Bills Digest no. 16 2006–07
Tax Laws Amendment (2006 Measures No. 4) Bill
2006
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
Concluding Comments
Endnotes
Contact Officer & Copyright Details
Passage History
Tax Laws Amendment (2006 Measures
No. 4) Bill 2006
Date introduced: 22 June 2006
House: House of
Representatives
Portfolio: Treasury
Commencement: The operative provisions of the Tax Laws Amendment
(2006 Measures No. 4) Bill 2006 commence on receiving Royal Assent.
Schedules 1, 2 and 4 as well as Schedule 3, items 1 and 2, will
also commence upon the Bill receiving Royal Assent. Schedule 3,
items 3 to 5 will commence retrospectively on 13 December 2005.
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CGT
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capital gains tax
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ITAA 1997
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Income Tax Assessment Act
1997
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ITAA 1936
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Income Tax Assessment Act
1936
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OECD
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Organisation for Economic Co-operation and Development
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OECD Convention
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OECD Model Tax Convention on
Income and on Capital
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Purpose
The Tax Laws Amendment (2006 Measures No. 4) Bill 2006 (Bill) is
an omnibus bill with each of the Schedules having its own purpose.
They are set out as part of the analysis of each of the four
Schedules below.
The Backgrounds to the respective
Schedules will be, where necessary, discussed as part of the
analysis of each of the Schedules below.
The following Part only provides a brief discussion of the
individual schedules. To avoid duplication between the Bills Digest
and the
Explanatory Memorandum, the reader may be referred to specific
passages in the
Explanatory Memorandum, for example, where examples highlight
the operation of the proposed new laws.
Schedule 1 will make modifications to the provisions regulating
capital gains tax (CGT) implications applying to asset disposals
triggered by marriage breakdowns. Where a capital gain or loss
applies to an asset disposal arsing as a consequence of a marriage
breakdown, it can be ignored. With respect to the current
arrangements, the CCH Australian Tax Master Guide 2006
notes that:
A compulsory same-asset roll-over happens if a CGT
event involves an individual (the transferor) disposing of an asset
to, or creating an asset in, his/her spouse or former spouse (the
transferee) because of: (a) a court order under the Family Law
Act 1975 or a corresponding foreign law; (b) a court-approved
maintenance agreement or a similar agreement under a foreign law;
or (c) a court order under the State Territory or for a law
relating to an de facto marriage breakdowns (s
126-5).(1)
The changes contained in this Bill were announced by the then
Minister for Revenue and Assistant Treasurer, the Hon. Mal Brough,
in 2005.(2)
Items 1 and 2 propose changes
to Subdivision 118B of the ITAA 1997. Subdivision 118B provides a
framework under which certain capital gains or losses arising from
a CGT event affecting a taxpayer s main residence may be ignored.
Section 118-110 provides for the so-called basic case,
subsequent sections provide expansions and limitations of the
basic case exemption.(3)
Item 1 inserts proposed section
118-75 concerning marriage breakdown settlements. It will
provide that a capital gain or loss can be disregarded if there is
a direct link between the gain on loss and an asset disposal
arising as a result of the breakdown of a marriage. The provision
also requires that it is reasonably likely that the breakdown is
permanent. Whether separation has occurred, is to be determined
under the provisions of the Family Law Act 1975.
Item 2 inserts proposed section
118-178 which will provide a limitation to the basic
case exemption where the CGT event occurs as the result of a
marriage breakdown rollover pursuant to Subdivision 126A ITAA
1997.
Items 3 and 7 add additional
subsections to sections 126-5 and 126-15 of the ITAA 1997.
Proposed subsection 126-5(3A) and
126-15(5) ensure that not only court-ordered CGT
events come within the ambit of the marriage breakdown roll-over
provisions, but also those which are the result of an arbitral
award or certain written agreements. However, the CGT events
triggered by arbitral awards and certain written agreements will
only benefit from the marital breakdown roll-over exemptions if
certain conditions can be fulfilled (items 4 and
8). The conditions will be set out in item
9, proposed section 126-25 and include
that:
- the couple has separated
- the separation is reasonably likely to be permanent, and
- the CGT trigger event is directly connected with the breakdown
of the marriage of the fact of marriage.
