Revised Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 7 Worker entitlement funds
Outline of chapter
7.1 Schedule 7 to this bill inserts sections 58PA and 58PB into the FBTAA 1986 and amends subsection 136(1) of the FBTAA 1986. These amendments provide an FBT exemption for certain payments to approved worker entitlement funds.
7.2 This Schedule also amends sections 112-50 (item 6 in the table) and 126-125 of the ITAA 1997 and inserts subsection 126-130(2) into the ITAA 1997. These amendments provide an automatic CGT roll-over to a fund that amends or replaces its trust deed in order to be approved as an approved worker entitlement fund under subsection 58PB(2) of the FBTAA 1986.
Context of amendments
7.3 Taxation Ruling TR 1999/5, which was issued by the Commissioner on 19 May 1999, ruled on the FBT treatment of certain payments to trusts by employers. The ruling is considered to apply to payments to worker entitlement funds. The ATO has stated that employers contributing to worker entitlement funds have until 1 April 2003 to comply.
7.4 However, payments made by a worker entitlement fund to an employee are also taxable in the hands of the employee as either ETPs or as salary or wages.
7.5 As a result, payments into worker entitlement funds for employees would be effectively taxed twice - once as a fringe benefit when paid into the fund and once when paid out of the fund.
7.6 An FBT exemption for certain payments to approved worker entitlement funds ensures that these payments are not taxed twice.
7.7 Funds may be required to change their trust deeds in order to satisfy the Commissioner that the criteria in the legislation is met. Satisfying the criteria is necessary before a fund can be prescribed for the purposes of the FBT exemption. A CGT event may occur as a result of such a change to a trust deed.
7.8 A CGT roll-over for a fund that amends or replaces its trust deed in order to be approved as an approved worker entitlement fund under subsection 58PB(2) of the FBTAA 1986 ensures that the fund does not incur a CGT liability as a result of complying with the criteria for the FBT exemption.
Summary of new law
7.9 The amendments will provide an FBT exemption for certain payments to approved worker entitlement funds.
7.10 The FBT exemption is designed to apply only to those payments where the use of a separate fund is necessary in order to provide for the protection and portability of employee entitlements.
7.11 In order for the FBT exemption to apply, the payments into an approved worker entitlement fund must be required under an industrial instrument and be for the purpose of making leave payments or payments when an employee ceases employment.
7.12 For the FBT exemption to apply, contributions must be made to an approved worker entitlement fund. Before a fund can be approved as an approved worker entitlement fund it will have to meet criteria concerning the level of employer control, the use of fund assets, the types of payments that the fund can make and the maintenance of worker entitlement accounts.
7.13 The Commissioner will be responsible for advising the Government and the Governor-General on whether funds meet the required criteria prior to the fund being prescribed by regulation.
7.14 Long service leave funds established and operating by or under Commonwealth, State or Territory legislation are taken to be approved worker entitlement funds without the need for them to be prescribed by regulation.
7.15 The amendments will provide an automatic CGT roll-over for a fund that amends or replaces its trust deed in order to be approved as an approved worker entitlement fund under subsection 58PB(2) of the FBTAA 1986.
7.16 CGT event E1or E2 may occur in relation to a CGT asset when a trust deed of a fund is amended or replaced. This amendment provides CGT relief if the trust deed of a fund is amended or replaced for the purpose of having the fund approved as an approved worker entitlement fund under subsection 58PB(2) of the FBTAA 1986. The CGT roll-over is only provided if the assets and members of the fund do not change as a consequence of the amendment or replacement.
Comparison of key features of new law and current law
| New law | Current law |
|---|---|
| From 1 April 2003, FBT does not apply to payments to an approved worker entitlement fund for leave entitlements or for entitlements when an employee ceases employment, where the payments are required under an industrial instrument. | FBT applies to payments to worker entitlement funds. |
| From 1 April 2003, a CGT liability does not arise when a trust deed is changed for the purpose of having the fund approved as an approved worker entitlement fund under subsection 58PB(2) of the FBTAA 1986. | A CGT liability may arise when a trust deed is changed for the purpose of having the fund approved as an approved worker entitlement fund under subsection 58PB(2) of the FBTAA 1986. |
Detailed explanation of new law
7.17 This amendment will provide an FBT exemption for certain payments made to approved worker entitlement funds.
7.18 The exemption is provided to certain payments into approved funds to ensure that it applies only to payments where the use of a separate fund is necessary in order to provide for the protection and portability of employee entitlements.
