House of Representatives

Explanatory Memorandum

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

Chapter 15 - Application of the measures and transitional provisions

Overview

15.1 Division 3 of Part 1 of the Bill deals with application and transitional matters. The amendments are of two kinds:

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application arrangements; and

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transitional arrangements.

Application arrangements

15.2 In general terms, the provisions dealing with trust losses (Schedule 2F) proposed to be inserted in the ITAA 1936 will apply to all transfers of losses after 1995 Budget time. 1995 Budget time means 7.30 pm, by legal time in the Australian Capital Territory (i.e. Eastern Standard Time (EST)), on 9May 1995. In some cases the 1996 Budget time or the 1997 Budget time is a relevant date. 1996 Budget time means 7.30 pm, by legal time in the Australian Capital Territory (i.e. EST), on 20 August 1996. 1997 Budget time means 7.30 pm, by legal time in the Australian Capital Territory (i.e. EST), on 13 May 1997. [Item 12]

Application of prior year loss rules

General

15.3 The earlier year loss provisions (defined in item 12 ) apply from the 1994-95 income year [subitem 13(1)] . However, the Bill ensures that the proposed prior year loss measures will apply only from 1995 Budget time for the 1994-95 and later income years by saying that if a test period would begin before 1995 Budget time, it is taken instead to begin at 1995 Budget time [subitem 13(2)] . This will be the case where the loss was incurred in the 1994-95 income year or an earlier income year.

15.4 The 'test period' is the period used in determining whether certain events that will prevent the deduction of a prior year loss have occurred. Subitem 13(2) also has the effect that the test period begins at the 1995 Budget time for the purposes of the provisions saying that a trust must be of a particular kind at all times, or certain times, during the test period.

Application of pattern of distributions test

15.5 There is also a provision to ensure that the pattern of distributions test that applies for non-fixed trusts (see paragraphs 7.12 to 7.13) will, in effect, only apply from the date of introduction of the 1995 Bill (see paragraph 3.3) into the Parliament. The application of this test is different because the details of the test, as they were presented in the 1995 Bill, were not effectively announced until 28 September 1995. This special application provision will ensure no retrospective operation of the test. It does this by saying that:

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the pattern of distributions test does not apply where the income (i.e. recoupment) year is the 1994-95 income year; and

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for the 1995-96 income year, at least part of a test year distribution that has to be taken into account in applying the pattern of distributions test must occur after 28 September 1995. [Subitem13(3)]

15.6 The Bill also modifies the pattern of distributions test to alleviate the impact of the trust loss measures in the transitional stages. Where distributions made prior to the 1995 Budget time have to be taken into account in applying the pattern of distributions test, all portions of all test year distributions received by members of the same family prior to and after the 1995 Budget time will be treated as having been received by the same individual. The family is determined by reference to a particular individual to whom part of a test year distribution has been made and the members of that individual's family (see section 272-95). [Subitem13(4)]

15.7 In the 1995 Bill, the period for which a test year distribution was determined for the pattern of distributions test was the income year only. This was changed in the exposure draft of the trust loss measures released on 10 February 1997 to the period to the end of two months after the end of the income year. This reflects the fact that, for administrative reasons, trust distributions may frequently not be able to be made in the income year. To prevent retrospectivity, if the income year is the 1995-96 or 1996-97 income year, the relevant period will be the income year. ^[F18] For the 1997-98 and later income years the period includes the two months after the end of the income year. [Subitem 13(5)]

Application of current year loss provisions

15.8 The current year loss provisions (defined in item 12 ) apply from the 1994-95 income year. However, various provisions ensure that they have no application prior to the 1995 Budget time.

