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Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018



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ISSN 1328-8091

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BILLS DIGEST NO. 123, 2017-18 19 JUNE 2018

Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018 Joseph Ayoub and Liz Wakerly Economics Section

Contents

Structure and purpose of the Bill ..................................... 3

Structure of this Bills Digest ........................................ 3

Committee consideration ................................................ 3

Senate Standing Committee for the Selection of Bills .............................................................................. 3

Senate Standing Committee for the Scrutiny of Bills .............................................................................. 3

Statement of Compatibility with Human Rights................ 3

Parliamentary Joint Committee on Human Rights ..... 3 Schedule 1—Multinational Anti-Avoidance Law (MAAL) ........................................................................... 4

Background ................................................................. 4

Policy position of non-government parties/independents .................................................. 6

Position of major interest groups ............................... 7

Financial implications .................................................. 7

Key issues and provisions ............................................ 7

Current law ................................................................ 7

Interposed trust or partnership ................................ 8

Lack of Independence ............................................... 8

Foreign entity participant .......................................... 9

Commencement .......................................................... 9

Schedule 2—Small business CGT concessions ................... 9

Background ................................................................. 9

Board of Taxation review ........................................ 10

Date introduced: 28 March 2018

House: House of Representatives

Portfolio: Treasury

Commencement: The first 1 January, 1 April, 1 July or 1 October to occur after the day of Royal Assent

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the Federal Register of Legislation website.

All hyperlinks in this Bills Digest are correct as at June 2018.

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Small business tax concessions ............................... 11

Small business CGT concessions—Basic Conditions ............................................................... 11

Policy position of non-government parties/independents ................................................ 12

Position of major interest groups ............................. 12

Financial implications ................................................ 13

Key issues and provisions .......................................... 13

Requirement 1: about the taxpayer ........................ 13

Maximum net asset value test (MNAVT) .............. 13 Carries on business ................................................ 14

Requirement 2: modified active asset test ............. 15 Active asset test .................................................... 15

Modified active asset test ..................................... 16

Stakeholder concerns ............................................ 20

Requirement 3: the Object Entity ........................... 21

Commencement ........................................................ 22

Senate Standing Committee for the Scrutiny of Bills .......................................................................... 23

Other provisions ........................................................ 24

Schedule 3—FinTech and venture capital amendments................................................................. 24

Background ............................................................... 24

Senate Standing Committee for the Scrutiny of Bills ............................................................................ 26

Policy position of non-government parties/independents ................................................ 27

Position of major interest groups ............................. 27

Financial implications ................................................ 28

Key issues and provisions .......................................... 28

Consequential amendments ..................................... 29

Application of amendments ...................................... 29

Schedule 4—Reparation payment tax exemption ........... 30

Background ............................................................... 30

Defence Abuse Response Taskforce ....................... 30

Policy position of non-government parties/independents ................................................ 31

Position of major interest groups ............................. 31

Financial implications ................................................ 31

Key issues and provisions .......................................... 31

Commencement ........................................................ 32

Other provisions ........................................................ 32

Appendix A: changes made by the proposed amendments to Basic Condition 5 ................................. 33

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Structure and purpose of the Bill The Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018 (the Bill) is divided into four schedules:

• Schedule 1 amends the Income Tax Assessment Act 1936 (ITAA36) to ensure that the Multinational anti-avoidance law (MAAL) applies where an Australian trust or partnership is interposed between a foreign entity and its Australian customers

• Schedule 2 amends the Income Tax Assessment Act 1997 (ITAA97) to include additional conditions that must be satisfied in order to access the small business capital gains tax (CGT), but only in relation to shares in a company or interests in a trust

• Schedule 3 amends the ITAA97 and the Venture Capital Act 2002 (VCA) to extend the venture capital tax concessions for investments in financial technology (FinTech) businesses and

• Schedule 4 amends the ITAA97 to exempt from income tax, payments made by the Commonwealth on recommendation of the Defence Force Ombudsman, as reparation for abuse by Australian Defence Force personnel.

Structure of this Bills Digest As the matters covered by each of the Schedules are independent of each other, the relevant background, stakeholder comments, committee consideration and analysis of the provisions are set out under each Schedule number.

Committee consideration

Senate Standing Committee for the Selection of Bills The Senate Standing Committee for the Selection of Bills recommended that the Bill not be referred to any committee.1

Senate Standing Committee for the Scrutiny of Bills The Senate Standing Committee for the Scrutiny of Bills (Scrutiny of Bills Committee) is concerned with the retrospective application of Schedule 2 to the Bill and the no-invalidity clause in Schedule 3 to the Bill.2 The Scrutiny of Bills Committee’s concerns are discussed further under each schedule number.

Statement of Compatibility with Human Rights As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible because it does not raise any Human Rights issues.3

Parliamentary Joint Committee on Human Rights The Parliamentary Joint Committee on Human Rights considers that the Bill does not raise human rights concerns.4

1. Senate Standing Committee for the Selection of Bills, Report, 5, 2018, The Senate, Canberra, 10 May 2018, p. 4. 2. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 5, 2018, The Senate, 9 May 2018, pp. 70-2. 3. The Statement of Compatibility with Human Rights can be found at pages 39-41 of the Explanatory Memorandum to the Bill. 4. Parliamentary Joint Committee on Human Rights, Human rights scrutiny report, 4, 8 May 2018, p. 97.

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Schedule 1—Multinational Anti-Avoidance Law (MAAL)

Background The MAAL is a general anti-avoidance mechanism contained in Part IVA of the ITAA36.5 It was introduced by the Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015 which came into effect on 11 December 2015 and applies to tax benefits obtained on or before 1 January 2016.

The purpose of the MAAL is to encourage entities to restructure and prevent entities from adopting future structures that are artificial or contrived so that business profits are not attributable to a permanent establishment (PE) and therefore taxed in Australia.6 Broadly, a PE is a place of business through which an enterprise wholly or partly carries on its business—for example, a branch, office or factory.7 If an enterprise has a PE in Australia then the income attributable to it is generally taxed in Australia.8

A foreign enterprise can avoid taxation of business profits by implementing arrangements that circumvent existing treaty-based or domestic law-based definitions of a PE. Examples of the most common PE-avoidance strategies include:

• using commissionaire arrangements—for example, where an entity sells products in a jurisdiction in its own name, but on behalf of a foreign enterprise that owns the products9

• fragmenting a cohesive business operation into a number of small operations (for example, having warehousing, transport and marketing operations conducted by associated entities) in order to argue that small operation is merely engaged in ‘preparatory or auxiliary activities’ and therefore exempt from the definition of a PE10 and

• splitting-up construction projects into a number of smaller, short-duration contracts between closely related enterprises to avoid the definition of a PE.11

The MAAL only applies to foreign entities that are significant global entities (discussed below) and which undertake significant activity in Australia.12 Figure 1 is a very basic example of a structure that might be used to avoid the existence of a PE in Australia.

5. Income Tax Assessment Act 1936 (ITAA36), section 177DA. 6. Explanatory Memorandum, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015, p. 24. 7. Australian Taxation Office (ATO), ‘International tax for business—Tax on income and capital gains’, ATO website, last updated 16 February 2016. 8. Ibid.

9. Organisation for Economic Co-operation and Development (OECD), ‘Preventing the artificial avoidance of permanent establishment status, action 7 - 2015 final report’, OECD/G20 Base Erosion and Profit Sharing Project, OECD publishing, Paris, 5 October 2015, p. 9. 10. Ibid., p. 10. 11. Ibid., p. 11. 12. ITAA36, section 177DA.

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Figure 1: Basic structure that may avoid the existence of a permanent establishment

Source: Explanatory Memorandum, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015, based on examples 3.9 and 3.8 at pp. 40-3.

It should not be concluded that the MAAL necessarily applies to the example in Figure 1 — this must be determined in accordance with the provisions of the MAAL under section 177DA of the ITAA36. However, Figure 1 does show how a foreign company may employ a basic structure to attempt to avoid the existence of a PE, where in practice the foreign company merely acts as an

administrative hub while the Australian entity undertakes extensive activities to generate sales in Australia.

While the MAAL encourages entities to restructure, it is a general anti-avoidance measure and is only used as a measure of last resort — for example, when the substantive provisions of the tax laws do not apply because of the use of artificial or contrived structures.13

From April 2016, the Australian Taxation Office (ATO) expressed concern that some taxpayers were restructuring in ways that undermined the policy intent of the MAAL and may have avoided its application.14 In September 2016 the ATO released Taxpayer Alert 2016/11 Restructures in response to the Multinational Anti Avoidance Law (MAAL) involving foreign partnerships in which it identified a particular structure that it considered attempted to avoid the application on the MAAL, stating:

The scheme that has come to our attention involves interposing an entity described as a partnership between the foreign entity originally making supplies to Australian customers and the Australian

13. Senate Standing Committee on Economics, Corporate tax avoidance: part III: much heat, little light so far, The Senate, Canberra, May 2018, p. 9. 14. ATO, TA 2016/2 Interim arrangements in response to the Multinational Anti Avoidance Law (MAAL), ATO website, Taxpayer Alert, 2016; ATO, TA 2016/8 GST implications of arrangements entered into in response to the Multinational Anti-Avoidance

Law (MAAL), ATO website, Taxpayer Alert, 2016.

Foreign Co.

Australian Customers

Foreign Co., is a business based in a foreign country. Aus Co. is located in Australia and is a wholly owned subsidiary of Foreign Co. Aus Co. searches for Australian customers, negotiates contract conditions with Australian customers and provides ongoing support to Australian Customers. However, all sales contracts are concluded between Foreign Co. and the customers and payment is made to Foreign Co. While Aus Co. does not enter into contracts with Australian customers, Aus Co. has extensive technical capability to support the Australian customers and Australian customers almost exclusively deal with Aus Co. Aus Co. charges Foreign Co. nominal fees for its services performed in Australia.

Aus Co.

Foreign country

Australia

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customers. The partnership has one resident corporate partner with a minority interest in the partnership, therefore purporting to characterise the partnership as an ‘Australian entity’ for the purposes of the MAAL. Agreements entered into purport to make the partnership the distributor of the products or services and the foreign entity its agent. The arrangements have little, if any, commercial basis and no changes are made to the underlying functions.