7.19 Before a fund can be prescribed by regulation it will have to satisfy certain criteria. The Commissioner will be responsible for determining whether or not worker entitlement funds meet the criteria.
What payments to approved worker entitlement funds will be exempt from fringe benefits tax?
7.20 A contribution to an approved worker entitlement fund must be required to be made under an industrial instrument. An industrial instrument, as defined in the FBTAA 1986, is a law of the Commonwealth or of a State or Territory or an award, order, determination or industrial agreement in force under any such law. This includes registered AWAs, an award or legislation. [Schedule 7, item 1, paragraph 58PA(b)]
7.21 The FBT exemption will not apply to payments made above those required under an industrial instrument. For example, if an AWA requires that the employer contribute $80 per week into an approved employee entitlement fund, but the employer contributes $100 per week, the FBT exemption will apply only to $80. FBT may be payable on the extra $20 contribution.
7.22 The contribution must also be required for the purposes of making leave payments or payments in lieu of leave or payments when an employee ceases employment. Contributions can also be made for the reasonable administrative costs of the fund. Reasonable administrative costs include the reasonable costs of administering the fund, but do not include payments by the fund for the purposes of providing goods or services to workers (other than a fund's own employees), contributors, beneficiaries of the fund or their associates [Schedule 7, item 1, paragraph 58PA(c)]
When is a fund an approved worker entitlement fund?
7.23 A fund will be an approved worker entitlement fund when it is:
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- a long service leave fund established and operating by or under a law of the Commonwealth, State or Territory; or
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- prescribed by regulation but not disallowed by the Treasurer.
[Schedule 7, item 1, section 58PB]
Long service leave funds established under a law of the Commonwealth, State or Territory
7.24 Funds established and operating by or under a law of the Commonwealth, State or Territory for the purposes of ensuring long service leave is paid will be approved worker entitlement funds. [Schedule 7, item 1, subsection 58PB(1)]
7.25 Funds other than those established under a law of the Commonwealth, State or Territory for the purposes of ensuring long service leave is paid will be an approved worker entitlement fund if the fund is prescribed by regulation. Even if the fund has been prescribed, it will not be an approved worker entitlement fund if the Treasurer has declared, in writing, that it is not [Schedule 7, item 1, subsection 58PB(2)] . The declaration will be a disallowable instrument [Schedule 7, item 1, subsection 58PB(3)] .
Criteria that funds must meet before they can be prescribed as an approved worker entitlement fund
7.26 Before a fund can be prescribed by regulation the Commissioner must be satisfied that it meets certain criteria. [Schedule 7, item 1, subsection 58PB(4)]
7.27 The management of the worker entitlement fund and the management of the investments of the fund must be at arm's length from the contributors to the fund and their associates. [Schedule 7, item 1, paragraph 58PB(4)(a)]
7.28 Under the fund's constituting documents, no more than 5% of the total assets of the fund are to be invested in an entity controlled by a contributor or an associate of a contributor. The constituting documents must also specify that the fund cannot provide or facilitate a loan or any other form of financial assistance to contributors or their associates or to those for whom contributions are made or their associates. [Schedule 7, item 1, paragraph 58PB(4)(b)]
7.29 A fund's constituting documents must limit payments from the fund. The limitations on the payments from the fund are to ensure that the main purpose of the fund is the protection and portability of worker entitlements. The fund will be able to make payments necessary to ensure the proper administration of the fund.
