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Monday, 21 October 2002
Page: 5527


Senator MURRAY (5:50 PM) —The New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Bill 2002 is a consequence of the government's new tax system. In August 1998, the government announced its new tax system election policy and, as part of its consequent comprehensive tax overhaul, business tax reform resulted from the July 1999 Ralph Review of Business Taxation. This bill further implements agreed measures arising from Ralph—which all parties supported—particularly those measures affecting the consolidation of losses. The essential purposes of the bill are to introduce a general value-shifting regime which will apply as an integrity measure to prevent tax minimisation through the shifting of values from one set of assets to another, providing capital gains tax relief where a separate entity is demerged from a group if certain conditions are met, introducing largely technical components of the consolidation regime—many concerned with the treatment of international income—and amending the simplified imputation system to incorporate existing integrity rules.

This bill has been to the Senate Economics Legislation Committee. Labor sent it there, and they were very right to do so. The committee's report is a useful analysis of both the bill and the surrounding issues. The bill is substantial, lengthy and complex, and its financial consequences are unclear. Supposedly, they are not very revenue significant; however, my interpretation of the evidence given to us and my feeling concerning this bill is that we should actually be very unsure as to its revenue consequences. The issue of potential compliance costs in particular has caused considerable angst, but it is notable that even those who were most strongly critical of both the complexity of the bill and the potential compliance costs still urged the committee and the Senate to pass the bill. In other words, they would prefer it passed, even with its deficiencies, because they believe its provisions will deliver greater efficiency and greater opportunities for economic improvement.

The committee has established that there are problems with respect to consolidations; with beneficial ownership; with the same business test; sharing agreements; losses from capital investments and the available fraction; overdepreciation and dividends; allocable cost amounts and uniform capital allowances; substituting accounting periods; continuity of ownership; profits accrued; linked assets and liabilities; privatised assets subject to particular uniform capital allowance limitations; and other matters. This long list, however, is of mostly technical issues. That is not to derogate from their importance; they do elicit strong opinions from those affected. Because of an implementation date of 1 July 2003 and high compliance requirements for those affected, there is some urgency in passing the bill.

While the proposed value-shifting rules have an association with the consolidation regime, they will also apply to capital gains tax events which are not connected with a consolidation. The proposed rules—known as the `general value shifting regime', GVSR, to emphasise their general application and also to distinguish them from the specific rules applying to value shifting which currently apply in relation to certain share arrangements and asset stripping—are an integrity or anti-avoidance measure. Members of the committee and witnesses will recall that there was some discussion as to whether this fairly complex integrity measure was warranted and whether part IVA would be sufficient in these respects. Frankly, I am not in a position to judge. The committee as a whole has accepted Treasury's advice that this is the best way to go.

The term `value shifting' applies in cases where the value of one asset has increased while there is a decrease in relation to another asset held by the same entity in order to achieve a better tax position for the asset holder. Because of that motive, you have to devise antitax avoidance integrity measures. As the valuation relates to assets rather than to income, the taxation advantage sought to be achieved will relate to capital gains tax rather than to income tax.

As noted, the proposed rules, while of general application, are associated with the introduction of the consolidation regime, which will substantially increase the opportunities for companies to revalue assets as subsidiary companies join a consolidated group. As under the consolidation regime, there will be no CGT implications from the change in ownership so long as the consolidation rules are followed. There will be an opportunity to value assets in such a way as to achieve the best CGT result. This is particularly the case for smaller individual assets, such as trading stock, and intangible assets such as goodwill, for which a range of valuations may be made.

Currently, there are specific rules relating to value shifting in relation to share value and asset stripping. Briefly, a tax advantage can be denied where there is a scheme under which value is shifted from one share to another to reduce the CGT payable on the disposal of the share from which the value has been shifted—in other words, where it was a tax avoidance measure. This can be achieved in a number of ways, such as by the issue of discounted shares to the taxpayer or an associate which reduces the value of the shares already held or by transferring value from shares subject to CGT to pre-CGT shares. Asset stripping can occur where value is transferred between companies under common ownership, with the result that either a capital loss is triggered or a capital gain is reduced. The Income Tax Assessment Act contains provisions to deny a tax advantage where there is value shifting or asset stripping of this type, but these rules have been subject to some criticism.

