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Taxation Laws Amendment Bill (No. 5) 1998

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1996-97-98

 

 

The Parliament of the Commonwealth of Australia

 

 

HOUSE OF REPRESENTATIVES

 

 

taxation laws amendment bill (NO. 5) 1998

 

 

 

Explanatory Memorandum

 

 

 

(Circulated by authority of the

Treasurer, the Hon Peter Costello, MP)



T able of contents

 

General outline and financial impact ............................................................................................ 1

Chapter

1.         Income Tax deductions for gifts and related matters........................................................................... 13

2.         Australia as a regional financial centre................................................................................................ 17

3.         Company tax instalments.......................................................................................................................... 79

4.         Non-arm’s length trust distributions etc to superannuation and similar funds............................. 81

5          Franking credits, franking rebates and the intercorporate dividend rebate................................. 89

6.         Distributions to beneficiaries and partners that are equivalent to interest................................. 127

7          Charges and penalties for failing to meet obligations..................................................................... 139

Index .................................................................................................................................................................... 169

 

 



G eneral outline and financial impact

Income tax deductions for gifts and related matters

Amends the income tax law to allow income tax deductions for gifts made to certain funds and organisations. Amendments are also made to ensure that grants paid to eligible businesses by the Katherine District Business Re-establishment Fund will be exempt from income tax.  A number of minor amendments to the gift provisions will also be made.

Date of effect:   Various (see chapter 1, page 14)

Proposal announced :  At various times during 1997 and 1998.

Financial impact:   No significant impact on revenue.

Compliance cost impact :  Compliance costs will be negligible.

Australia as a regional financial centre

Amends the Income Tax Assessment Act 1936 (the Act) to provide for the implementation of the 'Australia - A Regional Financial Centre' component of the Investing for Growth Statement announced by the Government on 8 December 1997.

The amendments in Schedule 3 relate to the interest withholding tax (IWT) exemption available under section 128F, the offshore banking unit (OBU) regime, the foreign investment fund (FIF) measures and the thin capitalisation provisions of the Act.

Section 128F

The interest withholding tax (IWT) exemption provided under section 128F of the Act will be widened by removing, for bearer and non-bearer debentures issued by companies, the present requirements that they be issued outside Australia and that the interest be paid outside Australia. However, the issue of bearer debentures will continue to be restricted to non-residents.

Offshore banking units

The OBU concessions will be expanded to:

·         extend the range of entities eligible to register as OBUs;

·         provide a tax exemption for income and capital gains of overseas charitable institutions managed by an OBU;

·         extend the range of eligible OBU activities to include:

-                                                                                        custodial services;

-                                                                                        trading in Australian dollars where the other party to the transaction is an offshore person;

-                                                                                        trading in gold bullion with offshore persons in any currency;

-                                                                                        trading in gold bullion with any person other than in Australian dollars;

-                                                                                        trading in base metals and palladium bullion with offshore persons in any currency;

-                                                                                        other trading activities (apart from currency trading) in Australian dollars with offshore persons;

-                                                                                        eligible contract activities in Australian dollars with offshore persons; and

-                                                                                        hedging in Australian dollars with related offshore persons;

·         remove the current anti-avoidance measure which prevents Australia being used as a conduit to channel loans to other countries;

·         reduce the capital gains tax liability where non-residents dispose of interests in ‘OBU offshore investment trusts’;

·         provide a foreign tax credit for foreign tax paid by Australian resident OBUs regardless of whether a Double Tax Agreement applies;

·         remove the requirement that OBUs maintain separate nostro and vostro accounts for OBU transactions; and

·         reduce the rate of OBU withholding penalty tax for breaches of the IWT concession from 300 per cent to 75 percent.

Thin capitalisation

This measure will relax the effect of the thin capitalisation “loan back” provisions so that an Australian subsidiary of a foreign bank may raise section 128F IWT exempt funds and on-lend those funds to a related Australian branch without affecting the subsidiary’s thin capitalisation position.

Foreign investment funds (FIFs)

Amends Part XI of the Income Tax Assessment Act 1936 (the Act) to provide an exemption from the FIF measures for interests in certain US FIFs. The exemption is intended to encourage Australian investment funds to be more efficient by exposing them to competition from US funds.

Changes to the calculation method in the FIF measures and consequential amendments to the general provisions for taxing trusts will also be made.

Date of effect:  The proposed measures in the package will generally apply from the date of introduction. In relation to the FIF measures the exemption will apply for notional accounting periods of FIFs ending on or after the date of introduction of the Bill. The amendments to the calculation method and the consequential amendments will apply in relation to assessments for years of income ending on or after the date of introduction of the Bill.

Proposal announced:   Foreshadowed in the 'Australia - A Regional Financial Centre' component of the Investing for Growth Statement announced by the Government on 8 December 1997.

Financial impact:  The package is estimated to cost $22 million in a full year. There may also be an indirect cost to the revenue as a result of the proposed FIF exemption because of increased investment in US FIFs. The cost to the revenue is unquantifiable because the amount of capital transferred to US funds will be dependent on prevailing economic conditions and on the investment strategies of Australian funds managers.

Compliance cost impact:   The compliance cost impact is incorporated into the Regulation Impact Statements. The Regulation Impact Statement for the withholding tax, OBU and thin capitalisation measures is at the end of Part 1 of Chapter 2 of the Explanatory Memorandum. The Regulation Impact Statement for the FIF measure is at the end of Part 2 of Chapter 2 of the Explanatory Memorandum.

Summary of the Regulation Impact Statement - Part 1 of Schedule 3

Interest Withholding Tax Exemption, Offshore Banking Units and Thin Capitalisation

Impact:   Low

The objective of the measures is to make our Australia more attractive as a regional financial centre. The package endeavours to develop our corporate debt market and increase Australia’s competitiveness as an offshore banking regime.

The global financial industry is growing rapidly. These measures provide the Australian financial sector with the opportunity to achieve higher levels of participation in international trade in financial services. The affected groups are financial intermediaries for whom non-residents are a significant client group, primarily banks and funds managers, and non-residents investing in or through Australia.

The proposed amendments represent a package which is aimed at providing greater certainty and reducing compliance costs and tax burdens in relation to financial sector activities.

The proposed legislation is estimated to negatively affect revenue to the amount of $22m in a full year. However, the package is expected to promote new business in the financial industry. To the extent that new business is generated revenue will increase.

The Treasury and the Australian Taxation Office will monitor these measures as part of the whole taxation system on a continuing basis. Furthermore, a task force within the Financial Sector Advisory Council was established as a consultative forum which will provide ongoing advice on the effect of the measures on Australia’s attractiveness as a regional financial centre.

Summary of Regulation Impact Statement - Part 2 of Schedule 3

Foreign Investment Funds

Impact:      Low

Main points:

·                                                                                                     The exemption will benefit resident taxpayers who hold interests in US FIFs.

-      The major impact is expected to be on superannuation and investment funds, who between them hold the majority of Australian interests in US FIFs.

·                                                                                                     The exemption is likely to increase Australian investment in US FIFs, particularly US mutual funds, that qualify for the exemption.

-      This investment is expected to be largely at the expense of direct investment in US securities, but also to some extent at the expense of investments in Australia and in other countries.

·                                                                                                     The exemption is likely to result in a minor reduction in compliance costs because the FIF measures will not apply to investments that qualify for the exemption

·                                                                                                     The cost to the revenue of providing the exemption is expected to be $2 million in the 1998/99 income year and $3 million annually for subsequent income years.

·                                                                                                     Some informal consultation on the exemption has been undertaken with industry and professional associations, in particular, with the Investment & Financial Services Association which represents Australian funds managers.

·                                                                                                     The measure is not controversial to the extent it benefits taxpayers, however, it may be opposed by funds managers who face greater competition.

Company tax instalments

Amends the Income Tax Assessment Act 1936 by excluding superannuation funds, approved deposit funds and pooled superannuation trusts from the grouping provisions contained in the company tax instalment system.

Date of effect:   The amendments will apply from the 1995/96 income year.

Proposal announced:   Assistant Treasurer's Press Release of 27 February 1997 (No. 1).

Financial impact:   The amendments may result in a deferral of revenue which cannot be quantified but is expected to be insignificant.

Compliance cost impact:   Compliance costs for affected taxpayers will be reduced.

Summary of Regulation Impact Statement

Impact:   Low

Main points:        

    Compliance costs for superannuation funds, approved deposit funds and pooled superannuation trusts will reduce because they will not have to consider whether the grouping provisions contained in the company tax instalment system apply.

    Furthermore, companies will not have to consider whether the grouping provisions apply to superannuation funds, approved deposit funds or pooled superannuation trusts that they control.

Policy Objective:

Implement the Government's announcement to exclude superannuation funds, approved deposit funds, and pooled superannuation trusts from the application of the grouping provisions contained within the company tax instalment system.

Non-arm’s length trust distributions etc. to superannuation and similar funds

Amends the Income Tax Assessment Act 1936 so that the special income of a complying superannuation fund, approved deposit fund (ADF) or pooled superannuation trust (PST) will include:

·         distributions from all trusts other than where the superannuation fund, ADF or PST has a fixed entitlement to income from that trust; and

·         non arm’s length trust distributions of income where the superannuation fund, ADF or PST has a fixed entitlement to income from that trust.

Date of effect:  Subject to a transitional arrangement, the amendments will apply to income derived after 2 pm by standard time in the Australian Capital Territory on 25 November 1997 (ie, the amendments will apply from the time of the Treasurer’s Press Release).

Proposal announced:   Treasurer’s Press Release No. 123 of 25 November 1997.

Financial Impact:  Estimated revenue savings of $15 million per annum.

Compliance Cost Impact:  Compliance costs are expected to be minimal as the measure will tighten an existing anti-tax avoidance measure. 

Dividend imputation: the holding period and related payments rules

Amends the Income Tax Assessment Act 1936 to prevent franking credit trading and mis-use of the intercorporate dividend rebate by denying the franking benefit or intercorporate dividend rebate from a dividend where the taxpayer does not satisfy:

     a holding period rule that, subject to certain exceptions, requires taxpayers to hold shares at-risk for more than 45 days (or 90 days for preference shares); and

     a related payments rule that requires taxpayers who are under an obligation to make a related payment with respect to a dividend paid on shares to hold the relevant shares at-risk for more than 45 days (or 90 days for preference shares) during the relevant qualification period.

Date of effect:  The holding period rule applies generally to shares and interests in shares acquired on or after 1 July 1997 unless the taxpayer became contractually obliged to acquire the shares before 7.30 pm AEST 13 May 1997; special rules affecting certain trusts take effect from 3 pm AEST 31 December 1997. The related payments rule applies to arrangements entered into after 7.30 pm AEST 13 May 1997.

Proposal announced:   1997-98 Budget (13 May 1997). Modifications to the original proposal were announced in Treasurer's Press Release No. 89 released on 8 August 1997, and Assistant Treasurer's Press Release No. AT/25 released on 31 December 1997.

Financial impact:  The holding period and related payments rules will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of franking credit trading and mis-use of the intercorporate dividend rebate. The rules are part of a package of measures targeting franking credit trading and dividend streaming. In the absence of the measures, to the extent that the revenue base would not be protected, there would be a significant revenue loss. While it is not possible to provide an exact estimate of the revenue loss that already existed from franking credit trading and dividend streaming, $130 million a year has been factored into the forward estimates for 1998-99 and subsequent years to take account of the effect of the measures on existing activities.

Compliance cost impact:   Taxpayers who are required to comply with the rules will incur additional compliance costs. The extent of the compliance costs incurred will vary depending on the facts and circumstances of particular cases. Accordingly, no reliable data on the amount of these costs is available.

Summary of Regulation Impact Statement

Impact:  Medium

Main points:

     Taxpayers who are required to comply with the rules will have to incur additional compliance costs.  The extent of the compliance costs which will be incurred by taxpayers will vary depending on the facts and circumstances of particular cases. Accordingly, no reliable data on the amount of these costs is available.

     Natural person shareholders (i.e. shareholders claiming franking rebates of $2000 or less) are exempt from the holding period rule and low-risk taxpayers (e.g. superannuation funds) will be able to elect to have a franking credit or rebate ceiling as opposed to applying the holding period rule.

     Only taxpayers who enter into related payment arrangements will incur costs in complying with the related payments rule.

Policy Objective

To prevent franking credit trading by implementing some of the measures announced by the Government in the 1997-98 Budget.

Distributions to beneficiaries and partners that are equivalent to interest

Amends the Income Tax Assessment Act 1936 to prevent franking credit trading and mis-use of the intercorporate dividend rebate by denying the franking benefit or intercorporate dividend rebate from a trust or partnership distribution attributable to a dividend where the distribution is equivalent to interest.

Date of effect:   The amendments apply to trust and partnership interests created or acquired, and finance arrangements entered into, after 7.30 pm AEST 13 May 1997, and to existing arrangements extended after that time.

Proposal announced:   The1997-98 Budget, 13 May 1997.

Financial impact:   The amendments will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of franking credit trading and mis-use of the intercorporate dividend rebate. The amendments are part of a package of measures targeting franking credit trading and dividend streaming. In the absence of the measures, to the extent that the revenue base would not be protected, there would be a significant revenue loss. While it is not possible to provide an exact estimate of the revenue loss that already existed from franking credit trading and dividend streaming, $130 million a year has been factored into the forward estimates for 1998-99 and subsequent years to take account of the effect of the measures on existing activities.

Compliance cost impact:  Taxpayers who enter into relevant arrangements will incur additional compliance costs in determining whether their distributions are equivalent to the payment of interest on a loan. However, the extent of the compliance costs which will be incurred by taxpayers will vary depending on the facts and circumstances of particular cases. Accordingly, no reliable data on the amount of these costs is available.

Summary of Regulation Impact Statement

Impact: Low

Policy Objective

     To prevent franking credit trading by implementing one of the measures announced by the Government in the 1997-98 Budget.

Charges and penalties for failing to meet obligations

Amends various Acts for which the Commissioner of Taxation has general administration to:

     replace the existing late payment penalty provisions with a tax deductible general interest charge on outstanding amounts;

     introduce a penalty for failing to notify the Commissioner of an obligation to remit a source deduction (eg PAYE, PPS, etc) or sales tax;

     introduce a penalty for failing to give the Commissioner an annual reconciliation statement of source deductions made; and

·                      make other consequential amendments to support the above measures.

Date of effect:  The new interest charge and the penalty for failure to notification and reconciliation statement penalties are to apply from 1 January 1999.

The interest charge for unpaid sales tax and source deductions will apply to amounts payable before that date.  However, this will not disadvantage taxpayers as the interest charge being proposed is lower than the current rate.

Proposal announced:  The 1998-99 Budget, 12 May 1998.

Financial impact:  The revenue impact of the changes cannot be quantified.  With greater automation of the penalty systems the incidence of imposition of late payment penalties is expected to increase.  However, penalties generally will be levied at a lower rate.

Compliance cost impact:              The amendments are not expected to impose any additional compliance costs on taxpayers .

Summary of Regulation Impact Statement

Impact:     Positive

Policy objective :

The policy objective of this measure is to replace the existing late payment penalty provisions in various Acts for which the Commissioner of Taxation has the general administration with a single tax deductable general interest charge on outstanding amounts.  T he new regime will be transparent, consistent, commercially based and easy to administer.  A further objective is to encourage withholders who cannot remit deductions by the due dates to notify the ATO of the existence of liabilities and to make sure withholders send in their annual reconciliation statements of deductions.

The proposals overcome problems with the current penalty regimes identified by the Small Business Deregulation Task Force .  The GIC will enable:

(a)          a common single rate of interest for all tax types where a payment is not received by the due date;

(b)          abolition of complex and punitive culpability elements that apply for the late payment of some taxes; and

(c)          simpler tax accounting and collection arrangements that will position the ATO to better assist taxpayers to minimise any escalation of amounts outstanding.

The failure to notify penalty will encourage withholders who cannot remit deductions by the due dates to notify the ATO of the existence of these liabilities.  The changes will eliminate the current high level penalties that are imposed on businesses that are unable to remit withheld amounts when they are due.

Assessment of impacts of the proposals:

The groups impacted by the new penalty regimes are as follows:

taxpayers -

by having consistent and more easily understood late payment penalties and more equitable and commercially acceptable failure to notify penalties, in particular small business taxpayers will not face heavy penalties where temporary cash flow problems prevent them from remitting withheld amounts on time;

tax agents and accountants -

who will find it easier to advise clients on penalty regimes;

the ATO -

who will find the new penalty regimes easier to administer; and

The Commonwealth Government - 

which, over time, should benefit from reduced levels of outstanding debt.

 



C hapter 1

Income tax deductions for gifts and related matters

Overview

1.1                        Schedule 1 to the Bill will amend the Income Tax Assessment Act 1997 (the Act) to:

·         allow income tax deductions for gifts of $2 or more to the funds and organisations listed in paragraph 1.3. This will be done by listing them in the relevant sections of the gift provisions in Division 30 of the Act. The index to the gift provisions will also be updated;

·         remove an inconsistency between the terms used in Division 30 of the Act and those used in the Marriage Act 1961 and Family Law Act 1975 ; and

·         make a minor technical correction with respect to the National Nurses’ Memorial Trust.

1.2                        Schedule 2 to the Bill will:

·         amend the Act to allow income tax deductions for gifts of $2 or more to the Katherine District Business Re-establishment Fund; and

·         enable grants paid to eligible businesses from that Fund to be treated as exempt income.

Explanation of the amendments

Deductions for gifts

1.3                        The amendments will result in gifts being tax deductible as follows:



 

Fund/organisation

Proposed section and item reference

Special conditions

Item number

Schedule 1

 

 

 

The Business Against Domestic Violence Reserve

30-45(2)

item 4.2.15

The gift must be made after 22 April 1998

Items 1 and 10

Mount Macedon Memorial Cross Restoration, Development and Maintenance Trust Fund

30-50(2)

item 5.2.8

The gift must be made after 8 February 1998

and before 9 February 1999

Items 3 and 13

Australian American Education Leadership Foundation Limited

30-80(2)

item 9.2.4

The gift must be made after 26 January 1998

Items 7 and 9

Sydney Talmudical College Association Refugees Overseas Aid Fund

30-80(2)

item 9.2.5

The gift must be made after 29 January 1998

Items 7 and 15

United Israel Appeal Refugee Relief Fund Limited

30-80(2)

item 9.2.6

The gift must be made after 29 January 1998

Items 7 and 16

St Patrick’s Cathedral Parramatta Rebuilding Fund

30-105

item 13.2.1

The gift must be made after 24 February 1998 and before 25 February 2000

Items 8 and 15

Schedule 2, Part 1

 

 

 

Katherine District Business Re-establishment Fund

30-45(2)

item 4.2.16

none

Items 1 and 2

 

Marriage Guidance

1.4                        Section 30-75 of the Act provides that a gift to a public fund providing money to be used in giving marriage guidance to persons in Australia through a voluntary organisation (or a branch or section of a voluntary organisation) will be deductible only if the organisation (or a branch or section of the organisation) has been declared by the Attorney-General to be a marriage guidance organisation.

1.5                        Section 30-75 is being amended to align the taxation law with the criteria used in the Marriage Act 1961 and the Family Law Act 1975 for approval by the Attorney-General of voluntary organisations involved in marriage education, family and child counselling, and family and child mediation. Also, the requirement for the Attorney-General to sign an instrument to certify an organisation has satisfied the criteria is being removed.  [Items 4 to 6, 11 and 12]

1.6                        These amendments will commence on Royal Assent.  [Item 17]

Technical amendments

1.7                        The Bill will make minor technical corrections to the Act with respect to the National Nurses’ Memorial Trust. Item 2 renumbers the item reference in subsection 30-50(2) of the Act and Item 14 includes the Trust in the gifts or contributions index in subsection 30-315(2) of the Act.

Katherine District Business Re-establishment Fund

1.8                        On 4 June 1998, the Treasurer announced that grants paid as part of a business re-establishment package to eligible businesses and primary producers in those parts of the Katherine region that were devastated by floods in January 1998 will be exempt from income tax.

1.9                        The grants (up to a maximum of $10 000 for each business) are paid from the Katherine District Business Re-establishment Fund (the Fund) to provide direct financial assistance to small businesses and primary producers to allow them to recommence business activities and re-establish local jobs.

1.10          Specifically, Part 2 of Schedule 2 will ensure that such a grant paid directly to an eligible taxpayer:

·         will be treated as exempt income;  [Item 3]

·         will not be taken into account in calculating their net exempt income for the purpose of determining whether or not tax losses of earlier income years are deductible; and  [Item 4]

·         will not give rise to a capital gain.  [Item 5]

1.11           These amendments only apply in relation to the 1997-98 income year [item 6] and are in addition to the gift deductible status for gifts or contributions made to the Fund (see paragraph 1.3 above).



C hapter 2

Australia as a regional financial centre

Overview

2.1                        The amendments contained in Schedule 3 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to implement a package of measures announced by the Prime Minister on 8 December 1997 as part of the Investing for Growth Statement. The package is designed to, among other things, further enhance Australia's credentials as a world financial centre. In particular, measures included in the 'Australia - A Regional Financial Centre' component of the Statement are aimed at making Australia a more attractive regional financial centre by building on Australia's existing advantages to ensure its participation in the increasing global trade in financial services.

2.2                        Part 1 of Schedule 3 contains amendments that will:

Section 128F interest withholding tax exemption

·         widen the interest withholding tax (IWT) exemption provided under section 128F of the Act by removing, for eligible debentures issued by companies, the present requirements that they be issued outside Australia and that the interest be paid outside Australia;

Offshore Banking Units

·         extend the range of entities eligible to register as Offshore Banking Units (OBUs);

·         provide a tax exemption for income and capital gains of overseas charitable institutions managed by OBUs;

·         extend the range of eligible OBU activities to include:

-                                                                                                           custodial services;

-                                                                                                           trading in Australian dollars where the other party to the transaction is an offshore person;

-                                                                                                           trading in gold bullion with offshore persons in any currency;

-                                                                                                           trading in gold bullion with any person other than in Australian dollars;

-                                                                                                           trading in base metals and palladium bullion with offshore persons in any currency;

-          other trading activities (apart from currency trading) in Australian dollars with offshore persons;

-          eligible contract activities in Australian dollars with offshore persons; and

-          hedging in Australian dollars with related offshore persons;

·         remove the current anti-avoidance measure in section 128GB which prevents Australia being used as a conduit to channel loans to other countries;

·         reduce the capital gains tax liability where non-residents dispose of interests in ‘OBU offshore investment trusts’;

·         provide a foreign tax credit for foreign tax paid by an Australian resident OBU regardless of whether a Double Tax Agreement (DTA) applies;

·         remove the requirement that OBUs maintain separate nostro and vostro accounts; and

·         reduce the rate of OBU withholding penalty tax for breaches of the IWT concession from 300 per cent to 75 per cent;

Thin Capitalisation

·         relax the effect of the thin capitalisation “loan back” provisions so that an Australian subsidiary of a foreign bank may raise section 128F IWT exempt funds and on-lend those funds to a related Australian branch without affecting the subsidiary’s thin capitalisation position.

2.3                        Part 2 of Schedule 3 contains amendments that will:

Foreign Investment Funds

      provide an exemption from the foreign investment fund (FIF) measures for interests in certain FIFs taxed on a worldwide basis in the United States (US);

      provide a limited exemption for interests in certain FIFs taxed as conduit entities in the US; and

      make these exemptions available when determining FIF income under the calculation method.

2.4                        Consequential amendments will also be made to ensure:

      the general trust provisions do not claw back the benefits of providing the exemption; and

      the trustee of a trust FIF that qualifies for the exemption is taxed on the Australian source income of the trust under the general trust provisions.

2.5                        Regulation Impact Statements for the changes are provided at the end of the explanation for each Part.

Summary of the amendments

Purpose of the amendments

2.6                        The purpose of these amendments is to further support the development of the funds management and corporate debt markets and to promote a more effective and competitive offshore banking regime. The measures will accommodate the integration of Australian financial markets into global markets.

2.7                        The amendment to the thin capitalisation provisions will make it easier for a foreign bank branch operating in Australia to access loan funds that are exempt from interest withholding tax (IWT) under section 128F. The amendment is required as a result of the interaction between Australia's thin capitalisation regime and IWT regime.

Date of effect

Section 128F, Offshore Banking Units and Thin Capitalisation

2.8                        Generally, the measures will apply from the date of introduction of the amending legislation.

Foreign Investment Funds

2.9                        The exemption from the FIF measures will have effect for notional accounting periods of FIFs ending on or after the date of introduction of the amending legislation.

2.10          The amendments to the calculation method and the consequential amendments to the general trust provisions will apply in relation to assessments for income years ending on or after the date of introduction of the amending legislation.

Part 1- Withholding tax, Offshore Banking Units and Thin Capitalisation

Overview of Part 1 of the Chapter

2.11          Part 1 of Schedule 3 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to implement the section 128F, OBU and Thin Capitalisation measures. These measures are contained in Part 1 of Chapter 2 as follows:

·                                                                                                     Section 128F - section 1 ;

·                                                                                                     OBUs - section 2 ; and

·                                                                                                     Thin Capitalisation - section 3 .

2.12          An explanation of the dates of application is contained in section 4 and a regulation impact statement for the changes is provided in section 5 .

Section 1      Section 128F interest withholding tax exemption

Background to the legislation

What is interest withholding tax (IWT)?

2.13       The taxation of Australian sourced interest paid or credited to non-residents, and residents operating through an offshore permanent establishment, is subject to the provisions contained in Division 11A of the Act. These provisions provide, in conjunction with the relevant Rates Act, that the recipient of Australian sourced interest is subject to withholding tax on the gross amount paid or credited. A rate of 10 per cent of the gross amount of the interest is imposed. The obligation for the collection of withholding tax is placed on the person making the payment.

What is the section 128F interest withholding tax exemption?

2.14          Under the current concession, the interest payable on debentures issued offshore is exempt from IWT provided certain conditions are met. Section 128F provides an exemption where a resident company issues debentures outside Australia; the interest payable by the resident company in connection with the debentures is paid outside Australia; the resident company issued the debenture outside Australia for the purpose of raising finance outside Australia; and the issue meets the requirements of the 'public offer' test.

The ‘public offer’ test

2.15          There are a number of tests listed under subsections 128F(3) and 128F(4) which are collectively referred to as the ‘public offer’ test. Companies are required, at the time of issuing debentures, to satisfy at least one of these tests in order to qualify for the section 128F exemption. The purpose of these tests is to ensure that lenders on overseas capital markets are aware that an Australian company is offering debentures for issue.

Loss of eligibility for the exemption

2.16          An issue of debentures will fail the public offer test with a consequential loss of eligibility for the exemption, if at the time of issue, the issuing company is aware that the debentures will be acquired by a resident or an associate of the company.

2.17          The exemption will also be lost where the company issuing the debentures had reasonable grounds to suspect that the debentures would be acquired by a resident or an associate. For example, if the Australian company issuing debentures was aware that a resident of Australia was proposing to acquire the debentures through an interposed overseas entity, the public offer test will not be satisfied for those debentures.

What is a debenture?

2.18          The term 'debenture, in relation to a company' is defined in section 6 of the Act as including stock, bonds, notes and any other securities of the company, whether constituting a charge on the assets of the company or not. This definition would include promissory notes or bills of exchange.

2.19          The amendments will make a distinction between bearer debentures and debentures other than bearer debentures. For ease of explanation this document will refer to debentures which are not bearer debentures as 'registered debentures'. Broadly speaking, a bearer debenture is a debenture where the interest is payable to the person in possession of the security and details of the holder are not recorded. A registered debenture is a debenture where the ownership of the security is recorded by the issuing company.

Operation of the proposed measures

2.20          In order to encourage the development of the domestic corporate debt market the Government has decided to widen the IWT exemption in respect of bearer and registered debentures issued by companies. It will remove the requirements that these debentures be issued outside Australia for the purpose of raising finance outside Australia and that interest payable must be paid outside Australia.

2.21          The proposed amendments will introduce a distinction between issues of registered and bearer debentures. Different requirements will be placed on the respective issues.

2.22          The wider exemption will not be available to Commonwealth Government securities or securities issued by State or Territory central borrowing authorities (sovereign issues). However, the existing section 128F exemption applying to offshore issues of debentures will continue to be available to these entities.

2.23          Companies will still need to meet the public offer test in respect of all issues.

Registered debentures

2.24          In the case of registered debentures, companies will be permitted to issue these in Australia and offshore. Additionally, both residents and non-residents will be permitted to acquire registered debentures. However, whilst interest payments made to non-residents will qualify for the IWT exemption, residents acquiring these debentures will be subject to tax on the interest by assessment.

2.25          There will be no restriction placed on where the interest is paid.

Bearer debentures

2.26          The proposed legislation will allow the issue of bearer debentures offshore or in Australia to non-residents. Where a resident acquires bearer debentures, however, the proposed legislation will deem the issue to have failed the public offer test with consequential loss of eligibility for the exemption.

2.27          There will be no restriction placed on where the interest is paid.

Simultaneous issues

The proposed amendments will permit debentures to be issued simultaneously in Australia and overseas.

Explanation of the amendments

2.28          The proposed amendments to section 128F will remove the requirements that debentures be issued outside Australia and that interest payable must be paid outside Australia. An overview of how section 128F will operate after the amendments is provided at the end of this section in flow chart form.

2.29          The repeal of paragraphs 128F(1)(c) and 128F(1)(d) will allow companies to issue registered and bearer debentures either in Australia or offshore and will no longer restrict where interest payments may be made. [Item 26] However, the wider exemption will not apply to sovereign issues.

The public offer test

2.30          Companies will still need to satisfy at least one of the public offer tests in respect of these issues. The existing requirement in paragraph 128F(3)(c) (the third public offer test) that the debentures be accepted for listing by an overseas stock exchange is amended by item 27 . This will remove the current restriction requiring the debentures to be listed on a stock exchange outside Australia and allow debentures to be listed on a stock exchange in Australia.

2.31          The proposed amendments, although permitting both onshore and offshore issues, will introduce a distinction between issues of registered and bearer debentures with different requirements placed on the respective issues.

Registered debentures

2.32          An issue of registered debentures will not fail the public offer test where a resident acquires registered debentures either within Australia or offshore. This is achieved by the amendments proposed by items 28 and 29 .

2.33          New subsection 128F(5A) will deem an issue of registered debentures to have failed the public offer test where the debentures are issued to associates of the company. The provision will apply to acquisitions of registered debentures both directly from the issuer or indirectly from an interposed trust or entity and to the acquisition of beneficial interests in the registered debentures. This rule also applies where the company issuing the registered debentures should have known that the debentures would be acquired by an associate. [Item 29]

Bearer debentures

2.34          In the case of bearer debentures, the existing restriction prohibiting the issue of debentures to residents and associates will continue to apply under subsection 128F(5). The issue will fail the public offer test, with consequential loss of eligibility for the exemption, if the company was aware at the time of issue, that the bearer debentures would be acquired by a resident of Australia or the issuing company’s associate. [Item 28]

2.35       In relation to both bearer and registered debentures, existing subsection 128F(6) will continue to deny the exemption if the issuing company was aware or should have been aware that the interest in respect of the debentures was paid to an associate of the company.

Central borrowing authorities

2.36          New subsection 128F(5B) will make it clear that the exemption will not be available to issues of bearer or registered debentures in Australia by:

·                                                                                                     Australian public bodies as defined in existing subsection 128F(7); or

·                                                                                                     State or Territory central borrowing authorities.

2.37          A 'central borrowing authority' is defined in new subsection 128F(5B) as a body established for the purpose of raising finance for a State or Territory. New subsection 128F(5B) provides examples of central borrowing authorities. [Item 29]

Non-resident subsidiaries of Australian resident companies

2.38          Subsection 128F(8) allows certain fully owned non-resident subsidiaries of Australian resident companies to raise finance for its parent whilst retaining the exemption. The proposed legislation amends subsection 128F(8) to remove the requirement that interest must be paid outside Australia. [Items 30 and 31]

Interest paid by companies on bearer debentures

2.39          The proposed amendments do not affect the operation of Division 11 of the Act. Therefore, under the proposed measures where a company issues bearer debentures to non-residents, either in Australia or offshore, and the issue is exempt under section 128F, paragraph 126(1)(c) of the Act will operate to exclude the issue from Division 11. However, where bearer debentures are issued to residents the issue will fail the public offer test and the exemption will not apply. In these cases, the company will be subject to the tax imposed by the Income Tax (Bearer Debentures) Rates Act 1971 if it fails to advise the Commissioner of Taxation of the names and addresses of the holders of bearer debentures which it has issued.

 

 



Section 2      Offshore Banking Units

Background to the legislation

The offshore banking unit regime

2.40          The term 'offshore banking' broadly refers to the intermediation by institutions operating in Australia in financial transactions between non-resident borrowers and non-resident lenders. It also includes the provision of financial services to non-residents in respect of transactions or business occurring outside Australia.

2.41          Under the present law, declaration as an OBU is confined to certain financial entities being authorised banks subject to the Banking Act 1959 , wholly owned subsidiaries of banks which are already registered as OBUs, State banks and other financial institutions that the Treasurer is satisfied are appropriately authorised to carry on business as dealers in foreign exchange: subsection 128AE(2).

2.42          Income derived by an OBU from 'OB activities' is effectively taxed at a concessional rate of 10 per cent. The meaning of an 'OB activity' is set out in sections 121D, 121E and 121EA of the Act. For ease of explanation this document refers to OBU activities rather than OB activities.

