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Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 [and] Excess Exploration Credit Tax Bill 2014



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BILLS DIGEST NO. 75, 2014-15 23 FEBRUARY 2015

Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 [and] Excess Exploration Credit Tax Bill 2014 Kai Swoboda and Les Nielson Economics Section

Contents

Abbreviations ...................................................................... 4

Purpose and structure of the Bills ........................................ 5

Committee consideration .................................................... 5

Senate Selection of Bills Committee........................................ 5

Senate Standing Committee for the Scrutiny of Bills .............. 5

Parliamentary Joint Committee on Human Rights .................. 6

Schedule 1—Fairer taxation of excess non-concessional contributions....................................................................... 6

Background .............................................................................. 6

Changes made to excess contributions tax arrangements by the Gillard Government ............................ 7

Coalition 2013 election policy and 2014-15 Budget announcement ...................................................................... 8

Post 2013 election policy development ................................ 8

Inspector-General of Taxation’s review into the ATO’s administration of the superannuation excess contributions tax ................................................................. 8

Draft legislation ................................................................... 9

Policy position of non-government parties/independents ..... 9

Position of major interest groups ............................................ 9

Financial implications .............................................................. 9

Statement of Compatibility with Human Rights ...................... 9

Key issues and provisions ...................................................... 10

Key provisions...................................................................... 10

Are the changes ‘fair’? ......................................................... 11

Date introduced: 4 December 2014

House: House of Representatives

Portfolio: Treasury

Commencement: The commencement and application of the measures in each Schedule is indicated in the key provisions section of this Bills Digest.

Links: The links to the Bills, its Explanatory Memoranda and second reading speeches can be found on the Bills’ home pages for the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 and the Excess Exploration Credit Tax Bill 2014, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the ComLaw website.

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Conclusion ........................................................................... 12

Schedule 2—Transferring the tax investigation functions to the Inspector-General of Taxation .................................. 13

Background ............................................................................ 13

Policy position of non-government parties/independents ... 13

Position of major interest groups .......................................... 13

Financial implications ............................................................ 13

Statement of Compatibility with Human Rights .................... 13

Key Issues .............................................................................. 14

Key provisions ........................................................................ 14

Transfer of complaints from the Ombudsman to the Inspector-General of Taxation............................................. 15

Concluding Comments........................................................... 15

Schedule 3—Capital gains tax exemption for compensation and insurance ............................................. 15

Background ............................................................................ 15

Policy position of non-government parties/independents ... 15

Financial implications ............................................................ 15

Statement of Compatibility with Human Rights .................... 16

Key provisions ........................................................................ 16

Schedule 4—Greater certainty in relation to fund mergers ............................................................................ 16

Background ............................................................................ 16

Facilitating superannuation funds mergers ........................ 18

Policy position of non-government parties/independents ... 19

Position of major interest groups .......................................... 19

Financial implications ............................................................ 19

Statement of Compatibility with Human Rights .................... 19

Key issues and provisions ...................................................... 19

Part 1 of Schedule 4 ............................................................ 19

Part 2 of Schedule 4 ............................................................ 20

Schedule 5—Disclosing tax information relating to proceeds of crime orders ................................................... 21

Financial implications ............................................................ 21

Statement of Compatibility with Human Rights .................... 21

Key provisions ........................................................................ 22

Concluding comments ........................................................... 22

Schedule 6—Exploration development incentive ................ 22

Background ............................................................................ 22

What is being proposed?..................................................... 22

What is a junior exploration company? .............................. 22

The importance of mineral exploration .............................. 23

Recent trends in resource exploration ................................ 23

Is there more to discover? .................................................. 25

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Policy Development............................................................. 25

Canada - an overseas example ............................................ 26

Comparison of Canadian Flow through Shares and Proposed Exploration Development Incentive ................... 27

Policy position of non-government parties/independents ... 27

Position of major interest groups .......................................... 27

Financial implications ............................................................ 28

Statement of Compatibility with Human Rights .................... 28

Key issues and provisions ...................................................... 28

Restrictions on types of companies that can issue EDIs ..... 29

What is greenfields minerals expenditure? ........................ 30

Creation of EDIs ................................................................... 30

Excess Exploration Credit Tax Bill 2014 ................................. 31

Concluding comments ........................................................... 31

Schedule 7—Miscellaneous amendments ........................... 31

Financial impact ..................................................................... 31

Human rights implications ..................................................... 31

Key provisions ........................................................................ 32

Commencement and application .......................................... 32

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Abbreviations The following abbreviations are used throughout this Bills Digest.

Abbreviation Definition

APRA Australian Prudential Regulation Authority

ATO Australian Taxation Office

ABS Australian Bureau of Statistics

Bill Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014

cap non-concessional contributions cap

CGT capital gains tax

Commissioner Commissioner of Taxation

ECT excess contributions tax

EDI exploration development incentive credits

GDP gross domestic product

GIC General Interest Charge

IGT Inspector-General of Taxation

IGTA Inspector-General of Taxation Act 2003

ITAA 1936 Income Tax Assessment Act 1936

ITAA 1997 Income Tax Assessment Act 1997

ITTPA Income Tax (Transitional Provisions) Act 1997

TAA 1953 Taxation Administration Act 1953

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Purpose and structure of the Bills The purpose of the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 (the Bill) is to amend various tax and superannuation laws to implement largely unrelated superannuation and tax administration measures.

The Bill has seven Schedules:

• Schedule 1 amends the Income Tax Assessment Act 1997 (ITAA 1997) and the Tax Administration Act 1953 (TAA 1953) to change the taxation treatment of excess non-concessional superannuation contributions

• Schedule 2 amends the Inspector-General of Taxation Act 2003 (IGTA) to transfer the tax investigation and complaint handling function of the Commonwealth Ombudsman to the Inspector-General of Taxation (IGT) and merge that function with the IGT’s existing function of conducting systemic reviews

• Schedule 3 amends the ITAA 1997 to provide an exemption from capital gains tax (CGT) for certain trustees and beneficiaries for certain compensation and insurance payments

• Schedule 4 amends the ITAA 1997 and the Income Tax (Transitional Provisions) Act 1997 (ITTPA) to provide that individuals whose superannuation benefits are involuntarily transferred from one superannuation plan to another are not disadvantaged by being unable to bring forward accumulated tax losses. The Schedule also amends the TAA 1953 to remove the need for a roll-over benefit statement to be provided to an individual whose superannuation benefits are involuntarily transferred

• Schedule 5 amends the TAA 1953 to allow taxation officers to record or disclose protected information to support or enforce a proceeds of crime order

• Schedule 6 amends the ITAA 1997, the Income Tax Assessment Act 1936 (ITAA 1936) and the TAA 1953 to provide a tax incentive to encourage investment in small mineral exploration companies undertaking greenfields mineral exploration in Australia. For constitutional reasons, the Excess Exploration Credit Tax Bill 2014 provides for the imposition of the excess exploration credits tax1 and

• Schedule 7 makes a number of miscellaneous amendments to various tax and superannuation laws. These include the A New Tax (Goods and Services Tax) Act 1999, the Excise Act 1901, the ITAA 1997, the Retirement Savings Accounts Act 1997 and the Superannuation Industry (Supervision) Act 1993.

This Bills Digest will consider the background, financial implications, compatibility with human rights, key provisions, commencement and application of the proposed amendments in each Schedule separately.

Committee consideration Senate Selection of Bills Committee The Senate Selection of Bills Committee has deferred consideration of the Bills.2

Senate Standing Committee for the Scrutiny of Bills The Senate Standing Committee for the Scrutiny of Bills had no comment on the Excess Exploration Credit Tax Bill 2014.3 The Committee noted the retrospective application of Schedules 1 and 3, and items 10 and 24 of Schedule 7 of the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014. However, as these provisions will not impact adversely on taxpayers, the Committee made no further comment.4

1. This is because section 55 of the Constitution provides that ‘Laws imposing taxation shall deal only with the imposition of taxation, and any provision therein dealing with any other matter shall be of no effect’. As a result, provisions dealing with the assessment and collection of taxation must be contained in a separate Bill (in this case, the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014).

2. Senate Selection of Bills Committee, Report No. 1 of 2015, The Senate, Canberra, 12 February 2015, p. 4, accessed 17 February 2015. 3. Senate Standing Committee for the Scrutiny of Bills, Alert Digest No. 1 of 2015, The Senate, Canberra, 11 February 2015, p. 13, accessed 17 February 2015. 4. Ibid., p. 29.

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Parliamentary Joint Committee on Human Rights The Parliamentary Joint Committee on Human Rights considers that the Bills do not raise human rights concerns.5

Schedule 1—Fairer taxation of excess non-concessional contributions Schedule 1 of the Bill amends the ITAA 1997 and the TAA 1953 to change the taxation treatment of excess non-concessional superannuation contributions so that taxpayers can avoid the payment of the tax if they choose to withdraw excess non-concessional contributions.

Background Concessional tax treatment of superannuation contributions is limited by caps on concessional contributions (essentially those superannuation contributions made by employers that are taxed at 15 per cent) and non-concessional contributions (generally contributions from after-tax income). The value of caps has changed over recent years (Table 1).

Table 1 Superannuation concessional and non-concessional superannuation caps, 2007-08 to 2014-15

Year Concessional contributions cap Non-concessional contributions cap (a)

2007-08 $50,000 ($100,000 for individuals aged 50 or over) $150,000

2008-09 $50,000 ($100,000 for individuals aged 50 or over) $150,000

2009-10 $25,000 ($50,000 for individuals aged 50 or over) $150,000

2010-11 $25,000 ($50,000 for individuals aged 50 or over) $150,000

2011-12 $25,000 ($50,000 for individuals aged 50 or over) $150,000

2012-13 $25,000 $150,000

2013-14 $25,000 ($35,000 for individuals who are aged 59 or more at the commencement of the year)

$150,000

2014-15 $30,000 ($35,000 for individuals who are aged 49 or more at the commencement of the year)

$180,000

Note (a) Individuals aged 65 at any time in a year may bring forward two years’ worth of entitlements to make non-concessional contributions and can therefore make three years’ non-concessional contributions in one year without exceeding the cap.

Source: Australian Taxation Office (ATO), ‘Concessional contributions cap’, ATO website, accessed 11 December 2014; ATO, ‘Non-concessional contributions cap’, ATO website, accessed 11 December 2014.

Caps on the amount of concessional and non-concessional superannuation contributions were first introduced in 2007 as part of the Howard Government’s ‘Simpler Super’ changes.6 Up until the 2012-13 financial year, a tax was applied on contributions in excess of the caps:

• excess concessional superannuation contributions (concessional contributions) were liable to a 31.5 per cent excess concessional contributions tax

5. Parliamentary Joint Committee on Human Rights, Eighteenth report of the 44th Parliament, The Senate, Canberra, 10 February 2015, pp.1-2, accessed 17 February 2015. 6. The Simpler Super superannuation changes were announced as part of the 2006-07 Budget. The proposed changes included the introduction of tax-free superannuation pension for people aged 60 or more: P Costello (Treasurer), Continuing tax reform: statement by the Honourable

Peter Costello MP, 9 May 2006, pp. 17-20, accessed 11 December 2014.

