House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 9 The elective financial reports method

Outline of chapter

9.1 This chapter outlines how the election to rely on financial reports operates. The chapter explains:

•

when the taxpayer may make the election;

•

the effect of the election;

•

the timing and quantum of gains and losses that are brought to account for tax purposes from financial arrangements to which the election applies;

•

the circumstances where an election ceases to apply; and

•

the effect of an election ceasing to apply.

Overview of the elective financial reports method

Financial reports method

9.2 The financial reports method allows taxpayers to calculate the gains and losses from financial arrangements by reference to relevant accounting standards. Accordingly, a taxpayer who makes a valid financial reports election can effectively rely on their financial reports (to the extent that they are in accordance with relevant aspects of accounting standards) for the purposes of complying with their tax obligations in respect of relevant Division 230 financial arrangements.

9.3 The purpose of this election is to reduce administration and compliance costs relating to the taxation of financial arrangements.

Election to rely on financial reports

9.4 The requirements that a taxpayer must satisfy in order to make an election to rely on financial reports include:

•

accounting and auditing requirements discussed in Chapter 5;

•

unqualified financial reports - the financial reports which the taxpayer relies upon must not have been subject to a relevant qualification in the auditor's report in the current year or in any of the previous four financial years; and

•

accounting systems - a taxpayer should have robust accounting systems in place which are reliable. Accounting systems with reliable controls and internal governance processes help to ensure compliance with accounting and (other) tax obligations. In the tax context, therefore, the systems, controls and processes must be reliable for the purpose of preparing the entity's tax return.

Commissioner's discretion

9.5 Both the audit and accounting requirements are subject to the Commissioner of Taxation's (Commissioner) discretion that allows the Commissioner to disregard a relevant qualified audit report, or relevant adverse audit or review relating to the accounting systems, for the purpose of determining whether a taxpayer is eligible to make the financial reports election.

Gains and losses from financial arrangements using financial reports

9.6 A taxpayer who makes a valid election to rely on financial reports will be able to calculate the gains and losses from financial arrangements by reference to relevant accounting standards. In other words, a taxpayer who makes a valid financial reports election can rely on their financial reports for the purposes of complying with their tax obligations in respect of relevant Division 230 financial arrangements.

Election ceases to apply

9.7 An election will cease to apply to a financial arrangement if any of the requirements for making the election are no longer satisfied. The election will cease to apply from the start of the income year in which this occurs. Where this happens the taxpayer will make a balancing adjustment gain or loss amount for the financial arrangement.

Context of amendments

9.8 Compared to the current tax law, the other tax-timing methods in Division 230 closely correspond with the financial accounting treatment of financial arrangements. This close correspondence provides opportunities for compliance cost savings. Subdivision 230-F (the elective financial reports method) provides further opportunities to lower compliance costs by, in effect, allowing taxpayers, in certain circumstances, to rely on their financial reports to determine the tax outcomes from their financial arrangements to which Division 230 applies.

Summary of new law

9.9 This chapter is to be read in conjunction with Chapter 5. Chapter 5 outlines a number of the common requirements and criteria that apply to various elective regimes in Division 230, including the regime in Subdivision 230-F, the subject of this chapter.

9.10 Before a taxpayer is able to make an election to rely on their financial reports, the taxpayer must satisfy a number of criteria in addition to the common criteria referred to in Chapter 5. These criteria are designed to ensure a high degree of integrity in the systems, controls and procedures behind the financial reports that the taxpayer seeks to rely on for tax purposes.

9.11 An intention of Subdivision 230-F is to further reduce administration and compliance costs. This is achieved by allowing taxpayers to calculate the gains and losses from financial arrangements by reference to relevant accounting standards. In effect, a taxpayer who makes a valid financial reports election can rely on their financial reports for the purposes of complying with their tax obligations in respect of relevant Division 230 financial arrangements.

