Federal Register of Legislation - Australian Government

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A Bill for an Act to amend the law relating to taxation, and for related purposes
Administered by: Treasury
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Registered 25 Jun 2015
Introduced HR 24 Jun 2015
Table of contents.

2013-2014-2015

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

HOUSE OF REPRESENTATIVES

 

 

 

tax and Superannaution laws amendment (2015 measures No. 2) BILL 2015

 

 

 

 

EXPLANATORY MEMORANDUM

 

 

 

 

(Circulated by the authority of the
Treasurer, the Hon J. B. Hockey MP)

 


Table of contents

Glossary.............................................................................................................. 1

General outline and financial impact............................................................ 3

Chapter 1              Tax relief for certain mining arrangements...................... 7

Chapter 2              Increasing the statutory effective life of in‑house software 35

Chapter 3              Income tax look-through treatment for instalment warrants and similar arrangements...................................................................... 41

Chapter 4              Company losses................................................................. 63

Index............................................................................................................... 105

 

Do not remove section break.


The following abbreviations and acronyms are used throughout this explanatory memorandum.

Abbreviation

Definition

CGT

capital gains tax

FIFO

farm-in farm-out

GST Act

A New Tax System (Goods and Services Tax) Act 1999

ITAA 1936

Income Tax Assessment Act 1936

ITAA 1997

Income Tax Assessment Act 1997

MEC group

multiple entry consolidated group

MYEFO

2014‑15 Mid‑Year Economic and Fiscal Outlook

SIS Act

Superannuation Industry (Supervision) Act 1993

TAA 1953

Taxation Administration Act 1953

TFN

tax file number

the 2014 amendments

Tax and Superannuation Laws Amendment (2014 Measures No. 3) Act 2014

UCA

uniform capital allowance


Tax relief for certain mining arrangements

Schedule 1 to this Bill provides tax relief to taxpayers entering into certain arrangements in relation to mining, quarrying and prospecting rights and information. Relief will apply to farm-in farm-out arrangements, interest realignment arrangements and expenditure relating to the improvement of mining, quarrying and prospecting information.

Date of effect: The amendments generally apply from 7:30 pm on 14 May 2013, the date of the original Budget announcement.

Proposal announced: The proposals were first announced in the 2013‑14 Budget. A further announcement was made in the 2014‑15 Budget.

Financial impact: Part 1 of Schedule 1 will have a small but unquantifiable cost to revenue. The financial impacts for Part 2 of Schedule 1 were accounted for with the passage of the Tax and Superannuation Laws Amendment (2014 Measures No. 3) Act 2014. Part 3 of Schedule 1 will have a zero financial impact.

Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights — Chapter 1, paragraphs 1.108 to 1.111.

Compliance cost impact: Low.

Increasing the statutory effective life of in-house software

Schedule 2 to this Bill amends Income Tax Assessment Act 1997 to better align the statutory effective life of in‑house software with the typical useful life of in-house software for businesses by extending the statutory effective life of in-house software from four to five years.

Date of effect: The amendments will generally apply to assets that are first used or first installed ready for use on or after 1 July 2015. The amendments to the timing of deductions for software development pools apply to expenditure incurred in income years commencing on or after 1 July 2015.

Proposal announced: This measure was announced in the 2014‑15 Mid‑Year Economic and Fiscal Outlook.

Financial impact: The measure has the following revenue implications over the forward estimates:

2014-15

2015-16

2016-17

2017-18

$140.0m

$280.0m

Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights — Chapter 2, paragraphs 2.21 to 2.24.

Compliance cost impact: This measure will result in a minor increase in compliance costs for taxpayers, estimated to be around $0.16 million each year over the forward estimates on an annualised basis.

Income tax look-through treatment for instalment warrants and similar arrangements

Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide income tax look-through treatment for instalment warrants, instalment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds. This look-through treatment ensures that most income tax consequences associated with the underlying asset of the trust flows through to the investor, and not the trustee.

Date of effect: These amendments apply to assets that are acquired by the trustee of an instalment trust in the 2007–08 or later income years. These changes, which are beneficial to taxpayers and implement industry practice, are retrospective to broadly align with the application date of the provisions which allow regulated superannuation funds to enter into certain limited recourse borrowing arrangements. A consequential amendment relating to the insertion of a definition in the ITAA 1997 dictionary applies from the day of royal assent.

Proposal announced: The former Assistant Treasurer announced the Government would proceed with this measure in a Media Release titled Integrity restored to Australia’s taxation system of 14 December 2013.

This measure was first announced by the previous Government in the 2010–11 Budget. As part of the 2011–12 Budget, the measure was extended following industry consultation to cover a larger range of arrangements.

Financial impact: This measure is estimated to have a negligible cost to revenue over the forward estimates period.

Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights — Chapter 3, paragraphs 3.79 to 3.83.

Compliance cost impact: These amendments have a low compliance cost impact, comprised of a low implementation impact and no change in ongoing compliance costs for the affected group.

Company losses

Schedule 4 to this Bill amends the company loss recoupment rules in the Income Tax Assessment Act 1997 by:

       modifying the continuity of ownership test for companies whose shares have unequal rights to dividends, capital distributions or voting power;

       ensuring that, for the purposes of applying the continuity of ownership test, the ownership of companies does not have to be traced through a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust; and

       clarifying that the entry history rule does not operate in relation to an entity that becomes a subsidiary member of a consolidated group or multiple entry consolidated group for the purposes of applying the same business test.

Date of effect: The measures to modify the continuity of ownership test for companies whose shares have unequal rights and to clarify the operation of the same business test for consolidated groups apply from 1 July 2002.

The measure to modify the continuity of ownership test so that ownership does not have to be traced through a complying superannuation fund and certain other entities applies from the 2011‑12 income year.

Proposal announced: The measures to modify the continuity of ownership test for companies whose shares have unequal rights and to clarify the operation of the same business test for consolidated groups were announced by the former government in the 2007‑08 Budget on 8 May 2007.

The measure to modify the continuity of ownership test so that ownership does not have to be traced through complying superannuation funds and certain other entities was announced by the former government in the 2011‑12 Budget on 10 May 2011.

The former Assistant Treasurer announced that the Commonwealth Government would proceed with these measures in the Assistant Treasurer’s Media Release of 14 December 2013.

Financial impact: These measures will have an unquantifiable but minimal cost to revenue.

Human rights implications: This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights — Chapter 4, paragraphs 4.130 to 4.133.

Compliance cost impact: Nil.

 


Chapter 1         
Tax relief for certain mining arrangements

Outline of chapter

1.1                  Schedule 1 to this Bill provides tax relief to taxpayers entering into certain arrangements in relation to mining, quarrying and prospecting rights and information. Relief will apply to farm-in farm-out (FIFO) arrangements, interest realignment arrangements and expenditure relating to the improvement of mining, quarrying and prospecting information.

1.2                  The relief is provided in situations where recently enacted integrity rules would otherwise operate to disadvantage taxpayers who engage in genuine exploration activities, and other legitimate arrangements.

Context of amendments

1.3                    The Tax and Superannuation Laws Amendment (2014 Measures No. 3) Act 2014 (the 2014 amendments) amended the uniform capital allowance (UCA) provisions in Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997). The 2014 amendments limited the immediate deduction available for the cost of acquiring mining rights and mining information first used for exploration (see section 40-80 of the ITAA 1997). An immediate deduction is now only available where the mining rights or information are acquired from a specified source (for example a government authority).

1.4                    The immediate deduction exists to support the exploration for resources. The explanatory memorandum to the 2014 amendments provides that the purpose of limiting the deduction was to address integrity concerns that deductions were being claimed for the acquisition of resources that had already been discovered.

1.5                    As originally announced in the 2013-14 Budget, the amendments limiting the immediate deduction would have provided relief for taxpayers entering into FIFO arrangements. The enactment of this relief, however, was deferred.

1.6                    In the 2014-15 Budget, the Government announced a further decision to provide relief to taxpayers who realign their interests in mining, quarrying and prospecting rights to facilitate common development projects. These realignments are known as interest realignment arrangements.

1.7                    Following further consultation with industry, the Government has also decided to amend section 40-80 to overcome a technical issue that may have prevented some taxpayers from claiming immediate deductions for expenditure incurred in enhancing mining, quarrying or prospecting information.

Operation of the current law

Disposals of mining, quarrying and prospecting rights generally

1.8                    Interest realignment and FIFO arrangements involve the disposal of mining, quarrying or prospecting rights. The current law applies differently depending on when the rights were acquired. Disposals of rights acquired between 20 September 1985 and 1 July 2001 (pre-UCA rights) are subject to the capital gains tax (CGT) rules. Disposals of rights acquired from 1 July 2001 (UCA Rights) are subject to the UCA regime, which commenced on that date (see section 40-77 of the Income Tax (Transitional Provisions) Act 1997).

1.9                  Expenditure that was incurred in acquiring pre-UCA assets is included in the cost base of the asset for CGT purposes. The capital gain or capital loss on the disposal of the right is recognised under the CGT rules. Generally, a capital gain or capital loss is the difference between:

       the capital proceeds received by a taxpayer when a CGT event happens to an asset; and

       the cost base of the asset.

1.10              Generally, where an asset has been disposed of for non-cash consideration, the capital proceeds received are taken to include the market value of the property the taxpayer receives, or is entitled to receive, in respect of the CGT event happening (paragraph 116-20(1)(b) of the ITAA 1997).

1.11                For UCA rights, taxpayers may deduct an amount equal to the decline in value of the right (depreciating asset) they hold during an income year. The decline in value is generally worked out by reference to the effective life of the depreciating asset.

1.12                When a UCA right is disposed of, a balancing adjustment event is triggered (section 40-285 of the ITAA 1997). This adjustment brings to account any difference between the tax written-down value (adjustable value) of the asset and the amount received on disposal (termination value). If the termination value exceeds the adjustable value, the difference is included in assessable income. Deductions are generally available if the adjustable value exceeds the termination value.

1.13                Generally, where a UCA right is disposed of for non-cash consideration, the termination value of the right includes the market value of any benefits received (item 4 of the table in subsection 40-305(1) of the ITAA 1997). Similarly, where a depreciating asset has been acquired for non-cash consideration, the first element of the asset’s cost includes the market value of that non-cash consideration (item 4 of the table in subsection 40‑185(1) of the ITAA 1997).

Interest realignment arrangements

1.14                An interest realignment occurs where the parties to a joint venture exchange interests in mining, quarrying or prospecting rights to pursue a single development project, with a view to aligning the ownership of individual rights with the ownership of the overall venture.

Example 1.1: Simple interest realignment example

Two mining companies own mining rights with respect to separate tenements, each worth $25 million. The two companies decide to form a joint venture as equal partners to develop the two tenements as a single project. As part of the joint venture, each company transfers 50 per cent of their original right to the other. Both companies now own 50 per cent of each right, collectively the common development project.

Each company’s rights now reflect their interest in the common development project. This is an example of an interest realignment arrangement.

1.15                When parties enter into an interest realignment arrangement, a balancing adjustment event occurs to each party in relation to the rights disposed of. An amount is immediately brought to account reflecting the difference between the market value of the new right and the adjustable value of the original right. Prior to the 2014 amendments, each party would be entitled to an immediate deduction for each right acquired under the arrangement if they subsequently first used their new right for exploration or prospecting. This would result in a tax neutral outcome provided there was no other consideration involved.

1.16                The cost of the new right acquired, however, will not qualify for an immediate deduction under the amended section 40-80. The cost of the new right (that includes the market value of the original right) is deductible only over the lesser of the new right’s effective life or 15 years. This outcome is not necessary to achieve the integrity objectives of the 2014 amendments and may have the effect of impeding interest realignment arrangements that encourage the joint development of resource discoveries.

Example 1.2: Interest realignment tax outcomes

Further to Example 1.1, the termination value of each company’s transferred right is $12.5 million (the market value of the new right received). Assuming the parties were previously entitled to an immediate deduction for the costs of the rights, $12.5 million will be included in each company’s assessable income. The 2014 amendments apply to the companies and the companies are not entitled to an immediate deduction for the cost of the new rights. The cost of each new right ($12.5 million) is deductible to its acquirer over the lesser of the asset’s effective life or 15 years. This produces a net income tax liability in the income year in which the realignment occurs.

Farm-in farm-out arrangements

1.17                A FIFO arrangement broadly involves the exchange of an interest in a mining, quarrying or prospecting right in return for an ‘exploration benefit’, usually an entitlement to receive exploration services or to have exploration expenditure funded by the other party. The initial owner of the right is known as the farmor. The person providing the exploration benefit in exchange for a part of the right is known as the farmee. The farmee may provide other consideration or commitments that do not relate to exploration benefits.

1.18                There are two broad types of FIFO arrangements — immediate transfers and deferred transfers. An immediate transfer occurs where the farmor transfers the right at the time the farm out agreement is entered into. A deferred transfer farm-out occurs where the farmor provides a right or option to the farmee to have right transferred to them after the agreed exploration or prospecting is carried out.

1.19                Under either type of arrangement, the farmee may agree to meet the expenses of the farmor in holding the farmor’s right so the farmor is ‘free carried’ in respect of its retained right in the tenement. This free‑carried commitment may include land tax payments and licence fees in addition to exploration commitments in relation to the farmor’s retained right. This is in addition to any expenses the farmee meets for their own costs in owning, or potentially owning, a right in the tenement.

1.20                The tax treatment of FIFO arrangements, prior to the 2014 amendments, is outlined in the Australian Tax Office’s Miscellaneous Tax Rulings MT 2012/1 and MT 2012/2. Under these rulings, a FIFO arrangement will generally have tax neutral outcomes for the farmor and the farmee to the extent the arrangement involved exploration benefits. However, where the arrangement includes the payment of cash or other consideration for the farmor’s original right, tax consequences may arise.

1.21                The rulings’ broadly tax neutral outcome relied on the availability of an immediate deduction under section 40-80 for the farmee’s cost of acquiring the right. This deduction would offset an amount that is included in the farmee’s assessable income that reflected the value of the mining, quarrying or prospecting right received as a reward for services or as the capital proceeds of CGT event D1 (creating a contractual right in another entity).

1.22                In light of the 2014 amendments, an immediate deduction will be unavailable and the farmee’s cost will only be deductible over the lesser of the right’s effective life or 15 years. Further amendments are necessary to ensure that FIFO arrangements do not have these tax consequences where those consequences could impede genuine exploration activity.

Improvements to mining, quarrying or prospecting information

1.23                Paragraph 40-80(1)(e) of the ITAA 1997 outlines some of the limitations on when a taxpayer can claim an immediate deduction for the costs of acquiring mining, quarrying or prospecting information. The limitations relate to where the taxpayer sources the information.

1.24                Paragraph 40-80(1AB)(d) provides that a taxpayer will not be entitled to an immediate deduction for the cost of improving information (a second element cost) if the information does not satisfy paragraph 40‑80(1)(e).

1.25                The operation of this criterion may mean that taxpayers are not entitled to immediate deductions for the expenditure incurred in improving mining information themselves. In those circumstances, providing an immediate deduction is appropriate and does not raise the integrity concern addressed through the 2014 amendments.

Summary of new law

1.26                Schedule 1 to this Bill provides tax relief for taxpayers entering into arrangements that support genuine exploration activity and other arrangements that do not raise integrity concerns.

1.27                Part 1 of Schedule 1 provides roll-over relief for taxpayers entering into interest realignment arrangements.

1.28                Part 2 provides a number of relief mechanisms for taxpayers entering into FIFO arrangements.

1.29              Part 3 amends section 40-80 to allow taxpayers to claim immediate deductions for expenditure that relates to certain improvements to mining, quarrying or prospecting information, regardless of how the original information was acquired.

Comparison of key features of new law and current law

New law

Current law

Interest Realignment Arrangements

A CGT roll-over will apply in relation to mining, quarrying or prospecting rights acquired prior to 1 July 2001 and disposed of under an interest realignment arrangement.

A balancing adjustment event roll‑over will apply to arrangements involving rights acquired on or after 1 July 2001.

Interest realignment arrangements will often result in a tax liability arising in the form of a capital gain or depreciating asset balancing adjustment event. Any liability will not be offset as the new right acquired is ineligible for an immediate deduction under section 40-80 of the ITAA 1997.

Farm-in Farm-out Arrangements

Consequences for Farmor

The market value of any exploration benefits received is treated as zero when working out the capital proceeds of the CGT event.

CGT event A1 occurs to the farmor when, under a FIFO arrangement, they dispose of a mining, quarrying or prospecting right acquired before 1 July 2001.

The termination value of the part of the right transferred will be reduced by the value of the exploration benefit received.

The adjustable value of the entire right is allocated to the cost of the retained part when the right is split immediately before the balancing adjustment event.

A balancing adjustment event occurs to the farmor when, under a FIFO arrangement, they transfer part of a mining, quarrying or prospecting right acquired after 1 July 2001.

For the balancing adjustment event, the termination value of the part disposed of includes the market value of exploration benefits received under the arrangement.

Farm-in Farm-out Arrangements

Consequences for Farmor

The farmor is not entitled to deduct the expense.

The farmor is entitled to a deduction for the expenditure incurred in acquiring the exploration benefit (section 40-730 or section 8-1 of the ITAA 1997). The expenditure is the market value of the part of the mining, quarrying or prospecting right transferred in return for the exploration benefit.

The cost base and reduced cost base of the contractual right are reduced by the market value of the contractual right.

The market value of any exploration benefits received is treated as zero when working out the capital proceeds of CGT event C2.

On entering into a FIFO arrangement, the farmor will acquire a CGT asset that is the contractual right to receive exploration benefits. CGT event C2 occurs to the farmor when it receives exploration benefits.

Consequences for Farmee

The receipt of the mining right is treated as non-assessable non-exempt income.

CGT event D1 does not occur if the right created in the other entity (the farmor) is a right to receive an exploration benefit under a FIFO arrangement.

The receipt of a mining, quarrying or prospecting right under a FIFO arrangement is assessable to the farmee under sections 6-5 or 15-2 of the ITAA 1997 to the extent that it is a reward for the service of providing exploration benefits.

The receipt is also treated as the capital proceeds of CGT event D1.

The first element of the cost of the mining, quarrying or prospecting right received is reduced by the market value of the exploration benefits provided.

The first element of the farmee’s cost of acquiring the mining, quarrying or prospecting right includes the market value of exploration benefits provided under the arrangement.

Improvements to Mining Information

Certain expenditure incurred in improving mining, quarrying or prospecting information is entitled to an immediate deduction, regardless of how the original information was acquired.

Expenditure incurred in improving mining, quarrying or prospecting information is only entitled to an immediate deduction if the original information was acquired from specified sources.

Detailed explanation of new law

Part 1: Interest realignment arrangements

1.30                Roll-over relief is provided for taxpayers who enter into interest realignment arrangements. An interest realignment arrangement is an arrangement that involves two or more parties that each hold mining, quarrying or prospecting rights that relate to a common development project the parties propose to undertake jointly. The project must relate to mining or quarrying operations as defined in subsection 40-730(7) of the ITAA 1997. The project may already exist or it may be a proposed project. [Schedule 1, item 1, paragraph 40-363(5)(a) of the ITAA 1997]

1.31                The effect of the arrangement must be to align the interests that each party has in each right with their interest in the common development project. The interests of the parties in the common development project are to be determined by reference to the estimated resources and reserves underlying the relevant rights. The estimation of resources and reserves is to be conducted using an appropriate industry practice. [Schedule 1, item 1, subsections 40-363(6) and (7), and paragraph 40‑363(5)(b) of the ITAA 1997]

1.32                The arrangement must not involve any other transfer of a mining, quarrying or prospecting right. [Schedule 1, item 1, paragraph 40‑363(5)(c) of the ITAA 1997]

1.33                It is not necessary that the rights exchanged relate to tenements with close geographical proximity provided they form part of the same project or proposed project. [Schedule 1, item 1, paragraph 40‑363(5)(a) of the ITAA 1997]

1.34                The exact form of roll-over relief will depend on the type of rights disposed of under the arrangement. Generally:

       where the original rights were acquired after 1 July 2001 (UCA rights), balancing adjustment roll-over relief will be available;

       where the original rights were acquired between 20 September 1985 and 1 July 2001 (post-CGT and pre-UCA rights), CGT roll-over relief will apply. Rights received under the arrangement will be deemed to have been acquired during that period; and

       where the original rights were acquired prior to 20 September 1985 (pre-CGT rights), the rights received under the arrangement will have pre-CGT status.

Uniform capital allowance balancing adjustment relief

1.35                Balancing adjustment event roll-over relief applies to interest realignments where the taxpayer’s original interest was acquired after 1 July 2001. [Schedule 1, item 1, subsection 40-363(1) of the ITAA 1997]

1.36                Taxpayers may choose to apply the roll-over. The choice must be made in writing when the taxpayer lodges their income tax return for the relevant income year. The Commissioner of Taxation may allow a longer period. [Schedule 1, item 1, subsection 40-363(2) of the ITAA 1997]

1.37                The effect of the roll-over is that a standard balancing adjustment (section 40-285) does not occur. [Schedule 1, item 1, paragraph 40‑363(3)(a) of the ITAA 1997]

1.38                The adjustable value of the taxpayer’s original right disposed of under the arrangement is transferred to the cost of the new right the same taxpayer received. [Schedule 1, item 1, paragraph 40‑363(3)(c) of the ITAA 1997]

Other Proceeds

1.39                As part of an interest realignment, a taxpayer may also provide or receive consideration other than mining, quarrying and prospecting rights. Consideration in the form of money is a common example that is often exchanged when parties have rights that do not equate to their interest in the common development project.

