House of Representatives

Explanatory Memorandum

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

Chapter 3 - Amendment of the income tax law

Outline of Chapter

3. 1 This Chapter explains amendments to the income tax law as a consequence of the introduction of the goods and services tax (GST). Amendments to the Income Tax Assessment Act 1997 (ITAA 1997) are contained in Schedule 3 to this Bill. Amendments to the Income Tax Assessment Act 1936 (ITAA 1936) are contained in Schedule 8 .

Context of Reform

3.2 From 1 July 2000 an entity that is registered for GST purposes will derive income and incur expenditure which includes GST. Asthe income tax law now stands, the GST-inclusive price of taxable supplies an entity makes would ordinarily be incorporated in its assessable income. Similarly, the entire expenditure incurred by an entity in making acquisitions would generally be deductible even though the entitlement to input tax credits will mean that the entitys resources would actually be diminished to a lesser extent.

3.3 These amendments put beyond doubt that GST on business inputs is to be excluded from assessable income and expenditure incurred, to the extent of any input tax credit entitlement. The exclusion of GST components from transaction amounts is also consistent with the design principle that GST is not a cost to business.

Summary of new law

Purpose of the amendments

3.4 The amendment of the income tax law by this Bill will ensure that the net GST liability of an entity is not itself subject to income tax and that entities will not incidentally obtain an additional income tax benefit for GST input tax credits which are refundable.

3.5 The exclusion of amounts relating to GST and input tax credits will apply to amounts of income and deductions, including elements in calculating these amounts, such as the cost base and reduced cost base for calculating capital gains and losses.

3.6 The amendments will also change some words used in the income tax law to make them consistent with meanings given by the A New Tax System (Goods and Services Tax) Act 1999 (GST Act).

Date of effect

3.7 The amendments will apply from 1 July 2000, the commencement of the GST. [Subclause 2(9)]

Detailed explanation of new law

3.8 The explanation of the effect on the income tax law has been divided into the following sections:

A.

Effect of GST on assessable income;

B.

Effect of GST on deductions;

C.

Effect of GST on capital gains tax (CGT);

D.

Other specific rules;

E.

Disregarding the effect of GST group and GST joint venture provisions;

F.

Change in terms to ensure consistency in meaning;

G.

Amendment of the ITAA 1936; and

H.

Transitional provisions.

A. Effect of GST on assessable income

3.9 The GST payable on a taxable supply [item 7, new paragraph 17-5(a)] , and the amount of any increasing adjustment relating to a supply (for example, if the price ultimately received is greater than that receivable at the time of the supply, thereby increasing the entitys net GST liability) [item 7, new paragraph17-5(b)] , is expressly excluded from assessable income and exempt income.

3.10 If the recoupment of an amount paid in acquiring something is included in assessable income, the GST effect of that recoupment is also excluded [item 7, new paragraph17-5(c)] . For example, a refund to you of an amount you have paid results in an increasing adjustment (because the input tax credit-entitling consideration you have given is reduced, thereby increasing your net GST liability). If that refund is included in assessable income, the increasing adjustment reflecting a reduction in the input tax credit attributable to the acquisition needs to be excluded from the assessable amount.

Amount included in assessable income for decreasing adjustment

3.11 In certain circumstances, an adjustment for GST purposes will result in an amount being included in assessable income. If there is a change in the creditable purpose of an acquisition resulting in a decreasing adjustment, it means that the net input tax credit effectively attributable to the acquisition has been increased (thereby decreasing the entitys net GST liability), even though the consideration paid remains unchanged.

3.12 This is the case when something acquired for use in making input taxed supplies is instead applied in making taxable supplies. This is also the case for something acquired for mixed use, when use in making taxable supplies increases relative to use in making input taxed supplies. Division 129 of the GST Act provides for increasing adjustments and decreasing adjustments because of changes in the creditable purpose of an acquisition or importation.

3.13 You will need to include an amount in your assessable income if you have a decreasing adjustment under Division 129. [Item 7, new section 17-10]

Example 3.1

A computer is acquired by a financial intermediary partly for making taxable supplies and partly for making input taxed supplies. At the time of acquisition it is intended that 10% usage of the computer will be for making taxable supplies. If, at the end of an adjustment period, it is determined that the proportion of use for making taxable supplies is actually 50% there will be a decreasing adjustment under Division 129 to compensate for the fact that the input tax credit had initially been underestimated.

