Bills Digest No. 193 1997-98 Taxation Laws Amendment Bill (No. 4) 1998


Numerical Index | Alphabetical Index

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
Purpose
Background
Main Provisions
Endnotes
Contact Officer & Copyright Details

Passage History

Date Introduced: 2 April 1998

House: House of Representatives

Portfolio: Treasury

Commencement: The measures contained in the Bill have various application dates. Except as otherwise described in the Main Provisions section, the measures described in this Digest commence on Royal Assent.

Purpose

The major amendments contained in the Bill relate to:

  • the removal of sales tax exemption for goods used by an exempt entity for commercial property purposes;
  • changes to the record keeping requirements for small businesses for fringe benefit tax purposes;
  • the treatment of assets for depreciation purposes when a tax exempt entity becomes subject to tax;
  • extending the period for which forgiven commercial debts may be offset against tax deductions and other tax reductions;
  • allowing gifts to the Menzies Research Centre to be deductible; and
  • limiting the deductions allowable in relation to hire purchase and certain other transactions where they give rise to 'excessive' deductions.

Background

As there is no central theme to the Bill, the background to the various measures will be discussed in the Main Provisions section.

Main Provisions

Sales Tax (Exemptions and Classifications) Act 1992

Item 1 of Schedule 1 of the Bill will amend this Act to remove a means of possible avoidance of sales tax where it is intended that the tax be payable. Item 192 of the Act provides that goods will be exempt where they are incorporated into a property always owned or leased by an exempt person/s or a foreign government/s. The reason for the exemption is not to require people or foreign governments who are not subject to sales tax for any transaction to pay the sales tax and then apply for a refund. However, as the item currently stands it would be possible for the exemption to be claimed by such people in respect of commercial property, which could give those operations a commercial advantage, which was not intended when the exemption was granted.

Item 1 of Schedule 1 will amend item 192 to provide that it will only apply to housing provided by an always exempt person at below market rates (eg. charitable accommodation); where the property is occupied principally by the always exempt person or foreign government; or it is used principally by a person providing services to an always exempt person or foreign government for the purpose of providing those services. Properties not eligible under item 192 are:

  • shops and shopping centres;
  • hotels;
  • casinos;
  • apartment blocks;
  • properties mainly consisting of or similar to those listed above; and
  • prescribed properties.

The explanatory memorandum to the Bill estimates the measure will raise $10 million in 1997-98 and $50 million in 1998-99 and subsequent years.

Application: Dealings after 2 April 1998.

Fringe Benefits Tax Assessment Act 1986

The main change to Fringe Benefits Tax (FBT) contained in the Bill relate to record keeping for small businesses and resulted from the November 1996 Report of the Small Business Deregulation Task Force. The Report contained a number of submissions from small business groups. In relation to FBT, the Task Force made a number of recommendations relating to matters such as the valuation of car benefits, the treatment of meals, car parking and taxi travel.(1) The recommendations were made on the basis that the tax law was complex and imposed a significant burden on small businesses to conform with the rules. The Report commented:

Small businesses complain of acting as unpaid tax collectors and an arm of governments.

The burden of managing complex, multiple taxation regimes is particularly onerous. While a business could possibly cope with each tax on its own, the administration of up to seven separate taxation or taxation reporting regimes .... could be overwhelming.(2)

(However, it may also be noted that there are a number of other compliance costs associated with the operation of a business, such as occupational health and safety, industrial relations, compliance with environmental requirements, superannuation - particularly when the choice of fund regime comes into effect - and other State, Federal and local requirements. A business, including a small business, would need to factor all these matters into account in formulating a business plan.)

The government's response to the FBT compliance measures were contained in the Prime Minister's statement More Time for Business, and expanded on by the Treasurer in a Press Release dated 24 March 1997. As noted in the second reading speech to the Bill, a number of the other measures noted above, such as taxi travel and car parking, have already been addressed by legislation.

