House of Representatives

Explanatory Memorandum

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

MAIN FEATURES

The main features of the Bills are as follows:

Taxation Laws Amendment Bill (No. 4) 1985

Entertainment Expenses (Clauses 6, 9, 10 and 23)

The Bill will implement the proposal, announced in the 19 September 1985 Statement on Reform of the Australian Taxation System, to deny income tax deductions for entertainment expenses.

Under the existing law, deductions are allowable for losses or outgoings incurred in entertaining existing or prospective clients, business associates, employees and others, provided the expenditure is incurred in the course of gaining or producing assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

With certain exceptions, entertainment expenses incurred after 19 September 1985 will no longer be tax deductible. Typical of the kinds of entertainment expenses that will no longer attract deductibility include those on business lunches and drinks, dinners, cocktail parties, staff social functions, sightseeing tours, sporting or theatrical events, and hospitality to selected guests at product launches or film premieres. Hostess allowances paid by employers to spouses of employees will not be deductible.

The following expenses will not fall within the general entertainment deduction prohibition:

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expenditure in the ordinary course of a business carried on for the purpose of providing entertainment (e.g., expenditure incurred in the operation of a theatre);

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entertainment made available to the general public for the purpose of business advertising or promotion (e.g., shows put on in a retail shopping mall);

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meals that are an ordinary incident of a business seminar;

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the cost of a person's meal while travelling on business away from home, otherwise than in the course of entertaining a client, etc.;

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the cost of overtime meals of an employee provided pursuant to an award or collective industrial agreement;

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expenditure in providing entertainment to the sick, disabled, poor or otherwise disadvantaged persons;

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in-house recreational facilities for employees;

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meals provided to employees (including directors) in an in-house dining facility or provided on-the-job to staff of restaurants, hotels and motels.

Special rules will apply with effect from the date of introduction of the Bill to deny deductions for the cost of meals provided to clients and other guests in in-house dining facilities.

Where an entertainment allowance is paid by an employer to an employee, deductions will continue to be available to the employer for payment of the allowance, but the employee will not be allowed a deduction for entertainment expenditure paid for from the allowance.

There will be a number of safeguarding provisions.

One will ensure that taxpayers cannot misuse the exceptions that relate to expenses incurred by persons who are in the entertainment business or who provide public entertainment for the purpose of promotion or advertising. Those exclusions will not apply if, through re-arrangement of supply contracts, taxpayers purport to charge for entertainments of the kind that were previously provided gratuitously to customers or clients.

Another will make sure that, where a hostess allowance for entertainment is given to the spouse of an employee, the exception for employee allowances cannot be availed of by the device of making the spouse an "employee".

The cost of entertainment that is paid for as part of a "package deal", e.g., for advertising services, will not be deductible. An example would be where a private viewing box is provided to a firm sponsoring a particular sporting event. In such cases, if the relevant contract does not separately specify the cost of the entertainment component or where the entertainment is provided under a collateral arrangement, the Commissioner of Taxation will be authorised to make a reasonable estimate of that component.

The general rule of non-deductibility of entertainment expenses will also extend to plant and equipment that is used in, or in connection with, the provision of entertainment. Depreciation allowances will not be available in respect of plant used after 19 September 1985 to the extent to which it is used for the purpose of providing entertainment of a "non-deductible" kind.

The rule will also apply to entertainment expenses incurred in being elected as a member, or in contesting an election for membership, of the parliament of the Commonwealth or a State or of a territory or local government body. To the extent that any such expenditure is incurred after 19 September 1985 in entertaining others - except where the entertainment is generally extended to the public - it will not be deductible. Deductions will not be denied, however, for the cost of a candidate's own meals whilst travelling away from home (unless in the course of entertaining someone).

Substantiation Requirements (Clauses 9, 14 and 23)

Subject to specific exemptions outlined below, the amendments proposed by the Bill will make it a requirement for deduction that documentary evidence be maintained to substantiate relevant employment-related expenses, and car and travel expense claims. Expenses in contesting an election for membership of a State or Commonwealth Parliament or territory or local government body will be subject to the substantiation requirements. The documentary evidence will need to be available on official request but it will not be necessary - nor is it intended - that such evidence be attached as a matter of course to income tax returns.

Substantiation requirements are to apply to most employment-related expenses. Examples include expenses incurred in deriving salary and wage income including such items as protective clothing, trade journals and subscriptions to trade, business or professional associations.

