Bills Digest 145 1996-97 Taxation Laws Amendment Bill (No. 2) 1997


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WARNING:
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.

CONTENTS

Passage History

Taxation Laws Amendment Bill (No. 2) 1997

Date Introduced: 13 February 1997
House: House of Representatives
Portfolio: Treasury
Commencement: The application dates of the various measures is outlined in the Main Provisions section.

Purpose

The Bill will mostly implement anti-avoidance measures announced in the 1996-97 Budget which are aimed at protecting revenue. Main amendments relate to:

  • the carrying foward of previous year capital gains losses for members of a company group to implement similar tests that apply to the carrying foward of income losses;
  • to apply the general anti-avoidance provisions of Part IVA of the Income Tax Assessment Act 1936(ITAA) to certain withholding tax transactions and to implement specific anti-avoidance provisions in respect of 'interest' payments and the inter-positioning of tax exempt, or minimal tax paying entities, in relation to the receipt of certain interest payments;
  • to introduce a 'public offer' test that will apply to increase the situations where Australian entities may raise funds through off-shore debentures;
  • to deny certain tax concessions to dual resident entities;
  • to remove the 'standard' employer deduction for superannuation deductions which will require employer contributors to calculate the amount that may be deducted in regard of each employee; and
  • to alter the rules that apply to the leasing of cars that have a value greater than the depreciation limit for luxury vehicles to ensure that the rules for luxury cars cannot be overcome by leasing arrangements.

Background

As there is no central theme to the Bill the Background to the various measures will be discussed below.

Main Provisions

Capital Gains Tax

The measures relating to Capital Gains Tax (CGT) were announced in the 1996-97 Budget and relate to the transfer of previous years capital losses between members of a company group, and, to a lesser extent, determining which year's capital losses can be carried forward to a future year.

Companies

Before dealing with the treatment of capital losses, it is relevant to deal with the treatment of situations where a company may carry forward a loss of ordinary income from a previous year, which may be used as a deduction in a future year. For the transfer of company losses a number of tests must be satisfied, the major ones being that the companies amongstwhich the loss is transferred satisfy either the continuity of ownership or continuity of business tests. These tests must be satisfied in the year in which the loss is transferred.

The continuity of ownership test provides that where losses are transferred between members of a company group, more than 50% of the shareholder's voting, dividend and capital rights need to be beneficially owned by the same people as at the time when the loss was incurred. This test aims to address the situation where prior year losses could be transferred between related companies even though the underlining ownership of those companies has significantly changed. For example, a profitable company may wish to buy a company that has made losses for a number of years and to subsequently use the losses to reduce it's own income, and therefore tax. As the company being acquired has accumulated losses, the price of the company may be less than the value of the tax deductions to the profitable company.

The continuity of business test provides that if a company is still able to claim prior year losses even if there has been a change in the continuity of ownership. Simply, this test provides that if there has been no change in the substantial nature of the business, the business has not entered into any substantially new activities and satisfies the anti-avoidance provisions, it will be able to carry forward prior year losses.

The situation with capital losses is significantly different in effect. While there are a provisions to prevent the transfer of capital losses in a year where neither the continuity of business or ownership is satisfied (subsection 160ZP(9)), capital losses from a previous year are deemed to have been incurred in the year in which the claim for the loss is made and are available to set off against capital gains as if the prior year losses were incurred in the same year that the gain was made. It is therefore possible for a company to acquire another company that has capital losses from previous years, become a related company and then transfer the acquired losses to offset a capital gain that will be reduced by the amount of the loss. This will reduce the amount of CGT payable on the acquiring company's capital gain.

It was announced in the 1996-97 Budget that the treatment of capital losses would be more generally aligned with that for income so that the continuity of business or ownership tests must be satisfied in relation to the year when a capital loss was incurred before the loss can be transferred to a group company.

Under Division 4 of Part IIIA of the ITAA, which deals, in part, with the transfer of capital losses between members of group companies, a group company is defined to be one which is a subsidiary of a company or two or more companies that are subsidiaries of the same company (section 160ZP). For capital losses to be transferred a number of conditions must be met, particularly that the companies between which the transfer occurs are group companies and thateither the continuity of ownership or business tests are satisfied (section 160ZP).

