Senate

Supplementary Explanatory Memorandum

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

Chapter 1 - Amendments to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997

Overview

1.1 The amendments to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 (the Bill) deal with technical issues designed to clarify the intended operation of the proposed provisions. The amendments also include a change to the transitional rules dealing with the making and revocation of family trust and interposed entity elections which has been necessitated by the delay in enactment of the legislation.

Explanation of the amendments

Definition of widely held unit trust

1.2 A unit trust will be a widely held unit trust if it is not closely held (see subsection 272-105(1)). A trust is closely held if 20 or less individuals directly or indirectly beneficially own 75% or more of the income and capital entitlements in the trust (see subsection 272-105(2)).

1.3 There is an argument that if a unit trust is owned by a non-fixed trust it is not closely held and therefore is a widely held unit trust. This result is contrary to the intention of the provisions. If left unaltered, the existing provisions may:

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deny unit trusts held 50% or more by non-fixed trusts the benefit of the non-fixed trust stake test in section 266-45 (section 266-45 is explained in paragraphs 6.18 to 6.24 of the Explanatory Memorandum to the Bill); and

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allow a unit trust owned by a non-fixed trust to deduct losses and debt deductions even though there has been an effective change in the underlying ownership of the trust.

1.4 Subsection 272-105(2) is being omitted and two new subsections substituted so that a unit trust is closely held if, in addition to the existing case, individuals do not hold, directly or indirectly and for their own benefit, fixed entitlements to 75% or more of the income or capital of the trust. Two subsections are being inserted to deal separately with the income and capital cases. This is intended to make the provisions easier to understand. [Request for amendments (1) and (2)]

Current year loss rules - exclusion of all excepted trusts

1.5 Section 268-15 deals with the division of the income year of a fixed trust held 50% or more by non-fixed trusts into periods for the purposes of calculating the net income and tax loss of the trust (see the explanation in paragraphs 8.10 to 8.11 of the Explanatory Memorandum to the Bill).

1.6 Under the Bill, only family trusts are excluded from the operation of paragraphs 268-15(3)(b) and (c) of the Bill. However, the intention is that all excepted trusts (including family trusts) be excluded from the operation of those paragraphs. To overcome this unintended consequence, the references to 'family trusts' and 'family trust' in paragraphs 268-15(3)(b) and (c) are being replaced with 'excepted trusts' and 'excepted trust' respectively. [Amendments (1) and (2)]

1.7 This will ensure that paragraphs 268-15(3)(b) and (c) are consistent with subsection 266-45(5), which is linked to those paragraphs. Subsection 266-45(5) excludes all excepted trusts (not just family trusts) from its operation. It will also ensure that paragraphs 268-15(3)(b) and (c) are consistent with the equivalent provisions in the company loss rules (see paragraphs 165-45(3)(b) and (c) in item 32 of Division 2, Part 3 of Schedule 2 to the Taxation Laws Amendment Bill (No. 6) 1997).

Family owned entities as members of the family group

1.8 A company, partnership or trust (an entity) will be a member of the family group of a family trust for the purposes of paragraph 270-25(1)(f) and subsection 272-90(5) where the individual specified in the family trust election, one or more members of his or her family and/or the trustee of a family trust of the same individual directly or indirectly beneficially own the entity. It has been argued that the provisions only allow one family trust to hold the fixed entitlements. This was not the intention.

1.9 While references to the singular normally include the plural, the reference to 'one or more' in relation to family members may create an implication that the reference to a trustee of a family trust does not include the plural.

