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This Digest was prepared for debate. It reflects the legislation as introduced
and does not canvass subsequent amendments. This Digest does not have
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the subsequent official status of the Bill.
Passage History
Purpose
Background
Main Provisions
Concluding Comments
Endnotes
Contact Officer and Copyright Details
Date Introduced: 29 October 1997
House: House of Representatives
Commencement: The Act which may be cited as the Taxation Laws Amendment Act (No. 6) 1997, commences on the day it receives Royal Assent. The amendments made to specified Acts commence on the date specified in each Schedule to the Bill and will be indicated under the main provisions of each Schedule in this Bills Digest.
The purpose of the Bill is to introduce the following measures.
As the Bill deals with disparate measures in each Schedule, for ease of reference, the background to the measures with significant revenue impact will be discussed with the main provisions.
Schedule 1 - Denial of Certain Artificial Capital Losses
At 3 pm on 29 April 1997, the Treasurer announced(2) that recent audit activities by the Australian Taxation Office (ATO), have revealed flaws in the existing law which allow large corporate groups to artificially multiply an actual economic loss several times over. This was possible through manipulation of the capital gains tax (CGT) provisions relating to rollover relief available on the transfer of an asset from one company to another related company. The artificial losses including the actual economic loss are then set off against any subsequent actual capital gains to reduce the amount of CGT payable on the actual capital gains.
An example of how losses can be artificially created was included in the attachment to the Press Release of 29 April 1997. This example illustrates how an actual economic loss of $0.7 billion incurred by one company in a chain of companies can be artificially increased to $3.5 billion, by liquidating in succession 4 interposed companies in the group of companies - the liquidation of each company giving rise to an additional artificial loss of $0.7 billion. The Explanatory Memorandum(3) too gives a similar example involving the liquidation of two companies whereby the actual economic loss of $0.7 billion is increased artificially to $2.1 billion by the liquidation of two companies in the chain of companies. This technique is referred to as unbundling group companies in a 'chain' before liquidating that chain.
This technique of artificially creating capital losses is made possible mainly by the potential for manipulating the rollover relief provisions in section 160ZZO of Part 111A the Income Tax Assessment Act 1936 (ITAA 1936) dealing with capital gains. Section 160ZZO provides that where an asset is transferred from a company to a related company, the general capital gains tax provisions do not apply to the disposal and acquisition. Instead, the company acquiring the asset is considered to have acquired it at the time and for the cost base or reduced cost base that applied to the company disposing of the asset. The Bill seeks to prevent the abuse of section 160ZZO by the specific provisions of Part 1 of Schedule 1. It is also envisaged that other provisions of Part 111A of ITAA 1936, could also be used to create artificial capital losses. To prevent such abuse the Bill strengthens the general anti-avoidance provisions in Part IVA of ITAA 1936 by the provisions in Part 2 of Schedule I.
Part 1 of Schedule 1 as mentioned earlier is a specific anti-avoidance provision and inserts proposed section 160ZPA which denies the use of certain capital losses incurred by a company. Part 1 does not apply if the company is a small business. The small business test provided in paragraph 160ZPA(4)(a) is that the sum of the net value of the assets of the company making the rollover loss as well as the net value of the assets of
entities connected with the company and associate partners do not exceed $5 million. Part 1 does not also apply where the asset which would create the loss is plant, machinery or building
used in a manufacturing business immediately both before and after the transfer and the transferee company used the asset for at least 12 months after the asset was transferred (proposed paragraph 160ZPA(5)(b)).
Part 2 of Schedule 1 amends Part IVA of the ITAA 1936 to enable it to apply to capital losses in the year in which they are created, rather than when a capital loss is set off against capital gains in that income year or a later income year. Part IVA contains the general anti-avoidance provisions and it confers on the Commissioner the power to cancel tax benefits under subsection 177F(1) when certain criteria set out in that Part are satisfied. Proposed paragraph 177C(1)(ba) extends the definition of 'tax benefit' to include a capital loss created by a scheme. Where a tax benefit is denied to one taxpayer under subsection 177F(1), the Commissioner has also the power under subsection 177F(3) to make compensating adjustments to another taxpayer if a different benefit would have arisen if the scheme had not been entered into. Item 9 inserts proposed paragraph 177F(1)(c) to authorise the Commissioner to cancel a tax benefit which is referable to a capital loss and proposed paragraph 177F(3)(c) authorises the Commissioner to make a consequential compensating adjustment in respect of any taxpayer. Item 12 amends subsection 177F(2G) to enable a taxpayer to object against a determination in relation to the cancellation of a capital loss.