9.12 The main requirements that a taxpayer must satisfy in order to make an election to rely on financial reports are:

•

accounting and auditing requirements - discussed as common requirements (common to all elective methods) in Chapter 5; and

•

unqualified financial reports - the financial reports which the taxpayer relies upon must not have been subject to a relevant qualification in the auditor's report in the current year or in any of the previous four financial years. This requirement, which is specific to the elective financial reports method, is discussed later in this chapter. Where this requirement is not satisfied, the Commissioner may waive the audit requirement for specific income years after consideration of certain factors.

9.13 Once an election has been made by a taxpayer, their financial arrangements will be subject to Subdivision 230-F if:

•

the financial arrangement is one to which Division 230 applies;

•

the taxpayer's financial reports recognise the financial arrangement;

•

it is reasonably expected that the overall gain or loss made on the financial arrangement is the same, using the financial reports election, as it would have been had the gain or loss been calculated under the provisions of Division 230 with the exception of Subdivision 230-F;

•

it is reasonably expected that the gain or loss will be recognised at approximately the same time as it would have been recognised had Subdivision 230-F not applied; and

•

it is a financial arrangement which the taxpayer starts to have in the income year in which the election is made or a later income year (or that is subject to a transitional election which is discussed in Chapter 13).

9.14 Where the financial reports election is made, Subdivision 230-F will determine the tax treatment of relevant financial arrangements except where Subdivision 230-E (hedging) applies. Hedging is excluded from Subdivision 230-F because the tax classification of gains and losses on hedges cannot be ascertained from the taxpayer's financial reports.

9.15 An election made under this Subdivision has effect from the income year in which it is made and to all future income years. It is irrevocable.

9.16 An election will, however, cease to apply to a financial arrangement if any of the requirements for making the election are no longer satisfied. The election will cease to apply from the start of the income year in which this occurs. In these circumstances, the taxpayer will be required to calculate a balancing adjustment gain or loss amount for each financial arrangement that is subject to the election.

9.17 Where an election ceases to apply, the taxpayer is able to make a new election when the requirements for making the election are once more satisfied, but this election will only apply to those arrangements the taxpayer starts to have in, or after, the year in which the election is remade.

Comparison of key features of new law and current law

Detailed explanation of new law

Conditions for making an election

9.18 Subdivision 230-F contains a number of specific requirements relevant to the financial reports election that are in addition to those requirements outlined in the 'common requirements chapter' (Chapter 5). Both the generic and specific requirements must be satisfied prior to making an election. This chapter outlines the particular requirements that are specific to Subdivision 230-F.

9.19 For a discussion of the accounting and auditing requirements, refer to Chapter 5. Chapter 5 also discusses which taxpayers are eligible to make a valid election.

Unqualified audit report

9.20 The requirement to have unqualified auditor reports for the current and four previous income years is unique to Subdivision 230-F. An auditor's report in this context is the year end report of an external auditor.

9.21 For an auditor's report to affect eligibility to make a financial reports election, the qualification must be in a respect that is relevant to the taxation treatment of financial arrangements. [ Schedule 1, item 1, paragraph 230-395(2)(c )]

9.22 Thus, it is possible for a taxpayer to have an auditor's report on the taxpayer's financial reports that is qualified, but still be able to elect to rely on the financial reports so long as the qualification is not relevant to the taxation treatment of a financial arrangement.

9.23 Relevance in this context is, however, not confined to a qualification made about the timing and quantification of gains and losses. For example, a relevant qualification may relate to the reliability of the recording of financial arrangements. This, in turn, can affect what is reported in profit or loss, which the financial reports election relies upon for the purpose of determining the taxation treatment of financial arrangements.

Example 9.1 : Qualified accounts

The auditor's report on the financial reports of Scruffy Ltd has been qualified in relation to the amount of directors' fees that have been recognised. As these fees have no impact on the recognition and measurement of gains or losses on relevant financial arrangements, the qualification will not prevent Scruffy Ltd from electing to rely on its financial reports for the purposes of Subdivision 230-F.

9.24 Where an auditor's report is qualified in a relevant respect in the current or four prior income years, the taxpayer cannot make the election to rely on their financial reports.

