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Tax Laws Amendment (2004 Measures No. 2) Bill 2004

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2002-2003-2004

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

HOUSE OF REPRESENTATIVES

 

 

 

Tax Laws amendment (2004 measures No . 2) bill 2004

 

 

 

 

EXPLANATORY MEMORANDUM

 

 

 

 

(Circulated by authority of the

Treasurer, the Hon Peter Costello, MP)

 



T able of contents

Glossary                                                                                                               1

General outline and financial impact............................................................ 3

Chapter 1            Life insurance companies................................................ 13

Chapter 2            Consolidation: providing greater flexibility..................... 59

Chapter 3            Venture capital partnerships.......................................... 143

Chapter 4            Fringe benefits tax housing benefits............................ 149

Chapter 5            Capital gains tax event K6 and demergers................. 151

Chapter 6            Deductions for United Medical Protection

Limited support payments.............................................. 155

Chapter 7            Goods and services tax amendments relating

to compulsory third party schemes............................... 159

Chapter 8            Public ambulance services............................................ 167

Chapter 9            Taxation of overseas superannuation payments....... 173

Chapter 10         Simplified imputation system - franked

distributions received through certain

partnerships and trusts................................................... 189

Chapter 11         Technical corrections to foreign tax credit provisions 211

Chapter 12         Amendments to the alienation of personal

services income provisions............................................ 213

Index                                                                                                                221



The following abbreviations and acronyms are used throughout this explanatory memorandum.

Abbreviation

Definition

ATO

Australian Taxation Office

CGT

capital gains tax

Commissioner

Commissioner of Taxation

COT

continuity of ownership test

CTP

compulsory third party

CUT

corporate unit trusts

DGR

deductible gift recipient

ETP

eligible termination payment

FBT

fringe benefits tax

FDA

foreign dividend account

FIF

foreign investment fund

GIC

general interest charge

GST

goods and services tax

GST Act

A New Tax System (Goods and Services Tax) Act 1999

ITAA 1936

Income Tax Assessment Act 1936

ITAA 1997

Income Tax Assessment Act 1997

MEC

multiple entry consolidated

NZ

New Zealand

PAYG

pay as you go

PSB

personal services business

PSI

personal services income

PTT

public trading trusts

SIS

simplified imputation system

TAA 1953

Taxation Administration Act 1953

UMP

United Medical Protection Limited

 



Life insurance companies

Schedule 1 to this bill modifies the operation of the income tax law affecting life insurance companies to:

·       overcome a range of technical difficulties that the life insurance industry has raised about the practical operation of the income tax law affecting them;

·       clarify how the two classes of taxable income or tax losses of life insurance companies are calculated;

·       ensure that the provisions in the Income Tax Assessment Act 1936 (ITAA 1936) relating to reinsurance with non-residents apply only to their accident and disability business;

·       ensure that certain aspects of the ITAA 1936 are effectively replicated in the Income Tax Assessment Act 1997 ; and

·       ensure that the interactions with other provisions in the income tax law work as intended.

Date of effect :  The amendments generally apply from 1 July 2000. Some of the amendments will potentially have an adverse impact on taxpayers and therefore apply from the date that this bill receives Royal Assent.

Proposal announced :  Most of the measures were announced in Minister for Revenue and Assistant Treasurer’s Press Release No. C96/02 of 11 September 2002. Other measures have not previously been announced.

Financial impact :  The financial impact of the amendments is expected to be negligible.

Compliance cost impact :  The measures are expected to have a minimal impact on compliance costs.

Consolidation: providing greater flexibility

Schedule 2 to this bill provides greater flexibility, clarifies certain aspects of the consolidation regime and ensures that the regime interacts appropriately with other aspects of the income tax law.

Date of effect :  The amendments generally have retrospective effect to 1 July 2002, which is the date of commencement of the consolidation regime. Full details concerning the date of effect of amendments are contained in the application and transitional provisions at the end of Chapter 2. The amendments are either beneficial to taxpayers or to correct unintended outcomes. All of the amendments to address unintended outcomes are consistent with the original policy intent for the consolidation regime and therefore have the same commencement date as the consolidation regime.

Proposal announced :  All these measures were foreshadowed in three press releases announced by Minister for Revenue and the Assistant Treasurer. They were Press Release’s No. C116/03 of 4 December 2003, No. C067/03 of 30 June 2003 and No. C019/03 of 27 March 2003.

Financial impact :  The majority of changes are not expected to impact on revenue. The revenue cost concerning membership rules for corporate unit trusts and public trading trusts are expected to be less than $2 million per annum from 1 July 2002.

Compliance cost impact :  The measures in this bill will provide taxpayers with additional flexibility in the transition to consolidation and are not expected to impact significantly on compliance costs.

Venture capital partnerships

Schedule 3 to this bill amends the Income Tax Assessment Act 1997 and the Income Tax Assessment Act 1936 to ensure that a limited partnership formed with a legal personality separate from its partners that is taxed as an ordinary partnership under the venture capital regime is a ‘partnership’ for income tax purposes. A transitional rule operates to backdate the registration or conditional registration of a limited partnership that would have been registered or conditionally registered between 2 December 2003 and the day this bill receives Royal Assent.

Date of effect :  2 December 2003.

Proposal announced :  This measure was announced in Minister for Revenue and Assistant Treasurer’s Press Release No. C112/03 of 2 December 2003.

Financial impact :  Nil.

Compliance cost impact :  Nil.

Fringe benefits tax housing benefits

Schedule 4 to this bill amends the Fringe Benefits Tax Assessment Act 1986 to allow for continuity of fringe benefits tax (FBT) treatment for non-remote housing benefits where administration and payment of FBT is devolved by State or Territory governments to a departmental level.

Date of effect :  The amendments will apply from 1 April 2001.

Proposal announced :  This measure was announced in the

2002-03 Mid-Year Economic and Fiscal Outlook .

Financial impact :  Nil.

Compliance cost impact :  Nil.

Capital gains tax event K6 and demergers

Schedule 5 to this bill amends the Income Tax Assessment Act 1997 to ensure that capital gains tax event K6 is not inadvertently triggered by the disposal of new interests in demerged entities.

Date of effect :  The amendments apply to shares or units acquired under a demerger on or after 1 July 2002.

Proposal announced :  This measure was announced in Minister for Revenue and Assistant Treasurer’s Press Release No. C097/03 of 16 October 2003.

Financial impact :  Nil.

Compliance cost impact :  The measure will decrease compliance costs for some taxpayers.

Deductions for United Medical Protection Limited support payments

Schedule 6 to this bill amends the Income Tax Assessment Act 1997 to ensure that all individuals who make United Medical Protection Limited (UMP) support payments will be entitled to an income tax deduction for the amount of their contributions in that income year.

Date of effect :  The amendment applies to UMP support payments made on or after 1 July 2003.

Proposal announced :  This measure was announced by the Australian Government on 17 December 2003.

Financial impact :  The measure has an estimated cost to revenue of $0.8 million in 2004-2005, $1.6 million in 2005-2006 and $1.5 million in 2006-2007.

Compliance cost impact :  Nil.

Goods and services tax amendments relating to compulsory third party schemes

Schedule 7 to this bill amends the A New Tax System (Goods and Services Tax) Act 1999 to ensure that the goods and services insurance provisions apply as intended to transactions undertaken by operators of compulsory third party schemes.

Date of effect :  1 July 2000.

Proposal announced :  These measures have not previously been announced.

Financial impact :  Nil.

Compliance cost impact :  These measures are expected to reduce compliance costs.

Public ambulance services

Schedule 8 to this bill amends the Fringe Benefits Tax Assessment Act 1986 to provide public ambulance services with the same fringe benefits tax (FBT) treatment as is provided to public hospitals. Public ambulance services will be able to access an FBT exemption of up to $17,000 of grossed-up taxable value per employee, and will also be able to access the remote area housing FBT exemption under the same criteria as applies to public hospitals. In addition, the Income Tax Assessment Act 1997 will be amended to allow public ambulance services to be endorsed to receive tax deductible gifts.

Date of effect :  The amendments will apply from 1 April 2004.

Proposal announced :  This measure was announced in Treasurer’s Press Release No. 2 of 20 January 2004.

Financial impact :  The revenue cost of the measure is expected to be $1 million in 2003-2004, $3.5 million in 2004-2005 and $5 million in each of 2005-2006, 2006-2007 and 2007-2008.

Compliance cost impact :  Nil.

Taxation of overseas superannuation payments

Schedule 9 to this bill amends the Income Tax Assessment Act 1936 to alter the taxation treatment that applies when payments are made from overseas superannuation funds. The amendments give effect to the Government’s response to the report by the Senate Select Committee on Superannuation on Taxation of Transfers from Overseas Superannuation Funds.

The key change will enable a taxpayer who is having their overseas superannuation paid directly to an Australian complying superannuation fund to elect to have part of the payment treated as a taxable contribution in the Australian fund. By doing so the fund, rather than the individual, will pay relevant tax arising on the payment and tax will be paid at the concessional superannuation fund rate rather than at the individual’s marginal rate.

A number of related amendments are also made to improve the operation and clarity of the provisions dealing with payments of overseas superannuation. 

Date of effect :  The amendments will apply to payments made on or after 1 July 2004.

Proposal announced :  This measure was announced in Minister for Revenue and Assistant Treasurer’s Press Release No. C092/03 of

30 September 2003.

Financial impact :  The amendments are expected to provide a first year revenue gain of $1.1 million and have a negligible long term impact.

Compliance cost impact :  Superannuation funds may incur some costs in processing the payments and deducting the appropriate tax.

Summary of regulation impact statement

Regulation impact on business

Impact :  The main impact will be on those individuals who have benefits from their overseas superannuation fund paid directly to a complying superannuation fund in Australia. Such individuals will benefit from not having to personally finance their tax liability from sources other than superannuation as well as from a reduced tax rate applying to the assessable amount of the payment.

Superannuation funds may incur some costs in processing the payments and deducting the appropriate tax.

Main points :

·          Individuals who have their overseas superannuation paid directly into an Australian complying superannuation fund will be able to elect to have part of the payment treated as a taxable contribution by the fund.

·          The Australian fund will have to give effect to the election and ensure the payment is appropriately taxed. This may involve some additional administration costs for the funds. However, as the election process will provide a mechanism by which the amount to be treated as a taxable contribution is identified, and as this amount of the payment is taxed in the same way as other taxable contributions to the fund, the impacts on fund processes are expected to be minimal.

Simplified imputation system - franked distributions received through certain partnerships and trusts

Schedule 10 to this bill amends, as part of the implementation of the simplified imputation system (SIS), Division 207 of the Income Tax Assessment Act 1997 which deals with the tax effect of receiving a franked distribution. The amendments will include adjustment rules to provide the calculation to adjust an entity’s assessable income where a franked distribution flows indirectly to the entity through a trust or partnership and the entity has no entitlement to a tax offset.

This bill will also amend the rules in the trans-Tasman imputation measures that adjust the assessable income of an Australian shareholder in receipt of a supplementary dividend paid by a New Zealand (NZ) company. The amendments will implement a minor policy change and ensure that the trans-Tasman adjustment rules are consistent with the adjustment rules in Division 207, introduced in Schedule 10 to this bill.

This bill also makes technical amendments and other consequential amendments to Division 207 and other parts of the SIS including an amendment to the exempting entity rules to ensure that the rules operate as intended in respect of certain tax exempt institutions that are entitled to a refund of imputation credits.

Date of effect :  The amendments to the SIS will generally apply to events arising on or after 1 July 2002, the commencement date of the SIS rules.

The amendments to the trans-Tasman imputation measures will apply from 1 April 2003, the commencement of those measures.

The amendments relating to the concept of non-assessable non-exempt income will apply to assessments for the 2003-2004 income year and later income years, consistent with the introduction of the non-assessable non-exempt concept in the income tax law.

The consequential amendment to the exempting entity rules will apply from 1 July 2000, the commencement date of the provisions allowing a refund of imputation credits for certain charities and gift-deductible organisations.

Proposal announced :  These rules are part of the SIS, which was announced as part of the Government’s business tax reform package. The proposal was announced in Treasurer’s Press Release No. 58 of 21 September 1999. On 14 May 2002, the Minister for Revenue and Assistant Treasurer announced in Press Release No. C57/02 the Government’s program for delivering the next stage of business tax reform measures including the SIS.

The trans-Tasman imputation measures were announced jointly by the Treasurer and the NZ Minister for Finance on 19 February 2003. (Treasurer’s Press Release No. 7 of 19 February 2003.)

Financial impact :  The amendments to Division 207 and consequential amendments to other parts of the SIS (except the amendment to the exempting company rules) will have no impact on revenue.

A reliable estimate of the revenue cost of the amendment to the exempting entity rules cannot be made.

The amendments to the trans-Tasman imputation measures are expected to have a small, positive but unquantifiable impact on revenue.

Compliance cost impact :  The SIS is designed to reduce compliance costs incurred by business by providing simpler processes and increased flexibility.

Technical corrections to foreign tax credit provisions

Schedule 11 to this bill changes the provisions dealing with the carry-forward of excess foreign tax credits to ensure those provisions refer to the correct paragraphs in the general foreign tax credit provisions.

Date of effect :  The amendments have retrospective effect to correct a technical problem with the current application of the relevant provisions.

Proposal announced :  This measure has not been previously announced.

Financial impact :  Nil.

Compliance cost impact :  The measures in this bill make a technical correction to the law to ensure the correct paragraph references are inserted in the excess foreign tax credit carry-forward provisions. 

Amendments to the alienation of personal services income provisions

Schedule 12 to this bill amends the alienation of personal services income (PSI) provisions contained in Part 2-42 of the ITAA 1997 to clarify when the Commissioner can make a personal services business (PSB) determination as is consistent with the policy intent.

Date of effect :  The amendments in Part 1 of Schedule 12 will apply to assessments for the 2000-2001 income year and each subsequent year.

The amendments in Part 2 of Schedule 12 will apply to assessments for the income year after the income year in which this bill receives Royal Assent and each subsequent income year.

Proposal announced :  The measure has not been announced.

Financial impact :  The revenue impact of the measure is unquantifiable however, it is expected to be insignificant.

Compliance cost impact :  Nil.

 

 



C hapter 1  

Life insurance companies

Outline of chapter

1.1         Schedule 1 to this bill modifies the operation of the income tax law affecting life insurance companies to:

·       overcome a range of technical difficulties that the life insurance industry has raised about the practical operation of the income tax law affecting them;

·       clarify how the two classes of taxable income and/or tax losses of life insurance companies are calculated;

·       ensure that the provisions in the Income Tax Assessment Act 1936 (ITAA 1936) relating to reinsurance with non-residents apply only to their accident and disability business;

·       ensure that certain aspects of the ITAA 1936 are effectively replicated in the Income Tax Assessment Act 1997 (ITAA 1997); and

·       ensure that the interactions with other provisions in the income tax law work as intended.

Context of amendments

1.2         The taxation treatment of life insurance companies was reformed with effect from 1 July 2000. Those reforms reflected recommendations made by the Review of Business Taxation. Legislation to implement those reforms (Division 320 of the ITAA 1997) was developed in consultation with industry and enacted by the New Business Tax System (Miscellaneous) Act (No. 2) 2000 .

1.3         These amendments respond to concerns raised by the life insurance industry and will improve the practical operation of the taxation regime for life insurance companies and its interaction with other aspects of the income tax law.

Summary of new law

1.4         The income of life insurance companies is divided into different types for income tax purposes. The three main types of income, which reflect the different types of business of life insurance companies, are:

·       the ordinary class of taxable income that is taxed at the company tax rate;

-            income derived in relation to risk business and ordinary investment business is included in this class;

·       the complying superannuation class of taxable income that is taxed at a rate of 15%;

-            income derived in relation to complying superannuation business is included in this class; and

·       non-assessable non-exempt income derived in relation to immediate annuity business.

1.5         The amendments ensure that:

·       the taxable income of the complying superannuation class and the ordinary class are worked out separately; and

·       tax losses of one class can only be applied to reduce future income of the same class.

1.6         The amendments also modify the taxation treatment of each type of business.

1.7         In relation to risk business, the amendments ensure that:

·       for life insurance companies, the provisions in the ITAA 1936 relating to reinsurance with non-residents only apply to accident and disability risk covered by the relevant reinsurance contracts;

·       certain reinsurance commissions are included in assessable income; and

·       the basis for determining the amount of the decrease in the value of policy liabilities that is included in assessable income is the same as the basis for determining the amount of the increase in the value of policy liabilities that is deductible.

1.8         In relation to ordinary investment business, the amendments:

·       clarify that the deduction for the capital component of ordinary investment policies does not apply to other types of policies;

·       ensure that funeral policies issued by friendly societies are taxed as ordinary investment policies;

·       ensure that the amount of the reduction in exit fees over the term of a life insurance policy is deductible; and

·       ensure that risk rider premiums are included in assessable income.

1.9         In relation to complying superannuation business, the amendments:

·       clarify the scope of the deduction for the capital component of premiums received in respect of virtual pooled superannuation trust policies;

·       clarify the scope of the liabilities that can be supported by virtual pooled superannuation trust assets;

·       allow up to 30 days after the time that the transfer value of virtual pooled superannuation trust assets is determined or the time that the value of the virtual pooled superannuation trust policy liabilities is determined, whichever is latter, to transfer excess assets out of the virtual pooled superannuation trust; and

·       impose administrative penalties for the failure to undertake the required valuations of assets and liabilities, or to transfer excess assets out of the virtual pooled superannuation trust, within the specified time periods.

1.10       In relation to immediate annuity business, the amendments:

·       modify the types of policies that are exempt life insurance policies;

·       clarify the scope of the liabilities that can be supported by segregated exempt assets;

·       allow up to 30 days after the time that the transfer value of segregated exempt assets is determined or the time that the value of the exempt life insurance policy liabilities is determined, whichever is latter, to transfer excess assets out of the segregated exempt assets; and

·       impose administrative penalties for the failure to undertake the required valuations of assets and liabilities, or to transfer excess assets out of the segregated exempt assets, within the specified time periods.

1.11       There are also a range of technical amendments that:

·       clarify the scope of the transitional measure for certain management fees that are non-assessable non-exempt income;

·       clarify the interactions between Division 320 and the uniform capital allowances system;

·       modify the operation of the transitional measures relating to the establishment of a virtual pooled superannuation trust and the segregated exempt assets;

·       ensure that the current Actuarial Standards are used for income tax purposes;

·       ensure that the non-resident proportion of foreign establishment amounts that is non-assessable non-exempt income is worked out consistently with the equivalent amount that was exempt income prior to 1 July 2000;

·       ensure that income derived by friendly societies in respect of sickness policies issued before 1 January 2003 is non-assessable non-exempt income; and

·       ensure that various provisions in the ITAA 1936 that apply to policies of life insurance are limited to policies issued by an Australian life insurance company.

Comparison of key features of new law and current law

New law

Current law

Tax losses of the complying superannuation class can be applied only to reduce future complying superannuation class income.

Tax losses of the ordinary class can be applied only to reduce future ordinary class income.

Tax losses of the complying superannuation class can be applied only to reduce future complying superannuation class income.

Tax losses of the ordinary class must be applied to reduce both future ordinary class income and future complying superannuation class income.

In relation to risk business:

·        the provisions in the ITAA 1936 relating to reinsurance with non-residents apply only to accident and disability risk covered by the relevant reinsurance contracts entered into by life insurance companies;

·        reinsurance commissions are specifically included in assessable income; and

·        the basis for determining the amount of the decrease in the value of policy liabilities that is included in assessable income is the same as the basis for determining the amount of the increase in the value of policy liabilities that is deductible.

In relation to risk business:

·        the provisions in the ITAA 1936 relating to reinsurance with non-residents apply to the whole of the risk covered by the relevant reinsurance contracts entered into by life insurance companies;

·        reinsurance commissions may not be included in assessable income; and

·        the basis for determining the amount of the decrease in the value of policy liabilities that is included in assessable income may be different to the basis for determining the amount of the increase in the value of policy liabilities that is deductible.

In relation to ordinary investment business:

·        the deduction for the capital component of ordinary investment policies does not apply to other types of policies;

·        funeral policies issued by friendly societies are taxed as ordinary investment policies;

·        the amount of the reduction in exit fees over the term of a life insurance policy is deductible; and

·        risk rider premiums are included in assessable income.

In relation to ordinary investment business:

·        the deduction for the capital component of ordinary investment policies may apply to other types of policies;

·        funeral policies issued by friendly societies may be taxed as risk policies;

·        the amount of the reduction in exit fees over the term of a life insurance policy may not be deductible; and

·        risk rider premiums may not be included in assessable income.

In relation to complying superannuation business:

·        the deduction for the capital component of premiums received in respect of virtual pooled superannuation trust policies is not reduced by the risk component of participating policies;

·        liabilities relating to virtual pooled superannuation trust policies and all relevant provisions for income tax can be supported by virtual pooled superannuation trust assets;

·        life insurance companies must transfer excess assets out of the virtual pooled superannuation trust within 30 days of the later of:

-      the time that the transfer value of virtual pooled superannuation trust assets is determined; and

-      the time that the value of the virtual pooled superannuation trust policy liabilities is determined; and

 

·        administrative penalties will be imposed if a life insurance company does not undertake the required valuations of assets and liabilities, or transfer excess assets out of the virtual pooled superannuation trust, within the specified time periods.

In relation to complying superannuation business:

·        the deduction for the capital component of premiums received in respect of virtual pooled superannuation trust policies is reduced by the risk component of participating policies;

·        liabilities relating to virtual pooled superannuation trust policies and relevant provisions for tax in respect of unrealised gains and for unpaid pay as you go instalments can be supported by virtual pooled superannuation trust assets;

·        life insurance companies must transfer excess assets out of the virtual pooled superannuation trust within 30 days of the time that the transfer value of virtual pooled superannuation trust assets is determined; and

 

 

 

 

·        no administrative penalties are imposed if a life insurance company does not undertake the required valuations of assets and liabilities, or transfer excess assets out of the virtual pooled superannuation trust, within the specified time periods.

In relation to immediate annuity business:

·        exempt life insurance policies include, among other things:

-      immediate annuity policies that satisfy certain conditions; and

-      part of a policy held by a complying superannuation fund or pooled superannuation trust where the relevant part satisfies certain conditions;

·        liabilities relating to exempt life insurance policies can be supported by segregated exempt assets;

·        life insurance companies must transfer excess assets out of the segregated exempt assets within 30 days of the later of:

-      the time that the transfer value of segregated exempt assets is determined; and

-      the time that the value of the exempt life insurance policy liabilities is determined; and

·        administrative penalties will be imposed if a life insurance company does not undertake the required valuations of assets and liabilities, or transfer excess assets out of the segregated exempt assets, within the specified time periods.

In relation to immediate annuity business:

·        exempt life insurance policies include, among other things:

-      all immediate annuity policies; and

-      policies held by a complying superannuation fund or pooled superannuation trust only where the whole of the policy satisfies certain conditions;

·        liabilities relating to exempt life insurance policies and relevant provisions for tax in respect of unrealised gains can be supported by segregated exempt assets;

·        life insurance companies must transfer excess assets out of the segregated exempt assets within 30 days of the time that the transfer value of segregated exempt assets is determined; and

·        no administrative penalties are imposed if a life insurance company does not undertake the required valuations of assets and liabilities, or transfer excess assets out of the segregated exempt assets, within the specified time periods.

 

Detailed explanation of new law

1.12       The amendments affect a broad range of issues relating to the operation of the income tax law for life insurance companies. In particular, the amendments affect:

·       the basis of working out the ordinary class and complying superannuation class of taxable income or tax losses;

·       the taxation treatment of risk business;

·       the taxation treatment of ordinary investment business;

·       the operation of the virtual pooled superannuation trust; and

·       the operation of the segregated exempt assets.

1.13       There are also a range of technical amendments.

Taxable income or tax losses of the ordinary class and the complying superannuation class

1.14       The amount of income tax that is payable by a taxpayer is generally worked out by applying the method statement in subsection 4-10(3). Step 2 in the method statement requires taxpayers to work out their basic income tax liability on their taxable income using the income tax rates that apply to them for the income year.

1.15       The basic income tax liability for a life insurance company depends on how much of the company’s taxable income relates to:

·       the complying superannuation class which is taxed at a rate of 15%; and

·       the ordinary class which is taxed at the company tax rate.

1.16       To enable a life insurance company to calculate its basic income tax liability and the amount of income tax that it has to pay, new Subdivision 320-D allows the company to have taxable incomes or tax losses for each of these classes. [Schedule 1, item 33, sections 320-130 and 320-131]

Working out the taxable income and tax loss of each class

1.17       Subdivision 320-D ensures that:

·       the taxable income of the complying superannuation class and the ordinary class are worked out separately; and

·       tax losses of one class can only be applied to reduce future income of the same class.

[Schedule 1, items 33 and 66, section 320-133 and the definition of ‘class’ in subsection 995-1(1)]

1.18       For these purposes, Subdivision 320-D allocates a life insurance company’s assessable income and deductions to the complying superannuation class and the ordinary class. The taxable income and tax losses of each class are then worked out under the ordinary provisions of the income tax law. A life insurance company can have:

·       taxable incomes of both classes for the same income year;

·       tax losses of both classes for the same income year; or

·       a taxable income of one class and a tax loss of the other class for the same income year.

[Schedule 1, item 33, section 320-135]

1.19       In addition, in certain circumstances other provisions in the income tax law (such as Subdivision 165-B) can apply so that a life insurance company can have a taxable income and a tax loss of the same class.

Complying superannuation class taxable income and tax losses

1.20       For the purpose of working out the taxable income or tax loss of the complying superannuation class under the ordinary provisions of the income tax law, sections 320-137 and 320-141 specify the assessable income, net exempt income, deductions and tax losses of the company that relate to the complying superannuation class.

1.21       The assessable income of a life insurance company that is allocated under subsection 320-137(2) to the complying superannuation class (complying superannuation assessable income) is:

·       assessable income derived from the investment of virtual pooled superannuation trust assets (this includes gains on the disposal of virtual pooled superannuation trust assets);

·       life insurance premiums transferred to the virtual pooled superannuation trust;

·       the amount that is included in assessable income because of section 320-200 as a result of an asset (other than money) being transferred from a virtual pooled superannuation trust where the transfer is made:

-            to reduce excess virtual pooled superannuation trust assets;

-            in exchange for money; or

-            in respect of fees or charges;

·       the transfer values of assets transferred to the virtual pooled superannuation trust to make up a shortfall in virtual pooled superannuation trust assets;

·       taxable contributions transferred from complying superannuation funds (section 275 transfers) in respect of virtual pooled superannuation trust policies;

·       specified roll-over amounts;

·       amounts received relating to dividends paid by listed investment companies to trusts or partnerships in respect of virtual pooled superannuation trust assets that are included in the company’s assessable income under subsection 115-280(4); and

·       the excess of relevant amounts credited to retirement savings accounts over relevant amounts debited from those retirement savings accounts;

-            as a consequence of changing the methodology for working out the complying superannuation class of taxable income, the provisions for working out the net amount credited to retirement savings accounts that is included in the complying superannuation class have been relocated and specific provisions relating to preventing losses from being applied against retirement savings accounts income have been removed.

[Schedule 1, item 33, section 320-137]

1.22       The deductions (other than tax losses) of a life insurance company that are allocated under subsection 320-137(4) to the complying superannuation class (complying superannuation deductions) are:

·       the component of life insurance premiums transferred to the virtual pooled superannuation trust that the company can deduct under section 320-55;

·       amounts the company can deduct (other than any tax losses) that relate to the investment of virtual pooled superannuation trust assets. These amounts include expenses incurred directly in respect of virtual pooled superannuation trust assets and amounts that the company can deduct under the capital allowances regime in respect of virtual pooled superannuation trust assets;

·       the amount that is allowed as a deduction because of section 320-200 as a result of an asset (other than money) being transferred from a virtual pooled superannuation trust where the transfer is made to:

-            reduce excess virtual pooled superannuation trust assets;

-            in exchange for money; or

-            in respect of fees or charges;

·       the transfer values of assets transferred from the virtual pooled superannuation trust to reduce excess virtual pooled superannuation trust assets;

·       amounts that the company can deduct under subsection 115-280(1) relating to dividends paid by listed investment companies in respect of virtual pooled superannuation trust assets; and

·       amounts that the company can deduct under subsection 115-215(6) in respect of net capital gains of trust estates that are attributable to virtual pooled superannuation trust assets.

[Schedule 1, item 33, section 320-137]

1.23       The taxable income of the complying superannuation class is worked out under section 4-15. Generally, as a result of applying section 4-15, a life insurance company will have a taxable income of the complying superannuation class for an income year if the company’s complying superannuation assessable income for that income year exceeds the sum of:

·       the complying superannuation deductions for that income year; and

·       tax losses of the complying superannuation class that the company can deduct in that income year.

[Schedule 1, items 33 and 67, subsection 320-137(1) and the definition of ‘complying superannuation class for a taxable income of a life insurance company’ in subsection 995-1(1)]

1.24       A tax loss of the complying superannuation class for an income year is worked out under section 36-10. Generally, as a result of applying section 36-10, a life insurance company will have a tax loss of the complying superannuation class for an income year if the company’s complying superannuation deductions for that income year exceed the sum of:

·       the complying superannuation assessable income for that income year; and

·       net exempt income for that income year that is attributable to the virtual pooled superannuation trust assets.

[Schedule 1, items 33 and 68, subsection 320-141(1) and the definition of ‘complying superannuation class for a tax loss of a life insurance company’ in subsection 995-1(1)]

1.25       A tax loss of the complying superannuation class is deducted on the same basis as other tax losses. However, a tax loss of the complying superannuation class for an income year can only be deducted in a later income year from:

·       net exempt income that is attributable to the virtual pooled superannuation trust assets for that later income year; and

·       that part of the complying superannuation assessable income that exceeds the complying superannuation deductions for that later income year.

[Schedule 1, item 33, subsection 320-141(2)]

Ordinary class taxable income and tax losses

1.26       For the purpose of working out the taxable income or tax loss of the ordinary class under the ordinary provisions of the income tax law, sections 320-139 and 320-143 specify the assessable income, net exempt income, deductions and tax losses of the company that relate to the ordinary class.

1.27       The assessable income of the company that is allocated to the ordinary class (ordinary assessable income) is the amount of the company’s assessable income that is not complying superannuation assessable income.

1.28       The deductions (other than tax losses) that are allocated to the ordinary class (ordinary deductions) is the amount of the company’s deductions (other than tax losses) that are not complying superannuation deductions.

1.29       The taxable income of the ordinary class is worked out under section 4-15. Generally, as a result of applying section 4-15, a life insurance company will have a taxable income of the ordinary class for an income year if the company’s ordinary assessable income for that income year exceeds the sum of:

·       the company’s ordinary deductions for that income year; and

·       tax losses of the ordinary class that the company can deduct in that income year.

[Schedule 1, items 33 and 71, section 320-139 and the definition of ‘ordinary class for a taxable income of a life insurance company’ in subsection 995-1(1)]

1.30       A tax loss of the ordinary class for an income year is worked out under section 36-10. Generally, as a result of applying section 36-10, a life insurance company will have a tax loss of the ordinary class for an income year if the company’s ordinary deductions for that income year exceed the sum of:

·       the company’s ordinary assessable income for that income year; and

·       the company’s net exempt income (other than net exempt income that is attributable to the virtual pooled superannuation trust assets) for that income year.

[Schedule 1, items 33 and 72, subsection 320-143(1) and the definition of ‘ordinary class for a tax loss of a life insurance company’ in subsection 995-1(1)]

1.31       A tax loss of the ordinary class is deducted on the same basis as other tax losses. However, a tax loss of the ordinary class for an income year can only be deducted in a later income year from:

·       net exempt income (other than net exempt income that is attributable to the virtual pooled superannuation trust assets) for that later income year; and

·       that part of the ordinary assessable income that exceeds the ordinary deductions for that later income year.

[Schedule 1, item 33, subsection 320-143(2)]

Tax losses held as at 1 July 2000

1.32       Prior to 1 July 2000, tax losses of life insurance companies that were carried forward from a previous income year were applied, in the first instance, to reduce the equivalent of the ordinary class of taxable income.

1.33       Consistent with this approach, as a transitional rule, tax losses that arose before 1 July 2000 and are carried forward will be tax losses of the ordinary class and can be deducted only from future ordinary class income. [Schedule 1, item 80, section 320-100 of the Income Tax

(Transitional Provisions) Act 1997]

Working out the amount of income tax payable by a life insurance company

1.34       The amount of income tax payable by a taxpayer is generally worked out by applying the method statement in subsection 4-10(3). That method statement is modified for a life insurance company so that:

·       steps 1 and 2 in the method statement are applied to work out separately:

-            the amount of the company’s basic income tax liability for its taxable income of the complying superannuation class; and

-            the amount of the company’s basic income tax liability for its taxable income of the ordinary class; and

·       for the purposes of step 4 in the method statement, the amount of income tax payable by the company is the sum of its basic income tax liabilities for each class reduced by its tax offsets.

[Schedule 1, item 33, subsection 320-134(1)]

1.35       The amount worked out under step 4 in the method statement is taken to be the company’s income tax on its taxable income for the income year. In addition, except for the purposes of working out the company’s income tax liability for an income year, the company’s taxable income for a year is taken to be equal to the sum of the taxable incomes of the two classes for that year. This will ensure that the company is issued with only one notice of assessment for the income year and will have only one debt payable to the Commonwealth. [Schedule 1, item 33, subsection 320-134(2)]

1.36       In addition, subsection 320-134(1) applies in working out the amount of the company’s income tax if certain assumptions were made. It applies in the same way in working out the company’s income tax under section 4-10 (except in regard to those assumptions). This means that the modifications to section 4-10 will be recognised, for example, in applying the assumptions made in section 67-30 (which determines when a taxpayer can get a refund of a tax offset). [Schedule 1, item 33, subsection 320-134(3)]

Example 1.1

MB Life has the following income and expenses for the year ending 30 June 2004:

·          Complying superannuation class

-          premiums received      $10,000

-          investment income           $900

-          deductible expenses      $1,200

-          net exempt income            $80

·                  Ordinary class

-          premiums received      $15,000

-          investment income        $2,000

-          deductible expenses         $700

-          net exempt income            300

In relation to the premiums received, MB Life can deduct:

·          virtual pooled superannuation

trust premiums                            $10,000

·          ordinary premiums                      $13,000

MB Life made the following transfers in cash to the virtual pooled superannuation trust during the income year:

·          premiums

(subsection 320-185(3))             $10,000

·          subsection 320-180(3)

transfers                                           $270

MB Life also transferred $150 in cash from the virtual pooled superannuation trust in respect of fees imposed during the income year.

The assessable income allocated to the complying superannuation class and the ordinary class is as follows:

 

Complying superannuation class

($)

Ordinary class

($)

Investment income

900 [1]

2,000 [2]

Premiums

10,000 [3]

15,000 [4]

Subsection 320-180(3) transfers to the virtual pooled superannuation trust

270 [5]

n/a

Fees transferred from the virtual pooled superannuation trust

n/a

150 [6]

Total Assessable Income

11,170

17,150

The deductions (other than tax losses) allocated to the complying superannuation class and the ordinary class are as follows:

 

Complying superannuation class

($)

Ordinary class

($)

Premiums

10,000 [7]

13,000 [8]

Expenses

1,200 [9]

700 [10]

Assets transferred to the virtual pooled superannuation trust under subsection 320-180(3)

n/a

270 [11]

Fees transferred from the virtual pooled superannuation trust

150 [12]

n/a

Total deductions (other than tax losses)

11,350

13,970

MB Life’s complying superannuation deductions exceed its complying superannuation assessable income. Therefore, MB Life does not have a taxable income of the complying superannuation class for the income year.

Instead, MB Life has a tax loss of the complying superannuation class. The tax loss of the complying superannuation class is calculated under Division 36 as follows:

Complying superannuation deductions

$11,350

Less complying superannuation assessable income

$11,170

Less total net exempt income that relates to the complying superannuation class

$80

Tax loss of the complying superannuation class

$100

MB Life’s ordinary class assessable income exceeds its ordinary class deductions. Therefore, MB Life has a taxable income of the ordinary class for the income year. The company’s taxable income of the ordinary class for the income year is calculated under section 4-15 as follows:

Ordinary assessable income

$17,150

Less ordinary deductions

$13,970

Taxable income of the ordinary class

$3,180

MB Life did not have any tax offsets for the income year. Therefore, the amount of income tax payable by MB Life is $954 (i.e. taxable income of the ordinary class ($3,180) multiplied by the company tax rate (30%)).

No income tax is payable in relation to the complying superannuation class because MB Life has a complying superannuation class tax loss for the income year. That tax loss can be deducted in a later income year only from complying superannuation class income.

Provisions in the Income Assessment Act 1997 that apply only to the ordinary class

1.37       Most provisions in the income tax law that affect the amount worked out for taxable income or tax losses also apply to the taxable income and tax loss that are worked out for both the complying superannuation class and the ordinary class.

1.38       The only exceptions to this principle are section 36-55 and Division 165 (other than Subdivision 165-CD). These provisions will not affect the taxable income or tax loss of the complying superannuation class. [Schedule 1, item 33, section 320-149]

1.39       Section 36-55 allows an entity that has excess franking tax offsets because it has insufficient tax payable on taxable income to convert the excess into an equivalent amount of tax loss. This tax loss is then aggregated with any other tax loss for the year and the aggregated amount becomes the tax loss for the income year. Section 36-55 can apply only to the ordinary class because excess franking tax offsets relating to the complying superannuation class are refundable tax offsets.

1.40       Division 165 essentially prevents a company from deducting prior year tax losses unless it satisfies the continuity of ownership test. If the company does not pass this test, it can still claim a deduction if it passes the same business test.

1.41       In some circumstances Division 165 (other than Subdivision 165-CD) modifies the way in which net capital gains and net capital losses are calculated. As net capital gains and net capital losses are elements that are used to work out the amount of taxable income or tax loss, section 320-149 ensures that the provisions in Division 165 (other than Subdivision 165-CD) do not apply to capital gains and capital losses on virtual pooled superannuation trust assets.

1.42       Subdivision 165-CD applies to prevent multiple recognition of losses when significant equity and debt interests that entities have in a loss company are realised. Subdivision 165-CD is not covered by section 320-149 and therefore will continue to apply to the taxable income or tax losses of both the complying superannuation class and the ordinary class.

Consequential amendments

1.43       As a result of modifying the way in which the ordinary class and complying superannuation class of taxable income and tax losses are calculated, a number of consequential amendments are made to the ITAA 1997 and to the Taxation Administration Act 1953 (TAA 1953).

1.44       Consequential amendments to the ITAA 1997:

·       include the transfer values of assets transferred to and from the virtual pooled superannuation trust in the company’s assessable income;

·       allow the company to deduct the transfer values of assets transferred to and from the virtual pooled superannuation trust; and

·       insert various notes to guide readers, modify the checklist of deductions, modify guide material and various headings in Division 320, and repeal obsolete provisions and definitions.

[Schedule 1, items 2 to 6, 9, 10, 28, 31, 32, 34, 35, 48, 49, 74, 76, 77, 79, 81, 98, 99, 101, 105 and 106, sections 4-15, 12-5, 36-25, 320-1, 320-5, 320-15, 320-35, 320-87, 320-120, 320-125, 320-165 and 713-530 and subsection 995-1(1)]

1.45       Consequential amendments to the TAA 1953 modify the method statement for working out the adjusted taxable income of a life insurance company for pay as you go instalment purposes. [Schedule 1, items 84 and 107, subsection 45-330(3) in Schedule 1 to the TAA 1953]

Risk business

Reinsurance with non-residents

1.46       Section 148 of the ITAA 1936 deals with reinsurance with non-resident insurers. Subsection 148(1) broadly ensures that, where an Australian insurer reinsures the whole or part of any risk out of Australia with a non-resident:

·       the reinsurance premiums paid or credited are not allowable deductions to the Australian insurer; and

·       the reinsurance premiums paid or credited are not included in the assessable income of the non-resident reinsurer.

1.47       In addition, any amount recovered by the Australian insurer from the non-resident reinsurer in respect of a loss on any risk reinsured does not form part of the assessable income of the Australian insurer.

1.48       Subsection 148(2) allows an Australian insurer to make an election so that subsection 148(1) does not apply to reinsurance contracts it enters into during an income year and all subsequent income years. If an Australian insurer makes a subsection 148(2) election:

·       the Australian insurer is required to furnish returns and to pay tax as agent for all non-resident insurers with whom it has reinsurance contracts; and

·       the Australian insurer is assessed on, and is liable to pay tax on, an amount equal to 10% of the gross premiums paid or credited to non-resident reinsurers in an income year.

1.49       The effect of making an election is that the Australian insurer is essentially taxed on the non-resident reinsurance on the same basis as resident reinsurance. That is, the Australian insurer can deduct the reinsurance premiums paid to non-resident reinsurers and includes reinsurance recoveries in its assessable income.

1.50       Prior to the introduction of Division 320, section 148 applied only to the accident and disability business of life insurance companies. The Division 320 amendments unintentionally broadened the scope of section 148.

1.51       Section 148 is amended so that, in relation to a life insurance company, it applies only to the whole or part of a risk that:

·       is covered by a disability policy (as defined in subsection 995-1(1) of the ITAA 1997); and

·       relates to a disability benefit.

[Schedule 1, item 1, subsection 148(10) of the ITAA 1936]

1.52       Consequential amendments to various provisions in Division 320 relating to reinsurance exclude amounts received or recovered under a contract of reinsurance that relate to a risk to which subsection 148(1) of the ITAA 1936 applies. [Schedule 1, items 7, 8, 29 and 70, paragraphs 320-15(1)(b) and (c), section 320-100 and the definition of ‘net risk component’ in subsection 995-1(1)]

1.53       As a consequence of the amendment to modify the definition of ‘net risk component’, the transitional provisions relating to the change in value of liabilities in respect of continuous disability policies in section 320-30 will operate as intended.

Reinsurance commissions

1.54       Amounts received or recovered by a life insurance company that are a refund, or in the nature of a refund, of a life insurance premium paid under a contract of reinsurance (other than amounts that relate to a risk to which subsection 148(1) of the ITAA 1936 applies) are included in assessable income under paragraph 320-15(1)(c). Reinsurance commissions are intended to be specifically included in assessable income under this paragraph. Alternatively, they would be included in assessable income under section 6-5 as income according to ordinary concepts.

1.55       The amendments will remove any doubt about this outcome by specifically including all reinsurance commissions (other than reinsurance commissions that relate to a risk to which subsection 148(1) applies) in a life insurance company’s assessable income. [Schedule 1, item 116, paragraph 320-15(1)(ca)]

1.56       New paragraph 320-15(1)(ca) may have the effect of broadening the scope of the current law if it can be established that reinsurance commissions are not included in assessable income under either paragraph 320-15(1)(c) or under section 6-5. Therefore, this amendment will apply to reinsurance commissions received or recovered by a life insurance company after the date of Royal Assent. [Schedule 1, subitem 126(8)]

Decrease in the value of risk liabilities

1.57       Section 320-85 allows a deduction for increases in the value of risk liabilities relating to certain life insurance policies. Decreases in the value of risk liabilities are included in assessable income under paragraph 320-15(1)(h).