It may be argued that the arrangements should be caught by the general anti-avoidance provisions contained in Part IVA of the ITAA 1936, particularly as the application of Part IVA was considerably expanded in the recent High Court decision in Spotless Services Ltd v Federal Commissioner of Taxation(4). However, as the operation of Part IVA depends on the existence of a scheme, it may also be argued that such transactions are not part of a scheme by an individual taxpayer and so are not covered by Part IVA. While the introduction of specific anti-avoidance schemes may be necessary in circumstances such as those addressed by this area of the Bill to ensure that schemes by large corporations will be 'caught' if there are doubts about the application of Part IVA, it will add to the complexity and compliance costs of all taxpayers. In this connection it should be noted that while Part 1 does not apply to small business and manufacturing business assets, there is no such exclusion of small business and manufacturing business assets from the operation of Part 2 which amends Part IVA. The applicability of Part 2 to small businesses may add to their compliance costs.
Financial Impact
The Explanatory Memorandum states that the measures will protect approximately $100 million in revenue per year, commencing in 1997-98.
Application
Part 1 will apply where the rollover of the asset subsequently disposed of occurred before 3 pm on 29 April 1997.
Part 2 will apply to capital losses resulting from schemes entered into after 3 pm on 29 April 1997. Where both measures could apply Part 1 would apply before Part 2.
Schedule 2 - Concessional Tracing Rules for Company Loss etc. Provisions
Under the income tax law a company has to satisfy certain tests before prior year losses can be recouped in a later year of income. These tests are contained in sections 80A to 80F of the ITAA 1936 and Divisions 165, 166 and 175 of the ITAA 1997. The company can carry forward a loss if there is continuity of majority beneficial ownership of certain dividend, capital and voting rights of the company in the year the loss is incurred as well as in the year when the loss is recouped or set off against profits. This is referred to as the continuity of ownership test. Where the continuity of ownership test is not met, the company can carry forward a loss, if among other things, it carries on the same business as it carried on at the time of change in ownership. This is referred to as the same business test. Similar tests apply to limit the deductibility of a company's current year losses in sections 50A to 50N of the ITAA 1936 and Divisions 165, 166 and 175 of the ITAA 1997. The bad debt deduction rules, which are similar to the prior year losses provisions, are contained in sections 63A to 63C of the ITAA 1936. It is relevant to note that as part of the Tax Law Improvement Project (TLIP), the ITAA 1997 contains the rewritten company loss provisions applicable from the 1997-98 income years. For income years prior to 1997-98 the provisions of the ITAA 1936 apply. The company debt deduction provisions have not been re-written as yet.
The continuity of ownership tests contain rules for tracing ownership through interposed entities where some of the shares in a company are held otherwise than by natural persons. Where an interposed entity is a discretionary trust, tracing of beneficial owners cannot occur as beneficiaries of a discretionary trust do not have fixed interests in the income or capital of the company or an interposed entity. Thus a company is unable to carry forward losses where 50% or more of the interests in a company are held by a discretionary trust or trusts including family discretionary trusts. This is referred to as the 50% stake test. The same business test is not available to a company where the majority of shares are held by discretionary trusts.
The Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 (trust losses Bill) which was introduced into Parliament on 1 October 1997 proposes to insert Schedule 2F into the ITAA 1936. The proposed Schedule 2F contains rules to restrict the recoupment of prior year and current year losses and debt deductions of trusts. However, there are concessional tracing rules in Schedule 2F which are available to family trusts. The amendments in Schedule 2 of the Bill will make available to companies two of these concessional tracing rules that are available to trusts. The two concessions are the family trust concession and the alternative condition.
The Family Trust Concession
Part 1 of Schedule 2 will make amendments to the ITAA 1936 and the ITAA 1997 so that the family trust concession will be available to companies. Part 2 of Schedule 2 makes amendments to Schedule 2F of the trust losses Bill which are necessary to complement the extension of the family trust concession to companies.
