House of Representatives

Explanatory Memorandum

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

Chapter 4 Investment-related Lottery Winnings

[Clause: 31, 65, 70, 72, 73, 75, 85]

Overview

Assesses on their winnings the winners of certain investment-related lotteries which are drawn or decided on or after the day on which this Bill receives Royal Assent.

The amendment will only apply if the lottery is a return on an investment. For instance, it could be a benefit of depositing money with a financial institution.

Prizes won in ordinary lotteries, such as lotto, are not affected.

The amendment does not apply if either the prize won or the right to participate in investment-related lottery is already taxable.

Summary of the proposed amendments

4.1. The Income Tax Assessment Act 1936 will be amended to assess the winners of certain investment-related lotteries on their winnings, as announced in the Budget.

4.2. The amendment will only apply if the lottery is a return on an investment. That includes the depositing of money with a financial institution. Consequently, the amendment does not affect ordinary lotteries, caskets, art unions, raffles and so on.

4.3. Nor do the amendments apply if either the prize won or the right to participate in the lottery arrangement is already taxable. For example, if the lottery arrangement arises because of a person's employment, the value of the right to participate in the lottery would be assessable as a fringe benefit under the Fringe Benefits Tax Assessment Act 1986 . If the lottery arises because of some business relationship between the provider of the prize and the recipient, an amount would be assessable under the non-cash business benefits provision, section 21A of the Act.

4.4. The amendments will apply to prizes drawn or decided after the date of Royal Assent of this Bill.

Background to the legislation

4.5. Generally, wins from gambling or lotteries are not treated as assessable income. However, certain financial institutions have sought to provide such wins in addition to, or as a substitute for, assessable interest income. In effect, a taxable receipt is replaced by a non-taxable receipt.

4.6. For instance, a financial institution might offer the chance to win a prize in a lottery instead of paying interest on deposits made to certain accounts. Yet the amount of the prize might reflect the total interest that it would have had to pay on deposited funds. Alternatively, the prize might be offered in addition to a fairly low rate of interest already payable on the accounts.

4.7. The windfall gain is to be treated as part of the return on a person's investment and given the same treatment as other returns on investments. The value of the prize will be included in assessable income, provided that neither the value of the right to participate in the investment-related lottery nor the prize won in the investment-related lottery is otherwise taxable.

Explanation of the proposed amendment

4.8. The proposed section 26AJ will bring to tax the value of any prize which is provided under an investment-related lottery. [Clause 31]

4.9. The provision categorises the winnings that might arise from an investment-related lottery into three classes of prizes:

•

cash;

•

loan benefits; and

•

other property or services.

4.10. There are separate valuation rules for each class of prize. [Paragraphs 26AJ(1)(a) and (h) to (j)]

Note : All references to a prize in this chapter should be read as a reference to any one of these classes.

What is an investment-related lottery?

4.11. There are three elements which determine whether an arrangement is an investment-related lottery:

•

the prize must be won in a lottery or similar arrangement;

•

the chance to win the prize (called the "betting chance") must arise because the taxpayer holds an investment with an investment body such as a bank; and

•

the betting chance must not otherwise be taxable. [Paragraphs 26AJ(1)(b) to (g)]

The prize must arise from a lottery

4.12. The prize must arise as a matter of chance. The concept of chance is very broad and includes not only lotteries but also betting, pool betting and any other form of gambling as well as any game with prizes. It is similar to that contained in subsection 160ZB(2), which exempts lottery and betting winnings from capital gains tax.

4.13. For example, a game with prizes might include a simple questionnaire which is given to participants in relation to their investment. A prize would be taxable when, for example, it is awarded to the first ten correct answers to the question, "What is the interest rate on our term deposits?"; so would a prize given to a winner picked from a hat, or with the best football tipping record. [Paragraph 26AJ(1)(b)]

4.14. Section 26AJ will not apply to loans provided by Starr-Bowkett building societies, which use a ballot system to determine when the members are entitled to receive the loans. Each member of a Starr-Bowkett building society has an entitlement to receive a loan, which is usually applied to buying or constructing a home. Only the time when the loan is granted is determined by ballot. The loan itself is not won in a lottery. [Subsection 26AJ(10)]

The chance to win the prize must be a return on an investment

4.15. The chance to participate in the lottery is referred to as the betting chance . The betting chance must be provided at least partly in connection with an investment of the taxpayer with another person, called the investment body . The connection between the betting chance and the investment may only be partial. [Paragraph 26AJ(1)(c)]