Accounting systems

9.25 The degree of integrity of a taxpayer's accounting systems and controls is relevant in determining the appropriateness of making an election under this Subdivision. The election under this Subdivision is designed to assist taxpayers in reducing their compliance costs without inappropriate tax outcomes being obtained. As such, there is a requirement that, in order to make a valid election, a taxpayer should have robust accounting systems in place which are reliable. Accounting systems with reliable controls and internal governance processes help to ensure compliance with accounting and tax obligations. In the tax context, therefore, the systems, controls and processes must be reliable for the purpose of preparing the entity's tax return. Remedial action that has been taken in relation to processes that do not impinge on matters relevant to the preparation of the tax return would, for example, typically not lead to the conclusion that the processes are not reliable. Overall, reliance on such systems, controls and processes will reduce tax compliance costs and provide amounts for tax purposes which do not provide an inappropriate tax benefit. [ Schedule 1, item 1, paragraph 230-395(2)(d )]

9.26 External auditors or a regulatory authority or agency may provide opinions on the quality of the accounting systems used by a taxpayer in an audit. Where an adverse assessment has been provided by an external auditor or a regulatory authority or agency on the quality of the accounting systems, this could indicate a system deficiency which may impact on the reliability of the gains or losses brought to tax under Subdivision 230-F. Accordingly, where an external audit, or a review, conducted in the financial year in which the election is proposed to be made or any of the four financial years prior to that year, has included such an adverse assessment of the taxpayer's accounting systems, the taxpayer cannot make the election to rely on their financial reports. [ Schedule 1, item 1, paragraph 230-395(2)(e )]

9.27 It should be noted that internal audits and reviews (or an audit or review of a kind prescribed by regulation) are to be disregarded for this purpose. [ Schedule 1, item 1, subsection 230-395(3 )]

9.28 In determining whether accounting systems, controls and internal governance processes are reliable, regard should be had to the current accounting definition of 'reliable'. The Framework for the Preparation and Presentation of Financial Statements issued by the Australian Accounting Standards Board states, in paragraph 31, that:

'To be useful, information must also be reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent.'

Commissioner discretion

9.29 Subsection 230-405(1) provides the Commissioner with a discretion to disregard a relevant qualified audit report, or relevant adverse audit or review relating to the accounting systems, for the purpose of determining whether a taxpayer is eligible to make the financial reports election. In exercising this discretion, the Commissioner must take account of the following factors:

•

the reason for non-compliance with the particular accounting standard;

•

what remedial action (such as changes to accounting systems and controls and internal processes) has been undertaken to address the non-compliance with the accounting standards;

•

whether the taxpayer is subject to any regulatory oversight (eg, by the Australian Securities and Investment Commission or the Australian Prudential Regulatory Authority) and, if so, any opinions prepared by those regulators in respect of changes to accounting systems and controls, or to internal governance processes; and

•

any other relevant matter.

[ Schedule 1, item 1, subsections 230-405(1) and (2 )]

9.30 While Subdivision 230-F provides the Commissioner with a discretion to disregard paragraphs 230-395(2)(c) and (e), the purpose of the discretion is not to reduce the level of integrity and reliability of financial reports which are required for the purposes of Subdivision 230-F. Rather, the discretion is designed to provide a basis to ensure that the compliance cost saving in Subdivision 230-F will be available to a taxpayer despite not technically being able to satisfy paragraphs 230-395(2)(c) and (e) - refer to Chapter 5 for discussion of these factors.

9.31 Particular emphasis is to be placed on what, if any, external regulation or review the taxpayer is subject to. That is, independent verification by an external regulator as to the quality of the accounting systems and any remedial action undertaken will be an important factor.

9.32 Where a relevant qualification is in respect of a minor matter in an auditor's report, it will be possible for the Commissioner to determine that the audit requirements under paragraphs 230-395(2)(c) and (e) have been satisfied in the income year in which an auditor's report is qualified. What is minor will depend on the context and the circumstances of the particular case. Depending on the circumstances, it may be important for the Commissioner to be satisfied that appropriate remedial action has been undertaken by the taxpayer.