1.58       The amendments clarify that paragraph 320-15(1)(h) and section 320-85 both apply to risk liabilities relating to life insurance policies other than:

·       policies that provide for participating benefits or discretionary benefits;

·       exempt life insurance policies; or

·       funeral policies.

[Schedule 1, items 13, 16 and 27, paragraph 320-15(1)(h) and subsections 320-15(2) and 320-85(2)]

Ordinary investment business

Scope of section 320-75

1.59       Currently, section 320-75 allows a deduction for, in essence, the capital component of premiums received in respect of ordinary investment policies. The amount of that deduction is, broadly, the sum of premiums received in respect of ordinary investment policies reduced by the amount of those premiums that an actuary determines to be attributable to fees and charges. The actuary’s determination must have regard to changes in the net current termination value of relevant policies over the income year. The net current termination value of a policy at a particular time is, broadly, the amount that the company would pay to the policyholder if the policy was terminated at that time.

1.60       The amendments clarify that section 320-75 can apply only to ordinary investment policies (including funeral policies). An ordinary investment policy is a life insurance policy that is not:

·       a virtual pooled superannuation trust life insurance policy;

·       an exempt life insurance policy;

·       a policy that provides for participating or discretionary benefits; or

·       a policy (other than a funeral policy) under which benefits are paid only on the death or disability of a person.

[Schedule 1, items 24 and 73, subsection 320-75(1) and the definition of ‘ordinary investment policy’ in subsection 995-1(1)]

Funeral policies

1.61       Funeral policies are investment products primarily issued by friendly societies. Funeral policy benefits can only be paid on the death of a person to pay for the person’s funeral. The amendments clarify that funeral policies are appropriately treated as ordinary investment policies rather than as risk policies. [Schedule 1, items 16, 23 to 27 and 73, subsections 320-15(2), 320-70(2), 320-80(2) and 320-85(2) and the definition of ‘ordinary investment policy’ in subsection 995-1(1)]

Exit fees

1.62       Many life insurance companies charge exit fees. Exit fees are typically levied if a policyholder terminates a policy within, for example, the first four or five years. However, an exit fee diminishes over time. That is, the exit fee that applies to a policy that is terminated after one year is substantially greater than the exit fee that applies to a policy that is terminated after three or four years. In most cases, no exit fee is payable if the policy has been held for more than four or five years.

1.63       Exit fees (however described under the terms of a policy) levied on ordinary investment policies are included in assessable income in the year a policy is taken out. This arises because:

·       premiums paid to the company are included in assessable income under paragraph 320-15(1)(a); and

·       a deduction is allowed under section 320-75 for the sum of the net premiums received less the amount of those net premiums that an actuary determines to be attributable to fees and charges.

1.64       Therefore, in the absence of any other fees, the amount deductible under section 320-75 would be the premium received reduced by the exit fees.

1.65       The section 320-75 mechanism effectively allows a deduction to reflect reductions in exit fees on ordinary investment policies over time. However, the mechanism is ineffective if the life insurance company does not receive any premiums in respect of an ordinary investment policy in a particular income year.

1.66       To overcome this anomaly, a life insurance company will be allowed a deduction for a reduction in exit fees if an actuary determines that:

·       there has been a reduction in the income year of exit fees that were imposed in respect of ordinary investment policies in a previous income year; and

·       that reduction has not been taken into account in a determination made by the actuary under subsection 320-75(2).

[Schedule 1, item 24, subsection 320-75(4)]

Example 1.2

On 14 December 2001, Natasha takes out an ordinary life insurance investment policy with MB Life and paid a premium of $10,000. The premium included fees (other than exit fees) of $150. In addition, an exit fee is payable if Natasha terminates the policy within three years.

·          The exit fee payable if the policy is terminated in the first year is $420.

·          The exit fee payable if the policy is terminated in the second year is $370.

·          The exit fee payable if the policy is terminated in the third year is $130.

In the 2001-2002 income year, MB Life will:

·          include the premiums of $10,000 in assessable income (paragraph 320-15(1)(a)); and

·          claim a deduction under subsection 320-75(2) for $9,430 - that is, the premiums ($10,000) reduced by the amount of the premium that relates to fees and charges ($150  +  $420).

Natasha pays additional premiums of $1,000 on 14 December 2002. No fees or charges are included in the premium. Therefore, in the 2002-2003 income year, MB Life will:

·          include the premiums of $1,000 in assessable income; and

·          claim a deduction under subsection 320-75(2) for $1,050 - that is, the premiums paid ($1,000) plus the increase in net current termination value of Natasha’s policy caused by the reduction in the exit fees ($50).

Natasha does not pay any further premiums but continues to hold the policy. MB Life will be entitled to deductions under subsection 320-75(4) as a consequence of the reduction in exit fees on the policy of:

·          $240 in the 2003-2004 income year; and

·          $130 in the 2004-2005 income year.

Risk riders

1.67       Ordinary investment policies can have risk riders attached. Risk riders confer risk benefits in return for the payment of additional premiums.

1.68       Risk rider premiums levied on ordinary investment policies are usually included in assessable income because:

·       premiums paid to the company are included in assessable income under paragraph 320-15(1)(a); and

·       a deduction is allowed under section 320-75 for the sum of the net premiums received less the amount of those net premiums that an actuary determines to be attributable to fees and charges.

1.69       Therefore, in the absence of any other fees and charges, the amount deductible under section 320-75 would be the premium received reduced by the risk rider premiums.

1.70       However, the section 320-75 mechanism is ineffective if:

·       the life insurance company does not receive any premiums in respect of ordinary investment policies in a particular income year; and

·       risk rider premiums are charged on those policies.

1.71       To overcome this anomaly, amounts imposed by a life insurance company in respect of risk riders for ordinary investment policies in an income year during which the company did not receive any premiums for those policies will be included in the company’s assessable income. [Schedule 1, item 14, paragraph 320-15(1)(ja)]

Operation of the virtual pooled superannuation trust

1.72       Section 320-170 allows a life insurance company to establish a virtual pooled superannuation trust by segregating assets to support liabilities in relation to complying superannuation business. The virtual pooled superannuation trust is taxed in broadly the same way as a complying superannuation fund. Income generated on virtual pooled superannuation trust assets is included in the company’s taxable income of the complying superannuation class and taxed at a rate of 15%.

Deduction for premiums in respect of virtual pooled superannuation trust policies

1.73       Section 320-55 allows a deduction for premiums received by a life insurance company in respect of virtual pooled superannuation trust life insurance policies. The amount allowed as a deduction is the premiums received reduced by the death and disability component of those premiums.

1.74       Where a risk rider attaches to an investment policy, and that policy provides for participating or discretionary benefits, a life insurance company can classify the rider as a participating or discretionary policy. As they are attached as a rider, the premium is often separately identified.

1.75       Currently section 320-55(2) denies a deduction for the risk rider premium because it is separately identified. This inappropriately results in premiums being assessable to the virtual pooled superannuation trust but the claims not being deductible.

1.76       The amendments modify section 320-55 to ensure that the deduction allowed in respect of premiums received on virtual pooled superannuation trust life insurance policies is not reduced by risk riders on policies that provide for participating or discretionary benefits. [Schedule 1, item 22, subsection 320-55(3)]

Value of assets that can be held in the virtual pooled superannuation trust

1.77       The amendments clarify that the transfer value of assets held in the virtual pooled superannuation trust at a particular time must not exceed the sum of:

·       the company’s virtual pooled superannuation trust liabilities at that time; and

·       any reasonable provision made by the company at that time in its accounts for liability for income tax in respect of the assets segregated.

-            A reasonable provision made by the company in its accounts for liability for income tax includes provisions for current tax and for tax on unrealised gains in respect of the virtual pooled superannuation trust assets.

[Schedule 1, items 36, 39, 40 and 42 to 44, subsections 320-170(3) and 320-185(1), paragraph 320-195(3)(c) and subsection 320-195(4)]

Annual valuation of virtual pooled superannuation trust assets and liabilities

1.78       If a life insurance company has established a virtual pooled superannuation trust, the company is required to undertake an annual valuation of virtual pooled superannuation trust assets and of virtual pooled superannuation trust policy liabilities within 60 days of the end of each income year (section 320-175). If the transfer value of virtual pooled superannuation trust assets exceeds the value of relevant liabilities, the company must transfer excess assets out of the virtual pooled superannuation trust within 30 days of valuing the assets (section 320-180).

1.79       In practice, the transfer value of virtual pooled superannuation trust assets may be determined earlier than the value of virtual pooled superannuation trust liabilities. Therefore, the amendments ensure that the 30 day time limit for transferring assets starts from the later of:

·       the time that the transfer value of virtual pooled superannuation trust assets is determined; and

·       the time that the value of virtual pooled superannuation trust liabilities is determined.

[Schedule 1, items 37, 38, 41, 45, 78, 95 and 97, sections 320-175 and 320-180, subsections 320-185(4 )and 320-200(1), section 713-525 and the definition of ‘valuation time’ in subsection 995-1(1)]

Administrative penalties for failure to undertake a valuation or to transfer assets

1.80       An administrative penalty will be imposed if a life insurance company does not undertake the required valuations or transfer excess assets out of the virtual pooled superannuation trust within the specified time periods.

1.81       The administrative penalty is equal to five penalty units (one penalty unit is currently $110) for each period of 28 days or part of a period of 28 days:

·       starting immediately after the end of the relevant 60 day or 30 day period; and

·       ending at the end of the day on which the valuation or transfer of assets is made.

[Schedule 1, item 125, section 288-70 in Schedule 1 to the TAA 1953]

1.82       The maximum penalty that can be imposed for each failure to make a valuation or to transfer excess assets is 25 penalty units (currently $2,750). [Schedule 1, item 125, subsection 288-70(5) in Schedule 1 to the TAA 1953]

1.83       The administrative penalty will apply in relation to a valuation time that occurs after the date of Royal Assent. [Schedule 1, subitem 126(11)]

Operation of the segregated exempt assets

1.84       Section 320-225 allows a life insurance company to establish a pool of segregated assets (segregated exempt assets) that are used to support liabilities in relation to exempt life insurance policies (i.e. broadly, immediate annuity policies). Income generated on the segregated exempt assets is non-assessable non-exempt income.

Exempt life insurance policies

1.85       Currently, a life insurance policy (other than a retirement saving account) is an exempt life insurance policy if, broadly:

·       the policy is held by the trustee of a complying superannuation fund and provides solely for the discharge of current pension liabilities of the fund;

·       the policy is held by the trustee of a pooled superannuation trust and provides solely for the discharge of current pension liabilities of the complying superannuation funds that are unit holders of the pooled superannuation trust;

·       the policy is held by another life insurance company and is a segregated exempt asset of that other company;

·       the policy is held by the trustee of a constitutionally protected superannuation fund;

·       the policy is an immediate annuity policy; or

·       the policy is a policy that provides for either an exempt personal injury annuity or an exempt personal injury lump sum.

1.86       The amendments:

·       ensure that an immediate annuity policy will be an exempt life insurance policy only if it satisfies certain conditions; and

·       allow part of a life insurance policy to be an exempt life insurance policy.

[Schedule 1, items 56, 57, 69 and 100, sections 320-246 and 320-247 and the definition of ‘exempt life insurance policy’ in subsection 995-1(1)]

Conditions for an immediate annuity policy to qualify as an exempt life insurance policy

1.87       When Division 320 was introduced, it was intended that the types of policy liabilities that could be supported by the segregated exempt assets would be broadly equivalent to the types of policies that qualified for exemption under the pre-July 2000 arrangements for taxing life insurance companies.

1.88       Under those pre-July 2000 arrangements, income in relation to most immediate annuity policies was exempt from tax only if those policies satisfied certain conditions.

1.89       The amendments essentially replicate those conditions. The conditions only apply to an immediate annuity policy where:

·       the purchase price of the policy consists wholly or partly of a rolled-over eligible termination payment; or

·       the policy was purchased after 9 December 1987.

[Schedule 1, item 57, paragraph 320-246(1)(e)]

1.90       These immediate annuity policies need to satisfy three conditions to qualify as an exempt life insurance policy.

1.91       First, the annuity must be payable until the later of:

·       the death of a person (or the last to die of two or more persons); or

·       the end of a fixed term.

[Schedule 1, item 57, subsection 320-246(3)]

1.92       Second, the annuity contract must not permit:

·       the total amount payable on the commutation of the annuity to exceed the reduced purchase price of the annuity;

-            the reduced purchase price of the annuity is the purchase price of the annuity reduced by the accumulated amount of the annual undeducted purchase price that has been excluded from assessable income under section 27H of the ITAA 1936; or

·       the residual capital value of the annuity to be greater than its purchase price.

[Schedule 1, item 57, subsection 320-246(4)]

1.93       Finally, there must be no unreasonable deferral of the payment of the annuity having regard to:

·       to the extent to which the annuity payments depend on investment returns of the life insurance company - when the payments are made and when those returns are derived;

·       to the extent to which the annuity payments do not depend on those investment returns - the relative sizes of the annuity payments from year to year; and

·       any other relevant factors - the Commissioner of Taxation can determine these other relevant factors.

[Schedule 1, item 57, subsection 320-246(5)]

An exempt life insurance policy includes part of a policy

1.94       Complying superannuation funds are exempt from tax on income relating to their current pension liabilities. Broadly, the amount that is exempt from tax is either the amount of income derived on segregated current pension assets or a proportion of income that is attributable to the current pension liabilities. Taxable income that is attributable to members in the accrual phase is taxed at a rate of 15%.

1.95       If a complying superannuation fund purchases a life insurance investment policy, the policy may be held to support liabilities of the fund in respect of both fund members who are accruing benefits and fund members who are being paid pensions.

1.96       Similarly, a pooled superannuation trust is exempt from tax on the proportion of its income that relates to the discharge of current pension liabilities of the complying superannuation funds that are unit holders of the pooled superannuation trust.

1.97       If a complying superannuation fund or a pooled superannuation trust purchases a life insurance policy that supports both members who are in the pension phase and members who are in the accrual phase, the amendments ensure that the policy is split into two policies.

1.98       The part of the policy that is taken to be an exempt life insurance policy is:

·       that part of the policy held by the trustee of a complying superannuation fund that provides solely for the discharge of current pension liabilities of the fund; or

·       that part of the policy held by the trustee of a pooled superannuation trust that provides solely for the discharge of current pension liabilities of the complying superannuation funds that are unit holders of the pooled superannuation trust.

[Schedule 1, item 57, section 320-247]

1.99       Where part of a policy is taken to be an exempt life insurance policy, the remainder of the policy is treated as a separate policy. That separate policy will usually be a virtual pooled superannuation trust policy. [Schedule 1, item 57, subsection 320-247(3)]

1.100     The extent to which a policy is taken to be an exempt life insurance policy can vary from time to time. For example, if a member of a complying superannuation fund that holds a life insurance policy commences to receive a pension, the life insurance company can transfer assets from the virtual pooled superannuation trust to the segregated exempt assets (subsection 320-195(1)). In these circumstances, the proportion of the policy that is taken to be an exempt life insurance policy will increase.

1.101     Similarly, as the proportion of the complying superannuation fund’s current pension liabilities changes because, for example, the fund commences new pension payments or because members join or leave the fund, there will be a corresponding change in the proportion of the policy that is taken to be an exempt life insurance policy.

Value of assets that can be held in the segregated exempt assets

1.102     The amendments clarify that the transfer value of assets held in the segregated exempt assets at a particular time must not exceed the amount of the company’s exempt life insurance policy liabilities at that time. [Schedule 1, items 50, 53, 54 and 59, subsections 320-225(3) and 320-240(1) and paragraph 320-250(2)(c)]

Annual valuation of segregated exempt assets and exempt life insurance policy liabilities

1.103     If a life insurance company has established a pool of segregated exempt assets, the company is required to undertake an annual valuation of those assets and of exempt life insurance policy liabilities within 60 days of the end of each income year (section 320-230). If the transfer value of segregated exempt assets exceeds the value of the exempt life insurance policy liabilities, the company must transfer excess assets out of the segregated exempt assets within 30 days of valuing the assets (section 320-235).

1.104     In practice, the transfer value of segregated exempt assets may be determined earlier than the value of exempt life insurance policy liabilities. Therefore, the amendments ensure that the 30 day time limit for transferring assets starts from the later of:

·       the time that the transfer value of segregated exempt assets is determined; and

·       the time that the value of exempt life insurance policy liabilities is determined.

[Schedule 1, items 30, 51, 52, 55, 58, 61, 78, 96 and 97, sections 320-105, 320-230, and 320-235, subsections 320-240(4) and 320-255(1), section 713-525 and the definition of ‘valuation time’ in subsection 995-1(1)]

Administrative penalties for failure to undertake a valuation or to transfer assets

1.105     An administrative penalty will be imposed if a life insurance company does not undertake the required valuations or transfer excess assets out of the segregated exempt assets within the specified time periods.

1.106     The administrative penalty is equal to five penalty units (one penalty unit is currently $110) for each period of 28 days or part of a period of 28 days:

·       starting immediately after the end of the relevant 60 day or 30 day period; and

·       ending at the end of the day on which the valuation or transfer of assets is made.

[Schedule 1, item 125, section 288-70 in Schedule 1 to the TAA 1953]

1.107     The maximum penalty that can be imposed for each failure to make a valuation or to transfer excess assets is 25 penalty units (currently $2,750). [Schedule 1, item 125, subsection 288-70(5) in Schedule 1 to the TAA 1953]

1.108     The administrative penalty will apply in relation to a valuation time that occurs after the date of Royal Assent. [Schedule 1, subitem 126(11)]

Miscellaneous technical amendments

Transitional exemption of certain management fees

1.109     As a transitional measure, one-third of certain management fees derived by life insurance companies is treated as non-assessable non-exempt income (section 320-40). The transitional measure ceases to apply from 1 July 2005.

1.110     The transitional measure applies to specified management fees received on certain types of life insurance policies that were in force as at 30 June 2000.

1.111     The amendments clarify the types of management fees that qualify for transitional relief.

1.112     Management fees on virtual pooled superannuation trust policies are identified by transfers from the virtual pooled superannuation trust. The amendments ensure that specified management fees that qualify for transitional relief do not include:

·       amounts transferred from the virtual pooled superannuation trust that relate to expenses incurred by the company in respect of policies that provide for participating or discretionary benefits; and

·       amounts transferred from the virtual pooled superannuation trust that represent the recovery of expenses that should have been paid directly from the virtual pooled superannuation trust under subsection 320-195(4).

[Schedule 1, items 17 and 18, paragraph 320-40(5)(b) and subsection 320-40(5A)]

1.113     Similarly, management fees on exempt life insurance policies are identified by transfers from the segregated exempt assets. The amendments ensure that specified management fees that qualify for transitional relief do not include:

·       amounts transferred from the segregated exempt assets that relate to expenses incurred by the company in respect of policies that provide for participating benefits or discretionary benefits; and

·       amounts transferred from the segregated exempt assets that represent the recovery of expenses that should have been paid directly from the segregated exempt assets under subsection 320-250(3).

[Schedule 1, items 19 and 20, subsections 320-40(6) and 320-40(6A)]

1.114     Currently, management fees on ordinary investment policies are identified, broadly, by the difference between the premiums received in respect of those policies and the sum of:

·       the amount that can be deducted under section 320-75; and

·       the risk component of claims paid.

1.115     The amendments ensure that specified management fees that qualify for transitional relief include management fees that are included in assessable income under paragraph 320-15(1)(k). They also clarify that paragraph 320-15(1)(k) does not apply to amounts that are included in assessable income as a consequence of a transfer from a life insurance company’s virtual pooled superannuation trust or segregated exempt assets. [Schedule 1, items 15 and 21, paragraph 320-15(1)(k) and subsection 320-40(7)]

Interaction with the uniform capital allowance system

1.116     When a life company transfers an asset to or from its virtual pooled superannuation trust or segregated exempt assets, the company is taken to have sold and repurchased the asset at that time. Section 320-200 and section 320-255 specify the consideration that the company is taken to have sold and repurchased the asset for.

1.117     Where the asset transferred to or from the virtual pooled superannuation trust or segregated exempt assets is a unit of plant or a depreciating asset, the deemed sale of the asset triggers the taxation consequences that arise under the capital allowances system.

1.118     The amendments clarify the interaction between Division 320 and the capital allowances system to ensure that the intended outcome is achieved. That is, the amendments clarify that, for the purposes of former Division 42 (which, broadly, applies to a unit of plant that the life insurance company started to hold before 1 July 2001):

·       in relation to the deemed sale of a unit of plant:

-            the sale is a balancing adjustment event;

-            the consideration that the company is taken to have sold the asset for is the termination value of the asset for that event; and

-            the company ceases to be the owner or quasi-owner of the asset at the time of sale; and

·       in relation to the deemed purchase of the unit of plant:

-            the company only became the owner or quasi-owner of the unit of plant at the time of the purchase;

-            the consideration that the company is taken to have purchased the asset for is the asset’s cost; and

-            the company acquires the asset from an associate of the company.

[Schedule 1, items 46 and 65, subsections 320-200(2A) and 320-255(9)]

1.119     Similarly, the amendments clarify that, for the purposes of Division 40 (which, broadly, applies to depreciating assets that the life insurance company started to hold after 30 June 2001):

·       in relation to the deemed sale of a depreciating asset:

-            the sale is a balancing adjustment event;

-            the consideration that the company is taken to have sold the asset for is the termination value of the asset for that event; and

-            the company stopped holding the asset at the time of sale; and

·       in relation to the deemed purchase of the depreciating asset:

-            the company only began to hold the asset at the time of the purchase - consequently, the start time of the asset is the time that the company first uses the asset or has it installed ready for use for any purpose after the time of the deemed purchase;

-            the consideration that the company is taken to have purchased the asset for is the first element of the asset’s cost; and

-            the company acquires the asset from an associate of the company.

[Schedule 1, items 87 and 93, subsections 320-200(2A) and 320-255(9)]

1.120     The amendments also:

·       insert notes to guide the reader in Division 40;

·       clarify that the company can claim deductions that are allowed in relation to an asset under the former Division 42 or under Division 40 at the time the life insurance company transfers the asset to or from its virtual pooled superannuation trust or to its segregated exempt assets;

·       modify terminology used in section 320-255 to reflect terminology used in the former Division 42 and in Division 40; and

·       remove redundant provisions in section 320-255 and a redundant definition.

[Schedule 1, items 47, 62, 63, 64, 85, 86, 88 and 89 to 94, section 40-15, subsections 320-200(4), 320-255(3A), 320-255(5) and 320-255(7) and the definition of ‘notional adjustable value’ in subsection 995-1(1)]

Example 1.3

On 14 September 2004, MB Life transfers a depreciating asset to its segregated exempt assets. The asset was purchased for $100,000 and, prior to the transfer, had only been used for the purposes of producing assessable income. At the time of the transfer:

·          the market value of the asset is $65,000; and

·          the adjustable value of the asset is $40,000.

The assets decline in value for the income year for the period up to the time of the transfer is $2,500.

As the asset is a depreciating asset, MB Life is deemed to have sold and repurchased the asset at the time of the transfer for a consideration equal to its market value at that time - that is, $65,000 (subsection 320-255(6)).

In relation to the deemed sale:

·          the transfer of the asset to the segregated exempt assets is a balancing adjustment event (subparagraph 320-255(9)(a)(i));

·          the termination value of the asset for the purposes of working out the balancing adjustment under Division 40 is $65,000 (subparagraph 320 255(9)(a)(ii));

·          as the termination value is more that the adjustable value, MB Life will include the difference ($25,000) in its ordinary assessable income for the 2004-2005 income year (subsections 40-285(1), 320-255(6) and 320-255(9) and paragraph 320-139(a)); and

·          as MB Life stops holding the asset at the time of the deemed sale (subparagraph 320-255(9)(a)(iii)), MB Life can claim a deduction of $2,500 for the asset’s decline in value during the income year up to the time of the transfer (section 40-25 and paragraph 320-139(b)).

In relation to the deemed purchase:

·          MB Life is taken to have held the asset from the time of the transfer - that is, from 14 September 2004 (subparagraph 320-255(9)(b)(i));

·          the first element of the cost of the asset is $65,000 (subparagraph 320-255(9)(b)(ii)); and

·          MB Life cannot claim a deduction for the assets decline in value during the period the asset is held in the segregated exempt assets as the asset is used to produce non-assessable non-exempt income (section 40-25).

On 1 December 2006, MB Life transfers the depreciating asset from the segregated exempt assets. At that time:

·          the market value of the asset is $50,000; and

·          the adjustable value of the asset is $45,000.

As the asset is a depreciating asset and the asset’s market value at the time of the transfer ($50,000) is less than its market value at the time it was transferred to the segregated exempt assets ($65,000), MB Life is deemed to have sold and repurchased the asset at the time of the transfer for a consideration equal to its market value at the time the asset was transferred from the segregated exempt assets -  that is, $50,000 (paragraph 320-255(8)(b)).

In relation to the deemed sale:

·          although a balancing adjustment event occurs as a result of the transfer (paragraph 320-255(9)(a)), a balancing adjustment is not made because the asset was used to produce non-assessable non-exempt income (sections 40-285 and 40-290); and

·          MB Life cannot claim a deduction for the asset’s decline in value for the income year for the period up to the time of the transfer period because the asset was used to produce non-assessable non-exempt income (section 40-25).

In relation to the deemed purchase:

·          MB Life is taken to have held the asset from the time of the transfer - that is, from 1 December 2006 (subparagraph 320-255(9)(b)(ii));

·          the first element of the cost of the asset is $50,000 (paragraphs 320-255(8)(b) and 320-255(9)(b));

·          if MB Life started to use the asset immediately after it was transferred, the assets start date is 1 December 2006. Therefore, MB Life can claim a deduction for the asset’s decline in value from 1 December 2006 (section 40-25 and paragraph 320-139(a)); and

·          as the asset is deemed to be acquired from an associate, MB Life must use the same method to work out the decline in value that was used when the asset was originally purchased (subparagraph 320-255(9)(b)(iii) and sections 40-65 and 40-95).

Transitional rules relating to pre-July 2000 virtual pooled superannuation trust and exempt life insurance policy liabilities

1.121     As a transitional rule, a life insurance company that segregated assets before 1 October 2000 was taken to have established the virtual pooled superannuation trust or segregated exempt assets on 1 July 2000.

1.122     In addition, subsections 320-175(1) and 320-230(1) of the Income Tax (Transitional Provisions) Act 1997 ensured that no tax consequences would arise in respect of assets transferred to meet pre-July 2000 virtual pooled superannuation trust and exempt life insurance policy liabilities.

1.123     The amendments clarify that life insurance companies cannot obtain an advantage by delaying the transfer of assets to the virtual pooled superannuation trust or segregated exempt assets to meet pre-July 2000 policy liabilities. That is, the amendments ensure that:

·       if assets are transferred to the virtual pooled superannuation trust on or after 1 October 2000 to meet pre-July 2000 virtual pooled superannuation trust liabilities, then the assets will be deemed to be sold and repurchased in accordance with section 320-200; and

·       if assets are transferred to the segregated exempt assets on or after 1 October 2000 to meet pre-July 2000 exempt life insurance policy liabilities, then the assets will be deemed to be sold and repurchased in accordance with section 320-255.

[Schedule 1, items 82 and 83, paragraphs 320-175(1)(e) and 320-230(1)(e) of the Income Tax (Transitional Provisions) Act 1997]

1.124     The amendments will ensure that, if assets are transferred to the virtual pooled superannuation trust or segregated exempt assets on or after 1 October 2000 to meet relevant pre-July 2000 liabilities, then, for example:

·       the company will have a capital gain tax event in relation to the assets transferred;

·       the company will include in its assessable income the amount that is assessable because of section 320-200;

·       the company can deduct the amount that is deductible because of section 320-200;

·       the company will not include the transfer value of assets transferred in assessable income; and

·       the company will not be able to claim a deduction for the transfer value of assets transferred.

1.125     In addition, currently the transitional provisions can inappropriately disadvantage a life insurance company in circumstances where, for example:

·       the company correctly transferred assets having a transfer value equal to its pre-July 2000 virtual pooled superannuation trust liabilities to the virtual pooled superannuation trust before 1 October 2000;

·       subsequent increases in the transfer value of assets (due to market fluctuations) caused the company to transfer excess assets out of the virtual pooled superannuation trust; and

·       assets need to be transferred back to the virtual pooled superannuation trust as a result of further market fluctuations which caused a subsequent decrease in the transfer value of assets.

1.126     The amendments ensure that the transitional provisions do not apply to:

·       assets transferred to support pre-July 2000 virtual pooled superannuation trust liabilities if, at any point in time prior to the transfer, the company had transferred assets to meet the whole of its pre-July 2000 virtual pooled superannuation trust liabilities; or

·       assets transferred to support pre-July 2000 exempt life insurance policy liabilities if, at any point in time prior to the transfer, the company had transferred assets to meet the whole of its pre-July 2000 exempt life insurance policy liabilities.

[Schedule 1, items 82 and 83, subsections 320-175(1A) and 320-230(1A) of the Income Tax (Transitional Provisions) Act 1997]

Example 1.4

At 30 June 2000, MB Life had a liability of $10,000 under a life insurance policy. The liability relates to a virtual pooled superannuation trust life insurance policy that, from 1 July 2000, is to be discharged out of virtual pooled superannuation trust assets.

MB Life transfers assets to its virtual pooled superannuation trust to meet half of the policy liability on 14 September 2000. Assets to meet the balance of the liabilities are transferred to the virtual pooled superannuation trust on 30 November 2000. In both cases, the transfer value of the assets transferred is $5,000 and the amount that could be included in the company’s assessable income because of section 320-200 is $300.

No tax consequences will arise for MB Life as a result of the transfer made on 14 September 2000 as the assets are transferred before 1 October 2000 to meet part of a virtual pooled superannuation trust liability that existed before 1 July 2000.

In relation to the transfer made on 30 November 2000:

·          MB Life will include $300 in its ordinary assessable income (i.e. the amount that is included in assessable income because of section 320-200); and

·          the transfer values of the assets transferred will not be included in MB Life’s complying superannuation assessable income or in its ordinary deductions.

In the 2001-2002 income year, the transfer values of the assets that relate to the liabilities fall by $1,500. To make up the shortfall, MB Life transfers $1,500 in cash to the virtual pooled superannuation trust. As MB Life had previously transferred assets to meet all of its virtual pooled superannuation trust policy liabilities as at 1 July 2000, the transfer values of the assets transferred is included in MB Life’s complying superannuation assessable income and ordinary deductions.

Actuarial standards

1.127     Division 320 requires life insurance companies to value life insurance policy liabilities for various purposes. Depending on the circumstances, actuaries are required to determine the appropriate value of policy liabilities using either the Solvency Standard or the Valuation Standard.

1.128     Currently, the Solvency Standard is defined to mean:

·       for a life insurance company other than a friendly society, Actuarial Standard 2.02; and

·       for a life insurance company that is a friendly society, Actuarial Standard (Friendly Societies) 2.01.

1.129     Similarly, the Valuation Standard is defined to mean:

·       for a life insurance company other than a friendly society, Actuarial Standard 1.02; and

·       for a life insurance company that is a friendly society, Actuarial Standard (Friendly Societies) 1.01.

1.130     Both the Solvency Standard and the Valuation Standard have been revised since the introduction of Division 320. Therefore, the amendments modify the definitions of ‘Solvency Standard’ and ‘Valuation Standard’ to ensure that the relevant Standard as currently in force under the Life Insurance Act 1995 is used for the purposes of determining the value of the relevant policy liabilities in Division 320. [Schedule 1, items 123 and 124, definitions of ‘Solvency Standard’ and ‘Valuation Standard’ in subsection 995-1(1)]

·       The current Solvency Standard for life insurance companies (including friendly societies) is Actuarial Standard 2.03.

·       The current Valuation Standard is:

-            for a life insurance company other than a friendly society, Actuarial Standard 1.03; and

-            for a life insurance company that is a friendly society, Actuarial Standard (Friendly Societies) 1.02.

1.131     The new Actuarial Standards apply for all valuations made in respect of periods ending on or after 30 June 2002. Therefore, the amendments apply with effect from the income year in which 30 June 2002 occurs. [Schedule 1, subitem 126(10)]

Amounts received in respect of foreign life insurance policies

1.132     Prior to 1 July 2000, life insurance companies were exempt from tax on certain income attributable to policies issued by foreign permanent establishments (former section 112C of the ITAA 1936).

1.133     That exemption was intended to be replicated under Division 320 by treating the non-resident proportion of foreign establishment amounts as non-assessable non-exempt income (paragraph 320-37(1)(c)).

1.134     The former section 112C:

·       limited the exemption to income that was derived from assets belonging to a permanent establishment that were held to cover liabilities referable to policies issued by the permanent establishment; and

·       worked out the amount that was exempt from tax on the basis of the average value of relevant policy liabilities.

1.135     Those conditions were not effectively replicated on the transfer of the provisions to Division 320.

1.136     Therefore, the amendments ensure that the non-resident proportion of foreign establishment amounts that is treated as non-assessable non-exempt income under paragraph 320-37(1)(c) is consistent with the amount attributable to policies issued by foreign permanent establishments that was formerly exempt from tax under the former section 112C. [Schedule 1, items 117 to 122, paragraph 320-37(1)(c) and subsections 320-37(1A) and 320-37(2)]

1.137     The amendments may potentially result in an increase in the tax liability of a life insurance company and therefore apply to the 2003-2004 income year and later income years. [Schedule 1, subitem 126(9)]

Friendly society sickness policies

1.138     Prior to 1 July 2000, friendly societies were exempt from tax on, among other things, income attributable to funeral policies and sickness policies.

1.139     Under Division 320, income derived by friendly societies that is attributable to funeral policies issued before 1 January 2003 is non-assessable non-exempt income (paragraph 320-37(1)(d)).

1.140     Therefore, for consistency, the amendments ensure that income derived by friendly societies that is attributable to sickness policies issued before 1 January 2003 is also non-assessable non-exempt income. [Schedule 1, items 102 and 103, paragraph 320-37(1)(d)]

1.141     A sickness policy is defined to mean a life insurance policy issued by a friendly society for the sole purpose of providing:

·       sickness benefits; or

·       sickness and funeral benefits.

[Schedule 1, item 75, definition of ‘sickness policy’ in subsection 995-1(1)]

1.142     A friendly society’s sickness policy business does not include registered health insurance business that is exempt from tax under section 50-30.

References to a policy of life assurance in the

Income Tax Assessment Act 1936

1.143     In some cases, the ITAA 1936 refers to ‘a policy of life assurance’. Under the common law, a policy of life assurance may include a policy issued by a non-resident life insurance company.

1.144     The amendments change these references to a ‘life assurance policy’ to ensure that the relevant provisions apply only to policies issued by Australian resident life insurance companies. [Schedule 1, items 108 to 115, paragraph (f) of the definition of ‘dividend’ in subsection 6(1), paragraph 26(i), section 26AH, subparagraph 102AE(2)(b)(iv), sections 282A, 291A and 297A of the ITAA 1936]

1.145     To ensure that no taxpayers are disadvantaged, the amendments apply to amounts received or derived after the date of Royal Assent. [Schedule 1, subitem 126(7)]

Application and transitional provisions

1.146     Most of the amendments apply from 1 July 2000 because:

·       the new regime for taxing life insurance companies (Division 320) commenced on 1 July 2000; and

·       the amendments have generally been sought by the life insurance industry to clarify the operation of the income tax law and ensure that it operates as intended.

1.147     However, some amendments that affect Division 320 have been made after 1 July 2000. Consequently, the amendments to these provisions apply from the date of application of the original amendments.

1.148     Other amendments apply prospectively as they potentially have an adverse impact on life insurance companies.

·       The amendments to remove any doubt that reinsurance commissions are included in assessable income apply to reinsurance commissions received or recovered by a life insurance company after the date of Royal Assent [Schedule 1, subitem 126(8)] .

·       The amendments to impose administrative penalties on life insurance companies that do not undertake required valuations of assets and liabilities relating to the virtual pooled superannuation trust and the segregated exempt assets or fail to transfer excess assets from the virtual pooled superannuation trust or the segregated exempt assets apply to a valuation time that occurs after the date of Royal Assent [Schedule 1, subitem 126(11)] .

·       The amendments to narrow the scope of foreign establishment amounts that are included in non-assessable non-exempt income apply to the 2003-2004 and later income years [Schedule 1, subitem 126(10)] .

·       The amendments to change various references to a ‘policy of life assurance’ to a ‘life assurance policy’ in the ITAA 1936 apply to amounts received after the date of Royal Assent [Schedule 1, subitem 126(7)] .



C hapter 2  

Consolidation: providing greater flexibility

Outline of chapter

2.1         Schedule 2 to this bill contains the following modifications to the consolidation regime:

·       membership rules for corporate unit trusts and public trading trusts, multiple entry consolidated (MEC) groups, and interposed head companies;

·       cost setting for assets that the head company does not hold under the single entity rule;

·       leaving rules for partners and partnerships;

·       deferred acquisition payments;

·       application of transitional cost setting provisions to MEC groups;

·       continuity of ownership test (COT) concession for foreign losses;

·       interactions with international tax rules;

·       consolidation liability rules;

·       calculation of capital gains tax (CGT) cost base assumed CGT event;

·       interaction with the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 ; and

·       privatised assets.

2.2         All references to legislative provisions in this chapter are references to the Income Tax Assessment Act 1997 ( ITAA 1997) unless otherwise stated.

2.3         Unless otherwise stated, reference in the chapter to a consolidated group should be read as including a MEC group.

Context of amendments

2.4         With the introduction of the consolidation regime, a number of modifications are being made to provide greater flexibility, further clarify certain aspects of the consolidation regime and to ensure that the regime interacts appropriately with other aspects of the income tax law.

Summary of new law

Corporate unit trusts and public trading trusts can be treated like head companies of consolidated groups

2.5         Part 2 of Schedule 2 to this bill allows corporate unit trusts (CUTs) and public trading trusts (PTTs) that are subject to Divisions 6B and 6C of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) to make an election to be treated like a head company of a consolidated group. In doing so they will also be treated like a company for income tax and related purposes. This will allow wholly-owned subsidiaries of such a trust to also be treated like subsidiary members of the consolidated group.

2.6         Once a CUT or PTT has made this election it will continue to be treated like a company for income tax and related purposes for the rest of its existence, even if the group it heads deconsolidates or it fails the definitional requirements of a CUT or a PTT that are found in Divisions 6B and 6C of Part III of the ITAA 1936 respectively.

Multiple entry consolidated groups and interposed head companies

2.7         The amendments made by Part 3 of Schedule 2 to this bill will:

·       align the period in which a choice is made to continue as a consolidated group, under section 124-380 (exchange of shares in one company for shares in another company), with the notification period for events affecting consolidated groups under section 703-60;

·       ensure that changes to the membership of a consolidated group which occur more than 28 days before formation of the group are notified by the head company of the group rather than the company that made the choice to consolidate, where they are different because of the existence of an interposed company; and

·       ensure that the CGT roll-over relief available under Subdivision 126-B applies only to members of consolidated groups or to companies that are not members of consolidatable groups.

Cost setting for assets that the head company does not hold under the single entity rule

2.8         Part 4 of Schedule 2 to this bill amends the consolidation cost setting rules to ensure that the assets of a joining entity that do not become assets of the head company under the single entity rule have their tax cost reset when the entity joins the consolidated group. Intra-group assets, such as a loan from one group entity to another, are the main example of assets that do not become assets of the head company when the entities become members of a consolidated group.

Cost setting rules for partners and partnerships leaving a consolidated group

2.9         Part 5 of Schedule 2 to this bill provides special rules for determining the income tax consequences that arise where a partner or a partnership leaves a consolidated group. A minor amendment is also made to ensure that a partner’s share of the overall foreign losses of a partnership are included when calculating the partner’s allocable cost amount on entry.

Treatment of deferred acquisition payments

2.10       Part 6 of Schedule 2 to this bill ensures that, when an entity makes a deferred acquisition payment after the joining time (or becomes required to make such a payment), the allocable cost amount of the joining entity will be required to be recalculated to include the amount of the deferred acquisition payment.

Application of transitional provisions cost setting rules to multiple entry consolidated groups

2.11       Part 7 of Schedule 2 to this bill amends the transitional provisions relating to the cost setting rules to ensure that those provisions apply appropriately to MEC groups. This is achieved by ensuring that the following can be transitional entities:

·       all subsidiary members of a MEC group, other than non-head company eligible tier-1 companies and transitional foreign held subsidiaries; and

·       eligible tier-1 companies of a potential MEC group that are ‘rolled down’ to become subsidiaries of another eligible tier-1 company and remain wholly-owned subsidiary members at all times.

Foreign losses and the continuity of ownership test concession

2.12       Part 8 of Schedule 2 to this bill changes the recoupment tests applied to foreign losses incurred by companies from those contained in the ITAA 1936 to those in the ITAA 1997. This change ensures that foreign losses are eligible for the ‘3-year continuity of ownership test concession’ (the 3-year COT concession) that allows certain losses to be used over three years instead of under the ‘available fraction’ method.

Trading stock election in relation to foreign investment fund interests

2.13       Part 9 of Schedule 2 to this bill inserts new rules to ensure that the entry history rule in Part 3-90 does not adversely affect the head company’s ability to make elections in relation to a foreign investment fund (FIF) trading stock interest that it has when an entity joins a group. They also ensure the exit history rule in Part 3-90 does not adversely affect the leaving entity’s ability to make elections in relation to trading stock interests in FIFs that it has upon leaving the group. However, the new rules do not affect the decisions that the head company has made in relation to its own trading stock interests in FIFs.

Foreign dividend accounts and consolidation

2.14       Part 9 of Schedule 2 to this bill ensures a provisional head company of a MEC group to credit the foreign dividend account (FDA) with the amount of an assessable non-portfolio dividend that is paid to a subsidiary member of the group and on which foreign tax was paid. The provisional head company is taken to have paid the foreign tax actually paid by the subsidiary member.

2.15        Part 9 of Schedule 2 to this bill also inserts a provision to ensure that the calculation of a FDA debit in relation to an Australian taxable dividend takes account of non-portfolio dividends paid throughout the income year to the members of a consolidated group. This is relevant for a head company of a MEC group that was not the provisional head company during the year.

2.16       The new rules also ensure a FDA surplus cannot be transferred by a company to a related company that is a member of a consolidated group where the paying company is not a member of the group.

Foreign tax credits and consolidation

2.17       Part 9 of Schedule 2 to this bill:

·       provides that where entities with excess foreign tax credits join a consolidated group at the start of the head company’s income year, the head company will be able to use those credits at the end of that income year;

·       ensures the head company will be able to use excess foreign tax credits from a joining entity’s non-membership period where the entity joins a consolidated group before or at the start of the head company’s income year and that income year starts after the corresponding income year of the joining entity; and

·       inserts a rule which explicitly implements the policy that once an entity joins a consolidated group any foreign tax credits it has whether from a non-membership period or from prior years will only be available to the head company of that group.