1.10 To remove doubt, subparagraph 270-25(1)(f)(iii) and paragraph 272-90(5)(c) are being replaced to make it clear that the trustees of one or more family trusts can hold the relevant fixed entitlements. [Amendments (3) and (9)]

Recoupment of tax payable by non-resident entities

1.11 Section 271-65 deals with the recoupment of family trust distribution tax payable by non-resident entities (called 'primary interposed entities' in the section). However, paragraph 271-65(2)(b) incorrectly uses the term 'primary entity' rather than 'primary interposed entity'. The amendments correct this error. [Amendments (4), (5) and (6)]

Family control test

1.12 For a trust to make a family trust election, the family must actually control the trust in the initial year for which the election is to be effective. Likewise, for a company, trust or partnership (entity) to make an interposed entity election to be included in the family group of a family trust, the family must actually control the entity in the initial year for which the election is to be effective. The family control test is explained in paragraphs 5.28 to 5.32 of the Explanatory Memorandum to the Bill.

1.13 Subsection 272-87(1) is being replaced [amendment (7)] and subsection 272-87(3) is being amended [amendment (8)] to deal with the two issues discussed below. Subsection 272-87(1) deals with the family control test for trusts making a family trust election or an interposed entity election. Subsection 272-87(3) deals with the family control test for interposed entity elections by companies and partnerships.

Legal or financial advisers

1.14 A legal or financial adviser to the family may be part of the controlling group for the purposes of the family control test applying to trusts. It has been argued in submissions to the Senate Economics Legislation Committee that the provision only allows one legal or financial adviser to be in the controlling group. This was not the intention. The arguments are essentially the same as outlined in paragraph 1.9.

1.15 To remove doubt, the substituted subsection 272-87(1) makes it clear that one or more legal or financial advisers can be part of the controlling group. [Amendment (7); new paragraph 272-87(1)(b)]

Family trusts holding fixed entitlements in an electing trust or entity

1.16 A trust will pass the family control test if, among other things, the individuals in the family have more than a 50% stake in the trust (see paragraph 272-87(2)(f)). Similarly, for a company or partnership (an entity) to make an interposed entity election to be part of the family group for the purposes of the family trust rules, the individuals in the family must beneficially own, directly or indirectly, more than 50% of income or capital entitlements in the entity in the initial year for which the election is to be effective (see subsection 272-87(3)).

1.17 As with other provisions that determine whether an entity is a family group member, ^[F1] it has been suggested that one or more trustees of family trusts in which the relevant individual is specified should be able to own the entitlements in a company, trust or partnership for the purposes of the family control test in paragraph 272-87(2)(f) and subsection 272-87(3).

1.18 For trusts, substituted subsection 272-87(1) provides that, for the purposes of paragraph 272-87(2)(f) only, the group may consist of the individual specified in the family trust election, one or more members of his or her family, the trustees of one or more trusts in which the individual is also specified, or a combination of any of those persons [Amendment (7); new paragraph 272-87(1)(c)].

1.19 For companies and partnerships, subsection 272-87(3) will be amended to provide that the group may consist of the individual specified in the family trust election, one or more members of his or her family, the trustees of one or more trusts in which the individual is also specified, or a combination of any of those persons [Amendment (8); new paragraphs 272-87(3)(c) and (d))].

Amendment of assessments

1.20 The proposed amendment to subsection 170(13) in item 11 of the Bill does not take account of the substitution of that subsection as part of the Tax Law Improvement Project (TLIP). The item is being changed so that the amendment fits in with the new subsection 170(13). [Amendment (10); new item 11]

Transitional arrangements for the pattern of distributions test

1.21 The pattern of distributions test will apply, among other things, to determine whether a non-family non-fixed trust is able to deduct losses and debt deductions (see paragraphs 9.34 to 9.57 of the Explanatory Memorandum to the Bill). There are transitional rules in items 13(4), 14(4) and 18(4) that are designed to alleviate the impact of the pattern of distributions test in the transitional stages (see paragraph 15.6 of the Explanatory Memorandum to the Bill).

1.22 The transitional rule in subitem 13(4), which applies for prior year loss purposes, treats a family as an individual for the purposes of the pattern of distributions test. This subitem is intended to apply to all distributions, whether before or after the 1995 Budget time, where a distribution prior to the 1995 Budget time has to be taken into account in applying the test.

