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Taxation Laws Amendment Bill (No. 4) 1990
House: House of Representatives
The Bill will amend the thin capitalisation rules, particularly in relation to foreign controlled financial institutions; deal with transitional provisions for the capital gains tax and the gold industry; and make minor amendments to the imputation system. Some changes will also be made to the areas eligible for the zone allowance rebate.
Thin capitalisation refers to the situation where a company operating in Australia has a ratio of foreign debt to equity that exceeds the amount allowed under the thin capitalisation rules. Where this occurs, the deduction allowed for the interest paid on the foreign debt will be limited to the amount that would be allowable if the limits were adhered to. The current limits are 3:1 (debt to equity) for most companies and 6:1 for financial institutions. Foreign controlled financial institutions are therefore in a more advantageous position than other foreign controlled companies.
The amendments to the thin capitalisation rules were announced by the Treasurer in a Press Release dated 30 March 1989. That Press Release also announced that most of the amendments would apply from 1 July 1987, the date of the introduction of the thin capitalisation rules. Prior to the introduction of the rules, much the same result was achieved through the use of foreign investment policy. In a further Press Release, dated 19 February 1990, the Treasurer announced the release of draft legislation dealing with the amendments. Following comments on the draft legislation, this Bill was introduced.
The increased complexity of the income tax laws over recent years has led to greater emphasis on the cost to industry of compliance, particularly under the self assessment system. In a recent draft report, titled Compliance Cost of Australian Public Companies' Income Tax, the Economic Research Centre of the University of Western Australia is reported as estimating that the net compliance cost was approximately 14% of tax revenue paid by public companies. The costs of compliance were proportionally higher for smaller companies. 1
A rebate is available for people living in isolated areas, with the amount of rebate depending on the classification of the area in which they live. There are two basic categories, Zones A and B, with a higher rebate allowed for Zone A areas due to greater isolation and higher costs of living. Within each of these zones there are also special areas, where greater isolation results in the inhabitants receiving a higher rebate than other inhabitants of the Zone. One of the decisions to be implemented by this Bill will be to include Nhulunbuy, a town on the edge of Arnhem Land, in the special area of Zone A. Changes will also be made to the status of Lord Howe Island, King Island and the Furneaux Group of islands.
The main amendments concern the thin capitalisation rules as they relate to foreign controlled banks (i.e basically, where the foreign interest holds 15% of the shares). The amendments will give a number of concessions to such institutions that will result in their being able to claim greater deductions than currently allowed by the thin capitalisation rules. This will be achieved by excluding accounts kept for covering foreign transactions (nostro and vostro accounts - for a definition of these accounts see below) from the relevant calculations of foreign debt and equity. The amendments will also exclude certain amounts, section 128F debentures and short term trade credits (as defined below) from the calculation of foreign equity for all bodies subject to the thin capitalisation rules. These exclusions are also of a concessionary nature. As well, certain resident holding companies currently exempt from the thin capitalisation rules will cease to be exempt. The other major change to these rules will allow the amount of foreign debt for a year to be calculated on a weighted average of such debt during the year, rather than the highest level of debt during the year as is the current situation.
The proposal to include Nhulunbuy in the special area in Zone A for rebate purposes will be accomplished by clause 7 which will deem the population of the town to be less than 2 500. The change in status of other areas will be achieved by clause 30. The effect of the amendments will be to include Lord Howe Island in Zone A and King Island and the Furneaux Group of islands, both in Tasmania, in Zone B.
A number of new definitions will be inserted into section 159GZA of the Income Tax Assessment Act 1936 (the Principal Act), which contains the interpretation provision for the thin capitalisation rules, by clause 9. The more important are:
*Foreign bank which is defined to be a non-resident company that carries out banking business in Australia.
*Nostro account: In relation to a financial institution, this will be an account held with a foreign bank that is kept solely to settle international transactions and deposits are held for a maximum of 10 days and overdrafts are repaid within 10 days.
*Nostro amount, which will be amounts owing by a financial institution where the amount is either held in a nostro account or is an overdraft on a nostro account.
*Vostro account is defined, for a financial institution, to be an account held by a foreign bank with the institution and the same conditions as noted in regard to nostro accounts apply.
*Vostro amount will be amounts owing to a financial institution and either held in a vostro account or is an overdraft on a vostro account.
The definition of foreign debt will be amended to exclude, for financial institutions, nostro amounts. (Clause 10 which will amend section 159GZF of the Principal Act.) The amendment will apply to the 1987-8 and later years of income (clause 31).
The definition of foreign equity is contained in section 159GZG of the Principal Act. The definition provides that the level of equity is to be reduced by amounts owed to a company by foreign controllers or their associates. Excluded from this reduction will be section 128F debenture amounts (see below) ; short-term trade credits (see below); and, for financial institutions, vostro amounts (clause 11). This amendment, and those dealing with the definition of the two terms referred to, will apply to the 1987-8 and subsequent financial years (clause 31).