15.9 A trust with a substituted accounting period for the 1994-95 income year that ends before the 1995 Budget time will not be required to apply the current year loss provisions for that year. [Subitem 13(6)]

15.10 The Bill also ensures that the current year loss rules operate only from the 1995 Budget time by saying the following about the events that may lead to a trust having to calculate its net income and tax loss in a special way:

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no abnormal trading in a trust's units is taken to have occurred in the 1994-95 income year before 1995 Budget time; and

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the fixed entitlements of persons to income or capital of a trust and the control of a trust that existed just before 1995 Budget time are taken to have existed throughout the 1994-95 income year to the 1995 Budget time; and

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a trust is taken to be of the same kind from the commencement of the 1994-95 year of income until the 1995 Budget time as it was at the 1995 Budget time. [Subitem 13(7)]

Application of debt deduction rules

15.11 For the debt deduction provisions (defined in item 12 ), ^[F19] similar rules to those applicable for prior year loss purposes apply, except that the 1996 Budget time is the relevant application date. [Item 14]

Application of income injection test

15.12 The income injection test in Division 270 applies for the 1994-95 and later income years. However, it will only apply where the following happens:

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the assessable income derived under an income injection scheme is derived after 1995 Budget time; and

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the benefit provided to the trust, beneficiary or associates under the scheme is provided after 1995 Budget time. [Item15]

Application of expanded definition of distribution

15.13 An expanded definition of distribution (see section 272-60) was included in the exposure draft on the trust loss measures released on 10February 1997. Since this change had not previously been announced, the wider definition will only apply after the date of introduction of the Bill into the Parliament. [Item 16]

Application of new section 63G

15.14 New section 63G of the ITAA 1936 as inserted by Item 2 will apply to assessments for the 1996-97 income year and later income years. This provision relates to debts written off as bad on the last day of an income year (see paragraph 14.9). The application of this provision has been set at the 1996-97 income year because the debt deduction provisions commence from the 1996 Budget time. [Item 17]

Application of foreign loss provisions

15.15 For the foreign loss rules contained in new subsection 160AFD(6A), similar rules to those applicable for prior year loss and debt deduction purposes apply, except that the date of introduction of the Bill into the Parliament is the relevant application date. [Item 18]

15.16 The provision applying the income injection test to foreign losses (see 160AFD(6B)) is the same as the general application provision for that test, except that the date of introduction of the Bill into the Parliament is the relevant application date. [Item 19]

Application of amendments of subsections 170(10) and 170(13)

15.17 Amendments to subsections 170(10) and 170(13) made by items 10 and 11 apply to assessments made either before or after the commencement of those items. These provisions deal with the amendment of assessments (see paragraphs 14.13 to 14.15. Because these amendments relate to the operation of the trust loss measures, they will not have any application before the commencement of those measures. [Item 20]

Application of consequential amendment to Fringe Benefits Tax Assessment Act 1986

15.18 The consequential amendment to section 136 of the Fringe Benefits Tax assessment Act 1986 (see paragraph 14.19) applies to benefits conferred either before or after Royal Assent. However, because this amendment relates to the operation of the trust loss measures, it will not have any application before the commencement of those measures. [Item 31]

Application of consequential amendment to Superannuation Contributions Tax (Assessment and Collection) Act 1997

15.19 The consequential amendment to section 43 of the Superannuation Contributions Tax (Assessment and Collection) Act 1997 (see paragraph 14.21) applies to the calculation of adjusted taxable income for the financial year that began on 1 July 1996 or a later financial year. This is the application date of the superannuation contributions tax measures. [Item 33]

Application of consequential amendment to Medicare Levy Act 1986

15.20 The consequential amendment to section 3 of the Medicare Levy Act 1986 (see paragraph 14.22) applies for the 1997-98 income year and all later income years. This is the application date of the measures that impose an increased Medicare levy on some taxpayers who do not have private health insurance. [Item 2 of Schedule 1 of the Medicare Levy Consequential Amendment (Trust Loss) Bill 1997]

Transitional arrangements

Family trusts

15.21 A trust can elect to be a family trust from the commencement of the proposed trust loss measures. However, family trust distribution tax will not be payable on any distributions outside the family group where certain transitional conditions are met. This effectively allows a trust to be treated as a family trust at all times from the commencement of the measures if it first becomes a family trust, fully subject to the family trust distribution tax rules, from 1 July 1997.

