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Tax Laws Amendment (2008 Measures No. 5) Bill 2008

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2008

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

HOUSE OF REPRESENTATIVES

 

 

 

tax laws amendment (2008 Measures n o . 5) bill 2008

 

 

 

 

EXPLANATORY MEMORANDUM

 

 

 

 

(Circulated by the authority of the

Treasurer, the Hon Wayne Swan MP)

 



T able of contents

Glossary.............................................................................................................. 5

General outline and financial impact............................................................ 7

Chapter 1            GST and the sale of real property — integrity measure 11

Chapter 2            Thin capitalisation — modification of the rules in relation to application of accounting standards....................................................... 33

Chapter 3            Interest withholding tax — extension of eligibility for exemption to state government bonds............................................................ 47

Chapter 4            Fringe benefits tax — jointly held assets...................... 51

Chapter 5            Managed funds:  changes to the eligible investment business rules      57

Index................................................................................................................. 69

 



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

Abbreviation

Definition

ADIs

authorised deposit-taking institutions

AEST

Australian Eastern Standard Time

AIFRS

Australian equivalents to International Financial Reporting Standards

Commissioner

Commissioner of Taxation

Corporations Act

Corporations Act 2001

FBT

fringe benefits tax

FBTAA 1986

Fringe Benefits Tax Assessment Act 1986

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

IWT

interest withholding tax

NAB case

National Australia Bank Ltd v FC of T  93 ATC 4914



GST and the sale of real property — integrity measure

Schedule 1 to this Bill amends the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) to maintain the integrity of the goods and services tax (GST) tax base by ensuring that the interaction between the margin scheme provisions (refer Chapter 1, paragraph 1.4) and the going concern, farmland and associates provisions does not allow property sales to be structured in a way that results in GST not applying to the value added to real property on or after 1 July 2000 by an entity registered or required to be registered for GST.

These amendments:

•        ensures that where the margin scheme is used after certain GST-free or non-taxable supplies, the value added by the registered entity which made that supply is included in determining the GST subsequently payable under the margin scheme;

•        ensures that eligibility to use the margin scheme cannot be reinstated by interposing a GST-free or non-taxable supply; and

•        confirms that the GST general anti-avoidance provisions can apply to contrived arrangements entered into to avoid GST.

Date of effect This measure has effect from the date of Royal Assent. 

Proposal announced This measure was announced in the 2008-09 Budget.

Financial impact This measure has the following revenue implications:

2007-08

2008-09

2009-10

2010-11

2011-12

Nil

$43m

$135m

$160m

$185m

The revenue impact has been revised since the 2008-09 Budget due to a change in the commencement date of the measure from 1 July 2008 to 1 January 2009, and an update of the base data used in the costing model.

Compliance cost impact Low.  This measure will result in a small increase in ongoing compliance costs as there may be additional information requirements for entities that purchase real property as a GST-free going concern or farmland and then subsequently decide to sell under the margin scheme.

Thin capitalisation — modification of the rules in relation to application of accounting standards

Schedule 2 to this Bill modifies the thin capitalisation regime contained within Division 820 of the Income Tax Assessment Act 1997 in relation to the use of accounting standards for identifying and valuing an entity’s assets, liabilities and equity capital.  It aims to adjust for certain impacts of the 2005 adoption of Australian equivalents to International Financial Reporting Standards on the thin capitalisation position of complying entities.  The amendments will, in specified circumstances:

•        prohibit entities from recognising:

-       defined benefit plan assets and liabilities; and

-       tax deferred assets and liabilities; and

•        permit entities to:

-       recognise internally generated intangible assets; and

-       revalue intangible assets, where this is currently prohibited due to the absence of an active market.

Date of effect The amendments will apply to assessments for each income year commencing on or after the date of Royal Assent.

Proposal announced The Treasurer and the Assistant Treasurer and Minister for Competition Policy and Consumer Affairs jointly announced the amendments in Media Release No. 053 of 13 May 2008.

Financial impact :  Unquantifiable.

Compliance cost impact :  M inimal.

Interest withholding tax — extension of eligibility for exemption to state government bonds

Schedule 3 to this Bill amends section 128F of the Income Tax Assessment Act 1936 to extend eligibility for exemption from interest withholding tax to bonds issued in Australia by state and territory central borrowing authorities.

Date of effect :  This amendment applies to interest paid on or after the date of Royal Assent.

Proposal announced :  This measure was announced in the Treasurer’s Media Release No. 058 of 20 May 2008.

Financial impact This measure has the following revenue implications:

2007-08

2008-09

2009-10

2010-11

2011-12

Nil

-$7m

-$17m

-$19m

-$21m

Compliance cost impact Nil.

Fringe benefits tax — jointly held assets

Schedule 4 to this Bill amends the Fringe Benefits Tax Assessment Act 1986 to ensure that the ‘otherwise deductible rule’ applies appropriately to benefits provided in relation to investments that the employee holds jointly with a third party.

Date of effect :  These amendments will apply from 7:30 pm Australian Eastern Standard Time (AEST) on 13 May 2008.

For employees who have entered into a salary sacrifice arrangement with their employer before 7:30 pm (AEST) on 13 May 2008 and which involves an expense payment fringe benefit related to the investment, the existing treatment continues to apply to benefits provided until 1 April 2009.

For employees who have entered into a loan arrangement before 7:30 pm (AEST) on 13 May 2008, the existing treatment that currently applies to the loan benefit continues to apply to benefits provided until 1 April 2009.

Proposal announced This measure was announced in the 2008-09 Budget and in the Treasurer’s Media Release No. 048 of 13 May 2008.

Financial impact :  This measure has these revenue implications:

2007-08

2008-09

2009-10

2010-11

2011-12

Nil

$4m

$15m

$15m

$15m

Compliance cost impact :  Minimal.

Managed funds — changes to the eligible investment business rules

Schedule 5 to this Bill amends Division 6C of the Income Tax Assessment Act 1936 to streamline and modernise the eligible investment business rules for managed funds. 

These amendments will:

•        clarify the scope and meaning of investing in land for the purpose of deriving rent;

•        introduce a 25 per cent safe harbour allowance for non-rental, non-trading income from investments in land;

•        expand the range of financial instruments that a managed fund may invest in or trade; and

•        provide a 2 per cent safe harbour allowance at the whole of trust level for non-trading income.

Date of effect This measure will apply to the income year of Royal Assent and later income years. 

Proposal announced This measure was announced in the 2008-09 Budget.

Financial impact This measure has an unquantifiable revenue cost impact that is not expected to be significant. 

Compliance cost impact This measure is expected to impose a small increase in compliance costs in the transitional year.  Ongoing compliance costs are expected to be reduced. 



C hapter 1     

GST and the sale of real property — integrity measure

Outline of chapter

1.1                   Schedule 1 to this Bill amends the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) to maintain the integrity of the goods and services tax (GST) tax base by ensuring that the interaction between the margin scheme provisions (see paragraph 1.4) and the going concern, farmland and associates provisions does not allow property sales to be structured in a way that results in GST not applying to the value added to real property on or after 1 July 2000 by an entity registered or required to be registered for GST.

1.2                   These amendments:

•        ensure that where the margin scheme is used after certain GST-free or non-taxable supplies, the value added by the registered entity which made that supply is included in determining the GST subsequently payable under the margin scheme;

•        ensure that eligibility to use the margin scheme cannot be reinstated by interposing a GST-free or non-taxable supply; and

•        confirm that the GST general anti-avoidance provisions can apply to contrived arrangements entered into to avoid GST.

Context of amendments

1.3                   GST is intended to be payable on the value added, including capital appreciation, to real property on or after 1 July 2000 (the date that GST commenced) by an entity registered for GST. 

1.4                   For real property, special rules exist that allow taxpayers an alternative means of calculating GST.  These rules are known as the margin scheme. 

1.5                   As a result, under the GST Act, registered businesses can calculate GST payable on supplies of new residential property or commercial property under the basic rules (GST is 1/11th of the GST-inclusive price) or, subject to certain conditions, under the margin scheme (GST is 1/11th of the margin). 

1.6                   The margin scheme was designed to ensure that GST is payable only on the incremental value added to land by each registered party in a series of transactions.  The margin scheme is generally used for new residential property developments.

1.7                   Under the margin scheme GST is generally payable only on the value added to property on or after 1 July 2000.  It levies GST only on the margin by which the value of the property increases each time it is sold by a registered entity on or after 1 July 2000.

1.8                   Ordinarily, the margin is calculated as the difference between the sale price of the property, and the consideration paid for its acquisition.  However, where the property was acquired before 1 July 2000, an approved valuation as at 1 July 2000 may be used.  This ensures that the property’s value prior to the introduction of the GST is not taxed.

1.9                   Purchasers of real property supplied under the margin scheme are not entitled to claim input tax credits for GST remitted by the supplier.  This ensures that each registered supplier in a series of transactions remits the GST applicable to the value added by them.  To ensure that the full amount of GST is payable, the margin scheme does not apply where the property has been acquired under the basic rules for the calculation of tax payable, as an input tax credit would generally have been claimed on the purchase of the property (and GST would effectively not have been collected).

1.10               However, an entity that would otherwise be prevented from applying the margin scheme, on the basis that it acquired the property as a taxable supply under the basic rules, can reinstate eligibility for the margin scheme by interposing certain GST-free or non-taxable supplies prior to selling the property under the margin scheme. 

1.11               This arises generally where property has been acquired as a GST-free or non-taxable supply and the margin scheme is available to calculate the GST payable on a subsequent supply of the property.  In these circumstances there is no requirement to take into account whether the sale before the GST-free or non-taxable supply would have been eligible for the margin scheme. 

1.12               These amendments aim to ensure that an otherwise ineligible supply cannot become ‘re-eligible’ for supply under the margin scheme as a result of interposing certain GST-free or non-taxable supplies.

1.13               The interaction of the margin scheme provisions (Division 75) of the GST Act with certain other provisions — such as the going concern (Subdivision 38-J) and farmland (Subdivision 38-O) provisions — has resulted in GST not being applied to the full margin of value added to real property within the GST system.  Similarly, GST is not calculated on the full margin of value added when real property has been acquired from an associate for no consideration.

1.14               This occurs because, under the margin scheme provisions, GST is only paid on the value added by the supplier of a taxable supply of real property.  However, real property may be acquired GST-free under the going concern or farmland provisions, or acquired from a registered associate without consideration.  When it is later sold under the margin scheme, GST would not have been applied to the full value added while the property was in the GST system.

1.15               The GST-free treatment assigned to going concerns (under section 38-325) and farmland (under section 38-480) is not granted with a view to removing value added by the supplier from the tax base.  Rather it is to relieve the recipient of the burden of obtaining additional funds to cover the GST included in the price of a going concern, when ordinarily they would be able to claim an input tax credit. 

1.16               However, where such a GST-free supply includes real property that is later sold under the margin scheme, the effect is that the value added to the real property before the GST-free supply is excluded for GST purposes.  This is contrary to the policy intent that GST be collected on the value added to real property by registered owners on or after 1 July 2000.  This deficiency arises irrespective of whether an entity is motivated by a desire to avoid tax. 

1.17               These amendments aim to ensure the appropriate amount of GST is collected on supplies of real property consistent with the policy intent of the GST system.

1.18               These amendments will also remove an unintended outcome that was created by the Tax Laws Amendment (2005 Measures No. 2) Act 2005 .  A technical deficiency in this amendment allowed an entity to eliminate or substantially reduce the amount of GST payable on a sale of real property it intended to make to a third party, by first supplying the property to a registered associate for no consideration.  This supply would not attract any GST.  The associated entity would then supply the property to a third party under the margin scheme, paying GST on a margin that would be much less than the margin that the original entity would have faced. 

