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Thursday, 19 June 2003
Page: 17032

Mr COX (1:30 PM) —Taxation Laws Amendment Bill (No. 5) 2003 contains eight schedules. Three deal with thin capitalisation, and the other five with foreign dividend accounts, the FBT exemption for public hospitals, reducing tax on eligible termination payments, the application of the same business test, and tax losses. Labor will support an overwhelming majority of this legislation, but move amendments to delete the provision for selective revaluation of assets in part 4 of schedule 1, bring forward the commencement date for schedule 2, and delete schedule 6 reducing the tax on ETPs and schedule 8, tax losses. We will refer the bill to a Senate committee to consider part 2 and part 4 of schedule 1 and part 2 of schedule 2. I will also move a second reading amendment.

As to the specifics of the bill, the thin capitalisation rules are designed to ensure that multinational entities do not allocate excessive debt to Australian operations to minimise tax. The first schedule will take effect from 1 July 2001. Part 2 carves out securitisation vehicles from the thin capitalisation regime. Securitisation vehicles are tax neutral entities that pool assets and are generally funded entirely by debt. The existing thin capitalisation legislation provides zero capital treatment for securitisation vehicles but does not contemplate origination, warehousing, two-tiered securitisation or synthetic securitisation or allow any residual equity in the securitisation vehicle. As a result, many securitisation vehicles have a proportion of their interest deductions denied.

Part 2 will exclude special purpose entities from the thin capitalisation rules for all or part of a year provided they are established for the purpose of managing some or all of the economic risk associated with assets, liabilities or investments. Whether the securitisation vehicle assumes the risk from another entity or creates the risk itself, at least half the entity's assets are debt funded and the securitisation vehicle is an insolvency remote special purpose entity according to the criteria of an internationally recognised rating agency.

The first test excludes entities that were not established for, or are not exclusively involved in, securitisation. The allowable arrangements include those where assets are purchased by the special purpose entity or where the risk is acquired but the underlying assets remain on the balance sheet of the originating entity. The second test recognises that, while the objective of securitisation or origination is to fund assets with debt that might take time to achieve, there might be some residual equity or there might be some credit enhancement. The third test is intended to ensure that the entity is unlikely to be subject to voluntary or involuntary insolvency proceedings. Whether the entity meets that test is to be determined by an internationally recognised rating agency.

The tests the rating agency is expected to apply to an entity include: that it be restricted to activities necessary to its role in the transaction, it is restricted from incurring additional indebtedness, it cannot be subject to a reorganisation merger or change of ownership, and it holds itself out to the world as a separate entity. Some rating agencies publish general criteria others specific criteria for particular types of entity. To take advantage of the exclusion, an entity must demonstrate it meets the criteria of an agency most applicable to its circumstances. It is not a requirement that the entity be rated by the agency. An entity may qualify as a special purpose entity but not be a securitisation vehicle. Conversely, an entity may be a securitisation vehicle but not qualify as a special purpose entity.

Where a special purpose entity is part of a thin capitalisation group it is not treated as part of the group for thin capitalisation purposes. An entity that is an exempt special purpose entity is not part of a consolidated group or multiple entry consolidated group. Equity provided to a special purpose entity will be treated as associate entity equity and a loan provided to a special purpose entity will not be treated as associate entity debt.

These new requirements are designed to give maximum flexibility for securitisation vehicles and groups using securitisation vehicles to obtain exemption from the thin capitalisation rules. I am concerned at having as a test the criteria of an `internationally recognised rating agency', because there are agencies of varying quality in this area. This is something to which I can attest from having been cold-canvassed some years ago in the Treasurer's office by an agency offering to rate the Commonwealth highly if it would subscribe to its services. That proposition did not go any further than that phone call but it demonstrates the potential for criteria of commercial convenience. Additional tests may be necessary to provide adequate integrity in this area.