15 (Emphasis added).

The ATO considered that such arrangements were inconsistent with the policy intent of the MAAL.16 The ATO was also concerned that the arrangements may not have been legally effective at avoiding the application of the MAAL and may also have enlivened other general anti-avoidance rules.17

In the 2017-18 Budget the Government announced that the MAAL would be amended so that it applies to:

… corporate structures that involve the interposition of partnerships that have any foreign resident partners; trusts that have any foreign resident trustees; and foreign trusts that temporarily have their central management and control in Australia. 18

The Government also announced that the measure would operate retrospectively from 1 July 2016—being the date that the MAAL came into effect.19

On 12 February 2018 the Government released the Treasury Laws Amendment (Measures for a later sitting) Bill 2018: MAAL as an Exposure Draft (the MAAL Exposure Draft) for public consultation.20

According to the ATO the MAAL has resulted in $7 billion worth of sales being ‘booked’ in Australia where previously they would have been moved offshore. It is important to note that this figure is not the revenue which is received by the Commonwealth as this is pre-tax figure which estimates the value of sales that are now ‘booked’ in Australia.21

Policy position of non-government parties/independents At the second reading of the Bill the proposed amendments in Schedule 1 received support from members of the ALP.22

Other non-government parties and independents do not appear to have expressed a view on Schedule 1of the Bill.

15. ATO, TA 2016/11 Restructures in response to the Multinational Anti Avoidance Law (MAAL) involving foreign partnerships, ATO website, Taxpayer Alert, 2016, p. 1. 16. Ibid., p. 2. 17. Ibid., pp. 1-3. 18. Australian Government, Budget measures: budget paper no. 2: 2017-18, p. 39. 19. Ibid. 20. The Treasury, ‘Toughening the Multinational Anti Avoidance Law’, the Treasury website, 12 February 2018; K O’Dwyer,

(Minister for Revenue and Financial Services), Public consultation to toughen the multinational anti-avoidance law, media release, 12 February 2018. 21. ATO, ‘ATO clarifies impact of the MAAL’, ATO website, last updated 25 October 2017. 22. M Thistlethwaite, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, House of Representatives, Debates, 10 May 2018, p. 3739; M Keogh, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, House of Representatives, Debates, 10 May 2018, p. 3748; Australia, House of Representatives, ‘Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, Votes and proceedings, HVP 109, 10 May 2018.

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Position of major interest groups Only three submissions appear to have been received during the short consultation period which closed on 23 February 2018.23

The Tax Justice Network Australia (TJN-Aus) supported the proposed amendments in the MAAL Exposure Draft as well as the retrospective application date of 1 January 2016.24 Similarly, the Australian Retailers Association (ARA) and the Australians to Stop Counterfeiting and Piracy (AUSCAP), which is convened by the ARA, broadly supported the MAAL Exposure Draft.25

Deloitte’s submission commented on the technical operation of the proposed amendments in the MAAL Exposure Draft, some of which have been incorporated into the proposed amendments.26

Details on the views of major interest groups in relation to the MAAL generally are contained in the Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015 Bills Digest.27

Financial implications The Explanatory Memorandum to the Bill states that the measure is estimated to have an unquantifiable gain to revenue over the forward estimates period.28

Key issues and provisions

Current law Under section 177DA of the ITAA36, the Commissioner of Taxation (the Commissioner) has the power to ‘look through’ arrangements that seek to prevent the attribution of income to a PE. Section 177DA of the ITAA36 (the MAAL) generally applies to a scheme if:

• a foreign entity supplies goods or services to Australian customers

• activities are undertaken by an Australian entity that is an associate of, or commercially dependant on, the foreign entity

• the foreign entity derives income from the supplies of the goods or services

• some or all of the income is attributable to the Australian PE and

• the principal purpose or one of the principal purposes of the scheme is to obtain an Australian tax benefit or to obtain both an Australian and foreign tax benefit.29

In order for the MAAL to apply, the foreign resident must be a significant global entity (SGE).30 An entity is an SGE for a particular income year if it is:

• a global parent entity with annual global income of AUD$1 billion or more or

• a member of a group of entities consolidated (for accounting purposes) where the global parent entity has an annual global income of AUD$1 billion or more.31

23. The Treasury, ‘Toughening the Multinational Anti Avoidance Law’, The Treasury website, op. cit. 24. Tax Justice Network Australia (TJN-Aus), Submission to Treasury, Toughening the Multinational Anti-Avoidance Law, 23 February 2018, p. 1. 25. Australian Retailers Association (ARA), Submission to Treasury, Toughening the Multinational Anti-Avoidance Law,

February 2018, p. 1. 26. Deloitte, Submission to Treasury, Toughening the Multinational Anti-Avoidance Law, 22 February 2018, p. 1. 27. J Olender and L Nielson, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015, Bills digest, 45, 2015-16,

Parliamentary Library, Canberra, 2015, pp. 20-2. 28. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 3. 29. ITAA36, section 177DA; ATO, ‘Combating multinational tax avoidance - a targeted anti-avoidance law’, ATO website, last

updated 10 August 2017. 30. Income Tax Assessment Act 1997 (ITAA97), paragraph 177DA(1)(c).

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It should be noted that the Government has subsequently announced that it will introduce a Bill to expand the definition of SGE effective from 1 July 2018, to include members of a group headed by trust, partnerships or an investment entity.32

The amendments made by Schedule 1 of the Bill only deem the supplies made by the interposed trust or partnership as being made by and therefore attributable to the foreign entity. However, the other requirements of the MAAL must still be satisfied in order for it to be applied by the Commissioner.

Interposed trust or partnership Schedule 1 to the Bill extends the circumstances in which the MAAL under section 177DA of the ITAA36 results in the general anti-avoidance rules applying in Part IVA of that Act, by attributing supplies made by an Australian trust or partnership to a foreign entity. As noted above, the ATO and the Government expressed concern that, while such arrangements may have technically avoided the application of the MAAL, they nevertheless contravened the intent of the MAAL.

In order for the extension to apply the following conditions must be satisfied:

• the trust estate or partnership makes a supply33 to an Australian customer which results in it deriving income34

• the trust estate or partnership has a foreign entity participant at any time in an income year in which income is derived from the supply35 and

• the trust estate or partnership has a relationship with the foreign entity that means that it is not independent to it at the time the supply is made—that is, they are connected with, would be an affiliate of, or are members of the same global group as a foreign entity.36

Lack of Independence In general terms, under proposed subparagraph 177DA(7)(d) the trust estate or partnership must lack independence from a foreign entity at the time that the supply is made. The Explanatory Memorandum explains the three ways in which this can occur:

One such circumstance is that the trust or partnership is ‘connected with’ the foreign entity within the meaning of section 328-125 of the ITAA 1997. Two entities are connected with each other if one entity controls the other or both entities are controlled by a third party. In this context, controlling an entity generally means being entitled to at least 40 per cent of any income distribution, capital distribution or voting rights of the entity.

Another such circumstance is where the trust or partnership would be an affiliate of the foreign entity within the meaning of section 328-130 of the ITAA 1997 if the trust or partnership were an individual or a company. This means that the trust or partnership would be expected to act at the direction of or in concert with the foreign entity when carrying on its business.

31. ITAA97, section 960-555; ATO, ‘Combating multinational tax avoidance - a targeted anti-avoidance law’, op. cit. 32. Australian Government, Budget measures: budget paper no. 2: 2018-19, 8 May 2018, p. 26. 33. Under ITAA36, section 177A(1) supply is given its meaning in section 9-10 of the GST Act, however it excludes certain supplies such as a supply of a debt or equity interest. Supply within the meaning of section 9-10 of the GST Act is very broad and

includes any form of supply whatsoever. 34. Proposed paragraphs 177DA(7)(a) and (b) of the ITAA36. 35. Proposed paragraph 177DA(7)(c) of the ITAA36. 36. Proposed subparagraphs 177DA(7)(d)(i) to (iii) of the ITAA36.

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The final circumstance is that the trust or partnership and the foreign entity are both members of a global group within the meaning of Part IVA (i.e. a group of entities consolidated for accounting purposes). 37

Foreign entity participant Item 1 of Schedule 1 to the Bill inserts a definition of foreign entity participant into subsection 177A(1) of the ITAA36 which contains defined terms that are used in Part IVA including those terms used in section 177DA (MAAL).

Under proposed subparagraph (a) of the definition of foreign entity participant, a partnership or trust estate will have a foreign entity participant if a beneficiary of the trust or a partner in the partnership is a foreign entity. A foreign entity is an entity that is not an Australian entity.38

Further, if a trust estate or partnership has a foreign entity participant then:

• a trust of which the trust estate or partnership is a beneficiary also has a foreign entity participant and

• a partnership in which the trust estate or partnership is a partner also has a foreign entity participant.39

As explained in the Explanatory Memorandum, ‘if Trust A is a member of Partnership B, which is a member of Trust C, then if Trust A has a foreign entity participant this results in Partnership B and Trust C also having a foreign entity participant.’40

Commencement While Schedule 1 of the Bill commences on the first day of the first quarter to start after the day of Royal Assent, the amendments apply retrospectively on or after 1 January 2016 (the original application date of the MAAL) in connection with a scheme, whether or not the scheme was entered into, or was commenced to be carried out, before that day.41

Schedule 2—Small business CGT concessions

Background Schedule 2 of the Bill amends the eligibility requirements a taxpayer must satisfy in order to access the small business capital gains tax (CGT) concessions when disposing of a share in a company or an interest in a trust.

This implements an integrity measure that was announced by the Government in the 2017-18 Budget.42 According to the Government announcement:

… some taxpayers are able to access these concessions [CGT small business concessions] for assets which are unrelated to their small business, for instance through arranging their affairs so that their ownership interests in larger businesses do not count towards the tests for determining eligibility for the concessions.

43

37. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, pp. 10-11. 38. ITAA36, subsection 177A(1), ‘foreign entity’ is defined by reference to subsection 995-1(1) ITAA97. 39. Proposed subparagraphs (i) and (ii) of the proposed definition of foreign entity participant in section 177A(1) of the ITAA36. 40. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, pp. 11. 41. Item 2 of the Bill and item 3 of Schedule 1 to the Bill. 42. Australian Government, Budget measures: budget paper no. 2: 2017-18, op. cit., pp. 38-9. 43. Ibid., p. 39.

