Bills Digest No. 51 1999-2000 Taxation Laws Amendment Bill (No. 8) 1999


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

Taxation Laws Amendment Bill (No. 8) 1999

Date Introduced: 30 June 1999

House: House of Representatives

Portfolio: Treasury

Commencement: Upon Royal Assent, however, the measures contained in the Bill have different application dates, which will be considered in the Main Provisions section of this Digest.

Purpose

The amendments contained in this Bill are:

  • Measures to correct problems arising from the interaction of the controlled foreign company provisions and the capital gains provisions of the income tax law (Schedule 1)
  • Measures to exempt from income tax post-judgment interest in respect of personal injury compensation awards (Schedule 2)
  • Measures to correct technical errors in the franking credit trading and dividend streaming rules (Schedule 3)
  • Measures to disallow deductions for bribes paid to foreign public officials (Schedule 4)
  • Measures to implement the Government's response to the report on philanthropy in Australia by the Business and Community Partnerships Working Group on Tax Reform (Schedule 5)
  • Measures to amend the rate of tax imposed on eligible insurance business of friendly societies and other registered organisations (Schedule 6)
  • Measures to correct technical errors to ensure that distributions of share premium comply with the capital streaming and dividend substitution rules (Schedule 7)
  • Measures to correct technical errors to ensure that notes on excess tax offsets (tax credits) are located in the most appropriate provisions (Schedule 8)
  • Measures to amend the company loss, bad debt and debt/equity swap deduction provisions to provide two concessional tracing rules (Schedule 9), and
  • Measures to amend trust loss provisions of the income tax law to extend the deadline for making family and interposed entity elections (Schedule 10).

Background

As this Bill contains no central theme the background to the various measures is included in the discussion of the main provisions.

Main Provisions

Controlled Foreign Corporations and capital gains tax (Schedule 1)

Introduction

The measures in Schedule 1 propose amendments to the controlled foreign company rules (CFC rules) of the income tax law. The purpose of the amendments is to correct shortcomings in the CFC rules arising from the interaction between those rules and the capital gains provisions of the income tax law.

Background

The controlled foreign company (CFC) provisions of the income tax law, Part X of the Income Tax Assessment Act 1936 (1936 Act), are anti-avoidance measures to prevent Australian taxpayers from making profits through foreign private corporations to avoid taxation in Australia. Prior to the commencement of CFC rules Australian taxpayers were able to avoid Australian taxation by creating companies in tax havens and using these companies to make profit. The company profits were concessionally taxed in the tax havens. If the profits were not distributed to the Australian shareholders, Australian income tax was not payable on the undistributed profits. To counter this avoidance technique the CFC rules impose tax on the Australian shareholders of controlled foreign corporations for the accrued profit made by such companies. This is done through an attribution process. The Australian shareholders are called attributable shareholders.

Under section 456 of the 1936 Act, if a CFC has attributable income for an income year in respect of an attributable taxpayer, the part of the CFC's income that is attributable to that taxpayer is included in the taxpayer's assessable income. The term CFC is defined in section 340 as being a foreign corporation which is controlled by Australian residents. The control tests are:

  • five or fewer Australian shareholders control at least 50 per cent of the company
  • an Australian shareholder controls at least 40 per cent of the company and the company is not controlled by shareholders who are independent of the Australian shareholder, or
  • the company is controlled by a group of five or fewer Australian shareholders.

The attributable income of a CFC is calculated under the same rules for the taxation of Australian companies. The level of taxation depends on where a CFC is resident. The world is divided into two categories: a broad exemption listed country; or a non-broad exemption listed country. A broad exemption country is a country with a comparable taxation system where the risk of a CFC being used for tax avoidance is lower (section 320 of the 1936 Act). A non-broad exemption listed country is a country whose tax system provides concessions and is the risk of a CFC being used for tax avoidance is greater (section 320 of the 1936 Act).

An exemption is provided for a CFC resident in either a non-broad listed exemption country or a broad listed exemption country that derives active income (section 432 of the 1936 Act). Active income is income which is derived from a genuine business operation. If more than 95 per cent of a CFC's income is derived from genuine business activities, the active income test is met. Active income is distinguished from passive income such as investing in securities. A feature of international tax avoidance is that transactions in relation to passive income are booked through tax havens to avoid taxation in the taxpayer's country of residence. For example if a CFC is used to operate a hotel overseas the income is treated as active income and it is not attributed to the Australian shareholders. This concession is provided to exempt from the CFC rules income derived overseas from genuine business activities.

The income of a CFC that is attributed to Australian taxpayers is called tainted income. There are several categories of tainted income and they are listed in section 317 of the 1936 Act, the definition provision for Part X. If a CFC derives tainted income in a non-broad exemption country and it does not pass the active income test, that income will be attributed to the Australian shareholders. On the other hand, in a broad exemption country, tainted income is income which receives concessional tax treatment. Countries with similar tax systems to Australia's income tax system provide certain tax concessions to overseas taxpayers generally, as an inducement for a non-resident person to carry on certain activities in that country. This is called tax competition between countries and has been recognised by the OECD as an emerging problem(1). If a CFC derives income that is concessionally taxed in a country with a tax system similar to the Australian system, the income is treated as tainted income.