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• excess non-concessional superannuation contributions (non-concessional contributions) were liable to a 46.5 per cent excess non-concessional contributions tax.

Concessional contributions are included in the non-concessional contributions to the extent that they are in excess of the concessional contributions cap for the year. The inclusion of these amounts in non-concessional contributions for the year had the effect that some, or all, of the excess concessional contributions were taxed at 93 per cent up until the 2012-13 financial year.7

The excess contributions tax arrangements do not make it unlawful for taxpayers to contribute amounts above the contributions caps. However, the tax seeks to deter excess contributions being made in any particular financial year and provides an incentive for taxpayers to save and contribute smaller sums over the course of their working lives.8

Over the last several years, the number of taxpayers affected by excess non-concessional contributions tax has been relatively small, with around 3,700 taxpayers issued with excess non-concessional contributions tax assessment notices by the ATO in 2013-14 (Table 2).

Table 2 Excess contribution tax assessments issued, 2011-12 to 2013-14

Cap type 2011-12 2012-13 2013-14

No. $ million No. $ million No. $ million

Concessional 64,424 170.7 9,332 25.6 63,312 178.4

Non-concessional 1,465 -1.9 1,029 4.9 3,034 66.5

Concessional and non-concessional

546 5.5 453 -0.4 661 11.5

Total 66,435 174.3 10,814 30.1 66,007 256.4

Source: Australian Taxation Office, Annual report 2013-14, p. 70, accessed 5 January 2015; Australian Taxation Office, Annual report 2012- 13, p. 56, accessed 5 January 2015.

Changes made to excess contributions tax arrangements by the Gillard Government The falling concessional contributions cap from 2009-10 contributed to increasing numbers of taxpayers becoming liable to excess contributions tax, with over 52,000 excess contributions tax assessments issued by the ATO in relation to the 2009-10 financial year compared to around 18,000 for the 2008-09 financial year.9 The Gillard Government responded to the increase by announcing in the 2011-12 Budget (legislated in mid-2012) that eligible individuals would have a once-only option to have excess concessional contributions taken out of their superannuation fund and assessed as income at their marginal rate of tax, rather than incurring excess contributions tax where the excess concessional contributions were less than $10,000 for 2011-12 or later years.10 These changes were supported by the Coalition, although further changes were foreshadowed as ‘anybody who has clearly made inadvertent mistakes in their excess contributions should have the capacity to rectify that without the absolutely disproportionate and excessive penalties that are being imposed by the ATO right now’.11

7. The 93 per cent tax rate could have been triggered as contributions that exceed the concessional cap are taxed at 31.5 per cent, in addition to the 15 per cent superannuation contributions tax, bringing the effective tax on these excess concessional contributions to 46.5 per cent. In addition to this, contributions that exceed the concessional cap are included in the non-concessional cap. Should these contributions then result in the non-concessional cap also being exceeded, the contributions are again subject to a tax of 46.5 per cent, bringing the possible tax total payable to 93 per cent.

8. Inspector-General of Taxation, Review into the Australian Taxation Office’s compliance approach to individual taxpayers — superannuation excess contributions tax: a report to the Assistant Treasurer, March 2014, p. 2, accessed 11 December 2014. 9. Australian Taxation Office (ATO), ‘Excess contributions tax statistical report: general information’, ATO website, accessed 11 December 2014. 10. Australian Government, Budget measures: budget paper no. 2: 2011-12, pp. 43-44, accessed 11 December 2014; Tax and Superannuation

Laws Amendment (2012 Measures No. 1) Act 2012, Schedule 4, accessed 11 December 2014. 11. M Cormann, ‘Second reading speech: Tax and Superannuation Laws Amendment (2012 Measures No. 1) Bill 2012’, Senate, Debates, 18 June 2012, p. 3496, accessed 12 December 2014.

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Further changes to excess concessional contributions tax arrangements were announced by the Gillard Government in April 2013.12 These changes, legislated in mid-2013, provided that individuals would be able to withdraw any excess concessional contributions made from 1 July 2013 from their superannuation fund and for these contributions to be taxed at the individual’s marginal tax rate, plus an interest charge to recognise that the tax on excess contributions is collected later than normal income tax.13 These changes were supported by the Coalition.14

Coalition 2013 election policy and 2014-15 Budget announcement Prior to the 2013 federal election, the Coalition’s policy on excess superannuation contributions noted that the former government had provided an ‘inadequate and partial response’ to the problem of inadvertent breaches of contribution caps and that a Coalition Government would:

… work with key stakeholders in the superannuation industry to develop an appropriate process that addresses all inadvertent breaches of the contribution caps where an individual can show that their mistake was genuine and the error would result in a disproportionate penalty. 15

In the 2014-15 Budget, the Government announced that individuals would have the option of withdrawing superannuation contributions in excess of the non-concessional contributions cap made from 1 July 2013 and any associated earnings, with these earnings to be taxed at the individual’s marginal tax rate.16 In announcing the policy the Minister noted that:

… Invariably these breaches of the non-concessional caps are inadvertent and can even be outside the direct control of the contributor. This punitive tax penalty is targeting people doing the right thing by saving more so they can look after their own needs in retirement reducing their reliance on the age pension. In Opposition we called on the previous government to fix this and promised that we would if they didn't. Today, the Abbott Government is honouring that election commitment by making sure inadvertent breaches of the non-concessional contributions cap do not incur a disproportionate penalty. This will ensure the treatment of excess concessional and non-concessional contributions is broadly consistent.

17

Post 2013 election policy development The proposed measure has been informed by a review of excess contributions tax arrangements by the IGT in early 2014 and by consultation on draft legislation in October 2014.

Inspector-General of Taxation’s review into the ATO’s administration of the superannuation excess contributions tax The IGT reported to the Government in March 2014 on its review of the ATO’s administration of the superannuation excess contributions tax (ECT) regime.18 The main concerns raised in submissions and stakeholder meetings during the review were that:

• the ECT disproportionately penalises taxpayers for genuine mistakes or matters beyond their control

• there are difficulties associated with determining the accuracy of information relied on by the ATO to identify excess contributions and the channels through which such information could be corrected where taxpayers felt there were errors or inaccuracies

12. W Swan (Treasurer) and B Shorten (Minister for Financial Services and Superannuation), Reforms to make the superannuation system fairer, joint media release, 5 April 2013, accessed 11 December 2014. 13. Tax Laws Amendment (Fairer Taxation of Excess Concessional Contributions) Act 2013, Schedule 1, accessed 11 December 2014. 14. T Smith, ‘Second reading speech: Tax Laws Amendment (Fairer Taxation of Excess Concessional Contributions) Bill 2013, Superannuation

(Excess Concessional Contributions Charge) Bill 2013’, House of Representatives, Debates, 20 June 2013, p. 6565, accessed 11 December 2014. 15. Liberal Party of Australia and the Nationals, The Coalition’s policy for superannuation, Coalition policy document, Election 2013, p. 4, accessed 11 December 2014. 16. Australian Government, Budget measures: budget paper no. 2: 2014-15, p. 19, accessed 11 December 2014. 17. M Cormann (Acting Assistant Treasurer), Superannuation excess contributions tax, media release, 13 May 2014, accessed 11 December 2014. 18. Inspector-General of Taxation, Review into the Australian Taxation Office’s compliance approach to individual taxpayers — superannuation

excess contributions tax: a report to the Assistant Treasurer, op. cit.

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• the ATO is adopting an inconsistent and narrower approach in relation to the Commissioner’s discretion to disregard or reallocate excess contributions than is warranted by the legislation

• there is insufficient communication by ATO officers and limited opportunities to engage with ATO officers in relation to ECT issues and

• there is insufficient public advice and guidance in respect of the ECT.19

While the IGT made a number of recommendations relating to the ATO’s administration of the ECT regime, it also made two recommendations to the Government. These recommendations were that the Government consider:

• whether the current treatment of excess non-concessional contributions should be aligned with that of excess concessional contributions to minimise adverse impacts on affected taxpayers

• whether the scope of the present Commissioner’s discretion to disregard or reallocate excess contributions is too narrow to provide relief in situations where an inadvertent breach has been made.20

The measures proposed by the Bill essentially implement the IGT’s recommendation to align the excess non-concessional contributions treatment with that of excess concessional contributions.

Draft legislation Draft legislation for the measure was released by the Treasury on 10 October 2014.21 The draft legislation is broadly similar to the provisions of Schedule 1 of the Bill.

Policy position of non-government parties/independents As of the date of writing, it appears that no party or member has publically expressed a position on this proposed change.

Position of major interest groups Superannuation industry groups generally support the proposed changes.22 One group, Industry Super Australia (which represents the interest of industry superannuation funds), opposes the measure, considering that the change undermines incentives to comply with the tax law and that ‘individuals who breach the law are given a free pass: they can have the excess contribution returned to them with no penalty’.23

Financial implications The Explanatory Memorandum notes that the measure has a cost to the budget of $39 million over the forward estimates.24 This is similar to the figure of $40.1 million estimated for this measure in the 2014-15 Budget.25

Statement of Compatibility with Human Rights The Statement of Compatibility with Human Rights for Schedule 1 can be found at pages 29 to 30 of the Explanatory Memorandum to the Bill. As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that Schedule 1 is compatible.

19. Ibid., p. 1. 20. Ibid., p. viii. 21. Treasury, ‘Reforming the superannuation excess non-concessional contributions tax’, Treasury website, accessed 12 December 2014. 22. Australian Institute of Superannuation Trustees (AIST), Submission to exposure draft on reforming the Superannuation Excess Non-

concessional Contributions Tax, 24 October 2014, p. 1-2, accessed 5 January 2015; Association of Superannuation Funds of Australia, Submission to exposure draft on reforming the Superannuation Excess Non-concessional Contributions Tax, 24 October 2014, p. 1-2, accessed 5 January 2015; SMSF Professionals’ Association of Australia (SPAA), Submission to exposure draft on reforming the Superannuation Excess Non-concessional Contributions Tax, 22 October 2014, p. 1, accessed 5 January 2015. 23. N Khadem, ‘Super caps changes “will aid the rich"’, The Australian Financial Review, p. 13, 30 October 2014, accessed 12 February 2015. 24. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, p. 3, accessed 14 January 2014. 25. Australian Government, Budget measures: budget paper no. 2: 2014-15, op. cit.

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Key issues and provisions The amendments proposed by Schedule 1 will provide individuals with a choice of how any assessed excess non-concessional contributions are treated for the 2013-14 or later financial years:

• an individual may elect to release from their superannuation interest (which may be held in one or more superannuation funds) an amount equal to the excess non-concessional contributions plus 85 per cent of an associated earnings amount (the latter component being reduced in recognition that a tax of 15 per cent has been imposed on earnings in the fund) or

• an individual may elect not to release these excess amounts from superannuation, in which case the current arrangements apply, with excess non-concessional contributions taxed at the top marginal tax rate.

Key provisions The amendments in Schedule 1 which relate to the ITAA 1997 deal with the tax implications of breaching the non-concessional contributions cap and the amendments to the TAA 1953 deal with the administration of these provisions by the Tax Commissioner.