Family trust elections

15.22 In general terms, a family trust election can be made to be effective from the 1997-98 or any later years of income [subitem 21(1)] . However, a trust can become a family trust from the start of the 1994-95, 1995-96 or 1996-97 income year by electing, generally in its 1997-98 return, to be a family trust from the start of that earlier income year. However, this can only be done if the family trust passes the family control test at all times from the beginning of the earlier income year to the end of the 1997-98 income year [subitem 21(2)] . The family control test is contained in section 272-87 and is discussed in paragraphs 5.28 to 5.30.

15.23 It is not necessary for the trust to lodge a family trust election until the due date for the return of income for the 1997-98 income year. If a trust is not required to lodge a return, the election must normally be lodged within 2 months of the end of the 1997-98 income year in accordance with paragraph 272-80(2)(b).

15.24 The election may need to be made from the start of the 1994-95 income year because of the way the application provisions for current year losses are drafted (see paragraph 15.10). However, those provisions, and the prior year loss provisions, have no impact before the 1995 Budget time.

15.25 If an election is made as discussed in paragraph 15.22, family trust distribution tax will be payable on any conferrals of present entitlement or distributions by the trust outside the family group at any time from when the election becomes effective. However, no tax is payable on any conferrals or distributions made before the 1995 Budget time [paragraph 21(3)(a)] . This ensures that there is no retrospectivity in the application of that tax.

15.26 Also, no family trust distribution tax is payable in any income year before the 1997-98 income year if the family trust meets a requirement. This is that the trust satisfies, in the income year, the ordinary tests for deductibility of prior or current year losses or debt deductions that will apply to trusts that are not family trusts (i.e. the trust is not prevented under the trust loss measures from deducting a tax loss or an amount in respect of a debt, or is not required to calculate its net income and tax loss under Division 268). [Paragraph 21(3)(b)]

Interposed entity elections

15.27 In general terms, an interposed entity election for a trust, company or partnership (entity) to be included in the family group of an individual specified in a family trust election can be made to be effective from a day after the start of the 1997-98 income year. [Subitem 22(1)]

15.28 However, an entity can make an interposed entity election to start from an earlier day (not before the 1995 Budget time) by making the election in its 1997-98 return. The election can only be made from a day in an earlier year of income if the entity passes the family control test ^[F20] from that day. This does not mean that the election can only be made from the day from which the family controls the entity: it can be made from a later day. Also, the entity cannot be treated as the member of the family group of an individual before the family trust election relating to that individual has been made [subitem 22(2)] . Family trust distribution tax would be payable on any conferrals of present entitlement or distributions outside the family group by the entity from the day the election becomes effective.

Jointly held trusts

15.29 Where two parties jointly operate a business through a fixed trust in which each party owns a 50% share, and one sells its share to the other or to a third party then, in the absence of a special provision, any deduction that is available for prior orcurrent year losses or debt deductions of the trust will be lost. This is because the party that remains in the trust does not maintain fixed entitlements to a greater than 50% share of the income and capital of the trust. This being the case the fixed trust would not be able to satisfy the 50% stake test that applies to fixed trusts to test continuity of ownership. The parties could be two individuals or family trusts or an individual or family trust and a non-fixed trust (not being a family trust).

15.30 The Bill includes transitional provisions that will apply to ensure that the trust loss measures do not prevent the deductibility of prior or current year losses or debt deductions in two sets of circumstances. Effectively, these transitional provisions will treat the 50% stake test as having been satisfied where certain conditions are met.

First circumstance - test period commencing before 1996 Budget time

15.31 The first circumstance is where a joint vehicle fixed trust existed as such at some time from the 1995 Budget time to the 1996 Budget time and the relevant test period commences before the 1996 Budget time. This provision will treat the 50% stake test as having been passed if:

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the 50% stake test cannot otherwise be passed by the fixed trust for the test period;

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the test period commences at the start of, or during, the 1994-95, 1995-96 or 1996-97 income years but not after the 1996 Budget time;

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at the start of the qualifying period, two individuals or an individual and a non-fixed trust each held, directly or indirectly, and for their own benefit, fixed entitlements to 50% of the income and to 50% of the capital of the trust; and

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throughout the qualifying period, one of those individuals or, in the case where an individual and a non-fixed trust each hold 50% of the fixed entitlements, the individual directly or indirectly held, for his or her own benefit, fixed entitlements to at least 50% of the income and 50% of the capital of the trust. [Subitem 23(2)] .

