Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Equity investments in small - medium enterprises
Overview
10.1 The amendments contained in Schedule 8 of the Bill clarify the operation of the provisions relating to equity investments in small and medium enterprises (SMEs) which are set out in Item 14 of Schedule 1 to the Taxation Laws Amendment Bill (No. 3) 1996.
Summary of the amendments
10.2 The amendments will clarify the operation of the SME provisions by modifying the requirement in sections 128TH and 128TJ that a company making an investment in an SME must be engaged in a business of lending money or must acquire SME shares in connection with such a business, by allowing as an alternative, the requirement that where the company making an investment in an SME is a subsidiary company within a wholly owned company group, the parent company or parent companies of the subsidiary company must be engaged in the business of lending money.
10.3 The amendments apply to eligible equity investments made on or after 1 July 1996. [Item 6]
Background to the legislation
10.4 Part 5 of Schedule 1 of the Taxation Laws Amendment Bill (No. 3) 1996 introduced a new Division 11B of Part III of the Income Tax Assessment Act 1936 ("the Act") to change the tax treatment of certain equity investments in small and medium enterprises (SMEs) where the investment is held by a lending institution. Any profit or loss from the eligible equity investments will now be taxed under Part IIIA, the capital gains tax provisions, rather than on revenue account.
10.5 There are certain criteria which must be met before these investments can receive this concessional tax treatment. One of the criteria requires that the taxpayer making the investment in the SME must be engaged in the business of money lending. If a lending institution wishes to use a subsidiary company to make these investments, it may not come within the terms of Division11B where the subsidiary company (the investor in the SME) is not in a business of lending money. The case law suggests that these investments may be taxed on capital account but there remains some uncertainty.
Explanation of the amendment
10.6 The amendments will modify the requirement in sections 128TH and 128TJ that a company making an investment in an SME must be engaged in a business of lending money or must acquire SME shares in connection with such a business, by allowing as an alternative, the requirement that where the company making an investment in an SME is a subsidiary company within a wholly owned company group, the parent company or parent companies of the subsidiary company must be engaged in the business of lending money. [Items 1 to 4]
10.7 The ultimate owner of the group does not have to be engaged in a business of lending money if it does not invest directly in SMEs. However, any company holding shares directly in a subsidiary company which wishes to access the tax concession must be engaged in a business of money lending.
10.8 The amendments also set out the meaning of 'subsidiary' and 'direct ownership group' for the purposes of Division 11B. New subsection 128TL(1) sets out three types of wholly owned company group relationships which constitute a parent/subsidiary relationship for this Division. The parent/subsidiary relationships are in similar terms to those already used in the Act. [Item 5]
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