1.40                For the party to an interest realignment that provides other consideration (the payer), the amount, or an equivalent amount, is added to the cost of the right received (see for example item 1 of the table in subsection 40‑185(1) of the ITAA 1997).

1.41                For the party receiving the consideration (the payee), the amount of other consideration (and only that amount) is included in their assessable income in the income year in which the balancing adjustment event occurred. This is achieved by deeming the adjustable value of the right provided to be the market value of the right received and applying an otherwise standard balancing adjustment calculation (termination value less adjustable value). [Schedule 1, item 1, subsection 40-363(4) and paragraph 40‑363(3)(b) of the ITAA 1997]

Example 1.3: Interest realignment with additional consideration

Brian and Mark are partners in a mining operation and each owns mining rights relating to the project. Each partner acquired his right after 1 July 2001.

Brian and Mark agree to enter into an interest realignment such that they will each hold a 50 per cent interest in each of the original rights. This will align with their interests in the joint venture.

Brian’s agrees to transfer 50 per cent of his right. That 50 per cent part has an adjustable value of $100 million. Mark agrees to transfer 50 per cent of his right. Mark’s 50 per cent part has an adjustable value of $50 million.

Brian’s right is expected to contain more resources than Mark’s right and is more valuable to the joint venture. Mark, therefore, agrees to transfer $50 million to Brian in addition to providing the 50 per cent interest in his mining right.

The $50 million is included in Brian’s assessable income and added to the cost of Mark’s new right. This reflects that Brian is disposing of a significant portion of his right for cash, which is not subject to the roll‑over relief offered for the exchange of rights.

Mark has not received any consideration other than a mining right so no amount will be included in his assessable income. The adjustable value of Mark’s original right is transferred to the cost of Mark’s new right. To this, Mark adds $50 million, being the amount of other consideration provided, for a total cost of $100 million.

The cost of Brian’s new right is $100 million, being the adjustable value of Brian’s original right.

Capital gains tax relief

1.42                CGT roll-over relief applies to interest realignments where the taxpayer’s original right was acquired prior to 1 July 2001.

1.43                The consequences, generally, for the roll-over are that any capital gain or loss is disregarded and the cost base of the original right disposed of is transferred to the right acquired. The specific consequences are detailed in existing Subdivision 124-A and new Subdivision 124-S. [Schedule 1, item 2, sections 124-1220 and 124-1225 of the ITAA 1997]

1.44                Where more than one right is provided, or more than one new right is received, the cost base of each new right must be determined on a reasonable basis. This allocation of the original cost base or cost bases is by reference to the number, market value and character of the original and new rights. [Schedule 1, item 2, section 124-1235 of the ITAA 1997]

1.45                The character of the rights could refer to the estimated resources or reserves of the rights, provided this was a reliable comparator, or other features. The reference to market value does not require a professional valuation to be obtained but is included as a factor to be considered when selecting a particular characteristic, such as resources, on which to allocate cost bases to achieve the required reasonable allocation of cost bases.

Other proceeds

1.46                Consideration other than mining, quarrying and prospecting rights are not eligible for CGT roll-over relief (they are ineligible proceeds and are attributed to an ineligible part of the original right). A partial roll-over remains available for the eligible part of the transaction. [Schedule 1, item 2, section 124‑1230 of the ITAA 1997]

1.47                For the party to an interest realignment that provides other consideration (the payer), the amount, or an equivalent amount, is added to the cost base of the right received. [Schedule 1, item 2, subsections 124‑1225(2) and (3) of the ITAA 1997]

1.48                The mechanism for assessing the ineligible proceeds differs slightly from the mechanism that applies to UCA rights. Under the UCA roll-over, all of the proceeds other than the relevant rights are assessable and the entire adjustable value of the original right is transferred to the new right.

1.49                Under the CGT roll-over, the cost base is apportioned between the eligible and ineligible parts of the original right and only that part that relates to the eligible part is used in the roll-over. A standard CGT event applies in relation to both the ineligible proceeds and the ineligible part of the original cost base reasonably allocated to that part. As a result, some of the cost base may be applied to reduce the amount of any capital gain arising from the ineligible proceeds.

Example 1.4: CGT interest realignment with additional consideration

Assume the same facts as in Example 1.3 except that both Mark and Brian acquired their interests between 20 September 1985 and 1 July 2001. Assume that the cost bases of their rights are equal to the adjustable value of those rights in Example 1.3.

Brian receives $50 million in cash that is an ineligible proceed. The cost base of his transferred right ($100 million) is apportioned between the eligible and ineligible parts of the right on a reasonable basis. Assume that this apportionment results in a $25 million cost base for the ineligible part and $75 million for the eligible part.

Brian makes a $25 million capital gain ($50 million cash proceeds less $25 million ineligible part cost base). Any capital gain or loss made on the eligible part of the interest is disregarded. The cost base and reduced cost base of Brian’s new interest is $75 million, the cost base of the eligible part.

Mark receives a complete roll-over. He makes no capital gain or loss and the cost base of his original interest ($50 million) is transferred to the new interest he received. To this, Mark adds $50 million, being the amount of other consideration provided, for a total cost base of $100 million.

Preserving uniform capital allowance and capital gains tax status of rights

1.50                Where a taxpayer disposes of a right under an interest realignment arrangement, the replacement right should have the same status as if it was acquired at the same time as the original asset.

1.51                That is, if the original asset has a pre-CGT status because it was acquired prior to 20 September 1985, the right received under the arrangement will continue to have the same status. [Schedule 1, item 2, section 124-1240 of the ITAA 1997]

1.52                A similar outcome arises for assets acquired between 20 September 1985 and 1 July 2001. Such an asset is a post-CGT and pre‑UCA asset. If disposed of under an interest realignment arrangement, the replacement right will have the same status as if it had been acquired during that period. [Schedule 1, item 4, subsection 40-77(1D) of the Income Tax (Transitional Provisions) Act 1997]

Disposals of multiple rights

1.53                There may be occasions where a party to an interest realignment arrangement is disposing of multiple rights. Some of those rights may have different CGT and UCA statuses. Indeed, it is possible that a taxpayer could dispose of a pre-CGT asset, a pre-UCA CGT asset and a UCA asset.

1.54                In these situations, each new right acquired will be split into two or three notional assets. This ensures that, following the roll-over, the taxpayer is in the same position in relation to the value of assets with specific tax characteristics. Different mechanisms apply depending on what combination of rights and asset statuses are disposed of under the arrangement.

1.55              Where a taxpayer disposes of both pre-CGT and post-CGT assets (but no UCA assets), each asset received under the arrangement is split into two assets, a pre-CGT asset and a post-CGT asset. The cost base of the post-CGT asset is determined by allocating the total cost bases of the original post-CGT assets between the new rights in proportion to the market values of each right received (disregarding the split). [Schedule 1, item 2, section 124-1245 of the ITAA 1997]

Example 1.5: Pre-CGT and Post-CGT Right Roll-Over

Paul has three mining rights, parts of which he disposes of under an interest realignment arrangement. The parts disposed have the following characteristics:

Right

CGT Status

Market Value

Cost Base

Right A

Pre-CGT

$100 million

NA

Right B

Post-CGT

$180 million

$110 million

Right C

Post-CGT

$120 million

$90 million

Under the arrangement, Paul receives two new mining rights. The rights have market values of $150 million and $250 million respectively.

Each new right is split into two assets, a pre-CGT asset and a post‑CGT asset.

Paul applies the statutory formula:

The total of the cost bases of the original post-CGT rights is:

The total of the market values of the new rights is:

The cost base of the post-CGT asset split from the first new right (market value $150 million) is:

The cost base of the post-CGT asset split from the second new right (market value $250 million) is:

1.56                Where the assets disposed of include UCA assets and pre-UCA assets, the rights received will be split to include a notional new UCA asset. The other split asset will be either a pre-CGT asset or post-CGT asset according to the status of the pre-UCA assets disposed of. If assets of all three statuses are disposed of, the rights received are split into three notional assets and the rules outlined in paragraph 1.55 and Example 1.5 apply to the two pre-UCA assets. [Schedule 1, item 2, section 124-1250 of the ITAA 1997]

1.57                To the extent a taxpayer disposes of UCA rights, the new right will also be a UCA right. [Schedule 1, item 4, subsection 40-77(1E) of the Income Tax (Transitional Provisions) Act 1997]

Interest realignment adjustments

1.58                An interest realignment adjustment occurs where, pursuant to the interest realignment arrangement, additional payments are made between the parties because of changes in the perceived contributions of the parties to the common development project. This may arise where the estimates about the level of resources or reserves in each right are varied. The interest realignment arrangement may provide that the party that is now believed to have contributed less resources or reserves to the project should provide additional consideration to the other parties. [Schedule 1, item 1, subsection 40‑364(7) of the ITAA 1997]

1.59                Where additional consideration is received under an interest realignment adjustment, a similar outcome will apply as if the consideration was made upfront. The only difference is that the tax outcome will arise in the income year in which the adjustment payment is made (it will not be necessary to reopen an earlier income tax assessment).

1.60                The amount of any adjustment payment will be included in the payee’s assessable income and the payer’s cost (or cost base) for their right received. The outcome will apply to any adjustment to the extent it included consideration other than a mining, quarrying or prospecting right. [Schedule 1, item 1, subsections 40‑364(1) and (2) of the ITAA 1997]

1.61                If the interest realignment adjustment takes the form of a contribution of an additional mining right, the adjustment provisions will not apply. This transaction would be treated as a new interest realignment arrangement. [Schedule 1, item 1, subsection 40‑364(7) of the ITAA 1997]

1.62                Further amendments are made to disregard the tax consequences of the contractual right that exists between the parties in relation to the adjustment:

       The market value of the contractual right is not included in the termination value of the recipient’s original mining, quarrying or prospecting right. [Schedule 1, item 1, subsection 40‑364(3) of the ITAA 1997]

       The market value of the contractual right is not included in the cost of a mining, quarrying or prospecting right acquired by the person providing the contractual right. [Schedule 1, item 1, subsection 40‑364(4) of the ITAA 1997]

       CGT events D1 and D3 do not occur to the person who provides the contractual right. [Schedule 1, item 1, subsection 40‑364(5) of the ITAA 1997]

       CGT event C2 does not occur to the person who receives an adjustment under a contractual right. [Schedule 1, item 1, subsection 40‑364(6) of the ITAA 1997]

Example 1.6: Interest realignment adjustments

Further to Example 1.3, 12 months after the interest realignment, additional estimates of the resources in the common development project are made. The estimates reveal that Brian’s original right had even more resources than expected while the estimate of resources in Mark’s original right remains unchanged.

Pursuant to the terms of the interest realignment arrangement, Mark provides an additional $10 million to Brian. Brian includes the $10 million in his assessable income. Mark includes the $10 million in the second element cost of the right he received from Brian. This inclusion increases the remaining adjustable value of the right (see section 40-85).

Part 2: Farm-in farm-out arrangements

1.63                Tax relief is provided to taxpayers entering into FIFO arrangements that support exploration and prospecting operations. A FIFO arrangement is eligible for tax relief if it is an arrangement where the farmor (or transferor):

       transfers part of their mining, quarrying or prospecting right to the farmee (an immediate transfer); or

       agrees to a future transfer or grants an option in relation to a future transfer (a deferred transfer),

in return for the farmee (or transferee) agreeing to provide exploration benefits to the farmor. Other consideration may be involved in the arrangement; however, this consideration will not be eligible for tax relief. [Schedule 1, item 10, subsection 40-1100(1)]

Exploration benefits

1.64                The concept of exploration benefits is critical to the existence of an eligible FIFO arrangement and the extent of tax relief provided. The relief is intended to support exploration activities. Benefits provided under a FIFO arrangement that are not exploration benefits are not eligible to receive tax relief.

1.65                Exploration benefits includes two types of activity undertaken by a farmee on the farmor’s behalf:

       The farmee may conduct the exploration activities itself or it may directly engage the service of a third party to undertake the activities. [Schedule 1, item 10, subparagraph 40-1100(2)(a)(i) of the ITAA 1997]

       Alternatively, the farmee may free-carry the farmor in respect of exploration expenses. That is, the farmee may meet, on the farmor’s behalf, the obligations that the farmor incurs during the term of the arrangement. The farmor may incur these expenses undertaking exploration activities itself or when another entity (an operator) issues cash-calls to the farmor with respect to exploration.

If the farmee provides reimbursements to the farmor for expenses paid by the farmor, the expenses must have been incurred, by the farmor, during the term of the arrangement. Reimbursement of expenses incurred prior to the FIFO arrangement is not an exploration benefit. [Schedule 1, item 10, subparagraph 40‑1100(2)(a)(iii) of the ITAA 1997]

1.66                Two limitations apply to the concept of what may be an exploration benefit. These limitations ensure the benefits relate to exploration of the farmor’s retained right and do not relate to the farmee’s right or to expenditure on development or production.

       Firstly, the benefit must be on the farmor’s behalf and must relate to the part of the farmor’s right not transferred under the arrangement. [Schedule 1, item 10, paragraph 40-1100(2)(b) of the ITAA 1997]

      In an immediate transfer, the benefit must relate to the farmor’s retained right.

      In a deferred transfer arrangement, the benefit must relate to that part of the farmor’s right that is not liable to be transferred.

If the farmee undertakes to explore the entire right originally owned by the farmor, only that portion of the exploration that relates to the farmor’s ultimately retained right is an eligible exploration benefit. Exploration to the extent that the farmee has an option or other right to acquire the right is not an exploration benefit provided to the farmor.

       Secondly, the expenditure must be of a kind that would be exploration expenditure deductible to the farmor if the farmor had undertaken the activity itself. That is, the expenditure must be of a kind referred to in section 40-730 or that would have been included the farmor’s cost of its mining, quarrying or prospecting information or in the cost of another depreciating asset that satisfied section 40-80. [Schedule 1, item 10, paragraphs 40-1100(2)(c) and (d) of the ITAA 1997]

1.67                The references to section 40-730 in subparagraphs 40‑1100(2)(c)(iii) and (d)(iii) are intended to apply to any payment that would be deductible to the farmor for the exploration activities referred to.

1.68                In some cases, an amount may be ineligible for a deduction under section 40-730 merely because it was eligible under another provision, such as section 8-1 (see section 8-10). Such amounts nevertheless satisfy the requirement in subparagraphs 40-1100(2)(c)(iii) and (d)(iii).

1.69                It is not sufficient that an amount satisfy subsection 40-730(1) if it is an amount to which subsections 40-730(2) or (3) applies. These include expenditure on development drilling for petroleum, expenditure on working a mining property and expenditure that is included in the cost of a depreciating asset. An amount also fails the requirements of the provision if the amount would be deductible under subsection 40-730(1) but is not deductible because of some other provision of the ITAA 1997. [Schedule 1, item 10, subsection 40-1100(3) and subparagraphs 40-1100(2)(c)(iii) and (d)(iii) of the ITAA 1997]

1.70                An exploration benefit includes the right to receive an exploration benefit. [Schedule 1, item 10, subparagraphs 40-1100(2)(a)(ii) and (iv) of the ITAA 1997]

Example 1.7: Exploration benefits

A farmor and farmee are parties to a FIFO arrangement and are equal partners in a joint venture. The venturers establish a joint venture operator to manage exploration activities for the project. The operator is responsible for paying for exploration activities. The operator is funded by cash-calls on the venturers. Cash-call funds are placed in the joint venture’s cash account and remain the property of the venturer who placed them there. When they are expended, they are expended on behalf of the venturers and the venturers incur that expenditure in proportion to their participating interest in the project.

Each time the venture operator calls for funds for exploration or prospecting, each venturer would normally contribute 50 per cent of the funds. The venture operator would then expend those funds on behalf of each of the venturers.

However, under the terms of the venturers’ FIFO arrangement, the farmee has agreed to meet all of the cash calls made on the farmor. In return, the farmor has agreed to a deferred transfer of part of its mining right to the farmee. Following the potential transfer, each venturer would own 50 per cent of the mining right.

Following the establishment of the arrangement, the operator issues cash calls to meet a $10 million exploration expense. Each venturer incurs an expense of $5 million because they are equal partners in the venture. Under the terms of the FIFO arrangement, the farmee contributes $10 million to the joint venture account, which the operator then expends.

The farmee has provided an exploration benefit of $5 million being the amount that related to the right the farmor intends to retain.

Consequences for the farmor

Tax relief for the farmor

1.71                For the farmor, the value of any consideration received for disposing of a right under a FIFO arrangement is reduced, for tax purposes, to the extent the consideration is an exploration benefit.

1.72                For a UCA right disposed of, the termination value of the right is reduced by the market value of the exploration benefit. Because the termination value ordinarily includes the market value of any exploration benefits received, it is not necessary to calculate the market value of the exploration benefit. The amounts offset each other. [Schedule 1, item 10, section 40-1105 of the ITAA 1997]

1.73                If the right disposed of was a pre-UCA right, the capital proceeds of the CGT event are reduced by the same amount because the market value of the exploration benefits is deemed to be zero. [Schedule 1, item 16, subsection 116-115(1) of the ITAA 1997]

1.74                On entering into the FIFO arrangement, the farmor will ordinarily acquire a contractual right to receive exploration benefits. This right is a CGT asset. When the contractual right is satisfied or partially satisfied (eg because the farmor receives the promised exploration benefits), CGT event C2 occurs to the farmor. The cost base and reduced cost base of this contractual right is reduced by the market value of the entitlement to receive exploration benefits. [Schedule 1, item 10, section 40‑1120 of the ITAA 1997]

1.75                To prevent any capital gain from arising in relation to exploration benefits received pursuant to the contractual right, the capital proceeds of the event are deemed to be zero to the extent they are exploration benefits. [Schedule 1, item 16, subsection 116-115(2) of the ITAA 1997]

Example 1.8: Tax relief for the farmor

A farmor enters into a FIFO arrangement. The farmor immediately transfers a part of his mining right to the farmee. The part of the right has an adjustable value of nil.

In return, the farmor receives $2 million cash and a contractual right to receive exploration benefits. The termination value of the farmor’s transferred mining right is $2 million, being the cash received. The market value of the contractual right would be included (item 4 of the table in subsection 40-305(1)) but the termination value is reduced by the same amount under the amendments (section 40-1105).

The farmor has a balancing adjustment event and includes $2 million in its assessable income ($2 million termination value less a nil adjustable value).

In the following year, the farmee provides a number of exploration benefits to the farmor pursuant to the arrangement. CGT event C2 occurs to the farmor, as the contractual right to receive exploration benefits is satisfied, in whole or in part. However, the cost base of the contractual right and capital proceeds of the CGT event are both nil (assuming no incidental costs). Therefore, no capital gain or loss arises.

Allocation of farmor’s adjustable value

1.76                When the farmor transfers part of a right, the right is taken to have been split into two depreciating assets immediately before the disposal (section 40-115). The adjustable value of the entire asset is normally apportioned to become the cost of each split asset (section 40‑205).

1.77                Under a FIFO arrangement, however, the entire adjustable value is allocated to the retained part. The farmor may still attribute a reasonable proportion of the incidental costs of splitting the mining, quarrying or prospecting right to the part disposed of under the arrangement. [Schedule 1, item 10, section 40‑1110 of the ITAA 1997]

Example 1.9: Allocation of farmor’s adjustable value

A farmor acquires a mining right for a cost of $60 million. The farmor is not entitled to an immediate deduction under section 40-80. The farmor enters into a FIFO arrangement and agrees to an immediate transfer of half of the right. In return, the farmor receives exploration benefits and $10 million in cash. The farmor’s cost incurred in splitting the mining right is $500,000.

The adjustable value of the mining right remained at $60 million immediately prior to the arrangement (no depreciation having been claimed). The right is split into two new assets, the retained part and the disposed part.

The cost of the retained part is $60.25 million, the adjustable value of the original right ($60 million) plus a reasonable proportion of the cost of splitting the asset (50 per cent of $500,000, or $250,000).

The cost of the disposed part is $250,000. This is the cost of the disposed part to the farmor immediately before the transfer. It is used only for the purposes of the farmor’s balancing adjustment calculation and does not influence the farmee’s cost of acquiring the right.

A balancing adjustment event occurs to the farmor. The termination value of the disposed part is $10 million. The adjustable value of the disposed part is its cost to the farmor, $250,000. The farmor will have $9.75 million included in its assessable income.

1.78                The allocation of the farmor’s adjustable value in this way supports the integrity of the 2014 amendments. If a taxpayer acquires a mining right in circumstances that do not qualify the taxpayer to an immediate deduction under section 40-80, the mining right will have a significant adjustable value. If a taxpayer were eligible to claim, in effect, an immediate deduction by disposing of part of the right under a FIFO arrangement, the integrity introduced in the 2014 amendments would be reduced.

Limits to corresponding deductions of the farmor

1.79                To ensure tax neutral outcomes, some corresponding deductions and other benefits are reduced to the extent of the tax relief provided.