Collection and recovery rules

2.18       Part 10 of Schedule 2 to this bill provides greater flexibility to the consolidation collection and liability rules contained in Division 721. In particular, the amendments:

·       modify the clear exit rule and the pay as you go (PAYG) instalment liability rules;

·       clarify that a group liability can be subject to only one tax sharing agreement; and

·       update references to the franking tax-related liabilities.

Calculation of cost base and reduced cost base - assumed capital gains tax event

2.19       Part 11 of Schedule 2 to this bill ensures that, whenever it is necessary for an entity to calculate the cost base or reduced cost base of a CGT asset, and a CGT event has not occurred in relation to that asset, the entity will be required to assume that a CGT event has occurred in relation to that asset.

Interaction with the Financial Corporations (Transfer of Assets and Liabilities) Act 1993

2.20       Part 12 of Schedule 2 to this bill amends the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 to ensure that the income tax relief provided by that Act applies appropriately to financial corporations that are members of consolidated groups.

2.21       The amendment ensures that upon the transfer of an asset or liability by a subsidiary member of a consolidated group, the group’s head company is eligible for any tax relief that would have, but for consolidation, been available to the subsidiary under the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 .

Tax cost setting for privatised assets

2.22       Part 13 of Schedule 2 to this bill amends the consolidation regime to ensure that where a tax exempt entity (or previously privatised entity) becomes a member of a consolidated group, the tax cost for depreciating assets of the entity is appropriately capped. The amendments also apply, in appropriate circumstances, to assets acquired from a tax exempt entity by an entity that becomes a member of a consolidated group. The amendments ensure that the consolidation cost setting rules which reset the tax cost for assets that an entity brings into a consolidated group do not override the special rules which apply to privatised entities.

Comparison of key features of new law and current law

New law

Current law

Corporate units trusts and public trading trusts can be treated like head companies of consolidated groups

CUTs and PTTs that are subject to Divisions 6B and 6C of Part III of the ITAA 1936 can elect to be treated like a head company of a consolidated group. But in doing so they are, in effect, also making an irrevocable election to be treated like a company for income tax and related purposes (applied law).

CUTs and PTTs cannot head consolidated groups.

Multiple entry consolidated groups and interposed head companies

The period in which a choice to continue as a consolidated group made under section 124-380 is aligned with the notification period for events affecting consolidated groups under section 703-60.

There is currently a discrepancy between notification periods affecting consolidated groups in sections 124-380 and 703-60.

Cost setting for assets that the head company does not hold under the single entity rule

Assets that do not become assets of the head company under the single entity rule have their tax cost reset. However, the reset tax cost for assets that do not become assets of the head company under the single entity rule does not alter the income tax consequences for the head company of the consolidated group.

Some uncertainty arose over the operation of the previous rules.

Cost setting rules for partners and partnerships leaving a consolidated group

Special cost setting rules apply where a partner or a partnership leaves a consolidated group. These rules apply both when a partnership leaves a consolidated group because the group disposes of some or all of its partnership cost setting interests in the partnership and when a partner leaves a consolidated group.

The existing tax cost setting rules do not contain special rules in relation to partners or partnerships leaving a consolidated group.

Deferred acquisition payments

The new rules will require a joining entity’s allocable cost amount to be recalculated where a head company makes a deferred acquisition payment or is required to make such a payment after the joining time, where the payment is in respect of acquiring the membership interests in the joining entity.

The existing tax cost setting rules do not permit a joining entity to include in its allocable cost amount any deferred acquisition payments that have not been made or are not required to be made before the joining time.

Application of transitional cost setting rules to multiple entry consolidated groups

The transitional provisions relating to the cost setting rules are extended to MEC groups.

The transitional provisions relating to cost setting rules do not apply to MEC groups.

Foreign losses and the continuity ownership test concession

Foreign losses incurred by companies are tested under loss recoupment rules contained in the ITAA 1997.

Foreign losses incurred by companies are tested under the loss recoupment rules contained in the ITAA 1936.

Foreign losses qualify for the 3-year COT concession in section 707-350 of the Income Tax (Transitional Provisions) Act 1997 because they are tested for deductibility under the ITAA 1997 company loss recoupment rules.

Foreign losses do not qualify for the 3-year COT concession in section 707-350 of the Income Tax (Transitional Provisions) Act 1997 because they are tested for deductibility under the ITAA 1936 company loss recoupment rules.

Trading stock election in relation to foreign investment fund interests

A head company can choose to value, at market value, interests in FIFs held as trading stock as a result of the single entity rule despite the effect of the entry history rule. Similarly, an entity that leaves a consolidated or MEC group is not prevented from making the election by the exit history rule.

The market value election can only be made by a taxpayer in relation to interests in FIFs that are trading stock if the election is made before the lodgement of an income tax return for the first year in which a notional accounting period ends for such FIFs. This election then applies to all future trading stock interests in FIFs.

Foreign dividend accounts and consolidation

No FDA credit will arise for a company that is a member of a consolidated group where that company receives a dividend from a related company that is not a member of the group.

The FDA rules allow the transfer of a FDA surplus to a related company until 30 June 2003.

Foreign tax credits and consolidation

A head company will be able to use, at the end of an income year, excess foreign tax credits transferred from entities that join the consolidated group at or before the start of the head company’s income year.

The head company can only use, at the end of an income year, excess foreign tax credits transferred from entities that joined the group before the beginning of that income year.

In special circumstances, a head company will be able to use, at the end of its income year, excess foreign tax credits that relate to a non-membership period (of a joining entity) that relates to the same income year.

The head company is able to use at the end of an income year, a joining entity’s excess foreign tax credits from earlier income years.

A provision explicitly implements the policy that an entity that leaves a consolidated group does not have access to excess foreign tax credits that it may have had before it joined the group.

Excess foreign tax credits are not transferred to an entity that leaves a consolidated group.

Collection and recovery rules

In certain circumstances, a former contributing member to a tax sharing agreement that has since exited the group can avoid joint and several liability for a group liability by providing the tax sharing agreement to the Commissioner of Taxation (Commissioner), when requested.

Only the head company can provide the tax sharing agreement to the Commissioner, when requested.

If the head company defaults on its PAYG instalment liability, the Commissioner will be prevented from seeking recovery from subsidiary members before the head company is given a consolidated PAYG rate.

If the head company defaults on its PAYG instalment liability, the Commissioner can seek recovery from subsidiary members before the head company is given a consolidated PAYG rate.

When allocating a consolidated group’s income tax-related liability under a tax sharing agreement, the group can allocate either the total amount or an amount equal to the total minus the PAYG instalment credits available to the head company.

The total amount of the group’s income tax-related liability must be allocated under a tax sharing agreement.

In relation to one or more liabilities, there can be only one tax sharing agreement which may incorporate one or more contributory members.

No equivalent.

Calculation of cost base and reduced cost base - assumed capital gains tax event

If it is necessary for a taxpayer to calculate the cost base or reduced cost base of a CGT asset at a particular time and a CGT event does not happen in relation to the asset at or just after that time, the new rule will require the cost base or reduced cost base to be calculated on the assumption a CGT event did happen in relation to the CGT asset at or just after that time.

It is not always necessary for a CGT event to occur in relation to a CGT asset for its cost base or reduced cost base to be calculated at a particular time.

Interaction with the Financial Corporations (Transfer of Assets and Liabilities) Act 1993

New rules in the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 will ensure tax relief provided under that Act to financial corporations will continue to be available where a financial corporation joins a consolidated group.

No equivalent.

Tax cost setting for privatised assets

Special rules apply to cap the tax cost for depreciating assets where a tax exempt entity (or previously privatised entity) becomes a member of a consolidated group.

The consolidation cost setting rules override the privatised asset provisions resulting in privatised entities being treated in the same way as taxable entities.

Detailed explanation of new law

Corporate unit trusts and public trading trusts can be treated like head companies of consolidated groups

2.23       Part 2 of Schedule 2 to this bill amends the consolidation membership rules to allow a corporate unit trust (CUT) or a public trading trust (PTT) that is subject to Division 6B or 6C of Part III of the ITAA 1936 to make an election to be treated like a head company of a consolidated group. But in doing so they are, in effect, also making an irrevocable election to be treated like a company for income tax and related purposes.

2.24       This income tax treatment may affect other entities as well, including members of the trust and entities in which the trustee holds membership interests. For example, it will allow wholly-owned subsidiaries of such a trust to be treated like subsidiary members of the consolidated group. [Schedule 2, Part 2, item 2, section 713-120]

Background

2.25       This measure was announced in Minister for Revenue and Assistant Treasurer’s Press Release No. C19/03 of 27 March 2003. In brief, certain CUTs and PTTs that elect to be taxed the same as companies can head consolidated groups. This is in keeping with an underlying principle of consolidation that entities that are taxed like companies should be able to head consolidated groups. Once a trust chooses to head a consolidated group it will continue to be taxed like a company even if the group it heads deconsolidates. Trusts that either cannot, or choose not to, head consolidated groups will continue to be taxed as the law currently stands.

2.26       The consolidation membership rules set out the circumstances in which an entity can head a consolidated group. One of these conditions is that the entity must have some or all of its taxable income taxed at a rate that is or equals the general company tax rate. CUTs and PTTs do not satisfy this condition because even though they are treated as a company for some purposes of the income tax law and are taxed at the company rate, they are not taken to be a company. Their tax treatment is not identical to that of ordinary resident companies (e.g. they use the trust loss provisions and are eligible to obtain the 50% CGT discount that a company cannot). Consequently, they have been precluded from heading consolidated groups.

How a trust can be treated like a head company of a consolidated group

2.27       A trust can make a choice to consolidate a consolidatable group as if the trust was a company if it:

·       is a CUT (as defined in Division 6B of Part III of the ITAA 1936) or a PTT (as defined in Division 6C of Part III of the ITAA 1936) for the income year. Trusts that are not taxed under these Divisions are not able to make the election to be treated like a head company of a consolidated group;

·       elects to be treated like a head company of a consolidated group (and as a consequence will be treated forever more like a company for income tax purposes);

·       is an Australian resident (but not a prescribed dual resident);

·       has at least one wholly-owned subsidiary;

·       is not a subsidiary member of a consolidatable or consolidated group;

·       is not an entity that is specifically precluded from being a member of a consolidatable or consolidated group; and

·       makes a choice to consolidate under section 703-50.

[Schedule 2, Part 2, item 2, section 713-130]

2.28       Where a CUT or a PTT owns a number of wholly-owned subsidiaries and it decides that it does not wish to be treated like a head company of a consolidated group, it may be possible for the CUT or PTT’s wholly-owned subsidiaries to form a consolidated group of which the CUT or PTT is not a member.

 

 

 

 

Example 2.1:  Trust not heading a consolidated group

A trust that is subject to Division 6B of Part III of the ITAA 1936 decides it does not want to be treated like a head company of a consolidated group. However, the entities that are legally owned by the trustee (and by each other) are able to independently form a consolidated group, the members being companies A, B and C.

 

 

 

 

 

 

 

 

 

 

 



Beneficial ownership

2.29       In order to be allowed to choose to consolidate the trust must have at least one ‘wholly-owned subsidiary’. However, a CUT or a PTT cannot have any wholly-owned subsidiaries because the definition of ‘wholly-owned subsidiary’ in subsection 703-30(1) cannot be satisfied. In brief, this subsection provides that an entity is a wholly-owned subsidiary of the holding entity (i.e. the CUT or the PTT) if all the membership interests in the subsidiary entity are beneficially owned by the CUT or the PTT. This condition cannot be satisfied because the unitholders of the CUT/PTT have a proprietary interest in the underlying assets of the CUT or the PTT. The trustee owns the assets legally but not beneficially (see Charles v Federal Commissioner of Taxation (1954) 90 CLR 598). This issue has been resolved by assuming that the trust beneficially owns the membership interests in other entities that are legally owned by the trustees. [Schedule 2, Part 2, item 2, paragraph 713-130(a)]

The effect of a trust electing to consolidate

Date of effect

2.30       The amendment comes into effect from the commencement of the consolidation regime (i.e. 1 July 2002) [Schedule 2, Part 1, item 1] . However, the date of effect of making this choice is the first day of a CUT or PTT’s income year [Schedule 2, Part 2, item 2, paragraph 713-130(b)] . This does not mean it must be the first income year in which an entity becomes a CUT or a PTT. It means the election does not have effect unless the day specified in the choice is the first day of a CUT or a PTT’s income year. The reason for this is that it reduces compliance costs. If a trust could make an election that comes into effect half way through its income year (which it cannot) it would have to work out its income tax liability for that year using both the income tax law that applies to companies as well as either Division 6B or 6C of Part III of the ITAA 1936. By not having to use these two disparate systems in the one income tax year the tax laws are simpler and less complex.

Example 2.2:  When a trust can head a consolidated group

A CUT whose income year ends on 31 January of each year chooses to consolidate the wholly-owned group as if it were a company. The earliest this trust can be treated like a head company of a consolidated group is 1 February 2003, this being the first day of its income year that starts after 1 July 2002.

Income tax treatment

2.31       From the date the election to consolidate the group comes into effect, a CUT or a PTT will remain a trust but will, for income tax related purposes only, be treated like a company (i.e. these trusts are not deemed to be companies for those purposes, they merely receive the same income tax treatment) [Schedule 2, Part 2, item 2, sections 713-125 and 713-130] . This treatment will continue even if the trust later fails the definitional requirements of a CUT or a PTT in Divisions 6B and 6C of Part III of the ITAA 1936 or if the group it heads later deconsolidates [Schedule 2, Part 2, item 2, paragraph 713-135(1)(b)] .

2.32       In order for the income tax related law that applies to companies to also apply to the trust, it is necessary to assume that the trust is a company (the assumed company ). The assumed company has the same characteristics as the trust in question, for example the business being undertaken and its membership interests. [Schedule 2, Part 2, item 2, section 713-130]

2.33       This income tax treatment may affect other entities as well, including employees of the trust and the trustees. For example, it will allow entities that are legally wholly-owned by the trustee (or other entities in the group) to be treated like subsidiary members of the consolidated group. [Schedule 2, Part 2, item 2, subsections 713-125(1) and (3)]

2.34       Subsection 713-135(2) lists the law (called the applied law ) that applies to the trust or trustee (as appropriate) of a trust that has elected to consolidate and thereby also effectively elected to be treated like a company for income tax related purposes [Schedule 2, Part 2, item 2, subsection 713-135(1)] . The expression ‘be treated as a company for income tax related purposes’ is intended to reflect that the other legislation administered by the Commissioner will also apply to the trust as if it were a company. This includes:

·       the ITAA 1936 (see the definition of ‘this Act’ in subsection 995-1(1) of the ITAA 1997);

·       the ITAA 1997 (see the definition of ‘this Act’ in subsection 995-1(1) of the ITAA 1997);

·       the International Tax Agreements Act 1953 (via paragraph 713-135(2)(e));

·       the Income Tax (Transitional Provisions) Act 1997 (via paragraph 713-135(2)(e)); and

·       the Taxation (Interest on Overpayments and Early Payments) Act 1983 (via paragraph 713-135(2)(e)).

[Schedule 2, Part 2, item 2, subsection 713-135(2)]

2.35       Further, all references in the applied law to trusts or trustees will not apply to a trust (or any trustees) that has made the choice to consolidate and be treated like a company. That is so even where the trust is no longer treated like a head company for income tax related purposes. The exceptions to this are certain penalty provisions and section 254 of the ITAA 1936. [Schedule 2, Part 2, item 2, subsection 713-140(2)]

2.36       When applying the ‘applied law’ to a trust (or to a trustee as appropriate) that has commenced being treated like a head company of a consolidated group, where appropriate, it is necessary to treat the characteristics of a trust as having a company equivalent [Schedule 2, Part 2, item 2, subsection 713-135(1) and note 2 to subsection 713-135(1)] . The practical application of this is that where there is a reference in the ‘applied law’ to a share, for example, it is necessary to read this as being a unit in a trust. But in all cases this can only occur where it is appropriate to do so. This must be determined on a case by case basis.

Example 2.3:  Script for script roll-over

Trust A is being treated like a head company of a consolidated group (and therefore is being treated like a company for income tax related purposes). It undertakes a scrip for scrip takeover of Company X. In order for section 124-780 to work, where the word ‘share’ is used it means ‘a unit in the trust’. Likewise, the word ‘company’ means ‘the trust’ and the term ‘voting shares’ means ‘trust voting interests’.

Given this, subparagraph 124-780(1)(a)(i) would read as follows: ‘a shareholder of Company X (the original interest holder) exchanges a share in the company (i.e. Company X) for a share (i.e. a unit in Trust A) (the replacement interest) in another company (i.e. Trust A)’.

If, instead, Company X undertakes a scrip for scrip takeover of Trust A, the appropriate modifications would mean that subparagraph 124-780(2)(a)(i) would read as follows: ‘a company (i.e. Company X) (the acquiring entity) that is not a member of a wholly-owned group becoming the owner of 80% or more of the voting shares (i.e. the trust voting interests) in the original entity (i.e. Trust A)’.

2.37       As mentioned above, the ‘applied law’ applies on and after the start of the day specified in the trust’s choice to be treated like a head company of a consolidated group [Schedule 2, Part 2, item 2, paragraph 713-135(1)(b)] . From this date, such a trust will no longer be assessed for income tax under either Division 6B or 6C of Part III of the ITAA 1936. It will be subject to the income tax law that applies to companies [Schedule 2, Part 2, item 3, note to subsection 102L(1); item 4, note to subsection 102T(1)] .

2.38       The ‘applied law’ also applies when it is relevant in relation to a time when the trust existed before the day it started being treated like a company for income tax purposes [Schedule 2, Part 2, item 2, paragraph 713-135(1)(c)] . This provision is needed so that if a trust needs to go back in time in order to work out its current income tax liability, it can go back in time and pretend, for that purpose only, it was being taxed like a company. This provision is not imposing any retrospective obligations on a trust. The ability to look back merely lets the entity go back in time, if need be, so that it can comply with its current income tax obligations.

Example 2.4:  Treatment of prior periods

Trust A has elected to consolidate and is treated like a head company of a consolidated group from 1 July 2002. From this date onwards it will also be treated like a company for income tax purposes. To see if it can bring unused carry-forward losses into consolidation it needs to pass the company COT or the company same business test. In order to pass either of these tests Trust A needs to go back to a time when it was still being taxed under Division 6B of Part III of the ITAA 1936 (i.e. prior to 1 July 2002). Paragraph 713-135(1)(c) allows Trust A to go back to the relevant time and pretend it was, at that time, being taxed like a company (even though this is not so). This will allow it to see whether it can pass the COT or the same business test.

Modifications to the ‘applied law’

2.39       Where appropriate, modifications to the ‘applied law’ may be required [Schedule 2, Part 2, item 2, paragraph 713-135(1)(a) and subsection 713-140(1)] . What is appropriate must be determined on a case by case basis. Subsection 713-140(2) provides a number of modifications to certain references in the ‘applied law’ so that they will apply appropriately to trusts that are being treated like companies for income tax purposes [Schedule 2, Part 2, item 2, subsection 713-140(2)] . For example, a reference in the ‘applied law’ to a body corporate includes a reference to a trust or trustee.

2.40       Another modification that may be required to the ‘applied law’, depending on the circumstances, is found in subsection 713-140(5) [Schedule 2, Part 2, item 2, subsection 713-140(5)] . Again, these modifications only apply when it is appropriate to apply them. These modifications are required because the ‘applied law’ refers to things that a trust may not be able to satisfy, given that it is a trust.

Example 2.5:  Modifications

A trust that is subject to Division 6B of Part III of the ITAA 1936 issues units to its employees in 2000. A restriction has been placed on these units, namely that employees cannot sell them until 2004.

On 1 July 2003 the trust commences being treated like a head company of a consolidated group (and therefore like a company for income tax purposes).

Item 3 of subsection 713-140(5) ensures that the income tax treatment of these units in the hands of the employees is not affected by the trust being subject to the income tax law that applies to companies. Therefore, in relation to these units, because the employees were not subject to Division 13A of Part III of the ITAA 1936 before their employer changed its income tax treatment they will not be subject to it after this event.

However, once a CUT or a PTT’s income tax treatment has changed so that it is being taxed like a company, any units or rights it subsequently issues to its employees will be subject to the ‘applied law’. Therefore, where units are treated as a share for income tax purposes and the conditions in Division 13A of Part III of the ITAA 1936 are satisfied, the employee will be subject to these provisions.

2.41       As mentioned above, references in the ‘applied law’ to trusts or trustees will not apply to a trust or trustee of a trust that has made the choice to consolidate and is treated like a head company of a consolidated group or where the trust is no longer being treated as a head company but is still being treated like a company for income tax and related purposes, the exceptions being certain penalty provisions and section 254 of the ITAA 1936. [Schedule 2, Part 2, item 2, subsection 713-135(3) and subsections 713-140(3) and (4)]

2.42       Subsection 713-135(3) provides that while an entity may be subject to the ‘applied law’ it does not make it liable for any criminal, civil or administrative penalty. This does not mean that where an entity breaches an obligation under the ‘applied law’ there will be no criminal, civil or administrative penalty imposed. It means that a trust or trustee will not be subject to penalties to which it would not otherwise have been subject. Therefore, the obligations in the ‘applied law’ that apply to companies will also apply to trusts and trustees of a trust that is being treated like a company. However, any penalty that might be imposed will be the penalty that is imposed for a trust or trustee (as appropriate) and not that of a company [Schedule 2, Part 2, item 2, subsection 713-140(3), note] .

Example 2.6:  Penalties

From 1 July 2003 a trust is being treated like a head company of a consolidated group. In 2005 it fails to lodge a tax return with the Commissioner. As a consequence, pursuant to subsection 286-75(1) of the Taxation Administration Act 1953 (TAA 1953) the penalty that will be imposed on the trust will be the penalty provisions that apply to trusts and not companies.

Consequences of failing the eligibility requirements

2.43       Once a CUT or a PTT has chosen to consolidate and is being treated like a head company of a consolidated group the income tax law and other ‘applied laws’ that apply to companies will continue to apply to it even if it fails to satisfy any of the definitional requirements of Division 6B or 6C of Part III of the ITAA 1936. Further, the trust will continue to be treated like a head company of a consolidated group. However, it is not treated as a head company if it fails the requirements of being a head company found in item 1 of subsection 703-15(2). For example, if a trust fails the Australian residency requirements (see subsection 6(1) of the ITAA 1936) it will be ineligible to continue to be treated like a head company of a consolidated group. This is so even if during the same period it satisfies the definition of resident unit trust in either section 102H or 102Q of the ITAA 1936. In such a case the trust will be taxed as if it were a non-resident company.

Resettlement of the trust

2.44       Where a trust is being treated like a company for income tax purposes (irrespective of whether it is still being treated like a head company of a consolidated group) and it undertakes activities that amount to a resettlement, a new trust will come into existence. The previous trust’s election to be treated like a head company of a consolidated group will have no effect on the new trust. Consequently, the new trust will be taxed under the trust provisions that are appropriate for the characteristics of the new trust. If it wishes to be subject to the consolidation regime it will have to satisfy the appropriate conditions found in Subdivision 713-C.

Multiple entry consolidated groups and interposed head companies

Alignment of notification periods

2.45       Subdivision 124-G provides CGT roll-over relief where a taxpayer exchanges shares in one company (the original company) for shares in another company (the interposed company) as part of a company reorganisation.

2.46       Where the original company is the head company of a consolidated group immediately before the exchange of shares and immediately after the completion of the exchange, the interposed company is the head company of a consolidatable group consisting of itself and the members of the group immediately before the exchange of shares, the interposed company must choose whether the consolidated group is to continue in existence. Currently this choice must be made within two months of the exchange of shares.

2.47       This time period for notification conflicts with the notice requirements in section 703-60 for events affecting a consolidated group, which requires notification within 28 days of an event. For example, under section 703-60 the head company of a consolidated group must notify the Commissioner within 28 days of an entity becoming a member of the group.

2.48       Subsection 124-380(7) is amended to change the notification period to within 28 days of the completion of the exchange of shares [Schedule 2, Part 3, item 5, subsection 124-380(7)] . This aligns the notification period with the requirements of section 703-60.

Notification of event affecting a consolidated group

2.49       Under section 703-50 a company that is the head company of a group may make a choice to form a consolidated group on a specified day. The company must give notice of the choice to the Commissioner within the period starting on the day specified in the choice and ending on the day of lodgement of the income tax return for the year in which the specified day occurs.

2.50       Subsection 703-60(2) provides that where an event affecting a consolidated group happens more than 28 days before the choice to consolidate is provided to the Commissioner, the company making the choice must advise the Commissioner of the event at the same time. However, this poses problems when an interposed company becomes the head company of the group before the choice to consolidate is given to the Commissioner.

2.51       Subsection 703-60(2) is amended so that the head company of the consolidated group provides notice of the event to the Commissioner at the same time as the choice to consolidate is provided. [Schedule 2, Part 3, item 8, subsection 703-60(2)]

Capital gains tax roll-over relief

2.52       Broadly, Subdivision 126-B provides CGT roll-over relief for wholly-owned groups when assets are transferred between:

·       non-resident companies; or

·       a non-resident company and the head company of a consolidated group.

2.53       Subsection 126-50(6) is amended to ensure that if at the time of the trigger event, the originating company or the recipient company is an Australian resident, the company must not be a member of a consolidatable group at that time (see Diagram 2.1), but it may be a member of a consolidated group (see Diagram 2.2) or a MEC group at the time (see Diagram 2.3). [Schedule 2, Part 3, item 7, subsection 126-50(6)]

 

Diagram 2.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Diagram 2.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Diagram 2.3

 

 

 

 

 

 

 

 

 

 

 

 

 



Cost setting for assets that the head company does not hold under the single entity rule

2.54       Under the previous cost setting rules there was uncertainty as to whether certain assets that do not become assets of the head company under the single entity rule have their tax cost set. This is because it was arguable that only assets that become assets of the head company have their tax cost reset.

2.55       The most common example of assets that do not become assets of the head company under the single entity rule would be intra-group assets. Intra-group assets involve an asset of a joining entity that corresponds to a liability of either the head company or another subsidiary member of the group. A loan from one group member to another is an example of an intra-group asset.

2.56       Broadly, when working out the income tax liability for a head company, section 701-10 sets the tax cost of each asset of an entity at the asset’s tax cost setting amount when the entity becomes a subsidiary member of a consolidated group. This process involves calculating an allocable cost amount for the entity which is then allocated to the assets of the entity to determine the tax cost for the assets.

2.57       Part 4 of Schedule 2 to this bill amends subsection 701-10(2) to ensure that assets which do not become assets of the head company have their tax cost set and that allocable cost amount is allocated to these assets. This ensures that the appropriate amount of allocable cost amount is allocated to the other assets of the entity. If an appropriate amount of the cost was not allocated to assets that do not become assets of the head company under the single entity rule then too much cost may be allocated to other assets which would distort the income tax outcomes for those assets. [Schedule 2, Part 4, item 11, subsection 701-10(2)]

2.58       The amendment ensures that assets of the joining entity, at the time it becomes a subsidiary member of the group, have their tax cost set - assuming that the single entity rule did not apply. The exclusion of the operation of the single entity rule ensures that intra-group assets and other assets that would be ignored as a consequence of the single entity rule have their tax cost reset.

2.59       As intra-group assets relating to synergistic goodwill have their tax cost set as a result of subsection 705-35(3) a note is added to the end of subsection 701-10(2) to refer to the operation of subsection 705-35(3). [Schedule 2, Part 4, item 11, note at the end of subsection 701-10(2)]

2.60       In addition, section 701-58 ensures that the tax cost which is set for assets that do not become assets of the head company under the single entity rule is not taken into account in applying the provisions mentioned in subsections 701-55(2) to (6) at the joining time. This ensures that the reset tax cost for assets that do not become assets of the head company under the single entity rule will not be used in working out any income tax consequences for the head company in relation to those assets. This is consistent with ignoring these assets as a consequence of the single entity rule. [Schedule 2, Part 4, item 13, section 701-58]

Overall foreign losses of a partnership

2.61       Foreign losses incurred by a partnership are quarantined in the partnership (unlike other partnership losses, which are distributed to the partners). There is currently no mechanism that enables these losses to be taken into account when calculating a partner’s allocable cost amount on entry to a consolidated group, as these losses are not ‘sorts of losses’ within the meaning of subsection 701-1(4).

2.62       Amendments made by this bill will ensure that, where a partnership has unutilised foreign losses at the joining time and a partner in the partnership joins the consolidated group, the loss will be a ‘sort of loss’ for the purposes of subsection 701-1(4). As a result, the partner will have to include their share of the partnership foreign loss when calculating their allocable cost amount at the joining time, in particular when determining any adjustments required under sections 705-100 (about losses accruing to a joined group before the joining time) and 705-110 (about losses transferred to a head company at the joining time). [Schedule 2, Part 5, item 31, subsection 713-225(6A)]

Cost setting rules for partners and partnerships that leave a consolidated group

2.63        The modifications to the general cost setting rules for setting the tax cost for assets of a partner or a partnership that joins a consolidated group are contained in Subdivision 713-E. Under these rules, partnerships are not treated as a joining entity for the purposes of Division 705. Instead, where a partner joins a consolidated group (and not the partnership), an allocable cost amount is worked out for the partner in the usual manner (as modified by Subdivision 713-E) and a tax cost is set for the partner’s individual interests in the assets of the partnership (called partnership cost setting interests). Where a partnership becomes a member of a consolidated group, the ‘underlying’ assets of the partnership have their tax cost reset by reference to the partnership cost pool (see sections 713-235 and 713-240). In this case, the partnership cost setting interests are then ignored.

2.64       The object of the amendments made by this bill to Subdivision 713-E is to allow a head company to determine the income tax consequences that arise where either a partner or a partnership leaves a consolidated group. A partnership may leave a group either as a result of the partner leaving or as a result of the head company of the group disposing of some or all of its partnership cost setting interests in the assets of the partnership.

Partnership was never part of the consolidated group - head company disposes of partnership cost setting interests

2.65       Where a partnership was never a member of a consolidated group (but the consolidated group held partnership cost setting interests in the partnership) no new rules are required for determining the income tax consequences of a disposal by the consolidated group of its partnership cost setting interests. The income tax consequences of this disposal will be determined under the existing CGT rules, as is the case outside of consolidation (see section 106-5).

Partnership leaves the consolidated group

2.66       Where a partnership ceases to be a subsidiary member of a consolidated group, the new rules in Subdivision 713-E will apply [Schedule 2, Part 5, item 32, subsection 713-250(1)] . In order to determine the income tax consequences of the partnership ceasing to be a subsidiary member, the head company will be required to apply the cost setting rules (in particular sections 701-15, 701-20, 701-45, 701-50 and Division 711), as modified by Subdivision 713-E [Schedule 2, Part 5, item 30, subsection 713-205(5); Part 5, item 32, subsection 713-250(2)] . The modified provisions operate:

·       as if the group’s partnership cost setting interests were the group’s only assets relating to the partnership; and

·       to set the tax cost of the group’s partnership cost setting interests in the assets of the partnership (this will require the group to cease to recognise the underlying assets of the partnership and instead recognise partnership cost setting interests in the partnership) [Schedule 2, Part 5, item 30, subsection 713-205(4)] .

2.67       In order to assist taxpayers, new notes have been inserted at the ends of subsection 701-15(3) and sections 701-20, 701-45, 701-50 and 701-60. These notes direct taxpayers to apply Subdivision 713-E when the leaving entity is a partnership. [Schedule 2, Part 5, items 20 to 27, subsection 701-15(3) and sections 701-20, 701-45, 701-50 and 701-60]

2.68       Further, the overview in section 713-200 has also been amended so that it now includes a reference to a partnership ceasing to be a member of a consolidated group as well as to the application of Division 711 in these circumstances. [Schedule 2, Part 5, items 28 and 29, section 713-200 and paragraph 713-200(b)]

2.69       A partnership can cease to be a subsidiary member of a consolidated group in one of two ways. Either the partner leaves the group (because the head company has disposed of its membership interests in the partner) or the head company disposes of some or all of its partnership cost setting interests in the partnership (including where only part of each interest is disposed of). In either case, the partnership will cease to be a ‘wholly-owned subsidiary’ and, as a consequence, will no longer be eligible to be a member of the group.

2.70       Regardless of how the partnership leaves the group, the special rules in Subdivision 713-E will apply to set the tax cost for the head company’s partnership cost setting interests in the partnership [Schedule 2, Part 5, item 32, subsection 713-255(1)] . However, no tax cost setting amount is worked out for membership interests in the partnership [Schedule 2, Part 5, item 32, subsection 713-255(2)] . Further, no allocable cost amount is worked out for the partnership.

Single entity leaving

2.71       In the case where the partnership leaves as a result of the group disposing of some or all of its partnership cost setting interests in the partnership (including where only part of each interest is disposed of), the partnership is the only entity that leaves the group. Where this occurs, immediately before the partnership leaves, the head company must cease to recognise the underlying assets of the partnership and instead begin to recognise partnership cost setting interests in the partnership. As a consequence, the head company will be required to set the tax cost of each partnership cost setting interest held by a partner that is a member of the group just before the leaving time. [Schedule 2, Part 5, item 32, subsection 713-255(3)]

2.72       The tax cost setting amount of each partnership cost setting interest is determined by reference to the terminating value of the underlying partnership asset to which the partnership cost setting interest relates. Specifically, the tax cost setting amount will be equal to the partner’s individual share of the terminating value of the underlying asset. [Schedule 2, Part 5, item 32, subsection 713-255(4)]

 

Example 2.7:  Determining the head company’s partnership cost setting interests just before a partnership leaves the consolidated group

If A Co sells all of its interests in the partnership, the partnership will cease to be a member of the consolidated group. Just before the partnership leaves, Head Co will cease to recognise the underlying assets of the partnership and instead begin to recognise partnership cost setting interests in the partnership. The tax cost of each partnership cost setting interest will equal the partner’s individual share of the terminating value of the underlying asset of the partnership to which the partnership cost setting interest relates.

Assuming A Co and B Co were equal partners, Head Co will be taken to have two separate partnership cost setting interests in each underlying asset of the partnership (six partnership cost setting interests in total). The tax cost of each partnership cost setting interest will be equal to 50% of the terminating value of the underlying asset to which the interest relates. Therefore, Head Co will have:

·        two partnership cost setting interests in trading stock (each with a tax cost of $50);

·        two partnership cost setting interests in land (each with a tax cost of $100); and

·        two partnership cost setting interests in plant (each with a tax cost of $150).

2.73       Note that, for income tax purposes, when a partnership leaves a consolidated group, the head company will not be taken to have disposed of the underlying assets of the partnership. [Schedule 2, Part 5, item 32, note to subsection 713-255(4)]

2.74       Once the head company has set the tax cost of its partnership cost setting interests in the partnership, it can then determine whether it has made a capital gain or loss on disposal of those interests under the normal CGT rules.

2.75       An additional consequence of a partnership leaving a consolidated group is that the head company will need to set a tax cost for any intra-group assets, such as loans between the group and the partnership. These intra-group transactions would previously have been ignored under the single entity rule.

2.76       Where the leaving entity is not a partnership, sections 701-20 will set the tax cost for head company core purposes of an asset consisting of a liability owed by the leaving entity to the group. Additionally, section 701-45 will set the tax cost, for entity core purposes, of an asset consisting of a liability owed by the group to the leaving entity. Similar rules are required where the leaving entity is a partnership to take into account the unique nature of partnerships. Consequently, section 713-260 will apply where:

·       a partnership ceases to be a member of the consolidated group;

·       an asset becomes an asset of the head company because the single entity rule ceases to apply; and

·       the asset consists of :

-            a partner’s interest in a liability owed by the group to the partnership; or

-            a partner’s share of a liability owed by the partnership to the group.

[Schedule 2, Part 5, item 32, subsection 713-260(1)]

2.77       Under section 713-260 these intra-group assets will have a tax cost equal to the market value of the asset at the leaving time. [Schedule 2, Part 5, item 32, subsection 713-260(2)]

2.78       Where section 701-20 or 701-45 operate to set the tax cost of these types of assets then section 713-260 will not have application.

Example 2.8:  Setting the tax cost of assets consisting of intra-group liabilities

Assume Head Co has lent the Partnership $100 (Loan 1) and the Partnership has lent Head Co $100 (Loan 2). As a result of A Co disposing of some of its partnership cost setting interests in the partnership, the Partnership will cease to be a member of the consolidated group.

Under the single entity rule, the loans to and from the Partnership would not have a tax cost as they would have been ignored for income tax purposes. However, when the Partnership leaves the group, the rules in section 713-260 will enable Head Co to set the tax cost of both of these intra-group assets.

The tax cost setting amount of the asset consisting of Loan 1 (which is a receivable in the hands of Head Co) will be equal to the sum of the market values of each partner’s individual share of the liability of the Partnership (see subparagraph 713-260(1)(c)(ii)). Assuming A Co and B Co were equal partners; each partner will have a 50% share of the $100 liability of the Partnership. Accordingly, Head Co’s tax cost for Loan 1 will be $100, being the sum of the market value of A Co and B Co’s share of the Partnership liability (assuming the original loan amount equals market value).

As with Loan 1, the tax cost of Loan 2 to Head Co will be equal to the sum of the market values of each partner’s interest in the asset of the Partnership. Accordingly, the tax cost will be $100, being the sum of A Co and B Co’s individual interests in the asset of the Partnership.

Multiple entities leaving

2.79       Where two or more entities leave a consolidated group at the same time and one of the leaving entities is a partnership, the multiple exit rules in Division 711 apply, as modified by Subdivision 713-E. Modifications to the multiple exit rules are required because Division 711 relies on the concept of membership interests, which are ignored where the entity concerned is a partnership. Special rules are also required to adjust a partner’s allocable cost amount so that it includes the partner’s share of a partnership’s liabilities and future deductions and to ensure that intra-group assets, which were previously ignored under the single entity rule, are appropriately included when calculating a leaving partner’s allocable cost amount.

2.80       Examples of when the modified rules in Division 711 would apply include where a partnership leaves a consolidated group as a result of a partner leaving or, if a partnership holds membership interests in a lower tier subsidiary and the partnership leaves because the group disposes of some or all of its partnership cost setting interests in the partnership. In both circumstances, more than one entity is leaving the consolidated group at the same time and one of the leaving entities is a partnership.

2.81       As is the case in a ‘normal’ multiple exit case under section 711-55, the modified exit rules operate such that a tax cost is set for membership interests or partnership cost setting interests (where the leaving entity is a partnership) in the lowest subsidiary member before a tax cost is set for any higher tiered subsidiaries (i.e. a ‘bottom-up’ approach is adopted). [Schedule 2, Part 5, item 32, subsection 713-255(5)]

2.82       In order for the multiple exit rules to work appropriately where a partnership is one of the leaving entities, section 711-55 is modified such that:

·       a reference in that section (except in paragraph 711-55(3)(a)) to membership interests, or to the tax cost setting amount of such interests, is taken to be a reference to a partnership cost setting interest in the partnership, or to the tax cost setting amount of such interests; and

·       the head company is required to set the tax cost of its partnership cost setting interests in the partnership by applying subsection 713-255(4).

[Schedule 2, Part 5, item 32, subsection 713-255(5)]

Example 2.9:  Multiple exit case - establishing the tax cost of membership interests and partnership cost setting interests when a partner and a partnership leave a consolidated group

Assume Head Co disposes of all of its membership interests in A Co, both A Co and the Partnership will exit the group. As two or more entities are leaving and one of the leaving entities is a partnership, the modified rules in Division 711 will apply to set the tax cost of Head Co’s partnership cost setting interests in the partnership.

The tax cost of each of Head Co’s partnership cost setting interests will be equal to each partner’s individual share of the terminating value of the underlying asset to which the partnership cost setting interest relates (see paragraph 713-255(5)(b) and subsection 713-255(4)).

Head Co will then determine the tax cost of membership interests in A Co in the usual manner (i.e. by reference to the assets A Co takes with it when it leaves the group), which will include its partnership cost setting interests in the partnership. Head Co may also retain some partnership cost setting interests in the partnership after A Co leaves.



Example 2.10:  Multiple exit case - establishing the tax cost of partnership cost setting interests and membership interests when a partnership and a lower tier subsidiary member leave a consolidated group

If Head Co disposes of any of its partnership cost setting interests in the partnership, both the Partnership and C Co (which is wholly-owned by the partnership) will leave the consolidated group. In accordance with the ordering rules in Division 711, a tax cost must first be set for the membership interests in C Co before a tax cost is set for the partnership cost setting interests in the partnership.

The tax cost of membership interests in C Co are worked out in the usual way, however, the modified rules in Subdivision 713-E apply to work out the tax cost of the partnership cost setting interests in the partnership (see subsections 713-255(1), (4) and (5)).

The tax cost of each of Head Co’s partnership cost setting interests in the partnership will be equal to each partner’s share of the terminating value of the underlying asset to which the partnership cost setting interest relates. One of the underlying assets of the partnership will be the partnership’s membership interests in C Co (whose tax cost is set under Division 711).

Adjustments to leaving partner’s allocable cost amount

2.83       As mentioned above, where a partner leaves a consolidated group, special rules are required in order to ensure that the leaving partner’s allocable cost amount includes the partner’s share of certain partnership attributes. Accordingly, section 713-265 requires that, where a partner leaves a consolidated group, it must adjust its allocable cost amount to include:

·       its share of partnership deductions to which the partnership becomes entitled;

·       its share of liabilities that the partnership owes to the old group; and

·       its share of liabilities owed to the partnership by the old group (which represent assets of the partnership).

2.84       The adjustments to the leaving partner’s allocable cost amount are achieved by modifying the way in which sections 711-35, 711-40 and 711-45 operate.

Modification to step 2 in working out a leaving partner’s allocable cost amount

2.85       Section 711-35 is modified so that it operates as if a deduction to which the partnership becomes entitled were a deduction to which the partner becomes entitled (to the extent of the partner’s individual share of the deduction) and is the same kind of deduction as the partnership deduction [Schedule 2, Part 5, item 32, subsection 713-265(2)] . This adjustment ensures that the value of the partnership deduction is reflected in the allocable cost amount of the partner as the deduction will eventually flow to the partner (via an adjustment to its partnership distributions).

Modifications to step 3 in working out a leaving partner’s allocable cost amount

2.86       The purposes of section 711-40 is to ensure that where members of the old group have liabilities consisting of amounts owing to the leaving entity, the leaving entity is able to include these amounts when calculating its allocable cost amount (as they are assets of the leaving entity). Under the single entity rule, these intra-group assets and liabilities would not have been recognised.

2.87       As no allocable cost amount is worked out for a leaving entity that is a partnership, without modification, section 711-40 will not apply. This would result in a partner not being able to include its share of partnership assets that consist of liabilities owed by members of the group to the partnership in its allocable cost amount. Accordingly, section 711-40 has been modified to treat such assets as being assets of the partner, and not the partnership, to the extent of the partner’s individual share. In other words, the liability is treated as if it is owed to the partner and not the partnership, to the extent of the partner’s share of the liability. [Schedule 2, Part 5, item 32, subsection 713-265(3)]

Modifications to step 4 in working out the leaving partner’s allocable cost amount

2.88       Section 711-45 operates to reduce a leaving entity’s allocable cost amount by the amount of liabilities owed by the leaving entity to the group. As no allocable cost amount is worked out for a partnership, any liabilities of the partnership that are recognised in its statement of financial position which are not liabilities of the partner will not be included in working out a partner’s allocable cost amount. This would result in these liabilities never being included in the leaving partner’s allocable cost amount, even though they are effectively liabilities of the partner.