Payments from the contributions to the fund
7.30 Under the fund's constituting documents, payments from contributions to the fund can only be made for the following purposes:
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- to pay worker entitlements to persons in respect of whom contributions are made;
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- to make investments to generate income from the assets of the fund;
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- to reimburse contributors who have paid entitlements directly to persons in respect of whom contributions are made;
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- to return contributions to contributors;
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- to pay, for the benefit of a person in respect of whom contributions are made, an ETP (within the meaning of section 27A of the ITAA 1936) into:
- -
- a complying superannuation fund (within the meaning of section 45 of the Superannuation Industry (Supervision) Act 1993 );
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- a complying approved deposit fund (within the meaning of section 47 of the Superannuation Industry (Supervision) Act 1993 ); or
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- a retirement savings account (within the meaning of the Retirement Savings Account Act 1997 );
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- to transfer contributions to another approved worker entitlement fund;
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- to pay the reasonable administrative expenses of the fund;
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- to pay amounts to a contributor's external administrator that would otherwise be payable as a reimbursement to contributors who have paid entitlements directly to persons in respect of whom contributions are made or to return contributions to contributors; or
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- to pay interest on, or to repay, money lent to the fund.
[Schedule 7, item 1, paragraph 58PB(4)(c)]
7.31 Payments to pay worker entitlements to persons in respect of whom contributions are made includes contributions made as required entitlement contributions and to which the FBT exemption will apply if made to an approved employee entitlement fund. It also includes other contributions to which the FBT exemption does not apply and which are subject to FBT when they are made into the fund. [Schedule 7, item 1, subparagraph 58PB(4)(c)(i)]
7.32 The funds also need to be able to undertake investments in order to generate income. As discussed in paragraph 7.28 there are limitations on the investments that the fund can undertake. [Schedule 7, item 1, subparagraph 58PB(4)(c)(ii)]
7.33 The funds will be able to reimburse contributors. Funds may choose to operate in such a way that contributors make contributions to the fund for leave entitlements or for payments when an employee ceases employment but retain the responsibility to pay such entitlements to employees when they fall due. The fund may then reimburse to the contributor the contributions made in respect of those entitlements. Funds will also be able to return contributions to contributors. For example, a contributor may mistakenly make a contribution in excess of that required and the fund will be able to return any excess. Another example may be where a fund makes a reimbursement to a contributor where it is no longer necessary to hold the entitlement because it will never fall due. Where a contributor appoints an external administrator, funds may make reimbursements of or return the contributor's contributions to the external administrator. [Schedule 7, item 1, subparagraphs 58PB(4)(c)(iii ), ( iv) and (viii)]
7.34 Funds will be able to transfer contributions to an approved worker entitlement fund. This may occur if a fund is wound up. The fund can also pay an ETP (within the meaning of section 27A of the ITAA 1936) in respect of a worker directly to a complying superannuation fund, complying approved deposit fund or a retirement savings account rather than directly to the employee. [Schedule 7, item 1, subparagraphs 58PB(4)(c)(v) and (viii)]
7.35 Payments can also be made for the reasonable administrative costs of the fund. Reasonable administrative costs include the reasonable costs of administering the fund, but do not include payments by the fund for the purposes of providing goods or services to workers (other than a fund's own employees), contributors, beneficiaries of the fund or their associates. [Schedule 7, item 1, subparagraph 58PB(4)(c)(vii)]
Payments from the income of the fund
7.36 Under the fund's constituting documents, payments from the income of the fund can only be made for certain purposes. These purposes are:
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- to make payments for the same purposes as payments made from contributions to the fund (other than the payment of worker entitlements);
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- to make payments to contributors to the fund; or
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- to make payments to other persons where the payment is specified in subsection 58PB(5).
[Schedule 7, item 1, paragraph 58PB(4)(d)]
7.37 Any income generated by the fund will be able to be used to supplement contributions in order to make payments that would otherwise be made from the contributions. Payments of worker entitlements from the income of the fund is, however, limited (see paragraphs 7.38 to 7.39). [Schedule 7, item 1, subparagraph 58PB(4)(d)(i)]
7.38 The fund can make payments out of the income of the fund to persons in respect of whom contributions to the fund have been made and where the contribution would be an exempt benefit under section 58PA if the fund were an approved worker entitlement fund. The payment can either be a payment of a worker entitlement where the contribution for that payment would be an exempt benefit under section 58PA if the fund were an approved worker entitlement fund or a payment of some kind other than a worker entitlement. That is, if an employer has placed an employee entitlement into an approved worker entitlement fund of a kind that receives the FBT exemption under section 58PA, then payments can be made out of the fund income to that employee for such FBT exempt worker entitlements or for reasons other than a worker entitlement. For example, the income of the fund can be distributed to that worker. Other worker entitlements, for example a fringe benefit that is not exempt under section 58PA, cannot be paid out of the income of the fund. [Schedule 7, item 1, subparagraphs 58PB(4)(d)(ii) and (iii)]
7.39 It is considered that a worker entitlement would include payments agreed between an employer and a worker in compensation for services rendered by the worker or payments to a worker stipulated in an industrial instrument. A worker entitlement would also include any benefit to be provided to the worker which has been agreed between an employer and a worker entitlement fund. However, an ex gratia distribution of income from the fund would not be considered to be a worker entitlement.