1.19               The general anti-avoidance provisions in the GST law provide the Commissioner of Taxation (Commissioner) with broad powers to cancel GST benefits that arise from contrived schemes. 

1.20               The GST general anti-avoidance provisions may only operate if the GST benefit obtained from a scheme is not attributable to the making of a choice, election, application or agreement that is expressly provided by the GST law.  These amendments will ensure that a GST benefit is not attributable to the making of a choice, election, application or agreement if the scheme was entered into for the sole or dominant purpose of creating a circumstance or state of affairs necessary to enable the choice, election, application or agreement to be made.

1.21               This measure will apply prospectively so that arrangements already entered into will not be impacted.

Summary of new law

1.22               Schedule 1 ensures that a supply that is ineligible for the margin scheme continues to be ineligible for the margin scheme after it is supplied as part of a GST-free sale of a going concern, as GST-free farmland, or it is supplied to a registered associate for no consideration. 

1.23               This is achieved by specifying that a supply is ineligible for the margin scheme if the previous supplier acquired the entire interest through a taxable supply on which the GST was worked out without applying the margin scheme.  This limited eligibility applies to supplies that are supplies of things that the supplier acquired through a new supply to the supplier. 

1.24               This Schedule also provides that where real property is acquired GST-free as part of a going concern, GST-free farmland, or from a registered associate for no consideration, the calculation of GST on the subsequent sale of that property under the margin scheme should also account for the value added by the previous owner.  The new calculation rules apply to supplies that are supplies of things that the supplier acquired through a new supply to the supplier.

1.25               New supplies are supplies made on or after the commencement of this Bill and are not made under a written agreement entered into before commencement or pursuant to a right or option granted before commencement, where consideration or a way of working out the consideration is specified. 

1.26               Finally, this Schedule amends the GST general anti-avoidance provisions to avoid any doubt that those provisions can apply to schemes that were entered into with the sole or dominant purpose of creating a circumstance or state of affairs that enable a choice, election application or agreement to be made that gives rise to a GST benefit.

1.27               This provision brings the GST general anti-avoidance provisions into line with similar provisions for income tax.  These amendments apply to a choice, election, application or agreement made on or after the commencement of this Bill.

Comparison of key features of new law and current law

New law

Current law

A supply of real property continues to be ineligible for the margin scheme if the previous supplier acquired the entire interest through a supply that was ineligible for the margin scheme.

Eligibility to sell a property under the margin scheme can be reinstated by interposing a GST-free supply of a going concern or farmland or a supply from an associate for no consideration prior to selling the property under the margin scheme.

A registered entity that supplies real property in the course or furtherance of its enterprise, as part of a GST-free going concern, as GST-free farmland, or as a non-taxable supply to a registered associate for no consideration does not pay GST on its value added.  However, if the entity that acquires the real property later sells it under the margin scheme, it pays GST both on its own value added, and the value added to the property by the registered entity from which it acquired the property.

A registered entity that supplies real property as part of a GST-free going concern, as GST-free farmland, or as a non-taxable supply to a registered associate for no consideration does not pay GST on its value added.  If the entity that acquires the real property later sells it under the margin scheme, it only pays GST on its own value added in these circumstances.  The value added by the entity from which it acquired the property is not taxed.

New law

Current law

A GST benefit is not attributable to the making of a choice, election, application or agreement if the scheme was entered into for the sole or dominant purpose of creating a circumstance or state of affairs necessary to enable the choice, election, application or agreement to be made.

The GST general anti-avoidance provisions may only operate if the GST benefit obtained from a scheme is not attributable to the making of a choice, election, application or agreement that is expressly provided by the GST law.

Detailed explanation of new law

1.28               GST cannot be minimised by interposing certain GST-free or non-taxable supplies prior to a sale under the margin scheme.  It is necessary to look through certain GST-free sales or non-taxable supplies when determining how to apply the margin scheme.

Eligibility for the margin scheme

1.29               A supply is ineligible for the margin scheme if it was purchased under the basic rules (ie, not using the margin scheme).  This is because the purchaser would already have been entitled to claim an input tax credit, and should not be entitled to further relief under the margin scheme.  This principle should apply whether or not there has been an interposed GST-free sale or non-taxable supply (of the kind to which these amendments apply).

1.30               A supply of real property that would have been ineligible for the margin scheme, cannot become re-eligible for the margin scheme because it was acquired as part of a GST-free going concern or as GST-free farmland or from an associate for no consideration.   [Schedule 1, item 2]  

1.31               This reflects the same treatment that applies to real property that has been inherited from a deceased person (paragraph 75-5(3)(b) of the GST Act), supplied from a member of a GST group (paragraph 75-5(3)(c) of the GST Act) or from a joint venture partner (paragraph 75-5(3)(d) of the GST Act).  However, one main difference between the new eligibility provisions and the current provisions is that the new provisions only require an entity to look back through one transaction to determine eligibility. 

1.32               It is recognised that limiting the look through test to determine eligibility to the preceding acquisition may enable eligibility for the margin scheme to be reinstated in instances where a sale of property made under the basic rules is followed by two or more interposed GST-free sales of a going concern or farmland or two or more interposed sales from an associate for no consideration.  However, limiting the requirement to look through one transaction seeks to achieve a balance between the risks to revenue and the complexity and compliance costs that would be involved in tracing back through a number of transactions between unrelated parties. 

1.33               The general anti-avoidance provisions may be applied to contrived arrangements that seek to benefit from the opportunity to reinstate eligibility for the margin scheme by, for example, artificially interposing two or more GST-free sales before a supply under the margin scheme. 

1.34               It is also recognised that an acquisition from an associate may not be by means of a supply, for example, some acquisitions by government entities may be made without a supply.  New subsection 75-5(3A) specifies that the requirements in subparagraphs 75-5(g)(iii) and (iv) will not apply where the acquisition by an associate for no consideration is not by means of a supply.  This means that new paragraph 75-5(3)(g) will also apply where property is acquired for no consideration from an associate regardless of whether the associate makes a supply.  [Schedule 1, item 3]

Example 1.1 :  Ineligibility for the margin scheme following supply of going concern

A is registered for GST, and held vacant land before 1 July 2000.  A sells the property to B, a property developer who is also registered for GST.  This sale is made under the basic rules.  A and B do not use the margin scheme, because B wishes to be eligible to claim an input tax credit on the purchase.

B begins construction of a unit complex on the vacant land.  Before completing construction, B sells the partly constructed unit development to C, along with the necessary arrangements for C to carry on its construction.  B and C have agreed that this is a supply of a going concern.  Therefore B does not remit GST, nor is C entitled to an input tax credit.

C finishes the development, and sells a unit to D, who is a private individual not registered for GST.  This is a taxable supply of new residential premises.  C cannot make the sale to D under the margin scheme, because B acquired the property under the basic rules, and would therefore also have been ineligible to apply the margin scheme.

This example can also be followed using this diagram:

If B had purchased the property under the margin scheme then the margin scheme could have been applied to C’s sale to D.

Example 1.2 :  Ineligibility for the margin scheme following supply to a registered associate for no consideration

Kit Holdings is registered for GST.  It acquires land in Sandy Bay under the basic rules.  Later, Kit Holdings transfers the land for no consideration to an associated company, Kit Homes.  When Kit Homes sells the land, it will be ineligible to use the margin scheme.

Alternatively, if Kit Holdings had acquired the land under the margin scheme, then the GST payable on the sale by Kit Homes could have been calculated under the basic rules or under the margin scheme.

Eligibility and partial supplies

1.35               Under existing subsection 75-5(2), where real property is acquired partly through a supply that is ineligible for the margin scheme, and partly through a supply that is eligible for the margin scheme, the margin scheme can be used for the subsequent supply.  However, in these circumstances, the existing section 75-22 requires an increasing adjustment, reflecting the input tax credit entitlement for that part of the acquisition that is ineligible for the margin scheme. 

1.36               Subsection 75-22(1) does not apply in relation to the scenarios described in new paragraphs 75-5(3)(e) to (g) as the supplier in these circumstances is not entitled to an input tax credit for the acquisition.  Instead, it is the previous supplier that had the input tax credit entitlement. 

1.37               Similarly, subsection 75-22(1) does not apply where property is supplied GST-free as part of a going concern or GST-free farmland or as a non-taxable supply to a registered associate for no consideration, where the entity making the GST-free or non-taxable supply acquired part of the property through a supply that was ineligible for the margin scheme.

1.38               For an increasing adjustment to apply in these circumstances, new subsections 75-22(3) and (4) have been inserted.  [Schedule 1, item 10]

1.39               New subsection 75-22(5) specifies the amount of the increasing adjustment.  In recognition that there may be difficulties for the supplier in obtaining the information to determine the input tax credits to which the previous supplier was entitled, the provision allows an adjustment to be calculated using an approved valuation. 

1.40               Where an entity chooses to use an approved valuation, the amount of the increasing adjustment is equal to 1/11th of an approved valuation of the part of the real property that either, was ineligible for the margin scheme, or would have been ineligible for the margin scheme at the time of the previous supplier’s acquisition.  Alternatively, the increasing adjustment will be 1/11th of the consideration provided by the previous supplier to acquire that part of the real property.   [Schedule 1, item 10]

Calculating the margin for a supply of real property after certain GST-free or non-taxable supplies

1.41               Where property has been supplied GST-free as part of a going concern, as GST-free farmland, or as a non-taxable supply to a registered associate for no consideration, the entity making the GST-free or non-taxable supply does not have a GST liability for the value they have added to the property.  Instead, the calculation of the margin on a subsequent sale of such properties under the margin scheme only takes into account the value added by the supplier under the margin scheme. 

1.42               The approach is to look through the prior GST-free sale or non-taxable supply in order to calculate the margin for supplies of property under the margin scheme.  The margin is based on the consideration paid by the previous entity for their acquisition, or on a valuation of the property when the previous entity acquired the property or first become registered on or after 1 July 2000.  In this way, the overall GST liability cannot be reduced by resetting the margin by way of a GST-free supply or a non-taxable supply to a registered associate for no consideration.  [Schedule 1, item 4]

1.43               As stated, a valuation of a property may be required in order to calculate the margin.  In particular, where an entity acquired land before 1 July 2000 and was required to be registered for GST at the commencement of GST, a 1 July 2000 valuation applies for the purposes of determining the margin. 

1.44               Where an entity acquired real property on or after 1 July 2000 and was registered at the time of acquisition, a valuation of the property at the time of acquisition or the consideration for the acquisition may be used for the purposes of determining the margin. 

1.45               Where real property is acquired by an entity on or after 1 July 2000 and the entity was not registered or required to be registered for GST at the time of acquisition, the value of the property at the time that the entity is first registered or required to be registered applies for the purposes of determining the margin.

1.46               New subsection 75-11(6A) recognises that an acquisition from an associate may not be by means of a supply, for example some acquisitions by government entities may be made without a supply. 

Example 1.3 :  Calculation of the margin following a GST-free sale

A is registered for GST, and held land before 1 July 2000 valued at $110,000.  A sells the land to B for $165,000.  The margin scheme is applied to this sale.  A’s GST liability is based on A’s value added.

B begins operating an enterprise of construction and sale of a unit complex, and later sells the construction site as part of a going concern to C.  Because B and C agree to treat the supply as a GST-free going concern, B pays no GST on the sale price of $440,000 for the site. 