Amendments to section 160ZP require capital losses to be offset against capital gains in the year accrued, and allow any access losses to be accrued (Items 10 to 14 of Schedule 1). Item 15 is the major operative provision and provides that where an agreement is made to transfer a loss to another group company (the agreement is necessary for the transfer to occur), the loss will only be transferable to the degree that:

  • where the loss and the gain are accrued in the same year of income and the continuity of business or ownership tests are satisfied, the amount of the loss; or
  • in other cases (ie. where neither test is satisfied) the amount of the loss incurred in the same year as the gain is accrued [proposed subsection 160ZP(7AAA)].

Individuals

The principal that capital losses must be used to offset capital gains in the year incurred, or in the next year that an offset is claimed, will be extended to individuals. This will have little practical effect for individuals.

The explanatory memorandum to the Bill estimates the revenue increase from this measure to be $20 million in 1996-97; $80 million in 1997-98; and $55 million in 1998-99 and 1999-2000.

Application: The amendments will apply to the 1996-97 and later years of income. If there is a carry-over of losses from previous years at the end of the 1995-96 year of income (Item 22).

Withholding Tax

Schedule 2 the Bill contains a number of amendments relating to withholding taxwhich are aimed to reduce avoidance of the tax.

Withholding tax is imposed on interest, royalties and dividends paid to a non-resident. Generally, the system works by requiring the entity paying the interest, royalty or dividend to subtract a certain percentage of the payment before remitting the remainder of the amount overseas. There are a number of specific exclusions from the withholding tax scheme, such as fully franked dividends, and the rate of withholding tax may be effected by any double tax agreement Australia has with the country to which the payment is remitted. Interest payable to a non-resident who is conducting business in Australia through a permanent establishment will not be subject to withholding tax as it will be subject to normal Australian taxation.

In the 1996-97 Budget a number of anti-avoidance means were announced in regard to withholding tax. The proposals are for an extension of the general anti-avoidance provisions in Part IVA of the ITAA to be extended to withholding tax and to make a number of specific amendments aimed at particular types of payments (interest, royalty or dividend) and particular tax minimisation schemes. Until recently, the scope of Part IVA had been restricted by a number of High Court decisions and it is likely that doubts as to the reach of Part IVA resulted in the specific anti-avoidance provisions contained in the Bill.

However, the High Court in Commissioner of Taxation v Spotless Services Limited, the judgement of which was delivered on 3 December 1996, significantly extended the scope of Part IVA. In summary, Part IVA requires that there be a sole or dominant purpose when entering into a scheme to obtain a tax benefit. Prior to the Spotless case, it was considered that so long as the transaction was commercially viable or the obtaining of a tax benefit was less than 50% of the reason for entering the transaction, Part IVA would not apply. This was overturned by the Spotless case and the Commissioner now has a discretion to deny a tax benefit even if the scheme is commercially viable if of the opinion that the sole or dominant purpose of the scheme was to obtain a tax benefit. The High Court also found that a purpose could be a dominant purpose even though that purpose comprised less than 50% of the total purposes for entering into the transaction. This appears to give the Commissioner significantly greater power to use Part IVA in relation to 'artificial' transactions that have the result of reducing the amount of tax that would have been payable had the transaction not been entered into. The full scope of the Spotless decision has yet to be tested.(1)

Item 12 of Schedule 12 will insert a new section 177CA into Part IVA of the ITAA which will provide that the Part will apply if a taxpayer is not liable to pay an amount of withholding tax that would, or could reasonably be expected to have been, included in liability to pay withholding tax had the scheme not been entered into. Where a tax benefit is subject to proposed section 177CA, the Commissioner may determine that all or part of the amount is subject to withholding tax. If such a determination is made, it is to apply, and the amount assessed will be payable, and the taxpayer may appeal against the determination, which is normal taxation practice (Items 13 and 16). If the Commissioner determines that withholding tax, or additional withholding tax, is payable, penalty rates will apply to the difference between the amount of tax paid, if any, and the amount determined by the Commissioner (Item 17).

Schedule 2 will also insert a new definition of interest for the purposes of withholding tax. Currently, the term interest is defined to include 'an amount in the nature of interest'. Item 1 of Schedule 2 will repeal this definition, while Item 3 will insert a new definition so that interest will include:

  • an amount in the nature of interest; or
  • an amount that could reasonably be regarded as equivalent of interest, a substitute for interest or an amount received in exchange for interest.