The capital gains provisions(2) of the income tax law(3) subjects to tax gains that are not assessable under another provision of the income tax law. It is a residual taxing mechanism and may generally only be applied if another provision of the income tax law is inapplicable. Under the Income Tax Assessment Act 1997 (1997 Act) capital gains applies if a listed CGT event takes place. The main CGT event is the disposal of an asset acquired on or after 20 September 1985.(4)

Interaction of CFC measures and the capital gains tax provisions of the income tax law

The capital gains provisions of the income tax law apply to the determination of attributable income. The capital gains provisions are modified for attribution purposes by Subdivision 7C of Part X of the 1936 Act. The capital gains tax (CGT) provisions provide for deferral of a tax event for capital gains purposes if assets are transferred within a wholly owned group of companies. This is called roll-over relief. Without the roll-over relief a tax event would arise from the transfer of an asset by one company to another company and this may hinder the efficient operation of a group companies. The tax event is deferred until either the asset is transferred by the transferee company to another person or the transferee company leaves the company group.

The roll-over relief for asset transfers within a wholly-owned group is in sections 160ZO and 160ZZOA of the 1936 Act for income years up to and including the 1997-98 income year. From the 1998-99 income year new capital gains provisions came into effect - Parts 3-1 and 3-3 of the 1997 Act. The group company roll-over provisions in the 1997 Act are Subdivision 126-B and CGT event J1.

1997 Budget Announcement

The Government announced in the 1997-98 Budget that:

The Government intends to correct several anomalies that have been identified concerning the interaction of the controlled foreign company (CFC) measures and the capital gains tax (CGT) provisions. Three of the anomalies could, in combination, prevent the intended taxation in Australia of capital gains on the deemed disposal of tainted assets (assets held to derive tainted income such as interest and dividends) of a CFC. (A deemed disposal can occur, for example, when a CFC, which holds an asset which has been subject of rollover relief, ceases to be a member of a group.) A further anomaly which will be corrected is that shareholders of a CFC that holds a tainted asset and has taken advantage of the rollover provisions, may reduce their Australian tax liability by diluting their interest in the CFC between the time the rollover relief is obtained and when an asset disposal takes place.

The aim of the amendments proposed by Schedule 1 is to ensure that the roll-over relief provided to a CFC in respect of intra-group asset transfers ends on the transferee company leaving the group. This will counter the avoidance opportunities arising from group companies being able to transfer an asset to another group company which then leaves the group without incurring a liability under the capital gains provisions.

Attributable income of a CFC to include tainted income from capital gains on tainted assets deemed to be disposed of by a CFC on ceasing to be a member of a group

It is proposed that the income of a CFC will expressly include income derived from capital gains on tainted assets that are treated as being disposed of for capital gains purposes when the CFC discontinues being a group company. This is designed to ensure that the roll-over relief for transfers of assets within a group of companies ends on the transferee company ceasing to be a member of the group. According to the Explanatory Memorandum(5), the need for this amendment arose because the definition of the term 'disposal' in Part X of the 1936 Act may not include a notional disposal of certain assets of a CFC that ceases to be a group company after getting the benefit of roll-over relief under the capital gains provisions. The CFC rules are complex measures and contain terms that are defined. In such a legislative anti-avoidance code it is unlikely that a court would impute meanings into terms that are exhaustively defined. It would appear to be an oversight that the definition of disposal failed to refer to notional disposals of assets.

Capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group taken into account when applying the active income test

Under the existing CFC rules an exemption is provided for the attributable income of a CFC if the CFC passes the active income test. If a CFC derives income and passes the active income test, the income of the CFC will not be attributed to the Australian shareholders. In this situation the Australian shareholders are only taxed on the dividends they receive from the CFC. If, however, a CFC fails the active income test, the notional income of the CFC will be attributed to the Australian shareholders. Under the active income test the amount of active income and tainted income derived by a CFC is determined. If 95 cent of a CFC's income is active income it will pass the active income test.

The Government has identified a shortcoming in the active income test of the existing CFC rules. When the active income test is applied to a CFC the notional disposal of certain assets is not taken into account under the existing CFC rules. A notional disposal of income is treated as tainted income and if taken into account when applying the active income test will make it more difficult for certain CFCs to pass the active income test.

The amendments proposed by Items 6, 7, 21 and 22 are designed to include in the attributable income of a CFC notional disposals of assets for the purpose of the active income test of the CFC rules. This measure will improve the integrity of the active income test.

Capital gains on the deemed disposal of an asset by a CFC on ceasing to be a member of a group are included in designated concession income

Designated concession income is income that has derived in a broad exemption country but is concessionally taxed. This measure is designed to bring within the CFC rules income that is derived from a country that has a tax system similar to the Australian tax system but has been the subject of a tax concession. The Government has decided that under the existing law it is uncertain whether the 'designated concession income' of a CFC includes capital gains arising from notional disposals of assets by a CFC by ceasing to be a member of a company group.(6) It is proposed that the tax advantage provided by the CGT roll-over concession will end on the transferee company ceasing to be a group company.

Item 1 inserts a new definition of the term 'designated concession income' which includes notional disposals of capital gains arising from the operation of section 160ZZOA of the 1936 Act. Items 12, 13 and 14 propose amendments to the capital gains provisions of the 1997 Act.

