Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)CHANGE OF TITLE - TAX LAW IMPROVEMENT BILL (No. 1) 1998 - SENATE - Explanatory Memorandum.
General Outline and Financial Impact
A. General outline
This Bill, the Tax Law Improvement Bill (No. 2) 1997, is the third instalment of the rewrite of the income tax law produced by the Tax Law Improvement Project. The first instalment is contained in the Income Tax Assessment Act 1997 (1997 Act) and the second in the Tax Law Improvement Act 1997 which amended the 1997 Act. Both of these Acts apply with effect for the 1997-98 and later income years.
Tax Law Improvement Bill (No. 2) 1997
The first instalment of the rewritten law established the structure and framework for the 1997 Act, which is progressively replacing the Income Tax Assessment Act 1936 (the 1936 Act) . The second instalment comprised areas of law which affected a broad cross-section of taxpayers eg. the general depreciation provisions; and specialist topics relevant to specific groups such as land-holders.
This third instalment builds on the platform provided by the first two instalments and covers areas of the law which are significant for a broad range of taxpayers or specialist groups. It continues to adopt features designed to help people to more readily read, use and apply the new law and, as a result, lower costs of compliance. It is intended to apply with effect for the 1998-99 and later income years.
The Bill includes rewrites of provisions of the 1936 Act that deal with:
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- capital gains and losses;
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- company bad debts;
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- intellectual property;
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- horticultural plants;
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- averaging of primary producers tax liability;
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- environment protection; and
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- above-average special professional income.
These rewritten rules also include some enhancements to the operation of the 1936 Act which will make affected areas of the law simpler, clearer and less burdensome for taxpayers. They do this by:
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- clearly stating the rules;
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- standardising multiple rules that have essentially the same effect;
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- removing unnecessary requirements;
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- reducing some record-keeping obligations;
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- clarifying uncertain or ambiguous law;
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- bringing the law into closer alignment with administrative and commercial practice; and
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- addressing anomalies and inconsistencies.
As well, the Bill contains some transitional and consequential amendments that:
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- amend Commonwealth Acts including the 1936 Act and the 1997 Act that contain references to the existing law, to ensure that they reflect the rewritten provisions; and
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- make amendments closing off the application of provisions in the 1936 Act rewritten in the Bill.
The rewritten law will first apply for the 1998-99 income year.
The content of the Bill is arranged in ten schedules.
The amendments to the 1997 Act are in Schedule 1, in the order in which they will appear in that Act. They are in one schedule to keep all of the rewritten provisions together in the Bill.
The next eight schedules contain transitional and consequential amendments needed for subject areas of the rewritten provisions. For example, the transitional and consequential amendments for the intellectual property provisions are in Schedule 4 and those for horticultural plants are in Schedule 5.
Schedule 10 contains amendments to the Dictionary of defined terms.
Adoption of JCPAA recommendations
The following table lists the amendments to the Bill, and explanatory memorandum references, that give effect to recommendations made by the JCPAA in Report 356 for changes in relation to the Bill:
| Rec. No | Summary of recommendation | Bill or EM reference |
|---|---|---|
| 3 | Omit Division 138 of the Bill (and not include proposed Subdivision 118-F or Division 123) | section 102-20 |
| 6 | Clarify that a payment made to the holder of a unit or interest in a trust out of income previously taxed to the trustee is not subject to clause 104-70 (CGT event E4). | subsection 104-70(2) |
| 9 | Clarify that double taxation cannot arise where an amount is assessable under the ordinary income tax provisions, but not as a result of a CGT event. | subsection 118-20(1) |