The use of tax-exempt, inter-imposed entities to disguise the nature of the payment and final recipient is dealt with in Item 5. Proposed section 128AF provides that if a tax-exempt entity receives an amount attributable to interest, royalties or dividends, the amount is to be attributed to the non-resident. The provision aims to address the situation where payments are made to a tax-exempt body which then forwards all or part of the amount to the non-resident, who so avoids the need to pay withholding tax.

Royalties are dealt with in Items 6 to 11 of Schedule 2. The amendments will apply where a royalty is derived by a non-resident and:

  • the incomeis derived by a person who carries on business outside Australia or through a permanent establishment overseas and the royalty is not an outgoing wholly connected with the overseas operation; or
  • the royalty paid by non-residents in connection with the carrying on of a business in Australia.

In the first case, the royalty payment will be deemed not to be an outgoing incurred in carrying on the overseas business (which will mean that the royalty will be incurred in Australia and so subject to withholding tax). In the second case, the royalty will also be deemed to have been paid in relation to the Australian business, and so be subject to withholding tax. The measures are designed to address arrangements where an overseas establishment or resident is interposed between the payer of the royalty and the recipient which would have the effect of excluding the payment from Australian withholding tax (Items 6 and 7).

The explanatory memorandum to the Bill estimates that the measure will raise $85 million in 1996-97 and $100 million per year in later years.

Application: From 20 August 1996.

Further amendments relating to withholding tax and related matters are contained in Schedule 5 of the Bill. Section 128F of the ITAA provides for circumstances where withholding tax will not apply to certain debentures. A new section 128F will be substituted into the ITAA by Item 12 of Schedule 5. The new section will apply to certain debentures listed on overseas capital market and provides that the Division relating to withholding tax will not apply where:

  • the company was a resident of Australia when the debenture was issued and when interest was paid on the debenture;
  • the debenture was issued outside Australia for the purpose of raising capital outside Australia;
  • interest is paid outside Australia; and
  • the public offer test is satisfied.

There are a number of ways that the public offer test can be satisfied, including that the debenture was offered to 10 or more finance providers; was offered to at least 100 people who have acquired debentures in the past or are likely to be interested in acquiring debentures; or was offered to a dealer, underwriter or manager who will offer the debentures for sale within 30 days.

Where a non-resident subsidiary of a resident company issues debentures solely to raise funds for the parent company, the issue of debentures by the subsidiary will be taken to be an issue by the parent company and so an issue by an Australian resident.

A major difference between the current and proposed section 128F is that the proposed section does not contain a requirement that the funds raised be used in respect of an Australian business. In a Press Release dated 25 June 1996, the Treasurer stated:

The end use requirement in section 128F that the borrowed funds be used in an Australian business will be removed to extend the exemption to overseas borrowings to make loans to home buyers and consumers.

The public offer test is also new and will replace current tests that provide that regard is to be had to the method of the offering of the debentures. This requirement has developed into a test that requires debentures to be widely distributed on overseas markets. This will be replaced by the public offer test.

There will be transitional provisions so that if a debenture is issued after the date of effect of the amendment (1 January 1996) and before the passage of this legislation, the current law will have effect (Item 16).

The explanatory memorandum to the Bill estimates that the measure will have a negligable cost to revenue.

Application: 1 January 1996.

Dual Resident Companies

A company can be a resident of more than one country. Subsection 6(1) of the ITAA defines a resident company to be one which is:

  • incorporated in Australia;
  • is not incorporated in Australia and has either its central management and control in Australia; or
  • is not incorporated in Australia and the voting power in the company is controlled by Australian residents.

If a company is a resident company, including a dual resident company, it is able to claim a number of concessions that are not available to non-resident companies. It was announced in the 1996-97 Budget that a number of benefits available to dual resident companies would be removed and anti-avoidance provisions extended to certain dual resident companies. The measures are aimed at preventing companies that are not incorporated in Australia from using dual residency status where that status is based on an artificial scheme.

Item 1 of Schedule 3 will insert a definition of 'prescribed dual resident' into section 6 of the ITAA. There will two types of such residents:

  • where a company is a resident, there is an international tax agreement in force with the other country in which the company is a resident and the agreement contains a provision to the effect that the company is a resident of the foreign country; and
  • where the company is a resident solely because it has its management and control in Australia and it also has management and control in another country.