Overall gain or loss requirement

9.33 Once an election has been made to apply Subdivision 230-F, it only applies to those financial arrangements where, over the life of the financial arrangement, it could reasonably be expected that the same overall gain or loss is recognised for tax purposes as would have been recognised if Subdivision 230-F did not apply, but the other relevant methods under the provisions of Division 230 (including, where appropriate, the elective methods) had been chosen and had applied. [ Schedule 1, item 1, paragraph 230-410(1)(e) and subsection 230-410(2 )]

Substantially the same methods

9.34 A further requirement for an election under Subdivision 230-F to apply is that the results of the method used to determine the gain or loss on a financial arrangement for each income year in the financial reports is substantially the same as the results from the methods that would have applied under the provisions of Division 230, assuming the relevant methods (including, where appropriate, the elective methods) except for Subdivision 230-F had been chosen and had applied [ Schedule 1, item 1, paragraph 230-410(1)(f) and subsection 230-410(2 )]. The results from each of these methods would be expected to be substantially the same if the financial reports method spreads the gains or losses arising on the financial arrangement in the financial report in such a way that the gains or losses brought to account in each income year were similar to the spread of gains and losses brought to account under the other Subdivisions of Division 230 (assuming that the other relevant elective methods had been chosen and had applied).

9.35 In determining whether the results of the method are substantially the same, taxpayers are (in respect of financial arrangements that are not fair valued) to disregard the impact of impairment testing (ie, the possibility of making a provision for doubtful debts) from an accounting perspective, when they first start to hold the relevant financial arrangement. [ Schedule 1, item 1, subsection 230-410(2 )]

Assume other elections made

9.36 For the purposes of determining whether an entity reasonably expects to make the same overall gain or loss on a financial arrangement, and for determining whether the differences in methods applied under Division 230 (other than Subdivision 230-F), an entity is able to assume that a fair value election under Subdivision 230-C and a general foreign exchange retranslation election under Subdivision 230-D have been made. This prevents taxpayers from having to have valid elections in place solely for the purpose of being able to make a valid election under Subdivision 230-F. [ Schedule 1, item 1, subsection 230-410(7 )]

Which entities can elect the financial reports method?

9.37 Any entity that prepares audited financial reports and that satisfies the preconditions discussed above is able to make a financial reports election. [ Schedule 1, item 1, section 230-395 ]

Making the election

9.38 Any taxpayer may make a financial reports election, but it will only be valid for those taxpayers which meet the entry requirements.

9.39 In the case of a tax consolidated group or a multiple entry consolidated group (MEC group), elections are made by the head company of the group. Generally, an election under Division 230 will apply to all the relevant transactions of all members of the consolidated group or MEC group. However, there is an exception to this where a tax consolidated group or MEC group includes a member that carries on a 'life insurance business'. Where a member of the group carries on a life insurance business, the head company can specify whether or not the election will apply to the life insurance business carried on by that member of the group. [ Schedule 1, item 1, subsection 230-415(3 )]

9.40 A regulation-making power allows for regulations to be made specifying other types of businesses for which the fair value election in respect of financial arrangements will not apply. [ Schedule 1, item 1, subsection 230-415(4 )]

9.41 The making of a valid election and its application to a member of a consolidated group that carries on life insurance business is discussed in more detail in Chapter 5.

9.42 It is important to note, however, that an election under Subdivision 230-F does not in fact result in elections being made under Subdivisions 230-C and 230-D.

Financial arrangements subject to the election to adopt the financial reports method, and the effect of that election

To what financial arrangements does the election to adopt the financial reports method apply?

9.43 For a discussion of the common application of this election to financial arrangements, refer to Chapter 5.

9.44 An election under Subdivision 230-F applies to all financial arrangements first held in the income year in which the election is made and all future income years, providing they each satisfy the relevant conditions in subsection 230-410(1). For example, the overall gain or loss in the financial reports must reasonably be expected to be equivalent to that which would otherwise arise under Division 230 (apart from Subdivision 230-F).