| 11 | Include in the Bill or its explanatory memorandum a list of relevant provisions for each CGT event. | Chapter 2.4 of the explanatory memorandum |
| 12 | Clarify that a change of ownership does not occur where there is a mere change of trustee. | subsection 104-10(2) |
| 13 | Clarify that clause 104-20 (CGT event C1: Loss or destruction of a CGT asset) can apply to part of an asset. | subsection 104-20(1) |
| 14 | Make it clear that the adjustment to cost base under clause 104-70 is an annual adjustment. | subsection 104-70(4) |
| 15(a) | Clarify that clause 112-20 also applies where all of the expenditure incurred cannot be valued. | paragraph 112-20(1)(b) |
| 15(b) | Insert references to the relevant CGT event number for each item listed in the table in clause 112-45. | section 112-45 |
| 16(a) | Amend the headings to clauses 118-40 to 118-60. | section 118-40 |
| 16(b) | Clarify that the existing use of a dwelling for income producing purposes will not affect the determination of the six year period. | subsection 118-145(2) |
| 16(c) | Omit or common potential beneficiary from the definition of related business in subclause 118-250(4). | paragraphs 118-250(4) (a) (b) and (c) |
| 17 para 4.42 to 43 | Insert additional signposting. | section 112-35 and section 132-15 |
| 17 para 4.44 to 45 | Include your home as an example of a CGT asset. | subsection 100-25(3) |
| 17 para 4.46 to 49 | Clarify that a CGT event happens even if there is no capital gain or capital loss resulting from the event. | section 102-23 and section 102-25 |
| 17 para 4.50 to 4.51 | Clarify that the 12 month rule is satisfied where there are more than two roll-overs within a company group. | subsection 114-10(4) and (5) |
| 17 para 4.52 to 54 | Replace the word create with reconstruct to more appropriately convey the meaning of clause 121-20. | subsection 121-20(5) |
| 17 para 4.55 to 56 | Omit an appropriately qualified person in clause 121-20. | subsection 121-20(5) |
| 17 para 4.57 to 59 | Clarify in the explanatory memorandum that subclause 122-20(4) is not confined to contingent tax liabilities. | Part 2.15 of explanatory memorandum |
| 17 para 4.64 to 67 | Minor wording changes in clauses 165-93 and 165-117 and in section 165-5 of the 1997 Act. | section 165-93, section 165-117, Item 19 of Part2, Schedule 2 |
| 17 para 4.68 to 69 | Insert a simplified outline for Subdivision 387-C. | section 387-165 |
| 17 para 4.70 to 73 | Clarify that expenditure on obtaining taxation advice incurred prior to 1 July 1989 cannot be included in the cost base. | Item 2 of Part 1 of Schedule 2 |
| 17 para 4.74 to 4.76 | Remove the words for the income year from clause 100-15. | section 100-15 |
| 17 para 4.74 to 4.76 | Clarify in clause 102-1 that amounts otherwise included in a taxpayers assessable income are not also included in a net capital gain. | section 102-1 |
| 17 para 4.74 to 4.76 | In clause 104-90 replace or you acquired it by assignment with and you did not acquire it by assignment. | section 104-90 |
| 17 para 4.74 to 4.76 | Make a grammatical correction in clause 108-10. | section 108-10 |
| 17 para 4.74 to 4.76 | Remove the double negative in subclause 110-30(8). | subsection 110-25(8) |
| 17 para 4.74 to 4.76 | Remove the concept absolutely entitled to the net income of a trust in clause 118-35. | subsection 118-35(3) |
| 17 para 4.74 to 4.76 | Correct the formula. | subsection 140-90(3) |
| 17 para 4.74 to 4.76 | Reword subclause 387-195(2) to more accurately reflect its equivalent in the 1936 Act in relation to horticultural plants. | subsection 387-195(2) |
| 17 para 4.74 to 4.76 | Clarify to whom subclause 387-205(4) applies. | subsection 387-205(4) |
The following table is a quick reference guide to the structure of the Bill:
| Subject and Division nos. in 1997 Act | EM Chapter No. | Consequential and Transitional Schedule No. |
|---|---|---|
| Capital gains and loss provisions Divisions - 100, 102, 103, 104, 106, 108, 110, 112, 114, 116, 118, 121, 122, 124, 126, 128, 130, 132, 134, 136, 140, & 960 | 2 | 2 & 9 |
| Company bad debts Divisions - 165 & 166 | 3 | 3 |
| Intellectual property Division - 373 | 4 | 4 |
| Horticultural plants Division - 387 | 5 | 5 |
| Averaging primary producers tax liability Division - 392 | 6 | 6 |
| Environment protection Division - 400 | 7 | 7 |
| Above-average special professional income Division - 405 | 8 | 8 |
| Dictionary | 9 | 10 |
B. Summary of main changes
In addition to the general improvements in structure, presentation and readability of the areas being rewritten, the Bill makes a number of specific changes to the operation of the law. These mainly facilitate simpler and clearer expression and less arduous compliance requirements.
1. Exemption of personal use assets acquired for $10,000 or less
Change: Base the exemption for personal use assets on acquisition cost instead of disposal proceeds, with the consequence that it will no longer be necessary to keep records about personal use assets that cost $10,000 or less.