The Ralph Review of Business Taxation report entitled A tax system redesigned found many problems with the existing legislation, including inconsistent application with, for example, value shifting applying to shares in companies but not to interests in trusts and rules only applying where companies are under 100 per cent common ownership rather than under the same control. There are high compliance costs associated with ensuring there is no technical breach of the rules, and the legislation containing the rules is very complex, largely as a result of it being without a solid base and needing to be constantly amended.

To overcome these and other difficulties with the existing rules, as well as improving the integrity of the tax system, the Ralph report recommended a system of general value-shifting rules. As part of the recommendations, a de minimis exemption was proposed. This was seen as desirable to reduce compliance costs. The Ralph report stated that following consultation it was considered that a comprehensive de minimis exemption was needed which balances integrity considerations and containment of compliance costs—a small statement of large consequence, as we see in the legislation.

The Ralph report also made a number of recommendations regarding the new GVSR, including that the GVSR apply to all entities and their associates, that the rules apply where there is control rather than ownership of the other entity, that a de minimis rule be introduced and that value shifts be recognised at the time they occur rather than at the time they are realised—a real-time provision. The implementation of the GVSR was foreshadowed in the Treasurer's initial responses to the Ralph report. That announcement was connected with the initial deferment of the proposed entity taxation regime, which it now appears will not be implemented.

The GVSR to be implemented by this bill was announced by the Assistant Treasurer on 27 June 2002 as part of the second instalment of legislation dealing with consolidation. The proposals were described as an integrity measure to prevent revenue loss arising from asset revaluation when entities consolidated. The explanatory memorandum estimates the revenue gain from the GVSR at only $480 million over four years, which I guess you can lay off in this bill against the $1 billion cost to the revenue of consolidation. I must say that it is a complex way to raise $480 million. It can be seen from this revenue estimate that there is not expected to be a spike in revenue returns during the initial period of the operational consolidation regime, which could be expected if entity groups were waiting for the current legislation to be passed. It is also not clear whether the gain to revenue will exceed revenue loss that could be expected if the GVSR were not introduced, or from existing law, although the revenue gain appears to result from the extension of the rules to entities other than companies.

Turning to demergers, to my mind a demerger is, philosophically speaking, the reverse side of the merger coin. In other words, if you have tax and Corporations Law provisions allowing mergers you should have the same allowing demergers. Simplistically, the term `demerger' refers to the situation whereby an entity which operates in more than one area separates the various business activities into individual operations with separate identities and legal recognition and the interests in the new and old entities are in the same proportions. Currently, a demerger would result in capital gains tax consequences for the owners of the interests in the old and new entities, as the sale of the new entity would be considered a realisation of the value in the old entity and so a realisation of any gains or losses made would constitute a capital gains tax event. Put simplistically, the legislation is trying to render people no worse off as a result of demerger.

The Ralph report recommended that, subject to a number of conditions, a demerger should not give rise to a capital gains tax event. One of the main recommendations of the Ralph report was that there be no tax consequences where a widely held entity, generally one with 300 or more members, splits its operations into separate entities so long as the members' interests remain the same in nature and proportion—that is, in the same economic position—as they were prior to the demerger, and that the tax value of the members' interests be spread over the old and new interests. Secondly, the report recommended that a demerger be taken to be a realisation of assets not subject to CGT, as they were owned prior to the introduction of the CGT regime on 20 September 1985, and that the assets receive a value equal to that immediately after the acquisition as part of the new structure. Thirdly, the Ralph report recommended that the post-CGT assets have their value apportioned according to their existing CGT value—that is, that there not be a CGT event—and in the same proportion as their interests in the new entities.

The Ralph recommendations were made in the context of the introduction of the entity taxation regime which, according to reports concerning those proposed recommendations, now appears to have been deferred indefinitely. The Ralph report recommended that the demerger rules have effect from the same time as the entity taxation regime came into effect. Whilst I am talking about demergers, I should indicate that Senator Conroy raised the question of the 20 per cent arbitrary figure that was introduced. That was covered in the committee's considerations and in their report. I remain unconvinced by that 20 per cent cut-off. I am not going to do anything about it, but I would suggest that both the Treasurer and the Treasury keep their eye on it with a view to removing or amending it at some stage in the future. The only thing I can say is that I just do not really get it—and neither did Senator Watson when he was dealing with it.

