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This Digest was prepared for debate. It reflects the legislation as
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CONTENTS
Passage History
Purpose
Background
Main Provisions
Concluding Comments
Endnotes
Contact Officer and Copyright Details
Taxation Laws Amendment Bill (No. 5)
1999
Date Introduced: 11 March 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
the Digest.
The amendments
contained in the Bill are:
-
- Measures to ensure the sales tax exemption for goods placed in
properties owned or leased by always exempt persons or foreign
governments is only available for the purchase of goods acquired
for their own use (Schedule 1).
-
- Measures to treat certain hire purchase agreements as sale and
loan agreements for income tax purposes to ensure that excessive
tax benefits are not obtained
(Schedule 2).
As this Bill contains no central theme the
background to the two main measures is included in the discussion
of the main provisions.
Amendment of the Sales Tax
(Exemptions and Classifications) Act 1992
Sales tax generally applies to goods which are
manufactured in Australia or goods imported into Australia, for use
in Australia. Sales tax is a wholesale tax. The Sales Tax
Assessment Act 1992 provides that dealings with assessable
goods are subject to sales tax unless an exemption applies. The
exemptions from sales tax are contained in the Sales Tax
(Exemptions and Classifications) Act 1992 (ST(EC) Act).
Schedule 1 of the ST(EC) Act contains a list of goods that are
exempt from sales tax.
For the purposes of the sales tax law the term
an 'always exempt person' is defined in section 5 of the Sales
Tax Assessment Act 1992. The definition states that an always
exempt person means a person whose use of goods is always covered
by an exemption, irrespective of the way in which the goods are
used by that person. Examples of always exempt persons are:
government agencies; local councils; schools; public hospitals; and
benevolent funds. As a result of the proposed amendment to the
ST(EC) Act an always exempt person will not be exempt from sales
tax in all situations.
Under property law, goods used by a person in
the repair or construction of a building become part of the
building. Item 192 of Schedule 1 of the ST(EC) Act provides a sales
tax exemption to certain persons for goods that become integrated
with real property (buildings and structures). This exemption is
provided to two categories of persons: always exempt persons and
foreign governments. The provision applies to property that is
either owned or leased by the always exempt person or a foreign
government.
According to the Explanatory
Memorandum, the exemption is available regardless of whether
the always exempt person or foreign government ever occupies a
building in respect of which sales tax exemptions have been
obtained for goods used in construction of the building.(1) The
Explanatory Memorandum asserts that this exemption is
being used for commercial developments on property owned by always
exempt persons or foreign governments.(2) It also asserts that this
use of the exemption is a misuse and results in competitive
advantages to certain property developments. If a developer is able
to obtain a sales tax exemption for goods used in a property
development, that developer has a significant cost advantage over
developers who have correctly paid sales tax on goods used in a
development. The Explanatory Memorandum describes examples
of misuse of the exemption. It is stated that the following
developments on land owned by State and local governments benefited
from the exemption:
-
- the building of residential apartments by private developers,
and
-
- the refurbishment of shopping centres.
The measures contained in Schedule
1 of the Bill counter a shortcoming in the sales tax law
which allows a person who has a contract with an always eligible
person or foreign government to obtain an exemption from sales tax
on goods used in a property. The measures contained in
Schedule 1 of the Bill were first introduced into
Parliament on 2 April 1998 in Taxation Laws Amendment Bill (No 4)
1998. This Bill lapsed when Parliament was prorogued for the 1998
General Election.
Item 1 of Schedule
1 of the Bill amends Item 192 Schedule 1 of the ST(EC)
Act. Proposed Item 192(4) restricts the exemption
to the following situations:
-
- residential property which is provided by an always exempt
person, at a rate of rent that is below the market rate
-
- a property that is principally occupied by an always exempt
person or foreign government
-
- in the case of service providers to always exempt persons or
foreign governments, the property must be used principally for the
provision of those services.
Proposed Item 192(4)(b) directs
that the relevant property cannot be an 'ineligible property'. A
list of ineligible properties is contained in proposed Item
192(5). The list includes the following properties: shops
and shopping centres; hotels; casinos; apartment blocks. Properties
that are similar to one of the above listed properties are also
expressly excluded under proposed Item 192(5)(e).
Under proposed Item 192(5)(f) properties
prescribed for the purposes of the definition are also excluded
from the exemption.
The Explanatory Memorandum states that
the measures in proposed Item 1
of Schedule 1 will not apply to the private sector
involvement in infrastructure projects such as toll roads.(3) Under
proposed Item 192(4)(a)(ii) a
person who is involved in providing services for an infrastructure
project would be treated as a service provider to an always
eligible entity. Following the amendments, the goods used in such a
project would be eligible for the sales tax exemption under Item
192.