The measures is this Schedule will apply after this law receives
Royal Assent. According to the
Explanatory Memorandum, the financial impact and the compliance
costs are expected to be minimal.(4)
The proposed new law will allow the marriage breakdown roll-over
provisions to apply in situations where the transfer of assets is
the result of out-of-court settlements rather than court orders.
The out-of-court settlements contemplated in this measure are
arbitral awards and certain written or financial binding
agreements. Parliament may note that the measure will make no
changes to availability of the roll-over relief: only heterosexual
couples, married or in de-facto relationships, will
benefit from the expansion of the relief.(5) It will
continue to be unavailable to same-sex couples.(6)
Schedule 2 proposes changes to the consolidation rules relating
to consolidated groups or Multiple Entry Consolidated (MEC)
groups.(7) Specifically, the measure proposes to make
changes to the Income Tax (Transitional Provisions) Act
1997 (ITTPA) to remove a potential tax impediment to
demergers.
For the purposes of consolidation, the application of certain
pre-formation roll-over provisions is currently ignored to avoid a
head company artificially increasing the tax cost settings of
assets prior to, for example, a merger (section 701-35
ITTPA).(8)
However, where a demerger is planned, the demerging group may
transfer assets between its members in order to facilitate the
demerger. In this instance, ignoring the pre-formation roll-over
provisions can deprive the demerging group of the benefits of the
roll-over an important consideration for the viability of a
demerger. On the basis that tax considerations ought not to be an
impediment to a demerger, the
Explanatory Memorandum clarifies that the application of these
provisions in such circumstances is considered to be inappropriate
.(9) For further information, including in relation to
the context of the proposed measure, the reader is referred to the
discussion in the
Explanatory Memorandum.(10)
The proposed changes relate to current section 701-35 ITTPA.
Item 6, proposed subsection
701-35(2A) will provide that under certain circumstances
pre-formation roll-overs will not be ignored, removing a
significant impediment to demerging. Proposed paragraphs
701-35(2A)(a) to (c) will stipulate three
cumulative prerequisites which must be fulfilled for this
subsection to be triggered.(11)
Schedule 2 will apply retrospectively from 1 July 2002
(item 8). The anticipated costs to revenue are
estimated to be a total of $35 million, that is, $20 million for
the financial year 2006-07, and $5 million for each of the
financial years 2006-07 to 2009-10.
Schedule 3 contains amendments to the trans-Tasman simplified
imputation system measures. The measures have not been previously
announced.
In 2003, the Australian and New Zealand governments agreed to
implement measures to overcome what is generally referred to as the
triangular tax problem .
The triangular tax problem occurs where:
Australian shareholders in a New Zealand company
operating in Australia were unable to access Australian sourced
franking credits, with the same problem applying in reverse for New
Zealand shareholders in Australian companies operating in New
Zealand.(12)
Because companies were required to pay taxes without being able
to pass on franking credits to its shareholders, the triangular tax
problem resulted in the double taxation of distributions. To
overcome this problem, both jurisdictions implemented legislation
which enabled trans-Tasman companies to maintain franking or
imputation credit accounts reflecting the tax paid in the
respective comfort country.(13) For further background
on the introduction of the measures introduced to overcome the
triangular tax problem, the reader is referred to Bills
Digest No. 175 of 2002-03.(14)
Currently, the triangular tax problem still exists in relation
to non-assessable non-exempt income. The
Explanatory Memorandum notes that the current legislation does
not operate as intended in relation to this income. Schedule 3 will
make changes to the simplified imputation system to ensure that
franked distributions by a New Zealand company, which are exempt or
non-assessable non-exempt income, can be passed on by the
Australian company on a pro-rata basis to its shareholders.
