Bills Digest 15 1996-97 Taxation Laws Amendment Bill (No. 2) 1996


Numerical Index | Alphabetical Index

WARNING:
This Digest is prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments.

This Digest was available from 2 August 1996.

CONTENTS

Passage History

Taxation Laws Amendment Bill (No. 2) 1996

Date Introduced: 27 June 1996
House: House of Representatives
Portfolio: Treasury
Commencement: The measures discussed in this Digest have varing application dates, which are dealt with in the Main Provisions section of the Digest.

Purpose

The main amendments contained in the Bill deal with:

  • extending the concessional tax treatment in relation to Off-shore Banking Units to such entities with Australian investments below a certain level in their investment portfolio (although the income from Australian investments will not be subject to concessional treatment);
  • the repeal of a provision that has the potential to restrict certain off-shore mortgage transactions;
  • the treatment of commercial debt forgiveness;
  • the treatment of certain, award specific superannuation payments under the superannuation guarantee scheme;
  • the use of tax file numbers in the tracing of superannuation payments; and
  • the definition of small fringe benefits to provide that most benefits under $100 will be exempt.

Background

As there is no central theme to the Bill, the background to the various amendments will be discussed below.

Main Provisions

Offshore Banking Units

Under the Income Tax Assessment Act 1936 (ITAA), the Treasurer may declare certain organisations to be offshore banking units (OBUs). The organisations are:

  • banks authorised under the Banking Act 1959 to operate in Australia;
  • State authorities that operate as State banks;
  • a person in regard of whom the Treasurer is satisfied that that they are an authorised foreign exchange dealer; and
  • a company that is owned by an OBU, other than a foreign exchange dealer (section 128EA).

OBUs exist to facilitate the flow of international capital, with the purest form of an OBU being one that engages in borrowing funds overseas and on-lending the funds to a third party that is also not resident in Australia. However, the pure model is complicated by a number of factors, such as the desire to regulate the operations of an OBU in relation to residents to ensure that domestic banks are not disrupted by OBU activities, to attempt to restrict international money laundering and to require resident OBUs to contribute to taxation revenue.

Prior to 1992, Australian OBUs were offered concessions from withholding tax in relation to certain transactions in an attempt to attract more of the industry to Australia. The concessions proved insufficient, as OBUs continued to pay the normal rate of company tax on OBU income compared with concessional treatment available in other countries, particularly in very low tax 'tax havens'. In the 1992 One Nation statement, it was announced that the rate of company tax for OBUs would be reduced to 10% for income from certain, mostly non-resident related transactions. These are known as offshore banking activities (OBAs) and comprise some very technical financial definitions. In brief, OBAs are:

  • borrowing or lending currency or gold to or from a non-resident;
  • providing a guarantee or underwriting a risk in relation to offshore activities;
  • trading in securities issued by non-residents, shares or units in a trust issued by a non-resident, in futures, currency or currency options or certain precious metals that are not expressed in Australian currency;
  • entering certain contracts that are not expressed in Australian currency;
  • acting as a broker, agent or trustee for a non-resident in relation to an investment that is not made in Australian currency and involves investing outside Australia;
  • providing advice in relation to a type of investment referred to above; or
  • engaging in hedging activity in relation to borrowing or lending activities.

The reason for the 10% concessional tax rate given in the One Nation statement was :

A 10 per cent tax rate for profits from offshore banking will provide further stimulus to the development of offshore banking in Australia at a time when such activity might be shifted from Hong Kong to elsewhere in the Asia Pacific region.(1)

The operation of Australian and various overseas OBU concessions were examined in an article in the Taxation Institute of Australia's publication Taxation in Australia in August 1994. In relation to potential competitors in the Asia Pacific region, the most viable competitors were the Cook Islands and Singapore.

The Cook Islands is a 'tax haven' and imposes no tax on profits from the operation of OBUs. While OBU activity was growing in the early 1990s, recent events that have seen the Cook Islands facing potential bankruptcy are likely to remove some of the attractiveness of the Cook Islands as a place to invest in due to an increased risk of political instability.