Reduction in attribution percentage to be ignored in certain circumstances

The Explanatory Memorandum(7) states that schemes have been identified in which taxpayers seek to reduce the amount of CFC income that may be attributed to them by diluting their level of ownership. The shareholders dilute the ownership in a CFC which has obtained the benefit of roll-over relief and ceases to be a group company. It appears the existing CFC legislation does not contain adequate anti-avoidance measures to prevent taxpayers from avoiding tax by entering into schemes. It would also appear that the general anti-avoidance provision, Part IVA of the 1936 Act, could not be applied to counter the identified schemes.

Proposed section 460A is a specific anti-avoidance measure to prevent attributable taxpayers avoiding attributable income arising from notional disposal of assets for capital gains tax purposes (Item 8).

Application

The amendments made by Part 1 of the Schedule 1 apply in determining the attributable income of a CFC if a disposal was taken to have occurred under section 160ZZOA of the 1936 Act after 7.30 pm on 13 May 1997 and during a particular statutory accounting period of an attributable taxpayer (Item 11).

The amendments made by Part 2 of Schedule 1 apply in determining the attributable income of a CFC if a CGT event J1 of the 1997 Act (the redrafted capital gains provisions) is take to have take place at any time (Item 27).

Concluding comment

The measures were announced in the 1997-98 Budget and apply from the date of announcement - 13 May 1997. More than two years have elapsed between the date of announcement and the introduction of the measures on 30 June 1999. While the measures in Schedule 1 are anti-avoidance measures, the delay nevertheless results in uncertainty for taxpayers in a self assessment tax system. Moreover, taxpayers may have been required to lodge income tax returns for the 1996-97 and 1997-98 income tax years based on the Treasurer's press release. The Senate Standing Committee for The Scrutiny of Bills has stated on the issue of the delay that:

The amendments proposed by Part 1 of Schedule are to apply from 13 May 1997 - the date of the 1997 Budget. While the Committee generally accepts the need for Budget announcements to apply from the date of the Budget, on this occasion it seems to have taken more than 2 years for these changes to take legislative form. The Committee, therefore, seeks the Treasurer's advice as to the reasons for such retrospectivity in these circumstances, and which taxpayers or categories of taxpayers will be disadvantaged by that retrospectivity.(8)

Amendments to exempt from tax certain post-judgment interest payments
(Schedule 2)

Measure

The proposed amendments in Schedule 2 are the Government's response to the decision of the full Federal Court in Whitaker v FCT(9) in which Mrs Whitaker was held to be assessable on post-judgment interest. Senator Kemp announced on 24 March 1999(10) that the income tax law would be amended to exempt from tax post-judgment interest in respect of damages awarded for personal injury. He announced that the amendments would be retrospective from the 1992-93 income year, the income year in which Mrs Whitaker was awarded a judgment for personal injury.

Background

In Rogers v Whitaker(11) the plaintiff Mrs Whitaker was blinded as a result of an operation and she won an award of damages against her surgeon. Mrs Whitaker became entitled to pre-judgment interest and post-judgment interest in respect of claims for damages for personal injury.

The pre-judgment interest compensates a plaintiff for being deprived of money between the day the action arose and the date of judgment. The interest is calculated on a sum that is not known until the day of judgment and is part of the underlying cause of action. Post-judgment interest is paid to compensate a taxpayer for being deprived of the judgment award between the date of judgment and the completion of the appeal process. If a defendant unsuccessfully appeals a judgment he or she may be liable for post-judgment interest. Mrs Whitaker's surgeon was unsuccessful in his High Court appeal. Mrs Whitaker was awarded post-judgment interest for the period from the date of judgment to the completion of the High Court appeal.

In Whitaker v FCT(12), the taxpayer was found to be assessable on her post-judgment interest but not the pre-judgment interest. The distinction between the two for tax purposes was that the post-judgment interest was paid in respect of a known principal sum whereas pre-judgment interest relates to an unknown principal amount. The case was reported in the media and depicted as being a harsh result for the taxpayer.

Proposed amendments

Item 1 inserts new section 23GA into the 1936 Act to exempt post-judgment interest arising from damages for personal injury. This amendment applies for income years 1992 -93 to 1996-97 (Item 4(1) of Schedule 2). Items 2 and 3 insert new section 51-55 of the 1997 Act to exempt post-judgment interest for the 1997 Act. New section 51-55 applies from the 1997-98 income year (Item 4(2)).

Franking of dividends paid to shareholders (Schedule 3)

Schedule 3 proposes to amend the franking credit system and dividend system rules to correct shortcomings in the existing provisions of the 1936 Act. Schedule 3 also proposes to amend Taxation Laws Amendment Act (No. 3) 1998 to extend the scope of a transitional concession for the general anti-avoidance rule(13) and the specific anti-streaming rule.(14) The Explanatory Memorandum states that the purpose of the proposed amendments is to make corrections in order for the rules to operate as intended.(15)

The intercorporate dividend rebate is a tax credit mechanism to prevent the double taxation of dividends flowing through a chain of companies. If a company pays a dividend to a corporate shareholder, it will be able to obtain a credit for any income tax incurred in respect of the dividend. This mechanism allows a dividend to pass through several levels of corporate shareholders without any taxation being levied on the dividend. The dividend will generally be subject to tax in the hands of a shareholder that is not a company.