1.80                A farmor is not entitled to a deduction (generally a section 40‑730 deduction) for expenditure that is the expenditure of a part of its original mining, quarrying or prospecting right. [Schedule 1, item 10, subsection 40-1115(1) of the ITAA 1997]

1.81                To the extent that a farmor incurs an exploration or prospecting expense that is met by the farmee under a free-carry commitment, the deductibility of that expense to the farmor is reduced (see Example 1.10). This applies to all deductions, including those that arise from exploration or prospecting expenditure and immediate deductions available because the expenditure is included in the cost of a depreciating asset first used for exploration or prospecting. [Schedule 1, item 10, subsection 40-1115(2) of the ITAA 1997]

1.82                Consistently, if the farmor improves mining, quarrying or prospecting information they hold because they have received an exploration benefit, the farmor is not entitled to include any expenditure in the cost of the information to the extent it relates to exploration benefits received. [Schedule 1, item 10, section 40-1125 of the ITAA 1997]

Consequences for the farmee

1.83              For the farmee, any tax outcome arising from entering into the FIFO arrangement is reduced to the extent the farmee agrees to provide exploration benefits. Any income that would be included in the farmee’s assessable income because it was a reward for providing exploration benefits is treated as non-assessable non-exempt income. [Schedule 1, item 10, paragraph 40-1130(1)(b) of the ITAA 1997]

1.84                Similarly, CGT event D1 does not apply to bring about a capital gain for the farmee for creating a right in the farmor to receive exploration benefits. [Schedule 1, items 11 and 12, paragraphs 104-35(5)(f) and (g) of the ITAA 1997]

1.85                To ensure a tax neutral outcome, the depreciable cost of the transferred right in the hands of the farmee is reduced by the market value of the exploration benefits provided. Because the cost of the right ordinarily includes the market value of any exploration benefits provided, it is not necessary to calculate the market value of the exploration benefit. The amounts offset each other. [Schedule 1, item 10, paragraph 40-1130(1)(a) and subsection 40-1130(2) of the ITAA 1997]

1.86                Consideration other than the provision of exploration benefits is included in the cost of the farmee’s received right under the general rule in section 40-185 and is not modified by these amendments.

Availability of section 40-730 deductions

1.87                A farmee is generally entitled to a deduction under section 40‑730 for expenses incurred in conducting or funding exploration or prospecting on the farmor’s behalf.

1.88                When the farmee undertakes to fund exploration, the amount of the farmee’s commitment may be known and ascertainable or it may be contingent or other factors. It is intended that the same tax consequences should follow, regardless of whether the amount is known and ascertainable at the time of the FIFO arrangement. To achieve this, an amendment is required to deal with the interaction between known and ascertainable amounts and the availability of a section 40-730 deduction.

1.89                A known and ascertainable amount is included in the cost, to the farmee, of the mining, quarrying or prospecting right received under a FIFO arrangement (items 1 and 2 of the table in subsection 40‑185(1) of the ITAA 1997). When the farmee incurs the expense of this amount, a deduction under section 40-730 is denied because the amount has been included in the cost of the mining right received (subsection 40-730(3)).

1.90                This denial is inappropriate in the context of exploration benefits; the inclusion of the amount in the farmee’s cost is only notional because of the adjustment referred to in paragraph 1.85. An amendment is made to ensure that subsection 40‑730(3) does not apply to such known and ascertainable amounts that are also exploration benefits. [Schedule 1, item 10, paragraph 40‑1130(1)(c) of the ITAA 1997]

1.91                No amendment is required in the context of funding that is not known and ascertainable at the time of the FIFO arrangement. Such amounts are not included in the cost of the farmee’s mining, quarrying or prospecting right directly. What is included in the farmee’s cost is the market value of the undertaking, a non-cash benefit (item 4 of the table in subsection 40‑185(1)). When the expenditure is incurred, subsection 40‑730(3) does not apply to limit the availability of a section 40-730 deduction.

Example 1.10: Exploration benefits and section 40-730

A farmee enters into a FIFO arrangement. In return for receiving part of the farmor’s mining right, the farmee undertakes to free-carry the farmor in relation to all exploration of the farmor’s retained part for the next two years.

At the time of entering into the arrangement, the parties are aware that the farmor will incur $1.5 million in exploration expenses in the first year. It is not known what expenses will be incurred in the second year as this will depend on a number of factors.

The farmee’s cost is calculated under section 40-185. The farmee has incurred a liability to pay an amount ($1.5 million) and this is included at item 2 of the table in subsection 40-185(1). The farmee has provided a non-cash benefit in the form of a right to an unknown and unascertainable amount of money in year two. The market value ($ here because it is unnecessary to determine) of the non-cash benefit is included in cost at item 4.

Both the $1.5 million commitment and the unvalued commitment are exploration benefits. The cost, to the farmee, of the mining right received is therefore reduced to nil under paragraph 40-1130(1)(a):

In the first year, the farmee incurs the expense of providing the $1.5 million. Paragraph 40-1130(1)(c) applies to ensure that subsection 40-730(3) does not apply to deny a deduction under section 40-730 because the $1.5 million was notionally included in the calculation of the cost of the mining right.

In the second year, the farmor incurs exploration expenses of $2 million. The farmee funds this expense and incurs an expense of $2 million. Subsection 40-730(3) does not apply to the farmee’s expense because the $2 million was never included in the cost of the farmee’s mining right ($ was).

Note also that the farmor is not entitled to any deduction for either the $1.5 million or $2 million expenses it incurred because it was free‑carried by the farmee (see paragraph 1.81).

1.92                It is not intended that these amendments alter the current availability, to a farmee, of section 40-730 deductions in any other way.

Changes to an exploration benefit

1.93                When an exploration benefit is first provided on entering a FIFO arrangement, the benefit is a contractual right or entitlement to receive exploration benefits over time. At this point, tax relief is provided to the farmor and farmee. If the farmor later receives non-exploration benefits in relation to the contractual right, it is necessary to claw back the tax relief provided.

1.94                The potential for the claw back is established at the time the FIFO arrangement is entered into. The first element of the cost base and reduced cost base of the CGT asset that is the contractual right to receive exploration benefits is reduced by the market value of that right. [Schedule 1, item 10, section 40-1120 of the ITAA 1997]

1.95                When the contractual right is satisfied (because the farmee fulfils the obligation or the parties renegotiate the arrangement), CGT event C2 occurs to the farmor. The capital proceeds of the event that are genuine exploration benefits are given a market value of zero. To the extent the proceeds include benefits that are not exploration benefits, there is likely to be a capital gain. The extent of the gain is increased because of the reduction in the cost base of the contractual right. The rules ensure that the gain is recognised in the later income year, avoiding the need to reopen any income tax assessments made for earlier income years.

1.96                If there is more than one payment (or other consideration provided) in relation to the contractual right, CGT event C2 occurs in relation to each payment. For each event, the cost base of the contractual right is reduced proportionately for the purposes of calculating the specific capital gain or loss on the part satisfied (subsection 112-30(2)).

Example 1.11: Changes to an exploration benefit

A farmor disposed of a part of a mining right under a FIFO arrangement. The part has an adjustable value of nil per section 40‑1110. In return, the farmor received an entitlement to exploration benefits. The entitlement commits the farmee to spend $100 million on exploration of the farmor’s retained part.

The farmor receives no other consideration for the mining right and the termination value of the right is therefore zero. The farmor does not have any tax liability when disposing of the right.

In the following income year, the farmee provides exploration services to the farmor worth $50 million. The exploration is successful and substantial resource deposits are discovered.

CGT event C2 occurs to the farmor. The capital proceeds and the apportioned cost base are both nil because the event relates entirely to exploration benefits (it is assumed there were no incidental costs) (section 40-1120 and subsection 116-115(2)). No capital gain or loss arises.

In the third year, the parties agree to suspend further exploration and agree that the farmee can complete its obligations under the arrangement through contributions to development. The farmee provides $50 million worth of contributions to the development of the farmor’s retained right and discharges its obligations.

CGT event C2 occurs again to the farmor in relation to the second half of the exploration benefit. The capital proceeds are $50 million. The apportioned cost base remains nil, resulting in a capital gain of $50 million. This reflects the amount that would not have received the original tax relief if it was known then that the contractual right would not be realised through the receipt of exploration benefits.

Part 3: Improvements to mining, quarrying or prospecting information

1.97                Part 3 of Schedule 1 amends paragraph 40-80(1AB)(d) to allow taxpayers to claim immediate deductions for certain expenditure that relates to making improvements to mining, quarrying or prospecting information.

1.98                The expenditure will be deductible if that taxpayer was entitled to a deduction for the original information when it was acquired. In addition, an immediate deduction will be available where the improvement would be immediately deductible if it were a new asset the taxpayer had just acquired. This outcome is achieved through the use of the concept of ‘economic benefit’ (see section 40-190 of the ITAA 1997) to refer to the improvement made to the original information. [Schedule 1, item 20, paragraph 40-80(1AB)(d) of the ITAA 1997]

1.99              As a result, the deductibility of improvements to mining, quarrying or prospecting information will not depend on whether an immediate deduction would be available for the unimproved information. This is appropriate because the improvement will often be the result of the taxpayer acquiring additional information through exploration or prospecting activities.

Consequential amendments

1.100          Rights and obligations that arise under a FIFO arrangement and relate to the provision of exploration benefits are exempted from the Taxation of Financial Arrangement regime contained in Division 230 of the ITAA 1997. While the rights and obligations may amount to a financial arrangement (section 230-45), it is intended that the UCA and CGT rules alone will provide the tax outcomes for these arrangements. [Schedule 1, item 17, subsection 230-460(17A) of the ITAA 1997]

1.101          Definitions of ‘interest realignment arrangement’, ‘interest realignment adjustment’, ‘farm-in farm-out arrangement’ and ‘exploration benefit’ are added to the ITAA 1997 dictionary. [Schedule 1, items 3 and 18, subsection 995-1(1) of the ITAA 1997]

1.102          Legislative signposts to the operative amendments made by Part 2 are inserted into the list of non-assessable non-exempt income provisions, the list of cost base modifications in section 112‑97 and the list of capital proceeds modifications in section 116-25. [Schedule 1, items 6 and 13 to 15, sections 11-55, 112-97 and 116-25 of the ITAA 1997]

1.103          A guide is created to Subdivision 40-K, which outlines the consequences, under the UCA regime, for FIFO arrangements. [Schedule 1, item 10, section 40-1095 of the ITAA 1997]

1.104          Notes cross-referencing the operative amendments made by Part 2 are attached to the Division 40 rules for determining cost and termination value. [Schedule 1, items 7 to 9, notes to section 40-175 and subsections 40-180(4) and 40‑300(3) of the ITAA 1997]

Application and transitional provisions

1.105          The amendments in Part 1 and 2 of Schedule 1 apply to interest realignment and FIFO arrangements, respectively, that are entered into after 7.30 pm on 14 May 2013. This aligns with the application of the 2014 amendments. This means that an arrangement entered into prior to that date is subject to neither these amendments nor the 2014 amendments. [Schedule 1, items 5 and 19]

1.106          The amendments in Part 3 are directly aligned to the application provisions of the 2014 amendments. Generally, the present amendments apply to mining, quarrying or prospecting information that a taxpayer starts to hold after 7.30 pm on 14 May 2013. [Schedule 1, item 21]

1.107          The amendments in Schedule 1 address issues that arose through the passage of the 2014 amendments. Remedying these issues will be favourable to the affected taxpayers. As such, it is appropriate that the present amendments apply retrospectively from the date of application of the 2014 amendments.

Statement of Compatibility with Human Rights

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Tax relief for certain mining arrangements

1.108          This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

1.109             Schedule 1 to this Bill provides tax relief to taxpayers entering into certain arrangements in relation to mining, quarrying and prospecting rights and information. Relief will apply to farm-in farm-out arrangements, interest realignment arrangements and expenditure relating to the improvement of mining, quarrying and prospecting information.

Human rights implications

1.110          This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

1.111          This Schedule is compatible with human rights as it does not raise any human rights issues.

Do not remove section break.


Outline of chapter

2.1                  Schedule 2 to the Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to better align the statutory effective life of in‑house software with the typical useful life of in-house software for businesses by extending the statutory effective life of in-house software from four to five years.

Context of amendments

Operation of existing law

2.2                  Division 40 of the ITAA 1997 provides rules relating to the deductibility of expenditure on depreciating assets — assets with a limited effective life which are reasonably expected to decline in value over the period that they are used. A deduction is generally allowed (under Subdivision 40-B of the ITAA 1997) for the yearly decline in the value of a depreciating asset, until the cost of acquiring the asset has been fully written-off. The amount of the deduction available in each year in respect of an asset depends on a number of circumstances, including the type of asset, its cost, the period in which it was held by the entity seeking to claim the deduction, the extent to which it is used for a taxable purpose and the effective (useful) life of the asset.

Intangible assets and effective life

2.3                  For certain intangible assets, including in-house software, the effective life of the asset is set out in the legislation. In most cases the effective life is aligned with the duration of the right or licence underlying the intangible asset.

2.4                  For in-house software the ITAA 1997 prescribes an effective life of four years (item 8 in the table in subsection 40-95(7)). Additionally, subsection 40-70(2) of the ITAA 1997 prevents in-house software, amongst other assets, from being depreciated using the diminishing value method. This means that in-house software must be depreciated using the prime cost method, generally resulting in an equal deduction being available over each of the four years of its effective life (assuming it is used exclusively for a taxable purpose and pro-rated for the number of days in the year).

Deduction Pooling

2.5                  In some circumstances, taxpayers have the choice of allocating certain assets acquired in an income year to a pool. The pool is then treated as a single item for the purposes of the capital allowance rules. Generally, if a taxpayer decides to create a particular type of pool for expenditure in an income year, all expenditure of that type in the current income year and subsequent income years must be allocated to a pool.

2.6                  Expenditure incurred on developing in-house software may be allocated to a pool, referred to as a software development pool (see section 40-450 of the ITAA 1997). Section 40-455 provides that none of the value of the pool is deductible in the year it is created, 40 per cent of the value of a software development pool is deductible in the income year after it is created, 40 per cent is deductible in the following year and the remaining 20 per cent is deductible in the final income year.

2.7                  The Government announced this measure in the 2014‑15 Mid‑Year Economic and Fiscal Outlook (MYEFO) to increase the effective life of in-house software generally from 1 July 2015. The new effective life will align the statutory life of in-house software more closely with its useful life.

Summary of new law

2.8                    Schedule 2 to the Bill amends the ITAA 1997 to better align the statutory effective life of in-house software with the typical useful life of in-house software for businesses by extending the statutory effective life of in-house software from four to five years.

Comparison of key features of new law and current law

New law

Current law

In-house software has a statutory effective life of 5 years.

In-house software has a statutory effective life of 4 years.

Deductions can be claimed over five years for expenditure allocated to software development pools at the following rates:

Year 1 — Nil

Year 2 — 30%

Year 3 — 30%

Year 4 —30%

Year 5 — 10%

Deductions can be claimed over four years for expenditure allocated to software development pools at the following rates:

Year 1 — Nil

Year 2 — 40%

Year 3 — 40%

Year 4 — 20%

Detailed explanation of new law

2.9                  Schedule 2 to this Bill amends the ITAA 1997 to extend the effective life of in-house software.

Extending the effective life of in-house software

2.10                Presently, item 8 of the table in subsection 40‑95(7) of the ITAA 1997 specifies that the effective life of in-house software is four years.

2.11                Schedule 2 amends the statutory effective life to five years. [Schedule 2, item 1, item 8 in the table in subsection 40-95(7) of the ITAA 1997]

2.12                By amending the tax law to extend the statutory life of in-house software from four to five years the Government will better align the statutory effective life of in-house software with the typical useful life of in-house software.

Software development pools

2.13              Section 40-455 of ITAA 1997 sets out the deductions available in each year for expenditure allocated to a software development pool. These deductions will be altered to amend the timing of deductions for software development pools.

2.14              The current deductions for software development pools are as follows:

Year 1 — Nil

Year 2 — 40% of the expenditure allocated to the pool

Year 3 — 40% of the expenditure allocated to the pool

Year 4 — 20% of the expenditure allocated to the pool

2.15              These deductions will be replaced with the following deductions:

Year 1 — Nil

Year 2 — 30% of the expenditure allocated to the pool

Year 3 — 30% of the expenditure allocated to the pool

Year 4 — 30% of the expenditure allocated to the pool

Year 5 — 10% of the expenditure allocated to the pool

[Schedule 2, item 2, the table in section 40-455 of the ITAA 1997]

2.16              This change adjusts the time and rate over which taxpayers may obtain deductions for the value of expenditure assigned to a software development pool. The revised table will provide deductions over five years instead of four years.

2.17              These changes will better align the statutory effective life of in‑house software with the typical useful life of in-house software for businesses, consistent with the general change to the effective life of in‑house software.

Application and transitional provisions

2.18              The amendments will commence on the day of Royal Assent.

2.19              The amendment to the effective life of in-house software will apply to assets that are first used or first installed ready for use on or after 1 July 2015. [Schedule 2, item 3]

2.20              The amendments to the timing of deductions for software development pools will apply to expenditure incurred in income years commencing on or after 1 July 2015. [Schedule 2, item 3]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Increasing the statutory effective life of in‑house software

2.21              This schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

2.22              Schedule 2 to the Bill amends Income Tax Assessment Act 1997 to better align the statutory effective life of in‑house software with the typical useful life of in-house software for businesses by extending the statutory effective life of in-house software from four to five years.

Human rights implications

2.23              This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

2.24              This Schedule is compatible with human rights as it does not raise any human rights issues.

 


Outline of chapter

3.1                  Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to provide income tax look-through treatment for instalment warrants and instalment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds. This look-through treatment ensures that most income tax consequences associated with the underlying asset of the trust flow through to the investor, and not the trustee.

3.2                  All references are to the ITAA 1997, unless otherwise stated.

Context of amendments

What are instalment warrants and receipts?

3.3                  Instalment warrants are financial products that entail borrowing to acquire an asset, such as a share. The asset is held on trust during the life of the loan to provide security for the lender. The investor is required to pay one or more instalments to repay any outstanding amounts before taking legal ownership of the asset. Nevertheless the investor is entitled to the benefit of any income flowing from the asset (for example, dividends) while it is held on trust. It is common but not necessary (unless the investor is a trustee of a regulated superannuation fund) for the borrowing under these arrangements to be limited recourse in nature, meaning investors can ‘walk away’ from the investment rather than pay any outstanding instalments.

3.4                  Instalment receipts are similar to instalment warrants, although the key difference is that there is no ‘borrowing’. Rather, there is a provision of credit to acquire an asset that is held on trust until the purchase price of the asset is fully paid by the investor.

What is the taxation treatment?

3.5                  The long-standing industry practice for certain types of instalment warrant and instalment receipt arrangements has been to ignore the trust and treat the investor as the owner of the asset for capital gains tax (CGT) purposes. On the basis of this long-standing practice, a significant market for instalment warrants and instalment receipts has developed.

3.6                  The types of arrangements within this market have evolved over time and become more complex. Further, the superannuation law was amended in 2007 to allow regulated superannuation funds to invest in instalment warrants. As a result, these amendments seek to remove any uncertainty about how the income tax law applies and confirm the industry practice for these types of arrangements. This avoids any potential disruption to the significant market that developed on the basis of the long-standing industry practice.

Summary of new law

3.7                  These amendments provide income tax look-through treatment for instalment warrants and instalment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds. In particular, look‑through treatment is provided:

       to investors, for instalment warrant and instalment receipt arrangements over certain assets (broadly, direct and indirect interests in listed securities as well as unlisted securities in widely held entities); and

       to regulated superannuation funds, for any limited recourse borrowing arrangement that satisfies the relevant requirements of the Superannuation Industry (Supervision) Act 1993 (SIS Act).

Comparison of key features of new law and current law

New law

Current law

The investor holding the instalment warrant or instalment receipt over certain assets, rather than the trustee, is treated as the owner of the asset for income tax purposes (with some exceptions). This means that the trust is effectively ignored (and ‘looked through’) and anything that happens to or results from being the owner of the asset, such as receiving franked dividends, affects the investor and not the trustee.

Uncertainty has arisen about whether the trust relationship over an asset arising in an instalment warrant or instalment receipt arrangement can be ignored for income tax purposes. However, the long-standing practice has been to ignore the existence of the instalment trust for CGT purposes.

For an investor that is a trustee of a regulated superannuation fund, look‑through treatment is provided in respect of assets acquired under a limited recourse borrowing arrangement that satisfies the requirements of the SIS Act.

The trust is effectively ignored and anything that happens to or results from being the owner of the asset, such as receiving franked dividends, affects the investor (a trustee of the regulated superannuation fund) and not the trustee of the instalment trust.

Uncertainty has arisen about whether the trust relationship over an asset that arises in a limited recourse borrowing arrangement of a trustee of a regulated superannuation fund, can be ignored for income tax purposes. However, the long-standing practice has been to ignore the existence of the trust for CGT purposes.

Detailed explanation of new law

3.8                  These amendments provide income tax look-through treatment for instalment warrants and instalment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds. [Schedule 3, item 1, sections 235-1 and 235-805]

3.9                  Look-through treatment for most income tax purposes is achieved by:

       treating the investor, and not the trustee, as the owner of the assets of the instalment trust;

       treating any acts done by the trustee in relation to the assets of the instalment trust as if they had been done by the investor, instead of by the trustee;

       treating the investor as having the assets in the same circumstances as the investor actually has the interest in the trust; and

       ensuring any consequence arising under the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) for the trustee, is taken to have arisen for the investor.