Item 1 inserts proposed section
220-350 into the ITAA 1997. This provision will provide
that a franking credit will arise for the Australian company, where
a New Zealand company makes a franked distribution either out
of:
- attributed income (non-assessable non-exempt income pursuant to
section 23AI ITAA 1936)
- non-portfolio dividend (non-assessable non exempt income
pursuant to section 23AJ ITAA 1936), or
- attributed foreign investment fund income (non-assessable
non-exempt income pursuant to section 23AK ITAA 1936).
Where the distribution is only partially made as non-assessable
non-exempt income, proposed subsection 220-350(3)
will ensure that the amount of franking credit on the distribution
is available only for this part of the distribution.
Item 3 of Schedule 3 makes a consequential
amendment to the ITAA 1936 to ensure that companies conduit foreign
income is reduced to reflect the franking credit arising under
proposed section 220-35 ITAA 1997.
The amendments apply retrospectively from 1 April 2003. This is
the date from which New Zealand companies could maintain franking
accounts in Australia.
The
Explanatory Memorandum estimates that the financial impact of
this measure will be nil, with only negligible compliance costs for
taxpayers.(15)
Schedule 4 proposes substantial and consequential amendments to
the ITAA 1997, ITAA 1936 and the Financial Corporations
(Transfer of Assets and Liabilities) Act 1993 to implement
rules relating to capital gains or losses of foreign residents.
Under the current law, a foreign resident makes an income tax
relevant capital gain or loss from a particular capital gains tax
(CGT) event if the asset at the heart of the CGT event has the
necessary connection with Australia. Under the proposed measures,
foreign residents will only be taxed if the CGT event relates to an
asset which qualifies as taxable Australian property as defined
under the new law.
The measures were promised in the 2005/06 Budget. The Hon. Peter
Dutton, Minister for Revenue and Assistant Treasurer, announced the
measure on 22 June 2006. The Minister highlighted four for
introducing the measure, including:
- enhancing Australia s status as an attractive place for
business and investment
- addressing the disincentives to foreign investment (and
regional holding companies) in Australia arising from the current
broad, but ineffective, application of CGT to foreign
residents
- narrowing the range of assets on which a foreign resident is
subject to Australian CGT to Australian real property, and the
business assets of Australian branches of a foreign resident,
and
- protecting the integrity of this narrower CGT tax
base.(16)
Further, the measure is said to better align the Australian tax
framework with the recommendations by the Organisation for Economic
Co-operation and Development (OECD), especially as framed in the
OECD Model Tax Convention on Income and on Capital (OECD
Convention).
The core rules of this proposed measure will be contained in
proposed Division 855 of the ITAA 1997 Capital
Gains and foreign residents (item 2, Schedule 4).
Division 855 will be comprised of two subdivisions, with proposed
Subdivision 855A stipulating the circumstances in
which a foreign resident can disregard a capital gain or loss and
proposed Subdivision 855B providing special rules
for situations in which certain taxpayers become Australian
residents for tax purposes.
Proposed section 855-5 will set out the objects
of the subdivision which are to improve:
- first Australia s status as an attractive place for business
and investment (paragraph 855-5(1)(a)), and
- second the integrity of the CGT base (paragraph
855-5(1)(a)).
The provision also explains that the proposed measure will
further align Australia s tax laws with international tax
practice.
Proposed section 855-10 stipulates:
- that a capital gain or loss can be disregarded if the person is
a foreign resident just before the CGT event occurs and this event
occurred in relation to an asset that is not taxable
Australian property (paragraphs 855-10(1)(a) and
(b)), and
- the CGT assets in relation to which CGT events can occur
(subsection 855-10(2)).(17)
Proposed section 855-15 defines the five
categories of CGT assets which are considered to be taxable
Australian property . Assets which are taxable Australian property
include:
- taxable Australian real property (that is, pursuant to proposed
section 855-20, any real property situated in
Australia, but also mining, prospecting or quarrying rights)
- certain indirect Australian real property interests (these are
certain interests held through interposed entities, proposed
subsection 855-25(1)) to strengthen the CGT tax
base(18)
- those used in carrying on a business through a permanent
establishment in Australia (within the meaning of section 23AH ITAA
1936). Proposed section 855-35 provides that
capital gains or losses from business assets must be reduced if the
assets were used for business purposes only for part of the period
between their acquisition and the CGT event
- option or rights to acquire the above interests, and
- CGT assets covered by subsection 104-165(4) ITAA 1997.