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The Government announced that the measure would have effect from 1 July 2017, meaning that subject to timing rules in the tax laws, CGT events that occur from 1 July 2017 would be subject to the new rules.

On 8 February 2018 the Government released the Treasury Laws Amendment (Measures for a later sitting) Bill 2018: improving the small business CGT concessions as an Exposure Draft (the CGT Exposure Draft) for public consultation.44 At the time of writing, Treasury had not publicly released the submissions. However, some stakeholders have made their submission publicly available.

Stakeholders raised a number of concerns about the CGT Exposure Draft. While Schedule 3 to the Bill differs from the CGT Exposure Draft, the following key stakeholder concerns remain:

• that the proposed amendments increase the complexity of an already complex regime45

• that the proposed amendments—the full extent of which could not have been anticipated from the 2017-18 budget announcement—apply retrospectively from 1 July 201746 and

• that the requirement that the Object Entity meet the maximum net asset value test or CGT small business entity test is complex and will likely exclude some taxpayers on the basis of issues that do not reflect integrity concerns.47

Relevant stakeholder concerns are discussed in further detail under key issues and provisions.

Board of Taxation review The Board of Taxation (BOT) has since announced that it will conduct an independent, self-initiated review of Australia’s small business tax concessions.48 According to the consultation guide released by the BOT the ‘review will involve assessing the effectiveness of existing concessions and, where appropriate, recommending new concessionary approaches to the Government.’49

While the review of the small business tax concessions is in its early stages, the BOT has developed a set of principles to evaluate the current and future tax concessions, namely:

• concessions should be designed having regard to the small business life cycle

• concessions can assist with small business cash flow

• concessions should relieve the compliance burden for small business

• concessions should promote growth and innovation

• concessions should be targeted and affordable and

• concessions should not incentivise complex structuring.50

44. The Treasury, ‘Improving the integrity of the small business CGT concessions’, The Treasury website, 8 February 2018; S Morrison, (Treasurer), Improving the integrity of the small business CGT concessions: exposure draft released, media release, 8 February 2018.

45. Chartered Accountants Australia and New Zealand (CAANZ), Submission to Treasury, Improving the small business CGT concessions, 28 February 2018, p. 5; Institute of Public Accountants, Submission to Treasury, Improving the integrity of the small business CGT concessions, February 2018, pp. 3-4; BDO, Submission to Treasury, Improving the integrity of the small business CGT concessions, 28 February 2018, p. 4; The Tax Institute, Submission to Treasury, Improving the integrity of the small business CGT concessions, 1 March 2018, p. 2.

46. CAANZ, Submission, op. cit., p. 3; BDO, Submission op. cit., p. 3; The Tax Institute, Submission op. cit., p. 1. 47. BDO, Submission op. cit., p. 4; CAANZ, Submission, op. cit., p. 5. 48. Board of Taxation (BOT), Review of small business tax concessions: consultation guide, Australian Government, Canberra, May 2018.

49. Ibid., p. 3. 50. Ibid., pp. 9-12.

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The BOT expects to have its final report to Government by October 2018.51

Small business tax concessions There are a range of tax concessions that are available to small business entities, such as simplified depreciation rules, simplified record keeping obligations, concessions relating to income tax, GST, FBT and excise and CGT concessions.52 The proposed measure contained in Schedule 2 to the Bill relates to the CGT concessions available to small business entities, namely:

• 15-year exemption: a capital gain from disposing an active asset can be disregarded if held continuously for 15 years and the taxpayer is aged over 55 and is retiring or permanently incapacitated

• 50 per cent reduction: capital gain from disposing an active asset is reduced by 50 per cent (in addition to the general capital gains discount available for assets that are held for 12 months or more)

• retirement exemption: capital gains from disposing active assets are exempt up to a lifetime limit of $500,000 if the proceeds are used in connection with retirement and

• rollover relief: deferring all or part of a capital gain made from disposing an active asset.53

Small business CGT concessions—Basic Conditions A taxpayer must meet basic eligibility requirements (Basic Conditions) in order to access the small business CGT concessions. A summary of the Basic Conditions are set out in Figure 2.

Figure2: Basic Conditions for CGT concessions.

1. a GCT event happens in relation to the asset for example, the asset is sold 2. the event would have resulted in a capital gain if it weren’t for the concessions 3. the taxpayer satisfies one of the following: a. be a CGT small business entity that is, a small business entity with an aggregated

turnover of less than $2 million b. the total net value of CGT assets owned by taxpayer, entities connected with it and its affiliates does not exceed $6 million (i.e. satisfy the maximum net value asset test) c. is a partner in a partnership that is a small business entity and the CGT asset is an

interest in a partnership or an asset used in business of the partnership d. the taxpayer doesn’t carry on business but the CGT asset is used in a business carried on by a small business entity that is the taxpayer’s affiliate or an entity connected with it

(passively held assets) 4. the GCT asset satisfies the active asset test 5. if the CGT asset is a share in a company or an interest in a trust, then either of the following additional requirements must be satisfied:

a. the taxpayer is a CGT concession stakeholder in the company or trust or b. CGT concession stakeholders in the company or trust together have a small business participation percentage in the taxpayer of at least 90%. Source: ITAA97, section 152-10.

The proposed amendments under Schedule 2 of the Bill only apply to Basic Condition 5 above— that is, when the CGT asset is a share in a company or an interest in a trust. The company or trust

51. Ibid., p. 13. 52. ATO, ‘Small business entity concessions— Concessions at a glance’, ATO website, last updated 1 September 2017. For a full list of concessions see: BOT, Review of small business tax concessions: consultation guide, op. cit., pp. 5-8.

53. ITAA97, Subdivisions 152-B to 152-E.

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in which the taxpayer holds the share or asset is referred to as the Object Entity. If the Object Entity holds a share or interest in a company or trust, that company or trust is referred to as the Later Entity.

Policy position of non-government parties/independents While members of the ALP supported the Bill in the House of Representatives, Matt Thistlethwaite (Deputy Chair of Standing Committee on Economics) considered that they should not apply until 8 February 2018, stating:

They [tax professionals] argue that, to help prevent adverse consequences for taxpayers who have been acting in good faith but couldn't reasonably be expected to foresee the detailed amendments finally unveiled in the exposure draft, the implementation date should be changed from 1 July 2017, as per the original budget announcement, to 8 February 2018. That's the exposure draft release date. In light of those stakeholder concerns, Labor supports the start date being 8 February 2018, as proposed by the tax professionals community.

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At the second reading stage, Matt Keogh MP also stated:

There are other parts of what I referred to as the euphemistic use of 'other measures' in this bill. We see the improvement of tax integrity not only by looking at tax havens and other areas of multinational taxation but by looking at improving the integrity of the small-business CGT concessions. There are some amendments Labor thinks should be made in this area.

55

Other non-government parties and independents do not appear to have expressed a view on Schedule 2 of the Bill.

Position of major interest groups As noted above, stakeholders were broadly concerned with the complexity and narrowing of the small business CGT concessions under the CGT Exposure Draft. While there has not been significant commentary since the Bill was introduced into Parliament, in its article titled Failing to see the forest from the trees - changes to small business CGT Concessions, Hall & Wilcox, a tax advisory firm stated:

While the measures in the Bill are an improvement to those announced in the Exposure Draft, some major issues still remain. For example, the requirement for the Object Entity to meet the MNAVT [maximum net asset value test] or small business entity test will exclude taxpayers who are presumably outside the integrity concern. Further, under the shield of its original announcement on 9 May 2017, the Government has retained a retrospective application date of 1 July 2017.

… a question arises as to whether the Bill will result in an integrity improvement or a broader shift away from the policy intentions which have underpinned the SBCGT Concessions since their introduction in 1999.

It is also interesting to note that while the Government has focused on improving integrity measures in relation to the SBCGT Concessions, it hasn’t addressed the apparent complexity inherent in the rules which many in the industry have lamented for some time. Finally, one could question whether the

54. M Thistlethwaite, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’,op. cit., p. 3741; Australia, House of Representatives, ‘Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, Votes and proceedings, op. cit.

55. M Keogh, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, op. cit., p. 3748.

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Government appreciates that the measuring stick for a small business may change over 17 years; given that the MNAVT has only increased by $1 million in that amount of time. 56

Financial implications The Explanatory Memorandum to the Bill states that the measure is estimated to have an unquantifiable gain to revenue over the forward estimates period.57

Key issues and provisions Item 2 of Schedule 2 repeals the current Basic Conditions that must be satisfied when the CGT asset is a share in a company or an interest in a trust and replaces it with the conditions outlined below.

The current additional Basic Conditions that apply in relation to a share in a company or an interest in a trust are given effect by proposed paragraph 152-10(2)(d), namely:

• the taxpayer is a CGT concession stakeholder in the company or trust or

• CGT concession stakeholders in the company or trust together have a small business participation percentage in the taxpayer of at least 90%.

Proposed paragraphs 152-10(2)(a) to (c) broadly impose three additional requirements that must be satisfied:

• the taxpayer satisfies the maximum net asset value test or the taxpayer must have carried on a business just prior to the CGT event58

• the Object Entity must be a CGT small business entity for the income year or satisfy the maximum net asset value test59 and

• the shares or interests in the Object Entity must satisfy a modified active asset test that looks through shares in companies and interests in trusts to the activities and assets of the underlying entities.60

Appendix A illustrates the changes made by the proposed amendments to Basic Condition 5.

Requirement 1: about the taxpayer Proposed paragraph 152-10(2)(b) requires that the taxpayer either satisfy the maximum net asset value test or the taxpayer ‘carries on business’ just prior to the CGT event happening. According to the Explanatory Memorandum ‘[t]his ensures that entities do not benefit from this concession where the relevant business activities are too remote to justify the entity receiving a concession for business activities.’61

Maximum net asset value test (MNAVT) The maximum net asset value test is an existing feature of the small business capital gains tax concessions.62 Broadly, the test requires that that just prior to the CGT event, subject to specific exclusions,63 the CGT assets of the taxpayer, any entities connected with the taxpayer and any

56. Hall & Wilcox, ‘Failing to see the forest from the trees - changes to small business CGT Concessions’, Hall and Wilcox website, 1 May 2018, the article was published by Thomson Reuters in Weekly Tax Bulletin. 57. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 3. 58. Proposed paragraph 152-10(2)(b) of the ITAA97. 59. Proposed paragraph 152-10(2)(c) of the ITAA97. 60. Proposed sections 152-10(2)(a), 152-10(2A), 152-10(2B) of the ITAA97. 61. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 20. 62. ITAA97, section 152-10(1)(a)(i). 63. Ibid., sections 152-20(2), (3), (4).