The general rule is that an expense will be regarded as substantiated only if a taxpayer is able to produce a receipt, invoice or other documentary evidence that shows the amount, date and essential character of the expense. For individual items of expenditure of less than $10 which total less than $200 in a year of income, a taxpayer will be entitled to maintain a contemporaneous record of the expenditure instead of individual receipts. A relieving provision will also apply where a person is able to demonstrate that records have been lost through circumstances beyond his or her control or where it would be impractical to obtain receipts.

More detailed substantiation requirements are to apply in relation to car expenses; although as explained below, there will also be alternative standard claims available in certain cases.

The requirements will extend to claims relating to the use of passenger cars, station wagons, mini buses, panel vans, utilities or other small capacity commercial vehicles; although taxis, panel vans, utilities and non-passenger commercial vehicles, the private use of which is restricted to from home to work travel are to be excluded from the new requirements.

In addition to the need to be able to verify actual expenditure on, for example, registration, insurance, petrol and service charges, taxpayers seeking to deduct the business proportion of those expenditures are to be required to maintain daily log books or similar records in which details of business trips are recorded.

Alternative arbitrary bases for deduction without full substantiation are to be available for car expenses.

Where annual business use exceeds 5,000 kilometres the taxpayer will be entitled to claim a deduction equal to 1/3rd of relevant expenses and costs or, alternatively, a deduction equal to 12% of the purchase price of the motor vehicle. Where the vehicle is acquired under a lease, the 12% deduction will be based on the market value of the vehicle on entry into the lease. The value on which the 12% deduction is to be based will be subject to the limit under the existing law on the cost price of cars for depreciation purposes. The current limit for these purposes is $26,660.

Where the 1/3rd of annual vehicle costs option for deduction is adopted, the taxpayer will be required to meet the basic substantiation requirements as to documentation of expenditure but will be relieved of the requirement to maintain log books as to the business proportion of kilometres travelled. Where the 12% of cost basis of deduction is adopted, the taxpayer will only be required to substantiate the purchase price.

For cars with an estimated business use in a year of less than 5,000 kilometres, the taxpayer will be entitled to a deduction determined by applying a standard rate per kilometre. For these purposes the standard rates are to be prescribed by Regulation. Under this option, a taxpayer will not be required to maintain documentation relating to expenses; nor will full substantiation of business kilometres be required. Rather the deduction is to be allowable on the basis of detailed and reasonable estimates of business use.

More stringent rules are also to apply to substantiate the business purpose of overseas travel and extended domestic travel. In addition to the basic substantiation requirements evidencing expenditure, it will also be necessary to maintain a diary of business activities conducted during the trip.

In addition, the amendments proposed by the Bill will deny deductions for travelling expenses in respect of a spouse who accompanies an employee or self-employed person on a business trip. This exclusion will not apply where there is a genuine and substantial business purpose for the spouse's presence, independent of the fact of being the spouse of the person. These rules will extend to de facto partners and other relatives.

Two general exclusions from the substantiation requirements are to apply to employment-related expenses of employees. Under the first of these, substantiation will not apply to claims within the limits of reasonable domestic travel and meal allowances paid under the terms of an award relating to the provision of overtime meals. Claims which exceed the amount of reasonable travel or overtime meal allowances or which are made in respect of allowances that are excessive in amount, will be subject to the substantiation requirements.

The other general exclusion from the substantiation requirements is for employment-related expenses (including employees' car and travel expenses) where aggregate claims in the particular income year do not exceed $300.

The substantiation requirements are to apply with effect for the income year commencing 1 July 1986, so that documentary evidence of expenditure incurred on or after that date will be required. Log books (in relation to car expenses) and diaries (in relation to travel expenses) will similarly be required from that date. As a general principle, employees will be required to maintain records for a period of 3 years and 6 months from the date of lodgment of the return in respect of which the claims are made. To the extent that the documentary evidence relates to expenses incurred in carrying on a business - which may be the case for car or travel expenses - the basic retention period will be 7 years.

Taxation of public trading trusts (Clauses 15 and 16)

The Bill will give effect to the proposal, announced in the 19 September 1985 Statement on Reform of the Australian Taxation System, to extend the corporate unit tax arrangements of Division 6B of Part III of the Income Tax Assessment Act 1936 ("the Assessment Act") to public unit trusts which operate a trade or business.

The taxable income of a public unit trust operating a trade or business will be taxed at the rate applicable to companies - presently 46 per cent. Distributions to unitholders of trust income or other profits derived by the trustee will be taxed on the basis applicable to dividends paid by a company. The measure will be given effect by inserting in the Assessment Act a new Division 6C modelled on the corporate unit trust provisions of Division 6B.