The measures contained in Schedule
1 of the Bill are expected to result in an estimated gain
to the revenue of $10 million in 1997-98 and $50 million in
1998-99.(4) The implication from the large estimated gain to the
revenue is that tax avoidance arrangements were being used to
exploit the exemption.
Application
Item 2 of Schedule
1 of the Bill sets the application date as dealings after
2 April 1998. The measures do not apply to goods acquired on or
before 2 April 1998. The first Bill was introduced into the House
of Representatives on 2 April 1998.
Arrangements treated as a sale and loan
and limited recourse debt
Under the existing income tax law, taxpayers are
entitled to a deduction for capital allowances such as
depreciation. The capital allowance is based on the cost of the
asset and certain capital expenditure. Any related finance
transactions are not taken into account for capital allowance
purposes.
Generally a capital allowance requires a
balancing adjustment to be made when the depreciated property is
sold for a price which is different from its value for capital
allowance purposes. If a person sells an asset for an amount that
exceeds the depreciated value of the asset for income tax purposes,
the seller will be subject to income tax on the difference between
the depreciated value and the sale value of the asset. This process
captures the tax benefit, in the form of depreciation deductions,
that the seller has obtained by depreciating an asset to a value
below its market value.
In the case of assets that are financed under
hire purchase agreements or by limited recourse debt arrangements,
the total cost of an asset may not be paid by the purchaser if an
amount remains unpaid at the termination of a lease. For example,
if the cost of an asset is $100,000 and the asset is acquired under
a finance agreement, the taxpayer will be able to claim capital
allowance deductions on the asset from a starting value of
$100,000. Should the seller not require payment of the full loan
and interest, the buyer might obtain an excessive depreciation
deduction because of the reduced cost of the asset. The existing
income tax law does not require an adjustment to be made for such a
reduction in the cost of an asset. This provides tax avoidance
opportunities for certain taxpayers.
The measures in Schedule 2
counter arrangements that allow taxpayers to acquire assets under
finance arrangements that result in excessive capital allowance
deductions being obtained because the full consideration for an
asset is not paid. The proposed measures will require such persons
to make adjustments for capital allowance purposes to reflect the
actual cost of an asset where the expenditure has been financed by
a hire purchase arrangement or limited recourse debt.
The measures were first announced by the
Treasurer in the 1997 Budget.(5) The Budget announcement contained
the following example of the operation of the existing law and
proposed amendments:
Existing Law
Plant purchased for $10,000 under a hire
purchase agreement may be re-possessed for non-payment after two
years. If at that time the plant has been depreciated for tax
purposes by $7,000 but the taxpayer has paid only $4,000 of the
hire purchase cost, the taxpayer would have obtained a tax gain
which exceeds costs by $3,000. A further deduction would be
available to the taxpayer equal to the difference between the
depreciated value of $3,000 and the taxpayer's disposal price - in
this case nil because the plant was repossessed. For a total outlay
of $4,000, the taxpayer's deductions would be $10,000.
Amended Law
The $6,000 of the unpaid cost under the hire
purchase arrangement - adjusted if necessary for any further amount
the taxpayer was required to pay - would be treated as
consideration on disposal, thereby creating a balancing charge of
$3,000 ($6,000 less the depreciated value) to offset the $7,000
depreciation already deducted. The taxpayer's net tax deductions
then would be $4,000 - equal to net outlays.(6)
The Treasurer announced, by Press Release
No. 21 of 27 February 1998, changes in the way the measures
would be implemented and some technical amendments. The measures
contained in Schedule 2 were first introduced into
Parliament on 2 April 1998 in Taxation Laws Amendment Bill (No. 4)
1998. This Bill lapsed when Parliament was prorogued for the 1998
General Election.
Under the limited recourse debt measures (debt
that is not to be fully repaid), a taxpayer will be denied the
opportunity to claim capital allowances that exceed the cost of an
asset. Hire purchase arrangements will be treated as limited
recourse debt to bring these arrangements within the scope of the
limited recourse debt measures. In addition, hire purchase
arrangements will be recharacterised through the use of a legal
fiction as a sale of property and concurrent loan.