Operation of the proposed measures

2.43          The proposed amendments extend both the range of eligible entities and eligible activities. The measures will increase the attractiveness of the OBU regime by reducing the compliance burden and widening the concessions available.

Entities eligible to apply for OBU status

2.44       As mentioned above, declaration as an OBU is currently confined to the financial entities listed in subsection 128AE(2). In order to facilitate greater non-bank competition for offshore business, the Government has decided to extend OBU status to:

·                                                                                                     funds managers, which are money market corporations subject to the Financial Corporations Act 1974 or fully owned subsidiaries of these corporations;

·                                                                                                     holders of securities dealers' licences under the Corporations Law ;

·                                                                                                     holders of investment advisers' licences under the Corporations Law ;

·                                                                                                     life insurance companies registered under the Life Insurance Act 1995 ; and

·                                                                                                     other companies, including providers of custodial services, determined by the Treasurer to be OBUs.

Income tax exemption for offshore charities managed by an OBU

Charitable institutions

2.45          Currently, non-resident charitable institutions whose investments are managed by an OBU receive the same tax treatment as other offshore investors. Namely, income and capital gains derived from the offshore assets are exempt. However, income or capital gains derived from Australian assets are not exempt from income tax and are subject to Part IIIA of the Act.

2.46          To encourage funds management by OBUs as well as investment in Australia by offshore charities, the Government has decided to exempt all income and gains of overseas charitable institutions where:

·                                                                                                     the investments which give rise to the income or gains are managed by an OBU; and

·                                                                                                     the charitable institution is exempt from tax in its home jurisdiction.

2.47          For the purposes of the measure overseas charitable institutions will be defined as those which would be exempt under item 1.1 of section 50-5 of the Income Tax Assessment Act 1997 if they:

·                                                                                                     had a physical presence in Australia and incurred their expenditure and pursued their objectives principally in Australia; and

·                                                                                                     are exempt from income tax in the country in which they are resident.

2.48          The proposal is similar to the existing portfolio investment activity described in subsection 121D(6A) of the Act. This activity allows OBUs to manage portfolio investments on behalf of non-residents subject to a 10 per cent limit on Australian assets. However, under the proposed activity there will be no limitation on the proportion of Australian assets which may be held.

The OBU’s fee income

2.49          Consistent with the portfolio investment activity under subsection 121D(6A), OBUs will only be eligible for the 10 per cent concessional tax rate on the component of the management fee which relates to the foreign assets. The component relating to the Australian assets will be taxed at the full company rate.

Extension of eligible OBU activities

Custodial services

2.50          The Government has decided to extend the range of OBU activities to allow OBUs to provide custodial services to non-residents.

What are custodial services?

2.51          Custodial service providers (custodians) offer a broad range of services directed at investment related activities. In contrast to fund managers, custodians perform these functions at the direction of their clients. Some common entities providing custodial services as part of their broader activities are global banking groups, funds management groups and insurance companies.

2.52          Custodial services include the following:

      safe-keeping of assets (the physical security and storage of assets);

      settlement of transactions (the finalisation of financial matters to the point of settlement);

      foreign exchange dealings;

      collection of income (the collection and distribution of interest and dividend income);

      corporate actions (the notification of and follow-up regarding upcoming corporate events in which clients have an interest);

      securities management;

      reporting and advisory services; and

      tax reclamation (obtaining tax refunds where appropriate).

Implementation of the measure

2.53          Currently OBUs undertaking ‘portfolio investment’ activities described in subsection 121D(6A) are allowed to make and manage investments on behalf of non-residents. Under this activity OBUs are permitted to invest in Australian assets subject to a 10 per cent limit (by value) on the Australian asset component of each investment portfolio.

2.54          As custodians provide similar services to those provided by fund managers, the new custodial services activity will be included within the existing portfolio investment activity. The amendments will allow OBUs to undertake custodial services at the direction of non-residents.

The OBU’s fee income

2.55          Consistent with the portfolio investment activity under subsection 121D(6A), OBUs will only be eligible for the 10 per cent concessional tax rate on the component of the management fee which relates to the offshore assets. The component relating to the Australian assets will be taxed at the full company rate.

Currency trading

2.56          Under the current concessional tax regime OBUs are allowed to trade on their own behalf in spot or forward foreign currency, or options or rights in respect of foreign currency, with any person, but not where the trade involves Australian currency on either side of the transaction: paragraph 121D(4)(e).

2.57          The proposed legislation extends this activity in order to allow transactions in Australian currency where the other party to the transaction is an 'offshore person'. The term ‘offshore person’ is defined in section 121E and in broad terms means non-residents (excluding Australian branches of non-residents), foreign branches of Australian residents and OBUs. The measures, however, continue to prohibit Australian dollar trading with Australian residents not operating through foreign branches.

Gold trading

2.58          The range of eligible OBU activities also permits OBUs to trade in gold bullion with offshore persons where any money payable or receivable is not Australian currency: paragraph 121D(4)(f).

2.59          The proposed legislation will extend this activity by broadening the parties with which an OBU may trade and removing, in the case of offshore persons, the currency restriction. The proposal is as follows:

·                                                                                                     offshore persons - the existing currency restriction will be removed and OBUs will be permitted to trade in gold bullion with offshore persons where any money payable or receivable under the trade is in Australian currency; and

·                                                                                                     residents and non-residents operating through a permanent establishment in Australia - OBUs will be permitted to trade in gold bullion with residents and Australian branches of non-residents but the existing currency restriction will apply. That is, no Australian dollar transactions will be permitted.

Metals trading

2.60          Trading with an offshore person in silver and platinum bullion, or rights in respect of such bullion, is permitted under the OBU regime, as long as any money payable or receivable is not Australian currency. The measures will remove the currency restriction.

2.61          Currently physical trading in the base metals (aluminium, aluminium alloy, zinc, tin, lead, nickel and copper) is not a 'trading activity' under subsection 121D(4) and, therefore, is not an eligible OBU activity.

2.62          At present, physical trading in palladium bullion is also not an eligible OBU activity. Palladium is a rare element of the platinum group and is traded in the precious metals market.

2.63          Derivative transactions in base metals and palladium bullion, however, are currently eligible contract activities under subsection 121D(5). In order to allow all transactions in an OBU’s global commodities book to be eligible OBU activities, the Government has decided to extend trading activities to include physical trading in base metals and trading in palladium bullion with offshore persons in any currency. These measures have been provided as a result of industry representations. They were not included in the Statement.

Other trading activities

2.64          Currently OBUs are permitted to undertake a number of distinct trading activities (apart from currency trading) with offshore persons where any money payable or receivable is not in Australian currency or where the shares, eligible contracts, securities or units traded are not denominated in Australian currency: subsection 121D(4). It is proposed to extend this activity to allow transactions in Australian currency with offshore persons.

Eligible contract activities

2.65          Under the existing concessions OBUs are allowed to enter into a futures contract, a forward contract, an options contract, a swap contract, a cap, collar, floor or similar contract with offshore persons where any money payable or receivable is not in Australian currency: subsection 121D(5). This activity will be extended to allow transactions in Australian currency with offshore persons.

Hedging

2.66          Hedging of interest rates and currency is used to manage exposure to risk from borrowing and lending activities. Hedging is currently permitted with an offshore person in Australian currency as long as the counter-party is not a 'related person': subsection 121D(8).

2.67          In broad terms, a ‘related person’ is an associate of the OBU or any permanent establishment of the OBU through which activities other than OBU activities are carried on. The terms ‘related person’ and ‘associate’ are defined in section 121C.

2.68          The Government has decided to extend this activity by removing the 'related person' restriction. This will allow OBUs to trade in Australian currency with their associates and offshore permanent establishments (for example, a branch).

Interest paid on offshore borrowings under 'conduit' arrangements

2.69          Section 128GB provides a n exemption from IWT on interest or gold fees paid by OBUs to non-residents where the money or gold borrowed is part of a borrowing activity and the money or gold is used to fund other OBU activities. Subsection 128GB(3) is a measure designed to protect another country’s tax base by preventing an OBU situated in Australia being used as a conduit to channel the loan. It does this by denying the IWT exemption where an OBU is used as a mere conduit for a loan transaction.

2.70          In order to increase the attractiveness of the concessional tax regime by allowing back-to-back offshore loans through an OBU, the Government has decided to remove this anti-avoidance measure.

Capital gains tax exemption for disposals of interests in ‘OBU offshore investment trusts’

2.71          The Government has decided to reduce the capital gains tax (CGT) liability of non-residents disposing of their units in ‘OBU offshore investment trusts’. The purpose of the measure is to remove the CGT liability on gains relating to the underlying foreign assets held by these trusts.

What is an OBU offshore investment trust?

2.72          Under subsections 121D(6) and 121D(6A) an OBU may undertake investment activities on behalf of non-residents as trustee or central manager and controller of a trust. The trust is broadly referred to as an ‘OBU offshore investment trust’.

The Australian asset percentage

2.73          The portfolio investment activity described by subsection 121D(6A) allows OBUs to invest in Australian assets on behalf of non-residents subject to a 10 per cent limit on the Australian asset component of each investment portfolio. In broad terms, the ‘Australian asset percentage’ of an investment portfolio is the percentage of Australian assets held in the portfolio.

2.74          In the case of an investment activity under subsection 121D(6), OBUs are not permitted to invest in Australian assets. Therefore, in these cases the Australian asset percentage will be zero.

Capital gains tax implications

2.75          If a non-resident beneficiary of an OBU offshore investment trust disposes of an interest (unit) in the trust a CGT liability may arise. However, this will only be the case where the unit is a CGT asset having the 'necessary connection with Australia'.

2.76          In this context, category number 6 of section 136-25 of the Income Tax Assessment Act 1997 provides that a unit in a unit trust has the necessary connection with Australia if:

·                                                                                                     the unit trust is a resident trust for CGT purposes for the income year in which the CGT event (the disposal of the unit by the beneficiary) happens; and

·                                                                                                     the beneficiary, and their associates, beneficially owned at least 10% of the issued units in the trust at any time during the 5 years preceding the CGT event (the disposal of the units by the beneficiary).

2.77          The proposed legislation reduces the CGT liability to make it proportional to the share of the gain which relates to any underlying Australian assets held by the OBU offshore investment trust under subsections 121D(6) and 121D(6A) where:

      the OBU offshore investment trust is a unit trust; and

      the 'Australian asset percentage' is not more than 10 per cent.

OBU income and foreign tax credits

2.78          Under the foreign tax credit system, a foreign tax credit is available only to residents for foreign tax paid on foreign income. A foreign tax credit is not available for offset against Australian tax payable on OBU income because the income is deemed to have an Australian source: section 121EJ. Instead the OBU regime allows a tax deduction: section 121EI.

2.79          Under the terms of a number of Australia's double tax agreements (DTAs), however, the source article provides that where foreign tax is paid on income, the source of the income is deemed to be in the foreign country. Where this arises the legislation makes it clear that OBUs cannot claim both a foreign tax credit and a deduction: subsection 121EI(2).

2.80          To provide for greater neutrality in the treatment of OBUs which are residents of Australia, the Government has decided to provide a foreign tax credit for foreign tax paid by these OBUs regardless of whether a DTA applies. As is currently the case, however, an OBU will not be permitted to claim both a foreign tax credit and a deduction.

2.81          OBUs which are non-residents will still be permitted to claim a deduction as they will not be entitled to a foreign tax credit.

Separate nostro and vostro account requirement

2.82          As the law now stands, OBUs are required to maintain a separate pool of funds and to keep separate identifiable records, including separate ‘nostro accounts’ in respect of OBU activities. These records must be maintained as though the OBU were a bank conducting banking activities with another person: section 262A. Vostro accounts may also be maintained by financial institutions.

2.83          In the context of Australian OBUs, nostro (our) accounts are foreign currency denominated accounts maintained by Australian OBUs with foreign banks for the purpose of settling foreign currency transactions. Vostro (your) accounts are Australian dollar accounts maintained by foreign banks with Australian OBUs for the purpose of settling foreign currency transactions.

2.84          In order to reduce compliance costs, the proposed legislation will remove the requirement to operate separate nostro or vostro accounts. However, an OBU will still need to maintain sufficient records, in accordance with generally accepted accounting principles and section 262A, to identify OBU transactions passing through the accounts.

Reduction of OBU withholding penalty tax

2.85          An OBU may be liable under section 128NB of the Act for a special penalty tax where funds, that are subject to the OBU interest withholding tax concession under section 128GB of the Act, are dealt with by the OBU in a manner excluded by the legislation. For example, where the funds are lent directly or indirectly to an Australian resident, used for general banking activities or used for other purposes by the financial institution of which the OBU is a part.

2.86          The penalty tax is imposed by the Income Tax (Offshore Banking Units) (Withholding Tax Recoupment) Act 1988 at a rate of 300 per cent on the amount of withholding tax that would have been paid if the concession had not applied.

2.87          The Government has decided that the current level of penalty is excessive. The measure will amend the Income Tax (Offshore Banking Units) (Withholding Tax Recoupment) Act 1988 to reduce the penalty tax from 300 per cent to 75 per cent. The proposed new rate is more in line with penalties applying to breaches of the OBU income tax concessions, however, it will continue to provide a significant disincentive to use funds subject to the IWT concession for general banking activities.

Explanation of the amendments

Entities eligible to apply for OBU status

2.88          Item 23 amends subsection 128AE(2) to extend the range of entities which the Treasurer may declare as OBUs. These are:

·                                   life insurance companies registered under the Life Insurance Act 1995 ; [New paragraph 128AE(2)(d)]

·                                   a company incorporated under the Corporations Law that provides funds management on a commercial basis other than solely to related persons. The company may be either:

1.       registered and included in the category of money market corporations under the Financial Corporations Act 1974 ; or [New subparagraph 128AE(2)(e)(i)]

2.       a fully owned subsidiary of a corporation in 1 above ; or [New subparagraph 128AE(2)(e)(ii)]

3.       a holder of a dealer's licence or an investment adviser's licence granted under Part 7.3 of the Corporations Law ; and [New paragraph 128AE(2)(e)(iii)]

·                                   other companies, including providers of custodial services, determined by the Treasurer to be OBUs. [New paragraph 128AE(2)(f ) ]

2.89           For the purposes of new paragraph 128AE(2)(f ) new subsection 128AE(2AA) will require the company to make a written application to the Treasurer. [Item 24] The Treasurer’s determination must specify the date when the company commences to be an OBU. [New subsection 128AE(2AB)]

2.90          The determination under new subsection 128AE(2AA) must be made in accordance with written guidelines made by the Treasurer under new subsection 128AE(2AD) . These guidelines are disallowable instruments for the purposes of section 46A of the Acts Interpretation Act 1901 . Broadly speaking, this means that the disallowable instruments must be laid before both Houses of Parliament and that either House may pass a resolution disallowing any of the instruments. [New subsection 128AE(2AE)]

Income tax exemption for offshore charities

Eligible overseas charitable institutions

2.91          Item 4 will insert a new definition into section 121C in order to define institutions which will be eligible for the exemption. Broadly, the term overseas charitable institution is defined to mean an institution whose income:

·         would be exempt from tax under item 1.1 of section 50-5 of the Income Tax Assessment Act 1997 if the charitable institution had a physical presence in Australia and incurred its expenditure and pursued its objectives principally in Australia ; and

·         is exempt from income tax in the country in which it is resident.

Investment activity - Portfolio investment for charitable institutions

2.92          The proposed amendments will insert a new activity which is described in the legislation as investment activity - portfolio investment for charitable institutions. For ease of explanation the new activity will be referred to in this document as the ‘charitable investment activity’. [Items 5 and 16 - new subsection 121D(6B)] The charitable investment activity is similar in concept to the existing portfolio investment activity under subsection 121D(6A).

2.93          The meaning of the term investment activity will be extended to include the managing as a broker, an agent, a custodian or a trustee of a portfolio investment during an investment management period for the benefit of overseas charitable institutions where the portfolio investment was made by the OBU or the overseas charitable institution. [Item 15 - new subsection 121D(6B)]

2.94          The new activity will link into the existing definition of ‘portfolio investment’ in subsection 121DA(1). This definition is to be amended by item 17 to include the management by an OBU as custodian, under a contract or trust instrument, of investments for the benefit of an overseas charitable institution.

Investment management period

2.95          The investment management period means either the whole or a part of a year of income. [New subsection 121D(6B)]

The OBU’s fee income

The Australian asset percentage

2.96          Unlike the existing portfolio investment activity under subsection 121D(6A), the charitable investment activity does not place a limit on the proportion of Australian assets which may be held in the investment portfolio. Therefore, the Australian average percentage will not be relevant when determining whether the activity constitutes a charitable investment activity.

2.97          However, from the perspective of the OBU’s fee income, the average Australian asset percentage will be relevant when determining the proportion of this income which will be subject to the concessional rate of tax. This percentage is essentially the average, over a defined period, of the monthly Australian asset percentages of the investment portfolio. The calculation of this percentage is shown below.

Monthly Australian asset percentage

2.98          The 'monthly Australian asset percentage' is, in broad terms, the percentage of Australian assets, calculated by reference to the value of the assets, in the investment portfolio for a particular month or part of a month: subsection 121DA(3). The calculation of the monthly Australian asset percentage for part of a month will be necessary where, for example, the OBU commences or ceases to manage an investment portfolio part way through the month.

2.99          The monthly Australian asset percentage must be calculated according to reasonable accounting practice and on the same basis for all months of a year of income. This allows OBUs to use their existing records to calculate the monthly Australian asset percentage. It also provides flexibility in that it does not impose any stringent timing requirements as to when the calculations must be done, as long as it is consistent during the year of income: subsection 121DA(4).

Average Australian asset percentage

2.100        The 'average Australian asset percentage' is the average, over the year of income, of the monthly Australian asset percentages: subsection 121DA(2). Item 18 will amend subsection 121DA(2) which defines the term 'average Australian asset percentage' so that a link is created with the new charitable investment activity under new subsection 121D(6B) .

Assessable OB income

2.101     In broad terms, the income from OBU activities is taxed at a rate of 10 per cent. Rather than providing a special rate of tax for this purpose, the assessable income and allowable deductions are adjusted downwards to achieve the same result. Each amount of income and each amount of allowable deduction is reduced by a fraction referred to as the 'eligible fraction'. The eligible fraction is 10 divided by the general company tax rate applicable to the year of income. As the rate of company tax is currently 36 per cent the fraction is:

                                                      10/36

2.102         Item 19 will amend subsection 121EE(3A) in order to reduce the OBU's assessable OBU income (that is, income from eligible OBU activities) by the average Australian asset percentage in respect of the portfolio investment concerned. This will have the effect of taxing the fee income derived from the non-Australian asset component of the investment portfolio at the concessional rate of 10 per cent. The fee income derived from managing the Australian asset component of the portfolio will not be eligible for the concessional tax rate and will be subject to the general company tax rate.

Allowable deductions

2.103        The reduction in the OBU's assessable OBU income (as explained in the previous paragraph) will mean that expenses incurred in managing a charitable investment portfolio will not fall within the definition of 'exclusive OBU deduction' in subsection 121EF(3). The expense will, therefore, relate to both OBU and non-OBU activities and will need to be apportioned as a general OBU deduction: subsection 121EF(4).

Example

2.104        AusOBU managed a charitable investment portfolio for three and a half months during a year of income. The portfolio comprised shares in both resident and non-resident companies. AusOBU produced reports on the portfolio it managed from its records on a monthly basis. It used this information to calculate the average Australian asset percentage.

AusOBU derived a fee of AUD57,500 for managing the portfolio.

A

B

C

D

F

Month

Total Value of the Investment Portfolio AUDm

Australian Asset Value AUDm

Monthly Australian Asset Percentage    (C ¸ B)

Average Australian Asset Percentage

1

5.0

4.5

4.5 ¸ 5.0 = 90%

 

2

5.5

5.0

5.0 ¸ 5.5 = 91%

 

3

6.0

6.0

6.0 ¸ 6.0 = 100%

 

4

5.75

5.5

5.5 ¸ 5.75 = 95%

 

 

 

 

 

94%

 

Assessable OBU income

$57,500 x 94% = $54,050

Therefore, AusOBU would be concessionally taxed on AUD3,450.

The exemptions from income tax and withholding tax

2.105        The income and gains derived by the overseas charitable institution from the assets managed by an OBU under the new charitable investment activity will be exempt from income tax. The form of the exemption will depend on whether the OBU is acting in the capacity of trustee of an OBU offshore investment trust or as custodian, broker or agent of the overseas charitable institution. Additionally, the type of income will also determine the form of the exemption.

Income tax and capital gains derived through OBU offshore investment trusts

2.106        The proposed legislation amends section 121EL to exempt income and gains of the OBU offshore investment trust derived in the course of, or in connection with, an investment activity covered by new subsection 121D(6B) . [Item 21] New paragraph 121ELA(1)(b) will exempt distributions of income from the OBU offshore investment trust to the overseas charitable institution.

Income tax and capital gains derived through OBUs acting as custodian, broker or agent

2.107        Where the investment is managed by the OBU as custodian, broker or agent, income from the charitable investment activity will be derived by the overseas charitable institution. New paragraph 121ELA(1)(a) will provide an exemption for income derived by an overseas charitable institution where:

·         the income is a payment or outgoing from an OBU; and

·         the payment or outgoing was made in relation to the OBU’s eligible activities. [Item 22]

Withholding tax exemption

2.108         Item 25 will amend paragraph 128B(3)(a) to provide an exemption from interest, dividend and royalty withholding tax in relation to income derived by an overseas charitable institution where that income is exempt under new subsection 121ELA(1) . [Item 22]

Extension of eligible OBU activities

2.109        As the proposed amendments have extensively widened the range of eligible activities (as described below) that qualify for the concessional tax treatment a summary has been included in Table 1 which appears at the end of this section.

Custodial Services

Extending the existing portfolio investment activity

2.110        The measures will extend the scope of the portfolio investment activity by allowing OBUs to make and manage investments as custodian on behalf of non-residents by amending subsection 121D(6A). [Item 13]

2.111        The term 'portfolio investment' is defined in subsection 121DA(1) as one or more investments managed by an OBU (as a broker, an agent or a trustee) under a contract or trust instrument for the benefit of a non-resident. Item 17 will amend the definition of ‘portfolio investment’ in section 121DA(1) to include the management by an OBU as custodian, under a contract or trust instrument, of investments for the benefit of a non-resident.

2.112        After these amendments the portfolio investment activity described in subsection 121D(6A) will allow an OBU to manage (as broker, agent, custodian or trustee) a portfolio investment during an investment management period for non-residents, where:

·                                                                                                     if the investments are shares in non-resident companies, units in non-resident unit trusts, land and buildings outside Australia or other foreign assets the investment is made with a non-resident;

·                                                                                                     if the investments are Australian things the investment is made with either a non-resident or resident;

·                                                                                                     the currency in which investments are made is not in Australian dollars;

·                                                                                                     the investment portfolio comprises more than one Australian thing; and

·                                                                                                     the average Australian asset percentage of the portfolio investment is 10 per cent or less.

2.113        Therefore, the expanded activity will allow OBU’s, subject to a 10% per cent limit, to manage as custodian Australian investments (e.g. shares in Australian companies, units in Australian unit trusts, land and buildings located in Australia) on behalf of non-residents.

2.114        Existing paragraph 121D(6A)(b) will also be amended to allow the non-resident investor as well as the OBU to make the investment which will be managed by the OBU. This will accommodate the situation arising under custodial services where the client makes the investment, for example purchasing an asset, and the custodian holds and deals with the investment at the direction of the client. [Item 14]

2.115        Consistent with the existing provisions, where the average Australian asset percentage in respect of the portfolio investment held under the custodial arrangement exceeds 10 per cent, the activity will not fall within the definition of a ‘portfolio investment activity' in subsection 121D(6A) and the whole of the fee income will be subject to the general company rate of tax.

The OBU’s fee income

2.116        As is currently the case, the OBU's assessable OB income from providing the services to the non-resident will be reduced by the average Australian asset percentage in respect of the portfolio investment concerned. An explanation on how this percentage is calculated is shown at paragraphs 2.96 to 2.100. This has the effect of taxing the fee income derived from the non-Australian asset component of the investment portfolio at the concessional rate of 10 per cent. The fee income derived from making and managing the Australian asset component of the portfolio will not be eligible for the concessional tax rate and will be subject to the general company tax rate: subsection 121EE(3A).

Currency trading

2.117        Item 10 inserts new paragraph 121D(4)(ea) which will allow OBUs to trade in any currency with an offshore person.

Gold trading

2.118        Item 11 repeals existing paragraph 121D(4)(f) and substitutes a provision which will apply solely to gold trading activities. New subparagraph 121D(4)(f)(i) will allow trading in gold bullion with an offshore person in any currency. New subparagraph 121D(4)(f)(ii) permits trading in gold bullion, or in options or rights in respect of such bullion, with a person other than an offshore person provided that any money payable or receivable is not in Australian currency.

Metals trading

2.119        New paragraph 121D(4)(g) will be inserted by item 11 to allow trading in silver, platinum or palladium bullion or in options or rights in respect of such bullion with an offshore person. This amendment extends the existing concessional activities by allowing trading in silver, platinum and palladium bullion with an offshore person in Australian currency.

2.120        New paragraph 121D(4)(h) expands trading activities to allow base metals trading with an offshore person in Australian currency. [Item 11]

Other trading activities

2.121        The proposed amendments to subsection 121D(4) made by items 6, 7, 8 and 9 allow trading in securities issued by non-residents, eligible contracts (where amounts payable are payable by non-residents), shares in non-resident companies and units in non-resident trusts with an offshore person to be in any currency.

Eligible contract activities

2.122     Existing subsections 121D(5) is amended by item 12 to extend eligible OBU activities to include eligible contract activities with an offshore person in Australian currency.

Hedging

2.123        Amendments to subsection 121D(8) by item 16 remove the ‘related person’ restriction.

Interest paid on offshore borrowings under 'conduit' arrangements

2.124         Item 32 repeals subsections 128GB(3) and 128GB(4) to allow back-to-back offshore loans through an OBU.

Capital gains tax exemption for disposals of interests in ‘OBU offshore investment trusts’

2.125        The proposed amendments will insert new subsection 121ELA(2) and new section 121ELB to give effect to the Government’s decision to reduce the capital gains tax liability of non-residents disposing of their units in OBU offshore investment trusts. [Item 22] The provision applying to the particular disposal will depend on whether the income, profits or gains of the trust came from an investment activity covered by existing subsections 121D(6) or 121D(6A) or new subsection 121D(6B) .

Investment activity under subsection 121D(6)

2.126        In the case of an investment activity under subsection 121D(6), OBUs are not permitted to invest in Australian assets and consequently the Australian asset percentage of the portfolio will be zero. Accordingly, new subsection 121ELB(1) provides that the non-resident makes no capital gain or capital loss from a disposal of a unit in an OBU offshore investment trust. [Item 22]

Investment activity - portfolio investment under subsection 121D(6A)

2.127        If the OBU offshore investment trust relates to an investment activity under subsection 121D(6A), the amount of the capital gain or capital loss made by a non-resident disposing of a unit in an OBU investment trust will depend on the average Australian asset percentage of the particular investment portfolio. [Item 22 - new subsection 121ELB(2)]

2.128        An explanation of the term ‘average Australian asset percentage’ is at paragraph 2.100. For the purposes of calculating the average Australian asset percentage in relation to an adjustment under new subsection 121ELB(2) , the investment management period of the portfolio investment is deemed to be the 12 month period immediately before the disposal. [New subsection 121ELB(3)]

2.129        Where the average Australian asset percentage of an OBU offshore investment trust is 10 percent or less, the capital gain or loss will be adjusted to make it proportional to the average Australian asset percentage of the portfolio. However, if the average Australian asset percentage is greater than 10 per cent, no adjustment will be permitted. [New subsection 121ELB(2)]

Example

2.130        The Happy Retirement pension fund owns 20% of the units in an offshore investment trust (the ABC unit trust). The ABC unit trust holds a portfolio which comprises 92 % foreign assets and the average Australian asset percentage is 8%. The pension fund disposes of its units and makes a capital gain of $10,000.

2.131        Under the proposed measure the capital gain would be reduced to be proportional to the average Australian asset percentage as follows:

     $10,000 x 8% = $800

Investment activity - portfolio investment for overseas charitable institution under new subsection 121D(6B)

2.132        Consistent with the Government’s decision to exempt certain overseas charitable institutions, new subsection 121ELA(2) will provide that an eligible institution makes no capital gain or capital loss from a disposal of its interest in an OBU offshore investment trust. [Item 22]

OBU income and foreign tax credits

2.133        In order to provide a foreign tax credit for foreign tax paid by an OBU item 20 inserts new subsection 121EJ(2) which deems, for the purposes of Division 18, income subject to foreign tax to have a foreign source. The existing section 121EI will continue to:

·                                   provide a deduction to non-resident OBUs for foreign tax paid (non-residents are not entitled to claim foreign tax credits); and

·                                   disallow a deduction where an OBU is entitled to claim a foreign tax credit.

Separate nostro and vostro account requirement

2.134        Item 34 removes the requirement that OBUs maintain separate nostro and vostro accounts for OBU transactions by inserting new subsection 262A(1B) .

Reduction of OBU withholding penalty tax

2.135        Item 37 amends section 7 of the Income Tax (Offshore Banking Units) (Withholding Tax Recoupment) Act 1988 to reduce the penalty tax rate of 300 per cent to 75 per cent.

Consequential amendments

2.136     Items 1, 2, and 3 are consequential amendments to subsection 121B(3) to reflect changes to the OBU regime.

2.137        Items 35 and 36 make consequential amendments to the Income Tax Assessment Act 1997 as a result of the measures.



Table 1. OBU activities that qualify for the concessional tax treatment are summarised in general terms below with relevant currency restrictions

 

Offshore persons s121E

 

Onshore Persons

Type Of Activity

Non-Resident (not a related person) s.121E(a)

Permanent Establishment of Resident s.121E(b)

Other unrelated OBUs s.121E(c)

Related Persons  s.121C

Branch of non-resident

Resident

Borrowing 121D(2)(a)

any currency

non-AUD

any currency

non-AUD

 

 

Lending 121D(2)(b)

any currency

non-AUD

any currency

any currency

 

 

Guarantees 121D(3)

any currency

any currency

any currency

non-AUD

 

 

Trading in currency 121D(4)(e) and (ea)

any currency 121D(4)(ea)

any currency 121D(4)(ea)

any currency 121D(4)(ea)

any currency 121D(4)(ea)

non-AUD 121D(4)(e)

non-AUD 121D(4)(e)

Trading in base metals 121D(4)(h)

any currency

any currency

any currency

any currency

 

 

Trading in gold 121D(4)(f)(i)&(ii)

any currency

any currency

any currency

any currency

non-AUD 121D(4)(f)(ii)

non-AUD 121D(4)(f)(ii)

Trading in platinum silver, and palladium 121D(4)(g)

any currency

any currency

any currency

any currency

 

 

Trading on Sydney Futures Exchange 121D(4)(d)

non-AUD

non-AUD

non-AUD

non-AUD

non-AUD

non-AUD

Other Trading 121D(4)(a) (b) and (c)

any currency

any currency

any currency

any currency

 

 

Eligible Contract Activity 121D(5)

any currency

any currency

any currency

any currency

 

 



 

 

Offshore persons s121E

 

Onshore Persons

Type Of Activity

Non-Resident (not a related person) s.121E(a)

Permanent Establishment of Resident s.121E(b)

Other unrelated OBUs  s.121E(c)

Related Persons  s.121C

Branch of non-resident

Resident

Investment 121D(6)

non-AUD

 

 

If non-resident offshore person -     non-AUD

 

 

 

Portfolio Investment includes custodial services 121D(6A)

non-AUD

 

 

If non-resident  non-AUD

non-AUD

 

 

Portfolio investment for overseas charitable institutions

 

This activity can only be undertaken with eligible overseas charitable institution. There are no currency restrictions.

 

Advising 121D(7)

This activity can only be undertaken with offshore persons. Currency is not relevant.

 

 

 

Hedging 121D(8)

any currency

any currency

any currency

any currency

 

 

 

Key: A greyed cell means this activity is not available;

         All legislative references are to provisions of the Income Tax Assessment Act 1936.

 

 



 

Section 3      Thin Capitalisation

Background to the legislation

2.138        The thin capitalisation rules of the income tax law, contained in Division 16F of Part III of the Income Tax Assessment Act 1936, are anti-avoidance measures aimed at limiting the amount of interest that can be claimed as a deduction in relation to certain foreign controlled entities and investments.

2.139        Thin capitalisation of investments in Australia is influenced by the preferential taxation treatment provided to debt funding relative to equity funding. In relation to the foreign debt of an Australian company, interest paid by the company is deductible against its income - and the interest paid to the foreigner is normally only subject to IWT at the rate of 10 per cent. However in relation to foreign equity, dividends paid to the foreign shareholders are generally paid from profits that have been subject to the 36 per cent company rate of tax and, under the imputation system, are not subject to dividend withholding tax. The difference between the treatment of debt funding and equity funding creates the incentive for foreign controllers to maximise the debt funding and minimise the equity funding of their investments in Australia.

2.140        The thin capitalisation rules place a limit, by means of a specified debt-to-equity funding ratio, on the amount of interest expense payable in relation to foreign debt that can be deducted for Australian tax purposes. If a taxpayer exceeds the gearing ratio, deductions for interest paid on the related-party debt are disallowed to the extent of the excess. The ratio of related-party foreign debt-to-equity cannot exceed 6:1 for financial institutions, and 2:1 for other taxpayers. The higher ratio of 6:1 is allowed for financial institutions in recognition of their special funding needs.