A major measure announced in relation to FBT compliance costs was that there would be an exemption from FBT record keeping where the value of the fringe benefits provided was $5 000 or less in a base year and thereafter does not significantly alter. A new base year will be required to be documented if the amount of FBT payable in later years increased or decreased by 20% or more over the current base year.

The explanatory memorandum to the Bill estimates the cost to revenue to be $5 million in 1998-99, $25 million in 1999-2000 and $20 million in both 2000-01 and 2001-02.

Part XI of the Act contains miscellaneous provisions, including section 132 which requires an employer to retain records relating to FBT for 5 years. Proposed Part XIA, which will be inserted into the Act by Schedule 12, will allow an exemption from section 132 in certain situations. The two conditions that must be satisfied for the exemption are:

  • the immediately preceding year was a base year [ie. a year where the employer carried on business for the whole of the year; a FBT return was lodged in respect of the year; records have been kept for the year; the amount of FBT payable did not exceed the threshold amount ($5 000 for 1996-97 and this amount indexed for later years) and the amount of FBT for the year is not calculated by reference to a previous base year]; or
  • some other year before the current year was a base year and that base year has been used to calculate FBT payable for every year between the base and current years; and
  • the employer has not received a notice requiring them to keep records (proposed section 135C).

If the conditions are satisfied, the employer will generally not have to keep records relating to FBT. However, records must still be retained in relationship to records provided to the employer by an associate and benefits provided when the employer was a government body or an exempt taxpayer. The Commission will have power to issue a notice requiring that records be kept again (proposed section 135E).

Records relating to the base year must be retained for 5 years after the last year that the base year was relied on (proposed section 135F).

A person, other than a government body or a tax exempt person, may choose to rely on the fringe benefits provided in the base year rather than the current year to calculate the FBT payable for the current year (proposed section 135G).

The exemption will not apply where the amount of fringe benefits provided in a year is more than 20% greater than in the base year (unless the difference is $100 or less). In relation to car benefits, the same method of calculating the value of the benefit, ie. the statutory or use methods, must continue to be used (proposed section 135K).

Where a business does not operate throughout the whole of the current year, the value of the benefits in the base year will be reduced in proportion to the period of the year in which the business operated only for part of the year (proposed section 135L).

Application: For benefits provided in the FBT year commencing on 1 April 1998 and later years. There are also transitional provisions that will allow the 1996 FBT year to be used so long as the amount of benefits provided in 1997 did not exceed the 1996 amount by more than 20%. This will allow the exemption to apply from the 1998 year.

The other amendment to this Act contained in the Bill will exempt from FBT benefits provided where:

  • the benefit is provided in respect of an employee in respect of an approved student exchange program participated in by the employee or an associate of the employee; and
  • the employer or an associate did not select or participate in the selection of, the participant.

Application: From tax years commencing on or after 1 April 1996.

Depreciation of Assets Disposed of by Exempt Entities

A number of organisations are tax exempt where they are organised as non-profit institutions, although certain income of such bodies may be subject to tax. Exempt entities fall into a number of categories, including: Australian government agencies; charities; education science and religious organisations; community service groups; non-profit friendly societies; non-profit associations established to promote tourism; and non-profit bodies established to promote sport, culture and recreation.

A number of difficulties arise when such bodies cease to be tax exempt, usually due to a change in their structure where they become subject to tax, such as a conversion to a public company. In relation to depreciation of the assets held by the body, the general rule is that the asset is to be taken to have always been used for the production of income so that, for example, the first three years use by an exempt body will be taken to have been for profit making purposes when calculating the value of the plant when determining the depreciation available to the now non-exempt body (so that the depreciable value will be lower than had the purchase price been used in the calculation). Whichever depreciation valuation is used, prime cost or depreciating value, the earlier use will be taken into account to reduce the value of the asset.

