and specifying the purchase price paid by the non-resident on acquisition of the security (which will govern the non-resident's liability to withholding tax in relation to the transfer under sections 128AA and 128AB). In that case, the holder is to be taken to have made for the purpose of the penalty tax provisions, a statement that the certificate relates to the "current acquisition transfer", i.e., acquisition by the transferee of the security. This sub-section is directed to the situation where a non- resident transferor supplies to a resident purchaser of a qualifying security a section 128AB certificate that relates to an earlier transfer of the security by the holder and thus provides incorrect information.

Sub-section (9D) will apply where a non-resident holder of a qualifying security that was acquired by the holder by transfer and which had previously been acquired by the holder by transfer on an earlier occasion, gives a section 128AB certificate to the issuer of the security on redemption or partial redemption of the security, and will have a similar operation to sub-section (9C).

Sub-section (9E) is an interpretative provision which provides that expressions used in new sub-sections (9A) to (9D) inclusive will have the same respective meanings as those expressions have in new Division 16E of Part III (clause 16 of the Bill) and that, those sub- sections will also apply in relation to notices, certificates and advices given in relation to securities affected by section 159GV of Division 16E (relating to the consequences of a material variation in the terms of a security) and section 159GZ of that Division (relating to stripped securities).

Clause 27: Assessment of additional tax

It is not proposed to proceed with this clause. Accordingly, no explanation is provided.

Clause 28: Notices in relation to certain securities

The provisions of new Division 16E of Part III of the Principal Act (to be introduced by clause 16 of the Bill) provide for an accruals basis of assessment to apply in relation to a resident holder of a qualifying security. Where the security has been acquired on issue, that basis will apply by reference to the issue price of the security. It will be the excess of the transfer price over the issue price of a qualifying security that will determine the withholding tax liability of a non-resident transferor of such a security to a resident (under section 128AA, to be inserted by clause 12 of the Bill), except where the non-resident transferor obtains a certificate from the Commissioner that specifies, among other things, the purchase price paid by the non-resident on an acquisition of the security from a resident, in which case the measure of the amount subject to withholding tax will be the excess of the transfer price over that purchase price (by section 128AB, also to be inserted by clause 12).

It is basic also to the application of those provisions that one of the criteria for determining whether a security is an affected qualifying security is that it was issued after 16 December 1984. The other criteria specified in the definition of "qualifying security" in sub-section 159GP(1) of new Division 16E will also be relevant to the determination of whether a particular security is an affected security.

Those provisions have been designed against the background that the issue date, issue price and other relevant factors of an affected security will in most cases be known to, or be capable of determination by, persons dealing in those securities, either by the terms of the security or otherwise. However, there would remain occasions where knowledge of part or all of the relevant information will be required for purposes of secondary market dealings. This would be particularly so in the case of a prospective resident purchaser of a security from a non- resident holder, because the original issue date will determine whether or not interest withholding tax applies in relation to the transaction, and the issue price will form the primary basis for determination of the amount subject to withholding tax (by new section 128AA).

This will not be a problem where the non-resident holder of an affected security actually purchased the security from a resident and supplies to the prospective purchaser a certificate from the Commissioner under new section 128AB that evidences the purchase price paid. In that case, the certificate from the Commissioner will identify the security concerned as a qualifying security and the purchase price specified in the certificate will form the basis for the withholding tax liability. However, relevant details will still be required in some other cases. It is necessary, therefore, that the legislation provide a means whereby the relevant information is capable of ascertainment.

Clause 28 proposes the insertion of a new section 265B in the Principal Act, which will facilitate the provision of the relevant information in relation to a security. It will enable, broadly, the holder of a security to apply to the issuer of the security for a notice under that section, and for the issuer of a security that receives such an application to issue such a notice specifying whether or not the security is a qualifying security. Where the notice specifies that the security is a qualifying security, section 265B will also require that the notice specify certain other factors, including the issue price.

Although the obligation to deduct interest withholding tax will rest with the resident purchaser of a qualifying security from a non-resident, section 265B provides that it is the holder of a security who may apply to the issuer of the security for a notice under the section. This is in order to obviate the need for an issuer to provide such a notice to any enquirer. Unless he or she is certain of the facts, a prospective resident purchaser of a security from a non-resident would run the risk of being in breach of the withholding tax provisions of the Principal Act, and of being liable for the attendant penalties (including liability for the relevant withholding tax) if there was a failure to obtain from the non-resident holder either a notice issued to that person by the issuer under section 265B or a certificate issued to the person by the Commissioner under section 128AB.