The broad architecture of the changed tax arrangement is included in items 4 to 6 which amend existing provisions in the ITAA 1997 about how excess non-concessional contributions are to be treated to provide for the release at the election of an individual of the excess and 85 per cent of the notional earnings on this amount.26

Item 7 amends the ITAA 1997 to provide for the inclusion in assessable income of:

• the amounts released that relate to the notional earnings (referred to as the associated earnings) as determined by the Tax Commissioner

• less a non-refundable 15 per cent tax offset on this amount.

The calculation of the associated earnings is specified in amendments to the TAA 1953 included in item 44.27 Proposed section 97-30 provides a formula based on the existing general interest charge (GIC) arrangements or an amount specified by the Minister (whichever is the lower).28 As noted in the Explanatory Memorandum, this approximation of associated earnings reduces complexity compared to if actual earnings were used and ‘as the GIC is on average higher than average superannuation fund returns, it incorporates a small but appropriate disincentive for individuals to exceed the cap’.29 However, proposed section 97-35 allows tax payers to challenge any excess non-concessional contributions determination made by the ATO in relation to them. In its submission on the draft legislation the Australian Institute of Superannuation Trustees supported the use of a lower rate, which would ‘nonetheless [be] sufficient to ensure the payments excess concessional contributions are discouraged’.30

There are a number of provisions that relate to more complex situations that may occur with defined benefit interests or situations where there may no longer be any monies remaining within the superannuation system. This may result in no associated earnings being included in an individual’s assessable income and/or no liability for excess concessional contributions tax. For example, item 15 (new section 292-467 of the ITAA 1997) caters for circumstances where individuals who make non-concessional contributions in excess of their cap for a financial year have already been paid some or all their superannuation benefits by the time they receive a determination from the Commissioner. This proposed new section will essentially provide for the Commissioner to confirm by means of a direction that an individual will not have excess non-concessional contributions that will be subject to excess non-concessional contributions tax for the financial year to which the determination relates.

Item 49 provides that the amendments proposed by Schedule 1 apply in relation to the 2013-14 financial year and later financial years.

26. Income Tax Assessment Act 1997 (ITAA 1997), accessed 18 February 2015. 27. Taxation Administration Act 1953 (TAA 1953), accessed 18 February 2015. 28. See section 8AAD of the TAA 1953 for the general interest charge rate. 29. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 20. 30. Australian Institute of Superannuation Trustees, Submission to exposure draft on reforming the Superannuation Excess Non-concessional

Contributions Tax, op. cit., p. 4.

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Are the changes ‘fair’? Perceptions of fairness can be related to the type of taxpayers affected by the ECT arrangements and the level by which the caps are breached. The most recent publicly available information as included in the Inspector-General’s review suggests that:

• only a relatively small number of taxpayers breach the non-concessional cap, with 1,940 assessments issued in relation to 2009-10 for breaches of the non-concessional cap only and 709 assessments issued in relation to breaches of the concessional as well as the non-concessional cap

• the amounts by which individuals breached the non-concessional caps are generally small with the median value for non-concessional contribution ECT assessments in 2010-11 of $5,876 and

• it is not only higher income earners that are penalised, with most breaches of the non-concessional caps being made by taxpayers who had taxable income of less than $50,000.31

The changes to the treatment of excess non-concessional contributions proposed by the Bill are based on perceptions that the current arrangements are ‘unfair’. This assessment of unfairness is largely based on the belief that breaches are largely ‘inadvertent’ and the excess contributions tax regime imposes penalties that are ‘disproportionate’.32 Similar concerns about the ‘fairness’ of ECT arrangements were behind the 2011 and 2013 changes to concessional contributions tax arrangements implemented by the former Government. Introducing the Bill into the Parliament for the 2011 changes (which provided for a one-off withdrawal of amounts in breach of the concessional contributions cap of less than $10,000), the then Minister noted that:

Schedule 4 gives eligible individuals the option to have excess concessional contributions taken out of their superannuation fund and assessed at their marginal tax rates, rather than incurring the potentially higher effective rate of excess contributions tax. This measure will make the concessional contribution caps fairer by giving most individuals who exceed their concessional contributions caps a second chance …Successful passage of this bill will make the concessional contributions caps fairer.

33

A similar sentiment was also expressed by the Minister in introducing the 2013 changes (which allowed for excess concessional contributions to be withdrawn and taxed at marginal rates plus an interest charge):

The legislation we are introducing today will make the taxation of excess contributions fairer. 34

The design of a tax penalty regime can incorporate a number of aspects that can give rise to perceptions about whether the system is ‘fair’ or ‘unfair’. For example, a recent report by the Inspector-General of Taxation (IGT) noted four principles that could be used for evaluating whether penalties encourage voluntary compliance:

• fairness

• comprehensibility

• effectiveness and

• ease of administration.35

The principle of fairness incorporates a number of components:

• horizontal equity — similarly treating taxpayers in substantially the same circumstances by reference to taxpayers’ wilfulness of non-compliance, level of sophistication and prior compliance history

• proportionality — the penalties reflect the culpability of taxpayers and the harm caused by their non-compliance and

31. Inspector-General of Taxation, Review into the Australian Taxation Office’s compliance approach to individual taxpayers — superannuation excess contributions tax: a report to the Assistant Treasurer, op. cit., pp. 26-29. 32. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 13. 33. B Shorten (Minister for Financial Services and Superannuation), ‘Second reading speech: Tax and Superannuation Laws Amendment (2012

Measures No. 1) Bill 2012’, House of Representatives, Debates, 1 March 2012, p. 2437, accessed 12 December 2014. 34. B Shorten (Minister for Financial Services and Superannuation), ‘Second reading speech: Tax Laws Amendment (Fairer Taxation of Excess Concessional Contributions) Bill 2013’, House of Representatives, Debates, 19 June 2013, p. 6221, accessed 9 February 2015. 35. Inspector-General of Taxation, Review into the Australian Taxation Office’s administration of penalties, February 2014, pp. 3-4, accessed

20 February 2015.

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• procedural fairness — the regulator to provide opportunities for taxpayers to be heard on the issues before imposing penalties and carefully considering any mitigating facts and circumstances.36

The remaining three principles—comprehensibility, effectiveness and ease of administration— also incorporate elements of fairness. That said, even when using a formal framework, a judgement about the relative fairness of any changes remains largely subjective.

Should the changes proposed by Schedule 1 of the Bill be passed by the Parliament, the ECT regime as a whole will be significantly different to the one that operated prior to the changes made in 2011 (Table 3). While the contributions caps continue to exist, deterrence has been weakened to the extent that individuals may now consider that they do not need to carefully monitor compliance with the caps.

Table 3 Excess contributions tax arrangements (and proposed arrangements) 2010-11 to 2013-14

Cap type 2010-11 2011-12 2012-13 2013-14 and later years

Concessional superannuation contributions

Amount of excess taxed at 31.5% (not including the 15% tax paid on contributions to the fund) bringing total tax paid to 46.5%.

One off refund offer of up to $10,000 with this amount taxed at marginal rates less 15% non-refundable tax offset. Amounts above $10,000 subject to total 46.5% regime.

One off refund offer of up to $10,000 with this amount taxed at marginal rates less 15% non-refundable tax offset. Amounts above $10,000 subject to total 46.5% regime.

Excess contributions included in assessable income (plus a shortfall interest charge) less a 15% tax offset. Taxpayer can elect to release up to 85% of excess amount.

Non-concessional superannuation contributions

Amount of excess taxed at 46.5%.

Amount of excess taxed at 46.5%.

Amount of excess taxed at 46.5%.

Taxpayer is subject to excess tax arrangements unless he or she elects to release excess contribution plus 85% of associated earnings. Associated earnings taxed at marginal rates less 15% non-refundable tax offset.

Source: Australian Taxation Office (ATO), ‘If you go over the concessional contributions cap’, ATO website, accessed 9 January 2015; Australian Taxation Office (ATO), ‘Non-concessional contributions’, ATO website, accessed 9 January 2015; Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 15.

Conclusion The changes proposed by Schedule 1 affect only a relatively small number of taxpayers, many of whom do not have relatively high incomes. The proposed changes weaken the existing deterrence for taxpayers who exceed non-concessional caps but there will continue to be a limit on annual contributions into tax preferred superannuation. Combined with the rise in the non-concessional cap to $180,000 from 2014-15, it is likely that only small numbers of taxpayers will be affected by the changed arrangements in the medium term.

36. Ibid.

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Schedule 2—Transferring the tax investigation functions to the Inspector-General of Taxation The purpose of the amendments in Schedule 2 is to transfer the investigative powers of the Commonwealth Ombudsman in relation to individual tax matters to the IGT.37

Background Under current arrangements taxpayers’ complaints about the administration of the various income tax acts may be investigated by the Commonwealth Ombudsman, who is also the Taxation Ombudsman.38

In the Portfolio Budget Statements 2014-2015, the Government announced a transfer of the tax complaint handling role from the Taxation Ombudsman to the IGT.39 Though a minor administrative change, it is nonetheless an unusual way in which to announce such changes.

Policy position of non-government parties/independents As of the date of writing, it appears that no party or member has publically expressed a position on this proposed change.

Position of major interest groups There has been no comment by any interest group on the proposed change.

Financial implications The Explanatory Memorandum states that the Government will provide an additional $0.1 million over four years from 2014-15 to transfer the tax complaint function.40 Budget Statement No. 2, 2014-15 shows the net movement in assets associated with this change (Table 4).

Table 4 Resources for transfer of functions ($m)

Year 2014-15 2014-16 2016-17 2017-18 Total

Inspector-General additional funding 0.7 0.7 0.6 0.7 2.7

Ombudsman, reduction in funding -0.6 -0.6 -0.6 -0.6 -2.4

Net result (rounded) 0.1 0 0 0 0.1

Source: Australian Government, Budget measures: budget paper no. 2: 2014-15, p. 217, accessed 9 January 2015.

As can be seen the total additional resources given to the IGT over four years is $2.7m. This expenditure is offset by a withdrawal of resources from the Commonwealth Ombudsman.41

Statement of Compatibility with Human Rights The Explanatory Memorandum contains contradictory statements regarding the human rights issues raised by Schedule 2. For example, on page four of the Explanatory Memorandum it is stated that Schedule 2 ‘…does not raise any human rights issues’ (emphasis added).42 However, the Explanatory Memorandum (at pages 51-52) then notes that Schedule 2 does in fact, raise human rights issues. For example, due to the IGT’s ability to request (but not require) an entities’ tax file number, the Bill engages issues related to a person’s right to privacy. However, the Explanatory Memorandum notes that ‘to the extent, [the ability to request a tax file number] may limit human rights, these limitations are reasonable, necessary and proportionate’.43

As noted above, the Parliamentary Joint Committee on Human Rights considers that the Bill does not raise human rights concerns.44

37. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 31. 38. Subsection 4(3) of the Ombudsman Act 1976, accessed 18 February 2015. 39. Australian Government, Portfolio budget statements 2014-15: budget related paper no. 1.16: Treasury Portfolio Inspector-General of Taxation, p. 277, accessed 15 December 2014.

40. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 4. 41. Australian Government, Budget measures: budget paper no. 2: 2014-15, op. cit., p. 217. 42. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 4. 43. Ibid., p. 52. 44. Parliamentary Joint Committee on Human Rights, Eighteenth report of the 44th Parliament, The Senate, Canberra, 10 February 2015, pp. 1-2,

accessed 17 February 2015.

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Key Issues There are a number of key issues in respect of this particular initiative:

• will a sufficient number of staff be transferred from the Ombudsman’s office to the IGT to cover the new function? and

• does the IGT’s office have a narrower range of powers than those available to the Ombudsman in relation to the exercise of this new function?

Key provisions Part 1 of Schedule 2 amends the IGTA.45

Item 3 widens the matters the IGT can investigate by repealing existing subparagraph 3(c) and substituting the new text contained in proposed paragraph 3(c) and (d). These will allow the Inspector-General to investigate individual taxpayer’s complaints. In addition, it allows the Inspector-General to incorporate individual taxpayer’s complaints into any systematic investigation.

Item 11 repeals existing Divisions 2, 3 and 4 of Part 2 of the IGTA and substitutes new text for these Divisions. Proposed section 7 will widen the existing powers of the Inspector-General and allows this office to conduct investigations of individual taxpayer’s complaints.

Existing section 9 allows the Inspector-General to set their own work program and requires them to consult with both the Auditor-General and Ombudsman once a year in setting this work program. Whilst this requirement is absent from the proposed changes, proposed section 9 gives the IGT a wide-ranging discretion in relation to conducting investigation. This includes the ability to decline to investigate a matter if the circumstances of that complaint do not warrant further attention being paid to it. Such circumstances include insufficient interest by the complainant in the subject matter of the complaint, a lack of action by the complainant in the available review tribunals, or if the requested investigation is of a frivolous or vexatious nature.46 There are similar provisions in the Ombudsman Act 1976, regarding investigations under that Act.47

Current section 10 of the IGTA requires the IGT to make a written report to the Minster at the conclusion of any investigation. Its replacement (proposed section 18) only states that the IGT may make a written report to the Minister, thus providing a significant degree of discretion to the IGT regarding what it chooses to report. This is a significant change between the existing and proposed legislation. The Explanatory Memorandum does not comment on this particular change. However, given the large number of investigations conducted into minor tax matters, it would appear that this change is designed to allow the IGT to focus its reporting efforts on major investigations with potentially systemic importance, thus reducing the amount of administrative work required to fulfil its reporting functions and hence increasing efficiency.

Item 11 also inserts a new Division 3 into Part 2 of the IGTA. It provides the IGT with most of the investigative powers provided to the Taxation Ombudsman by the Ombudsman Act for investigations related to the administration of taxation laws. In particular, proposed section 15 of the ITGA specifies that most of the powers under the Ombudsman Act 1976 can be exercised by the IGT in relation to the investigation of the administration of taxation laws. The exceptions appear to relate to matters that would not reasonably be associated with taxation related investigations (for example, misconduct by Parliamentary Department officers that is not related to taxation matters), and thus reflect the IGT’s narrower investigative focus compared to the Ombudsman.48

Item 28 amends existing section 41 of the ITGA to expand the information that is required in the IGT’s annual report to Parliament to include the number of:

• complaints received by the IGT under the IGTA

• investigations commenced and completed

45. Inspector-General of Taxation Act 2003 (IGTA), accessed 18 February 2015. 46. See proposed paragraphs 9(c), (d) and (e) for example. 47. Ombudsman Act 1976, section 6. 48. Ombudsman Act 1976, paragraph 8(10)(bb), (c) and (d).

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• times the IGT used its coercive investigatory powers provided by section 9 of the Ombudsman Act and the circumstances in which they were used.

Item 33 is a consequential amendment to the Ombudsman Act that ensures that the definition of taxation law provided by the ITAA 1997 applies to the IGTA.

Transfer of complaints from the Ombudsman to the Inspector-General of Taxation Proposed section 6D of the Ombudsman Act, at item 35, requires the Ombudsman:

• to transfer complaints that are solely about the administration of taxation laws to the IGT and

• not to investigate complaints only about the administration of taxation laws but

• allows the Ombudsman to jointly investigate a complaint with the Inspector-General, where only part of that complaint is about taxation law administration matters.

Concluding Comments The transfer of the investigation of individual’s taxation law administration complaints to the IGT gives that office a powerful source of information for the early detection of any systemic issues in the administration of these laws. Further, the additional resources given to the IGT (see financial implications above) may enable that office to undertake such investigations.

Given that the bulk of the Ombudsman’s investigative powers may be exercised by the Inspector-General under the proposed legislation, it appears that the IGT’s powers will be appropriate for its new responsibilities.

Schedule 3—Capital gains tax exemption for compensation and insurance The purpose of the amendments in Schedule 3 is to more firmly establish a legislative basis for the long standing practice of exempting certain compensation and damages payments from Capital Gains Tax (CGT).

Background The Commissioner of Taxation has had a long standing administrative practice to not tax any compensation received by way of a successful claim on an accident or illness insurance policy (that is, damages or compensation) under the CGT regime.49

Commonly, superannuation funds provide accident and illness insurance policies as part of their services to members. However, the Explanatory Memorandum notes that there has been an element of legal doubt about whether payments arising from a successful claim on such policies were subject to CGT upon payment.50 Successive governments have announced their intention to address this issue for both superannuation and non-superannuation related compensation payments.51 The provisions in Schedule 3 of the Bill remove the legal doubt.

Policy position of non-government parties/independents As of the date of writing, it appears that no party or member has publically expressed a position on this proposed change.

Financial implications This measure is estimated to have a small but unquantifiable cost to revenue over the forward estimates period.52

49. Commissioner of Taxation, ‘Capital Gains: will payments made under accident and health assurance policies be exempt from CGT?’, CGT Determination no. 14, ATO website, Canberra, 10 September 1991, accessed 16 December 2014. This ruling was reissued on 29 November 2006 in response to the rewriting of the relevant provisions in the Income Tax Assessment Act 1997.

50. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 53. 51. Australian Government, Budget measures: budget paper no. 2: 2011-12, op. cit., p. 18.; Australian Government, Budget measures: budget paper no. 2: 2012—13, p. 20, accessed 14 January 2015; A Sinodinos (Assistant Treasurer), Integrity restored to Australia’s taxation system, media release, 14 December 2013, p.4, accessed 16 December 2014.

52. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 5.

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Statement of Compatibility with Human Rights The Statement of Compatibility with Human Rights for Schedule 3 can be found at page 63 of the Explanatory Memorandum to the Bill. The Government considers that Schedule 3 is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Key provisions Item 3 of Schedule 3 repeals existing paragraphs 118-37(1)(a) and (b) of the ITAA 1997 and substitutes new text intended to put beyond doubt that compensation received personally, or as the beneficiary of a trust, is not subject to CGT.53

Items 4, 5 and 6 modify the table in section 118-300 of the ITAA 1997 so that the:

• trustee of a complying superannuation fund or other trust or

• a person who is a beneficiary of those entities

is not subject to CGT upon the receipt of monies arising from a successful sickness or accident insurance claim.

Items 4, 5 and 6 cover the receipt of lump sums or annuity payments.

Item 8 ensures that the amendments contained in Schedule 3 apply from the start of the 2005-06 income year (that is, in respect of payment received from 1 July 2005).

Schedule 4—Greater certainty in relation to fund mergers Schedule 4 of the Bill amends the ITAA 1997 and the ITTPA to so that when a member of a superannuation fund has their superannuation balance involuntarily transferred to another superannuation fund as a result of the merger of their existing superannuation into another, they are not disadvantaged. Schedule 4 also amends the TAA 1953 to remove the need for a roll-over benefit statement to be provided where superannuation benefits are involuntarily transferred.54

Background There has been ongoing consolidation by superannuation funds in recent years, with the number of large funds steadily declining (Figure 1).55 This decline in the number of funds in an industry with growing superannuation balances has meant that larger funds have been created. At the end of June 2013, the largest 20 superannuation funds accounted for around two-thirds of assets in superannuation funds (excluding self-managed superannuation funds), compared to around 45 per cent a decade earlier (Figure 2).56 Some Australian superannuation funds are also now amongst the largest in the world, with three Australian funds (AustralianSuper, QSuper and First State Super) among the largest 100 funds globally at the end of 2013.57

53. Income Tax Assessment Act 1997 (ITAA 1997), accessed 18 February 2015. 54. Explanatory Memorandum, op. cit., p. 65. 55. Australian Prudential Regulation Authority (APRA), Statistics: annual superannuation bulletin, June 2013 (revised 5 February 2014), pp. 20 and 28, accessed 6 January 2015.

56. APRA, Superannuation fund-level profiles and Financial Performance (issued 8 January 2014), excel data file, accessed 6 January 2015. 57. Towers Watson, The world’s 300 largest pension funds - year end 2013, September 2014, pp. 38-39, accessed 6 January 2014.

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Figure 1 Number of large superannuation funds and average fund size, June 2004 to June 2013

Source: as per footnote 55.

Figure 2 Largest 20 superannuation funds by asset size as a share of total superannuation fund assets (excluding self managed superannuation funds), June 2004 to June 2013 (per cent)

Source: as per footnote 56.

The external forces encouraging consolidation by superannuation funds have included regulatory changes with the introduction of licensing for trustees from 2005 and related compliance requirements. In addition to those external (regulatory) forces, the benefits of economies of scale in the industry have also encouraged consolidation.58

Scale-related factors that may encourage consolidation include the potential cost savings arising from greater negotiating power with external investment managers, asset diversification strategies and spreading fixed costs

58. K Liu and B Arnold, Superannuation and insurance: related parties and member cost, Australian Prudential Regulation Authority, Working paper, November 2012, p. 10, accessed 6 January 2014.