4.16. An investment is defined as "any mode of application of money for the purpose of gaining a return". Return is itself defined to include interest, income or profit. A deposit of funds with a financial institution to gain interest income would be an investment. The definition of return includes a return by way of profit so that an application of funds to gain a profit through capital growth would also be an investment as defined. [Subsection 26AJ(11)]

4.17. To ensure that a deposit of funds at nil interest is treated as an investment, the following test is applied: if the taxpayer had received a cash payment instead of the chance to participate in the lottery, and that cash payment would have been an investment return, then the taxpayer will be treated as having an investment. [Subsection 26AJ(9)]

The betting chance is not otherwise taxable

4.18. To some extent, this element is closely related to the investment nature of the lottery. It ensures that an amount is not taxable if either the value of the betting chance or the prize itself is already taxable. [Paragraphs 26AJ(1)(f) and (g)]

Taxing the prize

4.19. The taxpayer will be assessable on the value of the prize even though it may in fact be provided to an associate of the taxpayer, or to another person under an arrangement to which the taxpayer or associate is a party. The definition of associate used for this section is the same as subsection 26AAB(14) of the Act. Both person and arrangement are defined in very broad terms. [Paragraphs 26AJ(1)(a) and (e), subsection 26AJ(11)]

4.20. The time when the prize is taxed and the value at which it will be taxed depend on whether the prize is in the form of cash, other property or services, or a loan. [Paragraphs 26AJ(1)(a) and (h) to (j)]

If the prize is in cash

4.21. If the taxpayer, associate or other person is paid or credited with cash, the amount paid or credited is to be included in the taxpayer's assessable income in the income year in which the payment or crediting occurs. [Paragraph 26AJ(1)(i)]

If the prize is property or services

4.22. If the taxpayer, associate or other person is provided with property or services, the amount which is to be assessed is the arm's length value of the property or service provided in the income year less any contribution given by the recipient to acquire the property or service. The amount to be included in assessable income may be reduced if, had the taxpayer paid for the property or services, a deduction would have been allowable in respect of the expenditure. This is called the "otherwise deductible rule". [Paragraph 26AJ(1)(j), subsection 26AJ(3)]

4.23. The otherwise deductible rule allows a taxpayer to reduce the amount to be included in assessable income only if the cost of the prize would have been deductible on a once only basis if the taxpayer had to spend money to acquire it. That is, the deduction that would otherwise be allowable must not be partly allowable in one year and partly allowable in other years. [Subsection 26AJ(3)]

4.24. For example, suppose that Sandra wins a car which she uses only in her employment as a travelling salesperson. The cost of the car would have been deductible to her as depreciation. But as this deduction is not a "once only" deduction, Sandra would not be able to reduce the amount to be included in her assessable income. [See the definition of 'once only deduction', subsection 26AJ(11)]

4.25. In section 26AJ, property is meant to convey its ordinary meaning, for example cars, shares and so on. Services is defined in very broad terms similar to those used in the non-cash business benefits provision, section 21A. [Subsection 26AJ(11)]

4.26. That definition would cover the case, for example, where the prize is a waiver of interest which the recipient owes to the investment body on a loan taken out with the investment body. [See the definition of 'services' in subsection 26AJ(11)]

4.27. Services and property can be provided in a number of ways. Property is provided to a person when it is disposed of to that person. Property is deemed to have been provided to the recipient if the provider creates the property in the recipient. The property is deemed to be provided to the recipient when the property comes into existence. This means that in circumstances such as where the provider allots shares as a prize, property is taken to be provided and its value can be taxed. As regards services, "provide" extends to such things as allow, confer, give, grant or perform. [Subsections 26AJ(11) and (8)]

4.28. The amount to be included in assessable income is determined by reference to the arm's length value of the property or services. The arm's length value of property or services means the amount that the recipient could reasonably be expected to pay another party to obtain the property or services where both parties are acting independently. [Subsection 26AJ(11)]

4.29. As mentioned, any recipient's contribution is deducted from the value of the property or services. The recipient's contribution is defined as the amount of any consideration which the recipient paid to the provider for the property or service reduced by any reimbursement of that consideration paid to the recipient. A recipient's contribution will not arise where a person chooses to deposit funds in a bank account which pays no interest. Neither the deposit of funds with the investment body nor the forgoing of interest to gain an entitlement to participate in the investment-related lottery is a recipient's contribution. [Subsection 26AJ(11)]