Australia has an imputation system for the taxation of companies. Under the imputation system a company paying a dividend to shareholders is able to pass on a tax credit for the company tax it has paid. Dividends which carry a tax credit are called 'franked dividends'. Such dividends may be fully franked if the company's income was taxed at the corporate rate of tax, which is currently 36 per cent. Some companies are able to use tax concessions to reduce their company tax. The consequence is that such companies will be unable to fully frank their dividends. For example, if a company claims a deduction for research and development, its taxable income and in turn the income tax liability of the company will be reduced. This results in the company having fewer franking credits to distribute to shareholders. Such companies may partly frank their dividends. Some companies may not have a franking credit to pass on and may pay unfranked dividends.

A taxpayer receiving a franked dividend may use the franking credit against the tax payable on the dividend itself. If there is an excess credit, the taxpayer may use the credit against other income derived during the same income year. The imputation rules do not allow excess credits in one income year to be either refunded or carried forward to a future income year.

The inability of a shareholder to obtain a refund of tax or to carry forward a tax credit to a future income year was an intended feature of the income tax system.(16) This aspect of the imputation system creates the incentive for tax planners to create arrangements that ensure that franking credits are only paid to shareholders who can use the tax credit. The income tax law contains strict rules to counter such practices. There are rules to prevent the streaming of franked dividends to certain types of taxpayers and unfranked dividends to tax-exempt entities or taxpayers unable to use the franking credit.

The Government announced in its statement, Tax Reform, not a new tax, a new tax system(17) that it would tax trusts like companies to achieve tax neutrality. The features of the proposed system are:

  • A simplified imputation system involving full franking of all profits paid to individuals or other entities outside consolidated groups. The full franking would involve the taxing of all distributed profits at entity level - with all distributed profits then having attached imputation credits for the tax already paid.
  • Refunds of excess of imputation credits for resident individual taxpayers and complying superannuation funds.

The franking credit system and dividend streaming rules restrict the benefits of the franking credit system and intercorporate dividend rebate to taxpayers who are the economic owner of shares.

Non-deductibility of bribes (Schedule 4)

Introduction

The measures in Schedule 4 seek to prevent an income tax deduction arising from bribes paid to foreign public officials. The measures were recommended by the OECD Council on Bribery in International Transactions (OECD Council) to counter corruption of public officials in foreign countries. The initial recommendation of the OECD Council on measures to counter bribery in international transactions was adopted on 27 May 1994.(18) The recommendation on Anti-corruption Proposals for Bilateral Procurement was endorsed by the High Level Meeting of the Development Assistance Committee on 7 May 1996. The related recommendation on tax deductibility of bribes of foreign officials was adopted on 11 April 1996.(19) The OECD Council adopted the following recommendation on deny tax deductions for bribes paid to foreign officials on 23 May 1997:

IV. URGES the prompt implementation by Member countries of the 1996 Recommendation which reads as follows: "that those Member countries which do not disallow the deductibility of bribes to foreign public officials re-examine such treatment with the intention of denying this deductibility. Such action may be facilitated by the trend to treat bribes to foreign officials as illegal".(20)

By recommending that OECD member countries implement the measure, the OECD appears to be seeking to maintain competitive neutrality between member countries. This approach seeks to prevent the first countries to implement the measure to be at a competitive disadvantage because businesses in other countries can make bribes and then claim a deduction for these expenses.

The recent revelations of the Olympic city bid bribes indicates the consequences of corrupt practices becoming established. According to media reports, some Olympic officials requested bribes in return for agreeing to vote for a country's bid to be accepted. This practice forced some countries to make bribes to Olympic officials to try to secure votes to win the right to conduct either the Summer or Winter Olympics. The measures proposed in Schedule 4 will not apply to such situations because the Australian Olympic entity making a bid will not be a taxable entity. Moreover, the Olympic officials are not foreign government officials.

The measures in Schedule 4 complement amendments to the Criminal Code to counter the practice of paying bribes to foreign public officials. These amendments make it an offence under the Criminal Code for an Australian to pay a bribe to a foreign official.

Income tax deduction rules

Section 8-1 of the 1997 Act provides deductions for expenses incurred in gaining or producing assessable income or expenses incurred in carrying on a business for the purpose of producing assessable income. If a taxpayer can establish the connection between an expense and deriving assessable income, the taxpayer will be entitled to a deduction. The income tax law does not proscribe taxpayers from claiming income tax deductions for expenditure such as bribes provided the taxpayer can establish a connection between the bribe and deriving income. Consequently, under the existing law a taxpayer may claim a deduction for the cost of bribing a foreign public official involved in an international business transaction.

The measures

The Government supports the OECD recommendations on countering bribery of officials involved in international business transactions.(21) Proposed subsection 26-52(1) of the 1997 Act denies a taxpayer a deduction for a bribe to a foreign official. Proposed subsection 26-52(2) defines the meaning of the term 'bribe to a foreign public official'. The main element of the test is that the taxpayer incurs the expenditure with the intention of influencing a foreign public official in the exercise of the official's duties.

In order to prevent taxpayer being denied a deduction for legitimate payments to foreign officials, proposed subsection 26-52(3) states that an amount will not be treated as a bribe to a foreign official if no person would have breached a law of the particular foreign country. In Australia's self assessment tax system, an Australian taxpayer will require a knowledge of foreign criminal laws to meet this requirement. A prudent taxpayer who has been asked to make payments to foreign officials would firstly obtain advice on whether a particular payment to a foreign official is a criminal offence in the particular country. Secondly the taxpayer will have to obtain advice that the proposed payment is not an offence under the Criminal Code. Thirdly, the taxpayer will need advice on whether the proposed payment is not disallowed by the measures proposed in Schedule 4. These expenses will generally be deductible.