As indicated earlier, a section 265B notice may also be required by a prospective resident purchaser of a security in the secondary market for the purposes of determining whether the security concerned is subject to the accruals basis of assessment to be introduced by new Division 16E of Part III of the Principal Act and the various provisions of that Division.

Notes on the various sub-sections of section 265B follow.

Sub-section (1) is an interpretative provision which will carry over to section 265B the meanings of expressions used in the section that are defined in new Division 16E of Part III and enable the section to apply, so far as is relevant, to varied securities (section 159GV) and stripped securities (section 159GZ).

Sub-section (2) authorises the holder of a security (as defined in sub- section 159GP(1) of Division 16E), other than a prescribed security for the purposes of section 26C (which is precluded from being a qualifying security by paragraph (b) of the definition of that expression in sub-section 159GP(1)), to apply at any time to the issuer of the security for a notice under the section in relation to that security.

Sub-section (3) sets out the obligations of the issuer of a security who receives an application under sub-section (2) from the holder of the security, in relation to the issue of a notice to the applicant and the contents of the notice.

The sub-section requires a person who has issued a security, within 21 days of receipt of an application from the holder of the security, to issue a notice in writing to the holder. The notice must be expressed to be issued under section 265B; will be required to identify the security concerned; and whether the security is or is not a qualifying security. The expression "qualifying security" for this purpose will have the same meaning as that expression has for the purpose of the interest withholding tax amendments proposed by the Bill in relation to a transfer of such a security by a non-resident to a resident (e.g., section 128AA, to be inserted by clause 12), i.e., a security that would fall within the definition of "qualifying security" in sub-section 159GP(1) - also to be inserted by clause 12 - if paragraph (c) of that definition were disregarded.

As paragraph (c) of that definition will exclude a security with a term of less than one year from being treated as a qualifying security, the issuer of a security will be required to disregard the term of a security when determining whether a security is to be specified as a qualifying security or as not a qualifying security in a notice issued under section 265B.

This means that where a security with a term of less than 12 months meets the tests set out in paragraphs (a), (b), (d) and (e) of the definition of "qualifying security" in sub-section 159GP(1), the issuer will be required to specify in the section 265B notice that the security is a qualifying security.

Where a security is specified in such a notice as a qualifying security, paragraph 265B(3)(b) will require the notice to also state the issue price of the security and details of any partial redemption or any variation by which the security became a qualifying security.

Where a section 265B notice is used by the holder to which it is issued for withholding tax purpose, i.e., where a non-resident holder supplies the notice to a resident purchaser for the purpose of the withholding tax liability that will arise by reason of section 128AA on the transfer of the security by the non-resident holder to the resident, the specification in the notice that the security concerned is, or is not, a qualifying security will be able to be relied upon for that purpose.

However, a qualifying security for the purposes of the accruals method of assessment that is to apply in relation to such securities held by residents under new Division 16E (to be inserted by clause 16), will have the meaning as defined in sub- section 159GP(1) - i.e., the test that the term of the security will, or is reasonably likely to, exceed one year will apply. Accordingly, a holder of a security to which a section 265B notice is issued, or a person to whom that notice is given by the holder, e.g., a prospective purchaser, will be able to rely on a statement in the notice that the security is not a qualifying security where the notice is required for purposes of the accruals method of assessment of the relevant discount or other gain. However, full reliance could not be placed on the notice for those purposes should it state that the security is a qualifying security. In that case, it would still be necessary for the holder or other person to be satisfied that the term of the security exceeded one year before it could be concluded that the accruals method of assessment applied in relation to the security.

Clause 29: Amendment of assessments

Clause 29, which will not amend the Principal Act, is a standard measure that will preclude section 170 of the Principal Act - which sets out the time limits and other circumstances under which an income tax assessment may be amended - from operating to prevent an amendment of an assessment made before the Bill becomes law for purposes of giving effect to Part II of the Bill. Part II of the Bill contains the amendments of the Income Tax Assessment Act 1936.

This clause will be particularly relevant to the accruals basis of assessment that will apply in relation to discounts and other deferred interest gains accruing to resident taxpayers on securities that are qualifying securities for the purposes of that Division issued after 16 December 1984. For example, it will enable any assessment already issued for the 1984/85 year of income to be amended, where appropriate, to apply the accruals basis of assessment, rather than a realisation basis, in relation to such securities.

Clause 30: Application of amendments

This clause, which will not amend the Principal Act, specifies the years of income in which, or the dates from which, various amendments proposed in Part II of the Bill will apply. The clause also contains interpretative provisions relating to certain amendments.