0

600

1200

1800

2400

3000

3600

0

300

600

900

1,200

1,500

1,800

Jun 2004 Jun 2007 Jun 2010 Jun 2013

Average fund size ($m)

No. of funds

Corporate Retail

Industry Public Sector

Average fund size

0%

20%

40%

60%

80%

2004 2007 2010 2013

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for operating any fund (such as accounting and auditing services, legal advice, fund compliance testing and IT infrastructure) over a larger membership base.59

However, the evidence of scale-related benefits is not clear. While scale benefits have been identified in several studies of Australian superannuation funds (and in broader studies of the funds management industry generally), such benefits may decline or even become negative beyond certain sizes, may relate only to certain types of funds, or be related to the demographic profile of members.60

Facilitating superannuation funds mergers In October 2012, the Gillard Government’s Minister for Financial Services and Superannuation announced that superannuation tax arrangements would be changed so that superannuation fund members were not disadvantaged where their benefits were rolled over within a fund or between funds in response to expected fund mergers that were encouraged by the Stronger Super package of superannuation reforms.61 The then Minister signalled that the proposed measures would apply from 1 July 2013.62 The relevant Stronger Super changes that contribute to pressures for further consolidation of superannuation funds include:

• the introduction of MySuper, which includes a specific test for trustees to assess (on an annual basis) whether members who hold a MySuper interest are disadvantaged by insufficient scale compared to members who hold a MySuper interest in other funds (referred to as the ‘scale test’)63

• proposals for the auto-consolidation of ‘lost’ superannuation and small accounts as part of MySuper, so individuals have a smaller transfer of accrued default amounts for MySuper and

• the implementation of SuperStream reforms (data standards, etc.) which require superannuation funds (and employers) to upgrade their information technology systems to comply with the new mandatory data and e-commerce data requirements.64

Although announced as applying from 1 July 2013, the measure was not legislated. However, other measures to facilitate superannuation fund mergers in the form of capital gains tax relief for a limited period were enacted in 2011, with entities able to choose to take up capital gains tax loss relief where the transferring entity transfers assets to the receiving entity on or after 1 October 2011 and before 2 July 2017.65 This was followed by income tax relief applied for superannuation funds where there is a mandatory transfer of default members’ account balances to a MySuper product in another superannuation fund between 1 July 2013 and 1 July 2017.66 In each case, the changes were not opposed by the Coalition in opposition.67

In November 2013, the Coalition Government announced that the unlegislated measure discussed above would be the subject of further consultation.68 In December 2013, the Government announced that the measure would proceed with effect from 1 July 2015, and draft legislation was released by the Treasury for consultation in September 2014.69

59. Australian Prudential Regulation Authority (APRA), Effect of fund size on the performance of Australian superannuation funds, APRA, Working paper, March 2012, p. 6, accessed 6 January 2015. 60. Australian Prudential Regulation Authority, Effect of fund size on the performance of Australian superannuation funds, op. cit., pp. 30-31; H Higgs and A Worthington, ‘Economies of scale and scope in Australian superannuation (pension) funds’, Pensions, 17(4), 2012, pp. 252-259,

accessed 6 December 2014; J Bikker and J De Dreu, ‘Operating costs of pension funds: the impact of scale, governance, and plan design’, Journal of Pension Economics and Finance, 8(1), 2009, pp. 63-89, accessed 6 January 2015. 61. Australian Government, Mid-year economic and fiscal outlook 2012-13, October 2012, p. 178, accessed 12 February 2015. 62. B Shorten (Minister for Financial Services and Superannuation), Government reforms boost super savings and lower industry costs, media release, 22 October 2012, accessed 5 January 2014. 63. Superannuation Industry (Supervision) Act 1993, paragraph 29VN(b), accessed 6 January 2014. 64. This is because costs associated with the upgrade of systems may be substantial and may influence potential merger decisions. 65. Superannuation Laws Amendment (Capital Gains Tax Relief and Other Efficiency Measures) Act 2012, Schedule 1, accessed 6 January 2015. 66. Superannuation Laws Amendment (MySuper Capital Gains Tax Relief and Other Measures) Act 2013, Schedule 1, accessed 6 January 2015. 67. B Billson, ‘Second reading speech: Superannuation Laws Amendment (Capital Gains Tax Relief and Other Efficiency Measures) Bill 2012, Superannuation Auditor Registration Imposition Bill 2012’, Debates, House of Representatives, 29 October 2012, p. 12194, accessed 6 January 2015; T Smith, ‘Second reading speech: Superannuation Laws Amendment (MySuper Capital Gains Tax Relief and Other Measures) Bill 2013’, Debates, Federation Chamber, 20 June 2013, p. 6568, accessed 6 January 2015. 68. J Hockey (Treasurer) and A Sinodinos (Assistant Treasurer), Restoring integrity in the Australian tax system, joint media release, 6 November 2013, accessed 6 January 2015. 69. A Sinodinos (Assistant Treasurer), Integrity restored to Australia’s tax system, op. cit.; Treasury, ‘Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014: providing certainty for superannuation fund mergers’, Treasury website, accessed 6 January 2015.

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Policy position of non-government parties/independents As of the date of writing, it appears that no party or member has publically expressed a position on this proposed change.

Position of major interest groups Superannuation industry groups are supportive of the changes proposed by Schedule 4.70

Financial implications The Explanatory Memorandum notes that the changes proposed by Schedule 4 have a ‘nil’ financial impact.71

Statement of Compatibility with Human Rights The Statement of Compatibility with Human Rights for Schedule 4 can be found at page 75 of the Explanatory Memorandum to the Bill. The Government considers that the Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Key issues and provisions Under existing arrangements, the ‘proportioning rule’ in section 307-125 of the ITAA 1997 provides that any benefits paid from superannuation are taxable and tax-free in the same proportion as the superannuation interest, just before the benefit is paid.72 The tax-free component consists of the ‘contributions segment’ and the ‘crystallised segment’:73

• the contributions segment generally consists of all contributions made from 1 July 2007 that have not been included in the assessable income of the fund74 whereas

• the crystallised segment is calculated in relation to the value of the interest prior to 1 July 2007, taking account of the pre-2007 tax rates on various components.75

The taxable component of a superannuation interest is the value of the interest less the tax free component.76

The intention of the proportioning rule is to prevent members from choosing which components they withdraw when they take a superannuation benefit. In order to keep an individual in the same taxation regime after a superannuation fund merger, changes need to be made to the definitions of the contributions segment and crystallised segment and the proportioning rule.

Schedule 4 is comprised of two Parts. Under clause 2 of the Bill, both parts of Schedule 4 will commence on 1 July 2015.

Part 1 of Schedule 4 Item 9 of Part 1 of Schedule 4 provides that the amendments in Part 1 apply to involuntary roll-over of superannuation benefits paid on or after 1 July 2015.

Item 1 of Schedule 4 inserts proposed section 306-12 into the ITAA 1997 to introduce the concept of an ‘involuntary roll-over superannuation benefit’, which covers three circumstances involving a transfer of an individual’s superannuation interest (that is, before a superannuation pension has commenced being paid) or

70. Australian Institute of Superannuation Trustees, Submission to exposure draft on providing certainty for superannuation fund mergers, 20 October 2014, pp. 1-2, accessed 7 January 2015; Association of Superannuation Funds of Australia, Submission to exposure draft on providing certainty for superannuation fund mergers, 22 October 2014, pp. 1-2, accessed 7 January 2015.

71. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 6. 72. Income Tax Assessment Act 1997 (ITAA 1997), section 307-125, accessed 18 February 2015. 73. Income Tax Assessment Act 1997, section 307-210. 74. Income Tax Assessment Act 1997, section 307-220. The contributions segment can include a number of payments such as undeducted

contributions that an individual makes for a spouse, government co-contributions and contributions made for a child by an individual who is not the child’s employer, and a low income superannuation contribution. 75. Income Tax Assessment Act 1997, section 307-225. The crystallised segment is calculated by assuming that an eligible termination payment representing the full value of the superannuation interest was paid just before 1 July 2007. The crystallised segment of the superannuation

interest is so much of the value of the interest as consists of different components with different tax treatments such as the concessional component before 1 July 2007 (5% of the concessional component was included in assessable income and taxed at marginal rates) and the pre-July 83 component (before 1 July 2007, 5% of the pre-July 83 component was included in assessable income and taxed at marginal rates). 76. Income Tax Assessment Act 1997, section 307-215.

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benefit (that is, after a superannuation benefit has started to be paid) between superannuation plans without the consent of the individual concerned. This includes a situation where accrued default amounts are transferred to a MySuper product where the transfer happens between 1 July 2015 and 1 July 2017. The three circumstances which are classified as an involuntary roll-over benefit are:

• a payment transferring a superannuation interest of a member of a superannuation fund, a depositor with an approved deposit fund or a holder of a retirement savings account to a successor fund (other than a self managed superannuation fund) without the member’s, depositor’s or holder’s consent

• a payment transferring an accrued default amount of a member of a complying superannuation fund to a MySuper product in another complying superannuation fund where the transfer occurs between 1 July 2015 and 1 July 201777 or

• where a payment of consideration for the issue of a superannuation interest in an eligible rollover fund is made by a superannuation fund.78

As noted in the Explanatory Memorandum, ‘all three circumstances involve a transfer of an individual’s benefits between superannuation plans without the consent of the individual concerned’.79

Item 2 amends the proportioning rule as defined in section 307-125 of the ITAA 1997 so that if a superannuation benefit is an involuntary roll-over superannuation benefit paid from a superannuation interest and that interest was supporting a superannuation income stream immediately before that benefit was paid, then the proportion of the tax-free and taxable components is determined when that income stream commenced.

Item 3 inserts new provisions into section 307-220 of the ITAA 1997 that modify the method for determining the contributions segment. Proposed paragraphs 307-220(2)(ia) and (ib) provide that the tax free component of an involuntary roll-over superannuation benefit paid into the interest from another superannuation interest (other than one that was supporting an income stream immediately before that benefit was paid) is disregarded.

Item 4 inserts proposed subsection (5) into section 307-220 to provide that the contributions segment of the new interest in the new plan will not be limited by the old interest in the original plan immediately before the involuntary roll-over occurred.

Items 6 and 7 amend the ITTPA to provide that superannuation income streams paid prior to 1 July 2007 will effectively treat the new income stream from the new plan arising from the involuntary transfer as a continuation of the income stream paid from the original plan.80 This ensures consistency of taxation treatment of the income stream.

Item 8 amends the TAA 1953 to remove the requirement for the provider of a transferring plan to provide roll-over benefits statements to former members, depositors or account holders for involuntary roll-over superannuation benefits.81

Part 2 of Schedule 4 Items 11 to 13 amend existing section 307-210 of the ITAA 1997 (which defines the ‘tax free component’ of a superannuation interest) to add proposed subsection 307-210(2) which confirms how the tax free component of a superannuation interest is reduced when a superannuation benefit is paid from the interest. This has the effect of reducing the interest’s tax free component by the amount of the benefit’s tax free component.

Item 14 amends existing section 307-220 of the ITAA 1997 (which defines the ‘contributions segment’) by repealing existing subsection 307-220(1) and replacing it with new subsection 307-220(1). The new provision explicitly states that the definition of ‘contributions segment’ has effect subject to new subsection 307-210(2)— that is, the contributions segment may be reduced if a superannuation benefit is paid under new subsection 307-210(2).

77. The transfer must be the result of an election taken under paragraph 29SAA(1)(b) or section 388 of the Superannuation Industry (Supervision) Act 1993 (which deal with the transfer of accrued default amounts to MySuper products at the election of the superannuation fund in question, rather than the superannuation interest holder).

78. Such a transfer must be made under section 243 of the Superannuation Industry (Supervision) Act 1993. 79. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 70. 80. Income Tax (Transitional Provisions) Act 1997, accessed 18 February 2015. 81. Taxation Administration Act 1953 (TAA 1953), accessed 18 February 2015.