Proposed subsection 26-52(4) deals with facilitation payments. This provision treats an amount as not being a bribe paid to a foreign official if it is paid for the sole or main purpose of obtaining a 'routine minor government action'. Proposed subsection 26-52(5) defines the term 'routine government action'. The definition contains two tests, the first test is that the action of the official that is ordinarily performed by the official and that the action is listed in the second test (paragraph 26-52(5)(a)). The second test lists the following activities:

  • granting approvals that enable a person to do business in a foreign country (subparagraph 26-52(5)(b)(i))
  • processing government paperwork (subparagraph 26-52(5)(b)(ii))
  • providing the activities of police protection, mail collection or delivery (subparagraph 26-52(5)(b)(iii))
  • scheduling inspections in connection with contracts or the transit of goods (subparagraph 26-52(5)(b)(iv))
  • providing telecommunications services, power or water (subparagraph 26-52(5)(b)(v))
  • the loading and unloading of cargo (subparagraph 26-52(5)(b)(vi))
  • the protection of perishable goods (subparagraph 26-52(5)(b)(vii))
  • any other action of a similar nature (subparagraph 26-52(5)(b)(viii)).

The second test lists activities that are not treated as routine government action. This part of the test seeks to identify activities for which a payment to an overseas official may be a bribe. The expressly proscribed activities are:

  • a decision on whether to award new business (subparagraph 26-52(5)(c)(i))
  • a decision on whether to continue doing business with a particular person (subparagraph 26-52(5)(c)(ii))
  • a decision on the terms of a new business or an existing business (subparagraph 26-52(5)(c)(iii)).

Proposed subsection 26-52(6) directs that in determining whether a benefit may legitimately be given to another person certain issues should be disregarded. This provision is designed to prevent certain benefits having the form of a customary gift when it is in fact a bribe. The issues that must be disregarded are:

  • the fact that the benefit may be customary in the particular situation (paragraph 26-52(6)(a))
  • the value of the advantage (paragraph 26-52(6)(b)), and
  • official tolerance of the advantage (paragraph 26-52(6)(c)).

Capital gains tax provisions

Item 3 amends section 110-25 of the capital gains provisions of the 1997 Act to prevent bribes paid to foreign officials being included in the cost base for a capital gains tax event. This measure seeks to prevent some taxpayers from obtaining a tax benefit for bribe in a form other than a tax deduction.

Parallel measures implemented by other countries

The Government asserts in the Explanatory Memorandum(22) that the measures will not result in Australian businesses being at a competitive disadvantage because Australia's main trade competitors have parallel measures. It is asserted in the Explanatory Memorandum(23) that the US has similar measures which allow for facilitation payments. On the other hand, the Explanatory Memorandum(24) states that the UK does not allow a deduction for a bribe paid to a foreign official if the bribe is a criminal offence.

Commencement

The measures in Schedule 4 apply to expenditure incurred in the 1999-2000 income year and following income years (Item 6).

Philanthropy (Schedule 5)

The measures in Schedule 5 will amend the income tax law to implement the Government's response to the report on philanthropy in Australia by the Business and Community Partnerships Working Group on Taxation Reform. On 26 March 1999, the Government announced measures to encourage greater corporate and personal philanthropy in Australia. There are three different categories of gifts for which a deduction is available. This digest will briefly outline these categories.

Gifts

Under Division 30 of the 1997 Act, taxpayers are entitled to income tax deductions for certain gifts. Under section 30-15 donations to listed recipients can be claimed as income tax deductions. Examples of recipient organisations include public libraries, public hospitals and charitable organisations.

Cultural Gifts Program

The Cultural Gifts Program provides a tax deduction for gifts of significant cultural items to public art galleries, public museums and public libraries by offering donors a tax deduction. This program is administered by the Department of Communications, Information Technology and the Arts.

Capital gains and losses

Taxpayers may make a capital gain or loss in relation to a capital gains tax event. If a taxpayer donates an asset to a tax exempt body, a capital gains tax event arises as there has been a change in ownership of an asset. A capital gains tax asset is property which the owner may transfer to another person such as shares, real estate, buildings and collectables. Gifts of property that are within the scope of the Cultural Bequests Program do result in the donor making a capital gain or loss under section 118-60 of the 1997 Act. This provision provides that a capital gain or capital loss is disregarded for a testamentary gift of property under the Cultural Bequests Program.

Deductions for gifts of property valued at more than $5,000

Subsection 30-15(2) of the 1997 Act contains a table that lists the recipients, type of gift or contributions and directs how much can be deducted for gifts of property or donations. Item 1 of the table deals with the following category of recipient: funds, authorities or institutions listed by name or by type in Subdivision 30-B. Item 2 of the table deals with certain public funds.

Items 2 and 7 of Schedule 5 amends table item 1 and item 2 respectively to provide a tax deduction for property valued by the Taxation Commissioner at more than $5,000. The deductible amount is the value of the property determined by the Commissioner (Items 4 and 9 of Schedule 5). If donated property is worth more than $5,000 and is purchased within one year of making the gift the existing rules apply - the deductible amount is the lesser of the value of the property and amount paid for the property by the taxpayer (Items 3, 4, 8 and 9 of Schedule 5).