[Schedule 3, item 1, section 235-820]

What arrangements receive look-through treatment?

Instalment warrants

3.10              An instalment warrant is a derivative based investment product that involves an investor borrowing against an asset (such as a share or a unit in a unit trust) and repaying that loan in instalments over the life of the warrant. The asset is held on trust to secure the repayment of the loan, with the benefits of ownership of the asset (such as dividends and franking credits) flowing through to the investor. After the final payment is made, the investor obtains legal ownership of the asset. [Schedule 3, item 1, section 235-830]

3.11              Income tax look-through treatment is specifically provided for a trustee of a regulated superannuation fund that acquires an asset or assets through a limited recourse borrowing arrangement permitted under the SIS Act (see paragraphs 4.43 to 4.49). To ensure the look-through treatment provided in relation to these arrangements entered into by the trustee of a regulated superannuation fund are limited only to those permitted under the SIS Act, such a trustee is expressly excluded from the more general provisions that provide look‑through treatment for instalment warrant arrangements. [Schedule 3, item 1, paragraph 235-825(1)(b), subsection 235-830(2) and section 235-840]

Types of instalment warrants

3.12              There are broadly three different situations in which an investor acquires an instalment warrant (described below). Providing the relevant conditions are satisfied in these amendments, look-through treatment is available under each arrangement.

       ‘Cash applicants’ pay an upfront amount for an instalment warrant over a ‘new’ asset — that is, they have not previously owned the underlying asset or an instalment warrant over the underlying asset.

       ‘Share applicants’ effectively convert an asset they already own into an instalment warrant over that asset (which becomes the underlying asset). The applicant receives cash from the provider of the instalment warrant, reflecting the outstanding instalments the investor must pay to regain legal ownership of the asset (less fees and borrowing costs).

       ‘Roll-over applicants’ already hold an instalment warrant over the underlying asset, and instead of paying the outstanding instalment(s) at the maturity date, the applicant rolls the asset over into another instalment warrant. The investor may pay additional money or receive money back, in order to maintain an agreed leverage ratio.

[Schedule 3, item 1, sections 235-820, 235-825 and 235-830]

Instalment receipts

3.13              Instalment receipts are similar to instalment warrants, although the key difference is that there is no ‘borrowing’. Rather, the investor is provided with credit for the acquisition of the asset, with the payment of the purchase price being made in instalments over the life of the instalment receipt. [Schedule 3, item 1, section 235-830]

3.14              While trustees of a regulated superannuation fund are expressly excluded from accessing the instalment warrant provisions, (as discussed at paragraph 4.11 above) they are not excluded from the provision that provides income tax look-through treatment for instalment receipts because that exclusion only applies where the arrangement entered into by the trustee of the regulated superannuation fund includes a borrowing. [Schedule 3, item 1, subsections 235‑830(1) and (2)]

Secured financing arrangements generally

3.15              These amendments also cover secured financing arrangements that are structured in the same way as an instalment warrant or instalment receipt arrangement but are not necessarily so named, for example, certain limited recourse loan facilities. Provided the prescribed criteria in these amendments are satisfied, look-through treatment also applies to these types of arrangements. [Schedule 3, item 1, section 235-820, paragraph 235‑825(1)(a) and section 235-830]

Regulated superannuation funds

3.16              These amendments provide income tax look-through treatment for a regulated superannuation fund in respect of assets acquired under a relevant limited recourse borrowing arrangement. For these cases, income tax look‑through treatment applies if the rules specific to regulated superannuation funds are satisfied (see paragraphs 4.43 to 4.49, rather than 4.17 to 4.42). Where a regulated superannuation fund invests under an instalment receipt arrangement, income tax look-through treatment applies if the conditions described below are satisfied (see paragraph 4.50 describing the rationale for this requirement). [Schedule 3, item 1, sections 235‑830 and 235‑840]

What criteria do the arrangements need to satisfy to receive look‑through treatment?

3.17              Broadly, for income tax look-through treatment to apply, the arrangement must satisfy the following criteria:

       A trustee must acquire an asset or assets to either secure a borrowing made by the investor, or to secure a provision of credit made to the investor to acquire the asset or assets.

       The investor must have a beneficial interest in the asset or assets, as the sole beneficiary of the trust, and must be entitled to obtain legal ownership of that asset or those assets on discharging its obligations relating to the borrowing or the provision of credit.

       The investor must be entitled to the benefit of all income from that asset or those assets.

       The assets must be an asset that is (or is part of) the underlying investment of the trust - broadly, this is a listed or widely held security, or an indirect interest in such a security (referred to below as a ‘covered asset’ - see paragraphs 4.28 to 4.39).

[Schedule 3, item 1, subsection 235-830(1)]

3.18              The above requirements are explained in more detail below – see paragraphs 4.19 to 4.27.

Borrowing and provision of credit

3.19              The references to ‘a borrowing’ and ‘the borrowing’ do not necessarily require all loan amounts under the arrangement to be part of the same loan contract. Where an investor enters into more than one loan contract, provided they are part of one broader arrangement, this criterion is satisfied. [Schedule 3, item 1, paragraphs 235-830(1)(a) and (b)]

3.20              A key feature of an instalment receipt is that the investor is not required to pay the full purchase price of the asset upfront, rather the investor is provided with credit for the acquisition of the asset, with the payment of the purchase price being made in instalments over the life of the instalment receipt. This feature is therefore required for an instalment receipt arrangement to obtain look-through treatment under these amendments. [Schedule 3, item 1, paragraphs 235-830(1)(a) and (d)]

Entitlement to the benefit of all income

3.21              Where dividends paid in respect of the underlying asset are applied to reduce the outstanding loan balance under the arrangement, the investor is considered to have satisfied the condition required under these amendments that the investor benefits from all of the income from the asset (unless circumstances exist that suggest otherwise). Further, under some arrangements the investor may, for example, swap its dividend return on the underlying asset for a fixed return. Such an arrangement may not necessarily cause the investor to fail the requirement to be entitled to the benefit of all income from the asset. However, this is an objective test determined according to the facts and circumstances of each case. [Schedule 3, item 1, paragraph 235-830(1)(e)]

Obligations relating to the borrowing or provision of credit

3.22              The requirement for the investor to be entitled to acquire legal ownership of the asset on discharge of its obligations relating to the borrowing or the provision of credit makes it clear that that the only impediment to the investor having the right to acquire ownership of the asset are those obligations relating to the borrowing or provision of credit. [Schedule 3, item 1, paragraph 235-830(1)(f)]

3.23              The investor’s obligations relating to the borrowing or provision of credit may include amounts that are directly or indirectly related to the borrowing or provision of credit, such as interest, outstanding tax file number (TFN) withholding amounts (or any other withholding amounts) that relate to, or are in respect of, the borrowing or provision of credit. [Schedule 3, item 1, paragraphs 235-830(1)(a), (b) and (f)]

3.24              Look-through treatment only applies if the asset is not subject to any other charge, security or encumbrance. Any charge that arises in relation to the investor’s borrowing against the asset, or the provision of credit to acquire the asset, does not infringe this rule. The effect of this restriction is to ensure that the investor’s obligations relating to the borrowing, or provision of credit, are the only impediments to the investor taking legal ownership of the asset. [Schedule 3, item 1, subsection 235‑830(3)]

Sole beneficiary and joint holders of an interest in a trust

3.25              Consistent with the notion that the trust relationship in an instalment receipt or warrant arrangement exists to secure a borrowing made by, or credit provided to, the investor, look‑through treatment only applies if the investor is the sole beneficiary of the trust. Therefore, look‑through treatment is denied if the trust has more than one beneficiary. [Schedule 3, item 1, paragraph 235-830(1)(c)]

3.26              However, where the interest in the instalment trust is held by entities as joint tenants or tenants in common, these amendments apply in the same way to those joint holders as they do to a single owner. This allows joint holders, to together satisfy each of the instalment trust criteria (see paragraph 4.17), despite these criteria being phrased in the singular. Therefore, joint holders must together enter into the loan, or be provided credit together to acquire the asset jointly, to satisfy the relevant criteria. Further, joint holders must together be entitled to benefit from all income from the underlying asset and together be entitled to acquire legal ownership of the underlying asset on discharge of all their obligations under the arrangement. [Schedule 3, item 1, paragraph 235-815(1)(a), subsections 235‑815(3), 235-820(1) and 235-830(1)]

3.27              In particular, a joint holding does not infringe the rule that the investor must be the sole beneficiary of the trust. For example, if two entities jointly take out an instalment warrant over an asset and therefore jointly hold an interest in the trust holding the asset, the sole beneficiary rule is treated as being satisfied. [Schedule 3, item 1, paragraph 235-815(1)(a), subsections 235‑815(3) and 235-820(1) and paragraph 235‑830(1)(c)]

What assets of the trust are covered by the look‑through treatment?

3.28              These amendments provide look-through treatment for instalment warrant and instalment receipt arrangements over listed securities and unlisted securities in widely held entities that are held either directly or indirectly by the security trustee. Note there are special rules for certain situations where there is a temporary breach of this widely held requirement (see paragraphs 4.32 to 4.33). These amendments cover such assets, given the policy rationale is to reduce the uncertainty about how the income tax law applies to the significant established market for these products. [Schedule 3, item 1, sections 235‑830 and 235‑835]

Assets held directly by the trustee of the instalment warrant or instalment receipt trust

3.29              These amendments cover the same types of assets as are covered by Division 247 (capital protected borrowing rules). This is because a significant market developed for instalment warrants and instalment receipts over these types of assets. Therefore, in the cases where the trustee owns shares, units in a unit trust or stapled securities directly (ie Division 247 types of assets), look-through treatment is provided so that the investor in the instalment warrant or instalment receipt arrangement is treated as owning those assets instead of the trustee for most income tax purposes. [Schedule 3, item 1, section 235‑820 and subsection 235‑835(1)]

3.30              This treatment is only provided in respect of shares, units in unit trusts or stapled securities that are either listed on an approved stock exchange (as defined in subsection 995-1(1) of the ITAA 1997) or where the company or unit trust invested in is a widely held entity. ‘Widely held’ takes the same meaning as used in Division 247, thus the ‘widely held company’ dictionary definition in subsection 995 1(1) must be satisfied. For a unit trust, the ‘widely held unit trust’ definition in section 272-105 in Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) must be satisfied. [Schedule 3, item 1, subsection 235‑835(1)]

Assets held indirectly by the trustee of the instalment warrant or instalment receipt trust

3.31              In some cases, a trustee may hold the assets described above indirectly through another entity, such as an interposed fixed trust. Consistent with Division 247, these amendments ensure that where the trustee of the instalment warrant or instalment receipt trust holds an interest in an entity, such as an interposed fixed trust, the investor is treated as owning the interest in that trust. This treatment applies where the interposed fixed trust holds shares, units or stapled securities each of which is either listed or in a widely held entity. [Schedule 3, item 1, subparagraph 235-835(1)(a)(ii) and paragraph 235-835(1)(b)]

Example 3.1 

Matt, an Australian resident investor, acquires for his own benefit an instalment warrant over an interest in Clefton Fixed Trust. That is, Matt has an interest in an instalment warrant trust (Instalment Trust) and the trustee of Instalment Trust has an interest in Clefton Fixed Trust (which is not a unit trust).

The trustee of Clefton Fixed Trust holds shares and units in a variety of listed and widely held companies and unit trusts. Therefore, look‑through treatment is provided in respect of the Instalment Trust such that Matt is taken to own the interest in Clefton Fixed Trust.

Temporary breaches of the widely held requirements

3.32              Where the widely held requirements are failed on a temporary basis and the circumstances that resulted in this failure were outside the control of the investor, the widely held requirements are taken to be satisfied. This rule provides certainty to taxpayers as it avoids the potential for arrangements fluctuating in and out of income tax look‑through treatment. If this fluctuation is not avoided, the investor or the trustee would be subject to a CGT taxing point each time the income tax treatment changes. [Schedule 3, item 1, subsection 235-835(2)]

3.33              Whether a breach of the widely held requirements is temporary or not, is to be determined according to the circumstances of each case. However, breaches of the widely held requirements as a result of an entity being in a start‑up or wind-down phase are generally considered temporary in nature. [Schedule 3, item 1, subsection 235-835(2)]

Bonus interests

3.34              Where the trustee of an instalment warrant or receipt trust acquires a new asset relating to the underlying covered asset (for example, a bonus right as part of a corporate restructure), the covered asset requirements do not need to be satisfied in respect of that new asset in all circumstances. This exclusion from the covered asset rules recognises that investors may inadvertently breach the widely held requirement due to corporate actions, which may be outside the investor’s control. For consistency with the widely held rules, any right, option or similar interest to acquire a share or a unit in a trust, must be in respect of a company or unit trust that meets the widely held requirement described in paragraph 4.30. [Schedule 3, item 1, subsection 235-835(3)]

3.35              In cases where the new asset that is issued is a share, unit trust, or stapled security, the normal widely held rules as described above in paragraph 4.30 apply. [Schedule 3, item 1, section 235-835]

Assets held as part of a bundle or basket arrangement

3.36              Traditionally, instalment warrant and instalment receipt arrangements involved a single covered asset held in a trust with only that asset. These arrangements evolved such that arrangements involved bundles of identical assets and baskets of different assets. In order to provide look-through treatment for these arrangements involving bundles and baskets of assets, the covered asset rules described above do not restrict cases where the trust contains multiple covered assets. [Schedule 3, item 1, subsection 235-825(2), paragraph 235-830(1)(b) and section 235-835]

3.37              In the case of an instalment warrant bundle, this is a commercial term to describe multiple assets of the same type being held in the instalment warrant trust. For example, the trustee holds multiple XYZ Limited shares. In comparison, an instalment warrant basket refers to a basket of different widely held shares and units being held in the instalment warrant trust. For example, the trustee holds shares in ABC Limited, DEF Limited and XYZ Limited.

3.38              These amendments cover such arrangements where the bundle or basket of underlying assets consists of listed units or shares (held directly or indirectly by the trustee) or unlisted but widely held units or shares. [Schedule 3, item 1, section 235-835]

Replacement assets

3.39              The trustee of the instalment trust may hold assets that are replaced during the life of the agreement, for example, due to a corporate restructure where a share in one company is replaced with a share in another company. Therefore, providing both the original and replacement asset is a covered asset, this would mean that these amendments treat the investor as owning both the original and replacement asset. As the investor is taken to own both assets, CGT roll-over may then be available to defer any CGT liability arising from the change in ownership of the assets (providing relevant roll-over conditions are satisfied). [Schedule 3, item 1, section 235‑835]

What if an asset that is held in the trust is not a covered asset?

3.40              Where an asset acquired by the security trustee secures the borrowing or the provision of credit (ie it is part of the underlying investment of the trust) and that asset is not a covered asset, then look‑through treatment is not provided for any of the assets that make up the underlying investment. This may happen, for example, where the instalment warrant trust owns a closely held share or unit. [Schedule 3, item 1, sections 235-830 and 235-835]

What if an asset that is held in the trust does not secure the borrowing or the provision of credit?

3.41              Where an asset acquired by the trustee does not secure the borrowing or the provision of credit (ie it is not part of the underlying investment of the instalment warrant or instalment receipt trust), then that asset is not tested under these amendments and is not eligible for look‑through treatment. As this asset is not tested under these amendments, it does not impact on whether the asset that is part of the underlying investment of the trust receives look-through treatment. [Schedule 3, item 1, sections 235-830 and 235‑835]

Employee share schemes

3.42              Consistent with Division 247, no look-through treatment is provided for instalment warrant or instalment receipt trusts where part (or all) of the underlying investment is an employee share scheme interest, as defined in subsection 83A-10(1). Providing look-through treatment could inappropriately extend the scope of the employee share scheme provisions, as it would allow employers to satisfy the employee share scheme requirements by offering instalment warrants. [Schedule 3, item 1, subsection 235-835(4)]

Superannuation funds — Limited recourse borrowing arrangements

3.43              The SIS Act prohibits superannuation fund trustees from borrowing, or maintaining a borrowing of, money, subject to limited exceptions. This is to minimise assets of the fund being put at risk in the event of default on the loan.

3.44              One exception, contained in subsection 67A(1) of that Act (and its predecessor, former subsection 67(4A) of that Act) permits a trustee of a regulated superannuation fund to borrow money, or maintain a borrowing of money, on a limited recourse basis in certain circumstances to acquire assets that the fund would otherwise be permitted to acquire directly.

3.45              In order to prevent superannuation funds from being disadvantaged compared with other entities outside the superannuation system, this measure provides look-through treatment for a regulated superannuation fund in respect of an asset acquired under a limited recourse borrowing arrangement that, until the borrowing is fully repaid, is covered by subsection 67A(1) or former subsection 67(4A) of the SIS Act. [Schedule 3, item 1, sections 235-820 and 235-840]

3.46              Those provisions require regulated superannuation funds to use a trust to hold the asset or assets acquired using a limited recourse borrowing arrangement, which consequently may subject the regulated superannuation fund to a CGT taxing point on repayment of the borrowing. Such restrictions are not imposed on entities outside of superannuation. Therefore, by providing regulated superannuation funds with look-through treatment for any limited recourse borrowing arrangement that satisfies subsection 67A(1) or former subsection 67A(4A) of the SIS Act, this disadvantage is removed. [Schedule 3, item 1, sections 235‑820 and 235-840]

3.47              This income tax look-through treatment continues to apply, provided all eligibility criteria continue to be satisfied, after the borrowing is fully repaid until the instalment trust comes to an end (such as where the asset is transferred either to the investor or to a third party). [Schedule 3, item 1, section 235-820 and paragraph 235-840(b)]

3.48              While look-through treatment is provided for instalment warrant arrangements involving baskets of covered assets (see discussion above at paragraphs 4.36 to 4.38), the SIS Act does not now permit regulated superannuation funds to invest in such arrangements. Accordingly, look‑through treatment is not provided for regulated superannuation funds that acquire assets under arrangements that are not permitted under the SIS Act. [Schedule 3, item 1, section 235-820 and paragraph 235-840(b)]

3.49              Similarly, these amendments only provide look-through treatment for regulated superannuation funds in respect of replacement assets acquired under a limited recourse borrowing arrangement where the requirements of section 67B of the SIS Act are satisfied. [Schedule 3, item 1, section 235-820 and paragraph 235‑840(b)]

Instalment receipts

3.50              Look-through treatment in relation to instalment receipts (which involve a provision of credit to acquire the underlying investment rather than a borrowing) applies in the same circumstances for superannuation fund investors as for non-superannuation fund investors. This is because instalment receipt arrangements are not subject to the requirements in subsection 67A(1) or former subsection 67A(4A) of the SIS Act. [Schedule 3, item 1, sections 235-820, 235-825, 235‑830, and 235‑835]

How is look-through treatment provided under the income tax provisions?

3.51              By treating the asset as being an asset of the investor and not an asset of the trust, the amendments ensure the investor stands in the shoes of the trustee for most purposes of the income tax law (the key exceptions are discussed in paragraph 4.71). As emphasised by the object clause, this is a broad-based principle providing flow-through treatment of the income tax consequences to the investor. The parenthesised words in the key operative look-through provision, namely ‘instead of being an asset of the trust’, together with the express application of the Subdivision to the trustee, make it clear that the trust is ignored for most income tax purposes. This means that anything that happens to or results from being the owner of the asset, such as receiving franked dividends, affects the investor and not the trustee. [Schedule 3, item 1, section 235-810 and subsections 235‑815(2) and 235-820(1)]

3.52              To complement this broad-based principle, any acts done in relation to the asset by the trustee (such as selling the asset) are taken to have been done by the investor and not by the trustee. [Schedule 3, item 1, section 235-810 and subsection 235-820(2)]

Trust is effectively ignored for income tax purposes

3.53              Where all of the assets of the instalment trust are eligible for look‑through treatment, this has the effect that the trust does not exist for income tax purposes (apart from the key exceptions discussed in paragraph 4.71). This is because for a trust to exist, trust property must be held by the trustee. Where all the assets are treated as being held directly by the investor, no trust property exists and consequently no trust exists for most income tax purposes. Naturally, this has no effect on the existence of the trust at law. In these cases, where look‑through treatment applies to all of the assets, given the trust is taken not to exist for most income tax purposes, the investor’s interest in the trust is also ignored. This has the effect that no CGT consequences arise in respect of the investor’s actual interest in the trust. [Schedule 3, item 1, sections 235-810, 235‑815 and 235-820]

3.54              These amendments apply to the investor and the trustee of the instalment trust only. They do not apply for entities that hold indirect interests in the instalment trust — that is, through the investor. This accords with the purpose of these amendments, which is to ‘look through’ the instalment trust to the immediate investor (and not beyond). [Schedule 3, item 1, subsection 235-815(1)]

3.55              Importantly, however, these amendments do not operate for certain withholding tax purposes and the tax file number provisions (see paragraph 4.71). [Schedule 3, item 1, section 235-815]

Determining the characteristics of the asset held by the investor

3.56              Where these amendments treat the investor as the owner of the trust assets, the investor is taken to hold those assets on the same basis as the investor holds the interest in the trust at law. This means that all of the characteristics of the investor, such as how the investor entered into the arrangement and with whom the investor holds the interest, are taken to exist in respect of the asset instead. The effect of this is that the assets adopt the same characteristics of the investor’s actual interest in the trust, such as whether the asset is held on revenue or capital account or held as joint tenants or tenants in common. [Schedule 3, item 1, subsections 235-820(3) and (4)]

What are the income tax consequences of providing income tax look‑through treatment?