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affiliates of the taxpayer or entities connected with the taxpayer’s affiliates do not exceed $6 million.64

Generally an entity is ‘connected with’ another entity if either one controls the other, or both are controlled by the same entity.65 The control tests are designed to look through business structures that include interposed entities. If an entity (the first entity) directly controls a second entity, and the second entity controls (whether directly or indirectly) a third entity, the first entity is also taken to control the third entity.66 ‘Control’ is explained in Figure 3.

Figure3: control

Partnership, company or trust (other than a discretionary trust) Generally an entity controls another entity if it or its affiliates or all of them together: • own, or has the right to acquire ownership of, interests in the other entity that give the right to receive at least 40% of:

- any distribution of income or capital by the other entity or - if the other entity is a partnership, the net income of the partnership or • if the other entity is a company, owns, or has the right to acquire ownership of, equity interests (for example, a share) in the company that give at least 40% of the voting power in

the company.67 If an entity’s control percentage in another entity is at least 40% but less than 50%, the Commissioner may determine that the first entity does not control the other entity if they are satisfied that a third entity (not including any affiliates of the first entity) controls the other entity.68 Discretionary trust An entity controls a discretionary trust if the trustee either acts, or might reasonably be expected to act, in accordance with the directions or wishes of the entity and/or the entity’s affiliates.69 Source: ATO, Basic conditions for the small business CGT concessions—‘Connected entities’, ATO website, last updated 17 July 2017.

An ‘affiliate’ is an individual or company that in relation to their business affairs, acts or could reasonably be expected to act according to the entity’s directions or wishes or in concert with the entity. Trusts, partnerships, and superannuation funds are not affiliates.70

Carries on business If the taxpayer does not satisfy the maximum net asset value test then the taxpayer must have ‘carried on business’ just prior to the CGT event happening under proposed paragraph 152-10(2)(b).

The ‘carries on a business’ test gained attention in March 2017 when a footnote in Draft Taxation Ruling TR 2017/D2 Income tax: Foreign Incorporated Companies: Central Management and Control test of residency indicated that company will likely be carrying on business even if it merely holds passive investments where it is established or maintained to make profit or gain for its

64. Ibid., sections 152-15, 152-20(3)-(4). 65. Ibid., section 328-125. 66. Ibid. 67. Ibid., section 328-125(1)-(2). 68. Ibid., section 328-125(6). 69. Ibid., section 328-125(1), (3). 70. Ibid., section 328-130.

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shareholders.71 The tax profession considered that this view departed from the then ATO’s existing position and ultimately resulted in the removal of the ‘carries on business’ test from the eligibility criteria for the reduced corporate tax rate under the Government’s Enterprise Tax Plan.72

The ATO has since issued Draft Taxation Ruling TR 2017/D7 Income tax: when does a company carry on a business within the meaning of section 23AA of the Income Tax Rates Act 1986?, which provides guidance on the meaning of ‘carries on business’ in relation to companies.73 However, as Chartered Accountant’s Australia and New Zealand (CAANZ) noted in its submission on the CGT Exposure Draft:

These requirements will perpetuate the confusion over the meaning of “carrying on a business”. This issue has already gained significant attention in relation to access to the reduced corporate tax rate for small businesses. While the Australian Taxation Office (ATO) has issued some guidance in relation to companies, it does not extend to individuals or trusts where different considerations may apply.

74

(Emphasis added).

While confusion may remain about when a taxpayer is taken to be carrying on a business, it should be noted that the concept is still relevant to the CGT small business entity test, which in any event requires that the entity carries on a business in the income year.75

Requirement 2: modified active asset test The second requirement relates to the CGT asset, that is the share in the company or the interest in the trust. Proposed paragraph 152-10(2)(a) requires that the share in the company or interest in the trust satisfies a modified active asset test. To give context the proposed amendments, the existing active asset test is summarised below.

Active asset test The requirement that an asset be an active asset to be eligible for the CGT small business conditions is one of the Basic Conditions.76 The active asset test is satisfied if the asset was an active asset of the taxpayers:

• if the taxpayer owned it for more than 15 years—at least seven and a half years during the test period or

• if the taxpayer has owned it for 15 years or less—for at least half of the test period.

The test period begins when the taxpayer acquired the asset and generally ends when the CGT event occurs.77 Figure 4 sets out when a CGT asset will be an active asset.

71. J Ayoub, Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017, Bills digest, 71, 2017-18, Parliamentary Library, Canberra, 6 February 2018, p. 6. 72. Ibid. 73. ATO, TR 2017/D7 Income tax: when does a company carry on a business within the meaning of section 23AA of the Income Tax

Rates Act 1986?, ATO website, Draft taxation ruling, 2017. 74. CAANZ, Submission, op. cit., p. 5. 75. ITAA97, sections 152-10(1)(c)(i), 328-110(1)(a). 76. Ibid., section 152-10(1)(d). 77. Ibid., section 152-35.

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Figure 4: active asset

A CGT asset is an active asset if the taxpayer owns the asset and it is used, or held ready for use, in carrying on a business by the taxpayer, their affiliate or an entity connected with them. If the asset is intangible then it must be inherently connected with a business carried on by the taxpayer, their affiliate or an entity connected with them.78 A share in a resident company or an interest in a resident trust will be an active asset if the taxpayer owns it and the total of the following is 80% or more of the market value of all of the assets of the company or trust: 1. the market values of the active assets of the company or trust 2. the market value of any financial instruments of the company or trust that are inherently

connected with a business that the company or trust carries on and 3. any cash of the company or trust that is inherently connected with such a business.79 That is, ‘a share in a company or an interest in a trust is an active asset if the company or trust itself has active assets (and inherently connected financial instruments and cash) with a market value of at least 80% of the market value of all its assets.’80 Source: ITAA97, section 152-40.

Modified active asset test The active asset test is modified by proposed paragraph 152-10(2)(a) and proposed subsection 152-10(2A) where the CGT event relates to a share in a company or an interest in a trust. As stated in the Explanatory Memorandum, a taxpayer satisfies proposed paragraph 152-10(2)(a) if:

for the lesser of seven and a half years or at least half the period a taxpayer has held the share or interest at least 80 per cent of the sum of the:

• total market value of the assets of the object entity (disregarding any shares in companies or interests in trusts); and

• total market value of the assets of any entity (a later entity) in which the object entity had a small business participation percentage of greater than zero, multiplied by that percentage

must have related to assets that are:

• active assets; or

• cash or financial instruments that are inherently connected with a business carried on by the object entity or a later entity. 81

For the purposes of determining whether the assets held by a Later Entity are active assets, proposed paragraphs 152-10(2A)(c) modifies the active asset test so the assets will only be active at a time if the Later Entity is an entity:

• that is, at the relevant time, either:

- a CGT small business entity; or

- satisfies that maximum net asset value test in relation to the capital gain; and

78. Ibid., section 152-40(1)(a), (b). 79. Ibid., section 152-40(3)-(3B). 80. ATO, ‘When shares and trust interests are active assets’, ATO website, last updated 17 July 2017.

81. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 17.

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• in which the taxpayer has a small business participation percentage of at least 20 per cent or is a CGT concession stakeholder at the relevant time. 82

In determining whether the Object Entity or a Later Entity is a CGT small business entity or satisfies the maximum net asset value test, proposed paragraph 152-10(2)(c) and proposed paragraph 152-10(2B)(b) modifies the ordinary rules (discussed below).

Broadly, the modifications made to the active asset test by proposed paragraph 152-10(2)(a) and proposed subsection 152-10(2A) can be summarised as follows:

• firstly, proposed paragraph 152-10(2A)(b) excludes from the active asset test, a share in a company or an interest in trust that the Object Entity holds in a Later Entity (whether directly or indirectly). This is also the case for a Later Entity under proposed paragraph 152-10(2A)(c)

• secondly, proposed paragraph 152-10(2A)(a) and proposed subparagraph 152-10(2A)(c)(ii) excludes financial instruments and cash (point 2 and 3 in Figure 4) from the active asset calculation of both the Object Entity and any Later Entity if the company or trust acquired those assets for a purpose that included assisting an entity to otherwise satisfy the modified test.83 This is an integrity rule that is designed to discourage taxpayers from engaging in artificial arrangements which attempt to negate the modified active asset test84

• thirdly, under proposed paragraph 152-10(2A)(e) the value of assets held by a Later Entity are multiplied by the Object Entity’s small business participation percentage in the Later Entity— this effectively means that the value of the assets of a Later Entity is proportionate to the Object Entity’s interest in that entity and

• fourthly, assets held by a Later Entity will only be active assets if:

- the taxpayer has a small business participation percentage of 20% or more or the taxpayer is a CGT concession stakeholder85 and - the Later Entity is a CGT small business entity or it satisfies the maximum net asset value test (subject to modification under proposed subparagraphs 152-10(2B)(b)(iii) or (iv)).86

CGT concession stakeholder

An individual (that is, a natural person) is a CGT concession stakeholder of a company or trust if the individual is a significant individual.87 Generally, an individual is a significant individual in a company or trust if at that time, the individual has a small business participation percentage in

the company or trust of at least 20%.88 This is made up of the taxpayer’s direct and indirect interests.89 Figure 5 explains how the small business participation percentage is determined.

Ultimately, however the purpose of the test and, more broadly, the purpose of the modification under proposed paragraph 152-10(2B)(a) is to ensure that assets are only considered to be active if they are part of a businesses in which the taxpayer has some meaningful interest (that is, 20% or more). This is explained in the Explanatory Memorandum:

82. Ibid. 83. Proposed paragraph 52-10(2A)(a) of the ITAA97. 84. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 18.