A unit trust will come within the scope of the proposed amendments if, at any time during a year of income, it operates a trade or business and is also a "public unit trust". Public unit trusts of the more traditional kind the business of which is to invest in land or an interest in land for rental purposes, in equities or securities or a combination of these, will not be affected.

Reflecting the basic tests that apply in the existing corporate unit trust provisions, a trust will be a public unit trust in relation to a year of income where its units are listed on a stock exchange, are held by 50 or more persons or are available for investment by the public. With one exception, a unit trust will not be regarded as a public unit trust if 20 or fewer persons hold 75% or more of the beneficial interests in the income or property of the trust.(For this purpose, a person and his or her relatives or nominees will be regarded as one person).

The exception is where one or more persons or bodies exempt from income tax (including governments) hold units in a trust carrying entitlement to 20 per cent or more of the beneficial interest in the income or property of the trust. In such event a unit trust will be taken to be a public unit trust taxable as a company, even though it would not otherwise be one, e.g., because the number of unit holders is less than 50.

The income of a unit trust which, in relation to a year of income, meets the tests specified will be subject to tax at the general company tax rate. Distributions (referred to as "unit trust dividends") made to unitholders out of income or other profits derived by the trustee during a year of income for which the trust has been or will be taxed as a company will constitute assessable income in the hands of the unit holders as if they were dividends paid by a company.

To the extent that the income of a taxable unit trust consists of dividends paid by a company or unit trust dividends paid to it by another unit trust (including a corporate unit trust taxed as a company by Division 6B), the trustee will be entitled to a rebate of tax in the same way as dividend income derived by a public company is rebatable. Unit trust dividends received by a company will also qualify for rebate in the company's hands. The anti-avoidance provisions of the Assessment Act relating to dividend-stripping operations are also to be made applicable to cases where stripping operations are carried out in connection with unit trust dividends paid by a trustee.

The proposed amendments will apply in relation to the 1985-86 year of income and subsequent years for public unit trusts established after 19 September 1985. For trusts established on or before that date, the amendments will first apply to income of the 1988-89 year of income.

A number of related safe guarding measures will support the intended operation of these provisions.

The amendments in relation to public unit trusts are contained in clauses 15 and 16 of Part II of the Bill. Parts III, IV and V of the Bill contain consequential amendments of the Income Tax (Individuals) Act 1985, the Income Tax (International Agreements) Act 1953 and the Income Tax (Rates) Act 1982 respectively.

The Income Tax (Companies, Corporate Unit Trusts and Superannuation Funds) Amendment Bill 1985 will declare and impose tax at the rate of 46% on the net income of those public trading trusts to be subject to the new basis of taxation.

Rates of tax imposed on individuals and trustees generally (Clauses 25 to 28)

The Bill will ensure that rates of tax imposed on individuals and trustees generally will not apply to determine the tax payable by trustees of certain public unit trusts operating a trade or business that, by clauses 15 and 16, are proposed to be taxed as companies.

Taxation agreements with overseas countries (Clauses 29 to 32)

This Bill will amend the Income Tax (International Agreements) Act 1953 as a consequence of the proposal to tax certain public unit trusts operating a trade or business as companies, and to treat distributions to their unitholders as dividends.

Broadly, an effect of the agreements with other countries where foreign tax is paid on income derived by an Australian resident is that a credit is available to the taxpayer for the Australian tax or the foreign tax on the income, whichever is the lesser. Such a credit is not available, however, to companies for foreign tax on dividends that are effectively freed from Australian tax because of the rebate of tax allowable under section 46 or 46A of the Income Tax Assessment Act.

As public unit trusts operating a trade or business and taxed as companies will be entitled to the rebate of tax for dividends from companies and distributions from other unit trusts taxed as companies an amendment proposed by this Bill will ensure that a credit for foreign tax is not available on rebatable dividends derived by those public unit trusts.

Another matter is the rate of dividend withholding tax imposed on Australian dividends paid to a resident of a country with which Australia has a double taxation agreement. The normal rate of dividend withholding tax of 30% is reduced, generally to 15%, for dividends paid to a resident of an agreement country. By these amendments, it is proposed that the same reduced rate be applicable to unit trust dividends paid to a resident of an agreement country.

Rates of tax payable upon incomes other than incomes of companies, etc. (Clauses 33 to 35)

The Bill will amend the Income Tax (Rates) Act 1982 to ensure that the rates of tax declared by that Act for individuals and trustees generally do not apply to determine the income tax payable by a person in the capacity of trustee of a public unit trust operating a trade or business and to be subject to tax as a company.