Dividends

3.57              Where an investor holds an instalment warrant or instalment receipt over a share, any dividends paid on that share will be paid by the company to the trustee. As a result of the investor being treated as the owner of the share, the investor stands in the shoes of the trustee and the trust is ignored. The effect of this is that the dividend is taken to be received by the investor and not by the trustee for income tax purposes. This enables the dividend assessing provisions to be applied to the investor and not the trustee. [Schedule 3, item 1, subsection 235‑820(1)]

Example 3.2 

Henry, an Australian resident investor, acquires for his own benefit an instalment warrant over an XYZ share. Under the terms of the instalment warrant, Henry is entitled to the cash amount of the dividends payable on the XYZ share on the record date. As the trustee is the legal shareholder of the XYZ share, it is the trustee that receives the dividend. The terms of the instalment warrant require the trustee to pay the cash amount of the dividends it receives on the XYZ share to Henry as soon as practical after receipt and clearance of those dividends. Any dividend received by the trustee that is not immediately paid on to Henry is held on trust for Henry. The flow of the dividend can be represented diagrammatically as follows.

Cash amount of the dividendDividendTrusteeXYZHenryAs Henry is deemed to be the owner of the XYZ share, and the trustee is not, Henry is taken to stand in the shoes of the trustee. These amendments mean that Henry is treated as receiving the dividend, as the owner, directly.

As the trustee is treated as not being the owner of the XYZ share, it is not capable of being the shareholder. Rather, Henry, as the owner of the XYZ share, standing in the shoes of the trustee, is considered to be the shareholder for the purposes of the dividend assessing provisions, including the definition of ‘dividend’.

In addition, by treating Henry as the owner of the XYZ share and the trustee not to be the owner, the payment of the cash amount of the dividend from the trustee to Henry is ignored for income tax purposes.

As a result, Henry includes the dividends paid on the XYZ share in his assessable income under subparagraph 44(1)(a)(i) of the ITAA 1936.

Franking credits

3.58              Where dividends that are taken to have been received by the investor and not by the trustee are franked, these amendments also have the effect that the franking credits are taken to have flowed directly to the investor (instead of indirectly through the trust). This means that in determining the investor’s income tax consequences of receiving franked dividends from the underlying asset, being a share in a company, the investor applies section 207-20 (the general gross-up and offset rule) instead of section 207-35 (which applies for distributions made through trusts). In addition, in determining whether the investor is entitled to the franking credit, the qualified person rules in former Division 1A of Part IIIAA of the ITAA 1936 are applied to the investor directly instead of those rules relevant for trustees and beneficiaries. [Schedule 3, item 1, subsection 235-820(1)]

Capital gains tax

3.59              By treating the investor as the owner of the underlying asset from the time that the investor acquires the interest in the trust, these amendments make it clear that no CGT event, and therefore no CGT taxing point, happens on payment of the final instalment for the trustee or the investor. [Schedule 3, item 1, subsection 235-820(1)]

Example 3.3 

Jack, an Australian resident investor, acquires for his own benefit an instalment receipt over an ABC share on 1 July 2014. Under the terms of the instalment receipt arrangement, Jack is required to pay $4.00 (plus interest and transaction costs) upfront and $6.00 on 1 July 2015. The ABC share is held by the trustee of the instalment receipt trust to secure the provision of credit of $6.00. After payment of the $6.00, Jack receives ownership of the ABC share. No CGT event happens on transfer of the ownership of the share from the trustee to Jack as he is taken to have been the owner from the time of acquiring his interest in the instalment receipt trust and therefore there is no change of ownership.

3.60              These amendments also ensure that where the underlying asset is sold by the trustee, CGT event A1 happens for the investor instead of the trustee. Therefore, any capital gain or loss made on the sale is taken to have been made by the investor and not the trustee. [Schedule 3, item 1, subsection 235-820(2)]

3.61              For a share applicant, these amendments ensure that no CGT taxing point arises on transferring the asset into an instalment warrant trust. This is because the investor owns the asset prior to its being transferred into the trust, and the investor is treated as owning the asset throughout the term of the instalment warrant. As such, no CGT taxing point arises as there has been no change of ownership under the CGT provisions. Likewise, in applying the CGT discount on selling the asset, the investor retains its original acquisition time of when it acquired the asset. [Schedule 3, item 1, subsections 235-820(1) and (2)]

3.62              Similarly, for a roll-over applicant, these amendments ensure that no CGT taxing point would arise where an investor rolls over an instalment warrant into a new warrant over the same asset. This is because the underlying asset is still treated as being owned by the investor. [Schedule 3, item 1, subsections 235‑820(1) and (2)]

Prepayment rules

3.63              By treating the investor as the owner of the underlying asset instead of the trustee, the exception to the apportionment rule for prepaid expenditure in subsection 82KZME(5) of the ITAA 1936 for certain taxpayers can be satisfied, meaning that deductible prepaid expenditure would not be required to be apportioned across income years. That subsection prevents the proportional deduction rule in section 82KZMF from applying where the relevant taxpayer has borrowed money to acquire negatively geared real estate, shares or units in a unit trust which are expected to be income producing. [Schedule 3, item 1, subsection 235-820(1)]

Securities lending arrangements

3.64              Similar to the rule in subsection 26BC(2) of the ITAA 1936 (which concerns a person who is absolutely entitled to an eligible security), these amendments apply for the purposes of applying the securities lending arrangement provisions in section 26BC. This ensures that, for the purposes of applying those provisions, the investor is treated as the owner of the relevant eligible security rather than the trustee and any acts done by the trustee in relation to that eligible security are taken to have instead been done by the investor. [Schedule 3, item 1, subsections 235‑820(1) and (2)]

Income tax return

3.65              Section 161 of the ITAA 1936 provides that every person identified by the Commissioner of Taxation must prepare an income tax return. The Commissioner publishes a yearly notice that sets out these requirements (see, for example, Legislative Instrument F2014L00688, in relation to the 2013‑14 income year). In relation to a trust, the practice, subject to limited exceptions, has been to require an income tax return where the trustee of a trust estate has derived income, including capital gains. However, as these provisions ignore the trust where the underlying investments by the trust are in covered assets, no income tax return is required to be prepared by the trustee in these circumstances. Any income tax consequences in respect of the assets would be recognised in the investor’s income tax return. [Schedule 3, item 1, subsection 235‑820(1)]

3.66              In cases where the trust is not ignored because the trustee has invested in non-covered assets (see paragraph 4.40), an income tax return may be required to be lodged (subject to limited exceptions). [Schedule 3, item 1, subsection 235‑820(1)]

Interactions with other income tax provisions

3.67              It is not necessary to consider whether the underlying investments of the instalment trust would satisfy the CGT look-through provisions, namely whether a security arrangement exists (section 106-60) or whether there is absolute entitlement (section 106-50). It is unnecessary to consider whether such provisions apply, as these amendments ‘look through’ the trust for most income tax purposes. That is, they provide a more expansive look-through treatment than the security holding and absolute entitlement provisions, which only apply for CGT purposes. Given that the absolute entitlement rules and security holding rules also provide look-through treatment for CGT purposes, these amendments expressly exclude those provisions in order to give these amendments priority. [Schedule 3, item 1, subsections 235‑845(1) and (2)]

3.68              Additionally, Division 247, which isolates the cost of capital protection provided under a capital protected borrowing where it is not explicitly provided by way of a put option, continues to apply to arrangements (where relevant) that are subject to these amendments. [Schedule 3, item 1, subsection 235‑845(3)]

Interactions with the GST Act

3.69              No amendments are made to the GST Act. However, to ensure that these amendments, which affect the income tax provisions, interact appropriately with the GST Act, any consequence arising under the GST Act for the trustee as a result of anything done in relation to the underlying asset is taken to have instead arisen for the investor. This is the case even where that consequence would not have arisen if the investor had done that thing instead of the trustee. Given that the investor is taken to stand in the shoes of the trustee, this rule is necessary to ensure that any entitlements or liabilities of the trustee under the GST Act are appropriately taken into account by the investor for income tax purposes. [Schedule 3, item 1, subsection 235-820(5)]

3.70              For example, if the trustee receives a net input tax credit in relation to the instalment trust asset because the trustee has done something in the course of the enterprise of the trust, the impact of this input tax credit on the income tax provisions will flow through to the investor (such as to reduce the investor’s cost base for the instalment trust asset). This is despite the fact that the investor may not have received a net input tax credit in similar circumstances if, for example, the investor was not registered for goods and services tax. [Schedule 3, item 1, subsection 235-820(5)]

What income tax provisions do not receive look-through treatment?

3.71              While these amendments provide look-through treatment for the income tax provisions, certain exceptions apply to ensure the income tax law operates appropriately. These exceptions are consistent with the industry practice that has developed. Specifically, these provisions are:

       Part VA of the ITAA 1936, which contains the TFN provisions. Precluding these amendments from applying ensures that TFNs can be requested without breaching the TFN offence provisions in Subdivision BA of Division 2 of Part III of the Taxation Administration Act 1953 (TAA 1953).

       Subdivision 12-E of Schedule 1 to the TAA 1953, which deals with withholding amounts where an entity invests and has not supplied a TFN or Australian Business Number. The trust is required to be recognised as it is that entity that is legally investing in the investment body, rather than the investor.

       Subdivision 12-F in Schedule 1 to the TAA 1953, which deals with withholding tax for dividends, interest and royalty payments made to foreign residents. Recognising the trust ensures that the trustee has the obligation to withhold tax as required.

       Subdivision 12-H in Schedule 1 to the TAA 1953, which contains the managed investment trust withholding provisions. Recognising the trust ensures that the trustee has the obligation to withhold tax as required.

[Schedule 3, item 1, subsection 235-815(2)]

How long is look-through treatment provided under the income tax provisions?

3.72              The look-through treatment continues even after the investor pays the final instalment and discharges all their obligations relating to the borrowing or the provision of credit. That is, if the asset is continued to be held in the trust, look-through treatment continues to apply. This ensures that no CGT taxing point arises on legal transfer of the asset from the trustee to the investor after final payment is made. [Schedule 3, item 1, sections 235-820, 235-830, 235-840]

Consequential amendments

3.73              Consequential amendments are made to the ITAA 1997 dictionary, namely inserting the definitions of ‘instalment trust’, ‘instalment trust asset’ and ‘regulated superannuation fund’. [Schedule 3, item 5, subsection 995‑1(1) definition of ‘instalment trust’, ‘instalment trust asset’, and ‘regulated superannuation fund’]

3.74              By introducing a definition of a ‘regulated superannuation fund’ into the ITAA 1997 dictionary, existing provisions defining the term throughout the tax provisions are redundant. Therefore, consequential amendments are made to remove these redundant provisions. By replacing these redundant provisions with a direct link to the defined term in the ITAA 1997 dictionary, the consequential amendments provide the same outcome as the existing provisions which separately define the term. [Schedule 3, items 2 to 4 and 7, subsections 290‑60(4), 290‑230(4), section 295‑175, subsection 995‑ 1(1) (definition of ‘complying superannuation plan’), and subsection 355‑65(3) of Schedule 1 to the TAA 1953].

Application and transitional provisions

3.75              These amendments apply to assets that are acquired by the trustee of an instalment trust in the 2007-08 or later income years. These changes, which are beneficial to taxpayers and confirm the industry practice, are retrospective to broadly align with the application date of the superannuation provisions which allow regulated superannuation funds to enter into certain limited recourse borrowing arrangements. [Schedule 3, item 6, section 235-810 of the Income Tax (Transitional Provisions) Act 1997]

3.76              Applying these amendments from this time removes any uncertainty about how the law applied and ensures that the industry practice of ignoring the instalment warrant and receipt trust can continue to apply. In addition, introduction of these measures does not imply that look-through treatment was not available prior to 2007.

3.77              Consequential amendments related to the insertion of ‘regulated superannuation fund’ into the ITAA 1997 dictionary commence from the day of royal assent. As identified above in paragraph 4.74, this change simplifies the tax provisions and does not change the operative effect of the existing tax provisions that rely on this definition. [Clause 2]

Amendment of assessments

3.78              The operation of section 170 of the ITAA 1936 (which provides time limits for amending assessments) is modified where an assessment has been made prior to the commencement of these amendments. In these circumstances, these amendments provide that taxpayers are able to seek an amended assessment within two years of these amendments commencing. This ensures that taxpayers are still able to receive the benefit of these changes despite the delay between the application date and passage of these amendments. [Clause 4]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

3.79              This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

3.80              Schedule 3 to this Bill amends the Income Tax Assessment Act 1997 to provide income tax look-through treatment for instalment warrants and instalment receipts, and other similar arrangements, and for certain limited recourse borrowing arrangements entered into by regulated superannuation funds. This look-through treatment ensures that most income tax consequences associated with the underlying asset of the trust flow through to the investor, and not the trustee.

3.81              This means that the trust is ignored and anything that happens to, or results from, being the owner of the asset, such as receiving dividends and selling the asset, affects the investor and not the trustee.

Human rights implications

3.82              This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

3.83              This Schedule is compatible with human rights as it does not raise any human rights issues.

 


Chapter 4         
Company losses

Outline of chapter

4.1                  Schedule 4 to this Bill amends the company loss recoupment rules in the Income Tax Assessment Act 1997 (ITAA 1997) by:

       modifying the continuity of ownership test for companies whose shares have unequal rights to dividends, capital distributions or voting power;

       ensuring that, for the purposes of applying the continuity of ownership test, the ownership of companies does not have to be traced through a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust; and

       clarifying that the entry history rule does not operate in relation to an entity that becomes a subsidiary member of a consolidated group or multiple entry consolidated group (MEC group) for the purposes of applying the same business test.

4.2                  All legislative references in this Chapter are to the ITAA 1997 unless otherwise indicated.

Context of amendments

4.3                  Under the company loss recoupment rules, an entity is able to claim deductions for prior year tax losses or bad debts, or apply net capital losses, only if the tested company satisfies the continuity of ownership test or the same business test. The claiming entity and the tested company may not be the same entity.

4.4                  Similarly, any prior year losses or non-membership period losses of a company that joins a consolidated group or a MEC group can only be transferred to the head company of the group at the joining time if the tested company satisfies one of these tests.

Operation of the continuity of ownership test

4.5                  The continuity of ownership test broadly requires that the shares carrying more than 50 per cent of all voting, dividend and capital rights be beneficially owned by the same persons at:

       all times during the ownership test period; or

       specific testing times within the test period.

4.6                  The ownership test period is, generally:

       the period from the start of the loss year to the end of the income year in which the loss is to be deducted; or

       if the company joins a consolidated group or MEC group, the period from the start of the loss year to the end of a trial year.

4.7                  Concessional ownership tracing rules apply to widely held companies and certain other companies (known as eligible Division 166 companies).

4.8                  The amendments overcome difficulties that arise in the application of the continuity of ownership test where:

       a company has different classes of shares with unequal rights to dividends, capital distributions or voting power; and

       shares in a company (that is not a widely‑held or eligible Division 166 company) are held by superannuation funds and certain other entities.

4.9                  The amendments have been developed in consultation with key stakeholders and will provide them with greater certainty by reducing the risk of technical failures to the continuity of ownership test (which arise because a company is unable to determine whether a condition of the test is satisfied) and reducing compliance costs.

Companies with shares that have unequal rights to dividends, capital distributions or voting power

4.10              Companies may have difficulty in satisfying the continuity of ownership test where they have shares with unequal rights to dividends, capital distributions or voting power. In these circumstances, companies may technically be unable to meet the conditions required by the continuity of ownership test even though there is no significant change in underlying beneficial ownership during the ownership test period.

4.11              For example, a company which has more than one class of shares with different owners may be unable to satisfy the continuity of ownership test because, if the classes of shares have unequal rights to dividends and capital distributions or unequal voting power, it may be difficult to identify which particular group of owners have more than 50 per cent of the relevant rights or voting power at a particular time.

4.12              Where a company cannot work out whether it satisfies the continuity of ownership test, the company is regarded as being unable to satisfy the conditions required by the continuity of ownership test.

4.13              The amendments will improve the operation of the continuity of ownership test by modifying the test for companies that have shares with unequal rights to dividends, capital distributions or voting power.

4.14              These amendments apply from 1 July 2002 and are beneficial to taxpayers. Companies will have greater certainty in applying the continuity of ownership test to determine whether:

       prior year tax losses and bad debts can be deducted; or

       net capital losses can be applied.

Shares held by superannuation funds and certain other entities

4.15              If shares in a company (that is not a widely‑held or eligible Division 166 company) are held by an entity that is a complying superannuation fund, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust, the ownership of the company must be traced through the entity for the purposes of applying the continuity of ownership test. However, the ownership of widely‑held and eligible Division 166 companies does not have to be traced through these entities. This imposes an unnecessary compliance burden in determining the beneficial ownership of companies that do not qualify for these concessional tracing rules.

4.16              The amendments will improve the operation of the continuity of ownership test where shares in a company are held by an entity that is a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust by removing the need to trace ownership through those entities.

4.17              These amendments are also beneficial to taxpayers and apply from the 2011-12 income year.

Operation of the same business test

4.18              The same business test broadly requires a company to carry on the same business at the following times:

       immediately before the ‘test time’ (which is generally either the point in time at which the continuity of ownership test is no longer satisfied, or the start of the income year when the loss is incurred where it is not practicable for the company to show that there is a period during which it has satisfied the continuity of ownership test); and

       throughout the income year the loss is claimed as a deduction.

4.19              These times are modified when a company joins a consolidated group or MEC group.

4.20              Difficulties arise in applying the same business test to the head company of a consolidated group or MEC group because of the operation of the entry history rule.

4.21              The amendments will improve the operation of the same business test by clarifying that consolidated groups and MEC groups can disregard the entry history rule for the purposes of applying the same business test.

4.22              These amendments, which have been developed in consultation with key stakeholders, are beneficial to taxpayers and therefore will apply from 1 July 2002.

4.23              The amendments clarify the operation of the existing law and will make it easier for the head company of a consolidated group or MEC group to determine whether it has satisfied the same business test. Therefore, the amendments will give consolidated groups and MEC groups greater certainty greater certainty in applying the same business test to determine whether:

       prior year tax losses and bad debts can be deducted; or

       net capital losses can be applied.

Summary of new law

Modifications to the continuity of ownership test

Companies with shares that have unequal rights to dividends, capital distributions or voting power

4.24              The continuity of ownership test is modified for companies whose shares have unequal rights to dividends, capital distributions or voting power.

4.25              Under these modifications, if an entity is unable to work out whether a company satisfies a condition of the continuity of ownership test in respect of dividend or capital distributions, an entity may choose to reconsider the condition in up to three ways:

       the first way is to disregard debt interests;

       the second way is to disregard debt interests and certain secondary classes of shares; and

       the third way is to disregard debt interests and certain secondary classes of shares, and treat each of the remaining shares as having a specified percentage of the rights to receive dividends and capital distributions.

4.26              If a company has shares that have different voting rights or do not carry all of the voting rights in the company, then the continuity of ownership test may be applied by testing voting power solely by reference to the maximum number of votes that could be cast in a poll on:

       the election of the company’s directors; or

       an amendment to the company’s constitution (other than an amendment altering the rights carried by any of the company’s shares or other forms of voting power in the company).

Shares held by superannuation funds and certain other entities

4.27              The company loss recoupment rules will also be modified so that, in applying the continuity of ownership test, the ownership of companies that are not eligible to access the concessional tracing rules will not have to be traced through an entity that is a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust.

Modifications to the same business test

4.28              The same business test is modified for the head company of a consolidated group or MEC group to ensure that the entry history rule does not operate in relation to an entity becoming a subsidiary member of the group.

Comparison of key features of new law and current law

New law

Current law

Where an entity cannot work out whether a condition of the continuity of test is satisfied in respect of shares in a company which have unequal rights to dividends or capital distributions, the entity may choose to reconsider the test in up to three ways:

       the first way is to disregard debt interests;

       the second way is to disregard debt interests and certain secondary share classes;

       the third way is to disregard debt interests and certain secondary share classes, and treat the remaining shares as having certain relative rights (fixed percentage) to receive dividends and capital distributions.

As a result, a company that has shares with unequal rights to dividends or capital distributions will not fail the continuity of ownership where there is no significant change in underlying beneficial ownership during the ownership test period.

Under the company loss recoupment rules, a company is able to deduct prior year tax losses or bad debts, or apply net capital losses, only if it satisfies the continuity of ownership test or the same business test.

A company that has shares with unequal rights to dividends or capital distributions may technically fail the continuity of ownership test even though there is no significant change in underlying beneficial ownership during the ownership test period.

If the shares of a company have different voting rights, or do not carry all of the voting rights in the company, for the purpose of applying the continuity of ownership test, a choice can be made to test voting power solely by reference to the maximum number of votes that could be cast on a poll on:

       the election of the company’s directors; or

       an amendment to the company’s constitution (other than an amendment altering the rights carried by any of the company’s shares or other forms of voting power in the company).

As a result, it is likely that the company will not have a technical failure of the continuity of ownership.