The Treasurer's Press Release of 4 August 1997 notes that these rules can be circumvented by the sale of assets to a purchaser (including the new non-exempt body that is to 'take over' from the exempt entity). In such a case, the asset will be sold by the exempt body at a higher value than its depreciable value and the entity acquiring the asset will than be able to claim depreciation on the higher purchase value of the asset. The end result is that the entity acquiring the asset will be able to claim a higher amount of depreciation on the asset than if the asset was acquired at the depreciated price.

The Treasurer's Press Release announced that in such cases the use of the sale value of the asset could no longer be used for the future calculation of the depreciable value of the asset. Instead, the greater of the 'notionally written down' depreciation value or the pre-audited book value of the asset in the organisations audited annual accounts could be used by the acquiring entity to determine the depreciable value of the asset. Where the latter method is used, the value of the asset must have been recorded in the books of the organisation prior to 1 July 1997 and where this value is more than 12 months old this amount will be reduced by the notional tax depreciation that would apply to the asset.

Item 7 of Schedule 10 will insert a new Division 58 into the Income Tax Assessment Act 1997 (the 1997 Act) dealing with the depreciation of plant previously owned by an exempt entity.

A definition of pre-existing audited book value of plant is contained in proposed section 58-10. This will be where an annual balance sheet contains a value for the unit of plant and a final, unqualified report by a qualified independent auditor has indicated that value. If the balance sheet specifies a value for 2 or more units and one of those is the unit under consideration, the value of the unit is to be so much of the total value as is reasonably attributable to the unit (there is no provision relating to how the reasonable value is to be calculated).

The entity that ceases to be exempt is to choose if the value to be used for depreciation is to be the:

  • notional written down value (NWDV) (basically the depreciable value of the asset calculated under the normal depreciation rules less deductions that have been allowed in respect of the unit and other amounts that the entity ceasing to be an exempt entity can claim in the future); or
  • the undeducted pre-existing audited book value of the unit (basically the pre-existing audited book value plus capital improvements less, where the unit has been held for one or more years, any deductions claimed in respect of the unit) (proposed section 58-20).

Where NWDV is used, current rules relating to the cost of the unit to the entity disposing of it and the units effective life will apply when calculating the depreciation available (proposed sections 58-40 and 58-45). As well, subject to certain modifications, the entity may chose whether the diminishing rate or prime cost depreciation rates should apply if no previous choice was made.

Similarly, where pre-existing audited book value is used, modified current rules will apply to matters such as the nominated or elected depreciation percentage to apply (proposed section 58-135).

Proposed Subdivision 58-C deals with cases where plant is acquired from an exempt entity when acquiring the business. Plant will be determined to have been acquired in connection with the business from a tax exempt entity where:

  • the unit was used by the exempt entity in the course of a business and is used by the purchaser or another in the course of a business;
  • the unit was used by the exempt entity for functions not in the course of running a business and the purchaser or another uses the unit for those functions in the course of business;
  • the unit was acquired in connection with another unit, ownership of the unit gives the purchaser or another a right or obligation to perform functions in the carrying on of a business or confers a commercial advantage or opportunity connected with performing those functions and the unit is used for those functions or in taking the benefit or opportunity; or
  • the unit was acquired in connection with the acquisition of another asset from the exempt entity or an associate, by the purchaser or an associate and any of the above apply (proposed section 58-150).

Where the purchaser is taken to have acquired the asset when acquiring the business, the purchaser must chose whether the NWDV or per-existing audited book value is to be used. The depreciable value of the unit will be determined as if the unit had been used by the exempt entity for the purposes of business and depreciation claimed. The purchaser will be able to make the choices that would otherwise have been available to the exempt entity, such as effective life, choice of rates and the nomination or election of the depreciation percentage. The result will be that the depreciation rules will be the same regardless of how the unit is acquired from the exempt entity.