These changes will mean that foreign residents who invests in
shares in Australian companies or holding interests in certain
trusts will benefit significantly.(19)
Proposed section 855-25 stipulates that
interests held by a holding entity in another entity (called the
test entity) are indirect Australian real property
interests if:
- the non-portfolio interest test (paragraph
855-25(1)(a) this test is defined in proposed
section 960-195, see below), and
- the principal asset test (paragraph
855-25(1)(b) this test is defined in proposed
section 855-30, see below)
are fulfilled.
Proposed section 855-30 defines the
principal asset test. Proposed subsection
855-30(2) stipulates that an interest held by a holding
entity in a test entity fulfils the principal asset test if the
market value of the test entity s assets, which constitute taxable
Australian real property, exceeds the market value of those assets
which are not taxable Australian real property. Proposed
subsection 855-30(4) contains specific rules in
relation to the treatment of the market value referred to in
proposed subsection 855-30(2). This subsection is
linked to several forms of participation interests which are
further defined in proposed Subdivision 960-G Participation
interests in entities.(20)
Proposed section 855-40 makes provision for the
tax treatment of foreign residents in relation to fixed trusts. A
foreign resident may disregard gains derived from an interest in a
fixed trust if the gain is attributable certain CGT asset held by
the trust directly or indirectly and the asset is not taxable
Australian property within the meaning of proposed section 855-15
or fulfils the conditions set out in proposed subsections
855-40(5) to (8).
Proposed subdivision 855B sets out the rules
which govern the situation where certain foreign residents become
Australian residents for taxation purposes.(21) This
subdivision applies to individual taxpayers and entities (proposed
section 855-45), trusts (proposed section
845-50) and controlled foreign companies (proposed
section 855-55).(22)
The measure requires a number of consequential and other
amendments. These include amendments in relation to the managed
fund provisions (for example, items 29, 40 or
87), interests in active foreign companies
(items 83 to 86), provisions
concerning currency calculation (items 97 to
99) and several additions to, and deletions from,
the definition set out in section 995-1 (items 100
to 108). These amendments also include changes
to:
- sections 104-160, 165 and
170 ITAA 1997 CGT event I1 and I2: Individual,
company or trust stops being a resident. The amendments will ensure
consistency between the proposed new regime applying to foreign
residents and the provisions dealing with a taxpayer ceasing to be
a Australian tax resident, and
- Division 128 ITAA 1997 reflecting the changes
of this Schedule in relation to the current provisions regulating
the consequences of death for CGT purposes, especially the transfer
of assets held by a foreign resident just before dying to a legal
personal representative or beneficiary.(23)
The cost to revenue is expected to be $50 million for 2006-07,
and $65 million for each of the following years. The
Explanatory Memorandum notes that it is unlikely that the
measure will cause large compliance costs for taxpayers. However,
it is noted that the some foreign investors have increased
compliance costs if they have indirect holdings in Australian real
estate property .(24)
Foreign investors holding shares in Australian companies and
interests in certain trusts will gain significant benefits from
this measure because these interests are excluded from CGT for
foreign residents under the proposed regime. It has been noted that
the measure is likely to be successful, providing a good stimulus
for merger and acquisitions.(25) In their legal update
of 20 July 2006, tax experts from the national law firm Minters
Ellison identified several likely results from this measure,
including:
- Increased activity by non-residents in Australian unlisted
companies and unit trusts, and in interests of 10% or more in
Australian listed companies, where the underlying assets do not
comprise predominantly Australian real property
- [that] Australia will become a more desirable holding company
location
- [that] non-residents will be more likely to structure the
carrying on of a business in Australia via an Australian subsidiary
entity rather than an Australian branch, and
- An increase in Australian investment by
non-residents.(26)
Concluding comments
Where necessary, comments to each Schedule can be found
immediately after their respective discussion.