The effect of the amendments will be to place prescribed dual resident companies in the same position as non-residents for a number of purposes and to deny access to the following concessions:

  • rebates for certain unfranked dividends paid to a prescribed dual resident company;
  • certain transfers of losses between company groups where a prescribed dual resident company is involved; and
  • certain concessions that apply to resident companies in respect of security payments.

The changes will also treat prescribed dual residence companies as non-resident companies for the purpose of determining if a company is foreign controlled for the purpose of the thin capitalisation rules and for debt creation rules (the provisions relate to anti-avoidance measures in relation to non-resident companies and the effect of the latter amendments is to include prescribed dual resident companies in these regimes in the same manner as they now effect non-resident companies).

The explanatory memorandum to the Bill estimates that the measure will result in savings of $50 -$100 million per year.

Application: 1 July 1997.

Superannuation Contribution Limit

Section 82AAC of the ITAA provides limits on the amount that an employer may claim in respect of deductions for contributions to an employee's superannuation. There are currently two methods an employer of 10 or more employees may use to calculate their allowable deductions. First, and this method also applies to employers with less than 10 employees, there is an aged based limit so that the maximum deduction claimed is based on the age of the employee. The limits for 1996-97 are $9 782 for an employee under 35; $27 170 for those aged between 35 and 49; and $67 382 for those aged 50 and over. The deduction limits recognise that younger employees should be able to contribute for longer periods to provide adequate superannuation. The limits are subject to indexation. The second method is to calculate the deduction on the flat rate of $27 170 for each employee for 1996-97 (and this amount indexed for later years). This is known as the standard contribution rate.

The standard method provides greater administrative simplicity for employers with 10 or more employees. For example, if an employer has 100s of employees, the need to calculate the maximum deduction allowable in relation to each employee would be a considerable administrative exercise. The same would be true of a small business with 10 or more employees where the small employer would be required to make a calculation in respect of each employee. On the other hand, if an employer has a generally youthful workforce aged under 35 the standard method would allow significantly greater deductions than if the aged based method was used.

It was announced in the 1996-97 Budget that the standard provisions would be abolished from the time of the Budget announcement. The reason for the abolition is given in the second reading speech as:

The standard contribution limit was introduced for reasons of administrative simplicity. However, the standard contribution limit has been subject to abuse with some employers claiming deductions for contributions on behalf of particular employees well in excess of the age based limits.

The abuse has come at a cost to revenue and the Government believes that the standard contribution limit can no longer be justified.

The explanatory memorandum to the Bill estimates the revenue savings from this measure to be $35 million in 1997-98; $40 million in 1998-99; and $40 million in 1999-2000.

In relation to compliance costs the explanatory memorandum states:This measure will result in a slight increase in compliance costs for affected taxpayers.

Item 2 of Schedule 4 of the Bill will repeal subsections 82AAC(2D) to 82AAC(2H) of the Principal Act which contain the provisions for standard employer deductions.

As the measures were announced to apply during a financial year, Item 4 contains transitional provisions that provide that if an employer elects that subsection 82AAC(2D) is to apply to the financial year in which 20 August 1996 occurs, the maximum deduction that may be claimed in respect of an employee during that year is the maximum of either:

  • the amount of contributions made in respect of the employee until the time of the announcement; or
  • the individual deduction limit in respect of the employee.

Application: The year of income in which 20 August 1996 occurs and later years of income.

Luxury Car Leases

The use of car leases, rather than outright purchase of a vehicle, is becoming a more common method of financing a car, particularly for cars used in business.Where a car is purchased and used for business, the owner may claim a deduction in respect of use of the car for business purposes and claim depreciation on the vehicle up to a certain maximum level (currently $55 134). The limit is known as the luxury car threshold. The depreciation allowance, and the luxury car threshold, also apply to lessors in respect of the vehicles they lease.Changes to the treatment of car leases were announced in the 1996-97 Budget and are designed to counter schemes where the amount deductible under the lease, as lease payments, exceeds the amount that would otherwise be deductiblehad the car been purchased.While the luxury car threshold available to the lessor as owner of the vehicle would apply to set a maximum on the depreciation claimable, the additional value of depreciation above the luxury car threshold can be built into the lease and subsequently claimed as a deductionby the lessee where the vehicle is used for business purposes.