Arrangements treated as a sale
and loan
Proposed Division 240 contains
the rules that apply to treat hire purchase arrangements as a sale
and loan agreement. Proposed Division 240 provides
the rules for determining the income and deductions applicable to
the parties to a hire purchase agreement. Hire purchase agreements
are treated as limited recourse debt for the purposes of
proposed Division 243 to ensure that taxpayers may
not obtain deductions for capital allowances that exceed the actual
cost of an asset to a taxpayer (discussed below).
Proposed section 240-10 is the
application provision. It prescribes that an arrangement will be
treated as a notional sale and notional loan if it is a hire
purchase agreement in relation to any goods. It applies to all hire
purchase agreements.
Under this measure, a notional seller is treated
as having sold the property to a notional buyer to finance the
purchase price (proposed sections 240-17 and
240-20). The notional seller is the financier and the
notional buyer is the person receiving the finance to acquire
property. A notional loan is treated as having been provided by the
notional seller to the notional buyer. The notional loan is the
consideration for the sale of the property.
Proposed section 240-35 lists
the amounts that are to be included in the notional seller's
income. The notional seller's income includes the notional interest
in respect of the notional loan (proposed subsection
240-35(1)). If the property is not the notional seller's
trading stock, the profit is to include the seller's profit on the
transaction (proposed subsection 240-35(2)). Under
proposed subsection 240-50(1) the notional buyer
is entitled to a deduction for notional interest. The rules for
calculating the notional interest are contained in proposed
section 240-60.
Proposed Subdivision 240-D
provides that a notional buyer (the borrower) may be entitled to
deductions for the notional interest for the notional loan that the
notional seller is treated as having made. Under proposed
subsection 240-50(2) a notional buyer is generally
entitled to a deduction for notional interest.
Proposed Subdivision 240-G
contains income reconciliation rules for a notional seller. If the
sum of the amounts included in the notional seller's assessable
income differs from the finance charge, determined at the end of
the arrangement for the notional loan, an adjustment to the
seller's assessable income will be made. This adjustment mechanism
takes into account all the finance charges over the life of the
loan.
The formula for determining if an adjustment is
necessary is contained in proposed subsection
240-105(4). If the sum of the amount paid to the notional
seller and any termination payments is less than the amount
calculated under proposed subsection 240-105(4),
the difference is to be included in the notional seller's
assessable income. Proposed subsection 240-105(4)
directs that the formula is the sum of the 'notional loan
principal' and the 'assessed notional interest'. The assessed
'notional interest' is defined in proposed subsection
240-105(4) as the notional income that has been included
in the notional seller's assessable income. The term 'notional loan
principal' is defined in proposed section 240-25
as generally being the consideration for the sale of the
property.
If the notional loan principal and the assessed
notional interest calculated under proposed subsection
240-150(3) exceeds the amount calculated under
subsection 240-105(4), the notional seller is
entitled to a deduction for the difference. In this situation the
taxpayer has been assessed on amounts that it has not received and
the deduction corrects the situation.
Limited Recourse
Debt
Proposed Division 243 applies
where a taxpayer's deductions for capital allowances obtained for
expenditure, which has been financed by debt, are excessive because
part of the debt was waived by the lender. This is a tax avoidance
technique to inflate a taxpayer's cost base for capital allowance
purposes by writing off part of the debt used by the taxpayer to
acquire an asset. Proposed Division 243 ensures
that a taxpayer's deductions for capital allowances do not exceed
the actual cost of the asset to the taxpayer. If a taxpayer's
deductions for capital allowances exceed the actual cost of an
asset, proposed Division 243 requires the taxpayer
to treat the difference as income in the income year the loan is
terminated.
The criteria for the application of
proposed Division 243 are (proposed
section 243-15):
-
- a limited recourse debt has been used to finance expenditure
- at the termination of the debt arrangement, the debt has not
been fully discharged by the debtor, and
- the debtor has been able to obtain deductions for capital
allowances.
Under proposed subsection
243-15(2) an amount will only be included in the debtor's
assessable income if the net capital allowances have been
excessive, having regard to the amount of unpaid debt. The Digest
considers in detail the meaning of limited recourse debt,
termination of a debt arrangement, and whether the debtor has been
able to obtain excessive deductions for capital allowances.
What is limited recourse debt?
The first step is to determine if there is
limited recourse debt. The term 'limited recourse debt' is defined
in proposed section 243-20 as a loan to a borrower
for the acquisition of property under which the loan rights of the
lender are limited. There are four categories of limited recourse
debt.
The first category is in proposed
subsection 243-20(1) which lists the limitations that may
be imposed on a creditor in the case of default. In general the
lender has rights that are limited to the property acquired with
the debt, however, the value of the property may be significantly
less than the outstanding principal and interest. Due to the
recovery limitations in the loans, the lender does not have the
right to seek recovery of any outstanding amounts.