Turning to the consolidation provisions, the Ralph review recommended that consolidated income tax treatment for groups of entities be introduced. It recognised that the introduction of a consolidated regime would involve significant change but that the need for such reform stemmed from the high compliance costs, high tax revenue costs and concomitant complex anti-avoidance provisions associated with the current tax treatment of company groups. The review believed that consolidation would offer major advantages to entity groups in terms of both reduced complexity and increased flexibility in commercial operations, driven at present by intragroup transactions being ignored for tax purposes. It believed that the long-term benefits of this reform would be well worth the associated short-term transitional costs.

Somewhere in my memory is an estimate that about $39 billion of losses are hanging around awaiting the results of consolidation reform. What that eventually means in terms of potential dangers for revenue or potential income as a result of increased economic activity I do not know and I am pretty certain the Treasury do not know. Anyway, they have taken an educated guess that the cost is going to be $1 billion over the first four years.

The first stage of this consolidation round was passed in June this year and a third tranche was due—and I think has been announced—in September. While the principles behind the consolidation regime are relatively straightforward and well known, the provisions implementing the regime are complex and technical, with many different circumstances being covered. One of the challenges that should face the Treasurer, the Assistant Treasurer and the Treasury department is that, once all this has been bedded down and has found its way into the normal operation of the market, perhaps we can return to the tax law and try to find some way to simplify it—if we regard much of what we are doing now as transitional rather than stuff which should be in there permanently.

It is worth noting that foreign investment fund rules apply where a resident, including a company, invests in a vehicle which operates in an offshore low-tax area. The rules aim to prevent the use of such vehicles to minimise tax, although there are a range of exemptions from the foreign investment fund rules for genuine investments. FIF—as it is known—attribution accounts operate to allow credit in respect of tax paid to prevent double taxation of investment returns from taxation in the low-tax area and in Australia.

There is a series of transitional rules which will apply in respect of groups that consolidate in this financial year and in the next financial year. The main impact of the provisions is that a prospective head company may choose to have certain entities joining the group treated as chosen entities. These will receive concessional treatment, including that the value of trading stock need not be recalculated, that value shifting and loss transfer rules will not apply and that existing CGT cost bases may be retained for assets which have a value lower than their depreciated value. The provisions aim to allow the head company to accept the current tax valuations used by the joining entities during the transitional period. Imputation is a small but important part of the bill. Schedule 13 of the bill will introduce a number of technical rules aimed at preventing the trading of franking credits by companies which would otherwise not receive a benefit under the imputation system, because, for example, they are nonresidents or they receive exempt income.

In conclusion, the evidence that was presented to the Senate Economics Legislation Committee not only suggests but affirms across-the-board support for the bill regardless of its complexity and depth, the difficulties with compliance and the need for further amendment that was exhibited in the committee considerations. There are a number of submissions from what I would call serious players that pointed out shortcomings in the legislation which could be improved by amendments. We do not expect those amendments to be brought forward during this debate. We would expect, though, that Treasury would seek to add some of those amendments to the third tranche bill that is coming forward. I presume it is to be dealt with this year. If that were so, that would be helpful for many of those dealing with the bill.

There were legitimate calls for no further delay in the passage of this bill. I think that is accepted by all parties. Delays would significantly impact on demergers in particular and on consolidations. There seems to be an overwhelming cry for some stability and certainty following the great taxation change that has occurred over the last six years. During the committee process it was acknowledged that the underlying principles of the legislation are sound, are widely endorsed by business and have multiparty support in parliament. The introduction of the legislation to parliament was preceded by a lengthy, comprehensive period of consultation and review, which was regarded with some gratitude by those who had been consulted. Even though the legislation is long and complex, the professionals do seem to believe they can cope with that. There is ongoing review and that is proving constructive and productive. So although the bill remains with significant technical and design flaws, we do concur with the other political parties that it is necessary to pass it as urgently as possible. We will be supporting the bill and we will not amend it.