By interposing a GST-free sale, the tax on B’s value added becomes payable on C’s sale.  This potential tax liability was contemplated by the parties when they negotiated the GST-free sale price.  At the time of the GST-free sale, C could ensure that the necessary documentation evidencing B’s acquisition price of the real property was obtained.

C completes the construction and sells it to D for $495,000, applying the margin scheme.  In calculating the margin for the sale, C subtracts B’s acquisition price of $165,000 from C’s final sale price of $495,000.  This results in a margin of $330,000 for this supply.  C pays $30,000 in GST to the Australian Taxation Office.

This is equivalent to the outcome that would have been obtained had B sold the property to C under the margin scheme.  In this case B would have paid GST of $25,000, based on B’s margin of $275,000 ($440,000  -  $165,000).  C would have paid $5,000 GST, based on C’s margin of $55,000 ($495,000  -  $440,000).  The total GST collection from B and C would still have been $30,000.

This example can also be followed using this diagram:

Example 1.4 :  Calculation of the margin following supply to a registered associate for no consideration

A is registered for GST, and held land before 1 July 2000 valued at $110,000.  A begins construction of a unit complex on the land.  The property is transferred to its associate B, for no consideration.  A is not liable to pay any GST on the transfer because B is registered for GST and acquires the property solely for a creditable purpose.  The market value of the property at the time of the transfer is $440,000.

B completes construction, and sells new residential premises to C for $495,000, under the margin scheme.  The margin for this sale includes the value added by B of $55,000 ($495,000  -  $440,000) as well as the value added by A on or after 1 July 2000 of $330,000

($440,000  -  $110,000).  The total margin is therefore $385,000 ($495,000  -  $110,000), upon which $35,000 GST is payable.

This is equivalent to the outcome that would have been obtained had A sold the property to B under the margin scheme for its market value of $440,000.  In this case A would have paid GST of $30,000, being 1/11th of A’s value added of $330,000.  B would then have paid only $5,000 GST based on B’s value added of $55,000.  The total GST collection would still have been $35,000.

This example can also be followed using this diagram:

 

Example 1.5 :  GST-free farmland

Jack is a farmer who is registered for GST.  Jack owned property near Bendigo valued at $440,000 on 1 July 2000.  Jack farms sheep on this land until 2010, when he sells the land to Toby for $550,000, another farmer who is registered for GST.  Because Toby intends that a farming business be carried on, on the land Jack’s supply to Toby is GST-free. 

Toby is later approached by a developer that offers to buy the land in order to build residential premises.  If Toby sells the property under the margin scheme, the margin would be the difference between the sale price and the value of the property as at 1 July 2000.  Toby would have to remit GST on this margin, but the purchaser would not be entitled to an input tax credit.

Example 1.6 :  Land acquired on or after 1 July 2000 by an unregistered entity, that later becomes registered for GST

Land is acquired in 2002 by an unregistered entity.  In 2010, the entity becomes registered for GST.  In 2012, the property is supplied as GST-free farmland, then later sold under the margin scheme.  The margin for the later sale is based on an approved valuation or the GST-inclusive market value of the property when the entity became registered in 2010, not the consideration paid for the property in 2002.

Supplies between associates for no consideration

1.47               Division 75 applies to the sale of a freehold interest in land, a stratum unit or granting or selling a long term lease.  As a result, under the current law, Division 75 does not apply in relation to supplies between associates for no consideration.

1.48               To ensure that Division 75 can apply, new subsection 75-5(1B) specifies that a supply of real property to an entity who is your associate is taken to be a sale to your associate whether or not the supply is for consideration.  [Schedule 1, item 1]

1.49               Existing section 75-13 applies in relation to working out the margin for a supply to an associate.  A consequential amendment is made to section 75-13 to ensure that it applies where there is a supply between associates for no consideration.  [Schedule 1, item 8]

Calculating the margin for the supply of real property acquired through several acquisitions

1.50               There may be circumstances where more than one of the following provisions applies to the calculation of the margin for the taxable supply of real property; section 75-10 and subsections 75-11(1) to (7).  This may occur where there have been several acquisitions of real property which may later be combined or amalgamated. 

1.51               New section 75-16 specifies that where real property has been acquired through two or more acquisitions (partial acquisitions) the calculation of the margin under a particular provision is determined only to the extent that the supply is connected to the partial acquisition.  [Schedule 1, item 9]

Example 1.7 :  The margin for supply of real property acquired through several acquisitions

Bob acquired an interest as a GST-free supply of farmland.  Bob acquired a second interest from an unregistered vender.  The two interests are merged as part of a development and sold under the margin scheme. 

Section 75-16 provides that the calculation of the margin under subsection 75-11(5) should only apply to the extent that the interest was acquired pursuant to the GST-free supply of farmland. 

GST general anti-avoidance provisions

1.52               The general anti-avoidance provisions in Division 165 of the GST Act apply to artificial or contrived schemes that are entered into or carried out for the sole or dominant purpose of getting a GST benefit.  Through entering into or carrying out a scheme, an entity may create a circumstance or state of affairs that is necessary to make a choice, election, application or agreement allowed under the GST Act.  In this case, the GST benefit is not attributable to the choice, election, application or agreement. 

1.53               In particular, the provisions of this Schedule apply to tax the value added to real property by looking back through certain GST-free or non-taxable supplies.  However, in order to minimize complexity and record-keeping requirements for taxpayers, the taxpayer is required only to look back through one GST-free sale or non-taxable supply.  Taxpayers attempting to circumvent these provisions by contriving a string of GST-free sales may be subject to the application of the GST anti-avoidance provisions.

1.54               The reduction in the margin that arises because of the interposition of a GST-free or non-taxable supply is not attributable to, for instance, the agreement to apply the margin scheme or that a supply is a supply of a going concern, but rather to the overall arrangement, including the interposing of the intermediate supply, of which the choice or agreement is but one part. 

1.55               Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936), subparagraph 177C(2)(a)(ii) provides:

‘…the scheme was not entered into or carried out by any person for the purpose of creating any circumstance or state of affairs the existence of which is necessary to enable the declaration, agreement, election, selection, choice, notice or option to be made, given or exercised, as the case may be…’.

1.56               For the avoidance of doubt, new subsection 165-5(3) introduces into the GST Act a concept that is already found in subparagraph 177C(2)(a)(ii) of the ITAA 1936, so that if a GST benefit is attributable to the making of a choice, election, application or agreement, then consideration needs to be given to the purpose of creating any circumstance or state of affairs which enable such a choice, election, application or agreement.  [Schedule 1, item 11]

1.57               This exception is not limited to schemes involving real property and the margin scheme and applies to other schemes to which the GST general anti-avoidance provisions may apply. 

1.58               Division 165 is intended to apply to artificial or contrived schemes and not, for example, where parties merely take advantage of concessions, such as the margin scheme and grouping provisions in accordance with the objects of the provision. 

Example 1.8 :  When Division 165 will not apply

A vendor and purchaser initially instruct their solicitors to draft a contract of sale for a taxable supply.  Prior to the contract being executed the parties instruct their solicitors to amend the contract to reflect their agreement that the supply is of a going concern.  

In amending the contract, the parties have not entered into an artificial or contrived arrangement to obtain an unintended benefit contrary to the object of the GST Act.  They have merely taken advantage of the concession for a supply of a going concern.  There is no additional benefit involved.  Thus Division 165 does not apply.

1.59               However, where entities take steps to create a circumstance where a statutory choice may be exercised, as part of an artificial or contrived scheme to defeat the object of the GST Act or particular provisions of the Act — such as schemes that seek to use multiple applications of the going concern concession to avoid GST on the value added by registered entities — the new provision may be relevant to the application of Division 165. 

1.60               This new provision requires a conclusion to be drawn as to the purpose of creating the requisite circumstance or state of affairs consistent with the exception contained in Part IVA of the ITAA 1936.  The purpose must be the sole or dominant purpose.  This standard limits the potential application of the provision to those arrangements that are artificial or contrived in nature.  [Schedule 1, item 11]

Example 1.9 :  A string of going concern sales

A is registered for GST and acquires real property on 1 July 2008 for $660,000.  The property is acquired under the margin scheme.  A partly completes a residential development on the property.  On 17 June 2009 the market value of the property is $3.3 million.  If A were to sell this property under the margin scheme at its market value of $3.3 million, the GST payable would be $240,000, based on A’s margin of $2.64 million.

Instead, A transfers the property to B, as part of a GST-free going concern for $3.3 million.  If B were to sell the property under the margin scheme for the same amount, the GST payable would still be $240,000, as B is also required to account for the value added prior to A’s supply as a GST-free going concern. 

A has arranged with B to transfer the property back to them on 18 June 2009.  The property is still valued at $3.3 million.  However, A is later able to sell the property to C under the margin scheme for $3.4 million.  Because A had acquired the property from B as part of a GST-free going concern, A calculates the margin based on the difference between the final sale price ($3.4 million) and B’s acquisition cost ($3.3 million).  However, A is not required to look back further, hence A’s original margin of $2.64 million is not taxed.

This transaction is brought to the attention of the Commissioner, who seeks to apply the GST general anti-avoidance provisions.  Although the agreement to make a GST-free supply of a going concern is expressly provided for by Subdivision 38-J of the GST Act, this does not mean that any GST benefit received by A was attributable to the agreement, because the agreement was but one step in the arrangement.  Also, under the amendments, the exclusion of GST benefits attributable to agreements provided for under the Act does not apply as the creation of the circumstances or state of affairs was for the purpose of enabling the agreement to be made.

Application and transitional provisions

1.61               The amendments to Division 75 relating to eligibility to apply the margin scheme and dealing with the calculation of the margin for a sale under the margin scheme apply in relation to supplies that are supplies of things that the supplier acquired through a new supply to the supplier.  New supplies are supplies made on or after the commencement of this Bill and are not made under a written agreement entered into before commencement or pursuant to a right or option granted before commencement, where consideration or a way of working out the consideration is specified.

1.62               If a supply is made under a written agreement prior to the commencement of this Schedule, the supply of real property under that written agreement is not affected.  This means that where parties have already entered into a written agreement that specifically identifies the supply and identifies the consideration in money or a way of working out the consideration in money for the supply of real property, the law as it stood prior to these amendments continues to stand. 

1.63               The new rules apply only to parties entering into written agreements on or after the commencement of this Bill.  This ensures that when negotiating the terms of a supply of real property, the parties have the opportunity to negotiate the contract price based on any potential liability under these provisions, and have the opportunity to obtain evidence of consideration paid or relevant valuations.

1.64               The sale of a property that was acquired as part of a going concern, or from an associate, prior to the date of commencement will be subject to the existing rules.  This is illustrated in Diagram 1.1.

Diagram 1.1 :  Application of Schedule 1 to the calculation of the margin

If B had purchased the property from A under a written agreement entered into before commencement, that specified in writing the consideration or a way of working out the consideration, the existing rules would apply.  If B had similarly purchased the property from A under a right or option granted, that specified in writing the consideration or a way of working out the consideration for the supply before commencement, the existing rules would apply. 

1.65               The amendments to the GST anti-avoidance provisions apply to a choice, election, application or agreement made on or after the commencement of this Bill.  [Schedule 1, item 13]

Consequential amendments

1.66               There are also amendments reorganising assorted headings, notes and other things that need to be removed or changed because of the introduction of the new provisions.  [Schedule 1, items 5 to 7 and item 12]



C hapter 2     

Thin capitalisation — modification of the rules in relation to application of accounting standards

Outline of chapter

2.1                   Schedule 2 to this Bill modifies the thin capitalisation regime contained within Division 820 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the use of accounting standards for identifying and valuing an entity’s assets, liabilities and equity capital. 