The second category is in proposed
subsection 243-20(2) which treats a loan as a limited
recourse loan even if there is no express limitation in the loan
but it would be expected that the creditor's rights would be
limited to the property rights referred to in proposed
subsection 243-20(1). The criteria by which this
conclusion is to be determined are (proposed subsection
243-20(2)):
-
- the assets of the debtor
-
- any arrangements involving the debtor
-
- whether all the debtor's assets would be available for the
discharge of the debt, and
-
- whether the debtor and creditor are dealing with each other at
arm's length.
The third category is in proposed
subsection 243-20(3). Under this provision a loan is
treated as a limited recourse loan if there is no security provided
for the debt and it is reasonable to conclude that the rights of
the creditor are limited. The criteria by which this conclusion is
to be determined are listed in proposed subsection
243-20(3). The criteria are the same as those listed in
proposed subsection 243-20(2).
The final category of limited recourse loan is
defined in proposed subsection 243-20(4) as being
a notional loan under a hire purchase agreement. The legal fiction
of loans created in respect of hire purchase agreements
(proposed Division 240) is maintained for the
purpose of proposed Division 243 to treat such
loans as limited recourse loans.
When is a debt arrangement terminated?
The second step is to determine if a debt
arrangement has been terminated. Proposed section
243-25 lists the situations in which a debt
arrangement is treated as being terminated. A debt is treated as
being terminated if:
-
- it is actually terminated
-
- the debt is waived
-
- an agreement is made to waive or change the debt
-
- the creditor ceases to have an entitlement to recover the
debt
-
- the property acquired with the debt is given to the creditor
and part of the loan remains outstanding, or
-
- the debt becomes a bad debt.
When does proposed Division 243 apply?
The final step is to determine if the taxpayer
has obtained excessive deductions for capital allowances.
Proposed section 243-35 contains a formula for
determining if a taxpayer has obtained excessive deductions in
respect of an asset. The provision requires a taxpayer to determine
the sum of net capital allowances obtained (proposed
subsections 243-35(2)). The sum must be compared to the
capital deductions the taxpayer would have been entitled to if the
amount of unpaid debt had been taken into account (proposed
subsection 243-35(4)). The capital allowances received by
a taxpayer will be treated under proposed subsection
243-35(1) as having been excessive if the amount
calculated under proposed subsection 243-35(2)
exceeds the amount calculated under proposed subsection
243-35(4). Proposed section 243-35
ensures that a taxpayer cannot obtain additional tax benefits
because it has not fully discharged the loan.
If a taxpayer has obtained excessive capital
allowance deductions for the purposes of proposed
subsection 243-35(1), the taxpayer is required to include
the amount of the excess in its assessable income for the income
year in which the termination occurred (proposed section
243-40).
Application
The amendments relating to arrangements treated
as sale and loan generally apply from 27 February 1998
(Item 108 of Schedule 2). The amendments relating
to limited recourse debt generally apply from 27 February 1998
(Item 109 of Schedule 2).
Industry Concerns
The Minister for Financial Services and
Regulation, the Hon Joe Hockey MP, announced, in his Second Reading
Speech, that since the measures in Schedule 2 of
the Bill were first introduced (Taxation Laws Amendment Bill (No.
4) 1998), the Government had consulted with industry and
professional bodies. The Minister stated that '[t]wo major
technical changes to the original Bill are concerned with limited
recourse debt. . . . This will allow investors to refinance
assets without adverse tax consequences.' This statement refers to
proposed sections 243-15 and 243-50. Under
proposed section 243-15, if a limited recourse
debt is fully refinanced by another limited recourse debt between
parties that are dealing with each other at arm's length, the
refinancing will not result in an adjustment being made under this
measure. Although the Minister stated in his Second Reading Speech
that refinancing between arm's length parties will not be caught by
the measures, industry commentators have argued it is uncertain
whether the proposed provisions have resolved this issue.(7)
-
- The Explanatory Memorandum for Taxation Laws Amendment
Bill (No. 5) 1998, p. 8.
- Ibid.
- Ibid, p. 9.
- Ibid, p. 12.
- A full extract of the description of this measure is contained
in Treasurer's Press Release, no. 60, 13 May 1997.
- Ibid.
- The Australian Financial Review, 19 March 1999, 'New
Depreciation tax laws get a mixed response', p. 25.
Michael Kobetsky, Consultant
12 April 1999
Bills Digest Service
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ISSN 1328-8091
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