2.89       Section 711-45 has been modified so that where a partnership liability is recognised in the partnership’s statement of financial position and for that reason is not also included in the partner’s statement of financial position, it is treated as if it was a liability of the partner and not the partnership to the extent of the partner’s share of the partnership liability. This will allow the partner’s share of the partnership liability to be included in step 4 when working out the leaving partner’s allocable cost amount. [Schedule 2, Part 5, item 32, subsection 713-265(4)]

Partnership leaves the group - certain partnership cost setting interests treated as having been acquired before 20 September 1985

2.90       Where an entity that is not a partnership joins a consolidated group, the pre-CGT status of its membership interests are preserved by ‘tagging’ its underlying assets with a pre-CGT factor at the joining time. Where the joining entity is a partner in a partnership, one of its assets will include its partnership cost setting interests in the partnership. Therefore, if any of the membership interests in a partner are pre-CGT, each of its assets, including its partnership cost setting interests (where applicable), will receive a pre-CGT factor at the joining time. This allows the pre-CGT status of membership interests in a joining entity that is not a partnership to be preserved by being ‘stored’ in the cost of the assets of the joining entity.

2.91       If a partnership also joins the consolidated group (either at the same time as the partner or at a later time), any pre-CGT factor that was attached to the partnership cost setting interests of the partner(s) is effectively ‘pushed down’ onto the underlying assets of the partnership via section 713-245. This results in the underlying assets of the partnership receiving a pre-CGT factor at the time the partnership joins the consolidated group.

2.92       Where a partnership leaves a consolidated group and, in doing so, takes with it assets that have a pre-CGT factor, section 713-270 ensures that certain partnership cost setting interests are treated as having been acquired prior to 20 September 1985. This rule is akin to the rules contained in sections 711-65 and 711-70, which apply when the leaving entity is not a partnership.

2.93       Section 713-270 applies when any of the assets of the partnership at the leaving time has a pre-CGT factor under section 713-245 [Schedule 2, Part 5, item 32, subsection 713-270(1)] . This section modifies the operation of sections 711-65 (the basic case) and 711-70 (multiple exit case) by:

·       deeming the pre-CGT factor to be one which was determined under section 705-125 (instead of being determined under section 713-245). This amendment is required because section 711-65 only applies to assets whose pre-CGT factor was determined under section 705-125; and

·       modifying the sections so that, a reference in those sections to membership interests, where the entity is a partnership, is taken to be a reference to partnership cost setting interests that relate to assets of the partnership.

[Schedule 2, Part 5, item 32, paragraphs 713-270(2)(a), (2)(b) and (3)(a)]

2.94       Where the pre-CGT factor of an underlying asset of the partnership is equal to one, the partnership cost setting interest that relates to that asset is treated as being acquired prior to 20 September 1985. [Schedule 2, Part 5, item 32, paragraph 713-270(2)(c)] 

2.95       Where the pre-CGT factor of an underlying asset of the partnership is less than one, the partnership cost setting interest that relates to that asset (the actual interest) is split into two separate partnership cost setting interests. One of these partnership cost setting interests is treated as post-CGT and one is treated as being pre-CGT. The proportion of the actual interest that is treated as pre-CGT is equal to the pre-CGT factor of the actual interest. The pre-CGT factor of this partnership cost setting interest is deemed to be one. The remaining proportion of the actual interest is treated as post-CGT. [Schedule 2, Part 5, item 32, paragraph 713-270(2)(d)]

2.96       The reason for splitting the pre-CGT interests into two separate interests where the pre-CGT factor of the underlying asset of the partnership is less than one, is to remove the ability for taxpayers to choose which partnership cost setting interests are treated as pre-CGT and which are treated as post-CGT. If this requirement was not included and the pre-CGT factor of the underlying assets were, say 0.5, a taxpayer could effectively pick which 50% of its partnership cost setting interests it treats as pre-CGT and which 50% it treats as post-CGT. The provisions, therefore, ensure that taxpayers cannot manipulate the tax treatment of their partnership cost setting interests.

Example 2.11:  Certain partnership cost setting interests treated as having been acquired before 20 September 1985 - single exit case

When A Co disposes of its partnership cost setting interests in the Partnership, the Partnership will leave the consolidated group. Immediately before the Partnership leaves the group, Head Co will cease to recognise the underlying assets of the partnership and begin to recognise partnership cost setting interests in the partnership. Head Co will set the tax cost of its partnership cost setting interests in the partnership by reference to the terminating value of the underlying assets to which the partnership cost setting interest relates.

Because some of the underlying assets that are leaving the group with the Partnership have a pre-CGT factor, section 713-270 will apply to determine the number of partnership cost setting interests that are treated as being acquired prior to 20 September 1985.

Assuming A Co and B Co were equal partners, Head Co will have two partnership cost setting interests in the land of the partnership (held via A Co and B Co), each with a tax cost of $100 (being each partner’s share of the terminating value of the land). As the pre-CGT factor of the land is one, both partnership cost setting interests in the land are treated as pre-CGT (see paragraph 713-270(2)(c)). The income tax consequences of disposing of A Co’s interests is determined under the existing CGT rules.

Prior to applying paragraph 713-270(2)(d), Head Co will also have two partnership cost setting interests in both the equipment and plant of the partnership (four in total). As both of these assets have a pre-CGT factor of less than one (each has a pre-CGT factor of 0.5), each of these partnership cost setting interests is split into two separate interests (see paragraph 713-270(2)(d)). This results in Head Co having four partnership cost setting interests in each of these partnership assets.

Pre-CGT status of partnership cost setting interests in equipment

Prior to applying paragraph 713-270(2)(d), the tax cost of each partnership cost setting interest in the equipment of the partnership will be $50 (assuming A Co and B Co are equal partners), being equal to each partner’s share of the terminating value of the equipment (see subsection 713-255(4)).

Paragraph 713-270(2)(d) results in each of the actual interests being split into two separate interests, one being pre-CGT and one being post-CGT. Accordingly, two of the partnership cost setting interests in the equipment will be treated as pre-CGT assets and two will be treated as post-CGT assets. Those interests that are pre-CGT will have a pre-CGT factor of one for the purposes of paragraph 713-270(2)(c) (see subparagraph 713-270(2)(d)(i)).



The pre-CGT interests will consist of the fraction of the actual interest that equals the pre-CGT factor. In other words, the pre-CGT interests will equal half of the actual interest as the pre-CGT factor is 0.5. This results in the tax cost of each pre-CGT partnership cost setting interest being equal to $25 (0.50  ×  $50). The remaining two post-CGT partnership cost setting interests will also have a tax cost of $25 (being the remainder of the actual interest).

Pre-CGT status of partnership cost setting interests in plant

Applying the same rules to the partnership cost setting interests in the plant, Head Co will have four partnership cost setting interests in total, two of which will be treated as pre-CGT and two of which will be treated as post-CGT. Each partnership cost setting interest will have a tax cost of $12.50 (50%  ×  $50  ×  0.5). The two pre-CGT interests will have a pre-CGT factor of one.

2.97       Where a partnership leaves a consolidated group and another entity leaves at the same time (i.e. a multiple exit case), special rules modify the application of section 711-70 if any assets of the partnership have a pre-CGT factor. [Schedule 2, Part 5, item 32, subsections 713-270(1) and (3)]

2.98       Subsection 713-270(3) modifies the multiple exit case rules so that where a leaving entity is a partnership:

·       a reference in section 711-70 to membership interests is replaced by a reference to partnership cost setting interests; and

·       the requirement in subsection 711-70(4) to apply subsections 711-65(3) to (6) is replaced by a requirement to apply subsection 713-270(2).

2.99       The normal ‘ordering’ rules apply so that the allocable cost amount in the lowest tiered entity must first be worked out before the allocable cost amount of any higher tiered entities is worked out.

Example 2.12:  Certain partnership cost setting interests treated as having been acquired before 20 September 1985 - multiple exit case

Assuming Head Co disposes of some of its partnership cost setting interests in the Partnership (via A Co), both the Partnership and C Co will cease to be members of the consolidated group. As this is a multiple exit case and the Partnership holds some assets that have a pre-CGT factor, subsection 713-270(3) will apply. Assume for the purposes of this example that A Co and B Co are equal partners.

Section 711-70 (unmodified) requires that the cost base of membership interests in C Co be worked out before the cost base of any partnership cost setting interests are worked out. The cost base of membership interests in C Co will be worked out in the usual manner under Division 711. Assuming the old group’s allocable cost amount for C Co is $600, the cost base of each membership interest is $5 ($600/120 shares  =  $5). As the pre-CGT proportion is 50%, 60 of the 120 shares in C Co will be treated as pre-CGT, with each of these shares having a pre-CGT factor of one (see section 711-70). The remaining 60 shares in C Co will be treated as post-CGT. These shares have no pre-CGT factor.

Tax cost setting amount for partnership cost setting interests

The tax cost setting amount of partnership cost setting interests in the underlying assets of the partnership will be determined under section 713-255(4). As some of the underlying assets of the partnership have a pre-CGT factor, regard must also be had to the rules in section 713-270.

Similar to Example 2.11, the old group will have four partnership cost setting interests in equipment and four partnership cost setting interests in plant. This is because the pre-CGT factors of each of these assets is less than one, resulting in each partnership cost setting interest being split into two separate interests (prior to applying paragraph 713-270(2)(d), the old group held two partnership cost setting interests in each asset, one via A Co and one via B Co).

Of the four partnership cost setting interests in equipment, two will be treated as pre-CGT and two will be treated as post-CGT. Those interests that are treated as pre-CGT will have a pre-CGT factor of one for the purposes of applying paragraph 713-270(2)(c). Each pre-CGT interest is comprised of the fraction of the actual interest that equals the pre-CGT factor. This results in the two pre-CGT interests each having a tax cost of $25 ($100  ×  0.5  ×  0.5). The remaining two interests will also have a tax cost of $25, being the remainder (see subparagraph 713-270(2)(d)(ii)).

Applying the same rules to plant, the two pre-CGT partnership cost setting interests will have a tax cost of $20 ($80  ×  0.5  ×  0.5) and a pre-CGT factor of one for the purposes of applying paragraph 713-270(2)(c). The two post-CGT partnership cost setting interests will also have a tax cost of $20, being the remainder.

As the pre-CGT factor of the 60 pre-CGT shares in C Co is one, each partnership cost setting interest in the pre-CGT shares will also be treated as pre-CGT. The post-CGT shares will have no pre-CGT factor. Therefore the partnership cost setting interests in these shares will be treated as post-CGT. The tax cost of the partnership cost setting interests in the post-CGT shares will be equal to the partner’s share of the terminating value of the underlying asset. Each partner will have 30 partnership cost setting interests in the shares of C Co (one for each share). Consequently, as the terminating value of each underlying share is $5, the tax cost of each partnership cost setting interest in each share will also be $5. In total, the group will hold 60 post-CGT partnership cost setting interests (one for each post-CGT share) with a total tax cost of $300 ($5  ×  60).

The old group will also hold 60 pre-CGT partnership cost setting interests in the pre-CGT shares of C Co (each partner will hold 30 interests each). As the pre-CGT factor of each of the pre-CGT shares in C Co is one, there is no need to split these interests into two separate interests. As with the post-CGT interests, the tax cost of each pre-CGT partnership cost setting interest in each share will be $5, being equal to the terminating value of the underlying share.

Treatment of deferred acquisition payments

2.100     Certain commercial arrangements for the acquisition of an entity may provide for the consideration to comprise the payment of a lump sum payment plus a right to one or more future payments (referred to as ‘deferred acquisition payments’). These future payments are usually contingent upon certain events occurring at some later point in time, for example, the acquired entity achieving a specific profit forecast.

2.101     The amendments contained in Schedule 2 to this bill ensure that, for the purposes of working out a joining entity’s allocable cost amount, if a head company makes a deferred acquisition payment (or becomes required to make such a payment) after the entity joins a consolidated group, it will be taken to have always been able to include the payment in the joining entity’s allocable cost amount (in the step 1 calculation). [Schedule 2, Part 6, item 33, subsection 705-65(5B)] 

2.102     This will mean that, when such a payment is made by the head company (or the head company becomes required to make such a payment), it will need to recalculate the joining entity’s allocable cost amount as if the payment was included at the joining time. This is because the head company is taken to have always been able to take that payment into account. Consistent with the current CGT provisions, such payments may be in the form of money or property.

2.103     Currently a payment may not be taken into account at the joining time because, at the joining time, the payment was either not made or was not required to be made. As a result, the payment is not included in the cost base of membership interests in the joining entity at the joining time.

2.104     The joining entity’s allocable cost amount will, as a result of the future event, need to be restated. However, until the payment is made, or required to be made, the original allocable cost amount calculation is correct (as a consequence of the correct application of the CGT rules at that time). Consequently, Subdivision 705-E (which is about adjustments for errors) and CGT event L6 (which provides for a capital gain or loss where an error is made) will not apply.

2.105     Where several deferred acquisition payments are made during one income year, it is expected that the allocable cost amount will only need to be recalculated at the end of that income year and not every time a payment is made. Where there are payments which are made over more than one income year, then it is expected that the allocable cost amount will have to be recalculated for each income year and amended income tax returns lodged (where appropriate) for any prior years.

2.106     If the payment is made, or required to be made, outside of the amendment period, only those returns which can be amended will be able to be adjusted to reflect the effects of restating the allocable cost amount. However, this outcome should be limited to the extent that the deferred acquisition payments do not extend past the amendment period.

Example 2.13:  Recalculation of joining entity’s allocable cost amount when deferred acquisition payment is made (or required to be made)

Assume Head Co acquires A Co on 29 June 2003 for $100 and that Head Co and A Co form a consolidated group on 1 July 2003. The cost base of membership interests in A Co at the joining time is $100.

Assume that as part of acquiring A Co, Head Co agrees to make an additional payment of $100 to the previous owner if A Co has an accounting profit of $150 or more for the year ended 30 June 2004.

Assume that for the year ended 30 June 2004, A Co has an accounting profit of $200. As a result, Head Co is required to pay the previous owner an additional $100. The additional $100 is part of the cost to Head Co of acquiring the membership interests in A Co. Therefore, as soon as Head Co becomes obligated to pay the additional $100, it must recalculate the allocable cost amount for A Co on the basis that it had always paid $200 for A Co. This will result in Head Co having to recalculate the tax cost of A Co’s assets and may also result in Head Co having to lodge an amended income tax return for the year ended 30 June 2004.

Application of transitional cost setting rules to multiple entry consolidated groups

2.107     Division 701 of the Income Tax (Transitional (Provisions) Act 1997 provides for a modified application of the ITAA 1997 for certain consolidated groups (transitional groups) formed in the 2002-2003 and 2003-2004 financial years. Where a consolidated group is formed, with effect, before 1 July 2004, the head company may choose that assets of certain subsidiary members (transitional entities) retain their ‘costs’ for tax purposes. This choice enables existing groups to consolidate without valuing the assets of, or calculating allocable cost amounts for, subsidiary members. Transitional group and transitional entity are defined in section 701-1 of the Income Tax (Transitional Provisions) Act 1997 .

Modified effect of section 701-1 of the Income Tax (Transitional Provisions) Act 1997 for multiple entry consolidated groups

2.108     Part 7 of Schedule 2 to this bill amends Subdivision 719-C of the Income Tax (Transitional Provisions) Act 1997 to modify the application of section 701-1 to MEC groups [Schedule 2, Part 7, item 34, section 719-161] . Where the consolidated group is a MEC group, section 719-161 modifies section 701-1 so that it applies as if the consolidated group mentioned in section 701-1 is a MEC group [Schedule 2, Part 7, item 34, subsection 719-161(1)] .

2.109     The rules relating to groups formed after 1 July 2002 but before 1 July 2003 (subsection 701-1(2) of the Income Tax (Transitional Provisions) Act 1997 ) and to groups formed during the financial year starting on 1 July 2003 (subsection 701-1(3) of the Income Tax (Transitional Provisions) Act 1997 ) do not apply appropriately to MEC groups.

2.110     The problem arises with the definitions of ‘transitional entity’ in paragraphs 701-1(2)(b) and (3)(b), in that they do not apply to:

·       subsidiary entities of non-head company eligible tier-1 companies; and

·       transitional foreign-held indirect subsidiaries.

These subsidiary members of a MEC group cannot be transitional entities because they are not wholly-owned subsidiaries of the future head company.

2.111     It should be noted that neither a transitional foreign-held subsidiary nor an eligible tier-1 company that is not a head company of a MEC group are affected by Division 701-1 of the Income Tax (Transitional Provisions) Act 1997 . This is because neither have the tax cost of their assets reset at joining time (see section 701C-30 of the Income Tax (Transitional Provisions) Act 1997 for transitional foreign-held subsidiaries and section 719-160 of the ITAA 1997 for eligible tier-1 companies).

Group formed after 1 July 2002 but before 1 July 2003

2.112     Where a MEC group comes into existence after 1 July 2002 but before 1 July 2003, the group is a transitional group if at least one entity that became a subsidiary member of the group (on the day the group came into existence) is a transitional entity.

2.113     An entity is a transitional entity if:

·       the entity was a wholly-owned subsidiary of any entity that became a member of the group, and that was an eligible tier-1 company, at the time the MEC group came into existence, and had not been a wholly-owned subsidiary at any time after 1 July 2002 and before the day the MEC group came into existence; or

·       the entity was a wholly-owned subsidiary of any entity that became a member of the group, and that was an eligible tier-1 company, at the time the MEC group came into existence, and had remained a wholly-owned subsidiary from the earliest time after 1 July 2002 until the group came into existence.

[Schedule 2, Part 7, item 34, subsection 719-161(2)]

Group formed during financial year starting on 1 July 2003

2.114     Whe r e a MEC group comes into existence during the financial year starting on 1 July 2003, the group is a transitional group if at least one entity that became a subsidiary member of the group (on the day the group came into existence) is a transitional entity.

2.115     An entity is a transitional entity if:

·       just before 1 July 2003, it was a wholly-owned subsidiary of any entity that became a member of the group, and that was an eligible tier-1 company, at the time the MEC group came into existence; or

·       it remained a wholly-owned subsidiary of any entity that became a member of the group, and that was an eligible tier-1 company, at the time the MEC group came into existence from the earliest time after 1 July 2002 until the group came into existence.

[Schedule 2, Part 7, item 34, subsection 719-161(2)]

Rolldowns

2.116     If an entity is an eligible tier-1 company of a potential MEC group at 30 June 2003 and its shares are transferred to another eligible tier-1 company during the year commencing 1 July 2003 and before the group consolidates (i.e. it becomes a subsidiary of the other eligible tier-1 company), it cannot be a transitional entity under subsection 701-1(3) of the Income Tax (Transitional Provisions) Act 1997 . In this situation, the ‘new’ subsidiary member of the MEC group should be able to be a transitional entity so long as it remains a wholly-owned subsidiary of the future head company.

2.117     Amendment is therefore made so that an entity is a transitional entity, for the purposes of paragraph 701-1(3)(b) if:

·       the entity and another entity were members of a potential MEC group and were eligible tier-1 companies from just before 1 July 2003 until just before a time (the rolldown time), prior to the MEC group coming into existence (see Diagram 2.4);

 

 

 

 

 

 

 

 

 

 

Diagram 2.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



·       at the rolldown time, the entity became a wholly-owned subsidiary of the other entity (see Diagram 2.5);

Diagram 2.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



·       the entity remained a wholly-owned subsidiary of the other entity from the rolldown time until the MEC group came into existence;

·       the other entity remained a member of the potential MEC group as an eligible tier-1 company from just before 1 July 2003 until the MEC group came into existence; and

·       the other entity was an eligible tier-1 company and a member of the MEC group when it came into existence.

[Schedule 2, Part 7, item 34, subsection 719-161(3)]

Foreign losses and the Continuity of Ownership Test concession

2.118     The consolidation legislation provides a ‘3-year COT concession’ for certain company losses. This concession allows company losses that satisfy certain conditions to be utilised by the head entity over three years instead of under the ‘available fraction’ method. One of the conditions for access to this concession is that the company that actually made the loss met the conditions in section 165-12 in respect of the loss. The condition in section 165-12 is the COT. The new law changes the recoupment tests a company with a foreign loss must satisfy to be able to deduct the losses (section 160AFD of the ITAA 1936) from those in the ITAA 1936 to those in the ITAA 1997.

2.119     Paragraph 160AFD(6)(b) of the ITAA 1936 provides that overall foreign losses incurred by a company are deductible only if they satisfy the specified tests in the ITAA 1936. Companies are entitled to deductions for tax losses if the company satisfies the continuity of ownership test or the same business test (Subdivision 165-A). However, the deduction may be denied if income has been injected into a company because of an available tax loss (section 175-10) or an available tax loss has provided a tax benefit to someone else (section 175-15).

2.120     Paragraph 160AFD(6)(b) of the ITAA 1936 has been rewritten to align the treatment of foreign losses in the income tax law with those of other losses. Previous references to the tests in the ITAA 1936 have been replaced by references to the equivalent provisions in the ITAA 1997. The effect of aligning the treatment of foreign losses in the income tax law with that of other losses is that foreign losses are eligible for the ‘3-year COT concession’ contained in section 707-350 of the Income Tax (Transitional Provisions) Act 1997 . [Schedule 2, Part 8, item 35, paragraph 160AFD(6)(b)]

2.121     In applying the recoupment tests for tax losses and net capital losses, the loss year is taken to start at the time the loss was transferred to the head company (subsection 707-205(1)). This ensures that things that happened to the head company before the loss was transferred to it (and which may have already been taken into account in testing the loss for transfer) are not taken into account again. However, the consolidation changes in ownership of a loss company may continue to count in determining whether the continuity of ownership test is passed post-consolidation (section 707-210).

2.122     As these recoupment tests now apply to foreign losses, this rule has been expanded to apply to a loss of any sort which includes an overall foreign loss in respect of any or the four classes of assessable foreign income. The four classes of assessable foreign income are:

·       passive income;

·       offshore banking income;

·       lump sum payments from eligible non-resident non-complying superannuation funds; and

·       other income.

[Schedule 2, Part 8, item 36, subsection 707-205(1)]

Trading stock election in relation to foreign investment fund interests

2.123     There are special rules for valuing interests in FIFs that are trading stock (section 70-70). Generally, trading stock FIF interests are valued at cost unless an election is made to value the FIF interests at market value. The election must be made before the lodgement of the tax return for the first income year in which a notional accounting period of a FIF ends (subsection 70-70(3)). Trading stock interests in FIFs that are valued at market value are excluded from attributable income calculations under Part XI of the ITAA 1936.

2.124     All interests in FIFs that are trading stock must be valued at market value if the election is made. The election also applies to all future trading stock interests in FIFs. If the election is not made, the entity with the interests in the FIFs may have to include FIF income in its assessable income, under Part XI.

2.125     Where entities with interests in FIFs become subsidiary members of a consolidated group, a head company has those interests in FIFs under the single entity rule (section 701-1). The head company must determine whether those FIF interests are trading stock. If the FIF interests are trading stock, the rules allow the head company to make a decision as to whether it would value those interests at market value. The head company can only make a new choice if it has not previously held interests in FIFs as trading stock. [Schedule 2, Part 9, item 42, section 717-292]

2.126     Without the rules, the ordinary application of the entry history rule (section 701-5) in these circumstances would mean the head company was prevented from making the election to value the trading stock FIF interests at market value. This would happen because the head company would be considered to have held a trading stock FIF interest for which a notional accounting period had ended in a previous income year (if that was in fact the case for the subsidiary member).

2.127     The rules essentially prevent the entry history rule from treating the head company as holding the trading stock FIF interests from the time that the subsidiary member held those interests. This means the head company will have to make the market value election in the time required by subsection 70-70(3) as if the head company had just acquired the FIF interests. The head company will only be able to make this election if it had not previously held trading stock FIF interests. The new rules also prevent the head company from being bound by any earlier decisions made by subsidiary members as to how their trading stock FIF interests were valued. [Schedule 2, Part 9, item 41, section 717-285]

2.128     The head company will not be given a chance to change its own decision in relation to the valuation method used for trading stock FIF interests if it had previously held such interests before an entity became a subsidiary member. Any previous decision will apply equally to any new trading stock FIF interests the head company now holds via the subsidiary member.

2.129     As discussed above in relation to the entry history rule, the ordinary application of the exit history rule (section 701-40), may similarly affect the ability of an entity that leaves the group with FIF interests to make a different decision to that of the head company.

2.130     The amendments will allow an entity that leaves a group with FIF interests to make a decision about the valuation method it will use for FIF interests that are trading stock despite the decision made by the head company [Schedule 2, Part 9, item 49, section 717-320] . The leaving entity will not be bound by the decision made by the head company [Schedule 2, Part 9, item 46, section 717-310] .

2.131     Where an entity has trading stock FIF interests that it chooses to value at market value, that entity will be bound by that decision whether or not it joins a consolidated group and later leaves the group. Further, if the entity had not made the election then the fact that it joined a consolidated group would not enable it to change that decision after it left the group. Joining and leaving a consolidated group cannot be used as a way of reversing an earlier decision made under subsection 70-70(2).

Example 2.14

Assume that:

·          A Co is the head company of a consolidated group.

·          A Co does not hold any FIF interests as trading stock at 30 June 2005, the end of its income year. It has also not previously held FIF interests as trading stock.

·          B Co joins the group on 1 July 2005. B Co has FIF interests that are trading stock. B Co has made the election to value the FIF interests at market value. The FIF notional accounting periods end on 30 June.

·          C Co joins the group on 1 January 2007. C Co has FIF interests that are trading stock. C Co has not made the election to value the FIF interests at market value. The FIF notional accounting periods end on 30 June.

·          C Co leaves the group on 1 July 2007 with FIF interests that are trading stock.

When B Co joins the consolidated group, A Co must determine whether or not the FIF interests are trading stock. If the interests are trading stock then A Co can decide whether to value the interests at cost or market value before lodgement of its 2005-2006 tax return. If A Co chooses to value the FIF interests at market value then when C Co joins the group, A Co must decide whether or not C Co’s FIF interests are trading stock. If the interests are trading stock then A Co would have to value those interests at market value.

When C Co leaves the group with its FIF interests it will not be able to elect to value the trading stock FIF interests at market value.

If B Co leaves the group with interests in FIFs, it will have to value all trading stock FIF interests at market value.

Foreign dividend accounts and consolidation

2.132     The current FDA measure in Subdivision B of Division 11A of Part III of the ITAA 1936 was introduced to enable certain foreign source dividends paid to a resident company to be paid to non-resident shareholders free from dividend withholding tax to the extent that Australian company tax is not paid on the foreign dividends. The exemption from dividend withholding tax is provided where a resident company pays an unfranked dividend from the FDA. Broadly, the FDA is credited with foreign non-portfolio dividends and is debited with expenses, including Australian tax, that relate to those dividends. It is also debited with any dividends paid to foreign shareholders on which dividend withholding tax is not paid.

2.133     Current rules ensure the head company of a consolidated group or a provisional head company of a MEC group operate a single FDA. With the introduction of those rules, the grouping rules that were contained in the FDA provisions were phased out.

Provisional head company taken to have paid foreign tax

2.134     Under the operation of the current FDA rules, a credit arises in a FDA when an Australian resident company receives a foreign non-portfolio dividend that is either exempt under section 23AJ of the ITAA 1936 or foreign tax has been paid in relation to the dividend. The credit arises at the time the foreign dividend is received.

2.135     Section 717-10 deems a head company of a consolidated group to have paid the foreign tax that is actually paid by a subsidiary member. Section 719-2 ensures that section 717-10 also operates for a head company of a MEC group. However, section 719-2 does not cause section 717-10 to operate for a provisional head company of a MEC group.

2.136     Where a non-portfolio dividend is included in the assessable income of the head company of the MEC group, the new rules ensure the provisional head company is able to credit the FDA at the time the dividend is received where foreign tax was paid in relation to that dividend.

2.137     To achieve this, the provisional head company of the MEC group will be deemed to have paid any foreign tax actually paid by subsidiary members. [Schedule 2, Part 9, item 50, section 719-903]

Foreign dividend account debit

2.138     The amendments ensure the correct amount of a FDA debit is calculated for a head company of a MEC group where members of a consolidated group have received a non-portfolio dividend for which Australian tax will be paid by the head company. A debit is required for two reasons. First, one is needed to reflect the fact that because of the payment of tax there are fewer profits to distribute. Secondly, a debit is required to avoid an exemption from dividend withholding tax being available under both the FDA provisions and the imputation system. [Schedule 2, Part 9, item 50, subsection 719-903(5)]

Application of the removal of the grouping rules

2.139     Currently, it is not clear whether the FDA grouping rules apply in the situation where some members of a wholly-owned group consolidate but other members do not. This is particularly relevant to potential MEC groups but also applies to foreign loss companies that remain outside a consolidated group.

2.140     The rules will prevent transfers of FDA surpluses where the old FDA grouping rules apply to entities that are not part of a consolidated group and those entities pay a dividend to a related company that is a member of a consolidated group. The rules prevent a credit to the FDA arising for a head company of a consolidated group or a provisional head company of a MEC group when a company outside the group pays a dividend to a related company that is a member of the group. [Schedule 2, Part 9, item 51, subitem 12(5) of Schedule 9 of the New Business Tax System (Consolidation and Other Measures) Act 2003]

2.141     The payment of dividends by members of a consolidated group to related companies is governed by the current FDA rules which no longer allow the transfer of FDA surpluses to related companies by companies that are members of a consolidated group.

2.142     The new rules do not prevent FDA surpluses from being transferred between related companies, within certain transitional periods, where both companies are not members of a consolidated group.

Example 2.15

 

 

 

 

 

 

 

 

 

 



A Co and B Co are companies wholly-owned by a foreign parent, F Co A Co wholly-owns C Co and D Co. B Co owns 80% of E Co and D Co owns the remaining 20%.

A Co, B Co, C Co, D Co and E Co are all related companies that are eligible to form a MEC group, or A Co can form a consolidated group with C Co and D Co as subsidiary members.

On 1 July 2002 A Co, C Co and D Co form a consolidated group. E Co does not qualify as a subsidiary member of A Co’s consolidated group because A Co only holds 20% interest in E Co and not 100%.

E Co pays a dividend to its shareholders on 1 September 2002. E Co is able to pay a dividend to D Co but the dividend will not give rise to a FDA credit for A Co (or D Co as it is a subsidiary member).

The dividend paid to B Co would give rise to a FDA credit if E Co had a FDA surplus at the time it paid the dividend with a FDA declaration percentage.

Foreign tax credits and consolidation

2.143     The following minor amendments to the foreign tax credit provisions in the consolidation rules ensure the provisions operate as intended.

Consolidation foreign tax credit provisions

Head company using transferred excess foreign tax credits

2.144     Section 717-15 deals with the transfer of excess foreign tax credits from entities that become subsidiary members of a consolidated group to the head company of the group. This provision also enables the head company to appropriately use those excess credits.

2.145     Currently, secti o n 717-15 allows the head company to use excess foreign tax credits at the end of its income year from subsidiary members that joined the group before the beginning of that income year.

2.146     A minor amendment to subparagraph 717-15(1)(b)(i) ensures that the head company of a consolidated group can use excess foreign tax credits of subsidiary members at the end of its income year where those entities became subsidiary members at or before the start of the head company’s income year. [Schedule 2, Part 9, item 52, subparagraph 717-15(1)(b)(i) ]

Head company with a different year of income to a joining entity with excess foreign tax credits

2.147     Section 717-15 operates for entities with ordinary income years. It also generally operates appropriately for entities with a substituted accounting period. However, where the head company has a later balancing date for an income year to that of the joining entity, any excess foreign tax credits that the joining entity has for part of an income year ending at the time it joins the group (a non-membership period) may not be able to be used by the head company at an appropriate time. (See the diagram in Example 2.16.)

Example 2.16

JE (a joining entity) has an early balancing substituted accounting period (SAP). It joins a group before the beginning of the head company’s (HC) income year. HC does not have a SAP.

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Under the current operation of section 717-15, HC would not be able to use any excess foreign tax credits that JE may have in relation to the non-membership period (NMP) ending at the joining time until the end of the 2006-2007 income year. It is unable to use the excess credits at the end of the 2005-2006 income year because the NMP excess credits do not relate to an earlier income year in that case, something required by section 717-15. However, the head company should be able to use the NMP excess foreign tax credits at the end of the 2005-2006 income year because the joining time was at or before the start of that income year. The new rules achieve this result.

If all the NMP excess foreign tax credits are not used HC will amalgamate those credits with any other excess foreign tax credits that may arise at the end of the 2005-2006 income year.

2.148     Section 717-22 ensures a joining entity’s non-membership period will be treated as an earlier income year where the following conditions are met:

·       the head company and the joining entity have different balancing days for the same income year;

·       the entity joins the consolidated group at or before the first day of the income year of the head company and not on the first day of its own income year; and

·       the non-membership period for the joining entity relates to the same income year as the year of income of the head company that follows the joining time.

[Schedule 2, Part 9, item 56, section 717-22]

2.149     In these circumstances, the head company is able to use the excess foreign tax credits for the non-membership period at the end of the first income year that commences on or after the joining time (providing the other conditions for using excess foreign tax credits are met). [Schedule 2, Part 9, item 56, subsection 717-22(2), item 1 in the table]

2.150     Where the head company does not use all the excess foreign tax credits from such a non-membership period, those excess foreign tax credits are amalgamated with any excess foreign tax credits that the head company may have in relation to that first income year [Schedule 2, Part 9, item 56, subsection 717-22(2), item 2 in the table] . The head company can carry forward the excess foreign tax credits from both its income year and the non-membership period.

Excess foreign tax credits do not leave with a subsidiary member

2.151     Where an entity joins a consolidated group only the head company can use the excess foreign tax credits of that entity.

2.152     Where the entity subsequently leaves the consolidated group, it will not be able to use the excess foreign tax credits that it may have had prior to joining the group [Schedule 2, Part 9, item 56, section 717-28] . Under section 717-30, the entity will also not have excess foreign tax credits that relate to a period that it was a subsidiary member of a consolidated group.

2.153     These rules apply whether or not the entity becomes a member of another consolidated group or remains a separate entity.

Collection and recovery rules

2.154     Division 721 contains the consolidation collection and recovery rules for circumstances when the head company fails to meet its income tax-related liability. Broadly, where the head company fails to satisfy a group liability by the time that it becomes due and payable, each contributing member becomes jointly and severally liable for that liability. Contributing members can avoid joint and several liability if the group liability was covered by a valid tax sharing agreement that allocates the liability between the members of the group on a reasonable basis.

2.155     Part 10 of Schedule 2 to this bill provides greater flexibility and certainty to Division 721 by modifying the clear exit rule and the PAYG instalment liability rules, clarifying that a group liability can be subject to only one tax sharing agreement, and updating outdated legislative references.

Former contributing member to provide the tax sharing agreement to the Commissioner of Taxation in certain circumstances

2.156     Amendments made by this bill will expand the scope of subsection 721-25(3) to allow, in certain circumstances, a former contributing member which has complied with the clear exit provisions to provide the relevant tax sharing agreement to the Commissioner and thereby avoid joint and several liability for a group liability. [Schedule 2, Part 10, item 59, subsection 721-15(3A)]

2.157     The current effect of subsection 721-25(3) is that only the head company is allowed to provide the tax sharing agreement to the Commissioner when requested. If the head company fails to provide the tax sharing agreement to the Commissioner within 14 days of the request, the group liability is taken never to have been covered by a tax sharing agreement, and, consequently, the contributing members become jointly and severally liable for the group liability.

2.158     This result is inappropriate for an exited entity purporting to rely on the clear exit provisions. In these circumstances, without the tax sharing agreement, the exited entity cannot demonstrate to the Commissioner how the clear exit amount (a reasonable estimate of its share of the group liability based on the tax sharing agreement allocation) was calculated, and the Commissioner does not have the ability to consider whether this amount is reasonable.

2.159     This amendment will allow an exited entity to avoid joint and several liability for the group liability if the exited entity complies with the following conditions:

·       the group liability is taken never to have been covered by a tax sharing agreement due to the head company’s failure to provide the tax sharing agreement to the Commissioner within 14 days, pursuant to subsection 721-25(3) [Schedule 2, Part 10, item 59, paragraph 721-15(3A)(a)] ;

·       the Commissioner issued the contributing member written notice of the group liability [Schedule 2, Part 10, item 59, paragraph 721-15(3A)(b)] ;

·       the contributing member, to the best of its knowledge, left the group clear of the group liability in accordance with section 721-35 [Schedule 2, Part 10, item 59, paragraph 721-15(3A)(c)] ; and

·       the contributing member provides the tax sharing agreement to the Commissioner before its joint and several liability became due and payable [Schedule 2, Part 10, item 59, paragraph 721-15(3A)(d)] .

2.160     The first condition provides the basis for establishing that, under subsection 721-25(3), the group liability was taken never to have been covered by the tax sharing agreement, and, hence, the contributing members become jointly and severally liable for the debt. [Schedule 2, Part 10, item 59, paragraph 721-15(3A)(a)]  

2.161     The second condition provides that the Commissioner must issue the former contributing member written notice of the group liability under subsection 721-15(5) before the former contributing member is able to provide the tax sharing agreement to the Commissioner. The exited entity cannot provide the tax sharing agreement before such a request. This approach was taken because the exited entity may not be aware that its former head company has failed to provide the tax sharing agreement until it receives notice from the Commissioner to contribute to the group liability. In addition, this approach provides administration savings for the Australian Taxation Office. [Schedule 2, Part 10, item 59, paragraph 721-15(3A)(b)]

2.162     Further, this provision of the tax sharing agreement by the exited member will only operate for that exited member; the remaining members (including any other exited entity that has not taken advantage of this amendment) will be jointly and severally liable for the group liability.

2.163     The third condition provides that the exited entity must have attempted to utilise the clear exit provisions in section 721-35. These provisions allow the exiting entity which is party to a tax sharing agreement to pay to the head company a reasonable estimate of its share of the group liability, based on the allocation in the tax sharing agreement. However, without this amendment, the exited entity will not be able to rely on the tax sharing agreement if the head company does not provide the tax sharing agreement to the Commissioner. [Schedule 2, Part 10, item 59, paragraph 721-15(3A)(c)]

2.164     This amendment does not affect the other requirements for a clear exit in section 721-35, such as the requirement to exit the group before the head company’s due time. The effect of this amendment is that if the Commissioner determines that the tax sharing agreement complies with these requirements, the exited entity’s clear exit will not be precluded by virtue of the operation of subsection 721-25(3).

2.165     If the Commissioner were to determine that the tax sharing agreement was invalid, pursuant to subsection 721-15(1) the former contributing member will remain jointly and severally liable for the group liability.

2.166     The fourth condition requires the exited entity to provide the tax sharing agreement before its joint and several liability becomes due and payable. This will be 14 days after the Commissioner gives the member written notice of the liability. [Schedule 2, Part 10, item 59, paragraph 721-15(3A)(d)]

2.167     For general interest charge (GIC), the joint and several liability becomes due and payable on the day the notice is given, but will then be extinguished if the contributing member gives the tax sharing agreement to the Commissioner within 14 days. For each day that the GIC liability remains unpaid, subsection 721-17(2) provides that the Commissioner is taken to issue a new notice for each subsequent day. This provision is ignored so that for GIC liability the taxpayer must provide the tax sharing agreement within 14 days after the initial notice is given.

2.168     The fourth condition will also operate for all of the group liabilities reasonably allocated by the tax sharing agreement, if, at a later stage, the Commissioners seeks to recover any of those liabilities from the exited entity. This is on the condition that the tax sharing agreement appropriately describes the exited entity’s allocation of the new group liability (in addition to describing the original liability) and at that later date the tax sharing agreement contains all the information for the Commissioner to determine if the new liability is reasonably allocated. [Schedule 2, Part 10, item 59, paragraph 721-15(3A)(d)]

Head company liable for own quarterly pay as you go instalments before consolidated rate given

2.169     Amendments made by this bill will ensure that the quarterly PAYG instalment liability in item 30 in the table in subsection 721-10(2) does not include a head company’s quarterly PAYG instalment liability relating to the period before the quarter in which the head company is given a consolidated PAYG instalment rate. [Schedule 2, Part 10, item 58, subsection 721-10(3)]

2.170     Without this amendment, the reference to a PAYG instalment liability in item 30 in could include a PAYG instalment liability of the head company for a quarter before the quarter in which the head company receives a consolidated PAYG instalment rate from the Commissioner. Under the consolidation liability rules, liability for this instalment would then fall to the contributing members in the event of the head company defaulting. Prior to the quarter in which the group receives a consolidated PAYG instalment rate, each entity in the group continues to be liable for its own quarterly PAYG instalment at its previously determined rate. Each member continuing to pay its own respective PAYG instalment in this period is analogous to each member meeting its share of the group’s quarterly PAYG instalment liability.

2.171     Amendments made by this bill will prevent contributing members from being subjected to a quarterly PAYG instalment liability which is entirely attributable to the head company’s own activities.

2.172     This change does not affect the head company becoming liable for meeting the PAYG instalments on behalf of the group from the quarter in which the Commissioner has determined the group’s consolidated PAYG instalment rate.

2.173     This change is restricted to the quarters before the quarter in which the head company receives its consolidated PAYG instalment rate because of the effect of the following provisions:

·       section 45-705 of Schedule 1 to the TAA 1953, which ensures that the head company of a consolidated group, provisional head company of a MEC group or interposed head company will be liable for the group’s quarterly PAYG instalment from the beginning of the quarter in which the consolidated PAYG rate is given; and

·       section 45-61 of Schedule 1 to the TAA 1953, which provides that the liability for the quarter’s instalment is due on or before the 21 st day of the month after the end of the instalment quarter. Accordingly, the subsidiary members will not have already contributed their PAYG instalments for the same quarter that the head company is given the consolidated rate.

2.174     If a head company is interposed in a quarter before the group is given a consolidated PAYG rate from the Commissioner, this amendment will operate to exclude the interposed head company’s PAYG instalment liability from the group liability in item 30. Under section 45-740 of Schedule 1 to the TAA 1953, unlike other consolidation attributes, the PAYG instalment liability attributes of the original head company will not be treated as those of the interposed head company until the quarter in which the group is given a consolidated PAYG rate by the Commissioner.

2.175     The original head company remains liable for its PAYG instalment liability if a head company is interposed in a quarter before the quarter in which the group receives a consolidated PAYG rate. This is because the original head company’s PAYG instalment liability is not considered part of the interposed head company’s own PAYG instalment, and, hence, not a group liability, but instead is considered to be a liability of a subsidiary member.