85. Proposed paragraph 152-10(2A)(c) and proposed paragraph 152-10(2B)(a) of the ITAA97. 86. Proposed paragraph 152-10(2A)(c) and proposed paragraph 152-10(2B)(b) of the ITAA97. 87. ITAA97, section 152-60. Note that a spouse of a significant individual in the company or trust will be significant individual if the spouse has a small business participation interest in the company or trust at the time that is greater than zero. 88. Ibid., section 152-55. 89. Ibid., section 152-65.

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This condition prevents the concession from being available for interests in entities if most of the value of the assets of the entity is unrelated to its business activities. In such cases, while the entity carries on a small business, most of the value of the interest held by the taxpayer is not attributable to the small business and it is not appropriate for the small business concessions to apply to the disposal of the interest. The condition also recognises that an investment is effectively passive in nature if an entity has an interest of less than 20 per cent in another entity.

90 (Emphasis added).

Figure 5: small business participation percentage

Small business participation interest A taxpayer’s small business participation interest in a company or a trust is the total of the taxpayers direct and indirect participation percentages in the company or trust.91 Calculating the direct and indirect participation percentages differs for a company and a trust.92 If the entity is a company, the direct participation percentage is the smallest of the following percentage the taxpayer holds in the company: • the voting power in the company • entitlement to a dividend that the company may pay or • entitlement to a distribution of capital that the company may make.93 For example, if the taxpayer holds 30% of the voting power and is entitled to 25% of dividends paid or capital distributions made, then their direct small business participation interest is 25%. The test differs for a trust, but broadly it is the smallest of taxpayer’s entitlement to the income or capital of the trust.94 A taxpayer’s indirect small business participation percentage requires tracing an entity’s direct and indirect participation interest through a chain of interposed entities.95 Source: Subdivision 152-A, ITAA97.

As noted above the Later Entity must be also be a CGT small business entity or satisfy the maximum net asset value test, however, these ordinary tests are subject to modification under proposed subparagraphs 152-10(2B)(b)(iii) to (v).96 The Later Entity will not be a CGT small business entity if its aggregated turnover exceeds $2 million or its CGT assets exceeds $6 million.97 Figure 6 explains what an entity’s aggregated turnover includes.

90. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 18. 91. ITAA97, section 152-65. 92. Ibid., sections 152-70, 152-75. 93. Ibid., item 1 of the table in section 152-70(1). 94. Ibid., items 2-3 of the table in section 152-70(1). 95. Ibid., section 152-75. 96. Proposed paragraph 152-10(2A)(c) and proposed paragraph 152-10(2B)(b) of the ITAA97. 97. ITAA97, subsection 152-10(1AA) imposes the $2 million aggregated turnover limit by modifying section 328-110 of the

ITAA97.

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Figure 6: aggregated turnover

Aggregated turnover is defined under section 328-115 of the ITAA 1997 and includes: • an entity’s annual turnover and • the annual turnover of all entities that are affiliated or connected with the entity.98 An entity’s annual turnover is the total ordinary income that the entity derived in the ordinary course of ‘carrying on a business’ in the income year, subject to specific exclusions.99 An entity’s annual turnover differs from its assessable income because it does not include statutory income, being income that is deemed assessable because of a specific tax law.100 Source: J Ayoub, Treasury Laws Amendment (Enterprise Tax Plan Base Rate Entities) Bill 2017, Bills digest, 71, 2017-18, Parliamentary Library, Canberra, 6 February 2018, p. 11.

Proposed subparagraphs 152-10(2B)(b)(iii) limits the annual turnovers and GCT assets to be taken into account to those of the Later Entity, the Object Entity, each affiliate of the Object Entity, and each entity controlled by the Object Entity.101 But it does not include the assets or annual turnovers of those entities that can control the Object Entity.102

However, proposed subparagraphs 152-10(2B)(b)(iv) expands the number of entities considered to be connected with each other because the control percentage is reduced from 40% to 20%.103 Where entities are considered to be connected with each other:

• their annual turnover will count towards the Later Entity’s $2 million aggregate turnover threshold and

• their CGT assets will counts toward the $6 million maximum net asset value test.

This means that a Later Entity is more likely to exceed the thresholds and fail proposed paragraphs 152-10(2B)(a).

Also under proposed subparagraphs 152-10(2B)(b)(v), any determination made by the Commissioner under subsection 328-125(6) of the ITAA97 is disregarded, again potentially expanding the number of entities considered to be connected with each other.104

The Explanatory Memorandum sets out a number of examples which assist in understanding the practical application of the proposed amendments.105 The following example shows the effect of the modified active asset test as a result of connected entities:

Example 2.2: Connected entities and the modified active asset Charlotte owns 35 per cent of the shares in Colour Co. Colour Co carries on a business of wholesaling paint and related products and is a CGT small business entity (according to the general rules) in the 2019 20 income year.

Colour Co owns 20 per cent of the shares in three pigment suppliers Red Co, Green Co and Blue Co. Red Co and Blue Co are both CGT small business entities for the 2019-20 income year (and have been since

98. Ibid., section 328-115. 99. Ibid., section 328-120. 100. Ibid., sections 6-5 and 6-10. 101. Proposed subparagraph 152-10(2B)(b)(iii) of the ITAA97. 102. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 17.

103. Proposed subparagraph 152-10(2B)(b)(iv) of the ITAA97. 104. Under subsection 328-125(6) of the ITAA97, the Commissioner may make a determination that an entity does not control another entity, if broadly, the control percentage is at least 40%, but less than 50% and the Commissioner thinks that the entity is controlled by another entity. 105. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, pp. 19-20.

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Colour Co acquired its interest) according to the general rules. Green Co is not and has never been a CGT small business entity as it exceeds the turnover threshold.

On 3 March 2020, Charlotte sells her shares in Colour Co.

In working out if this interest satisfies the modified active asset test, when working out the total value of the assets of Colour Co, Charlotte must disregard the value of the shares Colour Co holds in Red Co, Blue Co and Green Co and include 20 per cent of the value of the assets of these companies.

Further, for the purposes of the modified active asset test, assets of later entities are only active if the entity is a CGT small business entity or satisfies the maximum net asset value test.

Green Co is not a CGT small business entity as its turnover is too high.

Additionally, Charlotte must treat Red Co, Blue Co and Green Co as being connected with Colour Co and with each other for the purposes of the test, because Colour Co holds 20 per cent of the shares of each entity.

Because they are treated as being connected with Green Co, Red Co and Blue Co are also treated as not being CGT small business entities for these purposes.

As a result, Charlotte is not able to treat the assets of Red Co, Blue Co or Green Co as active assets for the purposes of this test unless the entities satisfy the maximum net asset value test. 106

Stakeholder concerns Although the proposed amendments have been modified from the CGT Exposure Draft, stakeholders nevertheless considered that the provisions are overly complex. In this respect The Tax Institute noted that ‘[t]he provisions are complex and self-referential. In our opinion, the proposed legislation will not be easy to understand or apply’.107 Similarly BDO stated:

While the draft legislation can be lauded for addressing the integrity issues head-on, it struggles to adhere to the underpinning policy of the SBCGT concessions of reducing the tax cost and compliance burden for small business. That is, the draft legislation adds a further degree of complexity to existing provisions which are already perceived as complex. Of great concern, and something which afflicts tax law amendments from time to time, is that the proposed changes will exclude many genuine small taxpayers from obtaining the SBCGT concessions in an effort to prevent the troublesome few from accessing them. That is, it penalises the many for the sins of the few.

108 (Emphasis added).

The Institute of Public Accountants echoed similar sentiments, while CAANZ called for a review of the small business CGT concessions stating:

They are extremely complex provisions for tax agents to navigate, let alone a segment of the taxpayer community for whom tax compliance burdens are already relatively high. As drafted, the proposed amendments add to that complexity … our members advise us that this complexity has meant that some genuine small businesses miss out on the concessions. A fundamental review of the policy rationale for these provisions is needed. This is not a new issue. The Henry Review stated that”[sic]:

106. Ibid., p. 19. 107. The Tax Institute, Submission op. cit., p. 2. 108. BDO, Submission op. cit., p. 4.

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… Despite attempts to simplify the concessions, taxpayers are required to navigate a legislative maze of gateway and threshold conditions and then additional conditions that relate to each of the specific concessions. 109

(Emphasis added).

Requirement 3: the Object Entity The final condition that Schedule 2 of the Bill proposes is that the company or trust in which the taxpayer holds the share or interest (the Object Entity) either:

• be a CGT small business entity for the income year (that is, less than $2 million aggregated turnover)110 or

• satisfy the maximum net asset value test (that is, net CGT assets do not exceed $6 million).111

However, similarly to the modifications that apply to a Later Entity, the aggregated turnover and maximum net asset value tests are subject to modifications under proposed subparagraphs 152-10(2)(c)(iii) to (v), which include:

• only the CGT assets and annual turnovers considered are those of the later entity, the object entity, each affiliate of the object entity, and each entity controlled by the object entity112

• an entity is treated as controlling another entity if it has an interest of 20% or more rather than 40% under section 328-125 of the ITAA97113 and

• any determination made by the Commissioner under subsection 328-125(6) of the ITAA97 is disregarded.114

As noted in Requirement 2: modified active asset test above, the effect of these modifications is that because more entities are considered to be ‘connected with’ each other, their annual turnover and CGT assets must be included for the purposes of determining whether the Object Entity is a CGT small business entity for the income year or satisfies the maximum net asset value test.115 This is illustrated by Example 2.5 in the Explanatory Memorandum:

Example 2.5: Indirect investment in large business Tien owns 20 per cent of the shares in Investment Co, a company that carries on an investment business. Investment Co is a CGT small business entity (according to the general rules) for the 2020-21 income year.

Investment Co holds 20 per cent of Van Co, a transport company. Van Co’s turnover and assets mean that it is not a CGT small business entity in the 2020-21 income year and does not satisfy the maximum net asset value test at any point during the income year.

On 15 May 2021, Tien sells his shares in Investment Co. He is not eligible to access the Division 152 CGT concessions for any resulting capital gain.

Even if Tien satisfies the other conditions, he cannot satisfy the new condition requiring the object entity be a CGT small business entity or satisfy the maximum net asset value test due to the modifications that apply when determining this matter for the purposes of this condition.