Because deductions for the computer allow for input tax credit entitlements (see paragraph 3.19), a decreasing adjustment reduces the deductible amount. The amount included in assessable income under section 17-10 reverses the effect on deductions of the initial underestimation of the input tax credit.

3.14 You will also need to include an amount in your assessable income if you have a decreasing adjustment under Division 132 [item 7, new section 17-10] . This occurs if something that has been applied in making financial supplies is sold. The sale of the item as a taxable supply results in an increased input tax credit entitlement, reflected by the decreasing adjustment. Because that increased entitlement reduces the deductible amount, the amount included in assessable income under new section 17-10 reverses the effect on deductions of the initial underestimation of the input tax credit.

Excluding GST components when calculating assessable amounts

3.15 The basic rules of excluding the GST from assessable amounts and the amount corresponding to input tax credits from deductible amounts (see paragraph 3.19) extend also to amounts that constitute elements in the calculation of assessable income or deductions.

3.16 If an amount that is included in assessable income is calculated by subtracting amounts paid or payable from amounts received or receivable, the GST components of those amounts are excluded from the calculation. GST payable is therefore excluded from amounts received or receivable and amounts corresponding to input tax credits are excluded from amounts paid or payable. [Item 7, new section 17-15]

3.17 A note will be added to the core provision about assessable income to alert readers of the income tax law to these rules. [Item 1]

3.18 The terms GST [item 56] , taxable supply [item 70] , taxable importation [item 69] , increasing adjustment [item 61] and decreasing adjustment [item 55] , as defined in the GST Act, will be added to the Dictionary to the ITAA 1997.

B. Effect of GST on deductions

3.19 An amount corresponding to input tax credits to which you are entitled will be excluded from deductible losses or outgoings you incur [item 14, new section 27-5] . This is the counterpart of the rule about excluding GST from assessable amounts.

3.20 The amount of any decreasing adjustment is expressly made nondeductible [item 14, new section 27-5] . For example, if the price ultimately paid for something acquired is greater than the payment at the time of acquisition, the decreasing adjustment reflects the entitys increased input tax credit entitlement.

Deduction for increasing adjustments

3.21 In certain circumstances, an adjustment for GST purposes results in a deduction. If there is a change in the creditable purpose of an acquisition resulting in an increasing adjustment, it means that the net input tax credit effectively attributable to the acquisition has been decreased (thereby increasing the entitys net GST liability), even though the consideration paid remains unchanged. This is the case when something acquired for use in making taxable supplies. This is also the case for something acquired for mixed use, when use in making taxable supplies decreases relative to use in making input taxed supplies. Division 129 of the GST Act provides for increasing adjustments and decreasing adjustments because of changes in the creditable purpose of an acquisition or importation.

3.22 An increasing adjustment under Division 129 will be deductible provided the adjustment does not relate to an increased use of the item for private or domestic purposes [item 14, new subsections 27-10(1) and (2)] . Anincreasing adjustment relating to increased use of the item for private or domestic purposes reflects the fact that the incidence of GST rests on the person who applies goods or services for a private or domestic purpose.

3.23 An increasing adjustment under Division 138 of the GST Act on cessation of an entitys GST registration will be deductible providing the asset to which the adjustment relates is held, immediately after the registration is cancelled, for the purpose of gaining or producing assessable income [item 14, new subsection 27-10(3)] . A deduction will not be allowed if the registration cancellation occurs because the entity is not carrying on an enterprise.

Payment of GST disregarded

3.24 The payment of GST in accordance with Division33 of the GST Act is generally disregarded for income tax purposes. [Item 14, new subsection 27-15(1)]

3.25 There are exceptions if an importation is either not a creditable importation or is only partly creditable. In the former case, the GST paid on the importation may be deductible, that is, if the criteria for deductibility are otherwise satisfied. In the latter case, the part of the GST paid on the importation that is not matched by an input tax credit may be deductible. [Item 14, new subsection 27-15(3)]

3.26 Wine equalisation tax or luxury car tax included in a net amount for Division33 purposes will be deductible providing the criteria for deductibility are otherwise satisfied. [Item 14, new subsection 27-15(2)]

Excluding GST components when calculating deductions

3.27 The basic rules of excluding the amount corresponding to input tax credits for deductible amounts and the GST from assessable amounts (see paragraph 3.9) extend also to amounts that constitute elements in the calculation of assessable income or deductions.