1.23 It is arguable, because of the reference in paragraphs 13(4)(c) and (d) to "as mentioned in paragraph (a) of this subitem", that the rule will apply only to distributions made before the 1995 Budget time. Similar reasoning applies to the equivalent provisions in paragraphs 14(4)(c) and (d) (which apply for debt deduction purposes) and 18(4)(c) and (d) (which apply for foreign loss purposes).

1.24 To overcome this argument, subitems 13(4), 14(4) and 18(4) are being amended to make it clear that the transitional rule applies to all distributions that have to be considered in applying the pattern of distributions test where a distribution prior to the relevant commencement date has to be taken into account. [Amendments (11), (12), (13), (14), (15), and (16)]

Transitional arrangements for making family trust and interposed entity elections

1.25 The existing transitional arrangements in the Bill require family trust and interposed entity elections for the 1997-98 and earlier income years to be made in the 1997-98 tax return (or within 2 months after the end of the 1997-98 income year if no tax return is required). Because of the delay in enactment of the measures, it has not been possible for the Australian Taxation Office to make the necessary return form and systems changes. Consequently, alternative transitional provisions are required.

1.26 The new transitional arrangements are as set out below [Amendments (17), (18), (20) and (21)] :

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Taxpayers wishing to make the election for the 1997-98 or earlier years will be required to do so by the time of lodging their 1997-98 tax returns. If no tax return is required for 1997-98, the election will need to be made within 2 months after the end of that income year or such later day as the Commissioner allows.

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The election will need to be in a form approved by the Commissioner but will not need to be lodged with the Commissioner. However, the taxpayer will be required to keep the election for a period of 5 years after the election is made.

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A taxpayer who made the election in 1997-98 in respect of the 1997-98 income year or an earlier income year will be required to provide the Commissioner with details of the election as part of their 1998-99 tax return. If no tax return is required for 1998-99, the taxpayer will need to lodge details of the election within 2 months after the end of that income year or such later day as the Commissioner allows.

1.27 Section 262A of the Income Tax Assessment Act 1936 is being amended to make it clear that an election made in accordance with the above procedures must be retained by the taxpayer who made it for 5 years. This is a standard provision for retention of elections of this kind. [Amendment (10); new item 11A]

Revocation of family trust elections

1.28 The trust loss provisions allow a family trust election by a fixed trust to be revoked at a time when an individual other than a family member begins to hold some or all of the fixed entitlements in the trust (e.g. when the family sells the trust). The revocation is normally to be made in the return of income of the trust for the income year in which the non-family member begins to hold some or all of the fixed entitlements. If the trust is not required to lodge a return, the trustee is required to notify the Commissioner within 2 months after the end of the income year concerned. This is consistent with the way family trust elections are made.

1.29 There may be cases where the revocation could take place in an income year before 1998-99 (i.e. 1994-95, 1995-96, 1996-97 or 1997-98). For example, a fixed trust elects to be a family trust from the 1995-96 income year and the family disposes of its fixed entitlements in that trust in the 1996-97 income year. As the time for lodging its 1996-97 return has passed, the trustee could not notify the Commissioner of the revocation in its 1996-97 return.

1.30 A new transitional provision is being included in the legislation to overcome this problem. The rule provides, in essence, that where a revocation had to be made in a 1994-95, 1995-96, 1996-97 or 1997-98 tax return (or within 2 months after the end of the income year where a return is not required), it instead has to be made in the 1998-99 return (or within 2 months after the end of the 1998-99 income year where a return is not required). [Amendment (19)]

Adjusted taxable income for superannuation contributions tax purposes

1.31 The amendment in item 32 of the Bill that adds a paragraph to the definition of 'adjusted taxable income' in the Superannuation Contributions Tax (Assessment and Collection) Act 1997 does not specify that the new paragraph is to be inserted after paragraph (a) of the definition. The item is being amended to clarify this. [Amendment (22)]