Items 5 and 10 of Schedule 5 amend the special conditions for gifts to recipients in items 1 and 2 of the table in section 30-15(2). A new condition of deductibility of these gifts is that they are valued by the Commissioner. New section 30-212 provides the Commissioner with the capacity to charge a valuation fee in accordance with the Income Tax Regulations (Item 11 of Schedule 5). The Australian Valuation Office, which is part of the Australian Taxation Office, will prepare valuations for the Commissioner.

Gifts and contributions to political parties

The Taxation Laws Amendment (Political Donations) Bill 1999 (Political Donations Bill) amends the provisions on political donations listed in the table in section 30-15. Proposed subsection 30-242(2), contained in the Political Donations Bill, is amended by Item 12 of Schedule 5 to allow a gift of property valued at more than $5,000 to qualify for a tax deduction.

Proposed subsection 30-243(2) contained in the Political Donations Bill is amended by Items 13 and 14 to limit the deduction to $1,500 for contributions of more than $5,000 or a gift of property valued at more than $5,000. The $1,500 limit is imposed on deductions because proposed subsection 30-243(2A) limits deductions for political donations and gifts to $1,500.

Deductions for gifts to private funds

Schedule 5 amends section 30-15 of the 1997 Act to allow gifts to be made to certain private funds called prescribed public funds. Item 24 proposes to amend subsection 995-1(1) of the 1936 Act to define a prescribed public fund as a fund that is prescribed by the income tax regulations. The proposed provision expressly excludes funds that are declared by the Treasurer in writing to not be a prescribed public fund. Private funds have to obtain the approval of the Government to be prescribed in the regulations. If a prescribed public fund does not comply with the requirements, the Treasurer may declare the fund is not a prescribed public fund. From the date of declaration, gifts to such a fund will not be deductible under section 30-15.

Apportionment of donations made under the Cultural Gifts Program

New Subdivision 30-DB amends Division 30 of the 1997 Act (new section 30-247) to provide taxpayers with the opportunity to provide for apportionment of gifts over a maximum period of 5 income years (Item 16).

According to the Explanatory Memorandum(25), the Cultural Gifts Program is administered by the Department of Communications, Information Technology and the Arts. The program is designed to encourage donations of significant cultural gifts to the organisations listed in Items 4 and 5 of the table in section 30-15 of the 1997 Act. The categories of recipients are:

  • the Australiana Fund
  • a public library in Australia
  • a public museum in Australia
  • a public art gallery in Australia
  • an institution in Australia consisting of a public library, a public museum and a public art gallery or any two of them, and
  • the Commonwealth for the purposes of Artbank.

New subsection 30-247(1) provides a taxpayer with the option of making a written election to spread a deduction over a maximum period of 5 years. Under proposed subsection 30-247(2) the taxpayer must elect the proportion of the deduction that the taxpayer will deduct in each of the income years. Under proposed subsection 30-247(3) the taxpayer must make the election before the taxpayer lodges an income tax return for the income year in which the gift is made. Proposed subsection 30-247(4) requires a taxpayer to give a copy of an election under this provision to the Secretary of the Department which administers the National Galleries Act 1975. Proposed subsection 30-247(5) provides taxpayers with the ability to vary an election at any time for income years in which a return has not yet been lodged.

Capital gains tax exemption for gifts of property made under the Cultural Gifts Program and testamentary gifts of property to gift deductible organisations

Under existing section 118-60 of the 1997 Act gifts of property made under the Cultural Bequests Program are exempt from taxation under the capital gains provisions. Any capital gain or capital loss is ignored under this provision. Item 20 of Schedule 5 extends this exemption to testamentary gifts of property made to deductible organisations. Item 22 of Schedule 5 extends the exemption to gifts of property made under the Cultural Gifts Program. The amendment is designed to encourage persons to make testamentary gifts to recipients listed in section 30-15 of the 1997 Act.

Application

This measures in Schedule 5 apply to gifts made on or after 1 July 1999 (Item 26).

Rate of tax for friendly societies (Schedule 6)

The Government in its statement Tax Reform: not a new tax, a new tax system(26), announced changes to the tax treatment of life insurers that are being developed as part of the Review of Business Taxation. The Government announced that:

Under the entity tax regime, from the 2000-01 income year, the company tax rate would apply to a life insurer's income and deductions generated in relation to:

ordinary life insurance business - presently taxed at a separate trustee tax rate (39 per cent for life insurance companies and 33 per cent for friendly societies);

policies held by superannuation funds - both complying (currently attracting 15 per cent) and non-complying (currently 47 per cent); and,

contractual obligations on annuity contracts - with a deduction for the 'interest' component of annuity payments and associated expenses. Income from this business is currently exempt and associated deductions are not allowed.(27)

The Government has announced that the present taxation treatment of friendly societies will not be changed before the commencement of the new arrangements for taxing life insurers. The Government also announced that the trustee rate of tax for the eligible insurance business of friendly societies and other registered organisations would be retained at 33 per cent until 2000-01.(28)

The Explanatory Memorandum(29) states that the rate of tax will be changed so that it is the same as the company rate of tax for the 2000-2001 income year and following income years. This is subject to the recommendations of the Review of Business Taxation.