9.45 Where a financial arrangement is an intra-group transaction for the purposes of Australian Accounting Standard AASB 127 Consolidated and Separate Financial Statements (or comparable), the financial arrangement is deemed to be an arrangement that is recognised in a set of audited financial reports and classified as at fair value through profit or loss [ Schedule 1, item 1, subsection 230-410(3 )]. For further discussion of this, refer to Chapter 5.

9.46 An election under this Subdivision does not apply to financial arrangements that are held by a taxpayer in any income year prior to the making of the election under this Subdivision, except where a further election is made under the transitional arrangements (refer to Chapter 13). [ Schedule 1, item 1, paragraph 230-410(1)(b )]

9.47 Where a taxpayer has made an election under Subdivision 230-F, separate fair value and retranslation elections are not necessary for any financial arrangement which is subject to the election (though they can still be made and will apply if a financial reports election ceases to apply in circumstances where the requirements for those other elections continue to be satisfied). Where a taxpayer is unable to, or does not want to, make an election under Subdivision 230-F, they may still be able to make separate elections under Subdivisions 230-C and 230-D as appropriate.

Financial arrangements to which the elective Subdivisions do not apply

9.48 An election under Subdivision 230-F cannot apply to a financial arrangement where the arrangement is an equity interest and where:

•

the taxpayer is the issuer of the equity interest [ Schedule 1, item 1, subsection 230-415(1 )]; or

•

the equity interest is not classified or designated as at fair value through profit or loss, that is, the exclusion carves out equity interests that are fair valued through equity [ Schedule 1, item 1, paragraph 230-410(1)(d )].

For these purposes an 'equity interest' includes an interest in a trust or a partnership that satisfies the requirements of subsection 820-930(1). [ Schedule 1, item 7, subsection 820-930(1 )]

9.49 Where a member of a tax consolidated group or MEC group carries on a life insurance business, the head company is able to specify that an election under Subdivision 230-F will not apply to financial arrangements of the member of the consolidated group or MEC group to the extent that the financial arrangement relates to the life insurance business, as discussed in Chapter 5. [ Schedule 1, item 1, subsection 230-415(3 )]

9.50 An election under Subdivision 230-F does not apply to transactions that are subject to Subdivision 230-E (hedging). The reason for this is that the tax hedge rules allow for tax classification hedging, which is not reflected in financial reports. To preserve the after-tax symmetry in respect of hedging financial arrangements, it is essential that Subdivision 230-E take precedence over Subdivision 230-F. [ Schedule 1, item 1, subsection 230-40(7 )]

Effect of relying on financial reports

9.51 For a discussion of the common application of this election to financial arrangements refer to Chapter 5.

9.52 Where an election made under Subdivision 230-F applies to a financial arrangement, the gain or loss required by the relevant accounting standard to be included in profit or loss in the financial report for that financial arrangement will represent the gain or loss for income tax purposes.

9.53 In particular, the effect of making an election under this Subdivision is that the taxpayer relies on their financial reports to determine whether they have, and the amount of, a gain or loss from a relevant financial arrangement and when the gain or loss is regarded as arising. [ Schedule 1, item 1, section 230-420 ]

9.54 However, some specific adjustments are made to the amount of the gain or loss that is recognised for Division 230 purposes. The first of these adjustments relate to franked distributions and the second relates to amounts arising on impairment of certain financial arrangements.

Adjustment for franked distributions

9.55 Division 230 will not apply to franked distributions (received either directly or indirectly) and rights to receive franked distributions (either directly or indirectly). The effect of excluding franked distributions from the scope of the financial reports election is to ensure that these distributions will remain assessable in accordance with section 44 of the Income Tax Assessment Act 1936 (ITAA 1936). Assessing the distribution under section 44 of the ITAA 1936 rather than under Division 230 will ensure that the imputation system works appropriately in respect of distributions such that franking credits allocated to such distributions are available to the recipient in the income year in which the distribution is taxed to the recipient.