15.32 The qualifying period is the test period for which the 50% stake test has to be applied. For current year loss purposes, the qualifying period does not include any period before the 1995 Budget time. Also, for the purpose of this provision, the family trust tracing rule in subsection 272-30(2) applies so that the trustee of a family trust (as defined) is treated as an individual holding a fixed entitlement for its own benefit.

Example

15.33 A fixed trust has a prior year loss incurred in the 1993-94 income year. At the 1995 Budget time, Family Trust A and Family Trust B each held a 50% share of the fixed entitlements to both income and capital of the fixed trust. Both Family Trust A and Family Trust B have elected to be family trusts from the start of the 1994-95 income year. On 31 July 1996, Family Trust B sold 25% of its fixed entitlements to income and capital of the fixed trust to Family Trust A with the remaining 25% being sold to Josephine. The fixed trust seeks to recoup its 1993-94 loss in the 1996-97 income year.

15.34 The fixed trust fails the 50% stake test because there is only continuity of ownership of 50% of the fixed entitlements (by Family Trust A) throughout the test period (i.e. the period from the 1995 Budget time to the end of the 1996-97 income year). However, the fixed trust satisfies the transitional provision in subitem 23(2) because:

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Family Trust A has held, throughout the test period fixed entitlements to at least 50% of the income and 50% of the capital of the fixed trust; and

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at the start of the test period, Family Trust A and only one other individual (Family Trust B) each held fixed entitlements to 50% of the income and 50% of the capital of the fixed trust.

Second circumstance - test period commencing after 1996 Budget time

15.35 The second circumstance is where a joint vehicle fixed trust exists at the 1996 Budget time and the relevant test period commences after the 1996 Budget time. This provision says that the 50% stake test is taken to be satisfied if:

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the 50% stake test cannot otherwise be passed by the fixed trust for the test period;

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at the 1996 Budget time, two individuals, or an individual and a non-fixed trust, each held, directly or indirectly, and for their own benefit, fixed entitlements to 50% of the income and 50% of the capital of the trust;

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between the 1996 Budget time and the start of the test period, the two individuals, or the individual and the non-fixed trust, each continued to hold that same stake in the same way; and

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throughout the test period, one of those individuals or, in the case where an individual and a non-fixed trust each hold 50% of the fixed entitlements, the individual directly or indirectly held, for his or her own benefit, fixed entitlements to at least 50% of the income and 50% of the capital of the trust. [Subitem 23(3)]

Income injection test - family trusts

15.36 A transitional provision has been inserted into the Bill to ensure that an entity that makes an interposed entity election effective from the 1995 Budget time will not be an outsider to the relevant family trust at any time before the 1995 Budget time. In the absence of this provision, the income injection test may have applied because the entity making the interposed entity election would otherwise have been an outsider in relation to benefits covered by subparagraph 270-10(1)(b)(iii) provided to it before the 1995 Budget time. [Item 24]

Definition of family

15.37 The definition of family in section 272-95 was narrowed with effect from the 1997 Budget time so that it would be appropriate in the light of modifications made to the income injection test in relation to family trusts. Between the 1995 Budget time and the 1997 Budget time members of the family of a test individual include the following:

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the test individual's spouse or former spouse;

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a parent, brother, sister, child, nephew or niece of:

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the test individual; or

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the test individual's spouse; or

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a former spouse of the test individual;

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a child of any individual mentioned above who, under the trust, is capable of benefiting on the death of the test individual;

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a grandparent, great-grandparent, aunt or uncle of the test individual;

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a child of a child of the test individual;

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the spouse or a former spouse of any individual mentioned above. [Item 25]