If the shares of a company have different voting rights, or do not carry all of the voting rights in the company, the company may technically fail the continuity of ownership test because it is unable to determine the continuity of voting power.

For the purposes of applying the continuity of ownership test, the ownership of companies that are not eligible to access the concessional tracing rules will not have to be traced through an entity that is a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust.

For the purposes of applying the continuity of ownership test, the ownership of companies that are not eligible to access the concessional tracing rules must be traced through an entity that is a complying superannuation fund, a superannuation fund that is established in a foreign country and is regulated under a foreign law, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust.

For the purpose of applying the same business test, the head company of a consolidated group or MEC group will not need to take into account the history of a subsidiary member prior to the time that it joined the group.

For the purpose of applying the same business test, the head company of a consolidated group or MEC group may need to take into account the history of a subsidiary member prior to the time that it joined the group.

Detailed explanation of new law

Modifications to the continuity of ownership test

4.29              The continuity of ownership test is modified for companies whose shares have unequal rights to dividends, capital distributions or voting power so that companies may test the possession of those rights in a way that is analogous to a company whose shares are all of a single class with the same rights. [Schedule 4, item 1, sections 167‑1, 167‑5, 167-7 and 167‑75]

4.30              The modifications that apply depend upon whether the tested company has:

       shares with unequal rights to dividends or capital distributions (Subdivision 167-A); or

       shares with unequal voting rights or that do not carry all of the voting rights in the company (Subdivision 167-B).

4.31              An entity may choose to reconsider a condition of the continuity of ownership test using the Subdivision that is relevant for the tested company’s circumstances. For example, an entity may reconsider the test in respect of the tested company using:

       the dividend modifications only — because the tested company’s shares have equal rights to capital distributions and equal voting power;

       the voting power modifications only — because the tested company’s shares have equal rights to dividend and capital distributions; and

       all modifications — because the tested company’s shares have unequal rights to dividend and capital distributions, and some voting power is not attached to shares.

4.32              In some cases, the entity making the choice may not be the company to which the continuity of ownership test is being applied. For example, in the case of a consolidated group, the head company of the group is the entity that will make the choice to reconsider the continuity of ownership test. However, the head company may not be the entity being tested where the losses being utilised are ‘transferred losses’.

Companies with shares that have unequal rights to dividends or capital distributions

4.33              An entity can choose to reconsider the continuity of ownership test in respect of a company that cannot work out whether it satisfies the dividend or capital distribution conditions (including certain loss integrity rules) because the company has an unequal share structure, or because a holding company has an unequal share structure, in up to three ways:

       the first way is to disregard debt interests;

       the second way is to disregard debt interests (if any) and certain secondary classes of shares; and

       the third way is to disregard debt interests (if any) and certain secondary classes of shares (if any), and treat the remaining shares as carrying certain percentages of the rights to receive dividends and capital distributions.

[Schedule 4, item 1, section 167‑7]

4.34              The modifications must be applied in order. The second way can only be tried after the first way, while the third way can only be tried after the second way.

4.35              However, an entity is not prevented from reconsidering the test using the second and third ways if the tested company does not have debt interests. Similarly, an entity is not prevented from reconsidering the test using the third way if the tested company does not have debt interests or certain secondary share classes.

Example 4.1 

Quick Co has no debt interest shares. However, it has classes of shares that qualify as secondary classes of shares for the purpose of the second modification to the continuity of ownership test.

In reconsidering the continuity of ownership test in the first way, Quick Co has no debt interests, so the outcome of the continuity of ownership test does not change.

Quick Co then reconsiders the continuity of ownership test in the second way. Quick Co has shares that are disregarded as they are treated as secondary share classes by section 167-20. Those shares can be excluded from measuring the continuity of ownership in Quick Co.

4.36              The modifications, which are in new Subdivision 167‑A, apply in relation to a company if:

       disregarding the operation of Subdivision 167‑A, the company would fail the continuity of ownership test because it is unable to work out whether it satisfies a condition at the test time or for the test period; and

       the company, or a holding company that has a shareholding interest in the company, has an unequal share structure at the test time or at one or more times during the test period.

[Schedule 4, item 1, subsection 167‑10(1)]

4.37              Each condition listed in the tables in section 167-10 must be considered separately. The fact that a company is unable to work out whether a condition in respect of dividend distributions has been satisfied does not mean that the company will be unable to work out whether it has satisfied a condition in respect of capital distributions.

Example 4.2 

Company A is a widely held company that is subject to the concessional tracing rules when applying the continuity of ownership test.

Company A has ordinary shares and preference shares on issue. Both share classes are equally entitled to the same capital distributions. However, the preference shares have priority rights to dividends and are entitled to dividend distributions at 150 per cent the rate of the ordinary shares.

Company A can reconsider conditions that are concerned with the right to dividend distributions, but cannot reconsider conditions that are concerned with the right to capital distributions.

4.38              A condition of the continuity of ownership test may be considered at a particular time or times, in order to work out if the test is satisfied. If there is an unequal share structure at a particular test time, the condition can be reconsidered under Subdivision 167-A for that particular test time. A condition cannot be reconsidered under Subdivision 167-A if an unequal share structure is not present at the particular test time. [Schedule 4, item 1, subsection 167‑10(2)]

4.39              Consequently, it is possible to use a combination of conditions that have, and have not, been reconsidered when working out if the continuity of ownership test has been satisfied.

Example 4.3 

Company A, from Example 5.2, redeems its preference shares prior to the second test time under the continuity of ownership test. It reconsiders the condition under Subdivision 167-A at the first test time.

However, Company A cannot reconsider the conditions related to the right to dividend distributions under Subdivision 167-A for the second test time because it no longer has an unequal share structure.

What are the relevant conditions?

4.40              The conditions that can be reconsidered under Subdivision 167‑A are listed in the tables in subsections 167‑10(1) and (2). These conditions, which are summarised in Table 5.1, can be reconsidered by:

       first, disregarding debt interests;

       second, disregarding debt interests and certain secondary classes of shares; and

       third, treating the remaining shares as having fixed rights to dividends and capital distributions at certain times during the test period (or at one or more of the test times).

[Schedule 4, item 1, subsections 167‑10(1) and (2)]

Table 4.1 

Provision

Condition

Subsection 165- 12(3)

Subsection 165-12(4)

Paragraph 165-37(1)(b)

Paragraph 165-37(1)(c)

Subsection 165-123(3)

Subsection 165-123(4)

Paragraph 175-10(3)(b)

Paragraph 175-10(3)(c)

Paragraph 175-45(3)(b)

Paragraph 175-45(3)(c)

Paragraph 175-85(3)(b)

Paragraph 175-85(3)(c)

Subparagraph (b)(ii) of the definition of eligible Division 166 company in subsection 995-1(1)

Subparagraph (b)(iii) of the definition of eligible Division 166 company in subsection 995-1(1).

There must be persons who have rights to more than 50 per cent of the company’s dividends or capital distributions at all times during the test periods.

Subsection 166-145(3)

Subsection 166-145(4)

Subparagraph 166‑175(1)(e)(ii)

Subparagraph 166‑175(1)(e)(iii)

Paragraph 166-225(1)(b)

Paragraph 166-225(1)(c)

Subparagraph 166‑230(1)(a)(ii)

Subparagraph 166‑230(1)(a)(iii)

Paragraph 166-240(1)(b)

Paragraph 166-240(1)(c)

Subparagraph 166‑255(1)(e)(ii)

Subparagraph 166‑255(1)(e)(iii)

Subparagraph 166‑260(1)(e)(ii)

Subparagraph 166‑260(1)(e)(iii)

Paragraph 166-260(3)(b)

Paragraph 166-260(3)(c)

Paragraph 166-270(2)(c).

The company must be a widely held company or an eligible Division 166 company and there must be persons who have rights to more than 50 per cent of the company’s dividends or capital distributions at particular test times.

Paragraph 165-115C(1)(b)

Paragraph 165-115C(1)(c)

Paragraph 165-115L(1)(b)

Paragraph 165-115L(1)(c)

Subparagraph 165‑115X(1)(b)(ii)

Subparagraph 165‑115X(1)(b)(iii)

Paragraph 165-115Z(1)(b)

Paragraph 165-115Z(1)(c)

Paragraph 170-260(3)(b)

Paragraph 170-260(3)(c)

Paragraph 170-265(2)(b)

Paragraph 170-265(2)(c).

Testing whether there are persons who have rights to a certain percentage of the company’s dividends or capital distributions at particular test times.

Determining whether a company is an eligible Division 166 company

4.41              For the purposes of applying the continuity of ownership test, concessional ownership tracing rules apply to widely held companies and eligible Division 166 companies. A company is an eligible Division 166 company (as defined in subsection 995-1(1)) if, so far as is relevant, the company is not a widely held company and certain specified entities beneficially own:

       dividend stakes that carry rights to receive more than 50 per cent of any dividends that the company may pay; or

       capital stakes carry rights to receive more than 50 per cent of any distributions of capital of the company.

4.42              The specified entities are:

       widely held companies;

       superannuation funds and approved deposit funds;

       first home savers account trusts;

       special companies;

       managed investment schemes;

       non-profit companies; and

       charitable institutions, funds and bodies.

4.43              Currently, a company that has an unequal share structure may not qualify as an eligible Division 166 company because the dividend and capital distribution conditions are unable to be satisfied.

4.44              The conditions in the definition of eligible Division 166 company can be reconsidered under Subdivision 167‑A, even though the definition of an eligible Division 166 company doesn’t expressly apply to a particular period.

4.45              However, the condition in paragraph 166‑245(5)(b) cannot be reconsidered. That condition, broadly, modifies the ownership test tracing concession for certain types of entities (such as superannuation funds and managed investment schemes) with 10 members or fewer, where the proportion of voting power, rights to dividends or rights to capital distributions in, or paid by, the tested company which is attributed to each member of the entity under subsection 166-245(4) is less than 10 per cent.

When does a company have an unequal share structure?

4.46              A company has an unequal share structure at a particular time if:

       the company’s shares do not all carry the same rights to dividends or capital distributions of the company;

       some or all of the company’s shares carry discretionary rights to dividends or capital distributions of the company; or

       the company is a co-operative company that has on issue one or more interests (other than shares) in the company’s capital.

[Schedule 4, items 1 and 52, subsection 167-10(3) and the definition of ‘unequal share structure’ in subsection 995-1(1))]

4.47              A company is likely to have an unequal share structure at a test time (or during a test period) if, for example, it has:

       more than one class of shares on issue at the test time, where those classes of shares have different rights;

       a single class of shares on issue at the test time, where those shares have rights to dividend or capital distributions that are at the discretion of the company or some other entity; or

       more than one class of shares on issue at the test time, where those classes of shares have identical rights but those rights are discretionary.

4.48              A company may have both an equal and an unequal share structure during the test period or at different test times.

4.49              Where an unsatisfied condition is listed in the table in subsection 167‑10(1), Subdivision 167-A must be applied to the entire test period, even if a company is an unequally structured company for only part of the test period. This is because the company needs to satisfy the condition throughout the test period in order to pass the test, not just particular times within that period.

4.50              When measuring ownership changes, the modified rules will only have effect during the part of the period where the unequal share structure is in place.

4.51              Where more than one ownership test period applies, the company must have an unequal share structure for at least part of each period in order to reconsider the continuity of ownership test in each of those periods.

4.52              Although an entity can reconsider the continuity of ownership test for test times that occur when a company has an unequal share structure, it cannot reconsider the continuity of ownership test for test times, or another part of a test period, at which a company does not have an unequal share structure. In these instances, a combination of modified and unmodified tests will apply.

4.53              Where an unsatisfied condition is listed in the table in subsection 167‑10(2), a company must be eligible, and a choice must be made, to apply Subdivision 167-A separately at each relevant test time.

Example 4.4 

Company A has both ordinary shares and preference shares (a secondary share class) on issue at the start of a loss year. As a result, Company A has an unequal share structure at a particular test time.

Company A redeems all of its preference shares between test times. Consequently, it no longer has an unequal share structure from that time onwards as all of the shares carry the same rights. Therefore, Company A cannot choose to apply Subdivision 167-A from that time onwards.

Co-operative companies

4.54              A company that is a co-operative company may be able to issue interests, other than shares, in the company’s capital in order to overcome legislative restrictions relating to the issue of shares. For example, in New South Wales, section 269 of the Co-operatives Act 1992 allows co‑operative companies to issue co-operative capital units in order to obtain greater access to capital.

4.55              A co-operative company that issues co-operative capital units or similar interests may technically fail the continuity of ownership test, even though the ownership of the company remains unchanged. To overcome this difficulty, a co-operative company that has on issue one or more interests (other than shares) in the company’s capital will be taken to have an unequal share structure. [Schedule 4, item 1, paragraph 167-10(3)(c)]

Debt interests disregarded

4.56              An entity may reconsider the unsatisfied condition if the company being tested has an unequal share structure and was unable to satisfy a particular condition of the continuity of ownership test at the test time or during any part of the test period.

4.57              The first way that the entity can choose to reconsider an unsatisfied condition is to disregard any debt interests at the test time, or for the test period, in the unequally structured company. [Schedule 4, item 1, subsection 167-15(1)]

4.58              The way the entity prepares its income tax return is sufficient evidence of it choosing to disregard any debt interests for the purpose of working out whether a company satisfies a condition. [Schedule 4, item 1, subsection 167-15(2)]

4.59              A debt interest in an entity is defined to have the meaning given by Subdivision 974‑B (see the definition of debt interest in subsection 995‑1(1)). Broadly an interest in an entity will be a debt interest if it satisfies the debt test in section 974‑20. Where the characterisation of an interest changes, for example, from debt to equity or vice versa, a new interest in the company comes into existence at this time. This may result in the failure of the continuity of ownership test even though the beneficial owners of the interest have not changed.

Example 4.5 

Zed Co has the following shareholders on 1 July 2015:

       Alex owns 100 ordinary shares;

       Barry owns 100 ordinary shares;

       Claude owns 50 ordinary shares and 100 shares that are debt interests; and

       David owns 50 ordinary shares and 100 shares that are debt interests.

The shares that are debt interests have first priority rights to dividends and capital distributions.

It is assumed that the voting power in Zed Co did not change throughout the ownership test period.

Zed Co makes a $500 tax loss in the 2015-16 income year.

On 1 July 2016, Claude and David sell all of their ordinary shares and shares that are debt interests to Edward.

Zed Co has a taxable income (before deducting tax losses) of $1,000 in the 2016-17 income year. It seeks to deduct the $500 tax loss from its taxable income for the income year.

The ownership test period is from the start of the loss year (1 July 2015) to the end of the income year in which the loss is to be deducted (30 June 2017).

The continuity of ownership test is applied to all 500 shares in the first instance. On 30 June 2017, Alex and Barry hold 200 ordinary shares. These shares have been held throughout the ownership test period. As the 200 shares that are debt interests have different rights to dividend and capital distributions compared to the ordinary shares, Zed Co is unable to work out if it satisfies the dividend and capital distribution conditions of the continuity of ownership test.

However, as Zed Co has an unequal share structure, it reconsiders the dividend and capital distribution conditions under section 167-15. Zed Co reconsiders the unsatisfied conditions by disregarding the 200 shares that are debt interests during the test period.

As Alex and Barry have continually held 200 of the remaining 300 ordinary shares in Zed Co, they have held rights to more than 50 per cent of the company’s dividend and capital distributions throughout the ownership test period.

After disregarding the shares that are debt interests, Zed Co is able to work out whether it satisfies the dividend and capital distribution conditions of the continuity of ownership test. Zed Co satisfies the continuity of ownership test because of majority continuity of:

       voting power (as is assumed at the start of this example); and

       rights to dividends and capital distributions.

Therefore, Zed Co is able to deduct the prior year tax loss of $500 in the 2016-17 income year.

Secondary share classes disregarded

4.60              The second way that an entity can choose to reconsider an unsatisfied condition is to disregard the debt interests (if any) and certain secondary share classes in the unequally structured company. [Schedule 4, item 1, section 167-20]

4.61              The entity can choose to reconsider an unsatisfied condition by disregarding certain secondary share classes if:

       the unsatisfied condition cannot be worked out at the test time or during the test period because:

      there are no shares in the unequally structured company that are debt interests; or

      after disregarding shares that are debt interests, the unsatisfied condition remains unsatisfied;

       after disregarding shares that are debt interests (if any) in an unequally structured company, the company has on issue, at the test time or on the last day of the test period:

      the class or classes of ordinary or common shares that represent the majority of that company’s value; and

      at least one other class of shares (the secondary share classes);

       it is reasonable to conclude that the total market value of all of the secondary share classes on issue at the relevant time does not exceed 25 per cent of the total market value of all the company’s shares (other than debt interests); and

       it is reasonable to conclude that the market value of each of the secondary share classes on issue at the relevant time does not exceed 10 per cent of the total market value of the unequally structured company’s shares.

[Schedule 4, item 1, subsections 167-20(1) and (2)]

4.62              The total market value of the company’s shares at a particular time is the sum of the market values of all of the shares (other than debt interests) in the company at that time.

4.63              If a company has a secondary class of shares on issue during the test period but not at the end of that period, an entity cannot disregard the secondary class of shares for that test period.

Example 4.6 

Rush Co has two secondary share classes. The market value of the Class B shares is 15 per cent of the total market value of all of the company’s shares. The market value of the Class C shares is 9 per cent of the total market value of all of the company’s shares.

The Class C shares in Rush Co may be disregarded when reconsidering the continuity of ownership test.

Example 4.7 

Speedy Co has two secondary share classes. The market value of the Class B shares is 11 per cent of the total market value of all of the company’s shares. The market value of the Class C shares is 13 per cent of the total market value of all of the company’s shares.

Neither of these secondary share classes in Speedy Co can be disregarded when reconsidering the continuity of ownership test, because they each breach the 10 per cent requirement.

Example 4.8 

Tizzy Co has three secondary share classes. The market value of each secondary share class is 9 per cent of the total market value of all of the company’s shares.

None of these secondary share classes in Tizzy Co can be disregarded when reconsidering the continuity of ownership test, because in total, they breach the 25 per cent ceiling.

4.64              The market value used for the purposes of working out secondary share classes depends on the condition being reconsidered. For an ownership test period, the relevant market value is the market value of the shares on the last day of the test period. For test times, it is the market value at each of the relevant test times.

4.65              If a company’s shares are available and traded on the open market, the market value of the shares can be worked out on a reasonable basis having regard to the open market value of those shares.

4.66              An entity may reconsider an unsatisfied condition by disregarding all debt interests and those secondary share classes that satisfy the criteria in subsection 167-20(1). [Schedule 4, item 1, subsection 167‑20(3)]

4.67              The way that the entity prepares its income tax return is sufficient evidence of it choosing to disregard the secondary share classes and debt interests (if any) for the purpose of applying the continuity of ownership test. [Schedule 4, item 1, subsection 167-20(4)]

4.68              If an entity considers that it is impractical to work out the market value of shares, the entity may not choose to reconsider an unsatisfied condition in this second way. In that event, the entity may choose to use the third way to reconsider an unsatisfied condition.

Example 4.9 

Wai Co has the following shareholders on 1 July 2015:

       Frances owns 500 ordinary shares;

       Gabrielle owns 500 ordinary shares;

       Hermione owns 200 ordinary shares and 100 preference shares; and

       Indira owns 200 ordinary shares and 100 shares that are debt interests.

The shares that are debt interests have first priority rights to dividends and capital distributions, but do not carry any voting power (as determined under section 167-80). The preference shares have the second priority rights to dividends and capital distributions. For the purposes of this example, it assumed that the voting power in the company did not change throughout the ownership test period.

Wai Co makes a $1,000 tax loss in the 2015‑16 income year.

On 1 July 2016, Hermione and Indira sell all of their ordinary shares, preference shares and debt interest shares to Jacqueline.

On the last day of the ownership test period (30 June 2017), the market value of each ordinary share is $1 and the market value of each preference share is $1.50.

Wai Co has a taxable income (before deducting tax losses) of $4,000 in the 2016‑17 income year. It seeks to deduct the $1,000 tax loss from its taxable income for the income year.

The ownership test period is from the start of the loss year (1 July 2015) to the end of the income year in which the loss is to be deducted (30 June 2017).

The continuity of ownership test is applied to all 1,600 shares in the first instance. On 30 June 2017, Frances and Gabrielle hold 1,000 ordinary shares. These shares have been held throughout the ownership test period. As the different classes of shares do not have the same rights to dividends and capital distributions, Wai Co is unable to work out whether it satisfies the dividend and capital distribution conditions of the continuity of ownership test.

As Wai Co has an unequal share structure, it reconsiders the dividend and capital distribution conditions under section 167‑15. Therefore, Wai Co reconsiders the unsatisfied conditions by disregarding the 100 shares that are debt interests throughout the test period.

However, despite disregarding the shares that are debt interests, Wai Co is still unable to work out if it satisfies the dividend and capital distribution conditions of the continuity of ownership test.

Therefore, Wai Co further reconsiders the unsatisfied conditions under section 167‑20. On the last day of the test period (30 June 2017):

       the market value of 1,400 ordinary shares is $1,400;

       the market value of 100 preference shares is $150; and

       the total market value of all shares is $1,550.

The total market value of the secondary share class does not exceed 25 per cent of the total market value of all of Wai Co’s shares (excluding shares that are debt interests) on that day:

       $1,550.00  x  25 per cent  =  $387.50

       $150.00 is less than $387.50.