Commercial Debt Forgiveness

The Income Tax Assessment Act 1936 (ITAA) provides that where commercial debts are forgiven the amount of debt forgiven is to be offset against deductions and other tax reductions that may be claimed in the order of prior revenue losses, prior capital gains loses, certain deductions and the cost base of assets. The reason for the offset is that a deduction or capital loss may arise for the lender when the commercial debt is forgiven, even though the debtor may also claim a deduction on their liability to repay the debt even though it has been forgiven. Such arrangements may allow both entities to claim deductions and therefore could be used as a tax minimisation device. The rules described above in relation to the offset of forgiven commercial debts against possible deductions were introduced in 1996.

In relation to offsets against prior capital losses, subsection 160ZC(4E) of the ITAA provides that the forgiven debt may be used to reduce capital losses incurred in the immediately preceding year of income. This subsection will be amended by item 1 of Schedule 3 to provide that the offset may be against any capital loss incurred in a previous year of income, effectively allowing the offset to be made against any accumulated capital losses.

The amendment is estimated in the explanatory memorandum to have no significant revenue impact.

Application: Debts forgiven after 2 April 1998.

Gifts to the Menzies Research Centre

The Menzies Research Centre was established in 1995 to provide research into economic, social, cultural and political policies to enhance individual liberty, free speech, competitive enterprise and democracy. In practice, the Centre could be classified as a Liberal Party 'think-tank'. It is broadly equivalent to the Evatt Foundation which was established in 1979 and performs similar functions for the Labour Party.

The funding of organisations bearing the name of politicians has a relatively long history, though it must be noted that most of the bodies mentioned below perform a greater range of functions than purely party research. The Menzies Foundation was established in 1978 and, it is reported, that it subsequently received approximately $4.4 million prior to the Liberal party losing government in 1983. In relation to the Evatt Foundation, an initial grant of $250 000 was made in the 1984-85 Budget and this continued for eight years, comprising a total of $2 million. Further indexed grants were made in later budgets, the reported total contribution being approximately $3 million. There is also the Murphy Foundation which was established in 1987 and reportedly received total grants of approximately $1.2 million prior to the election of the current government which ceased grants to the organisation. The reported totals of the grants to foundations established in memory of these former politicians is Menzies: $4.62 million; Evatt: $3.24 million; and Murphy: $1.17 million.(3)

On 9 October 1996 the Minister for Administrative Services announced that annual grants would be made to the Menzies Research Centre and the Evatt Foundation and that both organisations would receive $100 000 per year. The Press Release announcing the grants did not specify if the grants were to be indexed or for how long they would continue.(4)

In relation to tax deductions for donations to such foundations, which are dealt with by this Bill, the Treasurer announced on 10 October 1996 that donations to the Menzies Research Centre of $2 or more would be deductible. Currently, donations of $2 or more are deductible if made to the Menzies Foundation or the Evatt Foundation as philanthropic trusts, while such donations to the Murphy Foundation are deductible as an education body.

Schedule 5 provides that donations of $2 or more to the Menzies Research Centre will be deductible if made after 2 April 1998. The Centre will be classified as a research recipient.

Hire Purchase and Limited Recourse Debt

It was announced in the 1997-98 Budget that certain adjustments would be made in the calculation of amounts included in income where depreciation and other measures have been used by a taxpayer to gain tax advantages that are greater than the amount expended by the taxpayer. The measures will apply in cases where hire purchase or non-recourse loans are involved (non-recourse loans are defined in the Bill - see below).

The example given in the Treasurer's Press Release of 13 May 1997 is of a taxpayer who purchases plant under hire purchase for $10 000 and which is repossessed after 2 years and payments of $4 000. The taxpayer has been able to claim depreciation of $7 000 and on disposal can claim a deduction for the difference between the depreciable value on disposal ($3 000) and the disposal value ($0 as it was repossessed). The taxpayer would therefore be able to claim total deductions of $10 000 for outlays of $4 000. It was proposed that the situation would be rectified by including the unpaid amount under the hire purchase agreement or non-recourse loan in the consideration deemed to have been received on disposal.