2.141        The ‘foreign debt’ of an Australian resident company is the interest-bearing debt which is owed to foreign controllers or their non-resident associates. For these purposes, a foreign controller is any non-resident that has substantial control of the voting power of the company, or is beneficially entitled to receive at least 15% of any dividends or other distribution of capital.

2.142        The ‘foreign equity’ of an Australian resident company is equivalent to the paid-up share capital and the opening balances of the accumulated profits and asset revaluation reserves beneficially owned by foreign controllers and their non-resident associates. As an anti-avoidance measure, the foreign equity is reduced by any amounts that have been loaned back to the foreign controller or non-resident associates. Thus, only the net amount will be treated as foreign equity. This is necessary to ensure that the foreign equity cannot be artificially inflated by lending back equity to foreign controllers which could then re-inject the funds into the Australian company as new share capital.

Interaction with Interest Withholding Tax regime

2.143        Interest withholding tax is ordinarily payable on interest paid by businesses in Australia to non-residents, subject to some broad exceptions. The IWT regime contains an exemption for interest paid by Australian resident companies on certain debentures that satisfy a public offer test (section 128F). This exemption is only available to Australian companies - it is not available to an Australian branch of a foreign bank.

2.144        However, foreign banks operating in Australia through branches are entitled to have an associated Australian company raise funds overseas under the section 128F exemption, and then on-lend those funds for use in the Australian branch. Companies established for this purpose are held to be ‘financial institutions’ for the purposes of the thin capitalisation rules by virtue of the definition provided in section 159GZA, and are therefore entitled to the increased gearing ratio of 6:1. The structure is illustrated in the following diagram.

Structure to enable foreign bank branch in Australia to access section 128F IWT exempt funds

 

Foreign Controller (Bank)

 

(Bank)

 
                                                                 Raises funds

                                                                 under section 128F

                                                                 IWT exemption

 

 

 



                            same  entity             subsidiary

 

Australian Financial Institution

 
 

 

 

 

 



                             On-lends funds

                             to related bank

                             branch

Explanation of the amendments

2.145        When a financial institution raises section 128F funds and on-lends those funds to a related foreign bank branch in Australia, paragraph 159GZG(1)(d) could apply to reduce the foreign equity of the financial institution. This is because funds that are on-lent to the branch are treated as a loan back to the foreign bank - since the branch is a part of the same legal entity as the foreign bank. The reduction of the financial institution’s foreign equity would limit its ability to raise funds from its foreign controller or non-resident associates.

2.146        This amendment will introduce new sub-subparagraph 159GZG(1)(d)(i)(C), which will allow the financial institution to on-lend funds raised under the section 128F exemption to a related Australian bank branch, without reducing the financial institution’s foreign equity. In order to prevent the foreign bank from artificially increasing its equity in the financial institution, the amendment is only available where the Australian bank branch can show that the funds made available are for use in its Australian business [item 33; new sub-subparagraph 159GZG(1)(d)(i)(C)] .

Section 4      Application - Withholding tax, OBU and Thin Capitalisation measures

2.147        The amendments made by Part 1 of Schedule 3 apply in relation to transactions entered into after the date of introduction. However, several specific application provisions are provided by Item 38 :

·                                                                                                     Item 20 applies to foreign tax paid after the date of introduction;

·                                                                                                     New subsection 121ELA(2) and new section121ELB apply to disposals after the date of introduction;

·                                                                                                     Items 23 and 24 apply to declarations made by the Treasurer after the date of introduction;

·                                                                                                     Items 26 to 31 apply to debentures issued after the date of introduction;

·                                                                                                     Item 32 applies to interest paid by an OBU after the date of introduction;

·                                                                                                     Item 33 applies in relation to amounts lent to Australian branches after the date of introduction;

·                                                                                                     Item 34 applies to the year of income before the year of income in which the date of introduction occurs and all later years of income; and

·                                                                                                     Item 37 applies to penalties imposed after the date of introduction.



Section 5  Regulation impact statement

Part 1 - Withholding Tax, Offshore Banking Units and Thin Capitalisation

Policy objective

2.148        On 8 December 1997 the Prime Minister announced, as part of the Investing for Growth Statement (the Statement), a package of measures which, among other things, are designed to further enhance Australia's credentials as a world financial centre. In particular, measures included in the 'Australia - A Regional Financial Centre' component of the Statement are aimed at making Australia a more attractive regional financial centre by building on Australia's existing advantages to ensure its participation in the increasing global trade in financial services.

Developing Financial Markets

2.149        In order to encourage the development of the domestic corporate debt market the Government announced a widening of the section 128F interest withholding tax (IWT) exemption by removing, for eligible debentures issued by companies, the present requirements that they be issued outside Australia and that the interest be paid outside Australia.

Competitive Offshore Banking Regime

2.150        For several years, Australia has provided a special Offshore Banking Unit (OBU) taxation regime intended to promote the provision of financial services for transactions between offshore parties. The regime exempts certain offshore parties from Australian taxes and provides an effective 10 per cent tax rate on the taxable income of OBUs, the financial intermediaries to these transactions. Most of the new tax measures seek to reduce tax burdens on income from offshore investments made by non-resident investors and on OBUs managing this business. Other measures seek to reduce compliance costs on OBUs undertaking this business from Australia.

Thin Capitalisation

2.151        In order to provide the Australian branches of Foreign Banks greater access to IWT exempt funds, the thin capitalisation measures will be relaxed. This will enable foreign owned financial institutions to raise IWT exempt funds and on-lend those funds to their related Australian bank branches without affecting the financial institution's thin capitalisation position.

Implementation options

2.152        In considering the options available it was decided that the possible option of implementing selective parts of the proposed package was not valid because it would undermine the achievement of the policy objective.

2.153        It is necessary to amend the Income Tax Assessment Act 1936 in order to implement the policy objectives outlined in the Statement. The amendments will take effect from the date of introduction. The following implementation options have been identified:

Section 128F IWT Exemption

(a)     Widen the IWT exemption in respect of corporate issues in relation to registered and bearer debentures to allow:

·         registered debentures to be issued in Australia to residents and non-residents

·         bearer debentures to be issued in Australia to non-residents only; and

·         interest to be paid in Australia.

Offshore Banking Regime

(b)     Expand the range of persons eligible to be an OBU to include:

·         funds managers, which are money market corporations subject to the Financial Corporations Act 1974 or fully owned subsidiaries of these corporations;

·         holders of securities dealers' licences under the Corporations Law ;

·         holders of investment advisers' licences under the Corporations Law ;

·         life insurance companies registered under the Life Insurance Act 1995 ; and

·         other companies (including providers of custodial services) as determined by the Treasurer.

Broadly speaking, the OBU regime will be extended to include funds managers, life insurance offices and providers of custodial services.

(c)     Exempt from tax all income and gains of offshore charitable institutions where:

·         the investments which give rise to the income or gains are managed by an OBU; and

·         the charitable institution is exempt in its home jurisdiction.

There will be no limitation placed on the proportion of Australian assets that may be held on behalf of the charitable institutions. However, OBUs will only be eligible for the 10 per cent concessional tax rate on the component of the management fee which relates to the offshore assets. The component relating to the Australian assets will be taxed at the full company rate.

(d)     Extend the range of eligible OBU activities to include custodial services provided to non-residents.

(e)     Extend the range of eligible OBU activities to include:

·                                                                                                     trading;

·         eligible contract activities; and

·         hedging activities

in Australian currency with offshore persons.

(f)      Extend the range of eligible OBU activities in gold trading to include:

·         gold bullion trading with an offshore person in any currency; and

·         gold bullion trading with residents and non-residents operating through a permanent establishment in Australia in any currency other than AUD.

(g)     Allow trading in base metals and palladium in any currency with offshore persons as eligible OBU activities. This measure was not announced in the Statement. The Government has decided to extend the concession following Industry representations.

(h)     Remove the current anti-avoidance measure which prevents Australia being used as a conduit to channel loans to other countries by repealing subsections 128GB(3) and 128GB(4).

(i)      Reduce the capital gains tax (CGT) liability of non-residents disposing of their units in an OBU offshore investment trust. This measure reduces the CGT liability to make it proportional to the share of the gain which relates to any underlying Australian assets where they constitute less than 10 per cent of the investment portfolio.

(j)      Allow Australian OBUs a foreign tax credit where OBU income is subject to foreign taxes regardless of whether a double taxation agreement (DTA) applies.

(k)     Remove the current requirement for OBUs to maintain separate nostro and vostro accounts for OBU transactions.

(l)                                                   Reduce the rate of OBU withholding penalty tax from 300 per cent to 75 per cent to bring it more into line with the penalties which apply to breaches of the OBU income tax concession.

Thin Capitalisation measures

(m)                                               Relax the effect of the thin capitalisation “loan back” provisions so that an Australian subsidiary of a foreign bank may raise section 128F IWT exempt funds and on-lend those funds to a related Australian branch without affecting the subsidiary’s thin capitalisation position.

Assessment of impacts (costs and benefits) of each implementation option

Impact group identification

2.154        The affected groups are financial intermediaries for whom non-residents are a significant client group, primarily banks and funds managers, and non-residents investing in or through Australia. World-wide the financial system has grown significantly over the past three decades. Australia is already participating in the international trade in financial services. Over the six years to 1996-1997 exports of financial services grew by more than 20 per cent. By increasing its role as a financial centre Australia can capitalise on opportunities for export growth.

2.155        The OBU related measures most effect those intermediaries that are eligible, or will under the measures become eligible, to operate as OBUs. Increased use of the OBU concessions may impose some additional administration costs on the Australian Taxation Office (ATO). The section 128F measure will be of particular benefit to corporate borrowers. The package will have a relatively small impact on Government revenue.

2.156        All of the measures address issues raised by taxpayers (or their representatives) consulted in the preparation of the package. The measures can therefore be expected to generally be welcomed by taxpayers, although some may consider that more far reaching measures are warranted.

Analysis of the costs and benefits associated with each implementation option

2.157        Quantitative data on the compliance and administrative costs of the measures have not been estimated. The assessment in this section is therefore of a qualitative nature. The measures represent a package which is aimed at providing greater certainty and reducing compliance costs and tax burdens in relation to financial sector activities.

Section 128F IWT Exemption

(a)                                                 Widening the section 128F IWT exemption will simplify the compliance arrangements for corporate issuers wishing to access the concession. Such borrowers will no longer be required to issue offshore in order to access the concession.

Offshore Banking Regime

(b)                                                 Expanding the range of entities eligible to be an OBU to include funds managers, life insurance offices and providers of custodial services will allow a broader range of financial market participants access to the concessional OBU tax regime. There is expected to be a small cost to revenue as some existing activities carried out under the standard taxation arrangements are transferred to the concessional regime. To the extent that greater use is made of the concessional regime there may be additional administrative costs for the ATO. However, expanding access to the concessions is expected to result in a deepening of the market and an increase in the amount of business generated, resulting in increased revenue.

(c)                                                 Exempting from tax the income and capital gains of offshore charitable institutions, managed by an OBU and exempt in their home jurisdiction, will provide a source of new business for OBUs. It will also provide scope for offshore charitable institutions, whose general exemptions were recently removed under the anti-avoidance measures relating to charitable trusts, to regain exempt status.

(d)                                                 Extending the range of eligible OBU activities to include custodial services provided to non-resident offshore persons will reduce uncertainty about the scope of eligible OBU activities. This measure will negatively effect revenue to the extent that these activities are currently undertaken within the standard taxation regime without concessional procedures.

(e), (f) & (g)          The eligible OBU activities involving trading, eligible contract, hedging and gold trading will all be expanded by the new amendments. Trading in base metals and palladium will also be allowed as eligible OBU activities. These measures will reduce tax burdens and negatively effect revenue to the extent that these activities are currently undertaken outside the concessional regime. Compliance costs may be reduced to the extent that the restrictions on OBU activities are less binding.

(h)                                                 Removing the section 128GB(3) exclusion from the OBU IWT exemption of ‘conduit’ arrangements will reduce uncertainty as to the provision’s application and remove complexity from the tax law.

(i)                                                   Reducing the CGT liability of non-residents disposing of their units in an OBU offshore investment trust will make these vehicles more attractive to non-resident investors. The measure will lower tax burdens on investors in these trusts, but do so at the expense of additional tax law complexity. There may be minor costs associated with OBUs assessing the underlying percentage of Australian assets. This concessional measure will negatively affect tax revenue from existing OBU offshore investment trust sources. However, this could be counterbalanced by the expected rise in new business utilising these financial instruments as a result of the concession.

(j)                                                   Allowing Australian OBUs a foreign tax credit (FTC) where OBU income is subject to foreign taxes, regardless of whether a DTA applies, may allow OBUs to reduce their tax burdens in some circumstances. There may be some increase in compliance costs to the extent that the FTC rules are more onerous to comply with than simply claiming a deduction for foreign tax. This is more than offset by the reduction of the OBU's tax burden achieved by including foreign tax credits instead of a deduction.

(k)                                                 Removing the current requirement for OBUs to maintain separate nostro and vostro accounts will reduce compliance costs for OBUs. There may be additional administrative costs for the ATO. The amendment is revenue neutral.

(l)                                                   The current level of penalties is considered excessive. Reducing the penalty tax from 300 per cent to 75 per cent will more closely align the penalties to those applying to the breaches of the OBU income tax concession. There will not be an additional administrative cost for the ATO.

Thin capitalisation measures

(m)                                               Relaxing the “loan back” provisions of the thin capitalisation regime will make it easier for Australian branches of Foreign Banks to access section 128F IWT exempt funds from their related Australian subsidiaries. This measure will reduce the tax burden of the Australian subsidiaries and have a negligible effect on revenue. The amendment will have minimal impact on compliance and administrative costs.

Consultation

2.158        The measures have been developed in close consultation with certain tax advisory practices with particular expertise in the financial services sector and with other financial market participants.

2.159        As part of the package, a task force within the Financial Sector Advisory Council (FSAC) was established as an ongoing consultative forum which will maintain a focus on the effectiveness of the measures and which will report on further options which could boost Australia's attractiveness as a financial centre.

Conclusion

2.160        The package of measures is the Government's preferred method for achieving the policy objective of making Australia a more attractive regional financial centre. Overall, the package is expected to reduce compliance costs.

2.161        The Treasury and the ATO will monitor this package of measures as part of the whole taxation system on an ongoing basis. Furthermore, the task force within the FSAC will provide advice on the effect of the measures on Australia’s attractiveness as a regional financial centre.



Part 2 - Exemption from the foreign investment fund (FIF) measures for interests in certain FIFs resident in the United States (US)

Overview of the FIF measures

2.162        Part 2 of Schedule 3 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to provide an exemption from the FIF measures for interests in certain US FIFs. The exemption forms part of a package of measures entitled “Investing for Growth” directed at developing and promoting Australia as a regional financial centre announced by the Treasurer on 8 December 1998.

2.163        The amendments will:

      provide an exemption from the FIF measures for interests in certain FIFs taxed on a worldwide basis in the US ( Section 1 );

      provide a limited exemption for interests in certain FIFs taxed as conduit entities in the US ( Section 1 ); and

      make these exemptions available when determining FIF income under the calculation method ( Section 2 ).

2.164        Consequential amendments will also be made to ensure:

      the general trust provisions do not claw back the benefits of providing the exemption ( Section 3.1 ); and

      the trustee of a trust FIF that qualifies for the exemption is taxed on the Australian source income of the trust under the general trust provisions ( Section 3.2 ).

2.165        A regulation impact statement for the changes is provided in Section 4 .

2.166        Unless otherwise stated, references to provisions of the law in Part 2 of this Chapter are references to provisions of the Act and item references are to Schedule 3 of the Bill.

Section 1  Exemption from the FIF measures

Summary of the amendments

Purpose of the amendments

2.167        The amendments will:

      provide an exemption from the FIF measures for interests in certain FIFs taxed on a worldwide basis in the US; and

      provide a limited exemption for interests in certain FIFs taxed as conduit entities in the US.

[Item 41]

Date of effect

2.168        The exemption will apply for notional accounting periods of FIFs ending on or after the date of introduction of the Bill . [Subitem 45(1)]

Background

2.169        The FIF measures (Part XI of the Act) apply to Australian residents who have an interest in a foreign company or foreign trust at the end of a year of income. Broadly, the FIF measures operate to approximate a resident taxpayer's share of the undistributed profits of a FIF (called FIF income) and assess the taxpayer on those profits. This treatment is directed at preventing deferral of Australian tax where profits are accumulated offshore in a FIF rather than remitted to Australian investors.

2.170        Exemptions from the FIF measures are provided for a wide range of investments in company FIFs engaged in active businesses where the risk of tax deferral is not likely to be significant. FIF investments subject to the controlled foreign company or transferor trust measures are also exempt.

Explanation of the amendments

2.171     The amendments will provide a further exemption from the FIF measures for interests in certain US FIFs. The exemption is intended to encourage Australian investment funds to be more efficient by exposing them to competition from US funds. The substantial similarity of US tax rules to those in Australia will ensure tax deferral opportunities do not arise because of the exemption.

2.172        The exemption will be inserted as Division 8 in Part XI of the Act. [Item 41] Division 8 previously contained an exemption from the FIF measures for approved country funds and was repealed with effect for notional accounting periods [1] of FIFs commencing on or after 1 January 1997.

What kinds of FIF interests qualify for the exemption?

2.173        The exemption will be available for FIF interests in:

      entities that are treated as corporations and are subject to tax on their worldwide income under the US Internal Revenue Code of 1986;

      regulated investment companies; and

      real estate investment trusts. [New subsection 513(1)]

Regulated investment companies and real estate investment trusts are fully distributing investment funds used widely in the US as vehicles for managing collective investments.

2.174        A limited exemption will be available for FIF interests in:

      limited liability companies taxed as partnerships in the US;

      limited partnerships taxed as partnerships in the US; and

      common trust funds. [New subsections 513(2), (3), (4) & (5)]

2.175     Note: If a limited liability company or a limited partnership is treated as a corporation and is subject to tax on its worldwide income under the US Internal Revenue Code 1986, it will qualify for the exemption under new subsection 513(1).

2.176     Limited liability companies and limited partnerships taxed as partnerships in the US and common trust funds are also commonly used as investment vehicles in the US. Only a limited exemption is to be provided for these entities, however, because they are taxed in the US as conduit entities and consequently they are not directly liable for US tax. The US tax liability is instead borne by investors in a conduit entity and Australian investors are generally not subject to tax in the US on non US source income derived through a conduit entity. An unqualified exemption for conduit entities could therefore create a significant risk to the revenue because it would allow Australian investors to hold non US investments through a conduit entity and be exempt from anti tax deferral rules in both Australia and the US.

2.177        The exemption will be available for interests held in the above mentioned conduit entities (referred to below as “specified conduit entities”) only where those interests are held for the sole purpose of investing directly, or indirectly through other entities, in a business conducted in the US and/or real property located in the US. [New paragraphs 513(3)(a) & (4)(a)] The sole purpose test will be satisfied for an interest held in a specified conduit entity if:

      the interest is held for the purpose of investing directly, or indirectly through other entities, in a business conducted in the US and/or real property located in the US; and

      the interest is not held for the purpose:

-      of making other types of investment in the US either directly or indirectly through other entities; or

-      of investing outside the US either directly or indirectly through other entities.

2.178     The types of investment covered by the second dot point will be referred to below as non-qualifying investments.

2.179     It is possible for an interest in a specified conduit entity to satisfy the requirements of the test even though the entity directly or indirectly makes non-qualifying investments. The test could be satisfied, for instance, if a taxpayer were to hold an interest in the entity for the purpose of investing into the US and it is incidental that the entity also has some non-qualifying investments.

2.180     The limited exemption is divided into two parts . [New subsection 513(2)] The first part provides an exemption for interests held in specified conduit entities that do not directly, or indirectly through other conduit entities, have non-qualifying investments. [New subsection 513(3)] There is a low risk of tax deferral benefits arising for investments through these entities because the US will normally tax Australian residents on an amount derived through a conduit entity if the amount arises from the conduct of a US business or from the disposal of real property located in the US.

2.181     The second part provides an exemption for interests held in specified conduit entities that directly or indirectly through other conduit entities, have some non-qualifying investments. [New subsection 513(4)] Tighter rules are required before an exemption can be provided for these interests because amounts derived by Australian residents through a conduit entity from sources outside the US are, for instance, unlikely to be taxed in the US.

2.182     Two ratios are used to limit the extent to which a specified conduit entity can hold non-qualifying investments. The first ratio provides that no more than five percent of a conduit entity’s FIF interests can be in FIFs that do not satisfy either the requirements for obtaining an unqualified exemption under new subsection 513(1) or the requirements of the first part of the limited exemption under subsection 513(3). [New paragraph 513(4)(b)] The following table summarises FIF interests held by a conduit entity that are to be taken into account in determining the 5 percent limit.

Table 1 - FIF interests counted towards the 5% limit

Value of FIF interests held in:

Counted towards the 5% limit?

Corporations that are subject to tax on their worldwide income under the US Internal Revenue Code of 1986

No

Regulated investment companies

No

Real estate investment trusts

No

Specified conduit entities that do not have non-qualifying investments (ie, specified conduit entities that satisfy the first part of the limited exemption)

No

Specified conduit entities that have non-qualifying investments but satisfy the second part of the limited exemption

Yes

Other FIFs

Yes

 

2.183        The calculation of the 5 percent limit is illustrated by the following example.

Example 1 -            Calculation of the 5% limit

Facts

            A US common trust fund holds interests in FIFs as shown in the following table.

FIF interests held in:

Value ($Million)

Counted towards the 5% limit?

Corporations that are subject to tax on their worldwide income under the US Internal Revenue Code of 1986

3

No

Regulated investment companies

5

No

Real estate investment trusts

1

No

Specified conduit entities that do not have non-qualifying investments (ie, specified conduit entities that satisfy the first part of the limited exemption)

1

No

Specified conduit entities that have non-qualifying investments but satisfy the second part of the limited exemption

2

Yes

Other FIFs

0

Yes

 

Consequences

In this case, the ratio would be calculated as 0.16 (ie, $2 million (total value FIF interests counted towards the 5% limit) / $12 million (total value of FIF interests)). Expressed as a percentage, a ratio of 0.16 means 16 percent of the common trust fund’s interests in FIFs are in non-eligible FIFs. An interest held in the common trust fund would therefore not qualify for the exemption because the fund’s interests in non-qualifying FIFs exceed the 5 percent limit.

2.184        The second ratio provides that no more than five percent of a specified conduit entity’s assets can produce income from sources outside the US or give rise on disposal to gains from sources outside the US. [New paragraph 513(4)(c)]

2.185     The ratios are to be determined using the value of FIF interests and assets shown in the accounting records of a specified conduit entity. [New subsection 513(5)] The ratios cannot be exceeded at any time during the notional accounting period of the entity. [New paragraphs 513(4)(b) & (c)]

2.186     The primary test for availability of the limited exemption is the purposive test, discussed previously, that an interest in a FIF must be held for the sole purpose of investing in the US and/or in real property located in the US. The role of the ratios is to limit the extent to which other investments held through a FIF will be accepted as incidental. A purposive test has been used as the primary test to prevent possible abuse of the limited exemption that could occur if a way were found to manipulate the ratios.

Treatment of interests held in controlled foreign trusts

2.187        The exemption will not be available for interests held in controlled foreign trusts. [New section 512A] These interests are currently exempt from the FIF measures under section 493.

2.188        The consequential amendments to the rules for taxing distributions from foreign trusts where an interest in a foreign trust qualifies for the exemption (refer to Section 3) will therefore not affect the taxation of distributions from controlled foreign trusts.

Summary of the availability of the exemption

2.189        The following table shows the availability of the exemption:

Table 2 -  Availability of the exemption from the FIF measures for interests in US FIFs

FIF interests held in:

Treatment

Corporations that are subject to tax on their worldwide income under the US Internal Revenue Code of 1986

Exempt*

Regulated investment companies

Exempt*

Real estate investment trusts

Exempt*

Limited liability companies taxed as partnerships in the US

Limited exemption*

Limited partnerships taxed as partnerships in the US

Limited exemption*

Common trust funds

Limited exemption*

Other US FIFs

Not exempt

*            The exemption is not available if the FIF interest is in a controlled foreign trust.

Section 2         Modifications to the calculation method for determining notional FIF income

Summary of the amendments

Purpose of the amendments

2.190        The amendments will ensure the exemption from the FIF measures for interests held in certain US FIFs is available when determining FIF income under the calculation method. This treatment will allow taxpayers to invest through up to two tiers of conduit entities that have significant investments in countries outside the US and still obtain the benefit of the exemption for investments held by the entities in US FIFs. [Items 42, 43 & 44]

Date of effect

2.191        The amendments to the calculation method will apply in relation to assessments for income years ending on or after the date of introduction of the Bill. [Subitem 45(2)]

Background

2.192        Under the calculation method (one of three methods available for determining FIF income), a FIF’s profits are determined using rules similar to (but simpler than) those that apply to determine the taxable income of a resident taxpayer. FIF income arises under this method equal to a taxpayer’s share of the calculated profit of a FIF. The share is based on a taxpayer’s interest in the FIF.

2.193        FIF income may notionally be included in the calculated profit of a FIF where the FIF has an interest in another FIF, called a second tier FIF (section 576). Notional FIF income can also arise where a second tier FIF has an interest in a third tier FIF and the calculation method is applied to determine the notional FIF income of the second tier FIF (section 579). Exemptions from the FIF measures are currently not available when determining notional FIF income from an interest in a second or third tier FIF (paragraph 575(2)(c)).

Explanation of the amendments

2.194        The exemption for interests in certain US FIFs will be available when determining notional FIF income under the calculation method. This will be achieved by amending paragraph 575(2)(c) to allow the exemption to be claimed when notionally applying the FIF rules under sections 576 and 579. Under this approach, sections 576 and 579 will no longer operate to include an amount of notional FIF income from an interest in a second or third tier FIF if the interest qualifies for the exemption. [Item 44]

2.195        The following example demonstrates how providing the new exemption when determining the calculated profit of a FIF will allow taxpayers to invest through up to two tiers of conduit entities that have significant investments in countries outside the US and still obtain the benefit of the exemption for investments held by the conduit entities in US FIFs.

Example 2 - Impact of providing the new exemption when determining the calculated profit of a FIF

Facts

            A resident taxpayer has a 10 percent interest in a US common trust fund that has the following FIF interests.

FIF interests held in:

Value ($Million)

Exempt?

Corporations that are subject to tax on their worldwide income under the US Internal Revenue Code of 1986

3

Yes

A wholly owned US limited partnership that holds FIF interests outside the US of $1.5 million and FIF interests in regulated investment companies of $0.5 million

2

No

 

·                The structure is illustrated by the following diagram.

            The taxpayer elects to use the calculation method to determine:

-                                                                       FIF income arising from the common trust fund; and

-                                                                       notional FIF income for inclusion in the calculated profit of the common trust fund for the trust’s interest in the US limited partnership.

            No amounts are derived by the common trust fund or the limited partnership.

Consequences

The calculated profit of the common trust fund will not include FIF income from its interests in the US companies because these interests will qualify for the new exemption. FIF income may notionally arise, however, for the interest held in the US limited partnership.

In determining the FIF income that arises from the limited partnership under the calculation method, the interest held by the US limited partnership in the regulated investment company will not give rise to notional FIF income because the interest will qualify for the new exemption. An amount of FIF income is likely to arise, however, for the interests the limited partnership holds in non US FIFs.

The net result is that notional FIF income will arise only for interests in non US FIFs held indirectly by the common trust fund through the limited partnership. The direct interests held by the common trust fund in the US companies and the interest held indirectly in the regulated investment company will be exempt from the notional application of the FIF rules in determining the calculated profit of the FIF.

2.196        Section 564, which excludes from notional income a dividend or distribution derived from another FIF, will generally not apply to dividends or distributions derived from a US FIF that qualifies for the new exemption. [Item 42] The exclusion under section 564 is provided to prevent double taxation that could occur if amounts included in notional FIF income under sections 576 and 579 were again included on distribution from a second or third tier FIF. The exclusion will now generally not be required for distributions from second or third tier FIFs that qualify for the new exemption because interests in these FIFs will not be taxed on an accruals basis.

2.197        The following example shows how an interest held by a FIF in a second tier US FIF that qualifies for the new exemption will be taxed under the calculation method both before and after the changes.

Example 3 -            Taxation of second tier FIF interests under the calculation method before and after the changes

Facts

            A second tier FIF that qualifies for the new exemption has $100 notional FIF income.

            The second tier FIF distributes an amount of $100 from the profits that gave rise to notional FIF income.

Current treatment

Before the amendments, the $100 notional FIF income from the second tier FIF would be included in the notional income of the first tier FIF under section 576. Section 564 would prevent double taxation by excluding the $100 distribution from the first tier FIF's notional income. The profits that give rise to the notional FIF income of the second tier FIF are therefore taxed on an accruals basis under the FIF measures and are exempt on distribution by the second tier FIF.

Treatment after the changes

After the amendments, no amount will be included in the notional FIF income of the first tier FIF under section 576. The $100 distribution would be included in the notional income of the first tier FIF, however, because section 564 will no longer apply to exclude the amount. The profits of the second tier FIF will therefore be taxed at the time the FIF makes a distribution.

2.198        Under new subsection 564(2), the exclusion under section 564 will continue to be available for distributions from second or third tier FIFs if those distributions are paid from profits that have previously been accruals taxed under the FIF measures. Profits derived by newly exempted FIFs may have been taxed previously if, for instance, notional FIF income arose for a second or third tier FIF in a period prior to the operation of the new exemption. [Item 43]

2.199        The exclusion will be available where a distribution derived by a FIF gives rise to a FIF attribution debit for a taxpayer in relation to the entity that makes the distribution. A FIF attribution debit arises where a distribution is made from profits that have previously been taxed on an accruals basis under the FIF measures. The amount of a distribution excluded under section 564 will equal the grossed-up amount of a FIF attribution debit (section 607A) that arises. The grossed-up amount is calculated by dividing the amount of the FIF attribution debit by a taxpayer’s attribution percentage in the FIF that receives the distribution.

2.200        The following example shows how to calculate the amount excluded under section 564 where a distribution made by a second tier FIF gives rise to a FIF attribution debit in relation to an attributable taxpayer.

Example 4 -            Calculation of the excluded amount where a FIF attribution debit arises for a distribution made by a FIF

Facts

            A resident taxpayer has a 10% interest in a first tier US FIF.

            The first tier FIF has a 25% interest in a second tier FIF that qualifies for the new exemption.

            The second tier FIF has a FIF attribution surplus of $1,000 in relation to the resident taxpayer due to the operation of the FIF rules in a period prior to the introduction of the new exemption.

            The second tier FIF distributes $100,000 to the first tier FIF - the first tier FIF derives no other amounts during the period and has no other FIF interests.

            The calculation method is used to determine the FIF income to be attributed to the resident taxpayer from the first tier FIF.

Consequences

Section 564 will operate to exclude the distribution made by the second tier FIF from the notional income of the first tier FIF to the extent of the amount of the grossed-up attribution debit that arises in relation to the resident taxpayer. An attribution debit of $1,000 will arise as a result of the distribution (ie, the lesser of the attribution surplus ($1,000) and the amount of the distribution ($100,000) multiplied by the resident taxpayer’s FIF attribution account percentage in the first tier FIF (10%)). The grossed-up amount of the attribution debit will therefore be $10,000 (ie, the amount of the FIF attribution debit ($1,000) divided by the resident taxpayer’s FIF attribution account percentage in the first tier FIF (10%)). Accordingly, $10,000 of the $100,000 distribution will be excluded from the notional income of the first tier FIF under section 564.

Section 3  Consequential amendments

2.201        Consequential amendments will be made to ensure:

      the general trust provisions do not claw back the benefits of providing the new exemption (discussed in Section 3.1 ); and

      the trustee of a trust FIF that qualifies for the new exemption is taxed on the Australian source income of the trust under the general trust provisions (discussed in Section 3.2 ).

Section 3.1      Exemption from section 97 of the general trust provisions for interests in US trust FIFs that qualify for the exemption

Summary of the amendments

Purpose of the amendments

2.202        The amendments will ensure section 97 of the general trust provisions does not claw back the benefits of providing the exemption from accruals taxation for US trust FIFs. [Item 39]

Date of effect

2.203        The amendments will apply in relation to assessments for income years ending on or after the date of introduction of the Bill. [Subitem 45(2)]

Background

2.204        Currently subsection 96A(1) ensures that the deemed entitlement rules in the general trust provisions (sections 96B and 96C) do not apply where an interest in a foreign trust is subject to the FIF measures. These rules operate through section 97 of the general trust provisions to accruals tax Australian beneficiaries on their share of the undistributed profits of a foreign trust. Subsection 96A(1) prevents double taxation by ensuring the deemed entitlement rules under the general trust provisions do not apply to an interest in a foreign trust that is subject to the FIF measures.

2.205        The rules to prevent double taxation in subsection 96A(1) would currently not apply, however, to an interest in a trust FIF that qualifies for the new exemption because subsection 96A(1) only applies to interests in foreign trusts that are subject to the FIF measures. The benefits of providing the exemption could therefore be lost because an interest in a US trust FIF that qualifies for the exemption would become subject to the deemed entitlement rules in the general trust provisions. The potential for benefits of providing the new exemption to be clawed back is demonstrated by the following example.

Example 5 -            Potential clawback of the new exemption under sections 96B & 96C

Facts

            A US common trust fund that qualifies for the new exemption is calculated to have net income of $1 million.