Existing law: Disposals of personal use assets are exempt where the disposal proceeds are $10,000 or less. This means that records must be kept of the acquisition holding costs for all personal use assets of any substance as taxpayers do not know in advance how much will be received for them.
Change: Reduce capital proceeds by any amount repaid, for which a deduction is not available. This is a new provision which more equitably reflects the outcome of the transaction and provides symmetry with the corresponding proposed treatment of the buyer.
Existing law: The 1936 Act does not allow a capital gain or loss to be adjusted if the seller subsequently repays any of the consideration.
3. When is a building or a capital improvement a separate asset from land?
Change: Exclude from separate asset treatment certain capital improvements to land and buildings, which entitle the owner to claim capital allowance deductions, but which are not subject to balancing adjustment provisions. This approach simplifies calculation and record-keeping requirements.
Existing law: Improvements on land, such as buildings or other capital improvements, that qualify for an income tax deduction are treated as separate assets. In contrast, property law treats land and improvements as a single asset. This means that the CGT provisions require taxpayers to apportion sale proceeds between land and individual improvements even though this is not required for other income tax purposes.
4. Disposal of asset within 12 months of roll-over
Change: For the transfer of a CGT asset from one entity to another that attracts roll-over relief, indexation is available if the combined period of ownership by both the transferor and the transferee is at least 12 months. Correspondingly, if roll-over relief applies to an entity that replaces a CGT asset with another asset, the 12-month period begins when the original asset (rather than the replacement asset) is acquired.
Existing law: The indexation clock is reset at transfer, meaning that the transferee must own the asset for at least 12 months to get indexation irrespective of how long the transferor owned it. For a replacement asset roll-over, the 12-month period begins at acquisition of the replacement asset (rather than the original asset).
5. Main residence exemption - changing main residences
Change: Extend the period during which an individual can have exemption for two dwellings to six months.
Existing law: If a person moves into a new dwelling before disposing of their old dwelling, the exemption can be claimed for two main residences for up to three months. The extended period allows more time for selling.
6. Main residence exemption - destruction of dwelling and sale of land
Change: Apply the main residence exemption rules to a disposal of vacant land where the dwelling on the land is accidentally destroyed, for example, by bushfire.
Existing law: Under the 1936 Act a person loses the main residence exemption if:
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- the residence is destroyed; and
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- the vacant land on which it stood is disposed of.
Deductions for company bad debts
All the changes made to the bad debt provisions ensure that they are as consistent as possible with the losses provisions.
1. Use of standard continuity of beneficial ownership test and same business test
Change: Adopt, for the bad debt provisions, the continuity of beneficial ownership and same business tests that apply to the losses provisions.
Existing law: Even though the rules are basically the same for deducting bad debts and losses, the structure, and to some extent the content, of the provisions has varied over time. This means the reader must be acquainted with three different sets of provisions that generally have the same application. The process of standardisation adopted in the rewrite makes this unnecessary because the structure of the bad debt provisions, to the extent possible, mirrors that of the losses provisions. This includes placing the bad debt anti-avoidance provisions in a separate Division.
2. Simplified tracing rules for listed public companies
Change: Adopt for bad debts, the simplified rules for tracing beneficial ownership in listed public companies that were developed for the losses provisions.
Existing law: As with the 1936 Act losses provisions, the existing bad debt provisions impose heavy evidentiary requirements on listed public companies when it is necessary to discover beneficial ownership of their shares.
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- The rewrite improves the structure of the intellectual property provisions by:
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- moving all existing capital expenditure provisions for intellectual property into one Division;
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- arranging the other provisions into Subdivisions each dealing with a component of the deduction calculation, or consequences of disposal.
1. Determination of effective life
Change 1: For the first time, provide for an effective life for petty patents that is commercially realistic and takes account of their shorter legal life compared with standard patents.
Existing law: Petty patents, which were introduced into Australia in 1979, are not specifically dealt with in the 1936 Act.
Change 2: Bring the effective life provisions for copyrights, and standard and petty patents issued after the commencement of the rewritten law, into line with the Copyright Act 1968 and the Patents Act 1990 .
Existing law: The 1936 Act has not been updated to reflect the legislative changes to effective life provisions in the Copyright and Patents Acts.
2. Termination value on an arms length disposal for no consideration
Change: Specify, where intellectual property is disposed of at arms length for no consideration, that the termination value is the written-down value.
Existing law: The 1936 Act does not specify what the termination value is in an arms length disposal for no consideration.