Company Law Review Amendments (Schedule 7)

Schedule 7 makes technical amendments to the 1936 Act to ensure that distributions of a share premium account are within the scope of the capital streaming and dividend substitution rules of the income tax law. The measures in Schedule 7 modify the amendments to the income tax contained in the Taxation Laws Amendment (Company Law Review) Act 1998 (Company Law Review Act).

The Company Law Review Act amended the income tax law to reflect changes to the company law. This Act also introduced several anti-avoidance rules including:

  • rules to prevent companies from giving shareholders bonus shares or other capital benefits in lieu of unfranked dividends (the capital streaming rules); and
  • a rule that counters capital benefits being provided to shareholders under an arrangement for the purpose of providing a tax benefit in connection with the capital benefit (the dividend substitution rule).

Companies incorporated under legislation other than the Corporations Law are subject to anti-avoidance rules. According to the Explanatory Memorandum(30) these companies still have par value shares and share premium accounts in respect of those shares. These companies a distribution with the same effect as a share capital by distributing share premiums. The present anti-avoidance rules only apply to distributions of share capital and not share premiums.

Items 4 to 9 of Schedule 7 will amend sections 45A, 45B and 45C of the 1936 Act to seek to ensure that distributions of capital with the appearance of share premiums attract the operation of both the capital streaming and dividend substitution rules to counter income tax avoidance.

Schedule 7 also contains technical amendments and corrections to the amendments made to the income tax law by the Company Law Review Act.

Technical Amendments (Schedule 8)

Schedule 8 contains minor technical amendments to the 1997 Act to place notes on excess tax offsets in the most appropriate places. Tax offsets are tax credits which a taxpayer deducts from the taxpayer's tax liability. The 1997 Act contains notes with directions to taxpayers.

Concessional tracing rules for company loss provisions (Schedule 9)

Introduction

The income tax law allows companies to use losses as a deduction against current year income or a deduction against income in a future income year. In order to be able to deduct losses a company must satisfy either the same ownership test or the same business test. The measures in Schedule 9 propose to introduce concessional tracing measures to allow certain companies to meet the same ownership test. These concessional tracing rules are currently available to trusts under the trust loss measures. These tracing rules are called the family trust concession and the alternative condition.

The debt deduction rules(31) of the income tax law impose limits on the deductibility of certain debts. These provisions apply tests similar to the prior year loss provisions applying to companies. The concessional tracing rules proposed in Schedule 9 will extend to the debt deduction rules.

The proposed measures will place both companies and trusts on an equal footing for the purpose of tracing interests by providing companies with the concessional tracing rules presently available to trusts. This will improve tax neutrality between trusts and companies.

This measure was initially introduced in Taxation Laws Amendment Bill (No. 6) 1997 which lapsed when Parliament was prorogued for the 1998 General Election. The reintroduced measures have been modified to comply with the drafting requirements of the Tax Law Improvement Project.(32)

Prior year loss rules

Under the income tax law a company may carry forward prior year losses to deduct the losses from income in future income years if it passes either the continuity of business test or the same business test. These tests are contained in sections 80A to 80F of the 1936 Act and Divisions 165, 166 and 175 of them 1997 Act.(33) The continuity of ownership test requires a 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 deducted from income.

The application of the ownership test to a company may require tracing through interposed structures, such as companies and trusts, to the underlying individuals who beneficially own interests in the company. If an interposed structure is a discretionary trust, tracing of beneficial owners cannot occur as beneficiaries of a discretionary trust do not have an interest in the income or capital of the company. This prevents a company from carrying forward losses if 50 per cent 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 per cent stake test.

If a company cannot satisfy the continuity of ownership test, the company can carry forward losses if it satisfies the same business test. The same business test requires a taxpayer company to carry on the same business throughout the income year in which the loss is incurred and the income year in which the income is derived. The same business test is not available to a company where the majority of shares are held through discretionary trusts.

The income tax law has tests similar to the same ownership test and same business test to restrict deductibility of a company's current year losses or from claiming deductions under the debt deduction rules.

Trust loss measures - special tracing rules

Schedule 2F of the 1936 Act(34) contains the trust losses measures. The trust loss measures generally prevent tracing of interests through discretionary trusts. Exceptions to this are two special tracing rules. The first special tracing rule is the family trust concession which applies if a fixed interest in a loss trust is held by a family trust. Under this concession the family trust is treated as an individual holding the interest for its own benefit. The second special tracing rule is called the alternative condition which applies for the purpose of the ownership test (50 per cent stake test) that applies to fixed trusts. If the interests in a fixed trust are held by discretionary trusts which result in the 50 per cent stake test not being passed, the fixed trust can still deduct its losses if certain conditions are satisfied. The current tracing rules for companies do not have the concessional tracing rules currently available to trusts.

Proposed amendments to the prior year loss rules, current year loss rules and debt deduction rules

First concession - family trust concession

Part 1 of Schedule 9 proposes amendments to the 1936 Act and the 1997 Act to make the family trust concession available to companies. This measure will allow for a trustee of a family trust to be treated as the shareholder of companies if a family trust holds shares in companies. This measure also applies to situations in which the trust holds an interest in shares. This allows the shareholding of trusts to be counted for the purpose of the loss carry forward measures. Without this amendment the shareholdings of family trusts would be ignored and may result in a taxpayer company failing the continuity of ownership test.

The proposed amendments will be made for the purpose of the prior year loss provisions, current year loss provisions, the debt deduction provisions and capital loss provisions of the income tax law.