Labor will not oppose part 2 of schedule 1, but will refer it to a Senate committee for examination. Part 3 of schedule 1 will give the choice to some financial entities to be treated in the same way as authorised deposit taking institutions. The thin capitalisation rules for banks are based on risk weighting assets and minimum capital requirements in the same way as prudential requirements operate. Part 3 will allow non-bank financial entities to elect to apply the authorised deposit taking institution methodology. The current thin capitalisation rules result in a lack of competitive neutrality because non-ADIs are subject to a definition of equity capital that is based on paid-up share capital, while the definition for ADIs is APRA's requirement for tier one capital. Some non-ADIs are part of foreign bank groups and have to operate within the risk weighting rules prescribed by foreign regulators. These are not precisely the same as Australia's but are not sufficiently different to greatly offend the competitive neutrality principle.

A number of types of entities could avail themselves of the new ADI rules, including merchant banks, finance and insurance companies. To qualify to apply the ADI rules, a financial entity must have 80 per cent of its assets meeting the definition of an on-lent amount. Where the entity's licence includes trading in derivatives, the total value of its on-lent amount plus the net unrealised gains from derivative trading must be at least 80 per cent of the value of assets. Precious metals can be included in calculating the 80 per cent rule. The head company of a consolidated group or multiple entry consolidated group that contains a financial entity must also comply.

The ADI rules differ depending on whether the entity is investing inward—into Australia—or outward—overseas. If a financial entity using the ADI methodology is an outward investor (financial) or an inward investment vehicle (financial), division 820-D applies as if it were an outward investing entity. Where the entity is an inward investor (financial), division 820-E applies as if the entity were an inward investing entity. Where an entity elects to use ADI methodology, this will not affect the calculation of associate entity debt or associate entity equity. Once having made the choice to apply the ADI rules, a taxpayer can only revert to the non-ADI rules either if it no longer meets the 80 per cent rule when tested at the end of the third financial year or if the commissioner approves a revocation of the choice because the taxpayer's business has substantially changed. Once a taxpayer reverts to the non-ADI rules, they may not apply the ADI rules at any time in the future.

Generally an election to be treated as an ADI will not flow into the classification process for resident thin capitalisation groups. The choice will also have no effect where the thin capitalisation group would be treated as an inward investing entity, were no choice to be made under section 820-430. In this situation the inward investing rules will continue to apply to the resident TC group. This exception effectively acts as a tie breaker where there would otherwise be a conflict between the ADI election and the resident TC grouping rules as to whether the inward or outward investing entity ADI rules should apply. A subsidiary is covered by the choice of ADI or non-ADI status made by the head company of a consolidated or a multiple entry consolidated group. This provides a tie breaker where there is a conflict between ADI rules and head and single companies. Labor will support part 3.

Part 4 of schedule 1 deals with revaluing assets for thin capitalisation purposes. Under the current rules an entity may value assets for thin capitalisation purposes by means other than those reflected in its accounts. However, the value must be determined by an independent valuer in accordance with relevant accounting standards. It is assumed that only an entity that carries assets on its balance sheet at the lesser of cost or recoverable amount would take advantage of this provision. Part 4 would allow a suitably qualified employee who has no other conflict of interest to do the revaluation provided it is verified by an independent valuer to the extent of agreeing on the methodology, assumptions, accuracy and reliability of the data and information used. It would also allow the revaluation of one or more assets in an asset class, provided no asset in that class has fallen in value. It should be noted that accounting standards would require all assets in that class to be revalued. Part 4 also allows an entity to cease revaluing its assets where it no longer wants to make use of that revaluation for thin capitalisation purposes. Revaluations must be done in accordance with the frequency required by the relevant accounting standard. Where revaluations cease, the entity must revert to book value.

Part 4 would require record keeping on revaluations for thin capitalisation purposes, including: the methodology used in the revaluation, including assumptions; how the methodology was applied, including data and other information used; the name and credentials of the expert; and the remuneration paid to the expert. Similar information is to be retained relating to the independent expert. I will move an amendment to delete the provision for selective revaluation of only some assets in a class. Labor will refer part 4 to the committee to consider the appropriateness of in-house valuations.