Further refinements to the proposed scheme were announced by the Treasurer in a Press Release dated 27 February 1998. The main changes over the previously announced scheme are that it will apply whether the relevant capital allowance provisions require a balancing adjustment on disposal or not and, secondly, that the calculation would be made on the termination of the hire purchase agreement or non-recourse loan. It was also announced that the purchaser under a hire purchase agreement would be treated as the owner of the good, so that the anti-avoidance provisions relating to capital allowances could apply to the purchaser.

It is estimated in the explanatory memorandum to the Bill that the measures will increase revenue by approximately $10 million in 1998-99, $30 million in 1999-2000, $25 million in 2000-01, $30 million in 2001-02 and $30 million in 2002-03.

Hire purchase arrangements are dealt with in proposed subdivision 240-A of the 1997 Act which will be inserted by Schedule 11.

There will be created a notional buyer and seller in relation to hire purchase arrangements (the purchaser being the notional buyer) and a notional transfer of the property to the notional buyer (proposed sections 240-17 and 240-20). There will be a notional loan from the notional seller to buyer that will run for the length of the agreement and the amount of consideration for the notional loan will be the arms length value of the transaction (proposed section 240-25).

The treatment of the deemed loan for the seller are dealt with in proposed subdivision 240-C. Principally, notional interest is to be included in the seller's income (the calculation of notional interest is contained in proposed section 240-60 and is to be determined by reference to the value of the arrangement, any amount payable on termination of the arrangement and the compound interest rate. If any of these amounts are not know, a reasonable estimate of the amount is to be substituted). Also included in the notional seller's income will be any profit on the notional sale of the goods. A notional sale will occur when the agreement is entered into. If there is a subsequent notional re-acquisition of the goods at the end of the agreement then any profit made on the further sale is also to be included in the income of the notional seller.

The buyer will be able to deduct notional interest payments but not arrangement payments which are, basically, amounts above the notional interest payment excluding penalty payments and amounts payable on the termination of the agreement (ie. any amount paid by the notional buyer to acquire the property, any payment to the seller for compensation due to damage to the property or the value at the end of the arrangement).

If the agreement is extended, the end of the first agreement will be taken to comprise a notional sale of the item and the new agreement to be one based on the value of the goods in an arms length transaction.

If, after the end of the arrangement, the notional buyer acquires the property from the notional seller, the transaction is largely to be disregarded, with the amount paid not being included in the sellers income or allowable as a deduction for the buyer, so that the rules relating to the notional sale will apply.

Where the notional buyer ceases to have a right to use the property, there will be a notional sale back to the notional seller for the arms length transaction value of the property. Special rules apply in relation to the disposal of cars to take account of the depreciated value of the vehicle

Major operative provisions are contained in proposed subdivision 240-G which deals with differences when the amount assessed to the notional seller is less than the 'finance charge'. In regard to the notional seller, where amounts paid to them exceed the notional loan principal and the assessed notional interest, the excess will be included in the assessable income of the notional seller. Similarly, where such an amount has been included in the assessable income of the notional seller or would have been included if the notional seller was subject to tax, the notional buyer will be able to claim an equal amount as a deduction.

Proposed Division 243 deals with limited recourse debts. A limited recourse debt is defined in proposed section 243-20 and is one where the right to repayment on default is limited to the debt property, goods produced by the property or the debtors rights on the loss or disposal of the property. Such a debt will also arise where it is reasonable to conclude that rights of the debtor are limited to the matters described above. There will also be a general power to consider a debt to be a limited recourse debt where, having regard to the circumstances, it is reasonable to assume that the right to recover the debt amount is limited. Similarly, even though any of the above provisions may apply, there is a power to determine that the debt is not a limited recourse debt having regard to all the circumstances.