2.2                   This measure aims to adjust for certain impacts of the 2005 adoption of the Australian equivalents to International Financial Reporting Standards (AIFRS) on an entity’s thin capitalisation position.  It does this by providing for the accounting standard treatment of specified assets and liabilities to be disregarded in certain circumstances. 

2.3                   This chapter outlines the circumstances in which certain assets and liabilities are not permitted to be recognised by particular entities for thin capitalisation purposes.  This relates to deferred tax assets and liabilities, within the scope of Australian accounting standard AASB 112 Income Taxes , and assets and liabilities arising from defined benefit plans, within the scope of Australian accounting standard AASB 119 Employment Benefits

2.4                   It also outlines those circumstances in which particular entities may choose to recognise or revalue certain intangible assets, contrary to the relevant accounting standard.  This primarily relates to intangible assets within the scope of Australian accounting standard AASB 138 Intangible Assets .

2.5                   This chapter identifies that those entities using the authorised deposit-taking institutions’ (ADIs) thin capitalisation rules are excluded from the scope of this measure.

2.6                   All references to legislative provisions in this chapter are references to the ITAA 1997 unless otherwise stated.

Context of amendments

2.7                   The thin capitalisation regime in Division 820 of the ITAA 1997 is designed to ensure that Australian and foreign-owned multinational entities do not allocate an excessive amount of debt to their Australian operations.  It does this by disallowing a proportion of otherwise deductible finance expenses (eg, interest) where the debt used to fund the Australian operations exceeds certain limits

2.8                   Accounting standards are required to be used as the basis for the identification and valuation (including revaluation) of assets, liabilities and equity capital for thin capitalisation purposes.

2.9                   This measure implements the joint announcement of the Treasurer and the Assistant Treasurer and Minister for Competition Policy and Consumer Affairs in Media Release No. 053 of 13 May 2008 that the Government will amend the thin capitalisation regime to accommodate certain impacts arising from the 1 January 2005 adoption of new accounting standards known as AIFRS. 

2.10               These standards replaced the previous Australian Generally Accepted Accounting Principles .  The adoption of AIFRS is regarded as aligning Australia more closely with international accounting practice.  These standards generally take a more conservative approach to the recognition and valuation of assets and liabilities.

2.11               The Government announced amendments to allow entities subject to the thin capitalisation regime to depart from current accounting treatment in relation to certain intangible assets and exclude deferred tax assets and liabilities and surpluses and deficits in defined benefit superannuation funds in undertaking necessary calculations. 

2.12               These amendments adjust for certain differences in treatment from the previous accounting standards, where the treatment under the new standards disregards the economic value attached to certain assets or would introduce volatility to thin capitalisation calculations.  They are intended to provide a sounder economic base from which to undertake thin capitalisation calculations, rather than introduce more concessionary arrangements. 

2.13               Prior to the new accounting standards, defined benefit plan assets and liabilities were not required to be recognised on balance sheets.  These items are potentially volatile, consequent on changes in underlying actuarial assumptions.  Further, it has been put forward that the new accounting requirements for income taxes has introduced volatility into the year-to-year thin capitalisation positions of entities.  This means future investment planning is conducted in a less certain environment.  It was concluded that exclusion was the best means of neutralising this volatility, without establishing an environment whereby taxpayers include such items only when it is favourable to do so.  This latter position would be inconsistent with the tax system integrity role performed by the thin capitalisation regime.

2.14               It is also accepted that certain intangible assets may have an economic value greater than that permitted to be recognised by the new accounting standards.  For example, monopoly distribution rights, despite the absence of an active market for such rights, could reasonably be expected to have a value over time that differs from the historic acquisition cost.  The approach adopted in the accounting standards recognises uncertainty exists as to what that value may be.  These amendments provide a framework to ensure a considered and fair value is recognised, which is as consistent as possible with the requirements embedded in the accounting standards.

2.15               This measure does not reflect an intention to neutralise all differences in outcome between the previous and current accounting standards, reflecting the obvious realignment of Australian financial reporting requirements with international practice and the key integrity role played by the thin capitalisation regime.  It is not intended to provide entities with scope to artificially inflate their asset base to support higher gearing levels inconsistent with the broader intent of this regime.

2.16               These amendments effectively establish the framework to apply on expiration of the current transitional arrangements.  The transitional arrangements enable entities to elect to apply the accounting standards as they existed at 31 December 2004 (rather than the current accounting standards) for a period of four income years commencing on or after 1 January 2005.  These arrangements are set out in section 820-45 of the Income Tax (Transitional Provisions) Act 1997 .

Summary of new law

2.17               For income years commencing on or after the date this Bill receives Royal Assent, entities will be able to deviate from the accounting standard treatment of certain assets and liabilities. 

2.18               Entities will not be permitted to recognise deferred tax assets or liabilities, or amounts arising from defined benefit plans that are required to be recognised as assets or liabilities.

2.19               Entities will be able to choose to recognise an intangible asset as an internally generated intangible asset, where recognition is currently prohibited under accounting standard AASB 138 Intangible Assets on the basis the asset cannot be reliably costed, provided other recognition requirements within the standard can be met.  This relates primarily to internally generated brands, mastheads, publishing titles, customer lists and items similar in substance.  Accounting standard requirements must then be complied with to the maximum extent possible (as if recognition were permitted).  A choice may be revoked prospectively.

2.20               Entities will also be able to choose to revalue an intangible asset that is subject to the measurement requirements in AASB 138 Intangible Assets but is unable to use the revaluation method under that standard due to the absence of an active market.  The revalued amount must be determined in accordance with the established rules, which include a requirement for the amount to be determined in compliance with the relevant accounting standards and for the valuation to be undertaken by an independent valuer or by an internal expert, using a valuation methodology endorsed by an external expert.  A choice may be revoked prospectively.

2.21               These amendments will apply for all purposes under Division 820, other than for entities using the ADI inward and outward investing entities thin capitalisation rules or for the purposes of section 820-960, which establishes record-keeping obligations for Australian permanent establishments.

Comparison of key features of new law and current law

New law

Current law

Certain entities must not recognise for thin capitalisation purposes assets or liabilities arising from defined benefit plans.

Entities must recognise for thin capitalisation purposes assets and liabilities as required by the accounting standards.

Certain entities must not recognise for thin capitalisation purposes deferred tax assets or deferred tax liabilities.

Entities must recognise for thin capitalisation purposes assets and liabilities as required by the accounting standards.

New law

Current law

Certain entities may choose, in writing, to recognise for thin capitalisation purposes one or more internally generated intangible assets that are determined not to meet the recognition criteria under accounting standard AASB 138 Intangible Assets as they cannot be reliably costed, where they satisfy the other recognition requirements.

Entities must recognise for thin capitalisation purposes assets and liabilities as required by the accounting standards.

Certain entities may choose, in writing, to revalue for thin capitalisation purposes one or more intangible assets that are unable to be revalued under accounting standard AASB 138 Intangible Assets due to the absence of an active market.

Entities must recognise for thin capitalisation purposes assets and liabilities as required by the accounting standards.

Such revaluations must be undertaken in compliance with existing subsections 820-680(2) and (2A).

No equivalent.

Recognition and revaluation under the above provisions must, to the maximum extent possible, comply with the accounting standards as if recognition or revaluation were permitted under the standard.

No equivalent.

The above amendments do not apply for the purposes of the Australian permanent establishment record-keeping requirements identified in section 820-960.

No equivalent.

The above amendments do not apply to entities subject to or electing to use the ADI inward or outward investing entities rules.

No equivalent.

Detailed explanation of new law

2.22               Subsection 820-680(1) establishes that an entity must comply with the accounting standards in determining what are its assets and liabilities and in calculating the value of its assets, liabilities and equity capital when undertaking its thin capitalisation calculations.  Subsection 820-680(1A) further states that an entity has an asset or liability at a particular time only if the accounting standard provides that the asset or liability can or must be recognised at that time.  Accounting standards has the same meaning as in the Corporations Act 2001.

Certain assets and liabilities not to be recognised for most thin capitalisation purposes

2.23               The amendments provide that certain assets and liabilities that would be required to be recognised for thin capitalisation purposes under the above provisions must not be recognised.

Deferred tax liabilities and assets not to be recognised

2.24               An entity must not recognise deferred tax liabilities or deferred tax assets for thin capitalisation purposes [Schedule 2, item 5, subsection 820-682(1)] .  Recognition would, otherwise, be required as a consequence of Australian accounting standard AASB 112 Income Taxes .

2.25               This exclusion has application for all purposes under Division 820, other than:

•        in relation to entities using the thin capitalisation rules for ADI inward or outward investing entities

— Subdivisions 820-D and 820-E [Schedule 2, item 5, subsection 820-682(3)] ; and

•        the record-keeping requirements applying to Australian permanent establishments in section 820-960 [Schedule 2, item 5, subsection 820-682(4)] .

2.26               The basis for the carve-out for entities using the ADI rules identified above reflects the different basis on which thin capitalisation calculations are undertaken for such entities, and the uncertain and potentially adverse impact these amendments may have for their thin capitalisation positions.  This carve-out would apply to entities that elect to use the ADI rules under Subdivision 820-EA, but not to those entities that elect out of these rules under section 820-588.

2.27               The section 820-960 carve-out from the exclusion reflects the wider role performed by this record-keeping requirement, which makes it inappropriate for these records to reflect adjustments specific to thin capitalisation calculations.  For example, these records are used for the purposes of Part IIIB of the Income Tax Assessment Act 1936 relating to Australian branches of foreign banks and other financial entities.

Defined benefit plan liabilities and assets not to be recognised

2.28               An entity must not recognise an amount arising from a defined benefit plan as an asset or liability for thin capitalisation purposes [Schedule 2, item 5, subsection 820-682(2)] .  This would, otherwise, be required as a consequence of Australian accounting standard AASB 119 Employee Benefits

2.29               This exclusion is intended to cover those circumstances in which an entity is required to recognise as assets or liabilities amounts arising from defined benefit plans provided as a direct consequence of its role as an employer providing post-employment benefits to employees or where such liabilities or assets are recognised by an entity on behalf of another member of a group.

2.30               This exclusion has application for all relevant purposes under Division 820, other than:

•        in relation to entities using the thin capitalisation rules for ADI inward or outward investing entities

— Subdivisions 820-D and 820-E
[ Schedule 2, item 5, subsection 820-682(3)] ; and

•        the record-keeping requirements applying to Australian permanent establishments in section 820-960 [Schedule 2, item 5, subsection 820-682(4)] .

2.31               The basis for these carve-outs from the general exclusion is discussed in paragraphs 2.26 and 2.27.

An entity may choose to recognise certain internally generated intangible assets

2.32               Certain assets within the scope of Australian accounting standard AASB 138 Intangible Assets are prohibited from recognition as internally generated intangible assets under that standard.  The basis for this exclusion is the determination within the standard that the expenditure on these items cannot be distinguished from the cost of developing the business as a whole (implying they cannot be reliably costed).

2.33               This relates to internally generated brands, mastheads, publishing titles, customer lists and items similar in substance (see paragraph 63 of AASB 138 Intangible Assets (compiled 25 October 2007)).