Part 5 of schedule 1 deals with arrangements for borrowing securities. The current thin capitalisation rules for reciprocal purchase agreements, sell-buyback arrangements and securities loan arrangements assume that the gross profit margin will be small and entities should not be required to hold a high amount of capital against the assets generated from these transactions. Part 5 refines these rules to provide more consistent thin capitalisation outcomes. The amendments introduce a new definition of borrowed securities amount. This is the liability incurred under a reciprocal purchase agreement, sell-buyback arrangement or securities loan arrangement. The calculation of adjusted average debt and non-debt liabilities will be adjusted to include the borrowed securities amount. The definition of an on-lent amount will be amended to include shares listed on an appropriate stock exchange. This reduces the equity requirement in the same way as is permitted by APRA. Calculation of the zero capital amount will be amended to only include amounts that have been received from the sale of debt interests under a reciprocal purchase agreement, sell-buyback arrangement or securities loan arrangement. This is consistent with commercial practice and APRA equity requirements. The calculation of the zero capital amount will be amended to ensure that the right to the return of collateral carries the same equity requirements as the collateral itself. Labor will support part 5.

Part 6 of schedule 1 deals with the definition of a financial entity. The thin capitalisation rules recognise that financial entities require higher debt funding than non-financial entities to support their financial intermediation activities. To qualify as a financial entity, an entity must hold an Australian financial services licence within the meaning of the Corporations Act 2001. That licence must cover dealing in securities, managed investment products and government debentures, stocks and bonds. Part 6 will add to the definition of financial entity a licence covering trading in derivatives. Part 6 will also allow an entity that does not have an Australian financial services licence, such as one regulated by an overseas authority or covered by a specific ASIC exemption, to qualify as a financial entity. Labor will support part 6.

Part 7 of schedule 1 deals with cost-free debt capital. The concept of cost-free debt capital seeks to prevent the thin capitalisation calculations being manipulated by the injection of interest-free loans just prior to valuation day. An interest-free loan is cost-free debt capital where the borrower and lender are subject to the thin capitalisation rules but have different valuation days or a different number of valuation days, or where only the borrower is subject to the thin capitalisation rules and the debt interest has been on issue for less than 180 days. Part 7 will amend the 180-day rule so that the debt must be held for 180 days but only part of that period needs to be before the valuation date to avoid the amount being treated as cost-free debt capital. Labor will support part 7.

Part 8 of schedule 1 deals with associate entity debt. The concept of associate entity debt is used to ensure there is no double counting of debt amounts that have been on-lent to an associate where the debt is also tested in the associate. Under the present law there is ambiguity as to whether the test applies to inward investors; part 8 ensures that it only applies to outward investors. Part 8 will also provide an exemption if a loan is on-lent to an associate if that entity is an exempt special purpose entity. Under the existing law, a loan to a foreign entity only qualifies as associate entity debt to the extent that it is attributable to the Australian operations of the foreign entity. Australian operations are defined as `carrying on a business at or through a permanent establishment'. Part 8 expands the definition to include `holding assets for the purpose of producing Australian assessable income'. This is consistent with the treatment of controlled foreign entity debt, controlled foreign entity equity and associate entity equity. Labor will support part 8.

Part 9 of schedule 1 deals with debt deductions for borrowing expenses. Part 9 provides consistency with other years in the tax treatment of borrowing expenses in the 1996-97 income year. Labor will support part 9. Part 10 of schedule 1 deals with foreign controlled Australian partnerships. Part 10 provides the same definition for foreign controlled Australian partnerships in the 1997 tax act as applies in the 1936 tax act. Labor will support part 10.

Part 11 of schedule 1 deals with the arms-length debt amount. The arms-length debt amount is used to determine the debt an independent lender would provide to the Australian operations of an entity. The arms-length debt amount is compared with the actual level of Australian debt. The existing law, however, does not refer to Australian operations. Part 11 provides that the arms-length debt amount would only apply to Australian operations. Labor will support part 11 of schedule 1.