109. IPA, Submission op. cit., pp. 3-4; CAANZ, Submission, op. cit., p. 5. 110. Proposed subparagraph 152-10(2)(c)(i) of the ITAA97. 111. Proposed subparagraph 152-10(2)(c)(ii) of the ITAA97. 112. Proposed subparagraph 152-10(2)(c)(iii) of the ITAA97. 113. Proposed subparagraph 152-10(2)(c)(iv) of the ITAA97. 114. Proposed subparagraph 152-10(2)(c)(v) of the ITAA97. 115. Proposed subparagraph 152-10(2)(c)(iv) of the ITAA97.

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For the purposes of this condition, Investment Co is considered to be connected with Van Co, as Investment Co holds 20 per cent of Van Co’s shares. As a result, for this purpose, Investment Co’s turnover and assets include the turnover and assets of Van Co. As Van Co is not a CGT small business entity and does not satisfy the maximum net asset value test, Investment Co is also treated as not satisfying these requirements (despite its status under the general rules in the tax law).

116

Stakeholders raised a number of concerns in relation to the equivalent of proposed paragraph 152-10(2)(c) of the CGT Exposure Draft. For example, CAANZ noted that the requirement that the Object Entity be a CGT small business entity or satisfy the modified active asset test discourages

collaborative business:

A person who owns 100% of a business worth $5.9m can claim the small business concession but two independent people who equally own a business worth $8m (that is $4m each) cannot. 117

BDO considered that this requirement will also exclude taxpayers who are ‘presumably outside the integrity concern’, stating:

For example, a taxpayer owns 30% of a company with a MNAVT [maximum net asset value test] of $10 million, such that their interest is only worth $3 million. The taxpayer otherwise meets the MNAVT or small business entity test. They will be precluded from applying the SBCGT concessions as the Object Entity (i.e. the company) doesn’t meet the MNAVT or small business entity test. This would seem to be collateral damage.

118

Paragraph 152-10(2)(c) of the CGT Exposure Draft additionally required that the Object Entity carry on business just prior to the relevant CGT event. While Schedule 2 of the Bill does not contain the requirement, the Object Entity must still be a CGT small business entity if it doesn’t satisfy the maximum net asset test.119 As noted above, a CGT small business entity must ‘carry on business’ in the income year.120 This provision may exclude entities that may be interposed for asset protection purposes, such as passively held assets in a trust if it fails the maximum net asset value test.121

Commencement While Schedule 2 of the Bill commences on the first day of the first quarter to start after the day of Royal Assent, the proposed amendments apply retrospectively to CGT events that occurred on after 1 July 2017.122

While the Government announced in the 2017-18 Budget that the amendments would apply from 1 July 2017, the CGT Exposure Draft was not released until 8 February 2018.123 In addition to the delay, stakeholders have taken issue with the retrospective commencement date on the basis that the proposed amendments go beyond the scope of the budget announcement.124 For example, CAANZ stated:

116. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 22. 117. CAANZ, Submission, op. cit., p. 5. 118. BDO, Submission op. cit., p. 4. 119. Proposed subparagraph 152-10(2)(c)(i) of the ITAA97. 120. ITAA97, sections 328-110(1)(a) and 152-10(1AA). 121. BDO, Submission op. cit., p. 2. Although pertaining to the now amended CGT Exposure Draft, the principle remains the same if

Zed Unit Trust’s fails the modified active assets test because its assets exceeds $6 million. 122. Item 2 of the Bill and item 3 of Schedule 2 to the Bill. 123. Treasury, ‘Improving the integrity of the small business CGT concessions’, op. cit.; S Morrison, Improving the integrity of the

small business CGT concessions: exposure draft released, op. cit. 124. CAANZ, Submission, op. cit., p. 3; BDO, Submission op. cit., p. 3; The Tax Institute, Submission op. cit., p. 1.

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We have reviewed the commentary that was issued by various accounting and information distribution organisations at the time of the Budget announcement and none of them contained analysis that was additional to that contained in pages 38-39 of Budget Paper 2. Some noted that they could not provide more information and suggested delaying transactions until legislation was released.

However, draft legislation was not released until 10 months later. Whilst some small businesses may have been able to delay their transactions, not all could. Numerous members have advised us that given the delay between the announcement and legislation many business transactions had to proceed. These transactions proceeded in good faith on the basis of the existing legislation and conservatively given the vagueness of the Budget announcement. Despite this, members have advised us that the draft legislation exceeds the expected scope of the Budget announcement and that many business transactions will now be adversely affected.

125

Similarly, in its submission on the CGT Exposure Draft, BDO stated:

The drastic increase in scope, which was not flagged in the 2017/18 Federal Budget announcements, means that the proposed retrospective provisions will adversely affect taxpayers who have sold shares in companies or interests in trusts since 1 July 2017 in reliance on the existing law and the plain meaning of the budget announcement.

126

As CAANZ raised in its submission, the retrospective operation will have flow on consequences for taxpayers who, for example have transferred amounts into superannuation that are non-taxable under the existing provisions but will no longer be treated as such.127 The Explanatory

Memorandum has attempted to address the retrospective application of the provisions and states:

This retrospective application is consistent with the Budget announcement by the Government on 9 May 2017 to ensure the small business CGT concessions are only available in relation to assets used in a small business and ownership interests in small businesses.

Taxpayers that sought to access the concessions in relation to the disposal of assets on or after 1 July 2017 where this is not consistent with the amended law do not receive the benefit of these concessions. This includes taxpayers that have sought to access the small business retirement exemption to reduce their CGT liability by contributing amounts to superannuation (in this case the amount contributed is not exempt from CGT and is a non-concessional contribution to superannuation for the relevant financial year).

This measure is an integrity measure. While its retrospective application may disadvantage some taxpayers that have sought to access the concessions after announcement, this application is necessary to minimise the scope for entities to inappropriately access the small business CGT concessions in the period after the measure was announced but before legislation is enacted.

128

Senate Standing Committee for the Scrutiny of Bills The Senate Standing Committee for the Scrutiny of Bills (Scrutiny Committee) also raised concerns about the retrospective application of Schedule 2 of the Bill. In particular, the Scrutiny Committee considered that the retrospective provisions back-dated to an announcement:

… challenges a basic value of the rule of law that, in general, laws should only operate prospectively (not retrospectively) … reliance on ministerial announcements and the implicit requirement that persons

125. CAANZ, Submission, op. cit., p. 3. 126. BDO, Submission op. cit., p. 3. 127. CAANZ, Submission, op. cit., pp. 5-6. 128. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 23.

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arrange their affairs in accordance with such announcements, rather than in accordance with the law, tends to undermine the principle that the law is made by Parliament, not by the executive. 129

While Schedule 2 of the Bill applies to a CGT event that occurs on after 1 July 2017 rather than the budget announcement,130 the Scrutiny Committee considers that some amendments may apply retrospectively if legislation is introduced within six months after the date of the announcement.131 The Scrutiny Committee requested advice from the Treasurer about how many individuals will be detrimentally affected and the extent of any such detriment.132 While a response was received by the Scrutiny Committee on 30 May 2018, at the time of writing it was not yet publicly available.133

The Scrutiny Committee also drew the attention to the fact that the Senate may decide not to pass the Bill without the commencement date being amended in accordance with Senate Resolution No. 44, which states:

Where the government has announced, by press release, its intention to introduce a bill to amend taxation law, and that bill has not been introduced into the Parliament or made available by way of publication of a draft bill within 6 calendar months after the date of that announcement, the Senate shall, subject to any further resolution, amend the bill to provide that the commencement date of the bill shall be a date that is no earlier than either the date of introduction of the bill into the Parliament or the date of publication of the draft bill.

134 (Emphasis added).

As noted above, the CGT Exposure Draft legislation was not released until 8 February 2018 being ten months after the date of the announcement.135

Other provisions Item 1 of Schedule 2 to the Bill amends the guidance material in section 152-5 of the ITAA97 which sets out the major conditions that must be satisfied for the small business CGT concessions to apply.

Schedule 3—FinTech and venture capital amendments Schedule 3 to the Bill amends the ITAA97 and the Venture Capital Act 2002 (VCA) to extend venture capital tax concessions to investments in financial technology (FinTech) businesses.

Background Venture capital is a mechanism for financing new, innovative enterprises at the start-up and early-expansion phases. Venture capitalists invest funds in such enterprises in return for an equity share. The funds are used to develop an enterprise’s ideas to the stage where their commercial potential is sufficient for the venture capitalist to sell its equity to another party.

FinTech refers to the use of innovative technology in the design and delivery of financial products and services to consumers. It has applications across lending, financial advice, investment management and payments services.136

129. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 5, op. cit., pp. 71. 130. Item 2 of the Bill and item 3 of Schedule 2 of the Bill. 131. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 5, op. cit., pp. 71. 132. Ibid., pp. 70-1. 133. Senate Standing Committee for the Scrutiny of Bills, ‘Ministerial Responses’, Australian Parliament House website. 134. The Senate, Procedural orders of the Senate of continuing effect: resolutions expressing opinions of the Senate: no. 44 taxation

Bills - retrospectivity, Australian Parliament House website. 135. Treasury, ‘Improving the integrity of the small business CGT concessions’, op. cit.; S Morrison, Improving the integrity of the small business CGT concessions: exposure draft released, op. cit.