2.34               These amendments provide that an entity may choose to recognise, for a period relevant for thin capitalisation purposes, assets specified in this standard that are deemed to fail to meet the requirements to be recognised as internally generated intangible assets on the basis they cannot be reliably costed (as described in paragraphs 2.32 and 2.33), provided these assets meet the remaining recognition requirements in the standard [Schedule 2, item 5, subsections 820-683(1) and (2)] .  For example, the prohibition within the standard on recognising expense incurred in the research phase would be applicable.

2.35               The relevant period would be all or part of an income year relevant for thin capitalisation purposes.  This enables recognition of assets at all valuation points within that period, as identified in the average value methods identified in Subdivision 820-G. 

2.36               Items recognised under these amendments must not amount to internally generated goodwill [Schedule 2, item 5, subsection 820-683(1)] .  The distinction between internally generated goodwill and internally generated assets for accounting purposes is evident from paragraph 49 of AASB 138 Intangible Assets (compiled 25 October 2007), which provides that goodwill is not an identifiable resource.  That is, it is neither separable (able to be sold, transferred, licensed etc) nor does it arise from contractual or other legal rights.  Therefore, for an asset to be recognised (or revalued as described in paragraphs 2.43 to 2.55) under these provisions it must meet the identifiability criteria outlined in paragraph 12 of AASB 138 Intangible Assets .

2.37               A choice must be made, in writing, prior to the due date for lodging an entity’s income tax return for the income year that contains the relevant period for thin capitalisation purposes.  A choice may relate to one or more assets.  The choice covers both the initial and future periods.  However, once a choice has been made, it is irrevocable for periods for which the relevant income tax return lodgment due date has passed, for so long as the entity recognises that asset as an asset of the entity.  [Schedule 2, item 5, subsection 820-683(3)]

2.38               A choice may be revoked in relation to future periods, provided this occurs, in writing, before the due date for lodging an entity’s income tax return for the income year of the relevant next period for thin capitalisation purposes [Schedule 2, item 5, subsection 820-683(4)] .  A decision to revoke a choice in relation to an asset does not mean that choice cannot be made again.

2.39               Once a choice has been made in relation to an asset, the requirements of the relevant accounting standards apply as if the asset had been able to be recognised under AASB 138 Intangible Assets [Schedule 2, item 5, subsection 820-683(5)] .  For example, the measurement requirements applying at and following recognition will apply in determining the appropriate carrying amount to be used for thin capitalisation purposes.  Similarly, the impairment testing requirements established within that standard would need to be satisfied.

2.40               As a natural outcome of this approach, where an asset is unable to be revalued under the above accounting standard due to the absence of an active market, the revaluation mechanism (see paragraphs 2.43 to 2.55) will be available to the entity in relation to that asset.  [Schedule 2, item 5, subsection 820-683(5)]

Example 2.1 :  Interaction of the recognition and revaluation provisions

Maher Co manufactures an extremely popular range of branded products.  It has developed its brand internally over an extended period.  

While identifiable as an intangible asset under AASB 138 Intangible Assets , the brand is not able to be recognised as an asset in the company’s financial reports.  Maher Co has, consequently, expensed the costs associated with its development.

However, Maher Co is satisfied the brand is an intangible asset, there is an identifiable stream of expected future economic benefit that will flow to the company that is attributable to the asset and associated expenses do not relate to a research phase.

As a result, Maher Co chooses, in writing, to recognise the brand as an asset for thin capitalisation calculation purposes.

Maher Co then looks to the measurement and related requirements of AASB 138 and other relevant accounting standards as if the asset had been recognisable under that standard. 

Maher Co determines this asset would not be able to use the revaluation model within AASB 138, due to the absence of an active market.  It then chooses, in writing, to use the revaluation provisions within the thin capitalisation rules.

Maher Co has the masthead revalued by an independent expert.  Having had regard, as far as practical, to the valuation requirements of the relevant accounting standards, the expert values the brand at $100.

2.41               The choice detailed above has application for all relevant purposes under Division 820 other than:

•        in relation to entities using the thin capitalisation rules for ADI inward or outward investing entities

— Subdivisions 820-D and 820-E [Schedule 2, item 5, subsection 820-683(6)] ; and

•        the record-keeping requirements applying to Australian permanent establishments in section 820-960 [Schedule 2, item 5, subsection 820-683(2)] .

2.42               The basis for these carve-outs from the general exclusion is discussed in paragraphs 2.26 and 2.27.

An entity may elect to revalue certain intangible assets

2.43               In complying with Australian accounting standard AASB 138 Intangible Assets , intangible assets are unable to use the revaluation model within that standard where there is no active market.  An active market is defined within the standard as a market in which all of the following conditions exist:

•        the items traded in the market are homogeneous;

•        willing buyers and sellers can normally be found at any time; and

•        prices are available to the public.

(The existence of an active market is the most reliable way of determining the fair value of an asset.  However, the fair value of an asset is more broadly defined in the accounting standards to be the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.)

2.44               In the above circumstance, an entity will be able to choose to revalue, consistent with the requirements established by these amendments, one or more of these assets for the relevant period (being all or part of an income year) [Schedule 2, item 5, subsections 820-684(1) and (2)] .  This covers all relevant valuation points within that period, as identified in the average value methods in Subdivision 820-G.  For example, where an entity has decided to use the opening and closing balances method for a period (see section 820-635), a revalued amount could be determined as the value for the first day of the period and for the last day of the period. 

2.45               A choice to revalue an intangible asset under these provisions may be made in relation to any intangible asset required to comply with AASB 138 Intangible Assets in relation to measurement at, or following, recognition of that asset.

2.46               A choice must be made in writing, and may cover one or more assets, including assets recognised under new section 820-683 [Schedule 2, item 5, paragraph 820-684(3)(a)] .  This choice must be made prior to an entity’s due date for lodgment of its income tax return for a particular income year, and has effect for future periods [Schedule 2, item 5, paragraphs 820-684(3)(b) and (c)] .  Once a choice is made in relation to an asset, it is irrevocable for periods for which the relevant income tax return lodgment date has passed.  A decision to revoke the choice must be made, in writing, prior to the lodgment date for the entity’s income tax return for a relevant period [Schedule 2, item 5, subsection 820-684(4)] .  This does not imply the revaluation amount cannot be amended.

2.47               A decision to revoke a choice in relation to an asset does not mean that a choice cannot be made again.

2.48               Revaluations are required to be undertaken in a manner consistent with existing subsections 820-680(2) and (2B) [Schedule 2, item 5, subsection 820-684(5)] .  These subsections, in essence, establish that revaluations must be undertaken either by an independent expert or by an internal expert, consistent with a valuation methodology that has been endorsed by an external expert.  The carve-out from the requirement to satisfy subsection 820-680(2) embodied in subsection 820-680(2A) would be expected to have no practical application in these circumstances.

2.49               The revalued amount arising from this process must comply to the maximum extent possible with the requirements of the relevant accounting standards.  That is, the carrying amount recognised for thin capitalisation purposes must reflect the accounting standard requirements that would have applied were revaluation permitted under accounting standard AASB 138 Intangible Assets .  This includes incorporating impairment and amortisation adjustments, where applicable.  [Schedule 2, item 5, subsection 820-684(6)]

2.50               The frequency of revaluation of an asset would be determined by reference to the general requirements of the accounting standards in relation to the revalued intangible asset.  For example, AASB 138 Intangible Assets requires revaluations to be made with such regularity that at the reporting date the carrying amount of the asset does not differ materially from its fair value.  For the purposes of these provisions, fair value would have its broader meaning (ie, without the requirement for it to be referenced to an active market).  The impairment testing requirements and outcomes in Australian accounting standard AASB 136 Impairment of Assets apply.

2.51               The decision to permit a revaluation choice under these provisions to be revoked will allow entities to avoid unnecessary compliance costs associated with revaluation obligations, should these prove unwarranted in the future.  The likelihood entities would switch between these provisions and accounting standard treatment to avoid the requirement to reflect a significantly reduced revalued amount, which is not the intent of these amendments, is minimised by Australian accounting standard AASB 136 Impairment of Assets .  This standard requires, for example, the annual impairment testing of intangible assets with indefinite useful lives (to compare the carrying amount of the asset with its recoverable amount).  This implies significant downward adjustments of a revalued amount are likely to be mimicked by a requirement to reduce the carrying amount under a cost model.

2.52               This approach seeks to ensure consistency with the valuation requirements applying to other assets and to minimise the scope for arbitrary outcomes that do not reflect valuation norms reflected in international accounting practice.

2.53               Existing record-keeping requirements in relation to revaluations and the independence of the valuer will apply to revaluations undertaken which are consistent with subsection 820-684(2).  These record-keeping requirements are currently contained in section 820-985.  [Schedule 2, items 7 and 8, subsections 820-985(1) and (3)]

2.54               The choice detailed above has application for all relevant purposes under Division 820, other than:

•        in relation to entities using the thin capitalisation rules for ADI inward or outward investing entities

— Subdivisions 820-D and 820-E [Schedule 2, item 5, subsection 820-684(7)] ; and

•        the record-keeping requirements applying to Australian permanent establishments in section 820-960 [Schedule 2, item 5, subsection 820-684(2)] .

2.55               The basis for these carve-outs from the general exclusion is discussed in paragraphs 2.26 and 2.27.

Commissioner of Taxation’s power to substitute a value

2.56               The Commissioner of Taxation’s (Commissioner) power to substitute one value for another in certain circumstances will include values included in an entity’s thin capitalisation schedule in relation to assets recognised or revalued under these amendments.  [Schedule 2, item 6, section 820-960]

2.57               This power is modified to reflect the choices to recognise or revalue assets provided for under these amendments.  The intention is that the Commissioner would not be able to substitute a value simply as a result of the exercise of such a choice, on the basis the outcome is inconsistent with the accounting standards.  However, the Commissioner would be able to have regard to general valuation concepts within those standards in considering an appropriate carrying amount. 

Application and transitional provisions

2.58               These amendments will apply to assessments for each income year commencing on or after the date this Bill receives Royal Assent.  There may be a period of overlap for certain entities between the date of effect of these amendments and the application of the existing transitional provisions (see section 820-45 of the Income Tax (Transitional Provisions) Act 1997 ).  In these circumstances, an entity that chooses not to use the transitional provisions will have immediate access to these provisions.  An entity that has chosen to use the transitional provisions for one last year would theoretically have access to these provisions, but there is not expected to be any practical effect due to the differences between the old and new accounting standards in these areas.  [Schedule 2, item 9] 

Consequential amendments

2.59               Consequential amendments are made to insert notes advising modifications have been made to the general applicability of accounting standards for the identification and valuation of assets and liabilities for thin capitalisation purposes and in relation to the application of the existing independent valuation requirements.  [Schedule 2, items 1 to 4, subsections 820-680(1), (1A), (2) and (2B)]



C hapter 3     

Interest withholding tax — extension of eligibility for exemption to state government bonds

Outline of chapter

3.1                   Schedule 3 to this Bill amends section 128F of the Income Tax Assessment Act 1936 (ITAA 1936) to allow bonds issued in Australia by state and territory central borrowing authorities to be eligible for exemption from interest withholding tax (IWT).

3.2                   Unless otherwise stated, all legislative references are to the ITAA 1936.

3.3                   States means the States and Territories unless otherwise indicated.

Context of amendment

3.4                   IWT is imposed on the payment of interest from Australia to non-residents, at a rate of 10 per cent of the gross amount of interest.  The obligation for collecting (withholding) the IWT is on the person making the payment (ie, the borrower). 

3.5                   Section 128F of the ITAA 1936 provides that where an Australian resident company, or a non-resident company carrying on business at or through a permanent establishment in Australia, issues a debenture or certain specified debt interests and the issue satisfies the public offer test, an exemption from IWT will apply.