- CCH, CCH Master Tax Guide 2006, Melbourne, 2006, p. 763.
- M Brough, then Minister for Revenue and Assistant Treasurer,
Extending The Marriage Breakdown Capital Gains Tax Roll-Over Relief
And Related Amendments,
Media Release, Canberra, 4 May 2005.
- The basic case stipulates that capital gains or losses
made from a CGT event that occur in relation to a taxpayer s
dwelling or the taxpayer s ownership interest in a dwelling can be
disregarded in certain circumstances.
- Explanatory Memorandum to the Tax Laws
Amendment (2006 Measures No. 4) Bill 2006, p. 4.
- According to Mal Brough MP, then Minister for Revenue and
Assistant Treasurer, the tax relief was specifically not extended
to same-sex couples because: The capital gains tax rollover on
marriage breakdown should not be the lead vehicle for the
implementation of social change . M Brough, then Minister for
Revenue and Assistant Treasurer, Answer to Question on Notice No.
243 Taxation: Capital Gains Tax (Questioner: M Danby MP), House of
Representatives, 9 December 2004, p. 193.
- This is a result of the definition chosen for de-facto in
section 995-1 of the ITAA 1997. See also the explanation in
Paragraph 1.20 of the
Explanatory Memorandum, op. cit., p. 12.
- The CCH Master Tax Guide 2006 explains that multiple entry
consolidated groups are groups of Australian resident wholly owned
subsidiaries of a common foreign holding company. CCH Master Tax
Guide 2006, p. 848.
- ibid., pp. 834 5.
- Explanatory Memorandum, op. cit., p.
22.
- ibid., pp. 21 3.
- For more information on the main provisions of Schedule 2, the
reader is referred to the
Explanatory Memorandum, ibid., p. 23.
- CCH, op. cit., p. 143.
- In Australia, the measure was incorporated as Division 220 into
the ITAA 1997 by the Taxation Laws Amendment Bill (No. 6) 2003. See
G Selleck and P Prince, Taxation Laws Amendment Bill (No. 6) 2003,
Bills
Digest, No. 175, Department of Parliamentary Services,
Canberra, 2002-03, pp. 9-11. In New Zealand, the measure was
enacted as the Taxation (GST, Trans-Tasman Imputation and
Miscellaneous Provisions) Act 2003.
- Selleck and Prince, ibid., pp. 9 11.
- Explanatory Memorandum, op. cit., p.
5.
- P Dutton, Minister for Revenue and Assistant Treasurer,
Government Introduces Further Improvements to the Tax System, Media
Release, No. 39, Canberra, 22 June 2006 (http://treasurer.gov.au/pcd/content/pressreleases/2006/039.asp).
- For details and further explanations in relation to the CGT
events covered by this measure, see the
Explanatory Memorandum, op. cit., pp. 35 6.
- ibid., p. 38.
- Deacons, Major Australian capital gains tax reforms for
non-residents introduced, Legal Update, June 2006.
- For a detailed explanation of the participation interests,
including several examples and diagrams which illustrate the
operation of the provision, the reader may refer to the
Explanatory Memorandum, op. cit., pp. 41 52.
- The original provisions dealing with this issue are located in
Division 136 which is to be repealed (item 1,
Schedule 4) and relocated to proposed Division
855.
- A controlled foreign company is defined in section 340
of the ITAA 1936 to mean a company resident in a so-called listed
country or an unlisted country if certain requirements are
fulfilled.
- For a detailed explanation of the consequential amendments the
reader may refer to the
Explanatory Memorandum, op. cit., pp. 56 60.
- ibid, p. 5.
- Corrs Chambers Westgarth Lawyers, Capital gains tax and foreign
residents, Legal Update, 30 June 2006.
- P Horden, Legal Update Capital Gains Tax and foreign residents,
Legal Update, Minter Ellison Lawyers, 20 July 2006.
Thomas John
15 August 2006
Bills Digest Service
Parliamentary Library
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ISSN 1328-8091
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