Singapore has a 10% tax rate on profits from the operation of OBUs, the same as the Australian rate. However, Singapore has the additional advantage that dividends paid to residents from OBU activity are also tax free. In Australia such dividends are taxed at marginal rates less any franking amount. However, as the rate of tax is 10%, any franking credits available are likely to be minimal. Singapore also enjoys other advantages over both Australia and the Cook Islands, the main one being that it is located in a time zone that is the closest between Japan and Europe for a major financial centre, thereby facilitating the 24 hour market between the major banking operations in the USA, Europe (principally London) and Asia (principally Hong Kong and Japan). In relation to the Australian move to match the Singaporian tax rate for OBUs to attract business to Australia the article comments:

Even if Australia matched incentives available in Singapore, that may not attract business, given the number of offshore centres and the fact that so many banks are established in Singapore.

Australia may well have entered the field too late to become a major player, although it could be expected that the incentives it offers would create some growth in the offshore banking industry.(2)

The proposal to allow OBUs to also have domestic investments, that will not be subject to the concessional tax rate but will allow OBU involvement in domestic investment, was first announced by the previous government as part of the Innovate Australia statement. The change was seen as allowing Australian based OBUs greater flexibility to allow them to compete more effectively for OBU business. The statement also included other, minor measures that will effect OBUs that will also be implemented by this Bill.

The second reading speech to the Bill supported the reasons for the amendments given by the previous government, also arguing that the amendments would enhance the development of OBUs in Australia.

A definition of 'portfolio investment' will be inserted into theITAA by item 11 of Schedule 1. The term is defined to be one or more investments managed for the benefit of a non-resident. The average Australian asset percentage (ASP) of a portfolio investment for a year will be the average of the ASP over the months of the yearly accounting period for the OBU. The monthly percentage will be worked out by determining the percentage of the value of 'Australian things' in the portfolio. An 'Australian thing' is defined to be:

  • a resident Australian company;
  • a resident unit trust;
  • land or buildings located in Australia;
  • a loan made to an Australian resident; or
  • in any other case, the 'thing' is located in Australia.

Item 10 of Schedule 1 of the Bill will insert a definition of 'portfolio investment' into the categories of OBA contained in section 121D of theITAA. The proposed definition provides that an activity will be an OBA, and therefore subject to concessional tax treatment, if the ASP is 10% or less of the individuals portfolio investment where it is a managed investment for a non-resident, the investment was made by the OBU, the investment was made with a non-resident and the investment was not made in Australian currency.

There are also a number of consequential amendments related to the above amendments, including the calculation of the tax payable (which is determined by a complex formula rather than a fixed 10% rate, although the result is a 10% tax rate), and the non-deductibility of foreign tax paid on such investments due to their concessional tax treatment.

Other amendments contained in Part 1 of the Schedule to the Bill also include minor changes to the OBU scheme, in particular to extend certain concessions currently available to activities involving money to similar activities that involve gold.

Application: For the 1996-7 and later years of income (Item 29).

Repeal of section 261

Another measure associated with Australia's position in regard to international transactions is the proposed repeal of section 261 of the ITAA.

Section 261 has a long history and was part of State Land Tax Acts prior to its inclusion in the original Commonwealth Income Tax Assessment Act 1915. Basically, section 261 provides that if a mortgage executed after 13 September 1915 provides for the mortgagor to be liable to pay the tax in respect of the mortgage, the agreement will be void. The original intention of the provision was to prevent a mortgage agreement from imposing taxation obligations on the mortgagor in addition to other obligations specified under the agreement.

While the application of section 261 to domestic mortgages has ceased to be relevant due to changes in changes in the market that have seen liabilities clearly expressed and not related to taxation obligation, the provision still has relevance for certain international transactions, where the potential impact of taxation is not as easily quantified. In many such transactions, the borrower (mortgagor if property is involved) agrees to provide certainty to the lender by agreeing upon a post tax return that involves the borrower agreeing to pay tax involved on the transaction. In modern terms, the tax involved is generally the interest withholding tax imposed on payments to non-resident lenders.