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On 21 March 2016, the Government published its FinTech statement which, among other things, committed to:

• ensuring that start-ups involved in FinTech, including in insurance and finance related activities, can be eligible investments for the purposes of the venture capital tax concession and

• introducing a mechanism by which Innovation Australia (now Innovation and Science Australia (ISA)) could issue binding advice in relation to the definition of activities ineligible for venture capital tax concessions.137

Schedule 3 to the Bill partially implements the measure ‘National Innovation and Science Agenda - expanding the new arrangements for venture capital limited partnerships’ from the 2016-17 Budget to ‘ensure that venture capital tax concessions are available for FinTech, banking and insurance related activities’.138

The Commonwealth provides various tax concessions to support Australian venture capital investments. Venture Capital Limited Partnerships (VCLPs) and Early State Venture Capital Limited Partnerships (ESVCLPs) aim to increase foreign investment in the Australian venture capital sector, providing certain foreign investors with tax exemptions on the profits on their investments:139

• the VCLP program provides for:

- flow-through tax treatment140 - an exemption from income tax on capital and revenue profits arising from the disposal of eligible investments - fund managers to be taxed on their carried interest in the partnership on capital account,

rather than as income • the ESVCLP program provides tax concessions for high-risk start-up entities:

- flow-through tax treatment - an exemption for Australian and foreign venture capital partners from income tax on capital and revenue profits from the disposal of eligible venture capital investments made by the ESVCLP and any other income earned on these investments

- taxing fund managers on their carried interest in the partnership on capital account, rather than as income.141 To be eligible for the tax incentives:

• a venture capital fund must be registered and remain registered as a VCLP or an ESVCLP. ISA’s Innovation Investment Committee registers VCLPs and ESVCLPs under the Venture Capital Act 2002

• VCLPs and ESVCLPs must only invest in entities that are predominantly engaged in activities that are not ineligible activities. Ineligible activities include: property development or land

136. M Blake, P Vanham and D Hughes, ‘Five things you need to know about FinTech’, World Economic Forum, 20 April 2016. 137. Australian Government, Backing Australian FinTech, 18 March 2016. ISA is an independent board, responsible for providing strategic whole-of-government advice on all science, research and innovation matters. Under subsections 118-425(14) and (14B) and 118-427(15) and (15A) of the ITAA97 and Division 362 in Schedule 1 to the Taxation Administration Act 1953, ISA

has the power to issue binding public and private rulings. 138. Australian Government, Budget measures: budget paper no. 2: 2016-17, op. cit., p. 22. 139. Department of Industry, Innovation and Science, Venture Capital Limited Partnerships, Business investment fact sheet, July 2016, p. 1. The program is also open to domestic investors. See also P Hawkins, Treasury Laws Amendment (2018

Measures No. 2) Bill 2018, Bills digest, 97, 2017-18, Parliamentary Library, Canberra, 5 April 2018. 140. Flow through treatment provides that the individual partners are taxed on their share of profits from the partnership, rather than the partnership itself being taxable. 141. Australian Taxation Office (ATO), ‘Venture capital and early stage venture capital limited partnerships’, ATO website, last

modified 1 December 2016.

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ownership; finance relating to banking, providing capital to others, leasing, factoring and securitisation; insurance; construction or acquisition of infrastructure facilities; and making investments (that are directed to deriving income in the form of interest, rents, dividends, royalties or lease payments).142 Eligible venture capital investments are defined in subdivision 118-F of the ITAA97.143

The close relationship between ineligible activities and FinTech has raised questions as to whether investment in companies and unit trusts engaged in the development of FinTech are eligible venture capital investments. Schedule 3 to the Bill amends the ITAA97 to provide that, despite existing rules concerning ineligible activities, an activity is not an ineligible activity for the purpose of the venture capital tax concessions if it is:

• developing technology in relation to finance, insurance or making investments

• ancillary or incidental to developing technology in relation to finance, insurance or making investments or

• covered by a finding from Innovation and Science Australia that it is a substantially novel application of technology.144

In his second reading speech, the Assistant Minister to the Treasurer, Michael Sukkar, stated that Schedule 3:

… demonstrates the government's continuing commitment to promoting a culture of entrepreneurship and risk taking in Australia and will help ensure innovative Australian businesses have access to the capital and, importantly, the expertise that they need to grow and succeed in this very competitive area.

145

Senate Standing Committee for the Scrutiny of Bills Proposed subsection 118-432(2) provides that ISA may, on application from a company or unit trust, make a finding that a specified activity is a substantially novel application of technology. This is known as a ‘private finding’. Schedule 3 makes an amendment to the VCA to provide that such a private decision is subject to internal and Administrative Appeals Tribunal (AAT) review in the same way as other administrative decisions relating to venture capital tax concessions.

Proposed subsection 118-432(5) provides that ISA must notify the applicant in writing of any decision about an application for a private finding, or refuse to make such a finding. Proposed subsection 118-432(6) provides that failure to notify an applicant does not affect the validity of the finding. This is a ‘no-invalidity’ clause. The Senate Standing Committee for the Scrutiny of Bills (the Committee) has ‘significant scrutiny concerns’ with no-invalidity clauses, as they ‘may limit the practical efficacy of administrative review to provide a remedy for administrative errors’.146

The Committee has sought justification for the use of a no-invalidity clause; and advice about how an applicant can appeal a refusal under proposed section 118-432(2) in circumstances where ISA does not notify the applicant of that refusal.

142. ITAA97, subsection 118-425(13). 143. ITAA97, section 118-425. 144. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 27.

145. M Sukkar, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, House of Representatives, Debates, 10 May 2018, p. 3752. 146. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 5, op. cit., p. 72.

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Policy position of non-government parties/independents At the second reading of the Bill, several concerns were raised by the ALP, specific to Schedule 3. Matt Keogh MP expressed ‘overall support’ for the legislation, but noted that ‘there are things in schedules 3 and 4 in particular that we say need to be improved or fixed up’.147 Matt Thistlethwaite MP, noted that there was still ‘some uncertainty about the long-term eligibility for concessions in the commercialisation process’, leading to ‘some uncertainty about whether investment decisions will actually be improved’.148 He argued that the Government should investigate the impact of venture capital concessions as a whole to ensure that they are operating as intended.149

The Shadow Minister for Employment Services, Workforce Participation and Future of Work, and Shadow Minister for the Digital Economy, Ed Husic MP, pointed out an apparent ambiguity in the legislation:

For example—and I had highlighted to me—in 3.26 of the explanatory memorandum it states that a FinTech may be eligible for the tax concession when developing its technology. However—and this is what has been raised with me—it then goes on to say that when a business is commercialising the technology it would no longer be eligible. As has been raised with me: 'This hardly seems like a certain, longer term platform for a venture capital firm to make an investment in a FinTech, given that the VC is only making the investment because it's hoping the FinTech will be able to commercialise and profit from the technology.’

150

Position of major interest groups FinTech Australia is a not-for-profit national association for the Australian FinTech start-up community. In February 2016, FinTech Australia published Priorities for reform of the Australian financial services industry in which it called for the removal of ‘finance, insurance and investment’ from section 118-425 (Meaning of eligible venture capital investment - investment in companies) of the ITAA97 as heads of ‘ineligibility’ for ESVCLP investments.151 It argued that this would enable FinTech ventures to receive funding from ESVCLP funds.

As an alternative, it is recommended that they be qualified with the proviso: ‘Except where such activities are delivered in a significantly more automated fashion than is customary within the industry or by way of a substantially new business model’. 152

In its submission to the Treasury consultation process ‘Encouraging venture capital investment in FinTech’, FinTech Australia recommended (as above):

In the short term, prior to legislative reform, [the Government should] issue a Ministerial Directive instructing Innovation and Science Australia to disregard those provisions of the [Venture Capital] Act where a fintech applies for a binding advice on eligibility. 153

In November 2017, FinTech Australia made a submission to Treasury on proposed venture capital and early stage investor tax concession amendments, calling for an amendment to the definition

147. M Keogh, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, op. cit., p. 3748. 148. M Thistlethwaite, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, op. cit., p. 3742. 149. Ibid. 150. E Husic, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, House of

Representatives, Debates, 10 May 2018, p. 3750. 151. FinTech Australia, Priorities for reform of the Australian financial services sector, op. cit. 152. Ibid., p. 24. 153. FinTech Australia, Submission to Treasury, Encouraging venture capital investment in FinTech, 3 June 2016.

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of ‘ineligible activities that an eligible investee company can undertake so as to further qualify which activities relating to finance may be considered eligible for the regime.’154

Financial implications The measure is expected to have an unquantifiable cost to revenue over the forward estimates period.155

The measure is expected to result in a small overall compliance cost impact, comprising a small implementation impact and a small increase in ongoing costs.156

Key issues and provisions Schedule 3 makes two changes to the activities that are ineligible activities for the purposes of the concessions. The amendments relate solely to reduce the scope of which activities are ineligible activities. Specifically, item 1 amends section 118-425 of the ITAA97 (Meaning of eligible venture capital investment - investment in companies) to specify that an activity is not an ineligible activity if it is:

• developing technology for use in relation to activities in finance, insurance or making investments157

• an activity that is ancillary or incidental to the activity of developing technology referred to above158

• an activity referred to above that is the subject of a finding in force under proposed section 118-432 which concerns findings by ISA of substantially novel applications of technology.159

The Explanatory Memorandum notes that the term ‘developing technology’ is deliberately broad:

• technology is defined as ‘the practical application of science and engineering’ and

• developing technology is designed to cover things done to create, understand and apply technological innovation including adapting existing technology for a novel use.160

Regulations can be made to prescribe activities to which the exclusion does not apply - this allows ‘a quick response to emerging issues that result in unintended outcomes without qualifying the broad operation of the provisions’.161

Item 2 contains identical amendments to section 118-427 of the ITAA97 (Meaning of eligible venture capital investment - investments in unit trusts).162

Item 3 inserts proposed section 118-432 (Findings of substantially novel applications of technology):

• ISA may, by legislative instrument, find that each activity within a specified class is a substantially novel application of one or more technologies (a public finding)163

154. FinTech Australia, Submission to Treasury, FinTech venture capital and early stage investor tax concession amendments, 14 November 2017. 155. Australian Government, Budget measures: budget paper no. 2: 2016-17, op. cit., p. 22. 156. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 5. 157. Proposed paragraph 118-425(13A)(a) of the ITAA97. 158. Proposed paragraph 118-425(13A)(b) of the ITAA97. 159. Proposed paragraph 118-425(13A)(c) of the ITAA97. 160. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 29. 161. Proposed subsection 118-425(13B) of the ITAA97; Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and

Other Measures) Bill 2018, p. 30. 162. Proposed subsections 118-427(14A) and (14B) of the ITAA97.

