House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer,the Hon. Peter Costello, MP)

Chapter 6 - General Losses

This chapter summarises the rewritten rules allowing deductions for losses that apply to taxpayers generally, and explains the changes the Income Tax Assessment Bill 1996 will make to these rules.

Overview of this chapter

This chapter deals with the general rules about losses.

The first part of the chapter summarises the losses rules that apply to taxpayers generally as they are proposed to be rewritten by clause 26-55, Division 36 and Subdivision 375-G of the Income Tax Assessment Bill 1996 .

The second part explains changes that the Bill proposes to their content.

The existing law on general losses is contained in sections 79C, 79E and 79F of the Income Tax Assessment Act 1936.

This summary is to orient readers to how the new law is structured and expressed. As these provisions have been in the law for some time, there is no need for a detailed exposition. An explanation is given of changes proposed to the general losses provisions.

A. Summary of the new law

Tax losses of earlier income years [Subdivision 36-A]

What is a tax loss?

A tax loss is the excess, in a year, of any deductions over the sum of assessable income and net exempt income.

When, and how, can a tax loss be deducted?

In a later year:

•

first, from any net exempt income;

•

then, from any assessable income.

Losses are deducted in the order incurred.

Net exempt income is

Exempt income (other than certain income that has been exempted so as to prevent double taxation), reduced by expenses incurred in deriving that income.

Effect of you becoming a bankrupt [Subdivision 36-B]

The general rule is

You cannot deduct a tax loss incurred before you became bankrupt (or were released from a debt under a bankruptcy law).

Exception: the rule does not apply if

You subsequently pay a debt that was taken into account in determining the amount of such a loss.

You can deduct so much of the amount repaid as does not exceed the amount of the loss.

However, if the loss was a film loss:

•

the debt must be incurred in deriving assessable film income or exempt film income; and

•

the amount you can deduct is limited to the amount of the film loss.

Film losses [Subdivision 375-G]

The general rule is

A film loss is deductible, in a later year, only from:

•

first, net exempt film income;

•

then, net assessable film income.

Film losses are deducted from film income ahead of other losses (overriding the general rule that losses are deducted in the order incurred).

What is a film loss?

A film loss is the film component of a tax loss. A tax loss has a film component if film deductions exceed the sum of assessable film income and net exempt film income.

The amount of the film component is the excess up to, but not exceeding, the amount of the tax loss.

Limit on certain deductions [clause 26-55]

The general rule is

The following deductions cannot create or add to a tax loss:

•

gifts;

•

promoters recoupment tax;

•

development allowance of a leasing company; and

•

superannuation contributions of self-employed persons and unsupported employees.

Exception to the rule

If a taxpayer is entitled to deductions under the mining and quarrying provisions, the deductions listed above may cause surplus mining and quarrying deductions to create a loss if the taxpayer so elects.

B. Discussion of changes

Clause 26-55 Limit on certain deductions

This clause will limit the amount that can be claimed for certain deductions, so that they cannot, as a general rule, create or add to a loss.

1. Change

The deductions that cannot contribute to a tax loss will be identified, and dealt with, in the same place and on the same basis. This will give a more generous treatment to the development allowance of a leasing company.

Explanation

The rule that the development allowance of a leasing company cannot create or add to a loss will now be subject to an exception to the extent that the leasing company is entitled to elective deductions under the mining and quarrying provisions.

2. Change

This clause will ensure that the limitation on certain deductions contributing to a loss does not apply to deductions that are also allowable under another provision of the law that is not limited in this way.

Explanation

Some deductions are allowable under two or more provisions of the law. The existing law that limits the deductions that can create losses does not recognise this possibility. However, the law is administered so that the limitation only applies if a deduction is allowable solely under deduction provisions that cannot contribute to a loss.

Clause 36-15 How to deduct tax losses

This clause will explain how tax losses of earlier years must be deducted.

Change

The clause will clarify that losses of an earlier year must only be offset:

•

against net exempt income remaining after allowing all deductions of the current year, (compared to simply requiring the earlier year losses be deducted from net exempt income of the current year); and

•

if assessable income exceeds deductions of the current year, against assessable income remaining after allowing all other deductions (compared to simply requiring the losses to be deducted from assessable income of the current year).

Explanation

The existing law could be interpreted as requiring:

•

deductions of the current year and a loss of a previous year to be offset against the same net exempt income,

and is not clear that:

•

prior year losses are to be deducted only from any assessable income remaining after all other deductions.

Clause 36-20 Net exempt income

This clause will define the term net exempt income . Tax losses of earlier years must be offset against any net exempt income.

1. Change

This clause will omit the exclusion, from net exempt income, of net exempt income from petroleum .

Explanation

This is a redundant reference. Prior to 1986, income from petroleum mined in Australia or Papua New Guinea was exempt if it was taxed in the country from which it was derived. This exemption was repealed when the foreign tax credit system was introduced.

2. Change

This clause will exclude, from net exempt income, employment fringe benefits that are subject to fringe benefits tax (FBT). These benefits will not have to be offset against losses.

Explanation

It is equivalent to double taxation of income to require that losses be offset against fringe benefits that have been taxed under the FBT law. Under the existing law, exempt foreign source investment income, which is exempted to prevent double taxation, is not required to be offset against losses. Excluding these benefits will remove an anomaly.

C. Date of effect

The new law will apply from 1 July 1996 and have effect for the 1996-97, and subsequent, income years. The application and transitional provisions relating to the proposed new law are contained in the Income Tax (Transitional Provisions) Bill 1996.

Substituted accounting periods

The new law is proposed to apply with effect from the beginning of the 1996-97 income year for all taxpayers, including those who have the approval of the Commissioner of Taxation to account for their income according to a year that commences other than on 1 July. For taxpayers whose 1996-97 income year commences before 1 July 1996, the new law would have effect from the commencement of their 1996-97 income years. For taxpayers whose 1996-97 income year commences after 1 July 1996, the new law would not have effect until the commencement of their 1996-97 income years.

D. Transitional arrangements

Tax losses and film losses of 1996-97 and subsequent income years [clause 36-100 of the Income Tax (Transitional Provisions) Bill 1996]

The amounts of tax losses and film losses of 1996-97 and subsequent income years will be determined under the new law. These losses will also be deductible under the new law.

Losses and film losses of 1989-90 to 1996-96 income years [clause 36-105 of the Income Tax (Transitional Provisions) Bill 1996]

Amounts of general domestic losses and film losses of the 1989-90 to 1995-96 income years will have been determined under the existing law. To the extent that these have not previously been deducted, they will be treated as tax losses and film losses deductible in the 1996-97 and later income years, under the new law.

Pre-1990 losses [clause 36-110 of the Income Tax (Transitional Provisions) Bill 1996]

Amounts of pre-1990 primary production losses will have been determined under the existing law. To the extent that these have not previously been deducted, they will be deductible in the 1996-97 and later income years, under the new law and subsections (9), (10) and (11) of section 80AA of the Income Tax Assessment Act 1936 .

These primary production losses will be deductible in the order in which they were incurred, after film losses but before other losses of the same or any other loss year.

E. Consequential amendments to the Income Tax Assessment Act 1936 and other Commonwealth legislation

Losses and foreign income [Schedule 1, item 70 of the Income Tax (Consequential Amendments) Bill 1996]

Subsections 79E(5) and (6) of the Income Tax Assessment Act 1936 prevent losses from being offset against assessable foreign income unless the taxpayer so elects. This protection will be preserved by a new section 79DA to be inserted in the Income Tax Assessment Act 1936 .