Schedule 6 of the Bill will insert a new Schedule 2E, dealing with the leasing of luxury cars, into the ITAA. A lease is defined to be any arrangement to let a car on hire where the right to uses the car is granted by the owner to another person for monetary or other consideration, or where such a right to use a car is transferred to a third person (ie. a sub-lease), but dose not include a short term hiring agreement or a hire purchase agreement (proposed section 42A-115).

The proposed Division will apply to leased luxury cars that are not held as trading stock where the lease is entered into after the time of the Budget announcement (ie 7.30 pm on 20 August 1996). If a lease is renewed after this time, it will be treated as a new lease and so be subject to the proposed Schedule (proposed section 42A-10). Where the proposed Division applies, the lessor will be treated as having disposed of the vehicle to the lessee, who will be deemed to be the owner of the car. However, if the car is sub-leased, the lessee will cease to be the owner of the vehicle (proposed section 42A-15).

The value of the lease will be the amount specified in the lease where the lease is negotiated at arms length. In other cases, it will be value of the vehicle if it were sold to the lessee at arms length. For sub-leases, the depreciated value of the car will generally be used (proposed section 42A-20).

Proposed section 42A-25 provides that the lessor will be deemed to have made a loan to the lessee and the value of the loan will be the value of the car plus a financial charge (this is defined in proposed section 42A-130 to be the total payments under the lease plus any other costs, such as any amount payable on the ending of the lease, less the notional loan principal, ie. basically the total amount payable under the lease less the value of the car).

The amount to be included in the lessor's income will be the accrual amount for the period of the loan during the financial year (this is the outstanding amount of the deemed loan on the car multiplied by the implicit interest rate). In addition, if the lessor makes a profit on an actual or nominal sale of the vehicle, such an amount is to be included in the lessor's assessable income (proposed section 42A-35).

The lessee will be able to claim a deduction for the notional loan for the period of the financial year in which the loan remains current. The lessee will not be able to claim a deduction for the actual lease payments (proposed sections 42A-50 and 42A-55).

Proposed section 42A-65 provides for adjustments of the lessor's assessable income on the termination, renewal or extension of a lease. The amount of the adjustment is based on the formula: notional loan principal (ie. the principal of the deemed loan under this Schedule) plus the assessed accrual amount (ie. the amount that is included in assessable income for the year under consideration). Where the total amount payable to the lessor exceeds the amount calculated under the formula, the excess is included in assessable income. Where the amount received is less than this amount, the difference is allowed as a deduction. Proposed section 42A-70 contains a mirror provision that provides that where an amount is included in assessable income under the previous section, an equal amount is allowable as a deduction to the lessee and, where a deduction is allowed under the previous section, an equal amount is included in the assessable income of the lessee.

If a lease is extended or renewed, after the adjustment described above is undertaken, proposed section 42A-80 takes effect. This section provides that the original notional loan will be deemed to have been repaid and a new notional loan entered into, and measures similar to those applicable to the original loan will apply. If an amount is paid by the lessee to acquire the car at the end of the lease, such an amount will not be assessable income for the lessor or as a deduction for the lessee. The lessee will be considered the owner of the car until it is disposed of (proposed section 42A-85). If the lessee ceases to have a right to use the vehicle, it will be deemed to have been disposed of to the lessor, who will be taken to have acquired the vehicle for the balance of the notional loan, less any amount paid to the lessor plus any amount refundable by the lessor, or, if it is impracticable to calculate this amount, the market value of the car.

The provisions apply to leases and not to short term hiring arrangements. However, where there are consecutive arrangements that extend for more than 6 months, the arrangement will be deemed to be a lease (proposed section 42A-125).

Endnotes

  1. The Information and Research Service will be releasing a Consultant Paper on the implications of the Spotless decision.

Contact Officer and Copyright Details

Chris Field
6 June 1997
Bills Digest Service
Information and Research Services

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.

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

ISSN 1328-8091
© Commonwealth of Australia 1997

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Published by the Department of the Parliamentary Library, 1997.

This page was prepared by the Parliamentary Library, Commonwealth of Australia
Last updated: 12 June 1997


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