            The trust has one Australian beneficiary who has a 10% interest in the property of the trust.

             The income of the trust is not distributed to the beneficiary during the year of income.

Consequences

The new exemption is intended to ensure that accruals taxation does not apply to the beneficiary's interest in the trust. Sections 96B and 96C would, however, currently deem the beneficiary to be presently entitled to 10% of the income of the trust ($100,000) due to the beneficiary's interest in the property of the trust. This amount would be accruals taxed under section 97 even though there has been no distribution from the trust and thus the benefit of the exemption from the FIF measures would be lost.

2.206        Significant compliance costs could also arise if section 97 were to apply to interests held in US trusts that qualify for the new exemption. A beneficiary would, for instance, be required to calculate the net income of a trust as if the trustee were a resident of Australia. This calculation could be onerous because it would require a full application of our domestic rules and in some cases the beneficiary may not be able to obtain the necessary information.

Explanation of the amendments

2.207        The amendments will ensure section 97 of the general trust provisions does not apply to interests in US trusts that qualify for the new exemption. Section 97 will continue to apply, however, to interests in controlled foreign trusts because these trusts are not subject to the FIF rules (section 493).

2.208        The exclusion from section 97 for interests in US trusts that qualify for the new exemption will be achieved by amending paragraph 96A(1)(c). [Item 39]

2.209        The net result will be that amounts distributed from a US trust that qualifies for the new exemption will continue to be assessable to the extent the amounts are paid from profits not previously taxed in Australia (section 99B).

Section 3.2      Taxation of Australian source income of US FIFs that qualify for the exemption

Summary of the amendments

Purpose of the amendments

2.210        The amendments will ensure a trustee of a trust that qualifies for the new exemption is taxed on the Australian source income of the trust under sections 99 or 99A. [Item 40]

Date of effect

2.211        The amendments will apply in relation to assessments for income years ending on or after the date of introduction of the Bill. [Subitem 45(2)]

Background

2.212        To avoid double taxation, a trustee is not assessable on Australian source income of a foreign trust to the extent the income is likely to have been included in the FIF income of a beneficiary. This treatment is achieved by subsection 96A(1A) which reduces the amount on which a trustee is taxed under sections 99 or 99A. The amount is reduced to the extent a beneficiary would have been assessable on the net income of the trust if not for the exclusion from section 97 that applies where a beneficiary is subject to the FIF measures (subsection 96A(1)).

2.213        The amount on which a trustee is taxed should not be reduced under subsection 96A(1A) in cases where a beneficiary’s interest in the trust is exempt from section 97 because of the new exemption for US FIFs. In this case, the Australian source income of the trust could completely escape Australian tax if the amount on which the trustee is taxed were reduced. The potential for Australian source income to escape Australian tax is demonstrated by the following example.

Example 6 - Potential for non-taxation of Australian source income

Facts

            A common trust fund that qualifies for the new exemption is calculated to have net income of $1 million.

            The net income is wholly referable to sources within Australia.

            The trust has a large number of Australian beneficiaries who in total have a 100% entitlement to the property of the trust.

            The income of the trust is not distributed to the beneficiaries during the year of income.

Consequences

The beneficiaries will not be taxed on the net income of the trust under section 97 because of the amendments to 96A(1)(c). In addition, the trustee will not be taxed on the undistributed income of the trust because subsection 96A(1A) will apply to reduce to nil the amount on which the trustee is taxed under sections 99 or 99A. The net income of the trust of $1 million will therefore be reduced to nil under subsection 96A(1A) because the beneficiaries would have been assessable on $1 million under section 97 if not for subsection 96A(1). In this regard, the beneficiaries would be deemed to be presently entitled to the entire income of the trust under sections 96B and 96C because they have a 100% interest in the property of the trust. The net result would be that neither the beneficiaries nor the trustee would be taxed on the undistributed Australian source income of the trust.

Explanation of the amendments

2.214        The amendments will limit the circumstances where subsection 96A(1A) will reduce the assessable income of a trustee. Normally the assessable income of a trustee is reduced by the amount that, disregarding subsection 96A(1), would have been included in the assessable income of a beneficiary under section 97. The amendments will provide that the reduction is not available if the new exemption applies to a beneficiary’s interest in the trust. [Item 40]

2.215     Double taxation will not arise on trust distributions made from Australian source income in cases where the trustee has been taxed on the income. In these cases, the distribution assessable under section 99B would be reduced to the extent it was made from amounts that were included in the assessable income of the trustee under sections 99 or 99A (subparagraph 99B(2)(c)(ii)).

2.216        The new arrangements for taxing the Australian source income of an exempt US trust FIF are shown by the following example.

Example 7 - New arrangements for taxing the Australian source income of an exempt US trust FIF

Facts

            A common trust fund that qualifies for the new exemption is calculated to have net income of $1 million.

            The net income is wholly referable to sources within Australia.

            The trust has a large number of Australian beneficiaries who in total have a 100% interest in the property of the trust.

           The income of the trust is not distributed to the beneficiaries during the year of income.

Consequences

The beneficiaries will not be taxed on the net income of the trust under section 97 because subsection 96A(1) is to be extended to apply to trusts that qualify for the new exemption. The trustee will be taxed on the Australian source income of the trust. In this regard, subsection 96A(1A) will not apply to reduce the amount on which the trustee is taxed under sections 99 or 99A.

Section 4         Regulation impact statement

Part 2 - Exemption for US FIFs and related measures

Policy objective

2.217        The proposed exemption for US FIFs from the FIF measures is intended to encourage Australian investment funds to be more efficient. The exemption was announced by the Treasurer in a press release on 8 December 1997 and forms part of the Government's strategy for Australian industry entitled "Investing for Growth". The exemption is intended to increase the efficiency of Australian investment funds by exposing them to greater competition from US funds.

2.218        The exemption has been limited to interests in certain US FIFs because the effectiveness of the FIF measures could be compromised if the exemption were to apply to all interests in US FIFs. The exemption will nevertheless provide increased competition for Australian funds managers. Competition will be increased because of the size, liquidity and efficiency of the US funds management industry. The risk to the revenue will not be greatly increased because the US tax rules are sufficiently robust to prevent tax deferral opportunities from arising for investments that qualify for the exemption.

Implementation option

2.219        It is necessary to amend the Act to provide an exemption from the FIF measures.

2.220        There are considered to be no alternatives to the structure of the exemption outlined below that would provide increased access to US FIFs without giving rise to significant tax deferral opportunities and increasing the risk to the revenue.

Structure of the new exemption

2.221        An unqualified exemption is being limited to FIFs that are taxed on a worldwide basis in the US. Consequently, an unqualified exemption will apply for most US company FIFs and for trusts treated as regulated investment companies (RICs) or real estate investment trusts (REITs). RICs and REITs are fully distributing investment funds used widely in the US as vehicles for managing collective investments.

2.222        In addition, a limited exemption will be provided for investments in certain companies and limited partnerships taxed as partnerships in the US and also for investments in common trust funds. These entities are commonly used by the funds management sector in the US. The exemption is being limited because these entities are taxed in the US as conduit entities and consequently the entities are not directly liable for tax. The US tax liability is instead borne by investors in the conduit entities and Australian investors are not normally subject to tax in the US on foreign income derived through the entities. Accordingly, an unqualified exemption has not been provided because it would allow Australian investors to hold non US FIFs through a conduit entity and be exempt from the anti tax deferral rules in both Australia and the US.

2.223        The exemption for investments in the abovementioned conduit entities is being limited to circumstances where a taxpayer can demonstrate that the investment was made for the sole purpose of investing within the US. Moreover, the exemption will normally not be available if the conduit entity either directly or indirectly has an interest in amounts derived from sources outside the US. An interest traced through an entity eligible for an unqualified exemption will not be taken into account for the purposes of measuring an indirect interest.

2.224        The exemption will only be available for a conduit entity that has an interest in amounts derived from sources outside the US if the value of the conduit entity's interests in non-exempt FIFs and in assets that produce amounts from sources outside the US do not exceed five percent of the total value of the conduit entity's interests in FIFs and assets respectively.

2.225        The exemption for US FIFs will also be available when determining FIF income under the calculation method (one of three methods available for determining FIF income). This treatment will allow look-through rules to apply where taxpayers can obtain the information necessary to comply with the method. The look-through rules will enable taxpayers to invest through up to two tiers of conduit entities that have investments in countries outside the US and still qualify for the exemption to the extent the entities have investments within the US.

Consequential amendments

2.226        Consequential amendments to the general trust provisions are required to ensure those provisions do not claw back the benefits from providing the new exemption. In the absence of the consequential amendments, the benefits of providing the new exemption could be lost because an investment in a trust FIF that qualifies for the new exemption would be accruals taxed under the general trust provisions.

2.227        Consequential amendments to the general trust provisions are also required to avoid onerous compliance costs arising where the exemption applies to trust FIFs. Without the amendments, beneficiaries would be required to make a net income calculation for investments in trust FIFs that qualify for the exemption. This calculation can be onerous because it requires a full application of our domestic rules and in many cases beneficiaries may not be able to obtain the information necessary to make the calculation.

Impacts (costs and benefits)

Impact group identification

2.228        The exemption will benefit resident taxpayers who hold interests in US FIFs. The major impact is expected to be on superannuation and investment funds, who between them hold the majority of Australian interests in US FIFs. The exemption will also affect some individual investors. Investments in controlled foreign companies and controlled foreign trusts will not be affected by the exemption because these interests are already exempt from the FIF measures.

2.229        The exemption is likely to increase Australian investment in US FIFs, particularly US mutual funds, that qualify for the exemption. This investment is expected to be largely at the expense of direct investment in US securities, but also to some extent at the expense of investments in Australia and in other countries.

Costs and benefits

2.230        It is estimated that approximately 1,000 taxpayers will directly benefit from the exemption. Approximately 80% of these taxpayers are individuals, partnerships and trusts, 15% are companies and 5% are superannuation funds. This estimate is based on the number of taxpayers returning FIF income in their income tax returns. Other taxpayers may be affected, however, because the exemption is likely to encourage more investment in US FIFs.

2.231        The exemption is likely to result in an initial and recurrent reduction in compliance costs because the FIF measures will not apply to investments that qualify for the exemption. The initial and recurrent reduction in compliance costs is expected to be minor.

2.232        The net effect of the exemption on administrative costs is uncertain because a reduction in existing administrative costs may be offset by other administrative costs. Existing administrative costs are likely to be reduced because it will no longer be necessary to ensure taxpayers are returning income from US FIFs that qualify for the exemption. Other administrative costs are likely to arise, however, because it will be necessary to monitor whether FIFs legitimately fall within the exemption.

Taxation revenue

2.233        The cost to the revenue of providing the exemption is expected to be $2 million in 1998/99 and $3 million annually for subsequent income years.

2.234        There may also be an indirect cost to the revenue as a result of the exemption because of increased investment in US FIFs. The indirect cost to the revenue is unquantifiable because the amount of capital transferred to US funds depends on prevailing economic conditions and on the investment strategies of Australian funds managers.

Consultation

2.235        The measure is in part a response to submissions to the Wallis Inquiry into the Australian financial system. Some informal consultation on the exemption has been undertaken with industry and professional associations, in particular, with the Investment & Financial Services Association which represents Australian funds managers. The measure is not controversial to the extent it benefits taxpayers, however, it may be opposed by funds managers who face greater competition.

Conclusion

2.236        The implementation option is considered the only effective means of achieving the policy objective of providing greater competition for Australian funds managers without giving rise to significant tax deferral opportunities. The option is expected to lead to an overall reduction in compliance costs for taxpayers who hold interests in US FIFs.

 



C hapter 3

Company tax instalments

Overview

3.1                        Schedule 4 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) by excluding superannuation funds, approved deposit funds, and pooled superannuation trusts from the grouping provisions contained in the company tax instalment system.

Summary of amendments

Purpose of amendments

3.2                        The purpose of the amendments is prevent the inappropriate application of the grouping provisions contained in the company tax instalment system to superannuation funds, approved deposit funds, and pooled superannuation trusts.

Date of effect

3.3                        The amendments will apply from the 1995-96 income year.  [Item 2 of Schedule 4]

Background to the legislation

3.4                        The timing of an entity's company tax instalment depends on whether the entity is classified as large, medium, or small. Broadly speaking, entities classified as small pay instalments later than medium entities and medium entities pay later than large entities.

3.5                        There are grouping provisions within the company tax instalment system that can reclassify a medium entity as large if it is part of a group of entities that, when consolidated, would be a large entity.

3.6                        The grouping provisions are an anti-avoidance measure designed to prevent large entities arranging themselves into several medium entities to gain a more concessional payment schedule.

3.7                        However, the current grouping provisions can inappropriately group employer companies and their superannuation funds when a large company could not arrange itself into, say, a medium company and a medium superannuation fund. Similarly they could also inadvertently operate to group approved deposit funds and pooled superannuation trusts with the company that established them.

Explanation of amendments

3.8                        Item 1 of Schedule 4 of the Bill amends paragraph 221AZMC(b) of the Act by excluding superannuation funds, approved deposit funds, and pooled superannuation trusts from the grouping provisions contained in the company tax instalment system. [Item 1 of Schedule 4; amends paragraph 221AZMC(b)]

3.9                        Therefore, a medium-sized company and the medium-sized employer superannuation fund that it established will not be grouped together to form a large entity for the purposes of the company tax instalment system.

3.10          However, where a superannuation fund, approved deposit fund, or pooled superannuation trust is individually classified as large, the entity will continue to pay instalments of tax under the instalment schedule applying to large entities.



C hapter 4

Non-arm’s length trust distributions etc. to superannuation and similar funds

Overview

4.1                        Schedule 5 of the Bill will amend section 273 of the Income Tax Assessment Act 1936 (‘the Act’) so that the special income of a complying superannuation fund, approved deposit fund (ADF) or pooled superannuation trust (PST) will include:

·         distributions from all trusts other than where the superannuation fund, ADF or PST has a fixed entitlement to income from that trust; and

·         non arm’s length trust distributions of income where the superannuation fund, ADF or PST has a fixed entitlement to income from that trust.

Summary of the amendments

Purpose of the amendments

4.2                        To tighten section 273, an existing anti-avoidance measure, to close a loophole which allows certain distributions of trust income to superannuation funds made under non arm’s length arrangements to be taxed at the concessional rate of 15%.

Date of effect

4.3         The amendments will apply (subject to the transitional arrangements discussed in paragraphs 4.5 - 4.11) to income derived by a complying superannuation fund, ADF or PST (‘a superannuation entity’) after 2 pm by standard time in the Australian Capital Territory on 25 November 1997 (ie, the amendments will apply from the time of the Treasurer’s Press Release) [Item 3 of the Schedule 5] .

4.4                        The amendments are strictly anti-avoidance in nature. The Government announced it would implement measures applying immediately to close the loophole allowing certain distributions of trust income to superannuation entities made under non arm’s length  arrangements relating to distributions of trust income. The amendments have been introduced as soon as practicable. 

Transitional Arrangements

4.5         The amendments are different in form to the measures announced on 25 November 1997. The announcement stated that the tax law would be amended so that trust distributions made from all trusts other than unit trusts to a superannuation entity would be treated as special income of the fund and taxed at the non-concessional rate of 47%. It was also announced that the law would be clarified to ensure that distributions from unit trusts to superannuation entities made in excess of an arm’s length amount would also be taxed at 47%.

4.6         There will be cases of genuine arm’s length investments by superannuation entities in fixed but non-unit trusts. Under the announcement income from such investments would automatically be treated as special income. It is more appropriate that investments of these kinds, involving a return by virtue of holding a fixed entitlement, be subject to the arm’s length test. The amendments will apply in this way.

4.7            The majority of investments by superannuation entities in unit trusts will be held as fixed entitlements. However there may be circumstances where investments in unit trusts could be held other than as a fixed entitlement.

4.8         Consequently, a transitional arrangement will apply from the date of the announcement until the end of the day of introduction of the legislation into the Parliament. This will ensure that superannuation entities that relied on the details contained in the announcement and which would otherwise be adversely affected under the amendments will be treated in accordance with the details as announced.

4.9         Accordingly, item 4 of the Schedule 5 ensures that assessable income derived by a superannuation entity in the capacity of holder of a unit in a trust estate, during the period beginning from the time of the Treasurer’s Press Release to the end of 2 July 1998, the day on which the legislation is introduced, is included as special income of the entity if, and only if:

·         there was an arrangement in relation to which some or all of the parties were not dealing with each other at arm’s length, which relates either to the acquisition of the unit, or to the derivation of the assessable income [item 4(1)(a)] ; and

·         the amount of that income is higher than might have been expected to have been derived by the entity if those parties had been dealing with each other at arm’s length in relation to the arrangement [item 4(1)(b] .

4.10       The word ‘arrangement’ has the same meaning as in new subsection 273(8) [item 4(2)] .

Background to the legislation

4.11       The taxation treatment of the income of a complying superannuation fund, ADF or PST (‘a superannuation entity’) is governed by Part IX of the Act. In general terms where a superannuation fund or an ADF complies with the requirements of the Superannuation Industry (Supervision) Act 1993 (the SIS Act), the trustee of such a fund is taxed on the taxable income of the fund at the concessional rate of 15% (where there is no ‘special component’ of the taxable income). Similarly, the trustee of a unit trust that is a PST for the purposes of the SIS Act is taxed on the taxable income of the fund at the concessional rate of 15% where there is no ‘special component’ of taxable income.

4.12       Where a superannuation entity derives assessable income that is included in the ‘special component’ of the taxable income of the entity, the trustee of the entity is taxed on that income at the rate of 47%. The assessable income that is included in the special component is termed ‘special income’ and is income derived from certain types of non arm’s length transactions (including the payment of certain private company dividends) that fall within the provisions of section 273 of the Act. 

4.13       Section 273 is designed to prevent income from being unduly diverted into superannuation entities as a means of sheltering that income from the normal rates of tax applying to other entities, particularly the marginal rates applying to individual taxpayers.

4.14       The ATO has become aware of arrangements which circumvent section 273. Under the arrangements, pre-tax income of a trust (usually a discretionary trust) is distributed to a complying superannuation fund set up for the benefit of the beneficiaries of that trust rather than to the beneficiaries themselves. The effect of the arrangements is that the income is taxed at only 15% as income of the superannuation fund rather than at the marginal rate of tax applicable to other beneficiaries.

4.15       It is doubtful whether subsection 273(4) of the Act, which seeks to tax income derived by a superannuation entity from a non arm’s length transaction at the non-concessional rate of 47%, would catch these discretionary trust distributions.

Explanation of the amendments

4.16          Item 2 of the Schedule 5 of the Bill will insert new subsections 273(6)-(8) to tighten subsection 273(4) to close a loophole which allows certain distributions of trust income to superannuation entities made under non arm’s length arrangements to be taxed at the concessional rate of 15%. Item 1 of the Schedule makes an amendment to subsection 273(4) as a consequence of the amendments made by [Item 2].

What Trust Distributions will be treated as Special Income?

Superannuation entity receives income from a trust where the trustee has a discretion to distribute income

4.17       Assessable income that is derived by a superannuation entity, other than through the holding of a fixed entitlement to income, in the capacity of beneficiary of a trust estate, will be regarded as special income of the entity under new subsection 273(6) . New subsection 273(6) will include as special income any assessable income derived by a superannuation entity in the capacity of beneficiary of the trust estate, the receipt of which is dependent on the trustee exercising a discretion to distribute trust income in favour of the entity. 

Example

A husband and wife are principals of a business. A discretionary trust is established to carry on the business, the beneficiaries of which are the principals, other family members and the superannuation fund. A superannuation fund is also established with the principals as the members of the fund. The trustees of both the discretionary trust and the superannuation fund are corporate trustees 100% owned by the principals. This ensures that the husband or wife has effective control over the activities of both the discretionary trust and the superannuation fund. 

The trustee of the trust exercises its discretion to distribute an amount of trust income to the trustee of the superannuation fund in preference to the other beneficiaries who would otherwise be taxable on the income at their applicable marginal rate in accordance with Division 6 of Part III of the Act. New subsection 273(6) would include any distribution made by the trustee to the superannuation fund as special income of the fund.

4.18       New subsection 273(6) would also cover distributions of income to a superannuation entity from a unit trust where the receipt of that income by the entity was dependent on the trustee exercising a discretion to distribute income in favour of the entity.

Superannuation entity receives income from a trust by virtue of holding a fixed entitlement to income of a trust acquired under non-arm’s length arrangements

4.19       Assessable income that is derived by a superannuation entity in the capacity of beneficiary of a trust estate with a fixed entitlement to income will be regarded as special income of the entity under new subsection 273(7) if both of the following tests are satisfied:

·         there was an arrangement in relation to which some or all of the parties were not dealing with each other at arm’s length, which relates either to the acquisition of the fixed entitlement to the income, or to the derivation of the assessable income [new paragraph 273(7)(a)] ; and

·         the amount of that income is higher than might have been expected to have been derived by the entity if those parties had been dealing with each other at arm’s length in relation to the arrangement [new paragraph 273(7)(b)].

4.20       The first test in new subsection 273(7) requires that there be an arrangement that relates either to the acquisition of the fixed entitlement to the income, or to the derivation of the assessable income. New subsection 273(8) provides that for the purposes of new subsection 273(7) , the word ‘arrangement’ means:

·         any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

·         any scheme, plan, proposal, action, course of action or course of conduct.

4.21       The second test in new subsection 273(7) requires that, where some or all of the parties have been found not to have dealt at arm’s length in relation to the arrangement, the amount of the income derived by the superannuation entity is higher than might have been expected to have been derived by the entity if those parties had been dealing with each other at arm’s length in relation to the arrangement.  

Examples of situations that would be covered by the amendments

Example One

At the beginning of the 1998-1999 financial year, the trustee of a superannuation fund acquired 20 $1 units in a unit trust. The directors and shareholders of the trustee company of the unit trust are members of the superannuation fund. Each unit conferred a fixed entitlement to distributions of income from the unit trust.  

There was a mutual understanding between the parties that subsequent to the acquisition of the units in the unit trust by the superannuation fund, $100,000 would be distributed each year to the unit trust from a discretionary trust of which the unit trust was a beneficiary. A distribution from the discretionary trust to the unit trust was made prior to the end of the financial year.

Units in the trust were purchased during the financial year by an arm’s length party for $10,000 each.

At the end of the financial year the trustee of the unit trust resolves to distribute the income of the trust to unit holders.

In these circumstances, the purchase of the units, the subsequent injection of funds from the discretionary trust and the distributions of trust income to the superannuation fund, being within the contemplation of the trustee of the superannuation fund and the trustee of the unit trust (whether or not it is in the contemplation of the trustee of the discretionary trust), would fall within the definition of ‘arrangement’ in new subsection 273(8) , being an arrangement that relates to the acquisition of a fixed entitlement to the income of the trust.

As the parties are not involved in real bargaining in relation to the arrangement, they are not dealing at arm’s length with each other in relation to that arrangement. This would be demonstrated by the fact the trustee of the superannuation fund acquired the units in the unit trust for less than market value consideration. The first test in new subsection 273(7)(a) would be satisfied.

The income of the unit trust has increased as a result of the distribution received from the discretionary trust under an arrangement some of the parties to which were not dealing at arm’s length. As a result the unit trust has more income available to be distributed to unit holders. If the parties were dealing at arm’s length no distribution to the unit trust from the discretionary trust could be expected and less income would have been available for distribution to unit holders.

Accordingly, the amount of income derived by the superannuation fund from the arrangement is greater than might have been expected to have been derived by the fund if the parties had been dealing with each other at arm’s length.

The test in new subsection 273(7)(b) would be satisfied.  The income derived by the superannuation fund will be treated as special income.

Example Two

On 20 October 1992, the trustee of a superannuation fund acquired 20,000 $10 units in a unit trust. Each unit conferred a fixed entitlement to distributions of income from the unit trust. The members of the superannuation fund are the 100% owners of the corporate trustees of both the superannuation fund and the unit trust.  The unit trust paid an arm’s length distribution to the superannuation fund and other unit holders for the 1993-98 financial years.

During the 1998-1999 financial year, the trustees of the superannuation fund, the unit trust and the ABC discretionary trust agree that before the end of the financial year the discretionary trust will distribute $100,000 to the unit trust. The trustee of the discretionary trust is also a corporate trustee 100% owned by the members of the superannuation fund. Also in that year, a private company which the members of the superannuation fund control lends $100,000 interest free to the unit trust.  At the end of that financial year the trustee of the unit trust resolves to distribute the income of the trust to the unit holders. 

The distribution received by the unit trust from the discretionary trust increases the income of the unit trust, which impacts on the amount available for distribution to unit holders. Therefore, the agreement between the trustee of the unit trust, the trustee of the superannuation fund and the trustee of the discretionary trust would be an arrangement that relates to the income derived by the superannuation fund within the meaning of new subsection 273(8) . As the parties are not involved in real bargaining in relation to the arrangement, they are not dealing at arm’s length with each other in relation to that arrangement. The test in new subsection 273(7)(a) would be satisfied.

As the trustee of the unit trust would not have to pay interest on the loan received from the private company the income of the unit trust would be increased, which would have an impact on the amount available for distribution to unit holders. Therefore the arrangement between the trustee of the unit trust and the private company would be an arrangement that relates to the income derived by the superannuation fund within the meaning of new subsection 273(8) . As the parties are not involved in real bargaining in relation to the arrangement, they are not dealing at arm’s length with each other in relation to that arrangement.  The test in new subsection 273(7)(a) would be satisfied.

The amount of income derived by the superannuation fund from the arrangement is greater than might have been expected to have been derived by the fund if the parties had been dealing with each other at arm’s length due to:

·         the increase in income of the unit trust as a result of the distribution of income from the discretionary trust to the unit trust (if the parties were dealing at arm’s length no distribution could be expected); and

·         the increase in the income of the unit trust as a result of the trustee not having to pay interest on the loan from the private company.

The test in new subsection 273(7)(b) would be satisfied.  The income derived by the superannuation fund will be treated as special income.

 



C hapter 5

Franking credits, franking rebates and the intercorporate dividend rebate

Overview

5.1                        The Bill will amend Part IIIAA of the Income Tax Assessment Act 1936 (the Act) to prevent franking credit trading and misuse of the intercorporate dividend rebate. The amendments will introduce:

       the holding period rule which, subject to certain exceptions, requires taxpayers to hold shares at-risk for more than 45 days in order to qualify for a franking benefit or intercorporate dividend rebate from a dividend, or, in the case of certain preference shares, more than 90 days; and

       the related payments rule which requires taxpayers who are under an obligation to make a related payment with respect to a dividend paid on shares to hold the relevant shares at-risk for more than 45 days (or 90 days for preference shares) during the relevant qualification period in order to qualify for a franking benefit or intercorporate dividend rebate from the dividend.

Summary of amendments

Purpose of amendments

5.2                        The purpose of the amendments is to protect the revenue by introducing a holding period rule and related payments rule for shares to curb the unintended usage of franking credits and misuse of the intercorporate dividend rebate by persons who are not effectively owners of shares or who are only very briefly owners of shares. This will counter certain tax avoidance schemes under which franking credits or the intercorporate dividend rebate are made available to such persons.

Date of effect

5.3                        The holding period rule is to apply to shares and interests in shares which were acquired on or after 1 July 1997, unless the taxpayer had become contractually obliged to acquire the shares before 7.30 pm AEST 13 May 1997. [Subitem 25(1)]

5.4                        New section 160APHL , which applies special rules for beneficiaries of certain trusts, takes effect at 3 pm AEST 31 December 1997 and applies to:

       shares or interests in shares which were acquired by a trust (other than a widely held public share-trading trust) after that time; and

       widely held public share-trading trusts established after that time. [Subitem 25(4)]

5.5                        The related payments rule applies to arrangements entered into on or after 7.30 pm AEST, 13 May 1997. However, shares or interests in shares acquired before that time are not exempt from the measure. Provided the arrangement is entered into after 7.30 pm AEST, 13 May 1997, the measures will apply. For example, if a financial institution issues endowment warrants after that time over shares which it acquired before then, the dividends payable on the shares will be within the measure notwithstanding that the shares were acquired before 7.30 pm AEST, 13 May 1997. [Subitem 25(5)]

Background to the legislation

5.6                        One of the underlying principles of the imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves: a degree of wastage of franking credits is an intended feature of the imputation system.

5.7                        In substance, the owner of shares is the person who is exposed to the risks of loss and opportunities for gain in respect of the shares. However, franking credit trading schemes allow persons who are not exposed, or have only a small exposure, to the risks and opportunities of share ownership to obtain access to the full value of franking credits, which often, but for the scheme, would not have been used at all, or would not have been fully used. Some of these schemes may operate over extended periods, and typically involve a payment related to the dividend which has the effect of passing its benefit in economic terms to a counterparty. The schemes therefore undermine an underlying principle of imputation.

5.8                        These or similar schemes also allow companies inappropriate access to the intercorporate dividend rebate, usually in circumstances where, because of a tax deduction against the assessable amount of the dividend, the rebate is not required to relieve the dividend from double taxation, but rather is used inappropriately to reduce tax on other income.

5.9                        The Bill introduces a holding period rule and a related payments rule which provides that taxpayers must satisfy certain criteria before they qualify for the benefits of franking and the intercorporate dividend rebate. The measures restore the underlying principle of the imputation system and prevent misuse of the intercorporate dividend rebate.

Explanation of the amendments

Qualification for franking credits, franking rebates and the intercorporate dividend rebate

5.10          Schedule 8 of the Bill inserts new Division 1A in Part IIIAA of the Act. The object of this new Division is to set out the circumstances in which a taxpayer is entitled to a franking credit, franking rebate or the intercorporate dividend rebate in respect of a particular dividend, whether received directly or indirectly though a trust or partnership. [Item 8; new section 160APHC]

5.11          To be entitled to a franking credit, franking rebate, or intercorporate dividend rebate in relation to a particular dividend, a taxpayer must be a ‘qualified person’ in relation to the dividend. Broadly speaking, to be a qualified person in relation to a dividend, a taxpayer must satisfy both the holding period rule (or certain alternative rules) and the related payments rule.

5.12          The paragraphs below explain that a taxpayer is a qualified person in relation to a dividend if the taxpayer satisfies the related payments rule and:

(a)    the taxpayer satisfies the holding period rule in relation to the dividend; [Item 8, new section 160APHO]

(b)    the taxpayer is a particular kind of taxpayer that elects to have a franking credit or franking rebate ceiling applied, calculated according to a prescribed formula; [Item 8, new section 160APHR]

(c)    the taxpayer is a natural person whose franking rebate entitlement for the year is less than $2,000; or [Item 8, new section 160APHT]

(d)    the dividend is paid on certain shares issued in connection with the winding up of a company. [Item 8, new section 160APHQ]

5.13          Where a taxpayer derives dividends through a distribution from a partnership or trust consisting wholly or in part of dividends, the taxpayer needs to determine what component of the trust or partnership distribution is attributable to a particular dividend, and then determine whether, in relation to that dividend, the taxpayer is a qualified person. However, by way of exception, a taxpayer who is a beneficiary of a widely-held trust need only determine whether he or she is a qualified person in relation to the trust distribution itself, rather than the particular dividends it may be comprised of (this is explained below).

5.14          The effect for a taxpayer of not being a qualified person in relation to a dividend or distribution is explained below. Deductions that may be available to certain beneficiaries and partners who are not qualified persons in relation to a trust or partnership distribution are also explained below.

(a) Satisfaction of the holding period and related payments rules

5.15          For the purposes of the holding period rule, a taxpayer who holds shares or an interest in shares on which a dividend or distribution has been paid is a qualified person in relation to the dividend if the taxpayer has held the shares or interest in shares at-risk, not counting the day of acquisition or disposal, for at least 45 days (or 90 days for certain preference shares). [Item 8, new section 160APHO]

5.16          To be a qualified person in relation to a dividend under the related payments rule, a person must be either:

·         at-risk in respect of the relevant shares or interests in shares for the relevant period during a qualification period around the ex-dividend day; or

·         if the taxpayer is not at-risk for the relevant period during the qualification period, the taxpayer or associate must not make a ‘related payment’ (explained below) in respect of the dividend.

If a taxpayer fails both these requirements, the taxpayer will not be a qualified person, and franking benefits and the intercorporate dividend rebate will be denied.

5.17          In the case of trust or partnership distributions consisting wholly or in part of dividends, the taxpayer must be either be at-risk for the relevant period (during the qualification period) in respect of the taxpayer's interest in the shares from which the dividend is derived; or must not make a related payment in respect of that component of the distribution consisting of the dividend, or the distribution as a whole. An exception to this rule is that a taxpayer who is a beneficiary of a widely-held trust need only be either at-risk in respect of the interest in the trust during a qualification period around the trust distribution date; or must not make a related payment in relation to the distribution as a whole, without regard to the particular dividends of which it is comprised. (This exception is discussed in more detail under the heading ‘Beneficiaries of a widely-held trust’ at paragraphs 7.136-7.138). [Item 8; new section 160APHP]

5.18          However, in these cases where a taxpayer holds shares indirectly through a trust or partnership (or through a chain of trusts or partnerships), if the trustee or partnership is not a qualified person in relation to a dividend, then the taxpayer cannot be a qualified person in relation to the dividend flowing through the trust or partnership. [Item 8; Notes to new subsections 160APHK(1) and 160APHL(1)

5.19          The holding period rule is a once-and-for-all test. It sets an initial threshold which only has to be crossed once. Therefore, once a taxpayer is a qualified person in relation to a dividend or distribution by virtue of the fact that the taxpayer has held the relevant shares or interest for more than 45 days, the taxpayer is taken to be a qualified person for the purposes of the rule in relation to future dividends or distributions paid on those shares or interest.