Under proposed subparagraph 50H(7)(a)(ii) to ITAA 1936 if a family trust owns or has an interest in any of the shares of a company, the trustee will be deemed to have a shareholding interest and be deemed the beneficial owner of shares in the company. If the trustee is a company, it will be treated as having the same ownership rights as a natural person. This ensures that the 50% stake test is satisfied if a discretionary family trust controls a company for the purpose of the prior year and current year loss rules in ITAA 1936. Proposed subsection 175-65(1) will have the same effect for the purpose of the prior year and current year loss rules in ITAA 1997. Proposed subsection 63A(6A) will provide that that the trustee of a family trust that owns shares in a company will be taken to beneficially own the shares for the purposes of the debt deduction rules.
The Alternative Condition
This Bill will make amendments to the ITAA 1936 and the ITAA 1997 to enable the alternative condition that is available to fixed trusts under the trust losses Bill to be available to companies under Part 3 of Schedule 2. The Bill will make amendments to the ITAA 1936 for the purpose of the current year loss rules and debt deduction provisions. It will also make amendments to the ITAA 1997 for the purpose of the prior year and current year loss rules. The tests contained in the 'alternative condition' were dealt with in Bills Digest No. 98 of 1997-98 to which reference is invited.(5)
Non-resident Trusts
Provisions are included in the Bill to ensure that the trust loss and company loss measures cannot be avoided where non-resident trusts are concerned. The Bill also includes provisions to enable the Commissioner to require a company to give information about present entitlement to, or distributions of, income or capital of non-resident family trusts that hold interests in the company.
Regulation Impact Statement
The Regulation Impact Statement(6) makes an assessment of the costs and benefits of the measures in Schedule 2. The salient features of this assessment are as follows.
It is relevant to note that the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 and three complementary Bill: Family Trust Distribution Tax (Primary Liability) Bill 1997; Family Trust Distribution Tax (Secondary Liability) Bill 1997 and the Medicare Levy Consequential Amendment (Trust Loss) Bill 1997 were the subject of a report by the Senate Economics Legislation Committee in December 1997. In view of the significance of the recommendations and observations in the majority and minority reports to the taxation of trusts generally, in the context of the Tax Reform agenda, the 'concluding comments' of this Bills Digest deals with these aspects.
Application
The amendments will take effect generally to company losses and debts incurred in 1996-97 or later years of income. These amendments were announced in the 1996-97 Budget of 20 August 1996.
Schedule 3 - Amendments to the Fringe Benefits Tax
In implementing Government's response to the recommendations of the Small Business Deregulation Task Force the amendments to the Fringe Benefits Tax Assessment Act 1986 (FBTAA) provide for three measures.
Schedule 4 - Temporary Importation of Goods
Wholesale sales tax (WST) applies to assessable dealings with goods produced in Australia or imported into Australia. Goods previously used in Australia are not liable to the WST. However, under the law goods can be imported for periods of less than 12 months free of WST under the special temporary importation provisions. These provisions have been abused to avoid WST by exporting such goods and re-importing them back on a permanent basis. Such re-imported goods are not liable to the WST being goods previously used in Australia. Proposed sections 9B and 51A to the Sales Tax Assessment Act 1992 seek to prevent this abuse. The amendments apply to the re-importation of certain goods which occurred after 7.30 pm by legal time in the Australian Capital Territory on 13 May 1997. The Explanatory Memorandum states that the estimated gain in revenue is $2 million per year from 1997-98 to 2000-2001.
Schedule 5 - Payments of Tax by Small Companies
Under the existing company tax instalment system, a company classified as small (ie. likely tax of less than $8 000) is required to make payment of tax in a single instalment. Thus, a small company with a 30 June balance date must pay the tax due on 1 December following the end of the income year. For companies classified as medium (ie likely tax between $8 000 and $300 000) or large (ie likely tax greater than $300 000), quarterly instalments of tax are required to be paid earlier than the payment schedule that applies to companies classified as small. However, under special administrative arrangements, a small company with a 30 June balance date pays its likely tax on 15 December and the balance, if any, together with the lodgment of its return on the following 1 March. These administrative arrangements have been made possible by the exercise by the Commissioner of discretion under section 206 of the ITAA 1936. This has contributed to uncertainty to small business as it was not clear whether the Commissioner would exercise his discretion in the same manner each year.