The market value of the preference shares ($150) does not exceed 10 per cent of the total market value of Wai Co shares on that day:

       ($150  +  $1,400)  x  10 per cent  =  $155

       $150 is less than $155.

Therefore Wai Co reconsiders the unsatisfied conditions having regard solely to the ordinary shares during the test period.

As Frances and Gabrielle have continually held 1,000 of the remaining 1,400 ordinary shares in Wai Co, they have held rights to more than 50 per cent of the company’s dividends and capital distributions throughout the ownership test period.

After disregarding the debt interests and the secondary share class, Wai Co is able to work out the dividend and capital distribution conditions of the continuity of ownership test. Wai Co satisfies the continuity of ownership test because of majority continuity of:

       voting power (as is assumed at the start of this example); and

       rights to dividends and capital distributions.

Wai Co is able to deduct the prior year tax loss of $1,000 in the 2016‑17 income year.

Shares taken to have fixed rights to dividends and capital distributions

4.69              The third way that an entity can choose to reconsider an unsatisfied condition is to treat certain shares in the unequally structured company as having fixed rights to dividends and capital distributions. [Schedule 4, item 1, section 167‑25]

4.70              A company with an unequal share structure can have its shares treated as having fixed rights to dividends and capital distributions if the unsatisfied condition cannot be worked out at the test time or for the test period where:

       there are no shares in the unequally structured company that are debt interests;

       after disregarding shares in the unequally structured company that are debt interests, the unsatisfied condition remains unsatisfied;

       the unequally structured company does not have secondary share classes; or

       the unequally structured company has one or more secondary share classes, but one or more of those secondary share classes cannot be disregarded because their combined or individual market value exceeds the thresholds to be disregarded.

[Schedule 4, item 1, subsection 167-25(1)]

4.71              An entity can choose to reconsider an unsatisfied condition by treating the shares on issue in the unequally structured company that remain after applying subsection 167‑25(3) (that is, the remaining shares) as having, at the test time, relative rights to receive dividends and capital distributions that are fixed. [Schedule 4, item 1, subsection 167‑25(4)]

4.72              The basis of working out the relative rights to receive dividends and capital distributions depends on whether or not it is reasonably practicable to work out the relative market value of each remaining share in the unequally structured company at the test time. [Schedule 4, item 1, subsection 167‑25(4), sections 167-30 and 167-35]

4.73              The way an entity prepares its income tax return is sufficient evidence of it choosing to treat the remaining shares in the tested company as having fixed rights to dividends and capital distributions for the purpose of working out whether a company satisfies a condition. [Schedule 4, item 1, subsection 167‑25(5)]

4.74              For provisions covered by item 1 in the table in subsection 167‑10(1), the conditions must be satisfied during the whole of, or at all times, during the test period. However, this rule is modified by section 167-40, which identifies specific valuing times within the test period. Each of these valuing times is a test time for the purposes of the third way to reconsider an unsatisfied condition. A fixed value is attributed to each remaining share at the relevant valuing times. [Schedule 4, item 1, sections 167-25, 167-30, 167-35 and 167-40]

4.75              The valuing times for the test period conditions listed in subsection 167-10(1) are all of the following times that occur during the test period:

       the time the period starts;

       the time just before, and the time just after, any of the following events that happen during the test period:

      the issue of shares of a class of remaining shares;

      the variation of rights attached to any remaining shares to receive dividends or capital distributions; or

      the redemption or cancellation of any remaining shares; and

       the time the period ends.

4.76              Any valuing time that occurs outside of the test period is disregarded. [Schedule 4, item 1 subsection 167‑40(2)]

4.77              There may be multiple valuing times, and consequently test times, occurring during a test period.

Example 4.10 

After disregarding shares that were debt interests and secondary classes of shares, Kaz Co reconsidered the continuity of ownership tests by fixing the rights attached to the remaining shares.

During the test period, Kaz Co issued a class of shares that is not disregarded under subsection 167-20(3) on two separate occasions.

Under subsection 167-40(1), the valuing times for Kaz Co are:

       the time the test period starts (the beginning of the loss year);

       the time just before the first issue of shares was issued;

       the time just after the first issue of shares was issued;

       the time just before the second issue of shares was issued;

       the time just after the second issue of shares was issued; and

       the time the test period ended (the end of the income year).

4.78              Where an unsatisfied condition has one or more fixed test times (that is, where the unsatisfied condition is covered by items 1 or 2 of the table in subsection 167-10(2)), a fixed value is worked out for, and attributed to, each remaining share at each of the fixed test times. [Schedule 4, item 1, sections 167-30 and 167-35]

Where it is practicable to work out the market value of each remaining share

4.79              Where it is reasonably practicable to work out the relative market value of each remaining share in the unequally structured company at the test time, each remaining share is treated at the test time as carrying the percentage of rights to receive dividend and capital distributions from the company worked out under the formula:

[Schedule 4, item 1, paragraph 167‑25(4)(a) and section 167‑30)]

4.80              For the purposes of applying the formula:

       the remaining shares are those remaining after disregarding debt interests and the secondary share classes disregarded under subsection 167-20(3);

       if the unsatisfied condition is covered by item 1 of the table in subsection 167‑10(1), the market value is worked out at each valuing time as each valuing time is a test time; and

       if the unsatisfied condition is covered by item 1 of the table in subsection 167‑10(2) the market value is worked out at the particular test time.

[Schedule 4, item 1, section 167‑30]

4.81              In the case where there is more than one test time, it is necessary to apply the formula at each test time.

Where it is impracticable to work out the market value of each remaining share

4.82              Where it is not reasonably practicable to work out the relative market value of each remaining share in the unequally structured company at the test time, or the sum of the market values of all of the remaining shares is nil, each remaining share is treated as carrying a percentage of rights to receive dividend and capital distributions from the company as is reasonable, worked out at:

       each of the valuing times (which are also test times), if the unsatisfied condition is covered by item 1 of the table in subsection 167‑10(1); or

       each test time, if the unsatisfied condition is covered by item 1 of the table in subsection 167‑10(2).

[Schedule 4, item 1, paragraph 167‑25(4)(b) and subsection 167‑35(1)]

4.83              In either case, regard should be had to the purpose of the unsatisfied condition.

4.84              In working out what is reasonable, regard must be had to:

       the company’s constitution;

       any agreements between the company and its shareholders (including any associate of a shareholder);

       any statement by the company of its policy in paying dividends or making capital distributions;

       the ability of an entity to control (either directly or indirectly through one or more interposed entities) how the company pays dividends or makes capital distributions;

       how the company has previously paid dividends or made capital distributions;

       whether all classes of shares carry substantially the same rights to receive dividends and capital distributions; and

       the principle that a tax loss or a bad debt should only be deductible, and a net capital loss should only be applied, if a majority of the persons entitled to the benefits of dividend and capital distributions of the company is maintained.

[Schedule 4, item 1, subsection 167‑35(2)]

Example 4.11 

Kommissar Co Pty Ltd has the following shareholders on 1 July 2015:

       Leisl owns 550 ordinary shares and 100 shares that are debt interests;

       Mark owns 300 preference shares; and

       Olivier owns 450 ordinary shares, 50 preference shares and 250 shares that are debt interests.

The shares that are debt interests have first priority rights to dividends and capital distributions. The preference shares have the second priority rights to dividends and capital distributions. The ordinary shares have last priority rights to dividends and capital distributions. For the purposes of this example, it is assumed that the voting power in the company remains unchanged throughout the ownership test period.

Kommissar Co makes a $1,000 tax loss in the 2015‑16 income year.

On 1 July 2016, Paula buys:

       250 debt interest shares from Olivier;

       300 preference shares from Mark; and

       230 ordinary shares and 100 debt interest shares from Leisl.

In the 2016‑17 income year, Kommissar Co has a taxable income (before deducting tax losses) of $5,000. It seeks to deduct the $1,000 tax loss from its taxable income for the income year.

The ownership test period is from the start of the loss year (1 July 2015) to the end of the income year in which the loss is to be deducted (30 June 2017).

The continuity of ownership test is applied to all 1,700 shares in the first instance. On 30 June 2017:

       Leisl holds 320 ordinary shares, which have been held throughout the ownership test period;

       Olivier holds 450 ordinary shares and 50 preference shares, which have been held throughout the ownership test period; and

       Paula holds 230 ordinary shares, 300 preference shares and 350 debt interest shares, which were acquired during the ownership test period.

As the different classes of shares do not all carry the same rights to dividends and capital distributions, Kommissar Co is unable to work out whether it satisfies the dividend and capital distribution conditions of the continuity of ownership test (that is, the conditions in subsections 165‑12(3) and (4) referred to in item 1 of the table in subsection 167‑10(1)).

As Kommissar Co has an unequal share structure, it reconsiders the dividend and capital distribution conditions under section 167‑15. Therefore, Kommissar Co reconsiders the unsatisfied conditions by disregarding the 350 shares that are debt interests throughout the ownership test period.

However, despite disregarding the shares that are debt interests, Kommissar Co is still unable to work out whether it satisfies the dividend and capital distribution conditions of the continuity of ownership test.

Therefore, Kommissar Co reconsiders the unsatisfied conditions under section 167‑20. After disregarding the 350 shares that are debt interests, Kommissar Co has:

       an ordinary or common class of shares — being the 1,000 ordinary shares; and

       a secondary class of shares — being the 350 preference shares.

To reconsider the condition, Kommissar Co must use the market values on the last day of the test period. On 30 June 2017:

       the market value of the preference shares is $525 (350  x  $1.50); and

       the total market value of all of the company’s shares (disregarding debt interests) is $1,525 ((1,000 ordinary shares  x  $1)  +  (350 preference shares  x  $1.50)).

As the market value of the preference shares ($525) exceeds 10 per cent of the total market value of all of the company’s shares ($1,525  x  10 per cent  =  $152.50), Kommissar Co cannot reconsider the unsatisfied conditions under section 167‑20 by disregarding the secondary class of shares (that is, the preference shares).

Therefore, Kommissar Co reconsiders the unsatisfied conditions under section 167‑25 as if:

       the shares in the company (the remaining shares) consisted solely of the ordinary shares and the preference shares — that is, the debt interest shares are disregarded; and

       those shares had fixed rights to receive dividends and capital distributions relative to their market value at each test time in the ownership test period.

The unsatisfied conditions are the conditions in subsections 165‑12(3) and (4). During the ownership test period (1 July 2015 to 30 June 2017) Kommissar Co has not issued shares, varied rights attached to any of the remaining shares or cancelled any of the remaining shares. Therefore, the valuing time is the time that the ownership test period starts and ends — that is, 1 July 2015 (paragraph 167‑40(1)(a)) and 30 June 2017 (paragraph 167-40(1)(c)).

On 1 July 2015 and 30 June 2017, the market value of each ordinary share in Kommissar Co was $1. The market value of each preference share at those times was $1.50.

Therefore, as it is reasonably practicable for Kommissar Co to work out the market value of each of the remaining shares as at 1 July 2015 and 30 June 2017, the remaining shares are taken to have relative rights to receive dividend and capital distributions worked out under the formula in section 167‑30 (paragraph 167‑25(4)(a)).

Applying that formula:

       each ordinary share is taken to carry 0.06557 per cent of the rights to receive dividends and capital distributions from the company at 1 July 2015 and 30 June 2017, worked out as follows:

       each preference share is taken to carry 0.09836 per cent of the rights to receive dividends and capital distributions from the company at 1 July 2015, worked out as follows:

Therefore, at 1 July 2015:

       Leisl, who held 550 ordinary shares, had 36.06 per cent
(550  x  0.06557 per cent) of the rights to receive dividends and capital distributions from the company;

       Mark, who held 300 preference shares, had 29.51 per cent
(300  x  0.09836 per cent) of the rights to receive dividends and capital distributions from the company;

       Olivier, who held 450 ordinary shares and 50 preference shares, had 34.43 per cent of the rights to receive dividends and capital distributions from the company — that is:

      the 450 ordinary shares had 29.51 per cent
(450  x  0.06557 per cent) of the rights to receive dividends and capital distributions from the company; and

      the 50 preference shares had 4.92 per cent (50  x  0.09836 per cent) of the rights to receive dividends and capital distributions from the company.

At 30 June 2017:

       Leisl, who held 320 ordinary shares, had 20.98 per cent
(320  x  0.06557 per cent) of the rights to receive dividends and capital distributions from the company;

       Olivier, who held 450 ordinary shares and 50 preference shares, had 34.43 per cent of the rights to receive dividends and capital distributions from the company — that is:

      the 450 ordinary shares had 29.51 per cent
(450  x  0.06557 per cent) of the rights to receive dividends and capital distributions from the company; and

      the 50 preference shares had 4.92 per cent (50  x  0.09836 per cent) of the rights to receive dividends and capital distributions from the company.

Leisl and Olivier have held rights to more than 50 per cent of Kommissar Co’s dividends and capital distributions throughout the ownership test period by using the third way. That is:

       Leisl and Olivier have continually held 50.49 per cent of the rights to receive dividends and capital distributions in respect of ordinary shares issued by Kommissar Co (770 ordinary shares  x  0.06557 per cent); and

       Olivier has continually held 4.92 per cent of the rights to receive dividend and capital distributions in respect of preference shares issued by Kommissar Co (50 preference shares  x  0.09836 per cent).

Kommissar Co satisfies the continuity of ownership test because of majority continuity of voting power (as assumed at the start of this example), and rights to dividends and capital distributions. Therefore, Kommissar Co is able to deduct the prior year tax loss of $1,000 in the 2016‑17 income year.

Application of these modifications to consolidated groups and MEC groups

4.85              Division 167 can apply in the case of a consolidated group or MEC group where the conditions in the continuity of ownership test are applied to a company. That company may be the head company of the group or another company.

4.86              The conditions of the continuity of ownership test could be reconsidered in the following circumstances, if the entity has an unequal share structure:

       utilising a group loss by the head company of a consolidated group (the conditions are examined for the head company);

       utilising a group loss by the head company of a MEC group — the conditions are examined for the top company of the MEC group;

       utilising a transferred loss by the head company of a consolidated group where the loss was transferred as a continuity of ownership test transfer (COT transfer) — the conditions are examined for the test company identified in Subdivision 707‑B;

       utilising a transferred loss by the head company of a consolidated group where the loss was not transferred as a COT transfer — the conditions are examined for the head company;

       utilising a transferred loss by the head company of a MEC group — the conditions are examined for the test company identified in Subdivision 719‑F;

       determining whether a company’s unused carry-forward losses can be transferred to the head company of a consolidated group or MEC group when the company joins the group — the conditions are examined for the joining company;

       determining if an entity can deduct a bad debt where Subdivision 709‑D applies where the debt was owed to a company in a debt test period — the conditions are examined for the company who was owed the debt during its debt test period, except where the company is the head company of a MEC group; and

       determining if the head company of a MEC group can deduct a bad debt, or could have deducted the debt in respect of its debt test period where Subdivision 709‑D applies — the conditions are examined for the top company of the MEC group pursuant to modifications in Subdivision 719‑I.

4.87              Apart from the conditions in the continuity of ownership test, Division 167 can also apply where, under a provision for consolidated groups or MEC groups, an unsatisfied condition listed in section 167‑10 or the voting power in a company is worked out. For example:

       whether there is a changeover time for a leaving entity for purposes of Subdivision 715‑A; or

       whether there is an alteration time for a leaving entity and whether the head company has a relevant equity interest in the leaving entity for purposes of Subdivision 715‑B.

4.88              The way the head company of the consolidated group or MEC group prepares its income tax return is sufficient evidence of its choosing to work out the unsatisfied condition for the test company under each of the ways it can reconsider the continuity of ownership test. [Schedule 4, item 1, subsections 167‑15(2), 167-20(4) and 167-25(5)]

Companies with shares that have unequal voting rights

4.89              Subdivision 167‑B modifies the way voting power in a company is worked out where shares in the company:

       do not all carry the same voting rights; or

       do not carry all of the voting rights in the company.

[Schedule 4, item 1, section 167‑75]

4.90              Voting power in a company may not be measurable by reference to its shares because:

       the constitution confers rights on an entity in relation to some or all matters affecting the company — for example, the constitution may grant a particular shareholder the right to as many votes as constitute a majority for an ordinary resolution or a three-quarters majority for a special resolution;

       the shareholders may enter into an agreement that certain (or all) shareholders must consent to pass a resolution on a particular matter, or may effectively grant a shareholder the power to veto a resolution on that matter;

       preference shares normally have limited voting rights compared to ordinary shares;

       some or all of the classes of shares have the power to appoint a certain number of directors of the company; or

       some other reason, for example, the constitution of the company confers voting rights on an entity that is not connected with a share‑holding.

[Schedule 4, item 1, subsection 167-80(1)]

4.91              The company may, or may not, be a party to an agreement or arrangement that is the source of unequal voting rights in the company’s shares.

4.92              An entity can choose to modify the way that voting power in a company is worked out at a particular time, if the shares in the company do not all carry the same voting rights or do not carry all of the voting rights in the company at that time. [Schedule 4, item 1, subsections 167‑80(1) and 167-85(1)]

4.93              If an entity makes such a choice, then the entity can choose which method it will use to determine the voting power in the company. The methods require the voting power in the company at that time to be worked out solely by reference to the maximum number of votes that could be cast on a poll, either:

       if the election of the company’s directors is determined by the casting of votes, on the election of a director of the company (assuming such a poll were to be held at that time); or

       on the adoption of a constitution for the company or the amendment of the company’s constitution (assuming such a poll were to be held at that time) other than an amendment altering:

      the rights carried by the company’s shares; or

      other forms of voting power in the company.

[Schedule 4, item 1, subsection 167-85(1)]

4.94              If one or more directors of a company are chosen by a particular shareholder, or are elected on a poll of the holders of a particular class or classes of shares, the voting power is worked out on a pro rata basis.

Example 4.12 

At a particular time, Wooster Co has five directors. Under the company’s constitution:

       Bertram (who is not a shareholder) chooses one director;

       the holders of Class A shares elect two directors by a majority vote of that class — there are five holders of the 2 million Class A shares, each holding 400,000 shares; and

       the holders of ordinary shares elect the remaining two directors by a majority vote of that class — there are 20 holders of the 6 million ordinary shares, each holding 300,000 shares.

Wooster Co chooses to work out voting power in the company under paragraph 167-85(1)(a) at the particular time.

Therefore, at that particular time:

       Bertram holds 20 per cent of the voting power in the company — one of five directors;

       each holder of Class A shares owns 8 per cent of the voting power in the company — two of five directors (40 per cent) divided by 5 shareholders with equal holdings; and

       each holder of ordinary shares owns 2 per cent of the voting power in the company — two of five directors (40 per cent) divided by 20 shareholders with equal holdings.

Example 4.13 

At a particular time, Cart Co has five directors. Under the company’s constitution:

       Beadle (who is not a shareholder) chooses one director;

       the holders of Class A shares elect two directors by a majority vote of that class — there are five holders of the 2 million Class A shares, each holding 400,000 shares; and

       all shareholders elect the remaining two directors (ie two-fifths of the directors) by a majority vote of that class — for this purpose Beadle is deemed to hold 2 million ordinary shares and each share in the company carries equal voting rights.

There are 20 holders of 6 million ordinary shares, each holding 300,000 shares.

In total, there are 10 million shares that have voting rights:

       Beadle is deemed to hold 2 million ordinary shares;

       Class A shareholders hold 2 million shares;

       ordinary shareholders hold 6 million shares.

Therefore, at that particular time:

       Beadle holds 28 per cent of the voting power in the company — that is, the sum of:

      20 per cent, being for one of five directors; and

      8 per cent, being for the election of the two directors (40 per cent  x  2 million shares/10 million shares);

       each holder of Class A shares owns 9.6 per cent of the voting power in the company — that is, the sum of:

      8 per cent, being for the election of two directors (40 per cent/5 shareholders); and

      1.6 per cent, being for the election of the remaining two directors (40 per cent  x  (2 million shares/10 million shares)/5 shareholders); and

       each holder of ordinary shares owns 1.2 per cent of the voting power in the company, being for the election of two directors — that is, 40 per cent  x  (6 million shares/10 million shares)/20 shareholders.

4.95              Voting power must be determined at each of the particular times the conditions of the continuity of ownership test are being considered.

4.96              Where voting power is being determined for a test period, voting power must be determined at each point the maximum number of votes that could be cast on a poll, established by the method chosen in subsection 167-85(1), changes during that period.

Example 4.14 

Patrician Co needs to work out whether it satisfies the voting power condition of the continuity of ownership test under subsection 165‑12(2) during an ownership test period from 1 July 2015 to 30 June 2017.

Patrician Co has two classes of shares on issue from 1 July 2015 to 30 November 2016:

       100 Class A shares that carried voting rights in relation to the election of the company’s directors;

       50 Class B shares that carried voting rights on all matters affecting the company.

On 30 November 2016, Patrician Co issued an additional 50 Class B shares. There were no other changes in the company’s voting power during the ownership test period.

Patrician Co chooses that the voting power in the company during the ownership test period will be worked out under paragraph 167-85(1)(a) by reference to the maximum number of votes that could be cast on the election of a director of the company. Therefore, both classes of shares will be counted.