The proposed Division will apply where a limited recourse debt is used to finance expenditure, the debt has not been repaid when terminated and the debtor can deduct a capital allowance (other than a development allowance or drought investment allowance) If the deduction in respect of the capital allowance has not been excessive, no amount is to be included in the debtor's assessable income (see below). Proposed section 243-25 lists a number of circumstances when a debt arrangement will be taken to have terminated, including:

  • when it actually terminates;
  • the obligation to repay the debt is waived or varied to reduce, transfer or extinguish the debt or an agreement is entered into for his purpose;
  • the creditor ceases to be entitled to recover the debt;
  • the property is surrendered because the debtor has failed to pay all or part of the debt; or
  • the debt becomes a bad debt.

The next step is to determine if there has been an excessive deduction. This will be calculated by determining the total deductions allowed in respect of the capital item, less any amount included in assessable income due to the operation of this proposed Division, and deducting from this amount the deductions that are allowable under the proposed Division. The later amount will be based on the earlier calculated amount less any part of the debt that remains unpaid.

The assessable income of the debtor is to be increased by the amount calculated above (proposed section 243-40). If the debtor makes a payment in respect of the debt after the debt has been terminated, the amount will be allowed as a deduction, although the amount of the deduction is not to exceed the amount included in assessable income due to operation of the proposed Division. Similarly, if the debt is re-financed and a payment is made by the debtor, a deduction will be allowed (proposed section 243-50).

Where the debtor is entitled to a capital allowance deduction, proposed section 243-55 provides for the amount of the deduction to be reduced by the amount worked out in the same manner as when determining if there has been an excessive deduction.

Where an amount relating to the debt is included in assessable in assessable income due to the operation of other provisions of the Act, an adjustment is to be made to reduce the amount included in assessable income under this proposed Division (proposed section 243-57).

The rules are to apply to partnerships and special rules are to apply where the liability between the partners changes (proposed sections 243-60 and 243-65).

Franking and Exempting Companies

The measures contained in the Bill form part of a package aimed at reducing dividend streaming and trading in franking credits. For more information on this area refer to the Digest for the Taxation Laws Amendment Bill (No. 7) 1997. The amendments contained in the Bill are largely of a technical nature aimed to address the situation where franked dividends are transferred between closely inter-related companies.

An exempting company will be one which is effectively owned by prescribed persons (proposed section 160APHBA of the ITAA). A prescribed person will effectively own of a company if 95% of the accountable shares, or interest in the shares, in the company are held either directly or indirectly for the benefit of prescribed persons. The prescribed persons will also have ownership if, having regard to the risks involved, it would be reasonable to conclude that such a degree of control exists (proposed section 160APHBB).

If an exempting company pays franked dividends to another exempting company and the companies are members of a company group or the first company holds a minimum of 5% of the receiving company and it is reasonable to conclude, on the basis of the risk involved, that the risks are borne by the first company, a franking credit will pass to the second company. In such a case, no franking credit will arise for the second company if the income is exempt (eg. where tax has already been paid and the income is transferred without further tax being payable). Also, if the income is partly exempt, a proportional reduction of franking credits will occur.

Where an exempting company franked dividend is paid or received, an account of the exempted franked dividend is to be established and whether there is a surplus or deficit calculated. When a company ceases to be an exempting company, a franking credit will exist for the company if it's exempting credit account is in a surplus, or if the exempting account is in deficit, a franking deficit will arise for the company.

There are also provisions dealing with the situation where franked dividends are passed to a partnership or trust from an exempting company. The amendments aim to ensure that the amount of franked dividends past will only be in proportion to the income received from the company, so that an exempting company will not be able to 'dividend stream' franking credits through a partnership or trust.

Application: Dividends paid on or after 7.30 pm on 13 May 1997 (ie. Budget time) unless dividends were declared by a public company before that time.

Endnotes

  1. Small Business Deregulation Task Force, Time for Business, November 1996, 31.

  2. Ibid., 29.

  3. The Sydney Morning Herald, 4 April 1998.

  4. Minister for Administrative Services, Press Release, 9 October 1996.

Contact Officer and Copyright Details

Chris Field
8 May 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.

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 1998

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, 1998.



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