Water conservation or conveyance expenditure (Clause 11)

The Bill will implement the proposal, announced on 19 September 1985 as part of the Statement on Reform of the Australian Taxation System, to replace the immediate income tax deduction for capital expenditure incurred by a primary producer on conserving or conveying water with write-off over 5 years. Such expenditure, where incurred under a contract entered into after 19 September 1985 and incurred primarily and principally for the purpose of conserving or conveying water, will be deductible by way of 5 equal annual instalments - that is, a 20% deduction will be allowable in the year in which the expenditure is incurred and in each of the subsequent 4 years.

Soil conservation expenditure (Clause 12)

Consequential on the proposed amendments of the water conservation or conveyance expenditure provisions (see notes above), the Bill will also amend the soil conservation expenditure provisions so that, to be deductible, such expenditure must be incurred primarily and principally for the purpose of soil conservation. This "primarily and principally" test, which is to have a counter part in the water conservation expenditure provisions, ensures that the two categories of deduction are mutually exclusive in their application to particular expenditure.

The soil conservation write-off is being extended to apply, where relevant, not only to expenditure in respect of soil erosion or salinity but more generally to expenditure in respect of land degradation. The concession will therefore apply, inter alia, to expenditure incurred in -

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an operation primarily and principally for the purpose of preventing or combating land degradation, otherwise than by the erection of fences; or

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an operation consisting of the erection of fences (including any extension, alteration or addition) primarily and principally for the purpose of excluding live stock or vermin from areas affected by land degradation in order to prevent or limit any extension or aggravation of that degradation and to assist in reclaiming those areas.

These amendments are to apply to expenditure incurred after 19 September 1985.

Taxation of carer's pension (Clause 5)

The Bill will give effect to the 1985-86 Budget announcement to introduce, from 1 November 1985, a carer's pension for people who provide constant care and attention to a severely handicapped age or invalid pensioner spouse or close relative. The carer's pension replaces, and by an amendment proposed in the Bill will be taxed on the same basis as, the former more limited spouse carer's pension paid under the Social Security Act. It will therefore be taxed -

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when paid to a male carer -

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if he is 65 years or older; or

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if the handicapped pensioner for whom he is caring, being a man, is 65 years or older or, being a woman, is 60 years or older; and

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when paid to a female carer -

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if she is 65 years or older; or-

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if the handicapped pensioner for whom she is caring, being a man, is 65 years or older or, being a woman, is 60 years or older.

The service pension formerly paid under Repatriation legislation to a male caring for his severely handicapped service pensioner wife has also been extended to cover persons caring for close relatives, and will be taxed on a similar basis to the former service pension that was payable only to a male carer. The rules outlined above for the social security carer's pension will apply where the handicapped person's service pension is paid because he or she is permanently unemployable. In other service pension cases, the carer's service pension will be taxable irrespective of age.

It has also been necessary to make a number of technical changes consequential on recent amendments of the Social Security Act 1947.

Commutations of immediate annuities (Clauses 7 and 8)

The Bill will also give effect to the proposal, announced on 22 August 1985, to counter a tax avoidance arrangement under which moneys other than retirement or employment termination payments are used to purchase an annuity payable immediately over a specified number of years, but with the intention that the annuity will be commuted in the short term. Under the arrangement, the greater part of the earnings on the principal sum are paid out on commutation so that they become payments subject to concessional treatment under the eligible termination payment provisions of the income tax law that apply to lump sum superannuation payments and similar payments made on retirement or termination of employment. The result is that, instead of the earnings being subject to full marginal rates of tax - as they would be if paid out over the purported life of the annuity or if the moneys were invested else where - they are subject to tax at a rate of no more than 30%, or 15% on the first $55,000 if the recipient is aged 55 or more. Moneys that have no relationship whatever with retirement or employment termination could, by this device, be used to generate earnings subject to concessional tax treatment.

Under amendments proposed by the Bill, earnings paid out on commutation after 22 August 1985 of an immediate annuity purchased on or after 1 July 1983 (the date from which the eligible termination payment provisions of the law first applied) will, to the extent that those earnings relate to moneys other than lump sum retirement or termination payments used to fund the purchase of the annuity, be subject to normal marginal rates of tax. The ability to "roll over"(i.e., preserve for future concessional tax treatment with tax-free accumulations) such annuity earnings by paying them into, for example, an approved deposit fund will also be denied. The amendments will not apply to alter the current concessional tax treatment of earnings related to any component of annuity principal funded by lump sum retirement or termination payments.