3.28 If a deductible amount is calculated by subtracting amounts received or receivable from amounts paid or payable, the GST components of those amounts are excluded from the calculation. GST payable is therefore excluded from amounts received or receivable and amounts corresponding to input tax credits are excluded from amounts paid or payable. [Item 14, new section27-20]

3.29 A note will be added to the core provision about deductions to alert readers of the income tax law to these rules. [Item 2]

3.30 The terms creditable purpose [item 54] and input tax credit [item62] , as defined in the GST law, will be added to the Dictionary to the ITAA 1997.

C. Effect of GST on CGT

3.31 This Bill will amend the disposal proceeds and cost base rules in the CGT provisions in a way consistent with the basic rules for the treatment of assessable amounts and deductions.

3.32 Elements of cost base and reduced cost base are to exclude amounts corresponding to input tax credits to which you are entitled in relation to those elements. [Item 38, new subsection 110-45(3A) and item39, new subsection 110-50(3A)]

3.33 Capital proceeds from a CGT event are to exclude any GST payable, that is, if the capital proceeds also constitute consideration for a taxable supply. [Item 40, new subsection 116-20(5)]

3.34 Any input tax credit for the acquisition of collectables and personal use assets will be excluded in determining whether the CGT exemption thresholds ($500 for collectables, $10,000 for personal use assets) are reached. [Items 41 and 42]

3.35 Consistent with the general rule about excluding an amount equal to the input tax credit, the reference to payments by a lessor to vary a lease or for the surrender of a lease is also to exclude the input tax credit for the variation or surrender [item 43] . These payments are taken into account in cost base calculations when a CGT event happens to a lessors interest in land that is the subject of a long-term lease.

D. Other specific rules

3.36 Consistent with the general rules about excluding the GST component from amounts that are taken into account in calculating assessable income and deductions, some specific rules will be inserted in relevant parts of the income tax law.

3.37 In calculating a balancing adjustment for depreciable plant, the termination value of plant is to exclude any GST component. [Item 33, new subsection 42-205(3)]

3.38 In determining the closing value of trading stock, an amount equal to the input tax credit that would arise on acquisition of the stock at that time is to be disregarded. [Item 35, new subsection 70-45(1A)]

3.39 In calculating a balancing adjustment for mining or quarrying property, the termination value is to exclude any GST component. [Item44, new subsection 330-490(3)]

3.40 In calculating a balancing adjustment for intellectual property, the termination value is to exclude any GST component. [Item 45, new subsection 373-70(3)]

3.41 In calculating a balancing adjustment for a forestry road or timber mill building, the termination value is to exclude any GST component. [Item 50, new subsection 387-490(3)]

E. Disregarding the effect of GST group and GST joint venture provisions

GST groups

3.42 Companies within a 90% owned group may consolidate their GST obligations for supplies to entities outside the group. GST is payable by the representative member of the GST group on taxable supplies made by all group members. A further consequence under Division48 of the GST Act is that intra-group transactions are not subject to GST.

3.43 For the purpose of accounting for GST in calculating taxable income, the GST liability of the representative member is to be treated as if it were payable on the taxable supplies and taxable importations made by each group member. [Item 7, newsubsection17-20(1)]

3.44 Similarly, the representative members entitlement to an input tax credit is to be treated as if each group member who made the acquisition or importation were entitled to the credit for the purpose of applying the rules in Division 27. [Item 14, new subsection 27-25(1)]

3.45 As intra-group transactions are not subject to GST there are no GST amounts to account for.

3.46 The terms GST group [item 57] and member , [item 64] as defined in the GST Act, will be added to the Dictionary to the ITAA 1997.