The amendments made by Schedule 5 implement Government's response to the report of the Small Business Deregulation Task Force, which recommended that more time should be provided for small businesses to meet their tax obligations. Proposed subsection 221AZK(2) provides that instalment taxpayers classified as small with a balance date of 30 June will be required to pay their likely tax on 15 December following the income year and the balance on the following 15 March. Corresponding dates will apply to small businesses that balance on dates other than 30 June. This concession is only available to instalment taxpayers that are classified as genuinely small. This group of small instalment taxpayers will include companies, corporate unit trusts, public trading trusts, superannuation funds, approved deposit funds and pooled superannuation trusts The concession will not apply to instalment taxpayers whose actual tax payable for the income year exceeds $300 000. Such taxpayers with a balance date of 30 June will pay the full tax liability on 1 December following the end of the income year (ie 18 months after the commencement of the income year). The Regulation Impact Statement states that this amendment will defer only a small amount of tax and, as a result, the interest cost to revenue will be insignificant.
The proposed amendment to the instalment schedule are to take effect from the 1996-97 income year. The amendments also change the classification system with effect from the 1997-98 income year.
Schedule 6 - Dividend Imputation and Retirement Savings Accounts
The purpose of the amendments to the ITAA 1936 proposed in Schedule 6 of the Bill is to ensure that no franking credit or debit arises from the payment or refund of tax where those amounts are attributable to the Retirement Savings Account (RSA) of a life assurance company. As part of the tax treatment of RSAs by amendments to the ITAA 1936 introduced by the Retirement Savings Account (Consequential Amendments) Act 1997 (RSA Act) this consequence applied to other entities such as banks, building societies and credit unions that are allowed to establish RSAs. The amendments in Schedule 6 of the Bill are necessary to provide the same tax treatment to RSAs established by life assurance companies as the amendments by the RSA Act did not have this effect . The amendments are to have effect to franking credits and debits arising for life assurance companies after the date of introduction of this Bill (ie 29 October 1997).
Schedule 7 - Deductible Expenditure and CGT Cost Bases
Under the existing law there is nothing to prevent a taxpayer who has claimed a deduction in respect of an asset in calculating income for income tax purposes from claiming the same deduction for capital gains purposes. The amendments in Schedule 7 are designed to prevent taxpayers from claiming a deduction for capital gains purposes to the extent that they would be able to claim a deduction for expenditure in calculating income. Proposed paragraph 160ZJA prevents the inclusion of an amount of expenditure in the cost base or indexed cost base of an asset to the extent that deductions are allowable to the taxpayer in calculating assessable income.
These changes were announced as part of the 1997-98 Budget and applicable to assets disposed of after 7.30 pm AEST on 13 May 1997. The Government received representations from the building and property industries that it would be unfair for measures to apply to expenditures incurred in respect of pre-Budget assets. Transitional measures included in Schedule 7 that would exclude from the measures, expenditure incurred on pre-Budget land or buildings only if the expenditure was incurred before 1 July 1997.
This CGT cost base adjustment measure is expected to provide a gain to revenue over the five years 1997-98 to 2001-02 of $325 million. This is $135 million short of the original Budget estimate and represents the cost of the concession made to representations from the building and property industries.
Schedule 8 - Passive Income of Insurance Companies
The amendments proposed in Schedule 8 are designed to correct a deficiency in calculating the passive income of the controlled foreign companies (CFCs) of Australian life and general insurance companies. Proposed section 446 to the ITAA 1936 will provide for a new formula to replace the existing formula for calculating passive income. The new formula will exclude from a company's passive income only the income derived on assets referable to insurance policies owned by non-residents that are not related to the company. The Explanatory Memorandum sets out clearly the technical changes and illustrates the use of the new formula.(10) The amendments apply to the passive income derived by an insurance company on or after 1 July 1997 and the estimated revenue savings is expected to be $10 million in each of the 1998-99, 1999-2000 and 2000-01 financial years.