Applying pay as you go instalment credits to income tax liability

2.176     Amendments made by this bill will allow a consolidated group to allocate a tax sharing agreement contribution amount for the group’s income tax-related liability that is either the total amount or an amount equal to the total less the PAYG instalment credits available to the head company on assessment. [Schedule 2, Part 10, item 60, subsection 721-25(1A)]

2.177     The group’s income tax-related liability is represented in item 25 in the table in subsection 721-10(2). This change provides that the requirement in paragraph 721-25(1)(c) (that the total amount be allocated) will be taken to be satisfied if an amount equal to the difference between the total liability and the PAYG instalment credits available to the head company on assessment is allocated instead of the total amount. This is the net amount the head company is required to pay to the Commissioner.

2.178     The change will not have the effect of treating an allocation of the total amount as unreasonable. If the group wishes instead to allocate the total amount, paragraph 721-25(1)(c) continues to allow the group to do so. The change provides an alternative way to satisfy this provision depending on the group’s circumstances.

2.179     Paragraph 721-25(1A)(b) requires that PAYG instalment credits have arisen before, at or after the head company’s due time. Section 45-30 of Schedule 1 of the TAA 1953 provides that the credits do not arise until the Commissioner makes an assessment of income tax. However, due to the self assessment system (pursuant to paragraph 166A(3)(d) of the ITAA 1936), the Commissioner is taken to have made an assessment on the day on which the return is lodged and this could occur at a time after the head company’s due time. [Schedule 2, Part 10, item 60, paragraph 721-25(1A)(b)]

2.180     Under subsection 721-25(1), these agreements are required to be in place just before the head company’s due time. It is acknowledged that the practical effect of this will be that groups will formulate their tax sharing agreements at a time before the assessment in contemplation of these credits arising on assessment. [Schedule 2, Part 10, item 60, paragraph 721-25(1A)(b)]

2.181     The relevant credits include the group’s consolidation PAYG instalment credits (section 45-30 of Schedule 1 to the TAA 1953) and those that arise for a head company during a consolidation transitional year (section 45-865 of Schedule 1 to the TAA 1953).

2.182     A tax sharing agreement that purports to utilise this amendment needs to be in a form that deals appropriately with entries and exits of group members before the end of the relevant income year. This is because paragraph 721-25(1A)(c) requires an allocation for each of the tax sharing agreement contributing members in relation to the group liability. [Schedule 2, Part 10, item 60, paragraph 721-25(1A)(c)]

One tax sharing agreement

2.183     Amendments made by this bill also clarify the intended operation of the law relating to the number of tax sharing agreements that a group is allowed to utilise to allocate the group liability among contributing members. The object of the tax sharing agreement provisions is that there should be a reasonable allocation of a group liability among one or more group members in accordance with a single agreement. [Schedule 2, Part 10, item 60, subsection 721-25(1B)]

2.184     This does not mean that each individual group liability as described in the table in subsection 721-10(2) must be the subject of a separate tax sharing agreement. A group’s tax sharing agreement can contemplate any number of group liabilities; however, a group cannot have two or more separate tax sharing agreements dealing with the same liability. Similarly, a group may have more than one tax sharing agreement provided the liabilities dealt with by one tax sharing agreement are not dealt with in any of the others. A tax sharing agreement that contemplates more than one group liability must be the only tax sharing agreement dealing with those liabilities.

2.185     Further, the tax sharing agreement can incorporate one or more contributing members. Only members of the group who contribute to the tax-related liability allocated by the tax sharing agreement need be included, as to include other members may be considered unreasonable.

Example 2.17

The WXYZ Group is a consolidated group consisting of the head company, W Co, and subsidiaries, X Co, Y Co, and Z Co. Apart from Z Co, the group is engaged in importing computer hardware from Taiwan and Vietnam. Z Co’s sole function is to provide corporate services to the importing arms of the group.

When allocating the group’s income tax-related liability (item 25 in the table in subsection 721-10(2)) in a tax sharing agreement, the group allocates the liability to X Co and Y Co as contributing members. The group considers it reasonable not to allocate any of this liability to Z Co as it is not engaged in any income generating function outside the group.

2.186     The effect of this change will be to void all of the tax sharing agreements that attempt to allocate the same group liability. If groups wish to replace an earlier tax sharing agreement with a later tax sharing agreement dealing with the same liability, they should ensure that the later tax sharing agreement completely voids the earlier allocation. If the later tax sharing agreement does not wholly replace the earlier allocation, it and the earlier allocation will be void.

Franking liabilities

2.187     The table in subsection 721-10(2) lists the tax-related liabilities of the head company and the periods to which the liabilities relate for the purposes of Division 721. The table includes items that refer to liabilities arising under the imputation system. These provisions have since been rewritten into the ITAA 1997, and, consequently, this bill updates the references to reflect the new provisions. [Schedule 2, Part 10, item 57, subsection 721-10(2), items 10, 15 and 20 in the table]

2.188     Item 20 refers to subsection 214-150(3) franking tax - amended assessments otherwise than because of deficit deferral. This concept did not previously exist in the ITAA 1936 and therefore reference to this liability has been introduced to reflect the new scope of that provision. [Schedule 2, Part 10, item 57, subsection 721-10(2), item 20 in the table ]

2.189     Similarly, in the redrafted imputation rules the concept of deficit deferral tax, which was contemplated in previous item 20 in the table, no longer applies. However, a similar effect is achieved by subsection 214-150(4) with an application of franking deficit tax liability. This concept has been reflected in item 22. [Schedule 2, Part 10, item 57, subsection 721-10(2), item 22 in the table ]

2.190     Further, the periods to which these liabilities relate have been amended so they are aligned with periods provided for in the liability provisions themselves.

2.191     The period for item 10 in the table will refer to the income year to which the franking tax relates, as opposed to the income year in which the franking tax becomes due and payable. The income year to which the franking tax relates is the income year before the income year in which the franking tax becomes due and payable. [Schedule 2, Part 10, item 57, subsection 721-10(2), item 10 in the table ]

Calculation of cost base and reduced cost base - assumed capital gains tax event

2.192     Under some of the existing CGT provisions, in order to work out the cost base or reduced cost base of a CGT asset, a CGT event is required. For example, subsection 110-25(2) (which includes certain capital expenditure incurred to increase an asset’s value in the asset’s cost base) and subsection 110-37(1) (which excludes from the cost base certain deductible expenditure). This is in contrast to the generality of the cost base and reduced cost base provisions of Division 110 of the ITAA 1997, which make no reference to a CGT event.

2.193     The intention of Division 110 was that the cost base or reduced cost base of a CGT asset should be able to be worked out at any particular time, regardless of whether there is a CGT event or not at that time (i.e. it is a ‘running balance’). Consequently, the amendments contained in Part 11 of Schedule 2 to this bill have been inserted to clarify the operation of Division 110.

2.194     This issue is of particular importance within the consolidation context, where, for certain purposes (e.g. where an entity joins a consolidated group), the group must determine the cost base or reduced cost base of its membership interests in a joining entity. In order to ensure that the correct cost base or reduced cost base is used, it is necessary for the group to assume that a CGT event occurs at the joining time. This is required so that any adjustments to the cost base or reduced cost base (e.g. indexation) can be taken into account at the joining time. As joining a consolidated group is not a CGT event, without the amendments contained in Part 11 of Schedule 2 to this bill, it may be argued that such adjustments would not occur. This is not the intended operation of Division 110 or Part 3-90.

2.195     The amendments to sections 110-25 and 110-55 ensure that:

·       if it is necessary to work out the cost base or reduced cost base of an asset at a particular time; and

·       a CGT event does not happen in relation to the asset at or just after that time then,

it is assumed that a CGT event has occurred in relation to the asset at or just after that time (but only for the purposes of working out the cost base or reduced cost base). [Schedule 2, Part 11, items 62 and 63, subsections 110-25(12) and 110-55(10)]

2.196     It is important to note that the amendments only assume a CGT event for the purposes of working out the cost base or reduced cost base of the asset. The amendments do not ‘refresh’ the acquisition time of the CGT asset, nor do they result in any of the elements of the cost base or reduced cost base becoming the first element (i.e. each element retains its character).

Interaction with the Financial Corporations (Transfer of Assets and Liabilities) Act 1993

2.197     The Financial Corporations (Transfer of Assets and Liabilities) Act 1993 ensures that foreign banks currently operating as an authorised bank subsidiary or money market corporation are not put at a disadvantage compared to new foreign bank entrants as a result of establishing branch banking operations in Australia.

2.198     Part 3 of the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 enables financial corporations to restructure their business at least cost. Part 3 achieves this by modifying certain provisions of the ITAA 1936 and the ITAA 1997.

2.199     When a consolidated group is formed, the group is treated as a single entity for income tax purposes. Broadly, this means on joining a consolidated group, the subsidiary members lose their income tax identities and are treated as parts of the head company of the consolidated group (rather than as separate entities) for the purposes of determining the head company’s income tax liability. In addition a consolidated group inherits the history of the joining entity. This means, things that happened to an entity before it became a subsidiary member of the group are attributed to the head company of the group.

2.200     Furthermore, when an entity becomes a subsidiary member of a consolidated group the membership interests in the entity held by the group are ignored and the cost, for tax purposes, of the assets which become those of the head company is set in accordance with the cost setting rules. These rules recognise the cost of the assets as an amount reflecting the group’s cost of acquiring the entity.

2.201     This bill amends Part 3 of the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 to modify its operation in relation to transfers of assets and liabilities from financial corporations that are subsidiary members of consolidated and MEC groups [Schedule 2, Part 12, item 65, subsection 14A(2)] . The object of section 14A is to ensure that, where appropriate, Part 3 applies consistently with the consolidation regime:

·       to affect the income tax position of the head company, rather than that of the subsidiary making the transfer; and

·       to determine the income tax position of the corporation receiving the transfer by reference to the income tax attributes of the head company.

[Schedule 2, Part 12, item 65, subsection 14A(1)]

2.202     This is achieved by modifying the provisions in Part 3 so that they apply consistently with the consolidation regime. Even though the head company of the group is not a financial corporation, the provisions will operate as if it were.

2.203     The provisions will apply to the head company in the same way as they would apply to the transferring corporation [Schedule 2, Part 12, item 65, subsection 14A(3)] . For example, subsection 15(1) determines the tax treatment of a transferring corporation for asset transfers. Broadly, it provides that when determining whether an amount is included in the assessable income of a transferring corporation as a result of an asset transfer, the transferring corporation is treated as if the transfer had not occurred. Where the transferring corporation is a subsidiary member of a consolidated or MEC group, subsection 15(1) is modified by subsection 14A(3) to apply to the head company - that is, when determining whether an amount is included in the assessable income of a head company, the head company is treated as if the transfer had not occurred.

2.204     The amendments in Part 3 of the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 will ensure that where the law affects the receiving corporation it does so on the basis of the consolidation rules applicable to the head company of the group. For example where an entity brought into a consolidated group has a cost base, that cost base will be reset by the head company’s tax cost setting once that entity becomes a subsidiary member of a consolidated group. [Schedule 2, Part 12, item 65, subsection 14A(4)]

2.205     To avoid doubt section 20, section 23, or Division 8 (which are about transfers of net capital losses, tax losses, and interest withholding tax), will not be affected by Part 3 of the Financial Corporations (Transfer of Assets and Liabilities) Act 1993 . This is because Subdivision 707-A of the ITAA 1997 prevents a subsidiary member of such a group from having such a loss to transfer to the receiving corporation. [Schedule 2, Part 12, item 65, subsection 14A(5)]

Tax cost setting for privatised assets

2.206     The amendments contained in Part 13 to Schedule 2 to this bill ensure an appropriate interaction between the consolidation regime and Division 58, former Division 58, Subdivisions 57-I and 57-J of Schedule 2D to the ITAA 1936 and section 61A of the ITAA 1936 (referred to as the privatised asset provisions). This is achieved by inserting special cost setting rules into the consolidation regime to appropriately cap the tax cost of depreciating assets of tax exempt or previously privatised entities that join a consolidated group.

2.207     Because tax exempt entities are not subject to balancing adjustment events, the absence of special rules (such as Division 58) would enable values to be shifted into depreciating assets and higher tax benefits to be claimed by the newly privatised business through greater tax depreciation deductions. The privatised asset rules generally apply where a tax exempt entity becomes to some extent a taxable entity or, in some cases, where assets are purchased in connection with a business by a taxable entity from an exempt entity.

2.208     Under the consolidation cost setting rules, where a consolidated group acquires a privatised entity (whether this is as a result of a past or prospective privatisation), the allocable cost amount for the privatised entity is based on the purchase price paid for the entity. This allocable cost amount will be allocated to the individual assets according to the consolidation regime’s market valuation mechanism and it is possible that the value of depreciating assets could be increased above the ‘capped’ value required by the privatised asset provisions. When an entity leaves the consolidated group, the entity would also continue to depreciate the asset from the higher value.

2.209     The consolidation regime did not previously contain rules to ensure that the tax cost of depreciating assets are appropriately capped where a tax exempt asset or entity (or a previously privatised asset or entity) becomes held by a consolidated group. In the absence of these amendments, that insert a cap into the consolidation cost setting rules, Division 58 would be overridden and past (and prospective) privatised assets and entities would be treated in the same manner as taxable assets and entities.

2.210     These amendments prevent this adverse outcome by inserting into the consolidation regime a cap on the cost setting amount that the head company of a joined group can use for determining deductions for the decline in value of a depreciating asset in a similar way to how the privatised asset provisions limit deductions for privatised assets.

2.211     The amendments made by Part 13 of Schedule 2:

·       trigger the operation of Division 58 and Division 57 of Schedule 2D to the ITAA 1936 immediately before an entity joins a consolidated group where the joining results in the entity ceasing to be a tax exempt entity;

·       cap (by reducing) the tax cost setting amount for depreciating assets of a privatised or formerly privatised entity (including in appropriate circumstances where an asset joins another consolidated group and has not been held by a previous consolidated group for at least 24 months or where the groups are associates); and

·       adds back the reduction (by increasing the step 1 amount of working out the allocable cost amount) in the tax cost where the assets leave the consolidated group in an entity (including adding back an appropriate amount where the privatised asset was brought into the consolidated group by a ‘chosen transitional entity’).

Background to the privatised asset provisions

2.212     The income tax law contains a number of regimes (some now repealed but with transitional application) to provide appropriate rules for the transfer of assets from a non-taxable entity to a taxable entity.

2.213     The current version of Division 58 (which commenced on 1 July 2001) applies where a tax exempt entity becomes taxable to any extent (an ‘entity sale’) or where a taxable entity acquires depreciating assets from a tax exempt entity in connection with the acquisition of a business from the exempt entity (an ‘asset sale’). The entity or asset sale must have occurred on or after 1 July 2001 including where the asset was acquired by the previously exempt entity or by the tax exempt vendor in an asset sale before that date.

2.214     The former version of Division 58 (which operated from 4 August 1997 to 30 June 2001) also applied to both entity and asset sales.

2.215     The former Division 58 replaced Subdivision 57-I and 57-J of Division 57 of Schedule 2D to the ITAA 1936 which applied to ‘transition taxpayers’ that became taxable on or after 3 July 1995. Under Division 57, Subdivision 57-I determined the deduction allowable to the transition taxpayer in respect of any period after the transition time for depreciation of a unit of property, if the property was owned by the taxpayer at the transition time. Subdivision 57-J modified the deduction rules to operate, for the income year in which the transition occurred and for later income years, as though the taxpayer’s income had never been exempt from income tax.

2.216     Division 57 also ensures that only those gains and losses, expenditure and receipts, which relate to the period after the transition were relevant to determining the tax liability. Certain Subdivisions of Division 57 are still operative and apply to privatisations that occur after 3 July 1995.

2.217     Section 61A of the ITAA 1936 clarified the operation of the depreciation provisions in respect of tax exempt entities that became taxable at any time between 1 July 1998 and 2 July 1995. Section 61A ensured that the depreciable assets of tax exempt entities which became taxable were brought into the tax system, for the purposes of the depreciation provisions, at their notional written down values as if they had always been used wholly for the purposes of producing assessable income.

Division 58 continues to operate for asset sales into a consolidated group

2.218     The amendments do not cover situations where a privatisation occurs by way of an asset sale directly into a consolidated group. This is because Division 58 applies in these situations without the need for any amendment to the consolidation rules. Division 58 will operate to appropriately cap the tax cost for the depreciating assets that are acquired in connection with a business from a tax exempt entity.

When the privatised asset provisions are triggered

2.219     When an entity, ceases to be a tax exempt entity because it joins a consolidated group (and therefore has its activities subject to tax as a result of being treated as part of the head company of the consolidated group under the single entity rule), then it is necessary to ensure that Division 58 and Division 57 of Schedule 2D to the ITAA 1936 apply. To ensure that those Divisions operate in these circumstances section 715-900 provides that the transition time (being the time that the entity ceases to be tax exempt) is taken to have occurred immediately before the joining time. [Schedule 2, Part 13, item 74, subsection 715-900(1)]

2.220     Section 715-900 ensures that entities which are subject to the privatised asset provisions as a result of a simultaneous transition and joining time are treated in the same manner as entities that join a consolidated group in circumstances where there has been a delay between the transition and joining times.

2.221     The effect of triggering the operation of Division 58, in the simultaneous transition case, will ensure that Division 58 operates to limit the adjustable value for the depreciating assets of the entity just before it joins a consolidated group. This has the effect of providing the joining entity with a terminating value for the depreciating asset which has been subject to the capping under Division 58. [Schedule 2, Part 13, item 74, subsection 715-900(2)]

2.222     The joining entity will also, in these circumstances, have to apply Division 58 to determine the deductions for decline in value that would have been available to the joining entity. This operates to provide the joining entity with relevant ‘history’ in relation to such things as the choice of method of depreciation which will be relevant in applying the capital allowance provisions in relation to the asset for the head company as a consequence of subsection 701-55(2).

2.223        As mentioned above parts of Division 57 of Schedule 2D to the ITAA 1936 remain operative and do things other than limit the cost of depreciating assets. Therefore, section 715-900 triggers these provisions in addition to the Division 58 capping rules. [Schedule 2, Part 13, item 74, subsection 715-900(2)]  

2.224     Broadly, Division 57 ensures that gains and losses, expenditure and receipts that relate to the period after the transition are appropriately taxed. For example, they determine what income is derived by the transition taxpayer at or after the transition time for services rendered by it, for goods provided by it or for any other things done by it before the transition time is treated as having been derived before the transition time.

Capping the tax cost setting amount of privatised assets

2.225        Section 705-47 ensures that where an entity that joins a consolidated group which holds a depreciating asset that has been subject to the privatised asset provisions (including as a consequence of the effect of section 715-900), the tax cost setting amount allocated to that asset is capped for depreciation purposes. The tax cost is capped by reference to the capped amount arising from the direct or indirect operation of the privatised asset provisions. For example, as a result of the operation of:

·       section 61A of the ITAA 1936 (which applied to tax exempt entities that became taxable between 1 July 1998 and 2 July 1995);

·       Subdivision 57-I or 57-J in Schedule 2D to the ITAA 1936 (which applied to tax exempt entities that became taxable between 3 July 1995 and 3 August 1997);

·       former Division 58 (which applied to tax exempt entities that became taxable and to asset sales in connection with a business from a tax exempt entity between 4 August 1997 and 30 June 2001); or

·       current Division 58 (which applies to tax exempt entities that became taxable and to asset sales in connection with a business from a tax exempt entity from 1 July 2001).

[Schedule 2, Part 13, item 67, subsection 705-47(1)]

2.226     The tax cost setting amounts allocated to privatised assets are capped to maintain two interrelated objectives of the privatised asset provisions by not re-allocating reduction amounts among other assets of the joining entity. The objectives are to ensure that there is no transfer of tax benefit to the tax exempt entity at the time of privatisation and that the purchasing company’s capital allowance deductions are capped.

2.227     A depreciating asset that an entity brings into a consolidated group when it becomes a subsidiary member will have its tax cost capped, that is, reduced to the joining entity’s terminating value for the asset (being the tax cost immediately prior to consolidation) where:

·       before the joining entity became a subsidiary member, the asset was held by an entity (not necessarily the same entity) that was tax exempt (i.e. an exempt Australian government agency or another entity whose income was exempt from tax);

·       the privatised asset provisions had directly or indirectly affected the amount that the joining entity could deduct for the asset; and

·       the tax cost setting amount (ignoring the operation of section 705-47) would have exceeded the joining entity’s terminating value.

[Schedule 2, Part 13, item 67, subsection 705-47(2)]

2.228     Cost setting amounts are capped where either the privatised asset provisions are triggered by the joining entity entering the consolidated group (because of the operation of section 715-900) or where the privatised asset provisions had previously applied to the privatised asset of the joining entity. Triggering the privatised asset provisions where they had previously applied prevents inappropriate tax benefit transfers by way of an immediate on-sale of an exempt asset after the cost setting rules have removed the effects of the capping through resetting the tax cost for the assets.

2.229     An example of where entry to a consolidated group triggers the privatised asset provisions is where the entity was exempt prior to entering the group at which time it will have become taxable.

2.230     Examples of where the privatised asset provisions had previously applied to the asset of the joining entity include where:

·       the asset was held by an entity (that had its deductions affected by the privatised asset provisions) prior to the asset being acquired by the joining entity. Here the effect of the above mentioned deductions extends to the joining entity because of a previous application of subsection 705-47(2);

·       subsection 705-47(2) affected the joining entity’s deductions for the asset because of the exit history rule. That is, the privatised asset provisions may have applied to cap the tax cost setting amount of the asset when it was purchased by a previous group and the asset then leaves that group when an entity leaves and joins another consolidated group;

·       a privatised asset held by an entity which joined a consolidated group and was treated as a chosen transitional entity (which do not have their asset’s tax cost reset) leaves the consolidated group and joins another consolidated group; and

·       a privatised asset is sold to a group (by an asset sale) and then leaves that group in a leaving entity that joins a second group.

2.231     Primarily, Division 58 caps the cost allocated to privatised assets for depreciation purposes, thereby limiting the amount of deductions for the asset’s decline in value and the amount of tax benefits that can be obtained by entities that purchase privatised assets. Under Division 58 entity sales and asset sales are treated consistently by providing a choice of how to work out the first element of cost of each individual depreciating asset based on the ‘notional written down value’ or the ‘undeducted pre-existing audited book value’. Once a method is chosen it will determine ‘the amount’ that is used in calculating the joining entity’s terminating value for the depreciating asset.

2.232     Where an entity leaves a consolidated group with a privatised asset that had its tax cost capped then it will continue to have its tax cost capped as a result of the exit history rule.

Situations in which the tax cost for depreciating assets are no longer capped

2.233     When the potential for tax benefit transfer no longer exists the capping of tax costs (achieved by either the privatised asset provisions or section 705-47) need not continue. The amendments included in this bill prevent the privatised asset provisions and section 705-47 applying indefinitely. In particular, they prevent a consolidated group that acquires an entity that was previously a member of another consolidated group from being subject to the capping rule in subsection 705-47(2) in certain circumstances.

2.234     Diagram 2.6 summarises whether the acquiring consolidated group will have its tax cost capped under these provisions when a privatised asset leaves a consolidated group and is acquired by another group.

Diagram 2.6:  Tax cost setting outcomes where a privatised asset leaves a consolidated group and is acquired by another group

2.235     Where just before the joining time an entity, that becomes a member of a consolidated group (the joined group), was:

·       neither an exempt Australian government agency nor an entity whose income was exempt from tax; and

·       meets one of the two conditions set out below within the period between when the asset last stopped being an exempt asset and the joining time (this period is called the pre-joining taxable period);

·       the head company of the joined group will not have to reduce the tax cost setting amount to the capped amount.

[Schedule 2, Part 13, item 67, subsection 705-47(3)]

2.236     The first condition is where a balancing adjustment event that occurred for the asset resulted in an amount being included in the entity’s assessable income or an amount being an allowable deduction for that asset. A balancing adjustment event in relation to a privatised asset ensures that the Division 58 objectives are met in that it ensures that tax benefit transfer does not occur. [Schedule 2, Part 13, item 67, subsection 705-47(4)]

2.237     The second condition is:

·       that for at least some of the pre-joining taxable period, the asset was held by the head company of a consolidated group (the earlier group) for a period (called the earlier group period) which:

-            started when the asset became held by the earlier group either because an entity joined the earlier group with the asset or because the head company of the group acquired the asset via an asset sale from a tax exempt entity; and

-            finished when an entity leaves the consolidated group with the asset or when the earlier group ceases to exist;

·       the head company of the earlier group, just before the end of the earlier group period, was not either an associate of the head company of the joined group just before the joining time or the same company as the head company of the joined group; and

·       the earlier group period was at least 24 months.

[Schedule 2, Part 13, item 67, subsection 705-47(5)]

2.238     The requirements in relation to testing whether the entities are associates and that the asset be held by the head company of a consolidated group for a period of at least 24 months are intended to provide integrity in ensuring that there is not a tax benefit transfer via an immediate on-sale of the privatised asset.

2.239     The 24-month period begins from the time the head company of a consolidated group acquires the asset (ignoring the inherited history rule). This is an integrity measure that requires the head company to hold the asset for a period of at least 24-months. Allowing the head company to include periods of time that subsidiary companies had held the asset (applying the inherited history rule) would undermine this test in certain cases.

2.240     Testing the relationship between the two consolidated groups requires determining whether the head company of the earlier group is an associate of the joined group just before the time it joins the joined group.

2.241     The subsidiaries of a MEC group that has a provisional head company are regarded as associates under subsection 318(2) of the ITAA 1936. This means that the privatised asset provisions would continue to apply if a privatised asset was transferred between MEC groups with a common top company.

Increase in step 1 amount when an entity leaves a consolidated group with an asset that had its tax cost capped

2.242     Where an asset, that has had its tax cost setting amount reduced either directly or indirectly under the privatised asset provisions, leaves a consolidated group the head company of the group may be entitled to increase its step 1 amount in working out the old group’s allocable cost amount for the purpose of setting the tax cost for membership interests in the leaving entity. The amount of the increase depends on whether the asset’s tax cost was limited by the operation of section 705-47 or because an asset that was subject to the privatised asset provisions was brought into a consolidated group with an entity that elected to be a chosen transitional entity and consequently retained the existing tax values for its assets.

Increase in step 1 amount where the tax cost was capped by section 705-47

2.243     Where the tax cost for a depreciating asset was reduced to the capped amount as a result of section 705-47 when an entity (whether or not it is the same entity as the leaving entity) joined the consolidated group and that asset leaves the group with the leaving entity then the amount of the reduction is added back in calculating the step 1 amount under subsection 711-25(3). The amount of the reduction in this case will be the difference between the tax cost that would have been allocated to the privatised asset but for section 705-47 and the tax cost that was set (after applying section 705-47). [Schedule 2, Part 13, item 72, subsection 711-25(3)]

2.244     Subsection 711-25(3) does not need to apply to asset sales under the former Division 58 because it ceased to apply from 1 July 2001 and assets sales to consolidated groups can only take place from 1 July 2002.

Increase in step 1 amount where the acquisition is by a consolidated group under an asset sale

2.245     Where an entity leaves a consolidated group and takes with it a depreciating asset for which the first element of its cost was set by reference to subsection 58-70(5) (because a member of the consolidated group acquired the asset in connection with a business from a tax exempt entity). That is, where subsection 58-5(4) applied and the amount of the cost is less than it would have been if the cost had not been reduced as a result of the operation of Division 58 (i.e. under item 11 of the table in subsection 40-180(2)) then the amount of the difference will be added to the step 1 amount. [Schedule 2, Part 13, item 72, subsection 711-25(4)]

Increase in step 1 amount where leaving entity takes asset brought into a group by a chosen transitional entity

2.246     There may also be an increase in the step 1 amount of the old group’s allocable cost amount in the following two circumstances that involve a subsidiary member leaving a group with a depreciating asset that entered the group within a chosen transitional entity. [Schedule 2, Part 13, item 75, subsection 701-50(1) of the Income Tax (Transitional Provisions) Act 1997]

2.247     The first circumstance is where the chosen transitional entity itself was privatised (an entity sale situation covered by Division 58, the former Division 58, Division 57 of Schedule 2D to the ITAA 1936 or section 61A of the ITAA 1936). [Schedule 2, Part 13, item 75, subsection 701-50(2) of the Income Tax (Transitional Provisions) Act 1997]

2.248     In this circumstance, where section 61A of the ITAA 1936, Subdivision 57-I in Schedule 2D to the ITAA 1936 or former subsection 58-20(4) (i.e. where the notional written-down method is used) applied and the amount of the purchase price for the entity that is reasonably attributable to the asset exceeds the difference between:

·       the amount treated as the cost of the asset under the relevant privatised asset provisions; and

·       the total amount treated under the relevant provisions as being deductions for capital allowance of the asset assumed to have been allowed for the period before the transition time.

Then the excess is added back for the purpose of working out the head company’s tax cost for the membership interests in the leaving entity. [Schedule 2, Part 13, item 75, subsection 701-50(3) of the Income Tax (Transitional Provisions) Act 1997]

2.249     In the circumstance, where former subsection 58-20(5) or Division 58 applied and the amount of the purchase price for the entity that is reasonably attributable to the asset exceeds the amount treated as being the cost or the first element of the cost of the asset under the relevant provision. Then the excess is added back for the purpose of working out the head company’s tax cost for the membership interests in the leaving entity. [Schedule 2, Part 13, item 75, subsection 701-50(3) of the Income Tax (Transitional Provisions) Act 1997]

2.250     The second circums tance is where the chosen transitional entity’s cost for the asset was limited be cause that entity or another entity acquired the asset in an asset sale covered by Division 58 or the former Division 58.

2.251     If either the former or current Division 58 applied to the asset sale and because of the acquisition the amount that could be deducted for the asset was reduced and the cost for the asset was less than what it would have been but for the operation of the privatised asset provisions (i.e. if former sections 58-160 and 58-220 and current subsection 58-70(5) had not applied) then the difference is added to the step 1 amount. [Schedule 2, Part 13, item 75, subsection 701-50(4) of the Income Tax (Transitional Provisions) Act 1997]

Where the reduction amount is not added back

2.252     In the case of a consolidated group joining another consolidated group, where the joined group acquires the head company (of the old group) that held the depreciating asset during the earlier holding period the reduction amount is not added back (because the cost for shares in the subsidiary member is not set in these circumstances) and the subsequent acquirer should be subject to the same tests that apply if a single entity were joining.

Retaining access to further deduction for certain balancing adjustments

2.253     In certain circumstances an entity that is subject to a balancing adjustment event that occurs for a depreciating asset may be entitled to a further deduction under subsection 40-285(3) of the Income Tax (Transitional Provisions) Act 1997 . This can occur where former Division 58, section 61A of the ITAA 1936 or where the transition time under Division 57 of Schedule 2D to the ITAA 1936 occurred before 1 July 2001.

2.254     Section 701-55(2) sets out how the depreciating asset provisions apply in relation to the asset for the head company where an entity joins a consolidated group with a depreciating asset. In particular, paragraph 701-55(2)(a) provides that the depreciating asset provisions apply as though the asset were acquired at the joining time. The operation of this provision would result in the head company (and, if an entity left with the asset, that entity) not being entitled to a further deduction under subsection 40-285(3) of the Income Tax (Transitional Provisions) Act 1997 .

2.255     Section 702-4 of the Income Tax (Transitional Provisions) Act 1997 ensures that where a balancing adjustment event occurs in relation to a depreciating asset that became, at some point, an asset of the head company of a consolidated group that subsection 40-285(3) of the Income Tax (Transitional Provisions) Act 1997 will continue to apply in appropriate circumstances. [Schedule 2, Part 13, item 76, subsection 702-4(1) of the Income Tax (Transitional Provisions) Act 1997]

2.256     An entity (including the head company of a consolidated group) will be entitled to a further deduction for a balancing adjustment event if the entity would have been entitled to the deduction if paragraph 701-55(2)(a) had not applied (i.e. the asset had not been deemed to have been acquired at a particular time) [Schedule 2, Part 13, item 76, subsection 702-4(2) of the Income Tax (Transitional Provisions) Act 1997] . However, the entity will not be entitled to the further deduction where the asset has had its tax cost reset as a result of joining a consolidated group (i.e. the tax cost for the asset is greater than its terminating value when it was brought into a consolidated group) [Schedule 2, Part 13, item 76, subsection 702-4(3) of the Income Tax (Transitional Provisions) Act 1997] .

Application and transitional provisions

2.257     The majority of amendments made by Schedule 2 apply on and after 1 July 2002. This is the date of commencement of the consolidation regime.

2.258     The amendments are either beneficial to taxpayers or correct unintended outcomes. All of the amendments to address unintended outcomes are consistent with the original policy intent for the consolidation regime and therefore have the same commencement date as the consolidation regime.

2.259     The following amendments do not apply on and after 1 July 2002:

·       the amendment made to subsection 124-380(7) is to apply to choices made after the commencement of the item. This ensures that the changes to subsection 124-380(7) are not retrospective [Schedule 2, Part 3, item 5, subsection 124-380(7)] ;

·       the amendment to subparagraph 717-15(1)(b)(i) will apply from 1 July 2004. This amendment is required for wholly-owned groups that consolidate after the transitional period. Transitional rules already allow the head company to use excess foreign tax credits of subsidiary members at the end of the first consolidation year in certain circumstances [Schedule 2, Part 9, item 53, subparagraph 717-15(1)(b)(i)] ; and

·       the amendments to the provisions dealing with the calculation of ‘cost base’ and ‘reduced cost base’ apply to assessments for the 1998-1999 and later income years. This is consistent with the first application of the CGT provisions in the ITAA 1997:

-            the amendment clarifies the operation of the law and ensures that taxpayers can make relevant cost base and reduced cost base calculations. Although the need for the amendment was identified in the consolidations context, the amendment applies for CGT purposes more generally. It is not expected that the amendments will adversely affect taxpayers [Schedule 2, Part 11, item 64] .

Consequential amendments

Cost setting for assets that the head company does not hold under the single entity rule

2.260     As a consequence of the change to subsection 701-10(2), an amendment to paragraph 104-510(1)(b) is made to allow assets that do not become assets of the head company to be included in the CGT event L3 calculation. This is achieved by restructuring paragraph 104-510(1)(b) to remove a reference to “assets of the head company”. [Schedule 2, Part 4, item 10, paragraph 104-510(1)(b)]

2.261     Consequential amendments are also made for the following:

·       paragraphs 713-205(3)(a) and 719-160(3)(a) to remove references to “assets that an entity brings into the group”. These references are replaced with a reference to “assets of an entity joining a group” [Schedule 2, Part 4, items 15 and 18, paragraphs 713-205(3)(a) and 719-160(3)(a) ] .

·       sections 717-275, 717-280 and 717-285 as a result of the provision that ensures the entry history rule does not affect when the head company may elect to value trading stock at market value [Schedule 2, Part 9, items 38 to 41, sections 717-275, 717-280 and 717-285] . Similarly, consequential amendments have been made to sections 717-300, 717-305 and 717-310 as a result of the provision that ensures the exit history rule does not affect when the leaving entity may elect to value trading stock at market value [Schedule 2, Part 9, items 43 to 48, sections 717-300, 717-305, and 717-310] .

·       to repeal paragraph 717-15(2)(b) and the example in subsection 717-15(3) as a result of the insertion of section 717-28 [Schedule 2, Part 9, item 54, paragraph 717-15(2)(b); item 55, subsection 717-15(3)] .

Multiple entry consolidated groups and interposed head companies

2.262     A consequential amendment is made to paragraph 701D-10(5)(a) of the Income Tax (Transitional Provisions) Act 1997 to update a reference to paragraph 126-50(6)(b) to subsection 126-50(6). [Schedule 2, Part 3, item 9, paragraph 701D-10(5)(a)]

Tax cost setting for privatised assets

2.263     As a consequence of inserting section 705-47, an amendment to subparagraph 705-55(b)(iii) is made to include section 705-47 in the order of application of sections 705-40, 705-45 and 705-50. The heading to section 705-55 is also amended to reflect this change. [Schedule 2, Part 13, items 68 and 69, heading to section 705-55, subparagraph 705-55(b)(iii)]

2.264     Consequential amendments are made to remove references to the “cost to the head company of assets that the entity brings into the group” in; item 1 in the table in section 701-60, note 1 to subsection 715-70(1), note 1 to subsection 715-225(1) and section 701-15 of the Income Tax (Transitional (Provisions) Act 1997 . As a consequence of the changes to subsection 701-10(2) these references are replaced with a reference to the “cost to the head company of assets of joining entity”. [Schedule 2, Part 4, items 14, 16, 17 and 19 ,table item 1 in section 701-60,

note 1 to subsection 715-70(1), note 1 to subsection 715-225(1), section 701-15 of the
Income Tax (Transitional Provisions) Act 1997 ]

 



C hapter 3  

Venture capital partnerships

Outline of chapter

3.1         Schedule 3 to this bill makes amendments to the definition of ‘partnership’ to ensure that a limited partnership formed with a separate legal personality that is taxed as an ordinary partnership under the venture capital regime is a ‘partnership’ for income tax purposes. It includes a transitional rule to allow limited partnerships that would have been registered or conditionally registered during a transitional period to have the registration backdated. The transitional period is the date from which the measure was announced (2 December 2003) to the date this bill receives Royal Assent.

Context of amendments

3.2         The venture capital regime established three kinds of limited partnerships as a mechanism for accessing the tax concessions under that regime. A key feature of the regime is that these limited partnerships are regarded as partnerships for income tax purposes. A limited partnership that is a separate legal entity registered under State, Territory or other law may be treated as a company, and not a partnership, under the income tax law. These amendments ensure that limited partnerships that are separate legal entities are eligible to access the venture capital concessions.

Summary of new law

3.3         A limited partnership that is incorporated as a separate legal entity and formed solely for the purpose of becoming a venture capital limited partnership, an Australian venture capital fund of funds or a venture capital management partnership and to carry on activities carried on by such bodies, is a partnership under the income tax law.

3.4         Registration or conditional registration of a limited partnership as a venture capital limited partnership or an Australian venture capital fund of funds that could not be registered during the period between 2 December 2003 (the date of announcement) and the day this bill receives Royal Assent is backdated to the day the Pooled Development Funds Registration Board would have granted registration or conditional registration if this law had been enacted on 2 December 2003.

Comparison of key features of new law and current law

New law

Current law

A limited partnership that is a venture capital limited partnership , an Australian venture capital fund of funds or a venture capital management partnership that is a separate legal entity is a partnership for income tax purposes.

A limited partnership that is a legal entity separate from that of its partners may not be a ‘partnership’ for income tax purposes.

A transitional rule allows the registration or conditional registration of a venture capital limited partnership or an Australian venture capital fund of funds to be backdated to the date (between the date of announcement and the date of Royal Assent) the Pooled Development Funds Registration Board would have granted registration or conditional registration.

A limited partnership with a separate legal personality cannot be registered as a venture capital limited partnership or an Australian venture capital fund of funds until this bill receives Royal Assent.

Detailed explanation of new law

Partnership definitions

3.5         The law enacting the venture capital regime (contained in Taxation Laws (Venture Capital) Act 2002 and the Venture Capital Act 2002 ) established three new limited partnerships and provided for their tax treatment as ordinary partnerships. The new partnerships are:

·       a venture capital limited partnership;

·       an Australian venture capital fund of funds; and

·       a venture capital management partnership.

3.6         Victorian and New South Wales partnership law has been amended to provide for each of these partnerships to be registered as a body corporate with legal personality separate from that of its partners. Some foreign jurisdictions also provide for limited partnerships to have a legal personality separate from that of its partners.

3.7         A partnership with a legal personality separate from that of its partners may not be regarded as a ‘partnership’ within the meaning of that term in the income tax law (subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)). The partners may not be carrying on business as partners or in receipt of income jointly, in which case, the association would not be a partnership for income tax purposes. If the partnership is a body corporate with a separate legal personality it may be a company under the income tax law (subsection 6(1) of the ITAA 1936).

3.8         The substantive definitions of ‘limited partner’, ‘limited partnership’ and ‘partnership’ have been removed from the ITAA 1936 and inserted into the Income Tax Assessment Act 1997 (ITAA 1997). Each definition in the ITAA 1936 has been amended to provide that the term has the same meaning as in the ITAA 1997. [Schedule 3, items 1 to 3]

Limited partnership

3.9         A new definition of ‘limited partnership’ is inserted into the ITAA 1997 to include partnerships formed as a separate legal entity solely for the purpose of becoming a venture capital limited partnership, an Australian venture capital fund of funds or a venture capital management partnership and to carry on activities as a body of that kind. [Schedule 3, item 4]

3.10       Paragraph (a) of the new definition combines the rewritten definition of ‘partnership’ with the previous definition of ‘limited partnership’ (in the ITAA 1936) which refers to the liability of at least one of the partners being limited. A partnership that is a limited partnership under the existing law continues to be a limited partnership under paragraph (a).

3.11       Paragraph (b) of the new definition deals with associations of persons formed with a legal personality separate from those persons. If the association of persons is formed solely for the purpose of becoming a venture capital limited partnership, an Australian venture capital fund of funds or a venture capital management partnership and to carry on activities as a body of that kind, it is a limited partnership for income tax purposes. Persons in an association of persons that is a partnership under paragraph (b) are partners in a limited partnership. Whether a person is a limited partner or a general partner is determined under the partnership agreement.

3.12       It may be argued that an association of persons with legal personality includes an entity that is not formed under a partnership law. However, the registration requirements of venture capital limited partnerships and Australian venture capital fund of funds (see sections 9-1 and 9-5 of the Venture Capital Act 2002 ) are such that they can only be satisfied by a partnership. For example, a company could not meet the registration requirements to be a venture capital limited partnership because it does not have a general partner and does not have a partnership agreement.

Partnership

3.13       The definition of ‘partnership’ has been amended and inserted into the ITAA 1997. Paragraph (a) of the new definition is the same as the existing definition in the ITAA 1936 except that it is rewritten in the style adopted for the ITAA 1997. A new paragraph (b) is inserted to expressly include a ‘limited partnership’ (see above). [Schedule 3, item 5]

Transitional provisions

3.14       The Pooled Development Funds Registration Board cannot register or conditionally register a limited partnership that is a separate legal entity as a venture capital limited partnership or an Australian venture capital fund of funds until the amendments contained in this bill are enacted. However, a transitional rule allows the Pooled Development Funds Registration Board to backdate the date of registration or conditional registration.

3.15       The transitional rule allows registration or conditional registration to be backdated if:

·       the partnership was formed as a legal entity on or after 2 December 2003 (the date the amendments were announced) and before the day this bill receives Royal Assent;

·       a general partner of the partnership made an application for registration of the partnership as a venture capital limited partnership or an Australian venture capital fund of funds under the Venture Capital Act 2002 ; and

·       the partnership could not be registered or conditionally registered before the day this bill receives Royal Assent only because the partnership has a legal personality separate from that of its members.

[Schedule 3, subitem 7(1)]

3.16       If the Pooled Development Funds Registration Board decided before the day the bill receives Royal Assent that it would have granted registration or conditional registration if the limited partnership had been recognised as a partnership for income tax purposes, registration or conditional registration will be backdated. The Board will be taken to have granted registration or conditional registration on the day it would have granted registration under section 13-1 of the Venture Capital Act 2002 , or conditional registration under section 13-5 of the Venture Capital Act 2002 , if these amendments had come into effect on 2 December 2003. In these cases, registration or conditional registration is taken to have been in force from the day the Board made its decision.