3.6                   In 1999, the requirement that these debentures be issued outside Australia was removed for most borrowers.  However, the liberalisation was not extended to the state central borrowing authorities.  As a consequence, the interest paid to non-residents on bonds issued in Australia by state central borrowing authorities is liable to IWT (unless exempt under a treaty or another arrangement). 

3.7                   Consequently, the state central borrowing authorities have continued to issue their bonds offshore to remove the liability to IWT and attract non-resident investors.

3.8                   Reflecting state central borrowing authorities’ concerns that this practice results in a segmented market, reduced liquidity and efficiency, and hampers the role the state government bond market performs in ensuring the stable operation of Australia’s financial markets, the Federal Government announced its decision to extend eligibility for exemption from IWT to domestically issued state government bonds.

3.9                   This is expected to result in the state central borrowing authorities unifying their bond issuances into one pool of funds, improving depth and liquidity in the market and broadening the potential investor base.  Ultimately, this should lead to a lower cost of capital (and hence financing costs) for state infrastructure projects.

3.10               Further, it is anticipated that by making state government bonds more attractive to foreign investors, some of the pressures facing the Commonwealth Government Securities market will be eased.

3.11               This measure will also define ‘bond’ for the purposes of this amendment, to provide greater certainty to market participants as to which instruments are eligible for exemption.  The intention is to ensure that a narrow, technical meaning of bond is not potentially adopted, for example, that a ‘bond’ must be issued by a company under its corporate seal or be labelled as a bond, that is inconsistent with the generally understood concept of a state government bond in the market place.

3.12               This amendment is principally intended to focus on the core debt issuances of state central borrowing authorities (typically issued as inscribed stock) that would be regarded as more closely duplicating the role of Commonwealth Government Securities in supporting the effective operation of Australia’s financial markets. 

Summary of new law

3.13               Schedule 3 removes the prohibition preventing bonds (as defined) issued in Australia by state central borrowing authorities from being eligible for the section 128F exemption from IWT.  This amendment will apply to interest payments made on or after the date of Royal Assent.

Comparison of key features of new law and current law

New law

Current law

Bonds issued by state central borrowing authorities are eligible for exemption from IWT under section 128F.

Bonds issued by state central borrowing authorities in Australia are not eligible for exemption from IWT under section 128F.

Detailed explanation of new law

3.14               This amendment makes it clear that bonds issued in Australia by state central borrowing authorities will be eligible for the exemption from IWT under section 128F of the ITAA 1936.  [Schedule 3, item 1]

3.15               However, the exemption will only be available in respect of bonds, as defined for the purposes of new subsection 128F(5B).  [Schedule 3, item 1]

3.16               The requirements of the public offer test will continue to apply to bonds (as defined) issued by the state central borrowing authorities as it applies to debentures and certain specified debt interests issued by other entities that use the section 128F exemption.

3.17               Accordingly, the exemption will only arise for interest payments on current bond issues where the issue would have satisfied the public offer test when it was made. 

3.18               The legislation makes no provision for deeming current bond issues to have satisfied the public offer test.  This position is reinforced by the Federal Government’s announcement that state government bonds will be eligible for exemption, and not simply exempt.

Definition of ‘bond’

3.19               For the purposes of subsection 128F(5B) a bond , in relation to a state central borrowing authorities is defined as including debenture stock and notes.  [Schedule 3, item 1]

3.20               It is intended that defining ‘bond’ in this manner will provide market participants with certainty around which instruments are affected by subsection 128F(5B) and, hence, eligible for exemption from IWT.

3.21               It is intended to avoid disrupting the common usage and understanding of the term for participants in the state government bond market, whilst ensuring that the changes remain consistent with the Federal Government’s intention and underlying policy rationale for this amendment. 

Application and transitional provisions

3.22               This amendment will apply to interest paid on or after the date of Royal Assent.  [Schedule 3, item 2]



C hapter 4     

Fringe benefits tax — jointly held assets

Outline of chapter

4.1                   Schedule 4 to this Bill amends the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) to ensure that where a fringe benefit is provided jointly to an employee and their associate, the employer’s fringe benefits tax (FBT) liability on the taxable value of the fringe benefit will only be reduced to the extent the employee’s share of the fringe benefit is used for income producing purposes.

Context of amendments

4.2                   Subsection 138(3) of the FBTAA 1986 deems a benefit provided jointly to an employee and one or more associates of the employee, to be provided solely to the employee.  This is to prevent the double counting of fringe benefits. 

4.3                   The ‘otherwise deductible’ rule is an important design feature of the FBT system and operates so that an employer can reduce the taxable  value of certain fringe benefits, when, if the employee had incurred the expenses themself, the employee could have claimed a personal tax deduction.  For example, if an employer provides an employee with a low interest loan to purchase an investment property, the employee can reduce the taxable value of the loan fringe benefit to the extent the interest would have been ‘otherwise deductible’ to the employee, had the employee incurred additional interest equal to the net value of the loan fringe benefit.  

4.4                   The operation of subsection 138(3) and the otherwise deductible rule was considered by the Federal Court of Australia in National Australia Bank Ltd v FC of T 93 ATC 4914 ( NAB case).  In the NAB case, an employer provided low interest loans jointly to the employee husband and his wife which were invested in a jointly held investment property (a loan fringe benefit).

4.5                   The Federal Court held that as a result of subsection 138(3), the employee was the sole recipient of the loan fringe benefit.  It further held that as sole recipient of the loan and sole investor of the proceeds, if the employee husband had incurred and paid unreimbursed interest on the loan, he would have been entitled to a deduction for the expense.  Thus, under the otherwise deductible rule in section 19 of the FBTAA 1986, the taxable value of the loan fringe benefit is reduced to nil so that the employer had no FBT liability arising from the loan fringe benefit provided to both the employee and his spouse.

4.6                   This outcome is inconsistent with the operation of the otherwise deductible rule as it would apply where a benefit is provided solely to an associate.  In these cases, the otherwise deductible rule does not apply to reduce the employer’s FBT liability for the fringe benefit, as the otherwise deductible rule does not apply where fringe benefits are provided to a spouse (associate).

4.7                   This outcome is also in conflict with the income tax position as determined by the courts that income and deductions arising from jointly owned rental property should be allocated between joint owners in accordance with their interest in the property (eg, joint tenants in a rental property would include 50 per cent of the rental income in their assessable income and claim 50 per cent of the rental property expenses).

4.8                   The anomaly has also led to arrangements involving expense payment fringe benefits where a spouse on a higher marginal tax rate salary sacrifices their income by an amount equivalent to the joint rental expenses.  This allows the spouse on the higher marginal tax rate through a salary reduction to effectively claim a deduction for the entirety of the rental expenses despite owning only a share in the property.

Example 4.1  

Paul’s income is subject to the top rate of taxation.  Paul and his wife Tracy jointly own a rental property, each with a 50 per cent interest.  Paul is the main income earner.

The rental income derived from the property is $20,000 and the associated deductible expenses are $10,000.

Paul’s employer reimburses Paul and Tracey $10,000 for the rent expenses.  Paul’s employer has no FBT liability on the fringe benefit because the ‘otherwise deductible rule’ operates to reduce the taxable value to nil.  This includes Tracy’s share of the expenses because, as a result of subsection 138(3) of the FBTAA 1986, Paul is taken to be the sole recipient of the fringe benefit. 

Paul can effectively pay 100 per cent of the expenses out of pre-tax income.  The tax saving from the arrangement is $4,650.

Another couple, Tony and Fiona also have a 50 per cent interest in a rental property and have the same incomes as Paul and Tracy.  Tony can claim a tax deduction for 50 per cent of the rental expenses.  Although the two couples are in similar financial circumstances, Tony is not able to enter into a salary sacrifice arrangement.  Tony’s tax saving is half that of Paul’s.

Comparison of key features of new law and current law

New law

Current law

An employer must adjust the taxable value of a fringe benefit (loan fringe benefit, expense payment fringe benefit, property fringe benefit and residual fringe benefit) provided jointly in relation to an income earning asset jointly owned by an employee and their associate, so that the taxable value of the fringe benefit is reduced only by the employee’s percentage of interest in the asset.

As a result of the NAB case an employer can reduce the taxable value of a fringe benefit provided jointly to an employee and their associate in relation to an income earning asset owned by both the employee and their associate. 

Detailed explanation of new law

4.9                   Schedule 4 inserts a new provision into the otherwise deductible rule for loan fringe benefits, expense payment fringe benefits, property fringe benefits and residual fringe benefits in subsections 19(1), 24(1), 44(1) and 52(1) of the FBTAA 1986 which will provide a different calculation for the application of the otherwise deductible rule where because of subsection 138(3) of the FBTAA 1986 a fringe benefit is provided jointly to an employee and their associate and is deemed to be provided solely to the employee.  [Schedule 4, items 7, 17, 30 and 39]

4.10               The change to the otherwise deductible rule in these circumstances operates to make a final adjustment to the notional deduction (ND) component in the formula (TV - ND) where TV is the taxable value.  The adjustment reduces the unadjusted notional deduction by the employee’s percentage of interest in the income producing asset or thing (whether tangible or intangible) to which the benefit relates.  This adjustment ensures that the taxable value of the benefit is only reduced by the employee’s share of the benefit.  [Schedule 4, items 8, 22, 31 and 40]

Example 4.2  

Neena and her husband Marek are jointly provided with a $100,000 low interest loan by Neena’s employer which they use to acquire shares.  The loan fringe benefit has a taxable value of $10,000.  Neena and Marek use the loan to purchase $100,000 of shares which they will hold jointly with a 50 per cent interest each.  Neena and Marek return 50 per cent of the dividends derived from the shares as assessable income in each of their income tax returns.

Under the current law (and as a result of the NAB case) the otherwise deductible rule would apply to reduce the taxable value of the loan fringe benefit ($10,000) (ie, in respect of both Neena and Marek’s share of the benefit) to nil and consequently the employer would have no FBT liability.

As a result of new paragraph 19(1)(i) and new subsection 19(5) the notional deduction of $10,000 is reduced by Neena’s percentage of interest in the shares (ie, 50 per cent so that the taxable value of the loan fringe benefit of $10,000 is reduced by $5,000).  The employer has an FBT liability on $5,000 which reflects the share of the loan fringe benefit that was provided to Marek.

4.11               The calculation used to adjust the notional deduction will also apply to reduce the taxable value of a loan, expense payment, property or residual fringe benefit in circumstances where the fringe benefit is applied only partly for income producing purposes, where more than one income producing asset is held or where there is a change, in the FBT year, of the employee’s percentage of interest in the income producing asset. 

Example 4.3  

Same as in Example 5.2 except Neena and Marek only use 50 per cent of the $100,000 loan for acquiring shares.  They use the other 50 per cent ($50,000) for a private overseas holiday.  The taxable value of the loan fringe benefit that relates to that part of the loan used for private purposes ($5,000) is not deductible to either Neena or Marek so the otherwise deductible rule does not apply to reduce that part of the loan fringe benefit. 

The taxable value of the loan fringe benefit that arises on that part of the loan that is used for acquiring shares can be reduced by Neena’s share of the benefit (ie, $2,500).  The employer can reduce the taxable value of the loan fringe benefit ($10,000) by $2,500.  The taxable value of the loan fringe benefit provided to Neena and Marek that will be subject to FBT is $7,500 ($10,000 - $2,500).