If the prize is a loan benefit

4.30. The value of a loan benefit is to be included in the assessable income of the taxpayer in each year of income in which the loan benefit arises. An otherwise deductible rule similar in principle to the one described above can again apply to reduce the amount to be included in assessable income. [Paragraph 26AJ(1)(h), subsection 26AJ(2)]

4.31. Loan is defined in very broad terms to encompass any transaction - including an advance of money, the provision of credit and the creation of other debt obligations - which in substance is a loan. [(Subsection 26AJ(11)]

4.32. A loan benefit arises where a person (the provider) makes a loan to another person (who, for the purposes of this provision, will be either the taxpayer, an associate of the taxpayer or another person under an agreement to which the taxpayer or associate is a party and who will be called the recipient). The loan benefit will be taken to have been given in each income year where the recipient is under any obligations to repay any part of the loan. A technical measure here ensures that an obligation to repay part of the loan is deemed to exist while the loan is outstanding even though no amount is currently due for payment or repayment. [Subsections 26AJ(4) and (7)]

4.33. A loan benefit may also arise on a deferred interest loan. A deferred interest loan is one where the interest payable on the loan accrues at intervals of greater than six months. A separate loan benefit is deemed to arise where the interest is payable on a loan at intervals of more than six months. The amount of any unpaid interest that accrues on the principal loan during each six month period is taken to be a separate loan made by the lender to the borrower free of interest. This additional loan extends from the end of the six month period until the interest is repaid. As this loan benefit is also defined by reference to an obligation to repay the loan, the technical measure discussed in the previous paragraph also applies here. [Subsections 26AJ(5), (11) and (7)]

4.34. The amount to be included as assessable income for a loan benefit is the amount by which a benchmark amount of interest, as defined, exceeds the amount of interest that has accrued on the loan for the current year of income. That amount may be reduced if the otherwise deductible rule applies. [Paragraph 26AJ(1)(h), subsection 26AJ(2)]

4.35. The benchmark amount of interest means the amount of simple interest that will accrue on the loan for the particular year of income if the interest is calculated on the daily balance of the loan at the benchmark interest rate for the year. The benchmark interest rate is the predominant interest rate for the month of June immediately preceding the relevant income year for new variable interest rate owner-occupier housing loans to individuals, as published by the Reserve Bank of Australia in the Statistical Directory of its monthly Bulletin. The benchmark interest rate for loan benefits provided in the 1991-92 income year is 13% per annum. [Subsection 26AJ(11)]

4.36. The otherwise deductible rule applied to loan benefits operates in much the same way as the otherwise deductible rule used for calculating the taxable value of loan fringe benefits under the Fringe Benefits Tax Assessment Act 1986 .

4.37. In effect, the otherwise deductible rule apportions the amount which is to be included in assessable income under paragraph 26AJ(1)(h) according to the percentage of the loan which is applied for income producing purposes. So, if a recipient of a loan uses all of the loan moneys to acquire an income producing asset, no amount will be included in assessable income. If only half of the loan is used to produce assessable income, the amount to be included in assessable income is halved. The following paragraphs explain how this result is achieved. [Subsection 26AJ(2)]

4.38. The basic component in the calculation is the amount that would be included in assessable income if not for the operation of the otherwise deductible rule: basically, the benchmark amount of interest minus actual interest accrued on the loan. That amount is referred to as the gross assessable amount . [Paragraph 26AJ(2)(a)]

4.39. There is then a need to ascertain whether the taxpayer would have been entitled to a once-only deduction (as explained above) if the taxpayer had paid interest on the loan equal to the benchmark amount of interest. This is called the gross deduction . [Paragraph 26AJ(2)(b)]

4.40. The next step in the calculation depends on whether interest accrues on the loan. In a simple case where no interest accrues on the loan, the gross deduction is deducted from the basic component, the gross assessable amount, to determine the amount of the loan benefit that is to be included in the taxpayer's assessable income. [Paragraph 26AJ(2)(c)]

Example 1

4.41. Robyn wins an interest free loan of $50,000 in an investment-related lottery. She uses half of the loan to buy a share portfolio and the other half to finance renovations to her home.

Step 1 Calculate the gross assessable amount. (The benchmark interest rate is assumed to be 15%.)