3.17       The effect of registration being taken to have been in force on the day the Pooled Development Funds Registration Board would have granted registration is that section 13-10 of the Venture Capital Act 2002 will apply. This allows conditional registration granted during that period to be backdated to:

·        the day the partnership was established if the partnership has only carried on activities related to becoming registered as a venture capital limited partnership or an Australian venture capital fund of funds (paragraph 13-10(2)(a)); or

·       if this is not the case, the day the Board made its decision to grant conditional registration (paragraph 13-10(2)(b)).

Example 3.1

Sky Limited Partnership registers as an incorporated limited partnership under Victorian partnership law on 2 February 2004 for the purpose of carrying on business as a venture capital limited partnership. It applies to the Pooled Development Funds Registration Board for registration on 3 February 2004 but has yet to raise capital. On 3 March 2004 the Board informs Sky Limited Partnership that it would have granted conditional registration on that day if the partnership had been recognised as a partnership under the income tax law.

Sky Limited Partnership raises $21 million and meets the other registration requirements of section 9-1 of the  Venture Capital Act 2002 . The partnership re-applies for registration on 20 April 2004. On 30 April 2004 the Board informs the partnership that it would have granted registration on that day if the partnership had been recognised as a partnership under the income tax law. Sky Limited Partnership can now begin its eligible venture capital investment program consistent with the conduct of its activities as a venture capital limited partnership. The bill receives Royal Assent at a later date.

The effect of paragraph (a) of subitem 7(2) (the transitional rule) is that Sky Limited Partnership’s registration as a venture capital limited partnership comes into force on 30 April 2004, the day the Board made its decision to register. That rule also has the effect that Sky Limited Partnership’s conditional registration as a venture capital limited partnership came into effect on 3 March 2004 and was therefore in force on the day the partnership was registered as a venture capital limited partnership.

The effect of paragraph (b) of subitem 7(2) is that as Sky Limited Partnership has only carried on activities as a venture capital limited partnership since its establishment, its registration is taken to have come into force on the day it was established (paragraph 13-10(2)(a) of the Venture Capital Act 2002 ).

If Sky Limited Partnership had met all the registration requirements when it applied for registration on 3 February and the Board decided that it would have granted registration on 25 February 2004, when the law was enacted, registration would have been taken to come into force on 25 February 2004 (section 13-1).

Application provision

3.18       The amendments apply from 2 December 2003, the date the Minister for Revenue and Assistant Treasurer announced the amendments. [Schedule 3, item  6]

 



C hapter 4  

Fringe benefits tax housing benefits

Outline of chapter

4.1         Schedule 4 to this bill amends the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) to allow for continuity of fringe benefits tax (FBT) treatment for non-remote housing benefits where administration and payment of FBT is devolved by State or Territory governments to a departmental level.

Context of amendments

4.2         A State or Territory may devolve the administration and payment of FBT to eligible State or Territory bodies. Where this happens, each nominated State or Territory body is treated as the employer of the relevant employees for the purposes of the FBTAA 1986.

4.3         At the time when FBT responsibilities are devolved, a requirement could be triggered to reassess the valuation and the character of fringe benefits provided to employees. Section 135X of the FBTAA 1986 allows for continuity of FBT treatment of certain benefits, to avoid the need for reassessment where there has been no material change in the provision of the benefit.

4.4         Section 135X has two objects. The first is to ensure that the calculation of the taxable value of certain fringe benefits is not affected as a result of a break in the continuity of certain record keeping requirements solely because of a ‘transitional event’. The second object is to preserve the character of certain benefits where that character would otherwise be lost solely because of a transitional event.

4.5         A transitional event includes situations where a State or Territory devolves the administration and payment of FBT to a nominated State or Territory body, or where such a devolution is revoked or varied, or where the nominated State or Territory body ceases to exist.

4.6         Section 135X allows the Commissioner of Taxation (Commissioner) to enter into a written agreement with the State or Territory about what is to happen when a transitional event occurs in respect of certain benefits.

4.7         Currently, a written agreement may be entered into when a transitional event occurs in respect of issues such as:

·       whether a register kept in relation to the value of car parking fringe benefits is a valid register; and

·       whether a year of tax is to be treated as a log book year of tax for the purposes of calculating the taxable value of car fringe benefits using the cost basis.

4.8         The amendment will allow a written agreement to be entered into when a transitional event occurs in respect of whether a year of tax that is a base year of tax for the purposes of calculating the taxable value of non-remote housing fringe benefits is to continue to be treated as a base year of tax.

Detailed explanation of new law

4.9         The amendment will allow the Commissioner to enter into a written agreement with a State or Territory about what is to happen when a transitional event occurs in respect of whether a year of tax that is a base year of tax for the purposes of calculating the taxable value of non-remote housing fringe benefits is to continue to be treated as a base year of tax. [Schedule 4, item 1, subsection 135X(3)]

4.10       This will allow for continuity of FBT treatment for non-remote housing benefits when a transitional event occurs.

Application and transitional provisions

4 .11      The amendment applies in respect of the FBT year beginning on 1 April 2001 and in respect of all later FBT years. [Schedule 4, item 2]

 



C hapter 5  

Capital gains tax event K6 and demergers

Outline of chapter

5.1         Schedule 5 to this bill amends the Income Tax Assessment Act 1997 (the ITAA 1997) to ensure that capital gains tax (CGT) event K6 is not inadvertently triggered by the disposal of new interests in demerged entities.

Context of amendments

5.2         Division 125 of the ITAA 1997 provides CGT relief for the demerger of corporate groups. Under a demerger, members of the head entity of a corporate group (a ‘demerger group’) acquire new direct ownership interests in one or more subsidiary members of the group (the ‘demerged entities’).

5.3         The CGT relief for demergers ensures that the pre-CGT status of membership interests is preserved. That is, the pre-CGT status of any original membership interests in the head entity carries over to new membership interests in the demerged entity.

5.4         CGT event K6 can give rise to a capital gain where a pre-CGT interest shields post-CGT assets owned by an entity. However, CGT event K6 does not apply to entities that have been continuously listed on a stock exchange for at least five years.

5.5         Membership interests in a demerged entity are usually listed on a stock exchange only after the demerger. Those membership interests do not qualify for the exclusion from CGT event K6 until the demerged entity has been listed on a stock exchange for at least five years. That is, even when the original membership interests in the head entity have been continuously listed on a stock exchange for at least five years, CGT event K6 may apply. As a result, the pre-CGT status of membership interests in the demerged entity is not preserved.

Summary of new law

5.6         The exclusion from CGT event K6 will apply to membership interests in a demerged entity where the combined period that the head entity and the demerged entity have been listed on a stock exchange is five years or more.

Comparison of key features of new law and current law

New law

Current law

CGT event K6 will not apply to interests in a demerged entity when the combined period that the head entity and the demerged entity have been continuously listed on a stock exchange is at least five years.

There is an exception from CGT event K6 for membership interests in entities that have been continuously listed on a stock exchange for at least five years.

Membership interests in demerged entities are not eligible for this exception unless the demerged entity has itself been continuously listed on a stock exchange for at least five years.

Detailed explanation of new law

5.7         CGT event K6 can give rise to a capital gain where a pre-CGT interest shields post-CGT property owned by an entity. However, CGT event K6 does not apply to entities that have been continuously listed on a stock exchange for at least five years.

5.8         This exclusion from CGT event K6 will apply to membership interests in a demerged entity where the combined period that the head entity and the demerged entity have been listed on a stock exchange is at least five years.

5.9         The modifications to the exclusion will apply to a demerged entity that is a company or a unit trust where:

·       the demerged entity has not been continuously listed for quotation on a stock exchange for at least five years [Schedule 5, item 1, paragraphs 104-230(9A)(b) and 104-230(9B)(b)] ;

-            the existing exclusion will apply if the demerged entity has been continuously listed for quotation on a stock exchange for at least five years; and

·       five years have not elapsed since the demerger [Schedule 5, item 1, paragraphs 104-230(9A)(c) and 104-230(9B)(c)] .

5.10       If these conditions are satisfied, the demerged entity is deemed, for the purpose of subsection 104-230(9), to have been listed for quotation on a stock exchange at all times that membership interests in the head entity of the demerger group were so listed. [Schedule 5, item 1, subsections 104-230(9A) and 104-230(9B)]

5.11       The amendments ensure that the exception from CGT event K6 will apply to membership interests in a demerged entity if, prior to the demerger, the head entity has been continuously listed for quotation on a stock exchange for at least five years.

5.12       If the head entity has been continuously listed for quotation on a stock exchange for less than five years, the exception from CGT event K6 does not apply to membership interests in the head entity at the time of the demerger. In these circumstances the demerged entity must be listed for quotation on a stock exchange for the remainder of the five years before the exception applies.

Application and transitional provisions

5.13       The amendments apply to shares or units acquired under a demerger on or after 1 July 2002. This is consistent with the application date of the demerger provisions in Division 125 of the ITAA 1997. [Schedule 5, item 2]

 



C hapter 6  

Deductions for United Medical Protection Limited support payments

Outline of chapter

6.1         Schedule 6 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to ensure that all individuals who make United Medical Protection Limited (UMP) support payments under Division 1 to Part 3 of the Medical Indemnity Act 2002 will be entitled to an income tax deduction for the amount of their contributions in that income year.

Context of amendments

6.2         Under the Medical Indemnity Act 2002 the Australian Government introduced a scheme to address the unfunded incurred but not reported (IBNR) liabilities of medical defence organisations and under the Medical Indemnity (IBNR Indemnity) Contribution Act 2002 it introduced a contribution scheme which imposes a liability on doctors to fund the scheme. The IBNR contribution scheme is one of several components of the Australian Government’s medical indemnity package, announced on 23 October 2002.

6.3         The Australian Government announced on 17 December 2003 that the IBNR contribution would be replaced by the UMP support payments. The Medical Indemnity Amendment Act 2004 and the Medical Indemnity (IBNR Indemnity) Contribution Amendment Act  2004 bring into effect these changes.

6.4         A reference to a UMP support payment may include a reference to an IBNR contribution for some purposes of the Medical Indemnity Amendment Act 2004 (see Schedule 1, item 6, subsection (3E)).

6.5         IBNR contributions made by doctors during 2003 were refunded, so it is expected that there will be no IBNR contributions for which a person could seek an allowable deduction.

Summary of new law

6.6         This amendment will allow individuals who are required to pay UMP support payments to deduct the amount of their payment from assessable income. This section will apply if a deduction would not otherwise be available.

Comparison of key features of new law and current law

New law

Current law

All individuals who are required to pay UMP support payments will be entitled to deduct the amount of their payments.

Certain individuals who are required to pay UMP support payments may be entitled to deduct the amount of their payments under the general deduction provisions.

Detailed explanation of new law

6.7         This amendment inserts a specific deduction into the ITAA 1997 to ensure that all individuals who are required to pay UMP support payments will be entitled to deduct the amount of their payments.

6.8         Contributions may already be deductible under section 8-1 of the ITAA 1997 to the extent that they are incurred in gaining or producing the taxpayer’s assessable income. However, these payments may not presently be deductible for all practitioners, including some individuals who have left the profession or retired.

6.9         This deduction will apply to those taxpayers who are not otherwise entitled to a deduction for their contributions. A taxpayer will not be entitled to a deduction under the new section if he or she is entitled to a deduction under a different provision of the tax law. This ensures that taxpayers cannot claim a deduction for their contribution amounts twice. [Schedule 6, item 2]

6.10       The allowable deduction in any particular income year will be equal to the amount or amounts actually paid in that income year. [Schedule 6, item 2]

Application and transitional provisions

6.11       The amendment applies to UMP support payments made from 1 July 2003. No UMP support payments were made before this time. [Schedule 6, item 4]

Consequential amendments

6.12       The amendment also inserts the definition of ‘United Medical Protection Limited support payments’ into the dictionary definitions in subsection 995-1(1) of the ITAA 1997. [Schedule 6, item 3]

 



C hapter 7  

Goods and services tax amendments relating to compulsory third party schemes

Outline of chapter

7.1         Schedule 7 to this bill amends the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) to ensure that the goods and services (GST) insurance provisions apply as intended to transactions undertaken by operators of compulsory third party (CTP) schemes.

Context of amendments

7.2         Amendments have previously been made to the GST Act to apply the insurance provisions to transactions undertaken by operators, including insurers, of CTP schemes. Division 79 introduced new provisions and modified others under Division 78 of the GST Act, that apply to CTP transactions. In addition, Division 80 introduced provisions that apply to CTP settlement sharing arrangements.

7.3         Some of the new and modified insurance provisions do not operate as intended. As a result, some operators of CTP schemes are unable to apply the law to some of their transactions. It is therefore necessary to amend the relevant provisions to ensure they operate as intended.

Summary of new law

7.4         This bill will amend several GST insurance provisions to ensure that they apply as intended to transactions undertaken by operators of CTP schemes.

Comparison of key features of new law and current law

New law

Current law

A contributing operator’s payment received by a managing operator pursuant to a settlement sharing arrangement , is not treated as a recovery made by the managing operator under the general insurance provisions.

A contributing operator’s payment received by a managing operator pursuant to a settlement sharing arrangement may also be treated as a recovery made by the managing operator under the general insurance provisions, resulting in more than one increasing adjustment for the operator.

Where an operator satisfies the premium selection test , and claims a decreasing adjustment on settlement of a claim under the insurance policy on the basis that the entity that acquired the policy was not entitled to an input tax credit for the premium, the operator has an increasing adjustment if it later became or becomes aware that the entity has such an entitlement.

Where an operator satisfies the premium selection test , and claims a decreasing adjustment on settlement of a claim under the insurance policy on the basis that the entity that acquired the policy was not entitled to an input tax credit for the premium, the operator has an increasing adjustment if it later becomes aware that the entity has such an entitlement.

An operator that makes a sole operator election will make a single election to apply the average input tax credit fraction in the calculation of all of its decreasing adjustments arising from settlements of claims under insurance polices.

An operator that makes a sole operator election may need to make a separate election to apply the average input tax credit fraction in the calculation of decreasing adjustments for each settlement it makes of a claim under an insurance policy.

A payment or supply made by an operator in connection with, but not under, a CTP insurance policy that commenced before 1 July 2003, can be treated as a CTP hybrid payment or supply made under the relevant CTP insurance policy.

A payment or supply made by an operator in connection with, but not under a CTP insurance policy that commenced before 1 July 2003, may in some circumstances, be treated as a compensation payment or supply.

An operator that charges a CTP premium, that is not consideration for a taxable supply made by the operator, is not entitled to a decreasing adjustment for any CTP compensation or ancillary payment or supply it makes under the CTP scheme.

An operator that charges a CTP premium, that is not consideration for a taxable supply made by the operator, may be entitled to a decreasing adjustment for any CTP compensation or ancillary payment or supply it makes under the scheme.

A payment or supply an operator receives in settlement of a claim it makes as an insured under an insurance policy it holds in respect of a CTP compensation or ancillary payment or supply is not treated as a general recovery under the CTP scheme.

A payment or supply an operator receives in settlement of a claim it makes as an insured under an insurance policy it holds in respect of a CTP compensation or ancillary payment or supply is treated as a general recovery under the CTP scheme.

Where an operator is exercising its rights to recover from another entity in respect of a CTP compensation or ancillary payment or supply it has made, and it receives a payment or supply made in compliance with a judgement or order of a court, the payment or supply is treated as made in settlement of the operator’s claim.

Where an operator is exercising its rights to recover from another entity in respect of a CTP compensation or ancillary payment or supply it has made, and it receives a payment or supply made in compliance with a judgement or order of a court, the payment or supply is not treated as settlement of the operator’s claim.

An operator that has made an election to apply the average input tax credit fraction, in the calculation of any decreasing adjustment arising from payments or supplies it has made in settlement of claims made under CTP insurance policies, will use the fraction relevant to the financial year in which the incident occurred.

An operator that has made an election to apply the average input tax credit fraction, in the calculation of any decreasing adjustments arising from payments or supplies it has made in settlement of claims made under CTP insurance policies, cannot determine the relevant fraction that applies in the calculation.

Under any settlement sharing arrangement , the operators are parties to the arrangement because the person(s) involved in the incident was, or was not, covered by an insurance policy.

Under various settlement sharing arrangements , the operators are parties to the arrangement depending upon whether the driver , or in other cases the owner or driver , involved in the incident was, or was not, covered by an insurance policy.

Detailed explanation of new law

Contributing operator payments and recovery provisions

7.5         Under sections 80-30 and 80-70 of the GST Act, a managing operator may have an increasing adjustment where it receives a contributing operator’s payment pursuant to a CTP settlement sharing arrangement. A contributing operator is an operator that makes a contribution (contributor’s payment) to settlements of claims made by a managing operator under a CTP settlement sharing arrangement.

7.6         The receipt of a contributing operator’s payment, by a managing operator, may be treated as a recovery under the insurance recovery provisions. This may result in an increasing adjustment arising for the managing operator under more than one provision of the GST insurance provisions. Therefore, the GST Act has been amended to include new subsections 78-40(2) and 79-70(2) to ensure that a contributing operator’s payment is not treated as a general recovery. [Schedule 7, item 1, subsection 78-40(2); item 6, subsection 79-70(2)]

Premium selection test

7.7         Under paragraph 79-10(2)(c) of the GST Act if an entity has selected a CTP premium offered to it on the basis that it has no input tax credit entitlement for the premium, and the operator later becomes aware that the entity did have an entitlement to an input tax credit for the CTP premium, the operator may have an increasing adjustment. The adjustment arises where the operator has previously claimed a decreasing adjustment in respect of a payment or supply made in settlement of a claim made under the policy.

7.8         Paragraph 79-10(2)(c) is amended to apply the same test as that contained within paragraph 79-10(1)(b), to ensure the provision applies where the operator became or becomes aware of the input tax credit entitlement of the entity that selected the premium. [Schedule 7, item 2, paragraph 79-10(2)(c)]

Sole operator election

7.9         Where a CTP scheme has an operator that has sole responsibility for the issue of insurance policies under the scheme, the operator may elect to apply the relevant scheme’s average input tax credit fraction in the calculation of any decreasing adjustment arising from the settlement of claims made under CTP insurance policies.

7.10       It was intended that subsection 79-15(4) of the GST Act operate to require the operator to make a single election to apply the average input tax credit fraction in its calculations. The election is to apply to all payments or supplies made by the operator in settlement of claims made under CTP insurance policies.

7.11       However, it is possible that subsection 79-15(1) operates to  require an operator to make a separate election to apply the average input tax credit fraction for each payment or supply it makes in settlement of a claim under each policy. This is contrary to the intended operation of the provision.

7.12       Therefore, subsection 79-15(4) has been amended to ensure that, where an operator makes a single election to apply the average input tax credit fraction , it will apply to all payments or supplies it has made in settlement of claims. [Schedule 7, item 3, subsection 79-15(4)]

Policies commencing prior to 1 July 2003

7.13       Under section 79-25 of the GST Act, a payment or supply made by an operator that is connected with, but not made under, an insurance policy is referred to as a CTP hybrid payment or supply . A CTP hybrid payment or supply is treated as a payment or supply made in settlement of a claim under an insurance policy.

7.14       However, under subsection 79-25(2) certain payments or supplies made in settlement of claims that would otherwise be a CTP hybrid payment or supply , are treated as payments of compensation. This means that the operator is required to apply the average input tax credit fraction in the calculation of any decreasing adjustment arising from payments or supplies it makes in settlement of a claim. Where an operator makes a payment or supply in settlement of a claim that relates to, but is not made under, a CTP policy that commences before 1 July 2003, the operator should be entitled to treat the payment or supply as a CTP hybrid payment or supply . Such treatment will ensure that the operator is able to claim a full decreasing adjustment for any payment or supply made in settlement of a claim in relation to that policy.

7.15       New subsection 79-25(2A) ensures that subsection 79-25(2) does not apply to a payment or supply that is made by an operator in relation to, but not under, a CTP insurance policy that commences before 1 July 2003. [Schedule 7, item 4, subsection 79-25(2A)]

Entitlement to decreasing adjustments

7.16       Under section 79-50 of the GST Act, an operator may be entitled to claim a decreasing adjustment for a CTP compensation payment or supply or a CTP ancillary payment or supply . However, an operator should only be entitled to claim a decreasing adjustment in relation to such payments or supplies if the operator imposes or charges a CTP premium that is consideration for a taxable supply made by the operator.

7.17       Under section 79-50, an operator that does not make taxable supplies may be able to access decreasing adjustments merely because another operator under the same scheme has a CTP premium that is consideration for a taxable supply. Section 79-50 has been amended to ensure that an operator’s CTP premium must be consideration for a taxable supply made by the operator before it is entitled to claim a decreasing adjustment in relation to any CTP compensation or ancillary payment or supply it has made under the scheme. [Schedule 7, item 5, paragraph 79-50(2)(a)]

Recoveries

7.18       The CTP recovery provisions operate to apply to recoveries made by operators exercising any rights to recover settlement amounts from another party. This means that where an operator has claimed a decreasing adjustment in respect of a payment or supply it has made in settlement of a claim under an insurance policy, it will have an increasing adjustment when it recovers any part of the settlement amount from another party. However, any amount received by an operator in settlement of a claim made by it under a policy of reinsurance it holds is not treated as a recovery.

7.19       Operators also acquire policies of insurance in respect of their risk to make CTP compensation or ancillary payments or supplies under a CTP scheme. If an operator receives a payment in settlement of a claim made by it under a contract of insurance, the operator will have to treat the amount as a general recovery. This treatment is inconsistent with the treatment that applies to payments received by operators under contracts of reinsurance.

7.20       New subsection 79-70(3) ensures that payments received by operators in settlement of claims they have made as insureds under policies of insurance, are not treated as general recoveries. [Schedule 7, item 6, subsection 79-70(3)]

Judgements and court orders

7.21       A payment or supply may be made by another party in compliance with a judgement or order of a court, to an operator that is exercising its rights of recovery in respect of a settlement it has made under a CTP scheme.

7.22       However, section 79-90 does not apply as intended to a payment or supply made by a third party to an operator that is exercising its rights of recovery in respect of a settlement it has made under a CTP scheme. This is because a payment or supply made by the third party would not, as currently required, have been in absence of the court judgement or order, a CTP compensation payment or supply or a CTP ancillary payment or supply. The payment received by an operator is a payment made in settlement of the operator’s claim against the third party.

7.23       Section 79-90 has been split into new subsections 79-90(1) and 79-90(2), that operate to ensure that recoveries made from third parties involving a judgement or court order are treated as intended under Division 79 of the GST Act. [Schedule 7, item 7, subsection 79-90(1); item 8, subsection 79-90(2)]  

Application of the average input tax credit fraction

7.24       Section 79-15 of the GST Act permits a CTP operator, that is the sole operator that issues CTP policies of insurance under a CTP scheme, to elect to apply the applicable average input tax credit fraction in the calculation of decreasing adjustments for payment or supplies made in settlement of claims made under the insurance policies. Section 79-95 of the GST Act sets out how to work out decreasing adjustments using the applicable average input tax credit fraction . However, the section did not provide a rule to allow an operator to determine which applicable average input tax credit fraction applies in the calculation of a decreasing adjustment relating to a payment or supply made in settlement of a claim under a CTP insurance policy.

7.25       Therefore, paragraph (c) has been added to the definition of applicable average input tax credit fraction in subsection 79-95(2) to provide that the operator uses the fraction that applies for the financial year in which the accident, or incident, occurred to which the claim relates. [Schedule 7, item 9, subsection 79-95(2)]

Payment or supply amount

7.26       In calculating the amount of a decreasing adjustment using the  average input tax credit fraction , the operator must first calculate the payment or supply amount to which the fraction is applied. Subsection 79-95(3) of the GST Act sets out a method statement for the calculation of the payment or supply amount. Step 3 in the method statement has been amended to correct its reference in that step from applicable average input tax credit percentage to that of applicable average input tax credit fraction. [Schedule 7, item 10, subsection 79-95(3)]

Owner or driver

7.27       Paragraphs 80-5(1)(b), 80-40(1)(b) and subparagraph 80-80(1)(b)(ii) of the GST Act set out part of the test to be satisfied in determining whether a CTP settlement sharing arrangement exists . Although each of these provisions should apply the same test to determine if a relevant arrangement is in operation, two of the provisions refer to circumstances involving owners or drivers while the other refers only to a driver. In order to ensure the consistency in interpretation of the provisions, each has been amended to refer to either person or persons. [Schedule 7, item 11, paragraph 80-5(1)(b); item 12, paragraph 80-40(1)(b); item 13, subparagraph 80-80(1)(b)(ii)]

Application and transitional provisions

7.28       The amendments apply, and are taken to have applied, in relation to the net amounts for tax periods starting on or after 1 July 2000. The application date is consistent with the commencement of the general CTP insurance provisions. [Schedule 7, item 14]

 



C hapter 8  

Public ambulance services

Outline of chapter

8.1         Schedule 8 to this bill amends the Fringe Benefits Tax Assessment Act 1986 to provide public ambulance services with the same fringe benefits tax (FBT) treatment as is provided to public hospitals. Public ambulance services will be able to access an FBT exemption of up to $17,000 of grossed-up taxable value per employee, and will also be able to access the remote area housing FBT exemption under the same criteria as applies to public hospitals. In addition, the Income Tax Assessment Act 1997 (ITAA 1997) will be amended to allow public ambulance services to be endorsed to receive tax deductible gifts.

Context of amendments

8.2         In the past, some public ambulance services had been accessing an FBT exemption for public benevolent institution s. Fringe benefits provided to an employee of a public benevolent institution are exempt from FBT, subject to a $30,000 cap. Public benevolent institutions can also be endorsed to receive tax deductible gifts.

8.3         The Full Federal Court decision of Ambulance Services of New South Wales v Deputy Commissioner of Taxation for the Commonwealth of Australia [2003] FCAFC 161 indicates that public ambulance services controlled by State or Territory governments are not public benevolent institutions . As such, these bodies cannot access the FBT exemption available to public benevolent institutions or be endorsed to receive tax deductible gifts as a public benevolent institution.

8.4         The amendments will allow fringe benefits provided to an employee of a public ambulance service to be exempt from FBT, subject to a $17,000 cap. This is consistent with the FBT treatment of employees of public hospitals. Public ambulance services will also be able to access the remote area housing FBT exemption under the same criteria as currently applies to public hospitals.

8.5         The amendments will also allow public ambulance services to be endorsed to receive tax deductible gifts.

Summary of new law

8.6         From 1 April 2004, where:

·       the employer provides public ambulance services or services that support those services; and

·       the employee is predominantly involved in connection with the provision of those services,

fringe benefits provided to an employee are exempt from FBT, subject to a cap of $17,000 grossed-up taxable value per employee.

8.7         From 1 April 2004, where:

·       the employer provides public ambulance services or services that support those services; and

·       the employee is predominantly involved in connection with the provision of those services,

a remote area (for the purposes of the remote area housing FBT exemption) will be one that is at least 100 kilometres from a population centre of 130,000 or more.

8.8         From 1 April 2004, certain gifts made to an endorsed:

·       public ambulance service; or

·       public fund established and maintained for the purpose of providing money for the provision of public ambulance services,

will be tax deductible.

8.9         These amendments will provide employees of public ambulance services with the same FBT treatment as is provided to employees of public hospitals. They will also allow public ambulance services to receive tax deductible gifts.

Comparison of key features of new law and current law

New law

Current law

From 1 April 2004, where:

·        the employer provides public ambulance services or services that support those services; and

·        the employee is predominantly involved in connection with the provision of those services,

fringe benefits provided to an employee are exempt from FBT, subject to a $17,000 cap.

Fringe benefits provided by an employer who provides public ambulance services or services that support those services do not receive any concessional FBT treatment.

However, where the employer is also a public benevolent institution then fringe benefits provided to an employee are exempt from FBT, subject to a $30,000 cap.

From 1 April 2004, where:

·        the employer provides public ambulance services or services that support those services; and

·        the employee is predominantly involved in connection with the provision of those services,

a remote area (for the purposes of the remote area housing FBT exemption) will be one that is at least 100 kilometres from a population centre of 130,000 or more.

Fringe benefits provided by an employer who provides public ambulance services or services that support those services have to satisfy the same definition of remote area as most other types of organisations, that is, a remote area is one that is:

·        at least 100 kilometres from a population centre of 130,000 or more; and

·        at least 40 kilometres from a population centre of 14,000 or more.

However, if the employer is a charity then a remote area is one that is at least 100 kilometres from a population centre of 130,000 or more.

From 1 April 2004, certain gifts made to an endorsed:

·        public ambulance service; or

·        public fund established and maintained for the purpose of providing money for the provision of public ambulance services ,

will be tax deductible.

Gifts made to a public ambulance service, or a public fund established and maintained for the purpose of providing money for the provision of public ambulance services, are not tax deductible.

However, if the public ambulance service is a public benevolent institution then gifts to the service can be tax deductible.

Detailed explanation of new law

$17,000 capped fringe benefits tax exemption

8.10       Section 57A of the Fringe Benefits Tax Assessment Act 1986 allows certain types of employers to access an FBT exemption. Section 5B sets out the method for calculating the fringe benefits taxable amount, including the exempt amount which is capped at $17,000 grossed-up taxable value per employee for public hospitals and $30,000 grossed-up taxable value per employee for public benevolent institutions (that are not public hospitals).

8.11       From 1 April 2004, where:

·       the employer provides public ambulance services or services that support those services; and

·       the employee is predominantly involved in connection with the provision of those services,

fringe benefits provided to an employee are FBT exempt, subject to a cap of $17,000 grossed-up taxable value per employee. [Schedule 8, items 1 to 5]

8.12       An employer would provide ‘services that support those services’ in circumstances such as where the employer operates a call centre which answers emergency telephone calls made to public ambulance services. This would be the case even in circumstances where the call centre operated calls for other emergency services.

8.13       An employer would not be providing ‘services that support those services’ in circumstances where the service being provided has only an indirect connection with the provision of public ambulance services, or is merely similar to the provision of public ambulance services. For example, a commercial provider of transportation to hospitals would not be providing services that support public ambulance services.

8.14       An employee would be ‘predominantly’ involved if for at least half of their employment with the employer over the course of the relevant FBT year, they were involved in connection with the provision of those services. An employee would be ‘involved in connection with the provision of those services’ if they were working as a public ambulance officer. An employee would also be ‘involved in connection with the provision of those services’ if they were providing secretarial services for an employer who provides public ambulance services or services that support those services.

Exemption for remote area housing fringe benefits

8.15       Housing fringe benefits are FBT exempt where provided in a remote area. A remote area (for the purposes of the remote area housing FBT exemption) is generally defined as one that is at least 100 kilometres from a population centre of 130,000 or more and at least 40 kilometres from a population centre of 14,000 or more.

8.16       However, in relation to public hospitals a remote area is defined as one that is at least 100 kilometres from a population centre of 130,000 or more. This definition also applies in certain other circumstances, such as where the employer is a charitable institution.

8.17       The amendments provide that, from 1 April 2004, where:

·       the employer provides public ambulance services or services that support those services; and

·       the employee is predominantly involved in connection with the provision of those services,

a remote area will be one that is at least 100 kilometres from a population centre of 130,000. [Schedule 8, items 6 and 7]

Deductible gift recipient status

8.18       The income tax law allows taxpayers to claim income tax deductions for certain gifts to deductible gift recipients (DGR). To be a DGR, a fund, authority or institution must fall within a category of organisations set out in Division 30 of the ITAA 1997 (or be mentioned by name under that Division). Section 30-17 includes a requirement for a fund, authority or institution to be endorsed by the Commissioner of Taxation in order to obtain DGR status.

8.19       The amendment establishes a new category of fund, authority or institution in Division 30. From 1 April 2004, taxpayers will be able to claim income tax deductions for certain gifts where they are made to an endorsed:

·       public ambulance service; or

·       public fund established and maintained for the purpose of providing money for the provision of public ambulance services.

[Schedule 8, items 9 and 10]

Application provisions

8.20       The amendments to the Fringe Benefits Tax Assessment Act 1986 apply in respect of the FBT year beginning on 1 April 2004 and in respect of all later FBT years. [Schedule 8, item 8]

8.21       The amendments to the ITAA 1997 apply to gifts made on or after 1 April 2004. [Schedule 8, item 11]

 



C hapter 9  

Taxation of overseas superannuation payments

Outline of chapter

9.1         Schedule 9 to this bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to alter the taxation treatment that applies when payments are made from overseas superannuation funds. The amendments give effect to the Government’s response to the report by the Senate Select Committee on Superannuation called Taxation of Transfers from Overseas Superannuation Funds .

9.2         The key change will enable a taxpayer who is having their overseas superannuation paid directly to an Australian complying superannuation fund to elect to have part of the payment treated as a taxable contribution in the Australian fund. By doing so the fund, rather than the individual, will include the relevant amount in assessable income and any tax will be paid at the concessional superannuation fund rate (15%) rather than at the individual’s marginal rate.

9.3         A number of related amendments are also made to improve the operation and clarity of the provisions dealing with payments of overseas superannuation.

Context of amendments

Background

9.4         It is an accepted principle that Australian residents should be taxed on their worldwide earnings. Consistent with this principle, where a superannuation benefit is paid from an overseas fund a tax liability may arise in respect of an amount reflective of the earnings on the overseas superannuation while the individual was an Australian resident.

9.5         If the payment is made within six months of the individual becoming an Australian resident the payment is tax free (by virtue of being considered an exempt non-resident foreign termination payment).

9.6         If the payment is made outside the six month period then the assessable amount is determined in accordance with a formula specified in section 27CAA of the ITAA 1936. Under this formula the assessable amount generally reflects the investment earnings on the overseas superannuation benefit between the time the individual became an Australian resident and the time the payment took place.

9.7         The assessable amount has until now been included in the assessable income of the individual taxpayer in the year the payment took place and has been taxed at the taxpayer’s marginal rate. Since any amount paid directly to an Australian fund is subject to the normal preservation requirements of Australian law (i.e. it will not normally be accessible until retirement after age 55) these amounts have not been available to the taxpayer to pay the related taxation liability.

Summary of new law

9.8         Schedule 9 to this bill will amend the ITAA 1936.

9.9         The key change will be to allow an individual who is having overseas superannuation paid directly to an Australian complying superannuation fund to elect to have part of the payment treated as a taxable contribution in the Australian fund. By doing so the fund, rather than the individual, will pay relevant tax on the payment and tax will be paid at the concessional superannuation fund rate rather than at the individual’s marginal rate.

9.10       This will overcome the difficulties experienced by individuals faced with a tax liability without recourse to funds to pay the liability due to the benefits being required to be preserved in the Australian fund until retirement.

9.11       The foreign investment fund (FIF) rules will also be amended to prevent double taxation where an amount that has been taxed under the FIF rules is also treated as a taxable contribution in an Australian fund (when the amount is paid to the Australian fund).

9.12       A number of related amendments will improve the operation and clarity of the law dealing with the taxation of overseas superannuation payments by:

·       clarifying that amounts paid into an Australian fund will be treated as undeducted contributions in the fund, unless they are amounts treated as taxable contributions;

·       ensuring that tax is not payable at the time a payment is made from one overseas fund to another, but only at the time the benefit is paid to an Australian fund or otherwise paid to or for the individual;

·       ensuring that certain capital amounts previously transferred into the paying fund do not form part of the taxable amount when the overseas benefit is paid;

·       providing a method to exclude from the assessable amount any amounts representative of earnings during periods of non-residency; and

·       inserting specific provisions to provide clarity over the treatment of partial payments.

9.13       The amendments do not affect the six month grace period.

9.14       If the overseas superannuation is not paid directly to an Australian complying superannuation fund (e.g. if the overseas superannuation is paid direct to the taxpayer) then the assessable amount will continue to be included in the taxpayer’s assessable income and taxed at their marginal rate.

9.15       The payments are not subject to the superannuation contributions surcharge as they do not meet the definition of ‘surchargeable amounts’ in the existing surcharge legislation (refer to section 8 of the Superannuation Contributions Tax (Assessment and Collection) Act 1997 ).

Comparison of key features of new law and current law

New Law

Current Law

Where a payment is made from an eligible non-resident non-complying superannuation fund direct to a complying superannuation fund in Australia, the individual will be able to elect to have part of the payment treated as a taxable contribution in the Australian fund.

By doing so the fund, rather than the individual, will pay the tax on the relevant amount and will do so at the concessional superannuation fund rate.

 

If the payment is made within six months of the individual becoming an Australian resident the payment remains tax free.

The FIF rules will prevent double taxation where an amount that has been taxed under the FIF rules is treated as a taxable contribution in an Australian fund (when the amount is paid to an Australian fund).

Amounts paid into an Australian fund will be treated as undeducted contributions in the fund, unless they are treated as taxable contributions.

Tax will not be payable at the time a payment is made from one overseas fund to another, but only at the time the benefit is subsequently paid to an Australian fund or otherwise paid to or for the individual.

Certain capital amounts previously transferred into the paying fund will not form part of the taxable amount when overseas benefits are paid.

Amounts representative of earnings during periods of non-residency will not be included in the taxable amount.

Specific provisions will provide clarity over the treatment of partial payments.

Where a payment is made from an eligible non-resident non-complying superannuation fund, then an amount (the assessable amount) reflecting earnings on the overseas superannuation fund since the individual became a resident of Australia is included in the individual’s assessable income and is taxed at marginal tax rates.

The individual has no access to money in the Australian fund (because of preservation requirements) to pay the tax liability.

If the payment is made within six months of the individual becoming an Australian resident the payment is tax free.

Detailed explanation of new law

Amendments to the Income Tax Assessment Act 1936

Replacement of section 27CAA with new section 27CAA

9.16       The existing section 27CAA is repealed and replaced with a new section 27CAA. The structure and provisions are unchanged in a number of respects. Where the new provisions are different they are explained in the remainder of this chapter. [Schedule 9, item 2]

Election to treat part of a payment to a complying superannuation fund as a taxable contribution

9.17       If an overseas superannuation benefit is paid for an individual from an eligible non-resident non-complying superannuation fund direct to a complying superannuation fund, and the individual no longer has an interest in the first fund after the payment (i.e. the payment represents payment of the individual’s entire benefit in the paying fund), the individual may elect for part of that payment to be treated as a taxable contribution by the complying superannuation fund. [Schedule 9, item 2, subsection 27CAA(3)]

9.18       If the individual makes such an election then the amount that would otherwise be included in their assessable income and taxed at their marginal tax rate in accordance with subsections 27CAA(1) and (2) will be reduced by the amount covered by the election. The amount covered by the election will be treated as a taxable contribution by the fund and taxed at the fund’s concessional tax rate (15%). [Schedule 9, item 2, subsection 27CAA(4); item 4, paragraph 274(10)(d)]

9.19       The election must be in writing and comply with requirements (if any) specified in regulations. The Australian Taxation Office is intending to develop a standard document which individuals can use when making the election to the fund and which will provide any necessary information that the superannuation fund requires to process the election. [Schedule 9, item 2, subsection 27CAA(5)]

Example 9.1

A taxpayer has $100,000 in an overseas fund which is paid direct to an Australian complying superannuation fund. Assume that the amount that would be assessable under the formula in subsection 27CAA(2) is $20,000. The taxpayer may elect under subsection 27CAA(3) to have $20,000 treated as a taxable contribution to the Australian fund. The Australian fund will tax the amount accordingly under paragraph 274(10)(d) and the amount to be included in the taxpayer’s assessable income will be reduced to $0 under subsection 27CAA(4).

Amendment to foreign investment fund rules to avoid double taxation

9.20       Where an Australian resident has an interest in an overseas superannuation fund, the person may be assessed for tax in respect of the fund’s earnings under the FIF rules. If the overseas superannuation is subsequently paid to an Australian fund, the amount of income that would be included in assessable income under section 27CAA, as a result of the payment, is exempt to the extent that it relates to amounts that have already been taxed under the FIF rules (section 23AK).

9.21       Under the proposed changes, an individual may elect for an amount that would otherwise have been included in assessable income under section 27CAA (when overseas superannuation is paid direct to an Australian fund), to be a taxable contribution in the Australian superannuation fund. To avoid double taxation, the individual will be entitled to a deduction, to offset assessable income to the lesser of the amount covered by the taxpayer’s election (i.e. the taxable contribution amount) and the FIF attribution surplus immediately before the transfer happens. [Schedule 9, item 5, section 533B]

9.22       When a taxable contribution amount is used to offset assessable income, a FIF attribution debit arises for that amount in relation to the FIF. The FIF attribution debit arises immediately after the taxpayer becomes entitled to the deduction. [Schedule 9, item 6, section 607AA]

Treatment of payments in terms of eligible termination payment components

9.23       The definition of ‘undeducted contributions’ in subsection 27A(1) is amended to provide that the portion of any payment from an eligible non-resident non-complying superannuation fund into an Australian fund that is treated as a taxable contribution will not be considered ‘undeducted contributions’ in the superannuation fund. Rather these amounts would, for the purposes of any later application of the eligible termination payment (ETP) provisions, fall by default into the post-June 1983 component. The remaining portion of any such payment (i.e. that part not considered taxable contributions) would be considered ‘undeducted contributions’. [Schedule 9, item 1]

Treatment of payments from one overseas fund to another

9.24       Where a payment is made from one eligible non-resident non-complying superannuation fund to another eligible non-resident non-complying superannuation fund this will no longer trigger a taxation liability at that time. [Schedule 9, item 2, paragraph 27CAA(1)(c)]

9.25       Instead the amount of that payment that would have otherwise been assessable at that time will now become assessable (by virtue of being considered a ‘previously exempt amount’) when payment is later made from the other eligible non-resident non-complying superannuation fund, or another subsequent eligible non-resident non-complying superannuation fund, to an Australian complying superannuation fund, or otherwise to or for the individual. This is achieved by the inclusion of ‘previously exempt amounts’ in the formula that determines the assessable amount for that subsequent payment. [Schedule 9, item 2, subsection 27CAA(2)]

9.26       Broadly a ‘previously exempt amount’ is an amount which would have been previously assessable under section 27CAA but for paragraph 27CAA(1)(c) which excludes payments from one eligible non-resident non-complying superannuation fund to another from being assessable. [Schedule 9, item 2, paragraph 27CAA(1)(c), section 27CAB]

9.27       A ‘previously exempt amount’ in respect of a relevant payment is defined as an amount:

·       to which the payment day entitlement, or part of it, is attributable (i.e. at least part of the payment day entitlement has arisen as a result of a previously exempt amount being paid into the paying fund); and

·       which would have been previously assessable under section 27CAA but for paragraph 27CAA(1)(c) (i.e. but for the payment having been made from one eligible non-resident non-complying superannuation fund to another eligible non-resident non-complying superannuation fund).

[Schedule 9, item 2, section 27CAB]

Example 9. 2 

Overseas Fund 1 pays $100 to Overseas Fund 2 (payment 1).

Overseas Fund 2 pays $200 to Overseas Fund 3 (payment 2).

Overseas Fund 3 pays $250 to, or in relation to, an Australian individual (payment 3).