The amendments in schedule 2 are to take effect from 1 July 2002. Some of the parts of schedule 2 are integrity provisions. It may be advantageous to have them commence at the same time as some of the benefits provided in schedule 1. I will move an amendment to part 1 of schedule 2 to make the commencement date, 1 July 2001, the same as for schedule 1.

Part 2 of schedule 2 deals with records about the Australian permanent establishment. The current law requires an inward investor carrying on business in Australia at or through a permanent establishment to prepare financial statements for their permanent establishment in accordance with Australian accounting standards and to be liable for a penalty if they do not. The commissioner has discretion to waive part or all of the requirements. Part 2 will provide exclusions where total revenue from the Australian permanent establishment is less than $2 million or where the business in Australia does not meet the definition of permanent establishment in the relevant double-tax agreement. Part 2 also allows the entity to prepare records using the accounting standards of Germany, Japan, France, USA, UK, Canada, New Zealand or the international accounting standards.

Part 2 extends the commissioner's discretion to minimise record keeping to classes of entities, but the exercise of that discretion must be published in the Commonwealth of Australia Gazette. The rationale for these amendments is to reduce compliance costs for taxpayers and administrative costs for the ATO. Labor will support the nominated list of accounting standards. However, I have some doubts about the $2 million threshold as a possible avenue for avoidance and will refer it to a Senate committee for examination.

Part 3 of schedule 2 deals with equity interests excluded in working out the safe harbour debt amount. Previously the risk that the thin capitalisation rules would be manipulated by raising equity was considered minimal because it was a protracted and costly exercise. However, under the debt-equity rules, some financial instruments commonly regarded as debt are now classified as equity. These types of equity can be readily moved into and out of an entity around valuation days. Part 3 introduces a new term, `excluded equity interest', where both the issuer and holder are subject to the thin capitalisation rules but have different valuation days or where only the issuer is subject to the rules and the equity interest is on issue for less than 180 days. Excluded equity interests reduce the maximum allowable debt when determining the safe harbour debt amount. This is an integrity measure to ensure that the issuer does not obtain an advantage by issuing equity interests prior to valuation day and cancelling them shortly thereafter. Equity interests must remain on issue for at least 180 days. Labor will support part 3.

Part 4 of schedule 1 deals with adjusted average equity capital for grouping purposes. The current law provides a methodology for determining adjusted average equity capital for the head company of a consolidated group or multiple entry consolidated group—an MEC being a foreign entity which has at least two wholly owned Australian subsidiaries which also have Australian subsidiaries—that is required to use the outward investing entity, ADI, rules. These rules apply where the group includes an Australian branch of a foreign bank. These calculations are currently based on the total entity and not just the Australian operations.

Part 4 will align the calculation of adjusted average equity capital for a head company of a consolidated or MEC group with the methodology set out in 820D. This excludes both the equity capital attributable to an overseas permanent establishment and controlled foreign entity equity net of CFE equity attributable to the overseas permanent establishment. A similar provision is provided for an Australian branch of a foreign bank. Labor will support part 4.

Part 5 of schedule 2 deals with disallowable deductions not included in the cost base of a CGT asset. The CGT rules allow non-capital costs of ownership of a CGT asset acquired after 20 August 1991 to be included in the cost base of the asset to the extent that they are not deductible for income tax purposes. However, that provision allows expenditure that was not deductible because of the thin capitalisation rules to be included in the GST cost base. Part 5 will exclude from inclusion in the GST cost base interest expenditure that is disallowed for deduction under the thin capitalisation rules. Labor will support part 5.

Part 6 of schedule 2 deals with the premium excess amount. The premium excess amount ensures entities are not penalised where the holding value of an investment in an associate is greater than the book value of an associate. This occurs where a premium has been paid for the investment. Current legislation has slightly varying definitions to identify the investment. Part 6 will align those definitions, and Labor will support it.

Part 7 of schedule 2 deals with the attributable safe harbour excess amount. The safe harbour excess amount determines the amount of excess debt capacity that an entity can carry back from an associate. Part 7 is a technical amendment covering inward investors, and Labor will support it.