In terms of sub-clause 30(1), the term "amended Act"- means the Principal Act (that is, the Income Tax Assessment Act 1936), as that Act is being amended by this Bill.

By sub-clause 30(2) the amendments proposed by clauses 5 and 8 relating to the exemption of certain components of the Commonwealth Formal Training Allowance will apply to assessments for the 1985-86 financial year and all subsequent years.

Sub-clause 30(3) will ensure that applicable remote area allowance paid during the 1985-86 financial year under a now repealed Repatriation statute will be treated as a prescribed allowance within the meaning of section 79A of the amended Act for that year (see notes on clause 8).

Sub-clause 30(4) will ensure that the amendments made by clauses 6, 10 and 16 - that relate to the introduction of an accruals basis of assessment for certain qualifying securities - apply from 17 December 1984, being the day following the day on which the Treasurer announced the proposal to introduce the accruals basis of assessment in respect of affected securities issued after the announcement date.

An explanation of sub-clauses 30(5) to 30(8) is contained in the notes on the clauses to which each of those provisions relates. Sub-clause 30(8) relates to the amendment being made by clause 17.

PART III - AMENDMENTS OF THE TAXATION ADMINISTRATION ACT 1953

Clause 31: Principal Act

This clause facilitates references to the Taxation Administration Act 1953 which, in this Part, is referred to as "the Principal Act".

Clause 32: Interpretation

This clause will introduce offence provisions relating to the issue and use of notices under proposed section 265B (clause 28 of this Bill) and the use of certificates issued by the Commissioner of Taxation under proposed section 128AB (clause 12 of the Bill). A notice under section 265B or certificate under section 128AB will be relevant to the determination of the withholding tax liability imposed by other provisions of the Bill on a non-resident holder of a security that is a qualifying security for those purposes on the sale of the security to a resident, while a section 265B notice may also affect the application of the accruals basis of assessment which is to apply in relation to resident holders of qualifying securities by other provisions of this Bill.

The clause will add 5 new sub-sections (new sub-sections (12) to (16)) to section 8J of the Principal Act, which, among other things, deals with offences relating to statements made for the purposes of the income tax law. These sections will ensure that, should a holder or issuer of a section 265B notice, or the holder of a section 128AB certificate, make a false or misleading statement in or about the notice or certificate or the contents of the notice or certificate, as the case may be, the issuer or holder will be liable to conviction for an offence against Part III of the Principal Act.

New sub-section (12) refers to the issue and use of a notice expressed to have been issued under section 265B. The three sub-paragraphs specify the circumstances to be covered by the sub-section. Paragraph (a) refers to the issuer of a notice under section 265B. Paragraph (b) refers to the use of the notice by the person to whom the notice was issued in relation to the transfer of the security identified in the notice. Finally, paragraph (c) is directed at the case where the person to whom the notice was issued advises another person, in writing, in relation to the transfer of the security identified in the notice, of a variation in the terms of the security or a partial redemption of that security (which could affect the liability of the holder to withholding tax in relation to the transfer or the application of the accruals basis of assessment in relation to the security).

In each situation referred to, the doing of the action described in the relevant paragraph is to be taken to have been made for a purpose in connection with the operation of a taxation law. The sub-section, will mean that should the notice or advice contain a false or misleading statement the person issuing or giving the notice or advice will be liable to prosecution under the provisions of the Principal Act for the making of a false or misleading statement.

Sub-section (13) of section 8J relates to the use of a section 265B notice in relation to the transfer of a qualifying security where, by virtue of' new section 128AA (see clause 12 of the Bill), the person will be liable to withholding tax in relation to the transfer - paragraphs (a), (b) and (c).

The other paragraphs, paragraphs, (d) and (e) refer to the situation where, after the notice was issued, the security was partially redeemed or its terms varied and the failure of the vendor to advise the transferee in writing that this partial redemption or variation had taken place. This notification is necessary as the calculation of the amount to be subject to withholding tax in relation to the transfer of the security will be affected by the fact that the security has been partially redeemed or its terms have been varied. For example, the amount subject to withholding tax as the result of the transfer is to be calculated, under section 128AA by reference to the "reduced issue price" of the security, i.e., the issue price reduced by the amount of any partial redemption. The notice under section 265B will only detail a partial redemption, if any, that occurred prior to the issue of the notice, so that it will be necessary for the vendor to notify the purchaser of any subsequent partial redemption in order that the correct amount of withdrawing tax can be determined.