Prior to 1992, section 261 had not been subject to any taxation rulings or subject to Court action. That changed with the case of David Securities Pty Ltd v Commonwealth Bank of Australia, where the High Court held that a standard international financing contract that required the borrower to pay the lenders mortgage tax liabilities prior to paying the specified interest to the lender was void. In the case, the tax liability borne by the borrower related to the withholding tax payable in respect of the interest payable to the lender.

As an after tax payment is a common feature of international financing, section 261 is largely out of line with international financial practice. The matter was discussed in an article published in Taxation In Australia, August 1994, which recommend the repeal of the section. The explanatory memorandum to the Bill estimates that the repeal of section 261 will have negligible revenue effect.

Item 36 of Schedule 1 of the Bill will repeal section 261 of the ITAA.

Application: In relation to mortgages entered into after 27 June 1996.

Forgiveness of Commercial Debt

The measures relating to the forgiveness of commercial debt were announced by the previous government in the 1995-96 Budget. Substantially the same provisions were included in Taxation Laws Amendment Bill (No. 5) 1995 which lapsed on the dissolution of Parliament for the 1996 General Election. Minor differences between the Bills exist in relation to related companies and record keeping, but these do not affect the general principles described below.

For taxation purposes, there needs to be a distinction made between when debts are waived by the creditor and when they are declared to be bad debts, which cannot be recovered and satisfy the criteria for bad debts contained in the ITAA. The amendments contained in the Bill relate to the position of the debtor where a debt is waived. The general position is that where a debt is waived it will cease to exist for taxation purposes and from the time the debt is extinguished neither the creditor or debtor will not be able to claim a tax benefit, such as the deduction of a bad debt.

In relation to the debtor, losses may result when the debt liability is taken into account in a year of income prior to the year in which the debt is waived. If the debtor has a tax loss for a year due to the debt, this loss will be able to be carried forward to offset tax liability in future years.

It should be noted that a deduction is allowable where outgoings are incurred in a year of income. The term incurred has been held by the courts to not only arise when expenditure is actually made, but also where a taxpayer is committed to a liability, even though there has been no actual expenditure(3) For example, where a liability to pay interest on a debt has arisen the taxpayer may include the interest due in determining whether a loss has been incurred, even if the interest has not been paid. This can lead to the situation where the interest is not paid by the debtor and accumulates as a debt to the creditor. If the debt is subsequently declared bad, the creditor will, if the requirements as to bad debts are satisfied, be able to deduct the full extent of the debt, including the unpaid interest, while the debtor will also have been able to use the interest liability as a deduction in the year it was committed to pay the interest and, if there was a loss in that year, to carry forward the interest component of the loss to future years. The debt may then be waived with no chance of the value of the debt being included in future income.

Changes to the above rules were announced in the 1995-96 Budget. The changes mean: ... the amount forgiven will reduce the debtor's future tax deductions by reducing in order the following amounts: prior revenue losses, prior net capital losses, underacted balances of capital expenditure and cost bases of capital assets. Budget Paper No. 1 also estimates the revenue gains through the measures to be $3 million in 1995-96, $20 million in 1996-97, $37 million in 1997-98, and $54 million in 1998-99.

Schedule 2 of the Bill will insert a new Schedule 2C into the ITAA dealing with commercial debt forgiveness. A debt will be a legally enforceable obligation to pay an amount to another, but if the waiver results in a fringe benefits tax liability it will be excluded from the definition of debt. Interest that has accrued but has not been paid will form part of the original debt. A debt will be a commercial debt if the interest payable on the debt, or interest that would be payable if the debt carried an interest rate, would be an allowable deduction, or would be deductible except from a provision of the ITAA that excludes the deduction. If the debt arises from a share issue, it will be a commercial debt if a dividend payable in respect of the share would be debt dividend as defined in the ITAA.