Schedule 9 - Average Calculated Liabilities of Life Assurance Companies
The purpose of the amendments proposed in Schedule 9 is to ensure that average calculated liabilities are used by a life company to determine the amount of income that relates to immediate annuity policies; the amount of income that is attributable to policies issued by overseas branches and the amount of income and capital gains to be allocated to each class of assessable income. Under the existing law liabilities for the above purposes are based on year end liabilities of a group of policies. Proposed section 114A sets out the steps that will be used to work out average calculated liabilities for a category of policies. The proposal to switch to average calculated liabilities was announced by Government on 29 April 1997 because using calculated liabilities at year end could distort these calculations if they do not reflect the respective proportions of these groups of policies held during the year. The Explanatory Memorandum sets out examples of the calculation of average liabilities under the proposed measures.(11) The amendments are expected to protect revenue in the order of $100 million and the amendments apply from the first year of income that commences on or after 29 April 1997.
Schedule 2D to the ITAA 1936 inserted by Taxation Laws Amendment Act (No. 3) 1996 ensured that depreciable assets of tax exempt entities which become taxable were brought into the tax system at their notional written down value (NWDV) in calculating allowable depreciation. Schedule 2D applied to depreciable assets of a tax exempt entity which became taxable after 2 July 1995. The purpose of the amendments in proposed section 61A is to ensure that depreciable assets of tax exempt entities which became taxable earlier than 3 July 1995 but not earlier than the start of the year of income in which 1 July 1988 occurred are brought into the tax system at their NWDV. The provisions will apply to Government exempt entities which are privatised either by legislation or sale to private interests and non-Government exempt entities which cease to be exempt. This puts beyond doubt the interpretation and administration by the Commissioner of Taxation of the provisions of section 61 of the ITAA 1936 for the specified period, prior to the enactment of Schedule 2D. No additional revenue is expected from this measure, but failure to implement this measure poses a potentially significant threat to revenue by way of claims relating to the period prior to 3 July 1995.
Trust Loss Legislation and Tax Treatment of Trusts in Tax Reform
The majority report of the Senate Economics Legislation Committee on the trust loss measures Bill in December 1997 notes the concerns that were raised before it in relation to the retrospectively of the trust loss measures, its complexity and the changed arrangements in relation to the definition of family for the purposes of establishing family trusts. The majority report recommended that the government should consider the evidence received by the Committee to determine whether there should be further amendments to those Bills. These very concerns can equally apply to the amendments proposed in Schedule 2 to Bill considered in this Bills Digest.
In the 1997-98 Budget(12) the Government indicated that it is concerned to ensure that the taxation provisions relating to trusts do not permit tax avoidance or undue tax minimisation.12 This followed the identification by the ATO High Wealth Individuals Task Force (HWITF) of the use of complex trust structures for tax avoidance or undue tax minimisation. Government indicated that it will undertake a review of the taxation of trusts after the ATO and the Treasury issue a discussion paper expected towards the end of 1997. This discussion paper has not been issued to date and it appears that this review will be part of the general Tax Reform agenda of the Government.
The minority report on the trust losses Bill, by the ALP members on the Senate Economics Legislation Committee, made the following specific comments on the extension of the family trust concession having regard to the focus on tax avoidance by high wealth individuals in recent years.
The concluding paragraph of the minority report indicated that Labor in government will review the whole issue of the taxation treatment of trust losses, but fell short of indicating whether this would be part of a total review of the taxation of trusts.
Senator A Murray of the Australian Democrats in his minority report recommended that
Mr Michael Carmody, the Commissioner of Taxation, recently raised for consideration the application of the company tax regime to trusts in the Government's proposed review of the taxation of trusts in the interests of enhancing the integrity of the income tax system.
The need for a review of the taxation treatment of trusts and recommendations that consideration should be given to taxing trusts as companies to reduce opportunities for tax minimisation has been commented upon in several reports in the past. The information and Research Services 1997-98 Budget Review gives a brief account of the recent reports, commencing with the Tax Reform Summit of 1985, where the application of the company tax regime to trusts has been suggested.(16)
Bernard Pulle
27 February 1998
Bills Digest Service
Information and Research Services
This paper has been prepared for general distribution to Senators and Members of the Australian Parliament. While great care is taken to ensure that the paper is accurate and balanced, the paper is written using information publicly available at the time of production. The views expressed are those of the author and should not be attributed to the Information and Research Services (IRS). Advice on legislation or legal policy issues contained in this paper is provided for use in parliamentary debate and for related parliamentary purposes. This paper is not professional legal opinion. Readers are reminded that the paper is not an official parliamentary or Australian government document.
ISSN 1328-8091
© Commonwealth of Australia 1997
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Published by the Department of the Parliamentary Library, 1997.