4.12               Consequential amendments are made to the otherwise deductible rules in sections 19, 24, 44 and 52 to ensure that the new provisions are linked appropriately with the existing rules.  [Schedule 4, items 1 to 6, 10 to 16, 18 to 21, 24 to 29 and 33 to 38]

Application and transitional provisions

4.13               The amendments apply to benefits provided from 7:30 pm Australian Eastern Standard Time (AEST) on 13 May 2008.  [Schedule 4, subitems 9(1) and 23(1), items 32 and 41]

4.14               For loans entered into before 7:30 pm (AEST) on 13 May 2008, the existing law will continue to apply to loan benefits provided before 1 April 2009.  [Schedule 4, subitem 9(2)]

4.15               For expense payment benefits, property benefits and residual benefits provided under a salary sacrifice arrangement, the changes will apply to agreements entered into after 7:30 pm (AEST) on 13 May 2008.  For agreements entered into before this time, employees will be able to utilise the current law until 1 April 2009.  [Schedule 4, subitem 23(2)]

Technical corrections

4.16               Part 2 of Schedule 4 to this Bill also makes some minor technical corrections to the FBT law.  The amendments will correct certain cross references and in line with current drafting practice, improve the readability of these provisions.  [Schedule 4, Part 2, items 42 to 75]



C hapter 5     

Managed funds:  changes to the eligible investment business rules

Outline of chapter

5.1                   Schedule 5 to this Bill amends Division 6C of the Income Tax Assessment Act 1936 (ITAA 1936) to streamline and modernise the eligible investment business rules for managed funds. 

5.2                   These amendments will:

•        clarify the scope and meaning of investing in land for the purpose of deriving rent;

•        introduce a 25 per cent safe harbour allowance for non-rental, non-trading income from investments in land;

•        expand the range of financial instruments that a managed fund may invest in or trade; and

•        provide a 2 per cent safe harbour allowance at the whole of trust level for non-trading income. 

5.3                   The introduction of these amendments will make it easier for managed funds, in particular property trusts, to comply with the law by reducing the scope for them to inadvertently breach Division 6C. 

5.4                   All references to legislative provisions in this chapter are references to the ITAA 1936 unless otherwise stated.

Context of amendments

5.5                   Division 6C applies to tax the income of certain ‘public unit trusts’ and their equity holders like companies and their shareholders if the trust is a ‘public trading trust’.  A public unit trust is a public trading trust if at any time during an income year it operates, or controls operations of an entity that carries on activity that is not an eligible investment business.  An eligible investment business is defined in section 102M of Division 6C as any, or any combination of:

•        investing in land (including the acquisition and development of land) for the purpose or primarily for the purpose of deriving rent; or

•        investing or trading in any, or any combination of, the financial instruments as listed in the definition in section 102M, paragraph (b).

5.6                   Consistent with the Government’s pre-election commitment, the Assistant Treasurer and Minister for Competition Policy and Consumer Affairs announced in Media Release No. 010 of 22 February 2008 that the Board of Taxation would examine options for the introduction of a specific tax regime for managed funds.  The review is also to include an examination of Division 6C.  The review is a key part of the Government’s commitment to enhance the competitiveness of Australian managed funds.  The Government also announced that pending the outcome of the review certain changes would be made in the interim to Division 6C to streamline and clarify the application of the eligible investment business rules.

Summary of new law

5.7                   These amendments will clarify the scope and meaning of investing in land for the purpose of deriving rent by ensuring that investing in land, including an interest in land, for the purpose of deriving rent is taken to include investing in fixtures on the land and investing in movable property (ie, chattels) customarily supplied, incidental and relevant to the renting of the land and ancillary to the ownership and utilisation of the land.

5.8                   These amendments will introduce a 25 per cent safe harbour allowance for non-rental, non-trading income from investments in land.  The allowance for non-rental, non-trading income from land is to operate as a safe harbour in conjunction with the existing rental purpose tests on an overall land portfolio basis.  If a trust does not meet this safe harbour, it can assess whether it is investing in land for the purpose, or primarily for the purpose of deriving rent under the existing law (ie, paragraph (a) of the definition of ‘eligible investment business’ in section 102M).

5.9                   These amendments will expand the range of permitted financial instruments that a managed fund may invest in or trade by extending the scope of financial instruments covered by the eligible investment rules to include financial instruments that are not already covered by paragraph (b) of the definition of ‘eligible investment business’ in section 102M that arise under financial arrangements in the Income Tax Assessment Act 1997 (ITAA 1997), other than certain excepted arrangements.  However, as per the note under subsection 102MA(1), nothing in paragraph (c) affects an activity that meets paragraph (a) of the definition of ‘eligible investment business’ in section 102M.

5.10               These amendments will provide a 2 per cent safe harbour allowance at the whole of trust level for non-trading income to reduce the scope for inadvertent minor breaches of the Division 6C eligible investment business rules.  The trustee of a unit trust will not be treated as carrying on a trading business if not more than 2 per cent of the gross revenue of the unit trust in an income year is not from eligible investment business and that income is not from carrying on a business that is not incidental and relevant to the eligible investment business.

5.11               The allowance is to provide for situations where the trustee derives some income that is not income from an eligible business investment and it is not from a separate business activity (ie, income from directors’ fees received from positions on company boards, certain guarantee or option fees, or income from an investment in a non-financial arrangement).

5.12               These amendments will apply to the income year of Royal Assent and later income years. 

Comparison of key features of new law and current law

New law

Current law

Investing in land is taken to include investing in fixtures on land and investing in movable property that is incidental and relevant to the renting of the land, customarily supplied or provided in connection with the renting of the land, and ancillary to the ownership and use of the land.

No equivalent.

New law

Current law

Financial instruments include additional financial instruments that arise under financial arrangements other than certain excluded arrangements.

Shares in a company are to include shares in certain foreign hybrid companies.

Financial instruments are limited to those listed in Division 6C.

A 25 per cent safe harbour allowance for non-rental income where that income is not from the carrying on of a business that is not ancillary and incidental to the renting of the land or excluded rent (ie, certain profit based rents).

No equivalent.

A 2 per cent of gross income safe harbour allowance for non-eligible investment business income.

No equivalent.

Detailed explanation of new law

Eligible investment business:  investments in land for the purpose, or primarily for the purpose, of deriving rent

5.13               Under the current law there is some uncertainty about the scope of the term investing in land .  These amendments clarify the meaning of investment in land by introducing into the law specific references to:

•        fixtures on land [Schedule 5, item 7, section 102M] ; and

•        moveable property that is incidental and relevant to the renting of the land, customarily supplied or provided in connection with the renting of the land, and ancillary to the ownership and use of the land [Schedule 5, item 8, subsection 102MB(1)] .

Example 5.1  

A public unit trust invests in land used as a shopping centre.  The property includes some fittings and moveable furnishings in the common areas that are for use by centre customers.  The investment in the fittings and moveable property are included as part of the investment in land.

Safe harbour allowance for non-rental, non-trading income from investments in land

5.14               A public unit trust is not characterised as a public trading trust in relation to investing in land so long as the public unit trust is investing in land for the purpose, or primarily for the purpose, of deriving rent.  While this test allows a degree of flexibility in its application, for certain taxpayers it may not necessarily provide the level of certainty they require.

5.15               In order to provide taxpayers with increased certainty while retaining the flexibility of the existing test, these amendments introduce a safe harbour allowance for non-rental, non-trading income from land.  The allowance is to operate on an overall land portfolio basis in conjunction with the existing rental purpose tests. 

5.16               The safe harbour allowance for the rental purpose test in relation to investments in land is taken to be satisfied if:

•        at least 75 per cent of the gross revenue from eligible investments in land is rent that is not excluded rent; and

•        none of the remaining non-rental gross revenue is excluded rent or is from carrying on a business that is not incidental and relevant to the renting of the land.

5.17               In working out the gross revenue for the purposes of the rent and other income safe harbour test:

•        capital gains and capital losses arising from disposals or other realisations of the ownership of land (including an interest in land) held for purposes of deriving rent are to be disregarded;

•        rent for the land includes payments for provision of services that are incidental and relevant to the renting of the land and ancillary to the ownership and use of the land [Schedule 5, item 8, subsection 102MB(3)] ; and

•        revenue must not include rent based on profits or receipts under an arrangement that is designed (to be objectively determined) to result in all, or substantially all, of what would otherwise be profits being transferred to another party to the arrangement [Schedule 5, item 5, section 102M] .

The words ‘or other realisations’ in the first dot point cover cases akin to a disposal.  An example would be where a statutory lease is in effect transferred to another entity.  They would not extend to cases such as granting a sublease for a premium, except if it gives rise to a disposal of the land.

Example 5.2  

A public unit trust earns $250 million in gross revenue in an income year from its investments in land.  Each of the trust’s investments has a purpose of deriving rent.  The revenue comprises:

Rent of the properties

$200m

Billboards and advertising on the properties

$25m

Mobile phone towers on the properties

$25m

Excluded rent

Nil

The trust would satisfy the 25 per cent safe harbour test as 80 per cent of its gross revenue from the properties is rent and the remaining revenue is not from carrying on a business that is not incidental and relevant to the renting of the land. 

Example 5.3  

A public unit trust owns and rents out a shopping centre that includes a car park for shopping centre customers.  To deter use by non-customers long-stay users are charged fees.  The revenue from car parking fees would be incidental to the rental of the land and would be non-rental income for the purposes of the safe harbour rule.  The income from the car park is not from carrying on a business that is not incidental and relevant to the renting of the land. 

Example 5.4  

A public unit trust acquires land and buildings which comprise of office accommodation for rent and parking for the tenants.  The trust subsequently decides not to make the parking available primarily for tenants but to run a car parking operation on the property.  The income from the car parking operation would not fall within the 25 per cent safe harbour as it is income from carrying on a business that is not incidental and relevant to the renting of the land.  The trust would be carrying on a trading business.

Eligible investment business:  financial instruments

5.18               Since the introduction of Division 6C in 1985 the number and variety of financial instruments available for investment has increased significantly.  In recognition of this change, these amendments amend the list of financial instruments in section 102M to include financial instruments that arise under ‘financial arrangements’ as defined in the ITAA 1997 other than certain excepted arrangements.  [Schedule 5, item 4, section 102M]

5.19               This amendment is to include certain financial instruments not already included in the existing list of financial instruments in the definition of ‘eligible investment business’.  The meaning of a financial instrument is discussed in the Australian Accounting Standards AASB 132 Financial Instruments:  Disclosure and Presentation and AASB 139 Financial Instruments:   Recognition and Measurement .  

Excepted arrangements

Leasing or property arrangements

5.20               Most leasing arrangements will not be financial arrangements, as under such an arrangement the taxpayer will not have insignificant non-cash settlable rights or obligations (the lessee’s right to use the relevant property being leased, and the lessor’s obligation to allow, and be deprived of, such use).  However, to the extent that particular leasing arrangements do satisfy the definition of a ‘financial arrangement’, the leasing or property arrangement exception will apply to exclude a right or obligation arising under:

•        a luxury car lease under Division 42A in Schedule 2E to the ITAA 1936 [Schedule 5, item 8, paragraph 102MA(2)(a)] ;

•        arrangements to which Division 240 of the ITAA 1997 apply [Schedule 5, item 8, paragraph 102MA(2)(b)] ;

•        a financial arrangement in the form of a loan that is taken to exist by subsection 250-155(1) of the ITAA 1997 [Schedule 5, item 8, paragraph 102MA(2)(c)] ; or

•        an arrangement that:

-       is a licence to use an asset [Schedule 5, item 8, paragraphs 102MA(2)(d) and (e)] ;

-       in substance or effect, depends on the use of a specific asset, and gives a right to control the use of that specific asset [Schedule 5, item 8, paragraphs 102MA(2)(d) and (e)] ; or

-       where that asset is goods or a personal chattel (other than money or a money equivalent), real property, or intellectual property [Schedule 5, item 8, paragraphs 102MA(2)(d) and (e)] .