GST joint ventures

3.47 Participants in a joint venture may consolidate their GST obligations for supplies to entities outside the joint venture. GST is payable by the joint venture operator on the joint ventures taxable supplies. A further consequence under Division51 of the GST Act is that supplies by one participant to another in the course of the joint ventures activities are not subject to GST.

3.48 For the purpose of accounting for GST in calculating taxable income, the GST liability of the joint venture operator is to be treated as if it were payable on the taxable supplies and taxable importations made by participants in the course of the joint ventures activities. [Item 7, new subsection17-20(2)]

3.49 Similarly, the joint venture operators entitlement to an input tax credit is to be treated as if each participant who made the acquisition or importation were entitled to the credit for the purpose of applying the rules in Division 27. [Item 14, new subsection 27-25(2)]

3.50 The terms GST joint venture [item 59] and participant [item 67] , as defined in the GST Act, will be added to the Dictionary to the ITAA 1997.

F. Change in terms to ensure consistency of meaning

Definition of market value

3.51 The definition of market value in the Dictionary to the ITAA 1997 will be modified to take into account the input tax credit that an entity would be entitled to if it acquired the thing being valued. The net effect on an entitys resources in acquiring something must allow for the fact that the consideration it gives is partly offset by the input tax credit it is entitled to. [Item 63]

3.52 The term GST-inclusive market value, as defined in the GST Act will be inserted in the Dictionary to the ITAA 1997. When this term is used it expressly includes the GST component that would be included in the price of something, that is, without adjusting for any input tax credit entitlement [item 58] . A specific rule for adjusting that value to account for the input tax credit entitlement may then be necessary as provided for in the context of deductible gifts that have been valued [item 17, new subsection 30-15(3), items 24 and 25 in relation to subsection 30-215(3] and item 28, new subsection 30-215(4)] .

3.53 The following table lists the provisions in the ITAA 1997 that have been amended so that terms used have meanings consistent with those in the GST Act.

3.54 Part 2 of Schedule 3 amends a number of provisions that will be affected by the change to the meaning of market value. Items 71 to 84 will replace existing references to market value that rely on the ordinary meaning of the term with a defined term. An asterisk indicates that the meaning given in the Dictionary applies to the term.

3.55 Not all references to market value have been asterisked. This is because the change in meaning resulting from the introduction of GST does not affect some things such as shares, and other securities, and payments that are not supplies.

Replacement of the term price

3.56 The term price is defined in the GST Act as having a GST-inclusive meaning see section 9-75 of that Act. This meaning may be misinterpreted if it is used in contexts where the rules in proposed new Division 27 (about deductibility, if there is an entitlement to an input tax credit) apply, or where it relates to a supply that may not be a taxable supply. References to price have therefore been changed if they appear in provisions of the income tax law in these contexts.

3.57 The following table lists the provisions in the ITAA 1997 that have been amended so that terms used have meanings consistent with those in the GST Act.

3.58 The term import is to be defined in the ITAA 1997 in the same way as in the GST Act [item 60] .

3.59 The term import is currently used, in the ordinary meaning of the term, in a provision of the ITAA 1997 dealing with the substantiation of depreciation expense. In this context, the substitution of the term with the defined term [item 51] does not alter the meaning of the provision.

G. Amendment of the Income Tax Assessment Act 1936

3.60 A number of provisions in the ITAA 1936 that currently use the term price will also be amended to remove the risk of misinterpretation. The following table lists the provisions that will be amended by Schedule8 to this Bill.

3.61 Subsection 6(1) which contains definitions of terms used in the ITAA 1936 will be amended to insert definitions to new terms inserted by the amendments. The terms to be inserted are creditable acquisition [item16] , GST Act [item 17] , net GST [item 18] , net input tax credit [item 19] , taxable supply [item 20] .

H. Transitional provisions

3.62 Entities holding goods immediately before the introduction of GST on 1 July 2000 that has wholesale sales tax embedded in its cost will be entitled to a special GST credit see section 16, A New Tax System (Goods and Services Tax Transition) Act 1999 .

3.63 The special GST credit is to be treated as an input tax credit for the purpose of applying the income tax amendments proposed by this Bill [Schedule 6, item 9] . This means that for calculating the amount of a deduction the expenditure incurred in acquiring the goods will need to be reduced by the amount of the special GST credit corresponding to the goods.