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Items 15 and 16 amend existing subsection 307-225(2) (which defines the ‘crystallised segment’) to explicitly state that the definition of ‘crystallised segment’ has effect subject to new subsection 307-210(2)—that is, the crystallised segment may be reduced if a superannuation benefit is paid under new subsection 307-210(2). The amendments proposed by items 14 to 16 will ensure that in the case of an involuntary roll-over from a superannuation interest that was not supporting an income stream (for example, a pension) immediately before the involuntary roll-over:

• the contributions segment of the new interest in the new plan will not be limited by the value of the old interest in the original plan immediately before the involuntary roll-over occurred and

• investment losses in the original plan are effectively ‘recovered’ in the new plan, as any tax free component lost as a result of the involuntary roll-over can be recouped on a later benefit payment from the new plan.82

Item 17 repeals the existing definition of ‘successor fund’ in subsection 995-1(1) of the ITAA 1997 and replaces it with a new definition. In effect, the amendment made by item 17 will ensure that transfers from an approved deposit fund to another superannuation fund, approved deposit fund or retirement savings account (being the successor fund) are captured in the definition of a successor fund, thus extending the operation of the involuntary roll-over benefit provisions discussed above. (The current definition only covers transfers from/to superannuation funds and retirement savings accounts.)

Schedule 5—Disclosing tax information relating to proceeds of crime orders The purpose of the amendments in Schedule 5 of the Bill is to amend the TAA 1953 to:

• allow taxation officers to record or disclose protected information for the purpose of supporting or enforcing a proceeds of crime or unexplained wealth order (in addition to the making, or proposed or possible making of such an order) and

• amend the definition of a ‘proceeds of crime order’ to clarify that it includes an ‘unexplained wealth order’ made under a state or territory law.

The main issue addressed by this Schedule is that Tax Officers may disclose relevant tax information to Commonwealth law enforcement agencies, but doubt exists on whether they can do so to a state or territory agencies in all relevant circumstances. As noted in the Explanatory Memorandum, this is because there is currently ambiguity as to whether certain state and territory unexplained wealth orders ‘correspond to’ Commonwealth unexplained wealth orders as defined in the Proceeds of Crime Act 2002, as required by existing subsection 355-70(5) of Schedule 1 of the TAA 1953, in order for the disclosure to be authorised.83

Proposed paragraph 355-70(5)(c) of Schedule 1 of the TAA 1953, at item 3 of Schedule 5, removes this ambiguity by removing the reference orders that correspond to those that may be made under the Proceeds of Crime Act 2002, and instead providing that a ‘proceeds of crime’ order includes any court order under a state or territory law that relates to unexplained wealth.

The practical impact of the proposed amendment will be to ensure that taxation information can be disclosed to state and territory law enforcement agencies for use in unexplained wealth investigations and prosecutions, even if there are differences between the relevant state or territory and the Commonwealth legislation.84

Financial implications The Explanatory Memorandum states that there are no financial implications arising from the amendments in Schedule 5.85

Statement of Compatibility with Human Rights The Statement of Compatibility with Human Rights for this Schedule can be found at pages 79-80 of the Explanatory Memorandum to the Bill. Though the measures in Schedule 5 raise some privacy concerns, the Government considers that they are consistent with the right to privacy because the records or disclosures will be authorised by law, and will not be applied in an arbitrary manner. Further, the Government considers that the

82. Explanatory Memorandum, op. cit., p. 72. 83. Taxation Administration Act 1953 (TAA 1953), accessed 18 February 2015. 84. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 79. 85. Ibid., p. 6.

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amendments provide a reasonable, necessary and proportionate means of achieving the legitimate objective of confiscating financial benefits gained through criminal activities.

As noted above, the Parliamentary Joint Committee on Human Rights considers that the Bill does not raise human rights concerns.86

Key provisions Items 1 and 2 of Schedule 5 amend subsection 355-70(1) of Schedule 1 of the TAA 1953 so that it is not an offence for a Tax Officer to disclose information to a state or territory law enforcement agency or a state or territory Royal Commission or Inquiry for the purposes of supporting or enforcing a proceeds of crime order. Whilst powers already exist for a Tax Officer to provide such information for the purposes of making, or proposed or possible making, of such orders, the amendment allows information to also be provided for the purpose of supporting or enforcing such an order.

Item 3 repeals and replaces paragraph 355-70(5)(c) of Schedule 1 of the TAA 1953 to clarify the ambiguity in the existing paragraph, discussed above. New paragraph 355-70(5)(c) by providing that a ‘proceeds of crime’ order includes any court order (including a direction or declaration) under a state or territory law that relates to unexplained wealth.

Concluding comments The amendments proposed by Schedule 5 of the Bill will remove existing legal ambiguity and strengthen the ability of Commonwealth, state and territory law enforcement agencies to recover proceeds of crime.

Schedule 6—Exploration development incentive The purpose of these amendments is to encourage investment in Australian junior mineral exploration companies through the creation of a new form of tax credits, to be known as Exploration Development Incentive Credits (EDIs). These credits arise from the amount of exploration expenditure that is unable to be claimed as a tax deduction by these companies.87

Background

What is being proposed? Briefly, a junior exploration company will be able to issue a limited number of EDIs when:

• it undertakes minerals exploration, onshore, within Australia (offshore exploration is specifically excluded),

• the exploration takes place in a greenfield location (see below) and

• the company is not producing mineral resources while undertaking this exploration, (other than petroleum).

The proposed scheme is to last for three years and has an annual overall limit on the number of EDIs that can be issued in respect of any one income year.88

What is a junior exploration company? Resource companies can be divided into either ‘senior’ or ‘junior’ companies. The senior companies have established mines and raise their exploration funding from their own operations. In contrast, so called junior companies can currently raise their exploration funding either from the stock market or via agreements with senior mining companies or other investors. They do not have internal sources of investment capital on which to draw.

While junior companies are relatively small in size they undertake a significant proportion of petroleum and other minerals exploration, often undertaking activity on behalf of larger companies.89 Typically, exploration costs far exceed the profits (if any) generated by junior mineral exploration companies. Such losses are very

86. Parliamentary Joint Committee on Human Rights, Eighteenth report of the 44th Parliament, The Senate, Canberra, 10 February 2015, pp. 1-2, accessed 17 February 2015. 87. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 81. 88. Ibid.

89. Productivity Commission, Minerals and energy resource exploration, Inquiry report no. 65, 27 September 2013, p. 45, accessed 12 February 2015.

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rarely utilised, as such companies rarely make sufficient profits to fully utilise all of their accrued losses as tax deductions.

The importance of mineral exploration In a recent report the Productivity Commission underlined the important position of the resources exploration industry:

Exploration is a prerequisite for the extraction of commercially valuable mineral and energy resources. Resource extraction is a major contributor to Australia’s overall economic activity, accounting for 9 per cent of GDP in 2011-12. As current reserves are depleted, the long term viability of resource extraction and its contribution to Australia’s economic growth will be underpinned by the ongoing discovery of high quality deposits.

90

Put simply, without exploration activity, eventually there would be no resources extraction industry.

Recent trends in resource exploration The amount of expenditure on mining exploration has fallen in real terms in recent years (Figure 3).91 From a high point of about $1.1 billion in the June 2012 quarter, exploration expenditure has declined to about $406.5 million in the March 2014 quarter before rising slightly.

Figure 3 Real expenditure on exploration, 2003 to 2014 ($ million)

Source: as per footnote 91.

A large proportion of the increase in overall exploration funding to June 2012 targeted the bulk commodities such as iron ore and coal, and especially the petroleum sector (Figure 4).92 It could be argued that Australia has already identified sufficient reserves of the onshore bulk commodities (that is, iron ore and coal) and gas (included in petroleum) commodities.

90. Ibid., p. 42. 91. Australian Bureau of Statistics (ABS), Mineral and petroleum exploration, cat. no. 8412.0, ABS, Canberra, September 2014, accessed 9 January 2015, adjusted for inflation by Parliamentary Library. 92. Australian Bureau of Statistics (ABS), Mineral and petroleum exploration, cat. no. 8412.0, op. cit; MinEx Consulting, ‘Bulk minerals now

accounts for over half of total spend: level of exploration by commodity in Australia: March 1990-December 2013, Challenges and opportunities for under-cover exploration in Australia’, Presentation to the Uncover Conference, Australian Academy of Sciences, Adelaide, 31 March 2014, accessed 5 December 2014.

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Figure 4 Petroleum and mineral exploration, 2003 to 2014 ($ million)

Source: as per footnote 92.

Despite exploration, recent results have not been encouraging:

• while Australia has always been a relatively costly location in which to explore, the cost of such activity has increased dramatically in recent years. For example, the cost per meter drilled in real terms has increased significantly since 200593

• the rate of discoveries has declined, fewer deposits are being found, with the average size of those deposits declining

• the quality (that is, ore grades) of new discoveries has also been declining and

• there are fewer highly desirable ‘giant’ deposits being found.94

In addition, recent exploration expenditure has tended towards activity aimed at extending the life of existing mines and wells (so called ‘brown field’ exploration) rather than looking for completely new deposits (that is, greenfield exploration) (Figure 5).95

Figure 5 Brown and greenfield exploration expenditure (non-petroleum), 2003 to 2014 ($ million)

Source: as per footnote 95.

While concentration on brownfield exploration is understandable in the light of recent high commodity prices (as expanding and exploiting existing deposits is a much faster process than exploiting new deposits), over the long term it restricts the supply of new deposits, particularly of new large high quality deposits (that is, if you are not finding many new deposits, you have even less chance of finding new ‘giant’ deposits). It is noteworthy that greenfield exploration is usually undertaken by junior resource companies, as it is a high risk, but very high reward, activity.96

93. Productivity Commission, op. cit., p. 48. 94. Ibid., pp. 48-50. 95. Australian Bureau of Statistics (ABS), Mineral and petroleum exploration, cat. no. 8412.0, op. cit. 96. Productivity Commission, op. cit., p. 47.

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Various contributing factors have been put forward for these trends:

• as already noted, it is potentially more profitable in times of rising or high mineral commodity prices to extend the life of existing deposits rather then look for new mining locations

• Australia is seen as a mature exploration location, with deposits being found at greater depth and with lower grade ores and

• other (less mature) countries are seen as having better prospects of containing accessible high grade deposits.

One commentator suggests that about fifty per cent of all new exploration funding is for activity outside Australia.97 With potentially fewer and lower quality discoveries and higher costs, and if developed lower yields from a new deposit per unit of input, investing in domestic mineral exploration activity is not as financially rewarding as it once was.

The major difficulty behind these causes is that Australia’s potential mineral deposits now lie under a cover of weathered material known as the ‘regolith’ and/or sedimentary material covering the base rocks. One estimate suggests that about 80 per cent of Australia is covered by such material.98 There are not as many indications of mineral deposits on the surface and deeper depth drilling (an expensive operation compared to other methods) has to be undertaken. In this environment traditional exploration techniques have not been as effective as they once were, hence leading to higher costs.

Is there more to discover? The above commentary is particularly pessimistic. Investors may easily come to the conclusion that investing in the Australian mineral exploration industry is to invest in an industry looking for minerals that are not there. As the following quote states, this is not the case:

Unfortunately, Australia is being seen increasingly as a mature mineral exploration destination. This perception has driven the increasingly globalised minerals industry to invest in exploration offshore. The perception is incorrect: our mineral-rich continent has yielded most of its wealth from only 20% of the exposed or near-exposed crust. The remaining 80%—an area of more than 7.5 million km

2 —is potentially as well-endowed, but this endowment is

concealed by cover of varying depth. This vast, relatively underexplored area presents an enormous opportunity for the discovery of resources in Australia. 99

The important point arising from this situation is that finding new mineral deposits may require new and highly sophisticated exploration methods.