Part 1 of schedule 3 deals with the definition of equity capital. In the existing law, equity capital is defined differently depending on whether the entity is an outward investing ADI, a trust or partnership or any other type of entity. Part 1 provides a new definition that applies to all entities. An equity interest is valued at its issue price less any unpaid amount. Equity capital also includes general reserves and asset revaluation reserves, opening retained earnings or accumulated losses—for example, negative retained earnings—current year earnings or losses net of expected tax and distributions, and provisions for distributions. Part 1 will take effect from 1 July 2003. Labor will support part 1.

Part 2 of schedule 3 deals with assets and liabilities. The thin capitalisation rules require an entity to comply with accounting standards for valuing assets, liabilities and equities. Currently, those terms have their normal legal meaning. This results in some assets and liabilities not being able to be valued using accounting standards. Part 2 defines assets and liabilities according to accounting standards. Labor will support part 2.

Schedule 4 deals with foreign dividend accounts. The purpose of a foreign dividend account is to ensure that unfranked foreign source dividends paid to nonresident investors by resident companies are exempt from dividend withholding tax. However, the interaction of section 25-90 with the FDA provision results in interest expenses failing to satisfy the conditions for an FDA debit. This results in the FDA being overstated. Schedule 4 reinstates as an FDA debt expenditure deductible due to the operation of section 25-90 incurred in respect of exempt dividends. Labor will support schedule 4.

Schedule 5 deals with the FBT exemption for public hospitals. Currently, public hospitals are classified as public benevolent institutions and are eligible for an FBT exemption with a ceiling of $30,000 per employee. The government has identified a possibility that a change of structure or governance for public hospitals could result in them no longer meeting the criteria for a public benevolent institution and therefore being ineligible for the FBT exemption. Schedule 5 will provide eligibility for the FBT exemption where an employee works in a public hospital and is employed by the public hospital or a government body. Schedule 5 gives the same treatment to the remote area housing FBT exemption for employees of public hospitals at least 100 kilometres from a population centre of more than 130,000. Labor will support schedule 5.

Schedule 6 would reduce the tax on excessive eligible termination payments. The excessive component of an ETP is that part of a payment that exceeds the taxpayer's reasonable benefit limit. The current RBL for a lump sum is $562,192 and for a pension it is $1,124,384. ETPs may have a number of components, but only some of them count towards the RBL and may result in an excessive benefit. In the case of a benefit paid by a superannuation fund, these are the retained amount of the CGT exempt component, the retained amount of the pre-July 1983 component, 85 per cent of the untaxed element of the retained amount of the post-June 1983 component and the taxed element of the retained amount of the post-June 1983 component. Currently, the whole of an excessive component is taxed at the top marginal rate of 47 per cent plus the Medicare levy. The government's policy rationale for the reduction is the 15 per cent contributions tax already paid on that part of the ETP. The government will argue that the new 38 per cent rate and the contributions tax of 15 per cent are equivalent to the 47 per cent rate. However, the effective rate will differ according to the circumstances of individual taxpayers.

Schedule 6 will also reduce the superannuation surcharge on taxpayers receiving an ETP with an excessive amount. The surcharge on contributions will be reduced by the lesser of the amount of the grossed up excessive component or the surcharge on the contributions. The excessive component is grossed up for any post-June 1983 taxed element by dividing that excessive component by 0.85 per cent. The reduction in the surcharge on contributions will prevent the surcharge applying in addition to the tax on the excessive component of an ETP for the year in which the ETP is paid. When this bill was introduced, the shadow Treasurer announced that Labor would oppose this measure. This measure has a current estimated cost of $5 million a year. Labor's policy is not to cut the surcharge for those on higher incomes but instead to reduce the contributions tax for all taxpayers.