Two different calculations must be done under subsection 165-12(2) for the ownership test period:

       150 shares should be counted until 30 November 2016; and

       200 shares from 30 November until 30 June 2017.

If there is less than 50 per cent continuity under either calculation, Patrician Co will fail subsection 165-12(2).

4.97              The way that the entity prepares its income tax return is sufficient evidence of it choosing to modify the way that voting power in a company is worked out at the particular time. [Schedule 4, item 1, subsection 167‑85(2)]

4.98              Section 167-85 can be applied to work out the meaning of terms that are used in, or for the purposes of, Part 3-5 of the ITAA 1997 (such as subparagraph (b)(i) of the definition of eligible Division 166 company in subsection 995-1(1)).

4.99              For the purpose of applying Subdivision 167‑B, shares that are dual listed company voting shares are disregarded. [Schedule 4, item 1, section 167‑90]

4.100          A dual listed company voting share is defined in subsection 125‑60(3) to mean a share in a company:

       that is issued as part of a dual listed company arrangement, mainly for the purpose of ensuring that shareholders of both companies involved in the arrangement vote as a single decision making body on matters affecting them; and

       that does not carry rights to financial entitlements (except the return of an amount paid up on the share and a dividend that is the equivalent of a dividend paid on an ordinary share).

4.101          If an entity chooses to apply section 167‑85 to modify the way that voting power in a company is worked out, the modified approach must be applied to all of the shares in the company, not the reduced pool of shares left after the application of the Subdivision 167‑A modifications.

Shares held by superannuation funds and certain other entities

4.102          Generally, in applying the continuity of ownership test, a company must trace its ownership through to its ultimate beneficial owners to determine whether certain conditions in section 165-12 are satisfied.

4.103          Currently, in applying the continuity of ownership test, where the ownership structure of the company includes one of a number of specified entities (broadly, government entities, non-profit bodies and charitable entities), the entity is treated as if it is a person (not a company).

4.104          As a result, it is unnecessary to trace through these entities to determine the ultimate beneficial owners of the shares in the company (section 165‑202).

4.105          The scope of section 165‑202 is being extended so that, in applying the continuity of ownership test, a company will also be able to treat the following entities in its ownership structure as if they are a person:

       a complying superannuation fund;

       a superannuation fund that is established in a foreign country and is regulated under a foreign law;

       a complying approved deposit fund;

       a special company; or

       a managed investment scheme.

[Schedule 4, item 56, paragraphs 165-202(1)(h) to (l)]

4.106          As a result, a company will not have to trace though such entities in applying the tests to determine whether a company has satisfied the continuity of ownership test.

4.107          Where the ownership structure of a company includes an entity that is a first home savers account trust, in applying the continuity of ownership test to the company, that entity will also be treated as a person (not a company). [Schedule 4, item 58]

Modifications to the same business test

4.108          The operation of the same business test is modified for the head company of a consolidated group or MEC group. The modifications clarify that, for the purpose of applying the same business test (section 165‑210), the entry history rule (section 701‑5) does not operate in relation to an entity becoming a subsidiary member of a consolidated group or a MEC group. [Schedule 4, item 54, section 165‑212E]

4.109          The amendment clarifies that the head company of a consolidated group or MEC group does not need to take into account the history of a subsidiary member prior to the time that the subsidiary member joined the group for the purposes of determining whether the head company can satisfy the same business test.

Consequential amendments

4.110          Consequential amendments are made to:

       notes in Divisions 165, 166, 170, 175, 974 and 995 so that they appropriately refer to the modifications to the continuity of ownership test made by new Subdivisions 167-A and 167‑B; and

       cross references in Division 707 so that relevant provisions appropriately refer to new Division 167.

[Schedule 4, items 2 to 51, sections 165‑12, 165‑37, 165‑40, 165‑115C, 165‑115D, 165‑115L, 165‑115M, 165‑115X, 165‑115Z, 165‑123, 165‑129, 166‑145, 166‑175, 166‑225, 166‑230, 166‑235, 166‑240, 166‑255, 166‑260, 170‑260, 170‑265, 175‑10, 175‑45, 175‑85, 707‑205, 974‑10 and 995‑1]

Application and transitional provisions

Companies with shares that have unequal rights to dividends, capital distributions or voting power

4.111          The amendments to modify the continuity of ownership test for companies with shares that have unequal rights to dividends, capital distributions or voting power apply from 1 July 2002. [Schedule 4, item 53 section 167‑1 of the Income Tax (Transitional Provisions) Act 1997]

4.112          That is, the amendments will apply to:

       any tax loss for an income year commencing on or after 1 July 2002;

       any net capital loss for an income year commencing on or after 1 July 2002; and

       any deduction in respect of a bad debt that is claimed in an income year commencing on or after 1 July 2002.

[Schedule 4, item 53, paragraphs 167‑1(1)(a) to (c) of the Income Tax (Transitional Provisions) Act 1997]

4.113          The amendments will also apply in determining whether any changeover time or alteration time occurred on or after 1 July 2002. [Schedule 4, item 53, paragraph 167‑1(1)(d) of the Income Tax (Transitional Provisions) Act 1997]

4.114          In addition, the amendments will apply to:

       any tax loss of a company for an income year commencing on or before 30 June 2002 that could have been deducted, in accordance with Divisions 165 and 166 as in force at that time, in the first income year commencing after 30 June 2002 if the deduction had not been limited by the company’s income for that income year; and

       any net capital loss of a company for an income year commencing on or before 30 June 2002 that could have been applied, in accordance with Divisions 165 and 166 as in force at that time, in the first income year commencing after 30 June 2002 if the application of the loss had not been limited by the company’s capital gains for that income year.

[Schedule 4, item 53, subsection 167‑1(2) of the Income Tax (Transitional Provisions) Act 1997]

4.115          The amendments to improve the operation of the continuity of ownership test for companies that have shares with unequal rights to dividends, capital distributions or voting power apply from 1 July 2002 as they are beneficial to taxpayers. Companies will have greater certainty in applying the continuity of ownership test to determine whether:

       prior year tax losses and bad debts can be deducted; or

       net capital losses can be applied.

4.116          The amendments have been developed in consultation with affected taxpayers and will reduce the risk of technical failures to the continuity of ownership test.

4.117          The application date for these amendments is consistent with the application date for amendments made by Schedule 1 to the Tax Laws Amendment (Loss Recoupment Rules and Other Measures) Act 2005. That Act introduced the modified continuity of ownership test for widely held companies and eligible Division 166 companies.

4.118          The effect of the amendments for a company with a substituted accounting period is that Division 167 applies for the first accounting period that commences after 1 July 2002.

4.119          For example, a company with a substituted accounting period of 1 April to 31 March, will not be eligible for the modified continuity of ownership test in respect of losses incurred in its income year commencing 1 April 2002, unless it could have deducted those losses under the existing rules in its income year commencing 1 April 2003.

4.120          If a pre-1 July 2002 loss is eligible for Division 167 (that is, it could have been deducted in an income year commencing on or after 1 July 2002), Division 167 will apply at all test times or throughout the test period. For example, if the loss was made in the 2000-01 income year and the company is seeking to deduct it in the 2011-12 income year, Division 167 will be available for use to test ownership in 2000-01 and 2011-12 (as well as intervening years).

4.121          Division 167 cannot apply to deductions for bad debts written‑off before 1 July 2002. Unlike tax losses, deduction for bad debts can be claimed in the income year the debt is written off. If the company’s deductions for that income year exceed its income, the bad debt deduction merely contributes to the loss (subject to the application of section 165‑132).

4.122          In some cases, a tax loss or a net capital loss is taken to have been made in the income year immediately before a changeover time (section 165‑115B). Division 167 will not apply to a loss that is treated as having been made in an income year commencing before 1 July 2002 unless the loss could have been used in the first income year commencing on or after that date.

Shares held by superannuation funds and certain other entities

4.123          The amendments to remove the need to trace a company’s ownership through superannuation funds and certain other entities applies to tax losses and bad debts that a company seeks to deduct, and net capital losses that a company seeks to apply, in the 2011-12 income year or in a later income year. The amendments will also apply in determining whether any changeover time or alteration time occurred in the 2011-12 income year or in a later income year. [Schedule 4, item 57]

4.124          In addition, the amendment to remove the need to trace through an entity that is a first home savers account trust applies to tax losses and bad debts that a company seeks to deduct, and net capital losses that a company seeks to apply in the 2011-12, 2012-13, 2013-14 and 2014-15 income years. [Schedule 4, item 58]

4.125          These amendments apply from the 2011-12 income year because they are beneficial to taxpayers. The amendments have been sought by affected taxpayers to provide them with greater certainty and reduce compliance costs.

Modifications to the same business test

4.126          The amendment to the same business test applies on and after 1 July 2002. [Schedule 4, item 55]

4.127          These amendments are beneficial to taxpayers as they clarify the operation of the existing law and will make it easier for the head company of a consolidated group or MEC group to determine if the same business test has been satisfied. Therefore, the amendments will give consolidated groups and MEC groups greater certainty in applying the same business test to determine whether:

       prior year tax losses and bad debts can be deducted; or

       net capital losses can be applied.

Amendment of assessments

4.128          Generally, the Commissioner of Taxation can amend an assessment of a company, other than a small business entity, within four years from the date of the notice of assessment (section 170 of the Income Tax Assessment Act 1936).

4.129          As the amendments that introduce Division 167 and amend the same business test apply from 1 July 2002, the period for amending assessments will be extended. That is, the operation of section 170 will be modified so that it does not prevent the amendment of an assessment if:

       the assessment was made before the date of commencement of Schedule 4;

       the amendment is made within four years after that commencement date; and

       the amendment is made for the purpose of giving effect to the amendments in Schedule 4.

[Section 4]

Statement of Compatibility with Human Rights

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Company losses

4.130          Schedule 4 to this Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

4.131          This Schedule amends the company loss recoupment rules in the Income Tax Assessment Act 1997 by:

       modifying the continuity of ownership test for companies whose shares have unequal rights to dividends, capital distributions or voting power;

       ensuring that, for the purposes of applying the continuity of ownership test, the ownership of companies does not have to be traced through a complying superannuation fund, a complying approved deposit fund, a special company, a managed investment scheme or a first home savers account trust; and

       clarifying that the entry history rule does not operate in relation to an entity that becomes a subsidiary member of a consolidated group or multiple entry consolidated group for the purposes of applying the same business test.

Human rights implications

4.132          This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

4.133          This Schedule is compatible with human rights as it does not raise any human rights issues.

 


Schedule 1: Tax relief for certain mining arrangements

Bill reference

Paragraph number

Item 1, subsection 40-363(1) of the ITAA 1997

1.35

Item 1, subsection 40-363(2) of the ITAA 1997

1.36

Item 1, paragraph 40‑363(3)(a) of the ITAA 1997

1.37

Item 1, paragraph 40‑363(3)(c) of the ITAA 1997

1.38

Item 1, subsection 40-363(4) and paragraph 40‑363(3)(b) of the ITAA 1997

1.41

Item 1, paragraph 40-363(5)(a) of the ITAA 1997

1.30, 1.33

Item 1, paragraph 40‑363(5)(c) of the ITAA 1997

1.32

Item 1, subsections 40-363(6) and (7), and paragraph 40‑363(5)(b) of the ITAA 1997

1.31

Item 1, subsections 40‑364(1) and (2) of the ITAA 1997

1.60

Item 1, subsection 40‑364(3) of the ITAA 1997

1.62

Item 1, subsection 40‑364(4) of the ITAA 1997

1.62

Item 1, subsection 40‑364(5) of the ITAA 1997

1.62

Item 1, subsection 40‑364(6) of the ITAA 1997

1.62

Item 1, subsection 40‑364(7) of the ITAA 1997

1.58, 1.61

Item 2, sections 124-1220 and 124-1225 of the ITAA 1997

1.43

Item 2, subsections 124‑1225(2) and (3) of the ITAA 1997

1.47

Item 2, section 124‑1230 of the ITAA 1997

1.46

Item 2, section 124-1235 of the ITAA 1997

1.44

Item 2, section 124-1240 of the ITAA 1997

1.51

Item 2, section 124-1245 of the ITAA 1997

1.55

Item 2, section 124-1250 of the ITAA 1997

1.56

Items 3 and 18, subsection 995-1(1) of the ITAA 1997

1.101

Item 4, subsection 40-77(1D) of the Income Tax (Transitional Provisions) Act 1997

1.52

Item 4, subsection 40-77(1E) of the Income Tax (Transitional Provisions) Act 1997

1.57

Items 5 and 19

1.105

Bill reference

Paragraph number

Items 6 and 13 to 15, sections 11-55, 112-97 and 116-25 of the ITAA 1997

1.102

Items 7 to 9, notes to section 40-175 and subsections 40-180(4) and 40‑300(3) of the ITAA 1997

1.104

Item 10, section 40-1095 of the ITAA 1997

1.103

Item 10, subsection 40-1100(1)

1.63

Item 10, subparagraph 40-1100(2)(a)(i) of the ITAA 1997

1.65

Item 10, subparagraphs 40-1100(2)(a)(ii) and (iv) of the ITAA 1997

1.70

Item 10, subparagraph 40‑1100(2)(a)(iii) of the ITAA 1997

1.65

Item 10, paragraph 40-1100(2)(b) of the ITAA 1997

1.66

Item 10, paragraphs 40-1100(2)(c) and (d) of the ITAA 1997

1.66

Item 10, subsection 40-1100(3) and subparagraphs 40-1100(2)(c)(iii) and (d)(iii) of the ITAA 1997

1.69

Item 10, section 40-1105 of the ITAA 1997

1.72

Item 10, section 40‑1110 of the ITAA 1997

1.77

Item 10, subsection 40-1115(1) of the ITAA 1997

1.80

Item 10, subsection 40-1115(2) of the ITAA 1997

1.81

Item 10, section 40‑1120 of the ITAA 1997

1.74, 1.94

Item 10, section 40-1125 of the ITAA 1997

1.82

Item 10, paragraph 40-1130(1)(a) and subsection 40-1130(2) of the ITAA 1997

1.85

Item 10, paragraph 40-1130(1)(b) of the ITAA 1997

1.83

Item 10, paragraph 40‑1130(1)(c) of the ITAA 1997

1.90

Items 11 and 12, paragraphs 104-35(5)(f) and (g) of the ITAA 1997

1.84

Item 16, subsection 116-115(1) of the ITAA 1997

1.73

Item 16, subsection 116-115(2) of the ITAA 1997

1.75

Item 17, subsection 230-460(17A) of the ITAA 1997

1.100

Item 20, paragraph 40-80(1AB)(d) of the ITAA 1997

1.98

Item 21

1.106

Schedule 2: In-house software

Bill reference

Paragraph number

Item 1, item 8 in the table in subsection 40-95(7) of the ITAA 1997

2.11

Item 2, the table in section 40-455 of the ITAA 1997

2.15

Item 3

2.19, 2.20

Schedule 3: Instalment trust

Bill reference

Paragraph number

Item 1, sections 235-1 and 235-805

3.8

Item 1, sections 235-810, 235‑815 and 235-820

3.53

Item 1, section 235-810 and subsections 235‑815(2) and 235-820(1)

3.51

Item 1, section 235-810 and subsection 235-820(2)

3.52

Item 1, section 235-815

3.55

Item 1, subsection 235-815(1)

3.54

Item 1, paragraph 235-815(1)(a), subsections 235‑815(3), 235-820(1) and 235-830(1)

3.26, 3.27

Item 1, subsection 235-815(2)

3.71

Item 1, section 235-820

3.9

Item 1, sections 235-820, 235-825 and 235-830

3.12

Item 1, sections 235-820, 235-825, 235‑830, and 235‑835

3.50

Item 1, section 235-820, paragraph 235‑825(1)(a) and section 235‑830

3.15

Item 1, section 235‑820 and subsection 235‑835(1)

3.29

Item 1, subsection 235‑820(1)

3.57, 3.58, 3.59, 3.63, 3.65, 3.66

Item 1, subsections 235-820(1) and (2)

3.61, 3.62, 3.64

Item 1, subsection 235-820(2)

3.60

Item 1, subsections 235-820(3) and (4)

3.56

Item 1, subsection 235-820(5)

3.69, 3.70

Item 1, sections 235-820, 235-830, 235-840

3.72

Item 1, sections 235-820 and 235-840

3.45, 3.46

Item 1, section 235-820 and paragraph 235-840(b)

3.47, 3.48, 3.49

Item 1, paragraph 235-825(1)(b), subsection 235-830(2) and section 235-840

3.11

Item 1, subsection 235-825(2), paragraph 235-830(1)(b) and section 235-835

3.36

Item 1, section 235-830

3.10, 3.13

Item 1, sections 235‑830 and 235‑835

3.28, 3.40, 3.41

Item 1, sections 235‑830 and 235‑840

3.16

Item 1, subsection 235-830(1)

3.17

Item 1, paragraphs 235-830(1)(a) and (b)

3.19

Item 1, paragraphs 235-830(1)(a), (b) and (f)

3.23

Item 1, paragraphs 235-830(1)(a) and (d)

3.20

Bill reference

Paragraph number

Item 1, paragraph 235-830(1)(c)

3.25

Item 1, paragraph 235-830(1)(e)

3.21

Item 1, paragraph 235-830(1)(f)

3.22

Item 1, subsections 235‑830(1) and (2)

3.14

Item 1, subsection 235‑830(3)

3.24

Item 1, section 235-835

3.35, 3.38, 3.39

Item 1, subsection 235‑835(1)

3.30

Item 1, subparagraph 235-835(1)(a)(ii) and paragraph 235-835(1)(b)

3.31

Item 1, subsection 235-835(2)

3.32, 3.33

Item 1, subsection 235-835(3)

3.34

Item 1, subsection 235-835(4)

3.42

Item 1, subsections 235‑845(1) and (2)

3.67

Item 1, subsection 235‑845(3)

3.68

Items 2 to 4 and 7, subsections 290‑60(4), 290‑230(4), section 295‑175, subsection 995‑ 1(1) (definition of ‘complying superannuation plan’), and subsection 355‑65(3) of Schedule 1 to the TAA 1953

3.74

Item 5, subsection 995‑1(1) definition of ‘instalment trust’, ‘instalment trust asset’, and ‘regulated superannuation fund’

3.73

Item 6, section 235-810 of the Income Tax (Transitional Provisions) Act 1997

3.75

Schedule 4: Company losses

Bill reference

Paragraph number

Item 1, sections 167‑1, 167‑5, 167-7 and 167‑75

4.29

Item 1, section 167‑7

4.33

Item 1, subsection 167‑10(1)

4.36

Item 1, subsections 167‑10(1) and (2)

4.40

Item 1, subsection 167‑10(2)

4.38

Item 1, paragraph 167-10(3)(c)

4.55

Item 1, subsection 167-15(1)

4.57

Item 1, subsection 167-15(2)

4.58

Item 1, subsections 167‑15(2), 167-20(4) and 167-25(5)

4.88

Item 1, section 167-20

4.60

Item 1, subsections 167-20(1) and (2)

4.61

Bill reference

Paragraph number

Item 1, subsection 167‑20(3)

4.66

Item 1, subsection 167-20(4)

4.67

Item 1, section 167‑25

4.69

Item 1, sections 167-25, 167-30, 167-35 and 167-40

4.74

Item 1, subsection 167-25(1)

4.70

Item 1, subsection 167‑25(4)

4.71

Item 1, subsection 167‑25(4), sections 167-30 and 167-35

4.72

Item 1, paragraph 167‑25(4)(a) and section 167‑30)

4.79

Item 1, paragraph 167‑25(4)(b) and subsection 167‑35(1)

4.82

Item 1, subsection 167‑25(5)

4.73

Item 1, section 167‑30

4.80

Item 1, sections 167-30 and 167-35

4.78

Item 1, subsection 167‑35(2)

4.84

Item 1 subsection 167‑40(2)

4.76

Item 1, section 167‑75

4.89

Item 1, subsection 167-80(1)

4.90, 4.93

Item 1, subsections 167‑80(1) and 167-85(1)

4.92

Item 1, subsection 167‑85(2)

4.97

Item 1, section 167‑90

4.99

Items 1 and 52, subsection 167-10(3) and the definition of ‘unequal share structure’ in subsection 995-1(1))

4.46

Items 2 to 51, sections 165‑12, 165‑37, 165‑40, 165‑115C, 165‑115D, 165‑115L, 165‑115M, 165‑115X, 165‑115Z, 165‑123, 165‑129, 166‑145, 166‑175, 166‑225, 166‑230, 166‑235, 166‑240, 166‑255, 166‑260, 170‑260, 170‑265, 175‑10, 175‑45, 175‑85, 707‑205, 974‑10 and 995‑1

4.110

Item 53 section 167‑1 of the Income Tax (Transitional Provisions) Act 1997

4.111

Item 53, paragraphs 167‑1(1)(a) to (c) of the Income Tax (Transitional Provisions) Act 1997

4.112

Item 53, paragraph 167‑1(1)(d) of the Income Tax (Transitional Provisions) Act 1997

4.113

Item 53, subsection 167‑1(2) of the Income Tax (Transitional Provisions) Act 1997

4.114

Item 54, section 165‑212E

4.108

Item 55

4.126

Item 56, paragraphs 165-202(1)(h) to (l)

4.105

Item 57

4.123

Bill reference

Paragraph number

Item 58

4.107, 4.124

Section 4

4.129

 

Do not remove section break.