3. Consideration for a non-arms length disposal for no consideration
Change: Specify, where there is a non-arms length disposal of intellectual property for no consideration, that the termination value is the greater of written down value and market value.
Existing law: In such a case, the 1936 Act provides only that the termination value be the value applied.
The rewrite improves the structure of the law by placing the main rules first followed by the less commonly used rules. This makes it easier to gain an overview of the circumstances to which the provisions apply.
1. Adoption of defined terms
Change: Clarify the type of expenditure which is deductible by defining the terms horticultural plant, commercial horticulture and horticultural business.
Existing law: The 1936 Act uses terms without defining them. These terms have been defined to provide certainty and clarity.
2. Determination of effective life
Change: Allow the first owner to use a horticultural plant for commercial horticulture to elect to adopt the Commissioners determination of effective life.
Existing law: Under the 1936 Act, it is the owner of the plant at the time when it could first be used for commercial horticulture who can elect to adopt the Commissioners determination of effective life. This is so irrespective of whether they in fact use the plant for commercial horticulture. It is more appropriate that the taxpayer who first uses a horticultural plant for income-producing purposes should make the decision.
Averaging of primary producers tax liability
The rewrite improves the structure of the law as it is designed to provide the answers to common questions, with each question answered in a separate subdivision. It uses meaningful terms for key concepts, defines each term only once, and provides a step-by-step calculation procedure. Guide material, signposting, and graphics also assist readers to understand the law and find their way through it.
1. Continuation of averaging where primary production activities have ceased.
Change: Allow a taxpayer who receives income from a primary production business that has ceased, to continue to even out their tax liability.
Existing law: Only individuals who carry on a primary production business in an income year qualify for averaging in that year. For many years, however, the Commissioner has applied averaging to taxpayers on the basis of continuity of income from year-to-year, even where the business has ceased. The rewritten law incorporates this administrative practice.
2. Permanent reduction in income
Change: Clarify that, when a permanent reduction of income occurs, the taxpayer has a choice whether averaging recommences.
Existing law: It is unclear whether this happens automatically or only at the election of the taxpayer. The Commissioners administrative practice, however, is to recommence averaging only where the taxpayer shows that a permanent reduction has occurred. The rewritten provision is consistent with this.
No policy changes have been incorporated in the rewrite. However, the rewritten provisions help readers to understand and access the law as they:
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- are in plain language;
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- adopt a more streamlined structure;
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- avoid unnecessary use of defined terms; and
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- provide links to other parts of the 1936 and 1997 Acts.
Above-average special professional income
The rewrite improves the structure and accessibility of these provisions by:
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- adopting a simpler process (using steps and tables) for calculating whether a special rate of tax applies to taxable income; and
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- signposting the reader to any specific rules that may apply.
C. Finding tables
This Explanatory Memorandum contains finding tables which cross-reference the existing and rewritten provisions to make it easier to find your way from the existing law to the new law, and vice versa (see Chapter 10).
D. Revenue impact
Overall, the Bill is expected to have a small cost to revenue but this may be made up by more accurate compliance due to greater clarity of requirements. Most measures will have no direct impact on revenue outcomes. Some proposals will result in insignificant, but unquantifiable, revenue costs.
E. Compliance impact
The Bill should achieve a noticeable reduction in compliance costs for those using the parts of the law it deals with. That reduction may not occur because of any single change but from the accumulation and combined impact of many small improvements.
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- The law will be clearer and simpler.
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- The following specific changes will contribute to reduction in compliance costs:
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- Excluding capital improvements from separate CGT asset treatment if the deductible improvement expenditure is not subject to balancing charge on disposal of the CGT asset to which the improvement is made. This simplifies record-keeping and capital gain or loss calculations.
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- Reducing, to a single calculation per year, the adjustment to the cost base of trust investments, irrespective of the number of non-assessable distributions made during an income year. This removes the need for separate calculations when more than one such distribution is made during a year.
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- Including explicit rules for the CGT roll-over on the incorporation of a business. The 1936 Act is expressed in terms of the transfer of a single asset to a company. On the incorporation of a business, the existing law would literally need to be applied separately to each asset that is transferred, rather than to the assets of the business as a whole.
- In addition, numerical examples have been included in the rewrite to assist with calculations.
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- Standardising the provisions for deductions for company bad debts with the losses provisions to the extent possible.
F. Date of effect
All measures in the Bill will apply from the beginning of the 1998-99 income year. For some measures, special transitional arrangements will apply. These are explained in the notes describing those measures.