Assume the assessable amount but for paragraph 27CAA(1)(c) would have been $20 on payment 1 and $100 on payment 2 and that the assessable amount (excluding previously exempt amounts) on payment 3 would be $50.

Then the assessable amount on payment 3 will be $50 plus all ‘previously exempt amounts’, which in this case would be

$20  +  $100.

The total assessable amount under section 27CAA would be

$50  +  $20  +  $100  =  $170.

Amending the definition of ‘additional contributions’ to ensure that certain capital amounts paid into a fund are not subsequently considered taxable under section 27CAA.

9.28       The broad intent of section 27CAA is to ensure that earnings of an Australian resident in an overseas fund are subject to tax. This is in part achieved by the formula in section 27CAA excluding contributions from being included in the amount that is assessable. However, payments into an eligible non-resident non-complying superannuation fund are not similarly excluded from that calculation and will thus be assessable when paid out unless specifically excluded. It is not appropriate for such payments to be assessable.

9.29       Accordingly, the definition of ‘additional contributions’ has been amended so that amounts paid from an eligible non-resident non-complying superannuation fund into the eligible non-resident non-complying superannuation fund that is the paying fund will be considered ‘additional contributions’ and thus will not be assessable when a payment is made from that fund (other than to the extent there are any associated ‘previously exempt amounts’ - see paragraph 9.25). [Schedule 9, item 2, subsection 27CAA(2), definition of ‘additional contributions’]

Ensuring only amounts attributable to periods of residency are included in the assessable amount

9.30       In certain circumstances it is possible that an individual may become an Australian resident, and then cease to be a resident for many years, before again becoming a resident and then arranging for their benefits to be paid into Australia. In this circumstance, currently the formula in section 27CAA effectively includes the earnings since the first day of residency in the assessable amount. This is not appropriate as the policy intent is only to tax earnings while the individual was an Australian resident.

9.31       To address this anomaly the amount that would otherwise be assessable under section 27CAA will be reduced so that the assessable amount only reflects periods of residency since the individual first became resident. This is achieved by multiplying the amount that would otherwise be the assessable amount by a factor representing ‘resident days’ over ‘total days’. [Schedule 9, item 2, subsection 27CAA(2)]

9.32       Resident days is the total number of days on which the taxpayer is a resident of Australia in the period from and including the relevant day for the relevant payment, up to and including the day on which the payment was made. Total days is the total number of days in the period from and including the relevant day for the relevant payment, up to and including the day on which the payment was made. [Schedule 9, item 2, subsection 27CAA(2)]

Determining the treatment of partial payments

9.33       In determining the assessable amount under section 27CAA, the formula in subsection 27CAA(2) provides that the assessable amount is determined by taking the ‘payment day entitlement’ and, among other things, subtracting ‘accumulated entitlement’ and ‘additional contributions’. To determine the treatment of partial payments, amendments have been made to these definitions.

9.34       The new definition of ‘accumulated entitlement’ ensures that if there has been a previous payment then in calculating the assessable amount for the second payment the accumulated entitlement is effectively reset, that is, it is the amount properly payable to the taxpayer out of the paying fund immediately after the most recent payment. [Schedule 9, item 2, subsection 27CAA(2), definition of ‘accumulated entitlement’]

9.35       Similarly, the new definition of ‘additional contributions’ ensures that if there has been a previous payment then in calculating the assessable amount for the second payment it is only additional contributions since the previous payment that are taken into account. [Schedule 9, item 2, subsection 27CAA(2), definition of ‘additional contributions’]

Example 9.3

Assume the vested benefit in an overseas fund is $110,000 (the ‘payment day entitlement’) on day of first payment and that the ‘accumulated entitlement’ for the purpose of this payment was $90,000. Also assume that ‘additional contributions’ and ‘previously exempt amounts’ both equal $0, and that ‘resident days’ divided by ‘total days’ equals one.

Assume the first payment is for $100,000. The assessable amount for the first payment will be $110,000  -  $90,000  =  $20,000.

The amount remaining after the first payment would be $10,000. Assume by the time of the second payment the vested benefit remaining is $15,000 and there were $2,000 additional contributions since the previous payment, and the full $15,000 is paid. The assessable amount for the second payment will be,

$15,000  -  $10,000  +  $2,000  =  $3,000.

Application provisions

9.36       The amendments made by this Schedule apply to payments made on or after 1 July 2004. [Schedule 9, item 7]

REGULATION IMPACT STATEMENT

Background

9.37       The current tax treatment of overseas transfers of superannuation into Australia is governed by section 27CAA of the ITAA 1936. Broadly, section 27CAA provides that lump-sum payments from foreign superannuation funds are subject to tax on any investment earnings that have accrued since the individual became a tax resident of Australia. Any tax liability under section 27CAA is included in the assessable income of the taxpayer in the year the transfer took place and is taxed at the taxpayer’s marginal rate.

9.38       An exception to section 27CAA (the ‘6 month rule’) ensures that lump-sum transfers within six months of an individual becoming an Australian resident taxpayer are tax free. The grace period is designed to give individuals sufficient time to transfer their superannuation entitlements to Australia while minimising the scope for these individuals to avoid paying Australian tax.

9.39       There is no legal requirement in Australia for the monies to be paid to an Australian regulated fund. However, once monies have been transferred into an Australian regulated fund they are preserved and generally cannot be accessed. The individual must pay any resulting tax liability from other sources.

Policy objective

9.40       The objectives are:

·       to address the problem of the tax payable when overseas superannuation is transferred to an Australian superannuation fund being payable by the individual with no recourse to the superannuation benefit to pay that liability; and

·       to encourage the timely transfer of superannuation benefits into Australia and enhance the fairness and efficiency of the superannuation system in relation to such transfers.

IMPLEMENTATION OPTIONS

Four options were considered

Option 1

9.41       Leave the calculation of the tax payable unchanged but enable the individual to access their superannuation lump sum in order to pay their tax liability.

9.42       This option would involve amending legislation to enable the individual to access so much of their superannuation as necessary to pay their tax liability under section 27CAA. This would involve amendments to the Superannuation Industry Supervision Act 1993 .

Option 2

9.43       Leave the calculation of tax payable unchanged, but make the tax liability payable by the superannuation fund.

9.44       This option would involve amending legislation to enable the superannuation fund to directly pay the individual’s tax liability arising under section 27CAA.

Option 3

9.45       Allow the taxable amount of the transfer to be treated as a taxable contribution in the superannuation fund.

9.46       This option would involve amending legislation to enable the individual (via an election process) to effectively transfer the taxation liability to the Australian superannuation fund, with the taxable amount then taxed in the fund at the concessional superannuation fund rate.

Option 4

9.47       Tax the taxable amount for the transfer at a flat rate of 15% (rather than at the individual’s marginal rate), and allow the individual access to the superannuation benefit to pay the tax.

9.48       This option would involve amending legislation to change the way tax is calculated on the overseas transfer and enable the individual to access so much of their superannuation as is necessary to meet that liability.

Assessment of impacts

Option 1

9.49       Leave the calculation of the tax payable unchanged but enable the individual to access their superannuation lump sum in order to pay their tax liability.

9.50       This option would involve amending legislation to enable the individual to access so much of their superannuation as necessary to pay their tax liability under section 27CAA. This would involve amendments to the Superannuation Industry Supervision Act 1993 .

Impact group identification

9.51       This option would affect individuals transferring their benefits, the funds that benefits are being transferred to, and the Australian Taxation Office (ATO).

9.52       The number of individuals who would be affected by the measure is not clear, however, in short it is comprised of all individuals who have or will migrate to Australia and have superannuation overseas which they wish to transfer to an Australian fund. To date it would appear that the main source of transferred funds has been the United Kingdom.

9.53       As at September 2003 there were 277,690 superannuation funds in Australia. However 275,523 of these are small (less than five member funds), the great majority of which would not receive overseas transfers.

Benefits

9.54       Individuals will benefit from not having to finance their tax liability from sources other than superannuation.

Costs

9.55       Individual costs would remain largely unchanged from the current arrangements, however in some instances they could fall as a result of not having to borrow money in order to finance their tax liability from non-superannuation sources.  Individuals would have to provide the superannuation fund with information (such as potentially their marginal tax rate) to enable the fund to determine the appropriate amount to release.

9.56       Superannuation funds will incur increased costs from managing applications for early release of superannuation for this purpose. This will involve seeking information from the individual in order to determine the appropriate amount to release to fund the tax liability. In addition, the fund may require information from the ATO regarding the size of the tax liability under section 27CAA. Changes to processes and computer systems could be required.

9.57       Additional costs for Government would arise if the ATO needed to identify and report to the fund the individual’s tax liability under section 27CAA.

Option 2

9.58       Leave the calculation of tax payable unchanged, but make the tax liability payable by the superannuation fund.

9.59       This option would involve amending legislation to enable the superannuation fund to directly pay the individual’s tax liability arising under section 27CAA.

Impact group identification

9.60       As for option 1.

Benefits

9.61       Individuals will benefit from effectively being able to finance their tax liability from their superannuation.

Costs

9.62       Superannuation funds will incur costs of calculating the tax liability and making the tax payment. Government would incur costs from the need to ensure the tax liability has been appropriately paid by the fund.

9.63       Superannuation funds will face increased costs from having to obtain information to calculate the individual’s tax liability under section 27CAA, such as potentially the individual’s marginal tax rate and other information relating to the transferred amount. There will also be processing and system costs incurred by funds to enable calculation and payment of the tax due to the ATO. Individuals will incur costs in providing information to their fund to enable the taxable amount to be calculated.

9.64       Government will face some administration costs in establishing and maintaining a system for the payment of tax by funds to the ATO in relation to overseas superannuation transfers, which has been paid by the individual until now.

Option 3

9.65       Allow the taxable amount of the transfer to be treated as a taxable contribution in the superannuation fund.

9.66       This option would involve the individual being able (via an election process) to effectively transfer the taxation liability to the Australian superannuation fund, with the taxable amount then taxed in the fund at the concessional superannuation fund rate.

Impact group identification

9.67       As for option 1.

Benefits

9.68       Individuals will benefit from not having to finance their tax liability from sources other than superannuation as well as from a reduced tax rate.

Costs

9.69       The Australian fund will have to ensure the transfer is appropriately taxed. This may involve some additional administration costs for the funds. However, as the election process will provide a mechanism by which the amount to be treated as a taxable contribution is identified, and as the taxable amount of the transfer is taxed in the same way as other taxable contributions to the fund, the impacts on fund processes are expected to be minimal.

9.70       Costs on Government may involve development of standard forms which individuals and funds can use in the transfer process. As tax will be payable by the fund in the same manner as the fund currently pays tax in respect of other taxable contributions there will be no additional costs for Government in the tax collection process.

Option 4

9.71       Tax the taxable amount for the transfer at a flat rate of 15% (rather than at the individual’s marginal rate), and allow the individual access to the superannuation benefit to pay the tax.

9.72       This option would involve amending legislation to change the way tax is calculated on the overseas transfer and enabling the individual to access so much of their superannuation as is necessary to meet that liability.

Impact group ident i fication

9.73        As for option 1.

Benefits

9.74       Individuals will benefit from being able to finance their tax liability from their superannuation.

Costs

9.75       Superannuation funds will incur increased costs from managing applications for early release of superannuation for this purpose. This will involve seeking information from the individual in order to determine the appropriate amount to release to fund the tax liability. In addition, the fund may require information from the ATO regarding the size of the tax liability under section 27CAA. Changes to processes and perhaps computer systems may be required.

9.76       The costs would thus be similar to those in option 1 but reduced by comparison because there would be no need to calculate the individual’s marginal tax rate.

9.77       Individuals would face costs in supplying the fund with the necessary information for the fund to calculate the taxable amount (as with option 1).

9.78       Additional costs for Government would arise if the ATO needed to identify and report to the fund the individual’s tax liability under section 27CAA.

Consultation

9.79       Consultations have been undertaken with key superannuation industry groups and other organisations who had previously made representations on the issue to the Senate Select Committee on Superannuation. Industry were supportive of an approach which allowed the individual to effectively transfer the taxation liability to the fund without imposing significant administrative costs.

Conclusion and recommended option

9.80       Option 3 is the recommended option. While there would be some administration costs for funds they would be minimised in comparison to other options and are justified given the benefits of the overall simplicity and equity of this approach.

9.81       Option 1 would impose more significant costs on funds, the ATO or both in ascertaining the exact amount able to be released by the fund.

9.82       Option 2 would also impose more significant compliance costs on funds through having to determine the amount that is taxable and developing new processes for paying the appropriate tax.

9.83       Option 4 would involve similar costs to option 1 for funds in determining how much is eligible for release to pay the liability.

 

 



C hapter 10

Simplified imputation system - franked distributions received through certain partnerships and trusts

Outline of chapter

10.1       Schedule 10 to this bill amends Division 207 of the Income Tax Assessment Act 1997 (ITAA 1997), as part of the implementation of the simplified imputation system (SIS), which deals with the tax effect of receiving a franked distribution. The amendments will include adjustment rules to provide the calculation to adjust an entity’s assessable income where a franked distribution flows indirectly to the entity through a trust or partnership and the entity has no entitlement to a tax offset.

10.2       The amendments will also:

·       rectify two technical defects that have been identified in Division 207;

·       make consequential amendments to other parts of Division 207 and other parts of the SIS;

·       update Division 207 so that it takes into account legislation that has been enacted since Division 207 came into operation; and

·       improve the readability of the provisions.

10.3       The anti-avoidance provisions in Division 7AA of Part IIIAA of the Income Tax Assessment Act 1936 (ITAA 1936), which are to be included in Division 207, will now be included in a later bill. These provisions apply to exempt institutions that are entitled to a refund of franking credits under the refundable tax offset rules in Division 67 of the ITAA 1997.

10.4       The trans-Tasman imputation measures in Division 220 of Part 3-6 of the ITAA 1997 that deal with the effects of receiving a supplementary dividend will also be amended to implement a minor policy change and ensure consistency with Division 207.

Context of amendments

10.5       The implementation of the SIS arose out of a recommendation of the Review of Business Taxation. In Treasurer’s Press Release No. 58 of 21 September 1999 the Government announced its proposal to implement the SIS which aims to reduce compliance costs incurred by business by providing simpler processes and increased flexibility. Minister for Revenue and Assistant Treasurer’s Press Release No. C57/02 of 14 May 2002 announced that the SIS would commence on 1 July 2002.

10.6       Division 207 of Part 3-6 of the ITAA 1997 is part of the core SIS rules introduced in the New Business Tax System (Imputation) Act 2002 .

10.7       Although the changes to Division 207 generally apply from 1 July 2002, taxpayers will not be adversely affected. These changes clarify the operation of Division 207 but they do not change the way the law is currently applied.

Summary of new law

Franked distributions received through certain partnerships and trusts

10.8       Taxation Laws Amendment Act (No. 4) 2003 , which received Royal Assent on 30 June 2003, introduced the new concept of non-assessable non-exempt income. It is necessary that the rules in Division 207 that deal with franked distributions made indirectly through trusts or partnerships properly deal with this class of income as well as exempt income. This is because a franked distribution may be exempt or non-assessable non-exempt income in the hands of a recipient entity.

10.9       In addition, it is necessary to amend the concept of:

·       a trustee’s or beneficiary’s share of the net income of a trust that is attributable to a franked distribution; and

·       a partner’s individual interest in the partnership’s net income (or partnership loss) that is attributable to a franked distribution.

This concept, which is present in the current and former imputation provisions, is used in determining an entity’s share of a franking credit where the distribution has flowed indirectly to the entity through a partnership or trust or through a chain of trusts and partnerships. The application of the concept needs to be clarified to ensure that partners, trustees and beneficiaries can benefit from franked distributions in cases where the deductions of the partnership or trustee exceed the franked distribution.

Adjustment where no tax offset is allowed

10.10     Subdivisions 207-D, 207-E and 207-F of Part 3-6 of the ITAA 1997 contain rules to provide for an adjustment to an entity’s assessable income where the entity receives a franked distribution indirectly through a partnership or the trustee of a trust but the entity is not entitled to a tax offset. The adjustment is required to prevent the entity’s share of a franking credit being inappropriately included in its assessable income.

10.11     These rules apply in the following cases:

·       the recipient of a franked distribution is a non-resident;

·       the franked distribution is not taxed in the hands of the recipient (i.e. the income is exempt income or non-assessable non-exempt income in the hands of the recipient); or

·       the imputation system has been manipulated, so that no imputation benefits arise or the imputation benefits are denied.

10.12     These Subdivisions currently provide that an adjustment is to be made but do not specify how the adjustment is to be calculated. It was initially intended that these rules, which are to have the same operation as the former imputation rules in Part IIIAA of the ITAA 1936, be included in a later bill in new Subdivision 207-J. However, they will now be incorporated in the existing Subdivisions in Division 207.

Trans-Tasman imputation measures

10.13     The trans-Tasman imputation measures in Division 220 of Part 3-6 of the ITAA 1997 provide for an adjustment to the assessable income of an Australian shareholder in receipt of a franked distribution from a New Zealand (NZ) company where that company has paid a supplementary dividend in relation to the distribution. These rules could not be completed until the adjustment rules in Division 207 were completed.

Detailed explanation of new law

Franked distributions received through certain partnerships and trusts

10.14     Subdivision 207-B is repealed and replaced with provisions that rectify a technical defect in the definition of the term ‘flow indirectly’. In addition, the concept of ‘an entity’s share of a franked distribution’ will replace the existing concept of a share (or interest) in the net income of a trustee of a trust or a partnership (or partnership loss) that is attributable to a franked distribution.

When does a franked distribution flow indirectly to an entity?

10.15     The definition of ‘flow indirectly’ in section 207-35 will be replaced so that a franked distribution can flow indirectly to an entity where the distribution, or part of the distribution, is exempt income or non-assessable non-exempt income in the hands of the recipient. Under the new definition, a franked distribution will be taken to flow indirectly to a partner in a partnership or to a beneficiary or the trustee of a trust if:

·       the distribution is made to a partnership or trustee of a trust or flows indirectly to the partnership or to the trustee or beneficiary of the trust as a partner or beneficiary [Schedule 10, item 7, paragraphs 207-50(2)(a), (3)(a) and (4)(a)] ; and

·       one of the following is satisfied:

-            the partner has an individual interest in the partnership’s net income or is allowed a deduction for a partnership loss under subsections 92(1) and (2) of the ITAA 1936 [Schedule 10, item 7, paragraph 207-50(2)(b)] ; or

-            the beneficiary has a share of the trust’s net income under paragraph 97(1)(a) of the ITAA 1936 or an individual interest in the trust’s net income under paragraph 98A(1)(a) or (b) or 100(1)(a) or (b) of the ITAA 1936 [Schedule 10, item 7, paragraph 207-50(3)(b)] ; or

-            the trustee is liable to be assessed on a share of the trust’s net income in respect of a beneficiary under section 98 of the ITAA 1936 or assessed on all or part of the trust’s net income for that year under section 99 or 99A of the ITAA 1936 [Schedule 10, item 7, paragraph 207-50(4)(b)] ; and

·       the entity’s share of the franked distribution as calculated in new section 207-55 is a positive amount. That is, the entity must have an entitlement to part or all of the franked distribution [Schedule 10, item 7, paragraphs 207-50(2)(c), (3)(c) and (4)(c)] .

10.16     The rule operates so that a franked distribution can flow indirectly where the distribution is exempt or non-assessable non-exempt income in the hands of a recipient. For example, the rule applies where the ultimate recipient is a non-resident and, because of section 128D of the ITAA 1936, the distribution is non-assessable non-exempt income in the hands of the non-resident entity. Section 207-50 also clarifies that a franked distribution can flow indirectly where there is a partnership loss, or deductions of the trustee of a trust or partnership exceed the amount of the franked distribution.

Example 10.1

A franked distribution of $70 with $30 franking credits attached is made to a partnership which has two equal partners, an individual and the trustee of a trust that has one beneficiary. The partnership has losses from another business activity of $200 and therefore has an overall loss of $100. A loss of $50 is distributed to the individual partner and to the trustee.

The trust has other income of $100 and therefore has net income to distribute to the beneficiary. Both the individual partner and the trustee are entitled to a franking credit of $15. The franked distribution flows indirectly to the ultimate recipients (i.e. the individual and beneficiary of the trust) as the franked distribution was taken into account in determining the partnership loss.

When does a franked distribution flow indirectly through an entity?

10.17     For the purposes of working out an entity’s share of the franked distribution, it is also necessary to describe where a franked distribution flows indirectly through an entity. This occurs where there is an entity (intermediary entity) and the franked distribution flows through that entity to another entity (the focal entity) [Schedule 10, item 7, subsection 207-50(5)] . These terms are used in the table in subsection 207 55(1) to determine an entity’s share of the franked distribution where it flows indirectly.

What is an entity’s share of the franked distribution?

10.18     Under the existing imputation rules in Subdivision 207-B, the concept of an entity’s share or interest in the net income of the trustee of a trust or partnership (or in the case of a partnership, an interest in the partnership loss) that is attributable to a franked distribution is used to determine an entity’s share of a franking credit in relation to the distribution. This concept also existed in the former imputation rules. However, the application of the concept is uncertain where the deductions of a partnership or trustee of a trust exceed the amount of the franked distribution. It is intended that partners, trustees or beneficiaries benefit from the franking credit in these circumstances even though there is no actual receipt of the franked distribution.

10.19        This defect is overcome by introducing the concept of an entity’s share of a franked distribution in new section 207-55. The share is taken to be a notional share because an entity may not actually receive its share of the franked distribution (i.e. the concept is defined so that it is undiminished by deductions of the partnership or trustee of a trust through which a franked distribution flows) [Schedule 10, item 7, subsections 207-55(1) and (2)] . That is, even though the entity does not receive an amount of the franked distribution because deductions exceed the amount of the franked distribution, the franking benefits may still flow through to the partner or beneficiary.

Example 10.2

A franked distribution of $70 with $30 franking credits attached is made to the trustee of a trust. The deductions incurred in deriving the distribution amount to $110. The trustee derives other assessable income of $100 so the net income of the trust is $90. The trustee has two equal beneficiaries to which the $90 is distributed.

The franked distribution is taken into account in determining the net income of the trustee and, as such, each beneficiary’s share of the franked distribution is $15 (this is despite neither beneficiary receiving an amount of the franked distribution because the deductions of the trustee exceed the amount of the franked distribution).

Under new section 207-45, both beneficiaries are entitled to a tax offset of $15.

10.20     An entity’s share of a franked distribution is determined under the table in new subsection 207-55(3). This calculation is used to determine the entity’s share of the franking credit on a franked distribution where the distribution flows indirectly. A focal entity’s share of a franked distribution is calculated by referring to the share of the intermediary entity’s share of the franked distribution to

which the intermediary entity is entitled. Column 2 in the table provides the intermediary entity’s share and column 3 in the table provides the focal entity’s share. The table operates so that an entity’s share of a franked distribution can be calculated where the distribution flows indirectly:

·       to a partner in a partnership or to a beneficiary or the trustee of a trust; or

·       through a chain of trusts or combination of trusts and partnerships.

An entity’s share of a franked distribution is its share of a franked distribution as the focal entity. [Schedule 10, item 7, subsection 207-55(3)]

Example 10.3

A franked distribution of $70 with $30 franking credits attached is made to a partnership. The partnership has two equal partners, an individual and a trustee with two equal beneficiaries.

When determining the share of a franked distribution to which the beneficiaries of the trust are entitled, apply item 4 in the table in subsection 207-55(2). In determining the trustee’s share of the franked distribution as the intermediary entity, apply column 2 in item 4 in the table which refers back to item 1 as the trustee is a partner in a partnership. As the trustee is entitled to a 50% share of the partnership’s net income its share of the franked distribution (as the focal entity) is $35.

To work out the beneficiaries’ share of the franked distribution apply column 3 in item 4. As each beneficiary’s share of the franked distribution is 50% of the trust’s net income, each beneficiary’s share of the franked distribution is $17.50. To work out each of the beneficiary’s share of the franking credit apply the formula in section 207-57.

10.21     In the case of a trust, the table operates so that if deductions exceed assessable income (i.e. there is a loss) there can be no amount which flows indirectly through it to another entity. [Schedule 10, item 7, column 2 in item 3 in the table in subsection 207-55(3)]

What is an entity’s share of the franking credit?

10.22     New section 207-57 operates to determine the amount of an entity’s share of the franking credit on a franked distribution. The following formula operates to allocate the franking credit:

               

[Schedule 10, item 7, section 207-57]

Example 10.4

Continuing Example 10.3, the trustee’s share of the franking credit on the franked distribution is equal to $15 ($30  ´   ($35/$70)) where $30 is the amount of the franking credit on the franked distribution, $70 is the amount of the franked distribution and $35 is the trustee’s share of the franked distribution. Each beneficiary’s share of the franking credit on the franked distribution is equal to

$7.50 ($30  ´   ($17.50/$70)) where $15 is the amount of the franking credit on the franked distribution, $70 is the amount of the franked distribution and $17.50 is each beneficiary’s share of the franked distribution.

Other amendments to Subdivision 207-B

10.23     Sections 207-40, 207-45 and 207-50 are repealed and replaced with sections 207-35 and 207-45. Subsection 207-35(1), which replaces section 207-40, grosses-up the partnership’s or trustee’s assessable income by the amount of the franking credits attached to a franked distribution made to the partnership or trustee. The grossing-up rules do not apply in relation to a corporate tax entity that is a partnership or trustee or a complying superannuation entity that is a trustee. Also, a technical defect relating to a distribution flowing indirectly to a

partner of a partnership or to a beneficiary or trustee of a trust in former paragraphs 207-40(1)(b) and 207-40(2)(b) is removed.

10.24     Subsection 207-35(3), which replaces section 207-45, identifies the amount of the franking credit included in an entity’s (i.e. a partner or a beneficiary or the trustee of a trust) assessable income when a franked distribution flows indirectly to it through a partnership or trust using the concepts introduced in new Subdivision 207-B. This subsection ensures that the amount included in the entity’s assessable income that is attributable to the franking credit on a franked distribution is always proportionate to the partner’s or beneficiary’s share of the franked distribution. [Schedule 10, item 7, subsection 207-35(3)]

10.25     A beneficiary’s share of the net income of a trust, for example, would generally include an amount attributable to the franking credit on a franked distribution received by the trustee, which would be included in the beneficiary’s assessable income under section 97, 98A or 100 of the ITAA 1936. The amount included in the beneficiary’s assessable income that is attributable to the franking credit on the franked distribution received by the trust should be, and would often be, proportionate to the beneficiary’s share of the cash amount of the franked distribution.

10.26     It is possible, however, that the amount attributable to the franking credit is not proportionate. For example, a discrepancy between the beneficiary’s share of the distribution and the amount of the franking credit included in the beneficiary’s assessable income may occur where the beneficiaries of a trust do not all have an interest in the dividend income of the trust. A share of the franking credit on a franked distribution would generally be included in the share of the net income of the trust of all the beneficiaries, including those beneficiaries who do not have an interest in the dividend.

10.27     In this case, the assessable income of the beneficiaries will be adjusted. The assessable income of the beneficiaries with an interest in the dividend income will include an amount equal to their proportionate share of the franking credit based on their interest in the dividend. The assessable income of the other beneficiaries will not include any amount attributable to the franking credit on the distribution.

10.28     An entity that is the ultimate recipient of a franked distribution to whom a distribution flows indirectly is entitled to a tax offset for that income year equal to its share of franking credit attached to the distribution. The ultimate recipients of a franked distribution are the recipients that can use the tax offset and include individuals, corporate tax entities, trustees that are liable to be assessed under section 98, 99 or 99A of the ITAA 1936 or trustees of eligible entities within the meaning of Part IX of the ITAA 1936 (e.g. certain superannuation funds, approved deposit funds and pooled superannuation trust). [Schedule 10, item 7, section 207-45]

Adjustment where franked distribution is not taxed

10.29     Existing Subdivision 207-D (which deals with franked distributions flowing indirectly to non-residents) and existing sections 207-110 and 207-115 of Subdivision 207-E (which deal with franked distributions that are exempt or non-assessable non-exempt income) will be amended. These rules are replaced with general rules to be contained in a new Subdivision 207-D which deal with franked distributions that are exempt or non-assessable non-exempt income in the hands of the recipient entity.

Adjustment where a distribution is made to an entity

10.30     If a franked distribution is made to an entity and the distribution is exempt income or non-assessable non-exempt income in the hands of that entity, then the franking credit on the distribution is not included in the entity’s assessable income and there is no entitlement to a tax offset. [Schedule 10, item 8, subsection 207-90(1)]

10.31     If a franked distribution is made to an entity, and part of that distribution is exempt income or non-assessable non-exempt income in the hands of the entity, then the franked distribution is taken to be reduced by that part and the amount of additional income included in the entity’s assessable income and the tax offset to which the entity is entitled are reduced proportionately [Schedule 10, item 8, subsection 207-90(2)] . For example, where a franked distribution of $70 with $30 franking credits is made to an entity and $35 of the distribution is non-assessable non-exempt income in the hands of the entity, then the entity only includes an additional amount of $15 in its assessable income

(i.e. gross-up is reduced to $15) and its tax offset is reduced to $15.

Adjustment where distribution flows indirectly to an entity

10.32     If a franked distribution that flows indirectly to an entity is exempt income or non-assessable non-exempt income in the hands of the entity, an adjustment is made to the entity’s assessable income to remove the entity’s share of the franking credit, there is no entitlement to a tax offset and the distribution does not flow indirectly through it to another entity. [Schedule 10, item 8, subsection 207-95(1)]

10.33     The effect of a distribution not flowing indirectly to another entity is that the lower tier entity will not have any amount of the franking credit included in its assessable income and will not be entitled to a tax offset. It should be noted that for other purposes of the income tax law the distribution flows through to a lower tier entity as exempt or non-assessable non-exempt income (i.e. the concept of ‘flow indirectly’ is only relevant for imputation purposes).

10.34     The adjustment to the entity’s assessable income is set out in Table 10.1. The adjustment is a deduction where the distribution flows indirectly to a partnership or beneficiary and a reduction when it flows indirectly to a trustee. Where a franked distribution flows indirectly to the trustee of a trust, reduction rules apply (as opposed to deduction rules) because the deductions of the trust have already been taken into account in determining the trust’s net income.

Table 10.1

Provision

Circumstance

Deduction allowed

Item 8,

subsection 207-95(2)

Franked distribution flows indirectly to a partner.

The entity is allowed a deduction for that income year equal to the entity’s share of the franking credit on the distribution.

Item 8

Subsection 207-95(3)

Franked distribution flows indirectly to a beneficiary of a trust.

The beneficiary can deduct the lesser of:

·        its share of the net income of the trust (the share amount mentioned in subsection 207-50(3); and

·        the amount of its share of the franking credit on the distribution.

Item 8

Subsection 207-95(4)

Distribution flows to trustee of a trust.

The trustee can reduce the net income of the trust by the lesser of:

·        the entity’s share of the amount of the net income of the trust mentioned in subsection 207-90(4); and

·        the amount of the entity’s share of the franking credit on the distribution.

10.35     The ‘lesser of’ rule that applies in the case of trusts ensures that a beneficiary or trustee is unable to create a loss as a result of the adjustment to remove the effect of a franking credit from an entity’s assessable income.

Example 10.5

A franked distribution of $70 with $30 franking credits attached is made to a trust with two equal beneficiaries, an individual and a company. The distribution is non-assessable non-exempt income in the hands of the company. Under subsections 207-95(1) and (3), the company is allowed a deduction equal to its share of the franking credit. The distribution (i.e. $15) and the company has no entitlement to a tax offset.

10.36     A rule similar to subsection 207-90(2) is included in relation to a franked distribution that flows indirectly to an entity where part of the share of the franked distribution is exempt or non-assessable non-exempt income in the hands of the entity. For the purpose of applying the deduction rules in subsections 207-95(2) and (3) and the reduction rule in subsection 207-95(4), the rule applies to reduce the amount of the franking credit referred to in those subsections in the same proportion that the share of the franked distribution is exempt or non-assessable non-exempt income. [Schedule 10, item 8, subsection 207-95(5)]

10.37     In addition, the franked distribution that flows through to an entity is reduced by the part of the distribution that is exempt or non-assessable non-exempt income. This ensures that the tax offset to which the entity is entitled is appropriately reduced. [Schedule 10, item 8, subsection 207-95(6)]

Example 10.6

A franked distribution of $70 with $15 franking credits attached is made to a partnership (i.e. a distribution that is not fully franked). The partnership includes an additional amount of $15 in its assessable income under section 207-35 because of the distribution.

The partnership has two equal partners, X and Y. X is a non-resident. X receives a distribution of $42.50 which includes a franked part of $17.50, an unfranked part of $17.50 and an additional amount of $7.50 due to the grossing-up of the partnership’s assessable income by the amount of the franking credit. Under section 128D of the ITAA 1936, the franked and unfranked parts are non-assessable non-exempt income in the hands of the non-resident. Therefore, the non-resident has assessable income of $7.50.

As such, subsection 207-95(1) applies to the non-resident and a deduction of $7.50 is allowed to remove the share of the franking credit from the non-resident’s assessable income.

Exceptions to the rule in Subdivision 207-D

10.38     As part of the restructure of Division 207, Subdivision 207-E now only deals with exceptions to the adjustment rules in Subdivision 207-D. These exceptions are the same as in existing section 207-120. This Subdivision entitles certain entities to a tax offset even though the franked distribution (or the share of the franked distribution) is exempt income or non-assessable non-exempt income in the hands of the recipient entity. Where the franked distribution is made to an entity, the tax offset is equal to franking credit attached to a distribution. Where the franked distribution flows indirectly to an entity, the tax offset is equal to the entity’s share of the franking credit.

10.39     The two exceptions to the rules in Subdivision 207-D are franked distributions made or flowing indirectly to:

·       exempt institutions that are eligible for a refund where the distribution does not flow indirectly to the entity as a partner in a partnership; and

·       eligible superannuation entities (i.e. complying superannuation funds, approved deposit funds and pooled superannuation trusts) and life insurance companies where;

-            the exemption under sections 282B, 283 and 297B of the ITAA 1936 and paragraph 320-35(1)(b) for income relating to current pensions applies; and

-            the income is non-assessable non-exempt income under paragraph 320-37(1)(a) or (d)) for income of a life insurance company that is a friendly society relating to income bonds, funeral policies and scholarship plans.

[Schedule 10, item 11, subsection 207-110(1)]

10.40     The effect of these rules is that the distribution does not flow indirectly through the entity to another entity and:

·       where the distribution is made to an entity, the entity is entitled to a tax offset equal to the franking credit on the distribution under section 207-20; or

·       where the distribution flows indirectly to an entity under subsections 207-50(2) to (4), the entity is entitled to a tax offset equal to its share of the franking credit under section 207-45.

[Schedule 10, item 11, subsection 207-110(2)]

10.41     The consequence that the distribution does not flow indirectly to another entity ensures that multiple tax offsets cannot be claimed from a single franked distribution. For example, this could occur where a charitable trust that is an exempt institution is a beneficiary of another exempt institution.

Manipulation of the imputation system

10.42     The consequences for an entity receiving a franked distribution where the imputation system has been manipulated are currently set out in Subdivision 207-F of the ITAA 1997. Section 207-145 deals with distributions made to an entity and section 207-150 deals with franked distributions that flow indirectly to an entity. It should be noted that under the definition of ‘flow indirectly’ in section 207-50 a franked distribution flows indirectly to a trustee liable to be assessed under section 98, 99 and 99A of the ITAA 1936.

Adjustment where distribution is made to an entity

10.43     Section 207-145 is repealed and replaced with rules with the following changes:

·       the references to a receiving entity are removed;

·       paragraph 207-145(1)(g) is inserted to ensure that if a distribution flows indirectly through a lower tier entity, franking benefits will not be available to the lower tier entity;

·       the reference to paragraph 204-30(3)(b) in paragraph 207-145(1)(b) is changed to paragraph 204-30(3)(c);

·       a reference to franking credit benefit is changed to imputation benefit, consistent with the terminology used in the SIS; and

·       an amendment to the rule in subsection 207-145(2), which apportions a franking credit in circumstances where the Commissioner of Taxation (Commissioner) makes a determination under paragraph 177EA(5)(b) of the ITAA 1936 that no imputation benefit is to arise in respect of a specified part of a franked distribution for an entity. The amendment ensures that the rule operates as intended. A rule is also included which reduces the franking credit on the distribution.

[Schedule 10, item 14, subsections 207-145(1) and (2)]

10.44     It is possible that the apportionment rule in subsection 207-145(2) (which reduces the entity’s gross-up and tax offset where there has been manipulation of the imputation system) and subsection 207-90(2) (which reduces the entity’s gross-up and tax offset where part of the franked distribution is exempt income or non-assessable non-exempt income in the hands of an entity) may both apply in relation to the same distribution. In this case, the rule in subsection 207-145(2) will apply after the appropriate reduction has been made under paragraph 207-90(2)(c). [Schedule 10, item 14, subsection 207-145(3)]

Adjustment where distribution flows indirectly to an entity

10.45     Section 207-150 currently deals with the consequences of receiving a franked distribution where the imputation system has been manipulated and the franked distribution flows indirectly to the recipient. Section 207-150 is repealed and replaced to include rules to adjust an entity’s assessable income where there has been manipulation of the imputation system and the entity’s entitlement to a tax offset is denied.

10.46     The deduction where a franked distribution flows indirectly to a partner or beneficiary of a trust, or reduction in the grossing-up of assessable income where the distribution flows indirectly to the trustee of a trust, is set out under subsections 207-150(2) to (4). These are the same amounts as set out in Table 10.1. [Schedule 10, item 14, subsections 207-150(2) to (4)]

10.47     If the deduction or reduction rules above apply to an entity, the entity is denied a tax offset and the franked distribution does not flow indirectly through the entity to other entities (i.e. no franking credit or tax offset will be available to lower tier entities). [Schedule 10, item 14, subsection 207-150(1)]

10.48     If the Commissioner makes a determination under paragraph 177EA(5)(b) of the ITAA 1936 that an imputation benefit is not to arise in respect of a part of a franked distribution, then the relevant entity’s share of the franking credit, as referred to in the adjustment rules in subsections 207-150(2) to (4), is proportionately reduced [Schedule 10, item 14, subsection 207-150(5)] . An additional rule is included which provides that the entity’s entitlement to a tax offset in relation to the reduced franked distribution that is not affected by the Commissioner’s determination, is also proportionately reduced so that it equals the remaining amount of the franking credit [Schedule 10, item 14, subsection 207-150(6)] .

Example 10.7

A franked distribution of $70 with $30 franking credit attached is made to a partnership with two equal beneficiaries one of which is X, an individual. The Commissioner makes a determination under paragraph 177EA(5)(b) in relation to 50% of X’s share of the franked distribution (i.e. $17.50 of the distribution).

X is entitled to a deduction under subsection 207-150(2) worked out under subsection 207-110(6) equal to,

$7.50 (($35  -  $17.50)/35)  ´   $15.

X is entitled to a reduced tax offset in relation to that part of the franked distribution that has not been subject to the determination. The reduced tax offset that is calculated under subsection 207-110(7) is $7.50 ($15  -  $7.50). This equals the reduced amount of franking credit included in X’s assessable income.

10.49     It is possible that an adjustment to an entity’s assessable income to remove its share of a franking credit could be allowed under subsection 207-150(1) (which applies where there has been manipulation of the imputation system) and subsection 207-95(1) (which applies when the whole of the distribution is exempt income or non-assessable non-exempt income in the hands of the entity). To avoid a double deduction, a deduction is only allowed under subsection 207-150(1). [Schedule 10, item 14, subsection 207-150(7)]

10.50     Subsection 207-150(5) (which applies where the Commissioner makes a determination under paragraph 177EA(5)(b) of the ITAA 1936 that an imputation benefit is not to arise in respect of a part of a franked distribution) and subsection 207-95(5) (which applies where part of the franked distribution is exempt income or non-assessable non-exempt income in the hands of the entity) could also both apply in relation to a franked distribution made to an entity. In this case the rule in subsection 207-150(5) is applied after the rules in section 207-95. [Schedule 10, item 14, subsection 207-150(8)]

10.51     Amendments are also made so that new section 207-150 incorporates the new concepts and terminology used in Subdivision 207-B. The reference in paragraph 207-150(1)(b) to 204-30(3)(b) is changed to paragraph 204-30(3)(c).

10.52      Sections 207-160, 207-165 and 207-170 describe when a franked distribution that flows indirectly through a partnership or trust is to be treated as equivalent to an interest payment. These rules which separately deal with distributions made to a partner in a partnership or a beneficiary or the trustee of a trust are merged into one rule that describes when a franked distribution is treated as an interest payment in these circumstances. The section is updated to be consistent with new concepts in Subdivision 207-B. [Schedule 10, item 15, section 207-160]

Amendment to trans-Tasman imputation rules

10.53     Division 220 of Part 3-6 of the ITAA 1997 contains rules which allow NZ companies to maintain an Australian franking account and attach Australian franking credits to dividends.

10.54     Sections 220-400 and 220-405 provide rules to deal with the effect of a NZ company paying a supplementary dividend in relation to a franked dividend to an Australian shareholder. A supplementary dividend is a payment paid by a NZ company to a non-resident shareholder as part of NZ’s foreign investor tax credit regime. In effect, it represents a refund of the NZ company tax paid in respect of the underlying income to ensure that the effective tax rate for a non-resident investor does not exceed the NZ company tax rate.

10.55     Section 220-400 reduces both the gross-up and the entitlement to a tax offset by the amount of the supplementary dividend where a distribution is made to an entity. Section 220-405 reduces both the additional amount included in a taxpayer’s assessable income because of a franking credit and the entitlement to a tax offset by the amount of a supplementary dividend where a distribution flows indirectly to a partner in a partnership or to a beneficiary or the trustee of a trust. These rules could not be finalised before the completion of Division 207.

10.56     Subsections 220-405(2) to (8) are repealed and replaced with provisions that provide for the necessary adjustments where a supplementary dividend flows indirectly to a partner or a beneficiary or the trustee of a trust.

10.57     In the case of a partner or beneficiary:

·       the partner or beneficiary is allowed a deduction that is equal to so much of its share of the supplementary dividend as does not exceed its individual interest or share amount referred to in subsections 207-50(2) and (3) for the income year; and

·       the tax offset to which the partner or beneficiary is entitled is reduced by the amount of the deduction but not by an amount that exceeds its share of the franking credit on the franked distribution.

[Schedule 10, item 40, subsection 220-405(2)]

10.58     In the case of a trustee:

·       the share amount as referred to in subsection 207-50(4) in relation to the franked dividend is reduced by the recipient’s share of the supplementary dividend but not by an amount greater than that share amount; and

·       the recipient’s tax offset entitlement is reduced by the amount of the reduction but not by an amount that exceeds its share of the franking credit on the franked distribution.