7.40 Before being able to be prescribed, a worker entitlement fund will have to meet criteria on fund records. Under its constituting documents, an account must be kept for each person in respect of whom contributions to the fund are made and the account must be kept in a manner that enables entitlements in respect of the person to be calculated. [Schedule 7, item 1, paragraph 58PB(4)(e)]
7.41 The amendments to the FBTAA 1986 have required, as a consequence, new definitions of 'approved worker entitlement fund', 'entity' and 'external administrator' to be inserted into subsection 136(1) of the FBTAA 1986. [Schedule 7, items 2, 3 and 4]
7.42 This amendment provides a CGT roll-over to a fund that changes or replaces its trust deed for the purpose of having the fund approved as an approved worker entitlement fund under subsection 58PB(2) of the FBTAA 1986 if the assets and members of the fund do not change as a result of the amendment or replacement. [Schedule 7, items 6 to 8, subsection 126-130(2) of the ITAA 1997]
7.43 CGT event E1 (creating a trust over a CGT asset) or E2 (transferring a CGT asset to a trust) can happen in relation to a CGT asset where a trust deed of a fund is amended or replaced. This amendment ensures that no CGT liability arises where a fund amends or replaces its trust deed for the purpose of having the fund approved as an approved worker entitlement fund under subsection 58PB(2) of the FBTAA 1986. This requires that the assets and members of the fund do not change as a consequence of the amendment or replacement.
7.44 The FBT exemption applies to benefits provided on or after 1 April 2003 and the CGT roll-over applies to CGT events that happen on or after 1 April 2003. [Schedule 7, items 5 and 9]
REGULATION IMPACT STATEMENT
7.45 To remove FBT from payments to worker entitlement funds where it is necessary for the payments to be made to the fund in order to provide for the protection or portability of employee entitlements.
7.46 Taxation Ruling TR 1999/5, which was issued by the Commissioner on 19 May 1999, ruled on the FBT treatment of certain payments to trusts by employers. The ruling is considered to apply to payments to worker entitlement funds. The ATO has stated that employers contributing to worker entitlement funds have until 1 April 2003 to comply.
7.47 Provide an FBT exemption for certain payments into approved worker entitlement funds.
7.48 Under this option the FBT exemption applies to certain payments into approved worker entitlement funds. A fund will be approved if it is prescribed by regulation. Before a fund can be prescribed the Commissioner must be satisfied that the fund meets the criteria set out in the legislation. The criteria cover the level of employer control, the use of fund assets, payments from the fund and maintenance of worker entitlement accounts.
7.49 Long service leave funds that are established and operating by or under a law of the Commonwealth, a State or a Territory will be taken to be approved worker entitlement funds without the need to be prescribed by regulation.
7.50 Only certain payments to approved worker entitlement funds will be covered by the FBT exemption. The FBT exemption will apply to payments made to approved worker entitlement funds that are required under an industrial instrument (as already defined in the FBTAA 1986) and are for the purposes of ensuring that an obligation to make leave payments or payments when an employee ceases employment is met.
7.51 Provide an FBT exemption for certain payments into worker entitlement funds that meet relevant criteria, without the need for the funds to be specifically prescribed in regulations.
7.52 Under this option the funds would self-assess whether or not they were covered by the exemption.
7.53 The groups affected by this measure are worker entitlement funds and employers who contribute to worker entitlement funds.