5.20          For example, if a taxpayer acquires a share on 1 September 1997 and, after holding it continuously at-risk, puts in place a risk diminution arrangement on 1 November 1997, the taxpayer will continue to be a qualified person in relation to the dividends paid on the shares for the purposes of the holding period rule (and therefore entitled to the franking credit and section 46 intercorporate dividend rebate on the dividends) because the taxpayer has held the shares for more than 45 days prior to putting the arrangement in place.

5.21          The related payments rule, however, is not a once-and-for-all test. That is, even if a taxpayer is a qualified person in relation to a dividend or distribution by virtue of the fact that the taxpayer has held the relevant shares or interest for more than 45 (or 90) days, the taxpayer is not taken to be a qualified person in relation to future dividends or distributions paid on those shares or interest if the taxpayer or associate is under an obligation to make a related payment in relation to the future dividends or distributions and has not held the shares at risk for the requisite period during the relevant qualification period (i.e. if the taxpayer triggers the related payments rule).

What is a share?

5.22          A share includes the interest of a partner in a corporate limited partnership and membership of a company which does not have share capital (e.g. companies limited by guarantee). [Item 8, new section 160APHD]

When does an interest in a share arise?

5.23          New section 160APHG provides that when a partnership or trust (other than a widely held trust) holds, acquires or disposes of shares or an interest in shares:

(a)  the relevant partners or beneficiaries (including potential beneficiaries of discretionary trusts) are taken to hold, acquire or dispose of an interest in the shares; and

(b)  the relevant partners or beneficiaries are taken to hold, acquire or dispose of their interests in shares at or during the time the partnership or trust holds, acquires or disposes of its shares or interests in shares.

5.24          Furthermore, when a taxpayer becomes or ceases to be a partner of a partnership or beneficiary of a trust which holds shares or interests in shares, the taxpayer is taken to acquire or dispose of an interest in the shares at the time the taxpayer becomes or ceases to be a partner or beneficiary. [Item 8; new subsections 160APHG(1)-160APHG(4)]

Note :         While a change in beneficiaries will not necessarily result in a new trust, a change in partners is generally considered to result in a new partnership for tax purposes. However, to avoid uncertainty, partnerships as well as trusts are included.

5.25          The amount of the interest in shares held through a partnership is specified in new section 160APHK , while new section 160APHL specifies the amount of a beneficiary's interest in shares held by a trust. [Item 8; new sections 160APHK and 160APHL]

Interests in shares held by widely held trusts

5.26          Where a widely held trust holds shares or interests in shares, and a taxpayer is, becomes or ceases to be a beneficiary of the trust:

(a)  the taxpayer is taken to hold, acquire or dispose of an interest in shares during or at the time the taxpayer becomes or ceases to be a beneficiary of the trust; but

(b) the interest is not taken to be an interest in the particular shares or interests in shares held by the trust.

Where a widely-held trust which did not previously hold any shares or interests in shares acquires shares or interests in shares:

(a)  the beneficiaries of the trust are taken to acquire an interest in shares, being their interest in the trust, at that time; but

(b) the interest is not taken to be an interest in the particular shares or interests in shares acquired by the trust.

Similarly, when a widely-held trust which held shares or interests in shares ceases to hold any shares or interests in shares, the beneficiaries of the trust are taken to have disposed of their interest in shares. [Item 8; new subsections 160APHG(5)-160APHG(8)]

When does a person ‘hold’ shares for the purposes of the holding period and related payments rules?

5.27          Generally, a taxpayer is taken to hold shares from the time the taxpayer acquires the shares until the time the taxpayer disposes of the shares. For acquisitions and disposals at a fixed price under an unconditional contract, the time of acquisition and disposal is the time of making the contract. [Item 8; new subsection 160APHH(1)]

5.28          This is because a taxpayer will assume the risks and opportunities of share ownership once he or she has an unconditional right and obligation to buy shares at a fixed price. (This would not be true if the share price could change:  for example, a contract to buy shares at the market price on a future day would leave risk with the seller until then.)

5.29          For example, if a taxpayer acquires an ordinary share on 1 November, the taxpayer would have to hold the share until at least 17 December to be a qualified person for the purposes of new section 160APHO .

5.30          The taxpayer is not required to hold shares or an interest in shares for more than 45 days before a dividend is paid to be a qualified person in relation to that dividend: days after the dividend is paid can also be counted (although they must be within the qualifying period explained below).

Special provisions relating to acquisition and disposal

5.31           New section 160APHH outlines several circumstances where a taxpayer may be taken to acquire or dispose of shares at a time other than the actual disposal or acquisition. 

5.32          For example, by virtue of new subsection 160APHH(3) a person who holds an instalment receipt under a trust which converts into an ordinary share (by the cancellation of the instalment receipt and the transfer of an equivalent number of shares to the instalment receipt holder on the payment of the final instalment) will be deemed to have held the ordinary shares from the time the instalment receipt was acquired. This is because the taxpayer has the same economic interest in the shares throughout. 

5.33          Similarly, new subsection 160APHH(2) provides that for the purpose of determining when shares are acquired, where shares (bonus shares) are issued in respect of existing shares (original shares):

·      if some part of the bonus shares is or is taken to be a dividend which is included in the assessable income of the taxpayer - the bonus shares are acquired when they were issued;

·      if no part is, or is taken to be, a dividend which is included in the assessable income of the taxpayer, the bonus shares are taken for the purposes of this Division to have been acquired when the original shares were acquired, and they are deemed to have been held for the same number of days as the original shares are taken to have been held.

In the first case, the re-investment of the dividend in shares is analogous to a new share purchase; while in the second case, the bonus share issue is like a share split rather than a new acquisition of shares.

5.34          In addition, new subsection 160APHH(8) provides that where a company (the first company) in a wholly-owned group disposes of shares to another company in the same group the holding period of the shares is to include the days on which the first company held the shares at risk. Economically there is no real change of ownership because there is no change in the underlying ownership of the companies.

5.35          Similarly, new subsection 160APHH(6) provides that if a taxpayer disposes of shares or interests under a securities lending arrangement which satisfies subsection 26BC(4) of the Act (and therefore is deemed not to have disposed of the shares or interests for the purposes of the ordinary income or capital gains provisions of the Act), then the taxpayer is also treated as not having disposed of the shares for the purposes of new section 160APHO. In such a case, the lender will still be taken to hold the shares for the purposes of determining whether the lender has satisfied the holding period rule in relation to dividends paid on the shares (during the loan period the dividends may, for imputation purposes, be passed back to the lender under section 160AQUA of the Act). Again, this is consistent with the underlying economic ownership of the shares.

Roll-over relief

5.36          Other cases where roll-over relief is available are:

     on the death of a person;

     where a person becomes subject to a legal disability (e.g. on becoming mentally incapacitated); and

    where there is a mere change of trustee or transfer of an asset between wholly-owned trusts.

[Item 8; new subsections 160APHH(4),(5) and (7)]

Disposals of shares taken to be disposals of related shares or interests

5.37          New section 160APHI ensures that the holding period operates on a ‘last-in, first-out’ basis (LIFO). This is because shares are fungible assets, and the sale of any one parcel of shares is economically equivalent to any other sale of any other parcel. LIFO prevents circumvention of the holding period rule by taxpayers with portfolios of ‘old shares’ buying new shares and selling old shares, as well as providing tax neutrality in a decision whether to make economically equivalent disposals of particular parcels of shares.

5.38          LIFO will apply to shares or interests in shares held by one taxpayer, but also to wholly owned company groups (which are effectively treated as one taxpayer for the purposes of the holding period rule) and to associates acting together under an arrangement. The purpose of the arrangement test is to prevent a taxpayer acting in collusion with an associate in such a way that, in essence, the taxpayer acquires shares or an interest in shares and then, under the arrangement, the associate disposes of substantially identical shares or securities which has a similar effect for the taxpayer as if the disposal had been by the taxpayer.

5.39          To achieve this, new section 160APHI provides that in determining whether a taxpayer has held particular shares or interests in shares (called the ‘primary securities’) for the requisite period of time during a qualification period regard must be had to whether a disposal of ‘related securities’ (defined below) by the taxpayer, an associate of the taxpayer or, if the taxpayer is a company, another company in the same wholly-owned group has occurred. Where such a disposal has occurred the taxpayer may be taken for the purposes of new section 160APHO to have disposed of (and immediately reacquired) the primary securities. For example, if on 1 July 1997 a taxpayer acquires 100 ordinary shares in a company and on 1 August disposes of 50 ordinary shares in the same company, irrespective of whether the shares disposed of are the shares acquired in July, the taxpayer will be taken to have disposed of 50 of the July shares. Moreover, if, for example, a person acquires 100 ordinary shares in a company and, under an arrangement with the person, a company controlled by the person disposes of 100 ordinary shares in the same company, the person will be taken to have disposed of the 100 shares.

5.40          Before a related security can be treated as the disposal of a primary security, the related security must provide the taxpayer or associate with a frankable or rebatable dividend or distribution corresponding to the dividend or distribution paid on the primary security (which is the dividend or distribution against which the rule is being applied).  As an example, a distribution paid by a trust holding only shares of a particular kind will correspond to a dividend paid on the shares if the distribution is attributable to that dividend. [Item 8, new section 160APHI]

What is a related security?

5.41          New subsection 160APHI(2) defines related securities as being the primary securities, securities which are substantially identical to the primary securities and substantially identical securities disposed of by a connected person (i.e. the taxpayer or associate). New subsection 160APHF(1) defines a substantially identical security as being any property that is economically equivalent to (or fungible with) the relevant shares or interests in shares. [Item 8, new subsection 160APHI(2)]

5.42          Accordingly, in relation to shares (the relevant shares), substantially identical securities include but are not limited to:

(a)     shares in the same company that are of the same class as the relevant shares;

(b)     shares in the same company that are of a different class where there is no material difference between the classes or shares that are exchangeable for shares in the same class as the relevant shares;

(c)     shares in another company that predominantly hold shares in categories (a) and (b); or

(d)     shares in another company which are exchangeable for shares in categories (a) and (b). [Item 8, new subsection 160APHF(3)]

5.43          In relation to an interest in the relevant shares, substantially identical securities include an interest in a trust or partnership that predominantly holds the shares in categories (a) and (b) in the previous paragraph. [Item 8, new subsection 160APHF(4)]

5.44          For example, in relation to an ordinary share, a converting preference share with a delta of +0.9 in relation to the ordinary share would be a substantially identical security to the ordinary share (the concept of delta is explained below).

5.45          There will be no double counting of disposals of securities. Therefore, if the disposal of a security triggers the holding period rule in relation to that security, it will not also trigger a disposal of another security, even if it is related. [Item 8; new subsection 160APHI(5)]

5.46          To avoid the need to track disposals of shares which are managed as or in a discrete fund in respect of which an election to adopt a formula-based ceiling is made under new section 160APHR , shares held in such funds are not related securities. [These elections are discussed in more detail under the heading ‘(b) Formula-based ceiling for certain taxpayers’ at paragraphs 7.103-7.111.] [Item 8; new subsection 160APHI(2)]

When does a person not hold shares for the purposes of the holding period and related payments rules?

5.47          In calculating whether a taxpayer has satisfied the requisite holding period, any days during which there is a materially diminished risk in relation to the relevant shares or interest are not counted. In other words, it is as if the taxpayer did not hold the shares on those days. There would be a material diminution of risk, for example, if a taxpayer has forward sold the shares or has taken a position in derivatives which eliminates the upside and downside risk of holding the shares. [Item 8, new subsection 160APHO(3)]

5.48          To determine whether there has been a material diminution of risk, it is first necessary to understand what is a ‘position’, and how a taxpayer's ‘net position’ is determined by reference to ‘long’ and ‘short’ positions. These terms are explained below at paragraphs 7.52-7.59.

5.49          New subsection 160APHJ(2) lists some examples of positions which, because they relate to substantially similar or related property, will have a delta in relation to the shares held by the taxpayer (‘substantially similar or related property’ refers to property sufficiently resembling the shares to exhibit a correlation in price movements). However, a position in other property could, as a matter of fact, have a delta in relation to shares if changes in its value exhibit a correlation with share price movements, notwithstanding that the property was not similar to the shares. For example, a company which derived most of its profits from the sale of one product might find that its share price was correlated with the price of that product; a derivative in that product could then be used to hedge shares in the company. Also, preference shares which behave like debt can be hedged by debt derivatives, such as bond futures; a purchase or sale of bond futures could therefore be a position in relation to those shares.

5.50          New subsection 160APHJ(2) also includes as possible positions embedded options, non-recourse loans and indemnities and guarantees. An embedded option is not an option, but an aspect of the price of something which behaves as if it were an option. For example, converting preference shares may convert into other shares on terms such as that up to a particular price (a notional strike price) the new shares received on conversion are of the same value as the money originally subscribed for the converting preference share, but above that price the new shares will be worth more than the money subscribed for the converting preference share. Such shares behave like debt with an option to purchase the new shares at the notional strike price, and are therefore said to have an embedded option, with a delta which can be calculated in the same way as for a real option. [Item 8, new section 160APHJ]

5.51          Similarly, a non-recourse loan, that is, a loan which is repayable only up to the value of certain property (e.g. shares), effectively contains a put option to sell the shares to the lender, and a delta can be calculated in relation to this notional option. The value to a taxpayer of an indemnity or surety in respect of share losses would also behave like an option to sell shares.

Position in relation to shares or interests

5.52          In the absence of regulations, new subsection 160APHJ(2) provides that a position in relation to shares or an interest in shares is anything that has a ‘delta’ in relation to the shares or interest. [Item 8, new subsection 160APHJ(2)]

5.53          ‘Delta’ is a well-recognised financial concept that measures the relative change in the price of an option or other derivative for a given small change in the price of an underlying asset.  An option with a positive delta indicates that its price is expected to rise and fall with the underlying asset, while a negative delta indicates an inverse relationship.

5.54          For example, if a taxpayer writes or buys a call option over shares in a company, the taxpayer has taken a position in relation to those shares because the obligation or right under the option provides an opportunity for profit or loss by reference to the market value of the shares (i.e. the option has a delta in relation to the shares - rises and falls in share price will affect the option price).

5.55          New subsection 160APHJ(1) provides that regulations may specify:

       what is a position;

       when a position relates to particular shares or interests; and

       how the delta of a position is to be calculated. [Item 8, new subsection 160APHJ(1)]

Short position

5.56          A short position in relation to shares is a position which has a negative delta in relation to those shares. This would include, for example, a short sale, a futures contract to sell shares, a sold call or a bought put, and a futures contract to sell a particular share index. [Item 8, new subsection 160APHJ(3)]

Long position

5.57          A long position in relation to shares is a position which has a positive delta in relation to those shares. For example, a share purchase, a bought future, a bought call and a sold put, and a futures contract to buy a particular index are long positions. [Item 8, new subsection 160APHJ(4)]

Net position

5.58          The net position of a taxpayer in relation to shares is calculated by adding the sum of the taxpayer's long positions to the sum of the taxpayer's short positions. [Item 8, new subsection 160APHJ(5)]

5.59          For example, if a taxpayer holds 1000 shares and buys one call option with a delta of 0.9 and one put option with a delta of -0.4, the taxpayer's net equity position would be determined by adding the deltas of the shares with the options:

[1000 + (1000 ´ -0.4) + (1000 ´ 0.9)]/1000 = 1.5

(The delta of the options is multiplied by 1,000 because option contracts are provided over a parcel of 1,000 shares).

Delta of position taken not to have changed

5.60     If a taxpayer acquires shares or interests in shares and takes a position in relation to the shares or interests, provided the taxpayer continues to hold the shares or interests and does not enter into any other positions in relation to the shares or interests, the delta of the position remains the delta of the position on the day on which the shares were acquired or the position was entered into, whichever is the later.

5.61     For example, a taxpayer buys 1000 ordinary shares and subsequently sells a call option which has a delta of 0.5 on the day the option was sold. Later, the shares fall in price and the delta rises to 0.8. The relevant delta for the purposes of the provision would be 0.5, the delta on the day the option was sold. [Item 8, new subsection 160APHJ(9)]

Certain short positions ignored

5.62     If a taxpayer holds shares in a company whose sole or dominant business is producing, purchasing, consuming, trading or otherwise dealing in certain commodities and a taxpayer is a controller of the company for the purposes of section 160ZZRN, then short positions held by the taxpayer in its shares in the company are disregarded under new subsection 160APHJ(6) if the positions relate to one of the listed commodities and are taken in the ordinary course of the taxpayer's business. The relevant commodities are set out in new subsection 160APHJ(7).

5.63     The purpose of this exception is to prevent the holding period rule applying inappropriately to deny franking benefits and the intercorporate dividend rebate on dividends paid to a company by a wholly-owned mining subsidiary where the parent company has, in the ordinary course of its business, hedged against the commodity being mined.

Positions of associates

5.64     Where, under an arrangement, an associate of the taxpayer has entered into a short position in relation to shares held by the taxpayer, the position is deemed to be a position entered into by the taxpayer. For example, if a taxpayer holds 1000 ordinary shares in company A and, under an arrangement, company B (which is controlled by the taxpayer) writes a call option on ordinary shares in company A, the option position taken by company B will be deemed to be an option position taken by the taxpayer. [Item 8, new subsection 160APHJ(8)]

Material diminution of risk

5.65      Regulations may prescribe the circumstances in which a taxpayer is taken to have materially diminished risk with respect to shares or an interest in shares. [Item 8, new subsection 160APHM(1)]

5.66     In the absence of regulations to the contrary, new subsection 160APHM(2) provides that a taxpayer is taken to have materially diminished the risks of loss and opportunities for gain with respect to shares or interests if the net position of the taxpayer results in the taxpayer having less than 30% of the risks and opportunities associated with the shares or interests. [Item 8, new subsection 160APHM(2)]

Examples

5.67     For example, a taxpayer who holds 1000 shares in a company and writes a call option with a delta of 0.6 in respect of those shares will not have materially diminished risk with respect to the shares because the net position of the taxpayer in relation to the shares would be in excess of 0.3. To determine the net position, the delta of the sold call option is subtracted (because it is a short position) from the delta of the shares (the delta of a share against which the delta of an option or other derivative is calculated is, by definition, +1). Accordingly, the net position of the taxpayer in relation to the shares is:

     [(1000 ´ 1) - (1000 ´ 0.6)]/1000 = 0.4

5.68     In contrast, a taxpayer who holds 1000 shares and writes a call option with a delta of 0.9 will have materially diminished risk with respect to the shares because the net position of the taxpayer in relation to the shares is 0.1.

5.69     It is possible to combine several options with a holding of shares to materially diminish risk with respect to those shares. For example, a taxpayer who holds 1000 shares in a company and writes a call option with a delta of 0.5 and buys a put option with a delta of 0.4 will have materially diminished risk with respect to the shares. To determine the net position, the deltas of the call and put option are subtracted (because they are short positions) from the delta of the shares. Accordingly the net delta of the shares and options is:

     [(1000 ´ 1) - (1000 ´ 0.5) + (1000 ´ -0.4)]/1000 = 0.1

5.70          Derivatives with different deltas should be added on a weighted basis. For example, if, in respect of a particular shareholding, a shareholder buys one call option with a delta of 0.4, two put options with a delta of 0.3 and three put options with a delta of 0.2 then, in respect of the shares, the total delta of the options is:

     [(1000 ´ 0.4) + (2000 ´ -0.3) + (3000 ´ -0.2)]/1000 = -0.8

Therefore the net position in relation to the shares is:

     -0.8 + 1 = 0.2

5.71          Similarly, through the use of various hedging techniques shares and options can be combined to produce a position where the taxpayer is not exposed to risk of loss. For example, a share trader who holds 600 shares in a company and writes a call option with a delta of 0.6 will have materially diminished risk with respect to the shares. This is because the net position of the taxpayer in relation to shares is less than 0.3:

     [(600 ´ 1) - (1000 ´ 0.6)]/1000

5.72          In addition, if a taxpayer has entered into a forward sale of shares or a futures contract to sell shares, the taxpayer will be deemed to have diminished risk with respect to the shares because the taxpayer's net position in relation to the shares would be less than 0.3. This is because the delta of the future or forward in relation to the shares would be -1. As a result, the net position of the taxpayer in relation to the shares would be:

     [(1000 ´ 1) - (1000 ´ 1)]/1000

When do beneficiaries under a trust have a material diminution of risk?

5.73          Some interests in shares held through a trust are inherently risk-less.  For example, a potential income beneficiary of a discretionary trust cannot be said to bear the risks of loss or opportunities for gain from shares held by the trust. To prevent such risk-less holdings being used to circumvent the holding period rule, special provisions apply to interests in shares held through trusts.

5.74          New section 160APHL determines how beneficiaries under a trust calculate the extent of their interests. This calculation is required to determine whether the beneficiary is holding the relevant interest at-risk.

5.75          In calculating the extent of a beneficiary's interest, it is necessary to distinguish between the interest of a beneficiary in shares held by a widely-held trust (as defined below), and the interest of a beneficiary in shares held by other trusts. This is because, for beneficiaries of a widely held trust, it is the interest in all the shares held from time to time by the trust that is relevant in determining whether a beneficiary holds an interest at-risk for the requisite period, while for beneficiaries of trusts other than widely-held trusts it is the interest of the beneficiary in particular shares that is relevant. Therefore the interest in shares of a beneficiary of a widely-held trust is taken to be that beneficiary's share of the dividend income from all shares (or interest in shares) held by the trust in respect of which the beneficiary receives a distribution, expressed as a proportion of the total dividend income received by the trust in relation to those shares. On the other hand, the interest of a beneficiary in each share (or interests in share) held by non-widely held trusts is that beneficiary's share in the income from that share, expressed as a proportion of the total dividend income received by the trust in relation to that share. [Item 8; new subsections 160APHL(5) and (6)]

5.76          For the purposes of calculating a beneficiary's net position under new subsection 160APHJ(5) , the interest in shares calculated in this way is a long position with a delta of +1 in relation to itself (in the same way that direct ownership of a share constitutes a long position in that share). [Item 8; new subsection 160APHL(7)]

5.77          However, this deemed long position is effectively cancelled by a matching short position for beneficiaries of trusts other than family trusts, deceased estate trusts and employee share scheme trusts (all of which are defined below). After the effective cancellation of the deemed long position, and assuming there are no other positions held by the beneficiary which relate to the trust holding (see below), a beneficiary of these other trusts has a long position in only so much of the beneficiary's interest in the shares held by the trust as is a fixed interest. As a result, if a beneficiary of such a trust does not have a fixed interest and has no other long positions which relate to the trust holding, the beneficiary's net position in his or her interest in the shares held by the trust will be zero, and the beneficiary will have materially diminished risks of loss and opportunities for gain for the purposes of new sections 160APHO and 160APHP . The consequence of having materially diminished risks and opportunities is that days on which this occurs are not counted in determining whether the beneficiary's interest in the shares has been held for the requisite period. [Item 8; new subsection 160APHL(10)]

5.78          For these purposes an interest is fixed if it is vested and indefeasible. An interest may be defeasible if it is redeemable for less than its value, or if its value can be materially reduced by the creation of other interests in the trust (which, in the case of a unit trust, includes the issue of further units). Special provisions apply in determining whether a unit-holder in a unit trust has a vested and indefeasible interest. [Item 8; new subsections 160APHL(12) and (13)]

5.79          Even if an interest is not fixed and indefeasible, the Commissioner may, in appropriate circumstances, deem it to be so. For example it may be appropriate to exercise this discretion, if necessary, in relation to beneficiaries of certain ‘hardship trusts’ (e.g. trusts established under workers' compensation legislation). [Item 8; new subsections 160APHL(14) and (15)]

Definitions of widely-held trusts, family trusts, deceased estate trusts and employee share scheme trusts

5.80          New section 160APHD provides a definition of widely-held trust. A trust is a not a widely-held trust if it is a non-fixed trust (as defined in Schedule 2F of the Act) or a closely-held fixed trust. A trust is a closely-held fixed trust if 20 entities (which include natural persons) or less (none of whom is an associate of any of the others) have interests in the trust that together entitle them to 75% or more of:

   the beneficial interests in the income of the trust; or

     the beneficial interests in the property of the trust.

In this context, beneficial interests refer to the immediate benefical interests of beneficiaries of a trust and not the ultimate beneficial interests. For example, a trust with only two superannuation funds as beneficiaries would not be widely-held even though there may be many ultimate ‘beneficiaries’ of the trust (i.e. the superannuation fund members). [Item 8; new section 160APHD]

5.81          Schedule 2F of the Act provides the definition of a family trust used for the purposes of the holding period rule. To ensure that a trust is not precluded from making a family trust election merely because the beneficiaries are unable to control the trustee, the definition in Schedule 2F has been modified by the Bill to include a category of trust where the only group able to benefit under the trust are family members. Thus a damages trust administered for the benefit of a disabled accident victim could be a family trust, even though the beneficiary is not necessarily in a position to control the trust. [Item 24; new paragraph 272-87(g)]

5.82          Deceased estate trusts are estates administered by executors or administrators: they are not trusts created by will. [Item 8; new paragraph 160APHL(10)(b)]

5.83          Employee share scheme trusts are trusts established to provide shares to employees under an employee share scheme for the purposes of Division 13A of Part III of the Act, provided that any forfeiture condition relating to the scheme does not extend beyond 10 years.  [Item 8, new section 160APHD - definition of ‘employee share scheme security’]

Other positions

5.84          Apart from the long position mentioned in new subsection 160APHL(7) , and the long position constituted by a beneficiary's fixed and indefeasible interest in the shares held by the trust, in working out whether there has been a material diminution of risk the beneficiary's other long and short positions are also counted.

5.85          In the case of trusts other than widely-held trusts, these other positions include positions of the trustee which are imputed to the beneficiary because they relate to the beneficiary's interest in the shares. A position of the trustee relates to a beneficiary's interest if:

     the position relates to shares in which the beneficiary has a vested and indefeasible interest; or

     the beneficiary stands to directly gain a benefit or suffer a loss from the position.

[Item 8; new subsections 160APHL(8) and (9)]

5.86          For example, a closely-held fixed trust established in January 1998 with two beneficiaries entitled to share equally in the trust income and capital (i.e. they have equal fixed interests in the corpus) holds 1000 shares in a company which were acquired at the time of the trust's establishment. In October 1998 the trustee appoints a third beneficiary, who shares in the trust income and capital equally with the original beneficiaries. At the same time the trustee buys a deep-in-the-money put option with a delta of -0.8 as against the shares (so that the risk with regards to the shares is materially diminished).

5.87          In this example, the original beneficiaries will continue to be eligible for franking benefits and the intercorporate dividend rebate in relation to dividends paid on the shares (provided they are not under an obligation to make a related payment) because they have held their interest in the shares at risk for the requisite period. However, the position entered into by the trustee in respect of the shares will be deemed to be a position of the beneficiaries. As a result, the new beneficiary will not be entitled to franking benefits because the beneficiary will not have held an interest in the shares for the requisite period of time to qualify for franking benefits and the intercorporate dividend rebate.

Example of the operation of new section 160APHL

5.88          Assume the trustee of a trust which is not a family trust, deceased estate trust or employee share scheme trust holds 2000 shares and that a beneficiary is entitled to half the dividends from those shares. The beneficiary's interest in those shares will be 50% of the trustee's holding, or 1000 shares. However, this long position is offset by a matching short position under new subsection 160APHL(10) , leaving the beneficiary with a long position of only so much of the beneficiary's interest as is a fixed interest. If the beneficiary does have a fixed interest of 30% or greater in the 1,000 shares (i.e. the equivalent of 300 shares), then there will not be a materially diminished risk in respect of the interest in the shares. On the other hand, if the beneficiary has a lesser fixed interest, or no fixed interest, in corpus (e.g. because the beneficiary is only a discretionary object of the trust) there would be a material diminution of risk.

When does the 45 or 90 day holding have to take place?

5.89          The relevant holding period has to occur during the ‘qualification period’. For the holding period rule the relevant qualification period is the ‘primary qualification period’; for the related payments rule it is the ‘secondary qualification period’. New section 160APHD defines the primary qualification period as the period commencing on the day after the day the taxpayer acquires the shares or interest, and ends on the 45th day (or 90th day for preference shares) after the day on which the shares or interests become ‘ ex-dividend ’. The secondary qualification period, if the shares are not preference shares, is defined as the period commencing on the 45th day before, and ending on the 45th day after, the day on which the shares or interest become ex-dividend . If the shares are preference shares, the secondary qualification period commences on the 90th day before, and ends on the 90th day after, the day on which the shares or interest become ex-dividend .

5.90          If a taxpayer is not under an obligation to make a related payment in relation to a dividend or distribution, the taxpayer will have to satisfy the holding period requirement within the primary qualification period.  If a taxpayer is under an obligation to make a related payment in relation to a dividend or distribution, the taxpayer will have to satisfy the holding period requirement within the secondary qualification period.

5.91          For these purposes, a share or interest becomes ex-dividend on the day after the last day on which the shares or interest in shares can be acquired by a taxpayer so as to become entitled to the dividend or distribution on the shares or interest. For example, if a company declares a dividend on 1 June, to be paid on 30 June, and the dividend can be paid to a shareholder who held shares up until 25 June (but no later), then the ex-dividend day is 26 June. [Item 8, new section 160APHE]

5.92          Therefore, a taxpayer who acquires shares on the day before the ex-dividend day will be a qualified person (for the purposes of the holding period rule) in relation to a dividend for the purposes of new section 160APHO provided the taxpayer immediately thereafter holds the shares for the requisite period.

What is a related payment?

5.93          A taxpayer or associate is taken for the purposes of the provisions to have made a related payment if the taxpayer or associate is under an obligation to pass the benefit of a dividend or distribution to other persons. The requirement that the benefit be passed on means that if the benefit of the dividend or distribution remains with the taxpayer, there will not be a related payment. For example there will not be a related payment merely because a dividend is paid directly into the taxpayer’s bank account. [New section 160APHN]

5.94          Although new section 160APHN uses the expression ‘related payment’ it is immaterial whether an actual payment or some other method is used to pass the benefit of the dividend to another person; any method of passing the benefit of a dividend to another person may be a ‘related payment’ within the meaning of the section. New subsection 160APHN(3) provides the following examples as transactions which may constitute the making of a related payment:

    any distribution, whether in money or other property, which is equal to, calculated by reference to or approximates the amount of the dividend or distribution;

    any amounts which are credited or notionally credited (explained below) to a party to the arrangement which are calculated by reference to, equal to or approximates the amount of the dividend or distribution; and

     any amounts payable to a party to the arrangement which are calculated by reference to, equal to or approximates the amount of the dividend or distribution. [Item 8; new subsection 160APHN(3)]

Notional crediting

5.95          Because a person does not need to receive an actual payment to receive the economic benefit of a dividend, a related payment includes a notional crediting of an amount which is calculated by reference to the amount of the dividend or distribution. A notional crediting of an amount usually involves having the extent of a person's obligation under an arrangement (e.g. a futures contract or warrant arrangement) determined by a formula which is calculated by reference to the amount of the dividend. A notional crediting differs from an actual crediting in that the dividend amounts are not actually attributed to the relevant person, that is, the relevant person has no actual rights in relation to the dividend . [Item 8; new subsection 160APHN(6)]

5.96          For example, holders of endowment warrants have their obligation under the warrants (i.e. price payable on completion of the warrants) reduced by the amount of dividends received by the issuing institution; however, the warrant holders cannot demand payment of the dividends in lieu of having the dividends offset against their obligations. Similarly, the buyer in a futures contract cannot demand that the seller pass on the cash amount of the dividend. The buyer is only able to receive the benefit of the dividend indirectly when the futures contract is settled.

5.97          Accordingly, if the amount payable on maturity of a security is calculated by reference to the amount of the dividend, the specific inclusion of the dividend amounts in the calculation of the amount payable will be a related payment.

Other examples of related payments

5.98          The following will also be related payments, provided they are calculated by reference to the amount of the dividend:

    amounts which are credited by way of discounts on debt securities;

    a partial, total or notional offset of interest payable on a loan arrangement; or

     an amount representing capitalised interest which is payable on the maturity of a security.

5.99          Likewise, where the price paid for a security includes an estimated dividend component, the offset of the interest component by the estimated dividend component will be a related payment. For example, the theoretical price of a share under a futures contract is usually calculated by taking the current market price, adding interest on the outstanding share price for the term of the contract, and subtracting expected dividends: the subtraction from the price of the expected dividends is a related payment.

5.100        Apart from cases where a payment or crediting relates to a particular dividend, there are cases where payments or credits are made in respect of a number of dividends, for example, under index derivatives. Where dividends are received from a number of shares and there is a matching outgoing under an index derivative, there may be a related payment. In some cases the related payment may be calculated in respect of dividends on shares which do not exactly match those held by the taxpayer. However, the match need not be exact for the payment to be a related payment, provided it is substantially the same. This is because small discrepancies in the relevant parcels of shares, particularly those shares with a low weighting in an index, will not necessarily prevent the payment under the derivative from effectively passing the benefit of the dividends to the counterparty. Generally, a correspondence between a share parcel and an index derivative which is sufficiently close to reduce risk materially in a qualification period will, if the index derivative requires a dividend equivalent benefit to pass to the holder of the derivative, also be sufficiently matched with the dividends on the parcel to constitute a related payment.