Gross assessable amount = Benchmark amount of interest - Interest accrued on the loan
= $50,000*15% - nil
= $7,500


Step 2 As only 50% of the loan is used for income producing purposes, the amount that would have been deductible if Robyn had paid the benchmark amount of interest (the gross deduction) is $3,750 (i.e. 50% of $7,500).

Step 3 The amount to be included in assessable income is the gross assessable amount ($7,500) minus the gross deduction ($3,750), that is, $3,750.

4.42. In a case where interest does accrue on the loan, steps one and two of the calculation are the same, but the third step of the calculation is slightly different. Then, the gross deduction is reduced by the amount that would be allowable as a once-only deduction on the interest that has accrued during the year. This is called the reducing amount . [Paragraph 26AJ(2)(d)]

Example 2

4.43. Robert wins a low interest loan of $50,000 in an investment-related lottery. Interest is payable at 5%. He uses 80% of his loan to buy an investment property and 20% to pay for an overseas holiday.

Step 1 Calculate the gross assessable amount. (The benchmark interest rate is assumed to be 15%.)

Gross assessable amount = Benchmark amount of interest - Interest accrued on the loan
= $50,000*15% - $50,000*5%
= $5,000


Step 2 As 80% of the loan is used for income producing purposes the amount that would have been deductible if Robert had paid the benchmark amount of interest is $6,000 (i.e. 80% of $7,500). The amount that would be deductible on the actual interest accrued on the loan (the reducing amount) is $2,000 (i.e. 80% of $2,500).

Step 3 The amount to be included in assessable income is the gross assessable amount ($5,000) minus the difference between the gross deduction ($6,000) and the reducing amount ($2,000), that is, $5,000 - $4,000 = $1,000.

Consequential amendments

Provisional Tax

4.44. Three consequential changes amend Division 3 of Part VI of the Act to ensure that the inclusion of an investment-related lottery prize in a taxpayer's assessable income in one year does not create a provisional tax liability in respect of the income of the following year. [Subsections 221YA(1C) and 221YDA(1AA), paragraph 221YCAA(2)(ka)]

Tax File Number

4.45. The tax file number provisions are being amended so that an amount of tax may be withheld from the payment of a cash investment-related lottery prize to the taxpayer, if the taxpayer has chosen not to provide a tax file number to the investment body. In effect, the investment on which the prize arises will be treated as an investment for the purposes of Part VA (the tax file number provisions of the Act) and Division 3B of Part VI (the tax file number withholding tax provisions). The amount of cash paid or credited to the taxpayer will be classified as income for the purposes of the tax file number withholding tax provisions. [Subsections 202D(8), 221YHZA(4)]

Commencement date

4.46. Only prizes in investment-related lotteries which are drawn or decided on or after the date of Royal Assent of this Bill will be liable to taxation. Accordingly, a prize won before that date, such as an interest free loan which is repayable over 10 years, will not be assessable even though benefits from the prize continue after the commencement of section 26AJ. The crucial date is the time when the prize is drawn or decided. If a recipient is entitled to choose between several prizes, the liability to tax depends on the time the entitlement arises, not when the recipient makes the choice. [Subclause 2(i) and 85(7)]

Clauses involved in the proposed amendments

Clause 31: Inserts new section 26AJ which will assess taxpayers on the value of prizes won under investment-related lotteries.

Clause 65: Amends section 202D to make a cash prize payable on an investment-related lottery subject to the tax file number provisions.

Clause 70: Inserts new subsection 221YA(1C) which ensures that an amount included in a taxpayer's assessable income under new section 26AJ is excluded for the purposes of calculating the taxpayer's provisional tax liability in relation to the next year.

Clause 72: Inserts new paragraph 221YCAA(2)(ka) which ensures that an amount included in a taxpayer's assessable income under new section 26AJ is excluded from the uplifted provisional tax amount calculation.

Clause 73: Amends subsection 221YDA(1AA) which allows a taxpayer to have provisional tax or an instalment of provisional tax recalculated on the basis of the taxpayer's own estimate of taxable income for the current year of income. The amendment will mean that estimates should not take into account an amount included in assessable income for the previous year under section 26AJ.

Clause 75: Amends section 221YHZA to allow an amount to be withheld from a cash prize paid to a taxpayer where the taxpayer has chosen not to quote a tax file number in respect of an investment-related lottery.

Clause 85: Provides that new section 26AJ will apply to prizes drawn on or after the date of Royal Assent of the Bill.