A debt will be taken to have been forgiven where:

  • the obligation to pay the debt is waived;
  • the right to legally enforce the debt lapses;
  • an agreement is entered into by the debtor and creditor where the obligation to pay all or part of the debt will cease at a particular time in the future and the debtor incurs no other obligation or only a nominal or insignificant obligation - in this case the debt is forgiven when the agreement is entered into;
  • the right to the debt is assigned, the assigned debt was not acquired in the course of trading on a securities market and either the creditor to whom the debt was assigned was an associate of the debtor or the new creditor and the debtor were parties to the agreement under which the debt was assigned; or
  • the person was owed money by a company and bought shares in the company and the company used those funds to repay part or all of the debt - in this case the debt will be considered to have been forgiven to the extent that the debt was paid from the funds paid for the shares.

A debt will not be taken to have been forgiven if the waiving of the debt results from bankruptcy, is effected by will or is forgiven for reasons of natural love and affection (which is not defined).

The value of the debt forgiven is calculated according to the following steps: First, the notional value of the debt is calculated. This will generally be the lesser of the value of the debt to the creditor assuming that the debtor was solvent when the debt was incurred and remains solvent, and this amount less any change in value due to changes in market variables, ie. exchange and interest rates, plus any deductions that have been allowed due to changes in market variables. Where the debt was incurred to finance the construction or acquisition of property and the creditor's rights are connected to the property, the notional value will be the lesser of the amount of the debt and the value of the rights over the property.

Secondly, the gross forgiven amount is calculated. This is the notional value of the debt less, when the transaction was conducted at arms length, any consideration paid in respect of the debt.

The next step is to calculate the net forgiven amount. This is the gross forgiven amount reduced by: any amount that will be included in income as a result of the debt forgiveness; any deduction that is reduced as a result of the debt forgiveness; and any amount by which the cost base of an asset is reduced due to the debt forgiveness. In relation to companies in a group, if an agreement is reached that the creditor will bear part of the loss for the debt and this reduces the capital loss that would otherwise be available to the creditor, the amount of the reduction in capital loss will also be taken from the gross forgiveness amount in determining the net forgiven amount.

The total net forgiven amount is to be used by the debtor in the following order:

  • to reduce deductible losses held by the debtor;
  • to reduce deductible capital losses held by the debtor;
  • to reduce deductions that would be allowed for expenditure in the year; and
  • to reduce the cost base of certain assets held by the person.

If there remains an amount of net forgiven debt after these reductions, it will generally be disregarded. However, if the body holding the net forgiven amount after these reductions is a partnership, the remaining net forgiven amount will be allocated to the partners in the same proportion as their share of partnership profits or losses.

Application: From 7.30 PM on 9 May 1995 (ie. from the announcement of the 1995-96 Budget).

Superannuation Guarantee

As originally enacted, the Superannuation Guarantee Charge (Administration) Act 1992 (SG Act) provided that an employer could discount any percentage of an employees earnings liable to be contributed under that Act by a percentage contribution required under an award. This did not provide for circumstances where an award specified a flat dollar rate of contribution. This matter was addressed by the Taxation Laws Amendment Act (No. 2) 1995 which provided for flat dollar contributions to be deducted from the SGC liability of an employer before calculating if any amount of charge is payable. This Bill further refines those amendments.

Item 4 of Schedule 3 will substitute a new formula into section 23 of the SG Act dealing with the calculation of the reduction of SGC liability for any flat dollar contribution. The new formula takes into account situations where an employee is employed for less than the hours specified in the award. Circumstances where the employee works greater hours than those specified are currently taken into account in the formula. Application: From 1 July 1994.

The amendments also provide that where an employer contributes to the Aberfoyle Award Superannuation Fund, which was established in 1987, the earning base for the purposes of the SGC is to be the earning base as specified in the award. This will allow contributions made under the award to satisfy the SGC requirements. Application: For 1995-96 and earlier years.

Tax file numbers - Superannuation

Tax file numbers (TFN) have a number of uses in superannuation, including in the tracing of unclaimed money, the transfer of money between funds and approved deposit funds and the supervision of funds. While TFNs have a role in the superannuation industry, there is no compulsion on a member of a fund to provide their TFN. Provisions dealing with TFNs aim to encourage the provision of the TFN, with the encouragement to members often being based on the greater ability to trace people who have unclaimed money in a fund. The amendments relating to TFNs will consolidate provisions in the Superannuation Industry (Supervision) Act 1993 (SIS Act) dealing with TFNs and require funds to request members who have not provided their TFN to do so. Members will not be compelled to provide their TFN.