9.56 Absent a specific rule, a dividend (distribution) may be declared in favour of a shareholder and the accounting standards (eg, Australian Accounting Standard AASB 118 Revenue ) would have required the taxpayer to recognise revenue (ie, a gain) in respect of the declared distribution based on the individual facts and circumstances relating to that dividend declaration. At this time, however, the dividend could not be franked. Later when the dividend is actually paid, that payment would not be assessed to the taxpayer because of the operation of the anti-overlap rule (section 230-20) and, accordingly, franking benefits would not be allowed to the shareholder.

9.57 The exclusion of distributions to the extent that they are franked will apply equally to distributions received directly by the taxpayer from a corporate tax entity or received indirectly by the taxpayer as a beneficiary of a trust or through a partnership. In these cases, a beneficiary of a trust (and equally a taxpayer that will receive franked distributions through a partnership) will only recognise a dividend either when it is received through the trust or when the dividend is declared but not paid and the beneficiary knows how much it will actually receive. If this cannot be determined by the beneficiary, then the exclusion will not apply. [ Schedule 1, item 1, section 230-480 ]

Example 9.2 : Dividend payment

On 1 July 2010 Barri Co acquires ordinary shares in UE Co for $50 million and makes the financial reports election in respect of all its financial arrangements. At 30 June 2011 the shares in UE Co have a market value of $65 million. On 1 May 2011 UE Co pays fully franked dividends of $6 million. Barri Co's taxable income for the 2010-11 year includes the fair value gain of $15 million ($65 million - $50 million) and a dividend of $6 million (ignoring grossing-up for franking credits). However, Division 230 will only assess the fair value gain of $15 million. The dividend paid by UE Co will be assessed under section 44 of the ITAA 1936.

At 30 June 2012 the shares in UE Co have a market value of $90 million. No dividends have been paid for this income year. Barri Co's taxable income for the 2011-12 income year includes the fair value gain of $25 million ($90 million - $65 million).

Adjustment for impairment of financial arrangement

9.58 Where a debt arrangement that is subject to the financial reports election subsequently becomes impaired (as determined under the Accounting Standards), the arrangement ceases to be subject to Subdivision 230-F, except where the arrangement is fair valued. This is because the arrangement ceases to satisfy the requirements of paragraph 230-410(1)(f) - that is, it cannot be said that the differences in the results of the accounting method and the compounding accruals method in Subdivision 230-B are reasonably expected to be not substantial. The reason for this is that the compounding accruals method does not recognise a provision for doubtful debts. Hence, the relevant financial arrangement will become subject to the remainder of Division 230, that is to a Subdivision of Division 230 other than Subdivision 230-F. If the financial arrangement falls within the scope of Subdivision 230-B (accruals and realisation method) and the impairment is later written-off as a bad debt, the provisions within Subdivision 230-B will apply to allow a deduction for amounts previously recognised as gains from the arrangement. Also, if at some future time, the debt arrangement ceases to be impaired, it cannot be subject to Subdivision 230-F again. [ Schedule 1, item 1, subsection 230-425(4 )]

9.59 Where a debt arrangement that is subject to Subdivision 230-F becomes impaired, and the financial reports election ceases to apply to it, the arrangement is specifically precluded from being subject to a balancing adjustment [ Schedule 1, item 1, subsection 230-430(4 )]. The reason for this is that if a balancing adjustment were applied at the time the financial arrangement becomes impaired, the taxpayer would receive an immediate deduction for the impairment of the debt arrangement. Such a result is contrary to the general policy in relation to doubtful debts for financial arrangements that are not subject to the fair value election (as described in Chapter 4).

Interaction with other tax-timing elections under Division 230

9.60 Where a taxpayer has made elections under Subdivision 230-C and/or Subdivision 230-D, and subsequently elects to apply Subdivision 230-F, the Subdivision 230-F election will apply to all financial arrangements entered into in the income year in which this election was made or a later income year, even if they would otherwise have been subject to Subdivision 230-C and/or Subdivision 230-D.