Rebate of tax on amounts paid under certain life assurance policies (Clause 18)

Under the existing law bonuses, and other amounts in the nature of bonuses, received by a taxpayer during the first 10 years of policies of life assurance issued after 7 December 1983 (or during the first 4 years of policies issued after 27 August 1982 and before 8 December 1983) are, by section 26AH of the Income Tax Assessment Act, generally included in the taxpayer's assessable income. If the amount so included in assessable income is in respect of a policy issued by a life assurance company the investment income of which is subject to tax, or by a friendly society, the taxpayer is entitled in his or her assessment for the year of income to a rebate of tax equal to 30% of that amount. The rebate of tax allowed is designed to broadly compensate for the tax paid by the life assurance company in respect of its investment income or paid by the friendly society in respect of its life assurance business.

State government insurance offices are, because of their status as public authorities for income tax purposes, exempt from Commonwealth income tax. Amounts paid on policies issued by those offices and to which section 26AH applies do not therefore presently attract the rebate of tax.

Amendments proposed by this Bill will extend the operation of the existing rebate provisions to assessable amounts received under life assurance policies issued after 27 August 1982 by the Government Insurance Office of New South Wales, the State Government Insurance Office (Queensland) and the South Australian State Government Insurance Commission. Entitlement to the rebate will be available from the commencement date of the existing rebate provisions. In return, the New South Wales, Queensland and South Australian Governments have agreed to reimburse the Commonwealth for the estimated Commonwealth revenue forgone by allowing the rebate.

Amendments contained in the Bill will also remedy a technical deficiency in the rebate provisions by ensuring that the rebate of 30% is available to trustees of taxable superannuation funds and ineligible (taxable) approved deposit funds where, by the operation of section 26AH, the funds' assessable incomes include bonuses, and other amounts in the nature of bonuses, received in respect of life assurance policies. Under the amendments the rebate of tax will apply to trustees of these funds from the year in which the rebate provisions first applied - generally the 1982-83 income year.

Repatriation legislation consequential amendments (Clauses 4, 5, 13, 17, 20, 21 and 22)

The Repatriation Act 1920, which was introduced immediately after World War 1, was the main statute that provided for the payment of pensions and for medical treatment of veterans and their dependants. That Act was subsequently extended to include within its scope World War 2 veterans.

The Repatriation legislation has, however, been characterised by increasing diversification and complexity with separate enactments to cover other conflicts in which Australia has been involved. Moreover, yet further Acts have been passed to deal with particular groups of servicemen and women not otherwise covered by existing laws.

The Veterans' Entitlements Bill 1985, which was introduced into the Parliament on 16 October 1985, is designed to rationalise and simplify the burgeoning body of Repatriation legislation in this area by replacing various Repatriation statutes with one consolidated Act - the Veterans' Entitlements Act 1985 - which is intended to come into operation on 5 December 1985.

As a consequence of those changes, this Bill will amend several provisions of the Income Tax Assessment Act 1936 (the 'Assessment Act') to ensure that references to repealed Repatriation statutes are replaced by references to the Veterans' Entitlements Act 1985. These amendments, which will operate on and from 5 December 1985, are not substantive in nature and will not affect the operation of the relevant provisions of the income tax law.

The Bill will also make a number of technical amendments of the Assessment Act as a consequence of the enactment of the Repatriation Legislation Amendment Act 1985 - Act No. 90 of 1985 - on 6 June 1985. Broadly stated, that Act overcame the effects of a recent High Court decision and implemented other changes to the repatriation system announced by the Treasurer in the Statement of Government Expenditure Saving delivered on 14 May 1985.

One particular change made at that time was to abolish future eligibility for certain pensions then payable under the Repatriation Acts to relatives of ex-servicemen. Such pensions then being paid were continued in force by the amending legislation. Amendment of the Assessment Act, to include appropriate references to the Repatriation Legislation Amendment Act 1985, was over looked at that time, and this Bill will rectify that situation, with effect from 6 June 1985. These amendments are also of a purely technical kind, and will not disturb the practical effect of the income tax law in this area.

Income Tax (Companies, Corporate Unit Trusts and Superannuation Funds) Amendment Bill 1985

This Bill will amend the Income Tax (Companies, Corporate Unit Trusts and Superannuation Funds) Act 1985 to take account of the extension of company tax arrangements to certain public unit trusts operating a trade or business under proposals contained in Part II of the Taxation Laws Amendment Bill (No. 4) 1985. The purpose of the amendments proposed by this Bill is to formally declare and impose at a rate of 46% the tax payable by trustees of the relevant public trading trusts.

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