Share price index (SPI) and other futures

5.101        It is necessary for the related payments rule to apply to Share Price Index (SPI) future transactions where the seller of the future hedges by holding the physical stock (i.e. a share portfolio which is closely correlated with the All Ordinaries Index (AOI)) and effectively credits the buyer with the estimated dividends on the shares through the price against which the contract is agreed to be settled. This is because otherwise such transactions could be used to generate inappropriate tax benefits. Such benefits would come about because the tax payable on the dividends is offset by the seller paying less tax on the profit on the futures transaction or generating a greater loss (by virtue of the fact that the seller receives less cash on settlement of the contract). The seller, however, remains in the same economic position because any reduction in cash received on the futures transaction is offset by the dividend income. In this case the profit made (and therefore the tax paid) by the seller on the sale price does not include the amount of the expected dividends so that, when the dividends are received, there has been an effective tax deduction against them. Any rebates attaching to the dividend are therefore used to offset the tax payable on other income. Taxpayers entering into such transactions are indifferent to rises and falls in the price of the shares, because any losses or gains made by the seller on the shares will be offset by equivalent gains or losses on the SPI contract.

5.102        In relation to equity swaps the financial institution which holds the legal title to shares is required to pay the counterparty an amount equivalent to the dividends received by it plus any capital gains under an obligation which is represented by the swap arrangement. The financial institution is under an obligation to make a related payment because under the swap arrangement the institution is obliged to pay the counterparty an amount which is calculated by reference to the amount of the dividend.

 (b) Formula-based ceiling for certain taxpayers

5.103        The above paragraphs explained how the related payments rule and the general holding period rule operate.  Below is an explanation of special cases where the taxpayer may be a qualified person irrespective of how long the shares or interests in shares are held.

5.104        The Bill provides that certain eligible taxpayers may elect to have franking credit or rebate ceilings applied in accordance with a particular formula on shares or interest in shares managed as or in a discrete fund. These eligible taxpayers are:

       listed widely-held trusts; [Item 8, new paragraph 160APHR(1)(a)]

       unlisted very widely held trusts; [Item 8, new paragraph 160APHR(1)(b)]

       life assurance companies; [Item 8, new paragraph 160APHR(1)(c)];

       general insurance companies; [Item 8, new paragraph 160APHR(1)(d)]

       friendly societies; [Item 8, new paragraph 160APHR(1)(e)]

       health insurance funds; [Item 8, new paragraph 160APHR(1)(f)]

       trustees of complying superannuation funds, other than excluded superannuation funds (which have fewer than five members and are subject to less regulation than larger funds); [Item 8, new paragraph 160APHR(1)(g)]

       trustees of funds which are complying approved deposit funds (ADFs), other than excluded ADFs; [Item 8, new paragraph 160APHR(1)(h)]

       trustees of unit trusts which are pooled superannuation trusts; [Item 8, new paragraph 160APHR(1)(i)]

       any other taxpayers who are declared by regulations to be an eligible taxpayer for the purposes of the election; [Item 8, new paragraph 160APHR(1)(j)] and

       unit trusts where at least 75% of the units are owned by any of the above entities (or entities unable to benefit from franking or the intercorporate dividend rebate, namely non-residents and tax-exempt entities). [Item 8, new paragraph 160APHR(1)(k) and new section 160APHS]

5.105        These taxpayers are treated differently because they would incur high compliance costs in meeting the requirements of the holding period rule, and because they are considered to be low revenue risk taxpayers. Moreover, their investment activities make comparison with a share index benchmark an appropriate alternative to the holding period rule.

5.106         The regulations can also provide for the inclusion of other low revenue risk taxpayers as eligible for making an election; such taxpayers generally also need to be subject to high compliance costs in applying the holding period rule. In this regard, closely-held investment vehicles and geared funds are likely to be higher revenue risk than low turn-over and fully invested funds, as well as funds owing a high level of fiduciary duties to investors; a high turn-over of shares, investments spread over a number of different funds and frequent use of derivatives are indicia of high compliance costs. [Item 8, new paragraph 160APHR(1)(j)]

 

5.107         An election to have a franking credit or rebate ceiling applied is irrevocable without leave of the Commissioner.

 

5.108         An eligible taxpayer who makes such an election is deemed to be a qualified person for the purposes of new section 160APHO in relation to every dividend paid in relation to the shares or interest in shares in respect of which the election is made during the time the election is in force. [Item 8, new subsection 160APHR(8)]

5.109        The election will not apply in relation to shares or interests which are subject to equity swaps or securities lending arrangements attracting the related payments rule. Therefore, if an eligible entity enters into such an arrangement, the entity is taken not to be a qualified person in relation to the dividend or distribution paid on the shares or interest which form the subject of the arrangement. Accordingly, if a superannuation fund enters into an equity swap where the fund is the legal holder of the shares but it is under an obligation to make a related payment with respect to the dividends paid on the shares, the election to have a franking rebate ceiling will not apply in relation to those shares. [Item 8; new subsections 160APHR(3) and 160APHR(4)]

5.110         If the Commissioner has made a determination under subsection 177EA(5) (the general anti-avoidance rule) in respect of dividends or distributions paid on shares or interests in shares, the Commissioner may also determine that the election to apply a franking credit or rebate ceiling made by the relevant taxpayer is effectively revoked. [Item 8; new subsection 160APHR(9)]

 

5.111         Where the following conditions are satisfied:

       there is an election in force in relation to shares or interests; and

       the Commissioner is of the opinion that the taxpayer has entered into an arrangement with a third party (e.g. the asset overlay manager) or an associate; and

       pursuant to the arrangement, the third party or associate has taken a position which materially diminishes the risks of loss and opportunities for gain in relation to the shares or interests but is not taken into account when calculating the net equity exposure under new subsection 160AQZF(2) ;

the relevant short positions are taken into account for the purposes of calculating the net equity exposure of the fund or taxpayer, and the Commissioner may determine that the election made by the relevant taxpayer ceases to have effect. [Item 8; new subsection 160APHR(10)]

Calculation of the franking credits ceiling

5.112        The maximum franking credits a taxpayer is entitled to during a year of income from dividends or distributions paid on shares and interests in shares held directly or indirectly by the taxpayer, which are managed by the taxpayer, or on the taxpayer's behalf, as or in a discrete fund, is not to exceed the ceiling amount in relation to the fund. If, for example, the taxpayer holds $100 million of shares which are divided into two $50 million funds, one managed by Fund Manager A, the other managed by Fund Manager B, the ceiling amount applies separately in relation to each fund. [Item 22, new subsection 160AQZC(1)]

5.113        For a particular year of income, unless regulations prescribe otherwise, the ceiling amount in relation to a fund is the notional total credit amount increased by 20%. [Item 22, new subsection 160AQZC(3)]

5.114        The notional total credit amount in relation to a fund is, unless regulations prescribe otherwise, the total amount of franking credits to which the taxpayer would be entitled in respect of dividends paid on a benchmark portfolio of shares (explained below). [Item 22, new subsection 160AQZC(4)]

5.115        Therefore the total amount of franking credits a taxpayer would be entitled to would depend on the franked dividend yield of the relevant benchmark portfolio. If the taxpayer is a life assurance company paid a class A franked dividend and the company is entitled to a class A franking credit then, in calculating the sum of the franking credits to which the company is entitled under new section 160AQZC, the class A franking credits are converted into equivalent class C franking credits (for other companies, no entitlement to a class A franking credit arises because such credits are converted into class C franking credits under section 160ASI of the Act). The benchmark yield is to be the yield calculated for the taxpayer's income year. [Item 22; new subsection 160AQZC(2)]

Calculation of the franking rebate and intercorporate dividend rebate ceiling

5.116        New section 160AQZD provides for the calculation of the maximum franking and intercorporate dividend rebates a taxpayer is entitled to from dividends or distributions paid on shares (and interests in shares) held (directly or indirectly) by the taxpayer, which are managed by the taxpayer, or on the taxpayer's behalf, as or in a discrete fund. The ceiling is calculated in an equivalent way to the calculation of the franking credit ceiling for companies (see paragraphs 7.112-7.115 above). [Item 22, new section 160AQZD]

Calculation of the ceiling for dividends received through trusts and partnerships

5.117        Trusts and partnerships receiving dividends (directly or indirectly from other trusts or partnerships) are not entitled to franking benefits or the intercorporate dividend rebate, but such benefits can flow through to the ultimate beneficiaries or partners.

5.118        If a trust is of a kind mentioned in new subsection 160APHR(1) , or a partnership is prescribed in regulations as being eligible to make an election under that section, the trust or partnership may elect to have a franking credit or rebate ceiling applied against shares or interests in shares managed as or in a discrete fund. In such a case the flow through of franking benefits or the intercorporate dividend rebate to the ultimate beneficiaries or partners needs to be limited by reference to the ceiling.

5.119        To implement this, new section 160AQZE limits the potential rebate amount flowing through the trust or partnership (i.e. the mechanism used in Part IIIAA of the Act to allow franking benefits to flow through a trust or partnership), while new section 45ZB caps the intercorporate dividend rebate available to corporate beneficiaries or partners that receive dividends indirectly through one or more interposed trusts or partnerships. [Item 8, new section 160AQZE; Item 5, new section 45ZB]

Standard benchmark portfolio

5.120        The standard benchmark portfolio applicable in respect of a fund managed by or on behalf of a taxpayer is to be a portfolio comprising the All Ordinaries Index (AOI) equal in value to the net equity exposure of the fund for the relevant year of income. [Item 22, new paragraph 160AQZF(1)(a)]

5.121        Some portfolios will legitimately have a higher franked dividend yield than an equivalent AOI holding. For example, a portfolio that matches the Banks and Finance Index will generally have a higher franked yield than one matching the AOI. To allow for this, taxpayers whose equity portfolio matches, or has a sufficient weighting towards, a recognised share index will be able to benefit from the higher yield such an index provides. In a few cases, the AOI may be inappropriately high; for example, where a fund specialises in low yielding or unfranked stocks. Accordingly, new paragraph 160AQZE(1)(b) allows for the making of regulations providing details of alternative benchmark portfolios. However, until those regulations are made taxpayers will be required to adopt the standard (AOI) benchmark portfolio. [Item 22, new paragraph 160AQZF(1)(b)]

Net equity exposure

5.122        To compare the franked yield from the taxpayer's fund with the benchmark portfolio, it is necessary to determine the net equity exposure of the fund for a year. Unless regulations prescribe otherwise, this is to be determined generally by calculating an average for the year based on weekly figures. [Item 22, new subsection 160AQZF(4)]

5.123        In calculating the net equity exposure of a particular fund for the purposes of the holding period rule, any positions which the taxpayer has which are subject to equity swaps or securities lending arrangements where the taxpayer is under an obligation to make a related payment with respect to the relevant dividends are ignored for the purposes of determining the net equity exposure of the fund. Therefore, in calculating the net equity exposure of the fund, the long position comprising the shares and the short position represented by the offsetting obligation are not taken into account when calculating the net equity exposure of the fund. [Item 8; new subsection 160APHR(5)]

5.124        For example, if Fund Manager A (who manages a fund of $50 million) has derivatives which, as against the shares held in the fund, have a delta of -0.1, the net equity exposure of the fund is:

     (50 million ´ 1) + (50 million ´ -0.1) = 45 million

Example of application of the ceiling

5.125        Suppose a complying superannuation fund (which is not an excluded fund) holds an equity portfolio with an average market value of $100 million and derivatives which, as against the shares, have a delta of minus 0.05 so that the net equity exposure would be $95 million. The AOI has, say, a 4% yield (70% franked) which would provide a franking rebate on a $95 million portfolio of $1.5 million ($95 million × 4% × 70% × 36/64). Therefore the taxpayer will be able to claim a franking rebate of up to $1.5 million plus 20% (i.e. $1.8 million). Any rebate above $1.8 million will be denied.

 (c) Small shareholder exemption

5.126         Taxpayers who are natural persons (i.e. not companies, trusts or partnerships) can also elect to have a franking rebate ceiling applied in relation to a year of income. If a natural person taxpayer makes such an election, the taxpayer is a qualified person for the purposes of the holding period rule in relation to every dividend paid during that year of income. [Item 8, new section 160APHT]

 

5.127        Under n ew section 160APHT , all natural persons will be able to elect to apply a franking rebate ceiling instead of satisfying the holding period rules. This ceiling will apply to franked income from all sources, not just from shares held directly by the taxpayer. For example, a franked distribution from a trust is included. [Item 22, new subsection 160AQZH(1)]

5.128        However, an electing taxpayer will not be taken to be a qualified person in relation to a dividend or distribution if the related payments rule applies to the dividend or distribution.

5.129         New subsection 160AQZH(1) provides that the sum of the franking rebates claimed by a natural person who has made an election in accordance with new section 160APHT is not to exceed the amount specified in new subsection 160AQZH(2) . [Item 22, new subsections 160AQZH(1) and 160AQZH(2)]

 

5.130         The amount provided in new subsection 160AQZH(2) is calculated by adding all franking rebates to which the relevant person would have been entitled if the taxpayer was a qualified person in relation to all dividends and trust and partnership distributions received in the income year in which the taxpayer has made the election, and subtracting $4 for every $1 of franking rebate in excess of $2,000. [Item 22, new subsection 160AQZH(2), 160AQZH(2) and 160AQZH(2)]

5.131        For example, a taxpayer who has made an election with a franking rebate of $2,001 would not be entitled to the rebate in excess of $2000 and will also have the remaining rebate reduced by $4, leaving an entitlement to a rebate of $1,996.

5.132        Taxpayers must elect to apply the threshold in relation to a particular year. If no election is made the ordinary holding period rule applies. The election need not be in a particular form.

5.133        A deduction is allowable for the gross-up amount of a dividend included in assessable income (e.g. under section 160AQT) for which the taxpayer is denied a franking rebate. The maximum deduction allowable is $2,500. [Item 22, new section 160AQZI]

 (d) Shares issued in connection with winding up

5.134         New section 160APHQ provides that if shares are issued and cancelled in the course of winding up a company and a dividend is paid on those shares, the taxpayer who holds the shares or an interest in the shares is a qualified person in relation to the dividend for the purposes of the holding period rule. However, if, for example, shares are issued in the course of winding up and then within 45 days are disposed of to a third party (as opposed to the issuing company), the taxpayer will not be a qualified person in relation to any dividends paid on the shares (this exception has been created because companies sometimes issue shares in the course of winding up to capitalise debt).

 

5.135        However, new paragraph 160APHQ(c) excludes dividends which attract the related payments rule.

Beneficiaries of a widely held trust

5.136        A taxpayer who holds an interest in shares as a beneficiary of a widely-held trust on which a distribution has been paid will be a qualified person in relation to any dividend paid on the shares from which the distribution is derived if the taxpayer has held the interest in shares during the relevant qualification period in relation to the interest (i.e. if the taxpayer or associate is under an obligation to make a related payment with respect to the distribution, the secondary qualification period, and if the taxpayer or associate is not under an obligation to make a related payment, the primary qualification period), not counting the day of acquisition or disposal, for 45 days. [Item 8, new subsection 160APHP(1)]

5.137        Unlike closely-held trusts, where a trustee of a widely-held trust enters into a position with respect to shares or an interest in shares (relevant shares) which form the property of the trust, the beneficiaries of the trust are not deemed to have entered into a proportionate position with respect to their interests in the relevant shares.

5.138        Therefore, beneficiaries of widely-held trusts do not have to be concerned with whether the trustee of the trust has taken a position with respect to the shares in the trust property. Only positions entered into personally by the beneficiary can materially diminish risk in relation to the beneficiary's interest. Provided the beneficiary personally satisfies the holding period requirements, the beneficiary will be a qualified person. [Item 8, new subsection 160APHO(2)]

What is the effect of not being a qualified person in relation to a franked dividend or distribution?

5.139        Where a taxpayer is not a qualified person in relation to a dividend or distribution, the taxpayer will be denied the franking credit (and therefore the franking rebate) and the intercorporate dividend rebate on the dividend or distribution.

5.140        As a result, the Bill will amend:

       section 160APP so that no franking credits arise upon the receipt of franked dividends if the company in receipt of the dividends is not a qualified person in relation to those dividends; [Item 9, amended subsection 160APP(6)]

       section 160APQ so that no franking credit arises in respect of a trust or partnership amount included in a company's assessable income if the company is not a qualified person in relation to the relevant dividend (i.e. the dividend to which the trust or partnership amount is attributable); [Items 10 and 11, new paragraphs 160APQ(1)(c) and 160APQ(2)(c)]

       section 160AQT so that no gross-up is made (and hence no entitlement to the franking rebate under section 160AQU arises) upon the receipt of a franked dividend if the taxpayer who receives the dividend is not a qualified person in relation to the dividend; [Items 12 to 16, new paragraphs 160AQT(1)(ba), 160AQT(1AB)(ba), 160AQT(1A)(ba) and 160AQT(1C)(ba)]

       section 45Z so that, for the purposes of determining whether company beneficiaries or partners will be entitled to the intercorporate dividend rebate, the trust or partnership distribution will not carry the right to an intercorporate dividend rebate if the company is not a qualified person in relation to the relevant dividend; [Items 1 to 4 , new paragraphs 45Z(1)(ca) and 45Z(3)(ca) and new subparagraphs 45Z(2)(c)(iia) and 45Z(4)(c)(iia)]

       sections 160AQX, 160AQY, 160AQYA, 160AQZ and 160AQZA so that no franking rebate arises in respect of a trust or partnership amount included in a taxpayer's assessable income, if the taxpayer is not a qualified person in relation to the relevant dividend; [Items 17 to 21, new paragraphs 160AQX(ca), 160AQY(ba), 160AQYA(1)(c)(ca), 160AQYA(ca) and 160AQZ(ca)]

       section 46 and 46A so that a company in receipt of a dividend will not be eligible for the intercorporate dividend rebate if the company is not a qualified person for the purposes of Division 1A in relation to the dividend. [Items 6 and 7 , new subsections 46(2B) and 46A(5B)]

Adjustments in relation to section 160AQT amounts

5.141        The amendments to sections 160AQX, 160AQY, 160AQYA, 160AQZ and 160AQZA will prevent a beneficiary or partner gaining franking credit benefits from a trust or partnership distribution if the relevant beneficiary or partner is not a qualified person for the purposes of Division 1A .

5.142        However, as section 160AQT requires an amount to be included in the assessable income of the trust or partnership to ‘gross-up’ the dividend, a beneficiary’s or partner’s share in the net income of the trust or partnership would be inappropriately increased.

5.143        Therefore the Bill will provide a tax deduction for a trust or partnership amount included in a taxpayer's assessable income where the taxpayer is not a qualified person for the purposes of Division 1A in relation to the relevant dividend. The amount of the deduction is to be the same as the amount currently allowed under section 160AR, i.e. the potential rebate amount. For the purposes of sections 111C, 116CF,116H and 116HB of the Act, this deduction relates exclusively to the trust or partnership amount referred to in new paragraph 160ARAB(1)(a) or 160ARAB(2)(a) . [Item 23 , new section 160ARAB]



Regulation Impact Statement: Franking credit trading (Holding period and related payments rules)

Specification of policy objective

5.144        The policy objective is to prevent franking credit trading by requiring that:

       shares be held ‘at-risk’ for more than 45 days before a shareholder is entitled to the franking credit and intercorporate dividend rebate (the holding period rule); and

       shares held by taxpayers who are under an obligation to make a related payment with respect to a dividend paid on the shares be held ‘at-risk’ for more than 45 days during the relevant qualification period before the shareholder is entitled to the franking credit and intercorporate dividend rebate (the related payments rule).

5.145        These measures form part of a package of measures to prevent franking credit trading which were announced in the 1997-98 Budget. The holding period rule applies from 1 July 1997 and the related payments rule applies from 13 May 1997.

Identification of implementation options

Background

5.146        One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax-exempts) to others who can fully use them, undermines this principle. Similarly, franking credit trading transactions can also pose a threat to the revenue where the dividends paid are rebatable under section 46 of the Income Tax Assessment Act 1936 (the ITAA) because they are paid to a company shareholder.

Implementation Option

5.147        The holding period and related payments rules deny franking credits and the intercorporate dividend rebate on dividends paid to holders of shares whose interest in the company is insufficient to justify the receipt of franking and other benefits accorded to true economic owners of shares.

5.148        The holding period rule applies to deny franking credits or the intercorporate dividend rebate where the taxpayer acquires shares or interests in shares and disposes of them (or equivalent shares or interests) within 45 days (or 90 days in the case of preference shares).

5.149        The related payments rule applies to deny franking credits or the intercorporate dividend rebate where the taxpayer is under an obligation to make a related payment in respect of a dividend and the taxpayer has not held the relevant shares at-risk for more than 45 days (or 90 days in the case of preference shares) during the relevant qualification period.

5.150        In determining whether shares or interests are held for the requisite period, days during which there is in place a risk diminution arrangement (e.g. if the shareholder has eliminated the risks and opportunities of share ownership by entering into a derivative transaction) are not counted.

5.151        An alternative approach to the holding period rule is available for certain taxpayers (e.g. superannuation funds and life companies) who face substantial compliance difficulties under the standard operation of the rule and which represent a relatively low risk to the revenue because of various regulatory and prudential requirements. This approach, referred to as the ‘formula approach’, reduces compliance costs by allowing eligible taxpayers to compare the actual franked return on a portfolio with a franked return on a benchmark portfolio consistent with the taxpayer's net equity exposure instead of applying the holding period rule. The ratio of franking rebates or credits to equity exposure must be within a specified limit; the taxpayer will not be entitled to any rebates or credits in excess of that allowed by the ratio.

5.152        Individual shareholders (natural persons) entitled to a franking rebate of $2,000 dollars or less annually will also be exempt from the holding period rule, thereby eliminating compliance costs on small individual shareholders.

5.153        Taxpayers electing to apply the alternative approach and individual taxpayers claiming franking rebates of $2000 dollars or less will, however, still be required to comply with the related payments rule. Therefore, if an electing taxpayer is under an obligation to make a related payment in respect of a dividend, the taxpayer will be required to hold the relevant shares for more than 45 days ‘at-risk’ (or 90 days in the case of preference shares) during the relevant qualification period.

 

Assessment of impacts (costs and benefits) of each implementation option

Impact group identification

5.154        The holding period rule will affect taxpayers, who buy and sell shares within 45 days, and taxpayers who enter into risk diminution arrangements (e.g. derivative transactions) within 45 days of acquiring shares. The related payments rule will affect taxpayers who have diminished risk with regards to their shares during the relevant qualification period and who are under an obligation to make a related payment with respect to a dividend. These taxpayers typically include share traders, options traders, merchant banks and investment companies. The rules will also affect members of the legal and accounting professions who advise these taxpayers.

5.155        The holding period and related payments rules will also have an impact on the ATO (in administering the rule, for example, information campaigns), the Government (in that the revenue base will be protected) and non-residents and tax-exempt shareholders (whose ability to transfer franking credits will be hampered).

5.156        Certain institutional investors such as superannuation funds will not be required to comply with the holding period rule because they will be able to adopt the formula approach. Similarly, as mentioned above, small individual shareholders will also be exempted from the holding period rule.

5.157        It is not possible to provide any numerical data on the numbers of taxpayers in particular stakeholder groups or the extent of their interests. This is because shares are often held through complicated trust, nominee or group company arrangements, or funds are invested by fund managers on behalf of clients. Accordingly, underlying ownership is difficult to trace.

Analysis of the costs and benefits associated with each implementation option

5.158        Certain institutional investors (such as superannuation funds) and natural person taxpayers with franking rebates of less than $2000 have been carved-out of the holding period rule because the policy objective of the rule is to prevent franking credit trading and not to inhibit legitimate risk management or bona-fide share investment. The absence of the carve-out would result in the legislation going beyond the Government's policy objective and attacking commercial transactions that do not have the effect of a franking credit trade.

5.159        The regulatory regime and the prudential requirements placed on entities like superannuation funds and life assurance companies (i.e. restrictions on gearing and use of derivatives) make it more difficult for these entities to engage in franking credit trading. In addition, as noted above, these taxpayers have been given a different treatment because they would incur high compliance costs in meeting the requirements of the holding period rule, and because they are considered to be low revenue risk taxpayers. Moreover, their investment activities make comparison with a share index benchmark an appropriate alternative to the holding period rule.

5.160        Natural person taxpayers claiming franking rebates of $2000 or less are unlikely to be engaging in franking credit trading because the transaction costs associated with a franking credit trading scheme would result in the elimination of any tax benefit derived.

5.161        The threshold has been set so that an individual investor with a share portfolio of between $50,000 and $100,000 could  be within the exemption (depending on the yield). Accordingly, any investors outside the threshold would not be within the small investor category. Data provided by the Revenue Analysis Branch of the Australian Taxation Office indicates that the number of individual taxpayers claiming franking rebates (imputation credits) of up to $2000 in the 1996 income year was 1,095,000. The numbers of taxpayers claiming rebates ranging from $2001 to $5000 was approximately 115,000. Accordingly, increasing the threshold to $5000 would not benefit a proportionately greater number of taxpayers but may create opportunities for abuse of the exemption. By contrast, the reduction of the threshold would impose unnecessary compliance costs on a large number of small shareholders.

5.162        The advantages of a provision where the Commissioner is not required to make some finding or determination such as the holding period rule are certainty and reduced administrative costs as compared to a test where some avoidance purpose has to be found. This certainty reduces the ATO's administrative costs because the provisions do not have to be applied on a case by case basis. It also reduces compliance costs for taxpayers by reducing uncertainty in the application of the law. However, taxpayers who are required to comply with the rules will have to incur additional compliance costs in tracking their share acquisitions and disposals and their derivative transactions on shares. The extent of the compliance costs which will be incurred by taxpayers will vary depending on the facts and circumstances of particular cases. Accordingly, no reliable data on the amount of these costs is available.

5.163        Taxpayers applying the formula approach generally already have the necessary information to perform the required calculations. Consequently, although there may be some (unquantifiable) costs in applying the formula approach, the approach does not require an extensive gathering of new information. The ATO will work with the ASX to ensure that costs are minimised by, wherever possible, providing taxpayers with any additional information required (e.g. yields on relevant indices). No reliable data on the extent of the administrative costs which will be incurred by the ATO is available. However, any costs that do arise for the ATO are not expected to be high and would be met within the ATO's existing budget allocation.

5.164        The related payments rule will only apply to taxpayers who enter into specific arrangements (i.e. where taxpayers have diminished risk with respect to their shares and are under an obligation to make related payments with respect to the dividends). This minimises the potential for the measure to apply to genuine commercial transactions and taxpayers' compliance costs will be kept to a minimum. Accordingly, the related payments rule should not impose high compliance costs on taxpayers.

Taxation revenue

5.165        The holding period and related payments rules will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of franking credit trading and mis-use of the intercorporate dividend rebate. The rules are part of a package of measures targeting franking credit trading and dividend streaming. In the absence of the measures, to the extent that the revenue base would not be protected, there would be a significant revenue loss. While it is not possible to provide an exact estimate of the revenue loss that already existed from franking credit trading and dividend streaming, $130 million a year has been factored into the forward estimates for 1998-99 and subsequent years to take account of the effect of the measures on existing activities.

Consultation

5.166        The ATO and Treasury held extensive consultations with peak bodies representing taxpayers and the investment community (including bodies representing the tax profession, the ASX, merchant banks, superannuation and investment funds) shortly after the Budget announcement on matters relating to the holding period rule. The issues discussed during the consultations concerned tailoring the risk diminution aspect of the holding period rule so that risk reduction strategies not having the effect of a franking credit trade would not be affected, and other issues concerning the general anti-avoidance rule and the specific anti-streaming rule.

5.167        As a result of these consultations, the risk diminution aspect of the holding period rule was tailored to exclude risk reduction strategies that do not have the objective effect of a franking credit trade. In addition, the formula approach was devised to provide institutional investors like superannuation funds an alternative to the holding period rule.

5.168        Details of the formula approach were finalised having regard to further consultations with interested parties (in particular, the general insurance, life and superannuation industries).

Conclusion

5.169        The holding period and related payments rules are important elements of the franking credit trading measures announced in the Budget and they ensure that taxpayers do not gain an undue tax benefit from entering into arrangements involving franking credit trading and mis-use of the intercorporate dividend rebate.

5.170        They implement this policy objective in a way that, as far as possible, minimises administrative and compliance costs while providing taxpayers with certainty (e.g. small shareholder exemption and eligible investor carve-out).

5.171        The ATO will monitor developments to detect any emerging possibility of significant revenue loss/deferral or unreasonable compliance costs arising from the rules. In addition, the ATO has consultative arrangements in place to obtain feedback from professional associations and the business community and through other taxpayer consultation forums.



C hapter 6

Distributions to beneficiaries and partners that are equivalent to interest

Overview

6.1                        The Bill will amend section 45Z and other provisions of the Income Tax Assessment Act 1936 (ITAA) to prevent trust or partnership distributions which are equivalent to the payment of interest on a loan from providing an entitlement to the intercorporate dividend rebate, franking credits or franking rebate.

Summary of amendments

Purpose of amendments

6.2                        The purpose of the amendments is to ensure that certain trust or partnership distributions which consist of dividends, but are effectively in the nature of interest, do not inappropriately carry franking benefits or receive the inter-corporate dividend rebate. The amendments will apply to taxpayers who hold a debt-like interest in shares indirectly through a trust or partnership; that is, to taxpayers who, under a trust or partnership, are effectively creditors rather than share owners. The amendments will curb the unintended usage of franking benefits and the inter-corporate dividend rebate by preventing the holders of indirect interests in shares from receiving those benefits for trust or partnership distributions consisting of dividends in the same circumstances in which direct holders of shares are denied those benefits for dividends. This will make the taxation treatment of such distributions consistent with the treatment of debt-dividends under existing section 46D of ITAA.

Date of effect

6.3                        The amendments apply to interests created or acquired, and finance arrangements entered into, after 7.30 pm AEST on 13 May 1997, and to existing arrangements extended after that time.

Background to the legislation

6.4                        Under existing section 46D, dividends (‘debt dividends’) which may reasonably be regarded as equivalent to interest on a loan are not eligible for the inter-corporate dividend rebate; nor are debt-dividends frankable dividends (section 160APA provides that debt dividends are not frankable). This prevents arrangements to pay effectively tax-free dividends in lieu of interest. It also reflects a basic principle of imputation that company tax should only be imputed to owners of true equity interests in companies, and not to persons who are effectively creditors. Such persons do not bear the economic risk of holding shares to the same extent as shareholders.

6.5                        Existing section 45Z generally extends the availability of the intercorporate dividend rebate to dividends derived indirectly through trusts and partnerships. An exception is where, as between the company paying the dividend and the trustee or partnership, the payment of the dividend is equivalent to the payment of interest on a loan. This exception does not, however, cover all cases where trust or partnership distributions consisting of dividends are equivalent to interest; for example, where the beneficiary or partner is receiving a distribution equivalent to interest, but the trustee or partnership is not. The Bill brings the taxation treatment of these cases into line with the existing treatment of other trust and partnership distributions of dividends which are interest-like in the hands of the trustee or partnership.

Explanation of the amendments

6.6         Schedule 9 of the Bill inserts new section 45ZA to deny the inter-corporate dividend rebate in certain circumstances. Broadly speaking, this provision applies if a distribution is made to a taxpayer in respect of an interest in a trust or partnership, or under a finance arrangement, and, having regard to the way in which the amount was calculated, the conditions applying to the payment of the amount and any other relevant matters, that amount may reasonably be regarded as equivalent to the payment (or crediting or application) of interest on a loan. [Item 2; new section 45ZA]

6.7         The key elements of the new section are that

·         an amount must be included in the assessable income of a taxpayer; [Item 2; new paragraph 45ZA(1)(a)]

·         the whole or part of that amount must represent a dividend; and [Item 2; new paragraph 45ZA(1)(b)]

·         the amount, or part of it, must be equivalent to interest on a loan. [Item 2; new paragraph 45ZA(1)(d)]

6.8                        In order to be captured by the new section the amount must also be either:

·    paid under a finance arrangement entered into after the commencing date; or

·    paid in respect of an interest created or acquired after the commencing date. [Item 2; new paragraph 45ZA(1)(c)]

6.9                        Similarly, amended section 160APQ provides that where partnership or trust distributions are equivalent to interest, franking credits do not flow to the relevant corporate partners or beneficiaries. [Item 5; new section 160APQ]

6.10          For beneficiaries and partners that are not companies:

    amended section 160AQX (franking rebate for beneficiaries of a trust who are resident individuals or registered organisations);

    amended section 160AQY (franking rebate for certain trustees who are beneficiaries of a trust);

    amended section 160AQYA (franking rebates for trustees of superannuation funds, approved deposit funds and pooled superannuation trusts who are beneficiaries of a trust or partners in a partnership);

    amended section 160AQZ (franking rebate for certain partners);

    amended section 160AQZA (franking rebate for certain life assurance companies who are beneficiaries of a trust or partnership);

provide that if the distribution from the trust or partnership is equivalent to the payment of interest on a loan, then no franking rebate or credit is to be allowed.

When is a distribution equivalent to interest on a loan?

Loan

6.11             For a distribution to be equivalent to interest on a loan there must be something analogous to a ‘loan’. ‘Loan’ is defined broadly to include the provision of credit or any other form of financial accommodation, and thus includes financing arrangements not strictly loans at law, such as:

     forbearing to collect payment of a debt which has fallen due;

     the discounting of bills of exchange or promissory notes; or

     the giving of a guarantee or surety.