[Schedule 10, item 40, subsection 220-405(3)]

10.59     However, if the franked distribution was:

·       exempt or non-assessable non-exempt income in the hands of the recipient entity; or

·       there had been manipulation of the imputation system so that no imputation benefits arise or the imputation benefits are denied,

then this section does not apply. [Schedule 10, item 40, subsection 220-405(4)]

10.60     If the franked distribution is partly exempt or non-assessable non-exempt income in the hands of the recipient, or the Commissioner has made a determination under paragraph 177EA(5)(b) in relation to a specified part of a distribution, then the franking credit is reduced by the supplementary dividend before the amount is further reduced under subsection 207-95(5) or 207-150(6). [Schedule 10, item 40,

subsection 220-405(5)]

10.61     A supplementary dividend flows indirectly to an entity in the same way a franked distribution flows through to an entity as if a reference to a share of a franked distribution were a reference to a share of the supplementary dividend. [Schedule 10, item 40, subsection 220-405(6)]

10.62        An entity’s share of a supplementary dividend is proportionate to its share of the franked distribution. [Schedule 10, item 40,

subsection 220-405(7)]

10.63     To remove doubt, section 220-405 will not have the effect of including the entity’s share of the supplementary dividend in its assessable income for an income year. [Schedule 10, item 40,

subsection 220-405(8)]

10.64     Subdivisions 207-B (which deals with the effect of receiving a franked distribution through a partnership or trust), 207-D (which deals with the case where there is no gross-up and tax offset where the distribution is non-assessable income) 207-E (which deals with the exceptions to the rules in Subdivision 207-D) and 207-F (which deals with the consequences where the imputation system has been manipulated) operate subject to this section. [Schedule 10, item 40,

subsection 220-405(9)]

Other amendments to Division 220

10.65        Items 33 and 34 make amendments to section 220-400 to insert references to section 207-20. [Schedule 10, items 33 and 34]

10.66     Items 32 and 39, which repeal paragraphs 220-400(1)(d) and 220-405(1)(e), make a minor policy change to remove a technical defect in these subsections [Schedule 10, items 32 and 39, paragraphs 220-400(1)(d) and 220-405(1)(e)] . These paragraphs require that that the taxpayer reduce both its gross-up (or assessable income where the franked distribution flows indirectly) and tax offset by the amount of the supplementary dividend if the taxpayer’s income tax is reduced to some extent by a foreign tax credit. The difficulty with the existing provisions is that whether the taxpayer uses any of its foreign tax credit during the income year depends on whether the taxpayer’s assessable income is reduced below the tax-free threshold as a result of the supplementary dividend, thus creating a circularity problem. In addition, these amendments will remove the potential for certain taxpayers to obtain the double benefit of being able to utilise foreign tax credits (which can be carried forward) in later income years and the full amount of the tax offset (i.e. unreduced by the amount of the supplementary dividend).

10.67        Item 35 repeals subsections 220-400(4) and (5) and replaces them with provisions that ensure that where a franked distribution is made to an entity and part of the distribution is exempt income or non-assessable non-exempt income in the hands of the entity or the imputation system has been manipulated (i.e. section 207-90 or 207-145 apply) then those rules operate as if the adjustments made in relation to supplementary dividends had been made first. [Schedule 10, item 35, subsections 220-400(4) to (6)]

10.68     Item 36 replaces the heading to section 220-405 so that it more accurately reflects its purpose. [Schedule 10, item 36, section 207-405]

10.69     Item 3 7 amends paragraph 220-405(1)(c) to include correct references to sections which provide for a taxpayer’s entitlement to a tax offset. [Schedule 10, item 37, paragraph 220-405(1)(d)]

Consequential amendments

Division 207

10.70     Item 23 repeals subsection 67-25(1B) of the ITAA 1997 and replaces it using the new terminology and concepts used in Division 207. [Schedule 10, item 23]

10.71     Items 3 and 4 make consequential changes to Part 3-6

of the ITAA 1997 by updating the legislative reference in paragraph 204-30(6)(b) and correcting the terminology in item 4 in the table in section 205-15. [Schedule 10, items 3 and 4]  

10.72     Items 5 and 6 make changes to the Guide to Division 207 and Subdivision 207-A that are consequential to the changes made to Subdivisions 207-B, 207-D, 207-E and 207-F including changes to section numbers and terminology. [Schedule 10, items 5 and 6]

10.73     Items 9 and 10 change the heading and the Guide Material to Subdivision 207-E to reflect its new purpose. Item 12 inserts a heading before section 207-130. [Schedule 10, items 9, 10 and 12]

10.74     Item 13 changes the Guide Material to Subdivision 207-F to reflect its new purpose. [Schedule 10, item 13]

10.75     Items 18 and 19 make changes to Division 208 that deal with exempting entities and former exempting entities to update section references. [Schedule 10, items 18 and 19]

10.76      Item 41 updates a reference in item 6 in the table in subsection 219-15(2) to update terminology, (i.e. ‘partnership or trust’ to ‘partnership or the trustee of a trust’). [Schedule 10, item 41]

10.77     Item 42 replaces subsection 220-410(2) to include appropriate references to provisions in Division 219 which deals with imputation for life companies. [Schedule 10, item 42]

Division 208

10.78     Division 208 of the ITAA 1997 contains rules designed to prevent franking credit trading for companies with controlling shareholders for whom franking credits have limited or no value. Generally, these rules treat franked distributions made by these companies (referred to as exempting entities) as being unfranked in the hands of the recipient shareholders.

10.79     Broadly, an exempting entity is a corporate tax entity where 95% of the accountable shares or interests in the entity are owned directly, or indirectly, by prescribed persons. Prescribed people are persons that have no, or limited use of franking credits. These include tax exempt entities and non-residents.

10.80     There is an unintended consequence with the interaction of Division 207, which allows certain tax exempt entities to claim a tax offset (i.e. an eligible institution), and Division 208. The consequence is that an eligible institution will be denied a tax offset (and therefore an entitlement to refundable imputation credits) if it holds 95% or more shares in a subsidiary (including where that percentage interest is held with other prescribed persons).

10.81     To rectify the technical defect, the definition of prescribed person and persons taken to be prescribed persons in Division 208 are amended so that a company or trustee that is eligible for a refund will not be a prescribed person. The amendment is also made for the purposes of the ITAA 1936. [Schedule 10, items 1, 2, 16, 17]

Amendments to definitions in subsection 995-1(1)

10.82     Consequential amendments are made to subsection 995-1(1) of the ITAA 1997 to make changes to the definition of ‘flows indirectly’, introduce the new definition of ‘share of a franked distribution’ and update a section reference in the definition of ‘share of a franking credit’. [Schedule 10, items 20 to 22]

Application and transitional rules

10.83     The amendments to Division 207 generally are to apply to events that occur on or after 1 July 2002, the commencement of the SIS rules. Other amendments that take effect from that date are those contained in items 29 and 41.

[Schedule 10, subitem 43(2)]

10.84     Amendments at items 24 to 28, which introduce the new concept of non-assessable non-exempt income, are to apply to assessments for the 2003-2004 income year and later income years, consistent with the introduction of the non-assessable non-exempt concept in the income tax law. [Schedule 10, subitem 43(3)]

10.85     The amendments to the trans-Tasman imputation measures take effect from 1 April 2003, the commencement of those measures. [Schedule 10, subitem 43(4)]

10.86        The amendment to the definition of prescribed person in sections 160APHBF and 160APHBG in the ITAA 1936 is to apply from 1 July 2000 (the commencement date of the provisions allowing a refund of franking credits for certain charities and gift-deductible organisations). [Schedule 10, subitem 43(1)]

Transitional

10.87     A transitional rule is required for the purposes of sub-paragraph 207-110(1)(b)(ii) so that, for the period from 1 July 2002 until the start of the 2003-2004 income year, the references to an amount being ‘non-assessable non-exempt income’ are treated as references to the amount being neither assessable income nor exempt income. This rule is necessary because Division 207 of the ITAA 1997 applies from 1 July 2002 and the relevant amendments to those provisions apply from that date. However, the amendments refer to ‘non-assessable non-exempt income’, a concept that does not appear in the law until the 2003-2004 income year. [Schedule 10, item 44]

 

 



Outline of chapter

11.1       Schedule 11 to this bill contains the following minor amendment that ensures that provisions for the carry-forward of excess foreign tax credits operate properly following changes to the foreign tax credit provisions that were made as a result of the Timor Sea Treaty.

11.2       Unless otherwise stated, references to legislative provisions are references to provisions contained in the Income Tax Assessment Act 1936 (ITAA 1936).

Context of amendments

11.3       Changes to the provisions dealing with the carry-forward of excess foreign tax credits are needed to ensure those provisions refer to the correct paragraphs in the general foreign tax credit provisions as these have been recently amended as a result of the Timor Sea Treaty.

Summary of new law

11.4       A change to the numbering of paragraphs in subsection 160AF(1) of the ITAA 1936 (which is the general foreign tax credit provision) as a result of the Timor Sea Treaty has been reflected in the foreign tax credit carry-forward provisions (section 160AFE of the ITAA 1936). 

Detailed explanation of new law

11.5       Section 160AFE allows a taxpayer to carry forward excess foreign tax credits for five years.

11.6       The amendments to section 160AFE ensure the correct paragraphs in section 160AF are referenced. [Schedule 11, items 1 to 4, section 160AFE]

11.7       The amendments to section 160AFE are made as a consequence of the changes to section 160AF which were made as a result of the Timor Sea Treaty.

Application and transitional provisions

11.8       The amendments to section 160AFE (dealing with the carry forward of foreign tax credits) consequent on the changes to section 160AF will apply from the time that the new section 160AFE applies to each taxpayer. [Schedule 11, item 5]



C hapter 12

Amendments to the alienation of personal services income provisions

Outline of chapter

12.1       Schedule 12 to this bill amends the alienation of personal services income (PSI) provisions contained in Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997) to clarify when the Commissioner of Taxation (Commissioner) can make a personal services business (PSB) determination as is consistent with the policy intent. The effect of the Commissioner granting a PSB determination is that the PSI provisions do not apply to the taxpayer.

12.2       The amendments will ensure that:

·       the Commissioner may provide a PSB determination in cases where a taxpayer satisfies the unrelated clients test and, but for unusual circumstances, less than 80% of the individual’s PSI would come from one source; and

·       the Commissioner may not provide a PSB determination to those taxpayers who, but for unusual circumstances, would satisfy the unrelated clients test, but did not satisfy or would not have satisfied, the rule requiring that less than 80% of the individual’s PSI is derived from one source.

Context of amendments

12.3       The PSI provisions, which have applied from 1 July 2000, implemented the recommendations of the Ralph Review of Business Taxation. The provisions are an important integrity feature of the income tax law which helps to ensure that the tax system is working fairly for all taxpayers.

12.4       The PSI provisions prevent individuals from reducing their tax by alienating income from their personal services to an associated entity (such as a company, trust or partnership) or claiming inappropriate ‘business’ deductions that would otherwise not be available if the individual were directly employed.

12.5       Unless certain key tests contained in the PSI provisions are satisfied, the PSI derived through the entity will be treated as income of the individual, and taxed accordingly.

12.6       The PSI legislation sets out four objective tests to allow individuals, and individuals operating through interposed entities, to self-assess whether they are carrying on a genuine PSB.

12.7       The primary test is the results test which considers whether the income earned is for producing a result, or whether the service provider has to supply the tools of trade or has to rectify any defects. If taxpayers satisfy this test, they are considered to be carrying on a PSB and the PSI provisions do not apply.

12.8       If taxpayers fail the results test, then they can self-assess to be carrying on a PSB provided:

·       less than 80% of an individual’s PSI comes from the one source (the 80% rule); and

·       at least one of the following tests is passed:

-            the employment test;

-            the separate business premises test; or

-            the unrelated clients test.

12.9       Notwithstanding the above, taxpayers can apply to the Commissioner for a PSB determination. The effect of the Commissioner granting a PSB determination is that the PSI provisions do not apply to the taxpayer. The Commissioner may only make a PSB determination where either:

·       in the absence of any unusual circumstances, the Commissioner is satisfied that the taxpayer could reasonably be expected to meet, or has met, either the results test, employment test, or separate business premises test (the unrelated clients test is not included as it is considered not rigorous enough in normal circumstances); and

·       where there are unusual circumstances, the Commissioner must be satisfied that, but for those unusual circumstances, the taxpayer would have passed at least one of the four PSB tests.

12.10     These amendments will clarify in which circumstances the Commissioner may or may not provide a PSB determination for the purposes of the unrelated clients test and whether the taxpayer satisfies the 80% rule or not.

Summary of new law

12.11     Under the new law, the Commissioner:

·       will be able to make a PSB determination in relation to those taxpayers who satisfy the unrelated clients test and, but for unusual circumstances, would also satisfy the 80% rule (Part 1 of Schedule 12); and

·       will not be able to make a PSB determination in relation to those taxpayers who, but for unusual circumstances, would satisfy the unrelated clients test, but did not or would not normally satisfy the 80% rule (Part 2 of Schedule 12).

12.12     These changes are of a technical nature which clarify the original policy of the PSI provisions.

Comparison of key features of new law and current law

New law

Current law

The Commissioner may appropriately provide a PSB determination to those taxpayers who actually satisfy the unrelated clients test and, but for unusual circumstances, would also satisfy the 80% rule.

It is unclear whether the Commissioner is able to provide a PSB determination to those taxpayers who actually satisfy the unrelated clients test and, but for unusual circumstances, would also satisfy the 80% rule.

The Commissioner may not provide a PSB determination to those taxpayers who, but for unusual circumstances, would satisfy the unrelated clients test, but did not satisfy, and would not normally have satisfied, the 80% rule.

The Commissioner may be obliged to provide a PSB determination to those taxpayers who, but for unusual circumstances, would satisfy the unrelated clients test, but did not satisfy, or would not have satisfied, the 80% rule.

Detailed explanation of new law

Part 1 - Amendments applying from the 2000-2001 income year

Individuals

12.13     The amendment repeals subsection 87-60(3) and replaces it with new provisions clarifying when the Commissioner may provide a PSB determination for an individual. The Commissioner may not provide a determination under subsection 87-60(1) unless he is satisfied that in the income year during which the PSB determination first has effect, or is taken to have first had effect at least one of the following alternatives in Table 12.1 is satisfied. [Schedule 12, item 1, subsection 87-60(3)]

Table 12.1:   Alternatives under which the Commissioner may provide a PSB determination

Provision

Alternatives

Conditions

Subsection 87-60(3A)

Results test, employment test or business premises test (this replicates the repealed subparagraphs 87-60(3)(a)(i) and 87-60(3)(b)(i)).

·        The individual could reasonably be expected to meet, or have met, the results test, employment test or business premises test; and

·        the PSI of the individual could reasonably be expected to be, or was, derived in the process of the individual conducting activities that met one or more of those tests.

[Schedule 12, item 1, subsection   87-60(3A)]

Subsection 87-60(3B)

Unusual circumstances prevented one of the four PSB tests from being met, including the unrelated clients test (this replicates the repealed subparagraphs 87-60(3)(a)(ii) and 87-60(3)(b)(ii)).

·        If it weren’t for unusual circumstances, the individual could reasonably have been expected to meet, or would have met, at least one of the four PSB tests; and

·        the PSI of the individual could reasonably be expected to be, or was, derived in the process of the individual conducting activities that met one or more of those tests.

[Schedule 12, item 1, subsection 87-60(3B)]

Subsection 87-60(4)

Unrelated clients test was met, but 80% or more of income was from the same source because of unusual circumstances.

·        The individual could reasonably be expected to meet, or have met, the unrelated clients test;

·        due to unusual circumstances applying to the individual in an income year, 80% or more of the PSI of the individual could reasonably have been expected to be, or would have been, income from the same entity; and

·        the PSI of the individual could reasonably be expected to be, or was, derived in the process of the individual conducting activities that met the unrelated clients test.

[Schedule 12, item 4, subsection 87-60(4)]

12.14     The first and second alternatives replicate the repealed subsection 87-60(3). The third alternative clarifies that the Commissioner may provide a PSB determination in cases where an individual satisfies the unrelated clients test and, if it weren’t for unusual circumstances, would satisfy the 80% rule.

Entities

12.15     The amendment repeals subsection 87-65(3) and replaces it with  new provisions clarifying when the Commissioner may provide a PSB determination for personal services entities. Generally, the Commissioner may not provide a PSB determination under subsection 87-65(1) unless satisfied that in the income year during which the determination first has effect, or is taken to have first had effect, at least one of the alternatives in Table 12.1 is satisfied for the personal services entity rather than for the individual. [Schedule 12, item 5, subsection 87-65(3)]

12.16     The third alternative in Table 12.1 applied to the personal services entity clarifies that the Commissioner can provide a PSB determination in cases where a personal services entity satisfies the unrelated clients test and, if it weren’t for unusual circumstances, would satisfy the 80% rule.

Example 12.1

David provides consultancy services to the food and beverage industry. He receives 60% and 40% of his PSI from two unrelated clients, client X and client Y respectively, for the 2000-2001, 2001-2002 and 2002-2003 income years. David self-assesses that he is carrying on a PSB.

During the 2003-2004 income year, David receives 95% of his PSI from client X because he takes a one-off, large contract from this client. He receives 5% of his PSI from client Y. He self-assesses that he is not a PSB because, although he passes the unrelated clients test, he fails the 80% rule (and nor does he pass the results test, employment test or business premises test).

However, under new subsection 87-60(5) he can seek a PSB determination from the Commissioner because:

·          he passed the unrelated clients test during that income year;

·          due to unusual circumstances, more than 80% of his PSI was income from the same client; and

·          David’s PSI was from conducting activities that met the unrelated clients test.

Part 2 - Amendments applying from the income year after the income year in which this bill receives Royal Assent

Individuals

12.17     Section 87-60 is amended, after the amendments in Part 1 of Schedule 12 have taken place, by deleting the reference to the unrelated clients test in subsection 87-60(3B) and adding a fourth alternative that confines when the Commissioner may provide a PSB determination in relation to the unrelated clients test, consistent with the policy intent. Under this additional alternative, the Commissioner may provide a determination under the following conditions:

·       if it weren’t for unusual circumstances applying to the individual in that year, the individual could reasonably have been expected to meet, or would have met, the unrelated clients test;

·       if 80% or more of the PSI of the individual could reasonably have been expected to be, or would have been, derived from the same entity, this was only because of unusual circumstances applying to the individual in the income year; and

·       the PSI of the individual could reasonably be expected to be, or was, derived from the individual conducting activities that met the unrelated clients test.

[Schedule 12, items 10 to 12, subsection 87-60(3), paragraph 87-60(3B)(a), section 87-60]

12.18     This amendment to Part 1 of Schedule 12 will ensure that the Commissioner may not provide a PSB determination to those individuals who, but for unusual circumstances, would satisfy the unrelated clients test, but did not satisfy and would not normally have satisfied, the 80% rule.

Entities

12.19     Part 1 of Schedule 12 is amended to ensure that the Commissioner may not provide a PSB determination to those entities who, but for unusual circumstances, would satisfy the unrelated clients test, but did not satisfy and would not normally have satisfied, the 80% rule.

12.20     Section 87-65, after the amendments in Part 1 have taken effect, is amended to ensure that in relation to the unrelated clients test, the Commissioner can only provide a PSB determination if the conditions applying to individuals in Part 2, applies to the entity. The unrelated clients test and the 80% rule apply, in this instance, to the personal services entity rather than the individual. [Schedule 12, items 13 to 15, subsection 87-65(3), paragraph 87-65(3B)(a), section 87-65]

Example 12.2

Robert provides consultancy services to the Information Technology industry through the SML family trust. He works mainly for only one client but also does a small amount (20% or less) of work for another client.

SML does not pass the 80% rule (and neither passes the results test, employment test nor the business premises test), but passes the unrelated clients test. SML cannot self-assess as a PSB, and nor can the Commissioner provide a PSB determination.

In a later year of income, due to unusual circumstances, SML temporarily loses its minor client. As such, SML fails the unrelated clients test.

However, the Commissioner cannot provide a PSB determination because SML usually fails the 80% rule and therefore, the condition in the new paragraph 87-65(6)(b) is not satisfied.

Consequential amendments

12.21     Items 2, 3, 6 and 7 make consequential changes to sections 87-60 and 87-65. [Schedule 12, items 2, 3, 6 and 7]

Application and transitional provisions

12.22     The amendments made by Part 1 of this Schedule, which will benefit taxpayers, will apply to assessments for the 2000-2001 income year and each subsequent income year. [Schedule 12, item 9]

12.23     The amendments made by Part 2 of this Schedule will apply to assessments for the income year following the year in which this bill receives Royal Assent and each subsequent income year. [Schedule 12, item 16]

 

 

 



I ndex         

Schedule 1: Life insurance companies

Bill reference

Paragraph number

Item 1, subsection 148(10) of the ITAA 1936

1.51

Item 2, section 4-15

1.44

Item 3, section 12-5

1.44

Item 4, section 36-25

1.44

Item 5, section 320-1

1.44

Item 6, section 320-5

1.44

Item 7, paragraph 320-15(1)(b)

1.52

Item 8, paragraph 320-15(1)(c)

1.52

Items 9 and 10, section 320-15

1.44

Items 13, paragraph 320-15(1)(h)

1.58

Item 14, paragraph 320-15(1)(ja)

1.71

Item 15, paragraph 320-15(1)(k)

1.115

Item 16, subsection 320-15(2)

1.58, 1.61

Item 17, paragraph 320-40(5)(b)

1.112

Item 18, subsection 320-40(5A)

1.112

Item 19, subsection 320-40(6)

1.113

Item 20, subsection 320-40(6A)

1.113

Item 21, subsection 320-40(7)

1.115

Item 22, subsection 320-55(3)

1.76

Item 23, subsection 320-70(2)

1.61

Item 24

1.61

Item 24, subsection 320-75(1)

1.60

Item 24, subsection 320-75(4)

1.66

Items 25 and 26, subsection 320-80(2)

1.61

Item 27, subsection 320-85(2)

1.58, 1.61

Item 28, section 320-87

1.44

Item 29, section 320-100

1.52

Item 30, section 320-105

1.104

Item 31, section 320-120

1.44

Item 32, section 320-125

1.44

Item 33, sections 320-130 and 320-131

1.16

Item 33, section 320-133

1.17

Item 33, subsection 320-134(1)

1.34

Item 33, subsection 320-134(2)

1.35

Item 33, subsection 320-134(3)

1.36

Item 33, section 320-135

1.18

Item 33, section 320-137

1.21

Item 33, subsection 320-137(1)

1.23

Item 33, section 320-139

1.29

Item 33, subsection 320-141(1)

1.24

Item 33, subsection 320-141(2)

1.25

Item 33, subsection 320-143(1)

1.30

Item 33, subsection 320-143(2)

1.31

Item 33, section 320-149

1.38

Item 34

1.44

Item 35, section 320-165

1.44

Item 36, subsection 320-170(3)

1.77

Item 37, section 320-175

1.79

Item 38, section 320-180

1.79

Item 39

1.77

Item 40, subsection 320-185(1)

1.77

Item 41, subsection 320-185(4)

1.79

Item 42

1.77

Item 43, paragraph 320-195(3)(c)

1.77

Item 44, subsection 320-195(4)

1.77

Item 45, subsection 320-200(1)

1.79

Item 46, subsection 320-200(2A)

1.118

Item 47, subsection 320-200(4)

1.120

Items 48 and 49

1.44

Item 50, subsection 320-225(3)

1.102

Item 51, section 320-230

1.104

Item 52, section 320-235

1.104

Item 53

1.102

Item 54, subsection 320-240(1)

1.102

Item 55, subsection 320-240(4)

1.104

Item 56

1.86

Item 57, section 320-246

1.86

Item 57, paragraph 320-246(1)(e)

1.89

Item 57, subsection 320-246(3)

1.91

Item 57, subsection 320-246(4)

1.92

Item 57, subsection 320-246(5)

1.93

Item 57, section 320-247

1.98

Item 57, subsection 320-247(3)

1.99

Item 58

1.104

Item 59, paragraph 320-250(2)(c)

1.102

Item 61, subsection 320-255(1)

1.104

Item 62, subsection 320-255(3A)

1.120

Items 63 and 64, subsection 320-255(7)

1.120

Item 65, subsection 320-255(9)

1.118

Item 66, definition of ‘class’ in subsection 995-1(1)

1.17

Item 67, definition of ‘complying superannuation class for a taxable income of a life insurance company’ in subsection 995-1(1)

1.23

Item 68, definition of ‘complying superannuation class for a tax loss of a life insurance company’ in subsection 995-1(1)

1.24

Item 69, definition of ‘exempt life insurance policy’ in subsection 995-1(1)

1.86

Item 70, definition of ‘net risk component’ in subsection 995-1(1)

1.52

Item 71, definition of ‘ordinary class for a taxable income of a life insurance company’ in subsection 995-1(1)

1.29

Item 72, definition of ‘ordinary class for a tax loss of a life insurance company’ in subsection 995-1(1)

1.30

Item 73, definition of ‘ordinary investment policy’ in subsection 995-1(1)

1.60, 1.61

Items 74, 76, 77 and 79, subsection 995-1(1)

1.44

Item 75, definition of ‘sickness policy’ in subsection 995-1(1)

1.141

Item 78, definition of ‘valuation time’ in subsection 995-1(1)

1.79, 1.104

Item 80, section 320-100 of the Income Tax

(Transitional Provisions) Act 1997

1.33

Item 81

1.44

Items 82 and 83, subsections 320-175(1A) and 320-230(1A) of the Income Tax (Transitional Provisions) Act 1997

1.126

Items 82 and 83, paragraphs 320-175(1)(e) and 320-230(1)(e) of the Income Tax (Transitional Provisions) Act 1997

1.123

Item 84, subsection 45-330(3) in Schedule 1 to the TAA 1953

1.45

Items 85 and 86, section 40-15

1.120

Item 87, subsection 320-200(2A)

1.119

Item 88, subsection 320-200(4)

1.120

Item 89, subsection 320-255(3A)

1.120

Item 90, subsection 320-255(5)

1.120

Items 91 and 92, subsection 320-255(7)

1.120

Item 93

1.120

Item 93, subsection 320-255(9)

1.119

Item 94, definition of ‘notional adjustable value’ in subsection 995-1(1)

1.120

Item 95, section 320-175

1.79

Item 96

1.104

Item 97, section 713-525

1.79, 1.104

Items 98 and 99, section 713-530

1.44

Item 100, section 320-246

1.86

Item 101, section 330-35

1.44

Items 102 and 103, paragraph 320-37(1)(d)

1.140

Items 105 and 106

1.44

Item 107, subsection 45-330(3) in Schedule 1 to the TAA 1953

1.45

Item 108, definition of ‘dividend’ in subsection 6(1) of the ITAA 1936

1.144

Item 109, paragraph 26(i) of the ITAA 1936

1.144

Items 110 and 111, section 26AH of the ITAA 1936

1.144

Item 112, subparagraph 102AE(2)(b)(iv) of the ITAA 1936

1.144

Item 113, section 282A of the ITAA 1936

1.144

Item 114, section 291A of the ITAA 1936

1.144

Item 115, section 297A of the ITAA 1936

1.144

Item 116, paragraph 320-15(1)(ca)

1.55

Item 117, paragraph 320-37(1)(c)

1.136

Item 118, subsection 320-37(1A)

1.136

Items 119 to 121, subsection 320-37(2)

1.136

Item 122

1.136

Items 123 and 124, definitions of ‘Solvency Standard’ and ‘Valuation Standard’ in subsection 995-1(1)

1.130

Item 125, section 288-70 in Schedule 1 to the TAA 1953

1.81, 1.106

Item 125, subsection 288-70(5) in Schedule 1 to the TAA 1953

1.82, 1.107

Subitem 126(7)

1.145, 1.148

Subitem 126(8)

1.56, 1.148

Subitem 126(9)

1.137

Subitem 126(10)

1.131, 1.148

Subitem 126(11)

1.83, 1.108, 1.148

Schedule 2: Consolidation etc.

Bill reference

Paragraph number

Part 1, item 1

2.30

Part 2, item 2, section 713-120

2.24

Part 2, item 2, section 713-125

2.31

Part 2, item 2, subsections 713-125(1) and (3)

2.33

Part 2, item 2, section 713-130

2.27, 2.31

Part 2, item 2, paragraph 713-130(a)

2.29

Part 2, item 2, paragraph 713-130(b)

2.30

Part 2, item 2, subsection 713-135(1)

2.34, 2.36

Part 2, item 2, paragraph 713-135(1)(a)

2.39

Part 2, item 2, paragraph 713-135(1)(b)

2.37

Part 2, item 2, paragraph 713-135(1)(c)

2.38

Part 2, item 2, note 2 to subsection 713-135(1)

2.36

Part 2, item 2, subsection 713-135(2)

2.34

Part 2, item 2, subsection 713-135(3)

2.41

Part 2, item 2, subsection 713-140(1)

2.39

Part 2, item 2, subsection 713-140(2)

2.35, 2.39

Part 2, item 2, subsection 713-140(3) and (4)

2.41

Part 2, item 2, note to subsection 713-140(3)

2.42

Part 2, item 2, subsection 713-140(5)

2.40

Part 2, item 3, note to subsection 102L(1)

2.37

Part 2; item 4, note to subsection 102T(1)

2.37

Part 3, item 5, subsection 124-380(7)

2.48, 2.259

Part 3, item 7, subsection 126-50(6)

2.53

Part 3, item 8, subsection 703-60(2)

2.51

Part 3, item 9, paragraph 701D-10(5)(a)

2.264

Part 4, item 10, paragraph 104-510(1)(b)

2.260

Part 4, item 11, subsection 701-10(2)

2.57

Part 4, item 11, note at the end of subsection 701-10(2)

2.59

Part 4, item 13, section 701-58

2.60

Part 4, item 14, table item 1 in section 701-60

2.264

Part 4, item 15, paragraph 713-205(3)(a)

2.261

Part 4, item 16, note 1 to subsection 715-70(1)

2.264

Part 4, item 17, note 1 to subsection 715-225(1)

2.264

Part 4, item 18, paragraph 719-160(3)(a)

2.261

Part 4, item 19, section 701-15 of the Income Tax (Transitional (Provisions) Act 1997

2.264

Part 5, items 20 and 21, subsection 701-15(3)

2.67

Part 5, item 22, section 701-20

2.67

Part 5, items 23 and 24, section 701-45

2.67

Part 5, item 25, section 701-50

2.67

Part 5, items 26 and 27, section 701-60

2.67

Part 5, item 28, section 713-200

2.68

Part 5, item 29, paragraph 713-200(b)

2.68

Part 5, item 30, subsection 713-205(4)

2.66

Part 5, item 30, subsection 713-205(5)

2.66

Part 5, item 31, subsection 713-225(6A)

2.62

Part 5, item 32, subsection 713-250(1)

2.66

Part 5, item 32, subsection 713-250(2)

2.66

Part 5, item 32, subsection 713-255(1)

2.70

Part 5, item 32, subsection 713-255(2)

2.70

Part 5, item 32, subsection 713-255(3)

2.71

Part 5, item 32, subsection 713-255(4)

2.72

Part 5, item 32, note to subsection 713-255(4)

2.73

Part 5, item 32, subsection 713-260(1)

2.76

Part 5, item 32, subsection 713-260(2)

2.77

Part 5, item 32, subsection 713-255(5)

2.81, 2.82

Part 5, item 32, subsection 713-265(2)

2.85

Part 5, item 32, subsection 713-265(3)

2.87

Part 5, item 32, subsection 713-265(4)

2.89

Part 5, item 32, subsection 713-270(1)

2.93, 2.97

Part 5, item 32, paragraphs 713-270(2)(a) and (2)(b)

2.93

Part 5, item 32, paragraph 713-270(2)(c)

2.94

Part 5, item 32, paragraph 713-270(2)(d)

2.95

Part 5, item 32, subsection 713-270(3)

2.97

Part 5, item 32, paragraph 713-270(3)(a)

2.93

Part 6, item 33, subsection 705-65(5B)

2.101

Part 7, item 34, section 719-161

2.108

Part 7, item 34, subsection 719-161(1)

2.108

Part 7, item 34, subsection 719-161(2)

2.113, 2.115

Part 7, item 34, subsection 719-161(3)

2.117

Part 8, item 35, paragraph 160AFD(6)(b)

2.120

Part 8, item 36, subsection 707-205(1)

2.122

Part 9, item 38, section 717-275

2.261

Part 9, items 39 and 40, section 717-280

2.261

Part 9, item 41, section 717-285

2.127, 2.261

Part 9, item 42, section 717-292

2.125

Part 9, item 43, sections 717-300

2.261

Part 9, items 44 and 45, section 717-305

2.261

Part 9, item 46, section 717-310

2.130

Part 9, items 46 to 48, section 717-310

2.261

Part 9, item 49, section 717-320

2.130

Part 9, item 50, section 719-903

2.137

Part 9, item 50, subsection 719-903(5)

2.138

Part 9, item 51, subitem 12(5) of Schedule 9 of the New Business Tax System (Consolidation and Other Measures) Act 2003

2.140

Part 9, item 52, subparagraph 717-15(1)(b)(i)

2.146

Part 9, item 53, subparagraph 717-15(1)(b)(i)

2.259

Part 9, item 54, paragraph 717-15(2)(b)

2.261

Part 9, item 55, subsection 717-15(3)

2.261

Part 9, item 56, section 717-22

2.148

Part 9, item 56, subsection 717-22(2), item 1 in the table

2.149

Part 9, item 56, subsection 717-22(2), item 2 in the table

2.150

Part 9, item 56, section 717-28

2.152

Part 10, item 57, subsection 721-10(2), item 10 in the table

2.187, 2.191

Part 10, item 57, subsection 721-10(2), item 15 in the table

2.187

Part 10, item 57, subsection 721-10(2), item 20 in the table

2.187, 2.188

Part 10, item 57, subsection 721-10(2), item 22 in the table

2.189

Part 10, item 58, subsection 721-10(3)

2.169

Part 10, item 59, subsection 721-15(3A)

2.156

Part 10, item 59, paragraph 721-15(3A)(a)

2.159, 2.160

Part 10, item 59, paragraph 721-15(3A)(b)

2.159, 2.161

Part 10, item 59, paragraph 721-15(3A)(c)

2.159, 2.163

Part 10, item 59, paragraph 721-15(3A)(d)

2.159, 2.166, 2.168

Part 10, item 60, subsection 721-25(1A)

2.176

Part 10, item 60, paragraph 721-25(1A)(b)

2.179, 2.180

Part 10, item 60, paragraph 721-25(1A)(c)

2.182

Part 10, item 60, subsection 721-25(1B)

2.183

Part 11, item 62, subsection 110-25(12)

2.195

Part 11, item 63, subsection 110-55(10)

2.195

Part 11, item 64

2.259

Part 12, item 65, subsection 14A(1)

2.201

Part 12, item 65, subsection 14A(2)

2.201

Part 12, item 65, subsection 14A(3)

2.203

Part 12, item 65, subsection 14A(4)

2.204

Part 12, item 65, subsection 14A(5)

2.205

Part 13, item 67, subsection 705-47(1)

2.225

Part 13, item 67, subsection 705-47(2)

2.227

Part 13, item 67, subsection 705-47(3)

2.235

Part 13, item 67, subsection 705-47(4)

2.236

Part 13, item 67, subsection 705-47(5)

2.237

Part 13, item 68, heading to section 705-55

2.263

Part 13, item 69, subparagraph 705-55(b)(iii)

2.263

Part 13, item 72, subsection 711-25(3)

2.243

Part 13, item 72, subsection 711-25(4)

2.245

Part 13, item 72, subsection 701-50(1) of the Income Tax (Transitional Provisions) Act 1997

2.246

Part 13, item 74, subsection 715-900(1)

2.219

Part 13, item 74, subsection 715-900(2)

2.221, 2.223

Part 13, item 75, subsection 701-50(2) of the Income Tax (Transitional Provisions) Act 1997

2.247

Part 13, item 75, subsection 701-50(3) of the Income Tax (Transitional Provisions) Act 1997

2.248

Part 13, item 75, subsection 701-50(4) of the Income Tax (Transitional Provisions) Act 1997

2.251

Part 13, item 76, subsection 702-4(1) of the Income Tax (Transitional Provisions) Act 1997

2.255

Part 13, item 76, subsection 702-4(2) of the Income Tax (Transitional Provisions) Act 1997

2.256

Part 13, item 76, subsection 702-4(3) of the Income Tax (Transitional Provisions) Act 1997

2.256

Schedule 3: Venture capital

Bill reference

Paragraph number

Items 1 to 3

3.8

Item 4

3.9

Item 5

3.13

Item  6

3.18

Subitem 7(1)

3.15

Schedule 4: FBT housing benefits

Bill reference

Paragraph number

Item 1, subsection 135X(3)

4.9

Item 2

4.10

Schedule 5: CGT event K6 and demergers

Bill reference

Paragraph number

Item 1, subsections 104-230(9A) and 104-230(9B)

5.10

Item 1, paragraphs 104-230(9A)(b) and 104-230(9B)(b)

5.9

Item 1, paragraphs 104-230(9A)(c) and 104-230(9B)(c)

5.9

Item 2

5.13

Schedule 6: Deductions for United Medical Protection Limited support payments

Bill reference

Paragraph number

Item 2

6.9, 6.10

Item 3

6.12

Item 4

6.11

Schedule 7: Compulsory third party insurance

Bill reference

Paragraph number

Item 1, subsection 78-40(2)

7.6

Item 2, paragraph 79-10(2)(c)

7.8

Item 3, subsection 79-15(4)

7.12

Item 4, subsection 79-25(2A)

7.15

Item 5, paragraph 79-50(2)(a)

7.17

Item 6, subsection 79-70(2)

7.6

Item 6, subsection 79-70(3)

7.20

Item 7, subsection 79-90(1)

7.23

Item 8, subsection 79-90(2)

7.23

Item 9, subsection 79-95(2)

7.25

Item 10, subsection 79-95(3)

7.26

Item 11, paragraph 80-5(1)(b)

7.27

Item 12, paragraph 80-40(1)(b)

7.27

Item 13, subparagraph 80-80(1)(b)(ii)

7.27

Item 14

7.28

Schedule 8: Public ambulances service

Bill reference

Paragraph number

Items 1 to 5

8.11

Items 6 and 7

8.17

Item 8

8.20

Items 9 and 10

8.19

Item 11

8.21

Schedule 9: Overseas superannuation payments

Bill reference

Paragraph number

Item 1

9.23

Item 2

9.16

Item 2, paragraph 27CAA(1)(c)

9.24, 9.26

Item 2, subsection 27CAA(2)

9.25, 9.31, 9.32

Item 2, subsection 27CAA(2), definition of ‘additional contributions’

9.29, 9.35

Item 2, subsection 27CAA(2), definition of ‘accumulated entitlement’

9.34

Item 2, subsection 27CAA(3)

9.17

Item 2, subsection 27CAA(4)

9.18

Item 2, subsection 27CAA(5)

9.19

Item 2, section 27CAB

9.26, 9.27

Item 4, paragraph 274(10)(d)

9.18

Item 5, section 533B

9.21

Item 6, section 607AA

9.22

Item 7

9.36

Schedule 10: Franked distributions received through certain partnerships and trustees

Bill reference

Paragraph number

Items 1, 2, 16, 17

10.81

Items 3 and 4

10.71

Items 5 and 6

10.72

Item 7, subsection 207-35(3)

10.24

Item 7, section 207-45

10.28

Item 7, paragraphs 207-50(2)(a), (3)(a) and (4)(a)

10.15

Item 7, paragraph 207-50(2)(b)

10.15

Item 7, paragraphs 207-50(2)(c), (3)(c) and (4)(c)

10.15

Item 7, paragraph 207-50(3)(b)

10.15

Item 7, paragraph 207-50(4)(b)

10.15

Item 7, subsection 207-50(5)

10.17

Item 7, subsections 207-55(1) and (2)

10.19

Item 7, subsection 207-55(3)

10.20

Item 7, column 2 in item 3 in the table in subsection 207-55(3)

10.21

Item 7, section 207-57

10.22

Item 8, subsection 207-90(1)

10.30

Item 8, subsection 207-90(2)

10.31

Item 8, subsection 207-95(1)

10.32

Item 8, subsection 207-95(5)

10.36

Item 8, subsection 207-95(6)

10.37

Items 9, 10 and 12

10.73

Item 11, subsection 207-110(1)

10.39

Item 11, subsection 207-110(2)

10.40

Item 13

10.74

Item 14, subsections 207-145(1) and (2)

10.43

Item 14, subsection 207-145(3)

10.44

Item 14, subsection 207-150(1)

10.47

Item 14, subsections 207-150(2) to (4)

10.46

Item 14, subsection 207-150(5)

10.48

Item 14, subsection 207-150(6)

10.48

Item 14, subsection 207-150(7)

10.49

Item 14, subsection 207-150(8)

10.50

Item 15, section 207-160

10.52

Items 18 and 19

10.75

Items 20 to 22

10.82

Item 23

10.70

Items 32 and 39, paragraphs 220-400(1)(d) and 220-405(1)(e)

10.66

Items 33 and 34

10.65

Item 35, subsections 220-400(4) to (6)

10.67

Item 36, section 207-405

10.68

Item 37, paragraph 220-405(1)(d)

10.69

Item 40, subsection 220-405(2)

10.57

Item 40, subsection 220-405(3)

10.58

Item 40, subsection 220-405(4)

10.59

Item 40, subsection 220-405(5)

10.60

Item 40, subsection 220-405(6)

10.61

Item 40, subsection 220-405(7)

10.62

Item 40, subsection 220-405(8)

10.63

Item 40, subsection 220-405(9)

10.64

Item 41

10.76

Item 42

10.77

Subitem 43(1)

10.86

Subitem 43(2)

10.83

Subitem 43(3)

10.84

Subitem 43(4)

10.85

Item 44

10.87

Schedule 11: Technical corrections

Bill reference

Paragraph number

Items 1 to 4, section 160AFE

11.6

Item 5

11.8

Schedule 12: Personal service business determinations

Bill reference

Paragraph number

Item 1, subsection 87-60(3)

12.13

Item 1, subsection 87-60(3A)

Table 12.1

Item 1, subsection 87-60(3B)

Table 12.1

Items 2, 3, 6 and 7

12.21

Item 4, subsection 87-60(4)

Table 12.1

Item 5, subsection 87-65(3)

12.15

Item 9

12.22

Items 10 to 12, subsection 87-60(3), paragraph 87-60(3B)(a), section 87-60

12.17

Items 13 to 15, subsection 87-65(3), paragraph 87-65(3B)(a), section 87-65

12.20

Item 16

12.23

 




[1]   Section 6-5 and paragraph 320-137(2)(a).

[2]   Section 6-5 and paragraph 320-139(a).

[3]   Paragraphs 320-15(1)(a) and 320-137(2)(b).

[4]   Paragraphs 320-15(1)(a) and 320-139(a).

[5]   Paragraphs 320-15(1)(db) and 320-137(2)(d).

[6]   Paragraphs 320-15(1)(da) and 320-139(a).

[7]   Section 320-55 and paragraph 320-137(4)(a).

[8]   Section 320-75 and paragraph 320-139(b).

[9]   Section 8-1 and paragraph 320-137(4)(b).

[10] Section 8-1 and paragraph 320-139(b).

[11] Subsection  320-87(2) and paragraph 320-139(b).

[12] Subsection  320-87(1) and paragraph 320-137(4)(c).