The amendments are substantially the same as those contained in Taxation Laws Amendment Bill (No. 5) 1995, which lapsed on the dissolution of Parliament for the 1996 General Election. The main difference between the Bills is that this Bill proposes to extend the provisions to public, as well as private, superannuation funds.

Item 15 of Schedule 3 will insert a new Part 25A, dealing with TFNs, into the SIS Act. Main features of the proposed Part are:

  • employees may provide their TFN to their employer;
  • if a TFN is provided, the employer may notify the trustee of the fund to which contributions are made in respect of the employee of the employee's TFN before another contribution is made in respect of the employee;
  • where a TFN is provided, the employer must generally provide the trustee with the TFN within 14 days of its provision;
  • a trustee may request a beneficiaries TFN at any time;
  • if a person is a beneficiary and the trustee does not have their TFN, the trustee must request that they provide their TFN (there will be no obligation for it to be provided);
  • TFNs may be used to locate and identify amounts held for a person and to comply with the SIS Act. They are to be destroyed when they cease to be of use; and
  • if money is transferred to another fund, the trustee of the first fund must provide the persons TFN to the trustee of the fund to which the money is transferred unless the person requests that it not be supplied (where the fund from which the money is transferred is an exempt public fund, there is no obligation on the trustee to provide the TFN, although the trustee may provide it).

Application: The later of 1 July 1996 and the 28th day after the Bill receives Royal Assent.

Fringe Benefits Tax

Section 58P of the Fringe Benefits Tax Assessment Act 1986 provides that fringe benefits are exempt from tax if they satisfy the criteria in the section. The main criteria are:

  • the benefit is 'small' - the Australian Taxation Office has taken the view that 'a benefit with a notional taxable value in excess of $50 is unlikely to be small....';
  • the frequency and regularity with which similar benefits are provided;
  • the sum of the value of small benefits provided during the year;
  • the difficulty for the employer of determining the value of the benefit; and
  • the circumstances in which the benefit is provided (TD 93/197).

In the Coalition's statement Capital Gains and Fringe Benefits Tax Reform, issued prior to the 1996 General Election, it was announced that the value for a benefit to be considered to be small would be increased to $100. The policy also announced that a Coalition government would simplify the rules in relation to entertainment and parking and consider aligning the fringe benefits tax year with the income year. It was estimated in the document that the combined cost of these measures would be $9 million per year. The explanatory memorandum to the Bill states that the proposed increase in the value of small benefits 'will have an unquantifiable cost to revenue.'

Item 1 of Schedule 5 of the Bill will remove the requirement in section 58P for a benefit to be 'small' and substitute the requirement that the benefit be less than $100.

Application: From the time the Bill receives the Royal Assent.

Endnotes

  1. One Nation, p. 77.
  2. Rodney Fisher, Offshore Banking Units, Taxation in Australia, August 1994.
  3. For example, see Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492.

Contact Officer and Copyright Details

Chris Field Ph. 06 277 2439
6 August 1996
Bills Digest Service
Parliamentary Research Service

This Digest does not have any official legal status. Other sources should be consulted to determine whether the Bill has been enacted and, if so, whether the subsequent Act reflects further amendments.

PRS staff are available to discuss the paper's contents with Senators and Members and their staff but not with members of the public.

ISSN 1323-9032
© Commonwealth of Australia 1996

Except to the extent of the uses permitted under the Copyright Act 1968, no part of this publication may be reproduced or transmitted in any form or by any means, including information storage and retrieval systems, without the prior written consent of the Parliamentary Library, other than by Members of the Australian Parliament in the course of their official duties.

Published by the Department of the Parliamentary Library, 1996.

This page was prepared by the Parliamentary Library, Commonwealth of Australia
Last updated: 5 August 1996

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