It will therefore include cases where the party accommodated is not the party liable, or primarily liable, to repay the funds advanced, nor even the party liable to make payments in the nature of interest in respect of the accommodation. In particular, it will include cases where, under a financial arrangement, the person receiving financial accommodation is an associate of the trust or partnership making the distribution, or the company paying the dividend (and cases where the person receiving the distribution is an associate of the person providing the financial accommodation). [Item 2; new subsection 45ZA(4)]

6.12        Therefore the ‘loan’, or its equivalent, need not subsist between the taxpayer receiving the distribution, and the trust, partnership or company making it, for new section 45ZA and associated provisions to apply. However, to be equivalent to interest on that loan the distribution must be made in respect of it.

6.13           The relationship in the nature of a ‘loan’ need not be an actual relationship of debtor and creditor as long as it is substantially equivalent to one. New section 45ZA is designed to deal with cases where the commercial and economic substance of a debt relationship has been replicated by obligations which do not amount in law to debt. For example, the right to receive a distribution in money or property at a later point in time equivalent in value to money or property supplied at an earlier point of time, or to call or put property at an agreed price equivalent to an amount paid previously for the property, may be equivalent in substance to a loan. Essentially anything which has the commercial effect of providing the borrower or accommodated party with the use of capital for a term may be equivalent to a ‘loan’; that is, anything equivalent to the hiring of money. [Item 2; new subsection 45ZA(4)]

6.14          Accordingly new section 45ZA and associated provisions encompass repayments by way of a provision for the repayment of the capital by a redemption, buy-back, distribution of capital, collateral payback or otherwise, including by way of understanding, guarantee, letter of credit or any other enforceable security.

6.15          Moreover, new subsection 45ZA(2) allows events occurring before or after the payment of the distributed amount which tend to indicate an equivalence to interest on a loan to be taken into account as ‘other relevant matters' under new paragraph 45ZA(2)(c) .

6.16          For example, if an instrument (such as a convertible redeemable unit in a unit trust) appeared to be redeemable only at the option of the issuer (the trustee) but statements are made by the issuer upon the announcement of the issue that a buyback is contemplated (e.g. to avoid dilution of the ordinary shareholders' equity), the provision would apply.

6.17          Similarly, if an announcement is made upon the issue of the units that a buyback of the shares allotted upon conversion of the units will be bought back, the provision would also apply.

6.18          Also, where the terms of the issue are such that a rational issuer would be commercially obliged to repurchase the units the arrangement may be effectively equivalent to a loan. It is a question of fact in each case whether, under an arrangement, temporary or permanent capital has been raised.

Interest

6.19           Having determined that there is something analogous to a loan, it must be determined whether the distributed amount is equivalent to interest on the loan (or other form of financial accommodation). ‘Interest’ refers to a reward for the use of money over time. Where a financing arrangement not amounting to a loan in the strict sense of the word (though falling within the extended definition of loan) is involved, ‘interest’ will refer to a reward in the nature of interest for that provision of credit or financial accommodation. As in the case of section 46D, whether or not a distribution is paid (‘the distributed amount’), in effect, in substitution for payments of interest under financing arrangements will be determined having regard to a number of specific criteria and any other relevant matters: new subsection 45ZA(2). The specific criteria are:

 

·    the way in which the distributed amount was calculated; and

·    the conditions applying to the payment of the distributed amount.

These criteria invite consideration of whether the distribution has been calculated in a manner analogous to the manner in which interest is calculated, that is, as a rate over time in respect of a principal sum; and similarly, whether the conditions under which the distribution is made, are analogous to the terms and conditions under which interest is payable on a loan, or equivalent financial arrangement.

6.20          In determining whether a distribution is equivalent to the payment of interest on a loan regard would be had, for example, to whether:

·    the distribution is for a fixed or variable percentage of a capital sum provided to some person;

·    the distribution is cumulative; and

·    directly, or by means of a collateral arrangement, the investment of the beneficiary or partner, can be redeemed or effectively recovered.

6.21           For example, if the ‘distributed amount’ is calculated as a percentage of the sum subscribed for the interest of the partner or beneficiary in the trust or partnership at a rate fixed at the time of subscription, so that the manner of calculation of the distributed amount corresponds with the calculation of interest, that would be a factor pointing clearly to equivalence to the payment of interest. (Similarly, if the distributed amount were calculated as a rate on a sum provided under a finance arrangement to an associate of the partnership or trust, that too would point to equivalence to interest.) Thus if a taxpayer subscribed money to a unit trust, and was entitled after 5 years to have his units redeemed for the amount subscribed (or bought at an equivalent price), and in the interim to receive distributions consisting of dividends at a certain rate with respect to the amount subscribed, it would be concluded that the distributed amount was equivalent to interest on a loan.

 

6.22           On the other hand, if a taxpayer subscribed money for units in a unit trust, which then invested the money in shares, and the unit holder was entitled to redeem or sell the unit at any time for a sum or price varying with the changing value of the shares, and until then to receive distributions of the dividends payable on those shares according to the beneficiary’s proportionate interest in the trust, there would not, absent other factors, be an equivalence between the distributed amount and interest on a loan. [Item 2; new subsection 45ZA(2)]

Finance arrangement

6.23          New subsection 45ZA(4) provides that a finance arrangement is any arrangement (as defined) carried out for a purpose which includes enabling a trustee, partnership or company (or an associate of the trustee, partnership or company) to obtain finance or to obtain an extension of an existing finance arrangement. Finance may be raised, for example, by the issue of shares or the creation of an interest in a trust or partnership.

6.24          Whether one of the purposes of any particular arrangement was to enable the trustee, partnership or company (or an associate) to obtain finance is a decision that must be made objectively in each case, taking into account the surrounding circumstances. For example, the issue of an interest in the trust or partnership that is redeemable may fall within the definition of a finance arrangement. On the other hand, an interest which was not redeemable generally would not come within the scope of new section 45ZA unless circumstances existed to indicate that the interest is to be, or was likely to be, effectively redeemed or extinguished in future.

Associate

6.25          New subsection 45ZA(4) provides that associate for the purposes of the provisions has the meaning given by section 318 of the ITAA, but that it also includes controllers of trusts and members of wholly-owned company groups.

Controller of a trust

6.26          A person is a controller of a trust if:

     the person beneficially owns, or is able in any way, whether directly or indirectly, to control the application of more than 50% of the interests in the trust property or in the trust income;

     the person has the power to appoint or remove the trustee of the trust; or

·    the trustee of the trust is accustomed or under a formal or informal obligation to act according to the wishes of the person. [Item 2; new subsection 45ZA(4)]

6.27          For the purposes of the associated provisions (i.e. amended sections 160AQX, 160AQY, 160AQYA, 160APQ and 160AQZA ) the definitions of associate and finance arrangement are the same as the definitions outlined in new section 45ZA.

Interests in discretionary trusts

6.28          New subsection 45ZA(4) provides that, for the purposes of these provisions, an interest in a trust will include the right of a discretionary object to receive, at the trustee's discretion, benefits under the trust. Accordingly, beneficiaries of a discretionary trust hold an interest in the trust if it holds shares and they can benefit from those shares (e.g. because the trustee can distribute dividend income to them).

When is a partnership or trust amount paid?

6.29          For the purposes of these measures, a trust or partnership amount is paid where an amount is included in, or allowed as a deduction from, a taxpayer's assessable income. Therefore, a distribution from a trust or partnership which is attributable to a dividend will be paid if the amount of the distribution will be included in the taxpayer's assessable income. [Item 2, new subsection 45ZA(4)]

6.30          The reference to allowable deduction is intended to deal with the case where a partnership makes a net loss. Each partner will be entitled to a deduction for their share of the loss. If the partnership derives dividends or other ‘franked’ distributions the amount of the loss will be reduced. The reduced deduction thus effectively includes the dividend in the partner's assessable income.

Non-residents

6.31          If a partner or beneficiary is a non-resident, any interest-like distribution from the trust or partnership to which the measures apply will be subject to dividend withholding tax in the same way as if the relevant dividend had been unfranked. [Item 3; new subsection 128B(3A)]

Deduction where franking rebate disallowed

6.32          The amendments made by items 6 to 11 prevent partners and beneficiaries receiving a franking rebate for distributions to which the measures apply. However, because of the operation of the section 160AQT gross-up to the assessable income of the trust or partnership, the partners’ or beneficiaries’ assessable income would include a grossed-up amount for which they do not receive a franking rebate. To prevent this, a tax deduction is allowed which removes so much of the beneficiaries' or partners' share in the net income of the trust or partnership as relates to the gross-up. [Item 12; new section 160ARAC]

Regulation Impact Statement

1.   Specification of policy objective

6.33          The policy objective is to prevent the unintended use of franking credits and the intercorporate dividend rebate by amending the Income Tax Assessment Act 1936 (the ITAA) to provide that if a distribution from a trust or partnership which is attributable to dividends is equivalent to the payment of interest on a loan, the relevant beneficiaries or partners will not be entitled to the intercorporate dividend rebate or franking benefits attaching to the distribution.

6.34          This measure forms part of a package of measures to prevent franking credit trading and dividend streaming which was announced in the 1997-98 Budget. The amendments apply from 13 May 1997.

2.         Identification of implementation options

Background

6.35          One of the underlying principles of the imputation system as introduced in 1987 is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use franking credits themselves. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax-exempts) to others who can fully use them, undermines this principle. Similarly, dividend streaming (i.e. the distribution of franking credits to select shareholders) undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings.

6.36          Trust and partnership structures can be set up that allow the streaming of franking credits to a third party; such structures can effectively allow the third party to receive interest-like returns that are fully franked. In contrast, investors who receive interest-like returns directly from a company are denied franking credits and the intercorporate dividend rebate under section 46D of the ITAA.

6.37          It is anomalous that equity benefits should flow to beneficiaries or partners who essentially have debt interests in the relevant trust or partnership holding shares while equity benefits are denied where the taxpayer holds a debt-like interest directly in the company. The proposed amendments to section 45Z and related provisions ensure that the treatment of such interests are consistent irrespective of whether they are held directly in a company or indirectly through a trust or partnership.

Implementation Option

6.38          The amendments to the ITAA ensure that, consistent with the operation of section 46D, where:

    the beneficiary of a trust becomes presently entitled to a share of the income of a trust estate or a partner in a partnership receives a share of the partnership income ;

    that share is attributable, wholly or partly, to dividends; and

    the entitlement of the beneficiary to its share of the trust's income or the entitlement of the partner to its share of the partnership's income is equivalent to an entitlement to interest on a loan,

no entitlement to the intercorporate dividend rebate, franking credits or franking rebate will arise in respect of the distribution.

6.39          The amendments to section 45Z and related provisions are the only option for implementing the Government's policy objective.

Assessment of impacts (costs and benefits) of the implementation option

Impact group identification

6.40          The proposed amendments will only affect those taxpayers (i.e. beneficiaries or partners) who receive distributions which are equivalent to interest on a loan. Therefore, only those taxpayers that enter into such arrangements, and their tax advisers (e.g. members of the legal and accounting professions), need to put their mind to the operation of the amended provision. It is unlikely that taxpayers will inadvertently trigger the operation of the provisions because the relevant arrangements are readily identifiable.

6.41          The proposed amendments will also impact on the ATO (in administering the rule), the Government (in that the revenue base will be protected) and non-residents and tax-exempt shareholders (whose ability to transfer franking credits will be hampered).

6.42          It is not possible to provide any numerical data on the numbers of taxpayers in particular stakeholder groups or the extent of their interests. This is because shares are often held through complicated trust, nominee or group company arrangements or funds are invested by fund managers on behalf of clients. Accordingly, underlying ownership is difficult to trace.

Analysis of the costs and benefits associated with the implementation option

6.43          The rule will only apply to taxpayers who enter into specific arrangements. This advantage will ensure that there will be minimal impact on genuine commercial transactions and taxpayers' compliance costs will be kept to a minimum. Accordingly, the proposed amendments should not impose high compliance costs on taxpayers.

6.44          Taxpayers who enter into relevant arrangements will incur additional compliance costs in determining whether their distributions are equivalent to the payment of interest on a loan. However, the extent of the compliance costs which will be incurred by taxpayers will vary depending on the facts and circumstances of particular cases. Accordingly, no reliable data on the amount of these costs is available.

6.45          No reliable data on the extent of the administrative costs which will be incurred by the ATO is available, however, any costs that do arise are not expected to be high and would be met within the ATO's existing budget allocation.

6.46          As mentioned above, section 46D currently does not apply to trust or partnership distributions which are equivalent to interest on a loan. It is anomalous that, while section 46D prevents streaming directly to third parties, it is possible under the current law to achieve exactly the same effect if the third party invests in shares indirectly through a trust or partnership rather than directly in the company. It would therefore be more equitable to ensure that the same rules apply to beneficial owners of shares through trusts and partnerships as apply to direct shareholders.

Taxation revenue

6.47          The amendments will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of franking credit trading and mis-use of the intercorporate dividend rebate. The amendments are part of a package of measures targeting franking credit trading and dividend streaming. In the absence of the measures, to the extent that the revenue base would not be protected, there would be a significant revenue loss. While it is not possible to provide an exact estimate of the revenue loss that already existed from franking credit trading and dividend streaming, $130 million a year has been factored into the forward estimates for 1998-99 and subsequent years to take account of the effect of the measures on existing activities.

Consultation

6.48          The ATO and Treasury held extensive consultations with peak bodies representing taxpayers and the investment community (including bodies representing the tax profession, the ASX, merchant banks, superannuation and investment funds) shortly after the Budget announcement of the franking credit trading and dividend streaming measures.

Conclusion

6.49          The proposed amendments are an important element of the franking credit trading and anti-streaming measures announced in the Budget and they ensure that taxpayers do not gain an undue tax benefit from entering into arrangements involving franking credit trading and dividend streaming.

6.50          They implement this policy objective in a way that, as far as possible, minimises administrative and compliance costs while providing taxpayers with certainty. This is because as stated above only taxpayers which enter into particular arrangements need to comply with the measures.

The ATO will closely monitor developments to detect any emerging possibility of significant revenue loss/deferral or unreasonable compliance costs arising from the rules. In addition, the ATO has consultative arrangements in place to obtain feedback from professional associations and the business community and through other taxpayer consultation forums.



C hapter 7

Charges and penalties for failing to meet obligations

Overview

7.1            The amendments in Schedule 8 of the Bill will amend the various Acts for which the Commissioner of Taxation has general administration to replace the existing late payment penalty provisions with a commercially realistic general interest charge on outstanding amounts. 

7.2            The Bill makes other changes to assist taxpayers in managing liabilities owing to the Commissioner of Taxation. The amendments implement the Government’s response to the Small Business Deregulation Task Force recommendation to rationalise, simplify and align late payment penalties with market interest rates.

Summary of the amendments

Purpose of the amendments

7.3                        The amendments will replace the various existing late payment penalties in the tax and related law with an interest charge based on an outstanding balance. The charge will be described as the general interest charge and will be worked out daily on a compounding basis. The charge will also apply where there are underestimates of instalments of tax and late lodgments of income tax returns by individual taxpayers. As part of the changes, penalties for failing to:

·                      notify the Commissioner by a certain time of an amount a person is liable to pay - to be known as the failure to notify penalty; and

·                      give the Commissioner by a certain time a reconciliation statement of source deductions made - to be known as the late reconciliation statement penalty;

are also introduced.  The introduction of these two new penalties is balanced by the removal of:

·                      the offence provisions that apply when a withholder fails to remit deductions by the due date; and

·                      the culpability penalty provisions that apply when a withholder fails to pay source deductions by the due date or a sales tax payer fails to furnish a return by the due date.

Date of effect

7.4                        The new general interest charge and notification penalties are to apply from 1 January 1999. [Items 184, 252, 269, 281, 287]

7.5                        An exception to this is the general interest charge for unpaid sales tax and certain source deductions.  The charge will apply to amounts payable before that date.  However, this will not disadvantage taxpayers as the interest charge proposed is a lower rate than the penalty rate which currently applies. [Subitem 184(4)]

Background to the legislation

New tax penalty arrangements

7.6                        In November 1996, the Small Business Deregulation Task Force made recommendations designed to alleviate the paper work and compliance burden imposed on small business.  The report specifically highlighted concerns taxpayers have about the imposition and calculation of penalties under the various taxation laws.

7.7                        In March 1997, the Prime Minister responded to the recommendations in his statement "More Time for Business".  The Government accepted that the complexity of the current penalty arrangements is a major factor contributing to confusion and misunderstanding among taxpayers.  The Commissioner of Taxation was asked to review all penalty arrangements with a view to rationalising and simplifying the system.

7.8                        The Australian Taxation Office (ATO), in consultation with professional bodies and taxpayer organisations, reviewed the penalty arrangements, in particular penalties under the various source deduction collection systems.  The review found that the current arrangements suffer from a number of drawbacks, including:

·                      penalty calculations are not easily understood by taxpayers;

·                      inconsistent penalty rates and calculations exist across the different taxes and between classes of taxpayers;

·                      the difficulties in having the ATO’s systems automate the calculation of penalties and to issue account statements;

·                      the rate of penalty does not reflect market interest rates; and

·                      the lack of commercial reality in the penalty rules which prevents the ATO from assisting taxpayers to minimise any escalation of debt.

7.9                        The amendments proposed in Schedule 8 will rationalise, simplify and align late payment penalties with market interest rates and should assist taxpayers to better manage their liabilities to the Commissioner of Taxation under various laws.

Explanation of the amendments

7.10          The amendments in Schedule 8 of the Bill basically centre around the following three new concepts:

·                      general interest charge (GIC);

·                      failure to notify penalty (FTN); and

·                      late reconciliation statement penalty (LRS).

7.11          The Schedule consists of six Parts. Part 1 contains provisions that explain how to calculate the GIC, FTN and LRS. These are being inserted into the Taxation Administration Act 1953 (TAA), item 1 - new Part IIA, Charges and penalties for failing to meet obligations. The New Part IIA , has the following four Divisions:

Division 1              The general interest charge [new sections 8AAA to 8AAH] ;

Division 2              The failure to notify penalty [new sections 8AAI to 8AAN] ;

Division 3              The late reconciliation statement penalty [new sections 8AAO to 8AAT] ; and

Division 4              Recovery of charges and penalties [new sections 8AAU to 8AAX].

7.12          Parts 2 to 5 of the Bill contain amendments necessary to ensure the liability for the GIC, FTN and LRS are established in the ITAA36 and other Acts as necessary. Having been established, they are applied and recovered under new Part IIA of the TAA. Part 6 of the Bill contains other minor amendments necessary to complement the new arrangements.

7.13          The various features of the GIC, FTN and LRS penalties and their application within and between the different Parts of the Bill are summarised in the following table which provides an overview of the amendments.

 

Concepts

Features

Location in Schedule 8 and new legislative references

 

Application to situations referred to in new subsections 8AAB(4) and (5) of the TAA which include:

Part 1 of Schedule 8 - new Part IIA of the TAA

GIC

GIC on unpaid amounts

 

 

·         failure to pay income and other taxes including instalments of provisional tax and the failure to remit source deductions (eg; PAYE, PPS and RPS);

Part 2 of Schedule 8

 

·         failure to deduct source deductions;

Part 2 of Schedule 8

GIC

GIC on other amounts

 

 

·         underestimates of provisional tax, fringe benefits tax or company instalments;

Part 3 of the Schedule 8

 

·         late lodgment of income tax returns by individual taxpayers;

Part 3 of the Schedule 8

 

·         amendment of assessments where there is a tax shortfall;

Part 3 of the Schedule 8

 

·         late payment of tax penalties;

Part 3 of the Schedule 8

 

·         failure to pay the FTN penalty imposed where a remitter does not notify the Commissioner of amounts to be paid; and

The GIC for failing to pay the FTN penalty is in new subsection 8AAN -Part 1 of Schedule 8.

 

·         failure to pay the LRS imposed where a remitter does not provide the Commissioner with a reconciliation statement in respect of amounts remitted.

The GIC for failing to pay the LRS penalty is in new subsection 8AAT -Part 1 of Schedule 8.

GIC

Calculation

The charge is calculated daily on a compounding basis and applied to the outstanding balance of any liability - new subsections 8AAC to 8AAD in Part 1 of Schedule 8.

GIC

Remission and Recovery

New sections 8AAE to 8AAH and 8AAV to 8AAX in Part 1 of Schedule 8.

 



Concepts

Features

Location in Schedule 8 and new legislative references

FTN penalty

Application to Sales Tax and the situations referred to in the table in new subsection 8AAJ(4) of the TAA. These situations deal with the payment of various amounts which have been deducted (eg; PAYE, PPS and RPS) and are payable to the Commissioner of Taxation.

The liability for the FTN penalty is created in Part 4 of Schedule 8.

FTN penalty

Calculation

The penalty is 8% per annum for the period the amount is not notified - new section 8AAK - Part 1 of Schedule 8.

FTN penalty

Remission and Recovery

New sections 8AAL to 8AAN and 8AAV to 8AAX in Part 1 of Schedule 8.

LRS penalty

Application to the situations referred to in the table in new subsection 8AAP(4) of the TAA. These situations deal with the provision of information in relation to amounts which have been deducted (eg; PAYE, PPS and RPS) and are payable to the Commissioner of Taxation.

The liability for the LRS penalty is created in Part 5 of Schedule 8.

LRS penalty

Calculation

The penalty is $10 per week (subject to a maximum of $200) for the period the statement is not provided - new section 8AAQ - Part 1 of Schedule 8.

LRS penalty

Remission and Recovery

New sections 8AAR to 8AAT and 8AAV to 8AAX - Part 1 of Schedule 8.

 

7.14          A more detailed explanation of the amendments associated with the introduction and application of the GIC, FTN and LRS penalties, including examples of both how the law is being amended and how the law will be applied, are provided below.

The general interest charge (GIC)

7.15       The table above refers to the situations where the GIC will replace existing penalties imposed throughout the income tax and related legislation for late payments of tax, charges and levies as well as in some other situations.

What amendments are required to incorporate the GIC?

7.16          The introduction of the GIC for a particular situation requires the following amendments:

·         the amendment or removal of the existing late payment penalty provisions. As mentioned above, these provisions could relate to the late payment of income or other taxes and the late or non payment of source deductions or the failure to deduct those amounts (eg; PAYE, PPS, RPS);

·         the replacement of those penalties with a liability to pay the GIC from the time the payment was due to be paid to the Commissioner of Taxation;

·         a trigger for the operation of the GIC in new Part IIA of the TAA by imposing the GIC for the period in respect of which amounts remain unpaid;

·         the making of consequential changes which are necessary to support the above amendments; and

·         if applicable, removal of the offence provisions for failing to pay amounts to the Commissioner of Taxation by the due date.

An example of how the amendments apply

7.17          A large remitter is currently required to make PAYE source deductions under section 221EAA of the Income Tax Assessment Act 1936 (ITAA36) and remit those deductions to the Commissioner of Taxation as required under section 220AAE.

7.18          The new GIC has potential application in the following situations:

·         where the source deductions are not made (situation 1) ; and

·         where the source deductions are made but not remitted to the Commissioner of Taxation as required under section 220AAE (situation 2) .

7.19           The amendments necessary in situation 1 are as follows:

·            amend the existing late payment penalty provisions - the amendments include the repeal and replacement of section 221EAA of the ITAA36 with new section 221EAA - item 59 .  With the exception of Government bodies, the current section has a flat administrative penalty equal to the undeducted amount and a penalty running at 16% per annum. The new subsection 221EAA(1) retains the obligation to make the deduction and, where the employer fails to do so, imposes a penalty equal to the undeducted amount.  This is the same as the existing ‘failure to make deductions’ penalty;

·            establish a due date for payment of the penalty - [new subsection 221EAA(2)] ;

·            impose the GIC on the undeducted amount from the time it is due to be paid - new subsection 221EAA(3) . This is calculated through the application of Division 1 in new Part IIA of the TAA [new sections 8AAA to 8AAH] ;

·            there are no offence provisions to be removed for situation 1 ;

·            consequential amendments - these will generally impact on the existing remission provision (section 221N) and the provision enabling the late payment penalty to be reduced on account of judgement interest being awarded to the Commissioner (section 221NA).  An amendment is necessary to section 221N so that the remission will now only apply to the penalty in respect of the undeducted amount.  This is because the 16% per annum penalty is being replaced by the new GIC in the TAA.  A further amendment is required to remove the judgement interest provision from the PAYE provisions as its function is now achieved through new section 8AAH in the TAA. [Items 1, 60 and 61]

7.20          The consequential amendments to the remission and judgement interest provisions discussed for situation 1 are also relevant for situation 2 .  Other amendments necessary for situation 2 involve:

·            replacing the existing late payment penalty provisions in section 220AAV with the GIC under the TAA [Item 52] ;

·            removing offence provisions for failing to pay amounts to the Commissioner of Taxation by the due date - this is currently in subsection 220AAE(3) and is removed by item 49.   New subsection 220AAE(3) imposes the GIC charge for the period during which the amounts are not paid to the Commissioner.

7.21           By way of example, the following table summarises the linkages between the various amendments required to replace two current late payment penalties associated with the penalty provisions currently in the ITAA36 and referred to in new section 8AAB  of the TAA.   Tables 1 and 2 at the end of this Chapter contain a more detailed summary of the other amendments involved for other areas of the laws where the new GIC will apply.  Many of the other amendments repeal various remission and judgment interest provisions scattered throughout the taxation laws. These are no longer required as the GIC regime in the TAA has a remission and judgment interest provision.

 

Replacing late payment penalties with GIC - summary of amendments

(I - Item; s - section; ss - subsection)

Item in section 8AAB table(s)

Topic

Amendments to create GIC liability

Consequential amendments - offence (O), remission (R), judgement (J)

10

Payment of RPS, PAYE & PPS

I 49 new ss220AAE(3)

I 52 repeals s220AV

O - I 49 repeals ss220AAE(3)

R - I 211 repeals s220AAX

J - I 211 repeals s220AAY

14

Deductions (RPS)

I 53; new s220AS

R - I 54 modifies s220AU

J - I 52 repeals s220AV

 

How is the GIC calculated?

7.22          New sections 8AAC and 8AAD in the TAA provides that the GIC will be worked out daily on a compounding basis.  The nominal annual interest rate from which the daily effective rate will be calculated is set at the weighted average yield for the 13 Week Treasury Note yield rate plus 8 percentage points.  The daily effective rate will be adjusted each quarter to reflect quarterly movements in the 13 Week Treasury Note yield.

7.23          The general interest charge rate for a day as defined in new section 8AAD in the TAA will be worked out by dividing the nominal annual interest rate by the number of days in the calendar year.

Example of how the GIC will be calculated

7.24          A taxpayer who has made PAYE deductions of $10,000 is required to remit those deductions to the Commissioner by 7 July 1999 and fails to do so.  The amount was still outstanding on 7 August 1999. Assuming the 13 week Treasury Note yield is 5%, the daily effective rate of interest is 13% divided by 365 or .0356%.  The 13% is obtained by adding 8% to 5% as provided for in new subsection 8AAD(1) of the TAA.  [Item 1]

7.25          New subsection 220AAE(3) in the ITAA36 provides that the GIC is payable on the unpaid amount in the period that:

·                      starts on the day the amount is due to be paid (7 July 1999); and

·                      ends on the last day on which, at the end of the day, any of the amount remains unpaid.

7.26          The amount of the GIC as at 7 July 1999 (as the amount remained unpaid) will be $3.56 (10,000 * .0356%). As the GIC is worked out daily on a compounding basis, the GIC for subsequent days will be calculated on the $10,000 plus the GIC from previous days.  The outstanding debt at the end of 7 August 1999, which if repaid on 8 August 1999, will be $10,111 [10,000 * (1.000356)^ 31 ].  The ^ symbol used in the formulae means ‘raised to the power of’ in the same way as 2^ 5 equals 32.  Using compound interest terminology, an amount A, if invested at an effective rate of I% per period for N periods will accumulate to A * (1 + I)^ N .

7.27          New sections 8AAE and 8AAF provide that the Commissioner of Taxation may notify in writing - in a specific notice or as part of any other notice issued in respect of the taxpayer - the amount of the GIC for a particular day or days.

7.28          The amendments also enable the Commissioner to remit the whole or any part of the GIC imposed on a taxpayer. [Item 1 - new section 8AAG]

The failure to notify (FTN) penalty

What amendments are required?

7.29          Schedule 8 will amend the tax laws to introduce a failure to notify (FTN) penalty which will apply to source deduction withholders and sales tax payers who fail to notify the Commissioner when an amount is due. New subsection 8AAJ(4 ) in the TAA lists the situations where the FTN will apply.  The amendments required to support the FTN penalty include:

·                      inserting new provisions in the relevant areas of the tax law creating liability for the FTN penalty.  The areas involved are those which currently require taxpayers to provide certain information to the Commissioner of Taxation.  [Items 253 to 268] ;

·                      removing administrative penalties and offence provisions, if any, which apply when taxpayers fail to remit amounts of source deductions and sales tax - Part 2 of Schedule 8 ; and

·                      inserting new provisions in the TAA that explain how to work out the FTN penalty.  [Item 1, new sections 8AAI to 8AAN]

Example of how the FTN amendments will apply

7.30          In situations where an investor does not provide a tax file number, an investment body is currently required to make deductions under section 221YHZC of the ITAA36 and remit those deductions to the Commissioner as required under section 221YHZD.

7.31          It is necessary to link the new FTN provisions in both the ITAA36 and the TAA to work out and apply the FTN penalty.  An example of a new FTN liability provision in the ITAA36 is new section 221YHZCA inserted by item 257 .

7.32          New section 221YHZCA requires investment bodies who have deducted amounts to notify the Commissioner, on or before the date those amounts are due to be paid, of the deductions made from interest, dividends or natural resource payments.  A failure to notify will create a FTN liability. [Item 257]

7.33          The taxation laws already provide for taxpayers to supply information to the Commissioner at the time of making a payment.  Where a payment is made by the due date in accordance with existing requirements, the notification obligation will be met.

7.34          Under subsection 221YHZD(1) of the ITAA36, the failure to meet the current deduction remittance requirements is an offence which carries a penalty of $5,000 and/or 12 months imprisonment.  Paragraph 221YHZD(1)(b) also contains a notification requirement which is no longer necessary as it will become part of the notification requirement in new section 221YHZCA .  These provisions will be removed to support the more commercially realistic FTN penalty. [Item 84 and 258]

7.35          The FTN penalty is designed to encourage taxpayers to notify the Commissioner of Taxation of liabilities with which the taxpayer is having difficulty - the emphasis being given to managing escalation and payment of the taxation debts in preference to taking prosecution action.

7.36          It is also necessary to provide for the new FTN penalty to be worked out and applied.  New sections 8AAI to 8AAN of the TAA provide for the FTN penalty and its determination once a FTN liability is created under the relevant provision in the ITAA36.  If the FTN penalty is not paid by the due date as provided in the Commissioner’s notice, new section 8AAN in the TAA will apply to impose the GIC on the unpaid penalty amount. [Item 1]

7.37           The following table summarises the linkages between the various amendments required to the ITAA36 to introduce the FTN penalty into new Division 2 of Part IIA in the TAA.  The penalty is being established to cater for notification of sales tax and various other remittances referred to in new subsection 8AAJ(4) of the TAA.  Once introduced, the amendments proposed in new section 8AAN of the TAA will allow the GIC to be applied to an unpaid FTN penalty from the time the penalty is due to be paid. [New section 8AAL]

FTN penalty - Summary of amendments required

Item in subsection 8AAJ(4) and in table

Topic

Amendments to create the FTN liability in the sales tax and income tax laws

Consequential amendments (eg Offence provisions)

In text

Sales tax assessable dealings with goods

[Item 265; new subsection 91Z(2A) and item 266; new section 95A]

[Item 267; exclude new section 95A from section 96 requirement]

1

RPS, PAYE & PPS deductions (large remitters)

[Item 254; new section 220AAGA]

[Item 52; to repeal section 220AAV offence]

2

RPS, PAYE & PPS deductions (medium remitters)

[Item 255; new section 220AAOA]

[Item 52; to repeal section 220AAV offence]

3

RPS, PAYE & PPS deductions (small remitters)

[Item 256; new section 220AATA]

[Item 52; to repeal section 220AAV offence]

4

Deductions from certain payments

[Item 257; new section 221YHZCA]

[Items 84 and 258; to repeal offence and notification requirement]

5

Withholding tax

[Item 260, new subsections 221YN(2), (2A) and (2B)]

[Item 89; repeal 221YN(2) offence]

6

Mining withholding tax

[Item 261; new subsections 221ZC(2), (2A) and (2B)]

[Item 95;to rpeal 221ZC(2) offence

7

Australian Film Industry Trust Fund accounts

[Item 264; new section 221ZNA]

[Item 100; repeal 221ZN(5) offence]

 

How is the FTN penalty calculated?

7.38          The FTN penalty will be calculated at a rate of 8% per annum of the amount not notified to the Commissioner of Taxation. [Item 1 - new subsection 8AAK(2) in the TAA ]

7.39          The Commissioner must notify in writing - in a specific notice or as part of any other notice issued in respect of the taxpayer - the amount of the FTN penalty for a particular day or days and the day on which the FTN is due and payable which must be at least 30 days after the notice is given to the taxpayer.  [Item 1 - new section 8AAL in the TAA ]

7.40          New subsection 221YHZCA(2) and other comparable provisions in Part 4 of Schedule 8 provide that the FTN penalty continues accruing until such time as the Commissioner is notified - or becomes aware through his own enquiries - of the correct amount the taxpayer should have paid. [Item 257]

7.41          New section 8AAM in the TAA allows the Commissioner to remit the whole or any part of the FTN penalty imposed on a taxpayer in certain circumstances. [Item 1]

7.42          New subsection 221YHZCA(3) in the ITAA36 and other comparable provisions being inserted into that Act in Part 4 of Schedule 8 provide that, for all source deductions, notification is to be in a form approved by the Commissioner.  This will allow emerging electronic technologies to be approved by the Commissioner for notification purposes.  In accordance with current arrangements, withholders and sales tax payers will not be required to advise of a “nil” liability where there have been no transactions for a period.  [Items 254 to 266]

7.43          Where a taxpayer fails to notify the Commissioner of Taxation of any source deduction required to be notified under the proposed amendments, the offence provisions in the TAA will be available to prosecute serious offenders.  Under subsection 8C(1) of the TAA, it is an offence to refuse or fail to give information to the Commissioner in the manner in which it is required under a taxation law.  This provision is currently relied upon in prosecution proceedings dealing with taxpayers who fail to lodge sales tax returns.