Where all the conditions contained in these paragraphs are satisfied, the vendor will be regarded as having made a statement, for a purpose concerning the operation of a taxation law, to the effect that the security was not so varied or partially redeemed. Where new sub-section 8J(13) applies, the person may be subject to the prosecution under provisions of the Principal Act.

Sub-section (14) refers to the use of a certificate issued by the Commissioner of Taxation under section 128AB in relation to the transfer of a qualifying security. The sub-section covers the situation where a person, on a previous occasion or occasions, has been the holder of the qualifying security that is the subject of the present transfer. By paragraph (a), the latest acquisition of the security on transfer is defined as the "current acquisition transfer" for the purposes of the sub-section. Paragraph (b) includes the requirement that withholding tax is liable to be paid under new section 128AA, in relation to the present transfer of the security. Paragraph (c) refers to the use by the person of a certificate issued to that person under section 128AB in relation to the transfer of the security by that person (so that the withholding tax will apply to the excess of the transfer price over the purchase price specified in the certificate). Paragraph (d) incorporates into the section the requirement that the taxpayer had acquired the security by transfer on other occasions before the current holding of the security.

The sub-section specifies, against this background, that, when using the certificate for the purposes of the present transfer of the security, the taxpayer is making a statement that the certificate relates to the circumstances of the last acquisition of the security. Where the certificate in fact relates to an earlier acquisition (and price paid at that time) of the security from a resident, the use of the certificate will constitute an offence under the Principal Act.

Sub-section (15) has the same effect as sub-section (14), but pertains to the use of a certificate expressed to have been issued under section 128AB in relation to a previously held security when the security is to be redeemed or partially redeemed.

Sub-section (16) is a drafting measure that has the effect, for the purposes of proposed sub-sections 8J (12) to (15) of the Principal Act of linking the meaning of terms used in those sub-sections to the meanings of those terms as they are used in new Division 16E of Part III of the Assessment Act (to be inserted by clause 16 of the Bill), and of ensuring that those sub-sections will apply to notices, certificates of advices issued or given in relation to transfers, etc., of securities affected by section 159GV (concerning the consequences of variations in the term of a qualifying security) and section 159GZ (which deals with stripped securities)

In relation to proposed sub-sections 8J(12) to (15) it should be noted that, although sub-sections 223(9A) to (9D) of the Income Tax Assessment Act 1936 being inserted by clause 26, specify broadly similar situations in which additional penalty tax may be imposed, a person cannot, by reason of sub-section 82E of the Principal Act, be liable to both statutory additional tax and conviction for an offence against the Principal Act.

PART IV - AMENDMENTS OF THE TAXATION LAWS AMENDMENT ACT (NO. 4) 1985

Clause 33: Principal Act

This clause facilitates references to the Taxation, Laws Amendment Act (No. 4) 1985 which, in Part IV, is referred to as "the Principal Act".

Clause 34: Commencement

By sub-section 2(4) of the Principal Act, section sub- section 5(3) and sections 13, 17, 20, 21 and 22 of that Act were to come into operation simultaneously with the Veterans' Entitlements Act 1985. As noted earlier in this explanatory memorandum, the abovementioned provisions of the Principal Act amended the Income Tax Assessment Act 1936 as a consequence of, and in anticipation of, the proposal to enact, inter alia, a new Veterans' Entitlements Bill to rationalise and simplify the existing body of Repatriation legislation.

The proposed Veterans' Entitlements Bill has now been enacted but is cited as the Veterans' Entitlements Act 1986. This clause will ensure that the provisions of the Principal Act come into operation on the day on which the Veterans' Entitlements Act 1986 comes into operation - it is expected that that Act will commence on and from 22 May 1986.

Clauses 35, 36, 38, 39 and 40 : Consequential changes

Each of these clauses proposes an amendment of sections 4, 5, 17, 21 and 22, respectively, of the Principal Act to incorporate, wherever necessary, appropriate references to the Veterans' Entitlements Act 986 and the Veterans' Entitlements (Transitional Provisions and Consequential Amendments) Act 1986: see earlier notes on the main features of this explanatory memorandum. The amendment does not affect the practical operation of the Principal Act.

The Veterans' Entitlements Act 1986 is to come into operation on 22 May 1986 and, by sub-clause 2(3) of the Bill, the amendments proposed by these clauses will commence to apply on the same day.

Clause 37: Repeal of section 13

Section 13 of the Principal Act amended section 79A of the Income Tax Assessment Act 1936 by inserting a new definition of "prescribed allowance", which refers to remote area allowances payable to certain welfare recipients under either Social Security or Repatriation legislation. The amended definition was to the same effect as the former definition, except insofar as it referred to the proposed Veterans' Entitlements Act.