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• ISA may, on application from a company or unit trust, make a written decision finding that a specified activity is a substantially novel application of one or more technologies, or refusing to make such a finding about a specified activity (a private finding)164

• ISA findings are in force for the period specified in the finding165

• an application for a private finding must be in an approved form166

• ISA must notify the applicant in writing of any decision relating to a private finding and167

• failure to provide a written decision does not affect the validity of the finding.168

Substantially novel activities in relation to FinTech could include activities that have moved from the development of technology to its application, but this application must be new or uncommon and must involve some degree of innovation.169 The Explanatory Memorandum notes that ‘novel’ does not have the specialised meaning it holds in the Patents Act 1990.170 It is expected that ISA will consult with the Commissioner of Taxation when making a finding.171

Several examples of eligible and ineligible activities are provided in the Explanatory Memorandum.172 However, and given the provision for regulations, it is apparent that there will be circumstances which have not yet been foreseen and which will require ISA to make a finding. It is not clear if the consequent resource impact for ISA has been included in the financial implications.

Item 5 makes an amendment to the VCA to provide that the decision by ISA to make (or not to make) a private finding is subject to internal and AAT review.173 As noted earlier in this Bills Digest, the Committee has raised ‘significant scrutiny concerns’ over this amendment and has sought justification for its use.

Consequential amendments Item 4 of Schedule 3 makes a consequential amendment to Division 362 (Rulings by Innovation and Science Australia that activities are not ineligible activities) in Schedule 1 to the Taxation Administration Act 1953 to insert a note to confirm that the power of ISA to make rulings (public and private) about ineligible activities extends to cover the changes made to eligibility as a result of these amendments.174

Application of amendments The amendments apply in relation to investments made on or after 1 July 2018 (item 6).

163. Proposed subsection 118-432(1) of the ITAA97. 164. Proposed subsection 118-432(2) of the ITAA97. 165. Proposed subsection 118-432(3) of the ITAA97. ISA is expected to balance the need for the status of particular activities to be reconsidered periodically with the need of stakeholders for certainty. 166. Proposed subsection 118-432(4) of the ITAA97. 167. Proposed subsection 118-432(5) of the ITAA97. 168. Proposed subsection 118-432(6) of the ITAA97. 169. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 30.

170. ibid., p. 30. 171. Ibid., p. 32. 172. See for example: Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, pp. 29, 31-2.

173. Proposed paragraph 29-1(m) of the VCA. 174. Proposed notes at the end of subsections 362-5(1) and 362-25(1) of the Taxation Administration Act 1953.

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Schedule 4—Reparation payment tax exemption

Background

Defence Abuse Response Taskforce The Defence Abuse Response Taskforce (the Taskforce) was established on 26 November 2012 to assist complainants that had suffered abuse in the Defence Force such as workplace discrimination, harassment, bullying, physical and sexual abuse that occurred prior to 11 April 2011.175

The Taskforce administered payments of up to $50,000 to persons who had suffered abuse in the Australian Defence Force.176 A payment under the scheme was not for compensation or damages and payments did not affect a person’s statutory, common law or other legal rights.177 Payments made under the scheme are exempt from income tax.178 The Taskforce made 1,723 reparation payments totalling $66.63 million, the breakdown of which is set out at Figure 7.179

Figure7: breakdown of reparation payments

Source: Taskforce, Defence Abuse Response Taskforce: final report, p. 15.

The Taskforce’s terms of reference included finalising reparation payments under the scheme by 30 September 2015.180 The Taskforce recommended that the Defence Force Ombudsman should be responsible for the Taskforce’s legacy work including an expanded complaints mechanism for

victims of abuse in Defence.181

In December 2017, Senator Marise Payne, the Minister for Defence, announced the establishment of the Defence Reparation Scheme, stating:

175. Defence Abuse Response Taskforce (Taskforce), Defence Abuse Response Taskforce: final report, Australian Government, March 2016, p. 11. 176. Defence Abuse Response Taskforce , ‘Reparation Scheme’, Taskforce website, last updated 15 April 2016. 177. Ibid. 178. ITAA97, item 1.7 of the table in section 51-5. 179. Taskforce, Defence Abuse Response Taskforce: final report, op. cit., p. 15. 180. Ibid., p. 8. 181. Taskforce, Defence Abuse Response Taskforce: final report, op. cit., p. 5.

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The DFO [Defence Force Ombudsman] will now commence assessing complaints already received since their role was expanded. The Ombudsman may recommend a payment in relation to a complaint of abuse if satisfied that:

- the abuse is reasonably likely to have occurred, and occurred on or before 30 June 2014; and

- the complaint relates to the most serious forms of abuse or sexual assault. 182

The Defence Force Ombudsman is established under the Ombudsman Act 1976 to investigate complaints made to them under the Act.183 The Defence Force Ombudsman has the power to make reparation payments for abuse under the Ombudsman Regulations 2017.184 The Ombudsman may recommend a payment of up to $45,000 to acknowledge the most serious forms of abuse and a payment of up to $20,000 to acknowledge other abuse involving unlawful interference accompanied by some element of indecency. An additional payment of $5,000 may also be recommended where the Ombudsman is satisfied that Defence did not respond appropriately to the incident of abuse.185

In the 2017-18 Budget it was announced that the Government would expand the scope of the Defence Force Ombudsman to make orders for reparation payments.186 According to the Explanatory Memorandum, Schedule 4 to the Bill ‘implements the tax consequences from the 2017-18 Budget of the Defence Force.’187

Policy position of non-government parties/independents At the second reading of the Bill, Matt Keogh MP (ALP) expressed ‘overall support’ for the legislation, but noted that ‘there are things in schedules 3 and 4 in particular that we say need to be improved or fixed up’ although he did not elaborate on specific matters.188

Position of major interest groups There do not appear to be any particular views expressed on making such payments tax exempt.

Financial implications The Explanatory Memorandum to the Bill states that the measure’s financial impact will be ‘Nil’.189 According to the 2017-18 Budget the cost of the overall measure ‘will be met from within the existing resources of the Department of Defence.’190

Key issues and provisions Item 3 of Schedule 4 to the Bill repeals item 1.7 in the table contained in section 51-5 of the ITAA97 (the Defence Abuse Reparation Scheme payments) and exempts from income tax reparation payments or additional payments from the Commonwealth made under the new

182. M Payne, (Minister for Defence), Reparation for survivors of Defence abuse, media release, n.d., received by Parliamentary Library on 15 December 2017. 183. Ombudsman Act 1976, section 19B. 184. Ombudsman Regulations 2017, regulations 14, 14B. 185. Commonwealth Ombudsman, ‘Reporting abuse in Defence’, Commonwealth Ombudsman website. 186. Australian Government, Budget measures: budget paper no. 2: 2017-18, op. cit., p. 79. 187. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 5. 188. M Keogh, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, op. cit., p. 3748. 189. Ibid., p. 5. 190. Australian Government, Budget measures: budget paper no. 2: 2017-18, op. cit., p. 79.

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scheme—that is, payments made on the recommendation by the Defence Force Ombudsman performing a function conferred by section 14 or 14B of the Ombudsman Regulations 2017.191

The exemption is necessary because as stated in the Explanatory Memorandum the payment is likely to be treated as income for the purposes of the tax laws:

One-off payments will generally have the character of ordinary income if they are received as a product of, or in relation to, employment, services rendered or the carrying on of a business.

As payments made by the Defence Abuse Response Taskforce arose out of an employment relationship with the Department of Defence or the Australian Defence Force, they could also be characterised as statutory income under section 15-2 of the ITAA 1997, which applies to allowances and other things provided in respect of employment.

192

In his second reading speech, the Assistant Minister to the Treasurer, Michael Sukkar considered that ‘Schedule 4 ensures the recipient of a reparation payment receives the full benefit of the payment and, importantly, is free from the obligation to pay income tax on it.193 Similarly, Jason Falinski MP stated:

Unlike compensation, a reparation payment represents an acknowledgement by Defence that the abuse suffered by the complainant was wrong, that it can have a lasting and serious impact and also that in the past Defence was not positioned appropriately to respond to abuse in many cases. The recipient of a reparation payment should receive the full benefit of that payment and, as such, the payment should be exempt from income tax.

194 (Emphasis added).

The existing exemption under item 1.7 of the table in section 51-5 of the ITAA97 for a payment by the Commonwealth under the Defence Abuse Reparation Scheme is repealed because no new payments are being made under that scheme.195

Commencement While Schedule 4 of the Bill commences on the first day of the first quarter to start after the day of Royal Assent, the amendments made by Schedule 4 apply from the 2017-18 income year onwards—that is, payments made from 1 July 2017 onwards.196

Other provisions Payments that are exempt from income tax are listed in section 11-15 of the ITAA97. This section is not operative but rather it is for ease of reference. Item 1 of Schedule 4 removes the Defence Abuse Reparation Scheme payments reference from the list. Item 2 of Schedule 4 to the Bill inserts the new exemption as outlined above.

191. ITAA97, section 6-20. 192. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, pp. 35-6. 193. M Sukkar, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, op. cit., p. 3752. 194. J Falinski, ‘Second reading speech: Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018’, House of

Representatives, Debates, 10 May 2018, p. 3745. 195. Explanatory Memorandum, Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018, p. 38. 196. Item 2 of the Bill and item 5 of Schedule 4 to the Bill.

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Appendix A: changes made by the proposed amendments to Basic Condition 5

Condition 5(a): Does the share in the company or interest in the trust satisfy the modified active asset test?

Condition 5(b)(i): Does the taxpayer satisfy the $6 million maximum net asset value test?

Condition 5(c)(i): Is the *Object Entity a small business entity (SBE) for the income year subject to the modification to the SBE test?

Condition 5(d)(ii): CGT concession stakeholders in the *Object Entity together have a small business participation percentage in the taxpayer of at least 90%?

Condition 5(d)(i): Is the taxpayer a CGT concession stakeholder in the *Object Entity?

CGT asset is a share in a company or an interest in a trust (Basic Condition 5)

Eligible for small business CGT concessions if other Basic Conditions satisfied

Not eligible for small business CGT concessions

Condition 5(c)(ii): Does the *Object Entity satisfy the $6 million maximum net asset value test subject to the modifications made to the test?

Condition 5(b)(ii): Is the taxpayer carrying on a business just before the CGT event?

*The company or trust in which the taxpayer holds the share or asset is the Object Entity.

Yes

Yes

No

No

No

No

Yes

Yes

No

Yes

Yes

No

Yes

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