Section 128F debenture amount is defined in proposed section 159GZJA to be, for a particular time, an amount owed to a company and:
*is owed by a foreign controller or a foreign associate of that person;
*the relevant debenture was issued to the person at least 30 days before the particular time;
*the debenture was issued to the person in their role as manager, dealer or underwriter of the debenture;
*the person disposes of the debentures within 30 days of their issue; and
*section 128F applies to any interest paid by the company (basically this section provides that Division 11A, which deals with interest and dividends subject to withholding tax, will not apply to interest on debentures that satisfy certain conditions [principally that the transactions occur outside Australia]).
Short term trade credit amounts are dealt with in proposed section 159GZJB. An amount owing to a resident company, partnership or trust will be a short-term trade credit at a particular time so long as the amount is owed by a foreign controller or a foreign associate of that person; the company etc. provides goods or services; and the company etc. has provided goods or services to the person and has allowed credit for a maximum of 30 days. The credit cannot be rolled over or extended. Similarly, a short-term trade credit will exist where an amount is owed to a foreign investor and the same matters are satisfied.
The position of a resident holding company that is owned by a foreign controller and holds shares in a resident financial company is dealt with in proposed section 159GZLA. The proposed
Taxation Laws Amendment Bill (No. 4) 1990section deals with resident financial companies that are banks and have one foreign controller, and resident holding companies that are not financial institutions, have no debts on which interest is payable, own shares in the resident financial institution and whose shares are owned by the foreign controller. Where all of these matters are satisfied, the resident holding company is to be treated as a non-resident, and so subject to the thin capitalisation rules. As well, if the resident holding company owes an amount to the foreign controller and interest is not payable on the amount, the foreign equity component will be reduced by that amount. The changes will have effect for the 1987-8 and later financial years (clause 31).
The weighted averaging provision for resident companies is contained in clause 14 which will amend section 159GZS of the Principal Act. Taxpayers will be able to elect that the weighted average will apply, rather than the current maximum foreign debt in the year. The formula for calculating the weighted average is based on a number of factors, including the average daily foreign debt and the number of days when the debt exceeded the amount allowed under the equity:debt ratio. Similar provisions will be inserted for resident company groups (clause 15); partnerships (clause 16); trust estates (clause 17); and foreign investors (clause 18).
The gold mining industry will become subject to tax from 1 January 1991, and clause 23 will insert a number of provisions that will make adjustments to the value of assets and trading stock for the purposes of the capital gains tax. Basically, proposed section 159GZZZBC provides that where an asset is disposed of after this date and its indexed cost base is less than its market value (the difference would be a capital gain), the person will be deemed to have disposed of the asset for its indexed cost base and re-acquired it for its market value on 31 December 1990. The future cost base for the asset will therefore be based on the market value. Similarly, where there would be a capital loss due to differences in the reduced cost base and market value at 31 December 1990, the person will be deemed to have disposed of and re-acquired the asset for its market value so that the future cost base will be based on the market value as at 31 December 1990 (proposed section 159GZZZBD).
The value of eligible trading stock (which is included to determine if a taxpayer has assessable income) for the gold industry after tax becomes payable is dealt with in proposed Sub-division E. At the beginning of the year when tax becomes payable, proposed section 159GZZZBH provides that the taxpayer may exercise the options under section 31 (cost price, market value or replacement cost) and that if no election is made, cost price will be used (this is generally the lowest amount). Similarly, when determining if there is any exempt income at the end of the year, the taxpayer will have the same options (proposed section 159GZZZBI).
Sub-section 160AQJ(2), which came into force in 1990, provides that a franking deficit tax which would otherwise be payable will be waived where the company has made an initial payment of tax in accordance with the new rules relating to the time for payment of company tax. The provision applies where the initial payment is equal to or greater than the amount of franking deficit tax that would be payable. Proposed section 160APMA will make it clear that a franking deficit equal to the amount of the tax waived will arise for the company. Similarly, proposed section 160APYC provides that where there has been an overpayment of tax and a subsequent refund or credit, the franking debit will also be adjusted to reflect the changed payment. (The franking deficits tax is imposed where the franking credits given exceed the actual franking level available.)
A member of the Parliamentary Research Service, Bernard Pulle (ext. 2469), has suggested that a means of simplifying the Principal Act would be to remove the thin capitalisation provisions and replace the revenue saving due to the provisions with a higher rate of withholding tax. He also argues that such action could be seen as more complementary to the measures contained in the Taxation Laws (Foreign Income) Bill 1990. However, this would remove one of the main features of the thin capitalisation rules, the encouragement of foreign equity rather than debt.
1. CAI, Media Statement, 7 October 1990.
Bills Digest Service
Parliamentary Research Service
For further information, if required, contact the Economics and Commerce Group on 06 2772460.
This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.
Commonwealth of Australia 1990
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Published by the Department of the Parliamentary Library, 1990.