Where requirements for election are no longer satisfied

9.61 Although an election to rely on financial reports is irrevocable, the election may cease to apply, depending on the circumstances, to either:

•

all of a taxpayer's financial arrangements; or

•

one or more particular financial arrangements of the taxpayer.

[ Schedule 1, item 1, section 230-425 ]

9.62 If an election to rely on financial reports ceases to apply to a particular financial arrangement, that election cannot subsequently reapply to it. [ Schedule 1, item 1, subsection 230-425(4 )]

9.63 Refer to Chapter 5 for further information as to when an election to rely on financial reports will cease to apply.

Balancing adjustment if an election ceases to apply

9.64 Where an election to rely on financial reports ceases to have effect in relation to, or ceases to apply to, a particular financial arrangement, from the start of a particular income year, a balancing adjustment is made at that time in respect of the arrangement [ Schedule 1, item 1, subsections 230-430(1) and (3 )]. A balancing adjustment does not apply to a financial arrangement where it becomes impaired (see paragraphs 9.58 and 9.59) [ Schedule 1, item 1, subsection 230-430(4 )].

9.65 The balancing adjustment is to be made in accordance with the balancing adjustment requirements as set out in Subdivision 230-G (see Chapter 10). The balancing adjustment made is the balancing adjustment the taxpayer would have made if the taxpayer disposed of each relevant arrangement at the start of the income year in which the election ceased to apply for its fair value and immediately reacquired it at that time for that value. [ Schedule 1, item 1, section 230-430 ]

9.66 In some limited circumstances, it is possible that no amount will be bought to account as a result of the application of the balancing adjustment where a financial arrangement ceases to be subject to Subdivision 230-F.

Example 9.3 : Hierarchy of elections and balancing adjustment

Bill Co has made valid elections under Subdivisions 230-C, 230-D and 230-F that apply to its income year that commences on 1 July 2008. As a result of the operation of Division 230, Bill Co relies on the operation of Subdivision 230-F to quantify its fair value and foreign exchange retranslation gains and losses - as opposed to relying on Subdivisions 230-C and 230-D.

In respect of the financial reports for the year ended 30 June 2011, the auditor's report is relevantly qualified such that Bill Co can no longer rely on Subdivision 230-F to determine its gains and losses. As the qualification is in respect of the accounting systems and controls, Bill Co is able to rely on Subdivisions 230-C and 230-D to determine the value of its relevant gains and losses in respect of relevant financial arrangements.

As a result of this, and the fact that Subdivision 230-F ceases to apply from the start of the income year, the balancing adjustment would be calculated as follows for a financial arrangement that is being fair valued.

Assume the following:

•

Acquired financial arrangement for $200 at 1 September 2009.

•

Fair value as at 30 June 2010 is $250.

•

Amount included in assessable income for year ended 30 June 2010 is $50.

Step 1 - the total of financial benefits received under the financial arrangement.

$250

Step 2 - the total of the financial benefits provided under the financial arrangement (ie, $200 for the acquisition) and the total of the amounts that have been included in assessable income before the transfer or cessation, as gains from the arrangement ($50 gain attributable to the change in fair value).

$250

Step 3 - compare the step 1 amount with the step 2 amount. If the amounts are equal, as they are in this example, no balancing adjustment is made.

9.67 Chapter 5, in respect of the elective Subdivisions, and Chapter 10 more generally, provide further detail as to the operation of the balancing adjustment rules contained in Subdivision 230-G.

Making of a new election

9.68 Where a taxpayer has made an election which ceases to have effect, they may later make a new election where the conditions for making an election are once more satisfied (refer Chapter 5). With respect to an election under Subdivision 230-F, if it ceased to have effect because of a qualified audit in respect of the treatment of a financial arrangement or an adverse assessment of the taxpayer's accounting systems in a report of an audit or review, the election can only be remade four years following the income year in which these particular requirements were first failed. [ Schedule 1, item 1, paragraph 230-395(2)(c) and subsection 230-425(2 )]