Example:     

7.44          An employer makes a deduction of $3,000 from wages of employees and this amount is due to be remitted to the Commissioner on 7 August 1999.  The employer does not pay by the due date and fails to notify the Commissioner by the due date that he has an amount to pay.  On 7 September 1999, the employer notifies the Commissioner of the amount that should have been paid on 7 August 1999.

7.45          The FTN penalty in this case will be $20 (8% p.a. * $3,000 * 31 days).  When the Commissioner has calculated the FTN penalty amount, he will send a notice to the employer specifying the amount of the penalty and the due date for payment of the penalty.  In addition to the FTN penalty, the employer will be liable to the GIC on the unpaid amount of $3,000 from 7 August 1999.  If the FTN penalty is not paid by the due date in the Commissioner’s notice, the GIC will also apply to that unpaid amount.

The late reconciliation payment (LRS) penalty

What amendments are required?

7.46          The Bill will amend the tax laws to introduce a late reconciliation statement (LRS) penalty which will apply when source deduction withholders fail to provide the Commissioner of Taxation with an annual reconciliation statement in respect of amounts withheld and forwarded to the Commissioner. New subsection 8AAP(4 ) in the TAA lists the situations where the LRS penalty will apply.  The amendments required to support the LRS penalty include introducing new provisions to:

·         support the various provisions in the tax law requiring reconciliation statements to be sent to the Commissioner that create a liability to the LRS penalty when those obligations are not met [Items 270 to 280] ; and

·         centralise the GIC and FTN penalty in the TAA where the LRS penalty is worked out and applied [Item 1 - new sections 8AAO to 8AAT]

An example of how the LRS Amendments will apply

7.47          As with the FTN penalty, it is necessary to link the relevant ITAA36 provisions to the TAA provisions which work out the LRS penalty.  An example of the new liability provisions is new subsection 221F(6) inserted by item 272 .

7.48          New subsection 221F(6) creates a new LRS liability in the ITAA36 for employers who fail to send in a yearly reconciliation statement of PAYE tax instalment deductions as shown in group certificates he or she has issued. Subsection 221F(5J) requires the statement together with total remittances of those amounts to be sent to the Commissioner by 14 August in each year. [Item 272]

7.49          It is also necessary to have provisions to work out and apply the LRS penalty.  New sections 8AAP to 8AAT in the TAA provide for the notification and collection of the LRS penalty once a LRS liability is created. [Item 1, new subsection 8AAP(2)]

7.50          The following table summarises the linkages between the various amendments required to the ITAA36 to introduce the LRS penalty into Division 3 of new Part IIA in the TAA.  The penalty is being established to encourage reconciliation statements in relation to various other remittances referred to in new subsection 8AAP(4) of the TAA.  Once introduced, the amendments proposed in new section 8AAT of the TAA will allow the GIC to be applied to an unpaid LRS penalty from the time the penalty is due to be paid.

LRS penalty - Summary of amendments required

Item in subsection 8AAP(4) table

Topic

Amendment to create the LRS liability in the ITAA36

Who has to provide the reconciliation statement

1

RPS payment report

[Item 271; new subsection 220AJ(5)]

A payer under the reportable payments system

2

PAYE deductions reconciliation statement

[Item 272;amended subsection 221F(6)]

An employer under the group tax system

3

PPS payment report

[Item 274; new subsection 221YHDC(9A)]

An eligible paying authority under the prescribed payment system

4

Statement of deductions from certain payments

[Item 276; new subsection 221YHZC(1AAA)]

An investment body who has made a deduction where a tax file number has not been supplied

5

Statement of withholding tax deductions

[Item 277; new subsection 221YN(2C)]

Person who has made a deduction from a dividend, interest or royalty payment

6

Statement of mining withholding tax deductions

[Item 278; new subsection 221ZC(2C)]

A person who has made a deduction from a mining payment

7

Farm management deposits report

[Item 279; new subsection 221ZXD(4)]

A financial institution

 

How is the LRS penalty calculated?

7.51          The LRS penalty will be calculated at a flat rate of $10 for each week, or part of a week up to a maxmium of $200 for each statement. [New section 8AAQ in the TAA ]

7.52          The Commissioner must notify in writing - in a specific notice or as part of any other notice issued in respect of the taxpayer - the amount of the LRS penalty and the day on which it is due.  The due date must be at least 30 days after the notice is given to the taxpayer. [Item 1 - new section 8AAR]

7.53           As with the FTN penalty, the Commissioner will be able to remit the whole or any part of the LRS penalty imposed on a taxpayer in certain circumstances. [New section 8AAS in the TAA ]

Example

7.54          An employer makes PAYE deductions during the year ended 30 June 1999 and fails to provide the Commissioner with a reconciliation statement by 14 August as required under subsection 221F(5J) of the ITAA36. The reconciliation statement was lodged on 30 September 1999 in response to a letter from the Commissioner.

7.55          New subsection 221F(6) will then apply so that the employer will be liable for the LRS penalty. [Item 272]

7.56       The LRS penalty for the period from 14 August 1999 to 30 September 1999 is $70 as the statement is overdue by 7 weeks.  When the Commissioner becomes aware that the statement has not been forwarded as required, he will send a notice to the employer specifying the amount of the LRS penalty and the due date for payment of the penalty.  If the LRS penalty is not paid by the date specified in the Commissioner’s notice, the GIC will also apply to that amount until the LRS penalty is paid.

Other amendments being made in Schedule 8

7.57          As well as introducing specific provisions necessary to establish the GIC and FTN and LRS penalties, other amendments are necessary to supplement their introduction as well as to provide other specific features in their application.  The following table summarises these other amendments

Amendment

References in Schedule 8 of the Bill

Exempting the Commonwealth and authorities of the Commonwealth from the GIC

Item 1 - new subsection 8AAB(3 ) in the TAA.

Exempting exempt Australian government agencies from the FTN and LRS penalties.  These agencies are defined in the Income Tax Assessment Act 1997 (ITAA97)

Item 1 - new subsections 8AAJ(3) and 8AAP(3 ) in the TAA.

Ensure the GIC is tax deductible

Item 130 in Part 2 - amends paragraph 25-5(1)(c) of the ITAA97.

Apply the method of calculating the Treasury Note Yield Rate in the TAA to the interest rate set by section 214A of the ITAA36.

Item 282 in Part 6.

Regulation Impact Statement - Charges and Penalties for failing to meet obligations

Policy objective

7.58          The policy objective of this measure is to replace the existing late payment penalty provisions in various Acts for which the Commissioner of Taxation has the general administration with a single tax deductible general interest charge on outstanding amounts and to impose FTN and LRS penalties.

Background

7.59          Following the release of the report of the Small Business Deregulation Task Force which raised concerns at recommendation 10(b) about tax penalty arrangements, the Prime Minister announced on 24 March 1997 in his statement ‘More time for Business’ that the Australian Taxation Office would review all late payment penalties in the taxation law.

7.60          This legislative proposal implements the Government’s decision to simplify tax penalty arrangements.

7.61          T he objective of the proposal is to replace the existing disparate late payment penalties with a new regime that is transparent, consistent, commercially based and easy to administer.  A further objective is to encourage withholders who cannot remit deductions by the due dates to notify the ATO of the existence of liabilities and to make sure withholders send in their annual reconciliation statements of deductions on time.

Implementation option

7.62          It is proposed to replace the late payment penalties that are currently imposed under any Act of which the Commissioner of Taxation has general administration with a commercially realistic general interest charge (GIC).  The new interest charge is to apply to all taxes, levies and charges administered by the Commissioner and will be:

·                      set in accordance with the weighted average yield of the 13 week Treasury Note rate plus 8 percentage points;

·                      varied to reflect quarterly movements in the 13 week Treasury Note rate;

·                      calculated daily on a compounding basis; and

·                      tax deductible.

7.63       These arrangements vary the rate and method of calculation of the current late payment penalties. The GIC is to apply from 1 January 1999.  As a transitional arrangement, the Commissioner will use his administrative discretion from 1 July 1998 to reduce existing late payment penalty rates across all taxes to a simple effective rate of 13.5% (not a compound rate).  Over a twelve month period this rate achieves close parity with the compounding rate of the proposed GIC.

7.64      There will be a new requirement for source deduction withholders and sales tax payers to notify the ATO of liabilities that cannot be paid by the due date.  Failure to notify the correct amount will result in the imposition of an 8% per annum penalty.  This failure to notify (FTN) penalty will replace the current penalties which range across the various types of taxes from 20% to 200% of the unremitted amount.

7.65          Complementing this will be a flat rate administrative penalty of $10 per week, up to a maximum of $200 per statement, for withholders who fail to lodge annual reconciliations statements on time.  Where people fail to furnish these statements they are currently liable for penalties upon prosecution.  This proposal provides a penalty as an alternative to prosecution action.

Assessment of impacts of the proposals

7.66          The groups impacted by the new penalty regimes are as follows:

taxpayers - by having consistent and more easily understood late payment penalties and more equitable and commercially acceptable failure to notify penalties, in particular small business taxpayers will not face heavy penalties where temporary cash flow problems prevent them from remitting withheld amounts on time;

tax agents and accountants - who will find it easier to advise clients on penalty regimes;

the ATO - who will find the new penalty regimes easier to administer; and

the Commonwealth Government - which, over time, should benefit from reduced levels of outstanding debt.

Assessment of costs

7.67          The quantifiable compliance costs relating to these proposals are those attributable to taxpayers familiarising themselves with any new obligations that relate to them. These costs are estimated to be:

·                                     New general interest charge

(i)          Initial costs                   $1.0m

(ii)         Recurrent costs   Nil

·                                     New FTN penalty

(i)          Initial costs                   $3.6m

(ii)         Recurrent costs   Nil

·                                     New LRS penalty

(i)          Initial costs (included above)

(ii)         Recurrent costs Nil

7.68       The following assumptions were used in determining these costs:

·                      In 1996/97 approximately 365,000 taxpayers were subject to late-payment penalties. Taxpayers will take ten minutes to familiarise themselves with the changes to penalty rates and methods of calculation.

·                      The ATO will notify all 950,000 withholders and sales tax payers of their new liability notification obligations and will provide details of the new administrative penalty for failing to lodge documents by the due date. Taxpayers will take fifteen minutes to familiarise themselves with the new requirements.

Assessment of benefits

7.69          The GIC will enhance the integrity of the taxation system.  Unlike the existing late payment penalties, the GIC will be easily understood by the tax community.  For the first time, the penalty for failing to pay debts by the due date will apply to all taxes in the same manner.  The GIC will enable the ATO to:

·                      provide some administrative saving through automating interest calculations thereby reducing the number of manual penalty calculations required to be done by the ATO;

·                      provide accurate and timely taxpayer account statements similar to most commercially administered credit accounts; and

·                      realise resource savings of $8.1m in 1998/99 increasing to $9.9m per annum from 1999/2000.

7.70          The Government will benefit in that taxpayers are more likely to reduce outstanding debts at a faster rate as a result of taxpayer account statements detailing the rate of debt escalation.  Improvements are likely to be made in the timing of resultant collections but increases in total revenue are expected to be minimal.

7.71          The failure to notify penalty will benefit taxpayers to the extent that penalties will be reduced where their cash flow position does not make it possible to remit withheld amounts by the due date.  All they have to do is notify the ATO of the debt.  This will allow the ATO to make an arrangement for the payment of the debt and any GIC that accrues on the debt.  These new arrangements will particularly benefit small businesses.

7.72          The new arrangements recognise that cash flow problems can impede payment of an amount by the due date but do not preclude a taxpayer from notifying the ATO of a liability.

Compliance

7.73          Compliance with withholding and sales tax reporting obligations is expected to improve under the proposed failure to notify regime as taxpayers will no longer have the same level of administrative penalties.  The imposition of FTN penalties will be the general ATO response to incidences where withholders or sales tax payers fail to notify their liabilities by the due date.  This will obviate the need for the Commissioner to institute prosecution proceedings in all but the most serious cases.

Consultation

7.74          The ATO has developed the proposed penalty regime in consultation with representatives of the tax profession and taxpayer organisations.  They are supportive of the changes but would prefer the charge uplift factor to be lower than 8 percentage points.

Conclusion

7.75          The proposals overcome problems with the current penalty regimes identified by the Small Business Deregulation Task Force.  The GIC will enable:

·         a common single rate of interest for all tax types where a payment is not received by the due date;

·         abolition of complex and punitive culpability elements that apply for the late payment of some taxes; and

·         simpler tax accounting and collection arrangements that will position the ATO to better assist taxpayers to minimise any escalation of amounts outstanding.

7.76          The failure to notify penalty will encourage withholders who cannot remit deductions by the due dates to notify the ATO of the existence of these liabilities.  The changes will reduce the level of administrative penalties that are imposed on businesses that are unable to remit withheld amounts when they are due.



TABLE 1

Introduction of the GIC -amendments to the ITAA36

Abbreviations used in table: (s - section; ss - subsection)

Item in section 8AAB table(s)

Topic

Amendments to create GIC liability

Other amendments - offence (O), remission (R), judgement (J), consequential (C)

1

Payment of withholding tax

[Item 10; new ss 128C(3)]

 

(R) [Item 11; repeal ss 128C(4)], [I 14; amends ss 128C(4AA)]

(J) [Item 15; repeal ss 128C(4A)]

(C ) [Item s 9; 12-14; 16]

2

Payment of franking deficit tax

[Item 19; new ss 160ARU(3)]

N/A

3

Payment of deficit deferral tax

[Item 20; new ss 160ARUA(2)]

N/A

4

Payment of franking additional tax

[Item 21; new ss 160ARV(2)]

N/A

5

Payment of franking deficit tax - amended assessments

[Item 23; new paragraph 160ARW(2)(c) & I 24; new ss 160ARW(3)]

(C) [Item 22; amends ss 160ARW(1)]

6

Returns by instalment taxpayers

[Item 190; new s 163AA]

(C) [Item 188, 189; amends s 163A]

7

Returns persons other than instalment taxpayers

[Item 191; amends ss 163B(1)]

[Item 193; new ss 163B(1A)]

[Item 197; repeals s 163C]

(R) [Item 195; repeals ss 163B(7)]

(C) [Item 192, 194-197; amends s 163A]

 

 

Item in section 8AAB table(s)

Topic

Amendments to create GIC liability

Other amendments - offence (O), remission (R), judgement (J), consequential (C)                                                           

8

Amended assessments

[Item 198; 199; 206 amends s 170AA]

 

(R) [Item 207; repeals ss 170AA(11)]

(C) [Item 207; repeals ss 170AA(9), 10, (12) & (13)]]

9

Payments of tax assessed

[Item 28; new ss 204(3)]

(R) [Item 29; repeals ss 207(1A) and 207A(4)]

(J) [Item 29; repeals ss 207(1B) and 207A(5)]

10

Payment of RPS, PAYE & PPS

(lage remitters)

[Item 49; new ss 220AAE(3)]

[Item 52; repeals s 220AAV]

(O) [Item 49; repeals ss 220AAE(3)]

(R) [Item 211; repeal s 220AAX]

(J) [Item 211; repeal s 220AAY]

11

Payment of RPS, PAYE and PPS deductions (medium remitters)

[Item 50; new ss 220AAM(3)]

[Item 52; repeals s 220AAV]

(O) [Item 50; repeals ss 220AAM(3)]

(R) [Item 211; repeals s 220AAX]

(J) [Item 211; repeals s 220AAY

12

Payment of RPS, PAYE and PPS deductions (small remitters)

[Item 51; new ss 220AAR(3)]

[Item 52; repeals s 220AAV]

(O) [Item 51; repeals ss 220AAR(3)]

(R) [Item 211; repeals s 220AAX]

(J) [Item 211; repeals s 220AAY

13

Non-electronic payment of RPS, PAYE and PPS deductions (large remitters)

[Item 210; new s 220AAW]

(R) [Item 211; repeals s 220AAX]

(J) [Item 211; repeals s 220AAY]

14

Deductions -Reportable payments (RPS)

[Item 53; new s 220AS]

(R) [Item 54; new s 220AU]

(J) [Item 55; repeals s 220AV]

 

Item in section 8AAB table(s)

Topic

Amendments to create GIC liability

Other amendments - offence (O), remission (R), judgement (J), consequential (C)                                                          

15

Payment of instalments by companies etc.

[Item 58; new s 221AZMAA]

(C) [Item 55 - 57]

16

Underestimation of instalments by companies etc.

[Item 212 to 219; amends s 221AZP]

(R) [Item 216; repeals ss 221AZP(4)]

17

Deductions from salary or wages (PAYE)

[Item 59; new s 221EAA ]

(R) [Item 60; amended s 221N]

(J) [Item 61; amended s 221NA]

18

Payment of provisional tax or instalments of provisional tax

[Item 65; new ss 221YD(3)]

(C) [Item 62-64, 66-72]

19

Provisional tax - income underestimated or PAYE deductions over-estimated

[Item 73; new ss 221YDB (1AAAA)]

(R) [Item 74; repeals ss 221YDB(4)]

(C) [Item 74-76]

20

Deductions from prescribed payments (PPS)

[Item 77 new s 221YHH]

(R) [Item 78, 79; amends s 221YHL]

(J) [Item 80; repeals s 221YHLA]

21

Deductions from certain payments (eg; interest, dividends)

[Item 83 new ss 221YHZC(3) to (5)]

(C) [Item 81, 82]

22

Payments of certain payments (eg; interest, dividends)

[Item 85 new ss 221YHZD(2)]

(O) [Item 84]

(R) [Items 86, 87]

(J) [Item 88]

Item in section 8AAB table(s)

Topic

Amendments to create GIC liability

Other amendments - offence (O), remission (R), judgement (J), consequential (C)                                                          

23

Payments of withholding tax (eg; interest, dividends)

[Item 90 new ss 221YN(4)]

(O ) [Item 89]

(C) [Items 91, 92, 93]

24

Payment of mining withholding tax

[Item 96 new ss 221ZC(4)]

(J) [Item 99]

(C) [Item 98]

25

Deductions of mining withholding tax

[Item 97 new ss 221ZD(1B)]

(see s 128C) as amended

(J) [Item 99]

(O) [Item 95]

(C) [Item 94]

26

Deductions - Australian Film Industry Trust Fund accounts

Item 103 new ss 221ZO(3)

(J) & (R) Item 106

(C) [Items 101, 102, 104, 107]

27

Payments - Australian Film Industry Trust Fund accounts

Item 105 new s 221ZP

(O) [Item 100]

(J) & (R) [Item 106]

28

Payments of farm management deposits

[Item 108 new ss 221ZXC(2)]

(R) [Item 109]

29

Understated farm management deposits

[Item 231; new ss 221ZXG(2)]

(R) [Item 109]

30

Payments of estimates of certain amounts

[Item 111 new ss 222A5A(3)]

(O) [Item 111]

(C) [Item 112 - Item 115]



TABLE 2

Replacing late payment penalties with GIC -amendments to Acts other than the ITAA36              (s - section; subsection - ss)

Item in ss 8AAB(5) table in the TAA

Act

Amendments to create GIC liability

Consequential amendments

1

Fringe Benefits Tax Assessemnt Act 1986

[Item 2; new s 93]

[Items 3 - 5; amend ss 94(2), 95(2) and 136(1)]

2

Fringe Benefits Tax Assessemnt Act 1986

[Item 185; amend ss 112(4)]

[Items 186 and 187; new ss 112(4A), repeal ss 112(6)]

3

Petroleum Resource Rent Tax Assessemtn Act 1987

[Item 232; new ss 65(1)]

[Items 233 - 245; amend s 65]

4

Petroleum Resource Rent Tax Assessemnt Act 1987

[Item 133; new s 85]

[Item 132; amend s 2]

5

Sales Tax Assessment Act 1992

[Item 136; new s 68]

[Items 134 and 135; amend s 5]

6

Sales Tax Assessment Act 1992

[Item 137; new s 91ZB]

[Items 134 and 135; amend s 5]

7

Sales Tax Assessement Act 1992

[Item 138; new s 91ZC]

[Items 134 and 135; amend s 5]

8

Superannuation Contributions Tax (Assessment and Collection) Act 1997

[Item 246; new ss 21(1)]

[Items 246 and 247; repeal ss 21(2), (4), (5) and (6)]



 

Item in ss 8AAB(5) table in the TAA

Act

Amendments to create GIC liability

Consequential amendments

9

Superannuation Contributions Tax (Assessment and Collection) Act 1997

[Item 248; new s 22]

[Items 246 and 247; repeal ss 21(2), (4), (5) and (6)]

10

Superannuation Contributions Tax (Assessment and Collection) Act 1997

[Item 141; new ss 25(1), (2) and (3)]

[Items 139 - 149; amend s 6, 26, 27, 37, 43, repeal ss 25(3A) and (4), repeal s 29]

11

Superannuation Contributions Tax (Members of Constitutionally Protected Superannuation Funds) Assessment and Collection Act 1997

[Item 249; new ss 18(1)]

[Items 249 and 250; repeal ss 18(2), (4), (5) and (6)]

12

Superannuation Contributions Tax (Members of Constitutionally Protected Superannuation Funds) Assessment and Collection Act 1997

[Item 152; new ss 21(1), (2) and (3)]

[Items 150 - 160; amend s 6, 22, 23, 31 and 38, repeal ss 21(4) and (6), repeal s 25]

13

Superannuation Guarantee (Administration) Act 1992

[Item 162; new s 49]

[Item 161; amend s 6]



 

Item in ss 8AAB(5) table in the TAA

Act

Amendments to create GIC liability

Consequential amendments

14

Taxation Administration Act 1953

[Item 1; new s 8AAN]

N/A

15

Taxation Administration Act 1953

[Item 1; new s 8AAT]

N/A

16

Taxation (Unpaid Company Tax) Assessment Act 1982

[Item 167; new s 13]

[Item 166; amend s 3]

17

Termination Payments Tax (Assessment and Collection) Act 1997

[Item 251; new s 13]

[Items 168 - 179; amend s 6, 17, 18, 25, 28A, 31, repeal ss 16(3A), (4), repeal s 20]

18

Termination Payments Tax (Assessment and Collection) Act 1997

[Item 170; new ss 16(1), (2) and (3)]

[Items 168 - 179; amend s 6, 17, 18, 25, 28A, 31, repeal ss 16(3A), (4), repeal s 20]

19

Tobacco Charges Assessment Act 1955

[Item 181; new s 18]

[Item 180; amend ss 4(1)]

20

Wool Tax (Administration) Act 1964

[Item 183; new s 38]

[Item 182; amend ss 4(1)]

 

 

 



I ndex

Schedule 1 - Income Tax deductions for gifts

Schedule 2 - Katherine District Business Re-establishment fund

Item No                                                                                            Paragraph No.

1.                                                                                                                                                            1.3

2.                                                                                                                                                     1.3, 1.7

3.                                                                                                                                                   1.3, 1.10

4.                                                                                                                                                   1.5, 1.10

5.                                                                                                                                                   1.5, 1.10

6.                                                                                                                                                   1.5, 1.11

7.                                                                                                                                                            1.3

8.                                                                                                                                                            1.3

9.                                                                                                                                                            1.3

10.                                                                                                                                                          1.3

11.                                                                                                                                                          1.5

12.                                                                                                                                                          1.5

13.                                                                                                                                                         .1.3

14.                                                                                                                                                          1.7

15.                                                                                                                                                          1.3

16.                                                                                                                                                          1.3

17.                                                                                                                                                          1.5

Schedule 3 - Australia as regional finance centre

Part 1 - OBU’s, withholding tax and thin capitalisation

1.                                                                                                                                                        2.136

2.                                                                                                                                                        2.136

3.                                                                                                                                                        2.136

4.                                                                                                                                                          2.91

5.                                                                                                                                                          2.92

6.                                                                                                                                                        2.121

7.                                                                                                                                                        2.121

8.                                                                                                                                                        2.121

9.                                                                                                                                                        2.121

10.                                                                                                                                                      2.117

11.                                                                                                                                2.118, 2.119, 2.120

12.                                                                                                                                           2.122, 2.125

13.                                                                                                                                                      2.110

14.                                                                                                                                                      2.114

15.                                                                                                                                                        2.93

16.                                                                                                                                             2.92, 2.123

17.                                                                                                                                             2.94, 2.111

18.                                                                                                                                                      2.100

19.                                                                                                                                                      2.102

20.                                                                                                                                           2.133, 2.147

21.                                                                                                                                                      2.106

22.                                                                                                          2.107, 2.108, 2.126, 2.127, 2.132

23.                                                                                                                                             2.88, 2.147

24.                                                                                                                                             2.89, 2.147

25.                                                                                                                                                      2.108

26.                                                                                                                                             2.29, 2.147

27.                                                                                                                                             2.30, 2.147

28.                                                                                                                                    2.32, 2.34, 2.147

29.                                                                                                                           2.32, 2.33, 2.37, 2.147

30.                                                                                                                                             2.38, 2.147

31.                                                                                                                                             2.38, 2.147

32.                                                                                                                                           2.124, 2.147

33.                                                                                                                                                      2.147

34.                                                                                                                                  2.34, 2.146, 2.147

35.                                                                                                                                                      2.137

36.                                                                                                                                                      2.137

37.                                                                                                                                           2.135, 2.147

38.                                                                                                                                                      2.147

39.                                                                                                                                           2.202, 2.208

40.                                                                                                                                           2.210, 2.214

41.                                                                                                                                            2.167,2.172

42.                                                                                                                                           2.190, 2.196

43.                                                                                                                                           2.190, 2.198

44.                                                                                                                                           2.190, 2.194

45.                                                                                                                     2.168, 2.191, 2.203, 2.211

Schedule 4 - Company tax instalment

1.                                                                                                                                                            3.8

2.                                                                                                                                                            3.3

Schedule 5 - Non-arm’s length trust distributions etc to superannuation and similar funds

Income Tax Assessment Act 1936

2.                                                                                                                                                          4.16

3.                                                                                                                                                            4.3

4.                                                                                                                                                   4.9, 4.10

Schedule 6 - Franking credits, franking rebates and the intercorporate dividend rebate

Income Tax Assessment Act 1936

1.                                                                                                                                                        5.140

2.                                                                                                                                                        5.140

3.                                                                                                                                                        5.140

4.                                                                                                                                                        5.140

6.                                                                                                                                                        5.140

7.                                                                                                                                                        5.140

8.                                    5.10, 5.12, 5.15, 5.17, 5.18, 5.22, 5.24, 5.25, 5.26, 5.27, 5.36, 5.41, 5.42, 5.43,

                         5.45, 5.46, 5.47, 5.50, 5.52, 5.55, 5.56, 5.57, 5.58, 5.61, 5.64, 5.65, 5.66, 5.75

                         5.76, 5.77, 5.78, 5.79, 5.80, 5.82, 5.83, 5.85, 5.91, 5.94, 5.95, 5.104, 5.106

                         5.108, 5.109, 5.110, 5.111, 5.119, 5.123, 5.126, 5.136, 5.138

9.                                                                                                                                                        5.140

10.                                                                                                                                                      5.140

11.                                                                                                                                                      5.140

12.                                                                                                                                                      5.140

13.                                                                                                                                                      5.140

14.                                                                                                                                                      5.140

15.                                                                                                                                                      5.140

16.                                                                                                                                                      5.140

17.                                                                                                                                                      5.140

18.                                                                                                                                                      5.140

19.                                                                                                                                                      5.140

20.                                                                                                                                                      5.140

21.                                                                                                                                                      5.140

22.                    5.112, 5.113, 5.114, 5.115, 5.116, 5.120, 5.121, 5.122, 5.127, 5.129, 5.130,

5.133

23.                                                                                                                                                      5.143

24.                                                                                                                                                        5.81

25.                                                                                                                                            5.3, 5.4, 5.5

Schedule 7 - Distributions to beneficiaries and partners that are equivalent to interest

2.                                                                                                 6.6, 6.7, 6.8, 6.10, 6.13, 6.22, 6.26, 6.29

3.                                                                                                                                                          6.31

5.                                                                                                                                                            6.9

12.                                                                                                                                                        6.32

Schedule 8 - Charges and penalties for failing to meet obligations

1.                                        7.11, 7.19, 7.24, 7.28, 7.29, 7.36, 7.38, 7.39, 7.41, 7.46, 7.52, 7.57, Table 2

2.                                                                                                                                                    Table 2

3.                                                                                                                                                    Table 2

4.                                                                                                                                                    Table 2

5.                                                                                                                                                    Table 2

9.                                                                                                                                                    Table 1

10.                                                                                                                                                  Table 1

12.                                                                                                                                                  Table 1

13.                                                                                                                                                  Table 1

14.                                                                                                                                                  Table 1

15.                                                                                                                                                  Table 1

16.                                                                                                                                                  Table 1

19.                                                                                                                                                  Table 1

20.                                                                                                                                                  Table 1

21.                                                                                                                                                  Table 1

22.                                                                                                                                                  Table 1

24.                                                                                                                                                  Table 1

28.                                                                                                                                                  Table 1

29.                                                                                                                                                  Table 1

49.                                                                                                                                         7.20, Table 1

50.                                                                                                                                                  Table 1

51.                                                                                                                                                  Table 1

52.                                                                                                                                         7.20, Table 1

53.                                                                                                                                                  Table 1

54.                                                                                                                                                  Table 1

55.                                                                                                                                                  Table 1

56.                                                                                                                                                  Table 1

57.                                                                                                                                                  Table 1

58.                                                                                                                                                  Table 1

59.                                                                                                                                                  Table 1

60.                                                                                                                                         7.19, Table 1

61.                                                                                                                                         7.19, Table 1

62.                                                                                                                                                  Table 1

63.                                                                                                                                                  Table 1

64.                                                                                                                                                  Table 1

65.                                                                                                                                                  Table 1

66.                                                                                                                                                  Table 1

67.                                                                                                                                                  Table 1

68.                                                                                                                                                  Table 1

69.                                                                                                                                                  Table 1

70.                                                                                                                                                  Table 1

71.                                                                                                                                                  Table 1

72.                                                                                                                                                  Table 1

73.                                                                                                                                                  Table 1

74.                                                                                                                                                  Table 1

75.                                                                                                                                                  Table 1

76.                                                                                                                                                  Table 1

77.                                                                                                                                                  Table 1

78.                                                                                                                                                  Table 1

79.                                                                                                                                                  Table 1

80.                                                                                                                                                  Table 1

81.                                                                                                                                                  Table 1

82.                                                                                                                                                  Table 1

83.                                                                                                                                                  Table 1

84.                                                                                                                                         7.34, Table 1

85.                                                                                                                                                  Table 1

86.                                                                                                                                                  Table 1

87.                                                                                                                                                  Table 1

88.                                                                                                                                                  Table 1

89.                                                                                                                                                  Table 1

90.                                                                                                                                                  Table 1

91.                                                                                                                                                  Table 1

92.                                                                                                                                                  Table 1

93.                                                                                                                                                  Table 1

94.                                                                                                                                                  Table 1

55.                                                                                                                                                  Table 1

96.                                                                                                                                                  Table 1

97.                                                                                                                                                  Table 1

98.                                                                                                                                                  Table 1

99.                                                                                                                                                  Table 1

100.                                                                                                                                                Table 1

101.                                                                                                                                                Table 1

102.                                                                                                                                                Table 1

103.                                                                                                                                                Table 1

104.                                                                                                                                                Table 1

105.                                                                                                                                                Table 1

106.                                                                                                                                                Table 1

107.                                                                                                                                                Table 1

108.                                                                                                                                                Table 1

109.                                                                                                                                                Table 1

111.                                                                                                                                                Table 1

112.                                                                                                                                                Table 1

113.                                                                                                                                                Table 1

114.                                                                                                                                                Table 1

115.                                                                                                                                                Table 1

130.                                                                                                                                                      7.57

132.                                                                                                                                                Table 2

133.                                                                                                                                                Table 2

134.                                                                                                                                                Table 2

135.                                                                                                                                                Table 2

136.                                                                                                                                                Table 2

137.                                                                                                                                                Table 2

138.                                                                                                                                                Table 2

139.                                                                                                                                                Table 2

140.                                                                                                                                                Table 2

141.                                                                                                                                                Table 2

142.                                                                                                                                                Table 2

143.                                                                                                                                                Table 2

144.                                                                                                                                                Table 2

145.                                                                                                                                                Table 2

146.                                                                                                                                                Table 2

147.                                                                                                                                                Table 2

148.                                                                                                                                                Table 2

149.                                                                                                                                                Table 2

150.                                                                                                                                                Table 2

151.                                                                                                                                                Table 2

152.                                                                                                                                                Table 2

153.                                                                                                                                                Table 2

154.                                                                                                                                                Table 2

155.                                                                                                                                                Table 2

157.                                                                                                                                                Table 2

158.                                                                                                                                                Table 2

159.                                 &