5.21               A luxury car lease within the meaning of Division 42A of Schedule 2E to the ITAA 1936 excludes hire purchase agreements and short-term hiring arrangements.  The leases that are subject to this Division are taxed as a notional sale (generally for the cost of the vehicle) and a loan transaction. 

5.22               Division 240 of the ITAA 1997 operates to tax some arrangements (such as hire purchase agreements), as a sale of property combined with a loan by the notional seller to the notional buyer to finance the purchase price.  Among other things, this Division determines the notional interest on this notional loan and how it is treated for tax purposes.

5.23               The third category under this exclusion broadly covers licences and leases over goods (other than money or a money equivalent), real property, and intellectual property.

5.24               Goods, personal chattels and real and intellectual property take their ordinary meaning, and so in a broad sense cover personal property (other than money or a money equivalent), land, and interests in land and rights in respect of creative and intellectual effort (including copyright, registered designs, patents and trademarks).

Interest in a partnership or a trust estate

5.25               A right that is carried by an interest in a partnership or a trust (or a corresponding obligation) will be subject to an exception if there is an interest or interests in the partnership or the trust estate, or the interest is an equity interest in the partnership or the trust.  The reference to an equity interest in the context of a partnership or a trust takes its meaning from section 820-930 of the ITAA 1997.  [Schedule 5, item 8, subsection 102MA(3)]

5.26               The exception also applies to a right that is carried by an interest in a trust estate (or a corresponding obligation) where that trust is managed by a funds manager or a custodian, or a responsible entity of a registered scheme.  [Schedule 5, item 8, paragraph 102MA(3)(c)]

5.27               What is meant by the reference to a funds manager and a custodian takes on its ordinary commercial meaning.  A responsible entity of a registered scheme draws its meaning from the Corporations Act 2001 (Corporations Act).  It is the company named in the Australian Securities and Investments Commission’s record of the scheme’s registration as the responsible entity or temporary responsible entity of a managed investment scheme registered under section 601EB of the Corporations Act.  In a general sense, a managed investment scheme as defined under the Corporations Act covers (subject to certain exceptions) a scheme where the contribution made by members to acquire interests in the scheme are pooled and used to produce benefits for members, where the members do not have day-to-day control of the operation of the scheme (see section 9 of the Corporations Act).

General insurance policies

5.28               A right or obligation under a general insurance policy is subject to an exception, except where the policy is a derivative financial arrangement and the taxpayer is not a general insurance company as defined by the ITAA 1997.  [Schedule 5, item 8, subsection 102MA(4)]

5.29               This exception ensures that eligible investment business does not include rights and obligations under those general insurance policies that are subject to taxation under Division 321 of Schedule 2J to the ITAA 1936.

5.30               A general insurance policy is defined in subsection 995-1(1) of the ITAA 1997 to mean a policy of insurance that is not a life insurance policy or an annuity instrument.  The term policy of insurance is not defined and is intended to take its ordinary meaning.  It may include a policy of reinsurance.  Examples of general insurance policies include fire, theft, injury, accidental damage, negligence, storm and professional indemnity insurance.

5.31               The activities of a general insurance business can be split into underwriting and investment activities.  Rights or obligations from underwriting activities of a general insurance company will usually be the subject of this exception and would therefore be excluded.

5.32               The exception does not affect the public unit trust’s ability to invest or trade in life assurance policies under paragraph (b) of the definition of ‘eligible investment business’ in section 102M, paragraph (b) of the ITAA 1936.  Nor does it preclude the trust insuring its rental properties, which is an activity that is incidental to investing in land for the purpose of deriving rent.

Certain guarantees and indemnities

5.33               A right or obligation under a guarantee or indemnity will be subject to an exception unless:

•        the guarantee or indemnity is of a financial arrangement that is a derivative financial arrangement for any income year [Schedule 5, item 8, paragraph 102MA(5)(a)] ; or

•        the actual guarantee or indemnity is given or entered into in relation to a financial arrangement [Schedule 5, item 8, paragraph 102MA(5)(b)] .

5.34               What is meant by a guarantee or an indemnity takes on its ordinary meaning to include a promise to answer for the debt or default of another, or to make good a loss suffered by a third party.

Example 5.5  

A public unit trust provides a guarantee in respect of performance of a loan agreement that is a financial arrangement.  Such a guarantee would not be an excepted arrangement. 

Superannuation and pension income

5.35               A right to receive, or an obligation to provide, financial benefits will be subject to an exception if that right or obligation arises from a person’s membership of a superannuation or a pension scheme.  This may include a right of a dependant of a member to receive financial benefits (or the corresponding obligation to provide financial benefits to that dependant).  It may also include a right or obligation arising from an interest in a complying or non-complying superannuation fund, a pooled superannuation trust or an approved deposit fund.  [Schedule 5, item 8, subsection 102MA(6)]

Retirement village residence contracts

5.36               A right or obligation arising under a contract that gives rise to a right to occupy ‘residential premises’ in a ‘retirement village’ is the subject of an exception.  [Schedule 5, item 8, subsection 102MA(7)]

5.37               These terms take their meaning from section 195-1 of the A New Tax System (Goods and Services) Act 1999 (GST Act).  That definition provides that a residential premises in a retirement village exists if:

•        the premises are occupied by one or more persons as a main residence;

•        accommodation in the premises is intended to be for persons who are at least the age of 55 years or older; and

•        the premises include communal facilities for use by the residents of the premises; but excludes:

-       premises used, or intended to be used, for the provision of residential care (within the meaning of the Aged Care Act 1997 ) by an ‘approved provider’ (within the meaning of that Act); and

-       ‘commercial residential premises’ as defined in section 195-1 of the GST Act.

Retirement village services contracts

5.38               A right or obligation arising under a contract under which a retirement village resident is provided with general or personal services in the retirement village is the subject of an exception.   [Schedule 5, item 8, paragraph 102MA(7)(b)]

A trading business

5.39               Division 6C applies to tax the income of certain public unit trusts like companies if the trust is a public trading trust.  A public unit trust is a public trading trust if it does not carry on an eligible investment business.  Under the current law even minor breaches of the eligible investment business rules therefore have significant consequences for a public unit trust.

5.40               These amendments introduce an allowance designed to reduce the scope for inadvertent minor breaches of the Division 6C eligible investment business rules, which would otherwise trigger company taxation for a trust.  This allowance is to provide for situations where the trustee derives some income that is not income from an eligible business investment and it is not from a separate business activity (eg, income from directors’ fees received from positions on company boards, certain guarantee or option fees, or income from an investment in a non-financial arrangement).  This allowance does not affect the operation of the control test in section 102N.  That is, it does not allow the trustee of the trust to own or control entities carrying on active trading businesses. 

5.41               Under these amendments an entity will be taken not to carry on a trading business in a year, if no more than 2 per cent of the gross revenue of the unit trust for the income year was income from other than eligible investment business, provided none of the revenue was not income from carrying on a business that is not incidental and relevant to the eligible investment business.  [Schedule 5, item 8, section 102MC]

Example 5.6  

In an income year a public unit trust earned $100 million gross revenue from eligible investment business and earned gross revenue from directors’ fees of $1 million and $0.5 million gross non-trading revenue from non-eligible investment business and no other revenue was earned.  The unit trust will not be taken to be carrying on a trading business in that income year.

Application and transitional provisions

5.42               These amendments apply from the income year of Royal Assent. 

5.43               The 25 per cent safe harbour allowance for non-rental, non-trading income from land investment and the 2 per cent safe harbour allowance for revenue from activities other than eligible investment business income do not apply for the income year of Royal Assent if the trustee of the unit trust chooses that those provisions are not to apply to that income year.  This provision is intended to deal with situations where the safe harbour rules would convert a public trading trust into a Division 6 trust and the trust wished to continue to be taxed like a company under Division 6C.  [Schedule 5, items 9 and 10]  

 



Schedule 1:  Goods and services tax and real property

Bill reference

Paragraph number

Item 1

1.48

Item 2

1.30

Item 3

1.34

Item 4

1.42

Items 5 to 7

1.66

Item 8

1.49

Item 9

1.51

Item 10

1.38, 1.40

Item 11

1.56, 1.60

Item 12

1.66

Item 13

1.65

Schedule 2:  Thin capitalisation and international financial reporting standards

Bill reference

Paragraph number

Items 1 to 4, subsections 820-680(1), (1A), (2) and (2B)

2.59

Item 5, subsection 820-682(1)

2.24

Item 5, subsection 820-682(2)

2.28

Item 5, subsections 820-682(3) and (4)

2.25, 2.30

Item 5, subsection 820-683(1)

2.36

Item 5, subsections 820-683(1) and (2 )

2.34

Item 5, subsection 820-683(2)

2.41

Item 5, subsection 820-683(3)

2.37

Item 5, subsection 820-683(4)

2.38

Item 5, subsection 820-683(5)

2.39, 2.40

Item 5, subsection 820-683(6)

2.41

Item 5, subsections 820-684(1) and (2)

2.44

Item 5, subsection 820-684(2)

2.54

Item 5, paragraph 820-684(3)(a)

2.46

Item 5, paragraphs 820-684(3)(b) and (c)

2.46

Item 5, subsection 820-684(4)

2.46

Item 5, subsection 820-684(5)

2.48

Item 5, subsection 820-684(6)

2.49

Item 5, subsection 820-684(7)

2.54

Item 6, section 820-960

2.56

Items 7 and 8, subsections 820-985(1) and (3)

2.53

Item 9

2.58

Schedule 3:  Interest withholding tax and state government bonds

Bill reference

Paragraph number

Item 1

3.14, 3.15, 3.19

Item 2

3.22

Schedule 4:  Fringe benefits tax

Bill reference

Paragraph number

Items 1 to 6, 10 to 16, 18 to 21, 24 to 29 and 33 to 38

4.12

Items 7, 17, 30 and 39

4.9

Items 8, 22, 31 and 40

4.10

Part 2, items 42 to 75

4.16

Subitems 9(1) and 23(1), items 32 and 41

4.13

Subitem 9(2)

4.14

Subitem 23(2)

4.15

Schedule 5:  Eligible investment business rules

Bill reference

Paragraph number

Item 4, section 102M

5.18

Item 5, section 102M

5.17

Item 7, section 102M

5.13

Item 8, subsection 102MB(1)

5.13

Item 8, subsection 102MB(3)

5.17

Item 8, paragraph 102MA(2)(a)

5.20

Item 8, paragraph 102MA(2)(b)

5.20

Item 8, paragraph 102MA(2)(c)

5.20

Item 8, paragraphs 102MA(2)(d) and (e)

5.20

Item 8, subsection 102MA(3)

5.25

Item 8, paragraph 102MA(3)(c)

5.26

Item 8, subsection 102MA(4)

5.28

Item 8, paragraph 102MA(5)(a)

5.33

Item 8, paragraph 102MA(5)(b)

5.33

Item 8, subsection 102MA(6)

5.35

Item 8, subsection 102MA(7)

5.36

Item 8, paragraph 102MA(7)(b)

5.38

Item 8, section 102MC

5.41

Items 9 and 10

5.43