Further, past Australian mineral exploration, when compared to trends in other countries and regions, has provided good value for money. Between 2003 and 2013 the value of mineral discoveries exceeded the total amount spent on mineral exploration. Only mineral exploration in Africa achieved a better outcome over this period. 100

Policy Development The incentives proposed by Schedule 6 of the Bill are not new. Tax incentives for small mining companies to undertake exploration applied during the 1960s and 70s and were one of the factors that produced the various mining booms of that era. These incentives were later repealed.101 Prior to the 2007 election, the Australian Labor Party included in its election policies the limited use of flow through shares (see below) to encourage mineral exploration.102 The Henry Tax Review recommended that if earlier access to tax benefits from

97. Ibid., p. 53 and following. 98. Australian Academy of Science, Uncover Group, Searching the deep earth: a vision for exploration geoscience in Australia, Canberra, 2012, p. 2, accessed 23 December 2014. 99. Ibid., p. 5. 100. MinEx Consulting, ‘How does Australia compare to the rest of the world? Spend and performance by region: 2003-12, Challenges and

opportunities for under-cover exploration in Australia’, Presentation to the Uncover Conference, Australian Academy of Sciences, Adelaide, 31 March 2014, accessed 5 December 2014. 101. F Anderson, ‘Junior miners welcome Coalition’s exploration tax break’, The Australian Financial Review, 5 September 2013, p. 9, accessed 14 January 2015. 102. Chris Evans, Labors plan for a stronger resources sector, Australian Labor Party policy document, Election document 2007, p. 7, accessed

23 December 2014.

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exploration expenses (relative to other expenses) is to be provided, it should take the form of a refundable tax offset at the company level for exploration expenses incurred by Australian small listed exploration companies, with the offset set at the company income tax rate (it also cautioned against having an unlimited scheme of this nature).103 The Henry Tax Review also noted that a ‘flow through share design’ (which is what the Bill proposes):

… is targeted at resident shareholders (to improve marketability) rather than at the company level, it makes the design of a flow-through scheme more complicated and therefore is likely to result in higher administration and compliance costs. It would also not assist in attracting investment from non-resident investors. 104

It would appear that the Government has noted the view that a flow-through scheme would not assist in attracting foreign investment, and hence has effectively restricted the proposed EDI scheme to Australian resident investors. For example, as a part of both the 2010 and 2013 election platforms the Coalition proposed a limited exploration incentive program for small exploration companies, stating that:

… a tax credit will be provided to Australian resident shareholders for eligible ‘greenfields’ exploration expenditure incurred in Australia. 105

The Minister for Industry and the Assistant Treasurer released a discussion paper on this proposal on 13 March 2014.106 Operational details for the proposed incentive were released on 2 July 2014.107 Treasury released draft legislation for comment on 10 October 2014.108

Canada - an overseas example Canada has had a flow through share regime for small mining companies for over 20 years. The current flow through share regime was introduced in 1986, but previous forms of the regime have been allowed by the Canadian income tax legislation since the 1950s.

A flow-through share is a newly issued common share of a corporation that is accompanied by an agreement to transfer for tax purposes certain expenses to an investor, up to the price paid for the share. An investor who purchases flow-through shares may deduct the transferred expenses when calculating taxable income. Individual investors who invest in mining flow-through shares may also be eligible for investment tax credits, including the federal 15 per cent Mineral Exploration Tax Credit and certain provincial investment tax credits.

Some of these tax benefits are partially recaptured over time: when the flow-through share is subsequently disposed of by the investor, the full proceeds of the disposition are recognised as a capital gain (as opposed to only the appreciation in share value). In addition, the value of any applicable investment tax credits is generally included in income in the following year.

The Canadian tax rules do not require that investors hold the flow-through share for a certain period in order to access the tax benefits. However, many flow-through share agreements include a clause that restricts the investor from selling the shares within a specified time period, which may range from four months to as many as 24 months. These clauses are aimed at preventing downward pressure on share prices when investors seek to sell the shares after taking advantage of the tax benefits. In addition, many flow-through shares are issued via private placement. In general, Canadian securities regulations require a four-month hold period for shares issued under a private placement. It is also interesting to note that often flow through shares are issued by Canadian companies at a premium to the listed market price, in recognition of the tax benefits that flow through to shareholders.

103. A refundable tax offset is one where the unused portion of the tax credit is refunded by the government in cash. The unused portion is that amount that is left over once the taxpayers’ payment obligations have been met. K Henry (Chair), J Harmer, J Piggott, H Ridout and G Smith, Australia’s future tax system: report to the Treasurer: part two - detailed analysis, Canberra, December 2009, p. 177, accessed 23 December 2014.

104. Ibid., p. 177. 105. Liberal Party of Australia, The Coalition's plan for real action on energy and resources, Coalition policy document, Election 2010, p. 7, accessed 23 December 2014. See also: The Coalition's policy for resources and energy, Coalition policy document, Election 2013, September 2013, p. 6, accessed 23 December 2014.

106. Treasury, ‘Policy design for exploration development incentive’, Treasury website, accessed 24 December 2014. 107. Treasury, ‘Operational details for the exploration development incentive’, Treasury website, July 2014, accessed 24 December 2014. 108. Treasury, ‘Exploration development incentive, draft legislation’, Treasury website, accessed 24 December 2014.

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There is no tax benefit that directly accrues to a Canadian corporation as a result of issuing flow-through shares. To the extent that a corporation eventually becomes profitable, the inability to use the expenses transferred via flow-through shares to reduce taxable income implies that the tax burden would be higher once the corporation becomes profitable than it otherwise would have been.

Flow-through shares occupy an important place in equity financing in Canada: from 2007 to 2012, approximately C$1.4 billion per year in public equity for the oil and gas, mining and clean energy sectors was raised via flow-through shares. This resulted in a tax credit of about eight per cent of total claimable expenses arising from these sectors being available to relevant shareholders.109 While they are available to all corporations incurring eligible expenses, flow-through shares assist primarily junior exploration companies whose access to other sources of financing may be limited. Through the flow-through share regime, the Canadian Government provides significant support for the exploration and development of natural resources: during the 2007 to 2012 period, federal tax expenditures associated with public and private issuances of flow-through shares, in addition to the Canadian Mineral Exploration Tax Credit (an incentive for investment in certain mining flow-through shares), averaged C$440 million per year. This support is complemented by additional incentives to flow-through share investors that are provided by certain provincial governments.110

Comparison of Canadian Flow through Shares and Proposed Exploration Development Incentive An obvious and important difference between the proposed Australian incentive and Canadian flow through shares is that the proposed Australian incentive would be limited to junior mining companies. Another significant difference is that in Canada the potential amount of the revenue forgone is uncapped and the flow through share scheme does not have a sunset clause. The incentives proposed by Schedule 6 of the Bill cap the amount of tax credit that may be issued at $100m over three years.111 Another important difference is that upon disposal of Canadian flow through shares, the full proceeds are recognised as a capital gain (as opposed to the appreciation in the share price for ordinary shares) and taxed accordingly (there is no minimum time for holding these shares before the Canadian capital gains tax provisions apply). No such treatment is proposed for Australian shares in participating junior explorers that have the proposed tax credit attached. That is, if these shares are sold within a year of purchase the gains or losses are recognised as ordinary income, if they are sold after a year’s ownership, they are taxed under the ordinary capital gains tax provisions (that is, 50 per cent discount of any gain arising). Finally, the Canadian scheme does not limit the exploration target, both brown and green field exploration can be undertaken by participating Canadian explorers. The proposed Australian scheme is restricted to greenfield exploration only.

Policy position of non-government parties/independents As of the date of writing, it appears that no party or member has publically expressed a position on this proposed change.

Position of major interest groups Obviously, the Australian mining and exploration industry strongly supports the proposed scheme.112 Some commentary suggests that the take-up of the scheme by junior explorers will be limited, due to the administrative complexity involved in administering the tax credits (a point made by the Henry Tax Review).113 For example, some junior mining companies may not have the resources to run a share register that has shares that qualify for the proposed tax credit and pre-existing shares that do not.114 One commentator noted:

The largest risk to the success of the exploration development incentive (EDI) is the budgetary cap [i.e. $100m over three years], as it introduces a source of risk that serves as a negative feedback to investors' sentiment. If the cap

109. Calculation by Parliamentary Library based on data in main reference (see below). 110. The above description of the Canadian flow through share scheme for mining companies was drawn from Canadian Department of Finance, ‘Tax expenditures and evaluations 2013, Part 2: tax evaluations and research reports’, Flow-Through Shares: a statistical perspective, on line report, 2013, accessed 24 December 2014.

111. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 81. 112. The Minerals Council of Australia, Timely support for exploration, media release, Canberra, 4 December 2014, accessed 14 January 2015. Association of Mining and Exploration Companies, Exploration development incentive essential for mineral explorers, media release, 5 March 2014, accessed 24 December 2014.

113. K Henry (Chair), J Harmer, J Piggott, H Ridout and G Smith, Australia’s future tax system: report to the Treasurer: part two - detailed analysis, op. cit., p. 177. 114. BDO Australia, Exploration Development Scheme, Information note, May 2014, accessed 24 December 2014.

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has been appropriately estimated, then it may serve to simply curtail excess interest. However, if the cap has been significantly underestimated it may prevent wide uptake of the EDI by potential investors or implementation by junior explorers. It is important that investors note that the purpose of the initiative may not be (at least initially) to allow investors to gain access to all exploration losses in the relevant year.

115

Other commentators expressed disappointment with the limited nature of the proposed scheme:

The EDI is a step in the right direction to encourage investment in junior explorers and comes after a great deal of lobbying by the exploration industry. It is to be hoped that the EDI is part way in the journey and not the end of the journey because it has some notable limitations. Most significantly, once a company obtains an inferred resource, further exploration expenditure relating to that resource is excluded from the scheme.

116

Financial implications The Explanatory Memorandum notes that the impact over the forward estimates period to 2017-18 is:

• $25m in 2016-17 and

• $35m in 2017-18.117

However, the Memorandum also notes that this measure will apply to exploration expenditure from the 2014-15 to the 2016-17 years, with the proposed credits to be issued in the 2015-16 to 2017-18 years. It further notes that:

… the total value of the tax incentives available to taxpayers in respect of expenditure in an income year is restricted to $25 million for greenfields minerals expenditure incurred by eligible companies in 2014-15, $35 million for greenfields minerals expenditure incurred in 2015-16 and $40 million for greenfields minerals expenditure incurred in 2016-17.

118

This suggests that an impact on the budget could occur earlier than the 2016-17 year, but will be limited to $100m in total over three years, beginning in the 2015-16 year.

It should be stressed that these amounts are the maximum amounts that may be involved, if all the EDIs created are claimed. If a sufficient number of EDIs are issued to corporations and certain life insurance companies, then treated as ordinary franking credits, the actual budget cost may be lower; as franking credits are less costly to the budget than the proposed EDIs (see below for further discussion).