Schedule 7 deals with the application of the same business test. The first part of schedule 7 deals with tax losses. Companies are allowed to deduct a prior year loss if they pass the continuity of ownership test. To pass the continuity of ownership test, more than 50 per cent of the ownership of the company must be maintained from the beginning to the end of the year in which the deduction is claimed. If the company does not pass this test, it can still claim the deduction if it passes the same business test. To pass the same business test, a company must carry on the same business both immediately before the disqualifying change of ownership and during the year it claims the deductions. Labor will support part 1. The second part of schedule 7 deals with bad debts. When seeking to deduct bad debts, the current law provides for a first continuity period and a second continuity period for applying the COT. If the debt was incurred prior to the current year, the first continuity period commences on the day the debt was incurred and finishes at the end of the income year, and the second continuity period is the current income year. Labor will support part 2.

Schedule 8 deals with tax losses. Corporate entities are not able to choose the amount of prior year tax losses they wish to deduct. As a result, any tax losses must be applied against any income in excess of allowable deductions. Previously, corporate groups would structure to receive distributions from outside the group into a holding company, with subsidiaries holding any losses. Under the previous loss transfer provisions, the holding company could choose not to absorb group losses against distributions from outside the group. The requirement to pool group losses under consolidation removed that option. A tax system redesigned recommended that entities be able to choose the proportion of prior year losses to be deducted. The review of business tax also recommended allowing companies to choose the amount of tax losses to deduct. The existing law results in tax losses being wasted.

Schedule 8 would provide a specific rule applying to corporate tax entities to complement the general rules applying to all taxpayers on how to deduct prior year losses. The new rule would operate in a similar manner to the general rule by offsetting the prior year tax losses against net exempt income. Schedule 8 would provide that any unused franking tax offsets would be converted into an equivalent amount of tax losses and be able to be carried forward for deduction in a later year of income.

The Leader of the Opposition announced in his budget reply that Labor would not proceed with this measure as an offset to the cost of Labor's Medicare package. This measure has a cost of $15 million in 2003-04, rising to $70 million in the third out year. In opposing this measure, Labor is not suggesting that it is bad policy or poorly designed, simply that it is of a lower priority than preserving bulk-billing. On that point, I move the second reading amendment that has been circulated in my name. I move:

That all words after “That” be omitted with a view to substituting the following words:

“whilst not declining to give the Bill a second reading, the House:

(1) condemns the Howard Government for its lack of fiscal control, having increased both outlays and tax substantially;

(2) notes that the Government has also allowed the budget position to materially deteriorate by failing to deliver its own stated objective of a revenue neutral outcome on the Review of Business Taxation and its failure to confront major threats to the revenue through a growing tax avoidance industry including through the use of offshore tax havens; and

(3) notes that, as a result of these failures, the Government lacks the capacity to enhance the international competitiveness of Australia's taxation system, return the full value of bracket creep either through tax cuts or services, provide the health and education services needed by low and middle income Australians, and support the provision of retirement incomes for all Australians.”

The Howard government has lacked financial control. It has taken policy decisions with a net negative impact on the budget bottom line of $65.4 billion as measured over current budget and forward estimates years. It has funded those new policy decisions by increasing total Commonwealth tax as a proportion of GDP from 23 per cent to 25 per cent. More recently, we have seen no action by the Howard government to deal with the emerging problem of the tax avoidance industry using tax havens.

The problem with this government's propensity to tax as much as it spends shows up in the budget surplus, which is smaller than the amount of bracket creep that has not been handed back to taxpayers after the $4 tax cut. If all bracket creep were handed back, the budget would be in deficit in the next two financial years. So, after an increase in taxation of 2 per cent of GDP but also new policy decisions costing $65.4 billion, the surplus is slim. Despite that spend, Australian families cannot find a bulk-billing doctor. Doing something about that is Labor's priority. (Time expired)

The SPEAKER —Order! It is well after 2 p.m. I had allowed the member for Kingston to continue in order to complete his speech but his allotted time has now expired, as has the time for the debate. I believe the matter has been dealt with, to reassure the member for Rankin. It being 2 p.m., the debate is interrupted in accordance with standing order 101A. The debate may be resumed at a later hour.