7.54 It is estimated that there are currently around 30 to 40 worker entitlement funds that, under option 1, may apply to the ATO in order to satisfy the Commissioner that the certain criteria for the FBT exemption are met. Under option 2 there would be no requirement that these funds be prescribed, so they would have to self-assess.
7.55 It is estimated that there are around 10,000 employers currently 'active' in respect of worker entitlement funds in the building and related industries. Employers would have to self-assess under both options as to whether the payments they are making into approved worker entitlement funds qualify for the FBT exemption.
7.56 Workers whose entitlements are provided for by payments into worker entitlement funds are also affected by this measure. Without the FBT exemption it is expected that employers would seek to cease contributing to such worker entitlement funds from 1 April 2003 because of the increased cost due to the imposition of FBT.
7.57 Under option 1 there will be some compliance costs involved for the worker entitlement funds that apply to be prescribed for the purposes of the FBT exemption. The funds may be required to provide the ATO with information such as how the funds operate, the documentation that governs their operation and documentation relevant to their establishment. For example, the funds may have to provide the ATO with copies of their trust deeds.
7.58 There would also be compliance costs for the funds associated with self-assessment under option 2, although the costs are likely to be smaller than under option 1. There may also be compliance costs on employers as they would have to inquire whether or not a fund has self-assessed itself as meeting the relevant criteria.
7.59 Option 2 would also provide less certainty to the funds in ascertaining whether or not they meet the criteria for the purposes of the FBT exemption. Option 1 provides certainty for the funds by naming them by regulation. The certainty provided by option 1 is also likely to limit the compliance costs on employers as they may not have to inquire whether or not a fund has self-assessed itself as meeting the relevant criteria.
7.60 Under both options, some funds may be required to change their constituting documents in order that certain payments into them qualify for the FBT exemption.
7.61 Option 1 is estimated to impose a small one-off administration cost on the ATO as the Commissioner will have to determine whether or not funds meet the relevant criteria before they are able to be prescribed by regulation. Option 1 will also involve some minor ongoing costs for the ATO in assessing future funds that may apply and in ensuring that those funds prescribed do not change their arrangements.
7.62 There could also be administration costs under option 2 as a result of funds and/or employers seeking certainty through the ATO rulings system. That is, funds may still seek certainty from the ATO by applying for a class ruling or sponsoring an employer in applying for a private binding ruling. The administration costs of option 2 would be reflective of how many funds sought rulings. If each fund sought a ruling the administration costs of option 2 would approach those of option 1.
7.63 Under both options there may be administration costs involved with employers seeking certainty through the ATO rulings system. That is, employers may seek private binding rulings to determine whether the payments they make to an approved worker entitlement fund satisfy the requirements for the FBT exemption.
7.64 The estimated cost to revenue of the measure is $1 million in 2003-2004, $6 million in 2004-2005, $10 million in 2005-2006 and $15 million in 2006-2007.
7.65 Option 1 provides certainty to the funds, employers and workers through setting out by regulation which funds are prescribed for the purposes of the FBT exemption. The certainty provided by option 1 is likely to reduce the compliance costs on employers as they may not have to inquire of a fund as to whether or not it has self-assessed itself as meeting the relevant criteria.
7.66 Prescribing the fund by regulation will also help to minimise the scope for tax planning opportunities to be undertaken. Without such prescription, that is if option 2 were adopted, there would be more scope for such tax planning opportunities as funds would be able to self-assess.
7.67 The benefit of both options is that they will ensure that the costs to employers in placing certain worker entitlements into approved worker entitlement funds will not increase as a result of the imposition of FBT.
7.68 Consultation on the criteria that the funds would have to meet before being able to be prescribed was undertaken with representatives of worker entitlement funds. As a result of that consultation a number of technical amendments were made to the criteria.
Conclusion and recommended option
7.69 Option 1 is preferred given that the prescription of certain funds by regulation will provide certainty to funds and employers and will minimise the scope for tax planning opportunities.
7.70 It is considered that the possible advantages of the lower compliance costs offered by option 2 due to self-assessment are outweighed by the compliance costs involved with the lower certainty for worker entitlement funds and employers ascertaining whether or not a fund is able to access the FBT exemption.
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