Part 2 of Schedule 9 proposes to amend the trust loss measures(35) to complement the extension of the family trust concession to companies.

Second concession - alternative condition

Part 3 of Schedule 9 proposes amendments to the 1936 Act and the 1997 Act to extend the alternative condition in Schedule 2F of the 1936 Act to companies. The alternative condition will allow certain companies which would otherwise have been unable to use losses to deduct losses under the prior year loss provisions, the current year loss provisions and the debt deductions provisions of the income tax law.

Non-resident trusts

A non-resident trust is a trust where either a trustee is a non-resident or the central management and control of the trust is outside Australia. Measures in Schedule 9 are designed to counter the use of a non-resident trust to avoid the application of the trust loss and company loss measures of the income tax law.

Schedule 9 provides the Commissioner of Taxation with the power to require a company to give information in certain situations on aspects of trusts that hold interests in a company (new sections 50HB, 50HC, 63AC and 63AD). Under the proposed amendment a company may be required to provide information on interests allocated to persons in the income or capital of a non-resident trust or distributions of income or capital to persons from a non-resident trust. If a company does not comply with a request under this measure the company will be treated as having failed the test being applied (prior year loss rules, current year loss rules and the debt deduction rules).

The failure by a company to comply with a request for information is not an offence or liable to a penalty under Part VII of the 1936 Act.

Application

Item 16 lists application dates for the proposed amendments in Part 1 of Schedule 9. Item 20 contains the application date for Part 2 of Schedule 9. Item 36 contains the application dates for Part 3 of Schedule 9.

Extension of transitional family trust and interposed entity election provisions (Schedule 10)

The trust loss measures were enacted in Taxation Laws Amendment (Trust Losses and Other Deductions) Act 1998. Schedule 10 proposes to extend the deadlines for making trust elections and interposed entity elections. Under this measure taxpayers will be able to make elections for the purpose of:

  • allowing a company to use the family trust concessional tracing rule proposed by Schedule 9 of Taxation Laws Amendment Bill (No. 8) 1999, and
  • the franking credit trading measures implemented by Taxation Laws Amendment Act (No. 2) of 1999.

Endnotes

  1. Harmful Tax Competition: An Emerging Global Issue (OECD, Paris, 1998).

  2. Also called the CGT provisions of the income tax law.

  3. Under the Taxation Laws Improvement Project, the provisions in the 1936 Act are being progressively redrafted and included in the 1997 Act. The capital gains provisions of the have been redrafted. The 1997 Act applies to 1997-98 income year and following income years. The 1936 Act applies to income years prior to the 1997-98 income years.

  4. CGT event A1, section 104-10 of the 1997 Act.

  5. Explanatory Memorandum for the Bill, para 1.25.

  6. Explanatory Memorandum for the Bill, para 1.64.

  7. Explanatory Memorandum for the Bill, para 1.41.

  8. Alert Digest, No. 11 of 1999 (11 August 1999) p 40.

  9. (1998) 38 ATR 219; 98 ATC 4285.

  10. Senator the Hon. Rod Kemp, Assistant Treasurer, Press Release No. 13 (24 March 1999) 'Tax Relief for Post-Judgment Interest Awards in Personal Injury Compensation Cases'.

  11. (1992) 175 CLR 479.

  12. (1998) 38 ATR 219; 98 ATC 4285.

  13. Section 177EA of the 1936 Act.

  14. Section 160AQCBA of the 1936 Act.

  15. Explanatory Memorandum for the Bill, para 3.4.

  16. Explanatory Memorandum for Taxation Laws Amendment Bill (No. 4) 1998, para 4.6.

  17. (AGPS, Canberra, 1998) 113.

  18. Decision reference: C(94)75/FINAL.

  19. Decision reference: C(96)27/FINAL.

  20. OECD Anti-Corruption Unit, Revised Recommendation of the Council on Combating Bribery in International Business Transactions (http://www.oecd.org/daf/nocorruption/revrece.htm).

  21. Second Reading Speech, Taxation Laws Amendment Bill (No 8) 1999.

  22. Explanatory Memorandum for the Bill, para 4.12.

  23. ibid.

  24. ibid.

  25. Explanatory Memorandum for the Bill, para 5.13.

  26. (AGPS, Canberra, 1998).

  27. ibid., p 120.

  28. ibid.

  29. Explanatory Memorandum for the Bill, para 6.3.

  30. Explanatory Memorandum for the Bill, para 7.5.

  31. Sections 63A to 63C of the 1936 Act and Divisions 165, 166, and 175 of the 1997 Act.

  32. ibid.

  33. Under the Taxation Laws Improvement Project, the provisions in the 1936 Act are being progressively redrafted and included in the 1997 Act. The company loss provisions of the have been redrafted. The 1997 Act applies to 1997-98 income year and following income years. The 1936 Act applies to income years prior to the 1997-98 income years.

  34. Inserted by the Taxation Laws Amendment (Trust Loss and Other Deductions) Act No. 17 of 1998.

  35. Schedule 2F of the 1936 Act.

Contact Officer and Copyright Details

Michael Kobetsky, Consultant
31 August 1999
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.

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and their staff but not with members of the public.

ISSN 1328-8091
© Commonwealth of Australia 1999

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Published by the Department of the Parliamentary Library, 1999.

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