As Clause 8 proposes an amendment of the definition of "prescribed allowance" and correctly cites the Veterans' Entitlements Act 1986, section 13 of the Principal Act is unnecessary. This clause proposes the repeal of that section : see also notes on clause 8.

PART V - AMENDMENT OF THE INCOME TAX REGULATIONS

Introductory Note

As indicated earlier in these notes. while the liability for interest withholding tax (IWT) is created under Division 11A of Part III of the Income Tax Assessment Act 1936 (the "Assessment Act"), the procedures for the collection of that tax are contained in Division 4 of Part VI of the assessment act and the Income Tax Regulations. To this end, sub- regulation 54ZF(1) defines "interest" only in terms of amounts that consist of interest or amounts in the nature of interest. Because of the amendments contained in clause 12 of this Bill relating to transfers of qualifying securities, payments under hire- purchase agreements or similar arrangements and indemnification payments on bills of exchange and promissory notes, there is a need to bring the definition of "interest" in sub-regulation 54ZF(1) into line.

There is also a need to ensure that the amendments of the Regulations have effect at the same time as the relevant amendments of the Assessment Act. Accordingly, a consequential amendment of the Income Tax Regulations is being made as part of the package of amendments contained in this Bill.

Clause 41: Income Tax Regulations

This clause provides for the Income Tax Regulations to be cited in this Part as "the Regulations".

Clause 42: Definitions

This clause will substitute a new definition of "interest" in sub-regulation 54ZF(1) which is identical to that proposed in sub-section 221YK(1) of the Assessment Act (by clause 19 of this Bill). By the amendment, interest for the purposes of the Regulations will extend to amounts that are, by other amendments contained in the Bill, to be deemed to consist of interest for the purposes of Division 11A of Part III of that Act.

Clause 43: Amendment or repeal of Regulations

As explained in the introductory note under this Part, the Regulations are being amended by this Part to ensure that they have effect at the same time as the complementary amendments of the Assessment Act. This clause is a formal provision that makes it clear that further amendment or repeal, by regulation, of the amended regulations to be enacted by this Part is not in any way prevented because the Regulations have been amended by an Act of the Parliament.

INCOME TAX (SECURITIES AND AGREEMENTS) (WITHHOLDING TAX RECOUPMENT) BILL 1986

This Bill will formally declare and impose an income tax, by the name of avoided withholding tax, liability for which is to be established by proposed section 128NA of the Income Tax Assessment Act 1936 ("the Assessment Act"). Section 128NA is to be inserted in the Assessment Act by clause 12 of the Taxation Laws Amendment Bill (No. 2) 1986.

The need for a separate Act to impose this tax arises because section 55 of the Australian Constitution only permits an Act imposing tax to deal with one subject of taxation. The enactment of this "taxing Act" will thus ensure that the Constitutional requirements are satisfied.

Clause 1: Short title

This clause provides for the Act imposing avoided withholding tax to be known as the Income Tax (Securities and Agreements) (Withholding Tax Recoupment) Act 1986.

Clause 2: Commencement

By this clause, this Act will come into operation on the same day as the Taxation Laws Amendment Act (No. 2) 1986, which will be the day that Act receives the Royal Assent.

Clause 3: Interpretation

This clause facilitates references to the Income Tax Assessment Act 1936 which, in this Act, is referred to as the "Assessment Act".

Clause 4: Incorporation

As usual in tax matters, legislation of this type is to be read as one with the "Assessment" legislation.

Clause 5: Imposition of tax

This clause has the effect of formally imposing an income tax on the avoided withholding tax amount referred to in proposed section 128NA of the Assessment Act, which would typically arise by the transfer of a qualifying security by a non-resident to a resident at less than its arm's length price. The circumstances under which the tax will be payable are explained in more detail in the notes on clause 12 of the Taxation Laws Amendment Bill (No. 2) 1986.

Clause 6: Amount of tax

Under this clause, the amount of the tax imposed by clause 5 is equal to the amount of the avoided withholding tax amount, as calculated in proposed section 128NA. This means that, where sub-section 128NA(1) applies, the resident purchaser of a qualifying security will be required to pay the whole of the withholding tax avoided by the transfer of the security at less than its arm's length price. Alternatively, where the avoided withholding tax amount stems from other circumstances to which proposed section 128NA will apply, such as the pre-payment of interest under a hire-purchase or similar agreement (sub-section 128NA(2)). the person who made the payment will be required to pay the amount of withholding tax sought to be avoided through the pre-payment.