Statement of Compatibility with Human Rights The Statement of Compatibility with Human Rights for Schedule 6 can be found at page 129-130 of the Explanatory Memorandum to the Bill. The Government considers that the Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Key issues and provisions Item 2 of Schedule 6 inserts proposed Division 418 into the ITAA 1997.119 Proposed Division 418 contains the provisions that will establish the proposed tax incentives for mineral exploration.

Proposed section 418-10 will allow individuals, who have been Australian residents for the whole of the relevant income year, to claim the proposed exploration development incentive tax offset (EDI).

Proposed section 418-15 provides that an EDI can only be received by Australian resident life insurance companies where they are using them to pay a pension entitlement.120 All other life insurance companies will be taken to receive ordinary franking credits in respect of the EDI they may receive (see proposed section 418-55).

115. Lindsay Reed and Michael McLaughlin (HWL Ebsworth Lawyers), ‘Exploration development incentive’, HWL Ebsworth Lawyers website, accessed 24 December 2014. 116. Allion Legal, Exploration development incentive: a government incentive to assist junior exploration companies to raise capital, Information sheet, 22 July 2014, accessed 24 December 2014. 117. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 7. 118. Ibid. 119. Income Tax Assessment Act 1997 (ITAA 1997), accessed 18 February 2015.

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Proposed section 418-20 allows Australian resident trusts and partnerships to also be issued with EDIs.

A notable exemption from the bodies that may be issued with EDIs is a ‘corporate tax entity’. However, corporations (such as, say, senior mining companies) will be issued with ordinary franking credits in respect of any relevant shares they may hold in a junior mineral exploration company. This is accomplished under proposed section 418-50, which provides for an ordinary franking credit to be added to the franking account of an Australian corporate entity in respect of any EDI they receive.

There is a significant difference between an EDI and a franking credit. When an individual receives a franking credit, they have to add the grossed up value of that franking credit to their assessable income. In contrast, when an individual receives an EDI they do not have to add the grossed up value of this credit to their assessable income. This makes the EDI more valuable than a franking credit for tax purposes and clearly increases the incentive for individuals, Australian resident trusts and partnerships to purchase shares to which an EDI may be attached.

Restrictions on types of companies that can issue EDIs Senior mining companies (as opposed to other non-mining companies) are subject to a number of important limitations, which effectively prevent them from issuing EDIs. Under proposed section 418-70 only a greenfield mineral explorer can issue EDIs. Under proposed section 418-75 a greenfields mineral explorer is an entity that:

• has greenfields minerals expenditure for the relevant income year (see below for further definition)

• is both a constitutional corporation and a disclosing entity for Corporations law purposes, and

• neither itself, nor ‘any other entity that is connected with or is an affiliate of the entity’ extracted minerals for the purpose of producing assessable income (except petroleum).

As noted in the Explanatory Memorandum:

‘Connected with’ and ‘affiliate’ are both defined within the existing tax law. Broadly, they apply to entities that control the first entity, are controlled by a third entity that also controls the first entity or which the first entity itself controls (see Subdivision 328-C of the ITAA 1997). In this context control may be direct or indirect. 121

The effect of the negative stipulation provided in proposed paragraph 418-75(1)(d)(ii) is that:

… entities that may themselves be small but which form part of a larger grouping of entities, some of which engage in mining, will not and are not intended to be able to participate in the EDI. While these entities may themselves be small, they are part of a wider economic structure that includes entities that have found or are in the process of exploiting known mineral resources. Again, where an entity is part of a wider economic structure that has recently been engaged in mining operations it will not be entitled to be a greenfields minerals explorer and access the EDI.

122 (emphasis added).

Whilst it remains a possibility that junior resource companies could be established and capitalised by a number of senior resource companies currently extracting minerals in such a way as to ensure that no one single senior resource company could be said to control (directly or indirectly) its exploration activities, this would appear unlikely. As such, the definition of greenfields mineral explorer contained in proposed section 418-75 gives legal effect to the stated policy intention of directing the benefit of the EDI scheme to junior resource companies, that are not part of a larger mining group, and their investors.

However, the exclusion of petroleum production from the negative stipulation provided in proposed paragraph 418-75(1)(d) is controversial, as it:

• excludes junior mining companies that may have some mineral production underway (other than petroleum) but may need to undertake greenfield mineral exploration to maintain their business and

120. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 87. See also: proposed paragraph 418-15(1)(d) which provides that the EDI must be a distribution to which paragraph 207-110(1)(b) of the ITAA 1997 would apply (which outlines the requirement for the distribution to be income from assets set aside to meet current pension liabilities).

121. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 94. 122. Ibid.

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• allows senior resource companies that only extract petroleum to invest in and then control (directly or indirectly) the activities of junior minerals resource companies that themselves subsequently generate EDIs (where as senior resource companies that extract other minerals along with petroleum cannot).

What is greenfields minerals expenditure? As noted above, to meet the definition of a greenfields mineral explorer, the company in question must incur ‘greenfields minerals expenditure’ for the income year in which it seeks to create EDIs. Proposed section 418-80 defines greenfields minerals expenditure to be the sum of:

• allowable depreciation on equipment used for exploration and

• amounts spent on such exploration.

However, proposed subsection 418-80(3) confines the definition by stipulating the above amounts must be spent in relation to exploration activity:

• only within mainland Australia—expenditure incurred in relation to offshore exploration for any mineral cannot give rise to an EDI

• where the exploration company holds a mining, quarrying or prospecting right and

• that the area under exploration has not been identified as containing an ‘inferred’ resource.

This last point is also controversial. According to the relevant standard specified in the proposed legislation an ‘inferred’ resource is one:

… for which quantity and grade (or quality) are estimated on the basis of limited geological evidence and sampling. Geological evidence is sufficient to imply, but not verify, geological grade (or quality) continuity. 123

The relevant standard goes on to note that an estimate of an inferred resource is not sufficient to allow any economic or technical mine site planning to take place. In other words, once an inferred resource has been identified additional exploration has to take place to allow the true extent of the deposit to be determined. This limit has been argued to prevent a company making such a discovery to maximise any profits, for it will preclude the creation of any EDI’s in respect of expenditure to prove up the inferred resource and may require the company to sell part of their interest to undertake that additional exploration.124 However, the Government expressed the view that:

The EDI is intended to support greenfields exploration — it is targeted to initial speculative activities where capital constraints are likely to be particularly acute. Even once a mineral resource has been identified, there is considerable work to be done in developing the identified resource into a mining operation. However, at this stage, raising capital is quite a different proposition, and assistance in the form of the EDI is less warranted. As a result, the EDI does not apply to expenditure in relation to an area where the existence of a mineral resource has been identified.

125 (emphasis added)

However, in practical terms, the requirement that the greenfields minerals expenditure relate only to activities undertaken in areas where no inferred resources have been identified will give effect to the policy of precluding most, if not all, brownfield exploration expenditure from being the source of EDIs.

Creation of EDIs Proposed section 418-70 allows only entities that were greenfields mineral explorers in the previous income year to create EDIs. Theoretically, an entity could be such an explorer for only one day in the previous income year to meet this particular requirement. Further, proposed subsection 418-70(5) provides that a greenfields mineral explorer cannot create EDIs more than once per year.

123. The Australian Institute of Mining and Metallurgy, Australian Institute of Geoscientists, Minerals Council of Australia, Joint Ore Reserves Committee, Australasian code for reporting of exploration results, minerals resources and ore reserves, Canberra, 20 December 2012, p. 12, accessed 5 December 2014.

124. Minerals Council of Australia et al, Exploration development incentive: policy design response to Treasury and Department of Industry, April 2014, pp. 4-5, accessed 9 February 2015. 125. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., p. 98.

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Proposed section 418-85 requires an exploration company not to create excess EDIs, and sets out the method by which a particular company may calculate the correct number of EDIs to create in respect of its greenfields minerals expenditure (in combination with the modulation factors to be calculated by the Commissioner for Taxation referred to in proposed section 418-90). It is by the use of the so called modulation factors and the reported greenfields minerals expenditure that the Commissioner limits the overall amount of EDIs issued in any one year to the nominated amount (see financial implications noted above).

Under proposed section 418-150, if a company creates excess EDIs it is liable to the excess exploration credit tax. The method of working out this tax is not included in this section. The actual amount of excess exploration credit tax is to be worked out under Schedule 1 of the TAA 1953 according to proposed section 418-155 of the ITAA 1997. This latter schedule is amended by other provisions in Schedule 6 of this Bill. For constitutional reasons this tax is imposed by the Excess Exploration Credit Tax Bill 2014 (see below for further comment).

Excess Exploration Credit Tax Bill 2014 This Act commences on the date of Royal Assent.126 Item 4 imposes the excess exploration credit tax (EECT) while item 5 provides that the amount of EECT will be calculated under proposed section 418-150 of the ITAA 1997 (see above).

The above is a brief commentary on the main provision implementing this new tax credit. Additional commentary on the above, and other, provisions is included in the Explanatory Memorandum.127

Concluding comments It would be easy to conclude that the combination of increasingly difficult geological conditions and the limited nature of the proposed scheme will not lead to many additional resources being discovered. However, this is a narrow view and additional points should also be considered:

• even if an exploration program, financed in part by the issue of EDIs, should not find any deposit the geological knowledge from that program will be available for other exploration efforts to work with. As such, any EDIs issued will still have a positive outcome even if no actual economic discovery is made (as it will contribute to more efficient and targeted prospecting in the future) and

• mineral exploration is an extremely high risk activity. A company may undertake an extensive exploration program and not find a worthwhile deposit. Given that such an outcome is highly likely a limited scheme is most appropriate.

Schedule 7—Miscellaneous amendments Schedule 7 amends a number of taxation and taxation-related superannuation laws. As the title to the schedule suggests, these changes are considered to be ‘miscellaneous’. The Explanatory Memorandum notes that the amendments include ‘style changes, the repeal of redundant provisions, the correction of anomalous outcomes and corrections to previous amending Acts’.128

The Explanatory Memorandum states that progressing such amendments gives priority to the care and maintenance of the tax system as recommended by a 2008 recommendation of the Tax Design Review Panel.129

Financial impact The Explanatory Memorandum to the Bill states that the amendments made by Schedule 7 are expected to have a minimal or nil revenue impact.130

Human rights implications The Government considers that Schedule 7 is compatible with human rights as it does not encroach upon any applicable rights or freedoms.131

126. Excess Exploration Credit Tax Bill 2014, clause 2. 127. Explanatory Memorandum, Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014, op. cit., pp. 81-130. 128. Ibid., p. 131. 129. Ibid., p. 9. 130. Ibid., p. 9. 131. Ibid., p. 149.

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Key provisions A comprehensive list of the amendments and their intended effects is available on pages 131-149 of the Explanatory Memorandum.

Commencement and application Item 15, in the table at clause 2 of the Bill, states that the amendments made by Part 1 of Schedule 7 commence on the day after Royal Assent.

Items 16 to 22, in the table in clause 2 of the Bill, state that the amendments made by Part 2 of Schedule 7 will apply retrospectively with commencement on various dates between 1 July 2012 and 11 July 2013.

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